Introduction
ZXY is a company in the production and sale of food products. The company deals with staples that are rated to have steady demands. The company has been in this business for more than a decade as per the financial information available. The company intends to expand its production capacity through a $7,000,000 investment on equipment where two new products are expected to be produced. The firm expects to dispose of the mentioned equipment at the cost of about $1000, 000 after ten years of usage. This report aims to give a check on the financials of ZXY, depreciation consideration, and to ultimately give a recommendation on the way forward in regard to the expansion plans given that the break-even rate of return is 12% or more.
Financial Information Analysis
An analysis of the financial information provided would start at differentiating revenue incomes for the two products the company sells namely products A and B. The revenue totality for product A over the ten year period is $34, 640,000 while that of product B is $22, 200,000 over the same year. The revenue trend for the years for product A can be observed to be steady, maintaining the figure $3,900,000 for a period of 6 years. The revenue trend for product B has been observed to be constantly increasing since it was launched in year four all the way to the last year. A sample segment shows that product B recorded $900,000 in year 4, $2,500,000 in year 6, $4,000,000 in year 8 and $5,500,000 in year 10 reflecting an upward trajectory trend.
The cost of goods segment analysis depicts that ZXY has various items that are constant or have been increasing steadily over the ten year period. Such items include plant equipment parts, plant equipment ongoing maintenance, health benefits, plant telephone, pest control, and miscellaneous equipment, etc. However, there are some notations to make on some other items here; for example, plant payroll expense has been observed to jump to a significant amount of over $1,000,000 by the 7th year. Another notable development is the SQF-FDA mandates cost that reflects as a plus in the statement due to the reduction observed from $90,000 to $30,000 covering two products in the market. The other notable cost under this segment is the plant supplies that can be observed to increase and fluctuate over the years.
An analysis of the expenses segment doesn’t show concern as much except for the interest on debt that has reduced over the years, which is another plus to the firm. The interest reduced from $90,627 in the year to $111 in the final year. The other big analysis tool for a firm in financial analysis is depreciation over the ten years. The depreciation in the first three years when only product A was being produced shows a huge accumulation leading up to the losses recorded in the same periods. The company however, recovered from the losses in net profit earnings of $992, 727 in year 3 to jump to a profit of $615, 998 in a year where profitability trend continued over to the next years. This was after the introduction of product B, whose response in the market was phenomenal, thereby recording increased revenues each year.
Depreciation as Factor of Consideration
Depreciation is the actual value decrease for equipment and machinery over time as usage increases. Depreciation can be accounted for using various formulas including and not limited to the straight-line process and the improved, enhanced total recovery system (MACRS). For ZYX there are the options of using both formulas in calculation considering that tax deductions are directly connected to depreciation. MACRS can be the best mode of depreciation accounting for ZYX, with the support points towards this being many. First of all, MACRS accommodates asset classification allowing for yearly tax deductions in portions. MACRS is characterized by high tax deductions in the early years of equipment acquisition and fewer deductions in the later years. MACRS cannot, however, be used for book depreciation as opposed to straight-line depreciation.
Straight-line depreciation involves the division of the depreciable value of the asset by the number of years the equipment is to be used. It assumes consistency and uniformity of operations during the period of consideration. It is efficient where the lifetime of the equipment has been pre-determined. On weighing the reasons why MACRS is better, in this case, is considering that the straight-line method is less attractive to use for equipment that is of large valuation. MACRS classification of usage and efficiency accounts for repair expenses for the plant and equipment as well as the performance of machinery over time as opposed to the straight-line method that takes uniformity as a generalization. The MACRS method is also advantageous to the ZXY as it provides for a way of checking the tax deductions in the firm in the long run. This is particularly important considering the fact that tax deductions accounted for an estimated $1,879,302 in year ten alone.
Recommendations
The decision to accommodate expansion in a company is one that cannot only be bound by the financials alone but also other factors such as market outlook and regulatory environments in areas of expansion. The financial assessment of ZXY stable and good to allow the expansion of the products. The rationale for this would be; SQF-FDA mandates costs are lower during the period when the two products A and B are being produced. This signals to a good regulatory environment encouraging more food products through mandates cost reduction. Good profitability trend has been witnessed after the product B was introduced as the financial information shows. ZYX has been on a profitability trend for seven years consecutive as per the financial information, thereby showing that the market is responsive to its products in particular product B that was probably improved. The firm upon taking up the expansion plan should take-up the MACRS depreciation formula so as to shield itself from the extrapolated tax deductions in the ten year period, as discussed above.
ZYX is thus not far off estimates nor unfit to consider expansion so long as the highlighted items in the various segment of this report under financial information are closely monitored.
References
Cohen, A. H. (1957). Depreciation in Tax and Financial Planning. Proc. Ann. Tul. Tax Inst., 6, 706.
Ferguson, B., & Smets, P. (2010). Finance for incremental housing; current status and prospects for expansion. Habitat International, 34(3), 288-298.
Trippi, R. R. (1972). Capital investment planning: expansion and replacement (Doctoral dissertation, Massachusetts Institute of Technology).
The details of the MACRS depreciation method retrieved from (2020): https://fitsmallbusinesss.com/macrs-.depreciationm-calculator///////
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