Smile Photo, Inc, is a nationally franchised company with over 50 outlets locked

Question

Smile Photo, Inc, is a nationally franchised company with over 50 outlets locked in the southern states. Part of the franchise agreement promises a centralized photo developing process with overnight delivery to the outlets. Because of the tremendous increase in demand for its photo processing. Emma DuBarry, the corporations president, is considering the purchase of a new, deluxe photo processing machine by the end of this month. DuBarry wants you to formulate a memo showing your evaluation of this purchase. Your memo will be presented at the board of directors' meeting next week. According to your research, the new machine will cost $320,000. It will function for an estimated five years and should have a $32,000 residual value. All capital investments are expected to produce a 20 percent minimum rate of return, and the investment should be recovered in three years or less. All fixed assets are depredated using the straight-line method. The forecasted increases in operating results for the new machine are as follows: 1. In preparation for writing your memo, answer the following questions: a. What kinds of information do you need to prepare this memo? b. Why is the information relevant? c. Where would you find the information? d. When would you want to obtain the information? 2. Analyze the purchase of the machine and dedde if the company should purchase it. Use (a) the net present value method, (b) the accounting rate-of-retum method, and (c) the payback period method. 3. What is the profitability index of the project? 4. What is the IRR of the project?

Explanation / Answer

1.a The memo will include a detailed analysis of the profitability of purchasing a new machine. It will tell the management whether purchase a machine or not. In the analysis, we will analyse what is the possible cash flows in the future years and explain the accuracy and the possibility of errors in these calculations. Once these cash flows are arrived at we will then calculate the capital budgeting techniques like NPV, IRR, etc to calculate the profitability of the project

1.b The information is relevant as we need to accurately determine the profitability and give a firm conclusion in memo advising whether the management should select or reject the project

1. c.You will find the information in historical books of account maintained by the company and identify a trend for the cash flows

1.d. The information needs to be obtained immediately since we have to arrive a conclusion in one week. You need to do a pessimistic analysis, an optimistic analysis and a normal analysis and find the sensitivity of the NPV. So this will take time and as the memo is due next week, we need to get the information immediately.

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