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Accounting Tools: Expansion Recommendation 1 Accounting Tools: Expansion Recommendation Professor Bitter Marcia Clarke MBA-FPX5010 Capella University January 1, 2024

Accounting Tools: Expansion Recommendation 2 Introduction ZXY, a dynamic and forward-thinking food company, is currently exploring avenues for expansion, contemplating the addition of two new products and the establishment of a second production facility. In this strategic proposal, ZXY aims to secure a $7,000,000 investment to acquire cutting-edge equipment, which is anticipated to have a productive lifespan of ten years. The company envisions the deployment of this investment to not only introduce innovative products but also to pave the way for a second production facility. As a part of the meticulous planning, ZXY plans to rent the facility while seeking to meet a substantial return on investment at a rate of 12%. Furthermore, at the end of the equipment's anticipated ten-year life cycle, assets are expected to retain residual value, with an estimated sell-off totaling $1,000,000. This paper undertakes a comprehensive analysis of the forecasted financials to discern the viability and strategic merit of ZXY's proposed expansion, scrutinizing key financial metrics and return expectations to ascertain whether the expansion aligns with the company's overarching objectives and growth trajectory. Analysis of Current Financial Information During a thorough examination of the forecasted income statement and cash flow statement provided by ZXY for the anticipated 10-year lifespan of the new equipment, notable trends emerge. The numerical projections indicate a progressive increase over time, aligning with the planned introduction of two new products and the establishment of a second production facility. It is crucial to underscore, however, that the success of the investment hinges on meeting a 12% return. The revenue forecast underscores that the initial phase of production for the first new product spans until the fourth year, at which point the second product is slated to commence production. The rigorous 12% return on the $7,000,000 investment equates to $840,000, a benchmark that is not met during the first three years. In the inaugural year of production for the first product, the projected cash flow stands at $-73,357, with a subsequent 1.253% increase in lost revenue by the third year, averaging around $-992,727. This preliminary phase poses a considerable financial challenge for ZXY. The introducing of the second product in year four, ZXY anticipates a positive cash flow, averaging $615,998. However, despite this positive trend, the cash flow fails to fully compensate for the accumulated debt in lost revenue, signaling potential challenges and risks for the company. The analysis suggests that ZXY may not achieve positive revenue until close to year five, nearly halfway through the expected lifespan of the equipment. Looking ahead to the projections beyond year five, the net revenue demonstrates a consistent upward trajectory, signifying positive developments for the company. Interestingly, the company foresees achieving a positive net income only after the second product is incorporated into production. This turning point is illustrated in the chart, where the net income is expected to reach $615,998. Considering the 12% rate and the 10-year lifespan, the cumulative projected cash flows amount to $6,947,667.83. Evaluating both products based on ZXY's projected income over the 10-year period, the total income is forecasted to be $56,840,000. Accounting for estimated product costs and a gross profit of $33,164,007, the net income is projected to culminate at

Accounting Tools: Expansion Recommendation 3 $17,339,027 after 10 years. While the forecast reflects an eventual positive outlook, the initial years pose financial challenges that necessitate a vigilant risk management approach. ZXY should carefully weigh the potential risks against the long-term gains, considering strategic adjustments to enhance the program's early-stage financial performance. The risks for the investment The initial three years of the proposed investment present a considerable level of risk for ZXY Company, marked by sustained negative cash flows and a lack of profitability. This phase poses a substantial financial challenge, and any unforeseen events during this critical period could potentially render the investment decision unfavorable. Analyzing the financial projections provided by the company reveals that actual profit is not anticipated until year eight. It is during this period that the accumulated losses from the initial three years are projected to be offset, and the company begins to generate positive returns. However, a notable challenge arises in the absence of current financial statements for ZXY Company. Relying solely on the 10-year projections makes the decision-making process more intricate, as there is no visibility into the company's current financial standing. Access to the latest financial statements would provide crucial insights into the company's current health and financial robustness. In an ideal scenario, having proof of ZXY Company's robust current financial status could significantly alleviate concerns regarding the associated risks. A strong financial standing would suggest that the company has the capacity to weather the initial challenging years of the proposed investment and is better positioned to absorb potential setbacks. Demonstrating financial stability could serve as a mitigating factor in the risk assessment and instill confidence in stakeholders considering the investment. While the 10-year projections outline a path to eventual profitability, the lack of current financial statements introduces a level of uncertainty and risk. Access to up-to-date financial information would provide a more comprehensive understanding of the company's financial health, aiding stakeholders in making informed decisions about the proposed investment. Types of Depreciations Straight Line vs a MACRS The approach to depreciation plays a pivotal role in assessing the financial implications of ZXY Company's investment in new equipment. Straight-line depreciation, a conventional method, scrutinizes the equipment's initial cost, its value after a defined useful life, and the total number of years in the lifespan. In contrast, the Modified Accelerated Cost Recovery System (MACRS), stipulated in the Internal Revenue Code (Marshall, McManus, & Viele, 2020), calculates depreciation deductions for tax purposes. Comparatively, MACRS facilitates more substantial deductions in the initial four years, while straight-line depreciation allows for smaller deductions during the same timeframe (CFI, n.d.). Examining straight-line depreciation within the context of the depreciation methods utilized, it becomes evident that the initial $7,000,000 investment in the equipment would not be fully recouped until the eighth year of the investment. This protracted recovery period implies that ZXY Company could experience financial uncertainty for the majority of the equipment's lifespan. This interpretation is consistent with findings from empirical studies, such as Ackermann et al. (2016), which delve into the impact of straight-line and accelerated depreciation rules on investment decisions. Similarly, studies like

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Accounting Tools: Expansion Recommendation 4 Ben-Shahar, Margalioth, and Sulganik (2009) shed light on the implications and considerations associated with straight-line depreciation in the real estate sector. Furthermore, literature by House and Shapiro (2008) explores the effects of temporary investment tax incentives, including bonus depreciation, providing theoretical insights complemented by empirical evidence. Hwang (2002) contributes to the discussion by examining forms and rates of economic and physical depreciation by asset type in Canadian industries, offering a broader perspective on depreciation methods. Johnson (2019) addresses the practical implications of depreciation strategies under new tax laws, offering essential insights for decision-makers navigating the intricacies of tax regulations. Although these academic perspectives provide valuable insights into depreciation methodologies, an important consideration is also the company's unique circumstances. Data from ZXY Company's Annual Report for 2021 (ZXY Company, 2022) could offer a more detailed understanding of its financial standing, serving as a crucial reference point for decision-makers contemplating the investment. Integrating both theoretical insights and real-world financial data is vital in making informed decisions regarding ZXY Company's investment in the new equipment. Recommendations After a thorough examination of the financial projections for the proposed expansion, my recommendation is to postpone the continuation of the expansion until the fourth year. The initial three years exhibit a notable weakness, with no revenue generated during this period. Employing a calculation method involving multiplying the cash flow by the initial 12% return, subtracting that result from the initial investment of $7,000,000, and subsequently evaluating the projected cash flow, the outcome indicates a deficit of $-50,883.10. To enhance the financial viability of the project, an alternative approach involves adjusting the return on investment from 12% to 10%. Utilizing this modified rate, the discounted cash flow subtracted by the investment amount yields a positive value of $1,025,581.87. In light of this calculation, the most favorable course of action for ZXY Company is to retain the initial investment amount of $7,000,000 while negotiating a reduction in the return from 12% down to 10%. This adjustment not only results in a net positive value of $1,025,581.87 over the 10-year lifespan but also provides the company with a more robust financial footing. By choosing this revised approach, ZXY Company can attain a stronger financial stability, mitigating the challenges posed by the initial three years of minimal revenue generation. This strategic adjustment not only aligns with prudent financial management but also positions the company for sustained growth and success throughout the duration of the proposed expansion. Conclusion Upon a thorough review and analysis of ZXY's financial statements, it becomes evident that pursuing the expansion within the first three years would not be a prudent investment decision, as the company is poised to incur losses during this period. The company has set a stringent requirement for a 12% return on the $7,000,000 investment, necessitating a minimum return of $840,000 to justify an expansion in production. A more viable option for ZXY would

Accounting Tools: Expansion Recommendation 5 be to engage in negotiations to secure a lower percentage, with 10% being the minimum threshold. This adjustment would enable the company to enhance its investment to $1,025,581.87 while retaining the initial $7,000,000 investment. By negotiating a lower return rate, ZXY can bolster its financial position, fostering increased revenue and cash flows that are integral to the successful implementation of the production expansion plan. Notably, the financial projections provided by ZXY do not reveal any capacity to support the proposed expansion within the initial three years. The absence of growth indicators in the provided financial information underscores the imperative to delay expansion plans until year four, aligning with the point when the company anticipates a positive trajectory in its financial performance. Negotiating a lower return rate is a strategic move for ZXY, allowing them to maintain their initial investment while increasing their financial capacity for the planned expansion. This approach is essential for ensuring a more robust financial foundation and setting the stage for successful and sustainable growth in the subsequent years.

Accounting Tools: Expansion Recommendation 6 References Ackermann, H., Fochmann, M., & Wolf, N. (2016). The effect of straight-line and accelerated depreciation rules on risky investment decisions: An experimental study. International Journal of Financial Studies, 4(4), 1-26. https://doi.org/10.3390/ijfs4040019 Ben-Shahar, D., Margalioth, Y., & Sulganik, E. (2009). The straight-line depreciation is wanted, dead or alive. The Journal of Real Estate Research, 31(3), 351- 370. https://doi.org/10.1080/10835547.2009.12091257 CFI. (n.d.). MACRS Depreciation. In Corporate Finance Institute . Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/accounting/straight- linedepreciation/ CFI. (n.d.). What is Straight Line Depreciation?. In Corporate Finance Institute . Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/accounting/straight- linedepreciation/ Cindy Hadinata, Farah Margaretha Leon. (2018). The influence of demography and risk tolerance toward portfolio invesment selection of post graduate students. Jurnal Manajemen, 22(3), 360-380. https://doi.org/10.24912/jm.v22i3.427 House, C. L., & Shapiro, M. D. (2008). Temporary investment tax incentives: Theory with evidence from bonus depreciation. The American Economic Review, 98(3), 737- 768. https://doi.org/10.1257/aer.98.3.737 Hwang, J. C. (2002). Forms and rates of economic and physical depreciation by type of assets in canadian industries. Journal of Economic and Social Measurement, 28(3), 89- 108. https://doi.org/10.3233/jem-2003-0206 Johnson, T. S. (2019). Depreciation strategies under the new tax law: What you need to know. Real Estate Issues, 43(6), 1-6. Marshall, D., McManus, W., & Viele, D. (2020). Accounting: What the numbers mean (12th ed.). New York, NY: McGraw-Hill. Data: ZXY Company. (2022). Annual Report 2021.

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