These are the speaker notes for a presentation on a warehouse expansion proposal.
Slide 1 – Cover
Slide 2 – The Situation
Thanks to record breaking sales and profits, Claire’s Antiques is able to consider expanding into new warehouses in the northern and western parts of the country. The company only has enough capital to invest in one of the warehouses. It has already been decided that a new building will be constructed and used for the next five years. At the end of that period, a new production facility will be built and the warehouse will be sold.
In order to analyze the costs and benefits of an investment, all cash flows must be converted to their value at a specified point in time. The most common method for doing this is present value which converts all future cash flows to their equivalent value at the present time (Atkinson, Kaplan, Matsumura, & Young, 2007). Throughout this presentation we’ll be looking at present value to measure the benefits of each investment.
Slide 3 – Research Results
In an effort to better understand the conditions available in each of the two proposed warehouse locations, an independent research team was hired to gather data. What they found is that the two areas have similar initial costs but a wide variance in variable cost and estimated revenue. Each of the numbers in this chart is necessary to analyze the investment and determine its worthiness.
Slide 4 – North Warehouse Details
This is a table detailing the investment in the northern location. As you can see, the investment period shows an initial investment in the building and advertising in year 0. Since this cash outflow occurs immediately, it happens in year 0. Therefore, it’s present value is not affected by time, and is equal to the total of the cash flow. The next five years all see sales revenue increasing at a 7% rate. After year 5, the building will be sold and the salvage value of $125,000 will be realized.
Adding up all the present values results in a net present value of $7,181. Since this value is positive it means there will be a return on the investment rather than a loss.
Slide 5 – West Warehouse Details
We apply the same analysis method to the numbers for the west warehouse. Again we sum the inflows and outflows for each period, add the tax savings from depreciation, and multiply that by the present value factor to determine the present value for each period. When we sum the present values for each period, we arrive at $17,131 net present value. Once again this value is positive, so the investment represents a gain rather than loss.
Slide 6 – Net Present Value
This graph illustrates the growth in net present value over time. As you can see, the west warehouse has a lower initial net present value. Thanks to its higher growth rate it eventually catches the net present value of the north warehouse.
Slide 7 – Which Warehouse?
After all the details have been analyzed, a decision must be made. For an investment to be considered, it’s net present value must be greater than $0 (Atkinson et al., 2007). Based on this criteria, both warehouses are acceptable investments. Since there is not enough funding for both warehouses, the only reasonable comparison is the total return based on net present value. In this case, the west warehouse returns $9,950 more than the north warehouse ($17,131 – $7,181). Therefore, the west warehouse is the best selection for the new warehouse location.
Slide 8 – Sensitivity Analysis
A sensitivity analysis is used by many industries to determine how resilient an analysis is to changing factors (“Sensitivity analysis”, 2008). For example, in the case of our warehouse selection process, we find that any reduction of sales growth will result in a loss. If the north warehouse experiences 6% growth rather than 7%, its net present value will fall to -$20,528. Simliarly, a 1% reduction in sales growth for the west warehouse will drop net present value for that investment to -$14,843.
Similarly, if we’ve misjudged the cost of capital neither warehouse becomes a profitable investment. At 11%, both the north and west warehouses drop below $0 net present value to -$37,806 and -$33,848 respectively.
It is important for Claire’s Antiques to realize that both investments do not have any room for margin. If the numbers generated by the research team are in any way over-optimistic, the investment will end up being a loser.
Slide 9 – References
Atkinson, A. A., Kaplan, R. S., Matsumura, E. M., & Young, S. M. (2007). Management accounting (5th ed.). Upper Saddle River, NJ: Pearson.
Sensitivity analysis. (2008). Oxford Reference Online. Retrieved December 18, 2008.