Financial Management Fine Health Inc.

Question: Discuss about the case study Financial Management for Fine Health Inc. Answer: Introduction In this report, an attempt is made to provide a detailed analysis of X-TRM project to the management of Fine Health Inc. The company has already incurred $2 million in research and development for developing next generation energy drinks for athletes. It is estimated that it will take approximately 4 to 6 years time to launch the energy drink. Therefore, the company is considering launching a perversion of the drink in spite of the existing controversies. The techniques of capital budgeting like Net Present Value (NPV), payback period, Internal rate of return (IRR) and profitability index are applied in this report to evaluate the project (Bierman and Smidt 2012). Evaluation of the project In this section, the capital budgeting techniques applied by the company to evaluate the project X-TRM are discussed. The capital budgeting is referred to as the process that a company applies for evaluating the viability of a long-term project or investments (Ahmed 2013). There are various capital budgeting techniques few popular of them are Net Present Value, Discounted Payback Period, Internal rate of return and profitability index. In this report all the mentioned capital budgeting techniques are applied so that the management could make an informed decision. Net Present Value The Net Present value is calculated by deducting initial cash outflow from the discounted cash inflow. This method is a popular project evaluation technique because the time value of money is considered. If Net Present value is positive that means the project is profitable and if the NPV comes negative then such projects should be rejected (Brigham and Ehrhardt 2013). In this case, for evaluating the project X-TRM a table is prepared showing the projected cash flow for 6 years. On analyzing, the table it can be seen that the company is expected to earn profits from the beginning and the project continue to be profitable for six years. Further the table also shows that the profit from the project is expected to rise continuously for 6 years which is a positive sign. Fig.1. Chart Showing estimated profit The net cash inflow for the project is calculated by adding back depreciation and deducting increase in working capital. The cash inflows from the projects are positive which implies that the project is estimated to be profitable. In this technique, cash inflows are multiplied with discounting factors so that present value of cash flow could be ascertained. The NPV of the project is $1399926.67 and if the project is evaluated based on NPV then the project should be accepted. Discounted Payback Period The payback period is the duration of time that is required to recover the amount invested in the project by the amount cash generated from the project. It is one of the simplest ways of evaluating risk associated with the project. It is calculated by dividing the initial cash outlay by the net cash flow generated from the project (Gorshkov et al. 2014). If a project is to be evaluated based on payback period then projects having low payback period should be accepted and projects having higher payback period should be rejected (Brigham and Houston 2012). In the case of Fine Health Inc the discounted payback period came to 4.6 years. The management requires that the payback period of the project should be 4 years. If the project is to be evaluated based on the required payback period then the project should be rejected. Internal Rate of Return Internal rate of return is a capital budgeting technique that measures the profitability of the project. The IRR is the discount rate that equates the net present value of the cash flow of the project with the initial cash outflow (Zsidisin 2016). The IRR is then compared with the required rate of return and if IRR is more than the required rate of return then the project should be accepted otherwise it should be rejected. In the case of Fine Health Inc the IRR is calculated after preparing the discounted cash flow and the calculation is shown in the appendices. The IRR of the project X-TRM comes to 9%. The weighted average cost of capital of the company is 13%. The weighted average cost of capital is that rate which the company has to pay to finance its project. It is the minimum cost, which the company has to incur for initiating a project so it is taken as the required rate of return (Bartlett et al. 2014). Therefore, the weighted average cost of capital is taken as internal rate of return and it is compared with IRR for evaluating the project. The weighted average cost of capital of the company is 13% whereas the IRR of the project is 8% so if the project is to be evaluated based on IRR then the project should be rejected. Profitability Index Profitability Index is an important capital budgeting techniques that is used to evaluate the projects. It is a useful technique to consider the viability or profitability of the project (McKinney, 2015). The profitability index is calculated by using cash inflow; cash out flow and discount rate. The formula of profitability index is: Profitability Index= 1+ Net present value/ Initial Investment Required. If the profitability index of the project is equal to or more than one then the project should be accepted. The project is worth executing because PI is more than one and that means expected return from the project is more than the required rate of return (Geisler and Wickramasinghe 2015). In the case of Fine Health Inc, the Profitability index of the new project is 1.40. As the profitability index is more than one that means the return from project X-TRM is greater than expected rate of return. Therefore, if the project is to be evaluated based on Profitability Index then the project should be executed. Recommendation The project X-TRM of the Fine Health Inc is analyzed based on the capital budgeting techniques. In this report, more than one technique have been used so the result is different for each techniques. If the project is to be evaluated only based on NPV then it is recommended that the projected should be executed. If the project is evaluated based on the payback period method then as the payback period of the project is less than the required rate of return then the project should be rejected. If the project is evaluated based on IRR then it is recommended that projected should be rejected, as it is less than the weighted average cost of capital. The profitability Index of the project is more than one so if the project is to be considered based on this then the project should be accepted (Frank and Pamela 2016). Conclusion The report provides a complete analysis of the profitability of the project based on capital budgeting techniques. The weighted average cost of capital is more than the IRR of the project and the payback period is more than the required period of 4 years. Further it should also be noted that there is a controversy that the drink causes health hazard which may result in reputational and financial damage. These aspects are not considered in capital budgeting techniques. Therefore based on the above analysis it can be concluded that the management should reject the project, as the return from the project is not an adequate compensation for risk taken. Reference Ahmed, I.E., 2013. Factors determining the selection of capital budgeting techniques.Journal of Finance and Investment Analysis,2(2), pp.77-88. Bartlett, G., Beech, G., de Hart, F., de Jager, P., de Lange, J., Erasmus, P., Hefer, J., Madiba, T., Middelberg, S., Plant, G. and Streng, J., 2014. 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