Capital Investment- Woody Train Cost Analysis

Capital Investment- Woody Train Cost Analysis

Question 1

Number of units sold = Total sales/cost per train £222,690 / £15 = 14,846 units.

Fixed Cost = 1,450 + 750 + 7,500 + 23,000 + 1,200 + 60,000 + 4,500 + 200 = £98,600

Variable Cost = 21,236 + 45,325 + 5,000 + 1,560 + 61,455 + 720 = £135,296

VC/Unit = 135296 / 14846 = £9.113

Unit Cost = 9.133 + 98600 / 14846 = £15.775

Question 2

The unit cost of a product is the total cost incurred by a company to produce, store, and sell a product or service in the market. WoodyTrain’s cost incurred in producing each train is £15.775. To get to that cost, we divided the fixed and variable costs by the number of units sold in that period. The total number of units sold is 14,846 units. This is extracted from the total revenue collected, which is sales divided by the price per train, which is £15. Fixed costs are costs that are constant despite the number of goods produced. In the case of WoodyTrain, the fixed costs are the expenses that were constant in the actual and the budgeted costs; the remaining expenses were considered to be variable expenses since the actual and budgeted costs do vary.

Raw material and labor to manufacture are also considered variable costs since the amount shall vary depending on the number of trains produced at a particular period. While setting up the prices, WoodyTrain should factor in the unit cost for the product. The company has been selling the product at £15, and the cost of producing each unit is £15.77; thus, the company has been producing at a loss. In that case, WoodyTrain should consider using the cost-based model in setting up its prices. The prices shall be “Cost + Markup Price”. At the same level of production, the company targets £20,000 profit.

20,000 = X – (FC+VC) TC X – 233,896

20,000 + 233,896 = £253,896 Total Revenue from Sales of 14846 Units.

253,896 / 14,846 = £17.10 shall be the new price per train

(17.10 – 15.00) / 15 = 14.01% markup.

Question 3: Viability of the Project

The Net Present Value (NPV) represents a series of discounted future cash flows to determine their value today. The cash flows are discounted using a predetermined interest or discount rate (Project Management info, 2021, 15). The decision criteria for NPV is to accept the project if NPV is positive and reject if NPV is negative (Reilly, 2011).

For WoodyTrain:

Cash flow = (£1,183),

Rate of return = 14%

Initial Capital = £15,890.

Since WoodyTrain’s NPV is negative, the project is not viable.

Profitability Index (PI) is the ratio of the present value of expected cash flows to the initial cash outflow/cash of investment. The index is useful for ranking since it shows the present value benefit per unit investment (Berk and DeMarzo, 2017). The method can also be referred to as Benefit-Cost Ratio (BCR). The decision criteria used in accepting or rejecting an investment using the PI approach is:

• If PI is less than 1, reject.
• If PI is greater than 1, accept.
• If PI = 1, indifference.

Using the PI approach for WoodyTrain:

The PI, in this case, is less than 1; hence, the project is not viable.

The Payback period evaluates the number of years taken by the company to recover the initial investment in a project from the cash flows generated. While comparing different payback periods from a project, an investor should select the project investment with the shortest payback period  (Berk and DeMarzo, 2017). The company had negative cash flow in the first period; hence, it could not recover the initial investment at the time. The cash flow for the period is £-1,183, while the initial capital is £15,890; hence, the company has not recovered any amount from its cash flows; therefore, the project is not viable.

To conclude, WoodyTrain should consider reviewing its costs and selling price in the market so as to meet its profit targets. The company can consider reducing the production cost of the product by either changing suppliers or reducing its labor costs to break even and make a profit. Alternatively, the company can increase the price per train to raise its revenue. However, WoodyTrain’s project is not viable at the moment.

References

Berk, J. and DeMarzo, P., 2017. Corporate finance. p.260.

Reilly, F., 2011. Investment Analysis & Portfolio Management. 10th ed. p.627.

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Knowing that the selling price of 1 train set is £15, what was the unit cost per train set?
Explain the calculation of unit costs and make pricing decisions using relevant data with numerical illustration. (3.3)

Capital Investment- Woody Train Cost Analysis

Assess the viability of a project using investment appraisal techniques such as NPV, IRR, PB, etc, which need to be discussed with a numerical illustration. (3.4)
Please refer to the details of the scenario given in the paper.