Acme Manufacturing produces a variety of window coverings, e.g., an assortment of blinds, shades and shutters. State and define three financial measures/metrics that could be useful in making a decision to add a new product line, such as bamboo blinds. State one advantage and one disadvantage of each. Finally, pick any one of these three measures and explain, with a simple numerical example, how you would calculate it directly or using EXCEL.
Three financial measures/metrics that could be useful in making a decision to add a new product line, such as bamboo blinds, are:
1. Profitability: Profitability measures how profitable a product or product line is. It helps determine if the new product line is able to generate profits and contribute positively to the company's overall financial performance.
- Advantage: It provides a clear indication of the financial viability of the new product line.
- Disadvantage: It may not take into account other non-financial factors, such as market demand or brand image.
To calculate profitability, you can use the formula:
Profitability = (Revenue - Cost of Goods Sold) / Revenue
For example, if Acme Manufacturing sells bamboo blinds for $10,000 and the cost of goods sold is $7,000, the profitability would be:
Profitability = ($10,000 - $7,000) / $10,000 = 0.3 or 30%
2. Return on Investment (ROI): ROI measures the return on the investment made in the new product line. It calculates the profitability of the investment relative to its cost.
- Advantage: It helps assess the efficiency and effectiveness of the investment, considering both profitability and cost.
- Disadvantage: It may not consider the time value of money or long-term impacts on the company's financials.
To calculate ROI, you can use the formula:
ROI = (Net Profit / Investment Cost) x 100
For example, if Acme Manufacturing invests $50,000 in establishing the bamboo blind product line and generates a net profit of $15,000, the ROI would be:
ROI = ($15,000 / $50,000) x 100 = 30%
3. Payback Period: The payback period measures the time it takes to recover the initial investment in the new product line from the cash flows it generates.
- Advantage: It provides information on the speed of recouping the initial investment.
- Disadvantage: It does not consider the timing and magnitude of cash flows beyond the payback period.
To calculate the payback period, you need to determine the net cash inflow per period and divide the initial investment by that amount. Here's a simple numerical example:
Let's assume Acme Manufacturing invests $100,000 in the bamboo blind product line and expects annual cash inflows of $30,000. To calculate the payback period:
Payback Period = Initial Investment / Annual Cash Inflows
Payback Period = $100,000 / $30,000 = 3.33 years
Using Excel, you can use the "NPV" function to calculate the present value of cash flows and determine the payback period more precisely.