Introduction

Edward wood is in the process of developing a steel business, he is in a position to invest £160,000 into the business. The business is due to commence trading on 1^st of January 2014, he wanted to see how much profits he will be earning in the two years of the company’s operational life.

Capital Requirements

We have divided the overall capital requirements into two parts.

Fixed Capital

Company requires the total fixed capital of £159,000 including £65,000 of fitting out of the warehouse, £32,000 of the office equipment and fitting out of the office and £62,000 of vehicles, which further includes the two second-hand flat-bed trucks of £52,000 and second-hand van worth £10,000. The important point is that these costs are not due in the first month of commencement of the business. Warehouse fitting out cost is payable in the month of March and cost of vehicles andoffice-related costs are due in the month of February, hence, we can use the initial investment of £160,000 in the capital required for the working capital and use the sales of the first month and second month to finance the fixed capital.

Working Capital

The company requires a total working capital of £95,000, which includes the £20,000 of lease payment that is due on 1^st of January and cost of goods sold of £75,000 as all suppliers will be paid cash-on-delivery for the moment and customer’s payments are due at the end of each month so at the initial level, we must require an amount for lease payment and for cost of goods sold.

Edward Wood Steel Stockholders A Cash Flow Exercise Harvard Case Solution & Analysis

Source of Capital

In the first month of business, the company does not require any amount, though it has negative cash flows but those negative cash flows are financed from initial investment of£160,000. In the second month of the business, the company has a negative cash flow of£70500. Now we have different options to finance that negative cash flow, first is overdraft facility. Overdraft facility has the set-up cost of £500 and it has an interest rate of 1% compounding per month, second is bank loan, which has the set-cost of £250 and 0.5% computing per month interest rate and the third option is stock issue, the company has the option to raise capital by issuing its stock and financethe negative cash flows.

Relying partially or wholly on bank loans and overdraft facilities

At this point in time, the company will be betteroff by wholly relying on the bank overdraft facilities. The firm has excellent revenues, which are enough to cover the cost and for short-term deficit in cash, the firm can use the bank overdraft to finance that negative cash flows until its revenues increase to a level to cover the cost.

Budget

We have developed a budget for the firm in which we proportionate the expenses in the respective months.We have considered an issue of depreciation in the budget analysis, we have calculated the depreciation for ware house, office and vehicles. We have assumed that these non-current assets will depreciate in 5 years with zero residual value and based on above analysis, we got the profit of £170,000 with an annual depreciation cost is £31,800 in the FY 2014. However, in the FY 2015, the profit increased to 310,000 due to increment in the sales............................

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