Case: Alfin Fragrances Case Solution
Criticism on Analyst Projection:
Independent analyst use residual cash flow method for reporting of cash statement. Residual method of cash flow provides better measurement of investment value creation by the company. Meanwhile the analyst does not take appropriate assumptions for the calculation of residual cash flows. In its projection, it takes the revenue growth rate of 75%, which is not reasonable assumption because it is the highest in the history and there is higher possibility that the growth rate will be not be at 75% inthe future. Moreover, the analyst assumes that the additions in working capital for the next year is 61% of the sales, which indicates that the analyst takes unpopular assumption, which is not based on historic data or industry practice.
Alternative for Residual Cash flow:
The company can follow standardized cash flow statements, which are broken into three parts. The first cash flow from operating activities,within flows and outflows from operations only,followedby investing activities, which highlighted the investment in fixed asset or long term investment. Lastly, the financing activities, which include the finances from debt or equities. This provides the shareholders and other stakeholders with a clear picture of cash inflows and outflows so that better decision making can be done.
Difference between Residual and Free Cash flows:
The main difference between the residual and free cash flow is the debt amortization. In residual value, the debt amortization reduces the cash flows for the company. However, the free cash flows does not consider the debt amortization because it generates the cash available for distribution among stakeholders. These stakeholders might include bondholders and shareholders. The residual model of cash flows can be changed in free cash flow model when the debt amortization is not included in the calculation. For better understanding, the free cash flow equation is provided below:
Free Cash Flows = Profit after Tax + Depreciation & Amortization – Change in Working Capital – Capital Expenditure.
Funding Requirement:
As indicated in the case, Alfin will generate$44 million revenue due to the successful brands launch. In thissituation, the company does not need to get external funding because the turnover is high, therefore the company will generate reasonable cash flows internally. In addition to this, in the case of analyst’s projection, the company has to reduce its debt levels, which might require funding. The debt levels of the company arenot significant and the company can easily pay off its commitments. Moreover, debt is a cheaper source of finance as compared to equity because the annual interest payments will result in tax savings. Apart from debt finance, the best source of finance is the internal generated finance because in that case, the company would not have to convince any financer and there is no additional cost for it. Thus, the company should focus on its operating activities and should executestrategies, which would resultin value creation for the shareholders.....................
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