In the five years since its founding, Online Advertising Responses, Inc. has grown rapidly. They currently have 20 employees and expect to hire another 20 in the new year to help manage a large new online state government advertising account. This type of expansion will require a significant investment in both expanded office space as well as general office equipment and technology equipment, including top-of-the line computers capable of handling advanced graphics software, printers, and other peripherals for each employee. They need a recommendation on what option would be the most cost-effective for them in terms of maintaining positive cash flow. In the past they have simply purchased whatever was needed outright.
A key consideration for their decision is that the company’s only source of revenue is commissions from their clients. Each client has different spending patterns so cash flow varies by quarter. In the fiscal year that just ended, quarterly cash flow from client commissions followed the pattern noted below. They assume that in the coming fiscal year a similar pattern will occur.
Quarter Client Commissions
Total FY $18,265,000
For the purposes of estimating cash flow for the next fiscal year, assume that the average salary for the 20 expected new employees will be $75,000. To accommodate the additional employees, assume an addition of another 3,000 square feet of office space at a cost of $175 per square foot.
If they were to buy office furniture for each new employee, the estimated cost is $3,000 per employee.
IT estimates that the appropriate technology package for hardware will be $8,000 per employee for an outright purchase. You should take into consideration the cash flow information for the fiscal year that’s just ending, which is provided below.
Management has asked their accountant to develop and prepare a recommendation on the best options:
To buy outright and own all furnishings and technology. The furnishings will be fully financed for three years at 5%. The technology will be financed less a down payment on the technology for 6 years. The finance manager is allowing us a $10,000 down payment. You will need to calculate the payments, online calculators are available to do that for you.
To consider an operating lease for all of the new equipment and furnishings. The vendor will lease the full amount for a monthly payment of $5,000 for the first three years and $2,500 for the last three. Vendor will reclaim the merchandise at the end of 3 and 6 years respectively.
To consider a capital lease for all of the new equipment and furnishings. The vendor will lease the full amount for 5% for 3 (furnishings) and 6 years (equipment). You will need to calculate payments on the full amount.
Your job is to evaluate the three alternatives and prepare a recommendation of 800 -1200 words. You must support your recommendation with an analysis of the impact on operating cash flow’s impacts from the different types of leases versus outright purchases. In your analysis, include calculations on the depreciation of both the technology items (with an expected life of 6 years) and the furnishings (with an expected life of 3 years). You analysis should include the formula for straight line depreciation which you will use. The furnishings will have a residual value of $0 while the technology will have a value of $500 per employee set up.
The following provides a statement of cash flows for the fiscal year that just ended. The company’s fiscal year aligns with a calendar year ending in December.
Statement of Cash Flows (Direct Method) for FY Ending 12/31
Client commissions $18,265,000
Employee salaries $3,450,000
Investing activities Amount
Purchase of equipment $140,000
Purchase of furnishings $60,000
Financing activities Amount
Additional owner’s equity $250,000
Cash on hand as of 12/31 $750,000
Average salary is $75,000.