Scenario Analysis In Finance – Term Paper

Finance Scenario Analysis Introduction

Scenario 1: Increased expenses used in financing 

Increasing the level of expenses alongside increased revenues in the overall leads to a decrease in the EBIT. The increase in the amount of expenses happens to be at a higher rate than that the increase in the revenue and this depreciates the level of operating income obtained after deducting expenses. Expenses such as advertising, sales and distribution as well as administration expenses have a heavy weight on the income level and this leads to the reduction in the profits level of the company. From the analysis, it is clear that the increase in the amount of corporate expenses as well as the selling, general and administrative expenses from (2.2M, 12.9M) in 1997 to (4.2M, 30.7M) in 1999 significantly affects the operating income. Ideally, selling, general and administrative expenses take a significant portion of the expenses. Irrespective of the tax amount charged, the net profit after taxes will always decrease with increase in the variable and fixed expenses. In the above scenario, EBIT decreased from $157,501 in 2001 to $252,034 in year 2004. 

Scenario 2: Financing assets through significant capital expenditure

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Ideally, increasing the amount of capital allocated to making capital expenditures through investment in assets is profitable and though leads to incurring of huge initial outlay, it results to increase in revenues especially when the items acquired are used in the generation of additional cashflows. The assets purchased have different payback times and while others take a short time to generate revenues which cover the costs incurred in purchasing them, others have long payback times but the overall aim was to generate an incremental cashflow which in this case can be seen to have increased from $2.035M in 1997 to 18.6M in 2001 and finally to $138.7 M in 2004. 

Scenario 3: Increasing debt ratio and earning per share

The increase in debt ratio which is brought about by increasing borrowings from external sources can be seen to have a negative effect on the cashflows mainly because it leads to the reduction in the equity level. Failure of the organization to generate enough cashflows from utilizing its assets efficiently and to be in a position to repay off its debts is what makes the cashflows adverse. One of the consequence of this is reduced earnings per share since more money is used to pay off debts and less is distributed to the shareholders.