Question

Kirby Company plans to begin selling a new product line. The company projectws sales for the next four years of $100,000, $230,000, $180,000 and $245,000. In order to meet these sales goals, Kirby Company needs to have 30% of the following year's sales on hand as inventory prior to the start of the year. How will these inventory purchases be reflected in the capital budgeting analysis for Kriby Company?

Answer 1

In Capital Budgeting analysis, the company analyse whether the investment in the project is feasable or not means, is it profitable to invest in the project or not. In this process we have to take into consideration Initial investment value and Net Cash inflows during the life of project which are discounted to present value to check its feasibility.
Net cash inflows are based on Revenues less: expenses per year i.e the amount company is earning every year. In expenses includes inventory used for generating revenues i.e Cost of goods sold. Here there is no relevance of purchase of inventory. the only main consideration is on Inventory used which is calculated as:
Opening Inventory + Puchases - Closing Inventory: Inventory used.
Hence by using the opening and closing balances of inventory we have to calculate Cost of goods sold which furthere reduced from revenues to result in profit .
Hence maintaining inventory 30% of following year's sales on hand and its purchases in prior year is not considered in capital budgeting instead inventory used in particular year is considered to arrive at Net Cash inflows.