1 / 10

Managing Finance and Budgets

Managing Finance and Budgets. Lecture 7 Activities & Solutions. Accounting Rate of Return – Further Example. PROJECT ONE PROJECT TWO Investment £300,000 £ 500,000 Cashflow Dep’n Net Profit Cashflow Dep’n Net Profit

hakeem-knox
Télécharger la présentation

Managing Finance and Budgets

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Managing Finance and Budgets Lecture 7 Activities & Solutions

  2. Accounting Rate of Return – Further Example PROJECT ONE PROJECT TWO Investment £300,000 £ 500,000 Cashflow Dep’n Net Profit Cashflow Dep’n Net Profit Year 1: 90,000 60,000 30,000 120,000 100,000 20,000 Year 2: 160,000 60,000 100,000 140,000 100,000 40,000 Year 3: 120,000 60,000 60,000 160,000 100,000 60,000 Year 4: 70,000 60,000 10,000 240,000 100,000 140,000 Year 5: 70,000 60,000 10,000 320,000 100,000 220,000 Totals: 510,000 300,000 210,000 980,000 500,000 480,000 ARR = Average profit/Average investment = (210,000/5)/ (300,000/2) = 28% (480,000/5)/(500,000)/2 = 38.4% In this case, the depreciation has been included as part of the Net Profit calculation

  3. Activity One A company is considering investing in either of two new machines which will help to increase its production. The first machine will cost £240,000, and the company estimates that it will have a working life of 5 years. The second machine will cost £360,000 and have a working life of 6 years. The net positive cash-flows as a result of cost savings from the new machine are shown below. Calculate the payback period and Accounting Rate of returns for each of the machines. Machine 1: Net Cash-flows: £ 90,000/yr for first 3 years £ 50,000/yr for remaining 2 years Machine 2: Net Cash-flows: £100,000 Year 1 £110,000 Years 2 £120,000 Years 3 and 4 £ 90,000 Years 5 and 6

  4. Activity One –Solution Part 1 Machine 1: Cost £240K Life 5 years Net Cash-flows: £ 90K /yr for first 3 years £ 50K /yr for remaining 2 years ARR Average Profit = [ (3 x 90000) + (2 x 50000) - 240000 ]  5 = 26000 Average Investment = (240000 + 0)  5 = 48000 ARR = 26000/48000 = 54.2% PP In the first two years, Total Cash flow = £180000, so the PP will occur sometime in year three Proportion of year three = (240000-180000)/90000 = 8 months PP = 2 years and 8 months

  5. Activity One –Solution Part 2 Machine 2: Cost £360K Life 6 years Net Cash-flows: £100K, £110K, £120K, £120K, £90K, £90K ARR Average Profit = [ (100000+110000+ 120000x2 +90000x2) - 360000 ]  6 = 45000 Average Investment = (360000 + 0)  6 = 60000 ARR = 45000/60000 = 75% PP In the first three years, Total Cash flow = £330000, so the PP will occur sometime in year four Proportion of year four = (360000-330000)/120000 = 3 months PP = 3 years and 3 months

  6. Activity One -Summary Machine 1: ARR = 45.8% PP = 2 years 8 months Machine 2: ARR = 75% PP = 3 years 3 months Analysis: If we opt for the Machine 1, it will cost less, and we will recoup our initial expenditure 7 months sooner. However the second machine promises greater return on our investment in the long run. Decision: If the company can secure the finances (e.g. long term loan over 4 years ), then Machine 2 represents a much better investment. If finances are a problem, then we may have to settle for Machine 1.

  7. Activity Two For the scenario described in Activity One, calculate a Net Present Value for each of the two machines, using a Discount Rate of 10% and a Discount Rate of 20%. The Discount Factors at the two rates are shown below: 10% 20% Year 1 0.909 0.833 Year 2 0.826 0.694 Year 3 0.751 0.579 Year 4 0.683 0.482 Year 5 0.621 0.402 Year 6 0.565 0.335

  8. Activity Two – Solution (1) MACHINE ONE MACHINE TWO Discount Discount Cashflow Factor DCF Cashflow Factor DCF Inv’mnt -240,000 1 -240,000 360,000- 1 360,000- Year 1: 90,000 0.909 81,810 100,000 0.909 90,900 Year 2: 90,000 0.826 74,340 110,000 0.826 90,860 Year 3: 90,000 0.751 67,590 120,000 0.751 90,120 Year 4: 50,000 0.683 34,150 120,000 0.683 81,960 Year 5: 50,000 0.621 31,050 90,000 0.621 55,890 Year 6: 90,000 0.565 50,850 Totals: 48,940 100,580 The above figures use a Discount Rate of 10%

  9. Activity Two – Solution (2) MACHINE ONE MACHINE TWO Discount Discount Cashflow Factor DCF Cashflow Factor DCF Inv’mnt -240,000 1 -240,000 360,000- 1 360,000- Year 1: 90,000 0.833 74,970 100,000 0.833 83,300 Year 2: 90,000 0.694 62,460 110,000 0.694 76,340 Year 3: 90,000 0.579 52,110 120,000 0.579 69,480 Year 4: 50,000 0.482 24,100 120,000 0.482 57,840 Year 5: 50,000 0.402 20,100 90,000 0.402 36,180 Year 6: 90,000 0.335 30,150 Totals: -6,260 -6,710 The above figures use a Discount Rate of 20%

  10. Activity Two – Solution Summary DF = 10% DF = 20% NPV of Machine 1 £48,940 -£6,260 NPV of Machine 2 £100,580 -£6,710 Analysis: • If the value of money is decreasing at 10% per annum (low risk, low inflation, low interest), then Machine 2 is a much better proposition, earning over £50K more. • However, if the value of money is decreasing at 20% per annum (high risk, high inflation, high interest) then Machine 1 is a slightly better proposition, as its loss is somewhat less. However, the value of purchasing any machine under these circumstances is questionable.

More Related