complete assignment

NAME :-CHAHAT SAGGAR

STUDENT ID :-PGDBM0171

MODULE TITLE :-MANAGEMENT OF FINANCIAL RESOURCES AND PERFORMANCE(MFRP)

PROGRAMME :-PGDBM ABP EXTENDED PROGRAMME LEVEL 7

PURPOSE OF ASSIGNMENT:-

SET DATE :-24TH MAY,2011

SUBMISSION DATE :-12th JUNE,2011

ACKNOWLEDGEMENT

I owe a great many thanks to a great many people who helped and

Supported me to prepare this assignment.

My deepest thanks to Lecturer, [Mr.O.JACOB] the Guide of the

project for guiding and correcting various documents of mine with attention and

care. He has taken pain to go through the project and make necessary correction as and when

needed.

I express my thanks to the Principal of, [REGENT INTERNATIONAL GRADUATE

SCHOOL, CROYDON], for

extending his support.

My deep sense of gratitude to [MR.K.JOHN] (DIRECTOR OF STUDIES] support and

guidance.

I would also thank my Institution and my friends without whom this project would have been

a distant reality. I also extend my heartfelt thanks to my family and well wishers.

CONTENTS

S.NO Topic name Page no

1 1(a) Sources of Finance 5-8

2 1(b) Various Risks involved in Project 9-12

3 1(c)Types of costs 13-19

4 2(a) Pay Back Period 20-22

5 2(b) ARR 23-30

6 2(c) NPV 31-35

7 3(a) Various financial ratios 36-39

8 3(b)Financial Position Report to Director 40-43

9 3(c)Limitation of interpretation techniques 44-46

10 References 47

1. Introduction

My assignment is based on the management of financial resources and

performance{MFRP}Investigation and Understanding regarding management and

finance in business , the main aim of this assignment is to understand the use of

various project appraisal techniques which would help in managing various financial

resources. This assignment has helped me a lot to understand the various risks to

be dealt while undertaking new projects.

Q1(a)

Sources of Finance for the Fleur International Public Liability Company (PLC).Public

liability company is a big type business. It is a limited company, a lot of people are involve in

it to manage this business. Public means that anyone can buy shares in the company if they

can find someone who wants to sell them.

Fleur PLC has main two type of sources of finance

1. Internal Sources of Finance for Fleur PLC

These are sources of finance that come from the business's assets or activities. Internal

finance is a quick and easy way to solve short term financial problems for most companies.

Retained earnings

For any company, the amount of earnings retained within the business has a direct impact on

the amount of dividends. Profit re-invested as retained earnings is profit that could have been

paid as a dividend. The major reasons for using retained earnings to finance new investments,

rather than to pay higher dividends and then raise new equity for the new investments, are as

follows:

a) The management of many companies believes that retained earnings are funds which do

not cost anything, although this is not true. However, it is true that the use of retained

earnings as a source of funds does not lead to a payment of cash.

b) The dividend policy of the company is in practice determined by the directors. From their

standpoint, retained earnings are an attractive source of finance because investment projects

can be undertaken without involving either the shareholders or any outsiders.

c) The use of retained earnings as opposed to new shares or debentures avoids issue costs.

d) The use of retained earnings avoids the possibility of a change in control resulting from an

issue of new shares.

2. External resources of finance

External resources of finance come from outside of the business.lf P L C finance has

resources below

A company might raise new funds from the following sources:

• The capital markets:

i) new share issues, for example, by companies acquiring a stock market listing for the

first time

ii) rights issues

• Loan stock

• Bank borrowing

• Government sources

Ordinary (equity) shares

Ordinary shares are issued to the owners of a company. They have a nominal or 'face' value.

The market value of a quoted company's shares bears no relationship to their nominal value,

except that when ordinary shares are issued for cash, the issue price must be equal to or be

more than the nominal value of the shares.

Deferred ordinary shares

They are a form of ordinary shares, which are entitled to a dividend only after a certain date

or if profits rise above a certain amount. Voting rights might also differ from those attached

to other ordinary shares.

Ordinary shareholders put funds into their company:

a) by paying for a new issue of shares

b) through retained profits.

Simply retaining profits, instead of paying them out in the form of dividends, offers an

important, simple low-cost source of finance, although this method may not provide enough

funds, for example, if the firm is seeking to grow.

Preference shares

Preference shares have a fixed percentage dividend before any dividend is paid to the

ordinary shareholders. As with ordinary shares a preference dividend can only be paid if

sufficient distributable profits are available, although with 'cumulative' preference shares the

right to an unpaid dividend is carried forward to later years. The arrears of dividend on

cumulative preference shares must be paid before any dividend is paid to the ordinary

shareholders.

From the company's point of view, preference shares are advantageous in that:

• Dividends do not have to be paid in a year in which profits are poor, while this is not the

case with interest payments on long term debt (loans or debentures).

• Since they do not carry voting rights, preference shares avoid diluting the control of existing

shareholders while an issue of equity shares would not.

• Unless they are redeemable, issuing preference shares will lower the company's gearing.

Redeemable preference shares are normally treated as debt when gearing is calculated.

• The issue of preference shares does not restrict the company's borrowing power, at least in

the sense that preference share capital is not secured against assets in the business.

• The non-payment of dividend does not give the preference shareholders the right to appoint

a receiver, a right which is normally given to debenture holders.

However, dividend payments on preference shares are not tax deductible in the way that

interest payments on debt are. Furthermore, for preference shares to be attractive to investors,

the level of payment needs to be higher than for interest on debt to compensate for the

additional risks

Loan stock

Loan stock is long-term debt capital raised by a company for which interest is paid, usually

half yearly and at a fixed rate. Holders of loan stock are therefore long-term creditors of the

company.

Loan stock has a nominal value, which is the debt owed by the company, and interest is paid

at a stated "coupon yield" on this amount.

Debentures are a form of loan stock, legally defined as the written acknowledgement of a

debt incurred by a company, normally containing provisions about the payment of interest

and the eventual repayment of capital.

Government grants : Fleur PLC company can get grants from government. It is generally

use by PLC company. Government grants can helps to set up the business.

Subsidy: Subsidy is that aid which is given by government to encourage the business man .it

is extra money is given to employees and workers. They get encouragement and they do work

with more attentively.

Q1(b)

Different Kind Of Risk in this project .

INTRODUCTION

Risk management is the identification, assessment, and prioritization of risks (defined in ISO

31000 as the effect of uncertainty on objectives, whether positive or negative) followed by

coordinated and economical application of resources to minimize, monitor, and control the

probability and/or impact of unfortunate events or to maximize the realization of

opportunities. Risks can come from uncertainty in financial markets, project failures (at any

phase in development, production, or sustainment life-cycles), legal liabilities, credit risk,

accidents, natural causes and disasters as well as deliberate attack from an adversary or

events of uncertain root-cause. Several risk management standards have been developed

including the Project Management Institute, the National Institute of Science and Technology,

actuarial societies, and ISO standards. Methods, definitions and goals vary widely according

to whether the risk management method is in the context of project management, security,

engineering, industrial processes, financial portfolios, actuarial assessments, or public health

and safety.

In project management, risk management includes the following activities:

• Planning how risk will be managed in the particular project. Plans should include risk

management tasks, responsibilities, activities and budget.

• Assigning a risk officer - a team member other than a project manager who is

responsible for foreseeing potential project problems. Typical characteristic of risk officer is a

healthy skepticism.

• Maintaining live project risk database. Each risk should have the following attributes:

opening date, title, short description, probability and importance. Optionally a risk may have

an assigned person responsible for its resolution and a date by which the risk must be

resolved.

• Creating anonymous risk reporting channel. Each team member should have

possibility to report risk that he/she foresees in the project.

• Preparing mitigation plans for risks that are chosen to be mitigated. The purpose of

the mitigation plan is to describe how this particular risk will be handled – what, when, by

who and how will it be done to avoid it or minimize consequences if it becomes a liability.

• Summarizing planned and faced risks, effectiveness of mitigation activities, and effort

spent for the risk management

Meaning of Risk

Risk is quite simply the combination of the probability of an event its consequences. As

much risk can be positive an event that is a opportunity or negative where the event represent

threat

Types of Business Risks

Business risks are of a diverse nature and arise due to innumerable factors. These risks may

be broadly classified into two types, depending upon their place of origin.

Internal Risks are those risks which arise from the events taking place within the

business enterprise. Such risks arise during the ordinary course of a business. These risks can

be forecasted and the probability of their occurrence can be determined. Hence, they can be

controlled by the entrepreneur to an appreciable extent.

The various internal factors giving rise to such risks are:-

• Human factors are an important cause of internal risks. They may result from strikes

and lock-outs by trade unions; negligence and dishonesty of an employee; accidents or deaths

in the industry; incompetence of the manager or other important people in the organisation,

etc. Also, failure of suppliers to supply the materials or goods on time or default in payment

by debtors may adversely affect the business enterprise.

• Technological factors are the unforeseen changes in the techniques of production or

distribution. They may result in technological obsolescence and other business risks. For

example, if there is some technological advancement which results in products of higher

quality, then a firm which is using the traditional technique of production might face the risk

of losing the market for its inferior quality product.

• Physical factors are the factors which result in loss or damage to the property of the

firm. They include the failure of machinery and equipment used in business; fire or theft in

the industry; damages in transit of goods, etc. It also includes losses to the firm arising from

the compensation paid by the firm to the third parties on account of intentional or

unintentional damages caused to them.

External risks are those risks which arise due to the events occurring outside the

business organisation. Such events are generally beyond the control of an entrepreneur.

Hence, the resulting risks cannot be forecasted and the probability of their occurrence cannot

be determined with accuracy.

The various external factors which may give rise to such risks are :-

• Economic factors are the most important causes of external risks. They result

from the changes in the prevailing market conditions. They may be in the form of

changes in demand for the product, price fluctuations, changes in tastes and

preferences of the consumers and changes in income, output or trade cycles. The

conditions like increased competition for the product, inflationary tendency in the

economy, rising unemployment as well as the fluctuations in world economy may

also adversely affect the business enterprise. Such risks which are caused by

changes in the economy are known as 'dynamic risks'. These risks are generally

less predictable because they do not appear at regular intervals. Also, such risks

may not necessarily result in losses to the firm because they may also contain an

element of gain for the firm. For instance, due to market fluctuations,a well known

product of a firm may either lose its demand or may occupy a larger market share.

• Natural factors are the unforeseen natural calamities over which an entrepreneur

has very little or no control. They result from events like earthquake, flood,

famine, cyclone, lightening, tornado, etc. Such events may cause loss of life and

property to the firm or they may spoil its goods. For example, Gujarat earthquake

caused irreparable damage not only to the business enterprises but also adversely

affected the whole economy of the State.

• Political factors have an important influence on the functioning of a business,

both in the long and short term. They result from political changes in a country

like fall or change in the Government, communal violence or riots in the country,

civil war as well as hostilities with the neighbouring countries. Besides, changes

in Government policies and regulations may also affect the profitability and

position of a enterprise. For instance, changes in industrial policy and Trade policy

annual announcement of the budget amendments to various legislations, etc. may

enhance or reduce the profits of a business enterprise.

• Liquidity Risk – The uncertainty introduced by the secondary market for a

company to meet its future short term financial obligations. When an investor

purchases a security, they expect that at some future period they will be able to

sell this security at a profit and redeem this value as cash for Consumption - this is

the liquidity of an investment, its ability to be redeemable for cash at a future date.

Generally, as we move up the asset allocation table – the liquidity risk of an

investment increases.

Thus, business risk takes a variety of forms. In order to face such risks successfully, every

businessman should understand the nature and causes of these risks as well as the various

measures which must be taken in order to minimise them.

Q1.C

Definition Of Cost :

DEFINITION:- One General definition of cost is :Cost is a foregoing or sacrifice ,measured

in monetary terms, incurred or potentially to be incurred ,to achieve a specific purpose.Cost is

a physical quantity measurement multiplied by a price measurement .

e.g. 100 units @ £5 = cost of £500

100*5 = 500

Classification of COST:-

1 Variable Cost

2 Fixed Cost

3 Semi Variable Cost

4 Direct Cost

5 Indirect Cost

6 Product Cost

7 Period cost

Activity and output

Meaning of activity:- Generally and physical operation that takes place in an

organisation .

Meaning of output:- The product or service provided by the organisation.

Need for the cost classification :

1 Planning

2 Decision making

3 Controls

Variable Costs:-(VC) When total cost changes in direct proportion to changes in volume, it

is called variable cost. Variable costs vary in proportionate and paralled manner with volume.

Mathematically, a linear relationship exists between variable costs and volume, If volume

increases by 10%, variable cost will also increase by 10%.

Variable costs are activity costs since they accrue when some activity is performed.

Basic Characteristics of variable costs:

1. Variable cost per unit remain constant .It is the total variable cost which varies

proportionately with volume.

2. It is relatively easy to identify variable cost with volume.they hardly pose problem of

allocation.

3. Generally variable costs are identifiable with responsibility centres at operating levels

of management. They are, therefore, controllable at departmental level.

Example of variable cost are :-

1 Materials used to manufacture a unit of output or to provide a type of service.

2 fuel used by plc company

3 commission paid to a sale person

4. Labour costs of manufacturing or unit of output or providing a type of service.

This chart shows the Variable Cost

Output number of

units

10 20 30

Total Cost (£) 100 200 300

If you want to produce 10 out put number of unit of any product the total cost

for it is £100 and if you produced 20 units, the variable cost increases at £200and if you

produces 30 units, the variable cost rises at £300 ,Total cost increased by £10 for every unit

produces. There is an increase in unit as activity increases

This diagram shows us Variable Cost there is an rise in unit as activity rise .You can see in

this diagram the activity in units level is 10units and total cost of production is £100 and then

with increase in unit the cost of production also increase and reaches at £200 and if you

produce 50 units its cost is equal to £500.

Fixed cost :- When total cost remain non variable(fixed) to changes in volume,it is called

fixed cost.Examples of fixed cost are:Depreciation,insurance,salaries,maintainence and

repairs.

Output(number of

vases)

10 20 30

Total cost (£) 300 300 300

1 Fixed cost remain @£300

2 Unit cost decreased as output increases, because the fix cost is spread over

more vases £30 per unit, 15 per unit and £10 per unit

This diagram shows us Fixed cost .Fixed cost remain fixed it does not vary with extra

production. If we produced 10 unit it is cost £300and if we produced 20units

,30units, 40units and 50units it remain fixed at £300 it does not vary at any

production.

Total cost :-The total cost is the sum of the fixed cost and variable cost.

TC=FC+VC

FC=TC-VC

VC=TC-FC

Table of data as showing variable cost, fixed cost and total cost .

Activity of

level

0 units

£

100 units

£

200 units

£

300 units

£

Variable cost 0 10 20 30

Fixed cost 20 20 20 20

Total cost 20 30 40 50

Above diagram shows Total Cost In the beginning of any business we put

fixed cost on land, building, machines and on computers it remains fixed and

after that Variable costs are spend in business. The Total cost is the sum of

fixed cost and Variable cost .

Semi variable costs:-

Example of semi variable costs are:-

1 Office salaries where there is a centre of long term clerical staff plus

employment of temporary staff when activity level rise

2 Maintenance changes where there is a fixed basic change per year plus a

variable element depending on the number of call out per year

STEP COST

This is a fixed cost that increases in steps. It may be noted that fixed costs are constant over a

range of volume. If the volume increases beyond a given range, fixed cost would increase.

Some fixed cost like supervision cost has a tendency of increasing in stepwise way. Such

fixed costs are called step fixed costs.

DIRECT COST: Direct costs are those cost items which can be traced logically and

conveniently, in their entirely, to a cost object. The wages paid to the workers who are

engaged in making is direct cost.

INDIRECT COST: Indirect costs are those cost items which cannot be traced or identified

directly with cost object. These are also known as overhead costs

PRODUCT COSTS: Those cost items which attach or cling to units of finished goods are

called Product costs. Traditionally in cost accounting cost of manufacturing a product are

called product costs. Thus product cost will consist of direct materials, direct labour and

reasonable share of factory overheads

PERIOD COSTS: Period Costs do not attach to products: they are incurred for time period

and are charged to profit and loss of that period. Non-Manufacturing cost, selling and general

and administrative costs are generally treated as period cost.

Q2 (a) Pay Back Period Chart (pbp)

Project (A) £

Project (B) £

Project (C) £

Project (D) £

Project (E) £

Outlay Net Cash flows

180000 180000 180000 180000 180000

Year 1 60000 70000 48000 40000 55000

Year 2 60000 70000 48000 60000 55000

Year 3 60000 70000 48000 65000 55000

Year 4 60000 70000 48000 80000 55000

Pay Back Period

3Years 2.5years 3.6years 3.2years 3.2years

Project(A)Year1+year2+year360000+60000+60000=180000 3yearsProject (B) Year1+year2 70000+70000= 140000180000-140000=4000040000/12=3333.333333.33*12/70000 =0.6months6months/12=0.5;therefore pbp =2+0.5=2.5years

Project( C)Year1+year2+year348000+48000+48000=144000180000-144000=3600036000/12=30003000*12/48000 =0.757months/`12=0.58;therefore pbp =3+0.58=3.6years

Project (D)Year1+year2+year340000+60000+65000= 165000180000-165000=1500015000/12=12501250*12/80000=0.1875=0.2months2months/12=0.16=3+0.16 pbp=3.2years

Project (E)Year1+year2+year355000+55000+55000=165000180000-165000=1500015000/12= 12501250*12/70000=0.214=0.2 months2months/12=0.163+0.16= pbp=3.2years

There are three Appraisal techniques or methods of capital Budgeting :-

1 Pay Back Period

2 Accounting Rate of return (ARR)

3 Net Present Value

1Pay Back Period : The payback period is both conceptually simple and easy to calculate. It

is also a seriously flawed method of evaluating investments.

The payback period is the time taken to recover the initial investment. So a £1m investment

that will make a profit of £200,000 a year has a payback period of five years. Investments

with a shorter payback period are preferred to those with a long period. Most companies

using payback period as a criterion will have a maximum acceptable period.

Advantages of payback period:-

1. It is easy to calculate.

2. It is easy to understand.

3. It places emphasis on projects which give early return of cash flows .

4. It is a cautious approach

Limitation of payback period

1. It ignores the time value of money

2. Cash flows earned should repay the capital sum invested plus interest

3 It ignores any cash flows origin after pay back date.

Q2 (b)There are three Methods of depreciation

1 Straight line method

2 Weighted Averages

3 Percentage written off

We are calculating Depreciation with straight line method

Depreciation on straight line method = 180000/4 =45000

Depreciation over four years

Straight line £45000 per year

Original cost 180000

Depreciation year 1 -45000

Value at the end of year 1 135000






Value at the end of year 4 00000Scrap value

Depreciation should be calculated @ 10% interest rate

10/100*180000=18000

Value 180000 -18000 Depreciation @10% year 1 162000

162000*10/100=16200

Depreciation @10% year2 162000 -16200

1458001458000*10/100=14580Depreciation @10% year3 145800 -14580 131220131220*10/100=13122Depreciation @10% year4 131220 -13122Scrap value 118098

CALCULATION OF ACCOUNTING RATE OF RETURN (ARR)

CASHFLOWS PROJECT A PROJECT B PROJECT C PROJECT D PROJECT E

OUTLAY (a) 180000 180000 180000 180000 180000

YEAR160000-45000=15000(wk1)

70000-45000=25000(wk2)

48000- 45000=3000(wk3)

40000-45000= -5000(wk4)

55000-45000=10000(wk8)

YEAR260000-45000=15000(wk1)

70000-45000=25000(wk2)

48000-45000=3000(wk3)

60000-45000=15000(wk5)

55000-45000=10000 (wk8)

YEAR360000-45000=15000(wk1)

70000-45000=25000(wk2)

48000-45000=3000(wk3)

65000-45000=20000(wk6)

55000-45000=10000 (wk8)

YEAR460000-45000=15000(wk1)

70000-45000=25000(wk2)

48000-45000=3000(wk3)

80000-45000=35000(wk7)

55000-45000=10000 (wk8)

Average Annual

Profit(b) 15000(wk9) 25000(wk10) 3000(wk11) 16250(wk12) 10000(wk13)

ARR=

b*100/a

(expressed as percentage)

15000*100/180000

=75/9

= 8.333% (wk14)

25000*100/180000

=125/9

=13.888% (wk15)

3000*100/180000

=30/18

=1.666% (wk16)

16250*100/180000

=1625/180

= 9.02% (wk17)

10000*100/18000

=50/9

=5.555% (wk18)

180000/4YEARS=45000

Workings

Project (A)

60000-45000=15000(wk1)

Project (B)

70000-45000=25000(wk2)

Project (C)

48000-45000=3000(wk3)

Project (D)

40000-45000= -5000(wk4)

60000-45000=15000(wk5)

65000-45000=20000(wk6)

80000-45000=35000(wk7)

Project (E)

55000-45000=10000(wk8)

(wk9)Average Annual Profit(b)=15000+15000+15000+15000 / 4

=60000/4

=15000

(wk10)Average Annual Profit(b)=25000+25000+25000+25000/4

=100000/4

= 25000

(wk11)Average Annual Profit(b)=3000+3000+3000+3000/4

=12000/4

=3000

(wk12)Average Annual Profit(b)= -5000+15000+20000+35000/4

=65000/4

=16250

(wk13)Average Annual Profit(b)= 10000+10000+10000+10000/4

=40000/4

=10000

(wk14) ARR=b*100/a

Project(A)

=15000*100/180000

=75/9

=8.333%

(wk 15) ARR=b*100/a

Project(B)

=25000*100/180000

=125/9

=13.888%

(wk16) ARR=b*100/a

Project(C)

=3000*100/180000

=30/18

=1.666%

(wk17) ARR=b*100/a

Project(D)

=16250*100/180000

=16250/1800

=9.02%

(wk18) ARR=b*100/a

Project(A)

=1000*100/180000

=100/18

=5.555%

Accounting Rate of return (ARR) Accounting rate of return, also known as the Average rate

of return, or ARR is a financial ratio used in capital budgeting. The ratio does not take into

account the concept of time value of money. ARR calculates the return, generated from net

income of the proposed capital investment. The ARR is a percentage return ARR is most

often used internally when selecting projects. It can also be used to measure the performance

of projects and subsidiaries within an organisation.

There are better alternatives which are not significantly more difficult to calculate.

The accounting rate of return is conceptually similar to payback period, and its flaws, in

particular, are similar

From the ARR calculation the decision would be as follows

1 Project B is most desirable project because this project gets highest value

of ARR that is equal to 13.888%

2 Project D is next in rank because this project gets second highest value of

ARR that is equal to 9.02 %

3 Project ( A) gets third position and project( E) gets fourth position

4 Project( C) is the least desirable because this project gets least value of ARR

Advantages of Accounting Rate of Return :

1 It is relatively easy to calculate

2 All cash flows are used.

3 It is easy to understand the result .

4It takes into the calculation all the profits.

5 It is based on the familiar accounting measured of profit.

Limitations of Accounting Rate of Return

1 It depends on profit , including the subjective accounting estimate of depreciation.

2 It ignore the time value of money .

Q2 ( C)

Here we are using third method of capital budgeting Net Present Value

Formula for Net Present Value 1 NPV= _____ - PV (1+r) n

Project (A)

60000 60000 60000 60000 NPV= ___ + _____ + _____ + _____ _ 180000

(1+0.1) 1 (1+1.01)2 (1+0.1)3 (1+0.1)4

60000 60000 60000 60000 = _____ + _____ + _____+ _____ _ 180000 (1.1) 1 (1.1)2 (1.1)3 (1.1)4

60000 60000 60000 60000 = _____ + _____ + _____ + _____ _180000 1.1 1.21 1.331 1.4641 = 54545.4545+49586.776+45078.888+40980.807 – 180000

= 190191.9255-180000

= 10191.925 Project (B)

70000 70000 70000 70000 NPV= ____ _____ _____ _____ _ 180000

(1+0.1)1 (1+1.01) 2 (1+0.1)3 (1+0.1)4

70000 70000 70000 70000 = _____ + _____ + _____ + _____ _ 180000 (1.1)1 (1.1)2 (1.1)3 (1.1)4

70000 70000 70000 70000 _____ + _____ + _____ + _____ _ 180000 1.1 1.21 1.331 1.4641 = 63636.363+57851.239+52592.036+47810.941 – 180000 = 221890.34-180000

= 41890.34

Project (C)

48000 48000 48000 48000

NPV= ____ + _____ + _____ + _____ _ 180000 (1+0.1)1 (1+1.01)2 (1+0.1)3 (1+0.1)4

48000 48000 48000 48000 = _____ + _____ + _____ +_____ _180000 (1.1)1 (1.1)2 (1.1)3 (1.1)4

48000 48000 48000 48000 = _____ + _____ + _____ + _____ _180000 1.1 1.21 1.331 1.4641 = 43636.363+39669.421+36063.110+32784.45– 180000 = 152153.539-180000

= -27846.461

Project (D)

40000 60000 65000 80000 NPV= ____ + _____ + _____ + _____ _ 180000

(1+0.1)1 (1+1.01)2 (1+0.1)3 (1+0.1)4

40000 60000 65000 80000 = _____ + _____ + _____ + _____ _ 180000 (1.1)1 (1.1)2 (1.1)3 (1.1)4

40000 60000 65000 80000 _____ + _____ + _____ + _____ _180000 1.1 1.21 1.331 1.4641 = 36363.636+49586.776+48835.46254641.076 – 180000 = 189426.95-180000 = 9426.95

Project (E)

55000 55000 55000 55000 NPV= ____ + _____ + _____ + _____ _ 180000

(1+0.1)1 (1+1.01)2 (1+0.1)3 (1+0.1)4

55000 55000 55000 55000 = _____+ _____ + _____ + _____ _180000 (1.1)1 (1.1)2 (1.1)3 (1.1)4

55000 55000 55000 55000 = _____ _____ _____ _____ _180000 1.1 1.21 1.331 1.4641 = 5000+45454.545+41322.314+37565.740 – 180000

= 17432.599 -180000

= - 5657.401

NET PRESENT VALUE (NPV) Explanation

The difference between the present value of cash inflows and the present value of cash

outflows. NPV is used in capital budgeting to analyze the profitability of an investment or

project.

NPV analysis is sensitive to the reliability of future cash inflows that an investment or project

will yield.

Formula:

In addition to the formula, net present value can often be calculated using tables, and

spreadsheets such as Microsoft Excel.

NPV in decision making

Another issue with relying on NPV is that it does not provide an overall picture of the gain or

loss of executing a certain project. To see a percentage gain relative to the investments for the

project

Results/Decisions

(1) Based on the above decision rule project will be accepted as it gives a

positive net present value.

(2) Project (B) is the most desirable project because it gets positive value of

NPV is equal to 41890.34

(3) project (B) is next rank because it gets second position is equal to positive

value of NPV is equal to10191.29

(4) Project ( C) and (E) would be rejected as gives a negative net present value.

Q3 (a)

Interpretation of Ratios analysis and Limitation

(wk1)Revenue=Last year sales – Present year sales = 240 – 200 = 40 Therefore= 40 × 100

200

= 20%

(wk 2)Return on capital employed (ROCE)

ROCE=Profit Before Interest and taxation× 100 Total Assets – Current Liabilities

2001 = 18 + 2 × 100 134 - 34= 20 × 100 100= 20%

2002 = 28 + 2 × 100 154 - 44= 30 × 100 100= 27.3%

(wk 3)Profit Margin Margin = Profit Before Interest and taxation × 100

Sales2001 = 20 × 100

200= 10%

2002 = 30 × 100 240= 12.5%

(wk 4)Asset Utilisation Asset turn over = Sales Total Assets – Current Liabilities2001 = 200

100= 2 times

2002 = 240 110= 2.2 times

(wk 5)Gross Profit MarginGPM = Gross Profit × 100 Sales2001 = 60 × 100

200 = 30%2002 = 80 × 100

240 = 33.3%

(wk 6)Net Profit MarginNPM = Profit before taxation × 100 Sales2001 = 18 × 100 200 = 9%2002 = 28 × 100 240 = 11.7%

(wk 7)Current Ratio = Current Assets Current Liabilities

2001 = 94 = 2.8 times 342002 = 112 = 2.5 times 44

(wk 8)Quick/Acid test ratio= Current Assets – Inventory/stock Current Liabilities2001 = 94 – 60 = 1 34

2002 = 112 – 70 = 0.95 44

(wk 9) Working Capital RatioNo. of days closed inventory is held = closed inventory × 365 cost of sales2001 = 60 × 365 140 = 156 days2002 = 70 × 365 160 = 160 days

(wk 10) No. of days credit given tocustomer = Trade receivable × 365 Credit sales

2001 = 30 × 365 200 = 55 days2002 = 40 × 365 240 = 61 days

(wk 11) No. of days credit taken fromsuppliers = Trade payable × 365 Cost of sales2001 = 28 × 365 140 = 73 days2002 = 32 × 365 160 = 73 days

(wk 12) Gearing = Debtors × 100 Equity2001 = 20 × 100 400 = 5%2002 = 20 × 100 500 = 4%(wk 13) interest cover = Profit before taxation Interest payable2001 = 20 = 10 times 2

2002 = 30 = 15 times 2(wk 14) Rate of Earning = Profit after taxation × 100 Equity2001 = 12 × 100 80 = 15%2002 = 16 × 100 90 = 18%

(wk 15) Earning per share = Profit after tax No. ordinary shares2001 = 12 = 20 pence/share 602002 = 16 = 26.7 pence/share 60

(wk 16) Price earning ratio = Market price Earning per share2001 = 400 = 20 times 20p2002 = 500 = 18.7 times 26.7p(wk 17) Dividend cover = Profit after taxation Dividend for period2001 = 12 = 2 times 62002 = 16 = 2.7 times 6 (wk 18) Dividend Yield = Dividend per share × 100 Share Price2001 = 20 × 100 400 = 5%2001 = 20 × 100 500 = 4%

APPENDIX TO REPORT

Particulars 2001 2002

Sales(wk 1) 200 % 240 %Return on capital employed wk (2) 20 % 27.3 %Profit Margin(wk 3) 10 % 12.5 %Asset Utilization (wk 4) 2 times 2.2 timesGross Profit Margin (wk 5) 30 % 33.33 %Net Profit Margin (wk 6) 9 % 11.7 %Current Ratio (wk 7) 2.8 times 2.5 timesQuick/Acid test ratio (wk 8) 1 % 0.95 %Working capital ratio (wk 9) 156 days 160 daysNo of days credit given to customer (wk 10) 55 days 61 daysNo of days credit taken by suppliers (wk 11) 73 days 73 daysGearing ratio (wk 12) 25 % 22 %Interest cover (wk 13) 10 times 15 timesRate of earning (wk 14) 15 % 18 %Earning per shares (wk 15) 20

pence/share26.7 pence/share

Price earning ratio (wk 16) 20 times 18.7 timesDividend cover (wk 17) 2 times 2.7 timesDividend yield (wk 18) 5 % 4 %

To: The Director, Fleur International LPC

From: The Chief Accountant

Subject: Analysis of Fleur International construction PLC’s performance to 30

September 2002

Date: 14 October 2002

The following report is submitted in agreement with your request to assess the

financial progress, performance and financial position of Fleur International

Construction for the year ended on 30 September 2002.

The report considers key areas of solvency, profitability and liquidity. It is based on

selected ratios calculation in attached Appendix.

Profitability

Sales increased by 20% from £200m to £240m and there is no indication that this

was due to cut in prices, as the gross profit margin has not fallen. The increase in

sales volume appears to be due to improvement in quality and more attractive credit

terms and being offered. The latter can be substantiated as the number of day’s

credit given to customer has extended by six days.

The primary measure of profitability, return on capital employed (ROCE), increased

from 20% to 27.3% indicating more efficient use of assets by management. This was

mainly due to more profitable sales as indicated by increase in gross profit margin

from 30% to 33.3% and improvement in cost control due to economies of scale as

indicated by improvement in net profit margin from 9% to 11.7%.

Solvency and gearing

Gearing was maintained at its low level and dropped from 25% to 22% due to a

higher profit retention policy. Interest cover increased by 5 times due to higher

profitability and no increase in interest payments. Future capital expenditure can be

debt financed to ease company’s short term liquidity which can come under pressure

in the following period.

Shareholder ratios

Earning per share increased by 35% from 20pence to 26.7pence . however, this was

not matched by the dividend payout which remained at 10pence per share, and price

earnings ratio declined from 20 times to 18.7 times which indicates that

shareholders were not satisfied with the dividend pay-out, and hence the share price

did not go up in line with improvement in performance.

Liquidity and working capital management

The company invested £5m in non-current assets during the year, which was

internally financed resulting in a slight deterioration in both current and acid-test

ratios. Both ratios gave adequate cover for short-term creditors. The cash operating

cycle increased by ten days due to increase in number of day’s credit given to

customers (six days) and increase in working capital ratio (four days). However, the

number of days credit taken from trade creditors remained the same (73 days),

resulting in further decline in liquidity ratios. The increase in credit to customers

appears to be made to attract new customers and to keep existing customers happy.

However, the increase in stock holding may be in anticipation of increased sales or

poor stock control.

Conclusion

The year ended 30 September 2002 was very reasonable with a steady increase in

market share and overall improvement in management efficiency, and the company

should look forward to 2003 with great self-confidence. However, attention should be

paid to the following:

Dividend payout should be increased in line with performance to boost share price

with will facilities any share issue. Short-term liquidity needs further attention. Any

further expansion should be debt financed.

Q3 (c)

Critically evaluate the limitations of interpretation techniques:-

The ratio analysis is a widely used to technique to evaluate the financial position

and performance of a business. But there are certain problems in using ratios. The

analyst should be aware of these problems. The following are some of the limitations

of the ratio analysis

1. It is difficult to decide on the proper basis of comparison.

2. The comparison is tendered difficult because of differences in situations of

two companies or of one company over years.

3. The price level changes make the interpretation of ratios invalid.

4. The differences in the definitions of items in the balance sheet and the profit

and loss statement make the interpretation of ratios difficult.

5. The ratios calculated at a point of time are less informative and defective as

they suffer from short-term changes.

6. The ratios are generally calculated from past finanacial statements and thus

there are no indicators of future.

Standards for Comparison:

Ratios of a Company have meaning only when they are compared

with some standards. It is difficult to find out a proper basis comparison. Usual

ally it is recommended that ratios should be compared with industry averages.

But the industry averages are not easily available.

Company differences:

Situations of two companies are never same. Similarly,

the factors influencing the performance of a company in one year may change

in another year. Thus. The comparison of the ratios of two companies

becomes difficult and meaningless when they are operating at different

situations.

Price Level:

The interpretation and comparison of ratios are also rendered invalid by the

changing value of money. The accounting figures, presented in the financial

statements, are expressed in the monetary unit which is assumed to remain

constant. In fact prices change over years which affect accounting earnings.

At least three effects of inflation can be identified.

1. The nominal value of inventory increases on account of the rising prices.

This result into “inventory profit”. A firm will lose in real terms if the general

price level increases faster than appreciation in the value of inventory.

2. The assets are stated at original cost(less depreciation) in the balance

sheet. Because of inflation, their current value or replacement cost will be

much higher than book value. Thus depreciation calculated on book value

will be very low.

3. Inflation affects accounting profits of the firms which borrow. If the interest

rate is fixed, shareholders gain at the cost of lenders. The real value of the

lenders obligation is reduced by inflation. The accounting profit does not

recognize the gain from borrowing arising due to inflation. Since the firms

will differ in terms of the nature of their inventory , age and type of assets

and debt policy, inflation will affect them differently

Different Definition:

In practice, differences exist as the meaning g of certain terms. Diversity

of views exists as to what should be included in net worth or shareholders,

equity, current assets or current liabilities. Whether preference share

capital and current liabilities should be included in debt in calculating the

debt equity ratio? Should intangible assets be excluded to calculate the

rate of return on the investment? If intangible assets have to be included,

how will they be valued? Similarly, profit means different things to different

people.

Changing situations :

The ratios do not have much use if they are not analysed over

years. The ratios at a moment of time may suffer from temporary changes.

This problem can be resolved by analysing trends of ratios over year.

Although trend analysis is more useful but the still analysis is static to an

extent. The balance sheets, prepared at different points of time are static

in nature. They do not reveal the changes which have taken place

between dates of two balance sheets. The statements of changes in

financial position reveal this information.

Past Data:

The basis to calculate ratios are historical financial statement.

The financial analyst is more interested in what happens in the future,

wh8ile the radios indicate what happen in the past. Management of the

company has information about the company’s future plans and policies

and, therefore is able to predict future happening to a certain extent. But

the outside analyst has to rely on the past ratios, which may not

necessarily reflect the firm’s financial position and performance in the

future.

References

BOOKS :- FINANCE SECOND EDITION MICHAEL FARDON, DAVID COXAccounting and finance, compiled by Leslie Chadwik Bradford University school of Management Business Studies For AS edited by Can Marcourse

http://en.wikipedia.org/wiki/Risk_management

http://www.investopedia.com/terms/n/npv.asp

http://en.wikipedia.org/wiki/Net_present_value

http://teachmefinance.com/capitalbudgeting.html

http://teachmefinance.com/capitalbudgeting.html

http://en.wikipedia.org/wiki/Net_present_value

http://www.investopedia.com/terms/n/npv.asp

http://en.wikipedia.org/wiki/Risk_management

complete assignment

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