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Evaluate The Sources Of Finance And The Cost Of The Finance Accounting Essay

Success of the right issues is depending on the performance of the company because if the existing shares performed then only the right issues will be successful. And the cost of right issues and dividend should be considered. Loans might be expensive if the interest rate is high. Further company has to consider the financial policy and the maximum gearing ratio that company can go.

Venture capital:

Might not work for public listed companies due to the share holders’ structure might change if the venture capital ask some major shares.

Task 02: Appraising projects using different methods

METHODE 02 DISCOUNDED PAYBACK

Project A

Y 0

Y 01

Y 02

Y 03

Y 04

Y 05

Inatial investment

-250,000.00

Cash flows

90,000.00

80,000.00

75,000.00

64,000.00

72,000.00

Net cash flow

-250,000.00

90,000.00

80,000.00

75,000.00

64,000.00

72,000.00

DCF

1.00

0.89

0.80

0.71

0.64

0.57

PV of cash flows

-250,000.00

80,357.14

63,775.51

53,383.52

40,673.16

40,854.73

Pay back

-250,000.00

-169,642.86

-105,867.35

-52,483.83

-11,810.67

29,044.06

Pay back peroid

=4+(11,810/40,854)

4.29

years

Project B

Y 0

Y 01

Y 02

Y 03

Y 04

Y 05

Y 06

Inatial investment

-275,000.00

Cash flows

86,000.00

92,000.00

78,000.00

83,000.00

67,000.00

Scrap value

10,000.00

Net cash flow

-275,000.00

86,000.00

92,000.00

78,000.00

83,000.00

67,000.00

10,000.00

DCF

1.00

0.89

0.80

0.71

0.64

0.57

0.51

PV of cash flows

-275,000.00

76,785.71

73,341.84

55,518.86

52,748.00

38,017.60

5,066.31

Pay back

-275,000.00

-198,214.29

-124,872.45

-69,353.59

-16,605.59

21,412.01

26,478.32

Pay back peroid

=4+(16,605/38,017)

4.44

years

METHODE 03 ACCOUNTING RATE OF RETURN

Project A

Y 0

Y 01

Y 02

Y 03

Y 04

Y 05

Cash flows

90,000.00

80,000.00

75,000.00

64,000.00

72,000.00

Net cash flow

90,000.00

80,000.00

75,000.00

64,000.00

72,000.00

depreciation Working 01

(50,000.00)

(50,000.00)

(50,000.00)

(50,000.00)

(50,000.00)

Profit

40,000.00

30,000.00

25,000.00

14,000.00

22,000.00

Average profit

=

Total profit

131,000.00

No of years

5

=

26,200.00

Accounting rate of return

=

average pofit

inatial investment

=

10.48%

working 01

Annual depreciiation

=

250,000/5

=

50,000.00

Project B

Y 01

Y 02

Y 03

Y 04

Y 05

Cash flows

86,000.00

92,000.00

78,000.00

83,000.00

67,000.00

Net cash flow

86,000.00

92,000.00

78,000.00

83,000.00

67,000.00

depreciation Working 02

(53,000.00)

(53,000.00)

(53,000.00)

(53,000.00)

(53,000.00)

Profit

33,000.00

39,000.00

25,000.00

30,000.00

14,000.00

Average profit

=

Total profit

141,000.00

No of years

5

=

28,200.00

average pofit

inatial investment

10.25%

working 02

Depreciation

=

(275,000-10000)/5

=

53,000.00

METHODE 04 NET PRESENT VALUE METHOD

Project A

Y 0

Y 01

Y 02

Y 03

Y 04

Y 05

Inatial investment

-250,000.00

Cash flows

90,000.00

80,000.00

75,000.00

64,000.00

72,000.00

Net cash flow

-250,000.00

90,000.00

80,000.00

75,000.00

64,000.00

72,000.00

DCF @ 12%

1.00

0.89

0.80

0.71

0.64

0.57

PV of cash flows

-250,000.00

80,357.14

63,775.51

53,383.52

40,673.16

40,854.73

Net present value

29,044.06

Project B

Y 0

Y 01

Y 02

Y 03

Y 04

Y 05

Y 06

Inatial investment

-275,000.00

Cash flows

86,000.00

92,000.00

78,000.00

83,000.00

67,000.00

Scrap value

10,000.00

Net cash flow

-275,000.00

86,000.00

92,000.00

78,000.00

83,000.00

67,000.00

10,000.00

DCF @ 12%

1.00

0.89

0.80

0.71

0.64

0.57

0.51

PV of cash flows

-275,000.00

76,785.71

73,341.84

55,518.86

52,748.00

38,017.60

5,066.31

Net present value

26,478.32

METHODE 05 INTERNAL RATE OF RETURN

Net present value @ 25%

Project A

Y 0

Y 01

Y 02

Y 03

Y 04

Y 05

Net cash flow

-250,000.00

90,000.00

80,000.00

75,000.00

64,000.00

72,000.00

DCF @ 25%

1

0.8

0.64

0.512

0.4096

0.32768

PV of cash flows

-250000

72000

51200

38400

26214.4

23592.96

Net present value

-38,592.64

IRR

=

11892.13237

17.58%

67,636.70

Net present value @ 25%

Project B

Y 0

Y 01

Y 02

Y 03

Y 04

Y 05

Y 06

Net cash flow

-275,000.00

86,000.00

92,000.00

78,000.00

83,000.00

67,000.00

10,000.00

DCF @ 25%

1

0.8

0.64

0.512

0.4096

0.32768

0.262144

PV of cash flows

-275,000.00

68,800.00

58,880.00

39,936.00

33,996.80

21,954.56

2,621.44

Net present value

-48,811.20

IRR

=

11,153.01

14.81%

75,289.52

Summary

Alternative ways of evaluating the project

Project A

Project B

METHODE 01 PAYBACK IN YEARS

3.08

3.23

METHODE 02 DISCOUNDED PAYBACK IN YEARS

4.29

4.44

METHODE 03 ACCOUNTING RATE OF RETURN

10.48%

10.25%

METHODE 04 NET PRESENT VALUE METHOD. (In millions)

29,044.06

26,478.32

METHODE 05 INTERNAL RATE OF RETURN

17.58%

14.81%

When considering the both projects using different investment appraisal techniques the following conclusion can be made.

Payback Period

This method is focusing how quick the company recovers the funds from the investment, it provides some information on the risk of the investment, and it is focusing on of liquidity.

When considering the payback method, project A have a short payback time compared to the project- B. so if the company use payback technique for the evaluation, then it should accept Project -A. (refer appendix 01 method 01)

However it didn’t indicate whether the investment increases the firm's value, or the potential benefits from the investment option. Further it ignores time value of money.

To incorporate the time value of money in payback method the company can use discounted payback method. If discounted payback method used the project -A have payback period of 4.29 years where as the project- B have a payback period of 4.44 years. Then the company accept Project –A since it has a lower payback time. (Refer appendix 01 method 02)

Accounting rate of return (ARR)

Next method is accounting rate of return (ARR), accounting rate of return for each projects under consideration, company can assess which of competing project would offer the best financial return on investment; this adds a modicum of predictability and control to the decision-making process. If this method used then the project-A have ARR of 10.48% where as the project- B have an ARR of 10.25%. Then the company should accept Project –A since it gives a higher ARR. (refer appendix 01 method 03)

However the accounting rate of return method uses income data rather than general cash flow information; this limits its accuracy for capital investments with high upkeep and maintenance costs, among others.

Net present value technique

NPV is essential for financial appraisal of long-term projects, it measures the excess or shortfall of cash flows, In the NPV model it is assumed to be reinvested at the discount rate used. In this project evaluation 12% is the discount rate (refer appendix 01 method 04) If this method used then the project-A have a NPV of £ 29,044 where as the project- B have NPV of £ 26,478. Then the company should accept Project –B since it gives a higher net present value. (Refer appendix 01 method 04)

However if the company have a higher risk premium then the NPV techniques will not be mush useful.

Internal rate of return (IRR)

The IRR calculates Break-even rate of investment that is it calculates an alternative cost of capital including an appropriate risk premium. The company can make a decision by comparing the company’s risk adjusted cost of capital with the project IRR.

If this method used then the project-A have an IRR of 17.58% where as the project- B have NPV of14.81%. Then the company should accept Project –B since it breakevens at a lower rate compared to the project A. however both are above the company’s cost of capital. (Refer appendix 01 method 05)

Task 03 Finish goods valuation and the master budget.

The master budget and the income statement.

Clockwork clown

windup train

Direct material

2

£10.00

£1.00

£5.00

direct llabour

2

16

8.5

12

variable overhead

7

10

fixed overhead

5

8

Cost of inventory

£38.00

£35.00

selling price

60

70

budgeted sales

450

500

opening inventory

20

50

closing inventory

30

40

raw material - opening inventory

50

- closing inventory

60

Total number of units to be produced

opening inventory

-20.00

-50.00

demand

450.00

500.00

closing inventory

30

40

Total in units

460.00

490.00

The required raw material

920.00

490.00

Total raw material

1410.00

opening

-50

closing

60

The material to be purchased

1420.00

Purchase Cost

7100.00

value of the closing finished goods

£1,140.00

£1,400.00

Income statement for the month December 200X

Clockwork clown

windup train

Sales

27,000.00

35,000.00

Total

Cost of production

62,000.00

opening balance

£760.00

£1,750.00

Purchases

2,510.00

direct llabour

£7,360.00

£5,880.00

7,100.00

variable overhead

£6,440.00

£4,900.00

13,240.00

fixed overhead

£4,600.00

£3,920.00

11,340.00

-Closing stock

-£1,140.00

-£1,400.00

8,520.00

Total cost of sales

-2,540.00

Gross profit

40,170.00

21,830.00

When considering the valuation of the finished goods it is valued at full cost that is it is valued with all the cost relating for the production of such inventories. This full cost valuation is used to prepare financial reporting purposes.

Both Clockwork clown and windup train inventories are valued at full cost, amounting to £1,140 £1,400 respectively (refer appendix 03)

When considering the master budget the company needs to buy 1,420 kg of the raw material X179. And the company’s forecasted profit is £ 21,830 million.

Task 04 – Ratio Analysis and purpose of financial statement.

Q1

Profitability ratios

GP margin

Gross profit/Revenue

34%

NP margin

Net profit/Revenue

26%

Liquidity ratio

Current asset ratio

Current asset/Current liability

1.622143

Efficiency ratio

Fixed asset revenue ratio

Fixed asset/Revenue

7.77803

Receivable revenue ratio

Receivable/Revenue

1.083004

Investment ratio

EPS

Profit attributable to equity holders/No of shares

34.0003

PE

Market price/EPS

20

I have analysed the Carson Cumber batch Plc. The companies GP margin is 34% and NP margin is 26%. Further company is revenue has been increased by 27% in 2010 when compare it with 2009. And the Net profit increased by 87% when compare it with 2009.

Balance sheet, profit and loss account and cash flow ensure the performance, position and the liquidity of the company. Purpose of these financial statements are as follows

Staffs: Staffs can assess the companies performances and they can ensure the careere of the staffs whether it will grow with the companies performances and this will lead to ensures the job security.

Share holders: share holders will ensure the performance of the company by looking at the financial statements and they can ensure the risk and the return of the company, further it will ensure the share holders to buy or sell decision.

Future investors: investors will be able to find out the investment related information such as EPS, PE to make decision.

Financing intuitions: This will ensure the financiers to identify the recoverability and the position of the company. And bank will be able to make decision on interest rate and the amount of the loan which can provide to the company.

Governments: This will ensures the government to decides whether resources are properly utilized and find out the tax exposure of the company.

Formats of financial statements will vary from organization to organization. For an example financing companies such as bank will not separate the current assets from fixed assets, because it is difficult to separate the deposits of the customers because bank doesn’t know that when customer will withdraw the deposits.

Further for manufacturing companies and trading companies they separate the fixed assets and current assets then only they will be able to find out the working capital requirement and they can find out the aging for receivables and stocks and they can provide the provisions based on that.

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