ASSIGNMENT

Financial Analysis

Question 1

(A)

The two possible course of action will include the following outcomes:

Building small facility: (60% of £700,000) and (40% of £ 520,000) = £ 628,000

Building large facility: (60% of £420,000) and (40% of £ 2100, 000) = £1092, 000

Based on the outcomes of probability of expected future cash flows it is therefore advisable for Allan to build large facility in order to satisfy current and future sales

(B)

Payback period

year

cash flow

Net cash flow

0

£ 1360,000

£ 1360,000

1

(£ 470000)

£ 890,000

2

(£ 580000)

£ 310,000

Since the cash flow proceeds in year 3 exceeds the required cash flow, therefore £ 310,000 /£ 580,000= 5 months

Therefore the payback period is 2 years and 5 months.

The accounting rate of return (ARR) Annual Depreciation = ( Initial Investment - Scrap Value ) / Useful Life in YearsAnnual Depreciation = (£ 1360,000)/ 4 = £340,000

0

1

2

3

4

Innitial investent

£ 1360,000

cashflows

£ 470000

£ 580000

£ 580000

£ 500000

Less depreciaition

(£ 340,000)

(£ 340,000)

(£ 340,000)

(£ 340,000)

Net cash flows

£ 130000

£ 240000

£ 240000

£ 160000

Average Accounting Income = (£ 130,000+ £240,000+£ 240,000+ £ 160,000) / 4

= £ 192,500

Accounting Rate of Return = 192,500 / 1360,000 = 14.15%

The net present value (NPV)

0

1

2

3

4

Innitial investent

£ 1360,000

cashflows

£ 470000

£ 580000

£ 580000

£ 500000

Discount factor (10%)

.909

.826

.751

.683

Net cash flows

£ 427,230

£ 479,080

£ 435,580

£ 341,500

NPV: (£ 427,230 + £ 479,080 + £ 435,580 + £ 341,500)- 1360000 = £ 323,390

As the discounted cash flows exceed the initial investment, it is therefore advisable to invest in this project.

(c) The main functions of budgets.

The main function of budget is to work as planning, forecasting and communicating tool. It also helps in evaluation, control and coordination, authorization and allocation of resources (JAY, P. (1972).pp 84-103).

Forecasting & Planning

A budget helps in planning as the decisions taken in the future usually depend on the forecast that have been prepared. Similarly forecasting can help in coordinating and predicating future constraints that will create problems in the achievement of organisational objectives.

Communication tool:

A budget can be used in forming a communication tool, which can be used to communicate resource constraints to the employees. It can be used in collecting information about resource constraints similarly it can be used in disseminating information to employees.

Authorization and allocation of resources

A budget can be used in authorization and allocation of resources to business units and divisions. This approach will help organisation in achieving a goal congruence approach.

(d)

Flexible budget

Actual cost

variance

Direct material

(8800 x 40) = £ 352,000

£ 364,000

£ 12,000 (A)

Direst labour

(8800 x 8) = £ 70,400

£ 78,000

£ 7600 (A)

Selling and distribution

(8800 x 12) = £ 105,600

£ 110,000

£ 4400 (A)

Bu carefully considering the revised flexible budget, it can be said that Andy's budget is based on obsolete assumptions. Similarly all the variances are adverse and the actual cost exceeds the flexible budget.

(e)

Material usage (11550× 3) - (5 x 2100 × 3)] = 3150 Adverse

Material price, (11550 ×2.8) - (11550 × 3)] = 2310 favourable

Labour efficiency (1000× 10) - (2100 x .5 × 10) = 500 favourable

Labour rate variances (1000 × 11) - (1000 × 10) = 1000 Adverse

(f)

Budget is controlled process of allocating financial and non financial resources quantatively, in order ...