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3.0 Introduction
Rock Field Plc is planning to undertake an investment proposal and directors have requested that
we should do the calculations of IRR of a project by calculating NPV we are also required to give
strengths and weakness of both techniques on financial and non financial grounds. on Executive
Directors of Rock Field PLc need some explanation about return on capital employed and payback period
When a business spent money on new non current assets it is known as Capital Investment.
The process of appraising the potential projects is known as investment appraisal
A capital budget :
The process of appraising the potential project is known as investment appraisal this appraisal
has the following features
* assessment of the level of expected returns earned for the level of expenditure made
* estimates of future costs and benefits over the projects life.
For the purpose of this section the following Appraisal techniques will be used as under
To appraise the overall impact of a project using DCF techniques involves discounting all the relevant
cash flows associated with the project back to their PV.
If we treat all the outflows of a project as negative and all inflows as positive the NPV of the project
is the sum of the PV of all flows as a result of doing the project.
Non executive Director of Rock Field has given the following expected cash flows for a proposed
capital investment.
Years Cash flows
$ 000
0 -89000
1 24000
2 49000
3 30000
4 20000
We will calculate the NPV of the project using 15% cost of capital as under:
IRR represent the discount rare at which the NPV of an investment is zero As such it represent
the break even cost of capital.
Projects should be accepted if their IRR is greater than the cost of capital.
IRR = L + NL * ( H -L )
NL-NH
Where :
so,
IRR =
3.3.2 Strengths of IRR
Decision rule:
• If the expected ROCE for the investment is greater than the target or hurdle rate then the project should be accepted.
3.4.1- Advantages of ROCE
simplicity
links with other accounting measures.
3.5-Payback period
The payback period is the time a project will take to pay back the money spent on it. It is based on expected cash flows and provides a mea
Decision rule:
Only select projects which pay back within the specified time period
Choose between options on the basis of the fastest payback
Provides a measure of liquidity.
Constant annual cash flows
initial investment
Payback period = –––––––––––––
annual cash flow
it is simple
it is useful in certain situations:-Rapidly changing technology and improving investment conditions.
it favors quick return:- helps company growth, minimizes risk and maximizes liquidity.
it uses cash flows, not accounting profit
ns.
SECTION 2:
2.0 Introduction :
In this section managers of Rock Field have requested explanation about different
types of budgeting systems and we are also required to explain advantages and
disadvantages of each
Managers of Rock Field need assistance with the current rolling budget in place
and they want suggestion about new budgeting system as they are not happy with
current budget system.
At the end of this section we are required to analyze financial data given to us for
the purpose of variances analysis with appropriate reasoning's.
2.1 BUDGET
The budget is a short term operating plan linked to the corporate plan and will
be used for detailed control.
A) Planning
A budgeting process forces a business to look to the future if a business does
not look to the future it will fail in short ,medium or long term.
B) Control
Actual results are compared against the budget and action is taken as appropriate
In many respects this is the most important aspect of budgeting.
C) Communication
The budget may form the basis of reporting hierarchy it is a formal communication
channel that allows junior and senior managers to converse.
D) Co-ordination
The business allows the business to co-ordinate all diverse actions towards
a common corporate goal
E) Evaluation
The budget may be used to evaluate the financial results of a part of business such
as cost centre It may further be used to evaluate the actions of a manager within
the business .
F) Motivation
The budget may be used as a target for managers to aim for Rewards should be
given for operating with in or under budgeted levels of expenditure
This section will look at different types of budgets and their explanation with
advantages and disadvantages as requested bt the managers of Rock Field
The aim is to keep tight control and always have an accurate budget for the next
12 months. its suitable if accurate forecast cannot be made.
2.3.8 Advantages
* Recourses should be allocated efficiently and economically
* Attention is focused on outputs in relation to value of money
* Wasteful expenditure is avoided
2.3.9 Disadvantages
* It may emphasize short term benefits to the detriment of long term
benefits
* Time and cost involved ate much higher
* It is difficult to compare and rank completely different types of Activities
Budgeting requires lots of information which can be from internal or external sources
information can be brained from the following sources
* previous years actual results
* estimates of costs of new products using work study techniques
* EOQ can be used to forecast optimal inventory level
* external sources ma include sullpiers price lists, estimate of inflation
and exchange rate movements etc
Managers of Rock Field are currently using rolling budget for which they are not happy
This type of budgeting system is suitable if future forecast cannot be made accurately
and thus management at the end of each period compares the result and add another
extra period with adding or removing a bit
This type of budget also require time and are generally considered more costly as they
increase work load.
The incremental budget starts with the previous budget or actual results and an incremental
amount is adjusted to cover inflation and other known changes which produce results
almost as actual.
This type of budgeting system is more convenient for managers of Rock Field to use as it is
quickest and easiest method.
Some financial data has been given to us about Rock Field lets a subsidiary company of Rock
Field plc variances analysis is given as under
Causes Of Variance
Fixed overhead expenditure variance can be caused by
* change in price relating to fixed overhead items
* seasonal effects
TABLE OF CONTENTS
Sr No Description
Section 1
1.0 Introduction
1.01 Back ground on Financial Management
1.1 REPORT TO THE MANAGING DIRECTOR OF ROCK FIELD PLC
1.2 Interpreting Financial Information
1.2.1 Users of Financial Statements
1.3 Ratio Analysis
1.3.1 Choice of Ratios
1.3.2 Users Need
1.3.3 DifferentDifferent
Types of Types
Ratios Of Ratios
1.3.4 Ratio analysis Of XYZ `s Financial Statements
1.4 Measuring Profitability Performance / Profitability Ratio Analysis
1.4.1 Ratio Analysis of Profitability
1.5 Measuring Working Capital Ratios
1.5.1 Working Capital Analysis using ratios
1.6 Long Term Financial Stability Ratios
1.6.1 Analysis of Long Term Financial Ratios
1.7 Investors Ratios
1.7.1 Analysis of Investor ratios
1.8 Share Holders Ratios
1.8.1 Dividend Based
1.8.2 Earning Based
1.9 Conclusion
Section 2
2.0 Introduction :
2.1 BUDGET
2.1.1 Purpose of Budgeting
2.2 Approaches To Budgeting
2.2.1 Top Down Budget
2.2.2 Bottom up Budget
2.2.3 Advantages of Participative budget
2.2.4 Disadvantages of Participative Budgets
2.3 Types of Budgets
2.3.1 Rolling budget
2.3.2 Advantages Of Rolling Budget
2.3.3 Disadvantages of Rolling Budget
2.3.4 Activity Based Budgeting
2.3.5 Advantages OF ABB
2.3.6 Disadvantages of ABB
2.3.7 Zero- Based Budgeting
2.3.8 Advantages
2.3.9 Disadvantages
2.4 Sources of Information For budgeting
2.5 New Budgeting System
2.6 Variances Analysis
2.6.1 Sales Variance
2.6.2 Material Variance
2.6.3 Labour Variance
2.6.4 Fixed Overhead Variance
Section 3
3.0 Introduction
3.1 Capital Investment
3.1.1 Capital Budgeting and Investment Appraisal
3.2 Investment Appraisal
3.2.1 Net present value
3.2.2 Calculation Of NPV
3.3 Internal Rate of Return
3.3.1 Calculating IRR Using Linear Interpolation
3.3.2 Strengths of IRR
3.3.3 Weakness of IRR
3.4 Return on Capital Employed
3.4.1 Advantages of ROCE
3.5 Payback period
3.5.1 Advantages of Payback period
3.5.2 Disadvantages of Payback period