ID 82001 ENTREPRENEURSHIP &

INTELLECTUAL PROPERTY

ASSIGNMENT 03

Name : H.P.W. Anupama

Reg No : SEU/IS/14/EG/062

Semester: 08
 Entrepreneurship & Intellectual Properties- ID 82001 (E/14)
Assignment

Answer All Questions

Question 1

Honda Chemicals plc is considering investing in a new chemical processing plant, but has the choice of
manufacturing one of two products on it. The firm requires a minimum return of 20% on any capital
expenditure. Details of the two proposals are summarised below:

Project A Initial capital cost Project B

Rs.200,000 Rs.250,000
Net cash inflows
Rs.50,000 Year 1 Rs.20,000
Rs.100,000 Year 2 Rs.150,000
Rs.200,000 Year 3 Rs.250,000
Rs.200,000 Year 4 Rs.100,000
Rs.100,000 Year 5 Rs.150,000

(a) Calculate the payback period average rate of return and the net present value for the two projects.

Use the following discount factors (20% discount rate):

Year 1 0.833
Year 2 0.694
Year 3 0.579
Year 4 0.482
Year 5 0.402

(b) On the basis of these measures only, which project would you recommend?

(c) What other factors, other than quantitative/financial factors, should you take into consideration when
deciding between projects?
Question 2

The manager of Perera Biochemical Ltd is considering relocation of the processing facilities. He has narrowed
down the choices to two options. Data relevant for this decision is as follows:

Location A

This location is in Colombo and, although a cheaper option, there would be higher operating costs due to the
higher wages that would need to be offered to recruit suitable workers. The capital cost of plant A is Rs.5
million.

Location B

This location is in Kandy would be very near transport links, which would save the firm money, but the site
is relatively expensive. The capital cost of plant B is Rs.10 million.

Forecast information for each of the plants was produced as follows:

Location A Location A Location B Location B

Revenue receipts Operating Revenue receipts Operating
payments payments
Rs. million Rs. million Rs. million Rs.million
Year 1 7.3 4.0 7.3 2.7
Year 2 7.5 5.2 7.5 3.3
Year 3 9.1 5.3 9.1 4.6
Year 4 9.8 6.5 9.8 5.5
Year 5 11.2 8.1 11.2 6.4

Additional information:

1. A modification to the plant at location B to treat the pollution would need an extra capital cost of Rs.2
million. In addition, operating payments would increase in each year by Rs.400,000.
2. The company's cost of capital is 10% per annum.
3. The following extract is from the present value table for Rs.1 at 10% per annum.

Year 1 0.909
Year 2 0.826
Year 3 0.751
Year 4 0.683
Year 5 0.621

Required: Produce net present value calculations for the locations A and B. For Location B provide figures
both for the plant in its basic form and also with the modifications to treat pollution.
Question 3

Walls Ltd is considering extending its operations into the production and sale of components used in the
making of lawnmowers. The components cost Rs.7 to manufacture and would be sold on to the lawnmower
manufacturer for Rs.12. A new machine will be needed costing Rs. 10,000 which is payable on 1 January in
Year 1.

The expected sales of these are as follows:

Units
Year 1 600
Year 2 650
Year 3 720
Year 4 800
Year 5 850

The cost of capital is 10%.

The following is an extract from the present value table for a cost of capital of 10%:

10%
Year 1 0.909
Year 2 0.826
Year 3 0.751
Year 4 0.683
Year 5 0.621

• It is assumed that revenues are received and costs are paid off at the end of each year.
• It is assumed that everything produced is sold

(a) Calculate the annual net cash flows for each year, which are expected to result from the purchase of the
machine.
(b) Using the expected annual net cash flows, calculate the net present value for the machine.
Question 4

Jhon runs a small antiques shop. He is a sole trader and views the shop as a 'hobby more than a job'. He is
curious about the financial performance of the shop and has provided extracts from two years' final
accounts. He would like you to analyse the accounts to assess the profitability of the firm. The sales and
balance sheet extracts are as follows:

2018 2019
Rs. Rs.
Sales 16,544 14,870
Cost of goods sold 9,536 8,390
Gross profit 7,008 6,480
Overheads 3,119 4,890
Net profit 3,889 1,590

Capital employed 59,490 57,980

Required

(a) Calculate for both years the following ratios:

(i) Return on capital employed

(ii) Gross profit percentage
(iii) Net profit percentage

(b) Using your results from (a), analyse the profitability of the shop.
Question 01
(a)
For Project A
Year Cash flow (Rs.) Present Value (Rs.) Cumulative Cash Flow
(Rs.)
0 (200,000) (200,000) (200,000)
1 50,000 50,000 * 0.833 = 41,650 (150,000)
2 100,000 100,000 * 0.694 = 69,400 (50,000)
3 200,000 200,000 * 0.579 = 115,800 150,000
4 200,000 200,000 * 0.482 = 96,400 350,000
5 100,000 100,000 * 0.402 = 40,200 450,000

Payback Period = 2 years + (50,000/200,000) = 2.25 years

Average Rate of Return = [(450,000/5) / 200,000] * 100 = 45%
Net Present Value = (-200,000) + (41,650+69,400+115,800+96,400+40,200) = Rs.163,450 /=
For Project B
Year Cash flow (Rs.) Present Value (Rs.) Cumulative Cash Flow
(Rs.)
0 (250,000) (250,000) (250,000)
1 20,000 20,000 * 0.833 = 16,660 (230,000)
2 150,000 150,000 * 0.694 = 104,100 (80,000)
3 250,000 250,000 * 0.579 = 144,750 170,000
4 100,000 100,000 * 0.482 = 48,200 270,000
5 150,000 150,000 * 0.402 = 60,300 420,000

Payback Period = 2 years + (80,000/250,000) = 2.32 years

Average Rate of Return = [(420,000/5) / 250,000] * 100 = 33.6%
Net Present Value = (-250,000) + (16,660+104,100+144,750+48,200+60,300) = Rs.124,010/=
(b)
Project A Project B Choice
1. Payback Period 2.25 years 2.32 years A
2. Average Rate of Return 45% 33.6% A
3. Net Present Value Rs.163,450/= Rs.124,010/= A

Suitable Project = Project A

(c) Project should satisfy the requirements of current and future legislation. And also, it
should match industry standards and good practice. Project should anticipate and should
deal with future threats.
Question 02
For Location A
Operating
Revenue receipts Cash flow Present Value
Year payments
(Rs. million) (Rs. million) (Rs. million)
(Rs. million)
0 - - (5.0) (5.0)
1 7.3 4.0 3.3 3.3 * 0.909 = 2.9997
2 7.5 5.2 2.3 2.3 * 0.826 = 1.8998
3 9.1 5.3 3.8 3.8 * 0.751 = 2.8538
4 9.8 6.5 3.3 3.3 * 0.683 = 2.2539
5 11.2 8.1 3.1 3.1 * 0.621 = 1.9251

Net Present Value = (-5.0) + (2.9997+1.8998+2.8538+2.2539+1.9251) = Rs. 6.9323 million

For Location B (Plant in its basic form)
Operating
Revenue receipts Cash flow Present Value
Year payments
(Rs. million) (Rs. million) (Rs. million)
(Rs. million)
0 - - (10.0) (10.0)
1 7.3 2.7 4.6 4.6 * 0.909 = 4.1814
2 7.5 3.3 4.2 4.2 * 0.826 = 3.4692
3 9.1 4.6 4.5 4.5 * 0.751 = 3.3795
4 9.8 5.5 4.3 4.3 * 0.683 = 2.9369
5 11.2 6.4 4.8 4.8 * 0.621 = 2.9808

Net Present Value = (-10.0) + (4.1814+3.4692+3.3795+2.9369+2.9808) = Rs. 6.9478 million

For Location B (With modifications to treat pollution)
Operating
Revenue receipts Cash flow Present Value
Year payments
(Rs. million) (Rs. million) (Rs. million)
(Rs. million)
0 - - (10.0+2.0) (12.0)
1 7.3 2.7 + 0.4 = 3.1 4.2 4.2 * 0.909 = 3.8178
2 7.5 3.3 + 0.4 = 3.7 3.8 3.8 * 0.826 = 3.1388
3 9.1 4.6 + 0.4 = 5.0 4.1 4.1 * 0.751 = 3.0791
4 9.8 5.5 + 0.4 = 5.9 3.9 3.9 * 0.683 = 2.6637
5 11.2 6.4 + 0.4 = 6.8 4.4 4.4 * 0.621 = 2.7324

Net Present Value = (-12.0) + (3.8178+3.1388+3.0791+2.6637+2.7324) = Rs. 3.4318 million

Question 03
For Year 01
Unit Sold = 600
Unit Sale Price = Rs. 12/=
Therefore, Revenue receipts = Rs.12/= * 600 = Rs.7,200/= -------- 01
Component Cost = Rs.7/=
Therefore, Operating payments = Rs.7/= * 600 = Rs.4,200/= ------ 02
Therefore, Annual Cash flow = Rs.3,000/= ------------- (02-01)
Similarly,
(a)
Revenue receipts Operating payments Cash flow
Year Unit Sold
(Rs.) (Rs.) (Rs.)
1 600 7,200 4,200 3,000
2 650 7,800 4,550 3,250
3 720 8,640 5,040 3,600
4 800 9,600 5,600 4,000
5 850 10,200 5,950 4,250

(b)
Operating
Revenue receipts Cash flow Present Value
Year payments
(Rs.) (Rs.) (Rs.x103)
(Rs.)
0 - - (10,000) (10.0)
1 7,200 4,200 3,000 3.0 * 0.909 = 2.727
2 7,800 4,550 3,250 3.25 * 0.826 = 2.6845
3 8,640 5,040 3,600 3.6 * 0.751 = 2.7036
4 9,600 5,600 4,000 4.0 * 0.683 = 2.732
5 10,200 5,950 4,250 4.25 * 0.621 = 2.63925

Net Present Value = (-10.0) + (2.727+2.6845+2.7036+2.732+2.63925) = Rs.3.48635 x 103

Therefore, Net Present Value = Rs.3,486.35
Question 04
For 2018
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
(i) Return on capital employed = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 × 100%

= (3,889/59,490) *100% = 6.54%

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
(ii) Gross profit percentage = 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 × 100%

= (7,008/16,544) *100% = 42.36%

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
(iii) Net profit percentage = 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 × 100%

= (3,889/16,544) *100% = 23.51%

For 2019
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
(i) Return on capital employed = 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑 × 100%

= (1,590/57,980) *100% = 2.74%

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
(ii) Gross profit percentage = 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 × 100%

= (6,480/14,870) *100% = 43.58%

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
(iii) Net profit percentage = 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 × 100%

= (1,590/14,870) *100% = 10.69%

(b) For 2018, the company net profit percentage is 23.51%. But in 2019 their net profit
percentage decreased to 10.69%. But, the gross profit percentage of 2019 (43.58%) is
quite increased than gross profit percentage of 2018 (42.36%). We can see the
overheads are increased in year 2019 (Rs.4890). Because of this increment we can see
the decrement in net profit in this company.