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FIN4001 Assessment Questions 2
The payback method is able to provide a manager with the knowledge on when the
company will be able to earn back its initial investment based on the cash inflows earned in
the future. This method is popular as it is easy to understand and calculate for the manager.
The amount of inputs required for the calculation of the payback period is low and it is easy
to calculate in comparison to the other capital budgeting tools that are available. Shorter
payback periods show that a project is low risk and managers prefer projects which are able
to earn back the investment in a short period of time. In terms of the disadvantages, it is seen
that the method ignores the concept of time value of money. This leads to a distortion of
value of cash flows that are earned (Bierman and Smidt, 2012). The payback method also
considers only cash flows that are earned till the payback condition is met. Any cash flows
earned after that time are ignored and are not taken into account. Another limitation is the
fact that this method is seen as being unrealistic. Business environments do not have the
scenarios that are considered by this method and investments are not just made one time.
Lastly, this method also does not take into account profitability.
understand the risk and return that the project will entail. In terms of the advantages of IRR, it
is seen that IRR takes time value of money into account which sees the value of a dollar as
being higher currently compared to a date in the future. IRR is also simple to interpret and
understand as the decision rule used in IRR is that if IRR is higher than the cost of capital, the
project is accepted otherwise it is rejected. The disadvantages of this method are that it
ignored economies of scale and assumes that the increase in size of the company will have no
impact on the cost structure of the company. In addition to that, it assumes that the
FIN4001 Assessment Questions 3
reinvestment rate will remain the same and will not change which is unrealistic. The method
becomes useless if there is a mix of positive and negative cash flows over the life of the
project. It can also be that if the cash inflows are not able to cover the initial cost, the IRR is
not calculated at all and increase in wealth of the company cannot be calculated by IRR
Question 3
Volume Price analysis. Contribution is seen as the difference between the selling price of a
product and the variable cost per unit associated with that product. It is helpful for a manager
as it allows the manager to determine breakeven quantities, values and levels that will be
required by the company based on its fixed costs. The goal of CVP technique is to aid the
manager in being able to determine the output levels that the company needs to produce
where it is able to cover all of its costs and with the use of contribution, a manager is able to
do that.
CVP technique allows a manager to be able to make a decision based on how the product
or service being provided can be carried out into the future. A manager uses CVP technique
to see how much contribution a product or service is adding to the profitability of a company.
Fixed costs are costs which are incurred and carried out regardless of the fact that the
company carries out production or not. Variable costs, however, are linked to the production
of a product or supply of a service (Guidry, Horrigan and Craycraft, 1998). Any product
which is yielding a negative contribution means that the variable costs of production are more
than the selling price. In case of a negative contribution, it will be better for a company to
discontinue the product as it is accumulating costs in the long run. If the contribution is
positive but the company is making a loss on the product due to fixed costs, it might still be
reasonable and feasible to continue production as the contribution is covering the variable
Due to this fact, it will be better to continue production. Sometimes, customers ask for
special orders where the price is discounted as the demand for the product increases. The
manager can again use CVP techniques to see whether he has additional capacity which can
be used for this purpose. If the additional capacity is present and the amount of contribution
added after the quantity of special order is taken into account, the manager should take the
special order.
CVP techniques are used by companies in order to make a decision regarding quantity of
production, cost and price levels as the company is impacted by fixed costs, variable costs
and selling price of the product. CVP techniques are used in managerial accounting as they
allow a manager to manage the day to day operations of the company. The CVP analysis does
have certain limitations in regards to its application as it takes into account a small time
period and the analysis is marginal in nature. The assumptions being made regarding stable
costs and revenue per unit means that only small deviations can be accounted for and when
large deviations do take place, the analysis becomes useless. This is due to the fact that costs
and prices change in the long run and all costs become variable costs in a large time frame.
In addition to that, it is difficult to identify costs as being rather fixed or variable and it is
difficult to categories costs which have both a fixed and variable component. Fixed costs are
also unlikely to stay constant over time as there is a tendency for all costs to change. Another
limitation of the analysis is that the analysis works for the range that was specified in the
beginning. If the variables go outside that range, the analysis becomes meaningless. The
analysis assumes that only production has an impact on the costs, however, factors like
inflation, efficiency, capacity and technology also have a significant impact on costs. It is
FIN4001 Assessment Questions 6
also assumed that the sales mix in terms of product range and prices remains same when the
market demand level will dictate how the products are sold and marketed.
FIN4001 Assessment Questions 7
Question 4
The opening statement of the financial position of the company will look like this at the
Fashion Clothing
Statement of Financial Position
As at 1st July 20X5
£ £ £
Non-current assets
Tangible non-current assets 150,000
Current Assets
Bank 50,000
Total Assets 200,000
Financed by:
Capital 200,000
Total Capital plus liabilities 200,000
In order to make the forecasted cash budget, the first task is to take the cash inflows
and outflows into account. The cash inflows for the company for the respective months were
from sales receipts which will be accounted for first. The next step is to take the cash
outflows which include the payment for materials as provided. The labor expenses are
divided over the 6 months to find the monthly cash outflows (Lerner, 1968). In terms of the
other expenses, the depreciation expense which has been given is a non cash expense. It is
taken into consideration when profit is calculated and it is deducted from cash outflows as it
will not be paid out of cash. The remaining figure of £330,000 is divided over the 6 months.
Lastly, the tax bill will be paid in December 20X5 which has been taken into account as well.
FIN4001 Assessment Questions 8
The net cash change is calculated and then the cash balance at the start of year is taken which
was £50,000. The closing balance for each month is calculated and the cash budget forecast is
prepared. The amount of cash at the bank is seeing to be negative throughout the 6 months
which shows the amount of overdraft facility that will be availed by the company from the
bank.
Cash Inflows
Sales receipt
150,00 120,000 150,000 210,000 260,000 285,000
0
Total Inflows
150,00 120,000 150,000 210,000 260,000 285,000
0
Cash outflows
Payment for materials
120,00 100,000 60,000 60,000 60,000 60,000
0
Labour expenses
80,000 80,000 80,000 80,000 80,000 80,000
Other expenses
55,000 55,000 55,000 55,000 55,000 55,000
Tax bill
20,000
Total Outflows
255,00 235,000 195,000 195,000 195,000 215,000
0
One of the expenses that has not been taken into account is the interest expense that
will be charged by the bank on the overdraft facility. It can be seen that the company will be
availing overdraft facility from July till December 20X5, however, no expense for interest
has been taken into account. A more accurate budget forecast would take this expense into
account as it will be charged by the bank and will have to be paid by the company.
FIN4001 Assessment Questions 10
References
Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of
Guidry, F., Horrigan, J.O. and Craycraft, C., 1998. CVP analysis: a new look. Journal of
86.
Martin, L.M., Warren‐Smith, I., Scott, J.M. and Roper, S., 2008. Boards of directors and