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:-24TH MAY,2011


:-12th JUNE,2011

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I owe a great many thanks to a great many people who helped and Supported me to prepare this assignment. My deepest thanks to Lecturer, [Mr.O.JACOB] the Guide of the project for guiding and correcting various documents of mine with attention and care. He has taken pain to go through the project and make necessary correction as and when needed.

I express my thanks to the Principal of, [REGENT INTERNATIONAL GRADUATE SCHOOL, CROYDON], for extending his support. My deep sense of gratitude to [MR.K.JOHN] (DIRECTOR OF STUDIES] support and guidance. I would also thank my Institution and my friends without whom this project would have been a distant reality. I also extend my heartfelt thanks to my family and well wishers.

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Topic name

Page no
5-8 9-12 13-19 20-22

1 1(a) Sources of Finance 2 1(b) Various Risks involved in Project 3 1(c)Types of costs 4 2(a) Pay Back Period

5 2(b) ARR


6 2(c) NPV 7 3(a) Various financial ratios

31-35 36-39

8 3(b)Financial Position Report to Director


9 3(c)Limitation of interpretation techniques


10 References


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My assignment is based on the management of financial resources and performance{MFRP}Investigation and Understanding regarding management and finance in business , the main aim of this assignment is to understand the use of various project appraisal techniques which would help in managing various financial resources. This assignment has helped me a lot to understand the various risks to be dealt while undertaking new projects.

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Q1(a) Sources of Finance for the Fleur International Public Liability Company (PLC).Public liability company is a big type business. It is a limited company, a lot of people are involve in it to manage this business. Public means that anyone can buy shares in the company if they can find someone who wants to sell them. Fleur PLC has main two type of sources of finance

Internal Sources of Finance for Fleur PLC These are sources of finance that come from the business's assets or activities. Internal finance is a quick and easy way to solve short term financial problems for most companies. Retained earnings For any company, the amount of earnings retained within the business has a direct impact on the amount of dividends. Profit re-invested as retained earnings is profit that could have been paid as a dividend. The major reasons for using retained earnings to finance new investments, rather than to pay higher dividends and then raise new equity for the new investments, are as follows: a) The management of many companies believes that retained earnings are funds which do not cost anything, although this is not true. However, it is true that the use of retained earnings as a source of funds does not lead to a payment of cash. b) The dividend policy of the company is in practice determined by the directors. From their standpoint, retained earnings are an attractive source of finance because investment projects can be undertaken without involving either the shareholders or any outsiders. c) The use of retained earnings as opposed to new shares or debentures avoids issue costs. d) The use of retained earnings avoids the possibility of a change in control resulting from an issue of new shares.

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External resources of finance External resources of finance come from outside of the business.lf P L C finance has resources below A company might raise new funds from the following sources: The capital markets: i) new share issues, for example, by companies acquiring a stock market listing for the first time ii) rights issues Loan stock Bank borrowing Government sources Ordinary (equity) shares Ordinary shares are issued to the owners of a company. They have a nominal or 'face' value. The market value of a quoted company's shares bears no relationship to their nominal value, except that when ordinary shares are issued for cash, the issue price must be equal to or be more than the nominal value of the shares. Deferred ordinary shares They are a form of ordinary shares, which are entitled to a dividend only after a certain date or if profits rise above a certain amount. Voting rights might also differ from those attached to other ordinary shares. Ordinary shareholders put funds into their company: a) by paying for a new issue of shares b) through retained profits. Simply retaining profits, instead of paying them out in the form of dividends, offers an important, simple low-cost source of finance, although this method may not provide enough funds, for example, if the firm is seeking to grow. Page 6

Preference shares Preference shares have a fixed percentage dividend before any dividend is paid to the ordinary shareholders. As with ordinary shares a preference dividend can only be paid if sufficient distributable profits are available, although with 'cumulative' preference shares the right to an unpaid dividend is carried forward to later years. The arrears of dividend on cumulative preference shares must be paid before any dividend is paid to the ordinary shareholders. From the company's point of view, preference shares are advantageous in that: Dividends do not have to be paid in a year in which profits are poor, while this is not the case with interest payments on long term debt (loans or debentures). Since they do not carry voting rights, preference shares avoid diluting the control of existing shareholders while an issue of equity shares would not. Unless they are redeemable, issuing preference shares will lower the company's gearing. Redeemable preference shares are normally treated as debt when gearing is calculated. The issue of preference shares does not restrict the company's borrowing power, at least in the sense that preference share capital is not secured against assets in the business. The non-payment of dividend does not give the preference shareholders the right to appoint a receiver, a right which is normally given to debenture holders. However, dividend payments on preference shares are not tax deductible in the way that interest payments on debt are. Furthermore, for preference shares to be attractive to investors, the level of payment needs to be higher than for interest on debt to compensate for the additional risks Loan stock Loan stock is long-term debt capital raised by a company for which interest is paid, usually half yearly and at a fixed rate. Holders of loan stock are therefore long-term creditors of the company. Loan stock has a nominal value, which is the debt owed by the company, and interest is paid at a stated "coupon yield" on this amount. Page 7

Debentures are a form of loan stock, legally defined as the written acknowledgement of a debt incurred by a company, normally containing provisions about the payment of interest and the eventual repayment of capital. Government grants : Fleur PLC company can get grants from government. It is generally use by PLC company. Government grants can helps to set up the business. Subsidy: Subsidy is that aid which is given by government to encourage the business man .it is extra money is given to employees and workers. They get encouragement and they do work with more attentively.

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Different Kind Of Risk in this project .

INTRODUCTION Risk management is the identification, assessment, and prioritization of risks (defined in ISO 31000 as the effect of uncertainty on objectives, whether positive or negative) followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities. Risks can come from uncertainty in financial markets, project failures (at any phase in development, production, or sustainment life-cycles), legal liabilities, credit risk, accidents, natural causes and disasters as well as deliberate attack from an adversary or events of uncertain root-cause. Several risk management standards have been developed including the Project Management Institute, the National Institute of Science and Technology, actuarial societies, and ISO standards. Methods, definitions and goals vary widely according to whether the risk management method is in the context of project management, security, engineering, industrial processes, financial portfolios, actuarial assessments, or public health and safety. In project management, risk management includes the following activities: Planning how risk will be managed in the particular project. Plans should include risk

management tasks, responsibilities, activities and budget. Assigning a risk officer - a team member other than a project manager who is

responsible for foreseeing potential project problems. Typical characteristic of risk officer is a healthy skepticism. Maintaining live project risk database. Each risk should have the following attributes:

opening date, title, short description, probability and importance. Optionally a risk may have an assigned person responsible for its resolution and a date by which the risk must be resolved.

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Creating anonymous risk reporting channel. Each team member should have

possibility to report risk that he/she foresees in the project. Preparing mitigation plans for risks that are chosen to be mitigated. The purpose of

the mitigation plan is to describe how this particular risk will be handled what, when, by who and how will it be done to avoid it or minimize consequences if it becomes a liability. Summarizing planned and faced risks, effectiveness of mitigation activities, and effort

spent for the risk management Meaning of Risk Risk is quite simply the combination of the probability of an event its consequences. As much risk can be positive an event that is a opportunity or negative where the event represent threat Types of Business Risks Business risks are of a diverse nature and arise due to innumerable factors. These risks may be broadly classified into two types, depending upon their place of origin. Internal Risks are those risks which arise from the events taking place within the

business enterprise. Such risks arise during the ordinary course of a business. These risks can be forecasted and the probability of their occurrence can be determined. Hence, they can be controlled by the entrepreneur to an appreciable extent. The various internal factors giving rise to such risks are: Human factors are an important cause of internal risks. They may result from strikes

and lock-outs by trade unions; negligence and dishonesty of an employee; accidents or deaths in the industry; incompetence of the manager or other important people in the organisation, etc. Also, failure of suppliers to supply the materials or goods on time or default in payment by debtors may adversely affect the business enterprise. Technological factors are the unforeseen changes in the techniques of production or

distribution. They may result in technological obsolescence and other business risks. For example, if there is some technological advancement which results in products of higher quality, then a firm which is using the traditional technique of production might face the risk of losing the market for its inferior quality product. Page 10

Physical factors are the factors which result in loss or damage to the property of the

firm. They include the failure of machinery and equipment used in business; fire or theft in the industry; damages in transit of goods, etc. It also includes losses to the firm arising from the compensation paid by the firm to the third parties on account of intentional or unintentional damages caused to them.

External risks are those risks which arise due to the events occurring outside the

business organisation. Such events are generally beyond the control of an entrepreneur. Hence, the resulting risks cannot be forecasted and the probability of their occurrence cannot be determined with accuracy.

The various external factors which may give rise to such risks are : Economic factors are the most important causes of external risks. They result from the changes in the prevailing market conditions. They may be in the form of changes in demand for the product, price fluctuations, changes in tastes and preferences of the consumers and changes in income, output or trade cycles. The conditions like increased competition for the product, inflationary tendency in the economy, rising unemployment as well as the fluctuations in world economy may also adversely affect the business enterprise. Such risks which are caused by changes in the economy are known as 'dynamic risks'. These risks are generally less predictable because they do not appear at regular intervals. Also, such risks may not necessarily result in losses to the firm because they may also contain an element of gain for the firm. For instance, due to market fluctuations,a well known product of a firm may either lose its demand or may occupy a larger market share. Natural factors are the unforeseen natural calamities over which an entrepreneur has very little or no control. They result from events like earthquake, flood, famine, cyclone, lightening, tornado, etc. Such events may cause loss of life and property to the firm or they may spoil its goods. For example, Gujarat earthquake caused irreparable damage not only to the business enterprises but also adversely affected the whole economy of the State.

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Political factors have an important influence on the functioning of a business, both in the long and short term. They result from political changes in a country like fall or change in the Government, communal violence or riots in the country, civil war as well as hostilities with the neighbouring countries. Besides, changes in Government policies and regulations may also affect the profitability and position of a enterprise. For instance, changes in industrial policy and Trade policy annual announcement of the budget amendments to various legislations, etc. may enhance or reduce the profits of a business enterprise.

Liquidity Risk The uncertainty introduced by the secondary market for a company to meet its future short term financial obligations. When an investor purchases a security, they expect that at some future period they will be able to sell this security at a profit and redeem this value as cash for Consumption - this is the liquidity of an investment, its ability to be redeemable for cash at a future date. Generally, as we move up the asset allocation table the liquidity risk of an investment increases.

Thus, business risk takes a variety of forms. In order to face such risks successfully, every businessman should understand the nature and causes of these risks as well as the various measures which must be taken in order to minimise them.

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Definition Of Cost : DEFINITION:- One General definition of cost is :Cost is a foregoing or sacrifice ,measured in monetary terms, incurred or potentially to be incurred ,to achieve a specific purpose.Cost is a physical quantity measurement multiplied by a price measurement . e.g. 100 units @ 5 = cost of 500 100*5 = 500 Classification of COST:1 Variable Cost 2 Fixed Cost 3 Semi Variable Cost 4 Direct Cost 5 Indirect Cost 6 Product Cost 7 Period cost Activity and output Meaning of activity:- Generally and physical operation that takes place in an organisation . Meaning of output:- The product or service provided by the organisation. Need for the cost classification : 1 Planning 2 Decision making 3 Controls

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Variable Costs:-(VC) When total cost changes in direct proportion to changes in volume, it is called variable cost. Variable costs vary in proportionate and paralled manner with volume. Mathematically, a linear relationship exists between variable costs and volume, If volume increases by 10%, variable cost will also increase by 10%. Variable costs are activity costs since they accrue when some activity is performed. Basic Characteristics of variable costs: 1. Variable cost per unit remain constant .It is the total variable cost which varies proportionately with volume. 2. It is relatively easy to identify variable cost with volume.they hardly pose problem of allocation. 3. Generally variable costs are identifiable with responsibility centres at operating levels of management. They are, therefore, controllable at departmental level. Example of variable cost are :1 Materials used to manufacture a unit of output or to provide a type of service. 2 fuel used by plc company 3 commission paid to a sale person 4. Labour costs of manufacturing or unit of output or providing a type of service.

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This chart shows the Variable Cost

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Output number of 10 units



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Total Cost ()




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If you want to produce 10 out put number of unit of any product the total cost for it is 100 and if you produced 20 units, the variable cost increases at 200and if you produces 30 units, the variable cost rises at 300 ,Total cost increased by 10 for every unit produces. There is an increase in unit as activity increases

This diagram shows us Variable Cost there is an rise in unit as activity rise .You can see in this diagram the activity in units level is 10units and total cost of production is 100 and then with increase in unit the cost of production also increase and reaches at 200 and if you produce 50 units its cost is equal to 500.

Fixed cost :- When total cost remain non variable(fixed) to changes in volume,it is called fixed cost.Examples of fixed cost are:Depreciation,insurance,salaries,maintainence and repairs.

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Output(number of 10 vases) Total cost () 300

20 300

30 300

1 Fixed cost remain @300 2 Unit cost decreased as output increases, because the fix cost is spread over more vases 30 per unit, 15 per unit and 10 per unit

This diagram shows us Fixed cost .Fixed cost remain fixed it does not vary with extra production. If we produced 10 unit it is cost 300and if we produced 20units ,30units, 40units and 50units it remain fixed at 300 it does not vary at any

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Total cost :-The total cost is the sum of the fixed cost and variable cost. TC=FC+VC FC=TC-VC VC=TC-FC Table of data as showing variable cost, fixed cost and total cost .

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Activity level Variable cost Fixed cost

of 0 units 0 20

100 units 10 20

200 units 20 20

300 units 30 20

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Total cost





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Above diagram shows Total Cost In the beginning of any business we put fixed cost on land, building, machines and on computers it remains fixed and after that Variable costs are spend in business. The Total cost is the sum of fixed cost and Variable cost .

Semi variable costs:Example of semi variable costs are:1 Office salaries where there is a centre of long term clerical staff plus employment of temporary staff when activity level rise 2 Maintenance changes where there is a fixed basic change per year plus a variable element depending on the number of call out per year

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STEP COST This is a fixed cost that increases in steps. It may be noted that fixed costs are constant over a range of volume. If the volume increases beyond a given range, fixed cost would increase. Some fixed cost like supervision cost has a tendency of increasing in stepwise way. Such fixed costs are called step fixed costs.

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DIRECT COST: Direct costs are those cost items which can be traced logically and conveniently, in their entirely, to a cost object. The wages paid to the workers who are engaged in making is direct cost. INDIRECT COST: Indirect costs are those cost items which cannot be traced or identified directly with cost object. These are also known as overhead costs PRODUCT COSTS: Those cost items which attach or cling to units of finished goods are called Product costs. Traditionally in cost accounting cost of manufacturing a product are called product costs. Thus product cost will consist of direct materials, direct labour and reasonable share of factory overheads PERIOD COSTS: Period Costs do not attach to products: they are incurred for time period and are charged to profit and loss of that period. Non-Manufacturing cost, selling and general and administrative costs are generally treated as period cost. Q2 (a) Pay Back Period Chart (pbp)

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Project (A) Outlay Net Cash flows Year 1 Year 2 Year 3 Year 4 Pay Back Period 180000 60000 60000 60000 60000 3Years

Project (B) 180000 70000 70000 70000 70000 2.5years

Project (C) 180000 48000 48000 48000 48000 3.6years

Project (D) 180000 40000 60000 65000 80000 3.2years

Project (E) 180000 55000 55000 55000 55000 3.2years

Project(A) Year1+year2+year3 60000+60000+60000 =180000 3years Project (B) Year1+year2 70000+70000= 140000 180000-140000=40000 40000/12=3333.33 3333.33*12/70000 =0.6months 6months/12=0.5;therefore pbp =2+0.5 =2.5years Project( C) Year1+year2+year3 48000+48000+48000=144000 180000-144000=36000 36000/12=3000 3000*12/48000 =0.75 7months/`12=0.58;therefore pbp =3+0.58=3.6years Project (D) Year1+year2+year3 40000+60000+65000= 165000 180000-165000=15000 15000/12=1250 1250*12/80000=0.1875=0.2months 2months/12=0.16=3+0.16 pbp=3.2years

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Project (E) Year1+year2+year3 55000+55000+55000=165000 180000-165000=15000 15000/12= 1250 1250*12/70000=0.214=0.2 months 2months/12=0.16 3+0.16= pbp=3.2years There are three Appraisal techniques or methods of capital Budgeting :1 Pay Back Period 2 Accounting Rate of return (ARR) 3 Net Present Value 1Pay Back Period : The payback period is both conceptually simple and easy to calculate. It is also a seriously flawed method of evaluating investments. The payback period is the time taken to recover the initial investment. So a 1m investment that will make a profit of 200,000 a year has a payback period of five years. Investments with a shorter payback period are preferred to those with a long period. Most companies using payback period as a criterion will have a maximum acceptable period. Advantages of payback period:1. It is easy to calculate. 2. It is easy to understand. 3. It places emphasis on projects which give early return of cash flows . 4. It is a cautious approach Limitation of payback period 1. It ignores the time value of money 2. Cash flows earned should repay the capital sum invested plus interest 3 It ignores any cash flows origin after pay back date.

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Q2 (b) There are three Methods of depreciation 1 Straight line method 2 Weighted Averages 3 Percentage written off We are calculating Depreciation with straight line method Depreciation on straight line method = 180000/4 =45000 Depreciation over four years Straight line 45000 per year Original cost Depreciation year 1 Value at the end of year 1 Depreciation year 2 Value at the end of year 2 Depreciation year 3 Value at the end of year 3 Depreciation year 4 Value at the end of year 4 Scrap value 180000 -45000 135000 -45000 90000 -45000 45000 -45000 00000

Depreciation should be calculated @ 10% interest rate 10/100*180000=18000 Value Depreciation @10% year 1 162000*10/100=16200 Depreciation @10% year2 162000 -16200 Page 28 180000 -18000 162000

145800 1458000*10/100=14580 Depreciation @10% year3 131220*10/100=13122 Depreciation @10% year4 Scrap value 145800 -14580 131220 131220 -13122 118098

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CALCULATION OF ACCOUNTING RATE OF RETURN (ARR) CASHFLOWS OUTLAY (a) YEAR1 YEAR2 YEAR3 YEAR4 Average Annual Profit(b) ARR= b*100/a (expressed as percentage) 15000(wk9) 15000*100/180000 =75/9 = 8.333% (wk14) 180000/4YEARS=4 5000 25000(wk10) 25000*100/180000 =125/9 =13.888% (wk15) 3000(wk11) 3000*100/180000 =30/18 =1.666% (wk16) 16250(wk12) 16250*100/180000 =1625/180 = 9.02% (wk17) 10000(wk13) 10000*100/18000 =50/9 =5.555% (wk18) PROJECT A 180000 6000045000=15000(wk1) 6000045000=15000(wk1) 6000045000=15000(wk1) 6000045000=15000(wk1) PROJECT B 180000 7000045000=25000(wk2) 7000045000=25000(wk2) 7000045000=25000(wk2) 7000045000=25000(wk2) PROJECT C 180000 4800045000=3000(wk3) 4800045000=3000(wk3) 4800045000=3000(wk3) 4800045000=3000(wk3) PROJECT D 180000 40000-45000= -5000(wk4) 6000045000=15000(wk5) 6500045000=20000(wk6) 8000045000=35000(wk7) PROJECT E 180000 5500045000=10000(wk8) 55000-45000=10000 (wk8) 55000-45000=10000 (wk8) 55000-45000=10000 (wk8)

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Workings Project (A) 60000-45000=15000(wk1)

Project (B) 70000-45000=25000(wk2)

Project (C) 48000-45000=3000(wk3)

Project (D) 40000-45000= -5000(wk4) 60000-45000=15000(wk5) 65000-45000=20000(wk6) 80000-45000=35000(wk7)

Project (E) 55000-45000=10000(wk8)

(wk9)Average Annual Profit(b)=15000+15000+15000+15000 / 4 =60000/4 =15000 (wk10)Average Annual Profit(b)=25000+25000+25000+25000/4 =100000/4 = 25000 (wk11)Average Annual Profit(b)=3000+3000+3000+3000/4 =12000/4 Page 31

=3000 (wk12)Average Annual Profit(b)= -5000+15000+20000+35000/4 =65000/4 =16250 (wk13)Average Annual Profit(b)= 10000+10000+10000+10000/4 =40000/4 =10000 (wk14) ARR=b*100/a

Project(A) =15000*100/180000 =75/9 =8.333%

(wk 15) ARR=b*100/a Project(B) =25000*100/180000 =125/9 =13.888%

(wk16) ARR=b*100/a Project(C) =3000*100/180000 =30/18 =1.666%

(wk17) ARR=b*100/a Page 32

Project(D) =16250*100/180000 =16250/1800 =9.02%

(wk18) ARR=b*100/a Project(A) =1000*100/180000 =100/18 =5.555% Accounting Rate of return (ARR) Accounting rate of return, also known as the Average rate of return, or ARR is a financial ratio used in capital budgeting. The ratio does not take into account the concept of time value of money. ARR calculates the return, generated from net income of the proposed capital investment. The ARR is a percentage return ARR is most often used internally when selecting projects. It can also be used to measure the performance of projects and subsidiaries within an organisation. There are better alternatives which are not significantly more difficult to calculate. The accounting rate of return is conceptually similar to payback period, and its flaws, in particular, are similar From the ARR calculation the decision would be as follows 1 Project B is most desirable project because this project gets highest value

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of ARR that is equal to 13.888% 2 Project D is next in rank because this project gets second highest value of ARR that is equal to 9.02 % 3 Project ( A) gets third position and project( E) gets fourth position 4 Project( C) is the least desirable because this project gets least value of ARR Advantages of Accounting Rate of Return : 1 It is relatively easy to calculate 2 All cash flows are used. 3 It is easy to understand the result . 4It takes into the calculation all the profits. 5 It is based on the familiar accounting measured of profit. Limitations of Accounting Rate of Return 1 It depends on profit , including the subjective accounting estimate of depreciation. 2 It ignore the time value of money .

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Q2 ( C) Here we are using third method of capital budgeting Net Present Value Formula for Net Present Value 1 NPV= _____ - PV (1+r) n Project (A) 60000 60000 60000 60000 NPV= ___ + _____ + _____ + _____ _ 180000

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(1+0.1) 1


(1+0.1)3 (1+0.1)4

60000 _____ + (1.1) 1

60000 60000 60000 _____ + _____+ _____ (1.1)2 (1.1)3 (1.1)4 60000 60000 60000 _____ + _____ + _____ 1.21 1.331 1.4641

_ 180000

60000 = _____ + 1.1


= 54545.4545+49586.776+45078.888+40980.807 180000 = 190191.9255-180000 = 10191.925 Project (B) 70000 NPV= ____ (1+0.1)1 70000 _____ (1+1.01) 2 70000 _____ 70000 _____ _ 180000

(1+0.1)3 (1+0.1)4

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70000 _____ + (1.1)1

70000 70000 70000 _____ + _____ + _____ (1.1)2 (1.1)3 (1.1)4


70000 _____ + 1.1

70000 70000 70000 _____ + _____ + _____ 1.21 1.331 1.4641


= 63636.363+57851.239+52592.036+47810.941 180000 = 221890.34-180000 = 41890.34

Project (C) 48000 48000 48000 48000

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NPV= ____ + _____ + _____ + _____ (1+0.1)1 (1+1.01)2 (1+0.1)3 (1+0.1)4 48000 48000 48000 48000 _____ + _____ + _____ +_____ (1.1)1 (1.1)2 (1.1)3 (1.1)4 48000 _____ 1.1 + 48000 48000 48000 _____ + _____ + _____ 1.21 1.331 1.4641

_ 180000



= 43636.363+39669.421+36063.110+32784.45 180000 = 152153.539-180000 = -27846.461

Project (D)

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40000 60000 65000 80000 NPV= ____ + _____ + _____ + _____ (1+0.1)1 (1+1.01)2

_ 180000

(1+0.1)3 (1+0.1)4

40000 60000 65000 80000 _____ + _____ + _____ + _____ (1.1)1 (1.1)2 (1.1)3 (1.1)4 40000 _____ + 1.1 60000 _____ + 1.21 65000 _____ + 1.331 80000 _____ 1.4641

_ 180000


= 36363.636+49586.776+48835.46254641.076 180000 = 189426.95-180000 = 9426.95

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Project (E) 55000 NPV= ____ + (1+0.1)1 55000 _____+ (1.1)1 55000 55000 _____ + _____ + 55000 _____

_ 180000

(1+1.01)2 (1+0.1)3 (1+0.1)4 55000 55000 55000 _____ + _____ + _____ (1.1)2 (1.1)3 (1.1)4


55000 _____ 1.1

55000 _____ 1.21

55000 _____ 1.331

55000 _____ 1.4641


= 5000+45454.545+41322.314+37565.740 180000 = 17432.599 -180000

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= - 5657.401


The difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project. NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield. Formula:

In addition to the formula, net present value can often be calculated using tables, and spreadsheets such as Microsoft Excel. NPV in decision making

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Another issue with relying on NPV is that it does not provide an overall picture of the gain or loss of executing a certain project. To see a percentage gain relative to the investments for the project Results/Decisions (1) Based on the above decision rule project will be accepted as it gives a positive net present value. (2) Project (B) is the most desirable project because it gets positive value of NPV is equal to 41890.34 (3) project (B) is next rank because it gets second position is equal to positive value of NPV is equal to10191.29 (4) Project ( C) and (E) would be rejected as gives a negative net present value. Page 42

Q3 (a) Interpretation of Ratios analysis and Limitation (wk1)Revenue=Last year sales Present year sales = 240 200 = 40 Therefore= 40 100 200 = 20% (wk 2)Return on capital employed (ROCE) ROCE=Profit Before Interest and taxation 100 Total Assets Current Liabilities 2001 = 18 + 2 100 134 - 34 = 20 100 100 = 20% 2002 = 28 + 2 100 154 - 44 = 30 100 100 = 27.3% (wk 3)Profit Margin Margin = Profit Before Interest and taxation 100 Sales 2001 = 20 100 200 = 10%

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2002 = 30 100 240 = 12.5% (wk 4)Asset Utilisation Asset turn over = Sales Total Assets Current Liabilities 2001 = 200 100 = 2 times 2002 = 240 110 = 2.2 times (wk 5)Gross Profit Margin GPM = Gross Profit 100 Sales 2001 = 60 100 200 = 30% 2002 = 80 100 240 = 33.3%

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(wk 6)Net Profit Margin NPM = Profit before taxation 100 Sales 2001 = 18 100 200 = 9% 2002 = 28 100 240 = 11.7% (wk 7)Current Ratio = Current Assets Current Liabilities 2001 = 94 = 2.8 times 34 2002 = 112 = 2.5 times 44 (wk 8)Quick/Acid test ratio = Current Assets Inventory/stock Current Liabilities 2001 = 94 60 = 1 34

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2002 = 112 70 = 0.95 44 (wk 9) Working Capital Ratio No. of days closed inventory is held = closed inventory 365 cost of sales 2001 = 60 365 140 = 156 days 2002 = 70 365 160 = 160 days (wk 10) No. of days credit given to customer = Trade receivable 365 Credit sales 2001 = 30 365 200 = 55 days 2002 = 40 365 240 = 61 days

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(wk 11) No. of days credit taken from suppliers = Trade payable 365 Cost of sales 2001 = 28 365 140 = 73 days 2002 = 32 365 160 = 73 days (wk 12) Gearing = Debtors 100 Equity 2001 = 20 100 400 = 5% 2002 = 20 100 500 = 4% (wk 13) interest cover = Profit before taxation Interest payable 2001 = 20 = 10 times 2

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2002 = 30 = 15 times 2 (wk 14) Rate of Earning = Profit after taxation 100 Equity 2001 = 12 100 80 = 15% 2002 = 16 100 90 = 18% (wk 15) Earning per share = Profit after tax No. ordinary shares 2001 = 12 = 20 pence/share 60 2002 = 16 = 26.7 pence/share 60 (wk 16) Price earning ratio = Market price Earning per share 2001 = 400 = 20 times 20p 2002 = 500 = 18.7 times 26.7p (wk 17) Dividend cover = Profit after taxation Dividend for period 2001 = 12 = 2 times 6 2002 = 16 = 2.7 times 6 (wk 18) Dividend Yield = Dividend per share 100 Share Price 2001 = 20 100 400 = 5% 2001 = 20 100 500 = 4%

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Particulars Sales(wk 1) Return on capital employed wk (2) Profit Margin(wk 3) Asset Utilization (wk 4) Gross Profit Margin (wk 5) Net Profit Margin (wk 6) Current Ratio (wk 7) Quick/Acid test ratio (wk 8) Working capital ratio (wk 9) No of days credit given to customer (wk 10) No of days credit taken by suppliers (wk 11) Gearing ratio (wk 12) Interest cover (wk 13) Rate of earning (wk 14) Earning per shares (wk 15) Price earning ratio (wk 16) Dividend cover (wk 17) Dividend yield (wk 18) 2001 200 % 20 % 10 % 2 times 30 % 9% 2.8 times 1% 156 days 55 days 73 days 25 % 10 times 15 % 20 pence/sha re 20 times 2 times 5% 2002 240 % 27.3 % 12.5 % 2.2 times 33.33 % 11.7 % 2.5 times 0.95 % 160 days 61 days 73 days 22 % 15 times 18 % 26.7 pence/share 18.7 times 2.7 times 4%

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To: The Director, Fleur International LPC From: The Chief Accountant Subject: Analysis of Fleur International construction PLCs performance to 30 September 2002 Date: 14 October 2002 The following report is submitted in agreement with your request to assess the financial progress, performance and financial position of Fleur International Construction for the year ended on 30 September 2002. The report considers key areas of solvency, profitability and liquidity. It is based on selected ratios calculation in attached Appendix. Profitability Sales increased by 20% from 200m to 240m and there is no indication that this was due to cut in prices, as the gross profit margin has not fallen. The increase in sales volume appears to be due to improvement in quality and more attractive credit terms and being offered. The latter can be substantiated as the number of days credit given to customer has extended by six days. The primary measure of profitability, return on capital employed (ROCE), increased from 20% to 27.3% indicating more efficient use of assets by management. This was mainly due to more profitable sales as indicated by increase in gross profit margin from 30% to 33.3% and improvement in cost control due to economies of scale as indicated by improvement in net profit margin from 9% to 11.7%. Solvency and gearing

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Gearing was maintained at its low level and dropped from 25% to 22% due to a higher profit retention policy. Interest cover increased by 5 times due to higher profitability and no increase in interest payments. Future capital expenditure can be debt financed to ease companys short term liquidity which can come under pressure in the following period. Shareholder ratios Earning per share increased by 35% from 20pence to 26.7pence . however, this was not matched by the dividend payout which remained at 10pence per share, and price earnings ratio declined from 20 times to 18.7 times which indicates that shareholders were not satisfied with the dividend pay-out, and hence the share price did not go up in line with improvement in performance. Liquidity and working capital management The company invested 5m in non-current assets during the year, which was internally financed resulting in a slight deterioration in both current and acid-test ratios. Both ratios gave adequate cover for short-term creditors. The cash operating cycle increased by ten days due to increase in number of days credit given to customers (six days) and increase in working capital ratio (four days). However, the number of days credit taken from trade creditors remained the same (73 days), resulting in further decline in liquidity ratios. The increase in credit to customers appears to be made to attract new customers and to keep existing customers happy. However, the increase in stock holding may be in anticipation of increased sales or poor stock control. Conclusion

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The year ended 30 September 2002 was very reasonable with a steady increase in market share and overall improvement in management efficiency, and the company should look forward to 2003 with great self-confidence. However, attention should be paid to the following: Dividend payout should be increased in line with performance to boost share price with will facilities any share issue. Short-term liquidity needs further attention. Any further expansion should be debt financed.

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Q3 (c)

Critically evaluate the limitations of interpretation techniques:The ratio analysis is a widely used to technique to evaluate the financial position and performance of a business. But there are certain problems in using ratios. The analyst should be aware of these problems. The following are some of the limitations of the ratio analysis 1. It is difficult to decide on the proper basis of comparison. 2. The comparison is tendered difficult because of differences in situations of two companies or of one company over years. 3. The price level changes make the interpretation of ratios invalid. 4. The differences in the definitions of items in the balance sheet and the profit and loss statement make the interpretation of ratios difficult. 5. The ratios calculated at a point of time are less informative and defective as they suffer from short-term changes. 6. The ratios are generally calculated from past finanacial statements and thus there are no indicators of future. Standards for Comparison: Ratios of a Company have meaning only when they are compared with some standards. It is difficult to find out a proper basis comparison. Usual ally it is recommended that ratios should be compared with industry averages. But the industry averages are not easily available. Company differences: Situations of two companies are never same. Similarly, the factors influencing the performance of a company in one year may change in another year. Thus. The comparison of the ratios of two companies becomes difficult and meaningless when they are operating at different situations. Page 53

Price Level: The interpretation and comparison of ratios are also rendered invalid by the changing value of money. The accounting figures, presented in the financial statements, are expressed in the monetary unit which is assumed to remain constant. In fact prices change over years which affect accounting earnings. At least three effects of inflation can be identified. 1. The nominal value of inventory increases on account of the rising prices. This result into inventory profit. A firm will lose in real terms if the general price level increases faster than appreciation in the value of inventory. 2. The assets are stated at original cost(less depreciation) in the balance sheet. Because of inflation, their current value or replacement cost will be much higher than book value. Thus depreciation calculated on book value will be very low. 3. Inflation affects accounting profits of the firms which borrow. If the interest rate is fixed, shareholders gain at the cost of lenders. The real value of the lenders obligation is reduced by inflation. The accounting profit does not recognize the gain from borrowing arising due to inflation. Since the firms will differ in terms of the nature of their inventory , age and type of assets and debt policy, inflation will affect them differently Different Definition: In practice, differences exist as the meaning g of certain terms. Diversity of views exists as to what should be included in net worth or shareholders, equity, current assets or current liabilities. Whether preference share capital and current liabilities should be included in debt in calculating the debt equity ratio? Should intangible assets be excluded to calculate the rate of return on the investment? If intangible assets have to be included, how will they be valued? Similarly, profit means different things to different people. Changing situations :

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The ratios do not have much use if they are not analysed over years. The ratios at a moment of time may suffer from temporary changes. This problem can be resolved by analysing trends of ratios over year. Although trend analysis is more useful but the still analysis is static to an extent. The balance sheets, prepared at different points of time are static in nature. They do not reveal the changes which have taken place between dates of two balance sheets. The statements of changes in financial position reveal this information. Past Data: The basis to calculate ratios are historical financial statement. The financial analyst is more interested in what happens in the future, wh8ile the radios indicate what happen in the past. Management of the company has information about the companys future plans and policies and, therefore is able to predict future happening to a certain extent. But the outside analyst has to rely on the past ratios, which may not necessarily reflect the firms financial position and performance in the future.

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BOOKS :- FINANCE SECOND EDITION MICHAEL FARDON, DAVID COX Accounting and finance, compiled by Leslie Chadwik Bradford University school of Management Business Studies For AS edited by Can Marcourse

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