School of Business and Law

Assignment On
Accounting Decision Making Technique

Name ID Semester Group Lecturer Due Date

Md. Kamal Hossain B0687MHMH0411 MFP semester 01 B S A Palan 22nd June 2011

Word 2000

ANSWER TO THE QUESTION NUMBER 01

Calculation of Payback, NPV and IRR for AP Company:
By considering the specific condition for specific proposal we get the output:

Year

Proposal 01 NCF 000 0 0 73 73 73

Proposal 02 NCF 000 66 66 66 66 66

Proposal 03 NCF 000 145 145 0 0 0

Proposal 04 NCF 000 16 16 16 16 16

Proposal 05 NCF 000 70 70 70 70 70

01 02 03 04 05

PAYBACK CALCULATION: The payback method is the time taken to recover the initial
investment. Equation for calculate the payback:

Payback period calculated by using cumulative cash flow. Cumulative cash flow = (some of cash inflow some of cash outflow).

Payback period for proposal 01:

Year Net Cash Flow 000 Cumulative Net Cash Flow 000 0 0+ 0=0 0 + 73 = 73 73 + 73 = 146 146 + 73 = 219

01 02 03 04 05

0 0 73 73 73

The initial investment for the proposal 1 is 100,000

So the Payback period = 3 + {(100,000-73,000)/73,000} = 3 + (27,000/73,000) = 3+ 0.369 = 3.369 = 3.37 years Or 3 years and (0.37 X 12) months = 3 years and 4.44 months

Payback period for proposal 02:

If the net cash flow for every year is same then the payback period of an annuity is (Initial investment / Net cash flow per period) (Brown et al, 2009/10) The initial investment for this proposal is 180,000. The payback period = (180,000 / 66,000) = 2.72 years Or 2 years and (0.72 X 12) months =2 years and 8.64 months.

Payback period for proposal 03:

Year 01 02 03 04 05 Net Cash Flow 000 145 145 0 0 0 Cumulative Net Cash Flow 000 145 145 + 145 = 290 0 + 290 = 290 0 + 290 = 290 0 + 290 = 290

The initial investment for the proposal 2 is 200,000 So the payback period = 1 + {(200,000 145,000)/145} = 1 + (55,000/145)

= 1 + 0.379 = 1.379 years Or 1 years and (0.379 X 12) months = 1 year and 4.54 months.

Payback period for proposal 04:

The net cash flow of this proposal is same for every year. The initial investment is 40,000. So the payback period = (40,000/16,000) years = 2.5 years Or 2 years and (0.5 X 12) months = 2 years and 6 months.

Payback period for proposal 05:

The net cash flow of this proposal is same for every year. The initial invest is 70,000. So the payback period = (70,000/70,000) years = 1 year. For this proposal the net cash flow of 1st year is equal to the initial investment, therefore the payback period is one year, that means from this proposal the company can get there payback within one year.

Net Present Value (NPV) calculation:

NPV = Sum of the discounted present value of future cash flows Initial investment (Brown et al, 2009/10).

Present Value =NCF for the year/ (1 + r)n Here, r = Discount rate.

n = number of period.

NPV for proposal 01: Year 01 02 03 04 05 NCF 000 0 0 73 73 73 PV calculation in interest rate of 10% 0/(1 + 0.1)1 0/(1+0.1)2 73/(1+0.1)3 73/(1+0.1)4 73(1+0.1)5 Total Present Value PV 000 0 0 54.845 49.859 45.341 =150.045

Initial investment is 100,000 So NPV at 10% = (150,045 100,000) =50,045

NPV for proposal 02:

Discounted Annuity Factor = (1-(1+r)-n)/r Total PV of an annuity = C x [1-(1+r)-n]/r Here, c = net cash flow per period.

r = Discount rate.
n = number of period. (Weston, 2001) Total Present Value of annuity = 66,000 X {1-(1+0.1)-5}/0.1 = 66,000 X {(1-0.621)/0.1} = 66,000 X (0.379/0.1) = 66,000 X 3.79 = 250,140 The initial investment is 180,000 So the NPV at 10% = (250,140 180,000) = 70,140

NPV for proposal 03: Year 01 02 23 24 05 NCF 000 145 145 0 0 0 PV calculation in interest rate of 10% 145/(1 + 0.1)1 145/(1 + 0.1)2 0/(1 + 0.1)3 0/(1 + 0.1)4 0/(1 + 0.1)5 The total PV PV 000 131.818 119.834 0 0 0 = 251.652

The initial investment is 200,000 So the NPV at 10% = (251,652 200,000) = 51,652

NPV for proposal 04:

Total Present Value of annuity = 16,000 X {1-(1+0.1)-5}/0.1 = 16,000 X {(1-0.621)/0.1} = 16,000 X (0.379/0.1) = 16,000 X 3.79 = 60,640 The initial investment is 40,000 So the NPV at 10% =(60,640 40,000) =20,640

NPV for proposal 05:

Total Present Value of annuity = 70,000 X {1-(1+0.1)-5}/0.1 = 70,000 X {(1-0.621)/0.1} = 70,000 X (0.379/0.1) = 70,000 X 3.79 = 265,300 The NCF is 70,000

So the NPV at 10% =(265,300 70,000) =195,300

IRR Calculation: IRR = Positive rate + Positive NPV (Positive NPV +Negative NPV) Ignore the negative sign and add the positive NPV to the Negative NPV. (Dyson 6th edition)
IRR for proposal 1:
DCF 1 20% NPV 1 6,966 IRR = 0.2 + DCF 2 25% NPV 2 8,798 Reference appendix 01 for NPV calculation 6,966 6,966 + 8,798 = 22.209% X (0.25 - 0.20)

X Range of rates

IRR for proposal 2: DCF 1 20 % NPV 1 17,373

Reference appendix 02 for NPV calculation IRR = 0.2 + 17,373 17,373+2,487 = 24.373% X (0.25 - 0.20)

DCF 2 25% NPV 2 (2487)

IRR for proposal 3:

DCF 1 25% NPV 1 8,800 Reference appendix 03 for NPV calculation IRR = 0.25 + 8,800 8,800 + 2,664 =28.838%

DCF 2 30% NPV 2 2664

X (0.30 - 0.25)

IRR for proposal 04:

DCF 1 25% NPV 1 3024 Reference appendix 04 for NPV calculation. IRR = 0.25 + 3,024 3,024 + 1040 =28.72% DCF 2 30% NPV 2 1,040 X (0.30 - 0.25)

IRR for proposal 05:

DCF 1 96% NPV 1 350 Reference appendix 05 for NPV calculation. IRR = 0.96 + 350 350 + 350 =100% DCF 2 97% NPV 2 350

X (0.97 - 0.96)

ANSWER TO THE QUESTION NUMBER 02

The AP Company they have five proposals for their company. Their current investment is limited to 300,000. Therefore, the company could not run all the proposal at the same time. For the reason they need to do ranking for choosing the proposal which one they can start first, and for the ranking in single period rationing they should use the NPV, which also called profitability index. For ranking Profitability Index explain here. Profitability Index: An index that attempts to identify the relationship between the costs and benefits of a proposed project through the use of a ratio calculated as:

Profitability index rule is the variation of the NPV rule. If NPV is positive profitability index would be greater than 1.other way if NPV is negative the profitability index would be less than 1. Calculation of profitability Index: The Profitability Index calculate as below

INVESTMENT
Proposal 1 Present Value of cash 150,045 inflow (a) Initial Investment (b) Profitability Index (a/b) 100,000 1.5 180,000 1.389 200,000 1.258 40,000 1.516 70,000 3.79 Proposal 2 250,140 Proposal 3 251,652 Proposal 4 60,640 Proposal 5 265,300

For ranking the Profitability rules is higher profitability index is the higher ranking. By using Profitability Index the ranking of proposals is Proposal05 --------> Proposal04 -------> Proposal01-------> Proposal02-------> Proposal03

01. The company have the 300,000 for all proposals. So by the ranking we got the proposal 5 in higher ranking. The initial investment for the proposal is 70,000 Money left for the other proposal is (300,000-70,000)=230,000 02. The second rank is proposal 4, and the initial investment is 40,000 Money left for others proposals is (230,000-40,000)=190,000 03. The third rank is proposal 1, and the initial investment is 1000,000 So money left for other proposals is (190,000-100,000)=90,000 04. The fourth rank is proposal 2, and the initial investment is 180,000 But they have 90,000 and its half of money of their investment.(180,000/90,000=2) That means they can start this proposal with the rest of money. Finally, they do not have any more money for the proposal 3 so they could not start the proposal.

ANSWER TO THE QUESTION NUMBER 03

For company before they start any proposal they should do the ranking for choosing the proposal. After ranking, they can consider the other factor analysis, like as SWOT and PEST. SWOT analysis: Definition: SWOT is stand for Strengths, Weaknesses, Opportunities, and Threats. These four factors provide a framework, which an organization can use to conduct a structured analysis of its operations. For strategic planning process, any business has two main parts. 01. Internal environment 02. External environment. The Strengths and Weakness are consider as internal environment and The Opportunities and Threats are consider as external environment. Strengths: Strength is capability and resources of a company. Strengths include: 01. Good products or service, which can attract the customer. 02. official article 03. Expert worker 04. well-built advertising. 05. Strong network for circulation. 06. Good business location. Strength also include tangible assets such as capital, equipment, credit and also the established customer. Weakness: Weakness means the lake of the business. in some part of company there could be some lake. The director or managers should be able to resolve the lake by their capability. Weakness includes: 01. untrained employee 02. Non-valuable products by comparing with others company product. 03. Location for the company.

Opportunity: Opportunity includes: 01. Extend the business. 02. Building the market such as internet. 03. New international market. 04. Positive market perception in business. Threats: Rivalry, breathing or prospective is the main threat for businesses. Its include 01. Increased trade barriers. 02. New parameter. 03. Price wars with the others company.

PEST Analysis: Before start the business its important things to consider the PEST analysis. So the AP company directors could consider the PEST analysis. PEST analysis stands for Political (p), Economic (E), Social(S), and Technological (T). Political Analysis: Political analysis includes: 01. How stable the political environment? 02. Government position in marketing principles. 03. Economical guidelines of government. 04. Competition directive. 05. Employment low. Economical Analysis: In economical analysis we consider these point 01. Exchange rate.

02. Inflation. 03. Taxation. 04. Tariffs. 05. Disposable income. Social analysis: Social analysis is also an important factor for the business. in this analysis also includes 01. Education. 02. Society. 03. Approach to work. 04. Fashions. Technological Analysis: Technological analysis includes: 01. Energy uses and cost. 02. Technical investment. 03. Rate of technological diffusion These factor the director could analyse before they take the decision.

ANSWER TO THE QUESTION NUMBER 04

In practice, the IRR method has been observed to be far more widely used than NPV In general NPV and IRR are mostly same things for decision making. They are same equation. They are as mike points out, discounted cash flows the time value of money. They are just targeting different points along the profit or loss curve. But,

Internal Rate of Return is easy to understand by an ordinary reader. For the decision making it is easy to take the decision for the management that which project they can choose because of its easily focused what an investment is going to give you term of percentage.

Positive cash flows are reinvested at the same rate of cost capital. In certain cash flow model are produced multiple result. IRR shows the percentage but NPV shows the pound() which is easier for the non accountant people.

Superiority of NPV: 01. Net cash flows emphasizes the importance of liquidity. 02. The time value of money is taken into account. 03. Easy to compare the NPV of different project. 04. NPV is straight forward for rationality. 05. NPV shows the amount of value.

References and Bibliography:

J. R. Dyson (2007) Accounting for Non-Accounting Students.8th edition. England, Prentice Hall. McLaney,E. and Atrill,P.(2010) Accounting :An Introduction. 5th edition. England, Prentice Hall. Mott, G.(2005) Accounting for Non-Accountants .6th edition.[e-book].Kogan Page Ltd. Brown, N; Porch, M; Thomas, I.(2009/10)AF4S01 Strategic Financial Management: Module Booklet.Glamorgan,University of Glamorgan Business School. Meckin, D.(2008) Naked Finance : Business Finance Pure and Simple.[e-book].Nicholas Brealey Publishing.
Weston, J.F.(2001)Finance & Accounting for Non-Financial Managers .[e-book].United States, McGraw-Hill Professional Publishing .

http://www.accountingformanagement.com/ranking_of_investment_projects_preference_decision s.htm http://www.accountingformanagement.com/net_present_value_method.htm http://www.scribd.com/doc/6049030/Investment-Appraisal-thesis http://www.wikicfo.com/Wiki/Default.aspx?Page=Net%20Present%20Value%20Method&NS=&Aspx AutoDetectCookieSupport=1 http://www.investopedia.com/terms/p/profitability-index-rule.asp http://www.quickmba.com/strategy/swot/ http://www.whatisswotanalysis.com/ http://articles.mplans.com/how-to-perform-a-swot-analysis/ http://www.thetimes100.co.uk/theory/theory--pest-analysis--166.php http://www.coursework4you.co.uk/essays-and-dissertations/pest-analysis.php http://www.netmba.com/strategy/pest/ http://tutor2u.net/business/strategy/PEST_analysis.htm http://www.marketingteacher.com/lesson-store/lesson-pest.html

http://www.finaticsonline.com/Freebies/IRR_vs_MIRR_vs_NPV_%5BFinatics%5D.pdf http://hspm.sph.sc.edu/Courses/Econ/invest/invest.html http://www.recreationalmath.com/help/irr.htm http://www.investopedia.com/terms/i/irr.asp http://thinkanddone.com/finance/irr.html http://www.fao.org/docrep/W4343E/w4343e07.htm http://www.finance30.com/forum/topics/1987892:Topic:52261?page=3&commentId=1987892%3A Comment%3A453878&x=1#1987892Comment453878 http://thinkanddone.com/finance/payback-period.html

Weingarten, H. (1969)Some new views on the payback period and capital budgeting decisions,Management Science.[Online]. 15(12),Business Source Premier, EBSCO host. John A. Tracy, CPA, accounting workbook for dummies, Copyright 2006 by Wiley Publishing, Inc., Indianapolis, Indiana. Published simultaneously in Canada.

APENDIX
APENDIX 01: NPV calculation for IRR of proposal 01

NPV at 20% Year NCF 000 Present Value calculation in interest rate of 20% 01 02 03 04 05 0 0 73 73 73 0/(1 + 0.2)1 0/(1+0.2)2 73/(1+0.2)3 73/(1+0.2)4 73/(1+0.2)5
Total Present Value NPV at 20%=(106,966 100,000) =6,966

Present Value 000

0 0 42.425 35.204 29.337

= 106.966

NPV at 25%

Year

NCF 000

Present Value calculation in interest rate of 25%

Present Value 000

01 02 03 04 05

0 0 73 73 73

0/(1 + 0.25)1 0/(1+0.25)2 73/(1+0.25)3 73/(1+0.25)4 73/(1+0.25)5

0 0 37.378 29.902 23.922

|Total PV= 91.202

NPV at 25%=(91,202 100,000) = (8,798)

APENDIX 02: NPV calculation for IRR of proposal 02 NPV at 20% Total PV of an annuity = C x [1-(1+r)-n]/r Total Present Value of annuity at 20%= 66,000 X {1-(1+0.2)-5}/0.2 = 66,000 X {(1-0.4019)/0.2} = 66,000 X (.5981/0.2) = 66,000 X 2.9905 = 197,373 The initial investment is 180,000 So the NPV at 20% = (197,373 180,000) = 17,373 NPV at 25% Total Present Value of annuity at 25%= 66,000 X {1-(1+0.25)-5}/0.25 = 66,000 X {(1-0.3276)/0.25} = 66,000 X (0.6724/0.25) = 66,000 X 2.6896 = 177,513

The initial investment is 180,000 So the NPV at 25% = (177,513 180,000) = (2487)

APENDIX 03: NPV calculation for IRR of proposal 03 NPV at 25%

Year

NCF 000

Present value calculation in interest rate of 25%

Present Value 000

01 02 23 24 05

145 145 0 0 0

145/(1 + 0.25)1 145/(1 + 0.25)2 0/(1 + 0.25)3 0/(1 + 0.25)4 0/(1 + 0.25)5
Total PV

116 92.8 0 0 0
=208.8

The initial investment is 200,000 So the NPV at 25% = (208800 200,000) = 8800

NPV at 30% :

Year

NCF 000

Present value calculation in interest rate of 30%

Present Value 000

01 02 23 24 05

145 145 0 0 0

145/(1 + 0.3)1 145/(1 + 0.3)2 0/(1 + 0.3)3 0/(1 + 0.3)4 0/(1 + 0.3)5
Total PV

111.538 85.798 0 0 0
=197.336

The initial investment is 200,000

So the NPV at 30% = (197,336 200,000) =(2664)

APENDIX 04: NPV calculation for IRR of proposal 04 NPV at 25% Total Present Value of annuity at 25%= 16,000 X {1-(1+0.25)-5}/0.25 = 16,000 X {(1-0.3276)/0.25} = 16,000 X (0.6724/0.25) = 16,000 X 2.689 = 43024

The initial investment is 40,000 So the NPV at 25% =(43024 40,000) =3,024 NPV at 30% Total Present Value of annuity at 30%= 16,000 X {1-(1+0.3)-5}/0.3 = 16,000 X {(1-0.2693)/0.3} = 16,000 X (0.730/0.3) = 16,000 X 2.435 = 38960

So the NPV at 30% =(38,960 40,000) =(1040) APENDIX 05: NPV calculation for IRR of proposal 04 NPV at 96% Total Present Value of annuity at 96%= 70,000 X {1-(1+0.96)-5}/0.96 = 70,000 X {(1-0.034)/0.96} = 70,000 X (0.965/0.96) = 70,000 X 1.005 = 70,350 NPV at 96% = (70,350 70,000) =350 NPV at 97% Total Present Value of annuity at 97%= 70,000 X {1-(1+0.97)-5}/0.97 = 70,000 X {(1-0.033/0.96} = 70,000 X (0.966/0.96) = 70,000 X 0.995 = 69650 NPV at 97% = (70,000 69650) =(350)