Capital Budgeting Analysis and Decision Making

This solved assignment focuses on capital budgeting analysis using Net Present Value (NPV) and Payback Period calculations. It involves evaluating an investment proposal for a machine purchase, determining its profitability, and comparing the results with predetermined criteria like payback period and minimum desired return. The assignment also delves into the significance of both techniques in decision-making, highlighting the strengths and limitations of each.

Running head: ACCOUNTING FOR BUSINESS
Accounting

Accounting for business 1
Question 1
Cash budget
The financial budget made to calculate budget cash inflows and cash outflows for a specific
period of time is known as cash budget. With the help of cash budget, the closing balance of
cash can also be ascertained. It helps in determining excessive cash or shortage of cash that is
expected during the period (Weygandt, Kimmel and Kieso, 2009). By preparing cash budget and
making the use of information derived from it, managers can take decisions accordingly.
Such as, if there are chances of cash shortage in future, then managers can take steps
accordingly like changing the credit policy. Similarly, if excessive cash will be there then,
plans like making investments and repayments can be made (Crosson and Needles, 2013). Cash
budget of Student Enterprises for the quarter ending 31 March 2018 is as follows:
Question 2
The difference between total sales and total variable cost is known as contribution. The
contribution then divided by sales and expressed as a percentage, is known as contribution
margin ratio. The total margin generated is basically the total earnings made by an enterprise
used to pay fixed expenses and earn profits (Heisinger, 2009). The margin should be high and
must be sufficient to cover all the fixed costs and administrative overheads. The method can
be used in determining the selling price in specific situations. It can also be useful in
identifying the impact on profits due to changes in sales (Rajasekaran, 2010). Formula for
calculating contribution margin ratio is:
Contribution Margin = (Sales-Variable costs) ÷ Sales
Part A
Cash Budget
For the Quarter ending 31 March 2018
Quarter 1
$
Beginning cash balance 79,550
Add: cash receipts
Cash Sales 162,624
Receipts from accounts receivables 145,640
Receipt of loan 28,500
Total receipts 336,764
Less: Cash payments
Office furniture purchased 27,176
Administrative expenses 24,816
Wages 85,020
Prepayments 9,295
Payments of accounts payable 93,104
Total cash payments 239,411
Cash surplus/(deficit) 97,353
Closing cash balance 176,903

Accounting for business 2
Contribution margin ratio for Printers
Particulars Printers
$
Contribution (Sales-variable cost) 836,000
Sales 3,096,000
Contribution margin ratio 27.00
Contribution margin ratio for faxes
Particulars Faxes
$
Contribution (Sales-variable cost) 530,000
Sales 1,595,000
Contribution margin ratio 33.23
Contribution margin ratio in total
Particulars Total
$
Contribution (Sales-variable cost) 1,366,000
Sales 4,691,000
Contribution margin ratio 29.12
Part B
Break even sales is that amount of revenue at which a firm earns zero profit. The point where
the sales and total cost are same. BEP sales exactly covers the basic fixed cost of the business
including all the variable costs associated with the sales. It is useful for the managers as it
gives an idea about the break even sales level, at which minimum sales are required to be
generated during a period in order to avoid the losses (Rich, et.al. 2011). To calculate BEP
sales, following formula is used:
BEP sales = Fixed costs ÷ Average contribution margin ratio
Particulars Total
$
Fixed costs
Direct Fixed costs 770,000
Common Fixed Costs 202,000
Total contribution margin ratio 29.12
Break even Sales 3,337,959.00
Student Industries sells IT equipment, specialising in printers and Faxes. The break even
sales for the company is $3,337,959. It is calculated by dividing the total of direct fixed costs
and common fixed costs with total contribution margin ratio. This BEP sale will be
apportioned to each of the item in their sales ratio respectively. The sales ratio of printers and
faxes is 0.66 and 0.34 respectively.

Accounting for business 3
For Printers, BEP sales is $2,203,010.25 which means the management is required to
generate this much of sales in order to cover the fixed cost associated with this product.
For faxes, BEP sales is $1,134,948.76 that is required to made by the management during the
given period of time, for covering up all the fixed costs associated with the product.
Particulars Printers Faxes
Sales 3,096,000 1,595,000
Total Sales 4,691,000 4,691,000
Sales ratio 0.66 0.34
Break even sales 2,203,010.25 1,134,948.76
Total Break even sales 3,337,959.00 3,337,959.00
Question 3
Net present value method which is also known as discounted cash flow method is most
commonly used capital budgeting technique used to determine the profitability of an
investment proposal. The method takes into account the time value of money and provides a
basis to take decision regarding accepting or rejecting a particular project. NPV is a simple
accounting difference between the present values of cash inflow and present values of cash
outflow. It may be positive, negative and zero. Generally, a project having high NPV is
considered to be more desirable (Bierman and Smidt, 2012).
NPV being positive
When the PV of cash inflows are greater than PV of cash outflows, then net present value
will be positive and it will be okay to accept the project (Baker and English, 2011).
NPV being Negative
If the PV of cash outflow is greater than PV of cash inflows, then NPV is said to be negative.
It will be better to avoid making investment in the project having negative NPV
NPV equals to zero
NPV is said to be zero when the cash inflows are equal to cash outflows. This will be a no
profit situation and the company can accept or reject the proposal.
Part A
Calculation of NPV at rate of 11%
Years Cash inflows pvf@11% Present values
0 -124,000 1 -124000
1 54,600 0.900900901 49,189.19
2 49,600 0.811622433 40,256.47
3 44,600 0.731191381 32,611.14
4 52100 0.658730974 34,319.88
NPV ($) 32,376.68

Accounting for business 4
Part B
Calculation of NPV at rate of 15%
Years Cash inflows pvf@15% Present values
0 -124,000 1 -124000
1 54,600 0.869565217 47,478.26
2 49,600 0.756143667 37,504.73
3 44,600 0.657516232 29,325.22
4 52100 0.571753246 29,788.34
NPV ($) 20,096.55
Part C
The above parts A and B shows the calculations of Net present value of a project at different
rates of return. If the funds are earned at the rate of 11%, then NPV will be $32,376.68 and if
the funds are earned at rate of 15%, then NPV will be $20,096.55. Both the NPVs are
positive and the company can invest in purchasing the machine. As it is said that, project with
high NPV will be more desirable to be accepted so at rate of 11%, NPV is more as compare
to that of at 15%. Hence, it is advisable to the company to use funds in purchase of the
machine and earning the return at 11%.
Part D
Years Cash inflows Cumulative Cash inflow
0 -124,000
1 54,600 54,600
2 49,600 104,200
3 44,600 148,800
4 52100 200,900
Payback period 2.38
The payback period is known as the time taken by an investment proposal in recouping the
initial investment. It is another technique of capital budgeting used for evaluating investment
proposals. If the project take much longer to recover the initial outlay, then it will be better to
reject the proposal. Similarly, if the payback period is shorter that means the project is able to
recover the outflow faster and should be accepted (Damodaran, 2010).In part D,
undiscounted payback period is calculated which is 2.38 years. This is more than the required
payback period of two years. On the basis of this, it is advisable to the management to ignore
the investment in this project as the period is higher than the required one.
But the calculated payback period is undiscounted and is not reliable. If discounted one is
calculated, then it will be within the requirements and company can invest in this project. As
the project have positive and high NPV and the discounted payback period will be as per the
requirements, then it will be advisable that management must invest in this proposal.

Accounting for business 5
References
Weygandt, J.J., Kimmel, P.D. and Kieso, D.E., 2009. Managerial accounting: Tools for
business decision making. John Wiley & Sons.

Accounting for business 6
Baker, H.K. and English, P., 2011. Capital budgeting valuation: Financial analysis for
today's investment projects (Vol. 13). John Wiley & Sons.
Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of
investment projects. Routledge
Crosson, S.V. and Needles, B.E., 2013. Managerial accounting. Cengage Learning.
Damodaran, A., 2010. Applied corporate finance. John Wiley & Sons.
Heisinger, K., 2009. Essentials of managerial accounting. Cengage Learning.
Rajasekaran, V., 2010. Cost Accounting. Pearson Education India.
Rich, J., Jones, J., Heitger, D.L., Mowen, M. and Hansen, D., 2011. Cornerstones of
Financial and Managerial Accounting. Cengage Learning.