Evaluating Investment Projects

This assignment delves into the analysis of investment projects by comparing two different equipment options (A and B) using techniques like Accounting Rate of Return (ARR), Internal Rate of Return (IRR), and Net Present Value (NPV). It highlights the strengths and weaknesses of each method, emphasizing the importance of considering time value of money and cash flow patterns. The assignment concludes by recommending a suitable design based on a comprehensive evaluation of the chosen metrics.

ACCOUNTING FOR BUSINESS

Answer - 1 :
(a)
LANDSCAPING BUSINESS
STATEMENT SHOWING CASH BUDGET FOR THREE MONTHS
FROM 01.07.2018 TO 30.09.2018
PARTICULARS JULY AUGUST SEPTEMBER
A. Opening Balance 26500 0 61800
B. RECEIPTS :
Fees 140000 160000 200000
Proceeds from the sale
of surplus non-current
assets
100000
C. TOTAL (A+B) 166500 260000 261800
D. PAYMENTS
Salaries & Wages 70000 70000 70000
Supplies 8500 9200 12000
New equipment 120000
Purchase of plants 42000 45000 61000
TOTAL (D) 240500 124200 143000
E. BALANCE (C-D) -74000 135800 118800
BORROWINGS/
INVESTMENTS 74000 -74000
CLOSING
BALANCE 0 61800 118800
Closing Balance Of
Loan 74000
Notes:
1. Since the balance goes negative in the month of August,we
would be borrowing an equal amount of it from bank.
2. Since the company generated enough cash in the month of
August,it repaid the loan amount taken from the bank.
(b) While the company purchase the equipment, the bank balance of the company goes negative
and therefore, a borrowing was made equivalent to that amount(Bruner, Eades and Schill, 2017).
But, if the company goes for the rental arrangement of $10000 per month, the bank balance

remains positive in all the three months. Also, the balance as on 30.09.2018 is $9000 more in
case of lease arrangement than in case of purchase.
However, an equipment usually have a life span of more than 5-6 years, therefore, the cost of
the equipment today would be equal to rent paid for 1 year consistently that is, the cost of the
equipment $120000 would be equal to 12 months and so, if the equipment is being used for more
than one year, the rental expense would be more than the original cost. Therefore, assuming that
the equipment is for more than one year at least, it is hitherto purchase the equipment so as to bear
the cost for once rather than bearing it for months and months.
LANDSCAPING BUSINESS
STATEMENT SHOWING CASH BUDGET FOR THREE MONTHS FROM
01.07.2018 TO 30.09.2018
PARTICULARS JULY AUGUST SEPTEMBER
A. Opening Balance 26500 36000 161800
B. RECEIPTS :
Fees 140000 160000 200000
Proceeds from the sale of
surplus non-current assets 100000
C. TOTAL (A+B) 166500 296000 361800
D. PAYMENTS
Salaries & Wages 70000 70000 70000
Supplies 8500 9200 12000
Rent Paid for the leased
equipment 10000 10000 10000
Purchase of plants 42000 45000 61000
TOTAL (D) 130500 134200 153000
E. BALANCE (C-D) 36000 161800 208800
BORROWINGS/
INVESTMENTS
CLOSING BALANCE 36000 161800 208800

Answer - 2 :
(a)
LANDSCAPING BUSINESS
CALCULATION OF CONTRIBUTION PER PRODUCT :
Sales Units 125000 75000 50000
Sales Mix Ratio 5 3 2
Particulars Amount ($) Amount ($) Amount ($)
Selling price p.u. 20 28 45
Variable cost p.u. 12 18 27
Contribution p.u. 8 10 18
Calculation of total Break-Even Units :
Average Contribution = ($8*5+$10*3+$18*2)/10 = $10.60
Breakeven Point = total fixed cost
Average contribution
Breakeven Point (Total
Units) =
402800 : 38000 units
10.6
Calculation of Break-Even Units of each product :
1 year old = 38000*5/10=19000 units
2 year old= 38000*3/10=11400 units
3 year old= 38000*2/10=7600 units
Notes :
1. The average contribution is calculated as fixed cost relates to the business
as a whole and not product wise.
2. The total break even units is then divided among the three products in the
given sales ratio.
(b)
LANDSCAPING BUSINESS
CALCULATION OF PROFIT/LOSS :
Sales Units 125000 75000 50000

Sales Mix Ratio 5 3 2
Particulars Amount
($)
Amount
($)
Amount
($)
Total
Amount
($)
Selling price p.u. 20 28 45
Variable cost p.u. 12 18 27
Contribution p.u. 8 10 18
Total Contribution
(Contribution p.u. *
Sales Units)
1000000 750000 900000 2650000
Total Fixed Cost 402800
Total Profit/(Loss) 2247200
(c) By altering the sales mix ratio, the company would be incurring an additional $50000 fixed
costs. However, considering the revenue earned after bearing the fixed costs, the company is
making a profit of $4,50,000 more. Thus, it is clear from the calculations that the company
should consider this initiative as it would be yielding more income than the initial sales mix
revenue (Clarke and Clarke, 1990).
LANDSCAPING BUSINESS
CALCULATION OF PROFIT/LOSS :
Sales Mix Ratio 30% 30% 40%
Sales Units (250000 units) 75000 75000 100000
Particulars Amount ($) Amount ($) Amount ($) Total
Amount ($)
Selling price p.u. 20 28 45
Variable cost p.u. 12 18 27
Contribution p.u. 8 10 18
Total Contribution (Contribution
p.u. * Sales Units) 600000 750000 1800000 3150000
Total Fixed Cost 452800
Total Profit/(Loss) 2697200

Answer-3 :
(a) Decision - making is one of the most crucial step of any business and therefore, a careful
analysis is to be done before making any investments or taking any loan. Similarly, in the present
case, the landscaping business is considering thr purchase of an equipment for which it has two
alternatives. While the office manager has calculated accounting rate of return (ARR), the
assistant office manager has calculated the internal rate of return (IRR).
However, the decision couldn't be taken only on the basis of ARR and IRR. There are other
financial information that the company has to consider before making a decision (Fairhurst,
2015):
 The time value of money should be considered so as to know whether the amount
invested today will be worth more than the same amount in the future, thus, considering
the earning capacity of the business and therefore, the efficiency of the two equipments.
 The future value of the cash inflows are to be taken into account because there are a
number of limitations related to ARR and IRR which completely makes the cash inflows
per annum out of picture.
(b) As an owner of the company, the given information is not sufficient for the decision making
purpose due to the following information (Hassani, 2016) :
 ARR doesn't include cash flows and shows an average profits which isn't appropriate for
decision purpose. It excludes the various other costs such as opportunity costs & savings.
In a similar way, the costs such as sunk cost or other fixed costs are considered in
accounting profits which is actually not relevant for decision purpose (Galbraith, Downey
and Kates, 2002).
 No matter IRR considers the time value of money, the decisions cannot be taken on this
basis as a high IRR may not always yield high NPV. In a similar way, a low IRR may
yield high NPV. Therefore, taking up a project with high IRR cannot always be a
profitable investment for the business. It ignores the actual dollar value of benefits
because of this. For example, a project value of $20, 00,000 with 18% rate of return is
obviously going to be chosen over the project value of $20,000 with 50% rate of return.
This can be understood simply by seeing and no comparison or calculations are to be
made. However, the IRR concept will rank the latter project first simply because the latter
one yields a return of 50% over former rate of return of 18%.
 IRR is calculated on the basis of trial and error method, which is again an inappropriate
factor for decison purpose. Also, multiple IRR problems arises when the cash flows
during the lifetime of the project comes out to be negative.
(c) If the calculated returns all exceed the entity's required minimum rate, the design to be
recommended to the owner is equipment B. Making decison on the basis of mere ARR isn't a
good idea as ARR doesn't consider the time value of money and therefore, excludes the concept

of cash flows which is the most vital part of any investment (Khan and Jain, 2014). The average
profits aren't the true reflection of cash flows as where it includes the sunk costs and other fixed
costs; it excludes the opportunity costs and savings, which are the actual key factors relevant for
a decision making. Also, the more the IRR is, the more profitable is the investment and vice
versa.

References:
Bruner, R., Eades, K. and Schill, M. (2017). Case studies in finance. Dubuque, IA: McGraw-Hill
Education.
Clarke, R. and Clarke, R. (1990). Strategic financial management. Homewood, Ill.: R.D. Irwin.
Fairhurst, D. (2015). Using Excel for Business Analysis A Guide to Financial Modelling
Fundamenta. John Wiley & Sons.
Galbraith, J., Downey, D. and Kates, A. (2002). Designing dynamic organizations. New York:
AMACOM.
Hassani, B. (2016). Scenario analysis in risk management. Cham: Springer International
Publishing.
Khan, M. and Jain, P. (2014). Financial management. New Delhi: McGraw Hill Education.