Capital Budgeting Decision Analysis

This assignment explores capital budgeting decisions by comparing two mutually exclusive projects, X and Y. Students are required to calculate key financial metrics such as Net Present Value (NPV), Payback Period, and Discounted Payback Period for each project. The analysis focuses on determining the most profitable project based on these metrics, considering that only one project can be selected.

[Type the company name]
Financial Management

Question 1: Budgeting
a) Preparation of financial statements
i) Annual Purchases Budget for Aluminium Windows Trading
Januar
y
Februar
y
Marc
h April May June July August
Septembe
r
Octobe
r
Novembe
r
Decembe
r
Opening
inventory 1,200 4,800 4,800
4,80
0 4,800
4,80
0 4,800 4,800 4,800 4,800 4,800 4,800
Sales 2,400 2,400 2,400
2,40
0 2,400
2,40
0 2,400 2,400 2,400 2,400 2,400 2,400
Closing
inventory 4,800 4,800 4,800
4,80
0 4,800
4,80
0 4,800 4,800 4,800 4,800 4,800 4,800
Purchase
s (units) 6,000 2,400 2,400
2,40
0 2,400
2,40
0 2,400 2,400 2,400 2,400 2,400 2,400
Total annual purchases = 32400 units
Purchases = Sales + closing inventory – opening inventory
ii) Annual Operating Expenses budget for the year
Month January February March April May June July August
Septembe
r October
Novembe
r December
Sales Revenue
$3,84,00
0
$3,84,00
0
$3,84,00
0
$3,84,00
0
$3,84,00
0
$3,84,00
0
$3,84,00
0
$3,84,00
0 $3,84,000
$3,84,00
0 $3,84,000 $3,84,000
Selling
expenses
Advertising $3,840 $3,840 $3,840 $3,840 $3,840 $3,840 $3,840 $3,840 $3,840 $3,840 $3,840 $3,840
Wages- shop $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000
Sales
commission $38,400 $38,400 $38,400 $38,400 $38,400 $38,400 $38,400 $38,400 $38,400 $38,400 $38,400 $38,400
Vehicle running
expenses $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500 $2,500
Delivery truck
expense $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000
Shop rent $3,600 $3,600 $3,600 $3,600 $3,600 $3,600 $3,600 $3,600 $3,600 $3,600 $3,600 $3,600
Total selling
expenses $65,340 $65,340 $65,340 $65,340 $65,340 $65,340 $65,340 $65,340 $65,340 $65,340 $65,340 $65,340
Distribution
expenses
Packing and
Freight $28,800 $28,800 $28,800 $28,800 $28,800 $28,800 $28,800 $28,800 $28,800 $28,800 $28,800 $28,800
Warehouse
rental $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000
Total
distribution
expenses $33,800 $33,800 $33,800 $33,800 $33,800 $33,800 $33,800 $33,800 $33,800 $33,800 $33,800 $33,800

Administration
expenses
Power $800 $800 $800 $800 $800 $800 $800 $800 $800 $800 $800 $800
Office salaries $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000 $20,000
Office rental $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000
Total
Administratio
n expenses
$30,800 $30,800 $30,800 $30,800 $30,800 $30,800 $30,800 $30,800 $30,800 $30,800 $30,800 $30,800
Total
operating
expenses
$129,940 $129,940 $129,940 $129,940 $129,940 $129,940 $129,940 $129,940 $129,940 $129,940 $129,940 $129,940
Total Operating expenses for the year = $1,559,280
iii) Abbreviated Budgeted Income Statement of Aluminium Windows Trading for the Year
using individual tax rate
Particulars Amount
Sales revenue $46,08,000
Less: Expenses
Selling expenses $7,84,080
Distribution expenses $4,05,600
Administration expenses $15,59,280
Operating income $18,59,040
Less: Income tax $6,04,403
Net income $12,54,637
Working Notes
Income tax for sole proprietor
Up to 14000 @10.5% $1,470
$14000-$48000 @ 17.5% $5,950
$48000-$70000 @30% $6,600
Over $70000 @33% $5,90,383
Income tax $6,04,403
(IRD)
iv) Abbreviated Budgeted Income Statement of Aluminium Windows Trading for the Year
using company tax rate
Particulars Amount

Sales revenue $46,08,000
Less: Expenses
Selling expenses $7,84,080
Distribution expenses $4,05,600
Administration expenses $15,59,280
Operating income $18,59,040
Less: Income tax @28% $5,20,531
Net income $13,38,509
(Tradingeconomics)
b) Yes, we recommend the company to turn into limited liability as the net income is higher
under limited liability as compared to sole proprietorship
Advantages of limited liability over sole proprietorship
Financial factors
i) Income of sole proprietors is taxed on a personal income tax basis whereas that of limited
liability is taxed on a corporate tax basis. As we can see the taxes paid are less in limited
liability when the level of income is high.
ii) The limited company is not exposed to certain federal taxes like limited companies
Non-financial factors
i) The liability of members of the company is limited to their share in the company unlike
sole proprietorship where the proprietor is completely liable personally also and in case of
losses may have to pay from personal assets.
ii) There is flexibility in management as they are not required to have board members or
annual meetings and thus the operations are more flexible.
Question 2: Make or Buy Decision
a) ABC Trading should make the component as the variable cost of $30 is less than the
buying cost of $40 and also the company has spare capacity which it can easily use to
produce the component. The fixed costs will not be affected because the company is already
incurring the fixed costs and an additional production will only reduce the fixed cost per unit.

The company will save $10 by making the product. The use of spare capacity will not
increase the fixed costs.
b) If ABC Trading produced the component at a cost of $30, it will lose contribution margin
from another product of $25 so the total cost of manufacturing the component will be $55
which is more than the buying cost. Hence the company should buy at $40 rather than
making in this case.
Question 3: Flexible Budgeting
a) The favourable or unfavourable variance analysis of the product X in the un-flexed budget
is as follows:
This
quarter
This
quarte
r
Year to
date
Year to
date
Year to
date
Budget($
)
Actual
($)
Variance
(Actual-
budget)
Variance
(U/F)
Budget($
)
Actual
($)
Variance
(Actual-
budget)
Variance
(U/F)
Expenses
Cost of sale 28,750 31,938 3,188 U 54,688 58,125 3,437 U
Electricity 1,875 2,000 125 U 3,750 3,666 -84 F
General
expense 5,563 5,979 416 U 10,625 11,038 413 U
Consultancy
fee 3,125 3,125 - NA 6,250 6,250 - NA
Advertising 5,563 5,131 -432 F 10,125 9,619 -506 F
Wages 15,938 17,400 1,462 U 31,250 33,419 2,169 U
Total
expenses 60,814 65,573 4,759 U 1,16,688
1,22,11
7 5,429 U
b) Since the quantities sold was more than the budgeted, the flexible budget and the variance
analysis is given below:
This
quarter
This
quarter
Yea
r to
date
Year to
date
Year to
date
Budget($
)
Flexible
budget($
)
Actual($
)
Varianc
e (U/F)
Budget($
)
Flexible
budget($
)
Actual($
)
Variance
(U/F)

Sales 2,800 3,450 11,200 13,800
Expenses
Cost of sale 28,750 35,424 31,938
-
3,486 F 54,688 67,383 58,125 -9,258 F
Electricity 1,875 2,310 2,000
-
310 F 3,750 4,621 3,666 -955 F
General
expense 5,563 6,854 5,979
-
875 F 10,625 13,092 11,038 -2,054 F
Consultanc
y fee 3,125 3,850 3,125
-
725 F 6,250 7,701 6,250 -1,451 F
Advertising 5,563 6,854 5,131
-
1,723 F 10,125 12,475 9,619 -2,856 F
Wages 15,938 19,638 17,400
-
2,238 F 31,250 38,504 33,419 -5,085 F
Total
expenses 60,814 74,932 65,573
-
9,359 F 1,16,688 1,43,776 1,22,117 -21,659 F
Note: The budgeted and actual sales for the year to date have been assumed to be the same
for each quarter and hence the sales units for the quarter have been multiplied by 4 to arrive
at year to date sales.
For flexible budgets, the expense per unit was calculated and the same was multiplied by
actual sales units i.e. 3450 to arrive at the flexible budgeted expenses items.
c) Yes, for expenses variance having a favourable variance is good because it means the
actual expenses are less than the budgeted expenses. Like the electricity expense is
unfavourable because the actual cost of advertising is $5131 whereas the budgeted cost was
$5563, so it is favourable and it is always better to have low expenses to increase profits.
d) Yes, we recommend Flexible budget to David Trading. As we can see the most of the
expenses variance was unfavourable in case of un-flexed budget because the budgeted
expenses were on the basis of budgeted sales of 2800 units. However, the actual units sold
was more than budgeted at 3450 units, so it is more logical that with more sale units, the

budgeted expenses should also increase according to the increased sales. Then the flexible
budgeted expenses should be compared to the actual expenses which are at 3450 units’ level
of sales. Under flexible budget, all the expenses variances have become positive or
favourable.
Question 4: Cash Budget
i) Schedule of cash receipts from Accounts Receivables for the three months to June 2017
Particulars April May June
Opening balance $1,53,000 $1,73,700 $1,86,000
Less:1st month sale receipts $75,600 $88,200 $92,400
Less:2nd month sale
receipts $15,300 $16,200 $18,900
Less:3rd month sale
receipts $9,600 $10,200 $10,800
Less: Bad debts $4,800 $5,100 $5,400
Add: Sales $126,000 $132,000 $132,000
Closing balance $1,73,700 $1,86,000 $1,90,500
ii) Schedule of cash payments of Accounts Payables for the three months to June 2017
April May June
Opening balance $23,400 $27,300 $28,600
Less: Cash paid $21,060 $24,570 $25,740
Less: Discount $2,340 $2,730 $2,860
Add: Purchases $27,300 $28,600 $28,600
Closing balance $27,300 $28,600 $28,600
iii) Cash Budget for the three months to June 2017
April May June
Opening balance $36,000 $43,340 $48,370
Add: Cash receipts $1,00,500 $1,14,600 $1,22,100
Total cash available $1,36,500 $1,57,940 $1,70,470
Less: cash disbursements
Purchases $21,060 $24,570 $25,740
Wages $49,500 $51,500 $51,500
Other expenses $22,600 $23,500 $23,500
Equipment $1,50,000

Dividend $10,000
Total cash disbursements $2,43,160 $1,09,570 $1,00,740
Cash surplus/deficit -$1,06,660 $48,370 $69,730
Loan $1,50,000 $0 $0
Closing cash balance $43,340 $48,370 $69,730
iv) Yes, the company should go ahead with the purchase of equipment costing $150,000 by
taking a loan of $150000 as the cash balance is positive in all the months from April to June.
In case the loan is not taken, then the company will not have sufficient cash balance to
finance the equipment and hence should not consider purchasing it.
Question 5: Capital Investment Decision
i) Annual net cash flows for Project X
Year 0 1 2 3 4 5
Cash inflow $50,000 $60,000 $70,000 $80,000 $90,000
Less: Variable cost $5,000 $6,000 $7,000 $8,000 $9,000
Less: Fixed cost $5,000 $5,000 $5,000 $5,000 $5,000
Less: Instalment cost $15,000
Operating income $25,000 $49,000 $58,000 $67,000 $76,000
Initial investment -$1,20,000
Annual net cash
flows -$1,20,000 $25,000 $49,000 $58,000 $67,000 $76,000
ii) Payback period, NPV, Discounted payback period for Project X
Year 0 1 2 3 4 5
Annual net cash
flows -$1,20,000 $25,000 $49,000 $58,000 $67,000 $76,000
Multiply: Cost of
capital $1 $0.909 $0.826 $0.751 $0.683 $0.621
Present value of
cash flows -$1,20,000 $22,727.27 $40,495.87 $43,576.26 $45,761.90 $47,190.02
NPV = Present value of cash inflows – cash outflow
= $199,751.32 - $120,000
= $79751.32
Payback period

Year
Net Cash
flows
Cumulative
cash flows
0 -$1,20,000 -$1,20,000
1 $25,000 -$95,000
2 $49,000 -$46,000
3 $58,000 $12,000
4 $67,000 $79,000
5 $76,000 $1,55,000
Payback period = 2 + (46000/58000)
= 2.79 years
Discounted payback period
Year
Present value
of cash flows
Cumulative
cash flows
0 -120000 -120000
1 $22,727.27 -$97,272.73
2 $40,495.87 -$56,776.86
3 $43,576.26 -$13,200.60
4 $45,761.90 $32,561.30
5 $47,190.02 $79,751.32
Discounted payback period = 3+ (13200.6 / 45761.9)
= 3.2 years
iii) Annual net cash flows for Project Y
Year 0 1 2 3
Cash inflow $50,000 $80,000 $1,00,000
Less: Variable cost $5,000 $8,000 $10,000
Less: Fixed cost $5,000 $5,000 $5,000
Less: Instalment
cost $10,000
Operating income $30,000 $67,000 $85,000
Initial investment -$1,20,000
Annual net cash
flows -$1,20,000 $30,000 $67,000 $85,000
iv) Payback period, NPV, Discounted payback period for Project Y

Year 0 1 2 3
Annual net cash flows -$1,20,000 $30,000 $67,000 $85,000
Multiply: Cost of capital $1 $0.909 $0.826 $0.751
Present value of cash
flows -$1,20,000 $27,272.73
$55,371.9
0 $63,861.76
NPV = Present value of cash inflows – cash outflow
= $146506.39 - $120,000
= $26,506.39
Payback period
Year
Net Cash
flows
Cumulative
cash flows
0 -$1,20,000 -$1,20,000
1 $30,000 -$90,000
2 $67,000 -$23,000
3 $85,000 $62,000
Payback period = 2+ (23000/85000)
= 2.2 years
Discounted payback period
Year
Present
value of
cash flows
Cumulative
cash flows
0 -$1,20,000 -$1,20,000
1 $27,272.73 -$92,727.27
2 $55,371.90 -$37,355.37
3 $63,861.76 $26,506.39
Discounted payback period = 2+ (37355.37 / 63861.76)
= 2.58 years
v) For a project to be accepted in capital budgeting it is necessary for the project to have a
positive NPV, the payback and discounted payback should be within the life time of the
project. The capital budgeting techniques results for projects X and Y is as below:

Techniques Project X Project Y
NPV $79751.32 $26,506.39
Payback period 2.8 years 2.2 years
Discounted payback period 3.2 years 2.58 years
From the above table we see that both projects have positive NPV and payback periods are
within the lifetime of the projects. However both the projects are mutually exclusive. For
mutually exclusive projects, the project with the highest NPV is selected. Mutually exclusive
projects means only project can be selected from the given options. Since Project X has a
higher NPV, hence Umang Trading Ltd should accept Project X.
Bibliography
IRD. (n.d.). Income Tax Rates. Retrieved September 18, 2017, from Inland Revenue:
http://www.ird.govt.nz/how-to/taxrates-codes/rates/itaxsalaryandwage-
incometaxrates.html
Tradingeconomics. (n.d.). New Zealand Corporate Tax Rate. Retrieved September 18, 2017, from
Trading Economics: https://tradingeconomics.com/new-zealand/corporate-tax-rate