Financial Decision Making

This document provides information on financial decision making, including topics such as costing, budgeting, investment appraisal, sources of finance, and management of working capital. It includes formulas, calculations, and interpretations. The document also discusses advantages and disadvantages of using the payback period method. Study material and solved assignments on these topics are available on Desklib.

FINANCIAL DECISION
MAKING

Table of Contents
MAIN BODY...................................................................................................................................2
Q1. Costing.................................................................................................................................2
Q2. Budgeting.............................................................................................................................4
Q3. Investment appraisal.............................................................................................................5
Q4. Sources of finance and management of working capital......................................................7
REFERENCES................................................................................................................................9

MAIN BODY
Q1. Costing
A
Variable manufacturing cost per unit
Total variable manufacturing cost per unit
Raw material 16
Direct labor 12
Total variable manufacturing cost per unit 28.00
Budgeted fixed manufacturing overhead rate per unit
Budgeted fixed manufacturing overhead
Manufacturing overhead 75000
Budgeted production 6000
Budgeted fixed manufacturing overhead 12.5
Total manufacturing cost per unit
Total manufacturing cost
Total variable cost 28.00
Fixed manufacturing overhead 11.90
Total manufacturing cost 39.90
B
Total variable cost per unit
Total variable cost per unit
Raw material 16
Direct labor 12
Fixed manufacturing 11.90
Total 39.90
Total cost per unit
Total cost per unit

Raw material 16
Direct labor 12
Selling (variable) 6
Fixed manufacturing overhead 11.90
Selling (fixed) 3.81
Total cost per unit 49.71
C
Breakeven point
BEP Formula Amount
SP per unit 55
Less: VC per unit 34
Contribution 21
BEP in units FC/ Contribution 4714.29
FC 99000
Contribution 21
BEP in amount 259285.71
SP 55
Margin of safety
Particular Formula Amount
Margin of safety
Actual sales- breakeven
point 1585.71
Budgeted sales 6300
BEP 4714.29
D
Profit statement using marginal costing
Marginal costing
Sales 6300*55 346500
Less: variable cost 6300*34 214200
Contribution 132300
Less: fixed cost
Manufacturing overhead 75000

Selling and administration 24000 99000
Net profit 33300
Q2. Budgeting
Particulars Basic Deluxe
Material M 24 20
Material S 0 8
Unskilled labor hours 16 24
Skilled labor hours 6 12
Increase in material price 25.00%
Increase in labor rate 5.00%
Production budget (units)
Material
M
Material
S
Sales in units (200/11*6) 109 91 (200/11*5)
+ Closing inventory 300 20
Total production required 409 111
- opening inventory 40 40
Units to be manufactured 369 71
Material usage budget (kg)
Material
M
Material
S
Budgeted Production Units 369 71
Material usage per unit of
output 11 1
Material usage 4060 71
Material purchase budget (kg)
Material
M
Material
S
Units to be Produced 369 71
Direct Materials Per Unit 11 1
Production Needs 4060 71
Desired Ending Inventory 300 20
Total Needs 4360 91
Less: Beginning Inventory 40 40
Direct Materials to be
Purchased (in kg) 4320 51
Cost of each unit 5 8

Total Purchase Cost 21600 428
Labor usage budget (in hours) Basic Deluxe
Planned Production in Units 369 71
× Direct Labor Hours per
Unit 2.5 4
Budgeted Direct Labor Hours 923 284
Labor budget (in £) Basic Deluxe
Planned Production in Units 369 71
× Direct Labor Hours per
Unit 2.5 4
Budgeted Direct Labor Hours 923 284
× Cost per Direct Labor Hour 8.4 12.6
Budgeted Direct Labor Cost 7751 3574
Q3. Investment appraisal
A. Accounting rate of return
Year Cash flow
Year 1 350000
Year 2 200000
Year 3 50000
Average profit 200000
Average investment 250000
ARR 80%
Interpretation- with help of average rate of return it was evident that the ARR of the project is 80
%. This states that if company will invest in the machinery then it will get good return and more
than 15%. Thus, it is advisable for the company to invest in the machinery.
B. Payback period method
Year Cash flow
Cumulative cash
flow
Year 1 350000 350000
Year 2 200000 550000
Year 3 50000 600000

Amount to be recovered 150000
0.75
Payback period 1.75 years
Interpretation- from the above calculation it is clear that the payback period is 1.75 years. This
suggest that the invested amount in machinery will be recovered back in 1 year and 8 months
approximately. This in turn reflects the as the company will recover its initial investment and
after that period company will start earning profits.
C. Net present value method at 15% discount rate
Year Cash flow
Discount rate
@15%
Discounted cash
flow
1 350000 0.87 304347.83
2 200000 0.76 151228.73
3 50000 0.66 32875.81
Total discounted cash
flow 488452.37
Initial investment 500000
NPV -11547.63
Interpretation- from the above table it is clearly visible that the net present value of the
investment is in negative. The negative NPV states that the present value of cost exceeds the
present value of revenue on the basis of discounted rate.
D. Internal rate of return
Year Cash flow
Year 0 -500000
Year 1 350000
Year 2 200000
Year 3 50000
IRR 13%
Interpretation- with the assistance of above calculation it is visible that IRR of the project is 13
% and this states that the return which company can earn is around 13 %. With the help of this
value the investor can analyse that whether they need to invest in the project or not.

E. Advantages and disadvantages of using payback period method
Advantages
 The major advantage of using payback period method for capital budgeting is that this is
more reliable technique and assist in deciding that after how much time the initial
investment can be recovered.
 Another benefit of using payback period is that risk of investment can be assessed with
help of payback period method.
Disadvantages
 The major drawback is that this ignores time value of money at time of calculating
payback period method.
 Another drawback of payback period is that it does not take into consideration the cash
inflow after the payback period.
Q4. Sources of finance and management of working capital
Sources of external finance
For the initial investment the amount of money is large and it is not possible that
company has all the money with them. Thus, here the company will have to borrow money for
the installation of the investment in the machinery. Thus, for this there are many different types
of sources from which finance can be arranged which are as follows-
Financial institution and bank- this is the major source of finance which can be used in
order to finance the initial investment amount. Under this source the company will take loan
from the financial institution or the bank. In this the company will get the required sum of money
and for this they will have to pay interest over the loan amount. This is a good source of finance
for company as this can be repaid in instalment and also will can be paid in future when the
machine start yielding profits (Landström, 2017).
Issue of shares- this is another major source of finance which can be used in order to
arrange finance for the purchase of machinery. Under this source of finance, the company issues
the shares of company to the general public. Then the amount collected from the issue of shares
can be used in order to purchase the machine.
Debenture- this is another type of source from which external finance can be arranged for
the installation of the new machine within the company. Under this source of finance, the

debenture is issued to the general public and with that money company can install the machines
(DeGennaro and Dobson, 2017).
Source for additional cash or short term finance
Along with the money to be borrowed for the installation of machine, in the same manner
the money will be required for the running and operating of the machinery till it is not in position
of earning. Hence, for this some short term sources of finance are as follows-
Short term loan- this is a source of finance under which the company takes some short
term loan in order to manage the day- to- day operations of the company. Under this source the
company takes loan for short period of time and meet all requirement and pay back the loan.
 The major advantage of using short term loan is that money is arranged in very less time
and the interest amount is also very low.
 The major drawback is that more of short term financing can have a negative impact over
the credit score of the company.
Trade credit- this is another source of short term finance under which the company asks
for credit extension by the supplier of goods. This credit extension is asked by the supplier as for
the repayment of the credit the company will be in a position to pay later (Lewis and Liu, 2020).
Thus, this credit provides company time to utilise that money in some other useful activity and
pay later.
 The major benefit of using trade credit is that this assist the company in better working
and running of business. The major reason underlying this is that when time is provided
by supplier for repayment then in that case company can use that money in other
activities.
 The major drawback is that if the company will not pay back the trade credit then the
supplier can take legal action against the company and also goodwill of company will
decrease.

REFERENCES
Books and Journals
DeGennaro, R.P. and Dobson, E.L., 2017. The future of angel finance. In THE WORLD
SCIENTIFIC REFERENCE ON ENTREPRENEURSHIP: Volume 2: Entrepreneurial
Finance—Managerial and Policy Implications (pp. 91-107).
Landström, H., 2017. Advanced introduction to entrepreneurial finance. Edward Elgar
Publishing.
Lewis, M. and Liu, Q., 2020. The COVID-19 Outbreak and Access to Small Business
Finance. 1. 1 Managing the Risks of Holding Self-securitisations as Collateral 2. 11
Government Bond Market Functioning and COVID-19 3. The Economic Effects of Low
Interest Rates and Unconventional 21 Monetary Policy 4. Retail Central Bank Digital
Currency: Design Considerations, Rationales, p.58.