Capital Budgeting Analysis

This assignment content covers various topics in economics and finance. In the economic aspect, it discusses production processes, opportunity cost, UK standard international classification, demand curve shifts, market types (monopoly and monopolistic), public goods, and circular flow of income. It also explains the determinants of market interest rates and financial statements. In the finance aspect, it covers capital budgeting, net present value method for project selection, and yield curves. The assignment concludes by summarizing the key points and providing references.

Financial & Economic literacy for managers

Introduction
In this present paper, we will analyze the impact of Financial and Economic Literacy for
Managers. In the first phase, we will describe the classification of production, opportunity cost,
evaluation of UK standards, demand curves and income and substitution effect. In the second
phase, we will explain types of markets, public goods, four macroeconomic policies and the
circular flow of income. In the third phase, we will describe four areas of finance, determinants
of market interest rates, formats of four basic financial statements, ratio analysis from the
financial statement of 2014. In the last phase, we will describe the importance of capital
budgeting, use of NPV technique, yield curve and the selection of projection among the two
projects.
Q1.
a. The production is defined as the process of converting the input into output. Following
are the three classifications of production process:
1. Job production
In this process, non-standardized products are produced according to the orders
received from the consumers. The machines and equipment are designed in such a
way that they can suit according to the requirements of a particular job (Jonsson et
al., 2015). For example: Stationary machinery layout.
2. Batch production
It is defined as the process in which repetitive production of goods take place, and
the order is received in advance. The job production is similar, but the quantity
varies. For example: Motor Manufacturing, Tinned food.

3. Flow production
It is defined as the process of manufacturing in a lot of standardized products. The
flow of production is continued and progressive. For example: Manufacturing of
cars.
b. Opportunity cost is defined as the potential benefit which is given up by choosing one
option over another. It is not allocated in the books of accounts but takes an important
role in decision making for selecting the project. It is a cost of choosing another option
between two or three options. The opportunity cost can be explained in terms of time,
mechanical output and others. It is the cost of missing an opportunity. For example The
raw material purchased can be purchased from two suppliers, company A and B. The cost
of purchasing from A is $10,500 and from B is %10,300. Then, the opportunity cost of
purchasing from A $100 in about B. The owner’s decision of purchasing from A will
consider the cost of lost opportunity to save $100.
c. The UK standard industrial classification was introduced in the UK in 1948. The purpose
of classification is to divide the business establishments and other statistical units on the
basis of economic activities in which they are engaged (Jones et al., 2013. The
framework of classification provides tabulation, presentation, collection and analysis of
data in monetary terms.It is evaluated by a hierarchy of five digit system. The UK SIC is
divided into 21 sections, and each is denoted by the single letter from A to U. The letters
are uniquely defined by next breakdown. The divisions are divided into three digit groups
then into four digit classes and again into subclasses if required.

d. The demand curve is defined as the curve which represents the demand for a particular
goods and services on a particular price. The graphical representation of demand curve
includes the price on Y-axis and quantity on the X axis. Following is the use of shift in
demand curve and movement along the demand curve.
 Shift in demand curve
It is used to determine the change in consumer’s preference. If the consumers are
satisfied and interested in buying the product on the prevailing price then the
demand shifts to the right. Similarly, if the consumers are not satisfied with the
product at a prevailing price, then the demand shifts to the left. The factors which
affect the demand curve include the change in consumer’s preference,
expectations, change in trend, income, and others.
 Movement along demands curve
The moving demand curve takes place by changes in price which affect the
demand due to which movement takes place along with the curve. It is used to
check the demand for change in price.

e. The increase in price has two effects which include income and substitution effect.
 Income effect
The income effect is used to determine how much increase in demand will
decrease the demand for goods and services.
 Substitution effect
The increase in demand forces the consumers to choose alternative goods. The
effect measures how much increase in price affects the consumers to select
alternate goods.
Q2.
a. The market is defined as the place in which different parties are engaged in
exchange for money. Following are the two types of markets:
 Monopoly market:
It is defined as the market in which there are a single seller and a large number of
buyers. The producer has control over a price. There is no competition in a

market, and the profit margin is high because the entry and exit are restricted. For
example: Federal Trade Commission.
 Monopolistic market:
It is defined as the market in which there are a large number of buyers and sellers.
The goods produced are differentiated by different marketing strategy which
includes advertising. For example: soap and detergent business.
b. Public good is defined as the goods which can be consumed by an individual
without affecting its availability for others. It is consumed by the society as a
whole, and it is financed by tax revenues. It is also known as non-rivalrous and
non-excludable. For example Public parks.
c. Government intervention is defined as the regulatory action which is taken by the
government through interference in the decision making of an organization or
individual relates to the social and economic matters. Following are the three
ways through which government intervenes in the market:
 Government intervention through rental market
The government can intervene through the culture of renting for accessing
accommodation. For example: The 54.1 percent of households in Germany are
renters due to the intervention of government in the marketplace.
 Government intervention through housing

The government can intervene through providing housing facilities. For example
House and development, the board provides approximately eighty percent housing
in Singapore.
 Government intervention through Multi-person housing
The low demand can be attained through limiting the size of a population and
underlying the demand for houses. For example: In Australia, the multi-house
system encourages the government intervention.
d. Following are the four macroeconomic policy objective which is perused by the
government:
i. Stable and sustainable economic growth and development
The stability and sustainability of economic growth refer to the growth in
national income which will be sustained in the future as well (Tomlinson
et al., 2014). The primary goal is to increase literacy rate, high standard of
living and others.
ii. Full employment
It refers to the situation in which the labor force is fully employed in
productive work.
iii. Stable prices
It refers to the mean average rise in price with a small amount.
iv. Balance of payment equilibrium and stability in exchange rate
The stability in the payment is required, which is a difference of domestic
transaction regarding the international exchange.

e. Circular flow of income
It is defined as the process in which the national income and expenditures are
moving in a circular flow.
 The inner flow includes inflow and outflow between household and firms. The
household provides services to the firm, and the firm provides goods. The
household provides land, labor and capital and firm provide rent, income, and
wages.
 The withdrawals include savings, taxation, and imports.
 The injections include capital spending, government expenditure, and export
expenditure.

Q3.
a. Following are the four major areas of finance:
a. Public accounting:
It includes audit, taxation, forensic, IT and system audit. The audit is mainly done
to render advice on the internal controls and the practices of accounting. The tax
is required to prepare tax returns. Forensic is used to investigate the potential
fraud and make recommendations for its preventions. The evaluation of
workflows and control in the system.
b. Corporate accounting:
It includes three stems mainly: audit and compliance, financial accounting, and
management accounting. The financial accounting is used to make journal entries,
reconciliations, preparation of financial statements and its analysis.
c. Corporate finance:
The corporate finance includes treasury, management accounting, and FP&A. The
treasury is used to manage banking relations, debt compliance and others. The
management accounting is used to take business decisions with budgets, forecasts
and cost analysis (Damodaran et al., 2016). FP&A includes project analysis,
return on investment and others.
d. Investment banking:
The investment banking includes money management, merger and acquisition,
private equity and venture capital. The money management is handled by money
manager through hedging of funds and investment banking. The merger and

acquisition help to go public. The private equity is used to buy investments. The
venture capital is used to find funds for the start-up of business.
b. Following are the determinants of market interest rates:
 Business risk
It refers to the risk associated with the future cash flows of a company.
 Financial risk
The Financial risk relates to the risk associated with the uncertainties of a
company. It includes the ability of a company to pay its debts.
 Liquidity risk
It refers to the risk associated with the liquidity of security. Higher the liquidity
then lowers the interest rates.
 Country-specific risk
It refers to the risk associated with the uncertainties and economic conditions of
the foreign economy.
 Expected inflation
The inflation rate reduces the purchasing power of due to which the interest rate
tends to rise.
 Liquidity premium
The less liquid security compensate the holder by order at a high rate of interest.
 Real-risk free rate
It considers no risk, but it reflects differences in timing.

c. Following are the four basic financial statements:
a. Income statement:
It is used to calculate the revenue, expenses, and profit/loss of a financial year.
b. Balance sheet:
It represents the assets, liability, and equity of a company in an accounting year.
c. Statement of cash flows:
It represents the cash inflow and outflow of a company in a particular accounting
year.
d. Statement of retained earnings:
It is mainly used in auditing financial statements packages.
d. Following is the calculation of ratios:
 Liquidity ratios
The current ratio is used to analyze the liquidity of a company. The ideal ratio is
2:1. The formula for calculating current ratio is current assets divided by current
liability.
The current ratio is 0.57 (Mark et al., 2014).
The current rate is satisfactory because it is near to 2:1.
 Market value ratios
The earning per share is used to calculate the earnings of a single share. The
formula for calculating earnings per share is net income divided by a number of
outstanding shares.
The Earnings per share is 0.64 (Mark et al., 2014).

 Debt management ratios
The debt equity is used to analyze the leverage of a company. Te debt ratio is
calculated by dividing debt by equity.
The debt-equity ratio is 0.61 (Mark et al., 2014).
The higher ratio indicates that the company is aggressive in financing its growth.
 Asset management ratios
The asset turnover is used to analyze the sales of a company from its assets. The
formula for calculating the ratio is sales divided by total assets.
The asset turnover ratio is 1.33 (Mark et al., 2014).
The higher ratio indicates that the performance of a company is better.
Q4.
a. Capital budgeting is defined as the process of taking decisions for long term investment.
It plays an important role because it creates accounting and measurability. The capital
budgeting is used for taking long-term investment decisions which require the long-term
investment of funds and time (Bierman et al., 2012. Following is the process of taking
capital budgeting decision:
1. Develop and create long-term strategic goals
2. Find out new investment projects
3. Forecast and calculate future cash flows
4. Facilitate the transfer of information
5. Screening and controlling of expenditure
6. Creation of decision

b. Net present value is defined as the method of capital budgeting. It is the difference
between present values of inflow less present value of outflow. It is also known as
discounted cash flow method. It is used to take the decision of accepting or rejecting the
project. It the net present value is positive then the project is accepted if the value is
negative then the project is rejected.
c. The yield curve is defined as the graphical representation of yield of similar-quality
bonds against its maturities. It is also known as the term structure of interest rates
(Greenwood et al., 2015). There are four types of a yield curve.
1. It refers to the yield on longer-term bonds which will continue to increase.
2. It represents the short-term yields are higher than long-term yields.

3. The flat yield curve is made when there is less difference in short and long term
yields.
d. Project selection on the basis of net present value:

NPV (Project A) = $15,625[(1/0.10)-(1/0.10*(1+0.10)^5)]-$50,000
= $15,625(3.7908)-$50,000
=$9,231.25
NPV (Project B) = $99,500(1/1.10^5)-$50,000
= $99,500(0.6209)-$50,000
=$11,779.55
Thus, the net present value of project B is higher than A. So, project B is selected.

Conclusion
The paper is segmented into two aspects namely economic and finance. In the economics, we
have discussed three production process namely job production, batch production and flow
production. The opportunity cost is defined as the cost of missing an opportunity. The main
purpose of the UK standard international classification is to provide the framework in which all
the business establishments are divided by economic activities. The shift in demand curve is due
to change in taste and preferences of consumers and movement along demand curve is due to
change in price. The increase in demand force consumers to buy substitute goods and the income
effect include at what price the income is affected. Two types of market explained are a
monopoly and monopolistic. The public goods are mainly the goods which are not affected by
the use of an individual. The inner circular inflow includes household and firms. The four major
areas include public accounting, corporate accounting, corporate finance, and investment
banking. The determinant of market interest rate includes business risk, liquidity risk, financial
risk country-specific risk, expected inflation and liquidity premium. The four financial
statements include income statement, balance sheet, statement of cash flows and statement of
retained earnings. The ratio analysis is done on the basis of four ratios. The capital budgeting is
important because it creates accountability and measurability. The net present value is used to
select the project on the basis of accepting the positive NPV project and reject negative NPV
project.

References
Greenwood, R., Hanson, S.G. and Vayanos, D., 2015. DP11005 Forward Guidance in the Yield
Curve: Short Rates versus Bond Supply.
Jonsson, H. and Rudberg, M., 2015. Production System Classification Matrix: Matching Product
Standardization and Production-System Design. Journal of Construction Engineering and
Management, 141(6), p.05015004.
Jones, J., 2013. UK Service Industries: definition, classification, and evolution. Research Note
Office for National Statistics. London: ONS.
Damodaran, A., 2016. Damodaran on Valuation: security analysis for investment and corporate
finance (Vol. 324). John Wiley & Sons.
Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of
investment projects. Routledge.
Tomlinson, J., 2014. British Macroeconomic Policy Since 1940 (Routledge Revivals). Routledge.
Mark and Spencer, (2014). Annual report and finnacial statement 2014. mark and spencer,
pp.89-91.