Business Finance - Business Report

This report discusses investment appraisal techniques and funding methods. It includes computation of payback period and net present value for all projects, ranking of projects using both payback and net present value method, and recommendation on best and profitable projects. It also discusses the strengths and weaknesses of payback and net present value method, and five qualitative factors which directors need to consider before making a final decision. Additionally, it includes a variance analysis statement for the variable cost element.

Business Finance - Business
Report

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................3
TASK...............................................................................................................................................3
(A)....................................................................................................................................................3
(a) Computation of Pay Back period for all projects..................................................................3
(b) Computation of Net present Value for all projects................................................................4
(c) Ranking of project using both payback and net present value method.................................5
(d) Recommendation on best and profitable projects.................................................................6
(e) Strength and Weaknesses of payback and net present value method....................................6
(f) Five qualitative factors which directors need to be considered before making final decision
.....................................................................................................................................................7
(B)....................................................................................................................................................8
(a)................................................................................................................................................8
(b)................................................................................................................................................8
C.......................................................................................................................................................9
a. Variance analysis statement for the variable cost element......................................................9
b. Explanations of identified variance in the above statement..................................................10
D.....................................................................................................................................................12
CONCLUSION..............................................................................................................................13
REFERENCES..............................................................................................................................15

INTRODUCTION
The present report is based on various tools and techniques associated with business
finance will be discussed that are useful in making decisions and establishing control. First of all,
investment appraisal techniques will be applied to a number of projects in order to provide
ranking and making decisions in case of mutually exclusive projects (Fandel Hofmann and
Schreck, 2020). Secondly, various funding methods will be critically evaluated along with
discussing the link between investment and financing decision made for the acquisition of a
company. Further, a variance analysis statement will be prepared with reference to the
production of chemical product along with explaining the causes of variances occurred. At last,
centralized and decentralized procurement will be differentiated on different bases along with
highlighting their respective benefits.
TASK
(A)
(a) Computation of Pay Back period for all projects
Formula of Pay back period (in case of even cash flows): Initial investment / Annual net cash
inflows.
Pay back period of Project A to F (even cash flow)
Projects
Initial
Investment
Annual cash net
inflow Pay-back period
A 1000000 300000
3.3 years
(£1000000 / £300000)
B 400000 100000
4 years
(£400000 / £100000)
C 700000 200000
3.5 years
(£700000 / £200000)
D 614500 100000
6.1 years
(£614500 / £100000)
E 500000 120000 4.1 years

(£500000 / £120000)
F 560000 100000
5.6 years
(£560000 / £100000)
Pay back period of Project G (uneven cash flow)
Year Annual cash flows (£) Cumulative annual cash flows
(£)
0 -200000 -200000
1 100000 -100000
2 100000 0
3 80000 80000
4 80000 160000
5 80000 240000
6 80000 320000
Formula of pay back period (in case of uneven cash flow): Year before full recovery + UN-
recovered cost at the start of the year / Cash flow during the year
= 1 + (100000 / 100000)
= 1 + 1 = 2 years.
(b) Computation of Net present Value for all projects
Net Present value formula = Present value of cash inflow — Present value of cash outflow or
Initial investment
Net present value of Project A to F
Projects Initial
investment
(a)
Annual cash net
inflow
(b)
Annuity factor
(c)
Present value
of cash inflow
(d) = (b) * (c)
Net Present
Value
(e) = (d) - (a)
A 1000000 300000 4.36 1306590 306590

B 400000 100000 3.17 316990 -83010
C 700000 200000 3.79 758160 58160
D 614500 100000 6.14 614460 -40
E 500000 120000 4.87 584208 84208
F 560000 100000 6.14 614460 54460
Net present value of Project G
Year Annual Cash net
inflow (£)
Discounting factor @
10%
Present Value of
cash inflow (£)
1 100000 0.91 90910
(100000 * 0.91)
2 100000 0.83 82600
(100000 * 0.83)
3 80000 0.75 60080
(80000 * 0.75)
4 80000 0.68 54640
(80000 * 0.68)
5 80000 0.62 49680
(80000 * 0.62)
6 80000 0.56 45120
(80000 * 0.56)
Total present value of cash inflow 383030
NPV = 383030 – 200000 = 183030

(c) Ranking of project using both payback and net present value method
Projects Ranking as per Payback
period
Ranking as per net present
value
A 2 1
B 4 7
C 3 4
D 7 6
E 5 3
F 6 5
G 1 2
(d) Recommendation on best and profitable projects
In the case when all projects are mutual exclusive, then in such situation a project with
the highest net present value or lowest pay back period is to be selected. The reason behind the
recommendation of NPV is such that it consider the time value of money concept. It means NPV
method covert the future cash flows into present cash flows using discounting factor or annuity
factor which is generally an important aspect for identifying profitable projects. Thus, it is
advisable to K plc that they should opt for the NPV method to identify and select best and
profitable projects (Ediwodjojo and Ginting, 2018). On this basis, Project A is suitable and
profitable to K plc company and they can invest money in this project.
(e) Strength and Weaknesses of payback and net present value method.
Strength of Payback period:
 The formula to compute the period in which company will recover its full initial
investment is straightforward.
 It is also one of the best method for the evaluation of projects quickly. It means the
project with lower payback period is best and profitable to company.

 It also helps in reducing the risk of losses which is basically a part of investments
(Novaldi, Zaenal and Yuliadi, 2019).
Weaknesses of Payback period:
 It does not consider the time value of money concept for the computation of pay back
period (Ediwodjojo and Ginting, 2018).
 This method also does not consider the amount of cash inflows after the payback period.
Strength of Net Present Value:
 This method incorporates the time value of money concept and discount the future cash
inflows in present using discounting factors.
 This is one of the simplest way to determine the value of the projects it will deliver to
company (JESSIKASARI and Siswoyo, 2018).
 One of the strength of this method is that it considers the company's cost of capital.
Weaknesses of Net Present value:
 The accuracy of results is depends upon the quality of input used in calculations.
 In case of different sizes of projects, comparing and estimating the best project is not
possible with this method.
 It does not consider qualitative factors.
(f) Five qualitative factors which directors need to be considered before making final decision
Before making any final decision, it is advised to the directors of K plc company that
they should consider the five qualitative factors which are as follows:
 Products: It is important for the director of K plc that they should consider whether the
product which they are going to sell to customers are safe and healthy or not in order to
manage their brand value in market.
 Community: This is another factor which have to be considered by K plc director. This
involves taking care of environment, donating funds for the welfare of society is
important to increase brand value of K plc in the eye of local community (Naveenkumar
and Baskar, 2020).

 Investors: Investors are the one who invest their money in the company so it is important
for the director that before making any decision they have to make sure that investors will
get higher return (Cumming and Groh, 2018).
 Customers: They are the one who are going to buy the products and service of K plc.
Thus, the director need to analyse the demand and preference of customer before making
any decision as customers preferences and taste changes over the period.
 Morale: Employees morale play significant role in productivity and efficiency of
production area of business (Naveenkumar and Baskar, 2020). Thus, it is important for K
plc that they should consider this factor as well.
(B)
(a)
The three alternative method of funding which is advisable to the director of K plc along
with its critical analysis and evaluation are as follows:
 Debt financing: This is the first method or source of financing in which director of K plc
can generate the funds from the market by issuing debentures. The benefit of using this
alternative is that the company can generate funds and also reduce their taxation cost. It is
because debt financing is provided tax saving benefit but on the other hand it also causes
loss to company (Mamo, Seychell and Grima, 2019). It is because the company need to
pay fixed amount of interest even in case of net loss.
 Retained earnings: This is another alternative of funding in which director of K plc
retained the net profit within the company as reserves rather than distributing it to
shareholders in the form of dividend. This is best for company to generate funds
internally. However, with this the company can't earn the interest income which they can
do it by investing such money in investment projects rather than retaining it within
company. It will not provide interest income benefit to K plc.
 Bank Loan: Taking the loan from banks is also one of the best sources of generating
funds. It is because director of K plc able to get the high amount of bank loan in low
interest rate easily from UK local and central banks. But, in order to get this loan the
company need to give some security such as fixed assets (Pham and et.al., 2020). This

also increase the chance of losing their assets in case if the company fails to repay the
loan to the company.
(b)
There is huge link between the company funds raising from above mentioned sources and
acquisition of unlisted company. It is because in order to acquire the unlisted company, K plc
need to pay purchase consideration to the acquiree company. So, at that time, acquirer company
can use the funds generate from debt capital, retained earnings and bank loan to pay amount of
purchase consideration to acquiree company. In this way, it can be said that finance and
investment decision are always linked with the acquisition of another company or unlisted
company. The unlisted company are those companies which are not listed on London stock
exchange or any other stock exchange (Paulet, 2018). Generating funds from various sources
helps the company to expand its business to the next geographical region or area. Also, the
company can also use this money to invest in new projects such as new plant and machinery the
impact of which they can increase their production level.
C.
a. Variance analysis statement for the variable cost element
PARTICULARS BUDGETED ACTUAL VARIANCES
Variable costs Qty Price Amoun
t in £
Qty Price Amoun
t in £
Absolute
in £
%
Direct Material
cost
S 9000 3 27000 8500 3.5 29750 -2750 -10.19%
T 18000 1 18000 18000 1 18000 0 0
Direct Labour costs 27000 10 270000 28000 10.5 294000 -24000 -8.90%

Variable overheads 27000 6 162000 - - 165000 -3000 -1.85%
Working notes:
Calculation of budgeted direct material costs = Actual production units * budgeted per unit cost
For S
Budgeted per unit cost of S= 1 kg * £3 = £3
Budgeted quantity for 9000 units of S = 1 kg per unit * 9000 units = 9000 kg
Budgeted direct material costs of S = 9000 * £3 = £27000
For T
Budgeted per unit cost of T= 2 kg * £1 = £2 or £1 per kg
Budgeted quantity needed for 9000 units of T = 2 kg per unit * 9000 units = 18000 kg
Budgeted direct material costs of T = 18000 * £1 = £18000
Budgeted Labour hours
Budgeted per unit labour cost = 3 Hours * £10 = £30
Budgeted labours for 9000 units = 3 Hours * 9000 Units = 27000 Hours
Budgeted direct labour costs = 27000 Hours * £10 = £270000
Budgeted variable overheads
Budgeted per unit variable overheads = 3 Hours * £6 per hour = £18 per unit
Budgeted variable overheads for 9000 units in terms of hours = 3 Hours * 9000 units = 27000
hours
Budgeted variable overheads in terms of £ = £6 * 27000 hours = £162000
b. Explanations of identified variance in the above statement
From the above statement, it has been identified that majorly there are unfavourable variances
for K Plc. in the areas such as direct material costs of S, direct labour costs and variable
overheads. However, the direct material costs associated with T is 0 which indicates that the
what has been budgeted was accurate and useful for the management as their performance in this
area is according to the budgeted one. For the other three unfavourable variances, the
explanations are as follows:
Direct material cost variance: This variance has been calculated for material S where the
difference has been obtained between actual cost incurred towards buying material S and the

standard cost associated with this material on the basis of actual production activities (in terms of
units). The cause of variance could be any like the difference between budgeted and actual
quantity of material used in the production of actual units. Here the quantity of material used is
favourable as the actual quantity of 8500 Kg is less than the budgeted quantity of 9000 Kg but
still there are unfavourable variance obtained for the cost of material S due to the variation in
actual and budgeted price per Kg of material S that is £3.5 and £3 respectively (Lueg, 2018). The
variation occurred in the price of direct material S is known as unfavourable direct material price
variance while the variation that take place between the actual and budgeted quantity of material
used in production of 9000 units is known as favourable direct material usage variance.
The reason for the variance occurred in price of direct material (S) could be the size of
order placed. As the consumption of S material has reduced in actual production activities and
accordingly there would be less quantity needed for which there may be less discount available
from supplier. This lead to paying more for the purchase of direct material (S) and accordingly,
there are unfavourable direct material price variances (Marzuki, Abdul Rahim and Ismail, 2019).
Another cause of this variance is the increase in inflation in the market due to which the general
price level has increased and resulted in higher costs of inputs like direct material. The last
reason of such unfavourable variances is that the usage of high or premium quality materials in
the production activities for which higher rates are paid. The reason for favourable direct
material usage variance could be the use of better technology and higher efficiency of labours
involved in the production process.
Due to all these reasons mentioned above, there is an unfavourable direct material price
variance of £2750 in absolute terms or -10.19% in relative terms.
Direct labour cost variance: There are unfavourable variance obtained for the costs associated
with the direct labour involved in the production of chemical product. From the above statement
it can been seen that both labour efficiency and labour rate variance are unfavourable for K plc in
producing chemical product which leads to unfavourable direct labour cost variance. Labour
efficiency variance can be identified through the difference in actual hours works against the
budgeted hours on the basis of actual quantity produced (OLADEJI, 2018). Here the budgeted
hours are 27000 while the actual hours worked is 28000 which indicates that the efficiency of
labour has reduced. The causes of reduction in labour efficiency are breakdowns or use of faulty

equipment, poor supervision and motivation and inclusion of inexperienced workers in the
process of production. In addition to this, there are also variances that can be seen through the
variation in labour rates paid per hour which has also contributed towards unfavourable direct
labour cost variance. The cause of this variance could be hiring more skilled and experienced
workers and effective negotiation carried out by labour unions which leads to paying more per
hour to the labourers.
Direct variable overhead variances: There is again unfavourable variance obtained for variable
overheads amounted to 3000 in absolute terms and -1.89% in relative terms. This variance in
variable overhead are related to the use of indirect labour in the production process and costs
associated with the same. The cause could be both higher actual hours worked and higher rates
paid to labourers involved (Legaspi, 2019). The reasons due to which the variance in hours and
rates occurred are use of inefficient technology, poorly motivated or unskilled workers which
leads to reduced efficiency of indirect labours. Also, the increase in labour rate may be resulting
from increase in industrial wage rate or effective negotiation from unions.
D.
Centralized procurement refers to the system where either the divisional level or company
headquarters are responsible for making decisions related to buying of raw materials and other
supplies (Aboelazm and Afandy, 2018). On the other hand, decentralized procurement refers to
that system of buying where decisions related to purchasing of raw materials and supplies are
made by or delegated to actual users in case where organizational activities are spread over
numerous plants and locations.
There are various bases on which centralized and decentralized procurement can be
differentiated from each other, such as the following:
Basis of difference Centralized procurement Decentralized procurement
Control There is effective control over buying
exercise imposed by top-level
management.
As purchasing is done by
actual users at distinct
locations, therefore effective
control is not possible
(Petersen, Jensen and Bhatti,

2020).
Economies of scale Large scale purchase made at company
headquarters or divisional level allows
for economies of scale (Aboelazm and
Afandy, 2018).
Small quantities bought at
different locations results in no
economies of scale.
Skills of purchaser Purchasing officers are highly skilled
and experienced and thus ensures
purchasing specialization.
Skills and experience of
purchasing officer at distinct
location is very limited and
thus there is no specialization
in purchasing.
Uniformity /
differences
As a single purchasing made at
divisional level or company
headquarters, there are uniformity in
procurement.
Differences in procurement
occurs due to purchasing made
at number of locations.
Benefits of centralized purchasing
 There are lower prices resulting from the availability of economies of scale.
 With the buying in bulk quantities, the buyer's position in bargaining get strengthened (Li
and Shi, 2019).
 There are lower overhead costs in terms of inventory carrying costs, transportation cost,
etc. Elimination of duplicate efforts resulting from buying activities could be possible.
Benefits of Decentralized purchasing
 It is beneficial that actual users made the buying decision due to having closer knowledge
about the requirements.
 Transportation costs get reduced that are incurred on transporting from central warehouse
to different units (Aboelazm and Afandy, 2018).
 The lead time involved in placing order and obtaining quantity get reduced.
 It facilitates democratic practices in management with the delegation of decision making
related to purchasing of raw materials.

CONCLUSION
After summing up above information, it is concluded that there are various other
alternatives of funding except equity financing which help K plc in not only generating money
but also using the same for acquisition of unlisted company. Further, the report has computed the
payback period and NPV of various projects along with the recommendation of Project A as
profitable. Lastly, the report has prepared the variance analysis statement and also difference
between centralized and decentralized procurement system.

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