Investment Analysis and Evaluation Methods

This assignment examines the financial viability of two investment projects through a comparative analysis. Students utilize established methods such as Accounting Rate of Return (ARR), Payback Period, Internal Rate of Return (IRR), and Net Present Value (NPV) to evaluate each project's profitability and risk. The analysis encompasses both optimistic and pessimistic forecasts for project cash flows, allowing students to explore the impact of uncertainty on investment decisions. Finally, a recommendation is provided based on the comparative results of these financial evaluation methods.

Solution 1
KPI Strategic or
operating
Driver or
outcome
a. Major brand building advertising spend Strategic Driver
b. Loan approval times Operating Outcome
c. Loan approved (in dollars) Operating Outcome
d. Loan applications numbers received online Operating Driver
e. Loans numbers sent for collection due to being 60 days overdue Strategic Outcome
f. Profitability of the loan book Strategic Outcome
g. Percentage of loans funded against loans approved Strategic Outcome
Solution 2
Sales Budget
Particulars Product A Product B Total
Budgeted sales unit 16,200 11,800
Sale price per unit ($) 14.35 12.20
Total budgeted sales revenue
($) 232,470.00 143,960.00 376,430.00
Production Budget
Particulars Product A Product B
Budgeted closing inventory units 8,100 6,600
Budgeted sales unit 16,200 11,800
Less: Budgeted opening inventory
units - 5,100 - 2,600
Budgeted production units 19,200 15,800
Purchases budget for components
Particulars Component X Component Y
Budgeted closing inventory units 46,000 19,500
Unit requirement for production
- Product A 96,000 38,400
- Product B 47,400 63,200
Less: Budgeted opening inventory
units - 38,000 - 13,500
Purchases required (in units) 151,400 107,600
Purchases budget in dollars
Particulars Component X Component Y Total
Purchases required (in units) 151,400 107,600
Per unit cost ($) 0.68 0.24
Purchases required ($) 102,952 25,824 128,776

Total labour hours and costs for the six months
Particulars Product A Product B Total
Budgeted production units 19,200 15,800
Labour hours per unit 2 1
Total labour hours 38,400 15,800 54,200
Labour cost per hour 4.50 4.00
Total labour cost ($) 172,800 63,200 236,000
Contribution per unit
Particulars Product A Product B
Sale price per unit ($) 14.35 12.20
Less:
Direct material per unit
($)
- Component X 3.40 2.04
- Component Y 0.48 0.96
Direct labour ($) 9.00 4.00
Contribution per unit ($) 1.47 5.20
Profit and Loss forecast for the six months
Particulars Product A ($) Product B ($) Total ($)
Sales 232,470 143,960 376,430
Less: Cost of goods sold
Direct material cost 62,856 35,400 98,256
Direct labour cost 145,800 47,200 193,000
Overhead 250,000
Estimated profit (loss) (164,826)
Solution 3
(a)
Sale price per unit = $250
Variable cost per unit= $185
Fixed cost = $250,000
Total units = 5,000
Contribution per unit = Sale price – Variable cost
= 250 - 185
= $65
Break-even point (in units) = Fixed costs / Contribution per unit

= 250000 / 65
= 3,846.15
Break-even point (in dollars) = (Fixed costs / Contribution per unit) x Sale price per
unit
= (250000 / 65) x 250
= $961,538.46
(b)
(c)
Profit when sales are 5000 units = (Units x Contribution margin) – Fixed costs
= (5000 x 65) - 250000
= $75,000
(d)
Lease rental = $200,000

Increase on profit on existing 5000 units = Units (Old variable cost – new variable cost)
= 5000 (185 - 175)
= $50,000
Profit due to additional 3100 units = Additional units (Sale price – new variable cost)
= 3100 (250 - 175)
= $232,500
Net increase in profit = Profit due to additional 3100 units + Increase on profit on
existing 5000 units – Lease rental
= 232500 + 50000 - 200000
= $82,500
BFC limited should lease the new equipment as there is profit after recovery of lease
rental.
Solution 4
Project cost = $20,000
Estimated life (in years) = 5
Residual value = $2,000
Required rate of return = 10%
Maximum payback (in years) = 3
Forecast 1
Year Cash flow Cumulative cash flow PV @ 10%
0 -$20,000 -$20,000
-
$20,000.00
1 $6,000 -$14,000 $5,454.55
2 $6,000 -$8,000 $4,958.68
3 $6,000 -$2,000 $4,507.89
4 $6,000 $4,000 $4,098.08
5 $8,000 $12,000 $4,967.37
$12,000 $3,986.56
Forecast 2

Year Cash flow Cumulative cash flow PV @ 10%
0 -$20,000 -$20,000
-
$20,000.00
1 $6,000 -$14,000 $5,454.55
2 $7,000 -$7,000 $5,785.12
3 $12,000 $5,000 $9,015.78
4 $3,000 $8,000 $2,049.04
5 $12,000 $20,000 $7,451.06
$20,000 $9,755.54
(a)
Depreciation per annum = (Project Cost – Residual Value) / Life
= (20000 - 2000) / 5
= $3,600
Forecast 1
Average accounting income = Average cash flow - Depreciation
= 6000 - 3600
= $2,400
Accounting rate of return = Average accounting income / Project cost
= 2400 / 20000
= 12.00%
Forecast 2
Average accounting income = Average cash flow - Depreciation
= ((6000 + 7000 + 12000 + 3000 + 10000) / 5) - 3600
= $4,000
Accounting rate of return = Average accounting income / Project cost
= 4000 / 20000
= 20.00%

Strength
ARR method is based on accounting profit hence measures the profitability of
investment.
Weakness
ARR ignores the time value of money.
(b)
Forecast 1
Payback period = 3 + (2000 / 6000)
= 3.33
= 3 years 4 months
Forecast 2
Payback period = 2 + (7000 / 12000)
= 2.58
= 2 years 7 months
Strength
It gives more important to liquidity.
Weakness
It ignores the time value of money and cash flow occurring after the payback period.
(c)
Forecast 1
IRR = 17.23%
Forecast 2

IRR = 26.32%
Strength
It gives importance to time value of money.
Weakness
It assumes all cash flows are being reinvested at the IRR rate which is impractical.
(d)
Forecast 1
NPV = $3,986.56
Forecast 2
NPV = $9,755.54
Strength
It gives importance to time value of money.
Weakness
It needs hurdle rate as an additional information for calculation. This hurdle rate
calculation is based on some assumptions and difficult to calculate.
Summary
Criteria Forecast 1 Forecast 2 Comments
Accounting rate of return 12.00% 20.00%
In both cases, ARR is more than cost of
capital. Hence, project should be
accepted.

Payback period
3 years 4
months
2 years 7
months
In case of Forecast 2, payback period is
less than 3 years. Hence, it should be
accepted.
IRR 17.23% 26.32%
In both cases, IRR is more than the cost of
capital. Hence, project should be
accepted.
NPV $3,986.56 $9,755.54
Since NPV is positive in both cases,
project should be accepted.
All the criteria are in favour of accepting the project. Therefore, project should be
accepted.