Accounting and Finance: Investment Appraisal and Budgeting

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Introduction to Accounting and Finance Assessment
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Table of Contents
Part A - Dexter Plc...........................................................................................................................3
Part B - Philly Ltd............................................................................................................................5
Part C - Sankrust Ltd.......................................................................................................................9
Reference list.................................................................................................................................16
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Part A - Dexter Plc
Prepare a Statement of Income for the year ended 31st December 2018 and a Statement of
Financial Position as at 31 December 2018 for Dexter Plc.
“Statement of Income” for Dexter Plc
Intended for the year ended Dec 31, 2018
Particulars Amount Amount
Total sales proceeds (£ 504000 + £ 129000) £633000.00
Less - Cost of sales or Cost of the goods sold (£ 243000 + £ 54000) £297000.00
Add - Stock-in-hand at the ending of the year £336000.00
Total gross earnings £672000.00
Less - Expenses made for operations
Expense for rent issued cleared off to the premises’ owner £90000.00
Prepaid rent £22500.00
Amount of depreciation incurred on the delivery van [(60000 -
12000) / 5]
£9600.00
Amount of workers’ wages £117000.00
Electric bills paid £5700.00
Expenses for running the company’s van £33600.00
Provisions kept for doubtful and bad debts £1500.00 £279900.00
Add - Workers’ wages outstanding £2175.00
Add - Outstanding electricity bills £2025.00
Total operating income £284100.00
Less - Taxes on business premises or rates £4980.00
Total or net earnings for the period £279120.00
“Statement of Financial Position” for Dexter Plc
As on Dec 31, 2018
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Particulars Amount Amount
“Assets”
“Current and liquid assets”
Inventories £336000.00
Receivables (debtors) £436500.00
Cash & equivalents £75000.00
£847500.00
“Long-term assets”
Actual worth of the delivery van £60000.0
0
Less - Amount depreciated on the delivery van [(60000 - 12000) / 5] £9600.00 £50400.00
£50400.00
Total worth of the assets £897900.00
“Liabilities”
“Current or immediate liabilities”
Outstanding workers' wages (dues) £2175.00
Outstanding bills for electricity (dues) £2025.00
Payables (creditors) £393000.00
£397200.00
“Long-term liabilities” Nil
“Equity structure”
Total capital introduced by the business owner £180000.00
Net earnings (brought forward from the statement of income) £279120.00
Total worth of the equity capital and liabilities £897900.00
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Part B - Philly Ltd
a. What is the contribution that each shelf makes towards covering fixed costs if it is sold
for £13?
The proportion of a company’s revenue, which has not been consumed by its variable
expenditure and contributes for covering its fixed expenditure, is known as “contribution” (Nagle
and Muller, 2017). The following is the computation of the contribution achieved from each
shelf sold in Philly Ltd -
Margin of contribution
= Price at which the shelves have been sold (per unit) - Variable costs incurred for their
manufacture
= £ 13.00 - (£ 1.85 + £ 2.95 + £ 5.25)
= £ 13.00 - £ 10.05
= £2.95
b. What is the break-even point and margin of safety in terms of both units and revenue if
each shelf is sold for £13?
In every company, “breakeven point” could be derived into two differing ways - one being
expressed in revenues and the other being expressed in units (Kleinberg et al., 2016). In the table
below, calculations have been shown for Philly Ltd’s point of breakeven -
“Breakeven point” (based in expressions of
units)
“Breakeven point” (based in expressions of
revenues)
Fixed amount of expenditure = £59000.00 +
£47600.00 = £106600.00
“Contribution margin” = Price at which the
shelves have been sold (per unit) - Variable
costs incurred for their manufacture = £2.95
“Breakeven point” = Fixed amount of
Fixed amount of expenditure = £59000.00 +
£47600.00 = £106600.00
“Contribution margin” = Price at which the
shelves have been sold (per unit) - Variable
costs incurred for their manufacture = £2.95
“Breakeven point” = Fixed amount of
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expenditure / Contribution = £106600.00 /
£2.95 = 36135 unit of shelves
expenditure / Contribution = £106600.00 /
(£2.95 / £13) = £469755 (approx)
Table 1: Calculation and comparison of Philly Ltd’s breakeven point based on revenues as
well as units sold
(Source: Created by the learner)
Based on the above presented computations,
Contribution margin
= (Company’s budgeted sales - Breakeven expressed in revenue) x 100 / Company’s budgeted
sales
= (53000 x £13.00 - £469755.00) x 100 / £689000.00
= 100 x 0.3182
= 31.820
= 31.82%
Therefore, 31.82% is Philly Ltd’s margin of safety while 36135 units and £469755.00 is its
breakeven expressed in units and revenue respectively.
c. Calculate the profit the company makes if it produces and sells 48,000 shelves at £13 per
shelf.
The profits, which a company has been able to earn over a specific period, can be found from the
deduction of “cost of sales” from “sales revenue” (Hoyle et al., 2015).
Profit to be made in Philly Ltd when the production and sales is 48000 units of shelves while
£13.00 is its selling price
= 48000 x £13.00 - (£106600.00 + 48000 x £10.05)
= £624000.00 - (£106600.00 + £504000.00)
= £624000.00 - £610600.00
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= £13400.00
d. Philly Ltd is considering whether to spend £45,000 on marketing and advertising but
consequently raising the selling price by 9%. At this new sales price and with the
advertising, sales (in units) will increase by 17%. Analyse whether this is a good strategy
for Philly Ltd?
It can be seen that Philly Ltd, in the present scenario, is considering investing money for
advertisements and marketing. If it makes this decision, then it is going to be a part of the
company’s fixed expenses. The following computations have been done based on the current
situation -
Fixed amount of expenditure = £59000.00 + £47600.00 + £45000.00 = £151600.00
Variable costs incurred for manufacturing = 53000 x £10.05 = £532650.00
Price at which the shelves have been sold (per unit) = £13.00 + 9% of £13.00 = £14.17
Volume of shelves sold = 53000 + 17% of 53000 = 62010 shelves
Therefore, depending on such computations, the total sales, which Philly Ltd will be earning by
these considerations = £14.17 x 62010 = £878681.70
Hence, these computations facilitate in finding out that if the company invests into
advertisements and marketing, the total sales to be made by it is going to improve due to the
increase in the price of sales as well as the increase in volume of shelves sold in it. Consequently,
one can say that this would be a good strategy for the company.
e. Identify and explain the underpinning assumptions attached to the break-even model
including analysing whether the model can successfully be utilised by a range of differing
businesses.
As stated by Badiru (2016), a number of assumptions are present within the technique or tool of
“breakeven analysis” is based. These assumptions are one of the main reasons behind the
limitations of the breakeven analysis as a model in the field of accounting and finance. Svensson
(2017) stated the following assumptions underpinned in the “breakeven model” -
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 All expenditure made by a company could be segregated either as fixed cost or as
variable cost. The company does not have any form of semi-variable expenses into its
context, which is next to impossible.
 Fixed expenditure is going to be remaining consistent despite of changes in the outputs
and their volumes
 The functions of revenue and cost stay linear
 Variable expenditure of a company could be changing, however, it will be directly
proportionate to the output volume
 Employee or workers’ productivity would be unaltered
 Selling prices would be consistent
 Product mix is going to be unaltered
 The units produced would be same as units sold off so that there are no stock-in-hand
However, the appropriateness or suitability of this model keeps differing in case of different
businesses. It is due to the drawbacks or loopholes present in it. Based on the assumptions
underpinned in the breakeven analysis model, it is ideal for the business organisations within
which only one sort of product or commodity is produced. In the words of Markytan et al.
(2018), it is not suitable for a business organisation that has varied product mixes to adopt or use
the breakeven analysis model. On the other hand, the breakeven analysis model would also not
be suited to business organisations within which the units manufactured are not equivalent to the
units sold off since it results into the formation of stock-in-hand and thus leads to wastage of the
manufactured outputs. Hence, one can analyse that the breakeven analysis model cannot be
utilised in a successful manner for all forms or kinds of business organisations except for a few
in which one product mix exists and all units produced are sold off.
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Part C - Sankrust Ltd
a. Calculate the Payback Period, the Accounting Rate of Return, and the Net Present Value
of the machine, and provide recommendations as to whether Sankrust should buy the
machine.
1. Calculating Sankrust Ltd’s “payback period” relative to the purchasing or acquisition of
the new machine
Particulars Flows of cash Cumulative
flows of cash
Worth of Sankrust Ltd's potential new machine (£40000000.0) (£29400000.0)
Cash flowing inwards the company at the ending of Year no.
1
£10600000.0 (£18800000.0)
Cash flowing inwards the company at the ending of Year no.
2
£10600000.0 (£8200000.0)
Cash flowing inwards the company at the ending of Year no.
3
£10600000.0 £2400000.0
Cash flowing inwards the company at the ending of Year no.
4
£10600000.0 £13000000.0
Cash flowing inwards the company at the ending of Year no.
5
£10600000.0 £23600000.0
Table 2: The flows of cash and the cumulating cash amounts from Sankrust Ltd's potential
new machine
(Source: Created by the learner)
Hence, “payback period”
= 2 + (£820000.00 / £10600000)
= 2+0.773
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= 2.77 years
2. Calculating Sankrust Ltd’s “accounting rate of return” relative to the purchasing or
acquisition of the new machine
Particulars Flows of cash Amount of
depreciation
in the value
of the asset
Average
value of the
yearly
income
Worth of Sankrust Ltd's potential new
machine
(£40000000.0)
Cash flowing inwards the company at the
ending of Year no. 1
£10600000.0 £7000000.0 £3600000.0
Cash flowing inwards the company at the
ending of Year no. 2
£10600000.0 £7000000.0 £3600000.0
Cash flowing inwards the company at the
ending of Year no. 3
£10600000.0 £7000000.0 £3600000.0
Cash flowing inwards the company at the
ending of Year no. 4
£10600000.0 £7000000.0 £3600000.0
Cash flowing inwards the company at the
ending of Year no. 5
£10600000.0 £7000000.0 £3600000.0
Table 3: Potential flows of cash, value of depreciation of assets and average value of the
yearly income from Sankrust Ltd's potential new machine
(Source: Created by the learner)
Hence, “accounting rate of return”
= £3600000.00 / £7000000.00 x 100
= 0.5142 x 100
= 51.44%
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3. Calculating Sankrust Ltd’s “internal rate of return” relative to the purchasing or
acquisition of the new machine
Particulars Flows of cash 7% discount
or capital
costs
Present
worth of the
flows of cash
(Flows of
cash x 7%
discount)
Worth of Sankrust Ltd's potential new machine (£40000000.0
)
Cash flowing inwards the company at the
ending of Year no. 1
£10600000.0 0.9350 £9911000.0
Cash flowing inwards the company at the
ending of Year no. 2
£10600000.0 0.8730 £9253800.0
Cash flowing inwards the company at the
ending of Year no. 3
£10600000.0 0.8160 £8649600.0
Cash flowing inwards the company at the
ending of Year no. 4
£10600000.0 0.7630 £8087800.0
Cash flowing inwards the company at the
ending of Year no. 5
£10600000.0 0.7130 £7557800.0
Total £43460000.0
Table 4: Calculation of the total present worth of the flows of cash of the Sankrust Ltd's
potential new machine
(Source: Created by the learner)
Hence, “net present value”
= £43460000.00 - £40000000.00
= £3460000.00
Recommendations for Sankrust Ltd
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The basis of taking decisions by using “investment appraisal techniques” is different when
differing techniques are applied. For example, Gorshkov et al. (2018) mentioned that when
“payback period” of any investment is considerably low, it might be accepted. Conversely,
Christodoulou et al. (2016) stated that based on “accounting rate of return”, an investment must
be selected if it is higher in comparison to “required rate of return”. Based on the calculations,
one can notice that Sankrust Ltd’s potential machine would be having low “payback period”
while its “accounting rate of return” is going to be remarkably higher than its needed rate. On the
other hand, when “net present value” is to be utilised as the base to take decisions on
investments, it should be seen whether the calculated “net present value” of the investment is
positive or not (Adusumilli et al., 2016). However, one can notice that Sankrust Ltd’s potential
machine has a positive present value. Therefore, all these factors collectively help in making the
recommendation to Sankrust Ltd that the company must be taking the decision to accept and
purchase the machine.
b. Produce a report that explains and analyses the key merits and limitations of the
differing investment appraisal techniques
Introduction
Consideration of the financial practicability of investments is an essential part of every business
organisation. This report would be outlining how effective investment appraisal techniques are
and what their constraints are when it comes to taking necessary decisions relative to investments
within a firm.
Analysing the pros and cons relative to differing techniques in investment appraisal
Differing techniques utilised for investment appraisal have differing advantages. At the same
time, they have a wide number of disadvantages or cons. In the below table, both these merits
and demerits have been revealed in detail -
Merits and pros Demerits and cons
1) PBP (Payback period)  Recovery of investments
and risks associated to
them are reduced with the
technique
 Not considered to be
realistic in the view of
non-accounting for
investment’s profitability
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