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Accounting Decision Making Technique
Md. Kamal Hossain B0687MHMH0411 MFP semester 01 B S A Palan 22nd June 2011
Word 2000
Year
01 02 03 04 05
PAYBACK CALCULATION: The payback method is the time taken to recover the initial
investment. Equation for calculate the payback:
Payback period calculated by using cumulative cash flow. Cumulative cash flow = (some of cash inflow some of cash outflow).
01 02 03 04 05
0 0 73 73 73
So the Payback period = 3 + {(100,000-73,000)/73,000} = 3 + (27,000/73,000) = 3+ 0.369 = 3.369 = 3.37 years Or 3 years and (0.37 X 12) months = 3 years and 4.44 months
The initial investment for the proposal 2 is 200,000 So the payback period = 1 + {(200,000 145,000)/145} = 1 + (55,000/145)
= 1 + 0.379 = 1.379 years Or 1 years and (0.379 X 12) months = 1 year and 4.54 months.
Present Value =NCF for the year/ (1 + r)n Here, r = Discount rate.
n = number of period.
NPV for proposal 01: Year 01 02 03 04 05 NCF 000 0 0 73 73 73 PV calculation in interest rate of 10% 0/(1 + 0.1)1 0/(1+0.1)2 73/(1+0.1)3 73/(1+0.1)4 73(1+0.1)5 Total Present Value PV 000 0 0 54.845 49.859 45.341 =150.045
r = Discount rate.
n = number of period. (Weston, 2001) Total Present Value of annuity = 66,000 X {1-(1+0.1)-5}/0.1 = 66,000 X {(1-0.621)/0.1} = 66,000 X (0.379/0.1) = 66,000 X 3.79 = 250,140 The initial investment is 180,000 So the NPV at 10% = (250,140 180,000) = 70,140
NPV for proposal 03: Year 01 02 23 24 05 NCF 000 145 145 0 0 0 PV calculation in interest rate of 10% 145/(1 + 0.1)1 145/(1 + 0.1)2 0/(1 + 0.1)3 0/(1 + 0.1)4 0/(1 + 0.1)5 The total PV PV 000 131.818 119.834 0 0 0 = 251.652
The initial investment is 200,000 So the NPV at 10% = (251,652 200,000) = 51,652
IRR Calculation: IRR = Positive rate + Positive NPV (Positive NPV +Negative NPV) Ignore the negative sign and add the positive NPV to the Negative NPV. (Dyson 6th edition)
IRR for proposal 1:
DCF 1 20% NPV 1 6,966 IRR = 0.2 + DCF 2 25% NPV 2 8,798 Reference appendix 01 for NPV calculation 6,966 6,966 + 8,798 = 22.209% X (0.25 - 0.20)
X Range of rates
DCF 1 25% NPV 1 8,800 Reference appendix 03 for NPV calculation IRR = 0.25 + 8,800 8,800 + 2,664 =28.838%
X (0.30 - 0.25)
X (0.97 - 0.96)
Profitability index rule is the variation of the NPV rule. If NPV is positive profitability index would be greater than 1.other way if NPV is negative the profitability index would be less than 1. Calculation of profitability Index: The Profitability Index calculate as below
INVESTMENT
Proposal 1 Present Value of cash 150,045 inflow (a) Initial Investment (b) Profitability Index (a/b) 100,000 1.5 180,000 1.389 200,000 1.258 40,000 1.516 70,000 3.79 Proposal 2 250,140 Proposal 3 251,652 Proposal 4 60,640 Proposal 5 265,300
For ranking the Profitability rules is higher profitability index is the higher ranking. By using Profitability Index the ranking of proposals is Proposal05 --------> Proposal04 -------> Proposal01-------> Proposal02-------> Proposal03
01. The company have the 300,000 for all proposals. So by the ranking we got the proposal 5 in higher ranking. The initial investment for the proposal is 70,000 Money left for the other proposal is (300,000-70,000)=230,000 02. The second rank is proposal 4, and the initial investment is 40,000 Money left for others proposals is (230,000-40,000)=190,000 03. The third rank is proposal 1, and the initial investment is 1000,000 So money left for other proposals is (190,000-100,000)=90,000 04. The fourth rank is proposal 2, and the initial investment is 180,000 But they have 90,000 and its half of money of their investment.(180,000/90,000=2) That means they can start this proposal with the rest of money. Finally, they do not have any more money for the proposal 3 so they could not start the proposal.
Opportunity: Opportunity includes: 01. Extend the business. 02. Building the market such as internet. 03. New international market. 04. Positive market perception in business. Threats: Rivalry, breathing or prospective is the main threat for businesses. Its include 01. Increased trade barriers. 02. New parameter. 03. Price wars with the others company.
PEST Analysis: Before start the business its important things to consider the PEST analysis. So the AP company directors could consider the PEST analysis. PEST analysis stands for Political (p), Economic (E), Social(S), and Technological (T). Political Analysis: Political analysis includes: 01. How stable the political environment? 02. Government position in marketing principles. 03. Economical guidelines of government. 04. Competition directive. 05. Employment low. Economical Analysis: In economical analysis we consider these point 01. Exchange rate.
02. Inflation. 03. Taxation. 04. Tariffs. 05. Disposable income. Social analysis: Social analysis is also an important factor for the business. in this analysis also includes 01. Education. 02. Society. 03. Approach to work. 04. Fashions. Technological Analysis: Technological analysis includes: 01. Energy uses and cost. 02. Technical investment. 03. Rate of technological diffusion These factor the director could analyse before they take the decision.
Internal Rate of Return is easy to understand by an ordinary reader. For the decision making it is easy to take the decision for the management that which project they can choose because of its easily focused what an investment is going to give you term of percentage.
Positive cash flows are reinvested at the same rate of cost capital. In certain cash flow model are produced multiple result. IRR shows the percentage but NPV shows the pound() which is easier for the non accountant people.
Superiority of NPV: 01. Net cash flows emphasizes the importance of liquidity. 02. The time value of money is taken into account. 03. Easy to compare the NPV of different project. 04. NPV is straight forward for rationality. 05. NPV shows the amount of value.
http://www.accountingformanagement.com/ranking_of_investment_projects_preference_decision s.htm http://www.accountingformanagement.com/net_present_value_method.htm http://www.scribd.com/doc/6049030/Investment-Appraisal-thesis http://www.wikicfo.com/Wiki/Default.aspx?Page=Net%20Present%20Value%20Method&NS=&Aspx AutoDetectCookieSupport=1 http://www.investopedia.com/terms/p/profitability-index-rule.asp http://www.quickmba.com/strategy/swot/ http://www.whatisswotanalysis.com/ http://articles.mplans.com/how-to-perform-a-swot-analysis/ http://www.thetimes100.co.uk/theory/theory--pest-analysis--166.php http://www.coursework4you.co.uk/essays-and-dissertations/pest-analysis.php http://www.netmba.com/strategy/pest/ http://tutor2u.net/business/strategy/PEST_analysis.htm http://www.marketingteacher.com/lesson-store/lesson-pest.html
Weingarten, H. (1969)Some new views on the payback period and capital budgeting decisions,Management Science.[Online]. 15(12),Business Source Premier, EBSCO host. John A. Tracy, CPA, accounting workbook for dummies, Copyright 2006 by Wiley Publishing, Inc., Indianapolis, Indiana. Published simultaneously in Canada.
APENDIX
APENDIX 01: NPV calculation for IRR of proposal 01
NPV at 20% Year NCF 000 Present Value calculation in interest rate of 20% 01 02 03 04 05 0 0 73 73 73 0/(1 + 0.2)1 0/(1+0.2)2 73/(1+0.2)3 73/(1+0.2)4 73/(1+0.2)5
Total Present Value NPV at 20%=(106,966 100,000) =6,966
NPV at 25%
Year
NCF 000
01 02 03 04 05
0 0 73 73 73
APENDIX 02: NPV calculation for IRR of proposal 02 NPV at 20% Total PV of an annuity = C x [1-(1+r)-n]/r Total Present Value of annuity at 20%= 66,000 X {1-(1+0.2)-5}/0.2 = 66,000 X {(1-0.4019)/0.2} = 66,000 X (.5981/0.2) = 66,000 X 2.9905 = 197,373 The initial investment is 180,000 So the NPV at 20% = (197,373 180,000) = 17,373 NPV at 25% Total Present Value of annuity at 25%= 66,000 X {1-(1+0.25)-5}/0.25 = 66,000 X {(1-0.3276)/0.25} = 66,000 X (0.6724/0.25) = 66,000 X 2.6896 = 177,513
The initial investment is 180,000 So the NPV at 25% = (177,513 180,000) = (2487)
Year
NCF 000
01 02 23 24 05
145 145 0 0 0
145/(1 + 0.25)1 145/(1 + 0.25)2 0/(1 + 0.25)3 0/(1 + 0.25)4 0/(1 + 0.25)5
Total PV
116 92.8 0 0 0
=208.8
The initial investment is 200,000 So the NPV at 25% = (208800 200,000) = 8800
NPV at 30% :
Year
NCF 000
01 02 23 24 05
145 145 0 0 0
145/(1 + 0.3)1 145/(1 + 0.3)2 0/(1 + 0.3)3 0/(1 + 0.3)4 0/(1 + 0.3)5
Total PV
111.538 85.798 0 0 0
=197.336
The initial investment is 40,000 So the NPV at 25% =(43024 40,000) =3,024 NPV at 30% Total Present Value of annuity at 30%= 16,000 X {1-(1+0.3)-5}/0.3 = 16,000 X {(1-0.2693)/0.3} = 16,000 X (0.730/0.3) = 16,000 X 2.435 = 38960
So the NPV at 30% =(38,960 40,000) =(1040) APENDIX 05: NPV calculation for IRR of proposal 04 NPV at 96% Total Present Value of annuity at 96%= 70,000 X {1-(1+0.96)-5}/0.96 = 70,000 X {(1-0.034)/0.96} = 70,000 X (0.965/0.96) = 70,000 X 1.005 = 70,350 NPV at 96% = (70,350 70,000) =350 NPV at 97% Total Present Value of annuity at 97%= 70,000 X {1-(1+0.97)-5}/0.97 = 70,000 X {(1-0.033/0.96} = 70,000 X (0.966/0.96) = 70,000 X 0.995 = 69650 NPV at 97% = (70,000 69650) =(350)