TIANYU LIU 12307766

Management Accounting Decision-

making

ACC9007M

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TIANYU LIU 12307766

TIANYU LIU

(LIU12307766)

Introduction

Company XYZ is a historic company.Business increasing

competitive with the rapid development of the global

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economy. As a Management accountant of XYZ, it is

significant to survey and research company's performance

for deciding and evaluating which is the major capital

investment project company should noteworthiness.There

are two conditions should be taken into account.In order

to make top manager satisfied who will approve the

investment project.Accountant should consider how to

achieve an average Accounting Rate of Return of 15%.

Moreover, company must receive enough payback in two

years because of the major available cash is come from

intracompany. These conditions must to satisfy at the

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same time to ensure the plan implements

smoothly.Potential project should be evaluated from the

date prepare by middle managers.To make shareholder's

equity maximize is the final purpose, through forecasting

operating costs, incremental revenues, residual values

and capital outplays.There is a vital limitation for XYZ

that it only develops and research in its own country.

This is definitely not a successful long-term plan for

this company to deal with business increasing

competition.Therefore, XYZ was taking up research a

series project that they did not have enough experience,

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involves developing new international market and new

technology.

ARR

Accounting Rate of Return(ARR) is measured by accounting

profit which has already taken into account the operating

cash flow after depreciation. Management accountant

should accept the project when Accounting Rate of Return

is higher than company's original target.There is some

advantage of Accounting Rate of Return. Firstly, it is

easy to calculate and understand. Secondly, it is widely

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used to show how attractive an investment project is.

Although ARR could provide a lot of useful information

about the company, but it still has obvious drawbacks.

Firstly, it not only based on cash flow lead to being

controlled easily, but also do not regard maximize

shareholder's wealth as their target. More seriously, it

ignores to consider the time of value whenever profit

happened. ARR is still unthoughtful to consider the

length of the project life and it utilizes the percentage

represents its relative rate, so it ignores specify the

amount of return on investment. For the above-mentioned

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reasons that ARR cannot provide a suitable advice whether

or not a project can increase corporate wealth.

Payback

Denzil Watson and Antony Head point out that the payback

method is the most popular investment appraisal method

but it has some fatal weakness.It reflects the require

time recovery to the original state of net cash flow.

(Denzil Watson and Antony Head,2007).The cost

disadvantage of the payback method is ignoring the time

value of money. It regards payment from different time

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monetary as equivalent.It does not consider cash flow

after the payback period,which is not measure

profitability. But the payback method advantage is easy

to calculate and convenient to use.Because it uses net

cash flows but not used in accounting profits, so it

cannot be easy to control by these specific accounting

policies.

There are a lot of difficult existing when using the

payback method. The biggest weakness of the payback

method is ignoring the time of value whenever profit

happens. It does not regard the project as a whole.For

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example, assuming XYZ company implemented project A to

forecast 800 pounds cash flows, but it won't consider

about the time of value.Therefore, top managers will

refuse implement this project. Because it cannot explain

why this project could maximize shareholder's equity. In

fact, company's acceptable payback period is uncertain,

so it is difficult to interpretation why this payback

period is better than another payback period. It is

necessary realize that cash flows outside of the payback

period are not ignored when the payback method is used,

but are considered and judgement by managers.

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Applicability

An average Accounting Rate of Return of 15% is not too

difficult to achieve. XYZ could utilize this method to

judge whether a project could be implement through

comparing with the expect Accounting Rate of Return of

15%. But it cannot determine whether or not to increase

company's wealth. Because of the limited availability of

cash within the company, XYZ company encounters cash flow

difficulties. Payback method is effective for this

company. Because the earlier to recover the capital could

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be the earlier again invest in another project.XYZ

Company cannot take too much risk, therefore payback

method is ignored to consider the time of value which is

uncertainty, risk is increasing with uncertainty. XYZ

company could reduce the payback period thus to reduce

the risk.

NPV AND IRR

In order to response to increased competition, the last

plan traded solely in its home country market does not go

far enough. Therefore, XYZ company was beginning to

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develop new international market and created new

products. It was inevitable to implement some long-term

project when to develop a new international market. But

the payback method and the ARR method both not consider

the time of value. This is obviously unacceptable to

provide an appropriate decision-making to increase

shareholder's equity.

Colin Drury points out that the most straightforward way

of determining whether a project yields a return in

excess of the alternative equal risk investment in trade

securities is to calculate the net present value (Colin

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Drury, 2012) Company could using NPV method to choice the

higher net present value project when two capital

investment programs is mutually exclusive. Net present

value considers the time value of money and it is

calculated by cash flow, not accounting profit.It also

considers all the related cash flows.It is better for

financial managers doing investment appraise. However,

net present value is not easy to calculate and

understand.It only can be used in a perfect capital

market.In fact, the company's cost of capital is

difficult to forecast and cost of capital always changes.

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But if financial managers have ability to forecast these

changes, so that the net present is easy to be adjusted.

Colin Drury points out that the internal rate of

return(IRR) is an alternative technique for use in making

capital investment decisions that also take into account

the time of value. The internal rate of return decision

rule is to accept all independent investment projects

with an IRR greater than the company's cost of capital or

target rate of return.(Colin Drury, 2012) it is a good

investment appraise tool which can help finance manger to

choice the independent investment programs, which

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internal rate of return greater than company's target

rate of return.

NPV and IRR are the better method to help the company to

determine the more suitable decision when to enter the

international market. Better understanding for cash flows

is significant for XYZ company.There is no conflict

between NPV and IRR, however, the present value method

should be preferred under these conditions. Firstly,

where mutually exclusive projects are being compared.

Secondly, where the cash flows of a project are not

conventional. Finally, where the discount rate changes

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during the life of the project. For example, if a

project's cash flow emerged different indication in a

continuous period, therefore this project would have more

than one IRR. If accountant utilizes IRR at this time

that will lead to making inaccurate decisions.But using

the NPV method will avoid this problem. Furthermore, in

order to develop international market, a lot of

investment projects are necessary. NPV method assumes

that cash flows can be reinforced elsewhere at a rate

equal to the cost of capital. This is a realistic

assumption, because of cost of capital represent

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opportunity cost that means top managers could choice the

best return of investment projects.

Risk evaluation

There are a lot of risks existing in development of XYZ

company.For entry to the international

market.Firstly,managers should consider the commodity

prices fluctuate and the changes in supply and demand.

Secondly, it is vital to consider the credit status of

main customer and main supplier. Finally, potential

competitors and competitors with their main products. But

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the main risk for the international market is the

exchange rate risk. Exchange rate risk is refers to the

money loss due to exchange rate change.(moneyterms, 2015)

currency price changes is unpredictable. Manager should

pay attention to consider exchange rate change and making

the best decision which is maximizing reduce the loss for

the company according to the marketing environment.For

the risk of development and research new product, the

shortage and liquidity of capital is probably the biggest

problem. Moreover, due to the investment in the fixed

asset which leads to increasing business activity, so the

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debt of the company, the cost of raw materials and

inventory will rise at the same time. Furthermore,

different national policy will largely affect the

company's plans which are cannot be forecast.

Risk avoidance

Denzil Watson and Anony Head points out risk refers to

sets of circumstances which can be quantified and to

which probabilities can be assigned.(Denzil Watson and

Anony Head, 2005) High profit is gained with the high

risk, but risk is able to appraise. There are serious of

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method to appraise risk which is helpful to establish

confidence for shareholders and bring more money to

invest in project.

Sensitivity analysis is a way of assessing the risk of an

investment project by evaluating how responsive the NPV

of the project is to changes in the variables from which

it has been calculated.(Denzil Watson and Anony Head,

2005) There are two means to measure sensitivity. One is

recalculated the net present value. Another one is turned

net present value to zero.Both these two methods give the

key variable for investment programs. Better

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understanding these variables will set up the correct

direction for top managers, to ensure project achieves

success. However, both these two methods have its own

shortcoming that they are not truthfulness.It does not

give date relates to the probability of changes in the

key variables which is necessary if the risk of the

project were to forecast.

The payback method could be used to make certain the

uncertainly of capital decision-making.Because of the

payback method is emphasizing liquidity which is

mentioned on the recent projects. Long-term programs will

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have more risk. Although the payback method has some

drawbacks as an appraise method, but it really a good way

to reduce the risk. All in all, both payback and net

present value are based are only forecast. It will reduce

the influence caused by exchange rate for cash flow.

It also could utilize the conservative forecasts method,

where estimate cash flows are decreased to a more safe

figure. Thus to reduce the influence caused by the

exchange rate. However, this reduction is subjective and

it has a lot of different for different projects.

Moreover, reduction is estimated by manager. Cash flows

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increased lead to a potential reduction before to commit

the investment projects. Furthermore, company may lost

many investment opportunities by the non-ideal cash

flows.

The greater the risk attached to future returns, the

greater the risk premium required. Discounted cash flow

investment appraisal methods are a good way to adjust

risk. Firstly, it not only considers the preferential of

time and liquidity, but also want compensation to use

their cash now. Risk reduction is its greatest purpose

that meanings investor tends to invest a low risk

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project. However, it is really difficult to determine the

size of risk to each investment project.But it could be

slove in two ways. One is distributing the different risk

level for each investment project and choice of the

appropriate discount rate to discount.Another way is

using a single overall discount rate.It could accurately

reflect the risk profile of an investment project.

However, if it has to be controlled poorly they will lead

to a wrong decision-making.

Conclusion

To enter into the international market is a big challenge

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for XYZ company. As a management accountant should pay

attention to company's current situation and combine

using these appraisal method to determine the most

suitable decision-making for company.It involves has a

deeper understanding of time of value, cash flow, NPV and

IRR.

Reference

Denzil Watson and Antony Head, 2005 ' The payback method,

An overview of investment appraisal methods.' Page 153

Colin Drury, 2012 'The concept of net present value,

capital investment decisions:Appraisal method, Management

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and cost accounting .' Page 308

Colin Drury, 2012 'The Internal rate of return, capital

investment decisions:Appraisal method, Management and

cost accounting.' Page 307

Denzil Watson and Antony Head, 2005 'Opportunity costs.

Investment appraisal:applications and risk, Corporat

Finance.' page 183

Denzil Watson and Antony Head, 2005 'Sensitivity

analysis,nvestment appraisal:applications and risk,

Corporat Finance ' page 192

Website:

http://moneyterms.co.uk/exchange-rate-risk/, 2005

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