Business Finance Final Assessment May 14

8/12/2019 Business Finance Final Assessment May 14

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Business Finance Final Assignment

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[Name of the Student]

[Name of the Institution]


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Task 1

Introduction

Investment appraisal is a technique and tool to find out the worth of an investment project. It

involves several techniques. Some are named as:

1. Payback Period

2. Net Present Value

3. Internal Rate of return

4. Accounting rate of Return

The payback period ensures when the investor will attain the worth of his investment in the

form of predicted cash flows (Rushinck, 1983). In our case, it is 1.8 years which is a pretty good

opportunity for Made up Hotels Plc.

The net present value entails the net worth of the investment project keeping in view the

future cash flows. This will allow an optimistic investor to proceed further with his decision to

invest or not to invest in this project.

The internal rate of return in computed because payback period does not involve the cash

flows. Hence, this technique is still better than it. It is computed by keeping the net present

value of the cash flows close to or equal to zero.

The accounting rate of return is also a better technique but not the best because the IRR is

dominated in the department of appraisal techniques. It shows the net worth of the project

over its useful years. The details are given below regarding this appraisal

These techniques are used by the investors to find out if the investment they are to make in any

project beneficial for them. The methods are discussed briefly when an investment appraisal is

prepared for Made up Hotels Plc since they are planning to invest in a hotel project with a cost

price of 64m.

We use present value of cash flows in order to find out the current value of future money or

streams of cash flows in which can help in making an investment appraisal for an investor.


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Investment Appraisal Report to Made Up Hotels Plc

Looking at the London hotel industry, we explore that the revenue available per room hasincreased in 2013 while keeping in view that the RevPAR has kept on increasing in the

successive years, we will assume that the cash inflows will show a better picture of cash

generation in the upcoming years (Hotels, 2013). The details are shown in the table below:

The projected cash flows are shown after estimating the variables for cash inflow and outflow.

There are several techniques to make an investment appraisal in order to find out if the

investment in purchasing the 160 bed hotel is a better option for Made up hotels Plc. The

sources of finance are not shown in the above table, but it is assumed that Made up hotels Plc

obtained financing from 32% term loan i.e. 20.5m and 43.5m in equity. This is because, they

are already an established business and the hotel industry of UK is already growing, so the

investors are well affirmed about their investment. These expenses are expected to be paid

within the 5th

Year. The upper chart can be diagnosed and the total net cash flow can be

calculated as 1142623 and that is equal to 519 m. This can be a better investment option.

However, there are other investment appraisal techniques. The second of such techniques is

the payback period. This determines the time period in which the initial outlay is paid through

the net cash inflows. As shown in the excel sheet, the payback period is 1 year and 8 months.

This is calculated through the following calculation:


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Year 1 net cash flow + 28/Year 2 net cash flow x 12 months = 1.8 Years

This shows that Made up Hotels Plc will be able to attain back their initial outlay in this time

period which is pretty good for them to take this project. Apart from that, the net present value

is another appraisal technique that can be used in order to f ind out the worthiness of this

particular investment. The table below shows the estimate of the cash flows and the way tocalculate the net present value. In this case, we use the cost of capital as 10%. This is estimated

after looking at the standard annual report of Millenium Hotel.

The net present value is 269.51073 m. This indicates that it is a better investment opportunity

for Made Up Hotels Plc. This investment in todays time value of money is worth this amount.

The Made up Hotels Plc should not ignore the opportunity as the growth of the hotel industry

in UK is already evolving.

The other technique involves the internal rate of return technique which involves the

equalization of an initial outlay and the present value of total cash flow to zero. This is attained

after the discount factor is 67%. The calculation and formulas are attached in an excel

worksheet.

This is not an accurate figure of IRR but within this hotel industry of UK, there is a great

opportunity to attain IRR with this rate and the sensitivity analysis is also carried out which will

indicate the possibilities for the changes in revenues reflecting the changes in IRRs. The

snapshot is given below after describing the scenario of sensitivity analysis.

The sensitivity analysis is also carried out which takes into consideration two conditions if the

revenue increases or decreases. However, the hotel industry entails that there would

successive increase in the revenues but can slow down like it did in 2012 during Olympic

comparatives. So, the sensitivity analysis is carried out in an excel sheet but the snapshots are

as under in order give a proper analysis to Made up Hotels.


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Scenario Summary

Current Values:

Revenue decreases by

1.5% Revenue increases by 6%

Changing

Cells:

$P$5 1.0426 1.0105 1.06

Result Cells:

$A$7 Total inflow Total inflow Total inflow

$B$7

$C$7 94 94 94

$D$7 98.0044 94.987 99.64

$E$7 102.1793874 95.9843635 105.6184

$F$7 106.5322293 96.99219932 111.955504$G$7 111.0705023 98.01061741 118.6728342

$H$7 115.8021057 99.03972889 125.7932043

$I$7 120.7352754 100.079646 133.3407966

$J$7 125.8785981 101.1304823 141.3412443

$K$7 131.2410264 102.1923524 149.821719

$L$7 136.8318942 103.2653721 158.8110221

$A$15 Net Cash flow Net Cash flow Net Cash flow

$B$15 -64 -64 -64

$C$15 38 38 38

$D$15 41.0044 37.987 42.64$E$15 47.17938744 40.9843635 50.6184

$F$15 47.53222934 37.99219932 52.955504

$G$15 49.07050232 36.01061741 56.67283424

$H$15 53.80210571 37.03972889 63.79320429

$I$15 65.73527542 45.07964605 78.34079655

$J$15 75.87859815 51.13048233 91.34124435

$K$15 81.24102643 52.19235239 99.82171901

$L$15 83.83189416 50.26537209 105.8110221

Current Values column represents values of changing cells at

time Scenario Summary Report was created. Changing cells for each

scenario are highlighted in gray.

The above chart shows that the current increase in revenues is 4.26% that is assumed after

looking at the Millenium hotel annual reports. But the conditions specified above are also

related to revenues which can either increase to 5% and then so on or decrease by 1.5%.


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Hence, the net cash flows are then calculated accordingly through the WHAT IF function which

are already shown in the excel file attached.

The second sensitivity analysis is related to the net present value in accordance with the same

cash inflows or revenues from the hotel project. The snapshot is as under:

Scenario Summary

Current Values:


1.5% Revenue increases by 6%

Changing

Cells:

$P$5 1.0426 1.0105 1.06

Result Cells:

$A$27 Present value Present value Present value

$B$27 -64 -64 -64

$C$27 31.98383974 31.98383974 31.98383974

$D$27 31.66292029 29.33293386 32.92590359$E$27 33.42306751 29.03435636 35.8593507

$F$27 30.89268771 24.69232277 34.41744413

$G$27 29.25913724 21.47195458 33.79215938

$H$27 29.43159427 20.26200012 34.89706734

$I$27 35.95944675 24.66011013 42.85509848

$J$27 38.08090976 25.66066494 45.84109048

$K$27 37.40562541 24.03080892 45.96069243

$L$27 35.41149805 21.23263639 44.69571924

$A$28 Net Present Value Net Present Value Net Present Value

$B$28 269.5107267 188.3616278 319.2283655Notes: Current Values column represents values of changing cells at

time Scenario Summary Report was created. Changing cells for each

scenario are highlighted in gray.

So, if the revenue decreases by 1.5%, then the net present value also decreases to 188m.

Therefore, if any unavoidable circumstances are witnessed then the revenue or cash inflow will

definitely decrease which is rare. Hence, the investment option is beneficial for Made up Hotels

Plc.

The scenario analysis can be further carried out to the change in revenue by 7% which wouldfurther indicate the change in net present value of the investment with the revenue increase by

7%. However, the risk is associated with the decrease in revenue by 1.5% which results in the

decrease in revenues, projected cash flows and the net present values of the investment. The

snapshot for the revenue increase by 7% is given below.


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Revenue increases by 7%

1.07

Projected cash flows

-6438

43.58

52.6206

56.154042

61.21482494

69.83986269

86.06865307

100.9434588

111.5095009

119.815166

Present value

-64

31.98383974

33.65175606

37.27775966

36.49627436

36.50040003

38.20479654

47.08250064

50.66011812

51.3420719

50.61122093

Net Present Value349.810738

Another basic technique that can help this investment appraisal to be more reliable is toinclude annual rate of return in order to find out the return on investment of 64m. This is

found out by the deducting the cash outflow from cash inflow and then dividing the result with

the number of useful years for the investment project i.e. 10 years. The normal annual rate of

return to be calculated with the normal increase in revenue that is by 4.26%. The rate of return

is computed as 51.9%. This is a moderate rate of return on the investment to Made up Hotels


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Plc. If we carry out the sensitivity analysis of this scenario, then the snapshot for this aspect is

given below:

ario Summary

Current Values:Revenue decreases by

1.5%Revenue increases by

6%Revenue increases by

7%Revenue increases b

6

ging

:

P$5 1.0426 1.0105 1.06 1.07 1.0

lt Cells:

E$39 ARR % ARR % ARR % ARR % ARR %

E$40 51.9275419 36.2681762 61.59947246 67.57461084 61.5994724

Notes: Current Values column represents values of changing cells at

time Scenario Summary Report was created.

The above chart ensures everything to the made up Hotels Plc that the annual rate of return is

extremely low when the revenue decreases to 1.5%. This entails that there can some

unforeseen circumstances which are rare but can occur that would result in the decrease of

revenue. Therefore, the overseen circumstances should be predicted before investing in this

project. However, with the past performance of hotel industry, the revenue has always

increased by 7 to 8%. The revenue increase by 6-7% has been included in the above analysis in

order to maintain the estimated figure with the actual figures that are still unknown to the

investors.

If we carry out the sensitivity analysis reflecting the IRR variations with the change in revenues,

the snapshot given below describes the analysis in the chart very effectively.

ario Summary

Current Values:


1.5%

Revenue increases by

6%

Revenue increases by

7%

Revenue decreas

ging

:

P$5 1.0426 1.0105 1.06 1.07

lt Cells:

A$35 IRR IRR IRR IRR IRR

B$35 67% 60% 71% 73%

Thus, the decision would be to invest in this project as the report entails that the decision is

valuable while purchasing a 160 bed hotel.

From the above analysis, we can find out that the investment appraisal techniques are meant

to serve one purpose only and that is to effectively find out whether investment is worthy of


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spending or investing funds on it. These techniques have their own pros and cons. But, it

usually provide a good insight of what can also be called as a recommendation to an optimistic

investor who is still thinking to investing on any particular project. These techniques are helpful

to the investors in many ways as they help them in making certain decisions regarding the

worth of investing funds in the specified project. This can be proved through the analysis we

carried out. The payback period, internal rate of return, net present value, and annual rate of

return are all the basic necessities of an investment appraisal. Without these techniques, it

would always be a difficult task to find out the true value of an investment or a project.


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Task 2

Sales Budget for Amor Bayo

Production Budget for Amor Bayo

Purchases budget for Amor Bayo:


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Cash budget for Amor Bayo


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Budgeted Income Statement


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Budgeted balance sheet for Amor Bayo

Amor BayoBudgeted Balance Sheet

December 31, 2014

AssetsCash 47,600.00

Accounts Receivable 54,000Inventory 17,500

Delivery Van 6,000Plant and Equipment (net) 13,000Total Assets 138,100.00

Liabilities and Shareholders' Equity

LiabilitiesNational Insurance 1600

Wages 28,000

Total Liabilities 29,600

Shareholders' EquityShare Capital 50,000Retained earnings 58,500

Total Shareholders' equity 108,500

Total Liabilities & Shareholders' Equity 138,100.00


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Task 3

Usefulness of classifying costs in different ways for businesses:

Cost classification is a process in which costs are categorized on the basis of common

characteristics.

Grouping costs on the basis of their nature, form, source or any other attribution makes it really

easy to understand their effects and ultimately to take decisions about costs and beyond any

shadow of doubt classifying costs makes learning cost and management accounting much

easier. It enables managers to ascertain one thing in many different ways and putting him in a

position to make the best possible decision.

Costs can be classified in number of ways however following is a list that contains some of the

common ways of classifying costs:

avoidable and unavoidable

controllable and uncontrollable

their behavior towards production activity (fixed, variable and semi-variable)

real and notional costs

relevant costs

normal and abnormal costs

functions to which they are connected responsibility centers to which they are connected

their direct and indirect nature

Sunk/committed and future/discretionary costs

Following are some of the advantages of classifying costs in different ways for managers:

1) It helps to price your product correctly.

2) It helps to analyze the whole activity under a situation.

3) It has to come from the shop floor level and cannot be implemented by only sitting in the

Board Room, so it gives closer operational view.

4) Unwarranted activity can be done away with.

5) Cost reduction and cost control

Therefore, after looking at the above information, it can be said that the cost classification is

very significant for the financial manager because he then be able to determine the cost

elements in order to make sure that they are appropriately used in further business decision


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making aspects (Oberholzer, 2004). Another significant point to include here would be that the

managers would be able to easily and effectively track an annual expenditure that would be

relative to the budget and hence, it would help them to know as to from where the expenditure

has greatest spending.

The bottom line is that it helps us in gathering of methods for the accumulation and generation

of cost data. It is also helpful in maintaining effective supervision in a corporation. It is also

considered important for the management use so that external financial reports can be easily

prepared (Ask.com, 2011) . The management will require information to make decisions on

different issues and this would definitely require cost classification.

b) Most profitable sales mix for wedding shoots:

Wedding Shoots

Take One % The Hollywood % The Epic %

Sales 64000 100% 93333 100% 66667 100%

Less Variable Expenses

Staff Wages 8000 13% 16000 17% 16000 24%

Other Variable Costs 6400 10% 6400 7% 6400 10%

Total Variable Costs 14400 23% 22400 24% 22400 34%

Contribution Margin 49600 78% 70933 76% 44267 66%

Less Fixed Costs 30000 30000 30000

Operating Income 19600 40933 14267

Profitable Sales Mix(FC/CM %)

38710 39474 45181

The Most profitable sales mix is 38710, 39474 and 45181 for Take One, The Hollywood

and The Epic respectively.


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Sales mix depends on the variables of total sales, sales mix, profit margins and weighted

average contribution margin. A company may have a product that dominates its total sales but

the cost of production of such product reduce the profit margin. Like in this case of Wedding

shoots, The Hollywood service is dominating total sales but the Epic service is most profitable.


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ReferencesAsk.com, 2011.Ask.com. [Online]

Available at: http://www.ask.com/question/why-is-cost-classification-important-to-managers

Hotels, M., 2013. Millenium Hotels. [Online]

Available at:http://www.millenniumhotels.com/content/dam/Millennium/CIR/Finance/02212014_Final%20Results%

202013.pdf

Oberholzer, M., 2004. Cost behaviour classification and cost behaviour structures of manufacturing

companies. Meditari Accountancy Research, 12(I), pp. 179-193.

Rushinck, A., 1983. Capital Budgeting Techniques, The Payback Period, The Net Present Value, The

Internal Rate of Return and their Computer Applications. Managerial Finance, 9(i), pp. 11-13.

Documents

Business Finance Final Assessment May 14