Q. Compare by quality of information for decision making and identify the best project by the criteria of long term increase in value. Convey your understanding of the time value of money principles used or not used in the 3 methods; NPV, IRR and MIRR.
From the information provided, the best project is Gas Station A. This is because of the following reasons. First, Gas Station A has a higher NPV of $32,644 as compared to that of Gas Station B of $16,115. This is because by using the NPV method, the time value of money is recognized as the cash flows are converted to the present value by applying the discount rate of 10%. The NPV is thus obtained by subtracting the present value of the cost of investment from the present value of the of the cash inflows. Since both investments have positive NPV, the option with highest positive value of NPV (Gas Station A).
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Secondly, Gas Station A has a higher IRR value of 41.421% as compared to that of Gas Station B of 36.602%. This comparison is done with respect to the cost of funds of 10%. The IRR is the rate which equates the present value of each cash inflow with the present value of the cash outflows of the investment. Thus, from the calculations, the rate at which the present value of Gas Project A is zero is higher than that of Project B. By this method, which takes the time value of money into account, Project A is more acceptable since as it yields a higher rate of return on the capital.
Lastly, Even though Gas Station A has a higher pay back period of 2 years than that of Gas Station B of 1 year, the criteria does not provide enough reason as to why Project B should be picked because the minimum mandatory pay back period was noted provided. Moreover, this method does not consider the time value of money, that is, the cost of capital and the rate of interest which are very important factors that need to be considered when making sound investment decisions.
Q. Average Production Process time is 40 days. Holding period for finished goods is 15 days. Average Debtors period is 35 days. Credit period is 40 days.
Estimate the average length of the firm’s short term operating cycle. How often would the cycle turn over in a year?
The Operating cycle of a firm is the number of days the firm takes in realizing its finished goods in cash and is therefore the time taken in selling the goods plus the time taken in recovering cash from the debtors.
The Operating Cycle = (40 + 15 + 35 + 40) days.
= 130 days.
The number of times the cycle would turn over in a year is given by;
Turn over periods = (365 days /130 days)
Answer = 2.807692308 times in a year.
Answer = 2 times in a year.
Assuming net sales of $1,200,000 and cost of goods sold of $900,000. Determine the average investment in accounts receivable, inventories and accounts payable. What would be the net financing need considering only these three accounts?
To calculate the average investment in inventories;
The Cost of goods sold per day = ($900,000) ÷ (365 days)
= $2,465.75 per day.
Average Inventories = Cost of goods sold per day × Days Inventory Outstanding
Where; days inventory outstanding = 15 days.
Average Inventories = ($2,465.75 per day) × (15 days)
Average Inventories = $36,986.30
To calculate the average investment in accounts receivable;
The accounts receivable turn over = (365 days) ÷ (35 days)
= 10.43
The average accounts receivable balance = ($1,200,000) ÷ 10.43
= $115,052.73
The percentage of the cost of goods sold to sales = ($900,000)/$1,200,000) × 100%
= 75%
The Average Investment in Accounts Receivable = $115,052.73 × 0.75
= $86,289.55
The average investment in accounts payable
The accounts payable turn over = (365 days)/(40 days)
= 9.125
The average accounts payable balance = ($1,200,000)/9.125
= $131,506.85
The average investment in Accounts Payable = ($131,506.85) × 0.75
= $98,630.14
Q. Cash discount offer of 2% if purchases are paid for within 10 days, otherwise the bill is due at the end of 60 days. Would you recommend borrowing from a bank at an annual interest rate of 18% to take advantage of the cash discount offer?
Since the max pay period for the offer is 10 days, number of periods = ( 365/10 )
= 36.5 days.
Effective rate of return, r = (( 1 + ( 0.18/ 36.5 ))^ 36.5) – 1
r = 19.67%
The borrowing is not recommended since after the 10 days the same amount borrowed, so as to be paid in cash, would accrue an interest rate of 19.67% as compared to the discount being offered of 2%. This means that more money would have to be paid to the bank as interest as compared to the discount received within the very 10 days.
