Transcript Slide 1

Accounting for Decision Making.
Sect 1-4
1
Topic 1: Accounting information & managerial decisions
Accounting is the process of:
Identifying
Economic information
for decisions and
Measuring
about an entity
informed judgments
Communicating
Accounting is the link between business activities and business decisions as
illustrated in the diagram below.
Business
Activities
Operating
Investing
Financing
Accounting
Measuring
Recording
Reporting
Analysing
Business
Decisions
Ingram et al (2005:59)
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Topic 1: Accounting information & managerial decisions
Accounting information
Traditional Financial
Accounting
Information
Financial
Information
•Balance sheet
•Income statement
•Cost of goods
Manufactured
•Gross profit
•Operating expenses
Non-financial
Information
Other
quantitative
information
•Percentage of defects
•Number of customer
complaints
•Warranty claims
•Units of inventory
Qualitative
information
•Customer satisfaction
•Employee satisfaction
•Product or service
quality
•Reputation
Source: Jackson and Sawyers (2006: 5)
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Topic 1: Accounting information & managerial decisions
The Decision-making Model
Step 4:
Select the best position
Step 3: Identify and analyse available
options
Step
2: Identify objectives
Step 1: Define the problem
4
Topic 2: Financial Statements & Accounting concepts
The flow from transactions to financial statements can be illustrated as follows:
Procedures for sorting,
classifying, and presenting
(bookkeeping)
Transactions
Selection of alternative
methods of reflecting certain
transactions (accounting)
Financial statements
The financial statements and what they are intended to report on are as follows:
Financial Statement
Reports on
Balance sheet
Financial position on a certain date.
Income statement
Financial performance for a particular period.
Statement of changes in equity
Investments by and distributions to owners.
Statements of cash flows
Cash flows during the period.
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Topic 2: Financial Statements & Accounting concepts
MVN ENTERPRISES
BALANCE SHEET AS AT 31 JANUARY 2011
R
ASSETS
Property, plant and equipment
Inventory (merchandise)
Accounts receivables
Cash
Total assets
247 000
19 000
28 500
151 400
445 900
EQUITY AND LIABILITIES
Equity
Liabilities
Non-current debt
Accounts payables
Total equity and liabilities
220 650
100 000
125 250
445 900
6
Topic 2: Financial Statements & Accounting concepts
MVN ENTERPRISES
INCOME STATEMENT FOR THE YEAR ENDED 31 JANUARY 2011
Sales
Cost of sales
Gross profit
Selling, general and administrative expenses
Operating profit
Interest expense
Net profit
R
300 000
(200 000)
100 000
(54 950)
45 050
(15 000)
30 050
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Topic 2: Financial Statements & Accounting concepts
MVN ENTERPRISES
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED
31JANUARY 2011
R
Balance at 31 January 2010
Additional capital contributed
Profit for the year
0
211 000
30 050
Drawings for the year
(20 400)
Balance at 31 January 2011
220 650
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Topic 2: Financial Statements & Accounting concepts
MVN ENTERPRISES
CASH FLOW STATEMENT FOR THE YEAR ENDED 31 MARCH 20.6
R
Cash flows from operating activities
135 800
Servicing of finance:
(15 000)
Interest paid
(15 000)
Cash flows from investing activities
Payment to acquire tangible non-current assets
(260 000)
(260 000)
Net cash outflows
(139 200)
Cash flows from financing activities
290 600
Net cash received from owner
190 600
Cash received from non -current loan
100 000
Increase in cash
151 400
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Topic 2: Financial Statements & Accounting concepts
NOTES TO THE CASH FLOW STATEMENT
Reconciliation of operating profit
R
Operating profit
45 050
Depreciation
13 000
Increase in inventory
(19 000)
Increase in accounts receivable
(28 500)
Increase in accounts payable
125 250
Net cash flows from operating activities
135 800
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Topic 2: Financial Statements & Accounting concepts
Direct Method
Shows the major classes of gross cash receipts and payments. This method starts with
Revenues and Expenses while also including Current Assets as well as Current Liabilities.
Indirect Method
Shows the net profit or loss as a starting point and makes adjustments for all transactions
of a non-cash items.
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Topic 3: Accounting & Presentation
Balance Sheet
Current assets
Inventories
Notes receivable
Accounts receivable
Short-term marketable securities
Cash and cash equivalents
Non-current assets
Land
Buildings and equipment
Assets acquired by lease
Intangible assets
Natural resources
Other non-current assets
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Topic 3: Accounting & Presentation
Balance Sheet
Owners’ equity
Ordinary shares
Preference shares
Retained income
Current liabilites
Accounts payable
Short-term debt
Current maturities of long-term debt
Non-current liabilities
Long-term debt
Other long-term liabilities
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Topic 3: Accounting & Presentation
14
Periodic LIFO of Corner Shelf Bookstore:
Cost
per
Book
Number of
Books
Total
Cost
Inventory at 12-31-09
1
@
$85
=
$ 85
First purchase (January 2010)
1
@
87
=
87
Second purchase (June 2010)
2
@
89
=
178
Third purchase (December 2010)
1
@
90
=
90
Total goods available for sale
5
$440
Less: Inventory at 12-31-10
4
350
Cost of goods sold
1
@
$90
$ 90
15
Perpetual LIFO of Corner Shelf Bookstore:
Cost
per
Book
Number of
Books
Total
Cost
Inventory at 12-31-09
1
@
$85
=
$ 85
First purchase (January 2010)
1
@
87
=
87
Second purchase (June 2010)
2
@
89
=
178
Third purchase (December 2010)
1
@
90
=
90
Total goods available for sale
5
$440
Less: Inventory at 12-31-10
4
351
Cost of goods sold
1
@
$89
$ 89
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Topic 4: Income statement & Cashflow
The following table represents a framework of the main items that are reported in an Income
Statement.
Income statement
Sales
Cost of sales
Gross profit
Other operating expenses
Income from operations
Interest expense
Interest income
Gains (losses) on sale of assets
Income tax expense
Net profit
Earnings per share
17
Cost of goods sold in arriving at gross profit:
R
R
Sales
R
100,000
Cost of goods sold
Inventory (1/1/06)
5,000
Purchases
45,000
Direct labour
30,000
80,000
Less: Inventory (31/12/06)
10,000
Net cost of goods sold
70,000
Gross profit on sales
30,000
Gross profit margin is simply the gross profit expressed as a percentage of sales. This ratio is
determined as follows:
=
Grossprofit
x100
Netsales
=
Gross profit margin
R30,000
x100
R100,000
=
30%
18
Consolidated statements of income (R millions)
Years ended Dec 2010
2010
2009
2008
Net income
34,209
30,141
26,764
Less: Cost of sales
14,463
13,047
13,446
Gross profit
19,746
17,094
13,318
4,778
4,360
4,034
Marketing, general, and admin
4,659
4,278
4,334
Impairment of goodwill
------
617
------
179
301
548
-------
5
20
9,616
9,561
8,936
10,130
7,533
4,382
Less: Research and development
Amortization and impairment of acquisitionrelated intangibles
Purchase in-process R&D
Operating expenses
Operating income
19
Indirect Method:
Statement of Cash Flows
Cash Flows From Operations
Net income
R
70
Add (subtract) adjustments:
Depreciation
Deferred taxes
100
10
Gain on the sale of machinery
(10)
Equity in long-term investment
(2)
Accounts receivable (use)
(80)
Inventory (source)
100
Accounts payable (source)
Net cash flow from operations:
20
208
Investing Cash Flows:
Purchase fixed assets (use)
Sale of old machine (source)
Net cash flow from investing:
(100)
30
(70)
Financing Cash Flows
10 year note (source)
100
Sale of common stock (source)
10
Dividends paid (use)
(6)
Repayment of mortgage note (use)
Net cash flow from financing:
Net cash flow (increase)
(50)
54
192
20
Direct Method:
Operating cash flows – Direct method
Cash inflows:
Sales
Increase in A/R (use)
Cash collections:
R
1600
(80)
1520
Cash inputs:
Cost of goods sold
Decrease in inventory (source)
Increase in A/P (source)
Cash inputs:
(1350)
100
20
(1230)
Other cash outflows:
Current income taxes
(35)
Interest paid
(47)
Other cash outflows:
Cash Flow From Operations:
(82)
208
Investing Cash Flows:
Purchase fixed assets (use)
Sale of old machine (source)
Net cash flow from investing:
(100)
30
(70)
Financing Cash Flows
10 year note (source)
100
Sale of common stock (source)
10
Dividends paid (use)
(6)
Repayment of mortgage note (use)
Net cash flow from financing:
Net cash flow (increase)
(50)
54
192
21
Question.
You are presented with the following information.
IQUAD Ltd Trading and profit and loss statement for the year ended 31 December 2010
R000
Sales
R000
1 000
Less: Cost of goods sold:
Opening stock
200
Purchases
700
900
Less: Closing stock
Gross profit
Operating expenses
300
600
400
(240)
Operating profit
160
Debenture interest
(10)
Net profit before tax
150
Taxation
(50)
Net profit after taxation
100
Dividends
(60)
Retained profit for the year
40
22
IQUAD Ltd Balance sheet at 31 December 2010
2009
2010
R000
Fixed assets at cost
900
Less: Accumulated depreciation
150
R000
R000
R000
1000
750
255
795
Current assets
Stock
200
300
Trade debtors
120
150
20
45
340
495
Trade creditors
70
90
Taxation
40
50
Proposed dividend
30
60
Cash
Less: Current liabilities
140
200
200
950
295
1090
Capital and reserves
Ordinary shares of R1 each
750
750
Profit and loss account
200
240
950
990
------
100
950
1090
Loans
Debenture stock (10% issued 1 Jan 2006)
Required: Prepare the cash flow statement for the year to 31 December 2010.
(20)
23
IQUAD Ltd
Cash flow statement for the year ended 31 December 2010
R000
Cash receipts
Sale of goods (R1000 + R120 – R150)
970
Issue of debenture stock (R100 – R0)
100
1070
Cash payments
Purchases (R700 + R70 –R90)
(680)
Operating expenses (R240 – (R255 – R150))
(135)
Debenture interest paid
(10)
Taxation
(40)
Dividends
(30)
Purchases of fixed assets (R1050 –R900)
(150)
(1045)
Increase in cash during the year
25
Cash at 1 January 2010
20
Cash at 31 December 2010
45
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The following information applies to Trustworthy Enterprises for November 2010:
02
The owner of Trustworthy Enterprises commenced business by investing R65, 000 cash.
06
Purchased equipment for R15, 000 cash.
10
The owner obtained a long-term loan of R30, 000 from the bank.
14
Purchased merchandise on credit for R40, 000.
28
Sold merchandise that cost R15, 000 for R26, 000 on credit.
31
Paid salaries to the employees, R6000.
Required:
a) Prepare the Balance sheet of Trustworthy Enterprises as at end November 2010.
b) Prepare the Cash Flow Statement for the month ended November 2010.
25
a)
Balance sheet of Trustworthy Enterprises as at 30 November 2010
ASSETS
R
Property, plant and equipment
15 000
Inventory
25 000
Accounts receivable
26 000
Cash
74 000
140 000
EQUITY AND LIABILITIES
Equity
70 000
Liabilities
Long-term debt
30 000
Accounts payable
40 000
Total equity and liabilities
140 000
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(b)
Cash flow statement of Trustworthy Enterprises for the month
R
ending 30 November 2010
Cash flows from operating activities
Net profit
(6000)
5 000
Increase in inventory
(25 000)
Increase in accounts receivable
(26 000)
Increase in accounts payable
40 000
Cash flows from investing activities
Purchase of plant, property and equipment
(15 000)
(15 000)
Cash flows from financing activities
95 000
Capital contributed
65 000
Cash received from long-term loan
30 000
Net increase in cash for the year
Cash (Opening balance)
Cash (Closing balance)
74 000
0
74 000
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Good luck with your studies
28
Accounting for Decision Making.
Sect 5-8
29
Sect 5: Cost-volume-profit relationships.
Using CVP analysis, managers would be able to get information to use in decision-making relating to:
•How profits are affected by a change in costs.
•What effect a change in sales volume will have on profit.
•The profit that is expected from a certain sales volume.
•How many units need to be sold to achieve a targeted profit.
•At what output of production will the income and costs be the same.
•Setting selling prices.
•Selecting the mix of products to sell.
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Calculation of operating profit.
Selling price per crate
R30
Variable costs per crate
R18
Fixed costs in respect of the product
R80, 000
Sales volume in crates
8000 crates
Applying these figures in the model results in the following operating profit:
Per unit
Sales
R30
Variable costs
R18
Contribution margin
R12
x
x
Volume
8 000
=
=
Total
%
R96 000
40
Fixed costs
(80 000)
Operating profit
R16 000
31
Drop in selling price by R6 and increase in sales volume to 12000 units.
The operating profit will be:
Per unit x
Sales
Volume =
Total
%
12 000
R72 000
25%
R24
Variable costs
18
Contribution margin
R6
Fixed costs
(80 000)
Operating loss
(R8 000)
32
Decrease in selling price by R6 accompanied by an increase in advertising expense of
R6 000 and an expected increase in sales volume of 19 000 units.
Operating profit is expected to be:
Per unit x
Sales
Variable costs
Contribution margin
Fixed costs
Operating profit
Volume =
Total
%
= R114 000
25%
R24
18
R 6
x 19 000
(86 000)
R 28 000
33
Calculating the volume of sales required to achieve a target level of operating profit of R46 000.
Per unit x
Sales
Variable costs
Contribution margin
Fixed costs
Operating profit
Volume =
Total
%
R30
18
R 12
x
?
= R126 000
40%
(80 000)
R 46 000
The required sales volume is 10 500 units (R126 000 / R12).
34
Greystone CC manufactures one product. The following details relating to the product applies:
Variable costs per unit
R
Total fixed cost
R 32 000
Selling price per unit
R
Number of units sold
72
82
6 000
Required:
i.
Calculate the break-even quantity and the break-even value.
ii. Calculate the margin of safety in terms of units and value.
Per unit x
Sales
Variable costs
Contribution margin
Fixed costs
Operating profit
Volume =
Total
R82
6000
R492 000
72
6000
(432 000)
6000
R 60 000
R 10
x
%
12,195%
(36 000)
R 24 000
35
i.
Break-even quantity
= Fixed costs / Contribution margin per unit
= R36 000 / R10
= 3 600 units
Total revenue at break-even
= Fixed costs / contribution margin ratio
= R36 000 / 12,195%
= R295 200 (or 3 600 x R82)
ii.
Margin of safety
= Sales units – Break-even sales units
(in terms of units)
= 6 000 – 3 600
= 2 400 units
Margin of safety
= Sales – Break-even sales
(in terms of value)
= R492 000 – R295 200
= R196 800
36
Operating leverage is calculated as follows:
Operating leverage =
Contribution.m argin
Operating. profit
The formula for the margin of safety is:
Margin of safety =
Sales  Breakeven .sales .x.100
Sales
37
Cost analysis for planning, control and decision-making.
Cost analysis for planning.
•Planning is the management process of identifying and quantifying the goals of the organisation.
•Strategic planning involves an identification of the long-term goals and drawing up plans to achieve them.
•A budget is a plan in financial terms that extends for a period in the future.
•Budgeting process. The first step in the budgeting process is to develop and communicate a set of broad
assumptions about the economy, the industry and the entity’s strategy for the budget period.
•The operating budget is a collection of related budgets comprising the sales forecast (or revenue budget), the
purchase/production budget, the operating expense budget, the income statement budget, the cash budget, and
the budgeted balance sheet. The operating budget is also called the master budget.
38
Cost analysis for decision making.
Net Present Value
•The difference between the market value of a project and its cost.
•How much value is created from undertaking an investment?
The first step is to estimate the expected future cash flows.
The second step is to estimate the required return for projects of this risk level.
The third step is to find the present value of the cash flows and subtract the initial investment. This
is to determine whether the project is viable.
Computing NPV for the Project
You are looking at a new project and you have estimated the following cash flows:
•Year 0:
CF = -165,000 (original investment)
•Year 1:
CF = 63,120
•Year 2:
CF = 70,800
•Year 3:
CF = 91,080
Your required return for assets of this risk is 12%.
CF3
CF1
CF2


2
•Using the formulas: NPV = (1  K e ) (1  K e ) (1  k e ) 3  Par.val
–NPV = 63,120/(1.12) + 70,800/(1.12)2 + 91,080/(1.12)3 – 165,000 = 12,627.42
39
Another way of determining NPV is as follows:
Year
Cash Flow
PV
1
63,120.00
56,363.39
2
70,800.00
56,453.16
3
91,080.00
64,845.76
=NPV @ 12%
177,662.91
Original Investment
-165,000.00
NPV
12,662.91
Decision rule.
•If the NPV is positive, accept the project. A positive NPV means that the project is expected to add
value to the firm and will therefore increase the wealth of the owners.
•Since our goal is to increase owner wealth, NPV is a direct measure of how well this project will
meet our goal.
•So, do we accept or reject the project?
NPV is positive at 12% - we can accept the investment!
40
Internal Rate of Return
Internal rates of return (IRR).
•This is the most important alternative to NPV.
•It is often used in practice and is intuitively appealing.
•It is based entirely on the estimated cash flows and is independent of interest rates found elsewhere.
•Definition: IRR is the return that makes the NPV = 0.
•Another way of putting it is that the IRR is the discount rate that equates the PV of cash inflows with the
initial investment associated with the project.
•Decision Rule: Accept the project if the IRR is greater than the required return.
41
Example:
The management of Tiger Engineering are considering the following investment project. The following
data is available:
Cost of plant and equipment
60 000
Salvage value
nil
Expected profit/loss
Yr 1
(15 000)
Yr 2
10 000
Yr 3
35 000
Tiger Engineering uses the straight-line method of depreciation for all fixed assets. The estimated cost of
capital is 10% p.a.
42
Cash flows.
Year
Profit/loss
Depreciation
Cash flow
1
(15 000)
20 000
5 000
2
10 000
20 000
30 000
3
35 000
20 000
55 000
ARR
Ave Pr ofits
ARR = AveInvestm ent
= 10000
30000
=
x100
x 100
33.33%
NPV
Year
Cash flow I
Discount factor 10%
PV I
0
(60 000)
1
(60 000)
1
5 000
0.9091
4 546
2
30 000
0.8264
24 792
3
55 000
0.7513
NPV
41 321
10 659
43
IRR
Year
Cash flow
Disc fact
PV
17%
PV
18%
0
(60 000)
1
(60 000)
1
(60 000)
1
5 000
0.8547
4 273
0.8475
4 237
2
30 000
0.7305
21 915
0.7182
21 546
3
55 000
0.6244
34 342
0.6086
33 473
NPV
17 530

1 1274
Disc fact
530
(744)
(Where do I get 1274 from? The diff between PV @ 17% and 18%.)
IRR = 17.42%
44
Quick example.
Suppose an investment will cost $90,000 initially and will generate the following cash flows:
•Year 1: 132,000
•Year 2: 100,000
•Year 3: -150,000
The required return is 15%.
Should we accept or reject the project?
Hurdle rate is 15%.
Year 0
-$90,000
Year 1
$132,000
Year 2
$100,000
Year 3
-$150,000
IRR
NPV fx 15%
Less initial investment
NPV at 15%
10.11%
Reject
$91,769.54
-$90,000.00
$1,769.54
Accept
45
EC Industrials manufactures a product, Brainagra that sells for R126 each.
The cost of producing and selling 240 000 units are estimated as follows;
Variable costs per unit:
Direct materials
R30
Direct labour
R18
Factory overhead
R12
Selling and administrative expenses
R15
R75
Fixed costs:
Factory overheads
R3 200 000
Selling and administrative expenses
R1 200 000
In the current year, to date 180 000 units were manufactured and sold. An additional 45 000 units are expected to
be sold on the domestic market during the remainder of the year. EC Industrials received an offer from Namibia
Wholesalers for 12 000 units of Brainagra at R84 each. Namibia Wholesalers will market the product in Namibia
with its own name brand and no additional expenses will be incurred by EC Industrials. The sale to Namibia
Wholesalers is not expected to affect domestic sales of the product and the additional units could be produced
during the current year using excess capacity.
As the Marketing Manager you are requested to make a decision to either accept or reject the above proposal and
to motivate the decision you have made.
(15)
46
A comparison of the sales offer of R84 with the selling price of R126 indicates that the offer should be rejected.
EC Industrials, however, has excess capacity and the focus should be on the relevant cost, which is the variable
cost. The difference in the profit from accepting the offer is calculated as follows:
Differential Revenue from accepting the offer:
12 000 units @ R84
R 1 008 000
Differential cost by accepting the offer:
12 000 units @ R60 (R30 + R18 + R12)
Differential profit from accepting the offer
(R 720 000)
288 000
The offer should therefore be accepted.
47
The following information relates to two projects, Project A and Project B from which one must be chosen by
Construction International.
After-tax cash flows
Year
Project A
Project B
1
0
36 000
2
18 500
36 000
3
36 200
36 000
4
123 000
36 000
Both projects require an initial investment of R117 700
As the project manager of Construction International you are required to:
3.1 Calculate the Net Present Value (NPV) for each project using a discount rate of 12%. Which project would
you use choose? Why?
3.2 Calculate the Internal Rate of Return (IRR) for both projects. Which project should be chosen? Why
(20)
48
PROJECT A
Year
Cash Inflow
Discount Factor
Present Value
1
0
0.8929
0
2
18 500
0.7972
14 748
3
36 200
0.7118
25 767
4
123 000
0.6355
78 611
Total Present Value
119 126
Investment
117 700
NPV (positive)
1 426
PROJECT B
Net Inflow
R 36 000
Discount factor
x 3.0373
Total Present Value
109 342
Investment
117 700
NPV (negative)
8 358
DECISION:
Project A should be chosen because the NPV is positive. Reject Project B because it has a negative NPV.
49
ii.
PROJECT A
Choosing the discount factor:
Step 1
Since we know the NPV is positive and above zero, although by a small margin, pick a higher discount rate e.g.
13% (Trial and error is used to obtain the higher rate).
Step 2
Year
Cash
Inflow
1
0
Discount
Discount
Present
Present
Factor
Factor
Value
Value
12%
13%
12%
13%
0.8929
0.8850
0
0
2
R 18 500
0.7972
0.7831
R14 748
R14 487
3
R 36 200
0.7118
0.6931
R25 767
R25 090
4
R123 000
0.6355
0.6133
R78 166
R75 435
Total PV
R118 681
R115 012
Investment
(R117 700)
(R117 700)
R 981
(R2 688)
NPV
50
Step 3
Interpolation:
The IRR is between 12% and 13%
IRR = 12 + ____981__
981+ 2 688
= 12 + 981_
3669
= 12.27%
51
PROJECT B
Choosing the discount factor:
Step 1
Since we know the NPV is negative, pick a lower discount rate e.g. 10% (Trial and error is used to obtain
the lower rate).
Step 2
Year Cash Inflow Discount Discount Discount
p.a.
Present
Present
Present
Factor
Factor
Factor
Value
Value
Value
10%
9%
8%
10%
9%
8%
114 116
116629
119235
Investment
117 700
117700
117700
NPV
(R3 584)
(R1071)
R1535
1-4
36 000
3.1699
3.2397
3.3121
52
Step 3
Interpolation: The IRR is between 8% and 9%
IRR = 8 +
__1535___
1071+1535
= 8+ 1535
2606
= 8.59%
Decision: Project A must be chosen because it has a higher IRR
(20)
53
Payback Period:
Project A
Project B
R42, 000
R45, 000
Year
Operating CF’s
Operating CF’s
1
14, 000
28, 000
2
14, 000
12, 000
3
14, 000
10, 000
4
14, 000
10, 000
5
14, 000
10, 000
Average
14, 000
14, 000
Initial investment
For project A, which is an annuity, the payback period is 3.0 years. Since project B generates a mixed stream
of cash inflows, the calculation of the payback period is not quite as clear cut. In year 1 the firm will recover
R28, 000 of its initial investment. In yr 2 R40, 000 will be recovered (28k + 12k). At the end of year 3, R50,
000 will be recovered. Since the amount received at the end of year 3 is greater than the initial investment, the
payback period is somewhere between 2 & 3 years. Only R5, 000 must be recovered during year 3. However
R10, 000 was recovered. Thus the payback period is 2.5yrs (2yrs + R5, 000/10, 000). If the maximum
acceptable payback period is 2.75yrs, project A would be rejected and project B accepted.
54
Analysis and interpretation of financial statements.
Ratio analysis consists of five major categories, namely:
• Liquidity ratios which indicate the ability of the organization to meet its short-term obligations.
• Profitability ratios which express the effectiveness of the company in earning profits and return on capital
invested.
• Financial leverage ratios which show the relative extent to which capital employed has been provided by
shareholders and providers of debt.
• Market ratios which reflect the performance of the share price on the stock exchange and the implications for
the shareholders of that share.
• Efficiency ratios reflect the management ability of the company with regard to its turnover and working
capital. This is also known as Activity Ratios.
55
1)
The three basic measures of liquidity are:
i.
Net working capital
= CA – CL
ii.
Current ratio
= CA/CL
iii.
Quick (acid-test) ratio = CA – inventory / CL
56
2)
Activity ratios.
i)
Inventory T/O =
Cost of goods sold / Inventory
ii)
Fixed asset Turnover = Sales / Net fixed assets
iii)
Accounts receivable T/O = Ann cr sales / Acc’s rec
iv)
Ave collection period = A/c’s rec / Ave sales per day
= (A/c’s rec / Ann sales)/360
57
•Profitability ratios.
Sales – cost of goods sold / sales = gross profs / sales
i)
Gross prof margin =
ii)
Operating prof margin = EBIT / Sales
= Operating profs / Sales
iii)
Return on Total Assets (ROA) = Net profs after tax / owners’ equity
iv)
Return on Equity (ROE) = Net profs after taxes / Owners’ equity
v)
Earnings per share (EPS) = Earnings available for common shareholders / no of shares of common
stock outstanding
58
4)
Leverage ratios.
i) Debt ratio = Tot liabilities / tot assets
ii) Debt-to-equity ratio = Long-term debt / owners’ equity
iii) Times interest earned ratio = EBIT / Interest
iv) Fixed-payment coverage ratio: EBIT + lease payments / int + lease payments + ((principal
payments + pref stock divs) x (1/(1-T)))
59
5)
Other ratios.
i)
Price / Earnings (P/E) ratio: Mkt P per share of common stock / after tax earnings per share
ii)
Dividend payout ratio: Ann divs per share/ After tax earnings per share
60
Barlow Company Income Statement for the year ended 31 December 2010
2010 (R,000)
2009 (R,000)
Sales revenue
3,074
2,567
Less: Cost of goods sold
2,088
1,711
986
856
Selling expenses
100
108
General admin expenses
194
187
35
35
Depreciation expense
239
223
Total operating expense
568
553
418
303
Less: Interest expense
93
91
Net profits before taxes
325
212
94
64
231
148
10
10
221
138
Gross profits
Less: Operating expenses
Lease expense
Operating profits
Less: Taxes (rate = 29%)
Net profits after taxes
Less: preferred stock dividends
Earnings available for common shareholders
61
Barlow Company Balance Sheet for the year ended 31 December 2010
Assets
2010 (R,000)
2009 (R,000)
Current assets
Cash
363
288
68
51
Accounts receivable
503
365
Inventories
289
300
1,223
1,004
Land and buildings
2072
1903
Machinery and equipment
1,866
1,693
Furniture and fixtures
358
316
Vehicles
275
314
98
96
4,669
4,322
Less: Accumulated depreciation
2,295
2,056
Net fixed assets
2,374
2,266
3,597
3,270
Marketable securities
Total current assets
Gross fixed assets
Other
Total fixed assets
Total assets
62
Liabilities and stockholders’ equity
2010 (R,000)
2009 (R,000)
Current liabilities
Accounts payable
382
270
79
99
159
114
620
483
1,023
967
1,643
1,450
200
200
191
190
428
418
1,135
1,012
Total stockholders’ equity
1,954
1,820
Total liabilities and stockholders’ equity
3,597
3,270
Notes payable
Accruals
Total current liabilities
Long-term debt
Total liabilities
Stockholders’ equity
Preferred stock – cumulative 5%, R100 par, 2,000 shares
authorized and issued
Common stock – R2.50 par, 100,000 shares authorized,
shares issued and outstanding in 2006: 76,262; in 2005:
76,244
Paid-in capital in excess of par on common stock
Retained earnings
63
Required: Calculate the following for Barlow Company for 2010.
a)
The acid-test ratio.
(2)
b)
The average collection period.
(2)
c)
The fixed asset turnover.
(2)
d)
The debt ratio.
(2)
e)
Operating profit margin.
(2)
f)
Net profit margin.
(2)
g)
Return on equity.
(2)
h)
Price/earnings ratio.
(2)
64
b)
Average collection period =
Current .Liabilitie s
Accounts.receivable
ave.sales. per.day
Sales
c)
Fixed asset turnover = Fixed .assets
d)
Debt ratio =
Total .liabilitie s
Total .assets
=
=
R1,223,000  R 289,000
620,000
=
Acid-test ratio = Current . Assets  Inventory
=
a)
R503,000
8,539
= 1.51
= 58.9 days
R3,074,000
= 1.29
2,374,000
R1,643,000
= 45.7%
3,597,000
65
e)
Operating profit margin = Operating . profit
f)
Net profit margin = Net . profits .after .taxes
g)
Return on equity = Net . profits .after .taxes = R 231,000 = 6.4%
Total .assets
Sales
Sales
h) P/E ratio =
=
=
R 418,000
3,074,000
= 13.6%
R 231,000
3,074,000
= 7.5%
3,597,000
Market. price. per.share.of .com m on.stock
Earnings. per.share
=
R32.25
R 2.90
= 11.1
66
Good luck with your studies
67