Investment Appraisal Report to Purchase a New Super Cruise Ship - Free Essay Example

Business Finance Contents Introduction Task-1 Investment Appraisal Report to Purchase a New Super Cruise Ship Task 2 (a) Sales, Purchases, Production and Cash flow Budget (b) Forecasted Income Statement and Balance Sheet Task-3 Guidance to the directors of Utopia on managing business finance Conclusion Reference Introduction Business is combination of the human activities directed for earning profit and giving service to the society. The activity of the business makes the product and service ready for consumer by the help of industry and commerce. Industry collects the consumable goods from the nature and processes it to make consumable goods. Again, commerce makes the goods and service available for the customers. But in all type of activities executed by industry and commerce needs capital and loan able funds. From where the finance will be collected, how much cost has to be sacrificed as cost of capital and other different things can be learned from business finance. Business finance helps stakeholder and business to understand how finance can be successfully used to derive most benefit from the finance. A successful business man can take necessary steps such as investment appraisal methods; understand the financial environment of the company to take investment decision. In that report, there is a dis cussion of investment appraisal report, different budget such as cash budget, production budget, guidelines on managing business finance are discussed in detail. Task-1 Investment Appraisal Report to Purchase a New Super Cruise Ship Investment Appraisal report Carnival, A Quality Cruises. I. Introduction Carnival Cruise is one of the renowned cruises and largest vacation company in the world. Their portfolio of cruise has branded cruises. It wants to expand its business by purchasing a new super cruise ship for $900 million. Thatà ¢Ã¢â€š ¬Ã¢â€ž ¢s why they go for different investment appraisal technique to know whether it is better purchase the cruise or not. This report will describe the financial viability of that company. Carnival Cruise has initial investment, sales and costs data. These data will help determine the suitability of purchasing the ship. In fine the report will make a recommendation by evaluating the results, strength and weakness of investment appraisal technique. In that report four investment appraisal methods are used. These are Accounting rate of return (ARP), Net present value (NPV), Payback period and internal rate of return. The result of these four methods may not be same because of their approaches and calculation. But it will help evaluate the results with different technique and make final decision. II. Investment appraisal methods Four appraisal methods can be categorized into two methods- discounting methods and non-discounting methods. The APP and Payback period are non-discounting and NPV and IRR are discounting methods. ARR can be found by dividing Average income by Average investment (Hansen and Mowen, 2007, p. 568). That method doesnà ¢Ã¢â€š ¬Ã¢â€ž ¢t consider the time value of money. It is considered as the drawback for ARR. To identify the recovery period of initial investment, payback period is commonly used (Brigham and Houston, 2007, p. 373). Result which provide shorter payback period is preferable rather than longer payback period. It ignores cash flow after payback period and time value of money (Kinney Raiborn, 2011, p. 655). In case of NPV method, we can find net value of the project by discounting cash flow at a specific rate. The major advantage of NPV is the discount of the future cash flow and it is preferable than any other methods. The disadvantage is that it supposes constant gearing for cost of capital (Delaney, 2008, p. 37). It is difficult to calculate cost of capital that is used for discounting cash flows (Howe, 1992, p. 34). Unlike NPV, IRR is used to discount the future cash flows. It tells about the margin of safety in term of decline of rate of return (Brigham and Daves, 2009, p. 421). III. Results of investment analysis Accounting Rate of Return (ARR): Particulars 2012($) 2011($) 2010($) Revenue 7688024 7537263 6752504 (-):Expenses 6899470 6605635 5949871 Operating profit 788,554 931,628 802,633 Net profit 788,554* 931,628* 802,633* *Tax effects should be ignored. Thatà ¢Ã¢â€š ¬Ã¢â€ž ¢s why net profit is same as operating profit. Average profit= ($788554+$931628+$802633)/3=$840,938 Average investment= ($900,000,000+0)/2= $450,000,000 ARR = Average profit / Average investment = $840,938/ $450,000,000 = 0.19% Payback Period: Initial Investment is $900,000,000 Year Cash flow $ Cumulative cash flow $ 2008-Year-1 300,000,000 300,000,000 2009-Year-2 230,000,000 530,000,000 2010-Year-3 130,000,000 660,000,000 2011-Year-4 400,000,000 1060,000,000 2012-Year-5 70,000,000 1130,000,000 Payback period = 3 + ($240,000,000/$400,000,000) = 3.6 years. Net Present Value (NPV): The incremental cash flows are: Year Cash flow $ 2008-Year-1 300,000,000 2009-Year-2 230,000,000 2010-Year-3 130,000,000 2011-Year-4 400,000,000 2012-Year-5 70,000,000 As, interest rate is 6% or, 0.06, The PV =$(300,000,000/1.06) + (230,000,000/1.06^2) + (130,000,000/1.06^3) + (400,000,000/1.06^4) + (70,000,000/1.06^5) =$966,014,093 So, NPV = PV à ¢Ã¢â€š ¬Ã¢â‚¬Å" Initial investment =$966,014,093-$900,000,000 =$66,014,093 Here, all the data are assumed. Internal Rate of Return (IRR): Internal rate of return is the interest rate that results in the net present value to zero. In that case, à ¢Ã¢â€š ¬Ã…“guess and checkà ¢Ã¢â€š ¬Ã‚  is the most popular to find it out. Assume, cost of capital is 8%. Here, initial investment $900,000,000 Year Cash flow $ 2008-Year-1 300,000,000 2009-Year-2 230,000,000 2010-Year-3 130,000,000 2011-Year-4 400,000,000 2012-Year-5 70,000,000 Letà ¢Ã¢â€š ¬Ã¢â€ž ¢s try 10% interest rate: Now: PV= -$900,000,000 Year-1: PV=$300,000,000/1.10=$272,727,272 Year-2: PV=$230,000,000/1.10^2=$190,082,645 Year-3: PV=$130,000,000/1.10^3=$97,670,924 Year-4: PV=$400,000,000/1.10^4=$273,205,382 Year-5: PV=$70,000,000/1.10^5=$43,464,493 Adding those up gets: NPV = -$900,000,000+$272,727,272+$190,082,645+$97,670,924+$273,205,382+$43,464,493 = -$110,849,284 I will take a better guess now, and try an 11% interest rate: Continued at 11% interest rate Now: PV= -$900,000,000 Year-1: PV=$300,000,000/1.11=$270,720,270 Year-2: PV=$230,000,000/1.11^2=$186,673,159 Year-3: PV=$130,000,000/1.11^3=$95,054,879 Year-4: PV=$400,000,000/1.11^4=$263,492,389 Year-5: PV=$70,000,000/1.11^5=$41,541,593 Adding those up gets: NPV = -$900,000,000+$270,720,270+$186,673,159+$95,054,879+$263,492,389+$41,541,593 = -42,517,710 I will take a better guess now, and try a 13% interest rate: Continued at 13% interest rate Now: PV= -$900,000,000 Year-1: PV=$300,000,000/1.13=$265,486,726 Year-2: PV=$230,000,000/1.13^2=$180,123,737 Year-3: PV=$130,000,000/1.13^3=$90,096,521 Year-4: PV=$400,000,000/1.13^4=$245,327,491 Year-5: PV=$70,000,000/1.13^5=$37,993,196 Adding those up gets: NPV = -$900,000,000+$265,486,726+$180,123,737+$90,096,521+$245,327,491+$37,993,196 = 80,972,329 I will take a better guess now, and try a 10.3% interest rate: Continued at 10.3% interest rate Now: PV= -$900,000,000 Year-1: PV=$300,000,000/1.103=$271,985,494 Year-2: PV=$230,000,000/1.103^2=$189,050,056 Year-3: PV=$130,000,000/1.103^3=$96,876,138 Year-4: PV=$400,000,000/1.103^4=$270,245,171 Year-5: PV=$70,000,000/1.103^5=$42,876,614 Adding those up gets: NPV= -$900,000,000 +$271,985,494+$189,050,056+$96,876,138+$270,245,171+$42,876,614 = -28,966,527 10.3% interest rate is good enough because using that interest rate we find the result close to zero. So, internal rate of return is 10.3% We can say investment will yield to 10.3% (if all goes as per plan). IV. Analysis of results IRR of 10.3% is also higher than the cost of capital of 8% which again approves the purchase. The ARR 0.16% which is substantially lower than the cost of capital of 8% and hence the ARR method does not approve the investment. The NPV is positive $66,014,093. Investment in cruise is also approved under the NPV method. Payback period is better when it is lower. V. Conclusions The results of the four different appraisal methods- Payback period, NPV, IRR and ARR may not provide same or unanimous result. In that report there has been a description about NPP, Payback period, ARR, IRR and these results may be compared with other project to find the suitability of the purchase of the cruise. Here, we compare our result with cost of the capital but will be more informative if we can make a comparison among or between companies. VI. Recommendations When we will compare the result between or among the projects, in that case we can recommend the suitable approach for the company. For an example, when one companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s payback period is less than other. In that case the first company is better to choose. Task 2 (a) Sales, Purchases, Production and Cash flow Budget Information given, Capital =  £70,000 Cutting machine =  £45,000 Delivery van =  £18,000 Estimated life of the machine = 10 years Estimated life of the van = 5 years Predicted cost for each toy, for wood =  £5.00 For varnish coating =  £1.00 Sales price per toy =  £12 Ending inventory at each month = 80% of sales Wages =  £5,000 Electricity costs per quarter =  £2,000 Rent for 12 months =  £12,000 Insurance =  £9,000 The forecasted sales in units are as follows: Month Sales Ending inventory (80%) Beginning inventory June 4,000, 3,200 0 July 5,000, 4,000 3,200 August 5,000, 4,000 4,000 September 8,000 6,400 4,000 October 9,000 7,200 6,400 November 9,000 7,200 7,200 December 11,000 8,800 7,200 January 6,000 4,800 8,800 Production Budget: Production Budget (units) = sales Budget (units) + Target ending finished goods inventory (units) à ¢Ã¢â€š ¬Ã¢â‚¬Å" Beginning finished goods inventory (units) Month Calculation Output Sales budget Ending finished goods inventory Beginning finished goods inventory Budgeted production June 4,000 4,000 0 = 8,000 July 5,000 4,000 4,000 = 5,000 August 5,000 6,400 4,000 = 7,400 September 8,000 7,200 6,400 = 8,800 October 9,000 7,200 7,200 = 9,000 November 9,000 8,800 7,200 = 10,600 December 11,000 4,800 8,800 = 7,000 Sales budget: Sales budget = (Forecasted units sale * Price per unit) à ¢Ã¢â€š ¬Ã¢â‚¬Å" Sales discount and allowances Month Calculation Output Forecasted sale Price per unit Discount allowances Budgeted sales June 4,000 12 0 48,000 July 5,000 12 0 60,000 August 5,000 12 0 60,000 September 8,000 12 0 96,000 October 9,000 12 0 1,08,000 November 9,000 12 0 1,08,000 December 11,000 12 0 1,32,000 Purchases Budget: Particulars June July August September October November December Production Budget 8000 5000 7400 8800 9000 10600 7000 (+)Ending Inventory 3200 4000 4000 6400 7200 7200 8800 Total Requirement 11,200 9,000 11,400 15,200 16,200 17,800 15,800 (-) Beginning Inventory 0 3200 4000 4000 6400 7200 7200 Purchased(In Unit) To be made 11,200 5,800 7,400 11,200 9,800 10,600 8,600 Purchased Budget(W-1) 67,200 34,800 44,400 67,200 58,800 63,600 51,600 Cash budget: Cash disbursements: June July August September October November December Production 8,000 5,000 7,400 8,800 9,000 10,600 7,000 Direct material: Wood ( £5) 40,000 25,000 37,000 44,000 45,000 53,000 35,000 Varnish coating ( £1) 8,000 5,000 7,400 8,800 9,000 10,600 7,000 Total 48,000 30,000 44,400 52,800 54,000 63,600 42,000 Cash budget: Particulars June July August September October November December Collections from customers 0 48,000 60,000 60,000 96,000 1,08,000 1,08,000 Disbursements: Manufacturing cost: Direct material (0) (48,000) (30,000) (44,400) (52,800) (54,000) (63,600) Wages (5,000) (5,000) (5,000) (5,000) (5,000) (5,000) (5,000) Non-manufacturing costs: Rent (7,000) Machinery van purchase (45,000) (18,000) Insurance (9,000) Ending balance (84,000) (5,000) 25,000 10,600 38,200 49,000 39,400 (b) Forecasted Income Statement and Balance Sheet Forecasted Income Statement Neptune Toys For the year ending December 31, 2015 Particulars Amount Amount Revenues 6,12,000 Cost of goods sold (W-2) (3,65,000) Gross margin 2,47,000 Operating cost Depreciation(W-3) 4,050 Wages (5000 * 7) 35,000 Electricity(2000*2+670) 4,670 Rent(12000/12*7) 7,000 Insurance (9000/12*7) 5,250 (60,100) Operating income 1,91,030 Forecasted Balance Sheet Neptune Toys As at December 31, 2015 Particulars Amount Amount Amount Assets: Current assets: Cash Ending Inventory(N-5) Prepaid electricity cost Cutting Machinery (-)Depreciation Delivery Van (-)Depreciation 45,000 (2250) 18,000 (1800) 73,200 271800 4,670 42,750 16,200 Total asset 408,620 Liability Equity: Current liabilities: Accrued Wage(5000*7) Rent Payable Insurance payable Account Payable Equity: Ownerà ¢Ã¢â€š ¬Ã¢â€ž ¢s Capital Retained earnings(Operating income) 35,000 7,000 5,250 100,340 70,000 1,91,030 Total Liability Equity 408,620 Notes to the financial statement- Notes-1: Purchase cost for toy: In June=11,200*(5+1) =67,200 In July =5,800*(5+1) =34,800 In August =7,400*(5+1) =44,400 In September =11,200*(5+1) =67,200 In October=9,800*(5+1) =58,800 In November =10,600*(5+1) =63,600 In December: Purchase cost for toy=8,600*(5+1) =51,600 Notes-2: Cost of goods sold: Particulars Amount Amount Total Beginning finished goods inventory, June 1, 2015 0 Direct materials used 3, 34,800 Direct manufacturing labor 0 Manufacturing overhead: Wages (5,000 * 7) 35,000 Cost of goods manufactured 3,69,800 Cost of goods available for sale 3,69,800 Ending finished goods inventory, Dec. 31, 2015 (4,800) Cost of goods sold 3,65,000 Notes-3: Depreciation calculation: Cutting Machine= (45000/10) =4500/2=2250 Delivery van= (18000/5) =3600/2=1800 Total Depreciation=2250+1800=4050 *Depreciation is calculated following Straight line Method. **Calculated half year depreciation. Note-4: Ending Inventory Calculation: Total Production unit= 55,800 Total production cost: Manufacturing cost 369,800 Electricity Bill 2,000 Total cost 371,800 Assume insurance and rent expenses are for office. Production cost per unit= (371,800/55,800) =6.663 (approx.) Ending Inventory= 40,800 Ending Inventory cost= (40,800*6.663) =271,800 (approx.) Task-3 Guidance to the directors of Utopia on managing business finance Utopia resort is one of the well-known company operates its exclusive holiday resort around the world. This holiday resort company charge  £4,000 for each of the person who enjoys their entertainment. Again there are lots of holiday Resort Company existing in the world that are competitor of Utopia company. So, it needs to manage its financial resources to strength its position in that type of business. A business may be benefited if they prudently and strategically manage its finance and it may help that company unlock additional financing and avoid uncertain cash flow problem (Cinnamon, Helweg-Larsen and Cinnamon, 2010). Managing Business Cash: The aim of the business is to ensure its sufficient cash facilities to keep that business going. It means it will get full on time payment for the respectable customers and successfully pay to its creditors and suppliers. Here Utopia is listed to London Stock Exchange to become a levered firm (Connolly, 2007). Managing Business Credit: How to successfully obtain credit is mainly focused in the business. Businesses must have to manage actively the business credit by credit payment and identifying and issues related with finance. Utopia needs to manage its credit by taking loan from the bank or from the stock market. Some important steps that need to follow to maintain better relationship with the bank includes: To inform bank about the business performance that it is doing well or not. To present current and accurate financial information. To invite bankà ¢Ã¢â€š ¬Ã¢â€ž ¢s relationship office to monitor how it operated. To be stick to the term of lending agreement. They should follow the above criteria to satisfy the Bank office to get financial support in time of need (Eiteman et al., 2001). Managing Business Credit policy: Getting paid in time is very important for any business to survive. That is also applicable for Utopia Resort Company. To minimize the credit loss, there is a need of clear and comprehensive credit policies, management and proper systems (Crowther, 2004). Financial Planning: To understand business financial position, to persuade lender to the business, there a necessity of good, proper and accurate financial planning. Utopia needs to structure a good financial planning to make them competitor for the other company in the holiday business (Groppelli and Nikbakht, 2000). Here some suggestion for the Utopia for their future financial plans: As there is a stiff competition from the other global competitor like USA companies etc in the market, the need to be careful in case of setting service charges. They should highlight some features of their business that are insufficient in other company. Such as, Utopia can take the advantage from media coverage of ship sinking, fire, virus in ship. And say the customer that they are free from these problems and there is a sufficient life saving boats in the mother ship. They can take help from bank and make them listed in the Stock exchange to make their business stronger and acceptable. They need to set most challenging financial strategies to keep control of the profitability in the expansion phase of the company (Myddelton, 2000). Conclusion Business and finance are interrelated with each other. Any business can be successfully operated if there is sufficient capital and effectively manage finance in the business. Here, in the assignment we discuss how a quality cruise plc uses investment appraisal techniques to find out how effective it will be if he/she invests his/her capital to buy a super cruise ship. We also use different accounting information to make that report knowledgeable. Here different budget like sales budget, purchase budget are calculated and forecasted income statement and balance sheet is given. There is a guideline of the director of Utopia about how to manage business successfully in time of expansion of the business. For that reason they have to maintain a good relation with the bank and they can go for stock exchange borrowing for their future finance needs. Reference Arya, A., Fellingham, J.C., and Glover, J.C., 1988. Capital budgeting: Some exceptions to the net present value rule. 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