Management Accounting Role in Operational Planning of Mipie - Coursework Example

REPORT BASED ON MIPIE CASE STUDY Name: Grade Course: Tutor’s Name: (31, December, 2010) Mipie Case Study Report Addressed to Board of Directors. The proposed and terminated project of outsourcing the company’s production would have been more profitable in that the following calculations indicted so. Accounting rate of return is average annual profit (15million pounds) divided by the capital employed during (68million pounds) multiplied by a hundred percent: The value of accounting rate of return before the proposal is effected shows a high value of profits of twenty two percent: ARR = 12/60 X 100 = 20% while when the project of outsourcing is implemented by the company the accounting rate of return reduces by half to 10 % [ARR = 7/68 X 100 = 10%] which is a good idea especially when one consider the fact that the project potential to yield future benefits is high. So the company should have considered adopting the project as it did not lead the company to lose even with the high costs incurred at the begging of the project. The proposal would have been marketed by considering the long time financial benefits of the proposal to the company operation rather than considering other shortcomings which in any case be solved over time especially with increasing experience in the field. The calculation obtained for net present value, the projects internal rate of return, accounting rate of return and the payback used in the evaluation al showed that the project had larger long time benefits than compared to short term especially when one considers the initial cost that is put in the evaluation and implementation of the alternative source of energy project which is derived in to two parts of the wind mills and the water lagoon (Pogue, 2004). The project proposal should have been marketed on the basis of broader evaluation rather than wholly depending on the four models of project evaluation. Other methods that look into the other real options and opportunities should have also been evaluated. For instance an in-depth analysis could have been carried for accounting rate of return, cost-benefit analysis to yield results for other factors that are not based on cash but affects the feasibility of the project, adjusted present value, real option which would have attempted to value of the managerial flexibility on the overall proposal and finally the modified internal rate of return which often makes explicit assumptions about the reinvestment of the cash flows. The company should also have considered the possibilities of the impacts that the new technology can have in increasing the benefits that can be derived by the company from the proposed project, for instance advance in technology would allow for reduced cost that will incurred by the end of the project time hence the probability of increased benefits hence giving the project an added reason to be implemented by the company. In addition to that the company would also have considered the advantages that come with the experience that they will earn over the future on the proposed alterative source of energy project (Pogue, 2004). Given the fact that new ideas will be picked along the way also fresh expertise will be able to gaining a deeper understanding on the project and this will boost their rewards especially if they are consulted by other firms on the acquired knowledge and experience. Through this the proposed project therefore yield additional benefits to the company and this would have been considered when deciding whether to other factors that affect the adoption of the proposal. Payback: The payback calculation of the company shows that largest cost occurs at the beginning of the project which cumulates over the three years where the savings are still used to pay for the initial costs incurred by the project and the project it’s still short of 1.9 million pounds to break even which is predicted to occur during the fourth year where as the waste water lagoon by the end of the fourth year is running at a short of 0.14 million pounds which breaks even at during the fifth year. It is calculated that the company will take a short while to achieve the additional financial outlay for the project. Its predicted that the payback for the wind turbines is under three years eight months while the lagoon payback is only under four years one month hence the given the fact that the project is expected to be completed in timeline of five years, the risk at that rate is relatively low hence its feasibility when long term benefits are considered. Accounting rate of return: The Accounting rate of return for the MITIE Company shows the profitability associated with the project of providing in alternative source of energy for the company operations. The calculated Accounting rate of return of the wind turbines was 4.3 million pounds as compared to 1.66 million of the lagoon when projected to five years which is the timeline of the project and from the results the values obtained shows that the company obtains a considerable returns from the project hence the project is feasible hence prompting the consideration on of other factors like the environmental impacts of the projects and the costs incurred. Internal rate of return: The internal rate of return using discounted cash flows finds the Net Present Value to be greater than zero and when compared to the market interest’s rates shows that the alternative energy saving project will yield better returns. When the internal rate on return of the project is calculated by applying the net present value on a 12% discounted arte shows that the result is positive hence the indication that the internal rate of return of the project s slightly above 12% discount rate thus the go ahead for the company on the investment on the project especially considering the fact that if an increase in prices of the future energy and cost of the project remains stable. Net Present value: Net present value shows that the alternative source of energy project is valuable as compared to the company investing in other projects. The rate takes into account the effect t of time on the investment and the effect on the rates on the present value. The net present value of the project calculated at a discount rate of 10% shows that there are les costs and more returns from the project. The net present value of the investment project on wind turbines and the lagoon water after discounting the expected cash flows indicates that the values are identical and The use of Net Present Value Evaluation is very useful in valuing of investment opportunities but it is by no means the perfect method as it has its own disadvantages. One of its biggest disadvantages is its sensitivity to discount rates. After all Net Present Value calculations involve summations of both positive and negative discount cash flows which are converted into a Present Value terms when the cash flows begins. Given the fact that present value computations of the discount rates of each denomination used hence it’s a very critical factor as it determines the value of final net present value thus a small change in the discount either positive or negative considerably affects the final output (Steiner, 1997). For instance if the calculations done on the net present value by using the appropriate ten percent would yield different values if it was done by using a discount rate of fifteen percent or even five percent hence the affecting the managerial decision son t adoption or abandonment of the proposed alterative project. by the act of an example to illustrate the point let’s say one is trying to put a value on an investment that five years up front today would cost four thousand pounds, but is expected to yield a thousand pounds in annual profits for all the five years of the project (that is amount for a total nominal amount of five thousand pounds), beginning at the year end. If a discounted rate of 5 percent is used to calculate the Net Present Value, the obtained five one thousand pounds payments will be equal to value of 4,329.48 pounds of today's pounds. By subtracting the four thousand pounds which was an initial payment, one is left with a Net Present Value of 329.28 pounds which is a varying value as compared to those derived from using difference discounted rates hence such variation end up determine the decision whether the project is either feasible or is definite not viable one. The use of Net Present Value requires discount rates to valuate thus posing the problem of choosing of correct rates to use for instance a project investment can be rejected if 10% is used yet same project is undertaken if five percent is the correct rate to use. Deciding on which rate to use is not an exact science as it entails a peg of a percentage number to an investment and taken to represent its risk premium. This fact therefore presents a dilemma on what rate to use for instance if by using five percent is a reasonable rate to use an investment is very safe then what happens if the investment has enough risks to warrant a discount rate of ten percent. Another issue that makes the use Net Present Value to evaluate investment opportunities is the complexity that comes with the possibility that an investment doesn’t have same level of risks throughout its entire implementation horizon. For instance if a project is to be implemented in five year time plan, it’s hard to handle situation where an investment has a high risk for the first year and low risk for the next four years. This forces one to try and use several discount rates which makes the Net present Value model more complex and demands more work in pegging of the multiple discounts and expect it to yields an accurate answer. In addition to that the use of net present value results in compounding of the risk premium which is a composite of the free risk rate and this hence makes the future cash flows to be discounted both by the risk free together with the risk premium which lead to compromise on the subsequent cash flows. This compounding effect can though be result to much lower net present value than what is otherwise calculated and this problem can be overcome by using certainty equivalent model which can be used to account the issue of the risk premium being compounded in the subsequent calculations hence no effect on the present value if the investments being evaluated. Finally, one of the major problems of using net present Value as an investment criterion is its trait of wholly excluding the values of possible real options that may be found to exist within an investment opportunity being evaluated. For an instance the company’s investment on alternative energy resource which takes five year to implement, the project has a monetary lose at its startup but the project is expected to have an opportunity of expanding greatly in next three years time (Toy, 1998). Knowing that the project has a real valuable option of expanding in the future calls for incorporation of such value in the total Net Present Value of the investment which in actual sense a standard Net Present Value formula does not provide any way to include the values of such real options. Analyzing the above problems associated with the net present Value model of valuing investment opportunities like the MiPie alternative energy resource, the model is by no doubt a very useful starting point to value investments but it’s definitely does not give a definite answer that investor can rely to make decisions on the right investment to adopt or to abandon thus there is need for making comparisons with other results obtained from other models that can be used to value the feasibility of investment opportunities. Other alternative methods of capital budgeting that can be used with Net present value include the following: Adjusted Present Value(APV) which is the net present value of project that is solely financed by equity in plus the present value of all other benefits of financing, payback period that measures that measures risk by measuring the required time to allow cash flows to equal the original outlay. Relying exclusively on management accounting can be dangerous and may at times lead the business in the wrong direction. For instance management accounting lacks standardization compared to financial accounting which is highly standardized hence the accountant often devises own systems and metrics to evaluate finances and this varies with individuals hence the risk of inconsistencies in the way financial evaluations and benchmarks are measured thus it requires very knowledgeable accountants to counter the setback. Also management accounting overlays an emphasis on quantitative information hence tend to ignore other factors that can not be measured in monetary value. This method can therefore calculate wage savings and certain increments in cost which might not occur e.g. the shipping or costs of importation. Management accounting fails to factor in things like savings related to good will of the members of the community or even the public relations issues that might arise from such decisions (Toy, 1998). On the other hand, management accounting plays a critical role in the operations of a company in that it’s used for internal matters that are concerned with specific need of the business like reporting analysis and variances and it varies with companies as it is dependent on the industry and the management style applied (Harvard Business School Press, 2009). The company needs the services of the management accounting for its management needs like decision making processes based on detailed financial information of the company, budgeting to mange and plan the use of its cash, costs and cost containment in the operations of the company and finally for other considerations like the evolving process like the effects of the new technologies on the company processes and operations. One of the critical roles of management accounting in MiPie is the utilization in carrying out of strategic planning of the organizations operations and techniques like practice of specific managerial techniques like budgeting which is basically used to bring the future of the organization into focus and predict outcome of some planned or anticipated organization’s operations. Secondly management accounting is used to evaluate the results of the company and often goes beyond the obvious answers that financial statements show. Without the analysis of the company’s financial statement, one is able to only get to know the company’s performance over a given period of time (Nitzan & Bichler, 2009). Such financial statements are used for analysis in financial ratios which then give the financial position of the company. The financial ratios plays a critical role in determining the company’s liquidity or its ability to pay its short term debts as well as its solvency or company’s ability to pay its long term debts. Through that analysis of financial ratios the company policy makers are able to develop the Going Concern Policy which is used to determine whether the company will remain viable and operational in the future or anticipated business ventures. In addition, management accounting provides the executive team with the necessary information in making rational managerial as well as financial decisions affecting the company operations (business decisions). By using techniques like variance analysis comparisons between budgeted and actual financial limits can be made hence keeping the company on the right track through avoidance of risk incidences like budget overshooting and low profit margins. Finally, management accounting plays a critical role in operational planning of the company where budgets are created once per year or before fiscal year stars and it involves allocation of finances to various departments of the company or to a group of individuals for a specified period (Toy, 1998). Through the study of the company’s historical trends of revenues, overhead costs and expenses begets are then created which are then carried forward to aid in prediction of the future conditions and trends of the company. The information obtained from the study is then used to build budgets for individual departments which are later incorporated in to the overall corporate budget. References Harvard Business School Press. (2009). Net Present Value and Internal Rate of Return: Accounting for Time. Harvard: Harvard Business School Press Nitzan, J & Bichler, S. (2009). Capital as Power. A Study of Order and Creorder. New York& London: Routledge Pogue, M. (2004). Investment Appraisal: A New Approach. Managerial Auditing Journal. 19 (4) Steiner, R. (1997). Mastering Financial Calculations: A Step-by-Step Guide to the Mathematics of Financial Market Instruments. New Jersey: Financial Times/Prentice Hall. Toy, N. (1998). Introduction to Financial Math. London: Adkins & Matchett Read More