Financial Calculations - Essay Example

Financial calculation Word count: 3318 Table of Contents Summary 3 Introduction 4 Question 4 Calculation of Payback period 4 Calculation of Average rate of return 6 Calculation of Net Present Value (NPV) 6 Question 2 7 Critical Evaluation and justification of the project recommended for investment 7 Non-financial evaluation 7 Internal context 7 External context 8 Financial evaluation 8 Question 3 10 Ethical consideration of the chosen project 10 Question 4 11 Evaluation of HR function model 11 Conclusion 12 Recommendation 12 Reflective statement 14 Reference List 15 Appendix 1 16 Appendix 2 16 Summary The report aims at evaluating investment plan that is strategized by LJC Ltd in order to expand its business so as to deliver right values and products to the Co-share, new client. The investment appraisal techniques employed by LJC Ltd to examine the financial health of the two projects are payback period, net present value and average rate of return. The final result indicated that Project A should be accepted by LJC Ltd so as to satisfy Co-share. Introduction Investment appraisal is a method of evaluating a particular project, which can be undertaken by a company. Its appropriateness is examined and the benefit is extracted so as to decipher whether it is acceptable by the company in the present situation (Schlingemann, Stulz and Walkling, 2009; Valipour, Moradi and Farsi, 2012). This is essential for developing a strong business relation between the suppliers and companies. The suppliers should abide the policies that are followed by the company. Similar case is seen in the case study of LJC Ltd. LJC Ltd is fruit and vegetable supplier, who aims at delivering value and good quality handpicked fruits and vegetables to the small retailers. Though it is a family run business, but it has seen success in the past 80 years through their business operation as a constant effort to connect to big companies. LJC Ltd is trying to negotiate with the small supermarket chain known as Co-share for the past twelve months. The deal is to manage the fruit and vegetable packing and distribution of Co-share. Co-share has 160 stores that are operating in South East and Midlands. The company is very strict regarding the business ethics and the fair trade policies. For LJC Ltd, the contract will increase the volume of products, which are managed by the business. In order to assist Co-share in their business, LJC Ltd has to use fair trade products and develop best HR practices such as equality policies and staff development. Project A and B is evaluated for identifying the best project for LJC Ltd. Question 1 Calculation of Payback period Payback period is the span of time, which is required for recovering cost of investment that is made by a company (Valerie, Cook and Ali, 2010; Marić, Kamberović and Radlovacki, 2011; Amihud and Mendelson, 2010; Arshad, 2012; Easley and O’Hara, 2009). The payback period for both the project is calculated henceforth: Project A As per Appendix 1a, it is observed that the project A will incur positive cumulative cash flow in the third year. Therefore, payback is calculated on the basis of the positive cash flow that is incurred from the project. The cumulative cash flow at the end of 4th year is £ 60500. Therefore, by applying the formula to calculate payback period the following results are obtained. Payback period = 3 years + (9000/29500) = 3.31 years. Project B As per Appendix 1b, it is observed that LJC Ltd will incur positive cumulative cash flow in the second year. The cumulative cash flow at the end of fourth year is £ 55,000. This indicates that the cumulative cash flow of Project B is lower than that of Project A. The payback period of Project B = 2 years + (20000/22000) = 2.91 years. Hence, the results can be summarized in the following table. Project Payback period in years A 3.31 B 2.91 From the above table it is quite obvious that Project B is profitable and acceptable for LJC Ltd as it will help in fulfilling the requirements of Co-share. Calculation of Average rate of return The average rate of return is the profit that is incurred by a particular project on the basis of investment made by the company (Faulkender and Petersen, 2009; Lee, Ng and Swaminathan, 2011). Project A In order to calculate the average cash flow of Project A, the cash flow for the 4 years is divided by the total number of years i.e. £(8000 + 18000 + 29500 +40000)/4 = £23, 875. However, the average rate of return for the project is evaluated based on the formula, which denotes average cash flow for the years divided by the initial investment. Hence, the ARR of Project A = (£23875/£35000)*100% = 68.21%. Project B Similar process is applied for calculating average rate of return of the Project B. For examining the average cash flow of Project B, the cash flow for 4 years is divided by the total number of years i.e. £(15000 + 22000 + 24000 + 29000)/4 = £ 22500. However, the average rate of return for the project is evaluated based on the formula, which denotes average cash flow for the years divided by the initial investment. Hence, the ARR of Project A = (£22500/£35000)*100% = 64.29%. Calculation of Net Present Value (NPV) The net present value of a project is very essential for a company as it identifies the real worth of the investment after a certain period of time (years). The basic rule for net present value is that the project with higher NPV value is profitable for the company and thus it can be accepted (Valerie, Cook and Ali, 2010; Marić, Kamberović and Radlovacki, 2011; Amihud and Mendelson, 2010; Arshad, 2012; Easley and O’Hara, 2009). Project A The discounting factor is considered as 12% and the net present value is calculated accordingly (Please refer to Appendix 2a). As per Appendix 2a, it is observed that after four years the net present value of Project A is £ 32,910.59. This amount will help LJC Ltd to develop a positive attitude towards accepting the introduction of new packaging system. The net present value of the company not only highlights the future value of the project but also indicates whether LJC Ltd will be benefitted from its acceptance. It is quite obvious that project with higher net present value is acceptable to the LJC Ltd. Project B As per Appendix 2b, it is evident that the net present value is £31,443.87 after four years. Comparing the two projects, it is identified that Project A is acceptable to LJC Ltd as the net present value is high against the second project. Hence, it can be determined that the introduction of the new packaging machine will be profitable for the company as compared to quality checking system. It is worth mentioning that the quality checking machine is competent enough to bring in success to LJC Ltd as Co-share desires to have quality food products. Nonetheless, the financial part of the investment indicates towards the fact that the first project or introduction of packaging system is acceptable as the net present value is high i.e. it will yield higher return than the second project. Question 2 Critical Evaluation and justification of the project recommended for investment The critical evaluation of the project related to LJC Ltd takes into account both non-financial and financial evaluation. Non-financial evaluation The non-financial evaluation of the project is executed with the help of both external and internal context. With regard to internal context the corporate culture and power control is highlighted to understand the management stability. However, the external context considers a PESTEL analysis of the UK, which can affect the business of LJC Ltd. Internal context Corporate Culture The corporate culture of LJC Ltd is complex as there are several changes within the management, which have affected the operation of the company. The purchasing director had taken a long maternity leave and is unsure that she will return after the baby is born. The sales director will be playing her role till she joins however, if the contract of Co-share is accepted by LJC Ltd then the director is not sure whether he can manage both the role. Power Control The power control of LJC Ltd is weak as there is no HR manager to manage the HR related issues in the company. The sales director has to play the role of purchasing director as there is lack of internal management. However, proper and powerful management is needed if the LJC Ltd takes the contract of Co-Share. External context In order to evaluate the external environment of LJC Ltd, adequate focus is given on the PESTEL analysis. The PESTEL analysis highlights the political, economic, social, technological, environmental and legal aspects of the UK. It is observed that the political upraising in a certain country always affects the business of the fruit and vegetable distributor. The distributors may not get the assistance from the political parties that are ruling in the country. In such a case, both the projects are not acceptable if there is not political support for LJC Ltd. The growth rate of GDP in the beginning of the years is observed to be 0.3%, in such a situation project B is to be accepted as the growth rate is expected to increase to 17%. The demand for fruits and vegetables has increased the trade volume of fresh items in the developing nations. This has encouraged the growth of small firms such as LJC Ltd. It has created more urban and rural jobs and has also reduced disparities in income level. The reduction in income level disparity in the country elevates the social status of the individuals. With the increase in number of fruit and vegetables distributor in a particular country supply has increased and the demand is well balanced. Financial evaluation Investment appraisal techniques better known as capital budgeting is referred to the planning process, which helps in ascertaining the investment situation of company in both short and long run (Valerie, Cook and Ali, 2010; Marić, Kamberović and Radlovacki, 2011; Amihud and Mendelson, 2010; Arshad, 2012; Easley and O’Hara, 2009; Valipour, Moradi and Farsi, 2012). The appraisal techniques are considered by companies that are based on the priorities of stakeholders and the management. The techniques help in long term growth of the company rather than earning short run profits (Campbell and Shiller, 2008; Elfani and Lois, 2010; Dechow, Kothari and Watts, 2008; Dechow, 2008; Finger, 2008; Garcia-Teruel and Martínez-Solono, 2009; La Porta, et al, 2009; Cooper, 2010; Carlson, Fisher and Giammarino, 2008; Faulkender and Petersen, 2009; Lee, Ng and Swaminathan, 2011). After examining the payback period, average rate of return and net present value of both the projects, it is observed that the first project can be accepted. The acceptance of the first project i.e. introduction of new packaging machine will increase the productivity of LJC Ltd to a great extent. In order to satisfy their client, Co-share, the company has to undertake a project, which will help them expand its business and meet the requirements of the clients. Co-share follows fair value trade and also applies the best human resource policies. To cope up with the expectation and principles of Co-share, LJC Ltd has to follow the rules of the former company. Co-share is a small supermarket chain, which owns about 160 stores that is based around South East and Midlands. It is basically a cooperative business, which is established on the fair trade practices and ethics. Hence, LJC Ltd cannot perform any unethical work that will harm the deal between the two companies. The fair trade practice of Co-share do not allow that the labour forces should be downsized based on the acceptance of any project. In order to work with Co-share and make the deal successful, the contractors of LJC Ltd should adopt best HR practices. The practices include equality policies and staff development. There is also a good provision for the LJC Ltd to get audited by Co-share. Co-share has the authority to audit the practices of the LJC Ltd and ensure that they are following ethical practices. The suppliers of LJC Ltd should also take part in several initiatives that will develop a good relationship with the investors or customers of the business. The audit will help LJC Ltd to highlight the best and worst practices that are followed by the company. However, the Project B can also be considered and comparing the two the final outcome is depicted. Quality checking system is important equipment in a company as it helps in determining whether the production team is successful in producing quality food and goods (Valipour, Moradi and Farsi, 2012). The introduction of such a system will enable LJC Ltd to control the quality of food products that are packed for Co-share. The system will also assist in reducing the number of staff in the warehouse; this will encourage reduction of strikes and ideal and also saves the amount that is paid to them as salary. The main advantage of reducing the warehouse staffs and increasing the efficiency of the machines is that productivity is expected to increase by 17%; though the same for Project B is expected to rise by 18%. Above all, the financial data pertaining to the cash flow is indicative of the fact that Project B is more profitable than project A and hence it should be accepted by LJC Ltd. The project not only provides lucrative business to the company but it also meets the requirement of Co-share for quality food products. Hence, Project B will be appropriate for LJC Ltd. Question 3 Ethical consideration of the chosen project The following ethical theories can be used in this context. Utilitarian theory: It is the most suitable ethical theory that can be used to describe the condition of LJC Ltd and Co-share. Utilitarian theory is present in normative ethics, which describes that moral action aims at maximising utility. In this case, the LJC Ltd was given the responsibility to manage the distributing business of Co-Share; hence the former has the interest of expanding its business and take high level contract so as to maximise its business profit (Arshad, 2012; Easley and O’Hara, 2009). In order to take the contract of Co-share, LJC Ltd has to change its human resource policy and form a more formal HR department where the responsibilities are distributed among a number of HR managers. It will help in resolving the problems or issues that have taken place in the company. It will in return increase the profit of LJC LTD as productivity will increase. Deontological theory: The theory indicates that an individual should follow moral rules at every step of his/her life. It develops guidelines, which should be followed by the individuals. In the context of LJC Ltd the activities attached to the acceptance of any of the project should be justified in order to avoid any problem in future. The activities are related to internal management, which is weak enough to accept the projects of Co-Share, as the latter company believes in formal and strict management structure, which the former does not possess. Intuitionism Theory: The theory is based on the mathematical evaluation of the projects. In this case, the projects are examined so as to decipher a clear understanding associated with increase in efficiency of the company through the acceptance of a project (Valerie, Cook and Ali, 2010; Marić, Kamberović and Radlovacki, 2011; Amihud and Mendelson, 2010). Question 4 Evaluation of HR function model With regard to the present situation of LJC Ltd, many HR functional model can be applicable. However, an appropriate one should be selected for choosing the best project among the two. The most suitable HR functional model for the LJC Ltd is proposed by Legge (1978). The author believed that the HR professionals can bring in changes in the organisation by motivating the employees. She had suggested three options through which the professionals can improve the efficiency of the employees and control the productivity level. The HR professional should play the following roles, within which two are operational and one is strategic. Conformist innovator: The HR manager should aim at improving the organsitional performance by focusing on prevailing managerial system. There is only one HR professional in LJC Ltd and the major decisions regarding any HR related issue is taken by the purchasing director. Hence, the power of the professional is not good enough to bring in changes in the organisation. The HR professionals should take in charge of the HR related issues and try to solve it by accepting the paradigms that are important for the organisation. He/she should follow the paradigm and not challenge it as it may lead to uprising in the organisation (Truss, Mankin and Kellihe, 2012). Deviant innovator: The deviant innovator aims at questioning the assumptions and find the best solution for the HR related issues. In this case, the HR managers persuade the line mangers for changing the working style at fundamental level. In case of LJC Ltd the HR professional should cooperate with the line managers and advice them to change the way of operation. This will improve the efficiency of the organisation and the project can be selected properly. Problem-solver: The HR professional should aim solving the HR related issues in the organisation. In such a situation, the HR professional in LJC Ltd should improve its productivity by focusing on eradicating the HR related issues. Conclusion LJC Ltd has successfully attracted clients for the past 80 years, which have helped the family business to grow. However, it has the urge to expand its business further so as to earn more profit and acquire more clients. Co-share is a small supermarket, which can be an efficient client for LJC Ltd as Co-share owns about 160 stores. More the number of stores more products are needed, this will help LJC Ltd to supply increased packaging products. After applying the investment appraisal technique to both the project that is decided by LJC Ltd, it is observed that the Project A is profitable to the company as s whole. Moreover, if the results of the techniques are treated separately then it is observed that the Payback period, net present value and average rate of return of the first project i.e. introduction of new packaging and ticketing machine is essentially successful for LJC Ltd. The project is accepted both financially and ethically as Co-share believes in ethical practices and LJC Ltd has to abide by the same so as to continue a harmonious relation with them. By accepting Project A, LJC Ltd cannot downsize the number of labour force in the packaging department as it will be unethical human resource practice for the company that is not supported by Co-share. With regard to the HR functional model, model proposed by Legge (1978) is appropriate for LJC Ltd. If the HR manager plays the functional role as directed by the model, then the company will be efficient enough to accept the project, which is selected for evaluating financially. Recommendation LJC Ltd has established its business successful over the past 80 years, which have also helped them to get contracts for distributing food and vegetable products to small and large firms. They have planned to get the contracts from Co-share, which is a small supermarket. This is a very potential client for LJC LTD as the customer base of the retailer is quite high; hence, the supplies are high. Hence, it is recommended that in order to develop a good relation with Co-share, LJC Ltd should abide by the human resources practices that are followed by the former. Co-share believes in ethical business and thus LJC Ltd should take care of the values that are practiced by the company. The fair trade policies and ethical business practices of Co-share should encourage LJC Ltd to undertake similar trade operations so as to make their client satisfied with the supplies. LJC Ltd should implement the HR functional model proposed by Legge (1978) in order to increase its efficiency. In order to do so the company should structure its HR department efficiently. It should also focus on improving its productivity by motivating the employees. Reflective statement The main calculation of the project has been done successfully along with the explanation. However, the piece of work does not take into account the real scenario of a company, where other factors are also taken into account apart from the financial data. This are totally ignored in the project and the calculations are made based on the data provided whereas there are many situational factors, which are not considered. The main strength of the piece of work is its result that is developed after a detailed calculation. I can improve the work if further details regarding operational and functional parts of the company are provided. Reference List Amihud, Y. and Mendelson, H., 2010. The liquidity route to a lower cost of capital. Journal of Applied Corporate Finance, 12, pp. 5–25. Arshad, A., 2012. Net Present Value is better than Internal Rate of Return Interdisciplinary Journal of Contemporary Research in Business, 4(8). Campbell, J. and Shiller, R., 2008. The dividend-price ratio and expectations of future dividends and discount factors. Review of Financial Studies, 1, pp. 195–228. Carlson, M., Fisher, A. and Giammarino, R., 2008. Corporate investment and asset price dynamics: Implications for the cross-section of returns, Journal of Finance 59, pp. 2577-2603. Cooper, I., 2010. Asset pricing implications of nonconvex adjustment costs and irreversibility of investment, Journal of Finance, 61, pp. 139-170. Dechow, P., Kothari, S. and Watts, R., 2008. The relation between earnings and cash flows. Journal of Accounting and Economics, 25, pp. 133-168. Dechow, P.M., 2008. Accounting Earning and Cash Flows as Measures of Firm Performance. Journal of Accounting and Economics, 18, pp. 3-42. Easley, D. and O’Hara, M., 2009. Information and the Cost of Capital. The Journal of Finance, 59(4), pp. 1553-83. La Porta, R., Lopez-de-Silanes, F., Shleifer, A. and Vishny, R., 2009. Investor Protection and Corporate Valuation. Journal of Finance, 57, pp. 1147–70. Elfani, M. and Lois, P., 2010. The Effect of Working Capital Management On Firm’s Profitability: Empirical Evidence From An Emerging Market. Journal of Business & Economics Research, 8(12), pp. 63-68. Faulkender, M., and Petersen, M. A., 2009. Does the source of capital affect capital structure? Review of Financial Studies, 19, 45-79. Finger, C. A., 2008. The Ability of Earnings to Predict Future Earnings and Cash Flow. Journal of Accounting Research, 32, pp. 210-223. Garcia-Teruel, P. J. and Martínez-Solono, P., 2009. Effects of Working Capital Management on SME Profitability. International Journal of Managerial Finance, 3(2), pp. 174-177. Lee, C., Ng, D. and Swaminathan, B., 2011. Testing international asset pricing models using implied cost of capital. Journal of Financial and Quantitative Analysis, 73, pp. 411-431 Marić, B., Kamberović, B. and Radlovacki, V., 2011. Observing the dependence between dynamic indicators of investment profitability - Relative net present value and internal rate of return. African Journal of Business Management, 5(26), pp. 10331-10337. Schlingemann, F. P., Stulz, R. M. and Walkling, R. A., 2009. Divestitures and the liquidity of the market for corporate assets. Journal of Financial Economics, 64, pp. 117-144. Truss, C., Mankin, D. and Kellihe, C., 2012. Strategic human resource management. Oxford:  Oxford University Press Valerie, G., Cook, C. and Ali, A., 2010. Using net present value methods to evaluate quality improvement projects. International Journal of Quality & Reliability Management, 27(3), pp.333 – 350. Valipour, H., Moradi, J. and Farsi, F. D., 2012. The Impact of Company Characteristics on Working Capital Management. Journal of Applied Finance & Banking, 2(1), pp. 105-125. Appendix 1 Appendix 1a Cumulative cash flow for Project 1 Year Net Cash Flow £ Cumulative cash flows £ 0 -35000 -35000 1 8000 -27000 2 18000 -9000 3 29500 20500 4 40000 60500 Appendix 1b Cumulative cash flow for Project 2 　Year Net Cash Flow £ Cumulative cash flows £ 0 -35000 -35000 1 15000 -20000 2 22000 2000 3 24000 26000 4 29000 55000 Appendix 2 Appendix 2a Year Net Cash Flow £ Discount factor 12% Cumulative cash flows £ 0 -35000 1 -35000 1 8000 0.89285714 7142.86 2 18000 0.79719388 14349.49 3 29500 0.71178025 20997.52 4 40000 0.63551808 25420.72 NPV 32910.59 Appendix 2b 　 Net Cash Flow £ Discount factor 12% Cumulative cash flows £ 0 -35000 1 -35000 1 15000 0.89285714 13392.86 2 22000 0.79719388 17538.27 3 24000 0.71178025 17082.73 4 29000 0.63551808 18430.02 NPV 31443.87 Read More