Accounting Business Reporting for Decision Making

522 Accounting: Business Reporting for Decision Making

Required

a. What is the PP for producing the photos and selling them at markets? 2 marks

b. If Eloise allows herself $22 000 in wages and she could earn 7 per cent elsewhere

on these funds, what is the NPV for the project? 4 marks

c. In your opinion, should Eloise undertake this project? Why or why not? Discuss with

reference to the ARR, PP and NPV. 4 marks

d. What are some of the risks and opportunity costs associated with this business venture? 4 marks

Self-evaluation activities

12.1 Nicholas Cash of Advantage Tennis Coaching (ATC) is considering the purchase of a bus to

transport junior elite players to various tournaments in South East Queensland and Northern

New South Wales. Purchase of the bus will require an initial outflow of $150 000. As a result of

attending the tournaments, Nicholas believes ATC can generate net cash inflows from sponsorship

deals, new player coaching fees and tournament prize money over the next four years of $46 000,

$57 500, $46 000 and $69 000 respectively. In addition, the bus is estimated to have a salvage value

of $57 500 at the end of year 4. Nick’s required rate of return is 10 per cent.

Required

Calculate each of the following measures and comment on their significance:

a. ARR b. PP c. net present value (NPV).

SOLUTION TO 12.1

a. ARR = Average profit/Average investment

= [($46 + $57.50 + $46 + $69 – $150)/4]/($150 + $57.50)/2

= 17.125/103.75

= 16.5%

This looks like an acceptable return.

b. PP = Initial investment/Net cash inflow

The initial investment is $150 000. This amount will not be recovered until the start of year 4,

if cash is received evenly throughout each year. So the PP is 3.007 years. This may or may

not be acceptable to the investors.

c. i. NPV = CF 1 /(1 + r ) + CF 2 /(1 + r )^2 + CF 3 /(1 + r )^3 +... + CFn /(1 + r )n – INV

($000) = 46/(1.1) + 57.5/(1.1)^2 + 46/(1.1)^3 + 126.5/(1.1)^4 – 150

= 41.82 + 47.52 + 34.56 + 86.40 – 150

= 60.30

With an NPV at $60 300, this project looks highly acceptable.

ii. We can also use the discount table to solve this problem:

NPV = –150 000 + 460 000 × 0.909 + 57 500 × 0.826 + 46 000 × 0.751 + 126 500 × 0.683

= –150 000 + 41 814 + 47 495 + 34 546 + 86 400

= 60 255

Comprehension questions

12.2 Discuss potential investment opportunities for each of the following: LO1

a. an airline

b. a service station

c. a cafe/restaurant

d. a recruitment company.

12.3 Investment decisions are made by managers in all types of business entities. Describe the

common features of investments that must be taken into consideration for any investment

decision making activity. LO1