Task 1: Analyzing the relevance of Cost Volume Profit (CVP) to Zoom Limited Company
CVP analysis as a concept becomes important when determining how the changes in costs and volume of output will affect the company’s operating income and profits (Alan 2004). The CVP analysis is based on the assumption that the company’s sales price per unit and variable costs per unit are constant; the overall fixed cost is constant and; that all that the company produces is sold out (Hans 2013). The CVP analysis involves several calculations and equations that incorporate the company prices, costs and other economic variables. The specific calculations that will be relevant to Zoom Limited Company based on the data presented will include the contribution margin, contribution margin ratio, breakeven point, and finally representing the information on a CVP graph.
Contribution Margin = Sales – Variable Costs or Price per Unit of sale minus unit variable costs while the contribution ratio (CR) is the ratio between contribution margin and sales (Hans 2013). The calculations below relate to the company’s CM and CR and become important when determining the amount of sales available for the company to cover its fixed costs.
CM = Selling Price per Unit – Variable Cost per Unit
CM = $ (12,000 – 3,500) x 1700 = $14,450,000
CR = CM/Sales = 14,450,000/ (12,000 x 1700) = 0.708 or 70.8%
The calculated ratio means that the company can comfortably use 70.8% of its sales to cover its fixed costs without incurring losses.
Break-even point on the other hand gives the amount of sales for which the company’s net income will be exactly equal to zero or the point at which the company will break-even (Hans 2013). With the break-even point, Zoom Limited Company will be in a position to determine the amount of sales that will equate revenues to the sum of variable costs and fixed costs according to the calculations below.
Letting the Break-even point to be Q*, then
Sales Revenues = $12,000Q*
Total costs = Fixed costs + Variable Costs = $ (10,625,000 + 3,500Q*)
For the Break-Even Point; $12,000Q* = $ (10,625,000 + 3,500Q*)
So that, $12,000Q* – $3,500Q* = $10,625,000
This means that $8,500Q* = $ 10,625,000, implying that Q* = 1,250 bikes
This also means that the Break-Even Sales Revenue = 1,250 x 12,000 = $15,000,000; the Break-Even Variable Costs = 1,250 x 3,500 = $4,375,000 and; Total Break-Even Cost = $ (10,625,000 + 4,375,000) = $ 15,000,000. So that $15,000,000 – $15,000,000 = 0, that is, Sales Revenue – Total Costs = 0 for the Break-Even Point.
The CVP graph can be represented as follows:
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Task 2: Producing a Report to the Owners of Drake Limited Based on the Investment Proposal
a. Identifying and explaining the key stages in capital budgeting process and the role of investment appraisal.
Capital budgeting is an important process that allows company managers to make proper decisions that relate to capital projects. Since the capital project is known to be large in most cases and holds higher levels of significance to the overall company business success, it is compelling for the process managers to make right decisions in areas of implementation and execution (Asma 2012). The activities that follow before the project is considered viable for implementation are usually the leading processes towards developing a viable project, and the project may take more than one year depending on its nature, resource and capital requirements, urgency, and skills of project team. It therefor follows that the procedures for capital budgeting are functions of the manager’s position in the organization, the organization’s complexities and the projects’ sizes (Jiri 2009). The procedures or stages in capital budgeting process include: brainstorming, project analysis, capital budget planning, and performance monitoring.
Brainstorming entails generating investment ideas, which may come from the opportunities available or challenges the organization is facing. The opportunities and challenges my come from the company’s functional areas, any of the departments, or even from outside the company (Belinda 2008). Through brainstorming, the company management generates good investment ideas that are viable both is costs and benefits.
The project analysis stage entails gathering of information that the project managers can use in cash flows forecast for the respective projects, and also to assist in the evaluation of project viability and profitability. The analysis stage allows the management to identify, evaluate and adjust for the pros and cons attached to the project.
After project analysis, the project managers engage in capital budget planning in order to organize those proposals that are profitable and coordinate those that will fit within the company’s performance strategies in addition to considering the project timing (Manuel & Raisinghani 2003). While performing capital budget planning, the management should understand that even though the projects may appear good when looked in isolation, they may finally become undesirable or incompatible with the company’s operational strategies. The stage is important since it also considers the real resource constraints, the project timing and activity prioritization.
The final stage of performance monitoring involves performing a post-audit of the entire project in relation to the projected results and also identifying all the differences that need to be explained for the purposes of aligning the projected result with the actual results (Arshad). The stage requires the management to explain how the company’s revenues, expenditure and cash flows compare to the predicted results of the project.
Investment appraisal and capital budgeting are related in the sense that they both facilitate the determination of the company’s long term and short term investments (Matthew, Stout & Robbins 2007). Through capital investment appraisal, the company management is able to budget for major capital investment projects while deciding on the future ventures, especially in new businesses as well as being able to expand and include new activities so that the same costs can be used to facilitate numerous projects (Thamhain).
b. Evaluate the following methods available to the company in appraising this investment
i. Net present value
NPV = Sum of Cash inflows – Sum of Cash outflows
| Year | 1 | 2 | 3 | 4 |
| Demand (Units) | 35,000 | 40,000 | 50,000 | 25,000 |
| Sales ($) | 840,000 | 960,000 | 1,200,000 | 600,000 |
| Costs ($) | 525,000 | 600,000 | 750,000 | 375,000 |
Calculating for the cash flows:
| Year | Cash Inflows | Discounting rate; (1 + 0.1) n
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PV of Cash Inflows |
| 0 | 1,000,000 | 1 | -1,000,000 |
| 1 | 840,000 | 1.1 | 763,636.36 |
| 2 | 960,000 | 1.21 | 793,388.43 |
| 3 | 1,200,000 | 1.331 | 901,577.76 |
| 4 | 600,000 | 1.4641 | 409,808.07 |
| SUM of NPV | 1,868,410.62 | ||
Decision criteria: NPV > 0, that is, a positive NPV means that the financial investment proposal is viable and should be considered for investments (Accepted).
ii. Internal Rate of Return
Since the NPV calculated above is positive, that is, NPV = 4,461,260, we re-calculate the NPV using a higher rate of return on capital say 90% in order to obtain a negative NPV.
| Year | Cash Inflows | Discounting rate; (1 + 0.7) n
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PV of Cash Inflows |
| 0 | 1,000,000 | 1 | -1,000,000 |
| 1 | 840,000 | 1.9 | 442,105.26 |
| 2 | 960,000 | 3.61 | 265,927.98 |
| 3 | 1,200,000 | 6.859 | 174,952.62 |
| 4 | 600,000 | 13.0321 | 46,040.16 |
| SUM of NPV | -70,973.98 | ||
IRR is given by the formula: IRR = R1 + (R2 – R1) {NPV1/ (NPV1 + NPV2}
Where R1 is the lower rate; R2 is the higher rate; NPV1 is the Net Present Value at lower rate and; NPV2 is the Net Present Value at Higher rate. This would mean that our IRR is calculated at:
IRR = 10 + (90 – 10) {1,868,410.62/ (1,868,410.62 + 70,973.98)}
IRR = 10 + 77.072 = 87.072
iii. Return on capital employed (accounting rate of return) based on average investment
ARR is a measure of Profitability that uses the company’s profits and various cash flows when appraising projects. With the ARR or ROCE, the company management is in a position to measure performance efficiency as far as profit generation is concerned (Jensson). This is a measure of the ration between average annual profits and average investments over the operational period.
Therefore, ARR = (Average Annual Profits/ Average Investments) x 100%
Where: Average Annual Profit = Total profit for the period/ number of years and; Average Investment = (Cost + Salvage Value)/2
| Year | 1 | 2 | 3 | 4 |
| Demand (Units) | 35,000 | 40,000 | 50,000 | 25,000 |
| Sales ($) | 840,000 | 960,000 | 1,200,000 | 600,000 |
| Costs ($) | 525,000 | 600,000 | 750,000 | 375,000 |
| Fixed Overhead Cost | 50,000 | 50,000 | 50,000 | 50,000 |
| Total costs | 575,000 | 650,000 | 800,000 | 425,000 |
| Yearly profit | 265,000 | 310,000 | 400,000 | 175,000 |
Cash flows = profit + Depreciation, Implying Depreciation = Cash flows – profit
And also, Depreciation = (Cost – Salvage Value)/ Useful life = (800,000 – 20,000)/4 = $195,000.
| Year | Cash flows | Depreciation | Profit |
| 1 | 265,000 | 195,000 | 70,000 |
| 2 | 310,000 | 195,000 | 115,000 |
| 3 | 400,000 | 195,000 | 205,000 |
| 4 | 175,000 | 195,000 | (20,000) |
Adjusted Profit = $ 370,000
Average profit = 370,000/4 = $92,000
Average Investment = {800,000 + (50,000 x 4) + 20,000}/4 = 255,000
ARR (ROCE) = (92,000/225,000) x 100% = 36.08%
This is a single project and therefore the project team is compelled to decide on the right ARR that will allow the company realize the projected profit levels.
iv. Payback period
This is the rate of time that the company will take to cover initial capital outlay on the investment. For since the capital inflows vary across the periods, the payback period can be calculated from the formula:
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PBP = Y +
Where Y is the year before full recovery
The project has an initial capital outlay of $800,000 plus the yearly fixed production overhead costs of $50,000 with varying cash inflows as presented in the table below.
This means that the total initial cost throughout the entire production period is $ (800,000 + 200,000) = $1,000,000.
| year | Cash flow | Cumulated Cash flow |
| 1 | 840,000 | 840,000 |
| 2 | 960,000 | 1,800,000 |
| 3 | 1,200,000 | 3,000,000 |
| 4 | 600,000 | 3,600,000 |
Year before full recovery (Y) = 1; Cash balance to pay back = $(1,000,000 – 840,000) = $160,000 and; Cash received the following year = $960,000
So that; PBP = 1 + (160,000/960,000) = 1 and 1/6 years or 1 year 2 months
This is a single project, and therefore the management must determine the desired PBP before investing the capital. However, a PBP of 1 year is desirable because it allows the management to prevent some the risks that would be associated with a longer PBP.
Task 3: Describing the five different types of budgets that could be prepared by Tesco plc and reasons for their usefulness
Financial budgeting is an important process in business operation since it allows for activity planning and control in a way that maximizes other operational procedures. Just like in other multinational retail companies, the managerial accounting techniques and the budgeting process in Tesco plc will ensure that the management approaches the company’s finances and financial situation in more operational way as well as providing the required information for strategic planning and control procedures (Matthew, Stout & Robbins 2007). From this perspective, it becomes important for the company management to define the specific format among the various budget formats that will allow proper forecast of departmental activities and also to address the company’s progress or downfalls with the aims of meeting particular goals. As a multinational retail company, Tesco plc could consider using the following five types of budgets: master budget, operational budget, cash flow budget, financial budget and static budget.
As a comprehensive budget, the master budget is important in projecting how the company’s management expects to conduct all its businesses over the budget period. By drawing the master budget for the specific fiscal year, the company management is in a position to summarize the projected activities, their costs, and returns (Matthew, Stout & Robbins 2007). The master budget is considered useful because it incorporates components like cash budgets, income statement budget and budgeted balances sheet, which are key when it comes to determining long term business operations and growth. This therefore means that the company’s master budget should include other interrelated budgets from the different departments in order to improve the planning and setting of performance objectives throughout the performance period (Alexei & Chiong 2011). Similarly, the company’s master budget will allow for performance improvement because it forms one of the basic tools that the management can use to keep departmental managers on the same page and also to highlight the company’s shared interests and not individual interests.
An operational budget incorporates both revenues earned and expenses incurred during the core business activities surrounding the company’s day-to-day operations. While the revenue component of the budget include the amounts earned from the sales of products and services, the expenses on the other hand include the costs of items sold, overhead costs and administrative costs (Alexei & Chiong 2011). Such costs are known to be directly related to the cost of producing goods and services. For Tesco plc, the operational budget becomes useful in ensuring that the complex budget is broken down into smaller periods like weekly or monthly for easy reporting. The operational budget will also allow the company management to compare the company’s ongoing results with the years’ budgeted results son that there is a possibility of planning and adjusting for the variations in sales and revenues. In other words, the operational budget will allow the company management to respond to business situations and anomalies as and when they occur (Alexei & Chiong 2011). This will allow for the day-to-day improvement in both financial budgeting and process control.
Another important type of budget to the company’s operation is the cash flow budget, which reports the cash inflows and cash outflows of the company on a day-to-day basis (Tony & Brown 2004). The budget type is useful in the sense that it will allow the company management to predict the company’s liquidity position, that is, the ability to generate more finances than the amount of money being paid out. Through the cash flow budget, Tesco plc management will have the opportunity to monitor and pinpoint shortfalls between everyday expenses and revenues or sales in order to normalize the shortfalls by allocating enough finances to cover part of the overhead costs (Maria & Pärsson 2010). Other than the mentioned importance, the company management will also find cash flow budget useful in determining the company’s production cycles and the levels of inventory for the purposes of resource planning. The main intention in this case is to ensure that the company’s resources are used optimally or rather no resource is left idle in respective warehouses. This will also bridge the gap between ordering and actual delivery so that the resource re-ordering point is maintained at the desired level for continuous production.
The fourth type of budget that will be useful to Tesco plc is the financial budget, which outlines the strategies followed in order to receive money as well as how the money received will be spent on corporate scale (Mária 2007). The financial budget contains the company’s revenues generated from core businesses and other income generating activities in addition to the overall costs incurred from capital expenditures. The budget is drawn from the general understanding that assets like property, company’s buildings, plant and equipment, and other investments have significant effects on the financial health and progress of the company. The type of budget will be useful to the company since it will allow the managers to control the pervasive effects of business cycles since it offers the opportunity to understand the implications of peaks and troughs on daily business operations. In this perspective, the company’s executive managers will have the opportunity to leverage finances and also value the company in a way that attracts mergers and public offerings in relation stock security.
The fifth and final type of budget is the static budget, which is known to contain elements like expenditure and sales, and the expenditures remain unchanged even with the changes in overall sales levels (Atushi, Fujimoto & Tomoyose 2010). Even though the static budgets are at times represented in terms of overhead costs, the budgets are considered to be free of traditional overhead costs. The static budget for the case of Tesco plc becomes useful in the sense that it will allow the management to determine the fixed amount of money to be allocated in the budget that can be spent by the existing departments without necessarily operating above the budget (Pall 2006). The budget also becomes useful where the company would want to seek external grants for running some of the expensive projects or complex business activities.
References
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Tony, G. & Brown L. 2004. The Ultimate Book of Business Skills: The 100 Most Important Techniques for Being Successful in Business. John Wiley & Sons.
Maria, G. & Pärsson, R. 2010. “Budget-a perfect management tool? A case study of AstraZeneca.” rapport nr: Ekonomistyrning 09-10-88.
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Pall, J. 2006. “Profitability assessment model.” Workshop on Fisheries and Aquaculture in Southern Africa: Development and Management. Windoek, Namibia. ICEIDA and UNU-FTP.
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Belinda, S. 2008. Essential Management Accounting: How to Maximize Profit and Boost Financial Performance. Kogan Page Publishers.
Jiri, S. 2009. “Quality assessment in translation.” CIUTI-Forum 2008 (enhancing translation quality: Ways, means, methods).
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Hans, T. J. 2013.”Contemporary methods for evaluating complex project proposals.” Journal of Industrial Engineering International 9.1.
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