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BBA 3211 Assignment 1 Answers

The document outlines an incremental cash flow schedule for a project over five years, showing a positive NPV of 1,881, indicating the project is worth pursuing. It also discusses limitations of the five-year analysis, forecasting challenges, appropriate discount rates, and non-quantifiable factors influencing investment decisions. Additionally, it provides a quarterly demand forecast for the first two years, highlighting seasonal adjustments affecting water demand.

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7 views

BBA 3211 Assignment 1 Answers

The document outlines an incremental cash flow schedule for a project over five years, showing a positive NPV of 1,881, indicating the project is worth pursuing. It also discusses limitations of the five-year analysis, forecasting challenges, appropriate discount rates, and non-quantifiable factors influencing investment decisions. Additionally, it provides a quarterly demand forecast for the first two years, highlighting seasonal adjustments affecting water demand.

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Chipalo
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© © All Rights Reserved
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COURSE: BBA 3211

DUE DATE: 04-01-2021


ASSIGNMENT ONE

(a)
Incremental cash flow schedule

Year: 0 1 2 3 4 5

Units 110,000 126,500 145,475 167,296 192,391

Additional units 30,000 46,500 65, 475 87 296 112,391


K’000 K‘000 K’000 K‘000 K’000 K’000

Variable costs

(K205.10 per unit) (6,153) (9,537) (13,429) (17,904) (23,051)

Additional fixed costs (50) (50)

Machine rentals

(From working) (22) (44) (44) (44) (66)

______ ______ ______ ______ _______

Allowable costs (6,175) (9,581) (13,473) (17,998) (23,167)

Incremental revenue

(Allowable costs + 25%) 7,719 11,976 16,841 22,498 28,959

Working capital (7,500) (30)

_______ ______ _______ ______ ______ _______

Net cash flow (7,500) 1,544 2,395 3,368 4,470 5,792

Discount factor at 20% 1.000 0.833 0.694 0.579 0.482 0.402

______ ______ _______ ______ ________ ______

PV (7,500) 1,286 1,662 1,950 2,155 2,328

______ ______ _______ ______ _______ ______

NPV 1,881

A positive NPV is observed. Therefore, the project is worth undertaking.

*PV – Present value NPV – Net present value

* Variable costs figures are obtained by multiplying unit variable cost by ‘additional units’ figures.

Workings

Year: 1 2 3 4 5

Demand (units) 110,000 126,500 145,475 167,296 192,391


Existing capacity 80,000 80,000 80,000 80,000 80,000

______ ______ ______ ______ ______

Extra capacity required 30,000 46,500 65,475 87,296 112,391

Number of machines required 1 2 2 2 3

Rental costs (ZMW): 22,000 44,000 44,000 44,000 66,000

Unit variable costs ZMW/unit

Labor 109.00 (45+64)

Material A costs 23.85

Material B costs 62.25 (5x12.45)

Variable overheads 10.00

____________

Unit variable costs 205.10

____________

* Rental costs are based on projected sales assuming 15% per annum growth.

* Allowable costs = Rental costs + Variable Costs

* Assume variable overheads absorbed equal variable overheads paid

(b) REPORT OF THE FINANCE DIRECTOR TO THE BOARD OF DRECTORS

DATE: 01/01/2021

This report seeks to explain in depth several factors that are directly linked to the
acceptance/rejection of the investment proposal.

(i) LIMITATONS OF THE FIVE YEAR ANALYSIS


In as much as a five year period may seem sufficient for the firm to formulate its
projections, there are still several limitations with this time frame.
Firstly, benefits or costs incurred after the five year period are not accounted for. In
several capital investments returns are seen after many years. Thus, a five year period
may not be sufficient for analysis. Another factor that should be considered is the fact
that the contract signed could be longer than 5 years. The analysis period in this case falls
short and does not give a full review of the project. Furthermore, the analysis overlooks
prospective physical site capacity increases that might span more than the
aforementioned 5 year period. Similarly, cheaper resources might be available and they
can work over a longer time period than five years. For example renting a machine might
prove more costly than buying one.
(ii) PROBLEMS AND DIFFCULTIES ASSOCIATED WTH FORECASTNG
Forecasting brings with itself many problems. It is essentially a subjective matter and
therefore issues arise when evaluating the proposal. The subjectivity involved in setting
probabilities means that the judgments may be incorrect, even though the Net Present
Value for the investment may be highly sensitive to changes in the probability
distribution. Likewise, over a long period of time, there will be less assurance of the
correctness of forecast figures. The predicted values will therefore not be reflective of the
actual happenings. Furthermore, the investment might be a one-off. It is quite unlikely
that there will be chance to repeat the investment subsequently. Thus, the average of the
anticipated returns will not be observed. Random factors such as human behavior and
weather patterns also hamper the forecasts. Additionally, the appraisal involves a forecast
of too many variables. This leads to less accuracy in the forecasts as over time there may
be too many changes to factor into the forecasts.
(iii) CHOICE OF AN APPROPRIATE DISCOUNT RATE
The choice of an appropriate discount rate requires a delicate balance between risk and
return. It is a core feature of the appraisal and the following factors should be considered:
Firstly, SWASCO is only investing in one of its sub-distributors NWRCO. So the
discount rate should reflect the hurdle rate of investing in one sub-distributor than
another. In other terms the discount rate value should compensate for the risk of only
investing in one sub-distributor. A case for a lower discount rate may be made because
it’s a long term contract meaning there could be secure cash flows. Furthermore, the
weighted average cost of capital would be a good discount rate especially at optimal
gearing. Lastly, Seeing as SWASCO is a credible and recognized company it has less
risk. Therefore, the discount rate can stay at the same level or can even be reduced.
(iv) NON-QUANTIFIABLE FACTORS THAT MIGHT INFLUENCE THE DECISION TO
ACCEPT THE PROPOSAL
The acceptance of the proposal is not only based on the NPV, but should also include
several non-quantifiable factors. To begin with, it should be acknowledged that legal and
technological circumstances will change over time. Hence, these anticipated changes
have to be factored into the decision making process. Similarly, the long-term strategic
objectives have to be looked at. The market positioning of the company over the long-
term is likely to be influenced by the short term decisions. Thus, even if not investing in
the project makes short-term financial sense, it may prove to be beneficial in the long-
term. In addition, there is a moral and community responsibility to provide clean and
sufficient water. Therefore, as long as accepting the proposal does not endanger the
firm’s long-term stability, it can be accepted. In the same vein, as long as the firm
satisfies its customers, demand could rise leading to more revenue. Furthermore
employees are secure because of the existing and proposed contracts. In a potentially
unstable labour market, this form of security is key.

(c)

Year 1 average quarterly demand = 200000/4 = 50,000

Year 2 demand = 200,000 x 115% = 230,000

Year 2 quarterly demand = 230000/4 = 57,500

YEAR QUARTER SEASONAL DEMAND


DEMAND(K’000) ADJUSTMENT FORECAST(K’000)
1 1 50 -0.08 46
2 50 0.02 51
3 50 0.15 57.5
4 50 -0.09 45.5
2 1 57.5 -0.08 52.9

The forecast demand in quarter 1 of year 2 is higher than most previous quarters because of the 15%
increase in demand. However, in quarter one a seasonal slump of 8% is recorded. This could be because
the first part of the year is the rainy season in Zambia. Thus, demand for water falls because customers
are able to get water directly from the rain or from wells which are now filled up.

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