Firm can carry out cost cutting exercise to reduce overhead expenses Question 2 b) * internal rate of return (IRR) =A + [a/(a-b) x (B-A)] where * A = is the discount rate which provides the positive NPV * A =is the amount of the positive NPV * B =is the discount rate which provides the negative NPV * b =is the amount of the negative NPV internal rate of return (IRR) (machine 1) = 12% + 66934 /(66934 + 7716) x (20- 12) =19. 73% internal rate of return (IRR) (machine 2) = 12% + 43400 / (43400+ 38517) x (20-12) =16. 238% Machine M1 should be invested because it has higher NPV than machine M2 2(c) Difference between IRR and NPV * While NPV is expressed in terms of a value in units of a currency, IRR is a rate that is expressed in percentage which tells how much a company can expect to get in percentage terms from a project down the years. NPV takes into account additional wealth while IRR does not calculate additional wealth * If cash flows are changing, IRR method cannot be used while NPV can be used and hence it is preferred in such cases * While IRR gives same predictions, NPV method generates different results in cases where different discount rates are applicable. * NPV is calculated in terms of currency while IRR is expressed in terms of the percentage return a firm expects the capital project to return; http://www. wikicfo. com/Wiki/Default. aspx?
Page=NPV%20vs%20IRR&NS=&AspxAutoDetectCookieSupport=1 viewed on 6th November 2012 http://www. differencebetween. com/difference-between-irr-and-npv/ viewed on 6th November 2012 (d) Based on our answers calculated in part (a), Machine 1 should be invested as it gives a larger profit than Machine 2 which is RM 66934. 3a) i) At reorder quality= 3000 units Total annual holding costs: Q/2 x Ch 3000/2 x 0. 2x30= 9000 Total annual ordering costs D/Q x Co (500x12)/3000xRM200=400 Purchase cost pxD Rm30x(500x12) =180000 Total annual inventory cost : RM189400 i) EOQ =(2xCoxD)Ch =2x200x(500x12)(0. 2x30) = 24000009000 =266. 67 units =267 units(rounded off) The EOQ of 267 units means that this is the economical quantity purchase since it minimizes the cost of ordering and holding inventory. iii) At EOQ : 266. 67 units Annual holding cost 266. 67units/2 x 0. 2 x 30 = RM800. 01 Ordering cost 6000/267. 66 x 200 = RM4483. 30 Purchase cost RM30 x (500x12) = RM 180000 Total annual inventory cost RM 185283. 31 iv) At reorder quantity of 3000 packets, the total annual inventory cost = RM 189400.
At EOQ, total annual inventory cost = RM 185284. 14. If Wita Sdn. Bhd orders at economic order quantity, the cost savings= RM 4104. 60 b) With a discount of 5% and an order quantity of 3000 units costs are as follows: Purchases (180000x95%) 171000 Holding costs (3000/2x0. 2x30x95%) 8550 Ordering costs (6000/3000)x RM200 400 Total annual cost 179950 It is advised that Wita Sdn.
Bhd should accept the discount given as it is cheaper. 3 (c) The 3 main stock costs are : 1) Holding Costs Holding costs also known as carrying costs will increase as the amount of stock held increases. The cost of holding cost include : * Finance cost , since capital is tied up in stocks * Warehouse and handling costs * Deterioration costs * Obsolescence cost * Insurance Costs * Pilferage costs 2) Ordering Costs There will be costs when placing orders with manufacturers.
Such costs will include delivery costs, and also administrative costs involved in placing order (staff costs, telephone chargers). The more orders taken the higher the charges will be. 3) Shortage Costs It occurs when the firm runs out of stock. The cost is difficult to estimate but is an essential in stock control. These may include: * Loss of sale, and the consequent loss of contribution that would have been earned from that sale * Additional costs involved in making emergency orders for goods * The costs of lost production, when stock-outs occur and production lines grind to a halt.
Staff will still have to be paid, even if they have no work to do. James C. Van Home, John M. Wachowicz Jr. ; 13th edition Sheridan Titman, J. Keown, John D. Martin ; 11th edition Brigham E. F and Houson J. F , 1st edition BPP Publishing Ltd. , December 2008 and June 2009 Question 4 a) Overcapitalization happens to a firm if its working capital is excessive for its needs. Excessive inventory, receivables and cash and very few payables will lead to a low return on investment, with a long term funds tied up in non-earning short term assets.
By comparing the volume of sales as a multiple of the working capital investment with previous year or with similar companies, it should indicate whether the total volume of working capital is too high. b) Signs of overcapitalization * Current ratio greater than 2:1 * Quick ratio more than 1:1 * Inventory and receivables collection periods being too long could indicate that the volume of inventories or receivables is very high. * Short period of credit taken from suppliers might indicate the volume of payables is too low c) Overtrading occurs when a business is conducting its business operations with inadequate capital.
It is also known as under-capitalization. When a business accepts work, and tries to fulfill it at a level that cannot be supported by its working capital or net current assets. It does not have enough cash and cannot obtain enough cash quickly. d) Symptoms of overtrading * Greatly increase in sales * Increase in receivable and longer time to pay * Taking longer credit from supplier because the business does not have the cash flows to pay sooner * Unusual inventory movement. Fall sharply in response to growing sales demand. * A falling of current ratio and quick ratio.
Because increases in inventory and receivables are financed mainly by increases in trade payables and overdraft * A rise in bank overdraft e) Measures to reduce overtrading * Finance expansion with long term sources of fund * Better control of debtors, stocks and creditors to improve liquidity * Restrict company expansion or slow down the rate James C. Van Home, John M. Wachowicz Jr. ; 13th edition Sheridan Titman, J. Keown, John D. Martin ; 11th edition Brigham E. F and Houson J. F , 1st edition BPP Publishing Ltd. , December 2008 and June 2009
