IntroductionThe paper aims to discuss the sophisticated and unsophisticated techniques that enables the firm to access a better project for future growth. It deals with a case study of up and coming Holloway catering. Sidney rich is the ambitious accountant of the firm and want to leave the firm after 3 years by providing better services to the firm. His better services enable him to gain a better job in a huge and well-renowned firm. In the present case he is dealing with three projects and wants to select the best that will provide an efficient growth to the firm.
The Chairman of the firm uses non-sophisticated technique and is unable to know other latest financial techniques. Sidney is required to present a better capital budgeting technique that not only show the statistical data but also provide a better understanding of the technique used. The paper first present the techniques used previously by the firm and later a sophisticated technique of finance is used by the accountant to show more accurate techniques. Net present value of the project with profitability index is sued to provide accurate results presenting time value of money associated with each project.
Later assumption of stock market behaviour with respect to Project C is presented. Payback PeriodThe payback period shows the time required to recover the initial investment. The payback period is the unsophisticated technique of capital budgeting as this tool does not include the time of money. Payback period for annuity and for mixed stream is calculated as accumulate Payback period for annuity= initial investment/annual cash inflowsPayback period for mixed stream= initial investment/ accumulated yearly cash inflowsProjectABCInitial Investment350,000350,000350,000Expected Cash Inflows in Year 1£100,000£40,000£200,000Year 2£110,000£100,000£150,000Year 3£104,000£210,000£240,000Year 4£112,000£260,000£40,000Year 5£138,000£160,000Year 6£160,000Year 7£180,000Payback Period3 years 4 month3 years2 yearsDecision criteriaIf the payback period is less than the period accepted by the firm, accept the projectIf the payback period is more than the accepted time for the firm, reject the project.
Accounting rate of returnThe accounting rate of return is an investment appraisal technique used to measure the profitability of the project. It shows comparison between the projects and it shows the income streams earn by the project but it is not capable to inform the time period of the earning.
The accounting rate of return in measured by the formulaAccounting rate of return = average annual rate of return/initial cost of investment Accounting rate of return for the project A = 27.5/20 =1.375%Accounting rate of return for the Project B = 26.4/20 = 1.32%Accounting rate of return for the Project C = 33/20= 1.65%Decision CriteriaThe accounting rate of the project C is highest than the other two project, therefore, it is recommended to adopt the Project C. Report for the ChairmanThe above two mentioned techniques do not involve the time value of money and thus more sophisticated techniques are required to access a better profit in the year.
The time and the money of the project are inextricably related. One of the principal ideas in the accounting is the relationship between the time and money known as time value of money. This economic principal is used by the firms to recognize that the passage of time affects the money, and thus advise you that you’d be better off to take dollar today.
To recognize that which project is better for the firm in the coming future sophisticated techniques (techniques involve time value of money) are advised to be used by the account and finance manager. What are these techniques and how it helps to recognise the worth of each project, is discussed below