Investment Appraisal Report to Purchase a New Super Cruise Ship

Introduction

Business is combination of the human activities directed for earning profit and giving service to the society. The activity of the business makes the product and service ready for consumer by the help of industry and commerce. Industry collects the consumable goods from the nature and processes it to make consumable goods. Again, commerce makes the goods and service available for the customers. But in all type of activities executed by industry and commerce needs capital and loan able funds. From where the finance will be collected, how much cost has to be sacrificed as cost of capital and other different things can be learned from business finance. Business finance helps stakeholder and business to understand how finance can be successfully used to derive most benefit from the finance. A successful business man can take necessary steps such as investment appraisal methods; understand the financial environment of the company to take investment decision. In that report, there is a discussion of investment appraisal report, different budget such as cash budget, production budget, guidelines on managing business finance are discussed in detail.

Task-1 Investment Appraisal Report to Purchase a New Super Cruise Ship

Investment Appraisal report

Carnival, A Quality Cruises.

I. Introduction

Carnival Cruise is one of the renowned cruises and largest vacation company in the world. Their portfolio of cruise has branded cruises. It wants to expand its business by purchasing a new super cruise ship for $900 million. That’s why they go for different investment appraisal technique to know whether it is better purchase the cruise or not. This report will describe the financial viability of that company. Carnival Cruise has initial investment, sales and costs data. These data will help determine the suitability of purchasing the ship. In fine the report will make a recommendation by evaluating the results, strength and weakness of investment appraisal technique.

In that report four investment appraisal methods are used. These are Accounting rate of return (ARP), Net present value (NPV), Payback period and internal rate of return. The result of these four methods may not be same because of their approaches and calculation. But it will help evaluate the results with different technique and make final decision.

II. Investment appraisal methods

Four appraisal methods can be categorized into two methods- discounting methods and non-discounting methods. The APP and Payback period are non-discounting and NPV and IRR are discounting methods. ARR can be found by dividing Average income by Average investment (Hansen and Mowen, 2007, p. 568). That method doesn’t consider the time value of money. It is considered as the drawback for ARR.

To identify the recovery period of initial investment, payback period is commonly used (Brigham and Houston, 2007, p. 373). Result which provide shorter payback period is preferable rather than longer payback period.

It ignores cash flow after payback period and time value of money (Kinney & Raiborn, 2011, p. 655).

In case of NPV method, we can find net value of the project by discounting cash flow at a specific rate. The major advantage of NPV is the discount of the future cash flow and it is preferable than any other methods.

The disadvantage is that it supposes constant gearing for cost of capital (Delaney, 2008, p. 37).

It is difficult to calculate cost of capital that is used for discounting cash flows (Howe, 1992, p. 34).

Unlike NPV, IRR is used to discount the future cash flows. It tells about the margin of safety in term of decline of rate of return (Brigham and Daves, 2009, p. 421).

III. Results of investment analysis

Accounting Rate of Return (ARR):

Particulars	2012($)	2011($)	2010($)
Revenue	7688024	7537263	6752504
(-):Expenses	6899470	6605635	5949871
Operating profit	788,554	931,628	802,633
Net profit	788,554*	931,628*	802,633*

*Tax effects should be ignored. That’s why net profit is same as operating profit.

Average profit= ($788554+$931628+$802633)/3=$840,938

Average investment= ($900,000,000+0)/2= $450,000,000

ARR = Average profit / Average investment = $840,938/ $450,000,000 = 0.19%

Payback Period:

Initial Investment is $900,000,000

Year	Cash flow $	Cumulative cash flow $
2008-Year-1	300,000,000	300,000,000
2009-Year-2	230,000,000	530,000,000
2010-Year-3	130,000,000	660,000,000
2011-Year-4	400,000,000	1060,000,000
2012-Year-5	70,000,000	1130,000,000

Payback period = 3 + ($240,000,000/$400,000,000) = 3.6 years.

Net Present Value (NPV):

The incremental cash flows are:

Year	Cash flow $
2008-Year-1	300,000,000
2009-Year-2	230,000,000
2010-Year-3	130,000,000
2011-Year-4	400,000,000
2012-Year-5	70,000,000

As, interest rate is 6% or, 0.06,

The PV =$(300,000,000/1.06) + (230,000,000/1.06^2) + (130,000,000/1.06^3) + (400,000,000/1.06^4) + (70,000,000/1.06^5)

=$966,014,093

So, NPV = PV – Initial investment

=$966,014,093-$900,000,000

=$66,014,093

Internal rate of return is the interest rate that results in the net present value to zero. In that case, “guess and check” is the most popular to find it out.

Assume, cost of capital is 8%. Here, initial investment $900,000,000

Here, all the data are assumed. Internal Rate of Return (IRR):ear	Cash flow $
2008-Year-1	300,000,000
2009-Year-2	230,000,000
2010-Year-3	130,000,000
2011-Year-4	400,000,000
2012-Year-5	70,000,000

Let’s try 10% interest rate:

• Now: PV= -$900,000,000
• Year-1: PV=$300,000,000/1.10=$272,727,272
• Year-2: PV=$230,000,000/1.10^2=$190,082,645
• Year-3: PV=$130,000,000/1.10^3=$97,670,924
• Year-4: PV=$400,000,000/1.10^4=$273,205,382
• Year-5: PV=$70,000,000/1.10^5=$43,464,493

Adding those up gets:

NPV = -$900,000,000+$272,727,272+$190,082,645+$97,670,924+$273,205,382+$43,464,493

= -$110,849,284

I will take a better guess now, and try an 11% interest rate:

Continued at 11% interest rate

• Now: PV= -$900,000,000
• Year-1: PV=$300,000,000/1.11=$270,720,270
• Year-2: PV=$230,000,000/1.11^2=$186,673,159
• Year-3: PV=$130,000,000/1.11^3=$95,054,879
• Year-4: PV=$400,000,000/1.11^4=$263,492,389
• Year-5: PV=$70,000,000/1.11^5=$41,541,593

Adding those up gets:

NPV = -$900,000,000+$270,720,270+$186,673,159+$95,054,879+$263,492,389+$41,541,593

= -42,517,710

I will take a better guess now, and try a 13% interest rate:

Continued at 13% interest rate

• Now: PV= -$900,000,000
• Year-1: PV=$300,000,000/1.13=$265,486,726
• Year-2: PV=$230,000,000/1.13^2=$180,123,737
• Year-3: PV=$130,000,000/1.13^3=$90,096,521
• Year-4: PV=$400,000,000/1.13^4=$245,327,491
• Year-5: PV=$70,000,000/1.13^5=$37,993,196

Adding those up gets:

NPV = -$900,000,000+$265,486,726+$180,123,737+$90,096,521+$245,327,491+$37,993,196

= - 80,972,329

I will take a better guess now, and try a 10.3% interest rate:

Continued at 10.3% interest rate

• Now: PV= -$900,000,000
• Year-1: PV=$300,000,000/1.103=$271,985,494
• Year-2: PV=$230,000,000/1.103^2=$189,050,056
• Year-3: PV=$130,000,000/1.103^3=$96,876,138
• Year-4: PV=$400,000,000/1.103^4=$270,245,171
• Year-5: PV=$70,000,000/1.103^5=$42,876,614

Adding those up gets:

NPV= -$900,000,000 +$271,985,494+$189,050,056+$96,876,138+$270,245,171+$42,876,614

= -28,966,527

10.3% interest rate is good enough because using that interest rate we find the result close to zero.

So, internal rate of return is 10.3%

We can say investment will yield to 10.3% (if all goes as per plan).

IV. Analysis of results

IRR of 10.3% is also higher than the cost of capital of 8% which again approves the purchase.

The ARR 0.16% which is substantially lower than the cost of capital of 8% and hence the ARR method does not approve the investment.

The NPV is positive $66,014,093. Investment in cruise is also approved under the NPV method.

Payback period is better when it is lower.

V. Conclusions

The results of the four different appraisal methods- Payback period, NPV, IRR and ARR may not provide same or unanimous result. In that report there has been a description about NPP, Payback period, ARR, IRR and these results may be compared with other project to find the suitability of the purchase of the cruise. Here, we compare our result with cost of the capital but will be more informative if we can make a comparison among or between companies.

VI. Recommendations

When we will compare the result between or among the projects, in that case we can recommend the suitable approach for the company. For an example, when one company’s payback period is less than other. In that case the first company is better to choose.

Task 2

Sales, Purchases, Production and Cash flow Budget

Information given,

Capital = A£70,000

Cutting machine = A£45,000

Delivery van = A£18,000

Estimated life of the machine = 10 years

Estimated life of the van = 5 years

Predicted cost for each toy, for wood = A£5.00

For varnish coating = A£1.00

Sales price per toy = A£12

Ending inventory at each month = 80% of sales

Wages = A£5,000

Electricity costs per quarter = A£2,000

Rent for 12 months = A£12,000

Insurance = A£9,000

The forecasted sales in units are as follows:

Month	Sales	Ending inventory (80%)	Beginning inventory
June	4,000,	3,200	0
July	5,000,	4,000	3,200
August	5,000,	4,000	4,000
September	8,000	6,400	4,000
October	9,000	7,200	6,400
November	9,000	7,200	7,200
December	11,000	8,800	7,200
January	6,000	4,800	8,800

Production Budget:

Production Budget (units) = sales Budget (units) + Target ending finished goods inventory (units) – Beginning finished goods inventory (units)

Month	Calculation	Output
	Sales budget	Ending finished goods inventory	Beginning finished goods inventory	Budgeted production
June	4,000	4,000	0	= 8,000
July	5,000	4,000	4,000	= 5,000
August	5,000	6,400	4,000	= 7,400
September	8,000	7,200	6,400	= 8,800
October	9,000	7,200	7,200	= 9,000
November	9,000	8,800	7,200	= 10,600
December	11,000	4,800	8,800	= 7,000

Sales budget:

Sales budget = (Forecasted units sale * Price per unit) – Sales discount and allowances

Month	Calculation	Output
	Forecasted sale	Price per unit	Discount & allowances	Budgeted sales
June	4,000	12	0	48,000
July	5,000	12	0	60,000
August	5,000	12	0	60,000
September	8,000	12	0	96,000
October	9,000	12	0	1,08,000
November	9,000	12	0	1,08,000
December	11,000	12	0	1,32,000

Purchases Budget:

Particulars	June	July	August	September	October	November	December
Production Budget	8000	5000	7400	8800	9000	10600	7000
(+)Ending Inventory	3200	4000	4000	6400	7200	7200	8800
Total Requirement	11,200	9,000	11,400	15,200	16,200	17,800	15,800
(-) Beginning Inventory	0	3200	4000	4000	6400	7200	7200
Purchased(In Unit) To be made	11,200	5,800	7,400	11,200	9,800	10,600	8,600
Purchased Budget(W-1)	67,200	34,800	44,400	67,200	58,800	63,600	51,600

Cash budget:

Cash disbursements:

	June	July	August	September	October	November	December
Production	8,000	5,000	7,400	8,800	9,000	10,600	7,000
Direct material:
Wood (A£5)	40,000	25,000	37,000	44,000	45,000	53,000	35,000
Varnish coating (A£1)	8,000	5,000	7,400	8,800	9,000	10,600	7,000
Total	48,000	30,000	44,400	52,800	54,000	63,600	42,000

Cash budget:

Particulars	June	July	August	September	October	November	December
Collections from customers	0	48,000	60,000	60,000	96,000	1,08,000	1,08,000
Disbursements:
Manufacturing cost:
Direct material	(0)	(48,000)	(30,000)	(44,400)	(52,800)	(54,000)	(63,600)
Wages	(5,000)	(5,000)	(5,000)	(5,000)	(5,000)	(5,000)	(5,000)
Non-manufacturing costs:
Rent	(7,000)
Machinery & van purchase	(45,000) (18,000)
Insurance	(9,000)
Ending balance	(84,000)	(5,000)	25,000	10,600	38,200	49,000	39,400

Forecasted Income Statement and Balance Sheet

Forecasted Income Statement

Neptune Toys

For the year ending December 31, 2015

Particulars	Amount	Amount
Revenues		6,12,000
Cost of goods sold (W-2)		(3,65,000)
Gross margin		2,47,000
Operating cost Depreciation(W-3)	4,050
Wages (5000 * 7)	35,000
Electricity(2000*2+670)	4,670
Rent(12000/12*7)	7,000
Insurance (9000/12*7)	5,250	(60,100)
Operating income		1,91,030

Forecasted Balance Sheet

Neptune Toys

As at December 31, 2015

Particulars	Amount	Amount	Amount
Assets: Current assets: Cash Ending Inventory(N-5) Prepaid electricity cost Cutting Machinery (-)Depreciation Delivery Van (-)Depreciation	45,000 (2250) 18,000 (1800)	73,200 271800 4,670 42,750 16,200
Total asset			408,620
Liability & Equity: Current liabilities: Accrued Wage(5000*7) Rent Payable Insurance payable Account Payable Equity: Owner’s Capital Retained earnings(Operating income)		35,000 7,000 5,250 100,340 70,000 1,91,030
Total Liability & Equity			408,620

Notes to the financial statement-

Notes-1: Purchase cost for toy:

• In June=11,200*(5+1) =67,200
• In July =5,800*(5+1) =34,800
• In August =7,400*(5+1) =44,400
• In September =11,200*(5+1) =67,200
• In October=9,800*(5+1) =58,800
• In November =10,600*(5+1) =63,600
• In December: Purchase cost for toy=8,600*(5+1) =51,600

Notes-2: Cost of goods sold:

Particulars	Amount	Amount	Total
Beginning finished goods inventory, June 1, 2015			0
Direct materials used	3, 34,800
Direct manufacturing labor	0
Manufacturing overhead: Wages (5,000 * 7)	35,000
Cost of goods manufactured		3,69,800
Cost of goods available for sale			3,69,800
Ending finished goods inventory, Dec. 31, 2015			(4,800)
Cost of goods sold			3,65,000

Notes-3: Depreciation calculation:

Cutting Machine= (45000/10) =4500/2=2250

Delivery van= (18000/5) =3600/2=1800

Total Depreciation=2250+1800=4050

*Depreciation is calculated following Straight line Method.

**Calculated half year depreciation.

Note-4: Ending Inventory Calculation:

Total Production unit= 55,800

Total production cost:

Manufacturing cost 369,800

Electricity Bill 2,000

Total cost 371,800

Assume insurance and rent expenses are for office.

Production cost per unit= (371,800/55,800) =6.663 (approx.)

Ending Inventory= 40,800

Ending Inventory cost= (40,800*6.663) =271,800 (approx.)

Utopia resort is one of the well-known company operates its exclusive holiday resort around the world. This holiday resort company charge A£4,000 for each of the person who enjoys their entertainment. Again there are lots of holiday Resort Company existing in the world that are competitor of Utopia company. So, it needs to manage its financial resources to strength its position in that type of business.

A business may be benefited if they prudently and strategically manage its finance and it may help that company unlock additional financing and avoid uncertain cash flow problem (Cinnamon, Helweg-Larsen and Cinnamon, 2010).

Managing Business Cash:

The aim of the business is to ensure its sufficient cash facilities to keep that business going. It means it will get full on time payment for the respectable customers and successfully pay to its creditors and suppliers. Here Utopia is listed to London Stock Exchange to become a levered firm (Connolly, 2007).

Managing Business Credit:

How to successfully obtain credit is mainly focused in the business. Businesses must have to manage actively the business credit by credit payment and identifying and issues related with finance.

Utopia needs to manage its credit by taking loan from the bank or from the stock market. Some important steps that need to follow to maintain better relationship with the bank includes:

• To inform bank about the business performance that it is doing well or not.
• To present current and accurate financial information.
• To invite bank’s relationship office to monitor how it operated.
• To be stick to the term of lending agreement.

They should follow the above criteria to satisfy the Bank office to get financial support in time of need (Eiteman et al., 2001).

Managing Business Credit policy:

Getting paid in time is very important for any business to survive. That is also applicable for Utopia Resort Company. To minimize the credit loss, there is a need of clear and comprehensive credit policies, management and proper systems (Crowther, 2004).

Financial Planning:

To understand business financial position, to persuade lender to the business, there a necessity of good, proper and accurate financial planning. Utopia needs to structure a good financial planning to make them competitor for the other company in the holiday business (Groppelli and Nikbakht, 2000).

Here some suggestion for the Utopia for their future financial plans:

• As there is a stiff competition from the other global competitor like USA companies etc in the market, the need to be careful in case of setting service charges.
• They should highlight some features of their business that are insufficient in other company. Such as, Utopia can take the advantage from media coverage of ship sinking, fire, virus in ship. And say the customer that they are free from these problems and there is a sufficient life saving boats in the mother ship.
• They can take help from bank and make them listed in the Stock exchange to make their business stronger and acceptable.
• They need to set most challenging financial strategies to keep control of the profitability in the expansion phase of the company.

Conclusion

Business and finance are interrelated with each other. Any business can be successfully operated if there is sufficient capital and effectively manage finance in the business. Here, in the assignment we discuss how a quality cruise plc uses investment appraisal techniques to find out how effective it will be if he/she invests his/her capital to buy a super cruise ship. We also use different accounting information to make that report knowledgeable. Here different budget like sales budget, purchase budget are calculated and forecasted income statement and balance sheet is given. There is a guideline of the director of Utopia about how to manage business successfully in time of expansion of the business. For that reason they have to maintain a good relation with the bank and they can go for stock exchange borrowing for their future finance needs.

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