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Business Accounting COST ACCOUNTING

1. Discounted Cash Flow Method: Discounted cash flow method refers to the method to evaluate a project after considering the time value of money or discounted cash flows . Under this method all the cash flows during the life of the projects are discounted on the basis of cost of capital. Net Present Value (NPV): NPV is a technique used in capital budgeting to see the project is profitable for the company or not. The acceptance of the project is based on the result of NPV as if it is positive then it should be selected and in the case of negative NPV it should be rejected. To compute: The NPV. Explanation: Statement that shows the calculation of NPV Particulars Cash flows Present value @16% Present values Initial investment in 0 year 100,000,000 1 Year 1 82,000,000 0.862 70,684,000.00 Year 2 82,000,000 0.743 60,926,000.00 Year 3 82,000,000 0.641 52,562,000.00 Year 4 82,000,000 0.552 45,264,000.00 Total 229,436,000.00 Net present value 129,436,000.00 Table (1) Spreadsheet working Notes: Figure (1) Working notes: Statement that shows the calculation of net cash flows Particulars 1 2 3 4 Sale price 100 100 100 100 Variable cost 50 50 50 50 Contribution margin per unit 50 50 50 50 Unit produced and sold 2,000,000 2,000,000 2,000,000 2,000,000 Total contribution 100,000,000 100,000,000 100,000,000 100,000,000 Less: fixed cost 18,000,000 18,000,000 18,000,000 18,000,000 Net cash flows 82,000,000 82,000,000 82,000,000 82,000,000 Table (2) Spreadsheet working note: Figure (2) Conclusion: Thus, the NPV of investment proposal is $129,436,000. 2 (a) To compute: The NPV if reduction in selling price by 20% Explanation: Statement that shows the calculation of NPV Particulars Cash flows Present value @16% Present values Initial investment in 0 year 100,000,000 1 Year 1 42,000,000 0.862 36,204,000.00 Year 2 42,000,000 0.743 31,206,000.00 Year 3 42,000,000 0.641 26,922,000.00 Year 4 42,000,000 0.552 23,184,000.00 Total 117,516,000.00 Net present value 17,516,000.00 Table (3) Spreadsheet working Notes: Figure (3) Working note: Statement that shows the calculation of net cash flows Particulars 1 2 3 4 Sale price 80 80 80 80 Variable cost 50 50 50 50 Contribution margin per unit 30 30 30 30 Unit produced and sold 2,000,000 2,000,000 2,000,000 2,000,000 Total contribution 60,000,000 60,000,000 60,000,000 60,000,000 Less: fixed cost 18,000,000 18,000,000 18,000,000 18,000,000 Net cash flows 42,000,000 42,000,000 42,000,000 42,000,000 Table (4) Spreadsheet working Notes: Figure (4) Conclusion: Thus, the NPV of investment proposal is $17,516,000. 2 (b) To compute: The NPV if increase in variable cost by 20% Explanation: Statement that shows the calculation of NPV Particulars Cash flows Present value @16% Present values Initial investment in 0 year 100,000,000 1 Year 1 62,000,000 0.862 53,444,000.00 Year 2 62,000,000 0.743 46,066,000.00 Year 3 62,000,000 0.641 39,742,000.00 Year 4 62,000,000 0.552 34,224,000.00 Total 173,476,000.00 Net present value 73,476,000.00 Table (5) Spreadsheet working Notes: Figure (5) Working Notes: Statement that shows the calculation of net cash flows Particulars 1 2 3 4 Sale price 100 100 100 100 Variable cost 60 60 60 60 Contribution margin per unit 40 40 40 40 Unit produced and sold 2,000,000 2,000,000 2,000,000 2,000,000 Total contribution 80,000,000 80,000,000 80,000,000 80,000,000 Less: fixed cost 18,000,000 18,000,000 18,000,000 18,000,000 Net cash flows 62,000,000 62,000,000 62,000,000 62,000,000 Table (6) Spreadsheet working Notes: Figure (6) Conclusion: Thus, the NPV of investment proposal is $73,476,000. 3. To explain: How the management will use the result calculated in part 1 and 2. Answer: The management can see that with the change in the selling price and in variable cost the NPV of the project will change with a very high amount. Explanation: When selling price is reducing by 20% the net cash flow will change to $42,000,000 and NPV will be $17,516,000. When the variable cost is increase by 20% the net cash flow is change to $62,000,000 and NPV will be $73,476,000. Conclusion: Thus, it is observed that with change in the percentage of variable cost and in selling price the NPV will be change.

1. Discounted Cash Flow Method: Discounted cash flow method refers to the method to evaluate a project after considering the time value of money or discounted cash flows . Under this method all the cash flows during the life of the projects are discounted on the basis of cost of capital. Net Present Value (NPV): NPV is a technique used in capital budgeting to see the project is profitable for the company or not. The acceptance of the project is based on the result of NPV as if it is positive then it should be selected and in the case of negative NPV it should be rejected. To compute: The NPV. Explanation: Statement that shows the calculation of NPV Particulars Cash flows Present value @16% Present values Initial investment in 0 year 100,000,000 1 Year 1 82,000,000 0.862 70,684,000.00 Year 2 82,000,000 0.743 60,926,000.00 Year 3 82,000,000 0.641 52,562,000.00 Year 4 82,000,000 0.552 45,264,000.00 Total 229,436,000.00 Net present value 129,436,000.00 Table (1) Spreadsheet working Notes: Figure (1) Working notes: Statement that shows the calculation of net cash flows Particulars 1 2 3 4 Sale price 100 100 100 100 Variable cost 50 50 50 50 Contribution margin per unit 50 50 50 50 Unit produced and sold 2,000,000 2,000,000 2,000,000 2,000,000 Total contribution 100,000,000 100,000,000 100,000,000 100,000,000 Less: fixed cost 18,000,000 18,000,000 18,000,000 18,000,000 Net cash flows 82,000,000 82,000,000 82,000,000 82,000,000 Table (2) Spreadsheet working note: Figure (2) Conclusion: Thus, the NPV of investment proposal is $129,436,000. 2 (a) To compute: The NPV if reduction in selling price by 20% Explanation: Statement that shows the calculation of NPV Particulars Cash flows Present value @16% Present values Initial investment in 0 year 100,000,000 1 Year 1 42,000,000 0.862 36,204,000.00 Year 2 42,000,000 0.743 31,206,000.00 Year 3 42,000,000 0.641 26,922,000.00 Year 4 42,000,000 0.552 23,184,000.00 Total 117,516,000.00 Net present value 17,516,000.00 Table (3) Spreadsheet working Notes: Figure (3) Working note: Statement that shows the calculation of net cash flows Particulars 1 2 3 4 Sale price 80 80 80 80 Variable cost 50 50 50 50 Contribution margin per unit 30 30 30 30 Unit produced and sold 2,000,000 2,000,000 2,000,000 2,000,000 Total contribution 60,000,000 60,000,000 60,000,000 60,000,000 Less: fixed cost 18,000,000 18,000,000 18,000,000 18,000,000 Net cash flows 42,000,000 42,000,000 42,000,000 42,000,000 Table (4) Spreadsheet working Notes: Figure (4) Conclusion: Thus, the NPV of investment proposal is $17,516,000. 2 (b) To compute: The NPV if increase in variable cost by 20% Explanation: Statement that shows the calculation of NPV Particulars Cash flows Present value @16% Present values Initial investment in 0 year 100,000,000 1 Year 1 62,000,000 0.862 53,444,000.00 Year 2 62,000,000 0.743 46,066,000.00 Year 3 62,000,000 0.641 39,742,000.00 Year 4 62,000,000 0.552 34,224,000.00 Total 173,476,000.00 Net present value 73,476,000.00 Table (5) Spreadsheet working Notes: Figure (5) Working Notes: Statement that shows the calculation of net cash flows Particulars 1 2 3 4 Sale price 100 100 100 100 Variable cost 60 60 60 60 Contribution margin per unit 40 40 40 40 Unit produced and sold 2,000,000 2,000,000 2,000,000 2,000,000 Total contribution 80,000,000 80,000,000 80,000,000 80,000,000 Less: fixed cost 18,000,000 18,000,000 18,000,000 18,000,000 Net cash flows 62,000,000 62,000,000 62,000,000 62,000,000 Table (6) Spreadsheet working Notes: Figure (6) Conclusion: Thus, the NPV of investment proposal is $73,476,000. 3. To explain: How the management will use the result calculated in part 1 and 2. Answer: The management can see that with the change in the selling price and in variable cost the NPV of the project will change with a very high amount. Explanation: When selling price is reducing by 20% the net cash flow will change to $42,000,000 and NPV will be $17,516,000. When the variable cost is increase by 20% the net cash flow is change to $62,000,000 and NPV will be $73,476,000. Conclusion: Thus, it is observed that with change in the percentage of variable cost and in selling price the NPV will be change.

Solution Summary: The author explains the Discounted Cash Flow Method, which evaluates a project after considering the time value of money or discounted cash flows. The Net Present Value (NPV) is used in capital budgeting to see the project

COST ACCOUNTING

COST ACCOUNTING

16th Edition

ISBN: 9781323169261

Author: Horngren

Publisher: PEARSON C

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COST ACCOUNTING

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