financial topics unit4.ppt

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PROJECT MANAGEMENT



Financial analysis evaluation



Payback period

(2)

FINANCIAL ANALYSIS

EVALUATION

(3)

Consider a company XYZ

specializing in manufacturing

and selling toys for kids.

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XYZ’s Balance Sheet

(Asset Side)

1. Amounts owed by

customers.

2. Cash/likely convertible

to cash within 1 year.

3. Original amount paid. 4. Acc. deductions for

wear and tear.

5. What BW owned

1. Amounts owed by

customers.

2. Cash/likely convertible

to cash within 1 year.

3. Original amount paid. 4. Acc. deductions for

wear and tear.

5. What BW owned

Acct. Rec.11 394

Cash + Inventories 801

Current Assets

Current Assets22 $1,195 _$1,195

Fixed Assets (@Cost)33 1030

Less: Acc. Depr. 44 (329)

Net Fix. Assets

Net Fix. Assets $ 701 _{$ 701}

Other Assets 273

Total Assets

Total Assets55 $2,169_$2,169

XYZ Balance Sheet (thousands) Dec. 31, 2007

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XYZ’s Balance Sheet

(Liability Side)

6. Debts payable < 1 year.

7. Debts payable > 1 year.

8. Note, Assets = Liabilities + Equity.

9. What XYZ owed and ownership position.

6. Debts payable < 1 year.

7. Debts payable > 1 year.

8. Note, Assets = Liabilities + Equity.

9. What XYZ owed and ownership position.

Current Liab.

Current Liab. 66 $ 500 $ 500

Long-Term Debt77 530

Shareholder’s equity

Shareholder’s equity $

$1,1391,139

Total Liab/Equity

Total Liab/Equity8,98,9 $2,169_$2,169

XYZ Balance Sheet (thousands) Dec. 31, 2007

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XYZ’s Income Statement

10. Received, or receivable, from customers.

11. Sales comm., adv., officers’ salaries, etc. 12. Earnings before

interests and taxes. 13. Cost of borrowed

funds.

14. Taxable income.

10. Received, or receivable, from customers.

11. Sales comm., adv., officers’ salaries, etc. 12. Earnings before

interests and taxes. 13. Cost of borrowed

funds.

14. Taxable income.

Net Sales $ 2,211

Cost of Goods Sold1010 1,599

Gross Profit $ 612

SG&A Expenses 11 11 402

EBIT12 $ 210

Interest Expense13 59

EBT 14 14 $ 151

XYZ’s Statement of Earnings (in thousands) for Year

Ending December 31, 2007

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Use of Financial Ratios

A

Financial Ratio

is

an index that relates

two accounting

numbers and is

obtained by dividing

one number by the

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Liquidity Ratios

Current

Current Assets Current Assets Current Liabilities Current Liabilities

For XYZ Dec 31, 2007

Current

Current Assets Current Assets Current Liabilities Current Liabilities

For XYZ Dec 31, 2007

Shows a firm’s ability

to cover its current

liabilities with its

current assets.

Balance Sheet Ratios

Liquidity Ratios

$1,195

$500

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Liquidity Ratio

Comparisons

Liquidity Ratio

Comparisons

XYZ

Industry

2.39

2.15

2.26

2.09

1.91

2.01

XYZ

Industry

2.39

2.15

2.26

2.09

1.91

2.01

Year

2015

2014

2013

Current

Ratio

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Financial Leverage Ratios

Debt-to-Total-Assets

Total Debt Total Debt Total Assets Total Assets

For XYZ December 31, 2007

Debt-to-Total-Assets

Total Debt Total Debt Total Assets Total Assets

For XYZ December 31, 2007

Shows the percentage

of the firm’s assets

that are supported by

debt financing.

Balance Sheet Ratios

Financial Leverage Ratios

$1,030

$2,169

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Financial Leverage

Ratio Comparisons

Financial Leverage

Ratio Comparisons

BW

Industry

.47

.45

.47

BW

Industry

.47

.45

.47

Year

2007

2006

2005

Debt-to-Total-Asset Ratio

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Coverage Ratios

Interest Coverage

EBIT EBIT Interest Charges Interest Charges

For XYZ December 31, 2007

Interest Coverage

EBIT EBIT Interest Charges Interest Charges

For XYZ December 31, 2007

Indicates a firm’s

ability to cover

interest charges.

Income Statement Ratios Coverage Ratios $210 $210 $59

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Coverage

Ratio Comparisons

Coverage

Ratio Comparisons

BW

Industry

3.56

5.19

4.35

5.02

10.30

4.66

BW

Industry

3.56

5.19

4.35

5.02

10.30

4.66

Year

2007

2006

2005

Interest Coverage Ratio

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Activity Ratios

Total Asset Turnover

Net Sales

Net Sales

Total Assets

For XYZ December 31, 2007

Total Asset Turnover

Net Sales

Net Sales

Total Assets Total Assets

For XYZ December 31, 2007

Indicates the overall effectiveness of the firm

in utilizing its assets to generate sales.

Income Statement / Balance Sheet Ratios Activity Ratios $2,211 $2,211 $2,169

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Activity

Ratio Comparisons

Activity

Ratio Comparisons

BW

Industry

1.02

1.17

1.03

1.14

1.01

1.13

BW

Industry

1.02

1.17

1.03

1.14

1.01

1.13

Year

2007

2006

2005

Total Asset Turnover Ratio

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Profitability Ratios

Gross Profit Margin

Gross Profit

Gross Profit

Net Sales

For XYZ December 31, 2007

Gross Profit Margin

Gross Profit

Gross Profit

Net Sales Net Sales

For XYZ December 31, 2007

Indicates the efficiency of operations and firm

pricing policies. Income Statement /

Balance Sheet Ratios Profitability Ratios $612 $612 $2,211

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Profitability

Ratio Comparisons

Profitability

Ratio Comparisons

BW

Industry

27.7%

31.1%

28.7

30.8

31.3

27.6

BW

Industry

27.7%

31.1%

28.7

30.8

31.3

27.6

Year

2007

2006

2005

Gross Profit Margin

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19

PAYBACK PERIOD:

Is the time required for a

firm to recover its original

investment.

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19

Example:

A confectionary upon starting up invested an amount of $1 million. It was expected that the annual cash inflow would be $ 0.5 million.

What would be the payback period?

Payback period

= Original investment ÷ Annual cash flows = $1,000,000 / $500,000

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21

PAYBACK PERIOD:

Uses

 Sets maximum payback period for all

projects; rejects any that exceed payback period

 Measures risk

 Riskier firms use shorter payback period

 In liquidity problems, use shorter payback

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Definition

Accounting rate of return (also known as simple

rate of return) is the ratio of estimated accounting

profit of a project to the average investment made

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Formula

Accounting Rate of Return is calculated using the following formula:

Average Accounting Profit ARR =

Average Investment

Average accounting profit is the arithmetic mean of accounting income expected to be earned during each year of the project's life time. Average investment may be calculated as the sum of the

(25)

Example



The

XYZ

Factory wants to replace an old machine with a new one. The old machine can be sold to a small factory for 400,000. The new machine would increase annual revenue by 6,000,000 and

annual operating expenses by 2,400,000. The new machine would cost 14,400,000.

Required:

 Compute accounting rate of return of the machine using above

information.



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Solution

Average Accounting Profit

 ARR =

Average Investment

 = 2,400,000 / 14,000,000**

 = 17.14%

** The amount of initial investment has been reduced by net realizable value of the old machine

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Definition AND FORMULA of PI

 Profitability Index is a ratio of cash inflow to the cash

outflow.

 Cash inflow is our benefit in the project and the initial

investment is our cost, which is why we also call it benefit to cost ratio.

 The calculation of PI is easily possible once we have the

cash inflows and outflows with appropriate discount rate are in place.

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Example

A company invested $20,000 for a project and expected NPV(Net Present Value) of that

project is $5,000.

Profitability Index = (20,000 + 5,000) / 20,000 =

1.25

That means a company should perform the

Profitability Index

project