Accounts and Finance

Accounts and Finance

Average rate of return

Average rate of return is a percentage that shows the amount of profit someone gets back from an investment. This takes into account the profit and not the time.

[Net return (profit) per annum / Capital Outlay (cost)] x 100 = ARR

Payback Period

The Payback Period is the amount of time a firm would take to recover the investment made. This takes into account the time and not the profit.

[Amount required / Net Cash Flow in year] x 12 = Payback Period

In the case UWP

There is not enough information to make an Average Rate of Return (ARR) or a Payback Period as the case does not explain how much profit would the hospital or the University generate. Maybe a reason why they do not tell us that information is because the intention of those projects are not financial but to be healthy to the community. Also we do not have a net cash flow forecast for each project so the Payback Period is not available for students. In case the IBO gives a cash flow, we just need to analyse the amount of profits the projects are going to be generating to put what we need in a formula.

In the case of Kos

We know how much profits the options available for him are going to be generating, what we do not know is how much does he have to invest so neither the ARR nor the Payback Period can be made.

Qualitative Investment Appraisal

Colonel Michael Donovan had the responsibility for investigating the feasibility of the two projects (Hospital/University). “He calculated that both projects would cost the same (Appendix 3). As a result, the decision about whether to build a university or a hospital WOULD NOT BE BASED UPON COST, BUT UPON OTHER FACTORS” (51-56) When we evaluate the two projects, it is important to consider the nature of this case: Qualitative Factors (those that cannot be measured) are really important since the purpose of the Mission is not to generate profit (money), but to create the adequate environment for social and political stability, peace and human development.

Some important qualitative factors are:

• Urgency: What does Loyka need more urgently: a Hospital or a University?
  • A country that recently suffered a civil war is usually a country that faces political instability, economic crisis, lack of infrastructure and hygiene.
  • Education and health are both considered basic needs.
  • There may be many people with permanent injuries or disabilities caused by the violence of the civil war. They need medical attention urgently.
  • Unhygienic environments provoke that diseases appear and spread. There may be many people who is sick and need medical attention.
  • There has been “human capital flight” (brain drain). How will Loyka rebuild itself if it does not have the human resources needed?
  • Education is considered indispensable for the future of a country. A nation needs educated people in order to be civilized, free, democratic, etc.
  • “Education makes a people easy to lead but difficult to drive: easy to govern, but impossible to enslave” Henry Brougham
  • A Hospital can attend people of any age. A University focuses on educating young people.
  • The benefits of a hospital will be almost immediately palpable (short-term, medium-term). People will be able to appreciate the benefits of a university in the future (long-term).
  • The construction of the University (25weeks) will take less time than the construction of the Hospital (30weeks).
  • The local governor who agreed to contribute the piece of land for the construction site preferred the new university campus rather than a hospital.

• Objectives: How does each project help to achieve the objectives of the Mission?
  • Image: Does the project put the image of the UWP at risk?
  • “[...] a university built by the UWP would become a symbol of foreign intervention in Loyka and would make it a target for critics of the government and of the UWP presence in the country” (80-83)
  • Workforce: What is the impact on the workforce (troops)?
  • “The project also had the support of the troops, who would feel empowered and would welcome working in new flexible matrix structures.” (90-91)

• Environment -> See PESTLE

• Ethical reasons -> See Ethical objectives

Important information for qualitative investment appraisal: 68-116

Working Capital / Circulating Capital

Working capital is the amount of money needed to pay for the day-to-day trading of a business. It reflects how well a business is performed. Working capital = current assets - current liabilities

In this case on Appendix 5a can be find useful information for calculating the working capital of Kos’ business.

Option 1: All figures $ in dollars per month

Gross profit (current asset) - Gas and vehicle maintenance, Rent of storage facility, interest(current liabilities) = $200 - $50 = $150

Option 2: Gross profit (current asset) - Gas and vehicle maintenance, Rent of storage facility, interest (current liabilities) = $2200 - ($400 + $200 + $100) = $1500

Working Capital Cycle

The working capital cycle are intervals between payments made by a business and the receipt of cash.

Lag 1: Purchase resources from suppliers on credit, which means obtaining the resources without having to pay for them immediately.

Lag 2: Resources turned into products.

Lag 3: Finished goods before they are sold

Lag 4: Goods sold to customer allowing customers to pay later.

In this case that time lags are present in Kos’ business and the UWP new project.

In Kos' business

Lag 1: Purchase of eggs, poultry, vegetables and other produce from local farms (61)

Lag 2: Do not transform the resources only resell them

Lag 3: Amount of time that Kos maintains the goods before selling them to the officers of dining hall. (62)

Lag 4: The case do not specify how the officers pay him.

Cash injection: (If expansion) Bank loan (130) and increasing working capital (156)

Cash drains:(If expansion) A new lorryand increase stockimpact in capital as wellexpenses would go up

In the UWP

Lag 1: Would be purchasing furniture and equipment for the construction of the new project.(Appendix 3)

Lag 2: Would be the construction time of the new project.

Lag 3: Time while people who would need the service provided by the new project arrive

Lag 4: Time while people would pay for the service that was provided

Cash injection: Capital that would be invested in the new project Cash drains: Land

Every business has different working capital needs depending their size, stock levels, debtors and creditors. If Kos maximize the scale of operation of his business (option 3) becoming a wholesaler would require an increasing working capital ( 156). Increasing the scale of operation of his business would need to manage higher stock levels since would become just-in-case. (137). Besides expanding his business would imply a time between buying stock financed by trade credit and finished products since he would need the bank loan.

Working capital and profit are not the same!

Kos’ expansion would be profitable as long as the UWP Mission remains in Loyka but if Kos do not has the enough working capital problems would arrive.

Economies of scale

When the cost per unit of a service or product is reduced and more is produced, there are economies of scale at work. (121)

Employing economies of scale to achieve the maximum number of products and services at the lowest price in a regular and dynamic business environment can be an arduous task, but it might be even harder when the economic climate is hostile and fickle (recessions, civil wars, etc.)

One of the reasons Kos is considering in expanding his business is the possibility to take advantage of economies of scale. However, he also fears that the logistics would get more complex. Not only that, but to collect more produce he would have to drive into unpaved roads away from UWP influence. The unpopularity of the “Olive Hats” and his relations to the UWP Mission and Colonel Donovan would present the danger of being considered a UWP collaborator at these remote communities. This could mean that the communities might refuse to sell their produce to him or, in a worse case, attempt to sabotage his equipment. However, the possibility of being able to run his business with no real threat to himself or his business still remains.

If more information if given about the rural communities’ opinion about the UWP Mission and their thoughts about Loykese who worked for them, it could be vital in determining if Kos’s expansion would be feasible or not, depending on the information. Kos would also need to invest in a truck to get as far away as he needed to get to said communities. Because of the unpaved roads, it is likely that said lorry would not last for a very long time without constant maintenance.

As a result from the construction of the new hospital or university many local entrepreneurs are likely to take advantage of the business opportunities and with this Kos can have a first-mover advantage.

Even though his deliveries to the UWP Mission where just in time, by increasing the scale of operation of his business could lead to complications like the need to manage stock level on a just-in-case basis. And to keep his products fresh he might need to invest in a storage facility equipment, however the just-in-case stock control would rise the possibility of waste.

Kos prepared a business plan and the income comparison showed that the expansion of his business would be very profitable, only as long as the UWP Mission remains in Loyka(see Appendix 5), and it is still unsire on how long the UWP Mission would remain in Loyka.

Glossary

Concept	Definition	Application to the case
Collateral	Assets used as a pledge to a loan. Most commonly used in mortgages.	If Kos were to use a bank loan, he would have to place the lorry(truck) he purchases as a collateral. (130)
Economies of scale	When the cost per unit is lowered the more units are made.	Economies of scale are one of the advantages that Kos Palouk would have if he expanded his scale of operations. (121)
Income statement	Also known as a profit-and-loss, this financial statement is used to measure how the business’s revenue measures up when compared to its expenses.	In this case, Kos made a profit-and-loss comparison between Options 1 (his current income: no change) and 2 (predicted income if he were to increase the scale of operation) to see the profitability of each option on a financial level. (142-143, Appendix 5a)
Just-in-case	When a large inventory is kept at hand in order to meet the needs of potential buyers.	If Kos were to expand his business, he would have to employ JIC instead of JIT. This means that the risk of spoilage would increase, although Kos believes that it would be minimal. (138-140)
Just-in-time	When a small amount of inventory is kept to increase efficiency. Relies on good relations with suppliers.	Kos uses this type of strategy with his business. However, if he were to expand, he would have to move to JIC. (136)
Land	The physical location of the business, including the surface and the underground.	Land is referred to when talking about where the hospital/university will be built. In this case, the government of Loyka offered the land to the UWP mission. (53)
Produce	Goods that are grown or brought forth--fruit, vegetables and other such foodstuffs fall in this category.	Kos purchases produce from local farms. In order to increase his capacity to transport produce, he would need to purchase a new lorry (truck). (128)
Profit and loss

Topics

• Business Organization and Environment
• Human Resources
• Accounts and Finance
• Marketing
• Operations Management

References

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