Understanding management accounting and financial management Assignment

Understanding management accounting and financial management - Assignment Example For this expansion setting up new plant is essential for Flight high ventures plc to increase the capacity. The inception of new plant will require initial outlay of ?4m. Along with this, research and development department is taking another project of product development with two options A and B. In this report these two options are evaluated using different techniques. Two projects A and B both are mutually exclusive need to decide which project is more suitable for the Flight high ventures plc. Both the projects have initial capital investment which is shown in annexure as negative. Project B has initial investment of ?1210000 and project A has lower initial investment of ?968000. Lower initial investment does not signify that it is better to accept or reject because there is difference in economy of scale in those projects. Hence the effect is reflected in profit earning and in cash flows per year. These two projects are evaluated using four different techniques like payback meth od, accounting rate of return method (ARR), net present value (NPV) and internal rate of return (IRR) (Collier, 2003, 185-193). Payback for the project A is 2.5 years and for project B is 3.5 years. Hence project ‘A’ needs 4.5 years to get repaid by its cash flow and project ‘B’ needs 3.5 years. This pay back period depends on the amount of investment and size of cash inflow. If the project has higher cash inflow at the initial time of the tenure of the project then it will effect on the payback time to be lessened. This concept is an advantage to pay back process as the risk of payment through early payment is reduced in this process. Another few advantages are like easy to calculate, simple concept and consideration of cash not profit only. But this procedure of evaluation has major flaw of non consideration of time value of money. Payback concept does not consider the cash inflow out of the stipulated time which may be for infinite for some projects. Hen ce the project size and the time are not under consideration of this method. (Kay, 2011, p.108) Accounting rate of return of any project is based on the average accounting profit and average capital investment. Here profit is considered in the calculation instead of the cash flow. Profit is counted after excluding depreciation from the cash flow. This ARR calculation has similarity with other calculation for return on investment (ROI) and return on equity (ROE). Only dissimilarity is in denominator. In ARR the main benefit than payback is the consideration of the project life span. Simple in calculation of ARR is another advantage. The result of ARR can help to compare more than one project and also with other financial ratios. But main advantage is similar to payback is, not of considering the time value. Other disadvantages are like not considering the scale of the project and timing (Atrill and McLaney, 2006, p.329- 332). (Damodaran, 2002) In those above two methods risk is consi dered in the calculation but inflation and interest foregone factor is not considered. In the NPV and IRR method time value of money is applied in the calculation. In NPV calculation the absolute size of the project is accounted and also in the discounting factor consideration of calculation of the discounting rate is important (McGrath, 1998). Usually cost of capital is considered in this calculation but this is the main advantage of NPV method, because of the hardness in calculation of cost of capital (Brigham, Enrhardt, 2010, 383). IRR is positive for the projects with unknown discount rate but known cash flows. Like NPV, IRR also considers risk and time value of money. But IRR ignores the change in discount rate and also the gives multiple result for the cash flow with combination of inflow and out flow.