ISAAC GUMBO

OPERATIONS MANAGEMENT

ASSIGNMENT 1

QUESTION 1

i. Net present value is a financial technique which uses a projects costs and returns
over time to determine if the project will make a positive return? Importantly it
takes into account the time value of money.
ii. Discounting cash flow concept is an evaluation method used to estimate the
attractiveness of an investment opportunity? It is a method of valuing a project,
company, or asset using the concepts of the time value of money. It applies to any
situation in which money is paid at one point and received at a different point.

b.

YEAR PROJECT A CUMULATIVE PROJECT B CUMULATIVE

CASH FLOW CASH FLOW
0 12000 -12000 12000 -12000
1 3000 -9000 6000 -6000
2 4000 -5000 5000 -1000
3 5000 0 3000 2000
4 6000 6000 2000 4000

𝑩
(i) Payback period for project A = A + 𝑪

𝟓𝟎𝟎𝟎
= 2 + 𝟓𝟎𝟎𝟎

= 3 Years.

Payback period for project B

𝑩
=A+𝑪

𝟏𝟎𝟎𝟎
=2+
𝟑𝟎𝟎𝟎

𝟏
= 2𝟑 = 2Years 4 months.

(ii) The annual rate of return for project A,

𝐶𝐹1 𝐶𝐹2 𝐶𝐹3
ARR = [ (1+𝑟)1 + (1+𝑟)2 (1+𝑟)3 …….] – initial investment.

The ARR should be equal to zero, and assuming it as 16.5%,

GUMBO ISAAC
 3000 4000 5000 6000
ARR = [(1+0.165)1 + (1+0.165)2 + (1+0.165)3 + (1+0.165)4 ] -12000 = -58.2

Say at 17%,
3000 4000 5000 6000
ARR = [(1+0.17)1 + (1+0.17)2 + (1+0.17)3 + (1+0.17)4 ] -12000 = -199.09

Say at 16.5%
3000 4000 5000 6000
ARR = [(1+0.163)1 + (1+0.163)2 + (1+0.163)3 + (1+0.163)4 ] -12000 = -4.87

The ARR = 16.3%

The ARR for project B,

6000 5000 3000 2000
At 15% ARR =[ (1+0.15)1 +(1+0.15)2 + +(1+0.15)4] -12000 = 114.16
(1+0.153

6000 5000 3000 2000

At 15.5% IRR =[ (1+0.155)1 +(1+0.155)2 + +(1+0.155)4] -12000 = 13.74
(1+0.1553

6000 5000 3000 2000

At 16% IRR =[ (1+0.16)1 +(1+0.16)2 + +(1+0.16)4 ] -12000 = -85.22
(1+0.163

Therefore the ARR for project B is 15.5%

(iii) Project B is faster in clearing investment capital and A is slower. The

returns on A are going up unlike returns on B which is going down. B has
got diminishing returns.
(iv)

Year CF A CF B Discount Project A Project B

factor
1 3 000 6 000 0.91 2 730 5 400
2 4 000 5 000 0.83 3 320 4 150
3 5 000 3 000 0.75 3 750 2 250
4 6 000 2 000 0.68 4 080 1 360
TOTAL 1880 1 207

The Net Present Value for project A,

For uneven cash flow,

𝑅1 𝑅2 𝑅3 𝑅4
NPV = [(1+𝑖)1 +(1+𝑖)2 +(1+𝑖)3 +(1+𝑖)4 ] – initial value.

3000 4000 5000 6000

NPV = [(1+0.1)1 +(1+0.1)2 +(1+0.1)3 +(1+0.1)4] – 12000 = 1887.71

Net Present Value for project B,

GUMBO ISAAC
 𝑅1 𝑅2 𝑅3 𝑅4
NPV = [(1+𝑖)1 +(1+𝑖)2 +(1+𝑖)3 +(1+𝑖)4 ] – initial value.

6000 5000 3000 2000

NPV = [(1+0.1)1 +(1+0.1)2 +(1+0.1)3 +(1+0.1)4] – 12000 = 1206.75

(v) Considering the Net Present Value, project A is the ideal one because it
has the higher present value.

QUESTION 2

a. Marginal costing applies only those costs to inventory that were incurred when each
individual unit was produced while absorption costing applies to all production costs
to all units produced.
b. Material X: 2m at$250 = 500

Labour : 4hours at $40 per hour = 160

Material Y: 1 unit at 50 per unit = 50

Total =$710

Overhead absorption rate of $20 x 4 hours = $80

Grand Total = $970

c. Three cost that exist in manufacturing systems include,

Labour costs- Labour cost also known as direct labour cost, is the sum of all wages
paid to employees, as well as the cost of employee benefits and payroll taxes paid by the
employer.

Material costs- The amount of money invested in the production of a product.

Overhead costs- Are all costs on the income statement except for direct labour, direct
materials, and direct expenses.

d. Marginal costing is the cost one additional unit of output. The concept is used to
determine the optimum production quantity for a company, where it cost the least
amount to produce additional units. The uses are:
iii. Cost Ascertainment- It facilitates the recording and reporting of costs. The
classification of costs into fixed and variable components makes the job of cost
ascertainment easier.
iv. Decision Making- It helps management decision making to maximise profits
through problem solving.

GUMBO ISAAC