Calculating profit using margin and mark up

Mark-up.

-It refers to profit expressed as a percentage of cost price/ purchase price/ cost of sales.

Formula for mark up

Mark up = gross profit × 100

Cost price

Question

Calculate mark up when given cost price as $100 000 and gross profit is $25 000

-Mark up can also be used to calculate profit when given cost price

Question.

Calculate profit when mark up is 25% and cost price $100 000

-to get the gross profit multiply the cost price by the mark up

Margin.

-it is gross profit expressed as a percentage of selling price/ sales/ net sales

Formula for margin

Margin = gross profit × 100

Selling price

Question.

Calculate margin when given gross profit of $20 000 and selling price of $100 00

Margin can also be used to calculate profit if give margin and selling price/ sales/ net sales

Question.

Calculate profit when margin is 20% and selling price is $100 000

-to get the gross profit multiply the selling price by the margin.

Relationship between margin and mark up

-when given margin we can determine mark-up and when given mark-up we can determine
the margin.

Determining margin from mark-up.

Mark up conversion margin

25%/ 25 25 = 25 0.2× 100 = 20%

100 100+25 125
Determining markup from margin.

margin conversion mark up

20%/ 20 20 = 20 0.25× f,mam100 = 25%

100 100 - 20 80

The basics of Capital budgeting.

 Capital budgeting involves planning and justifying how capital is spend on long term
capital projects.

 It encompasses the process of making decisions that establish criteria for investing
resources in long term capital projects or assets.

 It can be regarded as the process of identifying, analysing and selecting investment

projects whose returns in form of cash flows are expected to extend beyond one year.

 It involves selection decisions of investing in long term assets such as plant or

machinery.

 Capital budgeting involves planning and justifying how capital is spend on long term
capital projects.

 It encompasses the process of making decisions that establish criteria for investing
resources in long term capital projects or assets.

 It can be regarded as the process of identifying, analysing and selecting investment

projects whose returns in form of cash flows are expected to extend beyond one year.

 It involves selection decisions of investing in long term assets such as plant or

machinery.
Benefits of capital budgeting.

 Limited funds

 The investment in capital projects involves high risks.

 Investment in long term capital projects cannot be easily reversed and if reversed it
involves huge losses due to sunk costs

 Greatly affects the long term operations of a business

Capital budgeting techniques

 Major methods used to evaluate or appraise investment opportunities include:

1. Net present value.

2. Payback period

3. Discounted payback period

4. The average accounting return

5. The internal rate of return

6. The profitability index

The pay back period

 It is the time required to earn back the amount invested in a project from its net cash
flows.

 It is the number of years which it takes for the project’s net cash flows to recoup the
project’s initial investment.

 In other words it is the number of years required to recover the original cash outlay
invested in a project

The pay back rule

 An investment with a shorter payback period is considered to be better since the

investor’s initial outlay is at risk for a shorter period.

Merits of pay back period.

 It is easy to calculate and simple to understand.

  Pay-back method provides further improvement over the accounting rate return.

 Pay-back method reduces the possibility of loss on account of obsolescence.

 It is a cost effective method which does not require much of the time of finance
executives as well as the use of computers.

 Is useful in weeding out risky projects because it favours projects which generate
substantial cash flows in earlier years.

Demerits of pay back period.

 It ignores the time value of money.

 It ignores all cash inflows after the pay-back period.

 It is one of the misleading evaluations of capital budgeting.

Formula for calculating pay back period.

pbp = a + b × 12 months

whereby:

A = last period with a negative cumulative cash flow;

B = absolute value of cumulative cash flow at the end of the period A; and,

C = cash flow during the period after A.

Decision Rule

 A shorter discounted payback period indicates lower risk.

 Given a choice between two investments having similar returns, the one with shorter
payback period should be chosen.

 Management might also set a target payback period beyond which projects are
generally rejected due to high risk and uncertainty.

Question.

An initial investment of $2,324,000 is expected to generate $600,000 per year for 6 years.
Calculate the pay back period of the investment.
 CUMULATIVE
CASH FLOW
YEAR VALUES
$
$

0 -2,324,000 -2,324,000
1 600,000 -1724000
2 600,000 -1124000
3a 600,000 b-524000
4 600,000c -

5a 600,000

6 600,000

PBP = 3years + 524 000 × 12 months = 3 years 11 months

600 000