Company Background of Zylla Limited
Zylla Limited is a transportation firm. It operates several ferries that proving river crossing services to people, goods, and vehicles. Zylla Limited is considering the option to buy a new ferry for which director finance has asked to prepare a report
Scope of Report of Zylla Limited
The report will be issued on behalf of the director of finance to the Board of directors. This report will cover the details of sources of finance that can be available to organizations based on the repayment period. I.e. financing based on short and long term. The report will also cover different types of investment appraisal techniques available to the organization. On the bases of the information provided we will also be discussing the 1 suitable technique suitable for Zylla Limited.
Financing Sources- Short Term of Zylla Limited
Financing for the short term is targeted to congregate the current assets of the organization. Further such arrangements are made to pay for the liabilities of an organization that are current i.e. payable within a year. Usually different sources are available to raise the short term financing. This may include, Commercial Banks. Non-Banking Financial institutions, cooperative banks, and trade finance institutions, etc. The main sources of financing for the short term include, advance from customers, factoring, accruals accounts, public deposits, Commercial banks, and trade credit. Short term financing has different advantages and disadvantages ( Fosberg, 2012).
Approval within the shortest period is the major advantage of short term financing. For a short period, the organization will be paying back only for a shorter period. Further this short term finance can be utilized to window dress the organization’s worst credit history to improve the credit score. Flexibility and conveniences in short finance avoid customer emotional and psychological torture against heave interest payable
On the other hand, this short term long attracts high rates of interest payments is a major disadvantage. In case of failure to repay the short term financing, it will worst the credit score along with high borrowing cost due to risky credit clients for the lender. Due to easy access financing, the organization spends more than its affordability and waste the money at the expense of its own.
Financing Sources- Long Term of Zylla Limited
Usually, financing obtained for more than 1 year is considered a long term source of finance. This long term finance is obtained for organizational betterment i.e. expansion plan, acquisition of businesses, purchase of plant and property, or modernization. Usually different sources are available to raise long term financing. It includes retaining earning (internal sourcing), equity capital, preference capital, term loan, and debenture which are external. Long term financing has different advantages and disadvantages. Further, it helps to scatter maturities of long term debt (Sinha 2014)
Long-term financing allows a corporation to arrange in a line its resources arrangement with its long term goals. It helps to matches the duration of liabilities with asset-based arrangements. Long term commitment enables investors to increase cooperation in other projects with a trusted organization.
On the other hand, due to long term loans organization has to pay the big amount in term of volume to lenders. By this extraction of interest amount, Debt to income ratio will be affected adversely. As a result there will be slow growth in equity that will be observed at the organization.
Techniques for Appraisal of Investments of Zylla Limited
Investment appraisal is procedure by which project will evaluate the attractiveness of probable investments based on the conclusion of numerous capital budgeting and techniques of financing. In short, recognizing the target company’s long term development and expected organization net worth. There are different Investment appraisal techniques used according to the scenario of Target Company. It includes Payback Period, Accounting Rate of Return Method, Net Present Value, Internal Rate of Return Method, Internal Rate of Return Method, Profitability Index and Discounted Payback Period Method (Gardiner and Stewart, 2000)
Payback period technique is a procedure by which analysts can recognize the period in which the cost of the project will be recovered. Discounted payback period calculates by including the discounting the future cash flows. The accounting rate of returns refers to the calculation of net accounting profit as percentage capital investment whereas the internal rate of return calculates the future cash flows (discounted) at par with initial investment Net present value calculated the future cash inflow and outflow (discounted) from the project. Profitability index calculates calculation of earning on per dollar investment,
Acceptable Appraisal technique Zylla Limited.
According to the data provided, it seems that the organization should opt for an accounting rate of return. This method considers the earning concept as well as the depreciation expense over the entire life. The method considers the concept of calculating return rates based on the accounting concept. Further as this method deals with the rate of return so it will be easy for investors to review the proposal and take decision.
Accounting rate of return = Annual Profits (Average) /Investments (Average)
Annual profits (Average)= profits over investment period / Number of years.
Investment (Average) = (Book Value at Year 1 + Book Value at End of Useful Life) / 2
Annual profits(Average) | |||
Year | Inflows | Discount Factors | Inflows |
1 | 55,230 | 0.971 | 53,628.33 |
2 | 70,045 | 0.943 | 66,052.44 |
3 | 88,375 | 0.915 | 80,863.13 |
4 | 79,870 | 0.888 | 70,924.56 |
5 | 57,555 | 0.863 | 49,669.97 |
Total Inflows from Year 1 to Year 5 | 321,138.42 | ||
Less | Depreciation Expense | 27,000X5 | -135,000 |
Less | Decommission cost | 45,000X0.863 | -38,835 |
Annual Profit | =147,303.42 | ||
Annual Profit Average | 147,303.42/5 | 29,460.68 | |
Investment Average | |||
Book Value at Year 1 | 150,000.00 | ||
Book Value at End of Useful Life | 15,000.00 | ||
(150,000+15000)/2 | 82,500.00 | ||
Annual Profits(Average) /Investments (Average) | (29,490.68/82,500) | 0.357 | |
From the calculation, it is confirmed that the acquisition of ferry will generate 0.35 Cents per dollar invested or 35 % which far more than 3% cost of capital.
Conclusion
We have discussed sources of finance based on the short term long term and working capital needs of the organization. We have also gone through the number of techniques that can be used for different projects. Further we have applied the Accounting rate of return to calculate the rate of return. Our calculation suggested that the project is viable in terms of the accounting rate of returns.
