(a) The sales value at the split-off method
(b) The physical measure method
2. Allocate the joint costs to the two products Soda and Basalt using the net realizable method .
3. What is the gross margin for each product under each of the three methods of allocation?
The net present value of a project refers to the difference between the present value of the inflow of cash and the present value of the outflow of cash over a period of time. NPV essentially reflects the profitability of an investment project. Furthermore, the internal rate of return refers to the discount rate that essentially values the net present value (NPV) of all cash flows in regards to a particular project that is equal to zero. It should be noted here that the NPV and IRR are derived from the same formula. The issue presented in the question is that the two projects have been considered, Project A and B. An initial investment of AED 11,000 is required. The cash inflows occur at the end of each year. Therefore, the following computations have been carried out on the basis of the given considerations (Magni & Martin, 2017).
|
Req.1: |
|
|
|
Year |
Project A |
Project B |
|
0 |
AED -11,000 |
AED -11,000 |
|
1 |
AED 1,000 |
AED 5,000 |
|
2 |
AED 2,000 |
AED 4,000 |
|
3 |
AED 3,000 |
AED 3,000 |
|
4 |
AED 4,000 |
AED 2,000 |
|
5 |
AED 5,000 |
AED 1,000 |
|
Required Rate of Return |
8% |
8% |
|
NPV |
AED 338.09 |
AED 1,473.26 |
|
IRR |
9.00% |
14.93% |
The above table that has been presented shows the net present value and the internal rate of return computations for both of the projects. The table deduces that the internal rate of return and the Net present value of the projects are greater in case of Project B in comparison to Project A. Therefore, the project, which the Company should accept, is Project B.
|
|
Project A |
Project B |
||
|
Year |
Annual Cash Flow |
Cumulative Cash Flow |
Annual Cash Flow |
Cumulative Cash Flow |
|
0 |
AED -11,000 |
AED -11,000 |
AED -11,000 |
AED -11,000 |
|
1 |
AED 1,000 |
AED -10,000 |
AED 5,000 |
AED -6,000 |
|
2 |
AED 2,000 |
AED -8,000 |
AED 4,000 |
AED -2,000 |
|
3 |
AED 3,000 |
AED -5,000 |
AED 3,000 |
AED 1,000 |
|
4 |
AED 4,000 |
AED -1,000 |
AED 2,000 |
AED 3,000 |
|
5 |
AED 5,000 |
AED 4,000 |
AED 1,000 |
AED 4,000 |
|
Payback Period |
4.20 |
2.67 |
||
The payback period for each project refers to the time period that is needed by an investment project for the purpose of deriving the projected returns from the respective investment ventures. The payback period for Project A is 4.20 years and that for Project B is2.67 years.
In case the Company has the policy of accepting projects with 3 years or less, the company should accept the Project B.
|
Particulars |
2019 Beginning |
2019 Ending |
2020 Ending |
2021 Ending |
2022 Ending |
2023 Ending |
|
Cash Inflow: |
|
|
|
|
|
|
|
Option 1 |
AED 0 |
AED 6,000,000 |
AED 6,825,000 |
AED 7,717,500 |
AED 9,261,000 |
AED 10,939,556 |
|
Option 2 |
AED 0 |
AED 6,400,000 |
AED 7,175,000 |
AED 8,017,500 |
AED 9,461,000 |
AED 13,039,556 |
|
Option 3 |
AED 5,000,000 |
AED 6,600,000 |
AED 7,375,000 |
AED 8,217,500 |
AED 9,661,000 |
AED 21,239,556 |
|
Cash Outflow: |
|
|
|
|
|
|
|
Option 1 |
AED 0 |
AED 0 |
AED 0 |
AED -400,000 |
AED -1,200,000 |
AED -2,000,000 |
|
Option 2 |
AED -25,000,000 |
AED -3,000,000 |
AED -3,000,000 |
AED -3,000,000 |
AED -3,000,000 |
AED -3,000,000 |
|
Option 3 |
AED -40,000,000 |
AED -2,000,000 |
AED -2,000,000 |
AED -2,000,000 |
AED -2,000,000 |
AED -2,000,000 |
|
Option 1: |
|
|
|
|
|
|
|
Particulars |
2019 Beginning |
2019 Ending |
2020 Ending |
2021 Ending |
2022 Ending |
2023 Ending |
|
Expected Sales Unit |
|
60000 |
65000 |
70000 |
80000 |
90000 |
|
Production Level |
|
65000 |
65000 |
65000 |
65000 |
65000 |
|
Additional Sourced-Out Unit |
|
0 |
0 |
5000 |
15000 |
25000 |
|
Selling Price p.u. |
|
AED 100 |
AED 105 |
AED 110 |
AED 116 |
AED 122 |
|
Initial Investment |
AED 0 |
|
|
|
|
|
|
Sales Revenue |
|
AED 6,000,000 |
AED 6,825,000 |
AED 7,717,500 |
AED 9,261,000 |
AED 10,939,556 |
|
Cost of Sourced Out Unit |
|
AED 0 |
AED 0 |
AED -400,000 |
AED -1,200,000 |
AED -2,000,000 |
|
Net Operational Cash Flow |
|
AED 6,000,000 |
AED 6,825,000 |
AED 7,317,500 |
AED 8,061,000 |
AED 8,939,556 |
|
Salvage Value |
|
|
|
|
|
AED 0 |
|
Net Cash Flow |
AED 0 |
AED 6,000,000 |
AED 6,825,000 |
AED 7,317,500 |
AED 8,061,000 |
AED 8,939,556 |
|
Discount Rate |
10% |
|
|
|
|
|
|
NPV |
AED 25,135,745 |
|
|
|
|
|
|
Option 2: |
|
|
|
|
|
|
|
Particulars |
2019 Beginning |
2019 Ending |
2020 Ending |
2021 Ending |
2022 Ending |
2023 Ending |
|
Expected Sales Unit |
|
60000 |
65000 |
70000 |
80000 |
90000 |
|
Maximum Production Level |
|
100000 |
100000 |
100000 |
100000 |
100000 |
|
Additional Production |
|
40000 |
35000 |
30000 |
20000 |
10000 |
|
Normal Selling Price p.u. |
|
AED 100 |
AED 105 |
AED 110 |
AED 116 |
AED 122 |
|
Lower Selling Price p.u. |
|
AED 10 |
AED 10 |
AED 10 |
AED 10 |
AED 10 |
|
Initial Investment |
AED -25,000,000 |
|
|
|
|
|
|
Normal Sales Revenue |
|
AED 6,000,000 |
AED 6,825,000 |
AED 7,717,500 |
AED 9,261,000 |
AED 10,939,556 |
|
Sales at Lower Price |
|
AED 400,000 |
AED 350,000 |
AED 300,000 |
AED 200,000 |
AED 100,000 |
|
Annual Operating Cost |
|
AED -3,000,000 |
AED -3,000,000 |
AED -3,000,000 |
AED -3,000,000 |
AED -3,000,000 |
|
Net Operational Cash Flow |
|
AED 3,400,000 |
AED 4,175,000 |
AED 5,017,500 |
AED 6,461,000 |
AED 8,039,556 |
|
Salvage Value |
|
|
|
|
|
AED 2,000,000 |
|
Net Cash Flow |
AED -25,000,000 |
AED 3,400,000 |
AED 4,175,000 |
AED 5,017,500 |
AED 6,461,000 |
AED 10,039,556 |
|
Discount Rate |
10% |
|
|
|
|
|
|
NPV |
AED -3,674,756 |
|
|
|
|
|
|
Option 3: |
|
|
|
|
|
|
|
Particulars |
2019 Beginning |
2019 Ending |
2020 Ending |
2021 Ending |
2022 Ending |
2023 Ending |
|
Expected Sales Unit |
|
60000 |
65000 |
70000 |
80000 |
90000 |
|
Maximum Production Level |
|
120000 |
120000 |
120000 |
120000 |
120000 |
|
Additional Production |
|
60000 |
55000 |
50000 |
40000 |
30000 |
|
Normal Selling Price p.u. |
|
AED 100 |
AED 105 |
AED 110 |
AED 116 |
AED 122 |
|
Lower Selling Price p.u. |
|
AED 10 |
AED 10 |
AED 10 |
AED 10 |
AED 10 |
|
Cost of New Equipment |
AED 40,000,000 |
|
|
|
|
|
|
Less: Sale of Old Equipment |
AED 5,000,000 |
|
|
|
|
|
|
Initial Investment |
AED -35,000,000 |
|
|
|
|
|
|
Normal Sales Revenue |
|
AED 6,000,000 |
AED 6,825,000 |
AED 7,717,500 |
AED 9,261,000 |
AED 10,939,556 |
|
Sales at Lower Price |
|
AED 600,000 |
AED 550,000 |
AED 500,000 |
AED 400,000 |
AED 300,000 |
|
Annual Operating Cost |
|
AED -2,000,000 |
AED -2,000,000 |
AED -2,000,000 |
AED -2,000,000 |
AED -2,000,000 |
|
Net Operational Cash Flow |
|
AED 4,600,000 |
AED 5,375,000 |
AED 6,217,500 |
AED 7,661,000 |
AED 9,239,556 |
|
Salvage Value |
|
|
|
|
|
AED 10,000,000 |
|
Net Cash Flow |
AED -35,000,000 |
AED 4,600,000 |
AED 5,375,000 |
AED 6,217,500 |
AED 7,661,000 |
AED 19,239,556 |
|
Discount Rate |
10% |
|
|
|
|
|
|
NPV |
AED -4,114,470 |
|
|
|
|
|
The Net Present values of the three projects that have been computed shows the NPV of the three options. The NPV of option 1 reflects a positive value (AED 25,135,745) while the NPV of option 2 and that of option 3 reveals a negative figure of AED -3,674,756 and AED -4,114,470. This means that the option that should be used by the Company is Option 1. This is because it reflects a positive NPV. However, it should be noted here that the option 1 and the option 2 could also be considered by observing the following factors:
- The production level of 65,000 units with the existing equipment has been sourced out at a cost of AED 80 per unit.
- Moreover, the excess capacity in any of the five years period could be used for meeting the demands of other companies at a lower price. The lower price would result in ten dirhams per unit.
- Therefore, in order to derive a positive net present value in case of Option 2 and Option 3 the lower price should be more than 10 dirhams per unit.
|
Requirement 1.a: |
||
|
Particulars |
Amount |
|
|
Cost of Material |
AED 1,500,000 |
|
|
Conversion Cost |
AED 500,000 |
|
|
Joint Cost |
AED 2,000,000 |
|
|
|
Salt |
Chlorine |
|
Production (ton) |
1500 |
1000 |
|
Market Selling Price per ton |
AED 50 |
AED 150 |
|
Sales Value |
AED 75,000 |
AED 150,000 |
|
Allocation of Joint Cost |
AED 666,667 |
AED 1,333,333 |
|
Requirement 1.b: |
||
|
Particulars |
Amount |
|
|
Cost of Material |
AED 1,500,000 |
|
|
Conversion Cost |
AED 500,000 |
|
|
Joint Cost |
AED 2,000,000 |
|
|
|
Salt |
Chlorine |
|
Production (ton) |
1500 |
1000 |
|
Allocation of Joint Cost |
AED 1,200,000 |
AED 800,000 |
|
Particulars |
Amount |
|
|
Cost of Material |
AED 1,500,000 |
|
|
Conversion Cost |
AED 500,000 |
|
|
Joint Cost |
AED 2,000,000 |
|
|
|
Salt |
Basalt |
|
Production (ton) |
1500 |
1000 |
|
Market Selling Price per ton |
AED 50 |
AED 250,000 |
|
Sales Value |
AED 75,000 |
AED 250,000,000 |
|
Further processing cost |
|
AED -90,000 |
|
Net Realizable Value |
AED 75,000 |
AED 249,910,000 |
|
Allocation of Joint Cost |
AED 600 |
AED 1,999,400 |
|
Gross Margin under Split-Off Method: |
|
|
|
|
Particulars |
Soda |
Chlorine |
Basalt |
|
Sales Revenue |
AED 75,000 |
0 |
AED 250,000,000 |
|
Cost of Material & Conversion |
AED -666,667 |
AED -1,333,333 |
|
|
Transfer Cost |
|
AED 1,333,333 |
AED -1,333,333 |
|
Processing Cost |
|
|
AED -90,000 |
|
Gross Margin |
AED -591,667 |
AED 0 |
AED 248,576,667 |
|
Gross Margin % |
-788.89% |
0.00% |
99.43% |
|
Gross Margin under Physical Measure Method: |
|
|
|
|
Particulars |
Soda |
Chlorine |
Basalt |
|
Sales Revenue |
AED 75,000 |
AED 0 |
AED 250,000,000 |
|
Cost of Material & Conversion |
AED -1,200,000 |
AED -800,000 |
|
|
Transfer Cost |
|
AED 800,000 |
AED -800,000 |
|
Processing Cost |
|
|
AED -90,000 |
|
Gross Margin |
AED -1,125,000 |
AED 0 |
AED 249,110,000 |
|
Gross Margin % |
-1500.00% |
0.00% |
99.64% |
|
Gross Margin under NRV Method: |
|
|
|
|
Particulars |
Soda |
Chlorine |
Basalt |
|
Sales Revenue |
AED 75,000 |
AED 0 |
AED 250,000,000 |
|
Cost of Material & Conversion |
AED -600 |
AED 0 |
AED -1,999,400 |
|
Transfer Cost |
|
AED 0 |
AED 0 |
|
Processing Cost |
|
|
AED -90,000 |
|
Gross Margin |
AED 74,400 |
AED 0 |
AED 247,910,600 |
|
Gross Margin % |
99.20% |
0.00% |
99.16% |
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