Ethical Dilemma Post audit

Ethical Dilemma Post audit

Group Discussion

  1. (1) The Net Present value and present value index for Harding Properties

In order to determine the net present value for Harding properties we shall use the following formula;

Net present value (NPV) =present value of cash inflows less present value of cash outflows from the project. The formula for NPV=C0/ (1+i)0 +C1/ (1+i)1+C2/ (1+i)2………………….Cn/ (1+i)n

Whereby;

C0, C1, C2.……Cn——————————–Represents Cash outflow C0 and cash inflows C1, C2…..Cn

i————————————————–Represents interest rate or discount factor

n————————————————–Represents time period

If after calculating the NPV is a positive number the project is selected but if it is negative then it is rejected. The formula for calculating present value index (PVI) =Present value of future cash inflows/Initial investment. If the PVI is positive the project is accepted but if it is negative the project is rejected.

  • The net present value and present value index of Summit Apartments

The Net present Value (NPV) and the present value index (PVI) will be calculated using the formulas in (1) above. If the NPV and PVI are positive the project is accepted but if they are negative it is rejected.

  1. Between Summit Apartments and Harding Properties, EREIC should choose the project whose NPV and PVI are positive and higher than the other.
  2. If EREIC has $4,500,000 to invest and that any of the investable funds not invested in the two projects will be invested in a Certificate of Deposit earning 5 percent return will not affect the decision made in b) above unless the additional funds invested in the two projects  alter the NPV and PVI from the two projects. If the NPV and PVI of the chosen project falls below the one of the rejected project then the rejected project will be chosen. However,  funds invested in the Certificate of Deposit will not affect the NPV and PVI of the two projects because cash flows from the Certificate of Deposit will not be taken into account when calculating NPV and PVI of the two projects and hence the decision will not affect the decision made in b) above.
  3. The additional net cash inflow of $37,500 can affect the decision made in b) above if the NPV and PVI of Harding Properties increases and surpasses that of Summit Apartments. In that case Harding Properties project will be chosen by EREIC. The increase in market value of Harding Properties at the end of year 3 by $300,000 won’t have an impact on the NPV and PVI because it does not represent a cash inflow item. The only item that impacts on the project is the increase in net cash inflow of $37,500 which could raise PVI and NPV.

ATC10-3- Research Assignment

Capital budgeting decisions at Archer Daniels Midlands Company Limited as at June 2006

  1. a) The company announced that it will undertake major projects during 2006 to grow its business. The first is that it announced that it planned to construct two dry corn milling plants to expand its ethanol production capacity by 550 million gallons. The Company also announced plans to construct a new U.S. cocoa processing facility, U.S. biodiesel production facility and a polyhydroxy alkanoate (PHA) natural plastics production facility. The Company announced that it expected to spend approximately $3.1 billion to construct these facilities over the next four years.
  2. b) In 2006 the company spend $ 762,009,000 on new property, plant and equivalent. In total the company spent $ 1,761,424,000 on all forms of investment in financial year 2006
  3. c) The company, ADM, got the money to make all these investments from the following sources;
  • Cash generated from operating activities of $ 1,376, 041,000
  • Long term borrowings of $643,544,000
  • Net borrowings under line of credit agreements of $ 104,548,000
  • Other sources of $44, 409,000
  • Proceeds from sale of property, plant and equipment of $ 53,704,000
  • Distributions from affiliates excluding dividends of $ 57,690,000
  • Proceeds from sale of marketable securities of $ 581,489,000
  1. d) The interest rate that ADM agreed to pay on the most recent long term borrowings in 2006 was 5.375% which were $600 million debentures due in 2035.

ATC 10-4 –Writing assignment

Limitations of capital investment techniques

In evaluating whether Webb Publishing Company should invest in the Internet Company or Invest in the Printing Company the company can use capital budgeting techniques. The commonly used techniques are net present value, internal rate of return, payback period and unadjusted rate of return. Some of these techniques consider time value of money whereas others do not. Net present value technique is a capital budgeting technique that takes into account time value of money.  Net present value portrays the value of a stream of future cash flows which are discounted back to their present values using some percentage that represents the minimum desired rate of return. This return normally is the cost of capital of the company (Anthes, 2003).

Time value of money holds that a dollar in hand now is worthy more than a dollar to be received some time in future. This is because the dollar can be invested in make returns. The dollar to be received in future is worthy less because of effects of inflation on it. It is also uncertain. The major limitation of net present value technique is to determine the most appropriate discounting rate. The other imitation is to accurately determine future cash flows since business is uncertain and it is practically impossible to predict the future. The limitations notwithstanding, Webb Publishing Company can use net present value technique to make a decision on whether to invest in the internet company or the printing company. The invest opportunity which gives a higher positive net present value should be selected

Internal rate of return is another capital investment technique that Webb Publishing Company can use to make the investment decision. This method takes into account time value of money. The investment opportunity that has the highest internal rate of return which is higher than the company’s weighted average cost of capital should be selected. The limitation with this technique is that it is possible for a company to have two internal rates of returns and this poses a challenge on which one to rely on. The other limitation is that the method of determining internal rate of return is largely through guess work and again determining the future cash flows may be difficult, unrealistic and exaggerated.

Payback period is another method that can be used as it determines the time taken to recover the initial investment in each opportunity. The investment opportunity with the lowest payback is chosen. The main limitation with this technique is that it does not take into account the time value of money and also does not consider cash inflows beyond the payback period. It can therefore mislead an investment analyst (Dixon & Gupta, 2008).

The unadjusted rate of return is can also be used to determine which investment opportunity to choose. This rate of return is obtained by dividing expected future annual net income by the required investment. This method does not take into account the time value of money.  The benefits include that it is easy to use and understand, can be calculated using accounting data which is readily available  and takes into account the entire profitability of the project. The project with the highest rate of return is selected.

The main limitation with capital budgeting techniques is that they inhibit innovation and also it’s difficult to choose which one to use (Baldwin, 1991).

ACT 10-5 Ethical Dilemma

Post audit

Option A       year 1 year 2 year 3 year 4 year 5 Total
Initial Cash out flow 250,000
Cash flows for 5 years 90,000
Discounting rate 10%
Present value of future cash flowsC/(1+i)^n=
81818.18 74380.17 67618.33 61471.21 55882.92 341170.8
Net Present value Option 1=250,000-341170.8=91,171 

 

 

Option B       year 1 year 2 year 3 year 4 year 5 Total
Initial Cash out flow 250,000
Cash flows for 5 years 91,000
Discounting rate 10%
Present value of future cash flows
 C/(1+i)^n 82727.27 75206.61 68369.65 62154.22 56503.84 344961.6
Net Present value  actual=250,000-341170.8= 94,962

 

 

 

 

 

Option C       year 1 year 2 year 3 year 4 year 5 Total
Initial Cash out flow 250,000
Cash flows for 5 years 70,000
Discounting rate 10%
Present value of future cash flows
 C/(1+i)^n 63636.36 57851.24 52592.04 47810.94 43464.49 265355.1
Net Present value Option 2=250,000-341170.8= 15,355

 

If the projected cash flows were $90000 per year for five years then Mr Holts bonus would be

The net, Net present value difference between actual versus budgeted $94,962-$91,171=$3,791. The bonus would be 10% of $3,791=$379.1

When Mr Holt adjusted future cash flows downwards to $70,000 then the bonus would be

The net, Net present value difference between actual versus budgeted $94,962-$15,355=$79,607. The bonus would be 10% of $79,607=$7,960.70

  1. Mr Holt is guilty of ethical misconduct by using company funds to enrich himself. He is guilty of dishonesty and fraud. He has adjusted the figures downwards to benefit from his privileged position and that insider trading. He undertook gamesmanship by reducing projected cash flows to increase his bonus payment
  2. The bonus could most likely increase staff expenses and reduces net profits of the company which will reduce capital gains thus ratios such as return on capital employed and return on equity will be reduced. The shareholders will therefore have lesser dividends and also it will reduce earnings per share and affect the performance of the company’s stock in the securities exchange by reducing its price. The company will be unable to attract as much equity funds from investors in the public as would have been the case
  3. The best way to discourage gamesmanship through manager’s compensation is by giving performance shares to managers. In this way managers will be motivated to ensure the bottom line improves to enable them get higher shares. Another strategy is through profit sharing and stock options. By making managers shareholders of a company the owners ensure managers take a long term and sustainability view of their actions and reduces gamesmanship. Profit sharing strategies motivate managers to work hard to report high profit levels (Ward, 2003).

ATC10-6 Spread sheet assignment using Ms Excel

See attached spread sheet

 References

Anthes, G. H. (2003). Internal rate of return.Computerworld, 37(7), 32. Retrieved from http://search.proquest.com/docview/216102110?accountid=45049

Baldwin, C. Y. (1991). How capital budgeting deters innovation – and what to do about it. Research Technology Management, 34(6), 39. Retrieved from http://search.proquest.com/docview/213814647?accountid=45049

Dixon, T., & Gupta, R. (2008). It’s payback time. The Estates Gazette, , 133-134. Retrieved from http://search.proquest.com/docview/223784672?accountid=45049

Ward, M. (2003). Performance shares to gain strength. Workspan, 46(2), 20-23. Retrieved from http://search.proquest.com/docview/194706763?accountid=45049

 

 

 

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