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
