Financial Mathematics

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

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Calculating profit using margin and mark up

Formula for mark up

Mark up = gross profit × 100

Formula for margin

Margin = gross profit × 100

Relationship between margin and mark up

Determining margin from mark-up.

Mark up conversion margin

25%/ 25 25 = 25 0.2× 100 = 20%

margin conversion mark up

20%/ 20 20 = 20 0.25× f,mam100 = 25%

The basics of Capital budgeting.

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

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

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

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

 The investment in capital projects involves high risks.

 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.

3. Discounted payback period

4. The average accounting return

5. The internal rate of return

6. The profitability index

The pay back period

The pay back rule

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

Merits of pay back period.

 It is easy to calculate and simple to understand.

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

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.

A = last period with a negative cumulative cash flow;

C = cash flow during the period after A.

 A shorter discounted payback period indicates lower risk.

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

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