# Financial Forecast of Tricol plc. (Version 2)

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**Financial forecast for Tricol plc.**

**Introduction:**

As a financial advisor to the Tricol plc I will produce a report for analyzing the basic budgeting processes undertaken by the firm and evaluating the financial viability of its own distribution arm.

**Part A**

Flexible Budge for June | Per Unit | 2,000 Units |

￡ | ￡ ￡ | |

Direct Material (4 kg, ￡10/kg) | 40 | 80,000 |

Direct Labour (2 hours, ￡9/h) | 18 | 36,000 |

Variable Production Overheads | 2 | 4,000 |

Insurance Costs | 2,200 | |

Depreciation | 1,500 | |

Rent and Rates | 2,500 | |

Administration | 2,000 | |

Total | 128,200 |

The Flexed Budget for June | Flexed Budget 1,600 Units ￡ ￡ | Actual 1,600 Units
￡ ￡ | Variance | |

￡ | F/A | |||

Direct Material | 64,000 | 61,600 | 2,400 | F |

Direct Labour | 28,800 | 35,200 | 6,400 | A |

Variable Production Overheads | 3,200 | 3,200 | 0 | |

Insurance Costs | 2,200 | 2,400 | 200 | A |

Depreciation | 1,500 | 1,500 | 0 | |

Rent and Rates | 2,500 | 2,500 | 0 | |

Administration | 2,000 | 2,200 | 200 | A |

Total | ￡104,200 | ￡108600 | ￡4,400 | A |

1 | DIRECT MATERIAL TOTAL VARIANCE [(4 kg×1600)×￡10]-61,600 =￡2,400(F) |

2 | DIRECT MATERIAL USAGE VARIANCE ￡10×[(4 kg×1,600)-5,600 kgs] =8,000(F) |

3 | DIRECT MATERIAL PRICE VARIANCE 5,600 kgs×(￡10- ￡61,600/5,600 kgs) =￡5,600(A) |

1 | DIRECT LABOUR TOTAL VARIANCE [(2 hrs×1,600)×￡9]-￡35,200 =￡6,400(A) |

2 | DIRECT LABOUR RATE VARIANCE 3,520 hrs×(￡9-￡35,200/3,520 hrs) =￡3,520(A) |

3 | DIRECT LABOUR EFFICIENCY VARIANCE ￡9×[(2 hrs×1,000)-3,520] =￡2,880(A) |

Overhead Absorption Rate=Variable + Fixed budgeted overheads/Total budgeted activity =￡3,200+￡2,200+￡1,500+￡2,500+￡2,000 1,600 units =￡11,400/1600 =￡7.125
=(￡7.125×1,600)-(￡3,200+￡2,400+￡1,500+￡2,500+￡2,200) =￡11,400-￡11,800 =￡400(A) |

**Report**

Sales activity was not on target.

- Material Usage Variance

The Material Usage Variance is favorable. One possible reason for it is the company is now using higher-grade materials. Besides the company has recently concluded a higher-than-expected wage settlement for production operatives, so we can see that the company is using higher grade workforce. Otherwise, the company has recently upgraded the production machinery used for this product, so the material usage variance is favorable.

- Material Price Variance

The Material Price Variance is adverse. One reason is that because the higher quality used by the company so the cost on the material is higher than budgeted. Second, because the company has recently switched suppliers so we should find that the company may lose the discounts. Last, maybe the specification of this material has changed. So the cost of the material increases. Maybe due to the poor performance by the buying department staff, so the company paid more on the materials. On the other hand, maybe due to changes in market condition between setting standard and actual event, so the actual cost on materials changes.

- Labour Efficiency Variance

The company used 320 more labour hours than planned for the actual level of production. Possible reasons are:

- Lower labour efficiency because the labour are not familiar with the upgraded production machinery
- Using lower grade labors that are maybe lack of experience in their work.
- The company has recently concluded a higher- than– expected wage settlement but maybe it did not boost the efficiency of the workforces in fact
- Labour Rate Variance

The labour rate variance is adverse. One reason is that the company uses a higher grade of worker than was planned. So the actual labour rate per hour is increasing. Other reason may be that it is shortage of skilled labour in this company and there are unplanned overtime taking place. Maybe there are some changes in labour market condition. Because of these reasons the Labour Rate Variance is adverse finally.

- Overhead Variance

From the Flexed Budget for June we can find that there are adverse variance in the insurance costs and administration overhead. The insurance cost has increased from (￡2,200 to ￡2,400), which maybe caused by the new machinery, because the protection of the new machine requires higher insurance premium. The administration overhead has increased from (￡2,000 to ￡22,000), possible reasons are:

- The company brought more office stationery
- Depreciation of equipments in office
- Office rent and rates have increased
- More office salaries

** **

**Significance:**

- Material

Total=2,400/64,000×100%=3.75%

Usage=8,000/64,000×100%=12.5%

Price=5,600/64,000×100%=8.75%

- Labour

Total=6,400/28,800×100%=22.2%

Labor rate =3,520/28,800×100%=12.2%

Efficiency =2,880/28,800×100%=10%

- Overhead

400/11,400×100%=3.5%

All the rates of significance for Variance analysis of this company of this year are over3%, so the company must take action to investigate them for finding the main problems causing it.

**Recommendation**

- Company should take action to investigate the Variance with a rate of more than 3% to find the main problems causing them
- Investigate paying higher than expected wage while the labour efficiency variance is negative
- Source an alternative supplier offering the current grade at a lower price
- Identify if it would be possible to use a lower grade of material at a cheaper price, without compromising the quality of our product too severely
- Establish if it would be beneficial to negotiate a bulk order with the prospect of obtaining the material at a cheaper unit cost
- Employ staff with high quality to improve the labor efficiency, therefore it can decrease the labor hour.
- Train the workforce on their working skills to improve the labor efficiency, reduce the labor hour and result in increased scrap.
- Using some positive ways to increase the morale of our staff

**Conclusion**

The overall actual variance is adverse. One reason is that the company has recently upgraded the production machinery used for this product. Besides, the company has recently switched suppliers and is now using higher-grade materials. Otherwise, the company has recently concluded a higher-than-expected wage settlement for production operatives.

** **

** **

** **

**Part B**

Tricol plc is now considering the development of its own distribution arm. This operation would involve the purchase of several new motor vehicles, the acquisition of some adjacent land and a purpose-built loading unit. I will evaluate the financial viability of the investment proposal.

The two appropriate investment appraisal techniques used are Payback and NPV.

**Payback**

The total investment:￡100,000+￡600,000+￡900,000=￡1,000,000

Yearly Net Cash Flow ￡ | Cumulative Cash Flow ￡ | |

Profit in year 0 | (1,000,000) | (1,000,000) |

Profit in year 1 | 160,000 | (840,000) |

Profit in year 2 | 160,000 | (680,000) |

Profit in year 3 | 320,000 | (360,000) |

Profit in year 4 | 320,000 | (40,000) |

Profit in year 5 | 40，000 | NIL |

Profit in year 5 | 280,000 | 280,000 |

Net Cash Benefit | 280,000 |

40,000 / 320,000 of Years 5=1.5 months

Payback=4 years 1.5months

The expected revenue from the investment for year 5 is ￡360,000 but in fact only ￡40,000 will be used to recoup the initial investment, which is 1.5 months. Thus, the payback period for the investment will take 4 years and 1.5 months.

** **

**NPV**

** **

Annual Cash Flow | Present Value Factors at 10% | Present | Value | |

￡ | ￡ | ￡ | ￡ | |

0 | （1，000，000） | 1.000 | （1 000 000） | |

1 | 160，000 | 0.909 | 145，440 | |

2 | 160，000 | 0.826 | 132，160 | |

3 | 320，000 | 0.751 | 240，320 | |

4 | 320，000 | 0.683 | 218，560 | |

5 | 320，000 | 0.621 | 198，720 | 935，200 |

Net Present Value | ￡（64，800） |

The deficit means that the annual cash flows are not enough to allow more interest to be deducted and still repay the original investment. This investment is, therefore, not worthwhile as it less than fulfils the requirement of a 10% return.

**IRR**

I will set a rate of 5%.

Year | Present Value Factors at 5% | Present Value |

￡ | ||

0 | 1.000 | (1,000,000) |

1 | 0.952 | 152,320 |

2 | 0.907 | 145,120 |

3 | 0.864 | 276,480 |

4 | 0.823 | 263,360 |

5 | 0.784 | 250,880 |

Net Present Value | ￡88,160 |

The IRR for the project can be calculated as follows:

5%+(10%-5%)×[88,160/(88,160+64,800)]

=5%+5%×0.576

=5%+2.88%=7.88%

The actual rate of return must be less than 10%. This is because too much interest has been deducted to allow all the capital to be repaid.

If, instead of going for an estimated 10%, the annual cash flows had been repeatedly discounted at 1% intervals from the 5% required rate, then a zero Net Present Value would have been found at approximately 7.88%.

The IRR is an investment that is the required return that results in a zero NPV when it is used as a discount rate.

**Assumptions**

- Uncertainty does not exist
- There is no impact of taxation and inflation on the figures
- Unlimited funds can be raised at a competitive rate
- The “Market rate of return” will maintain the same during the period
- The total cost of project will be payable in the beginning year
- The expected revenue from the investment, that is the expected Net Cash Flow after deduction of all relevant costs is certain, and will be occurred
- Discount rate will not be change

**Viability of the proposed Investment**

Firstly, from Payback method we can see that the payback period for the investment will take 4 years and 1.5 months which is within the expected 5 years. Therefore, the investment is worthwhile. However, there will be some problems when using the Payback method, which are, ignoring risk and time value of money. Nobody can be sure whether or not the loss is going to take place and sums of money arising at different times are not directly comparable. So there will be some variable factors arising during the payback period. In addition, there is no allowance is made for interest on the initial capital investment.

Secondly, from the calculation for NPV above, it demonstrates that the NPV at the rate of return of 10% is minus ￡64，800, which is a negative sign for the investment. The actual rate of return must be less than 10%. The deficit means that the annual cash flows are not enough to allow more interest to be deducted and still repay the original investment. There are several advantages of using the NPV method, which are, the time value of money has been taken into account, and it also considers both magnitude and timing of expected cash flows in each period of a project’s life. This investment is, therefore, not worthwhile as it is less than fulfils the requirement of a 10% return.

To sum up, the investment is not worthwhile going ahead.

**Recommendation and conclusion:**

We can find out that when using the Payback Period method the investment is worthwhile going ahead, however, the investment project will not be worthwhile with NPV method because the company can not achieve the 10% market rate of return. Thus, I suggest the company would not go ahead with this investment and consider whether the investment may result in some problems to the company.

**Other Factors:**

- Whether the investment will cause pollution to the environment
- Whether the investment can boost the local economic.
- Whether this project can increase the employment
- Whether there is enough capital to invest on the project
- If the goal of the company in June is just to extend its market share but not to gain too much profit, the company can carry on this project
- Company should consider the useful time of the new machinery which is estimated about five years, however, in fact we can use it for more than five years or more
- We must consider any changes in any other legal, social, economic, political and technological factors in the modern global economy world