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Hi john how r u? john sir plz guide me about the following:
Q#1 A company wants to buy a vehicle which involves outflow of $1000,000 in year 1. The vehicle will have scrap value at the end of year 4 $200,000. Net operating cash flows are from year 1 to 4 are $220,000 in year 1, $300,000 in year 2, $440,000 in year 3 & $410,000 in year 4.
In addition, share of existing overheads are to be allocated to project, amounting to $ 100,000 per annum. Calculate the ARR using the following formula.
ARR= average annual profits/average investment
Q#2 John sir , what is difference among cash flows, net cash flows and net operating cash flows. These terms confuse me. guide me. In the above question net operating cash flows are more confusing for me.
Cash flows are simply cash receipts and cash payments.
Operating flows are the cash flows from trading – sales less material, running costs etc..
Net cash flows are the new of all the cash flows each year (so operating cash flows and also things like cash paid to buy a machine, cash received from scrapping a machine.
For Q1, the total operating cash flows over four years is 1,370,000. The total depreciation over four years is 800,000. The total share of overheads over four years is 400,000.
So the total profit is 170,000. So average profit is 170000/4 = 42,500 p.a.
The average investment is 600,000
So the ARR is 7.08%
Thanx alot john sir, i got the both questions
You are welcome 🙂
Mr John please guide
is investment not the following? Cost + scrap value + share o/h
ave inv = (1000000+400000+200000)/4=400000
No – the average investment is the average value on the Statement of financial position. The average of the initial cost and any scrap value.
Overheads are a Statement of profit and loss item – not part of the cost of the investment.
Also, to get the average of the initial investment and the scrap value you add them and divide by 2. For this is makes no difference how long the project lasts for.
It might help you to watch my free lecture on this.