Question 1
Determine the Economic Order Quantity given the data above
Economic order quantity = square root of [(2 x demand x ordering costs) ÷ carrying costs]
Where:
Q is the economic order quantity (units). D is demand (units, often annual), S is ordering cost (per purchase order), and H is carrying cost per unit.
At normal situation, the EOQ for the four scenarios are as shown above.
Produce sensitivity analysis assuming a change of up to 10% up or down on each of the factors individually and on all factors simultaneously.
Make a final recommendation to the board of the company, as to the number of units it should include in each order.
Considering the analysis done above, the company should consider the fast recovery scenario where it should be able to add 335 more units.
Question 2
Formulate this problem as a linear program and use Excel’s Solver to arrive at a solution. Write a short report describing your procedure, justify your formulation and give a recommendation to the firm on the best daily production mix.
Let
X1-1.8 litre engine
X2-2.0 litre engine
X3-2.5 litre engine
Objective Function is
Constraints
The model seeks to maximize the profitability from the engine manufacturing plant given different product mix. The costs and all other expenses related to the production have been considered. From the model above, it’s clear that the company should not produce any of the 1.8 litre engines. Further for maximum profits, the company should produce 2223 units of the 2.0 litre engines and 2000 units of 2.5 litre engines.
Question 3
What is the maximum John and Julia can borrow while taking advantage of the bank’s best mortgage rate;
Considering a joint salary, the total earnings will be 81,500 for the couple. Using an eligibility multiplier for this total, they will be able to qualify 3.25 times this amount that gives a total of £ 264,875.00.
The amount you advise them to borrow, given their financial and professional situation;
From the results shown above, the couple should consider going for the 2-bedroom mortgage as its just within the amount they can jointly qualify from the bank.
Which is the best mortgage that John and Julia to take out (assume they take out the amount you recommended in b);
Since the second option is the best for John and Julie whereby they will be required a total of 243,750 for the 2-bedroom, and the interest paid for the second option is a repayment fixed rate of 5 years of 2.34% whereby after that period the rates converts to the normal bank rates of 3.69%, the repayment fixed rate for 5 years is the best which is option 2.
Whether that advice would change if interest rates went up or down by up to three percentage points.
If the interest rates went up by 3 points, then the third option will be best for them whereby there will be interest only mortgage at 5% for the loan life where an investment fund needs to be created to pay an interest rate of 3.9% to cover mortgage repayment. Otherwise, if the rates go down by 3 points, Option 1 will be the best so that they pay a fixed rate of 1.89% for two years and then normal banks rates thereafter.
Question 4
Discuss and compare the different types of investment appraisal methods Garnett can use, including a discussion of the advantages and disadvantages of each.
There are three main investment appraisal techniques that Garnett can use namely; Accounting Rate of Return (ARR), Payback Period, and Discounting Cashflow (Ye, 2008).
ARR
This method compares the expected profits from an investment to the sum needed for an investment. ARR is normally calculated on average per annum on the expected life of a project investment capital. This method has several advantages. The method is easier to calculate and one can understand the payback period. It also recognizes the concept of net earnings as well as facilitating the comparison for a new product and the reducing product by cost. It also gives a clear picture on the profitability and satisfies the interest of the investors. However, the method presents contradicting results when one calculates return on investment and ARR at the same time. Further, the technique doesn’t consider time factor as well as other external factors that affect profits.
Payback Period
A technique that is used for assessing an investment by considering the length of time for repayment. The method is simple to use and presents simple concepts to understand. The technique is used for smaller projects and to make quick evaluations in projects. However, the method tends to ignore the time value of money as it doesn’t consider any cash flows from an investment as well as focusing on short term profitability.
Discounting Cashflow
The method utilizes a discounting rate that is used to work on the current equivalent for a future cashflow. The method has two methods of discounting; Net Present Value (NPV) and Internal Rate of Return (IRR). The technique considers all the underlying factors of a project (cost of equity, average cost of capital, growth rate, etc.) and can determine the intrinsic value of the asset. The method also relies on the free cash flows an aspect that is considered to eliminate the accounting policies. Further, the method allows project investors to incorporate the changes for the project in the valuation model. However, this technique is extremely affected by any assumptions made and are related to growth and discount rates. Also, the method is only suitable for long-term projects.
If Garnett had a rule that all investment projects need to payback within 3 years, what project would be chosen? Comment.
Option A would be the most suitable since its able to give returns within that period (In the second year-as it recovers by the end of the first year).
Make a recommendation as to which project should be undertaken.
As shown in the Table above, project B is more profitable as it provides a long-term solution even though the initial capital investment is very high. The payback period for project B is 4 years. Thereafter there is increased sales annually. Option A provides a quick response but not long lasting.
If Garnett believes there is an opportunity to start exporting its product line to another country once sales are finished in its home country (i.e. from year 5), and it thinks it will be able to generate cash flows of £250,000 in the first year, £750,000 in the second and £1,250,000 in the subsequent four years, would your answer to part c) change? How? (Note: production can’t be further increased in the future if option B is chosen now)
Yes. This is because, with a small investment the cashflow is still realized even after the payback period is reached. Compared to Option B where sales are decreasing from year 7, the first project is more profitable considering the amount that was invested in.
Question 5
Summarise the distribution of profits of the twenty branches and comment on the results, including identification of any particularly good or poorly performing branches.
From the results below, the mean profit is £43,530 while the maximum profit is £91,000 and minimum profit is £8,600. The total profit from the 20 branches is £870,000.
Identify whether there is evidence that the average number of lines stocked per branch is significantly different from 150.
Results as shown above reveal that the p-value is 0.021 which is less than 0.05 and therefore we reject the null hypothesis and then conclude that the average number of lines stocked per branch is not significantly different from 150.
Identify whether there is a significant difference between the profits of two groups of branches, split by the level of sales, with the threshold being £600,000.
Results as indicated in the table above show that the p-value is 0.451 and that means its greater than 0.05. therefore, we accept the null hypothesis and conclude that the profits of the groups of branches have a significant difference between the profits.
Based on this sample, provide a 98% confidence interval for the profits of the twenty branches and comment on the outcome.
Results as shown in the table above reveal that confidence level at 98% results to 14.23 interval for the 20 branches.
References
Ye, X. (2008). Property Investment Appraisal (3rd edition)20081Andrew Baum and Neil Crosby. Property Investment Appraisal (3rd edition). Oxford: Blackwell 2008. Journal of Property Investment & Finance, 26(6), pp.577-578.