Investment and profitability



Task 1: Investment evaluation - cost comparison
•The static cost method is based on a comparison of operating and one-off costs. It is assumed that
one variant has higher operating costs and the other one higher one-time costs, but does not differ
in its revenues.
•Task: We have to decide between two options of the same capacity investment. Option A has a
one-off cost of CZK 250,000 and annual operating costs of CZK 160,000, variant B of CZK 300,000 and
CZK 140,000. The expected life of both variants is 4 years.
•Task A: Compare the advantages of each alternative using absolute lifetime cost values.
•Task B: Assess the benefits of both investment options by calculating the payback period of
additional investment costs dn.

Task 1: Solution A
•Compare the benefits of each alternative with absolute lifetime cost values
•
•
•Option A will require costs over its lifetime:
•250,000 + 4 * 160,000 = $ 890,000
•
•Option B:
•300,000 + 4 * 140,000 = $ 860,000
•

Task 1: Solution of Question B
•payback time dn =
•
•where: NPs are operating costs (see the difference as "profit" - cost difference)
•NJ are one-time costs (see as an investment)
•A, B - investment variants
•
•Calculation:
Again, option B is more advantageous because the increased fixed costs of option B will be offset
in 2.5 years with the cost of option A due to lower operating costs. Thus, after 2.5 years, the
total cost of Option A will begin to exceed the total cost of Option B
(50,000 (300-250) will be reimbursed in 2.5 years, while the investment will continue to operate
for another 1.5 years)

Task 2
•Compare the advantages of individual investment alternatives by discounting future costs. Here's
an example, with one-off costs being spent in 0 and costing capital at 14%.
•To calculate the calculation tables for the individual variants:
Year
Costs
Discont rate
(14 %)
Disconted costs
0
1,0000
1
0,8772
2
0,7695
…
…
…
…

Task 2
•Option A
Year
Costs
Discont rate
Disconted costs
0
250000
1
250000
1
160000
0,8772
140352
2
160000
0,7695
123120
3
160000
0,675
108000
4
160000
0,5921
94736
890 000
716208

Task 2
•Option B
Again, variant B (716208 for A vs. 707932 for B) is preferred. This is particularly useful when
operating costs vary from year to year.
Year
Costs
Discont rate
Disconted costs
0
300000
1
300000
1
140000
0,8772
122808
2
140000
0,7695
107730
3
140000
0,675
94500
4
140000
0,5921
82894
860 000
707932

Task 3: Evaluation of investment options - financial mathematical procedures
•The streams of monetary expenditures and cash receipts are assessed up to the end of their
economic life or to a certain planning horizon.
•Task: There are two investment variants (A and B) for which the same capital expenditure is
assumed to be CZK 1,000,000, but different distribution of annual net cash flows (see table). The
cost of capital is 10%, the lifetime for both variants is the same (6 years). Compare these
options.

Task 3: Variants
Distribution of net income (cash flow) investment options A and B
Rok
Cah flow A
Cash flow B
Discont rate
(10 %)
Discont rate
(30 %)
0
-1000
-1000
1,000
1,000
1
300
100
0,909
0,769
2
600
200
0,826
0,592
3
400
300
0,751
0,455
4
300
400
0,683
0,350
5
200
500
0,620
0,269
6
100
600
0,564
0,207
900
1 100

Task 3: Task A
•Compare these investment options using the capital value method, ie using the transformation
formula:
•
•
•
•where:
•K = the value of the capital of the investment option
•Et = cash receipts at the end of period t
•At = cash expenses at the end of period t
•(Et-At) = net revenue at the end of period t
•i = calculation interest rate
•t = period (t = 0.1, 2 ..... n)
•n = economic life of the investment object

Task 3: Solution A
•It is about converting the values ​​of future income to their present value – t0
•
• KA = -1 000 + 300 * 0,909 + 600 * 0,826 + 400 * 0,751 + 300 * 0,683 + 200 * 0,620 + 100 * 0,564 =
454
•
• KB = -1 000 + 100 * 0,909 + 200 * 0,826 + 300 * 0,751 + 400 * 0,683 + 500 * 0,620 + 600 * 0,564 =
403
•
•The capital value of both variants is positive, both variants are advantageous and provide more
than 10% interest. Option A is preferable.

Profitability



Task 4: Profitability and liquidity in own resources financing
•Mr. Black has available cash of CZK 1,000,000 for his own funds. It offers an investment
opportunity, which, when it costs 1,000,000, - CZK, as it is estimated, will give him the following
one-off income with a different probability:
ž
ž
ž
ž
ž
ž
•How big is (1) - (5) the internal rate of return on investment, return on total capital and return
on equity of Mr. Black?
case
Cash flow(CZK)
probability %
(1)
1.500.000,-
5
(2)
1.115.000,-
50
(3)
1.040.000,-
30
(4)
800.000,-
10
(5)
0,-
5
(total loss)

•
•
•
•
•
•
•
•The total capital that Mr. Novák needs for this project is CZK 1,000,000, and the entire
investment is therefore financed by equity. The internal rate of return is thus an expression of
both the return on equity and total capital - in individual cases.
Task 4: Solution
Individual cases show the following internal rate of return (r)
case
1
2
3
4
5
r
50%
11,5%
4%
-20%
-100%

Task 5: Foreign funding, liquidity and bankruptcy
•Unlike the previous example, Mr. Smith does not want to invest his own resources. He wants to
borrow the required CZK 1,000,000.00 for a period of one year at an interest rate of 6%. The
interest is to be repaid together with the loan per year in one installment.
•
•What result does Mr. Smith achieve in cases (1) - (5)?

Task 5: Solution
•At interest rate on foreign capital 6% the debt is 1.060.000, - CZK. So Mr. black will achieve the
following results (all in CZK)
•
•
•
•
•
•
case
Revenues v t1
Payoff and interest rate
Result
(1)
1.500.000
1.060.000
+ 440.000
(2)
1.115.000
1.060.000
+ 55.000
(3)
1.040.000
1.060.000
-20.000
(4)
800.000
1.060.000
-260.000
(5)
0
1.060.000
-1.060.000

Task 6: Profitability, liquidity and bankruptcy in mixed financing in an individual enterprise
•As in Tasks 1 and 2, Mr. Black is offered an investment with an acquisition cost of CZK 1,000,000,
while any number of such projects may be executed simultaneously. It has CZK 1,000,000 of its own
resources.
•
•What profit or resp. losses will Mr. Black achieve from the current implementation of two projects
in cases (1) - (5), when he uses one project for his own project and the second (same) loan project
with 6% interest on foreign capital?
•
•How high is the return on equity for a given variety of results?
•
•What will be the wealth of Mr. Black?

Task 6 Results
•The overall result of both projects is the result of a project financed from own resources and the
result of a loan-funded project (tasks (1 and 2) .The return on equity is calculated as the ratio
of result and equity of CZK 1,000,000.
case
Profit/loss in CZK
ROE
Own financing (Equity)
Foreign financing (loan)
SUM
Revenue
Cost
Result
Revenue
Cost
Result
(1)
1.500.000
1.000.000
500.000
1.500.000
1.060.000
440.000
940.000
94%
(2)
1.115.000
1.000.000
115.000
1.115.000
1.060.000
55.000
170.000
17%
(3)
1.040.000
1.000.000
40.000
1.040.000
1.060.000
-20.000
20.000
2%
(4)
800.000
1.000.000
-200.000
800.000
1.060.000
-260.000
-460.000
-46%
(5)
0
1.000.000
-1.000.000
0
1.060.000
-1.060.000
-2.060.000
-206%

Task 6 Results
•Wealth after repayment of the loan and payment of interest
case
Revenue
Costs (payoff loan and interest)
Wealth
(1)
3.000.000
1.060.000
1.940.000
(2)
2.230.000
1.060.000
1.170.000
(3)
2.080.000
1.060.000
1.020.000
(4)
1.600.000
1.060.000
540.000
(5)
0
1.060.000
-1.060.000

Task 7 Business plan evaluation
•Sale price of the goods 1500 CZK/pc
•Planned production 200 pc
•Average variable cost
•Material 520 CZK/pc
•Other direct costs 680 CZK/pc
•Fixed costs 50000 CZK/year
•Depreciation is 80% of fixed costs, each year 10% od total assest depreciated
•Is the plan profitable?
•Is the plan profitable enough, when bank offers interest rate at 5%?
•

Task 8 Balance sheet analysis - profitability
Assets BS (32.12.2018) Liabilities          Costs  Profit/loss statement Revenues
Investment  6 000 Equity 24 000 Good purchase 6 000 Sales 20 000
Salaries 9 440
Current assets 37 600 Liabilities 16 000 Interest 960
Profit 3 600 Profit 3 600
43 600 43 600 20 000 20 000
Calculate ROA…
Calculate ROE…

Task 8 Solution
Assets BS (32.12.2018) Liabilities          Costs  Profit/loss statement Revenues
Investment  6 000 Equity 24 000 Good purchase 6 000 Sales 20 000
Salaries 9 440
Current assets 37 600 Liabilities 16 000 Interest 960
Profit 3 600 Profit 3 600
43 600 43 600 20 000 20 000
Calculate ROA…
Calculate ROE…

Task 8 Solution
Assets BS (32.12.2018) Liabilities          Costs  Profit/loss statement Revenues
Investment  6 000 Equity 24 000 Good purchase 6 000 Sales 20 000
Salaries 9 440
Current assets 37 600 Liabilities 16 000 Interest 960
Profit 3 600 Profit 3 600
43 600 43 600 20 000 20 000
Calculate ROA…
Calculate ROE…