Discounted Cash Flow Course Work

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1. a) Below is the decision tree that I have used to recommend the unit price to quote the customer based on greatest benefit to Capstick Limited.
From the decision tree, it is clear that the unit price that would accrue maximum benefit to the company is that of selling the units at £17, through sub-contracting.
b) Objective comparison of the in-house manufacture and sub-contracted routes shows that the sub-contracted route is more beneficial to the company since the production cost is lower by £0.5 per unit. The main disadvantage, however, is that this sub-contracted route rigidly fixes the units produced per year to 100 000. This may be disadvantageous should the company’s annual orders go either above or substantially below this value.
c) The qualitative factors the company should take into account when making this decision include:
i. The need to conserve their brand name since losing this major customer may diminish the company’s brand name.
ii. The fact that sub-contracting may lead to termination of employment of some members of staff. This may be expensive to the company in the short as the employees have to be sent away with termination benefits.
iii. That the 100 000 units per year contract is a guarantee that the company will be in this company for a long time.
2. a) The discounted cash flow over 5 years for the proposed new automatic equipment, were the Company to quote a unit price of £15 to the customer is given as:
Rate: 15%
Period (Years)
Cash Flow
PV Factor
Present Value
c) The company should consider such qualitative factors as:
i. The number of workers that may have to be laid off as a consequence of automation.
ii. Automation is likely to increase efficiency thus better delivery to customers.
iii. The lower costs of production associated with the equipment may lead to higher profits in the long term.
iv. The company may be forced to hirer more technical staff to operate the new equipment.
3. a) Recommended make up of the project team:
i. The project team should mostly be composed of shapers and innovators since they possess the right temperament to move this kind of project forward. in light of the aforesaid, the project team should be composed of:
1. The new manager
2. Sarah Evans
3. Martin Taylor
4. Joe Johnson
5. Ed Burrows
6. Susan Peters
We deliberately leave out John Smith and Peter Johns because, by virtue of their positions, they are part of the project. We include the new manager because his hiring is clearly informed by the anticipation of that which will be involved in this new project.
b) For the team leader I recommend Joe Johnson (the Technical Director). By virtue of his position, he should command respect from all the others because of his technical orientation and innovative personality. Another good choice would be Ed Burrows (CAD Manager), but he is of lower rank in Capstick Limited’s organizational chart and would thus not command the requisite respect from some of the colleagues who of are of higher rank in comparison to him. Burrow’s background in is his single greatest asset in this respect. The Chairman and the Managing Director should, of necessity, not be part of the team to avoid the risk of micro-management that would accompany such a structure.
c) Risk issues generated by the factors of personality and management will include:
i. Conflict in goals: While the innovators’ interest will majorly be that of technical creativity, the entrepreneurs will be driven by the desire to reduce costs thus reap maximum benefits. This will inevitably lead to conflicts since creatively designed projects usually cost more.
ii. Risk of delays due to insubordination is possible where the team leader does not command the confidence of other team members. This is especially so in this case as most the team members seem to be of the same rank leading to the attendant risk of reluctance to obey orders.
d) If the company recruits a new manager to lead the team, this manager ought to be able to quickly fit in the team, be a person of vision and with ability to influence people’s thinking processes. For the aforesaid reasons, the new manager ought to be an innovator, a shaper, a social being and be quick and firm at making decisions. This is especially important when viewed against the personalities he will be leading.
e) The new manager, as team leader, should report to Peter Jones, the Managing Director. This ensures that the integrity of the chain of command in the company is not compromised as would happen if he reported directly to the Chairman, John Smith. He must not report to any other manager since some of these managers are likely to be part of his team.
f) Advice for the Company and individuals to maintain objective control of the project:
To maintain objective control of the project, there is need to keenly follow the details of the plan of the project while additionally monitoring costs. The need to work effectively with team members while constantly monitoring project performance is also paramount. The team leader can achieve this by:
i. Constantly assessing project performance, paying particular attention to timely delivery of intermediate goals.
ii. Always taking corrective action where there is deviation from the plan so as to bring the project in conformity with the project original design and plan. The team leader may as well make some revisions to the plan taking emerging realities into account.
iii. Always reconfirming to team members the need to stick to the original plan as far as is realistically possible. Team members must know their responsibilities and understand the need to commit to deadlines.
iv. Trying to keep all the concerned informed of project developments. This is important in boosting morale where there are achievements, and also as a way of inviting critique where there are lapses in the project.
Determination of the Critical Path
From the above diagram, the critical path is given as C-E-I-J-K which gives a total of 52 weeks. The calculation is too basic to be included here-in.
Preceding activities
Optimistic time estimates to
Most likely time estimates tm
Pessimistic time estimates tp
Expected time
The expected time is given by
Expected time = (Optimistic + 4 x Most Likely + Pessimistic) / 6
Where te is the Expected time, to is the Optimistic time, tm is the most probable activity time and tp is the Pessimistic time.
The standard deviation = [ ( Pessimistic – Optimistic ) / 6 ]
Variance = [(Pessimistic – Optimistic) / 6]2
Schedule A-D-H-J-K
6. Specific rules that can be adopted to decide how to schedule the project and constraints to be taken into account:
i. There is need to schedule for unexpected delays and occurrences. Since this project will require the input of different departments such as engineering, IT and finance, there is need to take into account the fact that there may be delays due to the attendant bureaucracy that accompanies such.
ii. A strict one week interval for project performance review. Since this project will be intensive and demand contribution from multiple departments, there is need to review its performance over sufficient amount of time so that data can be collated adequately. Weekly review would be a good choice.
iii. Need to eliminate uncertainties by giving specific information – Since the success of this project will directly affect productivity of the company, there is need that the different departments concerned to be clear on their expectations of this project.
7. The probability that the work is completed within the expected time
From the schedule and calculations, the total expected time te is
te = 31.7 + 3.3 + 2.2 + 10.3 + 8.8 = 56 weeks.
to = 44 weeks
tp = 86 weeks
The standard deviation is given by
= (86 – 44) / (6) = 7
Variance = 49
Z = (D – Var) / St
= (56 – 49) / (7) = 1
From the tables of the normal distribution, the probability associated with Z = 1 is 0.8413
This indicates that the project will be completed by the expected date.
b) 5-weeks before the expected date = 56-5 = 51 weeks.
Z = (51 – 49) / (7) = 0.2857
From the table, the probability associated with Z = 0.2857 is given by 0.6141
8. To reduce the expected duration by 2 weeks, the probability is calculated as shown below
Z = (54 – 49) / (7) = 0.7143
From the table, the probability is 0.7560
From the Schedule (A-D-H-J-K) we can summarize the table as below
Preceding activities
Normal cost (per week)
Crash cost (per week)
Crashed duration
Crew size
Average normal cost per week = 23000/5 = 4600
Average Crashed cost per week = 37000/5 = 7400
Difference between the normal cost and the crashed cost (per week) = 7400-4600 = 2800.
Therefore, to reduce the expected duration by two weeks, the increase in cost is (2800 X 2) £5600.
Alternatively; from the probability of 0.7560, the increase in cost is given by 4600 (1/0.7560), which is approximately £6000.
10. a) If tasks G and I are sub-contracted, the following contractual terms ought to be given serious consideration;
i. The sub-contract should strictly be between the company and the sub-contracting firm, not individual team leaders. This protects the leaders against liabilities that may not be of their making.
ii. The contract should be very clear on what follows should there be a breach of contract so that sub-contractor faces liability for failure to deliver on his side.
iii. The contract should clearly indicate termination dates of the contract to avoid scenarios where the sub-contracting firm claims the tasks in perpetuity.
b) Differences in contractual terms for cases G and I may come in form of;
The contractual terms for cases G and I may be different due to such factors as;
Whether the sub-contractor is foreign or locally owned, or whether it is privately or government run. Locally owned and government run entities are thought to pose fewer default risks and their contractual agreements can thus be a bit
11 a) Cost variance of work performed so far;
Cost Variance (CV) = Budgeted Cost of Work Performed less Actual Cost of Work Performed
Thus CV = (150 000 – 140 000) + ((0.95 * 75 000) – (87 500)) + (125 000 – 120 000) + ((0.1 * 12 000) – 6000)) + (26250 – 27 750) + (10 000 – 9750) + ((0.05 * 18750) – 750) + 10 000 + ((0.65 * 16 000) – 3 000) + 40 000 + 40 000
The above translates to CV = £90 287.5
b) Scheduled Variance (SV) = Earned Value (EV) - Planned Value (PV)
Thus SV = (140 000 – 150 000) + (87 500 – 75 000) + (120 000 – 125 000) + (6 000 – 12 000) + (27 750 – 26 250) + (9750 – 10 000) + (750 – (0.2 * 18 750)) + 3 000
The above translates to CV = -£7250
This shows that we are behind schedule which corroborates the answer we found in part (a) where CV is positive with the consequence that what we budgeted for is being consumed at a slower than expected rate which can only imply a behind schedule scenario.
c) On the whole, the project is progressing well since major tasks such as A, B and C are almost, if not complete.
12. a)
b) This certainly affects the strategic decision taken earlier since the need to sub-contracting is eliminated. In this case, the cost of in-house manufacture is less than that of sub-contracting thus in–house manufacture is a viable option.
Again, with unit cost of production at £13.30 we can accept the customer’s offer of £15. It should be noted that the profit margin likely to accrue from this (£1.7) is a tad higher than the £1,5 we expected to gain by taking the risk of selling a unit at £17.
Freund, John E., Modern Elementary Statistics, New Delhi: Prentice-Hall of India Private Limited, 1979
Render, Barry and Stair Jr., Ralph M. - Quantitative Analysis for Management, Massachusetts: Allyn & Bacon Inc., 1982, pp. 525-563
Wiest, Jerome D., and Levy, Ferdinand K., A Management Guide to PERT/CPM, New Delhi: Prentice-Hall of India Private Limited, 1974

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