Jan Hoffman Flashcards
What does Goodwill mean?
When a business activity is sold, the price often includes an allowance for ‘Goodwill’. This is a value that is placed on the establishment of the business e.g having planning consent for the activity, having regular customers. From April 1 2002, tax allowances were introduced, to provide relief for the cost of intangible assets such as intellectual property and goodwill.
What are intangible assets?
Assets which are not considered to have a physical identity e.g. goodwill, patents,
trademarks, computer software.
Three methods of economic evaluation
- The NPV method applying an IRR to reflect the company’s after tax cost of capital
For a fixed value of IRR and the NPV for each project is calculated. The project with the highest NPV (at that
fixed IRR) is considered to provide the best financial return. This does not necessarily mean that it will be
selected, as other factors may influence the final choice of project (as above). However, a project with a negative value of NPV is unlikely to be selected (unless there are other strategic reasons for doing that project e.g. safety requirement).
- The IRR method
In this technique, the NPV calculations are performed on each option, searching for a value of IRR for each
option, at which the NPV for the project = 0. The project with the highest IRR is then considered to provide the best financial return. This method has a significant disadvantage, as there is an inherent assumption, that as you create cash over the duration of the project, you are then able to receive a return on that money at the same rate as that for
which you have calculated the IRR. This is complete nonsense! - Payback method
A fixed value of IRR is selected, and the number of years in which it takes for the cumulative PV to reach a
value of 0 is calculated. This means, that after allowing for the time value of money, the time it took to recover
all of our expenditure up to that point in time is calculated. The projects with the shortest ‘payback period’ would from a financial perspective be most attractive. However, this does not necessarily mean that it will be selected, as other factors may influence the final choice of project (for example – those in the ‘Triple Bottom Line’!).
IRR model assumptions
- The price of the products or services sold increase each year with inflation at the same rate each year,
and - The same rate of inflation applies to the operating costs.the
IRR excludes any allowance for inflation, and
it allows for the payment of tax (IRR rate after paying tax).
Sequence of project phases
Phase 1: Initiation of the project
Phase 2: Specifying the basis for the project
Phase 3: Screening alternatives and selecting the best route
Phase 4: Formulating the design basis for the selected option
Phase 5: The design specification
Phase 1
Initiation of the project The person (or group) that has made a request for this project should provide a brief description in writing of the benefits to be gained and what is required as an outcome. This is important in order to establish the correct starting point.
Further important considerations are:
Time-scale: You should have a clear understanding of how much time is available to complete the formal
review of the options, and then to complete the project. Are there any critical deadlines that have to be met?
Financial constraints: Is there a budget for this project, and/or does the money need to be spent/committed
within a certain time?
Confidentiality: How sensitive is this project? Are there groups within or outside the company, that need to
be informed at an early phase, and others who will only be informed at a later date or not at all?
Phase 2
Specifying the basis for the project
You now start to make use of the information gathered in Phase 1, you talk and obtain information from
parties that have an interest in the project, and you describe the information gathered in a formal manner. The approach at this preliminary screening stage should be very open, and all viable alternatives should be
considered. Some of these may have arisen as a result of asking other parties the question ‘how?’
Your report is likely to include the following sections:
- Aims & Objectives: the need for the project; incentives; purpose etc.
- Brief description of alternative solutions.
- The establishment of a ‘Base Case’ situation with which to compare the alternatives, or this could even be a ‘do nothing’ option.
- Indirect effects of the project on other parts of the business.
- Time-scales etc.
This formal document is called the: Draft ‘Project Basis Document’
You then distribute this Draft ‘Project Basis Document’ to all individuals who either:
- Need to be informed, or
- their comments are required.
This then constitutes a ‘1st Formal Review Phase’.
Phase 3
Screening alternatives and selecting the best route
You now consider in more detail the viable alternatives identified in Phase 2. All options must be considered
at the same level of detail. A cash flow projection is prepared for each option. This forms the basis of the financial assessment of choosing between the
options, however it is not the only consideration – we make decisions on a triple bottom line basis, with the
financial assessment forming just one part of this.
The level of detail is limited to that necessary to make a selection between the options considered.
Your report content is likely to include the following sections:
- Aims & Objectives = a clear statement should be provided.
- Review and discussion of each option.
o A more detailed discussion justifying why a particular option has been selected/
recommended.
- A summary table to illustrate how the options compare from a triple bottom line perspective,
including economic, environmental and social.
- A recommendation of the best option(s) based on the decision basis above
- Appendices with calculations – never present calculations in the main body of the report.
- Appendices or an additional volume or CD/flashdrive/file folder link with more detailed information (if necessary).
As mentioned above, when options are discussed and compared, many factors need to be considered NOT
JUST ECONOMIC AND ENGINEERING FEASIBILITY! The decision on choosing an option needs to be made using
all of these considerations – not just the cash flow analysis that is the focus on these lectures.
Triple bottom line
Traditionally, success only measured in terms of an economic bottom line but now environmental and social factors are also considered. When all three bottom lines are met, there is sustainability - optimal benefit. Factors include:
- People; worker happiness, safety
- Planet; ‘lifecycle assessment’, ‘environmental impact’, human health
- Profit; capital and operating costs, cashflow projections
Phase 4
Formulating the design basis for the selected option
The selected option in Phase 3 is now described in more detail. This new document and the description within will act as the basis for the development of a ‘Design Specification’.
NOTE: You should not be doing any detailed design work at this stage.
However, in this document you should provide:
- As much information as is available to describe in a quantifiable manner what is required. For
example, you may need to provide information on: operating temperatures; pressures; flow rates;
composition and properties of the feed; feed and product storage requirements (such as volumes);
materials of construction required; etc.
- A brief summary (that acts as a reminder) of options that were considered and why they were
rejected.
The purpose of this document is to ensure that all interested parties can comment and agree the basis for the design. The next phase of work is more expensive, and it is important to have a good, agreed starting point.
You then distribute a Draft of the ‘Design Basis for Selected Option’ document, to all individuals who either
need to be informed, or their comments are required. This then constitutes the ‘3rd Formal Review Phase’.
On receipt of written comments from all interested parties, you then take account of the comments and revise your document and produce the final version, which is once again circulated.
Phase 5
The design specification
In many large companies, the Engineering Division in the company would now normally handle this phase of
the project. If you are in a small company, then you may also have to deal with this aspect.
In Phase 5, the plant and equipment are specified in sufficient detail to enable a contractor to bid for the work. The contractor may be required as part of their brief to perform more detailed design work, or they may be able to supply plant and equipment to match the specification.
Once again a Draft of the ‘Design Specification’ document is circulated, but this time the list of individuals
consulted may be slightly different. On receipt of written comments from all interested parties, the document
is revised and a final version is produced, which is once again circulated.
This is then used to build the plant – going into the Build phase of the project.
Cost vs level of detail
The Person Day effort on the preparation of cost information is likely to rise exponentially with the level of detail required. This is the reason why all of the
options at the early phase in the evaluation process are not developed into a design specification.
Why might there be variations in capital tax allowances?
The method of calculating tax allowances depends on the capital item, and different methods apply in
different countries.
- Capital tax allowances can also change in response to government policy.
- Special rates may apply in a designated enterprise zone.
- Special rates may apply to small businesses.
- Special rates may apply to encourage investment in energy or environmental technologies.
Once a method is selected and agreed with a tax authority, then it is used in a consistent manner for
all projects in the company
Costs at the end of a project
For plant and equipment, it is not unusual for the final value to be very low as the equipment is disposed of as
scrap. In many cases there is also an additional operating cost that is incurred to dismantle and transport the scrap equipment to a disposal site, and an equipment disposal cost may also be incurred. In addition, it may be necessary to pay for the clean-up of any contaminated land, before the site can be sold (land reclamation costs).
