Return/profit

Discounted cashflow rate of return (DCFRR). This method is called the investors return on investment, internal rate of return, profitability index, interest rate of return, or discounted cashflow. A trial-and-error solution is necessary to calculate the average rate of interest earned on the company s outstanding investment in the project. It can also be considered the maximum interest rate at which funds could be borrowed for investment in the project, with the project breaking even at the end of its expected life. 

Myth 2 Social enterprises are non-profits. In fact, not all social enterprises are non-profits. Some are for-profit. Although still outside of mainstream social entrepreneurship, some for-profit startups include in their articles of incorporation clauses placing the need to be socially responsible equal to the need to return profits to shareholders. 

Return/profit "Givens" ITT under Harold Geneen, earnings per share objective Quality Low-cost manufecturing Customer service Growth Profit Portfolio management Information systems... 

Sales/marketing method Distribution method Natural resources Size/growth Return/profit... 

Keywords economic model, shareholder s profit, project cashflow, gross revenue, discounted cashflow, opex, capex, technical cost, tax, royalty, oil price, marker crude, capital allowance, discount rate, profitability indicators, net present value, rate of return, screening, ranking, expected monetary value, exploration decision making. 

Another useful profitability indicator is the internal rate of return (IRR), already introduced in the last section. This shows what discount rate would be required to reduce the NPV to zero. The higher the IRR, the more robust the project is, i.e. the more risk it can withstand before the IRR is reduced to the screening value of discount rate. Screening values are discussed below. 

The kinetic nature of the glass transition should be clear from the last chapter, where we first identified this transition by a change in the mechanical properties of a sample in very rapid deformations. In that chapter we concluded that molecular motion could simply not keep up with these high-frequency deformations. The complementarity between time and temperature enters the picture in this way. At lower temperatures the motion of molecules becomes more sluggish and equivalent effects on mechanical properties are produced by cooling as by frequency variations. We shall return to an examination of this time-temperature equivalency in Sec. 4.10. First, however, it will be profitable to consider the possibility of a thermodynamic description of the transition which occurs at Tg. 

As a general rule, acquisitions are considered for estabHshed products with above-average growth potentials. Often, entry by acquisition is more timely and profitable than internal development and subsequent plant constmction. EoUowing the latter course might take 5 to 10 years, during which time the highest return on investment (ROI) is lost. 

Essence of Profitability. If an investor purchases a computer in the morning and seUs it in the afternoon for a larger sum, then a return on the investment is realized. This is profit a reward for the effort (investment) made. A somewhat more difficult situation is the case of three choices having different purchase costs and expected selling prices ... 

The NPV represents the present-value net return, because provision has been made for capital recovery and the cost of capital. In other words, the NPV is a discounted net return or profit, analogous to the net return of the example introduced earher. 

More exactly, this third profitabiUty parameter is an average discounted annual net return rate on the total investment and corresponds to the net return rate of the example. It is a discounted annual rate of profit criterion that relates to the NPV as a discounted profit criterion. 

Possible numerators include the gross income net pretax income net after-tax income gross profit, ie, gross income minus book depreciation cash flow or net income. An average return value is selected by defining a typical or mature proof year as the basis of calculation. The denominator can be the original total investment, depreciated book-value investment, lifetime averaged investment, or fixed capital investment. 

Profitability Diag rams. Profitabihty diagrams of the type shown in Figure 3a for Venture A provide insight into venture profitabihty. Total return rate is defined as the sum of the discount rate and the net return rate (NRR). The discount rate, net return rate, and total return rate are all shown on the diagram as functions of the discount rate. Because the NPV is a nonlinear function of the discount rate, the NRR and total return rate are also nonlinear. The NRR, as a measure of the profitabihty, correctly decreases as the discount rate increases. 

Fig. 5. Effect of lifetime on profitability. Venture F has a shorter operating lifetime than Venture A, but the same investment and IRR (see Table 4) the NPV is the same at the 10% discount rate. The diagram indicates that the profitabiUty of Venture F is higher than that of Venture A at all discount rates the shorter lifetime leads to a higher annual net return rate (NRR). The IRR rate does not indicate this difference in profitabiUty.

The relationships among the various annual costs given by Eqs. (9-1) through (9-9) are illustrated diagrammaticaUy in Fig. 9-1. The top half of the diagram shows the tools of the accountant the bottom half, those of the engineer. The net annual cash flow Acp, which excludes any provision for balance-sheet depreciation Abd, is used in two of the more modern methods of profitability assessment the net-present-value (NPV) method and the discounted-cash-flow-rate-of-return (DCFRR) method. In both methods, depreciation is inherently taken care of by calculations which include capital recoveiy. 

FIG. 9-1 Relationship between annual costs, annual profits, and cash flows for a project. A d — annual depreciation allowance Acf — annual net cash flow after tax Ac/ = annual cash income Age = annual general expense Aqp = annual gross profit A/r = annual tax A e = annual manufacturing cost Avc/ = annual net cash income Avvp = annual net profit after taxes A/ p = annual net profit As = annual sales Apc = annual total cost (DCFRR) = discoiinted-cash-flow rate of return (NPV) = net present value. 

The fractional interest rate of return based on the net annual profit after tax and the original investment is... 

FIG. 9-6 Effect of straight-line depreciation on rate of return for a project. Abd — annual depreciation allowance A c/ = annual net cash income after tax Awwp = annual net profit after payment of tax Cj = total capital cost. 

Payback Period Another traditional method of measuring profitability is the payback period or fixed-capital-return period. Actually, this is really a measure not of profitability but of the time it takes for cash flows to recoup the original fixed-capital expenditure. 

Equation (9-54) may be solved for i either graphically or by an iterative trial-and-error procedure. The value of i given by Eq. (9-54) is known as the discounted-cash-flow rate of return (DCFRR). It is also known as the profitability index, true rate of return, investor s rate of return, and interest rate of return. 

When comparing project profitability, the ranking on the basis of net present value (NPV) may differ from that on the basis of dis-counted-cash-flow rate of return (DCFRR). Let us consider the data for two projects ... 

These (NPV) data are plotted against the cost of capital, as shown in Fig. 9-12. The discounted-cash-flow rate of return is the value of i that satisfies Eq. (9-5). From Fig. 9-12, (NPV) = 0 at a (DCFRR) of 11.8 percent for project C and 14.7 percent for project D. Thus, on the basis of (DCFRR), project D is more profitable than project C. 

The method of allocating overheads can seriously affect the assigned costs of a project and hence the apparent cash flows for that project . Since these cash flows are used to assess profitability by the net-present-value (NPV) and discounted-cash-flow-rate-of-return (DCFRR) methods, unfair allocation of overhead costs can result in a wrong choice between alternative projec ts. 

Row 2 in Table 9-24 is the profit margin (PM) of Eq. (9-127). In this case, the net profit referred to is the net annual profit after tax and depreciation Awp. The net sales is the revenue from annual sales As after deductions for returns, allowances, and discounts for gross sales. 

Row 3 in Table 9-24 is the return on equity (ROE) of Eq. (9-130). In this case, the net worth is the tangible net worth representing the sum of the preferred and common stocks and the surplus and undistributed profits or retained earnings, less any intangible items such as goodwill, etc. 

Absorption, rate-of-return, and marginal pricing have been considered here on the basis of manufacturing cost. Total cost, which is the sum of manufacturing and general costs, can also be considered as the basis. In this case the appropriate profit to consider is the net annual profit rather than the gross annual profit. 

If an option proves to be technically ineffective or inappropriate, it is deleted from the list of potential alternatives. Either follo ving or concurrent with the technical evaluation, an economic study is performed, weighing standard measures of profitability such as payback period, investment returns, and net present value. Many of these costs (or, more appropriately, cost saving may be substantial yet are difficult to quantify. (Refer to Economic Considerations Associated with Pollution Prevention.)... 

If utilities are supplied to the new project from some other source, the cost and amount must be determined. If purchased from a second party, the cost will be determined by contract and can be estimated by discussions with the vendor. If utilities are transferred from an affiliated source, the cost must include a profit to the supplying entity. Some estimators use a lower return on utility plants than on a new hydrocarbon processing unit, since the utility can be used for some alternate plant if the new one shuts down for any reason. However, the preferred analysis allows a high enough utility transfer price to provide the same return on the utilities as the new unit being studied. This can require a trial and error approach, especially if the utilities are a significant part of the selling price of the product. 

A simple return on equity can be used as a yardstick. Utilities are required by regulators to set their rates to obtain a given rate of return. This return is usually constant over the years and from project to project, so management must choose among projects on some basis other than profit. 

There are various indicators to determine the measure of profit for a process. In the following, we describe two of these indicators return on investment and payout period. The rate of return on investment (ROI) may be calculated as follows ... 

---