Cash Flow determination:

Top down approach

Fu-wang ceramic industry limited follow top down approach for determining its
cash flow.Fu wang ceramic industry uses top down approach by using items at the
top of the income statements and work down .the company uses top down
approach because the top-down approach is better than the bottom-up approach,
many investors have found the top-down approach useful in determining the most
promising sectors in a given market. The process of determining cash flow of fu
wang ceramic industry limited is-

At first they subtract all expenses and depreciation from sales.Then they get their
EBIT(Earning before interest and taxes).Then the company calculate the tax
amount by multiplying tax rate and EBIT.From EBIT tax is deducted and
depreciation is added.then the company get their operating cash flow.

All expenses of fu wang limited include cost of goods sold,administrative expen

ses,marketing expenses, miscellaneous expenses. Notice that when working down
the income statement the company added depreciation but the subtracted it. This is
because depreciation is not a cash expenses. However depreciation does play a big
role in operating cash flow because it reduces the taxable income which reduces
taxes which are a cash expense.

Statement of Cash Flow is prepared principally in accordance with IAS 7 as

adopted by ICAB as BAS 7 Cash Flow Statement and the cash flow from the
operating activities have been presented under top down method and considering
the provision of paragraph 19 of IAS 7 which provides that enterprises are
encouraged to report cash flow from operating activities using the top down
method.

In this feature, we take an in-depth look at the various techniques that determine
the value and investment quality of companies from an industry perspective.

Rate of cost of capital determination

Industry rate
As an emerging nation, the housing industry in Bangladesh have progressed
significantly in recent years, that inspired the ceramics industry also to expedite
investment into the industry. Fu-Wang Ceramics Industries Ltd. is a BBB rated
company in the ceramics industry of Bangladesh. While there are other players in
the industries playing competitive, the rating reflects the established position of
Fu-Wang Company in the tiles industry in Bangladesh with its prospective
domestic markets. While the rating factors significant experience of the promoters
reflected in marketing success of the company and good credit history, the rating is
constrained by weak financial position. This maybe a reason of increasing
investment in technology and in manufacturing process optimization phase.

Once the cost of equity is calculated, adjustments can be made to take account of
risk factors specific to the company, which may increase or decrease the risk
profile of the company. Such factors include the size of the company, pending
lawsuits, concentration of customer base and dependence on key employees.
If the company are going to adjust for say financial risk, take subject and compare
it to the average for the comps from which derived the beta. Look at debt/equity,
interest and fixed charge coverage, etc. You usually find that within an industry or
sub-industry, only a certain level of risk is tolerated, and your company is either
above or below that level. Adjust your cap rate for that but keep your adjustments
small because they are not well documented in the BV literature, and the company
think an adjustment to the denominator is magnified in the numerator.

The cost of capital is surely just one of several imprecise estimates that is going
into the valuation spreadsheet. Even though the cost of capital sounds like an
intellectual topic to talk, yet I believe we need to put more attention and time to
how we build up our expected future cash flows of the subject company.
Sensitivity analysis is quite crucial to this process. You might need to consider to
put the risk into the subject company's cash flows or the discount rate.

Techniques of capital budgeting

IRR(internal rate of return)
Once the internal rate of return has been computed, what does the manager of fu
wang company do with the information? The internal rate of return is compared to
the company's required rate of return. The required rate of return is the minimum
rate of return that an investment project must yield to be acceptable. If the internal
rate of return is equal to or greater than the required rate of return, than the
company accept the project. If it is less than the required rate of return, then the
project is rejected. Quite often fu wang company's cost of capital is used as the
required rate of return. The reasoning is that if a project cannot provide a rate of
return at least as greater as the cost of the funds invested in it, then it is not
profitable.

When the internal rate of return method is used, the cost of capital is used as the
hurdle rate that a project must clear for acceptance. If the internal rate of return of a
project is not great enough to clear the cost of capital hurdle, then the project is
ordinarily rejected.fu wang company set its hurdle rate at 15%.IRR is especially
important in our current economic climate, where businesses are trying to cut costs
and only invest in those projects which will yield a higher rate of return.

Fu wang company determine its internal rate of return as follows:

The company divide its total investment required by net annual cash inflow. the
internal rate of return cause the net present value of a project to be equal to zero.

Fu wang company uses IRR as capital budgeting technique because tells whether
an investment increases its firms value,consider all cash flow of the
project,considers the time value of money,consider the risk of future cash flows.

IRR is, however, the preferred practical application of capital budgeting

techniques due to its intuitive appeal. There are some complications which can
arise out of utilizing the IRR method when there is a nonconventional cash flow
pattern.at this situation the company uses the payback period.

Payback period
Fu wang company uses payback period because simple to compute,provide some
information on the risk of the investment,provide a crude measure of liquidity.The
company simply take the expected cash inflows per year expected after the initial
investment and find the breakeven point in where the cash inflows equals the initial
investment.Whenever that breakeven point occurs on your timeline, that is your
payback period. The simplicity of the method can allow it to be used as a filter for
those projects which should go on to a more in-depth method, such as those
explained below. If a project is not recommended based on the payback method,
then chances are pretty high the project should not even be considered for the other
methods.

At using payback period as to make accept-reject decisions,the decision criteria are

as follows:

If the payback period is less than the maximum acceptable payback period,accept
the project.

If the payback period is greater than the maximum acceptable payback

period,reject the project.