ACCA CAT Paper T10 Managing Finances Solved Past Papers

Certified Accounting Technician examination
Sample multiple choice questions – June 2009
Paper T10
Managing Finances
Section A only
All questions are compulsory
Note: Section B of the actual exam paper will contain four written questions
FOR FREE CAT & ACCA RESOURCES VISIT: http://kaka-pakistani.blogspot.com

The following questions are typical of those that will appear in Section A of the examination paper from June 2009
onwards. There will be a total of ten questions in section A.
All questions in Section A will be worth two marks each.
1 The following statements have been made about the benefits of debt finance compared to equity finance:
Statement 1: Interest payments on debt attract tax relief.
Statement 2: Control of the company is diluted.
Which of the above statements is true?
A Both of them
B Statement 1 only
C Statement 2 only.
D Neither of them.
(2 marks)
2 The selling price for a product is $62. It takes 2 hours of skilled labour to make the product and 3 kg of materials. Fixed
overheads are $435,000 per annum. The cost of labour is $11 per hour and materials cost $6 per kilogram. Variable
overheads are absorbed at the rate of $5 per direct labour hour. The company’s budgeted sales for the product for the
next year are 100,000 units.
What is the contribution per unit of the product?
A $12
B $22
C $23
D $17
(2 marks)
3 The break-even sales revenue for a product is $235,000. The selling price of the product is $25 per unit.
If budgeted sales are 10,000 units, what is the margin of safety, in units?
A 400
B 10,000
C 9,400
D 600
(2 marks)
2
4 Extracts from a company’s accounts show the following balances:
$000
Inventories 114
Trade receivables 216
Cash 42
Trade payables 180
Bank overdraft 60
Which of the following is the company’s quick ratio, calculated to the nearest two decimal places?
A 1.55
B 1.08
C 2.07
D 1.43
(2 marks)
5 The following statements have been made about inflation:

Statement 1: Inflation leads to a distribution of income and wealth.
Statement 2: If a country has a higher rate of inflation than its partners, its imports become relatively more expensive
and its exports become relatively cheaper.
Which of the above statements is true?
A Both of them
B Statement 1 only
C Statement 2 only
D Neither of them
(2 marks)
6 The net present value of a proposed project is $20,000 at a discount rate of 5% and $(28,000) at 10%.
What is the internal rate of return of the project, to the nearest one decimal place?
A 7.1 %
B 7.5 %
C 2.3 %
D 8.6%
(2 marks)
7 A company is considering increasing its credit period to customers from one month to two months. Annual revenue is
currently $1,200,000. It is expected that the increased credit period would increase sales by 25% and result in an
increase in profit of $45,000, before any INCREASE in finance charges have been taken into account. The company’s
cost of capital is 10%.
What is the financial effect of this proposal, after taking into account any increase in finances charges?
A Increase in profit of $35,000
B Decrease in profit of $35,000
C Increase in profit of $30,000
D Decrease in profit of $30,000
(2 marks)
3
8 Which of the following are assumptions used when calculating the economic order quantity for inventory?
(i) Lead time is constant
(ii) Demand is constant
(iii) Purchase costs are constant
A All three
B i and ii only
C i and iii only
D ii and iii only
(2 marks)
9 A company is considering undertaking a contract for a new client. The contract requires 100kg of material A. It has
200kg in inventory, which it bought last year at a cost of $10 per kg. The current resale value is $8, although to replace
the material today would cost $15 per kg. There is no other use for the material, except as a substitute for material B,
which costs $14 per kg.
What is the relevant price per kg of material A?
A $10
B $14
C $8
D $15
(2 marks)
10 A farmer grows carrots, which he currently digs up and sells in 10kg sacks, without washing the carrots or preparing
them in any other way. He is considering whether to trim them, wash them and package them up in 1kg cartons
instead of continuing to sell them in sacks.
Which of the following are relevant to his decision?
(i) The cost of growing the carrots
(ii) The sales value of the unprepared sacks of carrots
(iii) The costs of trimming and washing the carrots
(iv) The sales value of the new trimmed cartons of carrots
A All of them
B (i), (iii) & (iv) only
C (ii), (iii) and (iv) only
D (iii) and (iv) only
(2 marks)
End of Sample Questions
4
Answers
5
Sample Multiple Choice Question Paper T10 Answers
Managing Finance
1 B Only statement 1 is true
2 A Contribution per unit:

$
Sales price 62
Labour (2x$11) (22)
Materials (3 x $6) (18)
Variable overhead(2 x $5) (10)

Contribution per unit 12

3 D Break-even sales in units = 235,000/25 = 9,400.

Therefore, M of S = 10,000 – 9,400 = 600.
4 A (216 + 42)/(180 + 60) = 1.08, to 2 D.P.s

5 B Only statement 1 is true.
6 A
⎛ 20 ⎞
IRR = 5% + ⎜ + [10% – 5%]⎟
⎝ 20 + 28 ⎠
⎛⎛ 20 20 + [10% – 5%]⎞⎞⎞
⎛⎜ 20
⎝⎜ 20 + 28 ++ [10%
[10% – – 5%]
5%]⎟⎠⎟⎟⎠
[Distractors: ⎛⎜⎝⎝ 20 + 28
+
2020 28 ⎞⎠
⎜⎝ 20 – 28 x[10% – 5%]⎟⎠
B
⎛ 20 ⎞
IRR = 5% + ⎛⎛⎜ 20 x[10% –– 5%]
20 x[10% 5%]⎞⎞⎟
⎜⎜⎝⎝ 20 – 28 x[10% – 5%] ⎟
⎟⎠⎠⎠
⎛⎝ 20 20 –
– 28
28 20 ⎞
⎜⎝ 5% + x[10% – 5%]
20 – 28 ⎟⎠
C ⎛ 20 ⎞
IRR = ⎛⎜⎛ 5% 5% + 20 20 ⎞⎟⎞ x[10%x[10% ––– 5%]5%]
5%]
⎝⎜⎜⎝ 5% + 20 –– 28
+ 20 28 ⎟⎠⎟⎠ x[10%
⎛⎝ 20 – 28 ⎠ ⎞
⎜⎝ 5% + 28 x]10% – 5%]⎟⎠
D ⎛⎛ 20
20 x]10% – 5%]⎞⎞⎞
⎛ 5% +
+ 20
5% + x]10% – 5%]⎟
IRR = 5% + ⎜⎝⎜⎝⎜ 5% 28
28 x]10% – 5%]⎠⎟⎠⎟⎠
⎝ 28
7 D
$
Current receivables($1.2/12) 100,000
New receivables ($1.2 x 1.25/6) 250,000
Increase 150,000
Finance cost of increase at 10% 15,000
Net profit increase 45,000
Therefore overall increase is $30,000 ($45,000 – $15,000)
8 A All three are assumptions for EOQ calculations.
9 B The relevant cost is $14 per kg. Since the material has no other use except as a substitute for material B, it would either be
used in place of B or sold. As the company would only get $8 per kg from selling it, its best use is as a substitute, therefore
saving $14 per kg.
10 C The incremental revenue (iv – ii) should be compared to the incremental costs (iii) of preparing the carrots.
6
Paper T10
Managing Finances
ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION
ADVANCED LEVEL
WEDNESDAY 16 JUNE 2004
QUESTION PAPER
Time allowed 3 hours
ALL FOUR questions are compulsory and MUST be answered
The Association of Chartered Certified Accountants

ALL FOUR questions are compulsory and MUST be attempted
1 Paradise Ltd is a large company specialising in luxury holidays for the rich and famous. It has recently purchased an
uninhabited island, close to the popular resort of Luca, at a cost of £2 million. The company has already spent
£1·5 million on preparing the land for construction work. Over the next year it plans to develop the island extensively,
with the aim of making it one of the most exclusive holiday locations in the region.
An offer has just been made to buy the land for £5 million. Paradise Ltd has therefore decided to reappraise the project
in order to decide whether they should still proceed with the project, or should instead accept the offer. If they decide
to accept the offer, the sale will take place immediately, incurring legal fees of £20,000. If they reject the offer,
development will continue and accommodation will be available for rent in one year’s time.
The company’s project accountant has provided estimates of costs and revenues for the next five years as set out
below.
1. Total construction costs for the seven hotels on the island are £37 million. Of the total, £2 million has already
been spent in the form of down payments to several construction firms. These down payments are irrecoverable.
2. Total construction costs for the forty luxury self-catering lodges that will be attached to the hotels are £24 million.
A down payment of £4 million is required immediately.
3. The cost of furnishing the hotels and lodges is estimated at £3·2 million.
4. Each lodge will have its own private swimming pool. The cost of each pool is expected to be £12,000.
5. Six restaurants will be built on the island at a cost of £15 million. Paradise Ltd has already had to commit to
£3 million of these costs in order to attract the chefs it requires. Although these monies have not yet been paid
over, Paradise Ltd is contractually bound to pay them, irrespective of whether the project now proceeds.
6. A small parade of shops will be developed at a cost of £4 million.
7. Annual cash overheads are expected to be £2 million for the hotels. Revenues for the hotels are estimated at
£13 million per annum.
8. Maintenance costs for each of the lodges will be £7,000 per annum, compared to rental income of £390,000
per annum, per lodge.
9. Depreciation totalling £1·5 million per annum will be charged in Paradise Ltd’s accounts for the hotels, lodges,
restaurants and shops.
10. The restaurant and shops are expected to generate net income of £4·73 million per annum, in total.
11. Interest on money borrowed to finance the project will be £2·5 million per annum.
All the set-up costs will occur within the next year, before the resort is open. The annual revenues and overheads
relate to the four years following this. Assume that all cash flows occur at the end of each year, unless otherwise
stated, and that there are no terminal values to consider at the end of the four years.
The company’s cost of capital is 10% per annum.
2
Required:
(a) Explain the main principles used to differentiate between relevant and irrelevant costs for investment
appraisal, using the information in the question to illustrate your points. (8 marks)
(b) Calculate the project’s net present value (NPV) at the company’s required rate of return. Conclude as to
whether the company should accept the offer or continue with the project, giving a reason for your
conclusion. (16 marks)
(c) Calculate the internal rate of return (IRR) for the project, using the discount rates in the tables provided.
(4 marks)
(d) State three advantages and three disadvantages of using the IRR as a method of project appraisal.
(6 marks)
(e) Briefly outline each of the following stages involved in evaluating capital projects:
(i) Initial investigation of the proposal;
(ii) Detailed evaluation;
(iii) Authorisation;
(iv) Implementation;
(v) Project monitoring;
(vi) Post-completion audit. (6 marks)
(40 marks)
(Workings should be in £’000, to the nearest £’000.)
Present Value Table (extract)

Discount Rates (r)
Periods (n) 10% 20%
1 0·909 0·833
2 0·826 0·694
3 0·751 0·579
4 0·683 0·482
5 0·621 0·402
3 [P.T.O.
This is a blank page.
Question 2 begins on page 5.
4
2 Chocoholics Ltd sells high quality Belgian chocolates that it buys in ready-made. Its main attraction to customers is
that it gift wraps the items and delivers them to an address of the customer’s choice. The company has just expanded
its product range to include flowers.
You are an accounting technician and have been asked to prepare a cash budget for the next six months, incorporating
the sales of the new products. You have been provided with the following table of estimated revenues and their relative
costs. Other costs are also included in the notes below.
2004 July August September October November December
£’000 £’000 £’000 £’000 £’000 £’000
Sales 250 266 282 306 320 330
Purchases of chocolates and flowers 125 133 141 153 160 165
Administration expenses 155 160 162 165 168 170
Packaging costs 112 113 113 113 114 114
Miscellaneous expenses 116 116 117 117 118 118
Loan repayments 150 – – – 150 –
Notes:
1. Opening stocks of chocolates and flowers will amount to £250,000 at 1 July 2004. Closing stocks at
31 December 2004 are estimated at £170,000.
2. Suppliers allow one month’s credit. Purchases in June will total £60,000.
3. 30% of sales are paid for by cash but the remaining 70% take advantage of the company’s offer of ‘Buy now,
pay in one month’. June 2004 sales are expected to be £140,000.
4. Delivery costs are 1% of sales revenue each month, and are paid in the month in which they are incurred.
Administration and miscellaneous expenses are also paid as they are incurred.
5. Packaging expenses are paid two months after they are incurred. These costs were £1,000 in May and will be
the same in June.
6. The bank charges interest of 1% per month for the overdraft, calculated on the closing bank balance each month,
and payable the following month.
7. The bank overdraft at 1 July 2004 is expected to be £155,000.
8. The loan repayments above refer to an interest free loan obtained by the company when they moved their
business to a new bank.
9. The business has no depreciable fixed assets.
Required:
(a) Prepare a monthly cash budget for EACH of the six months to 31 December 2004, showing the cash balance
at the end of each month. (13 marks)
(b) Prepare a budgeted Profit and Loss account for the six month period ending 31 December 2004.
(7 marks)
Note: All workings should be shown clearly in order to score maximum marks. Please show workings in £’000,
to the nearest £’000.
(20 marks)
5 [P.T.O.
3 Rant Ltd manufactures and distributes plasma screen televisions to a number of electrical retailers. Due to the
increased popularity of these products, growth has been rapid and the Financial Director (FD) of the company is
concerned that the company is overtrading. Turnover has increased by 250% over the last year, and fixed assets have
increased by 75%. The bank overdraft limit of £3 million has been exceeded on five occasions in the last year,
culminating in a recent threat by the bank to withdraw the facility altogether.
Rant Ltd is a largely family-owned company, with twelve shareholders in total. Whilst the long-term plan involves
making a rights issue in two years’ time, none of the current shareholders are in a position to inject new capital into
the company at present. Neither do they wish to issue new shares outside the current group of shareholders, as they
do not want to lose their collective control of the company.
Some preliminary analysis has revealed that debtors are increasing rapidly and raw material stock days have gone up
from 30 days to 55 days. The FD is concerned that these stock levels are so high. He has asked you, an accounting
technician, to assist him in reviewing them.
One of the key costs of making a plasma television is the screen. These screens are bought in ready-made at a cost
of £250 per unit. It costs £150 to place an order for these screens, irrespective of the number of units ordered. At
current sales levels, which are expected to stabilise now, 150,000 screens are needed per annum. The cost of holding
one screen in stock for one year is £15.
Required
(a) Define the terms ‘over-capitalisation’ and ‘overtrading’. (2 marks)
(b) Briefly describe the symptoms of overtrading. Conclude whether Rant Ltd is overtrading, giving reasons for
your conclusion. (6 marks)
(c) Explain the four main types of costs associated with stock management. (4 marks)
(d) Explain how the economic order quantity (EOQ) model can assist in reducing stock costs, AND the
assumptions it is based upon. (4 marks)
(e) Calculate the EOQ for screens AND the number of orders to be placed per annum, using the data contained
in the question. (4 marks)
(20 marks)
Note: The formula for EOQ is 2 Co D

Ch
(where Co represents fixed cost of placing one order;
D represents annual demand in terms of units;
Ch represents cost of holding one unit of stock per annum.)
6
4 Clean Lens Ltd is a contact lens manufacturer and distributor producing an extensive range of contact lenses that are
distributed direct to customers via the Internet. It is a small company with five shareholders, all of whom are involved
in the running of the company.
The company is in the preliminary stages of developing a new type of contact lens, made of a unique material that
moulds to the shape of the eye, providing revolutionary comfort for the lens wearer. The company’s projections show
that profits of £1·3 million per annum are expected over the first five years, once sales commence.
In order to proceed with the project, further finance of £1·5 million is required. Clean Lens Ltd expects to fund the
project through a mix of debt and equity finance, and is considering approaching venture capital organisations.
Required:
(a) Briefly explain five factors that Clean Lens Ltd should take into account when deciding on the mix of debt
and equity finance. (10 marks)
(b) Identify and discuss five factors that a venture capital organisation should take into account when deciding
whether or not to invest in Clean Lens Ltd. (10 marks)
(20 marks)
End of Question Paper
7
Answers

ACCA Certified Accounting Technician Examination – Paper T10
Managing Finances June 2004 Answers
1 (a) Relevant costs

The following principles should be applied when identifying costs that are relevant to a period.
Relevant costs are future costs
A relevant cost is a future cost arising as a direct consequence of a decision. A cost which has been incurred in the past is
therefore totally irrelevant to any decision that is being made now. Such past costs are called ‘sunk costs’.
In Paradise Ltd’s project, the £1·5 million spent preparing the land for construction is a sunk cost, as is the £2 million down-
payment to construction firms. These costs should therefore be excluded when calculating the net present value of the project.
Relevant costs are cash flows
Only those future costs which are in the form of cash should be included. This is because relevant costing works on the
assumption that profits earn cash.
Therefore, costs which do not reflect cash spending should be ignored for the purpose of decision-making. This means that
the depreciation charges of £1·5 million should be ignored in the decision for Paradise Ltd.
Relevant costs are incremental costs
A relevant cost is the increase in costs which results from making a particular decision. Any costs or benefits arising as a
result of a past decision should be ignored.
Opportunity costs
An opportunity cost is the value of a benefit foregone as a result of choosing a particular course of action. Such a cost will
always be a relevant cost.
Other non-relevant costs
Certain other costs will be irrelevant to decision-making, such as ‘committed costs’. A committed cost is a future cash outflow
that will be incurred anyway, regardless of what decision will now be taken. The £3 million restaurant costs represent such
committed costs, and these will therefore be ignored for the decision-making process.
The interest costs of £2·5 million per annum are also ignored. This is not because they do not meet the above criteria, but
because they are taken into account in the discounting process. If these costs were included as relevant they would be double
counted.
(b) Net present value

Years
0 1 2 3 4 5 Total
£’000 £’000 £’000 £’000 £’000 £’000 £’000
Net sale proceeds foregone (4,980) (4,980)
Hotel building costs (35,000) (35,000)
Lodge building costs (4,000) (20,000) (24,000)
Furnishings (3,200) (3,200)
Swimming pools (480) (480)
Restaurants (12,000) (12,000)
Shops (4,000) (4,000)
Annual overheads – hotel (2,000) (2,000) (2,000) (2,000) (8,000)
Annual revenues – hotel 13,000 13,000 13,000 13,000 52,000
Rentals – lodges 15,600 15,600 15,600 15,600 62,400
Lodge overheads (280) (280) (280) (280) (1,120)
Restaurant/shop income 4,730 4,730 4,730 4,730 18,920
––––––– -–––––– ––––––– ––––––– ––––––– ––––––– –––––––
Net relevant costs (8,980) (74,680) 31,050 31,050 31,050 31,050 40,540
10% discount factors 1·000 0·909 0·826 0·751 0·683 0·621
––––––– -–––––– ––––––– ––––––– ––––––– ––––––– –––––––
Discounted cash flow (8,980) (67,884) 25,647 23,319 21,207 19,282 12,591
––––––– -–––––– ––––––– ––––––– ––––––– ––––––– –––––––
Since the net present value of the project is positive at £12·591 million, the company should proceed with it.
(Note: An alternative NPV calculation is shown overleaf, using an annuity factor. Where workings are shown clearly for the
‘net cash flow’ figures, full marks should be awarded for this method.)
11
Alternative presentation for 1(b)
Years Net cash flow DF/AF Present value
£’000 £’000
0 (8,980) 1·000 (8,980)
1 (74,680) 0·909 (67,884)
2–5** 31,050 2·881 89,455
––––––––
12,591
––––––––
**Annuity factor for T2 – 5 = 0·826 + 0·751 + 0·683 + 0·621.
(c) Internal rate of return

a
IRR = A + [ –––– x (B–A) ]
a–b
Where A is the lower rate and B is the higher rate; a is the NPV at the lower rate and b is the NPV at the higher rate.
(In this case, 20% has been used as the higher rate.)
12·591
10% + –––––– x (10%)
16·805
= 17%
––––
Working
Years
0 1 2 3 4 5 Total
£’000 £’000 £’000 £’000 £’000 £’000 £’000
Net relevant costs (8,980) (74,680) 31,050 31,050 31,050 31,050 40,540
–––––– –––––– –––––– –––––– –––––– –––––– ––––––
Discounted cash flow (8,980) (62,208) 21,549 17,978 14,966 12,482 (4,214)
–––––– –––––– –––––– –––––– –––––– –––––– ––––––
Net present value at 20% = – £4·214 million
(d) Advantages and disadvantages of IRR

Advantages include:
1. It takes into account the time value of money, which is a good basis for decision-making.
2. Results are expressed as a simple percentage, and are more easily understood than some other methods.
3. It indicates how sensitive decisions are to a change in interest rates.
Disadvantages include:
1. Projects with unconventional cash flows can have either negative or multiple IRRs. This can be confusing to the user.
2. IRR can be confused with ARR or ROCE, since all methods give answers in percentage terms. Hence, a cash-based
method can be confused with a profit-based method.
3. It may give conflicting recommendations to NPV.
4. Some managers are unfamiliar with the IRR method.
Note: Only 3 advantages and 3 disadvantages were required.
(e) The stages for project appraisal

(i) Initial investigation of the proposal
Firstly, a decision must be made as to whether the project is technically feasible and commercially viable. This involves
assessing the risks and deciding whether the project is in line with the company’s long-term strategic objectives.
(ii) Detailed evaluation
A detailed investigation will take place in order to examine the projected cash flows of the project. Sensitivity analysis is
performed and sources of finance will be considered.
(iii) Authorisation
For significant projects, authorisation must be sought from the company’s senior management and Board of Directors.
This will only take place once such persons are satisfied that a detailed evaluation has been carried out, that the project
will contribute to profitability and that the project is consistent with the company strategy.
(iv) Implementation
At this stage, responsibility for the project is assigned to a project manager or other responsible person. The resources
will be made available for implementation and specific targets will be set.
(v) Project monitoring
Now the project has started, progress must be monitored and senior management must be kept informed of progress.
Costs and benefits may have to be re-assessed if unforeseen events occur.
(vi) Post-completion audit
At the end of the project, an audit will be carried out so that lessons can be learned to help future project planning.
12
2 (a) Cash budget for the six months ended 31 December 2004
July August September October November December Total
£’000 £’000 £’000 £’000 £’000 £’000
Cash inflows
Sales receipts 173 255 271 289 310 323 1,621
–––– –––– –––– –––– –––– –––– –––––
173 255 271 289 310 323 1,621
–––– –––– –––– –––– –––– –––– –––––
Cash outflows
Payments to suppliers 160 125 133 141 153 160 1,772
Admin. expenses 155 160 162 165 168 170 1,380
Delivery costs 113 113 113 113 113 113 1,118
Packaging 1v1 111 112 113 113 113 1,113
Misc. expenses 116 116 117 117 118 1v8 1,142
Loan repayments 150 150 1,100
Overdraft interest 112 112 111 11 1,115
–––– –––– –––– –––– –––– –––– –––––
177 197 208 219 285 244 1,330
–––– –––– –––– –––– –––– –––– –––––
Net cash flow 11(4) 158 163 170 125 179 1,291
Opening balance (155) (159) (101) 1(38) 132 157 1,(155)
–––– –––– –––– –––– –––– –––– –––––
Closing balance (159) (101) 1(38) 132 157 136 1,136
–––– –––– –––– –––– –––– –––– –––––
Workings
1. Sales receipts
July August September October November December
£’000 £’000 £’000 £’000 £’000 £’000
Cash: 30% x £250 75
Credit: 70% x £140 98
––––
173
––––
Cash: 30% x £266 80
Credit 70% x £250 175
––––
255
––––
Cash: 30% x £282 85
Credit: 70% x £266 186
––––
271
––––
Cash: 30% x £306 92
Credit: 70% x £282 197
––––
289
––––
Cash: 30% x £320 96
Credit: 70% x £306 214
––––
310
––––
Cash: 30% x £330 99
Credit: 70% x £320 224
––––
323
––––
13
(b) Budgeted Profit and Loss Account for the six months ending 31 December 2004
£’000 £’000
Sales (w.1) 1,754
Less cost of sales (w.2) (976)
–––––
Gross profit 778
Delivery costs (w.3) 18
Administration expenses (w.4) 380
Miscellaneous expenses (w.5) 42
Interest (w.6) 3
––––
(443)
–––––
Net profit 335
–––––
Workings £’000
1. Sales:
––––––
(£250,000 + £266,000 + £282,000 + £306,000 + £320,000 + £330,000) 1,754
––––––
2. Cost of sales £’000
Opening stock 250
Purchases 877
(£125,000 + £133,000 + £141,000 + £153,000 + £160,000 + £165,000)
Closing stock (170)
–––––
957
Packaging 19
(£2,000 + £3,000 + £3,000 + £3,000 + £4,000 + £4,000)
–––––
Total 976
–––––
£’000
3. Delivery costs
–––––
(£3,000 + £3,000 + £3,000 + £3,000 + £3,000 + £3,000) 18
–––––
Note: Delivery costs could have been included in COS.
4. Administration expenses
–––––
(£55,000 + £60,000 + £62,000 + £65,000 + £68,000 + £70,000) 380
–––––
5. Miscellaneous expenses
–––––
(£6,000 + £6,000 + £7,000 + £7,000 + £8,000 + £8,000) 42
–––––
–––––
6. Interest (£2,000 + £1,000) 3
–––––
14
3 (a) Definitions
‘Over-capitalisation’ means that there is an excessive amount of the business’ money invested in assets.
‘Overtrading’ means that a business’ volume of trade is too large given the level of long-term capital at its disposal.
(b) Symptoms of Overtrading

The symptoms of overtrading are as follows:
– A rapid increase in turnover.
– A rapid increase in the volume of current assets, and sometimes fixed assets.
– A rapid increase in trade creditors and the bank overdraft, with very little increase in equity capital (if any).
– A significant reduction in liquidity ratios and an increase in debt ratios.
Conclusion for Rant Ltd
The first two of these symptoms are present for Rant Ltd, as turnover has increased by 250% and fixed assets have increased
by 75%.
In addition, the bank overdraft limit has been exceeded on five occasions, suggesting that there has been a rapid increase in
bank borrowing. We are also told that current shareholders cannot afford further shares at present, nor do they want new
shares to be issued to new shareholders, so the implication is that there has been no injection of additional equity finance
recently.
Finally, whilst we cannot calculate debt and liquidity ratios from the information, we can deduce, from the information given,
that they will have increased and decreased respectively.
We can therefore conclude that Rant Ltd is overtrading.
(c) Stock costs

The four main stock costs are as follows:
Holding costs
The cost of holding stocks includes the following:
– Finance cost, since capital is tied up in stocks
– Warehouse and handling costs
– Deterioration costs
– Obsolescence costs
– Insurance costs
– Pilferage costs.
Ordering costs
There will be costs for Rant Ltd when placing orders with manufacturers. Such costs will include delivery costs, and also the
administrative costs involved in placing order (staff costs, telephone charges, etc.)
Shortage costs
These may include:
– Loss of a sale, and the consequent loss of contribution that would have been earned from that sale.
– Additional costs involved in making emergency orders for goods.
– The costs of lost production, when stock-outs occur and production lines grind to a halt. Staff will still have to be paid,
even if they have no work to do.
Stock costs
The actual cost of the raw materials from the manufacturers (or goods for resale from the wholesalers).
(d) Rationale and assumptions

The economic order quantity (EOQ) model is used to decide the optimum order size for stocks. This then minimises the total
of ordering costs and stockholding costs.
Assumptions
It is based on the following assumptions:
– demand is constant
– the lead time is constant or zero (suppliers are reliable)
– purchase costs per unit are constant (i.e. no bulk discounts)
15
(e) EOQ calculation
The EOQ for Rant Ltd is calculated as follows:
2 Co D
Ch
= 2 × £150 × 150,000
£15
= 3, 000, 000
= 1,732.
The number of orders to be placed will therefore be 150,000/1,732
= 86 per annum.
4 (a) Debt vs equity

Factors that should be taken into account when deciding the mix of debt and equity finance are as follows:
(i) Cost
The higher the cost of funding, the lower the company’s profit. Equity funding is more expensive as an equity investor
is subject to both business and finance risk. The investor will therefore demand a higher return for his increased level
of risk.
(ii) Taxation
The tax treatment of the cost of financing needs to be taken into account. Interest on debt is tax deductible, whereas if
equity finance is raised, dividends paid to shareholders will not be tax deductible. This fact, combined with the lower
risk of debt financing, means that debt tends to be cheaper.
(iii) Control of the business
If finance is raised through the issue of shares to new shareholders, those shareholders become joint owners of the
business. The percentage of shares held by existing shareholders will therefore decrease. As this percentage decreases,
so does the individual shareholders’ voting power.
When deciding on the number of shares to be issued, the current shareholders will probably want to retain their voting
control. This should therefore be considered when deciding the mix of debt and equity.
(iv) The effect on gearing
Gearing measures the amount of debt compared to the amount of equity. If too much debt is issued, Clean Lens Ltd’s
gearing ratio will increase. Finance providers will then see the company as a high-risk investment, and will expect higher
returns to compensate for their increased risk. This may lead to unwillingness, on the part of finance providers, to lend
money to Clean Lens Ltd at all.
(v) Current level of debt and maturity of existing borrowings
A significant difference between debt and equity finance is that debt has to be repaid, but equity does not. If Clean Lens
Ltd already has substantial debt finance, then they will already be making repayments, or they will be committed to
making repayments in the future.
Therefore, when considering the mix of further debt and equity finance, they should ensure that they do not over-commit
themselves to future loan repayments.
(vi) Availability of finance
As Clean Lens Ltd is a private limited company, the availability of equity financiers may be limited. This will, to a certain
extent, dictate the mix of debt and equity finance.
NOTE: Only five factors were required.
16
(b) Venture capital
Factors that a venture capital organisation will take into account are as follows:
(i) Level of expertise of the company’s management
Venture capitalists will believe that the success of Clean Lens Ltd is highly dependent on the quality of the company’s
management team. They will expect Clean Lens Ltd to have a skilled team, who are experienced managers.
Management will also be required to show a high level of commitment to the project, and the company. As the owners
of the business are all involved in the running of the company, this should be proof of their commitment.
(ii) Level of expertise in production
The venture capitalists will seek assurance that the company has the necessary technical ability to be able to develop
and produce the new contact lenses. They will want evidence that the management and staff are technically competent.
(iii) The nature of Clean Lens Ltd’s new product
The venture capitalists will consider whether the development and production of the new lens is technically feasible.
They will employ experts in the field to examine the idea and assess whether the new lens will actually provide
revolutionary comfort.
(iv) The market and competition
They will seek assurance that there is actually a market for a new contact lens, as there are already so many different
products on the market. They will ask to see any market research that the company has carried out. The venture
capitalists will also look at the threat posed by new entrants in the contact lens market, and current rival producers.
(v) Future prospects
Since the risk involved in investing capital in the company is fairly high, the venture capitalists will seek to ensure that
the prospects for future profits compensate for the risk. They will therefore want to see a detailed business plan setting
out the future business strategy. Clean Lens Ltd has already prepared profit projections showing a very good margin on
the product.
(vi) Risk borne by current owners of Cleans Lens Ltd
The venture capitalists will expect to see that the current owners bear a high degree of risk. This will give them assurance
that the owners have the sufficient level of commitment to the company, as they themselves will have a lot to lose should
the company fail. As there are only five shareholders, it is likely that each of them has invested a significant amount of
money.
(vii) Exit route
The venture capitalists will try to establish a number of exit routes. These may include a sale of shares to the public,
following a flotation, a sale of shares to another business, or a sale of shares to the original owners.
(viii) Board membership
Since the venture capitalists will want to ensure that their investment is protected, they will required a place on the Board
of Directors. This will enable them to have their say on all significant matters affecting the business.
NOTE: Only five factors were required.
17
Managing Finances June 2004 Marking Scheme
Marks
1 (a) Relevant cashflows
RC = future cash flow 1
Not sunk costs 1
£1·5m and £2m = sunk cost 1
RC = form of cash 1
Ignore depreciation 1
RC arises as result of decision 1
Committed cost of £3m – ignore 1
Interest costs ignored 1
––––
8
––––
(b) NPV calculations
Opportunity cost 1
Hotel building costs of £35k T1 1
Lodge costs £4k T0 1
Lodge costs £20k T1 1
Furnishings/Swimming pools T1 1
Restaurants T1 1
Shops T1 1
Annual overheads hotel T2–5 1
Annual revenues hotel T2–5 1
Annual rentals lodges T2–5 1
Annual overheads lodges T2–5 1
Restaurant and shop profits T2–5 1
Net relevant cost totals 1
Correct 10% DFs 1
Correct discounted CFs 1
Correct conclusion 1
––––
16
––––
(c) IRR calculation
IRR calculation 2
NPV calculations 2
––––
4
––––
(d) IRR ads and disads
Each advantage 1
Each disadvantage 1
––––
6
––––
(e) Six stages
Each stage 1
––––
Total 6
––––
Total marks available 40
––––
19
Marks
2 (a) Cash flow forecast
Sales receipts 3
Purchases 1
Admin expenses 1
Delivery costs 1
Packaging 1
Miscellaneous expenses 1
Loan repayments 1
Overdraft interest 1
Net cash flow 1
Opening balance 1
Closing balance 1
––––
13
––––
(b) Profit and loss account
Sales 1
COS 3
Admin. and misc. expenses 1
Recalculating interest 1
Deriving net profit 1
––––
7
––––
––––
3 (a) Definition
Each definition 1
––––
2
––––
(b) Overtrading
Symptoms 2
Conclusion and reasons 4
––––
6
––––
(c) Stock costs
Each cost explained 1
––––
4
––––
(d) EOQ model
Explanation of model 1
Each assumption 1
––––
4
––––
(e) Calculations
EOQ calculation 3
Number of orders 1
––––
4
––––
––––
4 (a) Debt and equity

For each factor explained 2
––––
10
––––
(b) Venture capital
For each factor identified and discussed 2
––––
10
––––
––––
20
Paper T10
Managing Finances
ADVANCED LEVEL
WEDNESDAY 15 DECEMBER 2004
QUESTION PAPER
Do not open this paper until instructed by the supervisor
This question paper must not be removed from the examination

hall

1 Tots Ltd specialises in the importation and sale of equipment for children’s indoor play centres. The company was set
up two years ago by its joint shareholders, Mr and Mrs Brute.
The business has been very successful, expanding rapidly over the last year, and the cash balance in the company’s
current account has exceeded £1 million on several occasions recently.
Mr and Mrs Brute have asked you, an accounting technician for Tots Ltd, to assist them in managing their cash
balances over the next six months.
You have been provided with the following information.
(i) The bank balance on 1 January 2005 is forecast at £1·2 million in credit.
(ii) Sales for November and December 2004 are £1·3 million per month. They are expected to rise to £1·5 million
in January 2005, £1·7 million in February and £1·9 million in March. They will then fall to £1·4 million for
each of the following six months. This is due to a downturn in demand as the weather improves.
(iii) All sales are made on credit. 2% of debtors do not pay at all, 70% pay one month after sale and the remaining
28% pay two months after sale.
(iv) Purchases are made one month prior to sales, and two months’ credit is taken from suppliers.
(v) The company’s gross profit margin is 50%.
(vi) The cost of employing Tots Ltd’s permanent staff is £150,000 per month. Tots Ltd also employs temporary staff
during January, February and March at an additional cost equating to 3% of sales each month.
(vii) Tots Ltd uses a courier to despatch the equipment to its customers. The cost of this service is 2% of sales value
in January to March, falling to 1% thereafter.
(viii) Administration costs are forecast at £30,000 for January. These costs are directly proportional to sales each
month.
(ix) Mr and Mrs Brute will be attending a conference abroad in July 2005 at a total cost of £5,000. They must
complete the booking form and send it off, along with a deposit of £2,000, by the end of January 2005. The
final balance is due in June.
(x) The company charges depreciation of £45,000 each month.
(xi) Tots Ltd also owns two indoor play centres that it rents out at the rate of £3,500 each per month from January
to April, falling to £3,000 per month thereafter. All rents are received one month in advance.
(xii) The company will invest in a new computer system later in the year. This will be paid for by two equal
instalments of £200,000, one in June and one in September.
Required:
(a) Prepare a monthly cash budget for EACH of the six months to 30 June 2005, showing clearly any necessary
workings.
NOTE: All workings should be in £000.
Unless told otherwise, assume that payments are made in the month in which the costs are incurred.
(16 marks)
Mr and Mrs Brute are aware that the business is holding too much cash, but are unsure how to invest it safely. They
are very risk averse, having each lost a considerable amount of money on the Stock Exchange. They also want to
ensure that they retain enough cash to allow the business to meet its debts as they fall due.
(b) Briefly explain three motives for holding cash, as identified by Keynes. (6 marks)
2
(c) Define and explain the characteristics of THREE out of the four types of investment below. In light of the
characteristics you have identified, conclude as to whether you consider each of the investments you have
explained to be an appropriate use of Tots Ltd’s cash surplus.
(i) Certificates of deposit;
(ii) Gilt-edged securities (gilts);
(iii) Shares;
(iv) Bills of exchange. (18 marks)
Note: Each type of investment carries equal marks.
(40 marks)
3 [P.T.O.
2 Pooch Ltd makes and sells pet care products. The following projected data for the next year is available.
Sales £2,200,000
Costs as percentage of sales
Raw materials 15%
Direct labour 20%
Variable production overheads 11%
Fixed production overheads 10%
Other costs 12%
Working capital statistics
Average raw material holding period 4 weeks
Average Work-in-progress (WIP) holding period 2 weeks
Average finished goods holding period 4 weeks
Average debtors’ collection period 6 weeks
Average creditors’ payment period on:
Raw materials 4 weeks
Direct labour 1 week
Variable production overheads 8 weeks
Fixed production overheads 5 weeks
Other costs 12 weeks
Other relevant information
– All finished goods stock and WIP values include raw materials, direct labour, variable production overheads and
apportioned fixed production overhead costs.
– Assume WIP is 75% complete as to materials and 50% complete as to direct labour, variable production
overheads and fixed production overheads.
– Assume there are 52 weeks in one year.
– Assume that production and sales volumes are the same.
Required:
(a) Calculate the estimated average working capital required by Pooch Ltd for the year, showing clearly all
necessary workings.
NOTE: All workings should be in £.
(14 marks)
(b) Pooch Ltd is currently in dispute with one of its suppliers, Petcoats Ltd. Pooch Ltd is unsure of its legal
obligations regarding an agreement it made with Petcoats Ltd. The Financial Director of Pooch Ltd has asked
you, an accounting technician, to explain certain legal terms to him.
Define and briefly explain the following legal terms:

(i) ‘Offer’; (2 marks)
(ii) ‘Acceptance’; (2 marks)
(iii) ‘Consideration’. (2 marks)
(20 marks)
4
This is a blank page
Question 3 begins on page 6
5 [P.T.O.
3 Taxi Ltd is a long established company providing high quality transport for customers. It currently owns and runs 350
cars and has a turnover of £10 million per annum.
The current system for allocating jobs to drivers is very inefficient. Taxi Ltd is considering the implementation of a new
computerised tracking system called ‘Kwictrac’. This will make the allocation of jobs far more efficient.
You are an accounting technician for an accounting firm advising Taxi Ltd. You have been asked to perform some
calculations to help Taxi Ltd decide whether Kwictrac should be implemented. The project is being appraised over five
years.
The costs and benefits of the new system are set out below.
(i) The central tracking system costs £2,100,000 to implement. This amount will be payable in three equal
instalments: one immediately, the second in one year’s time, and the third in two years’ time.
(ii) Depreciation on the new system will be provided at £420,000 per annum.
(iii) Staff will need to be trained how to use the new system. This will cost Taxi Ltd £425,000 in the first year.
(iv) If Kwictrac is implemented, revenues will rise to an estimated £11 million this year, thereafter increasing by 5%
per annum (i.e. compounded). Even if Kwictrac is not implemented, revenues will increase by an estimated
£200,000 per annum, from their current level of £10 million per annum.
(v) Despite increased revenues, Kwictrac will still make overall savings in terms of vehicle running costs. These cost
savings are estimated at 1% of the post Kwictrac revenues each year (i.e. the £11 million revenue, rising by 5%
thereafter, as referred to in note (iv)).
(vi) Six new staff operatives will be recruited to manage the Kwictrac system. Their wages will cost the company
£120,000 per annum in the first year, £200,000 in the second year, thereafter increasing by 5% per annum
(i.e. compounded).
(vii) Taxi Ltd will have to take out a maintenance contract for the Kwictrac system. This will cost £75,000 per annum.
(viii) Interest on money borrowed to finance the project will cost £150,000 per annum.
(ix) Taxi Ltd’s cost of capital is 10% per annum.
Required:
(a) Calculate the net present value of the new Kwictrac project to the nearest £000. Use the discount factors
provided at the end of the question. (10 marks)
(b) Calculate the simple payback period for the project and interpret the result. (3 marks)
(c) Calculate the discounted payback period for the project and interpret the result. (3 marks)
6
(d) Taxi Ltd wants to ensure that it has enough cash available to pay the second and third instalments for the
Kwictrac system, when they fall due. The company has therefore decided to invest the cash on time deposits
with its local bank. The rates of interest paid by the bank are as follows:
6 month deposits 7% per annum
One year deposits 8% per annum
Two year deposits 9% per annum
Three year deposits 10% per annum
Interest is paid once a year, at the end of the year.
Calculate the total amount of cash that Taxi Ltd needs to put on deposit immediately in order to meet the
final two instalments for Kwictrac. (4 marks)
NOTE: You should assume that all cash flows occur at the end of the year, unless otherwise stated.
Present Value table (extract)

Periods (n) Discount rate (r)
10%
1 0·909
2 0·826
3 0·751
4 0·683
5 0·621
(20 marks)
4 Skint Ltd is a small family owned company that makes fuses for electrical plugs. It was set up twenty-five years ago
by its main shareholder, Mr Holmes, who is also the Managing Director of the company.
The company is facing short-term cash flow difficulties. It is already a highly geared company and Mr Holmes is
concerned that the bank will not lend it any more money. He is considering applying for a personal loan or giving a
personal guarantee in order to solve the company’s short-term cash flow difficulties.
Required:
(a) List and explain the general factors that will be taken into account by a bank when deciding whether or not
to lend money to a client. (14 marks)
(b) Briefly explain three characteristics that any security for a loan should have. (3 marks)
(c) Briefly describe the following:

(i) bullet repayment loan;
(ii) balloon repayment loan;
(iii) amortising loan (straight repayment loan). (3 marks)
(20 marks)
7
Answers

Managing Finances December 2004 Answers
1 – Tots Ltd
(a) Cash Budget

Note Jan Feb Mar Apr May Jun Total
£000 £000 £000 £000 £000 £000 £000
Cash inflows
Sales 1 1,274 1,414 1,610 1,806 1,512 1,372 8,988
Rental income 2 7 7 7 6 6 6 39
–––––– –––––– –––––– –––––– –––––– –––––– ––––––
1,281 1,421 1,617 1,812 1,518 1,378 9,027
–––––– –––––– –––––– –––––– –––––– –––––– ––––––
Cash outflows
Purchases 3 650 750 850 950 700 700 4,600
Permanent staff 150 150 150 150 150 150 900
Temporary staff 4 45 51 57 0 0 0 153
Delivery 5 30 34 38 14 14 14 144
Administration 6 30 34 38 28 28 28 186
Conference 2 3 5
Computer system 200 200
Depreciation – ignore
–––––– –––––– –––––– –––––– –––––– –––––– ––––––
907 1,019 1,133 1,142 892 1,095 6,188
–––––– –––––– –––––– –––––– –––––– –––––– ––––––
Net cash flow 374 402 484 670 626 283 2,839
Opening balance 1,200 1,574 1,976 2,460 3,130 3,756 1,200
–––––– –––––– –––––– –––––– –––––– –––––– ––––––
Closing balance 1,574 1,976 2,460 3,130 3,756 4,039 4,039
––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
––––––
(The total column is a useful arithmetic check but not specifically required by the question.)
Notes
1. Sales Nov Dec Jan Feb Mar Apr May Jun
£000 £000 £000 £000 £000 £000 £000 £000
Sales volume
Per the question 1,300 1,300 1,500 1,700 1,900 1,400 1,400 1,400
Sales receipts
70% paid in 1 month n/a n/a 910 1,050 1,190 1,330 980 980
28% paid in 2 months n/a n/a 364 364 420 476 532 392
–––––– –––––– –––––– –––––– –––––– ––––––
1,274 1,414 1,610 1,806 1,512 1,372
–––––– –––––– –––––– –––––– –––––– ––––––
2. Rental income Jan Feb Mar Apr May Jun Jul
£000 £000 £000 £000 £000 £000 £000
Play Centre 1 and 2
(2 x £3,000/£3,500) 7 7 7 7 6 6 6
––– ––– ––– ––– ––– –––
Received one month in advance 7 7 7 6 6 6
––– ––– ––– ––– ––– –––
7 7 7 6 6 6
––– ––– ––– ––– ––– –––
3. Purchases
Orders are made each month for the following month’s requirements, but 60 days credit is taken.
This means that the company is paying for the previous month’s purchase requirements each month.
Dec Jan Feb Mar Apr May Jun
£000 £000 £000 £000 £000 £000 £000
Sales volume
Per the question 1,300 1,500 1,700 1,900 1,400 1,400 1,400
Purchase requirements at 50% 650 750 850 950 700 700 700
–––––– –––––– –––––– –––––– –––––– ––––––
Payments to suppliers n/a 650 750 850 950 700 700
–––––– –––––– –––––– –––––– –––––– ––––––
4. Temporary staff (Jan to March only)
Jan Feb Mar
£000 £000 £000
Sales levels 1,500 1,700 1,900
–––––– –––––– ––––––
Temp costs at 3% 45 51 57
–––––– –––––– ––––––
11
5. Delivery costs Jan Feb Mar Apr May Jun
£000 £000 £000 £000 £000 £000
Sales levels 1,500 1,700 1,900 1,400 1,400 1,400
–––––– –––––– ––––––
Delivery costs at 2% 30 34 38
–––––– –––––– –––––– –––––– –––––– ––––––
Delivery costs at 1% 14 14 14
–––––– –––––– ––––––
6. Administration costs
Per the question, these costs are directly proportionate to sales.
£30,000/£1,500,000 = 2%, therefore calculate these costs as 2% of sales each month.
Jan Feb Mar Apr May Jun
£000 £000 £000 £000 £000 £000
Sales levels 1,500 1,700 1,900 1,400 1,400 1,400
–––––– –––––– –––––– –––––– –––––– ––––––
Admin costs at 2% 30 34 38 28 28 28
–––––– –––––– –––––– –––––– –––––– ––––––
(b) Motives for holding cash

The three motives for holding cash, as identified by Keynes, are:
(i) The transactions motive. This means that a business holds cash in order to make the payments that are necessary to
keep the business going, such as wages, taxes and payments to suppliers. If the business cannot meet its financial
obligations as they arise, it may cease to be a going concern. It is therefore the main motive for holding cash.
(ii) The precautionary motive. The second motive for holding cash is so that the business does not find itself in financial
difficulties should some unforseen expenses arise. In practice, businesses tend to cover themselves against this by
arranging overdraft facilitities with their banks. These do not cost businesses anything unless they are used.
(iii) The speculative motive. This refers to businesses holding cash in case an opportunity to invest and earn money arises.
Few businesses are likely to do this in practice as they will lose money whilst waiting for an opportunity to arise.
(c) Possible investments

(i) Certificates of deposit (CDs)
These are negotiable instruments in bearer form. Title belongs to the holder and can be transferred by delivering the
certificate to the buyer.
Bank and Building Societies issue these CDs, which will state on them the amount of the deposit and the date of
repayment. The deposit amount will usually be at least £100,000 and the repayment date will be anything from one
week to five years.
Repayment is obtained by presenting the CD to the issuer on the designated date. Alternatively, since CDs are negotiable,
they can be sold at any time by the holder.
CDs usually offer an attractive rate of interest and a low credit risk. They are useful for investing funds in the short term
since they can be sold at any time on the secondary market.
Since Tots Ltd has a large amount of cash available over a long period, it does not need instant access to all its cash.
It may therefore earn more interest from a money market time deposit, for example, rather than a CD.
(ii) Gilt-edged securities (gilts)
These are marketable British Government securities. The government issues them to finance its spending, but also uses
them to control the money supply. Most gilts have a face value of £100 at which the government promises to buy the
gilt back on a specific date in the future.
Gilts usually have fixed interest rates, although there are also various index-linked gilts. Where they are the index-linked
type, both the interest and the redemption value are linked to inflation, ensuring that a decent real return is gained.
Gilts may be ‘Shorts’ (repaid in less than five years), ‘Mediums’ (repaid in five to fifteen years), or ‘Longs’ (repaid in more
than fifteen years). Some of the older gilts, such as 31/2% War Loans, are irredeemable.
If you buy a gilt and hold it until it is repaid by the government, the return you get will be fixed from the outset. As the
government will not default on the debt and the interest to be earned is known in advance, this makes it a low risk
investment.
Gilts are also traded on the stock market, however, where their price can go up or down, depending on what people
think will happen with interest rates. When interest rates are expected to fall, the price of the gilt rises, and when interest
rates are expected to rise, the gilt price falls. Using gilts in this way makes them a more risky investment, but still
relatively safe when compared with buying shares on the stock exchange.
Gilts are transferrable on the secondary market in multiples of a penny, but if they are bought from new the minimum
investment is £1,000. There is no maximum investment limit. They are easy to transfer and title can even be passed
electronically now.
12
Given that the Brutes are very risk averse when it comes to investing surplus funds, gilts would be a good choice of
investment for Tots Ltd.
(iii) Shares
There are two main types of shares – ‘ordinary shares’ and ‘preference shares.’
Ordinary shares are issued to the owners of a company. These shareholders have the right to participate in the running
of the company through voting. They also share in the profits of the company through increases in the market value of
their shares and through the receipt of dividends.
Ordinary shareholders have no right to be paid dividends, however. In addition, should the company run into financial
difficulties, ordinary shareholders are the last group of people to be paid back from the sale of the company’s assets. In
practice, this means that the capital they invested in the company will usually be lost.
Ordinary shares are therefore a high risk investment. As Mr and Mrs Brute are very risk averse and have already lost
money on the stock exchange before, they should not purchase ordinary shares.
Preference shares are shares that have a fixed percentage dividend that is payable in priority to any ordinary dividend.
Similarly, preference shareholders will be paid in priority to ordinary shareholders on dissolution of the company.
These shareholders will not participate in the affairs of the company in the same way as ordinary shareholders since
they do not have the same voting rights.
Whilst the income from preference shares is more secure than the income from ordinary shares, the capital is still high
risk. Given Mr and Mrs Brutes’ previous experience, preference shares are not a good choice of investment for them.
(iv) Bills of exchange
A bill of exchange is an unconditional order in writing to pay money.
There are two types of bills of exchange. Firstly, ‘sight bills’, whereby the money is payable on demand. Secondly, ‘term
bills’, whereby the money is payable at a future date.
The maturity of term bills can vary from two weeks to six months. Their maximum value is £500,000 and they can be
denominated in any currency.
The ‘drawee’ is the party liable to pay the money; the ‘payee’ is the person who receives the money.
Banks and non-banking institutions are the main buyers of bills on the secondary market.
The buyer makes a profit by purchasing the bill at a discount to its face value, then receiving the full value at maturity,
or reselling it before this time.
The level of risk attached to bills depends on the credit quality of the drawer. If the drawer is a large company or
institution, the risk will be lower than if the drawer is relatively small and unknown.
Bills are not really a suitable investment for Tots Ltd as they are not in a good position to start assessing the credit quality
of drawers. Bills are more suitable for financial institution investors.
13
2 – Pooch Ltd
(a) Working capital

Sales for the year: £2,200,000
–––––––––––
The costs for the year are:
Raw materials £
£2,200,000 x 15% 330,000
Direct labour
£2,200,000 x 20% 440,000
Variable production overheads
£2,200,000 x 11% 242,000
Fixed production overheads
£2,200,000 x 10% 220,000
Other costs
£2,200,000 x 12% 264,000
––––––––––
1,496,000
––––––––––
––––––––––
Current assets:
Stock £ £
Raw materials 4/52 x £330,000 25,385
W-I-P
Materials 2/52 x £330,000 x 75% 9,519
Direct labour 2/52 x £440,000 x 50% 8,462
Variable and fixed production overheads 2/52 x (£242,000 + £220,000) x 50% 8,885
26,866
Finished Goods
Materials and direct labour 4/52 x (£330,000 + £440,000) 59,231
Variable and fixed production overheads 4/52 x (£242,000+ £220,000) 35,538
94,769
––––––––
Total stock value 147,020
Debtors 6/52 x £2,200,000 253,846
––––––––
Total value of current assets 400,866
––––––––
Current liabilites
Materials creditor 4/52 x £330,000 25,385
Labour creditor 1/52 x £440,000 8,462
Variable production overhead creditor 8/52 x £242,000 37,231
Fixed production overhead creditor 5/52 x £220,000 21,154
Other costs creditor 12/52 x £264,000 60,923
–––––––– ––––––––
Total value of current liabilities 153,155
––––––––
Working capital required ––––––––
(£400,866 – £153,155) 247,711
––––––––
––––––––
(b) Legal terms

Offer
An ‘offer’ is a definite promise to be bound on specific terms.
It can be made orally or in writing. It can also be implied from a person’s conduct by, for example, despatching goods in
response to an offer to buy.
It can be revoked at any time before it has been accepted.
Acceptance
‘Acceptance’ is the unconditional agreement, by the offeree, to all the terms of the offer.
As with an offer, it can also be oral, written or implied from a person’s conduct.
A request for information about an offer is not acceptance.
Consideration
‘Consideration’ is one party doing something in exchange for another party doing something.
Often, there is simply an exchange of promises, for example, Petcoats Ltd promises to supply items to Pooch Ltd and
Pooch Ltd promises to pay them.
Consideration is often simply the price. For example, when one of Pooch Ltd’s customers buys an item in the shop, their
consideration is the amount they pay for the goods.
14
3 – Taxi Ltd
(a) Net present value

Years
0 1 2 3 4 5 Net Present
£’000 £’000 £’000 £’000 £’000 £’000 Value
Implementation costs –700 –700 –700
Training costs –425
Increased revenues (1) 0 800 1,150 1,528 1,934 2,371
Cost savings (2) 0 110 116 121 127 134
Operative costs (3) 0 –120 –200 –210 –221 –232
Maintenance costs 0 –75 –75 –75 –75 –75
––––– ––––– ––––– –––––– –––––– ––––––
Net cash flow –700 –410 291 1,364 1,765 2,198
––––– ––––– ––––– –––––– –––––– ––––––
––––– ––––– ––––– –––––– –––––– –––––– ––––––
Discounted cash flow –700 –373 240 1,024 1,205 1,365 2,761
––––– ––––– ––––– –––––– –––––– –––––– ––––––
Notes
1. Increased revenues Years
1 2 3 4 5
£’000 £’000 £’000 £’000 £’000
Revenues + 5% each year 11,000 11,550 12,128 12,734 13,371
Without Kwictrac –10,200 –10,400 –10,600 –10,800 –11,000
–––––––– –––––––– –––––––– –––––––– ––––––––
Increased revenue 800 1,150 1,528 1,934 2,371
––––––––
–––––––– ––––––––
–––––––– ––––––––
–––––––– ––––––––
–––––––– ––––––––
––––––––
2. Savings in costs
Annual revenues 11,000 11,550 12,128 12,734 13,371
–––––––– –––––––– –––––––– –––––––– ––––––––
Savings at 1% 110 116 121 127 134
–––––––– ––––––––
–––––––– –––––––– –––––––– –––––––– ––––––––
–––––––– –––––––– ––––––––
3. Operative costs
–––––––– –––––––– –––––––– –––––––– ––––––––
Additional costs (+ 5% from T3) 120 200 210 221 232
––––––––
–––––––– ––––––––
–––––––– ––––––––
–––––––– ––––––––
–––––––– ––––––––
––––––––
4. Ignore depreciation as not a cash flow.
5. Ignore interest as this is already taken into account in the discounting process.
(b) Simple Payback

Time Annual cash flows Cumulative cash flows
0 –700 –700
1 –410 –1,110
2 291 –819
3 1,364 545
4 1,765 2,310
5 2,198 4,508
The simple payback period for the project is three years. This means that in three years’ time, the project has recovered its
costs and is then making a profit.
(c) Discounted Payback Period

Time Annual cash flows Cumulative cash flows
0 –700 –700
1 –373 –1,073
2 240 –833
3 1,024 191
4 1,205 1,396
5 1,365 2,761
The discounted payback period for the project is also three years. This means that in three years’ time, the project has
recovered its costs and is then making a profit. As this calculation is for the discounted payback period, the time value of
money has also been taken into account.
(Note: Students will still be awarded full marks where they have not rounded their calculations to the nearest year.)
15
(d) Time deposits
First instalment of £700,000:
1
Amount required now = £700,000 × ———
(1·08)
Amount required now = £648,148
Second instalment of £700,000:
1
Amount required now = £700,000 × ———
(1·09)2
Amount required now = £589,176
Total deposits = £1,237,324
4 – Skint Ltd
(a) Factors considered by a bank

The factors to be considered are set out below.
The character of the borrower
Before lending money, the bank will need to decide whether the borrower is of good character. This will involve looking at the
borrower’s past record and conducting a personal interview with the applicant.
If a person is applying for a loan, they will often be credit scored. If a company is making the application, the bank will
probably use key ratios to analyse the company’s financial position.
The ability to borrow and repay
The bank looks at a business customer’s financial performance in order to ascertain their likely future position.
If the owner re-invests profits in the business rather than drawing them all out, it shows that he has some confidence in the
success of the business. This makes the bank more likely to lend to the business.
When dealing with a company that is applying for finance, the bank may check whether the company has the authority to
borrow the funds it is requesting. The company’s articles of association provide this information.
The margin of profits
The bank lends money in order to make money. It needs to ensure that it makes enough of a profit to warrant the risk that it
takes by lending.
Most banks have lending policies which require them to charge different interest rates to customers depending on the reason
for the borrowing. This is because some types of lending are more risky than others.
Ultimately, it is the bank’s discretion to charge whatever interest rate it chooses. For risky ventures, the rate will obviously
be higher.
Purpose of the borrowing
The purpose of the borrowing affects not only the interest rate but also the bank’s decision as to whether or not to lend in the
first place.
A bank will not lend money for an illegal purpose. It will normally lend in order to finance working capital, provided that the
company’s liquidity position is still manageable.
Lending to finance new business ventures is more risky since many of them fail. The bank will be more cautious in these
cases.
Amount of the borrowing
Firstly, the bank will need to make sure that the applicant is not asking for more money than he needs for the purpose
specified. If he is, this casts doubt over his ability to repay.
Secondly, the bank needs to be sure that the applicant is asking for enough money. If he is not, the bank may well end up
having to lend more in order to safeguard the original loan.
Repayment terms
The bank must not lend money to a person or company who does not have the ability to repay it, with interest, irrespective
of any security available for the loan. Security should only be called upon as a last resort if there is a sudden unexpected
inability to pay.
A repayment term should be set which is realistic. Overdrafts are repayable on demand and are therefore more risky for the
borrower.
16
Insurance against the possibility of non-payment
When lending large sums of money to an individual or to a company, the bank may well ask for the loan to be secured. This
security may take the form of title deeds to property – either property of the company or the individual’s house, depending
on who is making the application for finance.
A borrower may take out payment protection insurance, so that his repayments are covered even if his financial position
deteriorates.
(b) Three characteristics

The three characteristics for security are as follows:
(i) Easy to take
This means that the security should be easy to obtain in the first place, for example, title documents to property.
(ii) Easy to value
The security should have a clearly identifiable value which is either stable or increasing, and which fully covers the
lending amount and the margin of profit.
(iii) Easy to realise
The security should ideally be readily available for sale. This ensures that the bank’s administrative costs are kept to a
minimum. Also, the risk of the security deteriorating between the time of default and the time of sale is minimised.
(c) Three terms

(i) Bullet repayment loan
None of the principal amount lent is repaid until the end of the loan period. The principal is then repaid in one big lump
sum.
(ii) Balloon repayment loan
Some of the principal is repaid during the term of the loan. A final substantial payment is then made at maturity.
(iii) Amortising loan (straight repayment loan)
The principal is repaid gradually over the term of the loan, along with the interest payments. Some mortgages are repaid
in this way.
17 [P.T.O.
Managing Finances December 2004 Marking Scheme
Marks
1 (a) Cash sales 3
Rental income 1
Purchases 2
Permanent staff 1
Temporary staff 1
Delivery 1
Administration 2
Conference 1
Ignoring depreciation 1
Computer system 1
Net cash flow/op bal/clos bal 2
–––
16
–––
(b) Each motive discussed 2

–––
Maximum marks 6
–––
(c) (i) CDs

Negotiable instrument 1
Transfer of title 1
Banks and BSs issue 1
Deposit amount 1
Repayment length 1
Obtaining repayment 1
Attractive interest 1
Low risk 1
Useful for short term 1
Conclusion for Tots Ltd 1
–––
Max marks 6
–––
(ii) Gilts
Marketable Gov securities 1
Face value usually £100 1
Fixed interest rates 1
Index-linked 1
Shorts/mediums/longs 1
Low risk if hold until repd 1
Explaining price/int rates rel 1
Higher if on secondary 1
Minimum investment 1
Electronic transfer available 1
Conclusion re Tots Ltd 1
–––
Max marks 6
–––
(iii) Shares
Two types 1
Ordinary shares:
– voting rights 1
– share in profits 1
– no right to dividends 1
– loss of capital 1
– conclusion 1
Preference shares:
– preferential dividends 1
– preference on winding up 1
– lack of participation 1
– conclusion 1
–––
Max marks 6
–––
19
Marks
(iv) Bills of exchange
Definition 1
Two types 1
Term bill details 1
Drawee and payee 1
Main buyers 1
Making a profit 1
Risk 1
Conclusion re Tots Ltd 1
–––
Max marks 6
–––
Total marks 40
–––
–––
2 (a) Calculation of each cost for yr 0·5

–––
Max marks 2·5
–––
Calculation of current assets:
Raw materials 0·5
WIP 4
Finished goods 2
Debtors 0·5
–––
7
–––
Calculation of current liabs
Materials creditor 0·5
Labour creditor 0·5
Variable overheads 0·5
Fixed overheads 0·5
Other costs 0·5
–––
2·5
–––
Working capital required 1
Presentation 1
–––
14
–––
(b) Definition of offer 1

Orally/in writing/implied 1
Withdrawal 1
–––
Max marks 2
–––
Definition of acceptance 1
Orally/in writing/implied 1
Request for information 1
–––
Max marks 2
–––
Definition of consideration 1
Exchange of promises 1
Price 1
–––
Max marks 2
–––
Total marks 20
–––
–––
20
Marks
3 (a) Implementation costs 1
Training costs 1
Increased revenues 3
Decreased costs 1
Operative costs 1
Maintenance costs 1
Ignore depreciation and interest 1
NPV 1
–––
10
–––
(b) Net cashflows 1

Cumulative cashflows 1
Interpretation and result 1
–––
3
–––
(c) Discounted net cashflows 1

Cumulative cashflows 1
Interpretation and result 1
–––
3
–––
(d) One year deposit 2

Two year deposit 2
–––
4
–––
Total marks 20
–––
–––
4 (a) Character of borrower 2

Ability to repay 2
Margin of profit 2
Purpose of borrowing 2
Amount of borrowing 2
Repayment terms 2
Insurance 2
–––
14
–––
(b) Each characteristic 1

–––
Total 3
–––
(c) Each explanation 1

–––
Total 3
–––
Total marks 20
–––
–––
21
Paper T10
Managing Finances
ADVANCED LEVEL
QUESTION PAPER

hall

1 Seventeen Ltd
Sally Sharp is the Managing Director of Seventeen Ltd, a production company responsible for the huge success of the
television programme ‘Pop Icon 1’ and ‘Pop Icon 2.’ The programme is just nearing the end of the second series, with
only four weeks to go before the public chooses a winner.
Sally is in the process of deciding whether to run a ‘Pop Icon’ tour. This would consist of twelve live performances, in
twelve different locations, during the month of September. The twelve finalists from the television programme would
all take part in the tour. Seventeen Ltd ran a ‘Pop Icon 1’ tour after the first series and this was a big success. Sally
is concerned, however, about the effect of the tour on the company’s cash flow, as the company currently has funds
tied up in several other projects.
You have been provided with the following information:
(i) Seventeen Ltd will open a separate bank account on 1 July 2005 for the tour, with an opening balance of
£500,000.
(ii) During the Pop Icon 1 tour, it was calculated that for each thousand votes cast during the final twelve television
programmes, one person attended the Pop Icon tour. This ratio is expected to remain the same for the second
Pop Icon tour, should it go ahead.
During the last eight weeks of Pop Icon 2, the public has cast a total of 180 million votes. This is an average of
22·5 million votes per week. Public interest is expected to increase over the final four weeks and it is therefore
estimated that votes for the remaining four weeks will be 100 million in total.
(iii) Tickets vary in price according to the seat location within each venue. Ticket information is as follows:
Ticket type Price Percentage of total tickets sold
Premium seats £35 10%
Arena floor £30 30%
Stalls £25 60%
It is expected that 20% of ticket revenues will be received in September, 30% in October, 30% in November and
the remainder in December.
(iv) At every live performance, a selection of souvenirs will be on sale, from mugs and t-shirts to CDs and DVDs.
From the Pop Icon 1 tour it has been calculated that for every ticket sold, an average of £6 is spent on souvenirs.
These monies are received by Seventeen Ltd in September.
(v) The souvenirs are purchased from two key suppliers – Records Ltd, who produce all the CDs and DVDs (50% of
total souvenirs sales), and Junk Ltd who produce everything else (remaining 50% of sales). The gross profit
margins for Seventeen Ltd are 25% for CDs and DVDs and 50% for everything else. All orders must be made
from both suppliers in August but whereas Records Ltd requires payment at the time of order, Junk Ltd provides
one month’s credit.
(vi) Each of the twelve performers will be paid £35,000 for his/her participation in the live tour. Of this amount,
£5,000 will be paid at the start of the tour at the beginning of September, with the remainder being paid at the
beginning of October.
(vii) Seventeen Ltd will pay an average of £150,000 to hire each of the twelve venues for the live tour. In order to
secure the venues, a deposit of 10% had to be paid in May for each venue out of one of the company’s existing
bank accounts. The remaining balances will be paid in August from the Tour bank account.
(viii) Seventeen Ltd will need to hire two tour buses in September – one for the performers and one for the crew. The
cost of these will be £10,000 each. In addition to these, six heavy vehicles will be required to transport
equipment. Each vehicle costs £12,000. All of these transport costs include driver costs and fuel. 75% of the
total transport costs (including buses) will be paid in September, with the remainder being paid in October.
(ix) For each performer on the tour, five members of crew are required over and above the already existing staff of
Seventeen Ltd. The average gross wage of each crewmember is £12,000 per month. Whilst all of these
crewmembers are required for the month of September, only half of them are needed for August. All
crewmembers are paid at the end of each month that they work.
2
(x) The crewmembers are hired through an agency, Hands on Deck Ltd. The agency charges a fee for each member
of crew hired through them. The fee is calculated as 10% of the gross monthly wage of each crewmember and
is paid for EVERY month that they work. Hands on Deck Ltd allows one month’s credit.
(xi) Publicity for the tour is expected to cost a further £2·5 million. Of this amount, 20% will be paid in July and
30% paid in August. Sally has negotiated delaying the remaining payment until November.
(xii) Other costs are estimated to be in the region of £240,000 IN TOTAL, incurred evenly through the months of July,
August, September and October. They will be paid in the month in which they are incurred.
(xiii) All workings should be in £’000, to the nearest £’000.
Required:
(a) Prepare a monthly cash budget for the Pop Icon 2 Tour for EACH of the six months to 31 December 2005,
showing clearly any necessary workings. (30 marks)
The following information applies to part (b) only.
Sally is concerned that the above calculations rely on the public’s average weekly votes increasing in the final four
weeks of the programme. They also rely on the assumption that there will be one ticket sale per thousand votes. Sally
is concerned about the effect on profit should these assumptions be wrong, with the second tour proving to be less
popular that the first one. She now wants you to assume that voting for the final four weeks of the programme stays
at the same average level as the previous eight weeks AND that for every TWO thousand votes only one person attends
the tour.
(b) Calculate the original profit of the project as per part (a) AND the revised profit/loss after the change in the
assumptions. (10 marks)
(40 marks)
3 [P.T.O.
2 Silly Filly Ltd
Silly Filly Ltd is a recently established company specialising in the manufacture of talking toy horses for children. The
Silly Filly range currently comprises three key products – all of which are toy horses – plus approximately thirty
accessories to complement the range, from stables to grooming kits.
The Silly Filly range has been such a success in the last year that the management is considering producing an
animated film to accompany the range. This is in accordance with the company’s long-term expansion plans,
culminating in a stock exchange flotation in three year’s time.
The film will take one year to make. In the year following that, sales of the film will commence.
You, an accounting technician for the company, have been asked to assist in appraising the project to decide whether
it should go ahead. The following information is relevant to your calculations.
(i) Market research has already been carried out at a cost of £1·2 million.
(ii) The services of a company specialising in animation will be required at a total cost of £520,000. 50% of these
costs will be paid immediately with the remainder being paid in one year’s time.
(iii) Two producers will be employed throughout the first year of the project. They will each be paid salaries of
£120,000.
(iv) Other production costs during the year are expected to be £650,000.
(v) A film director will be employed immediately on a one-year contract at a cost of £160,000.
(vi) The animated film is expected to generate revenues of £1·2 million in the first year of sales, £2·2 million in the
second year, and £1·6 million in the third year.
(vii) The two producers and the director will each be paid royalties from the film. These will be paid at the rate of
1·5% of gross revenues for EACH of the producers and 2% for the director. They will always be payable one year
in arrears.
(viii) Specialist equipment will need to be purchased immediately for the film production. This will cost £2·3 million
but can be sold at the end of the year for £1·7 million.
(ix) A loan for £1 million will be taken out to assist in financing the project. The loan will be repayable in two year’s
time, with interest of 8% per annum being payable for its duration.
(x) The company’s cost of capital is 10% per annum.
(xi) Assume that all cash flows occur at the end of each year, unless otherwise stated.
Required:
(a) Using the present value tables provided at the end of the question, calculate the project’s net present value
(NPV) at the company’s cost of capital. Conclude as to whether the company should proceed with the
project, giving a reason for your conclusion. (10 marks)
(b) List four costs associated with a new equity issue. (4 marks)
(c) Explain three reasons why a company may seek a stock exchange listing. (6 marks)
Present Value table (extract)
Periods (n) Discount rate (r) Discount rate (r)
10% 8%
1 0·909 0·926
2 0·826 0·857
3 0·751 0·794
4 0·683 0·735
5 0·621 0·681
(20 marks)
4
3 Duel Fuel Ltd
Duel Fuel is an energy company that buys gas in bulk and sells it to the main market providers in the UK. The
company’s credit control department is poorly run at present, following the resignation six months ago of the credit
controller. Poor credit control has had a serious effect on the company’s overdraft, which currently stands at £5
million, compared to £3 million at the same time last year. This, in turn, is pushing up interest costs.
The company is therefore considering factoring its debts to improve its cash flow and reduce costs.
Credit sales for the last year totalled £8·5 million, with average debtors of £4·3 million. Next year, sales are expected
to be 20% higher, and debtor days are expected to remain the same if the factoring arrangement is NOT entered into.
A factoring company has put forward the following proposal to Duel Fuel Ltd:
(i) The factor would immediately advance 70% of the value of sales invoices.
(ii) The factor will charge interest of 12% per annum on the advances.
(iii) The factor will charge an administration fee of 1·5% of turnover for the service.
(iv) Debtor days will be reduced to 60 days, the industry norm, as a result of stricter credit control procedures
Should Duel Fuel Ltd enter into the agreement, it will make both of the credit control staff redundant. They earn
salaries of £14,000 per annum each, but they will both be paid a redundancy package of £3,000 each.
Current bank overdraft rates are 9% per annum.
Required:
(a) Calculate for the coming year whether it is financially viable for Duel Fuel Ltd to factor its debts.
(10 marks)
(b) Identify five advantages of factoring. (5 marks)
(c) List five functions that a credit control department may undertake. (5 marks)
(20 marks)
5 [P.T.O.
4 Gym Jam Ltd
Gym Jam Ltd is a well-established company that hires out a range of top quality treadmills to gyms across the country,
under operating leases.
Over recent months, Gym Jam Ltd’s client base has expanded so rapidly that the company has struggled to finance
the level of treadmill purchases required to supply its new clients. The company used a loan from its local bank to
assist with its last bulk order of treadmill purchases two years ago. Interest on this loan was variable, being linked to
the bank’s base rate, and Gym Jam Ltd saw its interest charges steadily increasing over the two-year period. It is
now considering using finance leases (fixed interest) to acquire the next bulk order of treadmills.
In the last year, the company’s debtor days have increased from an average of 30 days to 45 days, partly because
sales ledger staff could not cope with the increased workload. Currently, all customers are invoiced every three months
(quarterly) for the hire of the treadmills, and most of them pay by cheque. Invoices are raised manually and state on
them that payment terms are 30 days from invoice date.
You are an accounting technician for the company, and have been asked to assist in resolving these problems.
Required:
(a) Briefly describe three key characteristics of an operating lease. (3 marks)
(b) Briefly describe five key characteristics of a finance lease. (5 marks)
(c) Identify four weaknesses in Gym Jam Ltd’s invoicing and credit control system and indicate how they can
be rectified. (4 marks)
(d) List the factors that affect the rate of interest for a loan. (6 marks)
(e) Explain why the interest charges on Gym Jam Ltd’s loan kept increasing. (2 marks)
(20 marks)
6
Answers

1 (a) Seventeen Ltd

Note Jul Aug Sep Oct Nov Dec Total
£’000 £’000 £’000 £’000 £’000 £’000 £’000
Cash inflows
Ticket sales 1 1,540 2,310 2,310 1,540 7,700
Souvenirs sales 2 1,680 1,680
––––– ––––– ––––– ––––– –––––
Total cash inflows 3,220 2,310 2,310 1,540 9,380
––––– ––––– ––––– ––––– –––––
Cash outflows
Purchases: Records Ltd 3 630 630
Purchases: Junk Ltd 3 420 420
Performers 4 60 360 420
Venue costs 5 1,620 1,620
Transport costs 6 69 23 92
Crew costs 7 360 720 1,080
Agency fees 8 36 72 108
Publicity costs 9 500 750 1,250 2,500
Other costs 60 60 60 60 240
––––– ––––– ––––– ––––– ––––– ––––– –––––
Total cash outflows 560 3,420 1,365 515 1,250 0 7,110
––––– ––––– ––––– ––––– ––––– ––––– –––––
Net cash flow (560) (3,420) 1,855 1,795 1,060 1,540 2,270
Opening balance 500 (60) (3,480) (1,625) 170 1,230 500
––––– ––––– ––––– ––––– ––––– ––––– –––––
Closing balance (60) (3,480) (1,625) 170 1,230 2,770 2,770
––––– ––––– ––––– ––––– ––––– ––––– –––––
Note: The ‘Total’ column above is not required but does provide a useful arithmetic check for accuracy.
Note 1 Ticket sales
Total votes
(180,000,000 + 100,000,000) 280,000,000
Estimated ticket sales
(280,000,000/1,000) 280,000
Allocated as follows:
Premium seats £’000
(280,000 x 10% x £35) 980
Arena floor
(280,000 x 30% x £30) 2,520
Stalls
(280,000 x 60% x £25) 4,200
––––––
Total revenues 7,700
––––––
Received in:
September (£7,700,000 x 20%) 1,540
October (£7,700,000 x 30%) 2,310
November (£7,700,000 x 30%) 2,310
December (£7,700,000 x 20%) 1,540
––––––––
7,700
––––––––
Note 2: Souvenirs sales £’000
Total number of tickets sold 280,000
Average souvenirs sale each 6
Total souvenirs sales 1,680
––––––––
9
Note: 3 Souvenirs purchases £’000
Total souvenirs sales 1,680
Split as follows:
DVDs/CDs – 50% 840
GPM at 25% (210)
––––––––
Therefore COS at 75% 630
Payable in August to Records Ltd ––––––––
Other souvenirs – 50% 840
GPM at 50% (420)
––––––––
Payable in September to Junk Ltd ––––––––
Note 4: Performers £’000
12 performers at £35,000 each 420
Split as follows:
Due September (12 x £5,000) 60
Due October (12 x 30,000) 360
––––––––
Note 5: Venue costs £’000
12 venues at £150,000 each 1,800
Less deposits paid (10% x £1,800,000) (180)
––––––––
Remainder due in August 1,620
––––––––
Note 6: Transport costs £’000
2 tour buses (2 x £10,000) 20
6 heavy goods vehicles (6 x £12,000) 72
––––––––
Total 92
75% due September 69
––––––––
25% due October 23
––––––––
Note 7: Crew costs £’000
Total number of crew required (12 x 5) 60
Total cost for August (30 x £12,000) 360
––––––––
Total cost for September (60 x £12,000) 720
––––––––
Note 8: Agency fees £’000
August staff
30 x £12,000 x 10% 36
Due September ––––––––
September staff
60 x £12,000 x 10%
Due October 72
––––––––
Note 9: Publicity costs £’000
July: £2,500,000 x 20% 500
––––––––
Aug: £2,500,000 x 30% 750
––––––––
Nov: £2,500,000 x 50% 1,250
––––––––
Note 10: Other costs £’000
July – Oct: £240,000/4 60
10
(b) Recommended method of calculation
Original level of profit per (a) £’000
Income 9,380
Less: expenditure per cash budget (7,110)
Less: venue deposits pd May (180)
–––––––
Profit 2,090
–––––––
Revised level of profit/loss £’000
Revised income: (£9,380 x 270/280) x 1/2 4,523
Less original expenses: (7,110)
(180)
Add: original souvenir expenses (£630 + £420) 1,050
Less revised souvenir expenses:
(£1,050 x 270/280) x 1/2 (506)
–––––––
Revised loss (2,223)
–––––––
Alternative method for calculating revised profit/loss
Revised profit/loss £’000 £’000
Ticket sales (note 1) 3,713
Souvenirs sales (note 2) 810
––––––– 4,523
Less expenses
Per original cash budget (7,110)
Less venue deposits paid May (180)
Add back original souvenir expenses 1,050
Less revised souvenir expenses (note 3) (506)
––––––– (6,746)
––––––––
Revised loss (2,223)
––––––––
Note 1: Revised ticket sales
Total votes
(180,000,000 + 90,000,000) 270,000,000
Estimated ticket sales
(270,000,000/2,000) 135,000
Allocated as follows:
Premium seats £’000
(135,000 x 10% x £35) 473
Arena floor
(135,000 x 30% x £30) 1,215
Stalls
(135,000 x 60% x £25) 2,025
––––––––
Total revenues 3,713
––––––––
Note 2: Revised souvenirs sales £’000
Total number of tickets sold 135,000
Average souvenirs sale each 6
Total souvenirs sales 810
––––––––
11
Note 3: Revised souvenirs purchases £’000
Total souvenirs sales 810
Split as follows:
DVDs/CDs – 50% 405
GPM at 25% 101
––––––––
Therefore COS @ 75% 304
––––––––
Other souvenirs – 50% 405
GPM at 50% 203
––––––––
––––––––
Total souv. expenses (£304,000 + £202,000) 506
––––––––
2 Silly Filly Ltd

(a) NPV
0 1 2 3 4 5
£’000 £’000 £’000 £’000 £’000 £’000
Revenues 1,200 2,200 1,600
Market research – sunk cost
Animation company costs (260) (260)
Producers’ salaries (240)
Other production costs (650)
Director’s salary (160)
Royalties (note 1) (60) (110) (80)
Specialist equipment (2,300) 1,700
Loan interest – irrelevant
–––––– –––––– –––––– –––––– –––––– ––––––
Net relevant cash flows (2,560) 390 1,200 2,140 1,490 (80)
Discount factor 1 0·909 0·826 0·751 0·683 0·621
–––––– –––––– –––––– –––––– –––––– ––––––
Discounted cash flow (2,560) 355 991 1,607 1,018 (50)
–––––– –––––– –––––– –––––– –––––– ––––––
The project should be undertaken as it has a positive NPV of £1·361 million.
Note 1: Royalties Years
0 1 2 3 4 5
Revenues 1,200 2,200 1,600
–––––– –––––– ––––––
Royalties: (2 x 1·5% + 2% = 5%) 60 110 80
–––––– –––––– ––––––
(b) Four costs of new equity issues

– Underwriting costs
– Stock exchange listing fees
– Costs of printing and distributing the prospectus
– Advertising costs
– Issuing house fees
– Solicitors’ fees
– Public relations consultancy fees
– Accountants’ fees
(Note: Only four were required.)
12
(c) Reasons for a stock exchange listing
Access to wider pool of finance
The level of finance available to a private unlisted company is limited. Therefore, if a company needs more finance than is
currently available to it, it may seek a stock exchange listing. A stock exchange listing may also improve the company’s credit
rating, meaning that more investors are willing to invest in it.
Enhancement of the company image
A company’s image is generally improved anyway when it becomes listed, as it is perceived as being more financially stable.
This may result in increased custom and increased buying power.
Increased marketability of shares
It is not very easy for a shareholder in a private company to sell his/her shares, and this in itself makes the investment more
risky. Once a company is listed on the stock exchange, its shares become far more marketable, thus making them far more
attractive.
Facilitation of growth by acquisition
Should a listed company wish to make an offer to takeover another company, they are in a much better position to do so than
an equivalent unlisted company. This is because the terms of the offer will probably include an exchange of the shares in the
acquiring company for those of the target company.
Transfer of capital by founder owners
A stock exchange listing gives founder members more opportunity to sell their shareholding, or part of it, leaving them free
to invest in other projects.
Note: Only three reasons were required.
3 Duel Fuel Ltd

(a) Whether to factor
Existing finance cost at 9%
New level of debtors = £4,300,000 x 120% £5,160,000
Overdraft cost per annum = £5,160,000 x 9% £464,400
––––––––––
Cost of factoring
New sales level = £8,500,000 x 120% £10,200,000
Debtors reduced to 60 days:
£10,200,000 x 60/365 £1,676,712
70% advanced by factor at 12%: £
£1,676,712 x 70% x 12% 140,844
30% still financed by overdraft:
£1,676,712 x 30% x 9% 45,271
Admin Fee:
£10,200,000 x 1·5% 153,000
Saved salaries
(2 x £14,000) – (2 x £3,000) (22,000)
––––––––––
317,115
––––––––––
Saving = £464,400 – £317,115 147,285
––––––––––
Conclusion
It is financially viable for Duel Fuel Ltd to factor its debts as a total saving of £147,285 will be made.
13
(b) Advantages of factoring
(i) Managers can concentrate on running the business rather than spending time dealing with problems relating to slow
paying debtors.
(ii) The factor will run the company’s sales ledger department, hence cutting running costs in this area.
(iii) The company’s cash flow position is improved, such that the company can pay its suppliers promptly and benefit from
early payment discounts.
(iv) The finance costs of the business are linked to its sales levels and will therefore only increase as sales levels increase.
(v) Expansion can be financed through sales, rather than through increased debt or any injection of capital.
(vi) Optimum stock levels can be maintained, since the cash is readily available for injection.
(vii) Insurance against the company’s bad debts is provided, since the factor takes over the risk of these losses if the
agreement is a ‘without recourse’ agreement.
Note: Only five advantages were required:
(c) Roles of credit control department

– Keeping the sales ledger up-to-date
– Pursuing overdue debts
– Investigating customers’ creditworthiness
– Dealing with customer queries about their account
– Advising customers on payment terms
– Giving references to third parties
Note: Only five roles were required.
4 Gym Jam Ltd

(a) Operating lease
– This is a rental agreement between two parties, whereby the lessor supplies equipment to the lessee.
– The lessor usually retains the responsibility for servicing and maintaining the leased equipment.
– The period of the lease is usually shorter than the asset’s expected useful economic life.
(b) Finance lease

– This is an agreement between the lessor, who provides finance for the asset, and the lessee.
– The person supplying the equipment is usually a third party; the lessor just finances the asset.
– The lessee is responsible for the service and maintenance of the asset.
– The lease has a primary period which covers all/most of the expected useful economic life of the asset.
– The lease usually has an indefinite secondary period whereby the lessee continues to lease the asset for a nominal rent.
(c) Weaknesses and rectifications

– Invoices are only raised quarterly, and using an inefficient manual system. A computerised invoicing system should be
introduced that automatically raises invoices every month.
– Cheques are a slow method of payment, and rely on the customer sending them by post. Direct debits should be set up
for customer payments instead.
– There are insufficient sales ledger staff to cope with the workload and this is causing a backlog. Additional sales ledger
staff should be recruited to assist with the increased workload.
– Customers are not penalised for late payment and are therefore paying late. An interest penalty should be imposed on
all late payments. Customers should be notified of this on their invoices.
(d) Factors affecting interest rate on loan

– Level of risk
– Interest rates in the economy
– Status of the borrower
– Security offered by the borrower
– Amount of the loan
– Purpose of the loan
– Duration of the loan
(e) Increase in interest charges

Interest charges persisted in increasing because the loan was linked to the Bank’s base rate. A bank’s base rate is based on
LIBOR – the London Inter-Bank Offered Rate. LIBOR is the rate at which a bank can borrow money on the Inter-bank market.
This LIBOR rate must have gone up, leading to an increase in Gym Jam Ltd’s bank’s base rate, and hence the rate of interest
on the loan.
14
Marks
1 (a) Cash budget
Total votes cast 1
Total tickets bought 1
Premium sales 1
Arena sales 1
Stalls sales 1
Total sales 1
Ticket sales – Sept 1
Ticket sales – Oct 1
Ticket sales – Nov 1
Ticket sales – Dec 1
Souvenirs Sales 1
Souvenirs Purchases – CDs 2
Souvenirs Purchases – Other 2
Performer costs – Sept 1
Performer costs – Oct 1
Venue costs 1
Transport costs – Sept 1
Transport costs – Oct 1
Crew costs – Aug 1
Crew costs – Sept 1
Agency costs – Sept 1
Agency costs – Oct 1
Publicity costs 1
Other costs 1
Net cash flows 1
Opening bank balances 1
Closing balances 1
Presentation 1
–––
Total 30
–––
(b) Profits – recommended method
Current profit figure 3
Revised income 2
Original expenses 1
Add back souvenir expenses 1
Revised souvenir expenses 2
Loss figure 1
–––
Total 10
–––
Total marks 40
–––
15
Marks
2 (a) NPV
Revenues 1
Market research – sunk cost 1
Animation company costs 1
Producers’ salaries 0·5
Director’s salary 0·5
Other production costs 0·5
Royalties 1
Special equipment 1
Loan interest – irrelevant 1
Discounted cash flow 1·5
Conclusion 1
–––
Total 10
–––
(b) Costs of new equity issue
For each cost 1
–––
Max marks 4
–––
(c) Stock exchange listing
For each reason explained 2
–––
Max marks 6
–––
Total marks 20
–––
3 (a) Whether to factor

New sales level 1
Current cost 1
New debtors level 1
Debtors at 60 days 1
Cost of 70% advanced 1
Cost of 30% not advanced 1
Admin fee 1
Saved salaries 1
Factor saving 1
Conclusion 1
–––
Total 10
–––
(b) Advantages
For each advantage 1
–––
Max marks 5
–––
(c) Roles
For each role 1
–––
Max marks 5
–––
Total marks 20
–––
16
Marks
4 (a) Operating lease
For each characteristic 1
–––
Max marks 3
–––
(b) Finance lease
For each characteristic 1
–––
Max marks 5
–––
(c) Weaknesses/rectifications
Computerised invoicing 1
Changing payment method 1
More staff 1
Interest penalty 1
–––
4
–––
(d) Interest rate factors
Each factor 1
–––
Max marks 6
–––
(e) Increasing interest
Base rate must have increased 1/
2
Base rate based on LIBOR 1/
2
LIBOR explained 1/
2
LIBOR must have increased 1/
2
–––
2
–––
Total marks 20
–––
17
Paper T10
Managing Finances
ADVANCED LEVEL
QUESTION PAPER

hall

1 Gold Club Ltd is a newly established company that has not yet commenced trading. The two shareholders/directors
are planning to set up an Internet business. With the help of finance from venture capitalists, they plan to set up a
website through which individuals can join a ‘Gold Club’. Membership of the club will provide members with a range
of quality travel services including access to a First Class lounge at airports, travel insurance for an unlimited number
of trips and discounted upgrades for seats on flights. It will take one year to set up the business.
You are an accounting technician who has been asked to appraise the investment of capital in the project based on
a six-year plan (one year to set up the business followed by five years of operation).
(i) Market research has been carried out at a cost of £200,000. This indicates that the number of new members
joining the club would be approximately 5,000 each year. Of these new joiners each year, 50% will renew their
membership ONCE, in the following year.
(ii) Membership fees for new members joining the club each year will be £500. Members renewing their
membership in the subsequent year will benefit from a reduced annual fee of £400.
(iii) The costs of setting up the website are as follows:
– Design costs: £1,220,000
– Administrative costs: £125,000
– Legal advice fees: £155,000
25% of these costs will be paid immediately as a deposit, with the remainder being paid in one year’s time.
(iv) The costs of the technical support for maintaining the website will be £100,000 for the first year it is in operation.
These costs will increase by 20% year-on-year thereafter.
(v) All new members will be issued with a club card, with an electronic chip in it. The cost of this card for Gold Club
Ltd will be £3 per member. Once the original card is issued, there will be no need to issue a further card for
renewal of membership. The supplier will be paid annually in arrears for all cards issued in that year. The first
payment is therefore due at the end of the second year.
(vi) For every member who uses a First Class lounge at any airport worldwide, a charge of £20 will be made to Gold
Club Ltd each time the lounge is used. It is estimated that 40% of members will use it three times a year, 30%
of members will use it twice a year, 20% will use it once a year and 10% will not use it at all.
(vii) Gold Club Ltd will purchase a travel insurance policy based primarily on the number of members in the scheme.
It is assumed that all members will make use of the travel insurance and the supplier will therefore charge Gold
Club Ltd £50 per member in the first year, increasing steadily by £2 per member each year after that. Each
member will have to e-mail the travel insurers with details of their trip in advance of each trip. Therefore, the
insurers will also charge Gold Club Ltd an administrative fee of £2 for every e-mail received. Gold Club Ltd
estimates that on average each member will send two e-mails per annum.
(viii) Gold Club Ltd will pay ten major airlines £100,000 EACH per annum in order to provide their members with
access to discounted seat upgrades.
(ix) Overdraft interest will be £5,000 per annum.
(x) Assume that all cash flows, including the receipt of membership fees, occur at the end of each year, unless
otherwise stated.
(xi) The company’s cost of capital is 10% per annum.
(xii) Workings should be in £’000, to the nearest £’000.
2
Required:
(a) Using the discount tables provided at the end of the question, calculate the project’s net present value (NPV)
at the company’s cost of capital. Conclude as to whether the company should proceed with the project,
giving a reason for your conclusion. (30 marks)
(b) Identify and discuss five factors that a venture capital organisation would take into account when deciding
whether or not to invest in Gold Club Ltd. (10 marks)
Present value table (extract)

Periods (n) Discount rates (r)
10% 20%
1 0·909 0·833
2 0·826 0·694
3 0·751 0·579
4 0·683 0·482
5 0·621 0·402
6 0·564 0·335
7 0·513 0·279
8 0·467 0·233
9 0·424 0·194
10 0·386 0·162
(40 marks)
3 [P.T.O.
2 Cleanly Ltd is a manufacturing company producing and selling a range of cleaning products to wholesale customers.
It has three suppliers and two customers. Cleanly Ltd relies on its cleared funds forecast to manage its cash.
You are an accounting technician for the company and have been asked to prepare a cleared funds forecast for the
period Monday 2 January to Friday 6 January 2006 inclusive. You have been provided with the following information:
(1) Receipts from customers
Customer name Credit Payment 2 Jan 2006 2 Dec 2005 sales
terms method sales
W Ltd 1 calendar month BACS £150,000 £130,000
X Ltd None Cheque £180,000 £160,000
(a) Receipt of money by BACS is instantaneous.
(b) X Ltd’s cheque will be paid into Cleanly Ltd’s bank account on the same day as the sale is made and will
clear on the third day following this (excluding day of payment).
(2) Payments to suppliers
Supplier Credit Payment 2 Jan 2006 2 Dec 2005 2 Nov 2005
name terms method purchases purchases purchases
A Ltd 1 calendar month Standing order £65,000 £55,000 £45,000
B Ltd 2 calendar months Cheque £85,000 £80,000 £75,000
C Ltd None Cheque £95,000 £90,000 £85,000
(a) Cleanly Ltd has set up a standing order for £45,000 a month to pay for supplies from A Ltd. This will leave
Cleanly’s bank account on 2 January. Every few months, an adjustment is made to reflect the actual cost
of supplies purchased (you do NOT need to make this adjustment).
(b) Cleanly Ltd will send out, by post, cheques to B Ltd and C Ltd on 2 January. The amounts will leave its
bank account on the second day following this (excluding the day of posting).
(3) Wages and salaries
December 2005 January 2006
Weekly wages £12,000 £13,000
Monthly salaries £56,000 £59,000
(a) Factory workers are paid cash wages (weekly). They will be paid one week’s wages, on 6 January, for the
last week’s work done in December (i.e. they work a week in hand).
(b) All the office workers are paid salaries (monthly) by BACS. Salaries for December will be paid on 2 January.
(4) Other miscellaneous payments
(a) Every Monday morning, the petty cashier withdraws £200 from the company bank account for the petty
cash tin. The money leaves Cleanly’s bank account straight away.
(b) The window cleaner is paid £30 from petty cash every Wednesday morning.
(c) Office stationery will be ordered by telephone on Tuesday 3 January to the value of £300. This is paid for
by company debit card. Such payments are generally seen to leave the company account on the next
working day.
(d) Five new computers will be ordered over the Internet on 5 January at a total cost of £6,500. A cheque will
be sent out on the same day. The amount will leave Cleanly Ltd’s bank account on the second day following
this (excluding the day of posting).
(5) Other information
The balance on Cleanly’s bank account will be £200,000 on 2 January 2006. This represents both the book
balance and the cleared funds.
Required:
Prepare a cleared funds forecast for the period Monday 2 January to Friday 6 January 2006 inclusive using the
information provided. Show clearly the uncleared funds float each day.
(20 marks)
4
3 Fibre Clean Ltd is a small company specialising in the cleaning of upholstery and carpets. All of the company’s current
customers are domestic and pay at the time the work is done. Mr Sykes, the owner, is considering undertaking a
number of commercial contracts instead of his domestic work because the profit margins are much higher. It is
standard practice in this sector to offer 30-day credit terms to customers. Mr Sykes is concerned about a number of
issues. Firstly, how he can ensure that he only provides credit to creditworthy customers. Secondly, how he will
manage the extra administrative workload and, finally, what the effect of providing credit will be on his cash position.
He is already overdrawn at his local bank.
A friend of Mr Sykes has suggested that he should obtain ‘trade references’ for his new customers and seek the advice
of a ‘credit reference agency’.
Required:
(a) Describe the following sources of externally generated information and their usefulness in assessing the
creditworthiness of Mr Sykes’ new customers:
(i) Trade reference;
(ii) Credit reference agency. (6 marks)
(b) Explain the meaning of ‘debt factoring’ and ‘invoice discounting’ to Mr Sykes. Highlight any key differences
between the two and suggest which one may be more useful for Mr Sykes. (5 marks)
(c) If Mr Sykes changes to commercial contracts, he expects sales for the next year to be £75,000, with customers
paying within the 30-day limit set. It would cost him £2,000 per annum to employ someone one day a week to
invoice customers and collect debts for him. Alternatively, his local bank has offered to provide a factoring service
for him, including the advance of 80% of his sales invoices. They would charge 2% of turnover for the
administration and charge interest of 8% per annum on advances. However, the bank would not invoice
Mr Sykes’ customers. He would need to employ somebody for half a day a week to do this, at a cost of £1,000
per annum.
Mr Sykes pays interest at the rate of 10% per annum on his overdrawn bank account.
Mr Sykes thinks that customers will pay within 30 days regardless of which option is selected.
Required:
Calculate and recommend whether or not Mr Sykes should factor his debts. (9 marks)
(20 marks)
5 [P.T.O.
4 (a) Define the term ‘financial intermediary’, distinguishing between a ‘broker’ and a ‘principal’. Give four
examples of organisations that act as financial intermediaries. (4 marks)
(b) Discuss four main benefits of financial intermediation. (8 marks)
(c) Briefly describe four main money market instruments. (4 marks)
(d) Governments use monetary policy to control prices, economic growth and employment levels.
Required:
Define ‘quantitative’ and ‘qualitative’ controls used by governments. (4 marks)
(20 marks)
6
Answers

1 Gold Club Ltd
(a) Time
0 1 2 3 4 5 6
£’000 £’000 £’000 £’000 £’000 £’000 £’000
Market research – ignore
Membership fees (notes 1 & 2) 2,500 3,500 3,500 3,500 3,500
Set-up costs (note 3) (375) (1,125)
Maintenance costs (note 4) (100) (120) (144) (173) (208)
Club cards (5,000 x £3) (15) (15) (15) (15) (15)
First Class lounge (note 5) (200) (300) (300) (300) (300)
Travel insurance (note 6) (270) (420) (435) (450) (465)
Upgrade costs (10 x £100k) (1,000) (1,000) (1,000) (1,000) (1,000)
Interest costs – ignore
–––––– –––––– –––––– –––––– –––––– –––––– ––––––
Net cash flow (375) (1,125) 915 1,645 1,606 1,562 1,512
––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
––––––
10% discount factors 1·000 0·909 0·826 0·751 0·683 0·621 0·564
–––––– –––––– –––––– –––––– –––––– –––––– ––––––
Discounted cash flow (375) (1,023) 756 1,235 1,097 970 853
–––––– –––––– –––––– –––––– –––––– –––––– ––––––
The net present value of the project is £3·513 million. The project should therefore be undertaken, since the net present value
is positive.
Note 1: Membership numbers Year 1 Year 2 Year 3 Year 4 Year 5
T2 T3 T4 T5 T6
New members 5,000 5,000 5,000 5,000 5,000
Renewals at 50% 2,500 2,500 2,500 2,500
–––––– –––––– –––––– –––––– ––––––
Total members 5,000 7,500 7,500 7,500 7,500
–––––– –––––– –––––– –––––– ––––––
Of which, new members 5,000 5,000 5,000 5,000 5,000
–––––– –––––– –––––– –––––– ––––––
Renewals 0 2,500 2,500 2,500 2,500
–––––– –––––– –––––– –––––– ––––––
Note 2: Fees Year 1 Year 2 Year 3 Year 4 Year 5
T2 T3 T4 T5 T6
New members 5,000 5,000 5,000 5,000 5,000
Fee per member £ 500 500 500 500 500
£’000 £’000 £’000 £’000 £’000
Total new member fees 2,500 2,500 2,500 2,500 2,500
–––––– –––––– –––––– –––––– ––––––
Renewal member numbers 0 2,500 2,500 2,500 2,500
Fee per member £ 400 400 400 400 400
£’000 £’000 £’000 £’000 £’000
Total fees from renewals 0 1,000 1,000 1,000 1,000
–––––– –––––– –––––– –––––– ––––––
Total fees 2,500 3,500 3,500 3,500 3,500
––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
––––––
Note 3: Set-up costs
Costs = £1,220k + £125k + £155k = £1,500k
T0: 25% x £1,500k = £375k
T1: 75% x £1,500k = £1,125k
Note 4: Maintenance costs Year 1 Year 2 Year 3 Year 4 Year 5
£’000 £’000 £’000 £’000 £’000
T2 T3 T4 T5 T6
£100k in first year 100
Increasing by 20% each year thereafter 120 144 173 208
–––––– –––––– –––––– –––––– ––––––
9
Note 5: First Class lounge Year 1 Year 2 Year 3 Year 4 Year 5
T2 T3 T4 T5 T6
Number of members 5,000 7,500 7,500 7,500 7,500
–––––– –––––– –––––– –––––– ––––––
£’000 £’000 £’000 £’000 £’000
40% x £20 x 3 120 180 180 180 180
30% x £20 x 2 60 90 90 90 90
20% x £20 x 1 20 30 30 30 30
–––––– –––––– –––––– –––––– ––––––
Total costs 200 300 300 300 300
–––––– –––––– –––––– –––––– ––––––
(There is effectively an average of two visits per club member per year.)
Note 6: Travel insurance costs Year 1 Year 2 Year 3 Year 4 Year 5
T2 T3 T4 T5 T6
Flat rate per member £ 50 52 54 56 58
E-mail costs: 2 x £2 4 4 4 4 4
–––––– –––––– –––––– –––––– ––––––
54 56 58 60 62
–––––– –––––– –––––– –––––– ––––––
Total number of members 5,000 7,500 7,500 7,500 7,500
£’000 £’000 £’000 £’000 £’000
–––––– –––––– –––––– –––––– ––––––
Total costs 270 420 435 450 465
––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
––––––
(b) Venture capitalists

Factors that a venture capitalist organisation will take into account are as follows:
(i) Level of expertise of Gold Club Ltd’s management
Venture capitalists will believe that the success of Gold Club Ltd’s membership scheme is dependent on the quality of
the two shareholders/directors. They will expect these two key personnel to show a high level of commitment to the
project. As both the existing owners of the business are all involved in the running of the company, this should be proof
of their commitment. The venture capitalists will also look at the amount of money that the owners themselves have
invested in the project in assessing their level of commitment. The venture capitalists will expect a place on Gold Club
Ltd’s Board of Directors so that they can have a say in future business strategy.
(ii) Level of expertise in the area of service
The venture capitalists will seek assurance that the directors have the necessary know-how and technical support to be
able to run the website properly. In addition, they will need assurance that Gold Club Ltd can really provide the services
to its customers.
(iii) The nature of Gold Club Ltd’s product
The venture capitalists will consider the feasibility of providing the service at the membership prices proposed. This will
involve analysing the cost estimates to ascertain their accuracy and ensuring, for example, that key airlines have agreed
to the discounted upgrades and to the use of their First Class lounges. The venture capitalists will need a high level of
assurance about the accuracy of the forecast membership numbers.
The venture capitalists will seek assurance that there is actually a market for the Club, as there are already some similar
memberships available in the market place. They will ask to see the market research that has already been carried out.
The venture capitalists will also look at the threat posed by new entrants in the market, and current rival membership
schemes.
Since the risk involved in investing in a new company is fairly high, the venture capitalists will seek to ensure that the
prospects for future profits compensate for the risk. They will therefore want to see a detailed business plan setting out
the future business strategy.
(vi) Exit routes
The venture capitalists will consider potential exit routes before they invest in the venture. They will not invest money in
a share of the business unless they are confident that it can be sold at some point in the future.
Note: Only five factors were required.
10
2 Cleanly Ltd
Cleared Funds Forecast

2 Jan 3 Jan 4 Jan 5 Jan 6 Jan
£ £ £ £ £
Receipts
W Ltd 130,000 0 0 0 0
X Ltd 0 0 0 180,000 0
–––––––– –––––––– –––––––– –––––––– ––––––––
130,000 0 0 180,000 0
–––––––– –––––––– –––––––– –––––––– ––––––––
Payments
A Ltd 45,000 0 0 0 0
B Ltd 0 0 75,000 0 0
C Ltd 0 0 95,000 0 0
Wages 0 0 0 0 12,000
Salaries 56,000 0 0 0 0
Petty Cash 200 0 0 0 0
Stationery 0 0 300 0 0
–––––––– –––––––– –––––––– –––––––– ––––––––
101,200 0 170,300 0 12,000
–––––––– –––––––– –––––––– –––––––– ––––––––
Cleared excess receipts
over payments 28,800 0 (170,300) 180,000 (12,000)
Cleared balance b/f 200,000 228,800 228,800 58,500 238,500
–––––––– –––––––– –––––––– –––––––– ––––––––
Cleared balance c/f 228,800 228,800 58,500 238,500 226,500
–––––––– –––––––– –––––––– –––––––– ––––––––
Uncleared funds float
Receipts 180,000 180,000 180,000 0 0
Payments (170,000) (170,300) 0 (6,500) (6,500)
–––––––– –––––––– –––––––– –––––––– ––––––––
10,000 9,700 180,000 (6,500) (6,500)
–––––––– –––––––– –––––––– –––––––– ––––––––
Total book balance c/f 238,800 238,500 238,500 232,000 220,000
––––––––
–––––––– ––––––––
–––––––– ––––––––
–––––––– ––––––––
–––––––– ––––––––
––––––––
3 Fibre Clean Ltd
(a) (i) Trade reference

A trade reference is a reference received from another business that the potential customer deals with. The trade referee
selected should offer similar terms to those now being offered to Mr Sykes’ customers, that is, 30-days terms.
A well known company stated as a referee should always be followed up, but if the name given is that of an unknown
company, it should be treated with caution. This is because there is an increased likelihood of collusion between Mr
Sykes’ new customer and their referee. Mr Sykes should contact the referee himself, enclosing a stamped addressed
envelope so that the reply comes direct to him. This prevents possible alteration by the customer.
The main problem with obtaining trade references arises from the fact that Mr Sykes’ potential customers are unlikely
to provide him with the names of referees who will provide bad references. They will only provide the names of those
creditors with whom they have a good credit history. Their usefulness is severely limited by this factor.
(ii) Credit reference agency
These agencies provide information about businesses so that their creditworthiness can be assessed by potential
suppliers. The level of information they hold varies. Some merely hold background information, for example, a set of a
company’s financial statements. Others hold more up to date information and may offer a credit rating.
Some of the main agencies include Equifax, Infolink, CCN, Moody’s and Dunn & Bradstreet.
The main restriction on the usefulness of these agencies is that the information is often out of date. They are also of less
use for assessing newer businesses which do not have enough history on which to base a credit assessment.
(b) Debt Factoring and Invoice Discounting

Debt Factoring
‘Debt Factoring’ is a service provided by factors whereby the factor collects debts on behalf of their client and often invoices
their client’s customers as well. The factor also advances, to its client, a proportion of the money it is due to collect (typically
about 80% is advanced).
Mr Sykes would find the service useful because he could both receive cash early and reduce administration.
11
There are two types of factoring agreements: ‘with recourse’ and ‘without recourse’ agreements. With the first of these
agreements, although the factor advances monies, the risk of non-payment of debts stays with the client. If a debtor defaults,
the factor has ‘recourse’ to their client for the money. If the agreement is ‘without recourse’ the factor bears the risk of non-
payment.
Debt factoring has to be paid for, usually as a percentage of the amounts advanced and as a percentage of turnover.
Agreements without recourse to the client obviously cost more. Mr Sykes would have to compare his total costs if he uses a
factor to his total costs if he does not use a factor before making a decision. He should also take into account the fact that
there is some stigma attached to debt factoring as clients sometimes assume that a business using a factor must be in
financial difficulty.
Invoice Discounting
Invoice discounting is a service whereby a provider (often a factoring company) purchases invoices from a client at a discount.
In this case, they are merely advancing cash, rather than providing a debt collection service.
Again there will be a charge for discounting, calculated as a percentage of the invoices purchased.
Given Mr Sykes’ concerns about his increased workload, a factoring arrangement would be far more suited to his needs.
(c) Cost of factoring

Cost of financing debtors £ £
Average debtors £75,000 x 30/365 6,164
20% financed by overdraft at 10% 123
Average level of factor’s advance:
£6,164 x 80% 4,931
Cost at 8% 394
––––––
Total cost of financing debtors 517
Sales administration cost
2% x £75,000 1,500
Invoicing administrator employed 1,000
––––––
Total cost of arrangement 3,017
––––––
Cost of not factoring
Cost of financing debtors
Average debtors £75,000 x 30/365 6,164
Financed by overdraft at 10% 616
Sales administration cost
New staff 2,000
––––––
Total cost of arrangement 2,616
––––––
The factoring arrangement would cost Mr Sykes £401 per annum more than not factoring. Therefore, he should not enter
into the agreement.
4 Financial matters
(a) Financial intermediaries

A financial intermediary is an organisation that brings together potential borrowers and potential lenders. Such an
intermediary can act as a broker, whereby they handle a transaction on behalf of others. Alternatively, they may act as a
principal, whereby they hold money balances of lenders for lending on to borrowers.
Examples of financial intermediaries include:
– Banks
– Building societies
– Finance houses
– Insurance companies
– Pension funds
– Unit trusts
– Investment trust companies
Note: Only four examples were required.
(b) Benefits of financial intermediation

(i) Lending/borrowing becomes easier
The intermediary has a whole range of lenders and a whole range of borrowers. This makes lending and borrowing
easier. Both parties know where to go to lend or borrow money since the services of financial intermediaries are
well-advertised.
12
(ii) Risk reduction
The intermediary helps to spread the risk of lending money to borrowers among the various lenders who deposit money
with the intermediary. This clearly benefits the lender.
In addition, intermediation reduces risk for the borrower too. For example, an organisation such as a unit trust company
invests money in a variety of stocks and shares thereby ensuring diversification. Individuals then buy a small share of
such investments, thus benefiting from risk reduction through diversification, but without having to invest large sums of
money in numerous investments.
(iii) Aggregation
The intermediary is able to aggregate the amount lent by savers into amounts which the borrower may require. This
makes the process of borrowing large sums of money much easier for the borrower. For example, if an individual
requiring £100,000 to buy a house had to approach numerous different lenders, the process would be time-consuming
and expensive.
(iv) Maturity transformation
The intermediary bridges the gap between the desire of many lenders for liquidity and the need of many borrowers for
long-term loans. In order to fulfil this role, it is essential that the intermediary keeps an adequate reserve of liquid assets.
(c) Financial instruments

– Deposits: deposits of money with financial intermediaries such as banks.
– Bills: short-term financial assets which can be converted into cash at short notice by selling them in the discount market.
– Commercial paper: short-term IOUs issued by large companies. They can either be held until maturity or sold on before
then.
– Certificates of deposit: available to customers who deposit a minimum of £50,000 for fixed terms. They can be held
until maturity or sold in the CD market.
(d) Monetary policies

Quantitative controls
Quantitative controls are those controls introduced by the government to restrict the amount of money lent by the clearing
banks.
Qualitative controls
These are where the government restricts the type of lending that banks can do, rather than the amounts which they can
lend. For example, the government may introduce incentives for lending to manufacturing businesses, or create disincentives
for lending to individuals.
13
Marks
1 Gold Club Ltd
(a) NPV
Ignore market research 2
Membership numbers 2
Membership fees 4
Set-up costs 2
Maintenance costs 1
Club cards 1
First class lounge 4
Travel insurance 3
Upgrade costs 1
Ignore interest costs 1
Net cash flow 2
Correct discount factors 1
Discounted cash flow 2
NPV 1
Conclusion and reason 2
Presentation 1
––––
Total 30
––––

For each factor discussed 2
––––
Max marks 10
––––
Total marks 40
––––
2 Cleanly Ltd
Receipts:
W Ltd 1
X Ltd 1
Payments:
A Ltd 1
B Ltd 1
C Ltd 1
Wages 1
Salaries 1
Petty Cash 1
Ignore window cleaner 1
Stationery 1
Total 1
Cleared excess 1
Cleared balance b/f 2
Cleared balance c/f 1
Receipts 1
Payments 1
Total book balance c/f 1
Correct presentation 2
––––
Total marks 20
––––
15
Marks
3 Fibre Clean Ltd
(a) References and agencies

(i) Trade reference
Definition 1
Similar terms 1
Well known co. vs unheard of 1
Contact directly 1
Limitation 1
––––
Max marks 3
––––
(ii) Credit reference agency
Provide info re suppliers 1
Detail of info varies 1
Main agencies 1
Out of date 1
Not good for new companies 1
––––
Max marks 3
––––
(1 mark each awarded for any useful comments)
(b) Factoring and invoicing

Factoring
Definition 1
Includes administration 1
With recourse agreements 1
Without recourse agreements 1
Cost 1
Invoice discounting
Definition 1
Advancing cash 1
Cost 1
Conclusion on most suitable 1
––––
Max marks 5
––––

Factoring
Average debtors figure 1
20% overdraft cost 1
80% advance figure 1
Cost at 15% 1
Sales admin cost at 2% 1
Invoicer cost 1
Not factoring
Overdraft cost at 100% 1
Administrator cost 1
Conclusion 1
––––
Total 9
––––
Total marks 20
––––
16
Marks
4 Financial matters
(a) Financial intermediaries

Definition 1
Broker/principal 1
Examples 2
(0·5 each, max 2 marks)
––––
Total 4
––––
(b) Benefits
Easier 2
Risk reduction 2
Aggregation 2
Maturity transformation 2
––––
Total 8
––––
(Award marks for all sensible points)
(c) Financial instruments

Each one 1
––––
Total 4
––––
(d) Monetary policies

Quantitative controls 2
Qualitative controls 2
––––
Total 4
––––
Total marks 20
––––
17
Paper T10
Managing Finances
ADVANCED LEVEL
QUESTION PAPER

hall

1 Maybay Hospital is a private hospital. Currently, all cleaning is undertaken by staff employed by the hospital. There
are 150 cleaning staff in total, of which half work full-time and half work part-time.
Over the last year there has been a serious outbreak of the MRSA bug (a bacterial infection resistant to antibiotics) in
the hospital. Cleaning standards have therefore become a key issue. The hospital is currently being sued by a group
of patients who are all claiming to have suffered from MRSA following admittance to Maybay. This has caused a
significant fall in the number of patient admissions and an increase in the hospital’s insurance costs.
The hospital managers are now considering whether they should continue with their existing cleaning staff (Option 1)
or contract out the cleaning function to external providers for the next five years (Option 2). The following information
has been provided:
1 Full-time cleaning staff work 35 hours a week and are paid £5·70 per hour.
2 Part-time cleaning staff work a 20-hour week and are paid £5·65 per hour.
3 Eight full-time supervisors are also employed, in addition to the cleaning staff, at a salary of £15,000 per annum
each.
4 Other staff costs, including pension costs, average £2,625 per annum per full-time employee (including
supervisors) and £1,215 per part-time employee.
5 If the cleaning continues to be done by hospital cleaners, it has already been decided that 10 new full-time
cleaners will be employed immediately. The hospital will also recruit a further 15 full-time cleaners in one year’s
time.
6 Total insurance costs for the whole hospital are currently £6·5 million per annum. The hospital estimates that
these will fall immediately by 10% if the cleaning is contracted out to an external provider. They will remain the
same if the cleaning is NOT contracted out.
7 Cleaning materials cost £1·44 million per annum. If an external provider is used in the future, they will provide
their own cleaning materials.
8 Independent inspectors inspect hospital hygiene standards every six months. Breaches of standards fall into one
of two categories: serious breaches, for which a fine of £10,000 per breach is imposed, and minor breaches, for
which a fine of £2,000 per breach is imposed. If the hospital does NOT contract out its cleaning, but the new
cleaners are employed, it is estimated that serious breaches can be limited to 22 per year and minor breaches
can be limited to 74 per year. The external providers expect to restrict these breaches to 17 and 50 respectively
in the first year, falling to 8 and 25 respectively per year thereafter. Even with a contracted out cleaning service,
the hospital will continue to be responsible for all payments of fines.
9 The hospital has invested heavily in floor polishing machines over recent years, and currently has 150 in total.
The external providers have offered to buy these immediately at a price of £4,000 each, should the contracting
out go ahead.
10 Adverse publicity resulting from the MRSA bug is costing the hospital £1·2 million per annum in lost contribution.
The external cleaning providers’ reputation is such that this amount can be totally eliminated immediately.
11 The external providers have offered to provide cleaning services for a contracted five-year period. The fees will be
£4·25 million for each of the first two years, increasing to £4·5 million per annum thereafter.
12 Administration costs are currently £300,000 per annum. They would fall to £270,000 per annum if the cleaning
were contracted out.
13 If the hospital decides to contract out the cleaning, it will be with immediate effect. A redundancy package has
been put together for current staff. Each full-time employee, including supervisors, will receive an average of
£5,000 and each part-time employee will receive an average of £3,000. These amounts will be payable
immediately.
14 The hospital managers have spent £60,000 researching and calculating their costs.
15 The hospital’s cost of capital is 10% per annum.
16 Assume that all cash flows occur at the end of each year unless told otherwise.
2
Required:
(a) Calculate the net present values of the costs of each of the two options above. Recommend whether the
hospital should continue with its existing staff (Option 1) or contract out of cleaning for the next five years
(Option 2). (30 marks)
(b) State four factors, other than cost, that should be taken into account when deciding whether to use the
external providers. (4 marks)
(c) Explain the main principles used to differentiate between relevant and irrelevant costs for investment
appraisal. Include a brief explanation of the treatment of finance costs. (6 marks)
NOTE: All workings and answers should be in £’000, to the nearest £’000.

10%
1 0·909
2 0·826
3 0·751
4 0·683
5 0·621
Annuity factor table (extract)

10%
1 0·909
2 1·736
3 2·487
4 3·170
5 3·791
(40 marks)
3 [P.T.O.
2 You have been provided with the following financial information relating to Health Foods Ltd.
Forecast Profit and Loss Account for the year ending 30 June 2007
£’000
Turnover 20,350
Operating costs (12,265)
–––––––
Operating profit 8,085
Interest payable (785)
–––––––
Profit before tax 7,300
Tax payable (2,230)
–––––––
Profit after tax 5,070
Dividends payable (2,270)
–––––––
Retained profit 2,800
–––––––
Extract from Historical Balance Sheet as at 30 June 2006 (Actual figures)
£’000 £’000 £’000
Fixed assets 8,000
Current assets
Stock 2,167
Debtors 2,543
Cash 1,264
––––––
5,974
Current liabilities
Trade creditors 1,737
Tax payable 1,895
Dividends payable 1,542
––––––
(5,174)
––––––
Net current assets 800
––––––
Net assets 8,800
––––––
––––––
Extract from Forecast Balance Sheet as at 30 June 2007
£’000 £’000 £’000
Fixed assets 8,300
Current assets
Stock 3,245
Debtors 3,318
Cash 2,984
––––––
9,547
Current liabilities
Trade creditors 1,723
Tax payable 2,289
Dividends payable 2,235
––––––
(6,247)
––––––
Net current assets 3,300
–––––––
Net assets 11,600
–––––––
–––––––
4
Additional information
1. Operating costs include depreciation of £200,000.
2. The company does not plan to sell any fixed assets over the next year.
3. Fixed assets are all tangible (physical) assets.
4. All finance costs are paid in the year in which they are incurred.
Required:
(a) Prepare a forecast cash flow statement for Health Foods Ltd for the year ending 30 June 2007 identifying
the net cash flow for the business.
Note: Accounting standards format is not required. (16 marks)
(b) Briefly describe the drawbacks of the Baumol (EOQ) cash management model. (4 marks)
(20 marks)
5 [P.T.O.
3 You are an accounting technician working at Shoes for You Ltd, a company that manufactures and distributes a range
of fashion shoes. All shoes are made at the company’s factory in the country of Bushai, where materials and labour
have historically been very cheap. The shoes are then exported to the UK where they are sold to a number of retail
outlets.
All costs are incurred in Bushai’s unit of currency. All materials are paid for in cash at the time of purchase. Production
staff are paid their wages daily in cash. They have not had a pay increase in the last year. All other overheads,
production and sales, are on credit.
All sales are to UK customers and are on credit. They are, therefore, invoiced (and amounts are received) in £ sterling.
Any finance needed for the business is also obtained from the UK.
You have estimated the figures below for the coming year. Sterling has been used for all figures so as to avoid any
distortion caused by high inflation in Bushai.
Sales £2,500,000
Average debtors £410,000
Materials purchases £630,000
Production staff wages £450,000
Other production overheads £350,000
Sales overheads £320,000
Net profit margin 30%
Average stocks:
Finished goods £325,000
Work in progress (65% complete) £195,000
Raw materials £133,000
Average creditors £73,000
The economy in Bushai has recently become unstable. This has led to a rapid increase in inflation levels over the last
year, from 10% at the beginning of the year to 25% at the end of the year. Interest rates are controlled by Bushai’s
central bank. Inflation in the UK has remained stable at about 4% per annum.
Required:
(a) Calculate the cash operating cycle. (10 marks)
(b) The raw material holding period has doubled over the last year.
State the main financial advantage and main financial disadvantage of this happening, paying attention to
the fact that inflation has increased over the year. (4 marks)
(c) Discuss BRIEFLY the general problems associated with inflation as listed below and consider how each
problem affects Shoes for You Ltd.
(i) Redistribution of income and wealth; (2 marks)
(ii) The balance of trade (Do NOT discuss exchange rates); (2 marks)
(iii) Higher interest rates. (2 marks)
(20 marks)
6
4 Financial analysts will use ratios to compare performance of companies in the same industry.
Lenders will frequently use ratio analysis to help them decide whether to lend to an individual in the first place and
whether to continue their financial support. Business owners and managers also use ratios to assess the financial
performance of their business. Such ratios may include earnings per share, interest cover, gearing and net profit
margin.
Required:
(a) Outline FOUR sources of finance (short and/or long-term) available to small and medium-sized businesses.
Ignore government grants, leasing and factoring. (12 marks)
(b) Discuss four limitations of ratio analysis. (8 marks)
(20 marks)
7
Answers

1 Maybay Hospital
(a) Option 1: Continue with existing staff Time

0 1 2–5
£’000 £’000 £’000
Full-time staff costs (1) 1,246 1,440
Part-time staff costs (2) 532 532
Cleaning materials 1,440 1,440
Insurance costs 6,500 6,500
Fines (3) 368 368
Administration costs 300 300
Research costs – ignore as sunk
––––– ––––––– –––––––
Net cash flow 0 10,386 10,580
10% discount factors (4) 1·000 0·909 2·882
Discounted cash flow 0 9,441 30,492
–––––
––––– –––––––
––––––– –––––––
–––––––
Total present value of costs of Option 1 over next five years is £39·933 million.
T1 T2–5
1. Full-time staff costs £’000 £’000
Wages: 85/100 staff x 35hrs at £5·70 x 52 weeks 882 1,037
Supervisors: 8 x £15,000 120 120
Other costs: £2,625 x 93/108 244 283
–––––– ––––––
1,246 1,440
–––––– ––––––
2. Part-time staff costs T1–5
Wages:75 staff x 20hrs at £5·65 x 52 weeks 441
Other costs: £1,215 x 75 91
––––
532
––––
3. Fines
Serious breaches (22 x £10,000) 220
Minor breaches (74 x £2,000) 148
––––
368
––––
4. Annuity factor
Annuity factor T2 – T5 = 3·791 – 0·909 = 2·882
Option 2: Contracting out Time
0 1 2 3–5
£’000 £’000 £’000 £’000
Annual contract fees 4,250 4,250 4,500
Revised insurance costs (£6·5m x 90%) 5,850 5,850 5,850
Revised fine costs (5) 270 130 130
Machine sales (150 x £4000) (600)
Saved revenue contribution (1,200) (1,200) (1,200)
Administration costs 270 270 270
Redundancy costs (6) 640
–––––– –––––– –––––– –––––––
Net cash flow 40 9,440 9,300 9,550
––––––
–––––– ––––––
–––––– ––––––
–––––– –––––––
–––––––
10% discount factors (7) 1·000 0·909 0·826 2·055
–––––– –––––– –––––– –––––––
Discounted cash flow 40 8,581 7,682 19,625
––––––
–––––– ––––––
–––––– ––––––
–––––– –––––––
–––––––
Net present value of costs of Option 2 is £35·928 million.
The hospital should therefore choose Option 2 and contract out the cleaning since the net present value of the costs is
£4·005 million less than for Option 1.
11
Yr 1 Yrs 2–5
5. Revised fines £’000 £’000
Serious breaches (17/8 x £10,000) 170 80
Minor breaches (50/25 x £2,000) 100 50
–––– ––––
270 130
–––– ––––
6. Redundancy costs
Full-time: 83 x £5,000 415
Part-time: 75 x £3,000 225
––––
640
––––
7. Annuity factor
Annuity factor T2 – T5 = 3·791 – 1·736 = 2·055
Note: It is the difference in the NPVs of the two options that is important, rather than the NPVs themselves.
(b) Other factors

Other factors to be considered, apart from cost:
(i) The experience of the external provider’s cleaners in the area of hospital cleaning.
(ii) The reliability of the cleaners in turning up for work.
(iii) The quality of the cleaning provided.
(iv) The effect on morale of remaining hospital staff if work is passed on to an outside provider and redundancies are made.
(v) The extent to which reliance can be placed on the external provider’s assertions re reducing fines and lost admissions.
(vi) The extent to which the cleaning materials used by the contractors are environmentally friendly.
Note: Only four factors were required. Marks will be given for any sensible suggestion.
(c) Relevant costs

The following principles should be applied when identifying costs that are relevant to a project.
therefore totally irrelevant to any decision that is being made now. Such past costs are called ‘sunk costs’.
Therefore, costs which do not reflect cash spending should be ignored for the purpose of decision-making.
A relevant cost is the increase in costs which results from making a particular decision. For example, an opportunity cost –
the value of a benefit foregone as a result of choosing a particular course of action – will always be a relevant cost. This is
because it is a future incremental cost.
Any costs or benefits arising as a result of a past decision should be ignored, for example, costs to which the business is
already committed.
Finance costs
Certain other costs will also be irrelevant to decision-making, such as ‘finance costs’. This is because interest has already
been taken into account in the discounting process.
2 Health Foods Ltd
(a) Projected cash flow statement £’000

Operating profit 8,085
Depreciation 200
Finance costs (785)
Tax paid (w.1) (1,836)
Dividends paid (w.2) (1,577)
Fixed asset purchases (w.3) (500)
Increase in stock (w.4) (1,078)
Increase in debtors (w.5) (775)
Decrease in trade creditors (w.6) (14)
––––––
Projected increase in cash over the year 1,720
––––––
12
Reconciled as follows: £’000
Cash per BS at 30/06/06 (1,264)
Cash per BS at 30/06/07 2,984
––––––
Projected increase in cash over the year 1,720
––––––
Workings
1. Tax paid £’000
Tax payable b/f at 01/07/06 (1,895)
Tax charge for y/e 30/06/07 (2,230)
Tax payable c/f at 30/06/07 2,289
––––––
Therefore cash paid (1,836)
––––––
2. Dividends paid
Dividends payable b/f at 01/07/06 (1,542)
Dividend charge for y/e 30/06/07 (2,270)
Dividends payable c/f at 30/06/07 2,235
––––––
Therefore cash paid (1,577)
––––––
3. Fixed asset purchases
Fixed assets b/f at 01/07/06 8,000
Depr’n charge for y/e 30/06/07 (200)
Fixed assets at 30/06/07 (8,300)
––––––
Therefore cash paid (500)
––––––
4. Increase in stock
Stock as at 30/06/07 3,245
Stock as at 30/06/06 (2,167)
––––––
Increase 1,078
––––––
5. Increase in debtors
Debtors as at 30/06/07 3,318
Debtors as at 30/06/06 (2,543)
––––––
Increase 775
––––––
6. Decrease in trade creditors
Trade creditors as at 30/06/07 1,723
Trade creditors as at 30/06/06 (1,737)
––––––
Decrease (14)
––––––
Note: full marks given for any method of arriving at projected increase in cash over the year. An example of another
approach is summarised below
£’000
Receipts (20,350 + 2,543 – 3,318) 19,575
Payments for operating expenses
(12,265 – 1,723 + 1,737 – 200 + 3,245 – 2,167) (13,157)
Interest paid (785)
Tax paid (w.1) (1,836)
Dividends paid (w.2) (1,577)
Fixed asset purchases (w.3) (500)
–––––
1,720
–––––
(b) Drawbacks of Baumol model

1. It does not take into account costs associated with running out of cash.
2. The model only works properly for a firm which uses up cash at a steady rate throughout the year. In practice, most
firms are likely to have large inflows or outflows of cash from time to time.
3. In practice, it will be difficult to predict future cash requirements with certainty.
4. Future interest rates are difficult to estimate.
5. It assumes that transaction costs are constant but, in practice, they may vary.
13
3 Shoes For You Ltd
(a) Days
Raw materials stock period:
Raw materials 133,000
–––––––––––– x 365 = ––––––––– x 365 77
Purchases 630,000
Credit taken from suppliers:
Creditors 73,000
––––––––––––––––––– x 365 = ––––––––– x 365 (40)
Credit overheads (w.1) 670,000
Work in progress:
Work in progress 195,000
––––––––––––––––––––––––––––––––––– x 365 = –––––––––––––––– x 365 77
Cost of sales (w.2) x degree of completion 1,430,000 x 65%
Finished goods:
Finished goods 325,000
––––––––––––– x 365 = –––––––––– x 365 83
Cost of sales 1,430,000
Credit allowed to debtors:
Debtors 410,000
–––––– x 365 = –––––––––– x 365 60
Sales 2,500,000
––––
257
––––
––––
The cash operating cycle is therefore approximately 257 days.
Working 1: Credit overheads
£
Production overheads 350,000
Sales overheads 320,000
––––––––––
Costs on credit 670,000
––––––––––
Working 2: Cost of sales
Materials 630,000
Wages 450,000
Production overheads 350,000
––––––––––
––––––––––
(b) Increase in raw material holding period

Advantage – Since prices are increasing, it makes sense to buy more raw materials before prices increase even more. Overall
purchase costs will therefore be lower.
Disadvantage – Stock holding costs will increase. These include the costs of working capital tied up in stock, warehousing
costs and deterioration costs.
(c) The general problems associated with inflation

(i) Redistribution of income and wealth
Inflation will lead to a redistribution of income and wealth. This is because debts, for example, lose their real value with
inflation. This kind of random redistribution is undesirable as those in positions of economic power tend to gain at the
expense of others.
In Shoes For You Ltd’s case, however, their income is received in sterling. Since this is a stable currency the value of
the company’s debts is not decreasing much in real terms.
(ii) The balance of trade may suffer
If a country has a higher rate of inflation compared to that of the countries it trades with, then its exports become more
expensive for its overseas partners and its imports become cheaper for its residents. This affects the balance of trade
adversely.
In the case of Shoes For You Ltd, the reason the shoes are made in Bushai is because of relatively low materials and
labour costs. Whilst production labour costs are not yet increasing because of fixed wages, materials costs are already
increasing dramatically and it may soon become cheaper to set up a factory elsewhere. In the long-term, labour costs
will have to increase as well otherwise workers will presumably seek employment elsewhere.
14
(iii) Higher interest rates
The central bank in Bushai may counter inflation by raising interest rates. This makes the cost of borrowing higher and
therefore limits investment opportunities. Since all the finance for Shoes For You Ltd is obtained from the UK, this
problem will not affect Shoes For You Ltd.
4 Sources of finance
(a) Sources of finance for SMEs

Equity
When the business is first set up, the first (probably main) source of finance will be equity injected by the owner, and possibly
by family and friends. The owner may have to re-mortgage his home to obtain funds.
Since the business will have few tangible assets at this stage, it will be difficult to obtain equity from elsewhere.
Once the business becomes more established, equity finance will become more readily available. Shares can be sold privately
to investors. Since equity owners also have the right to participate in the running of the business, through voting, the initial
owner may wish to sell a small number of shares to a number of investors so as to maintain control.
Overdrafts
An overdraft is a deficit on a bank current account.
Overdrafts are suitable for short-term borrowing only. This is because they are usually expensive, both in terms of arrangement
fees and in terms of interest charges. Also, they are repayable on demand. This means that the bank can withdraw the facility
at any time, usually at a time when the business most needs the cash because of financial difficulties.
Although overdrafts are not suitable for long term borrowing, they are often used as a permanent source of finance.
Loans
If an overdraft appears to be becoming too permanent, the bank may suggest that it is converted into a medium term loan.
In this way, the business is forced to start repaying some of it.
The bank may also provide loans for the purchase of fixed assets or for expansion of the business.
In general terms, overdrafts are more suitable for the financing of working capital and loans are more suitable for longer term
assets or projects.
Trade credit
Trade credit is often used as a source of finance for small and medium-sized enterprises (SMEs), particularly when the
business is first starting up. Ironically, this is the time when such finance can be difficult to obtain, due to lack of the
business’s reputation and credit history.
The cost of trade finance has to be weighed up, taking into account both loss of early payment discounts and loss of supplier
goodwill.
Business angel financing
Business angels may be either individuals or groups of individuals. They are characterised by their wealth! Such forms of
financing tends to be informal and it is very much a question of knowing the right people.
The informal nature of this type of financing can be both a strength and a weakness. It is a strength because many of the
onerous formalities relating to provision of information to financiers are avoided. However, it is a weakness because of the
lack of a formal business angel market through which finance can be sought.
Venture capital
Venture capitalists tend to invest in new businesses and specific expansion schemes. They tend to be attracted to businesses
that will eventually be listed on the stock exchange, both because businesses of this size will generate the largest profits and
because this also gives them an exit route in the future. Many of the smaller SMEs will simply not be big enough for venture
capital finance. Also, venture capitalists will want to become involved in running the business because of their need to protect
their investment.
Note: Only four sources were required.
(b) Limitations of ratio analysis

– On their own, ratios do not provide information that can be used to assess a business’s performance. They are only
useful when comparative figures are also available, whether these be budgeted figures, prior year figures, or figures for
similar companies.
– Where price inflation has occurred, ratios comparing different time periods will not be directly comparable. The wrong
conclusions may therefore be drawn about a business’s performance. In order to rectify this, adjustments would have
to be made to allow for price differences.
– Many of the key ratios used actually have numerous different definitions. For example, there are several ways of defining
gearing. It is therefore essential to ensure that the exact same definition is being used before ratio analysis is relied upon.
15
– When the performance of different companies is being compared, ratios are usually calculated from the companies’
financial statements. The problem with this is that these accounts will not have been prepared using exactly the same
accounting policies. For example, one company may use the straight line method for depreciation whilst the other uses
the reducing balance method. Therefore, once again, inaccurate conclusions may be drawn.
– Ratio analysis is only useful to the extent that key information is readily available. It may be that a business has changed
its management accounting system in the year meaning that comparable information is not available in the required
format.
– The information on which the ratios are based is historical – not current. A lot might have happened between the date
that the accounts were prepared and the date when they are being analysed.
NOTE: Only four limitations were required.
16
Marks
1 Maybay Hospital
(a) NPV of costs

Not contracting out:
F/T staff costs 5
P/T staff costs 2
Cleaning materials 1
Insurance costs 1
Fines 1
Administration costs 1
Annuity factor calculation 1
Net cash flow 1
DCF 2
Contractors’ research costs ignored 1
Net present value 1
–––
Max marks 16
–––
Contracting out
Annual contract costs 1
Insurance cost savings 1
Revised fine costs 2
Lost admissions 1
Machine sales 1
Reduced administration costs 1
Redundancy costs 1
Net cash flow 1
DCF 2
Net present value 1
–––
12
–––
Presentation 1
Conclusion 1
–––
2
–––
Total 30
–––
(b) Other factors

Each factor 1
–––
Max marks 4
–––
(c) Relevant costs

Future costs 1
Cash flows 1
Incremental costs 1
Opportunity costs 1
Committed costs 1
Finance costs 1
–––
6
–––
Total marks 40
–––
17
Marks
2 Health Foods Ltd
(a) Projected cash flow

Operating profit 1
Depreciation 1
Interest paid 1
Tax paid 2
Dividends paid 2
Fixed asset purchases 2
Increase in stock 2
Increase in debtors 2
Decrease in trade creditors 2
Projected cash flow 1
–––
16
–––
(b) Drawbacks of Baumol model

Each drawback 1
–––
Max marks 4
–––
Total marks 20
–––
3 Shoes For You Ltd
(a) Cash operating cycle

Credit overheads calculation 1
COS calculation 2
RM days 1
Creditor days 1
WIP days 2
FG days 1
Debtor days 1
Length of cycle 1
–––
10
–––
(b) Raw material holding period

Advantage 2
Disadvantage 2
–––
4
–––
(c) General problems of inflation

Redistribution – max. 2
Balance of trade 2
Higher interest rates 2
–––
Max marks 6
–––
(1 mark for each sensible comment, subject to the maximum)
Total marks 20
–––
18
Marks
4 Sources of finance
(a) Sources for SMEs

Equity 3
Overdrafts 3
Loans 3
Trade credit 3
Business angels 3
Venture capital 3
–––
Max marks 12
–––
(b) Limitations of ratio analysis

Each limitation 2
–––
Max marks 8
–––
Total marks 20
–––
19
Paper T10
Managing Finances
ADVANCED LEVEL
QUESTION PAPER

hall

1 Morello Landscapes is a small business established several years ago. The owner, Mr Morello, designs and landscapes
gardens for a range of clients using his team of five employees. The firm works on one job at a time. Mr Morello has
just signed a contract with a local building firm to landscape the gardens on a development of thirty executive houses.
His designs have already been accepted and he has agreed to complete the work within a six-month period, starting
on 1 January 2007. Should he fail to complete the work on time, he will have to pay a penalty. Should the work be
completed early, workers can begin working on the next project.
Mr Morello understands the importance of careful cash budgeting and wants to prepare the cash budget for the next
six months, from January to June 2007.
The following information has been obtained:
(i) Opening debtors are forecast to be £2,400, all of which will be received in January.
(ii) A price of £400,000 has been agreed for the contract. The amount will be paid in instalments as follows:
January 5%
February 15%
March 10%
April 10%
May 10%
June 50%
(iii) Opening creditors, which will be paid in January, are forecast to be as follows:
Materials £6,600
Miscellaneous £2,570
(iv) Five diggers will be hired at the start of the job in January to level the land. They will be hired for the whole
month at a cost of £1,200 each. The fee is payable in full on the first day of hire. A deposit of £500 per digger
is also payable at this point but this amount is refunded in full on the return of the vehicles on the first day of
February.
(v) Various materials are needed to complete the work and these will be purchased at different times over the six
months. Ace Ltd supplies all the soil and turf and Hardcastle Ltd supplies the sand, cement and bricks/stones.
Shrubs and ‘other materials’ are bought from several different companies. Materials have to be kept on the
driveways of the properties during the landscaping process. Since space is restricted, the following schedule of
purchases has been drawn up:
Materials Month Purchased Amount Credit terms
Soil January £12,600 None
Sand February £2,200 One month
Cement February £3,100 One month
Bricks/stones March £85,000 Two months
Turf May £48,000 One month
Shrubs May £16,700 None
Other materials Every month £2,000 per month None
The two key suppliers do charge delivery costs but these are already included in the above amounts. Both key
suppliers also give a 10% bulk order discount on any individual order that exceeds £40,000 in any given month.
Mr Morello has not taken any bulk discounts into account when calculating the above figures.
(vi) A waste disposal company has agreed to remove waste throughout the six months at a total cost of £8,500. This
must be paid in January.
(vii) Each of Mr Morello’s five employees is paid a salary of £21,600 per annum. They are all paid on the last working
day of each month for that month’s work. Mr Morello has also agreed to give each worker a bonus of £1,500 in
June for completion of the contract within the six-month period.
(viii) The firm uses three vans, which the five workers share. These are leased at an annual cost of £3,960 each,
payable in equal monthly instalments on the first day of each month.
2
(ix) Mr Morello himself uses a business car that has already been fully paid for. He plans to sell the car in April for
£3,000 cash, giving rise to an anticipated profit on disposal of £600. His replacement car, to be bought and
paid for in the same month, is expected to cost £18,500. He charges depreciation of £300 each month in his
accounts for the existing car and will charge £385 per month for the new car. Depreciation is charged in full in
the month of acquisition but not at all in the month of disposal.
(x) Mr Morello’s business account is expected to be overdrawn by £14,200 at the beginning of January.
(xi) The bank charges interest of 1% per month on an overdrawn balance, calculated on the closing bank balance
each month, and payable the following month. No interest is credited on positive balances.
Required:
(a) Prepare a monthly cash budget for each of the six months to 30 June 2007, showing the cash balance at
the end of each month. Assume that the contract is completed on time. (24 marks)
In the past, Mr Morello has had problems with Hardcastle Ltd delivering the wrong materials or delivering the
materials late. Its prices are so good that he does not want to buy from anybody else. However, it has been such a
problem that he is considering making all of these purchases at the beginning of January. He feels that it would also
be useful to have a basic understanding of the essential elements of a contract so that he knows his position when
dealing with problems with suppliers.
(b) Discuss the costs and benefits, for Mr Morello, of ordering materials early. No additional calculations are
required. (8 marks)
(c) Briefly outline two essential elements of a contract. Do not discuss ‘form’ since most contracts do not have
to be in any strict legal form. (4 marks)
(d) The local building firm that Morello Landscapes has entered into the new contract with has only been in business
for five years. Mr Morello therefore had to check on the creditworthiness of the firm.
List four external sources of information that Mr Morello may have used to provide assurance about the
creditworthiness of the local building firm. (4 marks)
(40 marks)
3 [P.T.O.
2 ‘Nippers’ is a children’s nursery. It is a profitable business and demand for child places always exceeds supply because
of the great shortage of local nurseries. It is owned and managed by a lady called Mrs Dibble. All the staff at the
nursery are either relatives or good friends of Mrs Dibble’s and even the shortest-serving member of staff has worked
at the nursery for ten years. Mrs Dibble is planning on retiring on her sixtieth birthday in six years’ time, at which
point she hopes to sell the business to one or some of the existing staff. She wants to work full-time until then since
she enjoys working so much.
She is currently considering whether to extend the building in order to create more space so that she can meet the
demand for nursery places. Mrs Dibble’s brother has offered to do the extension, by himself, at a very competitive
price. He is currently unemployed and he faces bankruptcy if he does not find work soon. Mrs Dibble estimates that,
with the extension, she would be able to sell the business as a going concern for £600,000 in six years’ time. Without
the extension, she would expect to sell it for £500,000 in six years’ time.
A local builder has recently approached Mrs Dibble with an unexpected offer to buy the nursery now for £850,000.
He hopes to build apartments on the land.
Mrs Dibble needs to decide whether to carry on in business without the extension (Option 1), have the extension built
(Option 2), or sell to the developer (Option 3). The following information is available.
1. Mrs Dibble has already obtained preliminary planning permission for the extension at a cost of £1,200.
2. Mrs Dibble’s building costs are estimated to be £85,000. Of this amount, £45,000 relates to materials and must
be paid immediately. The balance of the building costs relates to labour and will be paid on completion of the
work. The work would take one year to complete. The nursery would still be open as usual during the year so
revenue would be unaffected by the building work.
3. The nursery currently generates net cash inflows of £98,000 per annum. With the extension, these would rise
to £135,000 once the work is complete. Mrs Dibble pays herself a salary, but this amount has already been
deducted before arriving at the £98,000.
4. The nursery’s cost of capital is 10% per annum.
5. Assume that all cash flows occur at the end of each year, unless otherwise stated.
Required:
(a) Using the discount tables provided at the end of the question, calculate the net present value (NPV) of each
option at the business’s cost of capital. Based on these calculations, conclude as to which option Mrs Dibble
should choose. (16 marks)
(b) Outline four non-financial factors that Mrs Dibble should take into account before finally making a decision.
(4 marks)
Discount factor tables at a discount rate of 10%
Time Factor
1 0·909
2 0·826
3 0·751
4 0·683
5 0·621
6 0·564
Annuity factor tables at a discount rate of 10%
Time Factor
1 0·909
2 1·736
3 2·487
4 3·170
5 3·791
6 4·355
(20 marks)
4
3 Noise Ltd makes and sells sound equipment to a range of clients. Its main supplier, Speak Ltd, has never offered
discounts for early payment so Noise Ltd has always taken the full 60 days’ credit allowed by Speak Ltd.
Speak Ltd has recently been having problems collecting its debts on time. Following this, a decision has been made
to offer customers a 2% discount for all invoices paid within two weeks (14 days) of purchase.
Noise Ltd can invest cash to obtain an annual return of 12%.
Required:
(a) Determine whether it is financially viable for Noise Ltd to take advantage of the early payment discount.
(7 marks)
(b) From Speak Ltd’s point of view, what might be three benefits of offering such settlement discounts to its
customers? (3 marks)
(c) Discuss four features of a credit control system that would encourage customers to pay on time.
(10 marks)
(20 marks)
4 Zimmer plc is a listed company specialising in the manufacture and distribution of mobility aids, ranging from walking
sticks to wheelchairs. The company directors are considering branching out into the manufacture and distribution of
stair lifts. Such expansion would require considerable capital investment and the company is therefore considering
how it could finance the project.
Required:
Explain:
(a) the advantages and disadvantages, to a company, of debt finance over equity finance; (8 marks)
(b) the reasons why a company may choose to issue preference shares rather than ordinary shares or debt;
(4 marks)
(c) four factors that will be taken into account by a bank when deciding whether or not to lend money to a client.
(8 marks)
(20 marks)
5
Answers

1 Morello Landscapes
(a) Cash budget Jan Feb Mar Apr May Jun
£ £ £ £ £ £
Cash inflows
Opening debtors 2,400
Contract receipts 20,000 60,000 40,000 40,000 40,000 200,000
Returned deposits (5 x £500) 2,500
Car disposal proceeds 3,000
––––––– ––––––– ––––––– ––––––– ––––––– ––––––––
22,400 62,500 40,000 43,000 40,000 200,000
––––––– ––––––– ––––––– ––––––– ––––––– ––––––––
Cash outflows
Opening creditors:
– Materials 6,600
– Miscellaneous 2,570
Digger hire (5 x £1,200) 6,000
Digger deposit (5 x £500) 2,500
Materials:
– Soil 12,600
– Turf 43,200
– Sand 2,200
– Cement 3,100
– Bricks/stones 76,500
– Shrubs 16,700
– Other materials 2,000 2,000 2,000 2,000 2,000 2,000
Waste disposal 8,500
Salaries [(£21,600/12) x 5] 9,000 9,000 9,000 9,000 9,000 9,000
Bonus (5 x £1,500) 7,500
Van lease payments[(£3,960/12)x3] 990 990 990 990 990 990
New car costs 18,500
Depreciation – ignore (non-cash)
––––––– ––––––– ––––––– ––––––– ––––––– ––––––––
50,760 11,990 17,290 30,490 105,190 62,690
––––––– ––––––– ––––––– ––––––– ––––––– ––––––––
Net cash flow (28,360) 50,510 22,710 12,510 (65,190) 137,310
Opening balance (14,200) (42,702) 7,381 30,091 42,601 (22,589)
Overdraft interest (142) (427) – – – (226)
––––––– ––––––– ––––––– ––––––– ––––––– ––––––––
Closing balance (42,702) 7,381 30,091 42,601 (22,589) 114,495
––––––– ––––––– ––––––– ––––––– ––––––– ––––––––
(b) Benefits
Mr Morello will reduce his delivery costs since only one delivery from Hardcastle Ltd will be necessary.
He may also reduce his purchase costs by making purchases before any potential price rises come into effect.
He will also benefit from an increased bulk purchase discount, since he will now receive a 10% discount on the sand and
cement.
The materials will also be available as and when required. This means that workers will not have to sit idle waiting for
materials to arrive. There will therefore be a greater chance of the contract being completed on time. In turn, this means that
the penalty will not be payable.
Workers will also be able to start another job earlier should the contract be completed within the six month period. This will
bring extra revenue to the business.
Costs
If more materials are left on driveways for longer, there is an increased risk of stock loss either due to pilferage, weather, or
accidents. For example, the sand and cement may get damaged by rain/wind, and the stones/bricks may get cracked.
Since there is restricted storage space on the driveways anyway, some materials may need to be stored elsewhere, for which
there will be a cost (e.g. local warehouse).
Insurance costs will probably rise if greater quantities of stock are to be held at one time.
There is also the cost of capital being tied up in stock.
Finally, if the customer needs to change his requirements, pre-ordered materials may become surplus, resulting in increased
costs for Mr Morello unless the contract states that changes the customer will be responsible for such costs.
9
(c) Contracts
Legal intention
Both parties to a contract must have intended it to be legally binding. In commercial arrangements such intention is assumed.
In domestic or social arrangements such intention may need to be proved.
Offer
An ‘offer’ is a definite promise to be bound on specific terms. It can be made orally or in writing. It can also be implied from
a person’s conduct. An offer can be revoked at any time before it is accepted.
Acceptance
‘Acceptance’ is the unconditional agreement, by the offeree, to all the terms of the offer. As with an offer, it can also be oral,
written or implied from a person’s conduct.
Consideration
‘Consideration’ is one party doing something in exchange for another party doing something. Often, there is just an exchange
of promises, or alternatively, consideration may simply be the price.
Note: Only two elements were required.
(d) Sources
Bank references
Trade references
Credit reference agencies
The press
County Court records
Company Registry search
Informal conversations with people connected
Internet
NOTE: Only four sources were required.
2 ‘Nippers’
(a) NPV
Option 1: No change
Net present value = (£98,000 x 4·355) + (£500,000 x 0·564) = £708,790
Option 2: Extending the premises
Time
0 1 2–5 6
Planning permission
(ignore – sunk)
Building costs: materials (45,000)
Building costs: – labour (40,000)
Operating cash inflows 98,000 135,000 135,000
Sale price 600,000
–––––––– ––––––– –––––––– ––––––––
Net cash flow (45,000) 58,000 135,000 735,000
–––––––– ––––––– –––––––– ––––––––
Discount factor/Annuity factor 1 0·909 2·882 0·564
–––––––– ––––––– –––––––– ––––––––
Discounted cash flow (45,000) 52,722 389,070 414,540
–––––––– ––––––– –––––––– ––––––––
The NPV of option 2 is £811,332
Working 1
AF for T2 to T5 = 3·791 – 0·909 = 2·882
Option 3: Selling
Since the nursery would be sold immediately, the NPV of this option is simply the sale proceeds of £850,000 (applying a
discount factor of 1 at T0)
Mrs Dibble should sell to the developer (Option 3) since this option produces the highest NPV.
10
(b) Other factors to take into account
– If Mrs Dibble extends the nursery she will provide work for her brother and stop him from possibly going bankrupt.
– The extension will also provide much needed additional child care places for local children.
– The extension will enable Mrs Dibble to carry on working. She may have to look for a new job if she sells up, given that
she wishes to work until retirement age.
– Mrs Dibble's staff will all lose their jobs if she sells to the developer.
– The shortage of child care in the area will increase further if Mrs Dibble sells to the developer since all the children will
lose their places at the nursery.
– However, the building of the extension is likely to cause some noise and disruption at the nursery.
– Mrs Dibble may want the building to remain a nursery, in part as a monument to her good work over the years.
Note: Only four factors were required.
3 Noise Ltd
(a) Whether to pay within one week
Effective interest rate over 46 days is:
2
–– = 2·04%
98
Compound annual interest rate is:
[1·0204 365/46 – 1] x 100 = 17·38%.
365
(Simple annual interest rate is 2·04% x ––– = 16·18%.)
46
Noise Ltd should pay early as the annualised benefit of the discount (17·38%) exceeds the opportunity cost of capital (12%)
[Alternative method of calculation
Cost of not taking the discount:
⎛ 365 ⎞
⎜ 100 t –1⎟ × 100
⎜ 100 – d ⎟
⎝ ⎠
where d is the size of the discount;

t is the reduction in payment period in days which would be necessary to obtain the discount.
⎛ 365 ⎞
⎜ 100 46 –1⎟ ×100 =17·38%]
⎜ 98 ⎟
⎝ ⎠
(b) Benefits of offering settlement discounts

– Customers are encouraged to pay early, which reduces the costs associated with providing trade credit, such as financing
costs, and also the administrative costs of chasing debts.
– The cash flow position of Speak Ltd will be improved, enabling the company to maintain liquidity.
– Customers may actually buy more from Speak Ltd, as the discount may make their prices appear cheaper than those of
competitors.
– There may be fewer bad debts arising since customers are keen to pay early and benefit from discounts.
Note: Only three benefits were required.
(c) Credit control systems

Awareness of supplier’s terms
The customer must be fully aware of the supplier’s terms. As well as the terms being clearly printed in bold on the face of
every invoice, payment terms should be clearly stated in writing when the order is confirmed.
Even before this time, when the customer account is set up, the contract should state that the customer accepts the supplier’s
terms.
Accurate and prompt invoicing
Invoices should be correctly drawn up. They will need to include the customer’s name and address, product details and costs,
customer’s authorisation reference, purchase order number and supplier’s details. The invoice should be totalled correctly and
it should be clear where payment is to be sent to and by what time.
The invoice must be sent out promptly to maximise time for payment.
11
Awareness of customer’s systems
It is important to understand the payment system at your customer’s business. Some businesses make payments to suppliers
only once a month. If this is the case, they will have a cut off point each month by which invoices must be received and
processed. Some businesses have an informal policy that suppliers are not to be paid until a reminder or even final reminder
is received.
Some businesses will only pay out a certain amount each month in order to control their cash flow.
Without this knowledge of client’s systems, debts cannot always be collected promptly.
System of statements and reminders
Your customer should be sent a monthly statement showing, as a minimum, the individual invoices outstanding, the age of
the invoices and the total balance outstanding.
Late payments should always be followed by the issue of a reminder and perhaps a telephone call. Should the debt still
remain unpaid, a final reminder should be issued.
If all else fails and it appears that the customer has no intention of paying, the debt should be passed promptly to a debt
collection agency.
4 Zimmer plc
(a) Advantages of debt finance
– Debt finance is cheaper than equity finance. This is because, firstly, it is less risky for the lender and, secondly, interest
on debt is deductible for tax purposes whereas dividend payments are not.
– Issuing debt is relatively cheap compared to issuing equity. This is because there is no need to issue a prospectus etc
for a debt issue.
– The issue of debt does not affect ownership and control of the company because debt holders are not owners of the
company.
– It is easier to arrange debt finance than equity finance. The company law requirements and the Stock Exchange rules
(if it is a listed company) make the issue of equity quite a lengthy procedure.
Disadvantages of debt finance
– As the level of debt increases with each debt issue, the cost of equity will also increase to reflect the increased financial
risk of the company.
– Debt, unlike equity, has to be repaid at the end of its term. This can cause financial difficulty for the company if they
have insufficient funds. If a company cannot pay its debts it faces the risk of bankruptcy.
– Interest MUST be paid on debt whereas dividend payments on ordinary shares are discretionary. Unlike with dividends,
if the company is having a bad year it must still pay its interest charges.
– If the company has borrowed at a floating rate of interest, the company is subject to interest rate risk. This means it risks
having to pay increased interest charges if the interest rates go up.
– Security for the debt may be required by the lender. This can restrict the company’s use of the assets on which the debt
is secured.
– Loan agreements may make the company subject to restrictive covenants. These are effectively promises to keep, e.g.,
the current ratio at a certain level.
(b) Reasons for issuing preference shares

– Preference shares do not carry voting rights. This means that they do not give the purchaser any control over the
decisions made by the company. Hence, the issue of preference shares does not dilute control.
– Preference share capital is not secured on the assets of the company like debt. It does not therefore restrict the
company’s borrowing power or its use of its assets.
– Preference dividends do not have to be paid if the company cannot afford it, although they will often carry the right to
cumulative dividends, i.e. if the dividend is not paid one year, it is carried forward to the next year and so on.
– Irredeemable preference shares lower the company’s gearing ratio, which is generally seen as a good thing. However,
redeemable preference shares are usually treated as debt for the purpose of calculating the gearing ratio, so they WILL
increase gearing.
12
(c) Factors considered by a bank
The factors to be considered are set out below.
The character of the borrower
Before lending money, the bank will need to decide whether the borrower is of good character. This will involve looking at the
borrower’s past record and conducting a personal interview with the applicant.
If a person is applying for a loan, they will often be credit scored. If a company is making the application, the bank will
probably use key ratios to analyse the company’s financial position.
The ability to borrow and repay
The bank looks at a business customer’s financial performance in order to ascertain their likely future position.
If the owner re-invests profits in the business rather than drawing them all out, it shows that he has some confidence in the
success of the business. This makes the bank more likely to lend to the business.
When dealing with a company that is applying for finance, the bank may check whether the company has the authority to
borrow the funds it is requesting. The company’s articles of association provide this information.
The margin of profits
The bank lends money in order to make money. It needs to ensure that it makes enough of a profit to warrant the risk that it
takes by lending.
Most banks have lending policies which require them to charge different interest rates to customers depending on the reason
for the borrowing. This is because some types of lending are more risky than others.
Ultimately, it is the bank’s discretion to charge whatever interest rate they choose. For risky ventures, the rate will obviously
be higher.
The purpose of the borrowing affects not only the interest rate but also the bank’s decision as to whether or not to lend in the
first place.
A bank will not lend money for an illegal purpose. It will normally lend in order to finance working capital, provided that the
company’s liquidity position is still manageable.
Lending to finance new business ventures is more risky since many of them fail. The bank will be more cautious in these
cases.
Amount of the borrowing
Firstly, the bank will need to make sure that the applicant is not asking for more money than he needs for the purpose
specified. If he is, this casts doubt over his ability to repay.
Secondly, the bank needs to be sure that the applicant is asking for enough money. If he is not, the bank may well end up
having to lend more in order to safeguard the original loan.
Repayment terms
The bank must not lend money to a person or company who does not have the ability to repay it, with interest, irrespective
of any security available for the loan. Security should only be called upon as a last resort if there is a sudden unexpected
inability to pay.
A repayment term should be set which is realistic. Overdrafts are repayable on demand and are therefore more risky for the
borrower.
Insurance against the possibility of non-payment
When lending large sums of money to an individual or to a company, the bank may well ask for the loan to be secured. This
security may take the form of title deeds to property – either property of the company or the individual’s house, depending
on who is making the application for finance.
A borrower may take out payment protection insurance, so that his repayments are covered even if his financial position
deteriorates.
Note: Only four factors were required.
13
Marks
1 (a) Cash budget
Opening debtors 0·5
Contract receipts 2
Returned deposits 0·5
Van sales proceeds – correct fig. 2
Opening creditors:
– materials 0·5
– miscellaneous 0·5
Digger hire 0·5
Digger deposit 0·5
Materials:
– Soil 1
– Turf 1
– Sand 1
– Cement 1
– Bricks/stones 1
– Shrubs 1
– Other materials 1
Waste disposal 0·5
Salaries 0·5
Bonus 0·5
Van lease payments 1
New van costs 0·5
Depreciation – ignore 2
Net cash flow 1
Opening balance 1
Closing balance 1
Presentation 1
–––
24
–––
(b) Stock
Benefits
– delivery costs 1
– bulk order discount 1
– materials readily available 1
– no penalty 1
– increased revenue 1
– avoid price increases 1
Costs
– damage to stock 1
– warehouse cost 1
– insurance cost 1
– capital tied up 1
– materials becoming surplus 1
–––
Max. marks 8
–––
(c) Contracts
Each element 2
–––
Max. marks 4
–––
(d) Creditworthiness
Every source 1
–––
Max. marks 4
–––
Total marks 40
–––
15
Marks
2 (a) NPVs
Option 1
Correct relevant cash flows 1
Correct DF/AF 1
Follow-on NPV 1
Option 2
Planning permission 1
(ignore – sunk)
Building costs: materials 1
Building costs: – labour 1
Operating cash inflows 2
Sale price 1
Correct DF/AF 1
Net cash flow 1
Discounted cash flow 1
Follow-on NPV 1
Option 3
Correct NPV 1
Use of annuity factors 1
Conclusion 1
Presentation 1
–––
Max. marks 16
–––
(b) Factors
Each factor 1
–––
Max. marks 4
–––
Total marks 20
–––
3 (a) Discount calculation

Effective discount 3
Annualised 3
Conclusion 1
–––
Marks 7
–––
(b) Benefits of settlement discounts

Each benefit 1
–––
Max. marks 3
–––
(c) Features
Supplier’s terms 3
Accurate and prompt invoicing 3
Customer’s systems 3
Statements and reminders 3
–––
Max. marks 10
–––
Total marks 20
–––
16
Marks
4 (a) Debt
For each adv./disadv explained 2
–––
Max. marks 8
–––
(b) Preference shares

Each reason 2
–––
Max. marks 4
–––
(c) Bank lending

Each factor explained 2
–––
Max. marks 8
–––
Total marks 20
–––
17
Paper T10
Managing Finances
ADVANCED LEVEL
QUESTION PAPER

hall

1 Go Green Ltd is a small company specialising in the manufacture of a small range of environmentally friendly toiletries
and cleaning products. It is considering extending its production lines to include environmentally friendly soap and
washing-up liquid.
The company’s research and development department has already spent £450,000 developing the products and a
further £325,000 on test marketing them. If the company decides to proceed with the project, new machinery will
be purchased immediately and production will commence straight away.
Notes
1. Forecast sales in ‘000 units, are as follows:
Years
1 2 3 4 5
Soap 250 200 150 90 30
Washing up liquid 240 280 320 170 50
2. Forecasts for the revenues and costs per unit for each of the new products have been made, as detailed below.
However, these may need to be revised as per notes (a) to (c) below.
Soap Washing-up liquid
£ £
Selling price 1·75 1·60
Direct materials (0·15) (0·35)
Direct labour (note a) (0·25) (0·12)
Variable overheads (note b) (0·50) (0·24)
Allocated fixed overheads (note c) (0·65) (0·65)
–––––– ––––––
Profit £0·20 £0·24
––––––
–––––– ––––––
––––––
(a) The product cost cards for both products above have been prepared on the basis that each factory worker
is paid a standard hourly rate of £6. Further details of labour requirements are as follows:
Year one
Production of each unit of soap requires 2·5 minutes of one factory worker’s time. However, all workers are
currently working to full capacity. Therefore, for the first year’s production of soap, they will have to work
overtime, for which they are paid £7·20 per hour.
Production of each unit of washing-up liquid requires 1·2 minutes of one factory worker’s time. During the
first year, temporary workers provided by an agency will be used to produce the washing-up liquid at a cost
to the company of £7 per hour.
Years two to five
New permanent staff will be recruited to produce both soap and washing-up liquid. They will be paid at the
company’s standard hourly rate of £6 per hour.
(b) Variable overheads represent factory power costs, which vary according to labour hours worked.
(c) Allocated fixed overheads comprise factory rental costs of £0·10 per unit and depreciation of £0·55 per unit.
3. The company will need to purchase a new piece of machinery immediately costing £500,000 if the project is to
proceed. Some modifications will need to be made to the machinery on site. They will take place as soon as the
machinery is purchased and will take two days to complete. The cost of these will be £150,000, payable on
completion. The machinery will have no scrap value at the end of the project.
4. There are currently two production lines that are not in use on the top floor of the factory. If the project goes
ahead, these two lines will be used for production. If the project does not go ahead the top floor will be rented
out immediately to a third party, producing income of £125,000 per annum, receivable annually in arrears.
5. Go Green Ltd’s cost of capital is 10% per annum.
6. Assume that all cash flows occur at the end of the year unless otherwise stated.
2
7. All workings should be in £’000 to the nearest £’000.
Required:
(a) Using the discount factors provided, calculate the net present value of the proposed project over five years
and conclude whether the project should be accepted. (20 marks)
(b) Calculate the internal rate of return of the project using the tables provided. (5 marks)
(c) Calculate the discounted payback period for the project at the company’s cost of capital. If the company only
accepted projects with a discounted payback period of three years or less, decide whether the company
should accept this project. (4 marks)
The company has now decided that the project should be funded using debt finance, but it is unsure which form of
debt finance would be best.
Required:
(d) Discuss three factors that any business should consider when deciding whether a loan or an overdraft is the
best way to finance a project. (6 marks)
(e) Recommend and briefly explain whether an overdraft or a loan would be the most appropriate form of finance
for Go Green Ltd. (3 marks)
(f) What is the UK government’s ‘Loan Guarantee Scheme’ and how might it help Go Green Ltd, if required?
(2 marks)
Extracts from discount factor tables
Time Factor Factor
10% 20%
1 0·909 0·833
2 0·826 0·694
3 0·751 0·579
4 0·683 0·482
5 0·621 0·402
(40 marks)
3 [P.T.O.
2 Camp Ltd is a retailer of real wood flooring. It buys and sells 20,000 packs of flooring each year from its supplier,
Strong Ltd.
The real wood flooring from Strong Ltd costs £35 per pack. There is an order processing charge of £150 per order,
irrespective of the quantity of packs ordered, and Strong Ltd takes 10 days to deliver the wood flooring. The average
cost of holding one pack of real wood flooring for one year is £9.
A new supplier of real wood flooring, Fake Ltd, has offered Camp Ltd wood flooring on slightly different terms. Fake
Ltd guarantees that its wood will never arrive damaged since it uses special packaging designed for maximum
protection. It charges £34·95 per pack for the flooring. There is an order processing charge of £160 per order,
irrespective of the quantity of packs ordered, and Fake Ltd takes 7 days to deliver the goods. The average cost of
holding one pack of Fake Ltd’s real wood flooring for one year is £12. This is because the special packaging takes up
additional storage space.
The economic order quantity, which will minimise costs, is:
2CoD
EOQ =
Ch
Where Co = the cost of placing one order
D = the annual demand in units
Ch = the cost of holding one unit per annum.
Required:
(a) Under the current arrangement, calculate:
(i) the economic order quantity for packs of wood flooring;
(ii) the total cost (ordering, purchase and holding cost) of stocking wood flooring for one year. (5 marks)
(b) For the new supplier calculate:

(i) the economic order quantity for packs of wood flooring;
(ii) the total cost (ordering, purchase and holding cost) of stocking wood flooring for one year (5 marks)
Camp Ltd has decided that it is NOT going to change suppliers. It, therefore, contacts Fake Ltd and informs them that
it does not wish to change suppliers. Fake Ltd has now offered Camp Ltd a bulk purchase discount of 1% on all single
orders for 2,000 or more packs of wood.
Required:
(c) Calculate and conclude whether it is worth accepting the offer by ordering 2,000 packs at a time from Fake
Ltd. (4 marks)
(d) Outline three non-financial factors that should be taken into account when deciding whether to change
suppliers from Strong Ltd to Fake Ltd. (6 marks)
(20 marks)
4
3 Porkys Ltd is an ice cream manufacturing company preparing its accounts to 31 May each year. The company’s peak
season occurs in the months of July, August and September and it always prepares a profit forecast for this period.
The following cash budget has been prepared for the six months ending 30 November 2007.
Jun Jul Aug Sep Oct Nov
£’000 £’000 £’000 £’000 £’000 £’000
Receipts from sales 1,100 1,250 1,400 1,800 2,200 1,700
Sale of machinery – 45 – – – –
–––––– –––––– –––––– –––––– –––––– ––––––
Total receipts 1,100 1,295 1,400 1,800 2,200 1,700
––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
––––––
Payments
Ingredients 250 280 360 440 340 340
Labour 350 450 550 425 275 250
Sundry expenses 75 85 95 80 70 65
Purchase of machinery – – 120 – 60 –
Loan repayments 50 – 50 – 50 –
–––––– –––––– –––––– –––––– –––––– ––––––
Total payments 725 815 1,175 945 795 655
––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
––––––
Receipts less payments 375 480 225 855 1,405 1,045
Opening cash balance b/f 1,400 1,775 2,255 2,480 3,385 4,790
Interest received – – – 50 – –
–––––– –––––– –––––– –––––– –––––– ––––––
Closing cash balance c/f 1,775 2,255 2,480 3,385 4,790 5,835
––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
––––––
Notes/assumptions made when preparing the cash flow forecast
1 Customers always take two month’s credit.
2 The machinery to be sold for £45,000 will give rise to a profit on disposal of £3,000.
3 Depreciation of £13,000 will accrue during the three months ending 30 September 2007.
4 One month’s credit is always taken from suppliers of ingredients.
5 There are no stocks of raw materials or finished goods maintained.
6 Labour is paid by BACS on the last day of each month, for that month’s work.
7 Sundry expenses are all paid in the month in which they are incurred.
8 The loan repayment relates to an interest free loan obtained from Porkys Ltd’s parent company.
9 Interest is received by Porkys Ltd from the bank twice a year. The interest receivable for the peak season of July,
August and September is expected to be £30,000.
10 All workings should be in £’000s to the nearest £’000.
Required:
(a) Prepare a profit forecast for the three months ending 30 September 2007. Show all workings clearly. Where
any items have been excluded from the profit forecast, include a note to justify your treatment of the item.
(10 marks)
Porkys Ltd’s parent company is considering centralising the treasury function for the whole group.
(b) List four roles of a treasury department. (4 marks)
(c) Describe three advantages of having a centralised treasury department. (6 marks)
(20 marks)
5 [P.T.O.
4 Jay Ltd manufactures furniture. It has come under pressure in recent years to reduce prices in order to compete with
some larger competitors in the market. The company’s aim has therefore been to maintain sales levels, with the effect
that debtor control has been allowed to deteriorate. The company has always had a target of keeping the debtors
period at an average of 45 days.
Debtors as at 31 May 2007 are £323,654. Sales for the year ending 31 May 2007 were £1,581,743. This figure
included £14,250 of cash sales. During this time, debts of £26,784 were written off. All £26,784 relates to sales
made in the year ending 31 May 2007.
Required:
(a) Calculate the current debtors collection period, in days, from the above information. (3 marks)
(b) How much of the year-end debtors’ balance would have to be immediately recovered in order to reduce the
debt collection period to the target level? (2 marks)
(c) Calculate the company’s bad debt ratio for the year ended 31 May 2007. (2 marks)
(d) List five procedures that could be used to pursue the overdue debts. (5 marks)
Jay Ltd has carried out some of the procedures to collect debts. One of its major debtors is still refusing to pay on the
basis that it was not satisfied with the quality of some of the goods it received and had to make refunds to its own
customers. Jay Ltd does not want to sue the customer but has heard of ‘arbitration’.
(e) Explain what arbitration is, in this context. (2 marks)
(f) State two advantages and two disadvantages of using arbitration as opposed to taking a case to court.
(4 marks)
You have now learnt that arbitration will not be possible since your client informs you that it is actually insolvent. You
have heard that creditors can attempt to recover monies owing to them through ‘liquidation’.
(g) Briefly explain what happens when a company goes into liquidation. (2 marks)
(20 marks)
6
Answers

Managing Finance June 2007 Answers
1 Go Green Ltd
(a) NPV of the project 0 1 2 3 4 5

£’000 £’000 £’000 £’000 £’000 £’000
Product development costs – sunk
Test marketing costs – sunk
Net cash inflow – soap (w.1) 200 170 128 77 26
Net cash inflow – iquid (w.1) 209 249 285 151 45
Fixed overheads (irrelevant)
New machinery (500)
Modifications (150)
Lost top floor income (125) (125) (125) (125) (125)
–––––– –––––– –––––– –––––– –––––– ––––––
Net cash flow (650) 284 294 288 103 (54)
––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
––––––
Discount factors at 10% 1·000 0·909 0·826 0·751 0·683 0·621
–––––– –––––– –––––– –––––– –––––– ––––––
Present value (650) 258 243 216 70 (34)
––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
––––––
The net present value of the project is approximately £103,000. Since it is positive, the project should be accepted.
Working 1: Net cash inflow per unit
Soap Year 1 Year 2–5
£ £
Sales price 1·75 1·75
Direct materials –0·15 –0·15
Direct labour (£7·20 ÷ 60 x 2·5 for year 1) –0·30 –0·25
Variable overheads –0·50 –0·50
––––– –––––
Net cash inflow per unit 0·8 0·85
–––––
––––– –––––
–––––
Washing up liquid £ £
Sales price 1·60 1·60
Direct materials –0·35 –0·35
Direct labour (£7 ÷ 60 x 1·2 for year 1) –0·14 –0·12
Variable overheads –0·24 –0·24
––––– –––––
Net cash inflow per unit 0·87 0·89
–––––
––––– –––––
–––––
Working 2: Total net cash inflow per year
Soap 1 2 3 4 5
Sales in units (’000) 250 200 150 90 30
Net cash inflow per W.1 0·80 0·85 0·85 0·85 0·85
£’000 £’000 £’000 £’000 £’000
Total net cash inflow 200 170 128 77 26
–––––
––––– –––––
––––– –––––
––––– –––––
––––– –––––
–––––
Washing up liquid
Sales in units (’000) 240 280 320 170 50
Net cash inflow per W.1 0·87 0·89 0·89 0·89 0·89
£’000 £’000 £’000 £’000 £’000
Total net cash inflow 209 249 285 151 45
–––––
––––– –––––
––––– –––––
––––– –––––
––––– –––––
–––––
9
Alternatively, the answer may have been presented as follows, although it would have been more time effective to adopt the
former approach.
Year
0 1 2 3 4 5
£’000 £’000 £’000 £’000 £’000 £’000
Product development costs (sunk)
Test marketing costs (sunk)
Sales: soap 438 350 263 158 53
– washing up liquid 384 448 512 272 80
Direct materials: soap (38) (30) (23) (14) (5)
– washing up liquid (84) (98) (112) (60) (18)
Direct labour: soap (w.1) (75) (50) (38) (23) (8)
– washing up liquid (w.1) (34) (34) (38) (20) (6)
Variable overheads: soap (125) (100) (75) (45) (15)
– washing up liquid (58) (67) (77) (41) (12)
Fixed overheads (irrelevant)
New machinery (500)
Modifications (150)
Lost top floor income (125) (125) (125) (125) (125)
–––––– –––––– –––––– –––––– –––––– ––––––
Net cash flow (650) 283 294 287 102 (56)
––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
––––––
–––––– –––––– –––––– –––––– –––––– ––––––
Present value (650) 257 243 216 70 (35)
––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
––––––
The net present value of the project is approximately £101,000. The difference in NPV compared to the former method used
arises because of rounding differences.
Working 1: Direct labour
Soap: cost per unit in year 1 = £7·20 ÷ 60 x 2·5 = £0·30
1 2 3 4 5
Sales in units 250 200 150 90 30
Cost per unit 0·3 0·25 0·25 0·25 0·25
£’000 £’000 £’000 £’000 £’000
Annual cost 75 50 37·5 22·5 7·5
–––––
––––– –––––
––––– –––––
––––– –––––
––––– ––––
––––
Liquid: cost per unit in year 1 = £7 ÷ 60 x 1·2 = £0·14
1 2 3 4 5
Sales in units 240 280 320 170 50
Cost per unit 0·14 0·12 0·12 0·12 0·12
£’000 £’000 £’000 £’000 £’000
Annual cost 33·6 33·6 38·4 20·4 6
–––––
––––– –––––
––––– –––––
––––– –––––
––––– ––––
––––
(b) IRR of the project Time

0 1 2 3 4 5
£ £ £ £
Net cash flow (650) 284 294 288 103 (54)
–––––– –––––– –––––– –––––– –––––– ––––––
Present value (650) 237 204 167 50 (22)
––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
––––––
The net present value of the project at a discount rate of 20% is approximately £(14,000).
⎛ a ⎞ Where A is the lower rate and B is the higher rate; a is the NPV at the lower rate and b is the
IRR ≈ A + ⎜ × ⎡⎣B – A ⎤⎦ ⎟ NPV at the higher rate.
⎝a –b ⎠
⎛ 103 ⎞
IRR ≈ 10 + ⎜ × ⎡20 – 10⎤⎦ ⎟
⎝ 117 ⎣ ⎠
= 18·655%
= 18·803%
10
(c) Discounted payback period
Time Annual discounted cash flows Cumulative discounted cash flows
£’000 £’000
0 (650) (650)
1 258 (392)
2 243 (149)
3 216 67
4 70 137
5 (34) 104
The discounted payback period for the project is between two and three years. This means that the project will have recovered
its capital outlay at this point.
Since the company accepts projects with a discounted payback period of three years or less, the company should accept the
project.
(d) Factors to consider

If the cash is required to fund temporary shortfalls in cash, it is easier and more appropriate to obtain an overdraft. This is
because an overdraft is more flexible and can be increased or decreased (within its limit) on a day-to-day basis. The main
purpose of an overdraft is to fund day-to-day shortfalls in cash rather than long-term projects.
A loan, on the other hand, is more suitable for a fixed asset investment, the benefits of which will accrue over a number of
years.
Duration of the borrowing
This links in closely with the purpose of the borrowing. If the cash is needed for a long time, a loan should be sought.
Conversely, if the cash is only needed for a short time, an overdraft is more appropriate since this can be paid back just as
soon as the business can afford it. This means that the business only has to pay interest for as long as the borrowing is really
required, rather than interest being payable for the whole term of the loan.
Interest rates
The interest rates payable on an overdraft are often higher than the interest rates payable on a loan. This is because an
overdraft is such a flexible arrangement and that flexibility comes at a cost. A business will want to minimise the interest that
it pays out.
Security
This factor needs to be considered from two angles. Firstly, the bank will probably require security for a medium-term loan.
If the business has no security to offer then it may not be able to obtain the loan. An overdraft is more easily obtained without
security. This is because the bank can keep a close eye on the business’s cash flows and immediately demand repayment of
the overdraft if it has any cause for concern.
Secondly, the business may want to be secure in the knowledge that knows exactly how much its repayments will be and
when they will be due cash for a number of years. It has this security with a loan, whereas, with an overdraft, the bank can
demand repayment at any time.
Note: Only three factors were required.
(e) Finance for Go Green Ltd

The main reason why Go Green Ltd needs cash is to purchase the machinery costing £500,000. This is a fixed asset for
which the benefits will accrue over a long period of time. This would initially indicate that a medium-term loan would be more
appropriate.
A loan may be preferred by the bank since the new machinery may provide adequate security for the loan, although this
depends on the potential resale value of the machinery.
A loan would probably be preferred by Go Green Ltd because, firstly, the interest costs are likely to be lower and, secondly,
the bank cannot suddenly demand repayment of the money in full. This is reassuring, especially since the sales levels do not
rise really high until the third year of the project.
(f) Loan Guarantee Scheme

This scheme is available to small companies with turnover of £5.6 million per annum or less. Through this scheme, the
government facilitates lending to small businesses by providing security for up to 75% of the value of the loan, for loans of a
maximum amount of £250,000.
Therefore, Go Green Ltd could apply for this assistance if it meets the criteria, in order to obtain a loan to assist with the costs
of the machinery. This might be necessary if other security is not available i.e. if, for example, the machinery is not suitable
for use as security for the loan. This may be the case if the machinery’s resale value has been affected by the modifications
made to it.
11
2 Camp Ltd
(a) Current supplier

(i) EOQ
2CoD
EOQ =
Ch
Where the Co = the cost of placing one order
Ch = the cost of holding one unit per annum.
2 × 150 × 20, 000
EOQ =
9
= 816
(ii) Total cost:
Holding cost: average stock x unit holding cost
= (816 ÷ 2) x £9 = £3,672.
Ordering cost = number of orders x £150
Number of orders = annual demand ÷ EOQ
= 20,000 ÷ 816
= 24·5
Therefore ordering cost = £3,675 per annum.
Purchase cost = 20,000 x £35
= £700,000.
Total cost for one year = £3,672 + £3,675 + £700,000
= £707,347
–––––––––
–––––––––
(b) New supplier

(i) EOQ
2 × 160 × 20, 000
EOQ =
12
= 730
(ii) Total cost:
Holding cost: average stock x unit holding cost
= (730 ÷ 2) x £12 = £4,380.
Ordering cost = number of orders x £160
Number of orders = annual demand ÷ EOQ
= 20,000 ÷ 730
= 27·4
Therefore ordering cost = £4,384 per annum.
Purchase cost = 20,000 x £34·95
= £699,000.
= £707,764
–––––––––
–––––––––
(c) Discount
Holding cost = (2,000 ÷ 2) x £12 = £12,000.
Ordering cost = (20,000 ÷ 2,000) x £160
= £1,600.
Purchase cost = £699,000 x 99%
= £692,010.
= £705,610.
–––––––––
–––––––––
The discount means that it is worth changing suppliers.
12
(d) Non-financial factors
– Quality of Fake Ltd’s wood. This may not be as good as Strong Ltd’s wood, although it should be as there is very little
difference in price. The new wood should be closely inspected to ensure that it is of the same thickness as the current
wood.
– Reliability of Fake Ltd. Fake Ltd appears to have a shorter lead time for orders (seven days instead of 10 days) but if
they are not able to send stock consistently on time, Camp Ltd may end up running out of stock. This could mean that
customers go elsewhere, leading to lost revenue for the company.
– Packaging of Fake Ltd’s wood. Fake Ltd’s packaging needs to look attractive, otherwise customers will not buy it. In
addition, it needs to protect the wood well, as the guarantee claims.
– Range. There are many different types of wood, e.g. beech, maple and oak. Camp Ltd need to ensure that all the
currently stocked types of wood are on offer from the new supplier.
– Returns policy. Fake Ltd appear to offer a guaratee that the wood will arrive undamaged but Camp Ltd may still need to
make returns. Fake Ltd’s policy would need to be understood and the extent to which they are contactable to deal with
problems would be relevant.
Note: Only three factors were required.
3 Porkys Ltd
(a) Profit forecast for the three months ending 30 September 2007
£’000
Sales (1) 5,700
Purchases (2) (1,140)
Labour (1,425)
Depreciation (13)
Profit on disposal (3) 3
Interest receivable 30
Sundry expenses (260)
––––––
Net Profit 2,895
––––––
––––––
Workings
1. Sales = receipts from Sept, Oct and Nov. since the cash is received two months in arrears.
£1,800,000 + £2,200,000 + £1,700,000 = £5,700,000.
2. Purchases – paid one month in arrears so use CFF figures from Aug, Sep, Oct.
Ingredients: £’000
(£360,000 + £440,000 + £340,000) 1,140
––––––
3. Profit on disposal – it is this revenue figure that is relevant for the profit and loss forecast, rather than the actual sale
proceeds of £45,000 since this is a capital disposal.
Notes for items excluded from the profit forecast
1. Purchase of machinery – these are capital payments and are only relevant in so far as they are used to calculate
depreciation.
2. Loan repayments – ignored since these are capital in nature, not revenue.
(b) Roles of a treasury department

– banking
– cash management
– funding management
– foreign currency management
– corporate finance
– risk management
– insurance
Note: Only four were required.
(c) Advantages of a centralised treasury department

– higher interest rates may be attainable on investments because the department has larger amounts of cash available for
investment.
– experts can be employed with specialised knowledge, more qualified to make manage risk and make better investment
decisions.
13
– foreign currency management becomes easier, since the foreign currency expenditure in one company can be matched
with receipts in the same currency in another group company.
– lower interest rates may be sought for borrowing, since borrowing can be arranged for the group as a whole.
– the level of cash held for precautionary purposes can be minimised since only one amount will be required for the whole
group.
– the treasury department may be a profit centre in its own right, resulting in an increased likelihood of a profit being
made.
Note: Only three advantages were required.
4 (a) Current debtors collection period

Credit sales = £1,581,743 – £14,250
= £1,567,493
Debtor days= debtors/credit sales x 365
= (£323,654 ÷ £1,567,493) x 365
= 75 days.
(b) Debtors needs to be reduced to:

£1,567,493 x 45/365 = £193,253
Debts to be collected immediately = £323,654 – £193,253
= £130,401.
(c) Bad debt ratio

Bad debt ratio = bad debts/credit sales x 100%
= £26,784 ÷ £1,567,493 x 100%
= 1.7%
(d) Procedures for collecting debts

– Telephone customers and request that they pay their debts as soon as possible, informing them if they have exceeded
their credit period.
– Write to customers, enclosing a copy of their most recent statement showing all their outstanding invoices.
– Arrange a personal visit to customers’ premises so that you can discuss the need for payment and any reasons for non-
payment.
– Freeze customers’ accounts so that they are forced to pay before they can order more goods.
– Send customers formal warnings or final demands, stating that if their debts are not paid, further action will be taken,
and stating what that further action is.
– Refer the debts to a debt collection agency who will pursue debts on the company’s behalf.
– Arrange for your solicitor to send your overdue customers a letter stating that if payment is not received within a certain
period, legal proceedings will be commenced.
– Commence legal proceedings i.e. issue a summons or a writ (depending on the amount of the debt).
Note: Only five were required.
(e) Arbitration is the process whereby a debtor and a creditor enter into a written agreement to submit their dispute to a third
party who assists in its resolution. The parties produce all relevant documents to the arbitrator and are then examined under
oath. The decision of the arbitrator is final.
(f) Advantages
– less costly than court action
– more flexible
Disadvantages
– arbitrator’s powers not as extensive as a judge’s powers in court.
– arbitrator’s decision not as objective, since case not examined in same level of detail, or according to the rules of
evidence in court.
(g) Liquidation
The company is dissolved as a legal entity. Its assets are then sold to raise cash, which is used to pay creditors. Any money
left over (usually none!) is then given to the shareholders.
14
Marks
1 (a) NPV (Alternative method)
Ignoring development costs 1 Ignoring development costs 1
Ignoring test marketing costs 1 Ignoring test marketing costs 1
Net cash inflow – soap: sales fig. 1 Sales: soap 1
Direct materials 1 – washing up liquid 1
Direct labour 2 Direct materials: soap 1
Variable overheads 1 – washing up liquid 1
Net cash inflow – WUL: sales fig. 1 Direct labour: soap 2
Direct materials 1 – washing up liquid 2
Direct labour 2 Variable overheads: soap 1
Variable overheads 1 – washing up liquid 1
Fixed overheads – ignore 1 Fixed overheads – ignore 1
New machinery cost 1 New machinery cost 1
Modifications cost 1 Modifications cost 1
Lost top floor income 1 Lost top floor income 1
Net cash flow 1 Net cash flow 1
Present value 1 Present value 1
NPV 1 NPV 1
Conclusion 1 Conclusion 1
––– –––
20 20
––– –––
(b) IRR
NPV calculation at 20% 2
Correct IRR formula 1
Correct IRR calculation 2
–––
5
–––
(c) Discounted payback

Annual cash flows 1
Cumulative cash flows 1
Discounted payback calculation 1
Conclusion 1
–––
4
–––
(d) Factors
For each factor discussed 2
–––
Total 6
–––
(e) Recommendation
Recommendation 1
Reasons 2
–––
3
–––
(f) Loan guarantee scheme

What it is 1
How it might help. 1
–––
2
–––
Total marks 40
–––
–––
15
Marks
2 (a) Old supplier
EOQ 2
Total costs 3
–––
5
–––
(b) New supplier

EOQ 2
Total costs 3
–––
5
–––
(c) Discount
Total costs 3
Conclusion 1
–––
4
–––
(d) Factors
Each factor 2
–––
Max. 6
–––
Total marks 20
–––
–––
3 (a) Profit and loss forecast

Sales (right figure) 1
Purchases 1
Labour 1
Depreciation 1
Profit on disposal: correct figure 1
Interest receivable 1
Sundries 1
Forecast profit – correct figure 1
Note on mach. purchase 1
Note on loan repayments 1
–––
10
–––
(b) Roles of treasury department

Each role 1
–––
Max. 4
–––
(c) Advantages
Each advantage 2
–––
Max. 6
–––
Total marks 20
–––
–––
16
Marks
4 (a) Debtors collection period
Credit sales figure 1
Ratio calculation 2
–––
3
–––
(b) Debts collected

New debtors figure 1
Collect debtors figure 1
–––
2
–––
(c) Bad debts ratio

Ratio calculation 2
–––
2
–––
(d) Debt collection

Each method 1
–––
Max. 5
–––
(e) Arbitration
Written agreement 1
Under oath 1
Binding 1
–––
Max. 2
–––
(f) Advantages/disadvantages
Each one 1
–––
Max. 4
–––
(g) Liquidation
Dissolved 1
Assets sold 1
Cash paid to creditors/SHs 1
–––
Max. marks 2
–––
Total marks 20
–––
–––
17
Certified Accounting Technician Examination
Paper T10
Advanced Level
Managing Finances
Wednesday 12 December 2007
Time allowed
Reading and planning: 15 minutes
Writing: 3 hours
ALL FOUR questions are compulsory and MUST be attempted.
Do NOT open this paper until instructed by the supervisor.

During reading and planning time only the question paper may
be annotated. You must NOT write in your answer booklet until
instructed by the supervisor.
This question paper must not be removed from the examination hall.

1 Robo Clean Co is a recently established innovation company. It currently has one product on the market, the
‘Robovac’, a robotic floor cleaner. This has been extremely successful. The company is currently developing a new
robotic cleaner called ‘Robomum’ that vacuums, dusts and presses.
To date $120,000 has been spent on developing the product. The company has also incurred $250,000 of market
research costs, although the invoice for these costs has only just been received and will be paid in January.
Since the set-up costs are substantial, a final decision now needs to be made as to whether it is viable to manufacture
and sell ‘Robomum’. The following revenues and costs have been estimated:
1. A new factory, to be used solely for the production of ‘Robomum’, will need to be built. This will take nearly a
year to build and is expected to cost $11·75 million in total, payable in two instalments. The first instalment of
$6m will be paid at the start of the building work and the second instalment for the remaining balance will be
paid when the building work has been completed at the end of the year.
2. Robo Clean Co will immediately enter into a one-year contract with a project management company, who will
oversee the building of the factory. The total cost of this during the year will be $250,000.
Two production lines will need to be installed in the factory at a further cost of $1,500,000 payable at the end
of the build in one year’s time.
3. The machinery for the production of ‘Robomum’ also needs to be built-to-order and is expected to cost $2·5m,
payable in one year’s time. Its terminal value is nil. Depreciation will be charged as soon as production
commences (as soon as the build finishes in one year’s time) at 10% per annum on a straight-line basis.
Maintenance costs for the machinery are estimated at $250,000 per annum.
4. Production and Sales will commence in the year following the build. Sales quantities and prices for ‘Robomum’
are expected to be as follows:
Years 1 2 3&4 5 to 9
(each year) (each year)
Sales volume (’000 units) 5 10 30 50
Sales price ($) 1,000 800 700 500
It is anticipated that by the beginning of year 10, a new robotic helper will have replaced ‘Robomum’, hence
there will be no further sales.
5. Material costs for ‘Robomum’ are estimated at $125 per unit.
6. Labour costs are estimated at $100 per unit.
7. Fixed production overheads on the new factory are estimated at $240,000 per annum. Variable production
overheads are expected to be $50 per unit.
8. Head office costs of $4·5m per annum will be allocated to ‘Robomum’ when production commences. Of these
costs, only $3·7m is incremental.
9. The introduction of ‘Robomum’ is expected to adversely affect sales of ‘Robovac’. It is thought that, for every two
units of ‘Robomum’ sold, one unit of ‘Robovac’ will be lost. ‘Robovac’ is currently sold for $150 per unit and
generates a net cash flow of $50 per unit.
10. The company’s cost of capital is 5%.
11. Assume that all cash flows occur at the end of the year, unless stated otherwise.
12. All workings should be in $’000, to the nearest $’000.
2
Required:
(a) Using the discount tables provided, calculate the net present value (NPV) of the project at the company’s
cost of capital. Conclude as to whether Robo Clean Co should proceed with the project. (22 marks)
(b) Explain the main principles to differentiate between relevant and irrelevant costs for investment appraisal.
Wherever possible, use the costs of ‘Robomum’ to illustrate your answer. (6 marks)
(c) Define and distinguish between capital and revenue expenditure. Explain whether the $250,000 per annum
costs of maintaining the machinery for ‘Robomum’ are capital or revenue in nature. (6 marks)
(d) Robo Clean Co is considering alternative ways of funding the project. The machinery is one of the largest costs.
The company has heard of hire purchase agreements, finance leases and operating leases, but is not sure
whether any of these will be suitable, given that the machinery has to be built-to-order.
Briefly describe each of the following

(i) Hire purchase agreements; (2 marks)
(ii) Finance leases; (2 marks)
(iii) Operating leases. (2 marks)

5%
1 0·952
2 0·907
3 0·864
4 0·823
5 0·784
6 0·746
7 0·711
8 0·677
9 0·645
10 0·614
Annuity factor table (extract)

5%
1 0·952
2 1·859
3 2·723
4 3·546
5 4·329
6 5·076
7 5·786
8 6·463
9 7·108
10 7·722
(40 marks)
3 [P.T.O.
2 All Weather Windows Co manufactures and fits windows for domestic customers. The company needs to forecast its
working capital requirements for the year ahead. The following figures are available:
Sales revenue $7,600,000
Costs as percentage of sales revenue
Raw materials 22%
Direct labour 18%
Variable production overheads 7%
Apportioned fixed production overheads 12%
Other costs 5%
Working capital statistics
Average raw material holding period 6 weeks
Average work-in-progress (WIP) holding period 3 weeks
Average finished goods holding period 5 weeks
Average trade receivables’ collection period 2.5 weeks
Average trade payables’ payment period on:
Raw materials 8 weeks
Direct labour 2 weeks
Variable production overheads 4 weeks
Fixed production overheads 6 weeks
Other costs 3 weeks
1. All finished goods inventory and WIP values include raw materials, direct labour, variable production overheads
and apportioned fixed production overhead costs.
2. Assume WIP is 80% complete as to materials; 75% complete as to direct labour; 50% complete as to variable
production overheads and fixed production overheads.
3. Assume there are 52 weeks in one year.
4. Assume that production and sales volumes are the same.
Required:
(a) Calculate the estimated average working capital required by All Weather Windows Co for the year, showing
all necessary workings. (14 marks)
4
(b) All Weather Windows Co approaches its bank to ask for a loan to assist with a new machinery purchase. The
bank refuses the loan on the basis that the company is too highly geared and its interest cover is too low. The
industry averages for gearing and interest cover are as follows:
Industry average
(
Prior-charge capital
Gearing ––––––––––––––––– x 100%
Shareholders’ funds ) 100%
Interest cover 3 times

The following figures are extracts from All Weather Windows Co’s accounts:
Long-term loans $6million
Ordinary share capital $3 million
Reserves $1 million
Profit before interest $1.2million
Interest $500,000
(i) Calculate the company’s level of gearing (also known as leverage) using the same ratio as above, and
explain what it means when All Weather Windows Co is said to be ‘highly geared’. (3 marks)
(ii) Calculate the company’s interest cover and explain what it means when All Weather Windows Co is said
to have low interest cover. (3 marks)
(20 marks)
5 [P.T.O.
3 Cool Ski Co is a skiwear retailer operating through its website shop. It is run by its three directors/shareholders who
started the business three years ago. Its busiest months of the year are December, January, February and March, with
sales for the rest of the year being relatively insignificant.
In December the company prepares a cash budget for January, February and March. The following figures from its
profit forecast for December 2007 through to March 2008 are currently available. However, they may need to be
revised and should be read together with the notes below.
Dec Jan Feb Mar
$’000 $’000 $’000 $000
Sales revenue (1) 450 650 750 350
Purchases See notes 2 and 3
Staff costs (4) 45 60 70 30
Packaging costs (5) 7 10 12 6
Distribution costs (6) 35 50 58 28
Other costs (7) 50 75 85 55
Notes:
1. The company does not provide any credit to customers. However, customers who join the company’s members’
club are given a 5% discount on all of their purchases. Half of customers are club members. The sales revenue
forecasts above have been calculated before any discounts have been taken into account.
2. Purchases represent 40% of gross sales revenue. Sales revenue in November was $95,000.
3. Suppliers allow two months’ credit.
4 All staff are paid at the beginning of the month for the previous month’s work.
5. Packaging costs are paid one month after they are incurred.
6. Distribution costs are paid in the month in which they are incurred.
7. Other costs include depreciation of $12,000 per month. They also include rental costs of $30,000 per month,
which are paid quarterly in December, March, June and September. The remainder of ‘other costs’ are paid in
the month in which they are incurred.
8. The bank charges interest of 0·5% per month for the overdraft, calculated on the closing bank balance each
month, and payable in the following month.
9. The overdraft on Cool Ski Co’s bank account at 31 December 2007 is expected to be $500,000.
Required:
(a) Prepare a monthly cash budget for each of the three months to 31 March 2008, showing the cash balance
at the end of each month. (10 marks)
(b) Cool Ski Co is considering expanding its business. It wants to branch out into the manufacture of its own brand
of skiwear, and then expand its customer base to include wholesale customers, such as high street retailers. The
three directors/shareholders have produced a business plan and are now considering approaching a venture
capital organisation for finance.
Identify and discuss five factors that a venture capital organisation would take into account when deciding
whether or not to invest in Cool Ski Co. (10 marks)
(20 marks)
6
4 Waste Co is a waste management company, with one sole shareholder/director, Mr Trusty. It collects two types of waste
from businesses – recyclable waste and confidential waste. Since companies have increasingly become aware of both
the need for recycling and the need to protect confidential information, Waste Co’s client base has expanded rapidly
over the last two years.
As the business has expanded Mr Trusty has had less time available to focus on credit control. This has resulted in a
steady deterioration in accounts receivable collection and a rapid increase in Mr Trusty’s overdraft, despite high profits.
Mr Trusty’s bank has now refused to extend his overdraft any further and has suggested that he either employ a credit
controller or factor his accounts receivable.
The following information is available:
1. Credit sales for the year ending 30 November 2007 were $2,550,000 and average accounts receivable days
were 60. Sales are expected to increase by 25% over the next year.
2. If Mr Trusty employs a good credit controller, the cost to the business will be $47,000. It is anticipated that the
accounts receivable days can then be reduced to 40 days.
3. A local factoring organisation has offered to factor the company’s accounts receivable on the following terms:
(i) An advance of 80% of the value sales invoices (which Mr Trusty would fully utilise).
(ii) An estimated reduction in accounts receivable days to 35 days.
(iii) An annual administration fee of 1·3% of turnover.
(iv) Interest charge on advances of 12% per annum.
4. Current overdraft rates are 10% per annum.
5. Assume there are 365 days in a year.
Required:
(a) Explain the meaning of ‘debt factoring’ (accounts receivable factoring) to Mr Trusty, distinguishing between
‘with recourse’ and ‘without recourse’ agreements. (4 marks)
(b) Explain how debt factoring is different from ‘invoice discounting’. (2 marks)
(c) Calculate whether it is financially beneficial for Waste Co to factor its accounts receivables for the next year,
as compared to employing a credit controller. (10 marks)
(d) State four roles that a credit controller may play. (4 marks)
(20 marks)
7
Answers

1 (a) NPV
Time
0 1 2 3 4 5 6–10
$’000 $’000 $’000 $’000 $’000 $’000 $’000
Market research costs (sunk)
Development costs (sunk) –
Factory costs (6,000) (5,750)
Project management company (250)
Machinery costs (2,500)
Depreciation (non-cash) – – – – – –
Maintenance (250) (250) (250) (250) (250)
Production lines (1,500)
Sales revenue 5,000 8,000 21,000 21,000 25,000
Material costs (625) (1,250) (3,750) (3,750) (6,250)
Labour (500) (1,000) (3,000) (3,000) (5,000)
Fixed overheads (relevant as incremental) (240) (240) (240) (240) (240)
Variable overheads (250) (500) (1,500) (1,500) (2,500)
Head office costs (incremental element only) (3,700) (3,700) (3,700) (3,700) (3,700)
Reduced Robovac contribution (125) (250) (750) (750) (1,250)
–––––– ––––––– –––––– –––––– –––––– –––––– –––––––
Net cash flows (6,000) (10,000) (690) 810 7,810 7,810 5,810
–––––– ––––––– –––––– –––––– –––––– –––––– –––––––
Discount factor 1 0·952 0·907 0·864 0·823 0·784 3·393
Discounted cash flows (6,000) (9,520) (626) 700 6,428 6,123 19,713
The net present value of the project is $16·818 m. The company should therefore proceed with it.
Workings
AF for T6 – 10 = 7·722 – 4·329 = 3·393
(b) Relevant costs

The following principles should be applied when identifying costs that are relevant to a project.
therefore totally irrelevant to any decision that is being made now. Such past costs are called ‘sunk costs’. Examples of such
past costs are the development costs and the market research costs.
Therefore, costs which do not reflect cash spending should be ignored for the purpose of decision-making. An example of
such costs for the Robomum is the depreciation on the new machinery.
A relevant cost is the increase in costs which results from making a particular decision. For example, an opportunity cost (the
value of a benefit foregone as a result of choosing a particular course of action) will always be a relevant cost. This is because
it is a future incremental cost. An example of such an opportunity cost for the Robomum is the lost contribution from
decreased sales of Robovac.
Allocated fixed overheads are not normally incremental. In the case of the Robomum, however, the allocated fixed overheads
relate to a factory that is being built entirely for the production of Robomum. The costs are therefore relevant because they
are incremental.
As regards the allocated head office overheads, only the incremental part of these overheads is relevant i.e. the $3·7m. The
remainder of the $4·5m is irrelevant to the NPV calculation since it would have been incurred, irrespective of the emergence
of Robomum onto the market.
Certain other costs will also be excluded in the NPV calculation, such as ‘finance costs’. This is because interest has already
been taken into account in the discounting process.
(c) Capital and revenue expenditure

Capital expenditure is expenditure on the purchase of or improvement to fixed assets. Fixed assets are used in the business
to generate income over a number of years. The expenditure on them is therefore charged to the profit and loss account over
a number of years through a depreciation charge.
Revenue expenditure, on the other hand, is expenditure incurred in relation to sales, for example, materials and labour costs,
or overhead costs. It also includes the cost of maintaining, but not improving, fixed assets.
11
The maintenance costs of $250,000 per annum for the machinery are therefore revenue costs. This is because they do not
enhance the value of the machinery but merely keep it running properly so that production can continue.
(d) (i) Hire purchase

Hire purchase is simply a form of financing an asset through paying in instalments. The supplier of the goods sells them
directly to the financier (usually a finance house). The supplier then supplies the customer with the goods.
The customer will usually be required to pay a sizeable deposit towards the purchase price of the goods.
The goods remain the property of the financier until the end of the agreement, at which point the customer will have
paid for the goods in full.
The customer makes regular payments throughout the course of the agreement that consist of partly capital repayment
and partly interest.
(ii) Finance leases
A finance lease is similar in substance to a hire purchase agreement. The goods are sold to the lessor. The supplier of
the goods then supplies the customer with the goods.
In return, the customer makes regular payments to the lessor. Over the period of the lease, the lessee will have paid for
the full costs of the goods plus an additional amount equivalent to an interest charge.
Throughout the lease the lessee is responsible for maintaining the asset.
A finance lease usually has a primary period over which these significant payments are made. At the end of this primary
period, the lessee then enters a secondary period. During this time, he will pay a notional charge (perhaps as low as
$1 per annum) but continue to have full use of the asset. Alternatively, he may sell the asset on behalf of the lessor,
usually keeping most of the sale proceeds himself.
(iii) Operating leases
This type of lease is very different from a hire purchase agreement or finance lease. The equipment is supplied directly
to the lessee by the lessor. The lessee will make regular payments under the lease.
The lessor will be responsible for maintaining the asset so the lessee avoids the risks of ownership.
The period of the lease is often much shorter than the full life of the asset.
Since the machinery for Robo Clean is built-to-order, an operating lease would not be appropriate.
2 All Weather Windows
(a) Working capital requirements

$’000
Sales revenue for the year: 7,600
––––––
Raw materials costs
$7,600,000 x 22% 1,672
Direct labour costs
$7,600,000 x 18% 1,368
Variable production overheads
$7,600,000 x 7% 532
Fixed production overheads
$7,600,000 x 12% 912
Other costs
$7,600,000 x 5% 380
––––––
4,864
––––––
––––––
12
Current assets:
Inventory $’000 $’000
Raw materials 6/52 x $1·672m 193
W-I-P
Materials 3/52 x $1·672m x 80% 77
Direct labour 3/52 x $1·368m x 75% 59
Variable and fixed production overheads 3/52 x ($532k + 912k) x 50% 42
––––
178
Finished Goods
Materials and direct labour 5/52 x ($1·672m + $1·368m) 292
Variable and fixed production overheads 5/52 x ($532k + $912k) 139
––––
431
––––––
Total inventory value 802
Trade receivables 2·5/52 x $7,600,000 365
––––––
Total value of current assets 1,167
––––––
Current liabilities
Accounts payable:
Materials 8/52 x $1·672m (257)
Labour 2/52 x $1·368m (53)
Variable production overheads 4/52 x $532k (41)
Fixed production overheads 6/52 x $912k (105)
Other costs 3/52 x $380k (22)
––––––
Total value of current liabilities (478)
––––––
––––––
––––––
––––––
(b) (i) Gearing

It is calculated as follows:
Prior-charge capital
––––––––––––––––– x 100%
Shareholders’ funds
$6m
= ––––––––––– x 100%
$3m + $1m
= 150%
All Weather Windows’ gearing is 150% as compared to an industry average of 100%. The company is therefore said to
be ‘highly geared’ because its borrowings are simply too high compared to its level of equity.
(ii) Interest cover
It is calculated as follows:
Profit before interest
––––––––––––––––
Interest
= $1,200,000
–––––––––––
$500,000
= 2·4 times
All Weather Windows’ interest cover is only 2·4 times, meaning that its interest payments are only covered by its profits
2·4 times.The industry average for interest cover is 3 times. Therefore, compared to the industry that the company
operates in, its interest cover is deemed to be low, meaning that the profitability of the company is too low given its level
of interest.
13
3 Cool Ski Ltd
(a) Jan Feb Mar

$’000 $’000 $’000
Cash inflows
Sales revenue: non-members 325 375 175
Sales revenue: members (5% discount) 309 356 166
–––– –––– ––––
Cash inflows 634 731 341
–––– –––– ––––
Cash outflows
Purchases (w.1) 38 180 260
Staff costs 45 60 70
Packaging costs 7 10 12
Distribution costs 50 58 28
Other costs excl. rent (w.2) 33 43 13
Rent (3 x $30k ) 90
–––– –––– ––––
Cash outflows 173 351 473
–––– –––– ––––
Net cash flows 461 380 (132)
Opening balance (500) (42) 338
Overdraft interest (3) – –
–––– –––– ––––
Closing balance (42) 338 206
–––– –––– ––––
Workings
1. Purchases Nov Dec Jan
$’000 $’000 $’000
Gross sales revenue 95 450 650
–––– –––– ––––
Purchases at 40% 38 180 260
–––– –––– ––––
2. Other costs Each month
Jan Feb Mar
$’000 $’000 $’000
Per question 75 85 55
Less depreciation (12) (12) (12)
Less rental costs (30) (30) (30)
–––– –––– ––––
33 43 13
–––– –––– ––––

Factors that a venture capitalist organisation will take into account are as follows:
(i) Level of expertise of Cool Ski Co’s management
Venture capitalists will believe that the success of Cool Ski Co’s business is dependant on the quality of the management.
They will expect the three directors/shareholders to show a high level of commitment to the business. As all of the
existing owners of the business are all involved in the running of the company, this should be proof of their commitment.
The venture capitalists will also look at the amount of money that the owners themselves have invested in the project
in assessing their level of commitment. The venture capitalists will expect a place on Cool Ski Co’s Board of Directors
so that they can have a say in future business strategy.
(ii) Level of expertise in the area of service
The venture capitalists will seek assurance that the directors have the necessary know-how and technical support to be
able to run the business properly. The fact that the business has been supplying the public direct through its website for
the last three years is evidence of the ability of the directors/shareholders to run the company. However, running a
manufacturing business is going to be different from simply being a retailer, and dealing with wholesale customers is
different from dealing with the public direct. The directors have a lot to prove.
(iii) The nature of Cool Ski Co’s product
In order to succeed in manufacturing and selling their own brand of skiwear, the directors need to show that they have
excellent designs for a range of skiwear that people will want to buy and wear. The business already has a customer
base with members buying skiwear at reduced prices. This should help the directors in persuading the venture capitalists
that they have a likeable brand.
They will seek assurance that there is actually a market for the ski wear, as there are already some similar memberships
available in the market place. They will ask to see the market research that has already been carried out. The venture
capitalists will also look at the threat posed by new entrants in the market, and current rival membership schemes.
14
Since the risk involved in investing in a new or expanding company is fairly high, the venture capitalists will seek to
ensure that the prospects for future profits compensate for the risk. They will therefore want to see the business plan
setting out the future business strategy.
(vi) Exit routes
The venture capitalists will consider potential exit routes before they invest in the venture. They will not invest money in
a share of the business unless they are confident that it can be sold at some point in the future.
Note: Only five factors were required.
4 (a) Debt factoring

‘Debt factoring’ is a service provided by factors whereby the factor collects accounts receivable on behalf of their client and
often invoices their client’s customers as well. The factor also advances, to its client, a proportion of the money it is due to
collect (typically about 80% is advanced.)
Mr Trusty would find the service useful because he could both receive cash early and also delegate the administration of his
invoicing, accounting and accounts receivable collection work.
There are two types of factoring agreements: ‘with recourse’ and ‘without recourse’ agreements. With the first of these
agreements, although the factor advances monies, the risk of non-payment of accounts receivable balances stays with the
client. If a balance is not recovered, the factor has ‘recourse’ to their client for the money. If the agreement is ‘without recourse’
the factor bears the risk of non-payment.
Debt factoring has to be paid for, usually as a percentage of the amounts advanced and as a percentage of turnover.
Agreements without recourse to the client obviously cost more. Mr Trusty would have to compare the cost to those of
employing an individual to do his invoicing and obtaining insurance against unpaid accounts receivable balances. In addition,
there may be some stigma attached to debt factoring as clients sometimes assume that a business using a factor must be in
financial difficulty.
(b) Difference from invoice discounting

Invoice discounting is a service whereby a provider (often a factoring company) purchases invoices from a client at a discount.
In this case, they are merely advancing cash, rather than providing an accounts receivable collection service. For this reason,
there is no administration fee payable (like there is for factoring), making invoice discounting a cheaper option.
(c) Whether to factor accounts receivables

Cost of factoring
New sales level = $2,550,000 x 125% $3,187,500
Accounts receivable reduced to 35 days:
$3,187,500 x 35/365 $305,651
$
80% advanced by factor at 12%:
$305,651 x 80% x 12% 29,342
$305,651 x 20% x 10% 6,113
Admin fee: $3,187,500 x 1·3% 41,438
–––––––
76,893
–––––––
–––––––
Cost of not factoring but employing new staff
Accounts receivable reduced to 40 days:
$3,187,500 x 40/365 $349,315
$
Overdraft cost
$349,315 x 10% 34,932
Credit controller costs 47,000
–––––––
81,932
–––––––
–––––––
Waste Co should use the services of the factor since this will produce a saving, over the next year, of $5,039, compared to
employing a credit controller.
15
(d) Roles of a credit controller
May include some/all of the following:
– Updating the sales ledger
– Dealing with customers’ queries
– Assessing creditworthiness of new customers
– Establishing/updating payment terms for customers
– Regular review of the sales ledger
– Pursuing overdue accounts receivable balances
– Providing references for customers
16
Marks
1 (a) NPV
Market research costs ignored 1
Development costs ignored 1
Project management company 1
Factory costs 1
Machinery costs 1
Depreciation ignored 1
Maintenance 1
Production lines 1
Sales revenue 1
Material costs 1
Labour 1
Fixed overheads 2
Variable overheads 1
Head office costs (incremental element) 2
Reduced Robovac profits 2
Net cash flows 0·5
Discount factors/annuity factors 1
Discounted cash flows 0·5
NPV 1
Conclusion 1
–––
Total marks 22
–––
(b) Relevant costs

Future costs 1
Ignore sunk 1
Cash flows 1
Depreciation 1
Incremental 1
Opportunity costs 1
Lost contribution from Robovac 1
Fixed overheads 1
Head office 1
Finance costs 1
–––
Max marks 6
–––
(c) Capital/revenue costs

Capital costs 2
Revenue costs 2
Maintenance costs 2
–––
6
–––
(d) HP agreements and leasing

HP agreements 2
Finance leases 2
Operating leases 2
Correct mention of Robo Clean 1
–––
Max marks 6
–––
Total marks 40
–––
–––
17
Marks
2 (a) Working capital requirements
Calculation of each cost for year 0·5
–––
Max marks 2·5
–––
Calculation of current assets:
Raw materials 1
WIP 3
Finished goods 2
Debtors 1
–––
7
–––
Calculation of current liabilities
Accounts payable:
Creditor 0·5
Labour 0·5
Variable overheads 0·5
Fixed overheads 0·5
Other costs 0·5
–––
2·5
–––
Presentation 1
–––
14
–––
(b) (i) Gearing

Ratio calculation 1
Explanation 2
–––
3
–––
(ii) Interest cover

Ratio calculation 1
Explanation 2
–––
3
–––
Total marks 20
–––
–––
3 (a) Cash budget

Sales 2
Purchases 2
Staff costs 0·5
Packaging costs 0·5
Distribution costs 0·5
Other costs (excl. rent) 1
Rent 1
Net cash flows 0·5
Balance b/f 0·5
Balance c/f 0·5
–––
10
–––
(b) Venture capital

Per factor 2
–––
Max marks 10
–––
Total marks 20
–––
–––
18
Marks
4 (a) Factoring
Definition 1
Includes administration 1
With recourse agreements 1
Without recourse agreements 1
Other points 1
–––
Max marks 4
–––
(b) Invoice discounting

Advancing cash only 1
No a/cs rec’ble collection service 1
Cheaper 1
–––
Max marks 2
–––

New sales level 1
New accounts receivable 1
12% factoring charge 1
10% overdraft charge 1
1·3% admin fee 1
Cost of not factoring
New a/cs rec’ble figure 1
Overdraft cost 1
Credit controller cost 1
Logical approach 1
Conclusion/saving 1
–––
10
–––
(d) Roles of credit controller

Each role 1
–––
Max marks 4
–––
Total marks 20
–––
–––
Total marks for paper 100

––––
––––
19
Paper T10
Advanced Level
Managing Finances
Wednesday 11 June 2008
Time allowed
Writing: 3 hours
Extract from discount factor tables and annuity factor tables are on
page 2.

Extract from discount factor tables at a discount rate of 10%
Time Factor
1 0·909
2 0·826
3 0·751
4 0·683
5 0·621
6 0·564
7 0·513
8 0·467
9 0·424
10 0·386
Extracts from annuity factor tables at a discount rate of 10%

Time Factor
1 0·909
2 1·736
3 2·487
4 3·170
5 3·791
6 4·355
7 4·868
8 5·335
9 5·759
10 6·145
2
1 Alan Web is a famous musician and composer. He has recently teamed up with a successful producer of musicals,
David Daniels. Together, they are going to fund a new musical ‘The Fiesta’. The musical will run in Jamin (the capital
of Bundai) for five months. If it is successful, it will then tour the rest of Bundai for a further period.
Alan and David are each investing $100,000 in the production. They have opened a business bank account to be
used solely for the musical’s income and expenses. The investment cash will be paid into this account on 30 June
2008. Rehearsals will take place throughout the month of July, with the musical’s official opening night taking place
on 1 August.
Alan and David appreciate the need for cash forecasting and have made the following estimates for income and
expenses for the six months from 1 July to 31 December 2008:
1 Tickets for the musical will go on sale on 1 July. Tickets will be sold through an agent who is to be paid
commission by Alan and David. The price of tickets will vary according to the seat location. Prices are as follows:
Location of seat Price
Stalls $30
Front $20
Rear $15
Ticket sales each month will include not only tickets for that month’s performances but also advance bookings
for later months. Sales per month are expected to be as follows:
Jul Aug Sep Oct Nov Dec
Stalls 10,000 20,000 No further stalls seats available
Front 30,000 50,000 20,000 No further front seats available
Rear 10,000 30,000 40,000 50,000 45,000 35,000
The agent will pay the proceeds of ticket sales into Alan and David’s business account in the same month as the
tickets are sold to the public. The agent will then invoice Alan and David for the commission it charges of 6%.
This will be payable in the month following the ticket sales.
2 Sales from programmes, CDs and beverages are expected to be $150,000 in August and $175,000 for each
month thereafter. All costs relating to the production of these goods will be incurred in July. Costs represent 10%
of sales value.
3 All of the staff in notes 4 and 5 below will only receive 50% of their usual monthly salary for the month of
rehearsals.
4 The leading lady, who plays the key role in the musical, will be paid a salary of $16,000 per month. The
remaining 20 cast members (actors/singers) will be paid a monthly salary of $8,000 each. The leading lady and
the cast members will be paid at the end of each month for that month’s work.
5 A live orchestra will also be playing every night. The orchestra also starts rehearsing at the beginning of July.
There are 25 musicians in the orchestra, each of whom will be paid a salary of $4,000 per month. Musicians
will be paid at the beginning of each month for the previous month’s work.
6 Other production staff members are provided by an independent production company and are expected to cost
$80,000 per month in total. They will not be required until the musical opens in August. They will be paid at
the beginning of each month for that month’s work. However, in addition to this monthly cost, there will also be
a production company administration fee of 5%, payable monthly in arrears.
7 The production company charges a separate amount for the production equipment, also required at the beginning
of August. This is expected to be $33,000 per month, payable on the first day of each month.
8 The costumes for the cast will be made in July. A deposit of $50,000 needs to be paid at the beginning of July,
with the remaining balance of $25,000 to be paid at the end of that month.
9 The background for the stage is currently being painted by local artists. Its cost of $180,000 will be payable
upon its completion at the beginning of July.
3 [P.T.O.
10 The musical will be held at the National theatre, which must be hired for $600,000 per month, payable at the
beginning of each month. The theatre will be used for rehearsals in July as well.
11 Certain equipment, not supplied by the production company, costing $155,000 will be bought in July for the
production. Depreciation for the six-month period will total $31,000.
12 All workings should be in $’000 to the nearest $’000.
Required:
(a) Prepare a monthly cash budget for the musical for each of the six months to 31 December 2008, showing
the cash balance at the end of each month. (18 marks)
(b) Alan and David are very aware that their actual cash flow in the six months ending 31 December 2008 could
differ greatly if the above estimates prove to be inaccurate. They have heard of ‘sensitivity analysis’ and want to
know more about it.
Required:
Briefly explain sensitivity analysis and discuss how it might best be used to make the cash budget for the
musical more useful.
Note: no further calculations are required. (6 marks)
(c) Alan and David are considering whether they should set up their own company for future theatrical productions.
They want to know whether, over a ten-year period, it would save money.
If they set up the company, they would avoid the following annual costs:
(i) Estimated external production staff costs of $900,000.
(ii) Estimated administration fees of $45,000.
(iii) Estimated production equipment costs of $400,000.
However, they would incur the following set-up costs immediately:
(i) Legal costs of $4,000.
(ii) Company registration costs of $1,000.
(iii) Equipment costs of $1,800,000.
A further amount of $1·5 million would be payable for the equipment in one year’s time.
The following annual costs would arise:
(i) Staff salaries of $500,000.
(ii) Professional fees of $10,000.
(iii) Equipment maintenance costs of $75,000.
(iv) Depreciation costs of $200,000.
Alan and David will need to spend a considerable amount of time setting up the company. They estimate that,
as a result of this, their revenue may be $75,000 lower in the first year than it would otherwise have been (ignore
agent’s commission). Their cost of capital is 10% per annum.
Required:
Using the discount tables provided, calculate the net present value (NPV) of the proposal to set up the
production company, at the company’s cost of capital. Advise Alan and David whether they should set up
the company.
Note: show all workings in $’000. (10 marks)
4
(d) Alan and David have been advised that the ‘pay-back period method’ may also be a useful way of assessing
whether to set up the production company. They know nothing about this method of project appraisal.
Required:
(i) Explain the simple payback period method;
Note: calculations are not required. (2 marks)
(ii) State two differences between the calculation of the simple payback period of a project as compared to
the calculation of the net present value of a project; (2 marks)
(iii) State two advantages of using the simple payback period method as compared to other methods of
project appraisal. (2 marks)
(40 marks)
2 Light Co is a privately owned company specialising in the manufacture of lighting equipment. It supplies lighting to
customers, who take an average of 30 days to pay. It has an overdraft on its current account of $2m. The compound
annual interest rate charged on this account is 12%, with interest being charged to the account daily.
In order to reduce its overdraft, Light Co is now considering introducing discounts to customers who pay within
seven days.
Required:
(a) Calculate the maximum discount that Light Co should offer for payment within seven days if it wants to avoid
any increase in its overall finance costs and explain the basis of your calculation. (4 marks)
(b) Briefly explain the difference between simple and compound interest rates, using Light Co’s overdraft interest
as an example. (4 marks)
(c) One year later, despite introducing a tempting discount to customers, Light Co has found that very few customers
have paid early and taken the discount. In fact, receivables days have increased significantly, as has the
company’s overdraft. Light Co is therefore considering factoring its debts in the coming year.
Credit sales for the last year totalled $12 million, with average receivables of $2 million. Next year, sales are
expected to increase by 10%. Receivables days are expected to increase to 70 days if the factoring arrangement
is NOT entered into. A factoring company has put forward the following proposal to Light Co:
(i) Receivables days will be reduced to 28 days as a result of stricter credit control procedures.
(ii) The factor will charge interest of 13% per annum on the advances.
(iii) The factor will charge an administration fee of 1·5% of turnover for the service.
(iv) The factor will advance 80% of the value of sales invoices.
Should Light Co enter into the agreement, it will make its credit controller redundant. She earns a salary of
$18,000 per annum. Current bank overdraft rates have remained the same at 12% per annum.
Required:
Evaluate whether it is financially viable for Light Co to factor its debts in the coming year. (12 marks)
(20 marks)
5 [P.T.O.
3 The Kitchen Co is an innovation company set up two years ago by its key shareholder and director, Brian Geek. It
currently has a range of about two thousand kitchen products on the market, the most successful of which is a gadget
called the ‘Fish Eye’. This is a revolutionary utensil, the size of a kitchen knife, which plugs into the power supply
and is used on cooked fish to identify any fish bones that need to be removed prior to serving. The ‘Fish Eye’ exploded
onto the market two years ago, as the company’s introductory product, and sales have continued to grow rapidly ever
since.
One of Brian Geek’s friends has warned him about the high incidence of overtrading for new businesses selling high
demand, innovative products. Brian Geek is therefore concerned that The Kitchen Co’s financial position be carefully
monitored. Its turnover has increased by 100% over the last year, and its trade receivables and inventories have
doubled. The company’s current ratio has fallen over the last year from a ratio of 3:1 to a ratio of 2·5:1. The industry
norm is 2:1.
The company has a $1 million overdraft facility on its current account from its bank. Whilst the company has never
used even half of its limit, it often relies on the overdraft facility to finance its working capital.
Required:
(a) Explain the term ‘overtrading’. (2 marks)
(b) Describe the symptoms that MAY be present in a company that is overtrading. (5 marks)
(c) Briefly discuss whether The Kitchen Co is overtrading. (5 marks)
(d) One of the key components used to make the ‘Fish Eye’ is component X, which is imported from overseas. Brian
Geek wants to manage his inventory levels of component X more efficiently. He wants to make sure that he can
meet demand for production and sales whilst at the same time avoiding excessive inventory levels. The following
information relates to component X:
Cost of component X $24 per unit
Usage per day 1,000 units
Maximum lead time 20 days
Minimum lead time 10 days
Average lead time 15 days
Cost of ordering $650 per order
Holding costs $2 per unit per annum
Usage per day is always constant. The re-order level is set at the maximum expected requirement in lead time
plus 25%.
Required:
(i) Calculate the re-order level; (3 marks)
(ii) Calculate the Economic Order Quantity (EOQ) using the following formula:
2Co D
EOQ =
CH
Where Co = the cost of placing one order

CH = the cost of holding one unit per annum
Note: you should assume that there are 48 working weeks in the year and five working days in each of
the weeks. (2 marks)
(iii) Calculate the maximum inventory level for component X using the information provided. (3 marks)
(20 marks)
6
4 Banks and the money markets play an important role in a country’s economy.
Required:
(a) Explain the difference between retail banks and wholesale banks. (4 marks)
(b) Describe four functions of a central bank. (8 marks)
(c) Name the different money markets and briefly explain their role within the economy. (4 marks)
(d) Briefly describe four money market instruments. (4 marks)
(20 marks)
7
Answers

1 (a) Cash budget

Jul Aug Sep Oct Nov Dec
$’000 $’000 $’000 $’000 $’000 $’000
Receipts
Ticket sales (1) 1,050 2,050 1,000 750 675 525
Other sales (2) 150 175 175 175 175
–––––– –––––– –––––– –––––– –––––– ––––––
1,050 2,200 1,175 925 850 700
–––––– –––––– –––––– –––––– –––––– ––––––
Payments
Costs re ‘other sales’ 85
Leading lady’s salary 8 16 16 16 16 16
Other cast members 80 160 160 160 160 160
Musicians 50 100 100 100 100
Production company staff 80 80 80 80 80
Production company fee 4 4 4 4
Production equipment 33 33 33 33 33
Costumes 75
Stage background 180
Theatre hire 600 600 600 600 600 600
Equipment costs 155
Ticket agent’s commission (2) 63 123 60 45 41
–––––– –––––– –––––– –––––– –––––– ––––––
Total payments 1,183 1,002 1,116 1,053 1,038 1,034
–––––– –––––– –––––– –––––– –––––– ––––––
Net cash flow (133) 1,198 59 (128) (188) (334)
Opening balance b/f 200 67 1,265 1,324 1,196 1,008
–––––– –––––– –––––– –––––– –––––– ––––––
Closing balance c/f 67 1,265 1,324 1,196 1,008 674
––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
–––––– ––––––
––––––
Workings
(1) Ticket sales
Stalls $’000 $’000 $’000 $’000 $’000 $’000
Front 300 600
Rear 600 1,000 400
Total 150 450 600 750 675 525
–––––– –––––– –––––– –––––– –––––– ––––––
1,050 2,050 1,000 750 675 525
–––––– –––––– –––––– –––––– –––––– ––––––
(2) Ticket agent’s commission
–––––– –––––– –––––– –––––– –––––– ––––––
6% of sales, one month later 0 63 123 60 45 41
–––––– –––––– –––––– –––––– –––––– ––––––
(b) Sensitivity analysis

In order to prepare a cash budget, many assumptions have to be made. In the case of ‘The Fiesta’ the biggest assumption
being made is in relation to ticket sales. Whilst former experience of ticket sales for this type of musical can be used as a
basis for the sales estimates, the fact is that it is an unknown variable. This is also the case for ‘other sales’. Certain items in
the cash budget can be calculated with more certainty, for example, theatre hire costs, staff costs and production equipment
costs. This is because these costs are largely fixed, that is, they will not vary according to ticket sales. Sensitivity analysis is
less useful on these items unless there is uncertainty about their actual cost.
Sensitivity analysis uses models in order to determine the changes on our cash budget if some of the key variables change.
Given that ticket and other sales are the least predictable, sensitivity analysis would be most useful on these items. For
example, the cash budget could be reperformed on the assumption that ticket sales and other sales were 10%, 20% and
30% less than estimated. A computerised model could be used to make the calculations easier and the sensitivity analysis
more complicated.
Using sensitivity analysis in this way would make it easier to ascertain the level of risk attached to the project.
11
(c) Net present value T0 T1 T2–10
$’000 $’000 $’000
Saved production costs 900 900
Saved admin fees 45 45
Saved equipment costs 400 400
Legal costs (4)
Registration costs (1)
Equipment (1,800) (1,500)
Maintenance costs (75) (75)
Lost revenue (75)
Salaries (500) (500)
Professional fees (10) (10)
–––––– –––––– ––––––
Net cash flow (1,805) (815) 760
–––––– –––––– ––––––
Discount factor/annuity factor* 1·000 0·909 5·236
–––––– –––––– ––––––
Discounted cash flow (1,805) (741) 3,979
–––––– –––––– ––––––
* Annuity factor for T2–T10 = 6·145 – 0·909
= 5·236
The net present value of setting up the production company, as opposed to carrying on as normal, is $1·433 million. Alan
and David should, therefore, set it up.
(d) Payback method

(i) The payback period method assesses the feasibility of a project by ascertaining the length of time it takes for the
investment costs of a project to be paid back by the revenues/cost savings. It is therefore the length of time it takes for
the total cash inflows to equal the original cash outflows.
(ii) It is different from the NPV method because firstly, it looks at simple cash flows and not discounted cash flows, thus
ignoring the time value of money.
Secondly, whilst the NPV method takes into account all the cash flows over the life of the project, the payback method
disregards any cash flows arising after the original investment has been paid back.
(iii) – It is easy to calculate and easy to understand.
– It uses cash flows rather than profits, therefore it is less likely to be distorted by accounting conventions.
– It helps liquidity by taking into account the timescale rather than the overall cash flows.
2 (a) Maximum discount

Effective interest rate over 23 (30 – 7) days is:
(1·1223/365 – 1) x 100 = 0·717%
The maximum discount that Light Co should offer, if it does not want to increase its finance costs, is 0·717%.
Explanation
If customers are to be given a discount for paying within seven days, Light Co is effectively paying to receive the cash 23 (30
– 7) days early.
Therefore, in order to calculate the maximum discount that should be offered to customers for paying within seven days, it is
necessary to calculate the effective interest rate that Light Co is paying on its overdraft for the 23 day period. This figure should
then be the maximum amount that Light Co should offer its customers for early payment.
(b) Interest rates

Light Co has a compound annual interest rate of 12%, with interest being charged to its account daily. This 12% rate therefore
takes into account that, on an annual basis, interest is not only being charged on any capital amounts but also on any interest
that is debited to the current account each day. Therefore, it is called compound interest because interest is being paid on
capital AND interest over the course of the year.
A ‘simple’ interest rate, on the other hand, only takes into account the interest payable on any capital amounts. So, in Light
Co’s case, it ignores any interest payable that is incurred on the interest that is credited to Light Co’s account each day.
(Note: This could be demonstrated using numbers.)
12
(c) Whether to factor
Existing finance cost at 12% $
New sales figure ($12m x 1·1) 13,200,000
Receivables ($13,200,000 x 70/365) 2,531,507
Overdraft cost per annum at 12% 303,781
–––––––––––
–––––––––––
Cost of factoring
Sales 13,200,000
Receivables reduced to 28 days:
$13,200,000 x 28/365 1,012,603
–––––––––––
80% advanced by factor at 13%:
$1,012,603 x 80% x 13% 105,311
$1,012,603 x 20% x 12% 24,302
Admin. Fee:
$13,200,000 x 1·5% 198,000
Saved salary (18,000)
–––––––––––
309,613
–––––––––––
–––––––––––
Additional cost of factoring (5,832)
–––––––––––
–––––––––––
Conclusion
It is not financially viable for Light Co to factor its debts as an additional cost of $5,832 will arise.
3 (a) Overtrading
A company is said to be overtrading when its sales are expanding too quickly for it to finance them. Further explained, this
means that the volume of sales is too large given the level of long-term capital at the company’s disposal.
(b) Symptoms of overtrading

– A rapid increase in turnover
– A rapid increase in the volume of current assets and sometimes fixed assets
– A significant reduction in liquidity ratios
– An increase in debt ratios
– A rapid increase in trade payables
– A rapid increase in bank overdraft
(c) The Kitchen Co’s turnover has increased by 100% over the last year. However, since this is a new company and the ‘Fish
Eye’ is an innovative product for which this company is the sole retailer, one would expect to see a large increase in turnover.
Similarly, since sales have increased so much, trade receivables would have been expected to increase proportionately, which
they did. Since a 100% increase in turnover is effectively a doubling in turnover, the doubling of trade receivables was to be
expected.
Again, inventory levels have doubled. This is also linked to the doubling of turnover. Inventory levels would have been
increased in order to meet the increase in demand.
The company is relying heavily on its overdraft but it is not exceeding it; nor is it uncommon for a new business to rely on
this form of short-term finance to fund its working capital.
Whilst the current ratio has deteriorated it is still 2·5:1, which is higher than the industry norm.
In conclusion then, whilst the company’s financial position needs to be monitored carefully to ensure that sales do not spiral
out of control, the company does not currently appear to be overtrading.
(d) (i) Re-order level

Re-order level = max. lead time x usage x 125%
= 20 x 1,000 x 125%
= 25,000 units.
(ii) Economic order quantity
2Co D
EOQ =
CH
2 x 650 x 48 x 5 x 1,000
=
2
= 12,490 units.
13
(iii) Maximum inventory level
Calculated as follows:
Re-order level + re-order quantity – (minimum rate of usage x minimum lead time)
= 25,000 + 12,490 – (1000 x 10)
= 27,490.
4 (a) Retail and wholesale banks

Retail banks are those banks that specialise in the provision of banking facilities to the public and businesses. The amounts
of the deposits and loans that they deal with tend to be relatively small. In the UK, traditional high street banks such as
Barclays and LloydsTSB are retail banks. Much of their business is now done over the telephone and internet.
Wholesale banks, on the other hand, are banks dealing in larger deposits and loans. They are not in the business of providing
household mortgages and small loans to businesses and consumers. They tend to have a small number of large customers
and deal extensively in the foreign exchange market. They include merchant banks such as Kleinwort Benson and Hambros,
and finance houses.
(b) Functions of a central bank

Banker to the banks
It provides a payments system for transactions between banks.
Banker to the government
The central bank collects tax revenue and disburses government expenditure.
Issuance of currency
The central bank prints/mints and issues notes and coins for the government, usually backed by holdings of government
bonds.
Monetary policy function
The Central Bank executes monetary policy on behalf of the government. This facilitates the control of inflation, which is
damaging to the economy.
Reserve management
The central bank manages the portfolio of foreign exchange reserves of the country and may buy or sell them to influence the
exchange rate.
Maintain financial stability
The central bank does this through the supervision of other banks.
Lender of the last resort
A central bank may be called upon to act as lender of the last resort to the banking system.
(Government debt management
In several countries, central banks issue long term government debt in the market. This is no longer the common practice in
most countries today, however.)
(Note: Only 4 functions were required)
(c) Money markets

These are markets which trade money for short-term borrowing and lending, in wholesale amounts. They enable financial
institutions to cover short-term money shortages or to lend money profitably if they have surplus money. Trading is done either
over the telephone or electronically.
Money markets include a ‘primary market’ and a ‘secondary market’. The primary market is used by the central bank and
other approved banks and securities firms. The central bank uses it to smooth out shortages and surpluses of cash.
The ‘secondary market’ includes:
– the interbank market
– the eurocurrency market
– the certificates of deposit market
– the intercompany market
– the local authority market.
(d) Money market instruments

– Deposits: deposits of money with financial intermediaries such as banks.
– Bills: short-term financial assets which can be converted into cash at short notice by selling them in the discount market.
– Commercial paper: short-term IOUs issued by large companies. They can either be held until maturity or sold on before
then.
– Certificates of deposit: available to customers who deposit a minimum amount for fixed terms. They can be held until
maturity or sold in the CD market.
14
Marks
1 (a) Cash budget
Ticket sales 2
Other sales 1
Costs re ‘other sales’ 1
Leading lady’s salary 1
Other cast members 1
Musicians 1
Production company staff 1
Production company fee 1
Production equipment 1
Costumes 1
Background 0·5
Theatre hire 1
Equipment costs 1
Depreciation – ignore 1
Ticket agent’s commission 2
Net cash flow 0·5
Opening balance b/f 0·5
Closing balance c/f 0·5
–––
18
–––
(b) Sensitivity analysis

Each valid point 1
–––
6
–––
(c) NPV
Saved production costs 0·5
Saved admin fees 0·5
Saved equipment costs 0·5
Legal costs 0·5
Registration costs 0·5
Equipment 0·5
Maintenance costs 0·5
Lost revenue 2
Salaries 0·5
Professional fees 0·5
Depreciation – ignore 0·5
Net cash flow 0·5
Discount factors/annuity factor 0·5
Use of annuity factor 0·5
Discounted cash flow 0·5
Follow-on NPV 0·5
Conclusion 0·5
Presentation 0·5
–––
Maximum marks 10
–––
(d) (i) Payback explained

–––
Explanation 2
–––
(ii) Differences
Each difference 1
–––
Max marks 2
–––
(iii) Advantages
–––
Each advantage 1
–––
2
–––
Overall total 40
–––
15
–––
Marks
2 (a) Calculation 2
Explanation 2
–––
4
–––
(b) Simple/compound interest

Each point explained 1
–––
Max marks 4
–––
(c) Whether to factor

New sales level 1
New receivables level 1
Current cost 1
Receivables at 70 days 1
Cost of 80% advanced 2
Cost of 20% not advanced 2
Admin fee 1
Saved salary 1
Factor cost 1
Conclusion 1
–––
12
–––
Overall total 20
–––
–––
3 (a) Overtrading
–––
Explanation 2
–––
(b) Symptoms
Turnover 1
Current assets 1
Fixed assets 1
Liquidity ratios 1
Debt ratios 1
Trade payables 1
Bank overdraft 1
–––
Max marks 5
–––
(c) Discussion
Each point discussed 1
–––
Max marks 5
–––
(d) Inventory calculations

–––
(i) Re-order level 3
–––
–––
(ii) EOQ calculation 2
–––
–––
(iii) Maximum level 3
–––
Overall total 20
–––
–––
16
Marks
4 (a) Retail/wholesale banks
Retail banks 2
Wholesale banks 2
–––
4
–––
(b) Functions of central bank

Each function described 2
–––
Max marks 8
–––
(c) Money markets

Short-term 0·5
Wholesale amounts 0·5
Cover shortages 0·5
Facilitate use of surpluses 0·5
Primary market 0·5
Secondary market 0·5
Interbank market 0·5
Eurocurrency market 0·5
Certificates of deposit market 0·5
Intercompany market 0·5
Local authority market 0·5
Any reasonable point 0·5/1
–––––
Max marks 4
–––––
(d) Money market instruments

Deposits 1
Bills 1
Commercial papers 1
Certificates of deposit 1
–––––
4
–––––
Overall total 20
–––––
–––––
17
Paper T10
Advanced Level
Managing Finances
Wednesday 10 December 2008
Time allowed
Writing: 3 hours


1 Wicker Co manufactures chairs. It has recently been approached by one of its customers, Chill Co, a garden furniture
retailer, who has asked it to enter into a five-year contract to supply a particular range of chairs. The chairs will form
part of Chill Co’s new luxury collection that they plan to start selling in three months’ time. Production would therefore
have to commence as soon as possible.
There are three types of chairs in the collection – The Recliner (R), The Soother (S) and The Handy (H). Wicker Co
has collated the following information:
1 Chill Co estimates that it would purchase the following quantities of R, S and H over the five year period:
Year 1 Year 2 Year 3 Year 4 Year 5
R 20,000 22,000 24,200 26,620 29,282
S 25,000 27,500 30,250 33,275 36,603
H 30,000 33,000 36,300 39,930 43,923
Wicker Co’s intention is not to hold any finished goods inventory at the end of each year.
2 Chill Co will pay $200 for each R purchased, $100 for each S and $70 for each H.
3 Wicker Co will need to use a high-tech machine to make the chairs. This could be purchased immediately at a
cost of $200,000 and would have no scrap value at the end of the five years. Alternatively, Wicker Co has
another machine on site, for which it no longer has any use, which could be modified at an immediate cost of
$75,000. This machine would then be equivalent to the high-tech machine in terms of its capacity to make
chairs. This machine was bought two years ago at a cost of $300,000. If it is not used for the Chill Co contract,
it will be sold immediately for $100,000. If modified, it would have no scrap value at the end of the five years.
4 Wicker Co would also use some additional existing machinery to carry out the work on the chairs. Depreciation
of $45,000 per annum would be allocated to this contract.
5 Materials usage for each of the three chairs are as follows:
R S H
Wood X (m2) 1 2 3
Fabric (m) 3 2 1
6 Materials costs are as follows:
Wood X $14 per m2
Fabric $22 per m
Wicker Co already has 160,000m2 of wood X in inventory, which it ordered in error last month. Wood X cost
$20 per m2. If Wicker does not use wood X for this contract, it will either be used immediately as a substitute
for Wood Y, which currently costs $13 per m2, or sold for $11 per m2.
Also, Wicker Co already has 294,000m of fabric in inventory. The fabric cost the company $20 per metre. If it
does not use this fabric for the Chill Co contract, the fabric would be sold immediately for $10 per metre since
it has no other use for it.
7 Each chair requires the following amount of time from Wicker Co’s skilled and unskilled labour forces:
R S H
Skilled (hours) 2 2 2
Unskilled (hours) 1 1 1
At present, the company’s skilled labour force costs $8 per hour and its unskilled labour force costs $6 per hour.
The company’s skilled labour force is working to full capacity, so new staff will need to be recruited if the Chill
Co contract is entered into. These will cost $9 per hour and will be needed for the whole period of the contract.
However, there is an unexpected surplus capacity of unskilled labour for the first year. It is thought that existing
employees can provide 35,000 of the unskilled labour hours required in the first year, at no extra cost to the
company. The remainder of the unskilled hours required will be provided by the employment of additional staff
at $6 per hour.
8 Variable overheads will be incurred at the rate of $4 per skilled and unskilled labour hour used.
2
9 Fixed overheads are expected to be $400,000 per annum. Of these, $220,000 relates to apportionment of
factory rent. The factory space that would be used for the contract is currently unused and Wicker Co does not
foresee it being used at all in the future unless this contract is entered into. The remainder of the fixed overhead
cost relates to a new warehouse that would be rented to cope with the increased storage space required for the
Chill Co contract.
10 The company’s cost of capital is 11·5%.
Required:
(a) Within the context of relevant costing, explain how to determine the relevant cost of the following items for
the Chill Co contract:
(i) machine costs (note 3)
(ii) wood costs (note 6)
(iii) fabric costs (note 6)
Note: whilst you should explain the correct costs to be used, detailed calculations should be performed in (b)
below. (8 marks)
(b) Using the discount factors provided below, calculate the net present value of the contract and recommend
whether Wicker Co should enter into the contract. Workings should be in $’000, to the nearest $’000.
Discount factors
Time Factor
11·5%
1 0·897
2 0·804
3 0·721
4 0·647
5 0·580
(32 marks)
(40 marks)
3 [P.T.O.
2 Brush Co is a recently established company specialising in the manufacture of a range of drugs for the pharmaceutical
industry. Two brothers, Thomas and Gerald Broom, formed the company and have just finished the first year of
business. Sales are made to customers on 60-day payment terms and all suppliers offer 30 days’ credit. All of the
raw materials purchased by Brush Co only last for a limited time. Therefore, it is the company’s policy that such
chemicals are used within 75 days of purchase.
Whilst the brothers are experienced in the field of pharmaceuticals, they are finding it difficult to understand some of
the financial matters associated with running a company.
You are employed in the company as an accounting technician and have collated the following information for the last
year.
$
Sales 1,500,000
Raw material purchases 378,000
Direct labour costs 240,000
Variable production overheads 215,000
Apportioned fixed production overheads 185,000
Average receivables 356,000
Average inventories:
Work-in-progress (WIP) 58,000
Average payables:
Materials 45,000
Variable and fixed overheads 75,000
Direct labour 9,000
1 All finished goods inventory and WIP values include raw materials, direct labour, variable production overheads
and apportioned fixed production overhead costs.
2 Assume WIP is 70% complete.
3 Assume there are 365 days in one year.
4 Assume that production and sales volumes are the same.
5 The length of the average working capital cycle in this type of business is 90 days.
Required:
(a) Calculate Brush Co’s working capital cycle (cash operating cycle) in days. All workings should be rounded to
the nearest complete day. (10 marks)
(b) Explain what working capital management is and why it is important. (4 marks)
(c) From your calculations in part (a), identify possible concerns that Brush Co’s chief accountant may have
about the company’s working capital cycle. (6 marks)
(20 marks)
4
This is a blank page.
Question 3 begins on page 6.
5 [P.T.O.
3 Print Co is a printing company providing a range of printing services to commercial businesses and the public (non-
commercial customers.) It has three main suppliers, which it uses for the majority of its supplies, but also uses a
number of smaller suppliers for its sundry purchases. Whilst commercial customers are sometimes provided with a
credit facility, non-commercial customers must pay on the day with cash, cheque, debit or credit card. Print Co
prepares cleared funds forecasts on a weekly basis.
You are an accounting technician for the company and have been asked to prepare a cleared funds forecast for the
period Monday 19 January to Friday 23 January 2009 inclusive. You have been provided with the following
information:
1 Receipts
Commercial customers Month to:
Customer Credit terms Payment 19 Jan. 19 Dec. 19 Nov.
name method 2009 sales 2008 sales 2008 sales
Anchor Co 2 calendar months Cheque $18,000 $24,000 $16,000
Beauty Co 1 calendar month Cheque $13,000 $18,000 $17,000
Kent Co 1 calendar month BACS $20,000 $18,000 $15,000
Hut Co None Cash $2,200 $5,400 –
Light Co None Cheque $4,500 – $2,200
Non-commercial customers
Payment Mon Tue Wed Thu Fri Mon Tue Wed Thu Fri
method 12 13 14 15 16 19 20 21 22 23
Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan. Jan.
Cash $300 $230 – $120 – – $220 $350 – $430
Cheque $220 – – – – – – – – –
Debit card $255 $426 – – – $170 $210 – – –
Credit card – – – – – – – – – $3,500
Notes
(i) Receipt of money by BACS is instantaneous.
(ii) All commercial customers are reliable, as cheques are always received on 19th day of each month. They
are banked on the same day and clear on the fourth working day following the date of receipt.
(iii) Debit card payments are credited to Print Co’s account on the next working day following the date of sale.
They represent cleared funds as soon as they are credited.
(iv) Credit card receipts clear in Print Co’s bank account on the fifth working day following the day of sale.
(v) A ‘working day’ is a Monday, Tuesday, Wednesday, Thursday or Friday.
2 Payments to suppliers
Main suppliers
Supplier name Credit terms Payment Jan. 2009 Dec. 2008 Nov. 2008
method purchases purchases purchases
Ink Co 1 month Direct debit $6,500 $5,500 $4,200
Toner Co 2 months Direct debit $8,500 $8,000 $10,600
Paper Co 1 month Direct debit $7,200 $10,500 $5,400
Notes
(i) Print Co’s monthly direct debit payments will leave its account on 23 January.
(ii) Print Co pays its sundry suppliers by cheque each month. These total $8,200 for January and will also be
sent out on 23 January.
3 Wages and salaries
All staff are paid a monthly salary by BACS on the 22nd day of each month. The total salaries cost for January
is $9,600. BACS transactions are initiated and paid on the same day.
4 Other payments
Every Monday morning, the cashier withdraws $150 from the company bank account to use as petty cash. The
money leaves Print Co’s bank account straight away.
6
5 Other information
The balance on Print Co’s bank account will be $35,000 on 19 January 2009. This represents both the book
balance and cleared funds.
Required:
Prepare a cleared funds forecast for the period Monday 19 January to Friday 23 January 2009 inclusive using
the information provided. Show clearly the uncleared funds float and the total book balance carried forward each
day.
(20 marks)
4 Slim Jim Co is a five-year old private company specialising in the manufacture of a range of health drinks, foods and
supplements aimed at the fitness market. At present, their biggest customers are health food shops and fitness
centres. However, now that their brand has become established, the wealthy owners, who also manage the business,
are convinced that sales could be increased dramatically through the opening of an internet shop. They are currently
considering how best to fund the expansion of the business.
Funds would be needed to set up the website, expand manufacturing at the factory, and employ more staff to deal
with administration, despatch and delivery of the web orders.
It is estimated that $2 million would be needed for the expansion. At present, the market value of the company’s
equity is $4 million and the company has loans of $0·5 million, repayable in six months time. The company also has
cash built up from retained earnings of $1·3 million.
Required:
(a) Outline THREE appropriate sources of medium/long-term finance that may be available to Slim Jim Co to
finance its expansion. (Presume that government grants and leasing are NOT appropriate.) (5 marks)
(b) Discuss FIVE factors that Slim Jim Co should take into account when deciding on the mix of debt and equity
finance. (15 marks)
(20 marks)
7
Answers

1 Wicker Co
(a) Relevant costs

Machine costs
There are two alternatives to consider for the machine. The first is the purchase of the new machine for $200,000. This cost
has to be compared to the cost of not purchasing the new machine but instead, converting the old one. The total cost of this
latter option would be the conversion cost of $75,000 together with the lost sale proceeds of $100,000. The $75,000 is
relevant to the decision since it is an incremental cash flow if this option is chosen. The $100,000 is also relevant since it
is the opportunity cost of keeping the old machine. If it is kept, it cannot be sold and these potential sales proceeds are
therefore lost. Hence, the total costs of $175,000 ($100,000 + $75,000) must be compared to the cost of buying a new
machine, which is $200,000. The assumption is then made within relevant costing that the company chooses the cheaper
option which, in this case, is keeping the old machine and converting it. Hence, it is the $175,000 that is relevant to the
NPV calculation.
Wood X
In deciding the relevant cost for wood X, Wicker Co has to firstly decide what it would do with wood X if it did not use it for
this contract. It has two choices – either sell wood X for $11 per metre or use it as a substitute for wood Y, saving $13 per
metre. The best of these alternatives is to use it as a substitute for wood Y, saving $13 per metre. Next, Wicker Co should
compare the value of wood X as a substitute ($13 per m) to the cost of buying new wood for the Chill Co contract ($14 per
m). It is clearly better to use the wood for this contract. Therefore, the opportunity cost for wood X is $13 per m2, at T0.
$13 x 160,000 = $2·08 million.
From T2 onwards, the replacement cost of $14 per metre is the relevant cost. At no point is the $20 historic cost of wood X
relevant since it is a sunk cost.
Fabric costs
With regards to fabric, Wicker Co has two choices: either sell the fabric for $10 per metre or use it for the Chill Co contract.
Since the current cost of the fabric is $22 per metre, Wicker Co should use the fabric rather than selling it. The cost is therefore
the lost sale proceeds of 294,000 x $10. These lost sales proceeds of $2·94m are all included at T0 since, if it were not to
be used for this contract, the fabric would be sold immediately.
(b) Net present value

T0 T1 T2 T3 T4 T5
$’000 $’000 $’000 $’000 $’000 $’000
Sales (W1) 8,600 9,460 10,406 11,447 12,591
Machine modification (175)
Wood (W2) (2,080) – (2,464) (2,710) (2,981) (3,280)
Fabric (W3) (2,940) – – (3,727) (4,099) (4,509)
Skilled labour (W4) (1,350) (1,485) (1,634) (1,797) (1,977)
Unskilled labour (W5) (240) (495) (545) (599) (659)
Variable overheads (W6) (900) (990) (1,089) (1,198) (1,318)
Fixed overheads (180) (180) (180) (180) (180)
––––––– –––––– ––––––– ––––––– –––––– –––––––
Net cash flows (5,195) 5,930 3,846 521 593 668
––––––– –––––– ––––––– ––––––– –––––– –––––––
Discount factors 1 0·897 0·804 0·721 0·647 0·580
––––––– –––––– ––––––– ––––––– –––––– –––––––
Present value (5,195) 5,319 3,092 376 384 387
–––––––
––––––– ––––––
–––––– –––––––
––––––– –––––––
––––––– ––––––
–––––– –––––––
–––––––
The net present value of the contract is $4·363m. Since the net present value is positive, the contract should be entered into.
Workings
W1: Sales T0 T1 T2 T3 T4 T5
Annual sales levels per question
R: 20,000 22,000 24,200 26,620 29,282
S: 25,000 27,500 30,250 33,275 36,603
H: 30,000 33,000 36,300 39,930 43,923
––––––– ––––––– ––––––– ––––––– –––––––
Total sales levels 75,000 82,500 90,750 99,825 109,808
––––––– ––––––– ––––––– ––––––– –––––––
Sales revenue $’000 $’000 $’000 $’000 $’000
R: at $200 each 4,000 4,400 4,840 5,324 5,856
S: at $100 each 2,500 2,750 3,025 3,328 3,660
H: at $70 each 2,100 2,310 2,541 2,795 3,075
––––––– ––––––– ––––––– ––––––– –––––––
Total sales 8,600 9,460 10,406 11,447 12,591
––––––– ––––––– ––––––– ––––––– –––––––
11
W2: Wood T0 T1 T2 T3 T4 T5
R: annual sales level x 1m2 20,000 22,000 24,200 26,620 29,282
S: annual sales level x 2m2 50,000 55,000 60,500 66,550 73,206
H: annual sales level x 3m2 90,000 99,000 108,900 119,790 131,769
–––––––– –––––––– –––––––– –––––––– ––––––––
Total m required per annum. 160,000 176,000 193,600 212,960 234,257
–––––––– –––––––– –––––––– –––––––– ––––––––
$’000 $’000 $’000 $’000 $’000 $’000
Total cost at $13 per m2 (T0) & 2,080 – 2,464 2,710 2,981 3,280
––––––– –––––––– –––––––– –––––––– –––––––– ––––––––
$14 per m2 at T3 to 5.
W3: Fabric
R: annual sales level x 3m 60,000 66,000 72,600 79,860 87,846
S: annual sales level x 2m 50,000 55,000 60,500 66,550 73,206
H: annual sales level x 1m 30,000 33,000 36,300 39,930 43,923
–––––––– –––––––– –––––––– –––––––– ––––––––
Total m required per annum 140,000 154,000 169,400 186,340 204,975
Less: already in inventory –140,000 –154,000 0 0 0
–––––––– –––––––– –––––––– –––––––– ––––––––
Purchase requirements 0 0 169,400 186,340 204,975
–––––––– –––––––– –––––––– –––––––– ––––––––
$’000 $’000 $’000 $’000 $’000 $’000
Total cost at $10 for T0 2,940 – – 3,727 4,099 4,509
––––––– –––––––– –––––––– –––––––– –––––––– ––––––––
& T2/$22 T3–5
W4: Skilled labour

$’000 $’000 $’000 $’000 $’000
x 2 hours each, at $9 per hour. 1,350 1,485 1,634 1,797 1,977
–––––––– –––––––– –––––––– –––––––– ––––––––
W5: Unskilled labour
Total sales levels and hours required 75,000 82,500 90,750 99,825 109,808
Less: available unused hours –35,000 – – – –
–––––––– –––––––– –––––––– –––––––– ––––––––
Hours required 40,000 82,500 90,750 99,825 109,808
–––––––– –––––––– –––––––– –––––––– ––––––––
$’000 $’000 $’000 $’000 $’000
Total cost at $6 per hour 240 495 545 599 659
–––––––– –––––––– –––––––– –––––––– ––––––––
W6: Variable overheads
Hours required per unit 3 3 3 3 3
–––––––– –––––––– –––––––– –––––––– ––––––––
Total hours required 225,000 247,500 272,250 299,475 329,424
–––––––– –––––––– –––––––– –––––––– ––––––––
$’000 $’000 $’000 $’000 $’000
Total cost at $4 per hour 900 990 1,089 1,198 1,318
–––––––– –––––––– –––––––– –––––––– ––––––––
12
2 Brush Co
(a) Working capital cycle

Inventories: $ Days
Raw materials:
–––––––––––– x 365 = –––––––––– x 365 79
Purchases 378,000
Work in progress:
Work in progress 58,000
––––––––––––––––––––––––––––––––––– x 365 = ––––––––––––––––– x 365 30
Cost of sales (w.1) x degree of completion 1,018,000 x 70%
Finished goods:
––––––––––––– x 365 = –––––––––– x 365 75
Credit allowed to customers:
Receivables 356,000
–––––––––– x 365 = –––––––––– x 365 87
Sales 1,500,000
Credit taken from suppliers:
Materials:
Payables 45,000
–––––––––––––––– x 365 = ––––––––– x 365 (43)
Raw materials costs 378,000
Overheads:
Payables 75,000
–––––––––––––––––––– x 365 = ––––––––– x 365 (68)
Variable/fixed overheads 400,000
Labour:
Payables 9,000
––––––––––––––– x 365 = –––––––– x 365 (14)
Direct labour costs 240,000
––––
146
––––
––––
Working 1: Cost of sales $
Raw material costs 378,000
Direct labour 240,000
Variable production overheads 215,000
Apportioned fixed production overheads 185,000
––––––––––
1,018,000
––––––––––
––––––––––
(b) Working capital management

Working capital management involves:
– controlling the overall liquidity position of a business, and
– controlling the individual elements of working capital, namely inventories, receivables, cash and payables.
The aim of working capital management is to balance having too much working capital with having too little working capital.
Too much working capital is costly in terms of lost opportunities and finance charges for cash tied up; too little working capital
can lead to the inability to pay debts as they fall due, or necessitate the use of expensive short-term borrowing. It is therefore
important to manage it effectively.
(c) Concerns about Brush Co’s working capital cycle

– The receivables payment period is 87 days. This is too long, given that Brush Co only allows 60 days credit to
customers. Also, it is twice as long as the payment period for raw material supplies and overheads.
– The payment period for raw material supplies is 43 days and for overheads it is much higher, at 68 days. These periods
are both longer than the agreed credit period of 30 days. This could lead to interest being charged by suppliers and a
deterioration in the relationships with suppliers.
– Raw materials are held for an average of 79 days. Since it is the company’s policy to use raw materials within 75 days
of purchase, these inventories are too high. The company’s policy is being breached, which could lead to substandard
drugs being manufactured.
– Overall, the working capital cycle is too long. At 146 days, it is 56 days longer than comparative companies. This is
costing the company money in terms of cash tied up in working capital and lost opportunities elsewhere.
13
3 Print Co
Cleared Funds Forecast

19 Jan 20 Jan 21 Jan 22 Jan 23 Jan
$ $ $ $ $
Receipts (w 1)
Anchor Co 16,000
Beauty Co 18,000
Kent Co 18,000
Hut Co 2,200
Light Co 4,500
Non-commercial customers – method:
Cash 220 350 430
Debit card 170 210
Credit card
––––––– ––––––– ––––––– ––––––– –––––––
20,200 390 560 0 38,930
––––––– ––––––– ––––––– ––––––– –––––––
Payments
Ink Co 5,500
Toner Co 10,600
Paper Co 10,500
Other cheques
Salaries 9,600
Petty cash 150
––––––– ––––––– ––––––– ––––––– –––––––
150 0 0 9,600 26,600
––––––– ––––––– ––––––– ––––––– –––––––
Cleared excess receipts
over payments 20,050 390 560 (9,600) 12,330
Cleared balance b/f 35,000 55,050 55,440 56,000 46,400
––––––– ––––––– ––––––– ––––––– –––––––
Cleared balance c/f 55,050 55,440 56,000 46,400 58,730
––––––– ––––––– ––––––– ––––––– –––––––
Receipts 38,670 38,710 38,500 38,500 3,500
Payments (8,200)
––––––– ––––––– ––––––– ––––––– –––––––
38,670 38,710 38,500 38,500 (4,700)
––––––– ––––––– ––––––– ––––––– –––––––
Total book balance c/f 93,720 94,150 94,500 84,900 54,030
–––––––
––––––– –––––––
––––––– –––––––
––––––– –––––––
––––––– –––––––
–––––––
Working 1
Uncleared funds: Receipts $
Anchor (Nov. sales) 16,000
Beauty Co (Dec. sales) 18,000
Light Co (Jan. sales) 4,500
Debit (DR) card receipts 19 Jan 170
––––––––
Uncleared receipts 19 Jan 38,670
––––––––
Less: cleared DR card receipts from 19 Jan –170
Add: debit card receipts from 20 Jan 210
––––––––
––––––––
Less: cleared DR card receipts 20 Jan –210
––––––––
Uncleared receipts 21 and 22 Jan 38,500
––––––––
Less: cleared cheques from 19 Jan –38,500
Add: uncleared credit card receipts 3,500
––––––––
––––––––
––––––––
14
4 Slim Jim Co
(a) Sources of finance

(i) Retained earnings
This is the most obvious source of finance for at least part of the funds required. Slim Jim could use part of the
$1·3 million for the investment. However, given that the loan is repayable in six months time, the company must keep
$0·5 million back for this. Also, there are often cost overruns on this sort of project so Slim Jim must keep some retained
earnings back to cover these.
(ii) Loan
Slim Jim Co could take out a loan from the bank. It is unlikely to have access to any other source of debt provider (such
as the international bond market) since it is not a large company.
(iii) Rights issue of shares
Presumably, since we know that Slim Jim’s current owners are ‘wealthy’, they could inject more cash into the company
in the form of shares. This will prevent any dilution of control by selling shares outside of the company.
(iv) New share issue
This would have to be to private investors, unless the company were to be floated on the stock exchange.
(v) Venture capital
Slim Jim could approach a venture capital company with a view to obtaining funds for the expansion of the business.
However, venture capitalists would want to be closely involved with the new venture, even expecting a place on the
board of directors.
(b) Mix of debt and equity

Factors that should be taken into account are as follows:
(i) Cost
The cost of equity is higher than the cost of debt. This is because an equity investor takes a greater risk. If the company
goes into liquidation, an equity investor is the last person to be paid any money. Therefore, an equity investor expects
a higher return to reflect the risk he is taking. Also, whereas equity holders receive their return in the form of dividends,
lenders receive interest. Whilst interest payments are deductible for tax purposes, dividends are not. This makes the cost
of paying $100 in interest, for example, less than the cost of paying $100 in the form of dividends.
The tax relief element, combined with the lower risk element of debt, means that debt finance will definitely be cheaper.
(ii) Control of the business
Equity is normally injected into the business through the issue of ordinary shares. These allow the holder to share in the
ownership of the business and carry voting rights. Hence, a shareholder can participate in business decisions. The
market value of Slim Jim Co’s shares is currently $4 million. If the company issues a further $2 million of shares to
private investors, then one would expect the investors to gain about 1/3 of the total number of shares in issue (2:4).
This would give them a large degree of control over company decisions. Many resolutions of a company require 75%
of the votes and Slim Co would therefore be advised to think carefully before issuing shares giving new shareholders this
degree of control.
(iii) Current level of debt and maturity of existing borrowings
A significant difference between debt and equity is that debt has to be repaid, whereas equity does not. It is therefore
essential to review the level of Slim Jim’s current debt and the time period over which it has to be repaid. At present,
the company has $0·5 million of loans to be repaid over the next six months. Cash flow and profit forecasts would need
to be prepared in order to decide whether the company could undertake another loan at this point in time. There is not
enough information here to decide.
(iv) Effect on gearing
Gearing can be calculated in many ways but, in simple terms, it measures the amount of debt against the amount of
equity in a company. If debt is increased too much relative to equity, potential lenders will then see Slim Jim Co as a
high risk investment. They will then expect better returns to reflect their increased level of risk. At worst, they will refuse
to lend at all. Since Slim Jim Co has $4 million of equity and only has loans outstanding of $0·5 million (which will
have been repaid in six months anyway), gearing will increase substantially if the company issues $2 million of loans.
However, given the maturity of existing borrowings in six months, even with a full $2 million of loans, the company is
unlikely to be seen as so risky that a lender would not grant a loan. This assumes, of course, that the company can pay
the existing borrowings in six months without having to refinance them.
(v) Availability of finance
Slim Jim Co is a private company. This means that it cannot sell shares to the general public. Equity finance must come
from private investors. As such, the mix of debt and equity finance is restricted by the company’s ability to attract private
investors. It is probably going to be much easier for Slim Jim to obtain debt, rather than equity, finance. This is
presuming the company can offer some form of security for the loan. Debt finance would be restricted if this was not
the case, since the lender would view the debt as more high risk without security.
As regards equity finance, the company could consider floating its shares on the stock exchange in order to gain access
to a greater pool of investors.
15
Marks
1 (a) Costs explained
One mark per valid point 1
–––
Max. marks 8
–––
(b) NPV
Sales 6
Depreciation ignored 1
Machine – incl. f £100k 1
Machine – incl. £75k 1
Wood – 1 mark per year 5
Fabric – one mark per year 5
Skilled labour 2
Unskilled labour T1 2
Unskilled labour T2–5 2
Variable overheads 1
Fixed overheads – ignoring £220k 1
Fixed overheads – including £180k 1
Net cash flow 1
Present values 1
Net present value 1
Conclusion 1
–––
32
–––
–––
Total marks 40
–––
–––
2 (a) Working capital cycle

Raw materials period 1
Finished goods period 1
WIP period 2
Receivables period 1
Payables period (mats) 1
Payables period (o/heads) 1
Payables period (labour) 1
COS working 1
Total cycle 1
–––
10
–––
(b) Working capital management

Explanation of WCM 2
Why it is important 2
–––
4
–––
(c) Concerns
Each one identified & explained 2
–––
Max. 6
–––
–––
Total marks 20
–––
–––
17
Marks
3 Receipts:
Anchor Co 0·5
Beauty Co 0·5
Kent Co 0·5
Hut Co 0·5
Light Co 0·5
Non-comm. cash customers 1
Non-comm. DR card customers 1
Total receipts 1
Payments:
Ink Co 0·5
Toner Co 0·5
Paper Co 0·5
Salaries 1
Petty cash 1
Total payments 1
Cleared excess Rs over Ps 1
Cleared balance b/f 1
Cleared balance c/f 1
Uncleared receipts – 19 Jan 2
Uncleared receipts – 21 & 22 Jan 1
Uncleared payments – 23 Jan 1
Total book balance c/f 1
–––
Total marks 20
–––
–––
4 (a) Sources of finance

Max. marks for each source 2
–––
Max. overall 5
–––
(b) Mix of debt and equity

Cost 3
Control of the business 3
Current level of debt & maturity 3
Effect on gearing 3
Availability of finance 3
–––
15
–––
–––
Total marks 20
–––
–––
18

ACCA CAT Paper T10 Managing Finances Solved Past Papers

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

ACCA CAT Paper T10 Managing Finances Solved Past Papers

Uploaded by

Copyright:

Available Formats

Certified Accounting Technician examination

Sample multiple choice questions – June 2009

FOR FREE CAT & ACCA RESOURCES VISIT: http://kaka-pakistani.blogspot.com

5 The following statements have been made about inflation:

End of Sample Questions

1 B Only statement 1 is true

2 A Contribution per unit:

3 D Break-even sales in units = 235,000/25 = 9,400.

4 A (216 + 42)/(180 + 60) = 1.08, to 2 D.P.s

5 B Only statement 1 is true.

Therefore overall increase is $30,000 ($45,000 – $15,000)

8 A All three are assumptions for EOQ calculations.

ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION

WEDNESDAY 16 JUNE 2004

Time allowed 3 hours

ALL FOUR questions are compulsory and MUST be answered

The Association of Chartered Certified Accountants

FOR FREE CAT & ACCA RESOURCES VISIT: http://kaka-pakistani.blogspot.com

Present Value Table (extract)

Note: The formula for EOQ is 2 Co D

End of Question Paper

FOR FREE CAT & ACCA RESOURCES VISIT: http://kaka-pakistani.blogspot.com

1 (a) Relevant costs

(b) Net present value

(c) Internal rate of return

(d) Advantages and disadvantages of IRR

(e) The stages for project appraisal

(b) Symptoms of Overtrading

(c) Stock costs

(d) Rationale and assumptions

4 (a) Debt vs equity

NOTE: Only five factors were required.

4 (a) Debt and equity

ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION

WEDNESDAY 15 DECEMBER 2004

Time allowed 3 hours

ALL FOUR questions are compulsory and MUST be answered

Do not open this paper until instructed by the supervisor

This question paper must not be removed from the examination

The Association of Chartered Certified Accountants

FOR FREE CAT & ACCA RESOURCES VISIT: http://kaka-pakistani.blogspot.com

Define and briefly explain the following legal terms:

Present Value table (extract)

(c) Briefly describe the following:

End of Question Paper

FOR FREE CAT & ACCA RESOURCES VISIT: http://kaka-pakistani.blogspot.com

(a) Cash Budget

(b) Motives for holding cash

(c) Possible investments

(a) Working capital

(b) Legal terms

(a) Net present value

(b) Simple Payback

(c) Discounted Payback Period

(a) Factors considered by a bank

(b) Three characteristics

(c) Three terms

(b) Each motive discussed 2

(c) (i) CDs

2 (a) Calculation of each cost for yr 0·5

(b) Definition of offer 1

(b) Net cashflows 1

(c) Discounted net cashflows 1