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**FORMATION 1 EXAMINATION - APRIL 2005
**

NOTES

Answer 5 questions (Only the first 5 questions answered will be marked) All questions carry equal marks.

TIME ALLOWED:

Three hours and 10 minutes to read the paper.

INSTRUCTIONS:

During the reading time you may write notes on the examination paper but you may not commence writing in your answer book. Marks for each question are shown. The pass mark required is 50% in total over the whole paper. Start your answer to each question on a new page. You are reminded that candidates are expected to pay particular attention to their communication skills and care must be taken regarding the format and literacy of the solutions. The marking system will take into account the content of the candidates' answers and the extent to which answers are supported with relevant legislation, case law or examples where appropriate.

The Institute of Certified Public Accountants in Ireland, 9 Ely Place, Dublin 2.

THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND

**BUSINESS MATHEMATICS & QUANTITATIVE METHODS
**

FORMATION 1 EXAMINATION - APRIL 2005 Time Allowed: 3 hours and 10 minutes to read the paper Answer 5 questions Only the first five questions answered will be marked. All questions carry equal marks.

1.

The Superior Products company is purchasing a digital production machine. The cost accountant has received the following quotations from the BIA financial services company. You propose to use the Net Present Value method to assess the alternative proposals which are set out below. The machine is expected to have a life of 8 years. (i) (ii) (iii) Rent the machine for 120,000 pa payable in advance. Hire Purchase of the machine with a deposit of 150,000 and 7 equal annual payments of 100,000. At the end of 8 years the machine is owned by the company and sold for 50,000 Purchase the machine for 500,000 with a service contract of 40,000 p.a., payable in advance. At the end of 8 years the machine will be sold for 50,000.

Recommend the most appropriate option to the company using a cost of capital of 14%. [Total 20 Marks]

2.

Trainees in the production department of DIB Ltd. have recently undergone professional examinations. The company has received the distribution of examination results which are set out below. Marks 30 40 50 60 70 80 90 and and and and and and and less less less less less less less than than than than than than than 40 50 60 70 80 90 100 No. of Trainees 2 5 7 13 15 5 3

You are asked to provide the following information: (i) (ii) The mean and the median marks. (10 Marks)

Explain what the values calculated in (i) indicate about the distribution of marks, particularly with regard to the difference between the mean and median values. (10 Marks) [Total 20 Marks]

1

3.

The New Tyre Company has developed a new radial tyre supported by steel belts that will be sold through a chain of discount garages. Since this is a new tyre NTC considers that a guarantee offered with the tyre will aid its marketing. To support this you are asked to provide information on the number of miles the tyre will last. From road tests, NTC has estimated the mean tyre mileage at 36,500 miles and the standard deviation at 5,000 miles. The data collected indicates a Normal distribution. (i) (ii) Estimate the percentage of the tyres that last more than 40,000 miles. (8 Marks)

Estimate the guaranteed mileage if NTC does not want more than 10% to be eligible for the guarantee. (8 Marks) Briefly describe the principles used in the above calculations. (4 Marks) [Total 20 Marks]

(iii)

4.

A large multinational food company locates its fast-food outlets in areas where it estimates the youth population will provide adequate sales. The following table provides an estimate of the local population and quarterly sales for 10 restaurants.

Restaurant 1 2 3 4 5 6 7 8 9 10

Population (000s) 2 6 8 8 12 16 20 20 22 26

Quarterly Sales ( 000) 58 105 88 118 117 137 157 169 149 202

You are required to: (i) Draw a scatter diagram as a preliminary step in estimating the form of regression equation. (4 Marks) (ii) Derive the regression between the variables and position the regression line on the scatter diagram. (8 Marks) A further restaurant will be located in an area with a youth population of 21,000. Predict the quarterly sales for this restaurant. ( 8 Marks) [Total 20 Marks]

(iii)

2

5.

Constructor Ltd. is one of the major house building companies in Leinster. Its records show that it has doubled its construction programme of houses over the past 4 years with the usual peaks and valleys over time. The data from 2001 to 2004 is shown in the table below which shows the number of houses (in thousands) in each quarter over the four year period. Quarter Year 2001 2002 2003 2004 1 16 23.1 23.6 25.5 2 23 29.3 29.1 33.7 3 28.6 32.6 32.4 39.0 4 27.1 28.9 29.6 35.0

The MD asks you to prepare a report containing the following analyses. (i) (ii) Plot the trend in the data using centred moving averages. Explain how this process smoothes the data by isolating the trend and cyclical variations. (10 Marks) (10 Marks) [Total 20 Marks]

6.

As the investment adviser to CPA accounting you have been asked to deal with a wide range of problems. A number of the problems are set out below. Provide detailed solutions to the following: (i) A client wishes to repay a mortgage at level of mortgage required. 8,000 per year for 5 years at an interest rate of 12%. Calculate the (6 Marks) (ii) DIB Ltd produces batteries at a variable cost of 5 per unit and fixed costs of 20,000. The selling price per unit is 15. Write an equation to represent the company s costs and calculate the number of units required to make a profit of 8,000. (6 Marks) In (ii) above the following sample data was extracted from the battery production line. Sample mean = 950kg; sample standard deviation = 15kg; sample size = 36. Calculate the 95% confidence limits. (8 Marks) [Total 20 Marks]

(iii)

END OF PAPER

3

Suggested Solutions

**BUSINESS MATHEMATICS & QUANTITATIVE METHODS
**

FORMATION 1 EXAMINATION - APRIL 2005

Solution 1.

Net Present Value of Proposals. In all three cases the payments for years 1 to 7 can be treated as an annuity (i) Rental. The rent is payable in advance. Year Cash Flow Discount Factor NPV (ii) 0 ( 120,000) 1 ( 120,000) 1-7 ( 120,000) 4.288 ( 514,560) ( 634,560) Total

Hire Purchase. The deposit is paid in advance. Year Cash Flow Discount Factor NPV 0 ( 150,000) 1 ( 150,000) 1-7 ( 100,000) 4.288 ( 428,800) 8 50,000 0.351 17,550 ( 561,250) Total

(iii)

Purchase. Cash payment and one service fee is paid in advance. Year Cash Flow 0 ( 500,000) ( 40,000) Discount Factor NPV 1 ( 540,000) ( 40,000) 4.288 ( 171,520) 50,000 0.351 17,550 ( 693,970) 1-7 8 Total

Due to the lower cash out-flow, the hire-purchase option provides the best investment opportunity for the company. This reinforces the principle of net present value — if payments can be deferred over a longer period, the discounted cash flow is of greater benefit than paying cash in current terms.

4

Solution 2.

(i) The mean and median. Assuming that the data is continuous gives the mid points in the table. Class Boundaries 30 — 40 40 — 50 50 — 60 60 — 70 70 — 80 80 — 90 90 — 100 f 2 5 7 13 15 5 3 50 Cum freq 2 7 14 27 42 47 50 x 35 45 55 65 75 85 95 fx 70 225 385 845 1125 425 285 3360

Mean = x = ∑fx ∑f

= 3360 = 67.2 50

Median =

Lm + {N/2 - Fm-1} x Cm { fm }

where Lm Fm Cm = lower boundary of median class (60 — 70) = frequency of median class (13) = median class width (10), N = ∑f = 50

Fm-1 = cumulative frequency of class prior to median class (14)

Therefore, median

=

60 + { 51 - 14} x 10 2 13 68.85.

=

(ii)

The median has distinct advantages over the mean particularly in open ended distributions. The mean is generally used instead of the median especially if there is not much difference between them. The difference between them depends on the skewness of the distribution. The median splits the area under the frequency curve into two halves. If the distribution is symmetrical, then the mean and median will coincide. With a negatively skewed distribution the median exceeds the mean and with a positively skewed distribution the mean exceeds the median. In this case the median is greater than the mean. The distribution therefore has a negative skew. This demonstrates that there is a greater spread of marks amongst the trainees at the lower end of the scale.

5

Solution 3.

(i) At x = 40,000, z = x - µ where µ = 36,500, σ = 5,000 σ z = 40,000 - 36,500 5000 = 0.70. A Value of x = 40,000 on the Normal distribution corresponds to a value of z = 0.7 on the standard normal distribution. From the tables the area between the mean and z = 0.70 is 0.2580. Thus 0.5000 - 0.2580 = 0.2420 is the probability that it will exceed 40,000 miles. That is 24.2% of the tyres will exceed 40,000 miles. The appropriate diagram is shown below. (σ) = 5,000

P(x ‡ 40,000) P = 0.2580

Prob

µ = 36,500 0 0

40,000

Xi 0.5

0.7

Z

(ii)

According to the diagram below, 40% of the area must be between the mean and the guaranteed mileage.

(σ) = 5,000 10% of tyres eligible for discount

Prob Guaranteed mileage

µ = 36,500

Xi

0.4000, from the tables, is approximately 1.28 (0.3997) standard deviations below the mean, that is Z = - 1.28. To find the corresponding mileage z = x - µ = -1.28 σ x - µ = - 1.28σ x with µ = 36,500 and σ = 5,000 x = 36,500 - 1.28 (5000) = 30,100. = - 1.28σ + µ,

Thus a guarantee of 30,100 miles will meet the requirement that 10% of the tyres will be eligible for the guarantee. 6

(iii)

The normal distribution plays an important role in business applications since many business generate random variables with probability distributions that are well approximated by a normal distribution. It is used to detect disagreement between a set of data and the assumption of normality. It is perfectly symmetrical about its mean µ. It is defined as a normal distribution with µ = 0 and σ = 1. A random variable with a standard normal distribution is denoted by z and can be read from tables to find probabilities. To apply the tables to a normal random variable (x) we must first convert the value of x to a z-score. The population z-score for a measurement is defined as the distance between the measurement and the population mean divided by the population standard deviation. Thus the z-score gives the distance between a measurement and the mean in units equal to the standard deviation. That is z is a standard normal random variable such that z = x - µ σ Therefore, all probabilities associated with standard normal random variables can be depicted as areas under the standard normal curve.

Solution 4.

(i) Restaurant 1 2 3 4 5 6 7 8 9 10 Population (000s) x 2 6 8 8 12 16 20 20 22 26 Quarterly Sales ( 000) y 58 105 88 118 117 137 157 169 149 202

The size of the population is shown on the horizontal axis (the independent variable x) and the value of quarterly sales on the vertical axis (the dependent variable y). A scatter diagram enables us to observe the data graphically and to draw preliminary conclusions about the possible relationship between the variables. Quarterly sales appear to be higher in locations with larger populations . For this data, the relationship between the population size and sales appears to be approximated by a straight line — there seems to be a positive linear relationship between x and y> We therefore choose the simple linear regression model to represent the relationship between sales and population. The next step is to determine the values of a and b in the estimated regression equation where y = a + bx and y = estimated value of quarterly sales ( 000) x = the size of the population (000) for each restaurant a = the y intercept of the regression line b = the slope of the estimated regression line. The scatter diagram is shown below (and the regression equation in part (ii) is superimposed on it.

7

(ii)

The linear regression equation is: y = a + bx where ∑y = na + b∑x ∑xy = a ∑ x + b ∑x2 ; and a = ∑y - b∑x n n

b = n∑xy - ∑x∑y/n n∑x2 - (∑x)2 /n Restaurant 1 2 3 4 5 6 7 8 9 10 x 2 6 8 8 12 16 20 20 22 26 140 y 58 105 88 118 117 137 157 169 149 202 1,300 x2 4 36 64 64 144 256 400 400 484 676 2,528 xy 116 630 704 944 1,404 2,192 3,140 3,380 2,278 5,252 21,040

Inserting values gives b = 21,040 - 140 x 1,300/10 2,528 - 1402/10 21,040 - 18,200 2528 - 1,960 1300 - 5 x 140 10 10 = 5

=

a

=

=

60

Therefore, y = 60 + 5x. (iii) When x = 21, y = 60 + 105 = 165. Quarterly sales for this restaurant is predicted at 165,000. 8

Solution 5.

(i) The trend by means of centred moving averages. Quarter Year 2001 2002 2003 2004 Year 1 Quarter 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 16 23.1 23.6 25.5 New Houses (000s) 16.0 23.0 28.6 27.1 23.1 29.3 32.6 28.9 23.6 29.1 32.4 29.6 25.5 33.7 39.0 35.0 2 23 29.3 29.1 33.7 3 28.6 32.6 32.4 39.0 Moving Total 4 27.1 28.9 29.6 35.0 Moving Av. Centred Moving Av (TxC)

2

3

4

94.7 101.8 108.1 112.1 113.9 114.4 114.2 114.0 114.7 116.6 121.2 127.8 133.2

23.675 25.450 27.025 28.025 28.475 28.600 28.550 28.500 28.675 29.150 30.300 31.950 33.300

24.56 26.24 27.53 28.25 28.54 28.58 28.53 28.59 28.91 29.73 31.13 32.63

Trend — smoothed data.

(ii)

The data given in part (i) is a known time series. By drawing the centred moving average we are decomposing it to isolate the combined trend and cyclical components denoted by TxC. The isolation of TxC is based on the average excluding the effects due to seasonal and irregular variations. Because the data are listed by quarters it gives us the opportunity to isolate the trend and cyclical components by combining four quarters. The peaks and valleys that occur within each year are "smoothed". The column of centred moving averages represents estimates of the combined trend and cyclical components.

9

Recognising that the trend (T) is a long-term increasing or decreasing pattern and cyclical variations (C) is a pattern that repeats over time periods longer than one year, the combined effect of the TxC component is a longer term effect, that is, it eliminates the short-term effects from seasonal and irregular variations. The graph of the smoothed data gives the long term picture. It is possible to further decompose TxC so that the individual trend (T) and cyclical (C) components can be obtained. The trend equation is derived by regression analysis using the dependent variable Y (TxC) and independent X (quarters). The trend value can be derived for each quarter. The cyclical variation is then derived by C = TxC (from the data in part (i) T (from the regression line). Values of C are therefore expressed as index numbers that multiply C. In this way the value of C can be separated.

Solution 6.

(i) This is an annuity of 5 annual payments of (mortgage) is PV = 8,000 + 1.121 PV = a(1 - rn) 1- r where + 8,000. The interest rate is 12 per year. The present value of an annuity

8,000 1.125

a = regular sum received X discount factor, r = common ratio = 1/(1 + i), i = rate of discount, n = number of time periods. Therefore, PV = = = = 8,000 x 1 - (1/1.12)5 1.121 1 - (1/1.12) 7,143 x 1 - 0.8935 1 - 0.893 7,143 x 0.442 0.107 29,506.

(ii)

Equation to represent company s costs y = ax + b where y = total costs, x = number of units produced a = cost per unit, b = fixed costs. Therefore y = 5x + 20,000. To generate a profit of 8,000: Profit 8,000 x = total revenue - total costs = 15x - (5x + 20,000) = 2,800 units.

28,000 = 10x

(iii)

95% confidence interval and limits for µ µ = x – 1.96 (s/ˆn) = 950 – 1.96 (15/ˆ36) = 950 – 1.96 (2.5) = 950 – 4.9. Therefore, µ = 945.1kg to 954.9kg. We are 95% confident that the mean will lie within these limits

10

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