Financial

Management and
Control
PART 2
WEDNESDAY 10 DECEMBER 2003
QUESTION PAPER
Time allowed 3 hours
This paper is divided into two sections
Section A This ONE question is compulsory and MUST be
answered
Section B TWO questions ONLY to be answered
Formulae Sheet, Present Value and Annuity Tables are on pages
7 and 8.
P
a
p
e
r

2
.
4
Section A This ONE question is compulsory and MUST be attempted
1 At a recent meeting of the Board of Doe Ltd, a supplier of industrial and commercial clothing, it was suggested that
the company might be suffering liquidity problems as a result of overtrading, despite encouraging growth in turnover.
The Finance Director was instructed to report to the next Board meeting on this matter.
Extracts from the financial statements of Doe Ltd for 2002, and from the forecast financial statements for 2003, are
given below.
Profit and Loss Account extracts for years ending 31 December
2003 2002
000 000
Turnover 8,300 6,638
Cost of sales 4,900 3,720

Gross profit 3,400 2,918
Administration and distribution expenses 2,700 2,318

Operating profit 700 600
Interest 125 100
- -
Profit before tax 575 500

Balance Sheet extracts as at 31 December
2003 2002
000 000 000 000 000 000
Fixed assets 1,650 1,500
Current assets
Stocks 3,200 2,700
Debtors 2,750 2,000

5,950 4,700
Creditors: amounts due within 1 year
Trade creditors 2,550 1,800
Bank overdraft 2,750 2,300
Other liabilities 500 400

5,800 4,500

Net current assets 150 200

Total assets less current liabilities 1,800 1,700

Capital and reserves
Ordinary shares 400 400
Reserves 1,400 1,300

1,800 1,700

The Finance Director had reported to the recent board meeting that the bank was insisting the company reduce its
overdraft as a matter of urgency. It was suggested that the company could consider factor finance as an alternative
source of funds for working capital investment. The Production Director insisted that a new machine would be needed
to maintain growth in turnover and the Finance Director agreed to investigate how this might be financed.
2
Factoring
The Finance Director has found a factor who would take over administration of the companys debtors on a
non-recourse basis for an annual fee of 10% of turnover. The factor would advance 80% of the book value of debtors
at an annual interest rate 2% above the companys current overdraft rate. The factor expects to reduce the average
debtor period to 90 days. The company estimates that Doe Ltd could save 15,000 per year in administration costs.
No redundancy costs are expected.
The New Machine
The new machine wanted by the Production Director would cost 365,000 if purchased. The Finance Director is
confident this purchase could be financed by a medium-term bank loan at an annual interest cost of 10% before tax.
Alternatively, the machine could be leased for 77,250 per annum, payable annually in advance. The machine has
an expected life of five years, at the end of which it would have zero scrap value.
Sales and Costs of New Machine Output
The Finance Director has commissioned research that shows growth in sales of the output produced by the new
machine depends on the sales price, as follows:
Sales price New sales in year 1 Expected annual growth in sales
70 per unit 10,000 units 20%
67 per unit 11,000 units 23%
Variable costs of production are 42 per unit and incremental fixed production overheads arising from the use of the
machine are expected to be 85,000 per annum. The maximum capacity of the new machine is 20,000 units per
annum.
Other Information
Doe Ltd pays tax one year in arrears at a rate of 30% and can claim annual writing down allowances (tax-allowable
depreciation) on a 25% reducing balance basis. The company pays interest on its overdraft at approximately 6% per
annum before tax.
Average ratios for the business sector in which Doe Ltd operates are as follows:
Stock days 210 days Current ratio 135
Debtor days 100 days Quick ratio 055
Creditor days 120 days
Required:
(a) Write a report to the board of Doe Ltd that analyses and discusses the suggestion that the company is
overtrading. (12 marks)
(b) (i) Determine whether Doe Ltd should accept the factors offer. (7 marks)
(ii) What are the advantages to Doe Ltd of factoring its debtors? (8 marks)
(c) Discuss three ways (other than factoring) by which Doe Ltd might improve the management of its debtors.
(8 marks)
(d) Evaluate whether Doe Ltd should buy or lease the new machine, using an after tax discount rate of 7%.
(Assume that payment for the purchase, or the first lease payment, would take place on 1 January 2004.)
(9 marks)
(e) Calculate the optimum sales price for the output from the new machine. (Taxation and the time value of
money should be ignored.) (6 marks)
(50 marks)
3 [P.T.O.
Section B TWO questions ONLY to be attempted
2 Acred Ltd manufactures a single product. It is preparing monthly budgets for the six months from July to December
2004. The following standard revenue and cost data is available:
Selling price 1200 per unit
Materials 2 kg per unit at 240 per kg
Labour 180 per unit
Direct expenses 120 per unit
Sales in June 2004 and July 2004 are forecast to be 10,000 units in each month. As a direct result of marketing
expenditure of 95,000 in August 2004, sales are expected to be 11,000 units in August 2004 and to increase by
1,000 units in each month from September to December. Sales after December 2004 are expected to remain at the
December 2004 level.
25% of sales are paid for when they occur and 75% of sales are paid for in the month following sale. Stocks of
finished goods at the end of each month are required to be 20% of the expected sales for the following month. Stocks
of materials at the end of each month are required to be 50% of the materials required for the following months
production.
Materials are paid for in the month following purchase. Labour and direct expenses are paid for in the month in which
they occur. Overheads for production, administration and distribution will be 34,000 per month, including
depreciation of 12,000 per month. These overheads are payable in the month in which they occur. Acred Ltd has
a 750,000 bank loan at 8% per annum on which it pays interest twice per year, in March and September.
The cash balance at the end of June 2004 is expected to be 50,000.
Required:
(a) Prepare the following budgets for Acred Ltd on a month by month basis for the six month period from July
to December 2004:
(i) production budget (units);
(ii) cash budget. (13 marks)
(b) Critically discuss the relative merits of periodic budgeting and continuous budgeting. (7 marks)
(c) Discuss the consequences of budget bias (budgetary slack) for cost control. (5 marks)
(25 marks)
4
3 Basril plc is reviewing investment proposals that have been submitted by divisional managers. The investment funds
of the company are limited to 800,000 in the current year. Details of three possible investments, none of which can
be delayed, are given below.
Project 1
An investment of 300,000 in work station assessments. Each assessment would be on an individual employee basis
and would lead to savings in labour costs from increased efficiency and from reduced absenteeism due to work-related
illness. Savings in labour costs from these assessments in money terms are expected to be as follows:
Year 1 2 3 4 5
Cash flows (000) 85 90 95 100 95
Project 2
An investment of 450,000 in individual workstations for staff that is expected to reduce administration costs by
140,800 per annum in money terms for the next five years.
Project 3
An investment of 400,000 in new ticket machines. Net cash savings of 120,000 per annum are expected in
current price terms and these are expected to increase by 36% per annum due to inflation during the five-year life
of the machines.
Basril plc has a money cost of capital of 12% and taxation should be ignored.
Required:
(a) Determine the best way for Basril plc to invest the available funds and calculate the resultant NPV:
(i) on the assumption that each of the three projects is divisible;
(ii) on the assumption that none of the projects are divisible. (10 marks)
(b) Explain how the NPV investment appraisal method is applied in situations where capital is rationed.
(3 marks)
(c) Discuss the reasons why capital rationing may arise. (7 marks)
(d) Discuss the meaning of the term relevant cash flows in the context of investment appraisal, giving examples
to illustrate your discussion. (5 marks)
(25 marks)
4 Two important elements in the economic and financial management environment of companies are the regulation of
markets to discourage monopoly and the availability of finance to fund growth and development.
Required:
(a) Outline the economic problems caused by monopoly and explain the role of government in maintaining
competition between companies. (9 marks)
(b) Describe the methods of raising new equity finance that can be used by an unlisted company. (8 marks)
(c) Discuss the factors to be considered by a listed company when choosing between an issue of debt and an
issue of equity finance. (8 marks)
(25 marks)
5 [P.T.O.
5 Carat plc, a premium food manufacturer, is reviewing operations for a three-month period of 2003. The company
operates a standard marginal costing system and manufactures one product, ZP, for which the following standard
revenue and cost data per unit of product is available:
Selling price 1200
Direct material A 25 kg at 170 per kg
Direct material B 15 kg at 120 per kg
Direct labour 045 hrs at 600 per hour
Fixed production overheads for the three-month period were expected to be 62,500.
Actual data for the three-month period was as follows:
Sales and production 48,000 units of ZP were produced and sold for 580,800
Direct material A 121,951 kg were used at a cost of 200,000
Direct material B 67,200 kg were used at a cost of 84,000
Direct labour Employees worked for 18,900 hours, but 19,200 hours were paid at a
cost of 117,120
Fixed production overheads 64,000
Budgeted sales for the three-month period were 50,000 units of Product ZP.
Required:
(a) Calculate the following variances:
(i) sales volume contribution and sales price variances;
(ii) price, mix and yield variances for each material;
(iii) labour rate, labour efficiency and idle time variances. (8 marks)
(b) Prepare an operating statement that reconciles budgeted gross profit to actual gross profit with each variance
clearly shown. (5 marks)
(c) Suggest possible explanations for the following variances:
(i) material price, mix and yield variances for material A;
(ii) labour rate, labour efficiency and idle time variances. (5 marks)
(d) Critically discuss the types of standard used in standard costing and their effect on employee motivation.
(7 marks)
(25 marks)
6
7 [P.T.O.
3UHVHQW9DOXH7DEOH
Fresent value cf 1 i.e. (1 U)
Q
Where r ~ cisccunt rate
n ~ number cf periccs until payment
'LVFRXQWUDWHU
3HULRGV
(n) 1 2 3 4 5 6 7 8 9 10
1 0990 0980 0971 0962 0952 0943 0935 0926 0917 0909 1
2 0980 0961 0943 0925 0907 0890 0873 0857 0842 0826 2
3 0971 0942 0915 0889 0864 0840 0816 0794 0772 0751 3
4 0961 0924 0888 0855 0823 0792 0763 0735 0708 0683 4
5 0951 0906 0863 0822 0784 0747 0713 0681 0650 0621 5
6 0942 0888 0837 0790 0746 0705 0666 0630 0596 0564 6
7 0933 0871 0813 0760 0711 0665 0623 0583 0547 0513 7
8 0923 0853 0789 0731 0677 0627 0582 0540 0502 0467 8
9 0941 0837 0766 0703 0645 0592 0544 0500 0460 0424 9
10 0905 0820 0744 0676 0614 0558 0508 0463 0422 0386 10
11 0896 0804 0722 0650 0585 0527 0475 0429 0388 0305 11
12 0887 0788 0701 0625 0557 0497 0444 0397 0356 0319 12
13 0879 0773 0681 0601 0530 0469 0415 0368 0326 0290 13
14 0870 0758 0661 0577 0505 0442 0388 0340 0299 0263 14
15 0861 0743 0642 0555 0481 0417 0362 0315 0275 0239 15
(n) 11 12 13 14 15 16 17 18 19 20
1 0901 0893 0885 0877 0870 0862 0855 0847 0840 0833 1
2 0812 0797 0783 0769 0756 0743 0731 0718 0706 0694 2
3 0731 0712 0693 0675 0658 0641 0624 0609 0593 0579 3
4 0659 0636 0613 0592 0572 0552 0534 0516 0499 0482 4
5 0593 0567 0543 0519 0497 0476 0456 0437 0419 0402 5
6 0535 0507 0480 0456 0432 0410 0390 0370 0352 0335 6
7 0482 0452 0425 0400 0376 0354 0333 0314 0296 0279 7
8 0434 0404 0376 0351 0327 0305 0285 0266 0249 0233 8
9 0391 0361 0333 0308 0284 0263 0243 0225 0209 0194 9
10 0352 0322 0295 0270 0247 0227 0208 0191 0176 0162 10
11 0317 0287 0261 0237 0215 0195 0178 0162 0148 0135 11
12 0286 0257 0231 0208 0187 0168 0152 0137 0124 0112 12
13 0258 0229 0204 0182 0163 0145 0130 0116 0104 0093 13
14 0232 0205 0181 0160 0141 0125 0111 0099 0088 0078 14
15 0209 0183 0160 0140 0123 0108 0095 0084 0074 0065 15
8
0TT
3.7
$QQXLW\ 7DEOH
3UHVHQW YDOXH RI DQ DQQXLW\ RI LH
Where r ~ cisccunt rate
n ~ number cf periccs
'LVFRXQW UDWH U
3HULRGV
(n) 1 2 3 4 5 6 7 8 9 10
1 0990 0980 0971 0962 0952 0943 0935 0926 0917 0909 1
2 1970 1942 1913 1886 1859 1833 1808 1783 1759 1736 2
3 2941 2884 2829 2775 2723 2673 2624 2577 2531 2487 3
4 3902 3808 3717 3630 3546 3465 3387 3312 3240 3170 4
5 4853 4713 4580 4452 4329 4212 4100 3993 3890 3791 5
6 5795 5601 5417 5242 5076 4917 4767 4623 4486 4355 6
7 6728 6472 6230 6002 5786 5582 5389 5206 5033 4868 7
8 7652 7325 7020 6733 6463 6210 5971 5747 5535 5335 8
9 8566 8162 7786 7435 7108 6802 6515 6247 5995 5759 9
10 9471 8983 8530 8111 7722 7360 7024 6710 6418 6145 10
11 1037 9787 9253 8760 8306 7887 7499 7139 6805 6495 11
12 1126 1058 9954 9385 8863 8384 7943 7536 7161 6814 12
13 1213 1135 1063 9986 9394 8853 8358 7904 7487 7103 13
14 1300 1211 1130 1056 9899 9295 8745 8244 7786 7367 14
15 1387 1285 1194 1112 1038 9712 9108 8559 8061 7606 15
(n) 11 12 13 14 15 16 17 18 19 20
1 0901 0893 0885 0877 0870 0862 0855 0847 0840 0833 1
2 1713 1690 1668 1647 1626 1605 1585 1566 1547 1528 2
3 2444 2402 2361 2322 2283 2246 2210 2174 2140 2106 3
4 3102 3037 2974 2914 2855 2798 2743 2690 2639 2589 4
5 3696 3605 3517 3433 3352 3274 3199 3127 3058 2991 5
6 4231 4111 3998 3889 3784 3685 3589 3498 3410 3326 6
7 4712 4564 4423 4288 4160 4039 3922 3812 3706 3605 7
8 5146 4968 4799 4639 4487 4344 4207 4078 3954 3837 8
9 5537 5328 5132 4946 4772 4607 4451 4303 4163 4031 9
10 5889 5650 5426 5216 5019 4833 4659 4494 4339 4192 10
11 6207 5938 5687 5453 5234 5029 4836 4656 4486 4327 11
12 6492 6194 5918 5660 5421 5197 4988 4793 4611 4439 12
13 6750 6424 6122 5842 5583 5342 5118 4910 4715 4533 13
14 6982 6628 6302 6002 5724 5468 5229 5008 4802 4611 14
15 7191 6811 6462 6142 5847 5575 5324 5092 4876 4675 15
1 (1 U)
Q

U
End of Question Paper