Financial

Management and
Control
PART 2
WEDNESDAY 13 JUNE 2007
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, 8 and 9.
Do not open this paper until instructed by the supervisor
This question paper must not be removed from the examination
hall
The Association of Chartered Certified Accountants
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Section A This ONE question is compulsory and MUST be attempted
1 The finance director of GTK plc is preparing its capital budget for the forthcoming period and is examining a number
of capital investment proposals that have been received from its subsidiaries. Details of these proposals are as follows:
Proposal 1
Division A has requested that it be allowed to invest 500,000 in solar panels, which would be fitted to the roof of
its production facility, in order to reduce its dependency on oil as an energy source. The solar panels would save
energy costs of 700 per day but only on sunny days. The Division has estimated the following probabilities of sunny
days in each year.
Number of sunny days Probability
Scenario 1 100 03
Scenario 2 125 06
Scenario 3 150 01
Each scenario is expected to persist indefinitely, i.e. if there are 100 sunny days in the first year, there will be 100
sunny days in every subsequent year. Maintenance costs for the solar panels are expected to be 2,000 per month
for labour and replacement parts, irrespective of the number of sunny days per year. The solar panels are expected to
be used indefinitely.
Proposal 2
Division B has asked for permission to buy a computer-controlled machine with a production capacity of 60,000 units
per year. The machine would cost 221,000 and have a useful life of four years, after which it would be sold for
50,000 and replaced with a more up-to-date model. Demand in the first year for the machines output would be
30,000 units and this demand is expected to grow by 30% per year in each subsequent year of production. Standard
cost and selling price information for these units, in current price terms, is as follows:
/unit Annual inflation
Selling price 12 4%
Variable production cost 4 5%
Fixed production overhead cost 6 3%
Fixed production overhead cost is based on expected first-year demand.
Proposal 3
Division C has requested approval and funding for a new product which it has been secretly developing, Product RPG.
Product development and market research costs of 350,000 have already been incurred and are now due for
payment. 300,000 is needed for new machinery, which will be a full scale version of the current pilot plant.
Advertising takes place in the first year only and would cost 100,000. Annual cash inflow of 100,000, net of all
production costs but before taking account of advertising costs, is expected to be generated for a five-year period. After
five years Product RPG would be retired and replaced with a more technologically advanced model. The machinery
used for producing Product RPG would be sold for 30,000 at that time.
Other information
GTK plc is a profitable, listed company with several million pounds of shareholders funds, a small overdraft and no
long-term debt. For profit calculation purposes, GTK plc depreciates assets on a straight-line basis over their useful
economic life. The company can claim writing down allowances on machinery on a 25% reducing balance basis and
pays tax on profit at an annual rate of 30% in the year in which the liability arises. GTK plc has a before-tax cost of
capital of 10%, an after-tax cost of capital of 8% and a target return on capital employed of 15%.
2
Required:
(a) For the proposed investment in solar panels (Proposal 1), calculate:
(i) the net present value for each expected number of sunny days;
(ii) the overall expected net present value of the proposal;
and comment on your findings. Ignore taxation in this part of the question. (9 marks)
(b) Calculate the net present value of the proposed investment in the computer-controlled machine (Proposal 2)
and advise whether the proposal is financially acceptable. Assume in this part of the question that tax is
payable and that writing down allowances can be claimed. (15 marks)
(c) Calculate the before-tax return on capital employed (accounting rate of return) of the proposed investment
in Product RPG (Proposal 3), using the average investment method, and advise on its acceptability.
(6 marks)
(d) Discuss how equity finance or traded debt (bonds) might be raised in order to meet the capital investment
needs of GTK plc, clearly indicating which source of finance you recommend and the reasons for your
recommendation. (12 marks)
(e) At the end of the first year of production after implementation of Proposal 2, the finance director noted that a
mistake had been made in forecasting selling price inflation, which should have been 15% instead of 4%. He
has gathered the following information regarding selling price and sales volume.
Forecast standard selling price (4% inflation) 1248
Actual selling price 1236
Forecast and actual standard variable cost 420
Forecast sales volume 30,000 units
Actual sales volume 32,000 units
Required:
(i) Using a marginal costing approach and ignoring the mistake in forecasting selling price inflation,
calculate the selling price variance and the sales volume contribution variance, and reconcile budgeted
contribution to actual contribution. (4 marks)
(ii) Using a marginal costing approach, evaluate the selling price variance from an operational and planning
perspective and discuss briefly whether your evaluation provides the finance director with useful
information. (4 marks)
(50 marks)
3 [P.T.O.
Section B TWO questions ONLY to be attempted
2 Required:
(a) Outline the key stages in the planning process that links long-term objectives and budgetary control.
(10 marks)
(b) Explain the meaning of the terms fixed budget, rolling budget and zero-based budget, and discuss the
circumstances under which each budget might be used. (10 marks)
(c) Discuss whether time series analysis may be preferred to linear regression as a way of forecasting sales
volume. (5 marks)
(25 marks)
3 Woodside is a local charity dedicated to helping homeless people in a large city. The charity owns and manages a
shelter that provides free overnight accommodation for up to 30 people, offers free meals each and every night of the
year to homeless people who are unable to buy food, and runs a free advice centre to help homeless people find
suitable housing and gain financial aid. Woodside depends entirely on public donations to finance its activities and
had a fundraising target for the last year of 700,000. The budget for the last year was based on the following forecast
activity levels and expected costs:
Free meals provision: 18,250 meals at 5 per meal
Overnight shelter: 10,000 bed-nights at 30 per night
Advice centre: 3,000 sessions at 20 per session
Campaigning and advertising: 150,000
The budgeted surplus (budgeted fundraising target less budgeted costs) was expected to be used to meet any
unexpected costs. Included in the above figures are fixed costs of 5 per night for providing shelter and 5 per advice
session representing fixed costs expected to be incurred by administration and maintaining the shelter. The number
of free meals provided and the number of beds occupied each night depends on both the weather and the season of
the year. The Woodside charity has three full-time staff and a large number of voluntary helpers.
The actual costs for the last year were as follows:
Free meals provision: 20,000 meals at a variable cost of 104,000
Overnight shelter: 8,760 bed-nights at a variable cost of 223,380
Advice centre: 3,500 sessions at a variable cost of 61,600
Campaigning and advertising: 165,000
The actual costs of the overnight shelter and the advice centre exclude the fixed costs of administration and
maintenance, which were 83,000.
The actual amount of funds raised in the last year was 620,000.
Required:
(a) Prepare an operating statement, reconciling budgeted surplus and actual shortfall and discuss the charitys
performance over the last year. (13 marks)
(b) Discuss problems that may arise in the financial management and control of a not-for-profit organisation such
as the Woodside charity. (12 marks)
(25 marks)
4
4 TFR Ltd is a small, profitable, owner-managed company which is seeking finance for a planned expansion. A local
bank has indicated that it may be prepared to offer a loan of 100,000 at a fixed annual rate of 9%. TFR Ltd would
repay 25,000 of the capital each year for the next four years. Annual interest would be calculated on the opening
balance at the start of each year. Current financial information on TFR Ltd is as follows:
Current turnover: 210,000
Net profit margin: 20%
Annual taxation rate: 25%
Average overdraft: 20,000
Average interest on overdraft: 10% per year
Dividend payout ratio: 50%
Shareholders funds: 200,000
Market value of fixed assets 180,000
As a result of the expansion, turnover would increase by 45,000 per year for each of the next four years, while net
profit margin would remain unchanged. No capital allowances would arise from investment of the amount borrowed.
TFR Ltd currently has no other debt than the existing and continuing overdraft and has no cash or near-cash
investments. The fixed assets consist largely of the building from which the company conducts its business. The
current dividend payout ratio has been maintained for several years.
Required:
(a) Assuming that TFR is granted the loan, calculate the following ratios for TFR Ltd for each of the next four
years:
(i) interest cover;
(ii) medium to long-term debt/equity ratio;
(iii) return on equity;
(iv) return on capital employed. (10 marks)
(b) Comment on the financial implications for TFR Ltd of accepting the bank loan on the terms indicated above.
(8 marks)
(c) Discuss the difficulties commonly faced by small firms such as TFR Ltd when seeking additional finance.
(7 marks)
(25 marks)
5 [P.T.O.
5 The following financial information relates to PNP plc for the year just ended:
000
Turnover 5,2420
Variable cost of sales 3,1450
Stock 6030
Debtors 7445
Creditors 5745
Segmental analysis of debtors
Balance Average payment period Discount Bad debts
Class 1 200,000 30 days 10% none
Class 2 252,000 60 days nil 12,600
Class 3 110,000 75 days nil 11,000
Overseas debtors 182,500 90 days nil 21,900

744,500 45,500

The debtor balances given are before taking account of bad debts. All sales are on credit. Production and sales take
place evenly throughout the year. Current sales for each class of debtors are in proportion to their relative year-end
balances before bad debts. The overseas debtors arise from regular export sales by PNP to the USA. The current spot
rate is $17348/ and the three-month forward rate is $17367/.
It has been proposed that the discount for early payment be increased from 10% to 15% for settlement within
30 days. It is expected that this will lead to 50% of existing Class 2 debtors becoming Class 1 debtors, as well as
attracting new business worth 500,000 in turnover. The new business would be divided equally between Class 1
and Class 2 debtors. Fixed costs would not increase as a result of introducing the discount or by attracting new
business. PNP finances debtors from an overdraft at an annual interest rate of 8%.
Required:
(a) Calculate the net benefit or cost of increasing the discount for early payment and comment on the
acceptability of the proposal. (9 marks)
(b) Calculate the current cash operating cycle and the revised cash operating cycle caused by increasing the
discount for early payment. (4 marks)
(c) Determine the effect of using a forward market hedge to manage the exchange rate risk of the outstanding
overseas debtors. (2 marks)
(d) Identify and explain the key elements of a debtor management system suitable for PNP plc. (10 marks)
(25 marks)
6
7 [P.T.O.
Formulae Sheet
8
3UHVHQW 9DOXH 7DEOH
Present value cf 1 i.e. (1 + U)
Q
Where r ~ cisccunt rate
n ~ number cf periccs until payment
'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 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 0914 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 0350 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
9
$QQXLW\ 7DEOH
Present value cf an annuity cf 1 i.e.
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