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TOPIC 1

FEEDBACK TO REVIEW ACTIVITIES

Review activity 1.1

Wave Rider Case Study


High level of debt is the major problem confronting Brian Mackay. Causes of the problem include an accounting system which is not fully developed which means that Brian does not have access to necessary information to make decisions. In particular, there are cash flow problems relating to the bank and creditors and the ATO and lack of profitability due to high interest expense. He should: work out what he wants to achieve look at all possible alternatives (i.e. improve financial reporting and control systems; sell assets; refinance; tighten overheads; increase turnover; find new markets). evaluate consequences of each alternative choose a course of action.

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TOPIC 2
FEEDBACK TO REVIEW ACTIVITIES

Review activity 2.1

Wave Rider Case Study


1. Sales decreased by $91,471 from $1,467,042 (1989) to $1,375,571 (1990). Gross profit only decreased by $15,542. Expenses increased by $35,219 from $510,644 to $545,863. Major expenses included advertising, insurance, interest, rent and wages. In particular interest increased from $31,469 to $87,406 due to very high interest rates and high levels of debt due to increased borrowings over the past year. Net loss increased by $50,761 from $28,806 to $79,567. Liquidity is poor. There are insufficient current assets to cover current liabilities. A mistake Brian has made is borrowing on overdraft with higher interest rates instead of borrowing over a longer term which would improve the liquidity situation. High levels of debt (current and non-current liabilities) and current high interest rates (21 per cent) are causing interest expense to soar and is contributing significantly to the loss incurred. The high level of debt does not help the poor cash flow situation. The business is totally reliant on external funds hence the high levels of debt and associated problems high interest expenses, poor cash flow. Liabilities exceed total assets by $69,040.

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Review activity 2.2 1. Balance Sheet at end of Week 1 Assets Bank Computer Software Liability Loan from father Net assets Owners equity 2. $ 100 300 100 500 500 nil nil

The distinction between an asset and an expense can be unclear. In this case, when purchased, the software is best classified as an asset as future economic benefits would be expected to flow from purchasing the software. If the economic life of the software is expected to be two years, then the asset should be written off, i.e. treated as an expense, over the two-year period. Profit and Loss Statement for Week 2 $ 170 40 130

3.

Revenue less Expense Stationery Profit

Note that the stationery has been treated as an expense and the software has been treated as an asset at this stage. If the stationery had not been used at balance date, that part not used would be technically an asset. In practice, if the dollar amounts are relatively small, items which are technically assets are still treated as expenses as it is not expected to have a material effect on the calculation of profit and it saves the extra work involved in carrying the asset balance forward to the next accounting period.

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ACC00150 TOPIC 2 FEEDBACK TO REVIEW ACTIVITIES

4.

Balance Sheet at end of Week 2 Assets Bank Computer Software Liability Loan from father Net assets Owners equity Profit $ 230 300 100 630 500 130 130

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Statement of cash flows for the two-week period $ Operating cash flows Receipts from clients Payments to suppliers Investing cash flows Purchase of assets Financing cash flows Loan Net cash inflows Change in bank balance Opening Closing $ nil 230 170 ( 40) $

130 (400) 500 230

230

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TOPIC 3
FEEDBACK TO REVIEW ACTIVITIES

Review activity 3.1 Reading 3.2 by Bowlby highlights the importance of the costs associated with the cost-volume-profit analysis. Refer to the discussion list to see what fellow students have said about the issues.

Review activity 3.2 4 Square may be prematurely discontinuing new products by insisting that sales performance meet budgeted targets that were based on uncertain data. By doing so, 4 Square not only is losing the research and development costs sunk in these new products but also is foregoing the opportunity to make future profits. Such opportunities apparently exist, since a competitor marketed a product similar to 4 Squares adhesive fastener once 4 Square abandoned it. 4 Square could resolve this problem by implementing a policy in which new products are allowed a greater margin of error than more mature products in terms of meeting budgeted sales growth. The company could establish a range of likely sales performances based on differing market scenarios. Then 4 Square could compare actual sales to what sales should be given the situation that actually prevails.

Review activity 3.3 Budgets that are imposed on managers from above deprive managers from participating in the budget process. This creates a situation in which both the company and employee may suffer. The company does not receive input from managers who are in the best position to understand costs and

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processes. Further, a budgeting process that encourages manager participation communicates a sense of responsibility and fosters creativity. It also generates goal congruence since managers will have a greater tendency to achieve budgets in which they have a personal interest.

Review activity 3.4 1. When budgets are imposed on employees from above, employees may not embrace the budget as achievable or realistic and, accordingly, may not strive to meet the budget. When employees are active participants in the budget process and provide input, they will feel more attached to the budget, will have greater confidence in the budget, and will most likely strive to meet the budget. If employees performance is judged against a budget in which they had no input, they are likely to harbour feelings of unfairness. Budgets prepared in a participative manner require communication and input at many levels of the organisation. This communication process can result in a greater common awareness of organisational goals and can motivate employees by making them an important part of the budgeting process. When budgets are directed from above, employees may not understand the goals that were considered in developing the budget.

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TOPIC 4
FEEDBACK TO REVIEW ACTIVITIES

Review activity 4.1 Additional revenue per unit Costs per unit Direct material Direct labour Variable cost Special packing (per unit) Profit per unit 2.00 1.00 1.00 0.50 4.50 1.50 $6.00

Yes, Harbour Limited should accept the special order. An increase in profits for the four months will be 4,000 $1.50 = $6,000.

Review activity 4.2 $ Loss of revenue Cost savings: Variable Fixed Decrease in profit 31,250 1,000 $ 75,000

32,250 42,750

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TOPIC 6
FEEDBACK TO REVIEW ACTIVITIES

Review activity 6.1 The hierarchy could be changed so that each member has significant responsibility for one area of the business. The information needs to be collected from each source and considered individually. Currently there is no dissemination of financial information which will inevitably lead to inadequate information for timely decision making by management.

Review activity 6.2 The downturn in sales could be a result of: customers no longer identifying with the product range customers going to competitors products not enough new products to maintain sales (consider the product life cycle).

Review activity 6.3 As a marketing consultant for the meat industry you will be particularly concerned with the market segments showing low and falling demand, particularly where these market segments are a relatively large proportion of the total market. This includes New woman (2539 year olds), young single males (2024 year olds) and budget conscious housewives.

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Your response might focus entirely on marketing strategies to recapture these markets or to expand other markets. Alternatively you may suggest diversification of the industrys product range to appeal more to consumers with changing tastes. Before recommending these strategies you will require financial information regarding the relative profitability of each market segment by gender and age group, in total and per capita. You will also need projections of the potential profitability of any new products that are launched as part of a diversification strategy. Also historic sales and profit statements showing the impact of changes in consumer tastes would enable you to gauge the significance of the problem in financial terms.

Review activity 6.4 (a) (b) $37.50 / 1.25 = $30 Areas where costs will be incurred include: material costs labour costs packaging advertising and promotion.

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TOPIC 7
FEEDBACK TO REVIEW ACTIVITIES

Review activity 7.1

Spreadsheet solution formulas


A
Year 1 2 3 PV at 5% PV at 10% PV at 15%

B Net cash inflows($m) Henry 10 3 4


=NPV(0.05,B3:B5) =NPV(0.1,B3:B5) =NPV(0.15,B3:B5)

C
Roger 6 6 6 =PV(0.05,3,6) =PV(0.1,3,6) =PV(0.15,3,6)

Spreadsheet solution
A
Year 1 2 3 PV at 5% PV at 10% PV at 15%

B C Net cash inflows($m) Henry Roger 10 6 3 6 4 6


$15.70 $14.58 $13.59 ($16.34) ($14.92) ($13.70)

Note that I have used 5, 10 and 15 per cent as the discount rates. The best discount rate to use is a rate which represents the opportunity cost of receiving cash in a year rather than immediately. This might be Henry Jewells required return when he makes investments, or Roger s average cost of capital. In the unit ACC00152 Business Finance we show you a

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technique for calculating this discount rate. For now we will compare the present values at the three alternative discount rates. From this solution you should see that: The present value reduces as the discount rate increases. This is because the cost of receiving cash in the future increases as the interest forgone increases. The discount rate is an estimate of the interest lost as cash is received in the future rather than now. Henry receives less total cash flow than Roger $10m + $3m + $4m = $17m compared to $6m + $6m + $6m = $18m. The present value of Roger s income is greater at each discount rate, but the gap between the present values is reducing. If we are confident that the true discount rate is 15 per cent or less we can conclude that the PV of Roger s income is greater than Henrys. But as most of Henrys cash flow is received in year 1, the PV of his income is less sensitive to increasing discount rates than is the PV Rogers income. As we increase the discount rate above 15%, eventually the present value of Roger s income would fall below Henrys.

Review activity 7.2 (a) The inventory turnover is calculated by dividing cost of goods sold by average inventory. Average inventory is often approximated by taking the balance at the start of the accounting period plus the balance at the end of the accounting period and dividing by two. A high inventory turnover is a good sign for a business as it indicated that stock is selling quickly and this should result in a regular stream of cash flow coming into the business.

(b)

Question 7-36
1. ROA = 78200 + 4800 / ( [670000 + 730000] / 2 ) 100 = 11.9% (2) (3) ROE = 78,200 / (415,000 + 465,000) / 2 100 = 17.8% Debt ratio (2001) = (730,000 465,000) / 730,000 = 36.3%

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ACC00150 TOPIC 7 FEEDBACK TO REVIEW ACTIVITIES

Debt ratio (2000) = (670,000 415,000) / 670,000 = 38.1% Note that the debt ratio has fallen showing that a smaller proportion of Simpson Companys assets are financed by borrowings in 2001 compared to 2000. Remember the accounting equation: Total assets = Debt + Equity.

Review activity 7.3 PV = FV/(1 + i)n PV = $100/(1 + .01)6 PV = $94.20

Paying $100 in six months is equivalent to paying $94.20 now.

Review activity 7.4 Year 1 0.6% 1.4% 34% 2% Year 2 5.2% 11% 35.4% 6%

Return on sales ROA Gross profit Opertating profit%

Alarming negative trend in all profitability ratios with the exception of gross profit. This suggests the problem is below the gross profit line, requiring urgent attention be paid to the control of operating expenses.

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TOPIC 8
FEEDBACK TO REVIEW ACTIVITIES

Review activity 8.1 Operating cash flow has increased over the five-year period from $602.9m to $985.4m, which is an increase of 63 per cent. There was also a large increase from 1997 to 1998 of 26 per cent. Return on capital employed has averaged approximately 10 per cent over the five-year period and has not shown any major variation. Coles Myers share price showed high growth from 1995 to 1997, although it fell in 1998. (As at November 1999 share price had increased to $7.86.) Earnings per share has been consistent around 31 to 34 cents except in 1996 when it fell to 24.1 cents. The price/earnings ratio has increased since 1994 and in 1998 was 19.8 times, showing that investors are willing to pay almost 20 times current earnings to purchase a share. Net liabilities have increased to just above 60 per cent of net tangible assets. Net tangible assets equals total assets less intangible assets (e.g. goodwill) less total liabilities. This is an increase from 45.6 per cent in 1994, showing that Coles Myer has increased its level of borrowings relative to net assets.

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Review activity 8.2 One view might be that Jenny has performed her function on submission of the report to her boss and that any subsequent errors of judgment are not her responsibility. But this ignores the wider social responsibility and ethics associated with ignoring possible adverse outcomes of how the report is (mis)used. Doing nothing is certainly not the best option. Possibly Jenny could discuss the omissions from the report made to the Board with her boss. If this proves futile she could inform her boss that she is going to make a separate report to the Board. Most importantly she needs to talk about her concerns with a senior manager at the company whom she trusts to take the appropriate action to ensure employee safety is not at risk. Of course depending on her personal relationship with her boss and her employer and the lengths she has to go to, her career prospects could be jeopardised. There are employee grievance processes established to protect employees against unfair dismissal, bias etc.

Review activity 8.3 Project B is preferred because it has a higher NPV and IRR, although the payback is longer which indicates a higher risk in terms of the time it is expected to take to recoup the investment outlay.

Review activity 8.4 WMC has produced a very comprehensive environmental report. It is clearly monitoring its environmental performance and trying to improve this aspect of its business performance where possible. Some improvements have occurred in emissions of carbon dioxide and sulphur dioxide, but the environmental impact of WMC is clearly significant. Blackmores environmental performance has not been measured, although we are told new initiatives in packaging, recycling, waste and energy management have been implemented. Their environmental statement appears to express a concern towards the

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ACC00150 TOPIC 8 FEEDBACK TO REVIEW ACTIVITIES

environment, but their environmental impact cannot be assessed in the absence of relevant information. Blackmores product range and vision for the future appear to reflect their relatively high level of social responsibility. WMCs operations would necessarily have numerous negative social impacts, particularly from the effect of large scale mining operations on the health of employees and local communities. But given that there is a clear level of consumer demand (and need?) for the minerals produced by WMC their contribution to satisfying consumers needs must be acknowledged. WMC has significantly lower earnings per share and dividends per share than Blackmores. Similarly return on equity is much lower for WMC. WMC is a much larger company in terms of sales (25 times) and in terms of assets (260 times). Blackmores is much better at generating sales and profit from their investment in assets. The mining company requires an extremely large investment in assets relative to the sales generated from these assets. Mining tends to be a high risk investment, and on the five-year data set provided does not appear to compensate this extra risk exposure with higher returns.

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