SUGGESTED SOLUTIONS/ ANSWERS ~ EXTRA ATTEMPT EXAMINATIONS, MAY 2017, tof9 ‘STRATEGIC MANAGEMENT ACCOUNTING [62] - CHARTERED LEVEL Marks Question No. 4 (a) Transfer Prices using Activity Based Costing (ABC): Rupees Product Product "AXE? "RAX’ Materials cost 117.00 95.00 Labour cost (Rs.12 per hour) 6.00 9.00 Overhead cost [W-1] 160.57 66.75 Total cost 283.57 17075 0.5 ‘Add:10% mark-up 28.36 17.0805 Transfer price using ABC. 311.93 7878305 The transfer price for Product ‘AXE’ would be much higher than it is currently and the transfer price for Product ‘RAX’ would be much lower. At this lower cost, the manager of the retail division could sell Product 'RAX’ more cheaply at his target price of Rs.230, but Product ‘AXE’ ‘would make very little profit if itis Sold at Rs.320 when its activity based cost is nearly RS.312. gy Working: W-1: Overhead cost using ABC: Machine set up costs: Driver = Number of production runs Total number of production runs = 30(A) + 12(R) 42 Cost perrun = Rs.306,435 + 42 = RS7,296.07 01 Machine maintenance costs: Driver = Machine hours Total number of machine hours = 6,400(A) + §.450(R) 11,850 Cost per machine hour = Rs.415,105 = 11,850 Rs.35.03, ot Ordering costs: Driver = Number of purchase orders. Total number of purchase orders = 82(A) + 64(R) 146 Cost per order = Rs.11,680 + 146 Rs.80.00 ot Delivery costs Driver = Number of deliveries Total number of deliveries = 84(A) + 80(R) = 144 Cost per delivery = Rs.144,400 + 144 Rs.1,002.78 01SUGGESTED SOLUTIONS/ ANSWERS ~ EXTRA ATTEMPT EXAMINATIONS, MAY 2017, 2019 ‘STRATEGIC MANAGEMENT ACCOUNTING [62] - CHARTERED LEVEL Marks: Rupees Product Product ‘AXE’ ‘RAX’ Machine maintenance costs (Rs.35.03 per machine hr) (224,192 190,913 on Ordering costs (Rs.80 per order) 6,560, 5,120 on Daten cots e1,00278 pr debeng onsmggitty hone sumer runt roseed oon Si 5a20 Overhead cost per unit 160.57 66.75 05 Oram Using the ABC transfer price from part (a): Rupees Product Product rat {A) Production and sales (units) 3,200 5,450 (B)10% mark up 28.36 17.08 05 (C) Profit (A « B) 90,752 93,086. 183,838 15 Retail ision: (0) Seting pce 2000 260.00 oe eran a cere (F) Profit per unit (0-E) “607.7247 08 ror aati ome ams eeSUGGESTED SOLUTIONS/ ANSWERS ~ EXTRA ATTEMPT EXAMINATIONS, MAY 2017, 30f9 ‘STRATEGIC MANAGEMENT ACCOUNTING [62] - CHARTERED LEVEL Marks: Question No. 2 NPV of purchasing machine: Rupees in 000" Cash flows: YearO Year1 Year2 Year3 Year4 Total Capital Costs (28,800) - - _ 05 Annual maintenance costs = (2,250) (2,250) (2,250) 075 Disposal proceeds : : - 4500 4h. 05 Taxation (at 31% in following years) 698 698 698 0.75 Tax benefit on capita allowancetW) - = 1939 1,198 5,055 18 Net cash flows. (28,800) (2,250) (214) 4,086 5,753 02 Present value factor at 8% 1,000 0.926 0.857, 0.794 0.735 Discounted cash inflows (28,800) (2,084) (183) 3,244 4,228 (23,595) 03 Net present value of leasing machine: Cash Flows: YearO Year1 Year 2 Year3 Year4 Total “Annual lease rentle (10,800) (10,800) (10,800) Tax benefits: - - 3,348 3,348 3,348 0.75 Net cash ows (10,800) (10,800) (7,452) 3.348 3,948 4.25 Present Value factor at 8% 1.000 0.926 0.857 0.794 0.796 Discounted cash inflows (10,800) (10,001) (6,386) 2,658 2,461 (22,068) 03 ‘Therefore, the machine should be leased rather than purchased. 01 Working for Tax saving (purchasing option) ‘Tax benefit on capital allowances Yt Y2 Y3. Wiiten down value at start 28.800 24,480 20,808 Capital allowance: 4,320 3,672 16,308 Tax saving 4.909 4,198 5,055SUGGESTED SOLUTIONS/ ANSWERS ~ EXTRA ATTEMPT EXAMINATIONS, MAY 2017, 4ot9 ‘STRATEGIC MANAGEMENT ACCOUNTING [62] - CHARTERED LEVEL Marks Question No. 3 {a) Incremental Cash Flows of the Replacement Decision: Particulars 0 1 2 3 4 5 Incremental sales (cash) A - 113,750.00 118,760.00 113,750.00 113,780.00 113,750.00 0.5 Saving in cash operating cost. B = 22,750.00 _ 22,750.00 22,750.00 22,750.00 22,750.00 0.8 Dep on New machine 18% . 29,600.00 33,660.00 28,611.00 24,319.95 20,671.45, Dep. on Old machine 15% S (13,650.00) (11,602.50) (9,862.13) (8,982.81) (7,125.99) Incremental depreciation = 25,950.00 22,057.50 18,748.88 15,936.54 13,546.06 2.5 Eaming before income tax (eBiT) (Bc) 110,850.00 114,442.50 117,751.13 120,563.46 122,953.94 1.25 Less: Tax 31% S (34,270.50) (86,477.18) (36,502.85) (37,374.67) (38,115.72) 1.25 NOPAT - 76,279.50 78,965.33. 81,248.28 83,188.78 84,838.22 Free operating (NOPAT cash inflow +Dep) — — 102,228.50 101,022.83 99,997.15 99,12593 98,284.28 1.25 Capital expenditure (R.2,64,000 = Rs.45,500) Incremental salvage value (Rs.18,200 ~ Rs.4,550) - - - - - - 1365005 Incremental tax saving on loss on sale of machine (Rs.98,938 — Rs.35,827) x31% Incremental cash flows of the replacement decision = (204,395.00) _ 102,229.50 101,022.83 99,997.15 99,125.93 13159870 1.25 *91,000-45,500 x0.31 (218,500.00) = - = - - 0.50 05 {b) Computation of weighted average cost of capital of the company (WACC): D Rs.2 B + 8% = 18% Rs.20 oe Kd = 10.5% (1-0.31) 0s D Kex ( ace) o1 = (7.245% x 0.18) + (18% x 0.85) = 16.38% oF 16% Ke WACC =SUGGESTED SOLUTIONS/ ANSWERS ~ EXTRA ATTEMPT EXAMINATIONS, MAY 2017, 5of9 ‘STRATEGIC MANAGEMENT ACCOUNTING [62] - CHARTERED LEVEL Marks {c)_ Net Present Value: Particulars 0 1 2 3 4 5 Incremental cash flows of the replacement decision — (204,395.00) 102,229.50 101,022.83 99,997.15 99,125.33 131,598.70 PV factor 16% 4.000 0.962 0743 0641 0.852 0.476 Net Present value __~ (204,395.00) 75,078.42 64,063.94 54,746.04 62,655.85 140,276.13 03 (d) Discounted Payback Period: Particulars 0 1 2 3 4 5 Net Present value — (204,395.00) 88,128.88 75,076.42 64,063.94 54,746.04 62,655.85 Cumulative Present value = (204,396.00) (116,266. 12)(41,189.70) 22,874.24 77,620.27 140,276.18 1.25 Discounted Payback period = 2+41,189,70/ 64,063.94 = 2.64 Years 0.75 ‘Advise - The company should replace the existing machine with new machine. Question No. 4 {a) Base case NPV Use the beta of the printing industry to estimate the cost of capital. Bs =Be[E + {E +D(1-t)}] Assuming debt is risk free 05 a 8.1205 o5031) os Using CAPM : ky = 6 +(11.6 -6) 0.71 = 9.98% , say 10% a1 Rs'000" Cashflow Discount Present eae Rs.000 factor value 0 Investment (80,00) 1.000 (30.000) 0.6 4-10 After tax cash flows [6,000 (1-0.31)] 4140 «6.145 (25,440.30 10 Residual value 6000 0386 = 2.316 ot (2.2437) 08 Tax shield Tax relief = (Rs.10 million x 0.1 x 31%) + (Rs.6 milion x 0.07 x 31%) = 418,600 1.28 Present value of tax shield discounted at the risk free rate = Rs.418,500 x 7.36 = Rs.3,080,160 1.25SUGGESTED SOLUTIONS/ ANSWERS ~ EXTRA ATTEMPT EXAMINATIONS, MAY 2017, bof 9 ‘STRATEGIC MANAGEMENT ACCOUNTING [62] - CHARTERED LEVEL Marks Subsidy Benefits of lower interest rate, discounted at risk free rate = Rs.5 million x 0.03 x 0.69 x 7.36 = Rs.761,760 ct Issue costs Debt Rs.10 million x 1% = Rs.100,000 Equity Rs.9 million x 4% = Rs.360,000 a Adjusted present value Rupees Base case NPV (22,43,700) 05 Tax shield 3,080,160 0.25 Subsidy 0.25 Issue costs 05 Adjusted present value 05 The adjusted present value is positive, and therefore the project is worthwhile 05 {b) A typical NPV will use the weighted average cost of capital (WACC) as the discount rate. This will not be suitable if a significant project is funded mainly by debt. ot The use of debt finance can bring distinct advantages in terms of the tax savings on the interest payments and also disadvantages in terms of the issue costs of such finance. Both issues should be included in the assessment of projects funded mainly by debt. Only the adjusted present value (APV) technique does this. on APV is a Modigliani and Miller (MM) technique and ignores the financial distress costs associated with high levels of gearing. Financial distress costs are often triggered by a fall in the credit rating of the company and include falling sales and higher costs from suppliers. oO {c) Risks of Diversification: (Any two) 02 Following are the risks of diversification to Golden Industries Ltd: Expertise This investment is outside the existing mainstream activities of Golden Industries and there may be a lack of knowledge and expertise in, the printing industry within the company. This could affect the ability to make the investment successful Change of focus The investment in the printing industry may make management lose focus on its core mainstream activities. If this is the case the mainstream activities may suffer from reduced profitability and/or increased customer dissatisfaction Additional risk Using the average equity beta for the printing industry and the existing equity beta of Golden, It looks as though the printing industry is riskier than the existing operations of Golden Ind, Given Golden's relatively low asset beta, its shareholders may not be happy with a diversification into a riskier area.SUGGESTED SOLUTIONS/ ANSWERS ~ EXTRA ATTEMPT EXAMINATIONS, MAY 2017, Tof9 ‘STRATEGIC MANAGEMENT ACCOUNTING [62] - CHARTERED LEVEL Marks Question No. 5 (a) Financial Evaluation of Proposal-A: Rupees Sales (140,000 T shirts" Rs.90) 412,600,000 0s Cost of goods sold: Variable cost (5, 100,000°140%) 7,140,000 0s Fixed factory overhead 2,200,000 _ 9,340,000 0s Gross profit 3,260,000 0s ‘Administrative overhead (Fixed) 1,950,000 0s Selling and distribution cost: Commission (2% of sales) 252,000 os Delivery cost (R.0.5 per unit) 70,000 0s Fixed cost 500,000 822,000 __2.772,000 0s Profit 488,000 0s ‘The proposal is beneficial and will produce profit of Rs.488,000 as compared to the last year's break-even Os {b) Minimum Price: Revised variable cost for Punjab supply: Rupees Production cost (existing ) 51.00 os Packaging cost (additional) 0.75 0s 51.75 0.25 Existing sales + sale to Punjab - (variable cost + fixed cost)- target profit = 0 10,000,000 + 50,000x - (100,000*53.50+ 50,000°51.75+5,250,000) -1,000,000 = 0 15 10,000,000 + 50,000 x — 13,187,500 - 1,000,000 = 0 0s 50,000 x 4,187,500 0.25 x 83.75 0s Minimum Price should be Rs.83.75 per T- Shirt. W-1 Existing production cost 510,000 0.25 Commission (10,00,0000°2%) 200,000 0.25 Delivery cost (100,000*Re.0.Sper unit) 50,000 0.25 5350,000/100,000 = 53.5 0.25SUGGESTED SOLUTIONS/ ANSWERS ~ EXTRA ATTEMPT EXAMINATIONS, MAY 2017, Boo ‘STRATEGIC MANAGEMENT ACCOUNTING [62] - CHARTERED LEVEL Marks (c) Financial Evaluation of Proposal-C: Rupees Sales (165,000 T shirts" Rs.90 14,850,000 0s Cost of Goods sold! Variable cost @ Rs.51 8,415,000 0s Fixed factory overhead 2,200,000 __ 10,615,000 05 Gross profit 4,235,000 0.25 ‘Administrative overhead 41,950,000 0.25 Selling & distribution cost Commission ( 2% of sale) 297,000 0s Delivery cost (Rs.0.5 per unit) 82,500 0s Fixed costs (including advertising) 800,000 __3.129,500 05 Profit 1,105,500 0s Recommendation: Proposal-C results in profit of Rs.1,105,500 as compared to last ot year's break-even and is even better than Proposal-A, Question No. 6 (a) Formulation of Problem: Define variables Let x and y be the number of units made and sold of product Alpha and Beta respectively, Establish objective function Maximise contribution (C) = 500x + 875y subject to the constraints below. 05 $13,500. (direct labour)* ot s 6,000 (machine time) ot s 7,000 (direct material) ot s 4,800 (demand for X) 05 2 0 0.25 This constraint is that skilled labour minutes cannot exceed 13,500 minutes, and since a unit of X needs 2 minutes and a unit of Y needs 3 minutes, 2x + 3y cannot exceed 13,500. The other constraints are formulated in a similar way. 0.75 Introduce stack variables Introduce a slack variable into each constraint, to turn the inequality into an equation, Let a = the number of unused direct labour minutes b = the number of unused machine minutes c the number of unused Kilograms of direct material d= he amount by which demand for X fails short of 1,800 units Then 2x+3y+a $18,500 (direct labour) ot X+15y+b = 6,000 (machine time) ot X+05y+¢ = 7,000 (direct material) ot X+d = 1,800 (demand for x) 05 and_maximise contribution (C ) given by, C - 500X_- 875Y +0a + 0b + 0c + 0d = 0 05SUGGESTED SOLUTIONS/ ANSWERS ~ EXTRA ATTEMPT EXAMINATIONS, MAY 2017, goto ‘STRATEGIC MANAGEMENT ACCOUNTING [62] - CHARTERED LEVEL Marks: {b) There are six variables (x, y, a, b, ¢, d) and four equations. In any feasible solution four variables will have a non-negative value (as there are four equations), while two variables will have a value of zero o2 Question No. 7 (a) Calculation of net operating profit after tax (NOPAT) Rs. in mi ‘Operating profit 32.00 0.25 Taxation @ 31% (9.92) 05 22.08 0.25 ‘Add: back development costs 6.00 0.25 Less: one years amortisation of development cost Rs.6m/6) (1.00) oo NOPAT 27.08 08 Calculation of economic value of net assets: Rs. in million “Replacement cost ofnet assets R825 milion+Rs7omilion) ——~—~« 08 ‘Add back investment in new product to benefit future (8m-1m) 5 0s Economic value_of net assets 400 05 Calculation of Economic value Added (EVA) The capital charge is based on the weighted average cost of capital, which takes account of the cost of share capital as well as the cost of loan capital. Therefore the correct interest rate is 14%. Rs. in milion NOPAT 27.08 0.25 Less: Capital charge (14% x Rs.100 million) (14.00) 05 EVA 13.08 0.5 (b) The performance report is wrong in that the production manager is responsible for the acts of 05 the sales manager. While itis true that the production manager is under obligation to carry out the commitments made by the sales managers, in fuliling the commitment; he had to alter his ‘schedule of production. As a result, he had to incur more idle time than budgeted, as well as the set up cost and over-time premium. To the extent the excess costs (Rs.4,000) incurred can wholly and exclusive be attributed to the production of the rushed order sale, it would be unreasonable to attribute such costs to the production manager. It would seem reasonable to charge the sales manager with the costs specifically incurred to meet the special order. ‘Alternatively, a larger budget allowances for the production manager for set up and idle time should be provided THE END