You are on page 1of 7

CAT T10 Managerial Finance

Mock Examination December 2010

SECTION A – 20 MARKS – ANSWER TEN MULTIPLE CHOICE QUESTIONS


SECTION B – 80 MARKS – ANSWER FOUR COMPULSORY QUESTIONS.
Duration – 3 hours + 10 minutes

SECTION A – 20 MARKS – ANSWER TEN MULTIPLE CHOICE QUESTIONS

Question 1: Which of the following should be omitted from projected cash flows?

A: Incremental cash flows.


B: Sunk costs.
C: Residual value.
D: Company taxation.

Question 2: The role of a bank is to:

A: facilitate the flow of funds from savings-deficit units to savings-surplus units.


B: attract funds from the household sector to facilitate borrowing by the business
sector.
C: control the level of interest rates.
D: facilitate the flow of funds from savings-surplus units to savings-deficit units.

Question 3: Buying shares on the stock market is an example of:

A: a primary market transaction.


B: a secondary market transaction.
C: companies raising new funds.
D: companies raising funds from a secondary source.

Question 4: Trade credit is a form of:

A: long-term debt.
B: finance offered by banks.
C: short-term debt.
D: medium-term debt.

Question 5: Increasing the amount of debt held by a company:

A: decreases financial risk.


B: increases the variability of returns to shareholders.
C: decreases leverage.
D: has the effect of subordinating shareholders’ claims to cash flows.

1
Question 6: When considering a firm’s capital structure, a financial manager must:

A: make sure that business conditions are good when changing the level of debt.
B: balance the benefits of increased expected returns with increased financial risk.
C: be extra cautious during periods when the rate of return on assets is greater than
the interest rate on debt.
D: seek to reduce debt at all costs.

Question 7: Which of the following statements is true?

A: A company whose current assets comprise a relatively large proportion of its total
assets will often make greater use of short-term debt than other companies.
B: A company whose current assets comprise a relatively small proportion of its total
assets will often make greater use of short-term debt than other companies.
C: A company whose current assets comprise a relatively large proportion of its total
assets will often make greater use of long-term debt than other companies.
D: None of the above.

Question 8: The ‘just-in-time’ system of inventory control can be best explained as


the:

A: co-ordination of production processes so that raw materials and components are


delivered to the location where they are needed at precisely the times they are
required.
B: co-ordination of production processes so that raw materials and components are
delivered to the location where they are needed.
C: process of minimising total inventory costs.
D: method in which the supplier effectively passes on the cost of inventory storage to
the buyer.

Question 9: Asset liquidity can be best described as:

A: the ratio of total debt to total assets.


B: the length of time it takes to convert an asset to cash.
C: the ratio of current assets to current liabilities.
D: the ability to meet short-term creditors.

Question 10: An overdraft facility is:

A: an agreement by the bank to allow a customer to have negative cash balance.


B: cash held at the bank.
C: a form of factoring.
D: the ability to extend the term of an existing loan with the bank.

(Total 20 Marks)

2
SECTION B – 80 MARKS – ANSWER FOUR COMPULSORY QUESTIONS.

QUESTION 1

F1 Tyres Ltd imports tyres and sells to local distributors at $40, a mark up of 25% on cost.
The balance sheet of F1 Ltd as at 31 Jan 2011 is expected to be as follows:

F1 Ltd
Balance sheet as at 31 Jan 2011
$000’s $000’s $000’s
Cost Acc Dep NBV
Fixed assets
Fixtures & equipment 500 50 450

Current assets
Stock 320
Trade debtors 1,030
Prepayment of import permit 40
Cash 210
_____
1,600

Current Creditors:(Amounts falling due within one year)


Trade creditors 720
Corporation tax 80
Dividends 40
_____
840 760
Long term liabilities
6% Bank Loan (100 )
______
1,110
Financed by:
$0.20 ordinary shares 600
Share premium 100
Retained earnings 410
______
1,110

The data available from the master budget for the coming months were as follows:
Dec Jan Feb Mar Apr May Jun Jul Aug
Sales volume ( $‘000 ) 20 25 20 24 25 25 25 25 25
Salary ( $’000 ) 20 20 22 22 22 22 22 23 23
Expenses 50 52 50 50 50 51 50 50 50

Continue on next page

3
Continue from previous page

The following were noted for the operation:


1. 20% of all sales are cash sales with 40% taking one-month credit and 35 % taking two months credit,
the remainder are bad debts.
2. The company’s policy is to maintain enough stock at the end of each month to meet half the sales for
the next month.
3. Purchases are payable in the next month.
4. Salary and expenses are paid for in the month it is incurred.
5. Corporate tax accrued is payable in April 2011, dividend is payable in May 2011
6. Equipment which cost $40,000, and accumulated depreciation of $15,000 is expected to be disposed
in February for $30,000 cash.
7. Depreciation for equipment is to be provided for fixed assets held on balance sheet date at 10% cost,
depreciation for disposal during the year should be ignored.
8. The interest on loan is payable at the end of Jul 2011
9. Tax at 50% should be provided for profits
10. The company is expected to issue 500,000 shares at $0.80 per share in Mar 2011.

Required:

a) Prepare a cash-flow forecast for each of the six months for the period ending 31 Jul 2011.
(16 marks )

b) Discuss four advantages of preparing cash budgets. ( 4 marks )

(TOTAL 20 Marks)

4
QUESTION 2

Clear Vision Ltd is a manufacturer of DVD players and is considering the alternatives available to meet an
anticipated surge in demand over the next four years.

The board of directors had identified two mutually exclusive alternatives.

The first choice is to acquire a production plant from an existing competitor.

(i) The production plant will cost of $3,200,000 and will have a life of four years, after which, it will
have a zero scrap value.
(ii) The Production plant will produce an additional 8,500 DVD players per annum for the next four
years.
(iii) The sales price of each DVD player is estimated at $1,100 per unit for the next four years.
(iv) Each DVD player requires:
(1) Material costing $500.
This will increase at a rate of 3% per annum.
(2) Direct labour of 15 hours at $12 per hour in year one.
For each of the subsequent four years, pay will increase by 2% of the preceding year’s
level.
(3) Machine time of 5 hours at $8 per hour.
This will remain constant for the next five years.
(4) Fixed cost per annum is estimated at $500,000 per annum, this is estimated to increase
at a rate of 4% per annum.

The second option is to subcontract production of 8,500 DVD players per annum under a fixed contract for
the next four years.
(i) There is an annual subcontract fee payable at the end of each of the next four years commencing at
the end of year one at $100,000.
(ii) Over the next four years the subcontractor has agreed to produce and deliver up to a maximum
10,000 DVD players each year to the company for an agreed cost of $900 per unit.
(iii) The sales price of each DVD player is $1,050 due to the lower quality.

Clear Vision Ltd has already spent$50,000 conducting research into the viability of both options.

The cost of capital is 16%. Ignore taxation.

Required
a) Calculate the net present value of each of the options to the nearest $’000. State clearly any
assumptions made. ( 14 marks )
b) On the basis of the calculation made in (a) above, which of the two options would you choose
and why? ( 2 marks )
c) Outline four reasons to support careful evaluation of capital investment decisions
( 4 marks )
(TOTAL 20 Marks)

5
QUESTION 3

ABC Ltd uses an item of stock as follows.


Purchase price : $96 per unit
Annual demand : 4,000 units
Ordering cost : $300
Annual holding cost : 10% of purchase price

Required:
a) Discuss stock cost associated with holding
i) too high a stock level than necessary (2 marks)
ii) too low a stock level than necessary (2 marks)

b) Calculate the economic order quantity based on the above information (2 marks)

c) ABC Ltd currently placed orders in quantity of 800 units per order, calculate the annual savings by
switching to ordering the EOQ (4 marks)

d) Should the company order 1,000 units at a time if the supplier is offering an 8% discount? Show
workings to support your answer. (2 marks)

e)
Waterloo Trading Ltd is a distributor of a Japanese Branded tyres that is gaining a lot of popularity amongst
consumers. The business, which has annual credit sales of $6 million last year is expected to increase its
credit sales to $10 million in the next year.

With increased sales, the company has experienced working capital shortage, especially in the financing of
debtors. The average collection period for sales has averaged 50 days even though the stated policy of the
business is for payment to be made within 45 days. In addition, 1.5% of sales are written off as bad debts
each year.

The company has recently been in talks with a factor who is prepared to make an advance to the company
equivalent to 80 per cent of debtors, based on the assumption that customers will, in future, adhere to a 45
day payment period. The interest rate for the advance will be 14% per annum. The trade debtors are currently
financed through a bank overdraft which has an interest rate of 11 per cent per annum. The factor will take
over credit control procedures of the business and this will result in a saving to the business of $23,000 per
annum. However, the factor will make a charge of 2 per cent of sales for this service. The use of the
factoring service is expected to eliminate the bad debts incurred by the business.

Required:

a) Calculate the net cost of the factor agreement to the company and state whether or not the company
should take advantage of the opportunity to factor its trade debts.
( 8 marks )
(TOTAL 20 Marks)

6
QUESTION 4

a) Identify and briefly describe FOUR roles of financial intermediaries which help improve market
efficiency (8 marks)

b) Identify FOUR main factors to be considered when deciding on the appropriate mix of long-term or
short-term sources of debt finance. ( 8 marks )

c). Briefly outline TWO types of loan covenant, giving specific examples of covenants which may be
included in loan agreements and explain the purpose of each type of covenant. (4 marks)

(TOTAL 20 Marks)

END OF PAPER