University of Westminster

Westminster Business School

7ACCN018W
Financial Analysis for Managers
May 2020

Marking Scheme
Section A

Question 1

Sole Traders (0.5 mark per valid point – Max 3 marks)

 From an accounting point of view, a separate organization with a single
owner although they may be many employees
 In the eyes of the law, the owner and the business are the same
 Tend to be small retail establishments and individual professional or service
business - for example, a single dentist, attorney, or public accountant
 The sole trader is an individual entity that is separate and distinct from the
owner.
 The owner takes all the risk and rewards
 The owner has unlimited liability
 The owner pays personal income tax

Partnerships (0.5 mark per valid point – Max 3 marks)

 An organization that joins two or more individuals who act as co-owners and
so pool expertise and resources
 Dentists, doctors, lawyers and accountants tend to conduct their activities as
partnerships. Some can be large international firms.
 From the accounting point of view, the partnership is an entity that is separate
and distinct from each of the partners although not in the eyes of the law
 The partners share risks and rewards
 Partners are jointly and severally liable for the partnership debts
 In the case of limited liability partnership, the partners are only jointly liable
(not severally) for the partnership debts
 Partners pay personal income tax

Corporations (0.5 mark per valid point – Max 4 marks)

 Companies are separate legal entities

 Companies have limited liability
 Corporate creditors have claims against corporate assets only and not against
the shareholders.
 Individual shareholders are at risk only up to the amount they have invested in
the corporation.
 Creditors cannot hold investors liable for the corporation’s debts.
 The company pays corporate tax
 The company can be either private or public limited company
 The shares in a private limited company are held in the hands of a few family
members and friends and cannot be offered to the public
 Public limited company’s shares are held and can be bought & sold by the
public
 A listed public company’s share are traded on a recognized stock exchange
such as the LSE or AIM
Question 2 (2 marks for any valid point explained – Max 10 marks)
Profit is a measure of performance in financial terms, based on accounting concepts
whereas cash is what the company has at balance sheet date.

Accounting profit is a figure based on the accrual concept and accounting

adjustments. These accounting adjustments do not reflect cash movement but are
the result of managerial decisions on accounting policies. So differences between
cash and profit may result from:

1. Non-cash flow items –

- depreciation on fixed assets,
- amortisation of intangible assets;
- provision for doubtful debts;
- Provision for liabilities and charges
- loss/gain on disposal of fixed assets where profits are reduced/increased but
cash affected by the sale proceeds and not by the net book value.
- Write down of inventory values

2. Capital asset acquisition– where cash may be paid out but profit is not affected
for the whole amount of the expenditure but reduced by the amount of annual
depreciation

3. Raising loans and/or issuing shares where cash is raised but profit is not
affected

4. Loan repayment and share repurchase cause an outflow of cash but does not
affect the profit

5. Accrual basis accounting – where sales and purchases are made on credit in
one accounting period thus affecting the profits of that period but cash may be
received / paid in another accounting period.
(10 marks)
Question 3
Part (a) – 3 marks

Payback = 3 years + (460,000 – (176,800 - 83,100 + 294,400) / 2168,200 =

= 3.43 years
As it is more than 3 years, it should be rejected.

Part (b) – 3 marks

Year 1 Net cash flow £176,800

Year 2 Net cash flow £(83,100)
Year 3 Net cash flow £294,400
Year 4 Net cash flow £168,,200
--------------
£556,300
Less Total depreciation (£430,500)
--------------
Total Profits £125,800

Average annual profit = £125,800 / 4 = £31,450

ARR = Average annual profit / Average investment =

£40,700 / [(£460,000 + 29,500) / 2] = 12.85%

Part (C) – 4 marks (1 mark per valid point – max 4 marks)

 ARR is expressed in percentage which is readily understood by managers

 Being expressed in percentage means:
 projects’ sizes are ignored when comparing two or more projects
 Projects ’durations are ignored when comparing two or more projects
 ARR uses accounting profits. This is good on the one hand but also not the best
figure to use as it can be manipulated
 ARR ignores time value of money
 ARR ignores projects’ risks
Question 4
a) – 3 marks
Material total cost variance = Actual cost – budgeted cost for actual quantity
= £105,524 – (5,920 x £16.80) = £6,068 (A)

Material price variance = (AP – SP) x AQ

= [(£105,524 / 18,352) - £5.60] x 18,352 = £2,752.80 (A)

Material usage variance = (AQ – SQ) x SP

= [18,352 – (5,920 x 3)] x £5.60 = £3,315.20 (A)

b) – 4 marks
Labour total cost variance = Actual cost – budgeted cost for actual quantity
= £33,000 – (5,920 x £7.20) = £9,624 (F)

Labour rate variance = (AR – SR) x AHP

= [(£33,000 / 2,960) - £12] x 2,960 = £2,520 (F)

Labour efficiency variance = (AHW – SH) x SR

= [(2,960 – 120) – (5,920 x 0.6)] x £12 = £8,544 (F)

Idle Time Variance = Idle time x SR

= 120 x £12 = £1,440 (A)

c) – 1 marks
Fixed expenditure variance = budgeted FC – Actual FC
= £9,960 - £10,150 = £190 (A)

d) – 2 marks
Only significant variances in terms of overall size of the variance (favourable and
adverse) need be investigated since this process ties up management time and
resources.

Question 5
Opportunity Cost – 1 marks (0.5 mark for definition and 0.5 mark for example)
It is the benefit foregone by not taking the next best alternative.

For example, using an asset on a project deprives the entity of the proceeds
from the sale of that asset.

Committed Cost – 1 marks (0.5 mark for definition and 0.5 mark for example)
This is a cost that has yet to be incurred but as a result of a past decision and
thus cannot be avoided. The timing of cash outflow is irrelevant.
An example of a committed cost is cost of a lease agreement.

Specific Fixed Cost - 1 marks (0.5 mark for definition and 0.5 mark for example)
Any cost that is specific to the project and remains constant at all levels of activity of
the project that is under consideration.
An example of a specific fixed cost is project manager’s salary or hire cost of
equipment acquired specifically for the project.

Part (b) – 3 marks

Irrelevant costs are costs that have no impact on future decisions. These
include:
- Historic costs (e.g. the historic price paid for an item)
- Sunk costs (e.g. the cost of market research or advertising already
incurred)
- Committed costs (e.g. the rental lease contract or a non-refundable
deposit)
- General fixed costs (e.g. factor rent & insurance or senior managements’
salary)

Relevant cost here is:

M1  150 x £75.00 = £11,250 (Opp cost)

80 x £83.10 = £ 6,648 (Market price)

M2  40 x (£7) = £(280) (Opp cost)

22 x £40 £18,870) (Market price)
--------------
£18,498
(10 marks)
Total for Section (A) – 50 Marks

Question 6
Part (a) – 9 marks

Definition – A budget is a quantitative expression of the plans of the organisation for

a future period

Functions of budgets
1. To aid the planning of actual operations:
 by forcing managers to consider how conditions might change and what
steps should be taken now.
 by encouraging managers to consider problems before they arise.
2. To co-ordinate the activities of the organization:
 by compelling managers to examine relationships between their own
operation and those of other departments.

3. To communicate plans to various responsibility centre managers:

 everyone in the organization should have a clear understanding of the part
they are expected to play in achieving the annual budget.
 by ensuring appropriate individuals are made accountable for
implementing the budget.

4. To motivate managers to strive to achieve the budget goals:

 by focusing on participation
 by providing a challenge/target.

5. To control activities:
 by comparison of actual with budget (attention directing/management by
exception).

6. To evaluate the performance of both divisions and managers:

 by providing a means of informing managers on how well they or their
divisions are performing in meeting targets they have previously set.
Question 6 (b)
(13 marks) June July Aug
Sales 81,000 96,400 142,300
Purchases at 65% sales 52,650 62,660 92,495
Overheads exp 730 803 883

Cash Budget
  Jun Jul Aug Total
Receipts £ £ £ £
From Debtors after 1 month   54,000 64,267 118,267
From Debtors after 2 month     27,000 27,000
   ----------  ------------  ------------  ------------
Total Receipts 0 54,000 91,267 145,267
 Payments        
Suppliers / creditors   (52,650) (62,660) (115,310)
Salaries (6,450) (6,450) (6,450) (19,350)
Rent (7,900)     (7,900)
Overheads (365) (767) (843) (1,975)
Advertising   (8,000) (6,500) (14,500)
  ----------- ----------- ----------- -----------
Total Payments (14,715) (67,867) (76,453) (159,035)
         
Opening Balance 24,500 9,785 (4,082) 24,500
  ----------- ----------- ----------- -----------
Closing balance 9,785 (4,082) 10,732 10,732

Part (c) – 5 marks

1. Arrange a suitable overdraft facility at the bank

2. Arrange a short term loan
3. Rent/lease rather than buy the asset
4. Sell any surplus asset
5. Negotiate a longer payment terms with the suppliers
6. Consider giving a cash discount to trade debtors for early payment
7. Delay discretionary expenditure

8.
Question 7 – Duffman Ltd
Part (a)  – 3 marks
SP 1.75 0.25 mark
VC - M -1.05 0.5 mark
--------
Contribution 0.7 0.5 mark

Total Contribution = 795,000 x £0.70 = 556,500 0.5 mark

Less Fixed costs -268,700 0.25 mark
-------------
Profit 287,800 0.5 mark

Return on investment = Profit / investment

RoI = £287,800 / £2,800,000 = 10.28% Yes 1 mark

Part (b) – 3 marks

Required profit = Investment x 9% = £2,800,000 x 9% = £252,000 1 mark

Required contribution = (FC + Target return) / Quantity

= (£268,700 + £252,000) / 795,000 = ) = £0.65.5 1 mark
Min selling price = VC + Required cont = £1.05 + £0.655 = £1.71 1 mark

Part (c) – 3 marks

BEP = FC / Cont per unit 0.5 mark

BEP = £268,700 / £0.7 = 383,857 units 0.5 mark
BEB (£sales) = 383,857 x £1.75 = £671,750 1 mark

Break Even Point is the level of sales at which the company does 1 mark
not make any loss or profit

Part (d) – 2 marks

Margin of safety = (budgeted demand – BEP) / budgeted demand 0.5 mark
Margin of safety = (795,000 – 383,857) / 795,000 = 51.72% 1 mark

Margin of safety shows the percentage by which sales can fall

0.5 mark
before
the business starts to lose money.

(e) – 4 marks
Option (i)
Increase in demand = 795,000 x 6% = 47700 0.5 mark
Increase in contribution = 47700 x £0.7 = £33,390 0.5 mark
Less spending on advertising £25,000 0.5 mark
 -------------
 Extra profit   £8,390 0.25 mark
So this option is just about worthwhile 0.25 mark

Option (ii)
New contribution = old cont – decrease in SP = £0.70 - £0.10 =
0.5 mark
£0.60
New demand = 795,000 x 1.15 = 914250 0.5 mark
New total contribution = 914,250 x 0.60 = £477,000 0.5 mark
Old total contribution £556,500 0.25 mark
---------------
Reduction in profit -£(79,500) 0.25 mark
========
This option is NOT worth considering

Part (f) – 3 marks

SP on this order 1.40

Less VC -1.05
-------------
Contribution 0.35 1 mark

Total Contribution = 96,000 x £0.60 33600 0.5 mark

Less transportation cost -18000 0.5 mark
------------
Additional profit Accept 15600 1 mark
Old total profit 287,800 0.5 mark
-------------
New total profit 303400 0.5 mark

Part (g) - 4 marks

Max quantity available for Disco Stu = 1,200,000 – 795,000 = 405,000 0.5 mark
Min profit required = £2,800,000 x 12% = £336,000 0.5 mark
Less profit from current operation £287,800 0.5 mark
---------------
Required profit from the new order = £48,200 0.5 mark
Add the additional FC £22,500 0.5 mark
--------------
Required total contribution from order £70,700 0.5 mark
Required cont / unit = £70,700 / 405,000 = £0.17 0.5 mark
Minimum selling price = VC + Required cont = £1.05 + £0.17 = £1.22 0.5 mark
Part (h) – 3 marks
Limitations / assumptions of Break-Even Analysis

         The break-even graphs assume that cost and revenue behaviour patterns are
known and change on a straight-line basis as activity levels change.
         It may not always be feasible to split costs neatly into variable and fixed
categories. Some costs show mixed behaviour.
         The break-even assume that fixed costs remain constant over the volume
range under consideration. If that is not the case then the graph of total costs will
have a step in it where the fixed costs are expected to increase.
         Break-even analysis assumes input and output volumes are the same, so that
there is no build-up of stocks and work-in-progress.
         Break-even charts and simple analyses can only deal with one product at a
time. Using contribution/sales ratio assumes constant product mix
         It is assumed that cost behaviour depends entirely on volume.
Question 8

Part (a) - 21 marks

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Revenue 6,850 7,240 7,550 8,160 5,150.00 2.5 marks

Material cost (3,083) (3,372) (3,516) (3,801) (2,399) 2.5 marks
Specific
overheads (270) (284) (298) (313) (329) 2.5 marks
Supervisor
salary (75) (78) (81) (84) (88) 2.5 marks
Equipment (9,263) (3,088) 610 1 marks
Working capital (370) 370 1 marks
--------- ----------- ----------- --------- --------- -----------
Net cash flow (9,633) 335 3,506 3,654 3,962 3,315 3 marks
DF @ 8% 1.0000 0.9259 0.8573 0.7938 0.7350 0.6806 1.5 marks
PV (9,633) 310 3,006 2,901 2,912 2,256 3 marks

NPV = 1,753 Accept 1.5 mark

NOTE: R&D cost was ignored as it is a sunk cost

60% of overheads was ignored because it is general FC
Depreciation was ignored because it is not a cash
flow
Salary of new project manager was used because it is a relevant cost. Employees salary not relevant
as it is general FC
Bank loan interest was ignored because investing decision is separate from financing
decision

Part (b) – 4 marks

Advantages of using NPV over other investment techniques:
 It uses cash flow rather than profit and as such is less susceptible to
management manipulation
 It uses relevant cash flows throughout the life of the project
 It discounts the cash flows using a risk adjusted discount rate
 It provides a clear decision criteria
 By providing a value (NPV) rather than a percentage return, it is the most
suitable technique for wealth maximisation