ACCY 115 - Fundamentals of Accounting

Tutorial 7
Question 1

Chateau Affect Ltd produces a sauvignon blanc wine which next year’s budget was as follows:

annual sales 10,000 bottles

$ per bottle
selling price 20
variable costs 14
fixed costs 3
profit $3

In the face of an oversupply of sauvignon blanc in the market, if the selling price of Chateau Affect’s
wine were reduced by 10 percent per bottle what would be the sales revenue needed to generate
the original budgeted profit?
Show your workings.
Contribution Margin = Selling price – Variable Costs
Original = 20 – 14 = $6
New = 18 – 14 = $4
Total original budgeted contribution = $6 * 10,000 = $60,000
The required number of bottles to achieve the same contribution = $60,000 / $4 = 15,000 bottles

Sales 10,000*$20 200,000

Variable Costs 10,000*$14 (140,000)
Fixed Costs 10,000*$3 (30,000)
Profit $30,000

Sales 15,000*$18 270,000

Variable Costs 15,000*$14 (210,000)
Fixed Costs 10,000*$3 – DOES NOT (30,000)
CHANGE
Profit $30,000

This study source was downloaded by 100000866341848 from CourseHero.com on 07-07-2023 12:01:19 GMT -05:00

https://www.coursehero.com/file/78245548/ACCY-115-Tutorial-7docx/
 Sale Revenue required is $270,000 to calculate original budgeted profit.
Question 2

Yummy Foods Ltd manufactures three fresh yogurts – lemon, mango and nectarine. Dairy Foods Ltd
which supplies two key raw materials which are used in all three of Yummy’s yogurts has informed
the company that their employees are refusing to work overtime. This means that supply of the key
raw materials is limited to the following quantities for the next period:
Material A 1,030 kg
Material B 1,220 kg
No other source of supply can be found for the next period.
Information relating to the three yogurts produced by Yummy is as follows:

Lemon Mango Nectarine

Quantity of material used per carton of
48 pottles of yogurt
- Material A 2 1 4
- Material B 5 3 7
Maximum sales demand (units) 120 160 110
Contribution per unit sold $15 $12 $17.50

Owing to the perishable nature of the product no finished goods are held
Requirements
(a) Recommend a product mix that will maximise the profits of Yummy Foods Ltd for the
forthcoming problem. Show your workings.

Lemons Mango Nectarine Total

Maximum sales 120 160 110
demand
(Cartons)

Material A 2 1 4
required per
carton (kg)
Total material A 240 160 440 840
required (kg)

Material B 5 3 7
required per
carton (kg)
Total material B 600 480 770 1850
required

This study source was downloaded by 100000866341848 from CourseHero.com on 07-07-2023 12:01:19 GMT -05:00

https://www.coursehero.com/file/78245548/ACCY-115-Tutorial-7docx/
 There will be sufficient material A to satisfy the maximum demand for the products but material B
will be a limiting factor.

Lemons Mango Nectarine

Contribution per unit sold $15 $12 $17.50
Material B consumer (kg) 5 3 7
Contribution per kg of material B $3 $4 $2.50
(divide CM by Material B)
Ranking 2 1 3

The available material B will be allocated to the products according to this ranking, to give the
optimum production plan for the period.
PRODUCTION PLAN

Product Recommended production Material B utilised

(cartons)
Mango 160 (maximum) 480
Lemon 240 (maximum) 600
Nectarine 20 140 (balance)
1220

The available material B is allocated to satisfy the maximum market demand for mongo and lemon.
The balance of available material is allocated to the last product in the ranking, nectarine
(b) Yummy Foods Ltd has a valued customer to whom they wish to guarantee the supply of
50 cartons of each product next period. Would this alter your recommended production
plan? Show your workings.
PRODUCTION PLAN

Product Recommended production Material B utilised

(cartons)
Nectarine 50 350
Mango 160 (maximum) 480
Lemon 78 390 (Balance)
1,220
(c)

Question 3
The directors of Aotearoa Aluminium Ltd are considering closing one of the business’s factories.
There has been a reduction in the demand for the products made in the factory in recent years and

This study source was downloaded by 100000866341848 from CourseHero.com on 07-07-2023 12:01:19 GMT -05:00

https://www.coursehero.com/file/78245548/ACCY-115-Tutorial-7docx/
 the directors are not optimistic about the long-term prospects for these products. The factory is
situated in the lower South Island, in an area where unemployment is high.
The factory is leased and there are still four years of the lease remaining. The directors are uncertain
whether the factory should be closed immediately or at the end of the period of the lease. Another
business has offered to sub-lease the premises from Aotearoa paying them $40,000 a year for the
remainder of the lease period.
The machinery and equipment at the factory cost $1,500,000, and have a balance sheet value of
$400,000. In the event of immediate closure the machinery and equipment could be sold for
$220,000. Immediate closure of the factory would result in redundancy payments to employees of
$180,000.
If the factory continues in operation until the end of the lease period, the following operating profits
(losses) are expected:

Year 1 Year 2 Year 3 Year 4

$000 $000 $000 $000
Operating profit / (loss) 160 (40) 30 20
The above figures include a charge of $90,000 a year for depreciation of machinery and equipment.
The residual value of the machinery and equipment at the end of the lease period is estimated at
$40,000.
Redundancy payments are expected to be $150,000 at the end of the lease period if the factory
continues in operation. The business has an annual cost of capital of 12 per cent. Ignore taxation.

Required
a) Determine the relevant cash flows arising from a decision to continue operations until
the end of the lease period rather than to close immediately.
- In the event of the closure the machinery could be sold immediately. Therefore an opportunity
cost of $220,000 will be incurred if operations continue
- If operations continue there is a saving in immediate redundancy costs of $180,000. However,
redundancy costs of $150,000 will be paid in four years’ time.
- If operations continue the opportunity to sub-lease the factory will also be foregone and
therefore represent an opportunity cost of the decision
$000
Years 0 1 2 3 4
Operating profit/(loss) 160 (40) 30 20
Depreciation 90 90 90 90
Operating Cash Flows 250 50 120 110

CONTINUE UNTIL END OF LEASE

Years 0 1 2 3 4
Operating cash flows 250 50 120 110
Sales of machinery (220) 40
Redundancy costs 180 (150)
Sublease rentals (40) (40) (40) (40)
Working Capital Invested
(40) 210 10 80 (40)

This study source was downloaded by 100000866341848 from CourseHero.com on 07-07-2023 12:01:19 GMT -05:00

https://www.coursehero.com/file/78245548/ACCY-115-Tutorial-7docx/
 b) Calculate the net present value of continuing operations until the end of the lease period
rather than closing immediately (round your answers to the nearest whole number)
(40) 210 10 80 (40)

Discount Factor at 12% 1000 0.893 0.797 0.712 0.636

Present Value (40) 188 8 57 (25)

Net Present Value

The NPV of the decision to continue operations rather than close immediately is positive. Therefore
the company would be better off if the directors took this course of action. The factory should
therefore continue in operation rather than close down

c) What other factors might the directors take into account before making a final decision
of the factory closure?
The overall strategy of the business – The business may need to set the decision within a broader
context. It may be necessary to manufacture the products of the factory because they are integral
part of the business’s product range. Aotearoa Aluminium may wish to avoid redundancies in an area
of high unemployment for as long as possible

Flexibility - A decision to close the factory is probably irreversible. If the factory continues, however
there may be chance that the prospects for the factory will improve in the future

Accuracy of forecasts - the forecasts made by the business should be examined carefully.
Inaccuracies in the forecasts or any underlying assumptions may change the expected outcomes

Credit Worthiness of sub-lessee – the business should investigate the credit worthiness of the sub-
lessee. Failure to receive the expected sub-lease payment would make the closure option far less
attractive

d) State, with reasons, whether or not the business should continue to operate the factory
until the end of the lease period.
- The NPV of the decision to continue operations rather than close immediately is positive.
Therefore the company would be better off if the directors took this course of action. The
factory should therefore continue in operation rather than close down.

- This decision is likely to be welcomed by employees and the local community and would allow
the business to maintain its flexibility.

This study source was downloaded by 100000866341848 from CourseHero.com on 07-07-2023 12:01:19 GMT -05:00

https://www.coursehero.com/file/78245548/ACCY-115-Tutorial-7docx/
Powered by TCPDF (www.tcpdf.org)