Financial

Management and
Control
PART 2
WEDNESDAY 14 DECEMBER 2005
QUESTION PAPER
Time allowed 3 hours
This paper is divided into two sections
Section A This ONE question is compulsory and MUST be
answered
Section B TWO questions ONLY to be answered
Formulae Sheet, Present Value and Annuity Tables are on
pages 7, 8 and 9.
Do not open this paper until instructed by the supervisor
This question paper must not be removed from the examination
hall
The Association of Chartered Certified Accountants
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Section A This ONE question is compulsory and MUST be attempted
1 BFD Co is a private company formed three years ago by four brothers who, as directors, retain sole ownership of its
ordinary share capital. One quarter of the initial share capital was provided by each brother. The company has
returned a profit in each year of operation as shown by the following financial statements.
Profit and Loss Accounts for years ending 30 November
2005 2004 2003
000 000 000
Turnover 5,200 3,400 2,600
Cost of sales 4,570 2,806 2,104

Profit before interest and tax 630 594 496
Interest 70 34 3

Profit before tax 560 560 493
Tax 140 140 123

Profit after tax 420 420 370
Dividends 20 20 20

Retained profit 400 400 350

Balance Sheets as at 30 November
2005 2004 2003
000 000 000 000 000 000
Fixed assets 1,600 1,200 800
Current assets
Stock 1,450 1,000 600
Debtors 1,400 850 400

2,850 1,850 1,000
Current liabilities 2,300 1,300 450

Net current assets 550 550 550

2,150 1,750 1,350

Ordinary shares (1 par) 1,000 1,000 1,000
Reserves 1,150 750 350

2,150 1,750 1,350

BFD Co has an overdraft limit of 125 million and pays interest on its overdraft at a rate of 6% per year. Current
liabilities consist of trade creditors and overdraft finance in each of the three years.
The directors are delighted with the rapid growth of BFD Co and are considering further expansion through buying
new premises and machinery to manufacture Product FT7. This new product has only just been developed and
patented by BFD Co. Test marketing has indicated considerable demand for the product, as shown by the following
research data.
Year of operation 1 2 3 4
Accounting year 2005/6 2006/7 2007/8 2008/9
Sales volume (units) 100,000 120,000 130,000 140,000
Sales after 2008/9 (the fourth year of operation) are expected to continue at the 2008/9 level in perpetuity.
Initial investment of 3,000,000 would be required in new premises and machinery, as well as an additional
200,000 of working capital. The directors have no further financial resources to offer and are considering
approaching their bank for a loan to meet their investment needs. Selling price and standard cost data for Product
FT7, based on an annual budgeted volume of 100,000 units, are as follows.
2
per unit
Selling price 1800
Direct material 700
Direct labour 150
Fixed production overhead 450
The fixed production overhead is incurred exclusively in the production of Product FT7 and excludes depreciation.
Selling price and standard unit variable cost data for Product FT7 are expected to remain constant.
BFD Co expects to be able to claim writing down allowances on the initial investment of 3,000,000 on a straight-
line basis over 10 years. The company pays tax on profit at an annual rate of 25% in the year in which the liability
arises and has an after-tax cost of capital of 12%.
Average data for companies similar to BFD Co
Net profit margin: 9% Creditor days: 70 days
Interest cover: 15 times Current ratio: 21 times
Stock days: 85 days Quick ratio: 08 times
Debtor days: 75 days Debt/equity ratio: 40% (using book values)
Required:
(a) Calculate the net present value of the proposed investment in Product FT7. Assume that it is now
1 December 2005. (16 marks)
(b) Comment on the acceptability of the proposed investment in Product FT7 and discuss what additional
information might improve the decision-making process. (7 marks)
(c) BFD Co has received an offer from a rival company of 300,000 per year for 10 years for the manufacturing
rights for Product FT7. If BFD Co accepts this offer, it would not be able to manufacture Product FT7 for the
duration of the agreement.
Required:
Determine whether BFD Co should accept the offer for the manufacturing rights to Product FT7. In this part
of the question only, ignore cash flows occurring after the ten-year period of the offer. Assume that it is
1 December 2005. (6 marks)
(d) As the newly-appointed finance director of BFD Co, write a report to the board which discusses whether the
company is likely to be successful if it approaches its bank for a loan. Your discussion should include an
analysis of the current financial position and recent financial performance of the company. (16 marks)
(e) On the basis that BFD Co decided to invest and manufacture Product FT7, the actual data for the first year of
operation (2005/6) is now available and is as follows:
Number of units produced and sold 110,000
Selling price ( per unit) 1820
Direct material ( per unit) 710
Direct labour ( per unit) 170
Fixed production overhead ( per unit) 450
Required:
Calculate the following variances using marginal costing and absorption costing:
(i) sales price variance;
(ii) sales volume profit variance;
and comment on the relative values obtained. (5 marks)
(50 marks)
3 [P.T.O.
Section B TWO questions ONLY to be attempted
2 Required:
(a) Identify the types of responsibility centres used in responsibility accounting and discuss how the performance
of each responsibility centre type might be measured, including in your discussion examples of controllable
and non-controllable factors. (12 marks)
(b) Critically discuss whether return on investment or residual income should be used to assess managerial
performance in an investment centre. (13 marks)
(25 marks)
3 Linacre Co operates an activity-based costing system and has forecast the following information for next year.
Cost Pool Cost Cost Driver Number of Drivers
Production set-ups 105,000 Set-ups 300
Product testing 300,000 Tests 1,500
Component supply and storage 25,000 Component orders 500
Customer orders and delivery 112,500 Customer orders 1,000
General fixed overheads such as lighting and heating, which cannot be linked to any specific activity, are expected to
be 900,000 and these overheads are absorbed on a direct labour hour basis. Total direct labour hours for next year
are expected to be 300,000 hours.
Linacre Co expects orders for Product ZT3 next year to be 100 orders of 60 units per order and 60 orders of 50 units
per order. The company holds no stocks of Product ZT3 and will need to produce the order requirement in production
runs of 900 units. One order for components is placed prior to each production run. Four tests are made during each
production run to ensure that quality standards are maintained. The following additional cost and profit information
relates to product ZT3:
Component cost: 100 per unit
Direct labour: 10 minutes per unit at 780 per hour
Profit mark up: 40% of total unit cost
Required:
(a) Calculate the activity-based recovery rates for each cost pool. (4 marks)
(b) Calculate the total unit cost and selling price of Product ZT3. (9 marks)
(c) Discuss the reasons why activity-based costing may be preferred to traditional absorption costing in the
modern manufacturing environment. (12 marks)
(25 marks)
4
4 AGD Co is a profitable company which is considering the purchase of a machine costing 320,000. If purchased,
AGD Co would incur annual maintenance costs of 25,000. The machine would be used for three years and at the
end of this period would be sold for 50,000. Alternatively, the machine could be obtained under an operating lease
for an annual lease rental of 120,000 per year, payable in advance.
AGD Co can claim capital allowances on a 25% reducing balance basis. The company pays tax on profits at an annual
rate of 30% and all tax liabilities are paid one year in arrears. AGD Co has an accounting year that ends on
31 December. If the machine is purchased, payment will be made in January of the first year of operation. If leased,
annual lease rentals will be paid in January of each year of operation.
Required:
(a) Using an after-tax borrowing rate of 7%, evaluate whether AGD Co should purchase or lease the new
machine. (12 marks)
(b) Explain and discuss the key differences between an operating lease and a finance lease. (8 marks)
(c) The after-tax borrowing rate of 7% was used in the evaluation because a bank had offered to lend AGD Co
320,000 for a period of five years at a before-tax rate of 10% per year with interest payable every six months.
Required:
(i) Calculate the annual percentage rate (APR) implied by the banks offer to lend at 10% per year with
interest payable every six months. (2 marks)
(ii) Calculate the amount to be repaid at the end of each six-month period if the offered loan is to be repaid
in equal instalments. (3 marks)
(25 marks)
5 [P.T.O.
5 Thorne Co values, advertises and sells residential property on behalf of its customers. The company has been in
business for only a short time and is preparing a cash budget for the first four months of 2006. Expected sales of
residential properties are as follows.
2005 2006 2006 2006 2006
Month December January February March April
Units sold 10 10 15 25 30
The average price of each property is 180,000 and Thorne Co charges a fee of 3% of the value of each property
sold. Thorne Co receives 1% in the month of sale and the remaining 2% in the month after sale. The company has
nine employees who are paid on a monthly basis. The average salary per employee is 35,000 per year. If more than
20 properties are sold in a given month, each employee is paid in that month a bonus of 140 for each additional
property sold.
Variable expenses are incurred at the rate of 05% of the value of each property sold and these expenses are paid in
the month of sale. Fixed overheads of 4,300 per month are paid in the month in which they arise. Thorne Co pays
interest every three months on a loan of 200,000 at a rate of 6% per year. The last interest payment in each year
is paid in December.
An outstanding tax liability of 95,800 is due to be paid in April. In the same month Thorne Co intends to dispose
of surplus vehicles, with a net book value of 15,000, for 20,000. The cash balance at the start of January 2006
is expected to be a deficit of 40,000.
Required:
(a) Prepare a monthly cash budget for the period from January to April 2006. Your budget must clearly indicate
each item of income and expenditure, and the opening and closing monthly cash balances. (10 marks)
(b) Discuss the factors to be considered by Thorne Co when planning ways to invest any cash surplus forecast
by its cash budgets. (5 marks)
(c) Discuss the advantages and disadvantages to Thorne Co of using overdraft finance to fund any cash
shortages forecast by its cash budgets. (5 marks)
(d) Explain how the Baumol model can be employed to reduce the costs of cash management and discuss
whether the Baumol cash management model may be of assistance to Thorne Co for this purpose.
(5 marks)
(25 marks)
6
7 [P.T.O.
Formulae Sheet
8
N0TT
3.7
3UHVHQW 9DOXH 7DEOH
Present value cf 1 i.e. (1 + U)
Q
Where r ~ cisccunt rate
n ~ number cf periccs until payment
'LVFRXQW UDWH U
3HULRGV
(n) 1 2 3 4 5 6 7 8 9 10
1 0990 0980 0971 0962 0952 0943 0935 0926 0917 0909 1
2 0980 0961 0943 0925 0907 0890 0873 0857 0842 0826 2
3 0971 0942 0915 0889 0864 0840 0816 0794 0772 0751 3
4 0961 0924 0888 0855 0823 0792 0763 0735 0708 0683 4
5 0951 0906 0863 0822 0784 0747 0713 0681 0650 0621 5
6 0942 0888 0837 0790 0746 0705 0666 0630 0596 0564 6
7 0933 0871 0813 0760 0711 0665 0623 0583 0547 0513 7
8 0923 0853 0789 0731 0677 0627 0582 0540 0502 0467 8
9 0914 0837 0766 0703 0645 0592 0544 0500 0460 0424 9
10 0905 0820 0744 0676 0614 0558 0508 0463 0422 0386 10
11 0896 0804 0722 0650 0585 0527 0475 0429 0388 0350 11
12 0887 0788 0701 0625 0557 0497 0444 0397 0356 0319 12
13 0879 0773 0681 0601 0530 0469 0415 0368 0326 0290 13
14 0870 0758 0661 0577 0505 0442 0388 0340 0299 0263 14
15 0861 0743 0642 0555 0481 0417 0362 0315 0275 0239 15
(n) 11 12 13 14 15 16 17 18 19 20
1 0901 0893 0885 0877 0870 0862 0855 0847 0840 0833 1
2 0812 0797 0783 0769 0756 0743 0731 0718 0706 0694 2
3 0731 0712 0693 0675 0658 0641 0624 0609 0593 0579 3
4 0659 0636 0613 0592 0572 0552 0534 0516 0499 0482 4
5 0593 0567 0543 0519 0497 0476 0456 0437 0419 0402 5
6 0535 0507 0480 0456 0432 0410 0390 0370 0352 0335 6
7 0482 0452 0425 0400 0376 0354 0333 0314 0296 0279 7
8 0434 0404 0376 0351 0327 0305 0285 0266 0249 0233 8
9 0391 0361 0333 0308 0284 0263 0243 0225 0209 0194 9
10 0352 0322 0295 0270 0247 0227 0208 0191 0176 0162 10
11 0317 0287 0261 0237 0215 0195 0178 0162 0148 0135 11
12 0286 0257 0231 0208 0187 0168 0152 0137 0124 0112 12
13 0258 0229 0204 0182 0163 0145 0130 0116 0104 0093 13
14 0232 0205 0181 0160 0141 0125 0111 0099 0088 0078 14
15 0209 0183 0160 0140 0123 0108 0095 0084 0074 0065 15
9
0TT
.7
$QQXLW\ 7DEOH
Present value cf an annuity cf 1 i.e.
Where r ~ cisccunt rate
n ~ number cf periccs
'LVFRXQW UDWH U
3HULRGV
(n) 1 2 3 4 5 6 7 8 9 10
1 0990 0980 0971 0962 0952 0943 0935 0926 0917 0909 1
2 1970 1942 1913 1886 1859 1833 1808 1783 1759 1736 2
3 2941 2884 2829 2775 2723 2673 2624 2577 2531 2487 3
4 3902 3808 3717 3630 3546 3465 3387 3312 3240 3170 4
5 4853 4713 4580 4452 4329 4212 4100 3993 3890 3791 5
6 5795 5601 5417 5242 5076 4917 4767 4623 4486 4355 6
7 6728 6472 6230 6002 5786 5582 5389 5206 5033 4868 7
8 7652 7325 7020 6733 6463 6210 5971 5747 5535 5335 8
9 8566 8162 7786 7435 7108 6802 6515 6247 5995 5759 9
10 9471 8983 8530 8111 7722 7360 7024 6710 6418 6145 10
11 1037 9787 9253 8760 8306 7887 7499 7139 6805 6495 11
12 1126 1058 9954 9385 8863 8384 7943 7536 7161 6814 12
13 1213 1135 1063 9986 9394 8853 8358 7904 7487 7103 13
14 1300 1211 1130 1056 9899 9295 8745 8244 7786 7367 14
15 1387 1285 1194 1112 1038 9712 9108 8559 8061 7606 15
(n) 11 12 13 14 15 16 17 18 19 20
1 0901 0893 0885 0877 0870 0862 0855 0847 0840 0833 1
2 1713 1690 1668 1647 1626 1605 1585 1566 1547 1528 2
3 2444 2402 2361 2322 2283 2246 2210 2174 2140 2106 3
4 3102 3037 2974 2914 2855 2798 2743 2690 2639 2589 4
5 3696 3605 3517 3433 3352 3274 3199 3127 3058 2991 5
6 4231 4111 3998 3889 3784 3685 3589 3498 3410 3326 6
7 4712 4564 4423 4288 4160 4039 3922 3812 3706 3605 7
8 5146 4968 4799 4639 4487 4344 4207 4078 3954 3837 8
9 5537 5328 5132 4946 4772 4607 4451 4303 4163 4031 9
10 5889 5650 5426 5216 5019 4833 4659 4494 4339 4192 10
11 6207 5938 5687 5453 5234 5029 4836 4656 4486 4327 11
12 6492 6194 5918 5660 5421 5197 4988 4793 4611 4439 12
13 6750 6424 6122 5842 5583 5342 5118 4910 4715 4533 13
14 6982 6628 6302 6002 5724 5468 5229 5008 4802 4611 14
15 7191 6811 6462 6142 5847 5575 5324 5092 4876 4675 15
1 (1 U)
Q

U
End of Question Paper