STRATEGIC MANAGEMENT

ACCOUNTING [C2]
CHARTERED LEVEL
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Extra Reading Time: 15 Minutes

Maximum Marks: 100 Roll No.:
Writing Time: 03 Hours
(i) Attempt all questions.
(ii) Write your Roll No. in the space provided above.
(iii) Answers must be neat, relevant and brief. It is not necessary to maintain the sequence.
(iv) Use of non-programmable scientific calculators of any model is allowed.
(v) Read the instructions printed inside the top cover of answer script CAREFULLY before attempting the paper.
(vi) In marking the question paper, the examiners take into account clarity of exposition, logic of arguments,
effective presentation, language and use of clear diagram/ chart, where appropriate.
(vii) DO NOT write your Name, Reg. No. or Roll No., or any irrelevant information inside the answer script.
(viii) Question Paper must be returned to invigilator before leaving the examination hall.
D U RING E X TR A R EA DIN G T IM E , W R IT ING IS ST RICT L Y P R OH IBITE D IN T HE A NS WER S CR IPT

EXAMINEES ARE ADVISED TO MANAGE SOLUTIONS/ ANSWERS WITHIN PROPOSED TIME

Question No. 1 Proposed Time: Min. 25 Total Marks : 15

(a) Target costing is a useful tool for strengthening an organisations competitive position, but it may have
some adverse effects on organisation. What are the possible adverse effects of target costing?

(b) Versatile crockery is expert in manufacturing crockery items. Versatile crockery makes and sells three
products, A, B and C. The products are sold in the proportions i.e., A: B: C = 3:2:3. The organizations
fixed costs are Rs. 130,000 per month. Other details of the products are as follows:

Rs. per Unit

Product Selling Price Variable Cost
A 33 24
B 28 21
C 31 22

Required:
The organization wishes to earn a profit of Rs. 108,000 next month. Calculate the required sales value
of each product in order to achieve this target profit.

Question No. 2 Proposed Time: Min. 20 Total Marks : 10

A shopping mall has decided to acquire a new air-conditioning plant. The plant has a useful life of 10 years
and expected to have 10% residual value at the end of the time. It would cost Rs. 16 million to buy which
would be financed by borrowing. Alternatively it could be leased for 10 years at an annual rental of
Rs. 4 million payable annually in advance.
The tax rate is 35%, firm uses straight-line depreciation. All tax payment is paid last day of the year. The
after tax cost of borrowing is estimated 13%.

Required:
(a) Advise whether to buy or to lease the plant on the assumption that the company has sufficient taxable
profits to fully absorb all tax allowance rising from the buy or lease decision.

(b) List down any other factor which the company should take into account when making the buy or lease
decision.

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Question No. 3 Proposed Time: Min. 25 Total Marks : 15
The managers of Habib Inc are evaluating investment potential of Rs. 50 million. The investment would be a
diversification away from existing mainstream activities of stationery retail and into the printing industry. The
investment of Rs. 12 million would be financed by internal funds, Rs. 20 million by a rights issue and Rs. 18
million by long-term loans. The investment is expected to generate pre-tax net cash flows of approximately
Rs. 10 million per year, for a period of ten years. The residual value at the end of year ten is forecast to be
Rs. 10 million after tax. As the investment is in an area that the government wishes to develop, a subsidised
loan of Rs. 8 million out of the total Rs. 18 million is available. This will cost 4% below the companys normal
cost of long-term debt finance, which is 10%.
Habibs equity beta is 0.95, and its financial gearing is 60% equity, 40 % debt market value. The average
equity beta in the printing industry is 1.4, and average gearing 50% equity, 50% debt by market value.
The risk free rate is 4.5% per annum and the market return 14% per annum. Issue costs are estimated to be 2%
for debt financing (excluding the subsidised loan), and 5% for equity financing. The corporate tax rate is 31%.

Required:
(a) Calculate the Adjusted Present Value (APV) of the proposed investment.

(b) Discuss the circumstances under which APV might be a better method of evaluating a capital
investment.

(c) What are the possible adverse effects of this diversification on Habib Inc?

Question No. 4 Proposed Time: Min. 45 Total Marks : 25

Zohaib Engineering (Pvt.) Limited is planning to produce a new product; life cycle of the product would be
five years. The new project requires a new semi auto machine costing Rs. 1,700,000. An existing machine
with a book value of Rs. 700,000 and carrying value of Rs. 500,000 would also be used in the proposed
project. There is a sufficient capacity on the existing machine which has so far been under-utilized. The new
machine requires an additional space that could be leased for Rs. 65,000 per year payable in advance and
an additional amount of Rs. 200,000 for installation of machine, payable immediately.
Expected annual sales of the product would be 7,500 units, selling at Rs. 390 per unit. Unit costs would be
as follows:

Rupees
Prime cost (including 3 labour hours at Rs. 30 per unit) 190
Fixed costs including depreciation 120
310

At the end of the product life cycle the new machine would have a disposal value of Rs. 160,000.
As direct skilled labour is continuously in short supply in the city, labour resources would have to be diverted
from other work which currently earns a contribution of Rs. 20 per direct labour hour.
The overhead absorption rate would be Rs. 120 per unit and Rs. 30 per hour, but actual expenditure on
fixed overhead would remain unaltered.
Zohaib Engineering currently advertises their business in local newspapers and business directories, at a
cost of Rs. 120,000 per year payable in advance, but company will need an extensive one off
advertisement to promote the new product. This one off advertising on the Television will cost Rs. 500,000,
which will be paid immediately.
In addition to advertisement on television, company could advertise the move on the local radio. Cost of this
advertisement would be Rs. 240,000 which is also payable immediately.
Working capital of Rs. 200,000 would be immediately required, rising to Rs. 300,000 in the beginning of the
upcoming year and will remain at the same level until the end of the project, when it will all be recovered.

Required:
Prepare a net present value calculation over a five-year time period, given that the companys cost of capital
is 18%. On the basis of your calculation, advise the company whether they should introduce the new
product or not? Ignore the impact of taxation.
SMA-MP [Syllabus 2016] 2 of 4
Question No. 5 Proposed Time: Min. 20 Total Marks : 10
Cetrolite Ltd. has been engaged in the business of wide range of small electronic gadgets manufacturing
such as electric kettles, toasters, food mixers and irons for 10 years. The company supplies these
appliances to various outlets in south region and profitable since its second year of operations.
The company has recently received a request by one of the super outlets in south region to bid on the
manufacture of 14,500 toasters. In order to prepare the bid for 14,500 toasters Mr. Dawood, the Manager
Costing and Budgeting has gathered the following information about cost associated with the production of
toasters:

Rupees
Direct material (per unit) 1,200
*Direct labour (per direct labour hour) 220
**Machine costs (per unit) 320
Variable selling cost (per unit) 610
Variable overhead rate (per direct labour hour) 120
Fixed overhead rate (per direct labour hour) 90

2 direct labour hours are used to produce single unit of toaster.

Machine cost is not included in normal overhead rates because these machines are used to produce
toasters only.

Additional Information:
Mr. Dawood indicated that Rs. 520,000 would be allocated as fixed administrative expenses directly
traceable to the toaster product line.
The bid must be stated at full cost per unit plus a return on full cost of no more than 12% before income
taxes. Mr. Khan, CFO of super outlet has indicated that any bid over 3,200 per toaster will be rejected.

Required:
(a) Calculate the minimum price per toaster that Cetrolite Ltd. could bid for the super outlet that would not
reduce the Cetrolite income.

(b) Calculate the bid price per toaster using total cost and the maximum allowable return specified by the
super outlet.

(c) Ignoring the super outlet bid and using total cost-plus pricing formula, determine the mark-up
percentage required for the toaster product line to earn a target profit of Rs. 2,025,500 before taxes
during next year.

Question No. 6 Proposed Time: Min. 30 Total Marks : 15

GHM Company has two divisions, Division A and Division B. Division A produces standardized
rechargeable torch batteries which it sells to outside customers and transfers to Division B when needed.
Division B produces rechargeable torches in different sizes and sells in the market.
Division A manufactures and sells torch batteries as per below details:

Capacity in units 70,000

Selling price to outside customers (Rs. per unit) 120
Variable cost (Rs. per unit) 65
Fixed cost (based on capacity) (Rs. per unit) 36

Division B can use the battery produced by Division A in its medium size torches. The Division B is
currently purchasing 25,000 batteries per year from an external supplier at a cost of Rs. 116 per unit.
The Divisional Managers have full control over the commercial policy of their respective Divisions.

SMA-MP [Syllabus 2016] 3 of 4 PTO

Required:
(a) Calculate acceptable range of transfer price between the two divisions, if division A has excess
production capacity.
(b) Suppose Division A is operating at its full capacity to satisfy the demand of its outside customers,
determine the acceptable range of transfer price between the two divisions.
(c) Assume again that Division A is operating at its full capacity to satisfy the demand of external
customers, however, in case of internal transfer variable selling cost will be reduced by Rs. 7 per unit.
Determine the acceptable range of transfer price between the two divisions.
(d) Explain the potential benefits of operating a transfer pricing system within a divisionalized company.

Question No. 7 Proposed Time: Min. 15 Total Marks : 10

Division A of Zerox Ltd. a trading company, operating in Faisalabad Pakistan, currently has capital
employed of Rs. 1,200,000 and earns an annual profit (after depreciation) of Rs. 240,000. Finance director
of the company is considering an investment of Rs. 120,000 in an asset which will have a twelve-year life
with no residual value and will earn a constant annual profit after depreciation of Rs. 21,360. The companys
cost of capital is 17%.

Required:
Calculate the following:
(a) The return on divisional investment before and after the new investment.

(b) The divisional residual income before and after the new investment and its impact on cost of capital.

THE END

SMA-MP [Syllabus 2016] 4 of 4