PRIFYSGOL CYMRU : UNIVERSITY OF WALES ABERYSTWYTH EXAMINATIONS 1994 SEMESTER 2 AC10210: INTRODUCTION TO MANAGEMENT ACCOUNTING AND FINANCE Time: TWO Hours This paper consists of THREE sections Answer ONE question from each section. ALL questions carry equal marks. Explain any assumptions you need to make You will be provided with: i) Graph paper ii) Mathematical, Statistical and Financial Tables for the Social Sciences by Kmietowicz and Yannoulis SECTION A 1. Frodo Ltd which manufactures curtains purchases all its raw materials from a single supplier and uses two metres of the cloth for each pair of curtains. Variable costs at output below 5,000 pairs per year are #42 per pair, of which #20 is the cost of the cloth. However, the supplier offers a discount of 10% on all purchases if Frodo buys at least 10,000 metres of cloth and a further discount of #1.00 per metre on any additional purchases above 16,000 metres per year. The selling price of the curtains is #60 per pair and the fixed costs are #120,000 per annum. REQUIRED: (a) Calculate the contribution per unit at output levels (i) less than 5000 units (ii) 5,000 - 8,000 units (iii) more than 8,000 units (6 marks) (b) Prepare a break even or profit volume chart for Frodo and indicate any break even points. (9 marks) (c) Using your chart or otherwise, investigate the effect of raising the selling price to #65.00. (5 marks) 2. Gandalf plc produces one product: the "balrog". The standard costs for the product for a recent period were as follows: # Direct labour (2.5 hours at #5.00 per hour) 12.50 per unit Direct material (5.25kg at #6.50 per kg) 34.125 per unit Variable overhead 4.00 per unit Fixed overhead 30,000 The standard selling price of a balrog for the period was #80 and the budgeted level of production was 4,000 units. The actual results for the period have just become available and are as follows: # # Sales (4,500 units) 337,500 Direct labour (12,500 hours) 65,625 Direct material (22,500kg) 135,000 Variable overhead 16,550 Fixed overhead32,500 249,675 ------- 87,825 ------- REQUIRED: (a) Prepare a statement reconciling the budgeted profit with the actual profit, stating the variances in the way you think will be most helpful to management. (12 marks) (b) Write a report for the management drawing their attention to any important features of the statement and recommending action where appropriate. (8 marks) SECTION B 3. You have recently been appointed to the position of finance director of an international company, Williams Chocolate Biscuits plc. One of your first tasks is to advise your boardroom colleagues on which, if any, of three mutually exclusive investment projects to implement. The three projects have the following projected cash flows: Project A: a cash outlay of #10,000 at t0 and net cash inflows of #6,000, #5,000 and #3,000 at t , t and t 1 2 3 respectively. Project B: a cash outlay at t0 of #32,000 and annual net cash inflows starting at t1 of #5,500 in perpetuity. Project C: a cash outlay of #35,250 at t0 and net cash inflows of #18,000 #15,000 and #15,000 at t1, t2 and t3 respectively. The appropriate cost of capital for all three projects is 16%. REQUIRED: (a) For each project calculate its net present value and internal rate of return. Which project should the company invest in and why? (10 marks) (b) Using project C's anticipated cash flows, illustrate the economic interpretation of its net present value and internal rate of return. (6 marks) (c) In addition to your answer to part (a) above, what other factors should the company's directors consider before deciding which of the projects to invest in. (4 marks) 4. Cymysg plc is a quoted company which is attempting to estimate its cost of capital. The company has supplied you with the following information: The company has an issued share capital of 500,000 ordinary #1 (nominal value) shares, with a current market value, cum div, of 117p per share. The company also has #200,000 (nominal value) of 10% debentures which are redeemable at par in two years time and have a current market value, ex int, of #95.30 per unit of #100 and 100,000 #1 (nominal value) 6% preference shares, with a current market value, ex div, of 40p per share. The total dividend payable to holders of the ordinary share will be #60,000 this year, the share price will be quoted ex div from tomorrow. The directors anticipate that the dividend will increase by 5% per annum for the foreseeable future. The preference dividend and the debenture interest will be paid shortly Assume that the company pays corporation tax at the rate of 35% Required: (a) Calculate the company's cost of equity, preference and debenture capital. (10 marks) (b) Calculate the company's weighted average cost of capital. (5 marks) (c) What effect would an increase in the corporation tax rate have on the company's weighted average cost of capital. (5 marks) SECTION C 5. Explain carefully, giving examples, how the notion of 'relevant costs' assists decision makers in choosing between alternative courses of action. (20 marks) 6. Answer TWO of the following, each section carries equal marks (i) What advantages do the discounted cash flow (DCF) methods of investment appraisal have over the "traditional" methods? (10 marks) (ii) What conclusions do the "traditional view" and the "Modigliani and Miller view" (MM) draw with respect to the capital structure debate? (10 marks) (iii) What conclusions can be drawn from the "Fisher-Hirshliefer Two Period Investment Consumption Model"? (10 marks)