Financial

Management and
Control
PART 2
WEDNESDAY 15 JUNE 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
8, 9 and 10.
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 ARG Co is a leisure company that is recovering from a loss-making venture into magazine publication three years ago.
Recent financial statements of the company are as follows.
Profit and loss account for year ending 30 June 2005
000
Turnover 140,400
Cost of sales 112,840

Gross profit 27,560

Administration costs 23,000

Profit before interest and tax 4,560

Interest 900

Profit before tax 3,660

Taxation 1,098

Profit after taxation 2,562

Dividends 400

Retained profit 2,162

Balance sheet as at 30 June 2005

000 000
Fixed assets 50,000
Current assets
Stock 2,400
Debtors 20,000
Cash 1,500

23,900
Current liabilities 33,000

(9,100)

40,900
9% Debentures 2014 10,000

30,900

Financed by:
Ordinary shares, 1 par value 2,000
Reserves 27,000
Profit and loss 1,900

30,900

The company plans to launch two new products, Alpha and Beta, at the start of July 2005, which it believes will
each have a life-cycle of four years. Alpha is the deluxe version of Beta. The sales mix is assumed to be constant.
Expected sales volumes for the two products are as follows.
Year 1 2 3 4
Alpha 60,000 110,000 100,000 30,000
Beta 75,000 137,500 125,000 37,500
2
The standard selling price and standard costs for each product in the first year will be as follows.
Product Alpha Beta
/unit /unit
Direct material costs 1200 900
Incremental fixed production costs 864 642

Total absorption cost 2064 1542
Standard mark-up 1036 758

Selling price 3100 2300

ARG traditionally operates a cost-plus approach to product pricing.
Incremental fixed production costs are expected to be 1 million in the first year of operation and are apportioned on
the basis of sales value. Advertising costs will be 500,000 in the first year of operation and then 200,000 per year
for the following two years. There are no incremental non-production fixed costs other than advertising costs.
In order to produce the two products, investment of 1 million in premises, 1 million in machinery and 1 million
in working capital will be needed, payable at the start of July 2005. The investment will be financed by the issue of
3 million of 9% debentures, each 100 debenture being convertible into 20 ordinary shares of ARG Co after 8 years
or redeemable at par after 12 years.
Selling price per unit, direct material cost per unit and incremental fixed production costs are expected to increase
after the first year of operation due to inflation:
Selling price inflation 30% per year
Direct material cost inflation 30% per year
Fixed production cost inflation 50% per year
These inflation rates are applied to the standard selling price and standard cost data provided above. Working capital
will be recovered at the end of the fourth year of operation, at which time production will cease and ARG Co expects
to be able to recover 12 million from the sale of premises and machinery. All staff involved in the production and
sale of Alpha and Beta will be redeployed elsewhere in the company.
ARG Co pays tax in the year in which the taxable profit occurs at an annual rate of 25%. Investment in machinery
attracts a first-year capital allowance of 100%. ARG Co has sufficient profits to take the full benefit of this allowance
in the first year. For the purpose of reporting accounting profit, ARG Co depreciates machinery on a straight line basis
over four years. ARG Co uses an after-tax discount rate of 13% for investment appraisal.
Other information
Assume that it is now 30 June 2005
The ordinary share price of ARG Co is currently 400
Average interest cover for ARG Cos sector is 7
Average gearing for ARG Cos sector is 45% (long-term debt/equity using book values)
3 [P.T.O.
Required:
(a) Calculate the net present value of the proposed investment in products Alpha and Beta. (17 marks)
(b) Identify and discuss any likely limitations in the evaluation of the proposed investment in Alpha and Beta.
(6 marks)
(c) Evaluate and discuss the proposal to finance the investment with a 3 million 9% convertible debenture
issue. (8 marks)
(d) A detailed evaluation of the incremental fixed costs for the first year of producing Alpha and Beta reveals the
following information on the composition of the fixed costs and their associated cost drivers.
Fixed cost Cost driver Alpha Beta
Power, heating, etc. 505,000 Floor area 3,500 m
2
6,500 m
2
Salaries 300,000 Labour hours 10,000 15,000
Inspection costs 67,500 Inspections 3,000 3,750
Order processing 67,500 Orders 3,000 1,500
Maintenance 26,000 Maintenance hours 625 1,875
Set-up costs 34,000 Set-ups 120 50

1,000,000
Calculate activity-based recovery rates for each fixed cost and calculate the total standard cost per unit for
each product using an activity-based approach. Comment on the implications of your findings for product
pricing. (11 marks)
(e) Included in the debtors of ARG Co is an expected receipt of $500,000 payable in three months time. The
following exchange rates are available:
$/
Spot 17642 17962
Three months forward 17855 18174
Explain why ARG Co might wish to hedge its expected three-month dollar receipt using the forward market
and calculate the sterling value arising from a forward market hedge. (4 marks)
(f) Discuss how bills of exchange can be used to reduce the risk associated with the overseas debtors of
ARG Co. (4 marks)
(50 marks)
4
Section B TWO questions ONLY to be attempted
2 Required:
(a) Discuss how costing information and principles may be applied in a not-for-profit organisation in the following
areas:
(i) the selection of cost units;
(ii) the use of performance measures to measure output and quality;
(iii) the comparison of planned and actual performance. (10 marks)
(b) Discuss the key features of zero-based budgeting and explain how it may be applied in a not-for-profit
organisation. (8 marks)
(c) Briefly discuss how activity-based budgeting might be introduced into a manufacturing organisation and the
advantages that might arise from the use of activity-based budgeting in such an organisation. (7 marks)
(25 marks)
3 BRK Co operates an absorption costing system and sells three products, B, R and K which are substitutes for each
other. The following standard selling price and cost data relate to these three products:
Product Selling price per unit Direct material per unit Direct labour per unit
B 1400 300 kg at 180 per kg 05 hrs at 650 per hour
R 1500 125 kg at 328 per kg 08 hrs at 650 per hour
K 1800 194 kg at 250 per kg 07 hrs at 650 per hour
Budgeted fixed production overhead for the last period was 81,000. This was absorbed on a machine hour basis.
The standard machine hours for each product and the budgeted levels of production and sales for each product for
the last period are as follows:
Product B R K
Standard machine hours per unit 03 hrs 06 hrs 08 hrs
Budgeted production and sales (units) 10,000 13,000 9,000
Actual volumes and selling prices for the three products in the last period were as follows:
Product B R K
Actual selling price per unit 1450 1550 1900
Actual production and sales (units) 9,500 13,500 8,500
Required:
(a) Calculate the following variances for overall sales for the last period:
(i) sales price variance;
(ii) sales volume profit variance;
(iii) sales mix profit variance;
(iv) sales quantity profit variance
and reconcile budgeted profit for the period to actual sales less standard cost. (13 marks)
(b) Discuss the significance of the sales mix profit variance and comment on whether useful information would
be obtained by calculating mix variances for each of these three products. (4 marks)
(c) Describe the essential elements of a standard costing system and explain how quantitative analysis can assist
in the preparation of standard costs. (8 marks)
(25 marks)
5 [P.T.O.
4 As assistant to the Finance Director of RZP Co, a company that has been listed on the London Stock Market for several
years, you are reviewing the draft Annual Report of the company, which contains the following statement made by
the chairman:
This company has consistently delivered above-average performance in fulfilment of our declared objective of creating
value for our shareholders. Apart from 2002, when our overall performance was hampered by a general market
downturn, this company has delivered growth in dividends, earnings and ordinary share price. Our shareholders can
rest assured that my directors and I will continue to deliver this performance in the future.
The five-year summary in the draft Annual Report contains the following information:
Year 2004 2003 2002 2001 2000
Dividend per share 28p 23p 22p 22p 17p
Earnings per share 1904p 1495p 1122p 1584p 1343p
Price/earnings ratio 220 335 255 172 152
General price index 117 113 110 105 100
A recent article in the financial press reported the following information for the last five years for the business sector
within which RZP Co operates:
Share price growth average increase per year of 20%
Earnings growth average increase per year of 10%
Nominal dividend growth average increase per year of 10%
Real dividend growth average increase per year of 9%
You may assume that the number of shares issued by RZP Co has been constant over the five-year period. All
price/earnings ratios are based on end-of-year share prices.
Required:
(a) Analyse the information provided and comment on the views expressed by the chairman in terms of:
(i) growth in dividends per share;
(ii) share price growth;
(iii) growth in earnings per share.
Your analysis should consider both arithmetic mean and equivalent annual growth rates. (13 marks)
(b) Calculate the total shareholder return (dividend yield plus capital growth) for 2004 and comment on your
findings. (3 marks)
(c) Discuss the factors that should be considered when deciding on a management remuneration package that
will encourage the directors of RZP Co to maximise the wealth of shareholders, giving examples of
management remuneration packages that might be appropriate for RZP Co. (9 marks)
(25 marks)
6
5 TNG Co expects annual demand for product X to be 255,380 units. Product X has a selling price of 19 per unit and
is purchased for 11 per unit from a supplier, MKR Co. TNG places an order for 50,000 units of product X at regular
intervals throughout the year. Because the demand for product X is to some degree uncertain, TNG maintains a safety
(buffer) stock of product X which is sufficient to meet demand for 28 working days. The cost of placing an order is
25 and the storage cost for Product X is 10 pence per unit per year.
TNG normally pays trade suppliers after 60 days but MKR has offered a discount of 1% for cash settlement within
20 days.
TNG Co has a short-term cost of debt of 8% and uses a working year consisting of 365 days.
Required:
(a) Calculate the annual cost of the current ordering policy. Ignore financing costs in this part of the question.
(4 marks)
(b) Calculate the annual saving if the economic order quantity model is used to determine an optimal ordering
policy. Ignore financing costs in this part of the question. (5 marks)
(c) Determine whether the discount offered by the supplier is financially acceptable to TNG Co. (4 marks)
(d) Critically discuss the limitations of the economic order quantity model as a way of managing stock.
(4 marks)
(e) Discuss the advantages and disadvantages of using just-in-time stock management methods. (8 marks)
(25 marks)
7 [P.T.O.
8
Formulae Sheet
9 [P.T.O.
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
10
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