Financial

Management and
Control
PART 2
WEDNESDAY 14 JUNE 2006
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
P
a
p
e
r

2
.
4
Section A This ONE question is compulsory and MUST be attempted
1 The following financial information relates to Merton plc, a supplier of photographic equipment and film services to
the film industry.
Profit and loss accounts for years ended 30 April
2006 2005 2004
m m m
Turnover 1600 1450 1320
Cost of sales 1200 1053 957

400 397 363
Operating expenses 300 260 235

Operating profit 100 137 128
Interest 36 33 33

Profit before tax 64 104 95
Taxation 19 31 28

Profit after tax 45 73 67
Dividends 15 17 16

30 56 51

Share price at 30 April: 270 511 469
Balance sheets as at 30 April
2006 2005
m m m m m m
Fixed assets 45 35
Current assets
Stock 36 32
Debtors 41 24
Cash 1 16

78 72
Current liabilities
Trade creditors 17 11
Overdraft 8 1

25 12

Net current assets 53 60

Total assets less current liabilities 98 95
Long-term liabilities
10% debentures 2008 13 13
8% debentures 2013 25 25

38 38

60 57

Capital and reserves
Ordinary shares (50 pence par) 10 10
Reserves 50 47

60 57

Notes: All sales are on credit. Merton currently pays interest on its overdraft at an annual rate of 4%, although this
rate is variable.
2
Shareholders of Merton plc have been alarmed by the companys recent announcement that it intends to cut the total
dividend for the year. The announcement, which was released on 1 June 2006, also said that Merton plc is
considering expanding into the retail camera market, as a result of which it expects future share price growth and
dividend growth to be at least 8% per year. Following the announcement, the companys share price fell from 270
to 245 (on an ex dividend basis) where it has remained.
The Board of Merton plc has not announced how it plans to finance the proposed expansion into the retail camera
market, but it believes that the additional capital needed would be at least 19 million. It also believes that the
expansion will generate an after-tax return of 9% per year. The newly-appointed Finance Director has suggested a
rights issue to finance the proposed expansion, but he is concerned that the recent fall in the companys share price
may cause many shareholders to decide against taking up their rights. Merton plc has not issued any new shares for
the last three years.
The Finance Director believes that a rights issue would be a 1 for 2 rights issue at a 20% discount to the current
share price. The rights issue would be underwritten by the issuing house for a fee of 300,000.
The Finance Director decided when taking up his appointment that substantial improvement was needed in the area
of working capital management and asked the factoring subsidiary of a major bank to provide a quotation for
non-recourse factoring. The factor has indicated that it would require an annual fee of 05% of sales. It would advance
Merton plc 80% of the face value of sales at an interest rate 1% above the current overdraft rate. It expects the average
time taken by debtors to pay to fall immediately to 75 days, with a reduction to no more than the average for the
sector within two years.
The Finance Director has also been assured that bad debts, currently standing at 500,000 per year, would fall by
80%. Savings in current administration costs of Merton plc of 100,000 per year would be achieved as a result of
factoring.
The Finance Director has collected the following average data for the media sector:
Return on capital employed 12% Stock days 100 days
Gross profit margin 25% Debtor days 60 days
Net profit margin 8% Creditor days 50 days
Interest cover 8 times Current ratio 35 times
Gearing (debt/equity using book values) 50% Quick ratio 25 times
Required:
(a) Using appropriate ratios and financial analysis, comment on:
(i) the view of the Finance Director that substantial improvement is needed in the area of working capital
management of Merton plc; (10 marks)
(ii) the recent financial performance of Merton plc from a shareholder perspective. Clearly identify any
issues that you consider should be brought to the attention of the ordinary shareholders. (15 marks)
(b) Determine whether the factoring companys offer can be recommended on financial grounds. Assume a
working year of 365 days and base your analysis on financial information for 2006. (8 marks)
(c) Calculate the theoretical ex rights price per share and the net funds to be raised by the rights issue, and
determine and discuss the likely effect of the proposed expansion on:
(i) the current share price of Merton plc;
(ii) the gearing of the company.
Assume that the priceearnings ratio of Merton plc remains unchanged at 12 times. (11 marks)
(d) Calculate the ex dividend share price predicted by the dividend growth model and discuss the companys
view that share price growth of at least 8% per year would result from expanding into the retail camera
market. Assume a cost of equity capital of 11% per year. (6 marks)
(50 marks)
3 [P.T.O.
Section B TWO questions ONLY to be attempted
2 (a) Discuss the nature of the financial objectives that may be set in a not-for-profit organisation such as a charity
or a hospital. (8 marks)
(b) Explain the meaning of the term Efficient Market Hypothesis and discuss the implications for a company if
the stock market on which it is listed has been found to be semi-strong form efficient. (9 marks)
(c) Discuss the difficulties that may be experienced by a small company which is seeking to obtain additional
funding to finance an expansion of business operations. (8 marks)
(25 marks)
3 Ash plc recorded the following actual results for Product RS8 for the last month:
Product RS8 2,100 units produced and sold for 1450 per unit
Direct material M3 1,050 kg costing 1,680
Direct material M7 1,470 kg costing 2,793
Direct labour 525 hours costing 3,675
Variable production overhead 1,260
Fixed production overhead 4,725
Standard selling price and cost data for one unit of Product RS8 is as follows.
Selling price 1500
Direct material M3 06 kg at 155 per kg
Direct material M7 068 kg at 175 per kg
Direct labour 14 minutes at 720 per direct labour hour
Variable production overhead 210 per direct labour hour
Fixed production overhead 900 per direct labour hour
At the start of the last month, 497 standard labour hours were budgeted for production of Product RS8. No stocks of
raw materials are held. All production of Product RS8 is sold immediately to a single customer under a just-in-time
agreement.
Required:
(a) Prepare an operating statement that reconciles budgeted profit with actual profit for Product RS8 for the last
month. You should calculate variances in as much detail as allowed by the information provided.
(17 marks)
(b) Discuss how the operating statement you have produced can assist managers in:
(i) controlling variable costs;
(ii) controlling fixed production overhead costs. (8 marks)
(25 marks)
4
4 Sine Ltd produces a single product, Product DG, and is preparing budgets for the next three-month period, July to
September. The current cost data for Product DG is as follows.

Direct Material X 15 kg at 350 per kg 525

Direct Material P 20 kg at 450 per kg 900
Direct labour 12 minutes at 800 per hour 160
Variable production overhead 100 per unit 100
Fixed production overhead 300 per direct labour hour 060

1745

Sine Ltd experiences seasonal changes in sales volumes and forecast sales for the next four months are expected to
be as follows.
Month July August September October
Sales (units) 30,000 35,000 60,000 20,000
It has been decided that opening stocks of finished goods in August and September must be 20% of the expected
sales for the coming month. Closing stocks of finished goods in September must be 10% of the expected sales in
October. Stocks of finished goods at the start of July are expected to be 4,000 units. Opening stocks of finished goods
in July are valued at 69,800.
There will be 30,000 kg of Material X and 40,400 kg of Material P in stock at the start of July. These stocks will be
bought in June at the current prices per kilogram for each material. Further supplies of Material X and Material P will
need to be purchased for the higher prices of 380 per kg for Material X and 480 per kg for Material P due to
supplier price increases. Opening stocks of each material will remain at the same level as the start of July.
In any given month, any hours worked in excess of 8,000 hours are paid at an overtime rate of 1200 per hour.
Sine Ltd operates a FIFO (first in, first out) stock valuation system.
Required:
(a) Prepare the following budgets for July, August and September and in total for the three-month period:
(i) Production budget, in units;
(ii) Material usage budget, in kilograms;
(iii) Production budget, in money terms. (10 marks)
(b) Calculate the value of the closing stocks of finished goods at the end of the three-month period, and the value
of cost of sales for the period. (3 marks)
(c) Discuss the ways in which budgets and the budgeting process can be used to motivate managers to
endeavour to meet the objectives of the company. Your answer should refer to:
(i) setting targets for financial performance;
(ii) participation in the budget-setting process. (12 marks)
(25 marks)
5 [P.T.O.
5 Charm plc, a software company, has developed a new game, Fingo, which it plans to launch in the near future. Sales
of the new game are expected to be very strong, following a favourable review by a popular PC magazine. Charm plc
has been informed that the review will give the game a Best Buy recommendation. Sales volumes, production
volumes and selling prices for Fingo over its four-year life are expected to be as follows.
Year 1 2 3 4
Sales and production (units) 150,000 70,000 60,000 60,000
Selling price ( per game) 25 24 23 22
Financial information on Fingo for the first year of production is as follows:
Direct material cost 540 per game
Other variable production cost 600 per game
Fixed costs 400 per game
Advertising costs to stimulate demand are expected to be 650,000 in the first year of production and 100,000 in
the second year of production. No advertising costs are expected in the third and fourth years of production. Fixed
costs represent incremental cash fixed production overheads. Fingo will be produced on a new production machine
costing 800,000. Although this production machine is expected to have a useful life of up to ten years, government
legislation allows Charm plc to claim the capital cost of the machine against the manufacture of a single product.
Capital allowances will therefore be claimed on a straight-line basis over four years.
Charm plc pays tax on profit at a rate of 30% per year and tax liabilities are settled in the year in which they arise.
Charm plc uses an after-tax discount rate of 10% when appraising new capital investments. Ignore inflation.
Required:
(a) Calculate the net present value of the proposed investment and comment on your findings. (11 marks)
(b) Calculate the internal rate of return of the proposed investment and comment on your findings. (5 marks)
(c) Discuss the reasons why the net present value investment appraisal method is preferred to other investment
appraisal methods such as payback, return on capital employed and internal rate of return. (9 marks)
(25 marks)
6
7 [P.T.O.
Formulae Sheet
8
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
$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