Answers

Answers

FOUNDATIONS IN ACCOUNTANCY ? Paper FFM Foundations in Financial Management

Section A

1 B Receivables/credit sales x 365 = $5,000/(0?8 x $125,000) x 365 = 18 days

December 2011 Answers

2 D Interest cover = profit before interest and tax/finance charges = $55,000/$15,000 = 3?67

3 B by definition

4 B by definition

5 B The cost of not taking the discount can be calculated as (1 + 2?5/97?5)365/20 ? 1 = 59%

6 A by definition

7D Total cost at EOQ

Purchase price Ordering cost Holding cost Total annual cost

5,000 x $5 (5,000/2,000) x $100 2,000/2 x 0?05 x $5

Total cost at 3,000 units

Purchase price Ordering cost Holding cost Total annual cost

5,000 x $5 x 0?9 (5,000/3,000) x $100 3,000/2 x 0?05 x $5 x 0?9

Cost at 3,000 units is lower.

$ 25,000

250 250 25,500

$ 22,500

167 338 23,005

8 C by definition

9 A by definition

10 B Payback period = $30,000/$12,000 = 2?5 years Accounting rate of return = [($12,000 x 3 ? $26,000)/3]/$30,000 = 11?11%

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Section B

1 (a) Proposed move to the town centre

0

$

Lease

(3,500)

Hairdresser

Local papers

(2,000)

Local radio

(5,000)

Revenue increase (0?45 x $40,000)

Overheads ($4,000 ? $1,500)

Direct costs (0?05 x $18,000) Net cash flows

???????? (10,500)

Discount factors

1?000 ???????? (10,500) ????????????????

1 $ (3,500) (6,000)

Time

2

3

$

$

(3,500)

(3,500)

(6,000)

(6,000)

4 $ (3,500) (6,000)

18,000

(2,500)

(900) ?????? 5,100

0?909 ?????? 4,636 ????????????

18,000

(2,500)

(900) ???????

5,100

0?826 ???????

4,213 ??????????????

18,000

(2,500)

(900) ???????

5,100

0?751 ???????

3,830 ??????????????

18,000

(2,500)

(900) ???????

5,100

0?683 ???????

3,483 ??????????????

The net present value is $11,003, therefore Mrs Clip should move her business to the town centre.

5 $

(6,000)

18,000 (2,500)

(900) ???????

8,600 0?621 ??????? 5,341 ??????????????

(b) Advertising the move to the town centre on local radio

Time

0 1?5 1?5

Description

Advertising Extra revenue (0?05 x $40,000) Extra direct costs (0?05 x $2,000)

Cash Flow

(5,000) 2,000

(100)

Discount Factor

1 3?791 3?791

Present Value $

(5,000) 7,582 (379) ?????? 2,203 ????????????

The net present value is positive, and Mrs Clip should advertise the move to the town centre on local radio.

(c) Advantages and Disadvantages of net present value

Advantages ? It takes into account the time value of money. ? The calculation is based on cash flows which are less subjective than profits. ? The expected change in shareholder wealth is shown.

Disadvantages ? Some managers are unfamiliar with the concept of net present value. ? It ignores the short-term impact on the financial statements. ? It can be difficult to identify an appropriate discount factor. ? It can be difficult to identify the relevant future cash flows. ? It ignores how the investment is financed.

Note only TWO of each were required.

2 Forage Co

(a) Why a company needs to manage working capital

An organisation needs to manage its working capital, to ensure that the level of working capital held is neither too high nor too low. A balance has to be achieved to ensure that an organisation uses its assets efficiently to generate a return, and yet still retains a secure liquidity position.

If an organisation has too much working capital, it may suffer from over capitalisation. In this case, the organisation may for example lose revenue, if too much cash has been invested in inventories or receivables and can not be used to generate cash flow/return elsewhere.

If an organisation has too little working capital, it may face liquidity problems and suffer from overtrading. If the organisation does not have enough liquid resources to pay their debts as they fall due, expensive forms of short-term borrowing may have to be used.

(b) Overtrading

Overtrading arises when a company does not have sufficient working capital or long-term capital to finance the expanding sales.

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(c) Extent to which Forage Co is overtrading Turnover has increased by 40%. Although significant, this should be expected if a new innovative product is launched. Inventories have increased by 40%, which is in line with the increase in turnover. Trade receivables have doubled. This is of more concern, as it appears that they are rising faster than the level of turnover. This could increase the risk of liquidity problems. It is not unusual to use a bank overdraft to help finance working capital when a new product is launched, so the fact that Forage Co is considering applying for an overdraft or a loan is not a sign of overtrading. However, a permanent cash shortage can be a sign of overtrading and the cash levels should be monitored. In summary, the company is not exhibiting all the signs of overtrading, but the level of receivables and the cash levels need very careful monitoring.

(d) Factors to consider when deciding whether to apply for a bank loan, overdraft or combination Purpose of borrowing Overdrafts are usually provided to cover temporary cash shortfalls, or to support the financing of working capital. This is because the finance is required on some days, but not on others. Loans in contrast are normally provided to pay for longer term investment that will earn profits over a period of time. The repayments of the loan will occur whilst the profits are being earned. Forage Co should apply for an overdraft to finance the working capital and a bank loan to finance the investment in the new product. Duration of borrowing If finance is needed to cover temporary cash shortages, then an overdraft would be more suitable. If the borrowing is of a long-term nature, then a loan should be applied for. This ensures that the customer has the use of the money for the time required. It is possible to arrange an overdraft for long-term expenditure and then renew the facility each time it expires. However, this is often viewed as a risky option due to the ability of the bank to either not renew the facility or demand the overdraft is repaid at any time. If a core element of an overdraft seems to be a long-term feature of the business, the company could consider discussing with the bank the possibility of converting the core overdraft into a loan. The development of the Leakno would be considered of a long-term nature, due to the time taken from research and development of the product to the launch of a new product and profits being earned. It should therefore be financed by a loan. In the short term, Forage Co could finance the working capital by an overdraft, but if an element of the overdraft became permanent, then it could be converted into a loan. Security A bank often requires security for a loan, but will often give unsecured overdraft facilities. Forage Co is a manufacturing company with no other loans. It is probable that they do have assets which could be used as security. Interest Rates The interest rates on overdrafts are often significantly higher than the rates charged on loans. Interest is only charged on overdrafts on the amount outstanding, whereas with loans, interest payments are based on the full amount borrowed, whether all of the money is needed or not. The amount of money needed to cover working capital requirements will fluctuate, and therefore an overdraft could be considered more suitable as the interest cost could be lower if the facility is not used all of the time. Flexibility With an overdraft there is the ability to repay the amount borrowed without any early redemption or other fees. Early repayment of a loan will often incur such fees, and there is therefore less flexibility to repay the finance sooner than originally expected. Forage Co will need to try and reduce the cost of borrowing to an acceptable level. Note only FOUR were required.

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3 Potto Co

(a) Cleared Funds Forecast

Receipts Major Stores Wattle Co Fired Co Factory Shop Cash Cheques

Payments Clay Co Glaze Co Sundry Suppliers Factory workers Petty Cash

Cleared excess receipts over payments Cleared balance b/fwd

Cleared balance c/fwd

9 January $

25,000

750 ??????? 25,750 ???????

150 ???????

150 ??????? 25,600 12,000 ??????? 37,600 ??????????????

Uncleared funds float

Receipts (w1) Payments

Total book balance c/fwd

12,100

??????? 12,100 ??????? 49,700 ??????????????

Working 1

Uncleared funds receipts:

Fired Co (December sales) Factory shop cheque

Uncleared receipts 9 and 10 January Add factory shop cheque

Uncleared receipts 11 January Less cleared Fired Co Less cleared factory sale cheque from 9 January

Uncleared receipts 12 January Add factory shop debit card

Uncleared receipts 13 January

10 January 11 January 12 January 13 January

$

$

$

$

??????? 0

???????

5,000

??????? 0

???????

12,000

450 100 ??????? 12,550 ???????

25,000

15,000

??????? 5,000

??????? (5,000)

37,600 ??????? 32,600 ??????????????

??????? 0

??????? 0

32,600 ??????? 32,600 ??????????????

??????? 40,000 ??????? (27,450)

32,600 ???????

5,150 ??????????????

12,100

(40,000) ??????? (27,900) ???????

4,700 ??????????????

12,400

(40,000) ??????? (27,600) ???????

5,000 ??????????????

300

??????? 300

??????? 5,450

??????????????

350 ??????

350 ??????

6,000 ?????? 6,000 ?????? (5,650) 5,150 ??????

(500) ????????????

800 ??????

800 ??????

300 ????????????

$

12,000

100 ??????? 12,100

300 ??????? 12,400

(12,000)

(100) ???????

300

500 ???????

800 ??????????????

(b) (i) Standing order

? A standing order is an instruction given by Potto Co (as the paying business) to their bank to make a payment. ? The payment is for a fixed amount. ? The payment is at a fixed frequency. ? A standing order is usually used for regular payments such as rental.

(ii) Direct Debit

? Potto Co would send a completed direct debit mandate to Clay Co. ? It is Clay Co (as the beneficiary) who will make the arrangements for the payments. ? The amount of payment can be variable. ? The frequency of payment can be variable. ? A direct debit could be used for variable payments such as gas.

Note only TWO features were required for each

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4 (a) Contribution

Using the high low method to calculate the variable overhead cost per unit

($115,000 ? $80,000)/(15,000 ? 10,000) = $7 per unit

Fixed production cost $115,000 ? (15,000 x $7) = $10,000

Total variable costs

Labour Wood Metal Variable overhead

%

Sales price

100

Variable costs

80

???

Contribution

20

??????

$ 5 6 4 7 ??? 22 ??????

$ 27?50 22?00 ??????

5?50 ????????????

The contribution per unit is $5?50

(b) Breakeven point Breakeven point = fixed costs/contribution per unit Breakeven point = {$10,000 + ($2,000 x 12)}/$5?50 = 6,182 units

(c) Margin of safety Margin of safety = 12,000 ? 6,182 = 5,818 units Margin of safety = (12,000 ? 6,182)/12,000 = 48?48% This figure represents the amount by which sales can fall below the expected level before the company is in a nil loss/nil gain position, i.e. the sales can fall by 48?48% x 12,000 = 5,818 units before the company makes a nil gain.

(d) Sales Volume

Budgeted profit can be calculated as contribution less fixed costs

Budgeted profit at 12,000 units = 12,000 x $5?50 ? $10,000 ? $2,000 x 12 = $32,000

Need to calculate the new contribution

The new total variable costs

$

Labour

6

Wood

6

Metal

4

Variable overhead

7

???

23 ??????

New contribution = $27?50 ? $23?00 = $4?50

Units to make a profit of $32,000 = (fixed costs + $32,000)/contribution per unit

Units to make a profit of $32,000 = ($10,000 + $2,000 x 12 + $32,000)/$4?5 = 14,667

Alternative methods will gain full credit.

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