METAL BASHERS LIMITED
This company produces steel fa
ications for the construction industry. Steel girders and supports are cut to size and welded in the welding department and then painted in the paint shop before proceeding to the finishing department.
Details of the overheads incu
ed by the 3 production departments are given below along with information on the two additional departments, the canteen and the service department. The canteen is used by all the employees of Metal Bashers Ltd. but the canteen employees are too busy to make use of the canteen facilities themselves.
The service department repairs and cleans the machinery used in the 3 production departments. External catering equipment maintenance contractors service the canteen equipment.
Welding Painting Finishing Canteen Service
Overheads £100,000 £75,000 £43,000 £60,000 £42,000
No. employees 15 5 6 2 4
% usage of service Dept. 40% 30% 30%
Dept. labour hrs 30,000 12,500 10,000
Metal Bashers is cu
ently quoting for Job No 12359 which will require £1,500 of direct material, £2,000 of direct labour and £500 of variable overhead.
It is estimated that Job 12359 will use 120 hours of labour in the Welding department, 50 hours in the Painting department and 25 hours in the Finishing department. Overheads are abso
ed into jobs on the basis of direct labour hours in each department.
The Selling price for jobs is the total production cost of each job plus 40% of cost.
Required:
1. Calculate the overhead recovery rates for the Welding, Painting and Finishing departments.
2. Calculate the production cost and selling price of Job 12359.
BUSINESS DOCUMENT This document is intended for business use and should be distributed to intended recipients only.
PUZZLED LIMITED QUESTION
Puzzled Limited would like to increase its sales during the year to 31 May 2021.
To do so, it has several mutually exclusive options open to it as follows:-
· Reduce the selling price per unit by 15%
· Improve the product resulting in an increase in the variable cost per unit of £1.30
· Spend £15,000 on an advertising campaign
· Improve factory efficiency by purchasing more machinery at a fixed extra annual cost of £22,500
·
During the year to 31st May 2020, the company sold 20,000 units. The costs details were as follows:-
£000s
Sales XXXXXXXXXX
Variable Costs XXXXXXXXXX
Contribution XXXXXXXXXX
Fixed Costs XXXXXXXXXX
Profit XXXXXXXXXX
These cost relationships are expected to hold in 2020
Required:
1. Work out the unit cost position of the cu
ent situation to 31st May 2020 i.e. the contribution and the
eak even.
2. Work out the contribution and
eak even for each option.
3. Evaluate each option.
4. State which option you would recommend and why.
5. What other non-financial considerations should be taken into account in your decision?
BUSINESS DOCUMENT This document is intended for business use and should be distributed to intended recipients only.
MO JO EXAMPLE
Mo and Jo are planning to run a one day introductory course to teach students the basic techniques of being a DJ. All students will be charged a fee of £125 to include refreshments, lunch and all materials. The maximum number of students that can be accommodated is 20. The estimated running costs are listed below:-
£
Hire of premises 150
Lunch 10 per student
Advertising 300
Equipment hire 100
Refreshments 5 per student
Course instructor fee 400
Student materials 10 per student
Insurance 50
Fixed: XXXXXXXXXX XXXXXXXXXX = 1000
Variable: XXXXXXXXXX = 25 per student
Contribution: 125-25 = 100
BE: 1000/100 = 10
Profit for 20 stu: 20 – 10 x 100 = 1000
Loss for 5 stu: 5-10 x 100 = -500
Required:
1. Calculate the
eak-even point in terms of number of students. 12
2. Work out the following what if scenarios:-
a. What if 20 students enrolled?
. What if 5 students enrolled?
3. What if the price was increased to £160 and an extra £10 was spent on better materials?\
Cont: 160 – 35 = 125
BE: 1000/125 = 8
a. What if 20 students enrolled? 20 – 8 x 125 = 1500
. What if 5 students enrolled? 5 – 8 x 125 = -375
4. What if the price was reduced to £100 and advertising costs were cut by £100?
FC: 900
VC: 25
Cont: 100 – 25 = 75
BE : 900 / 75 = 12
a. What if 20 students enrolled? 20-12 x 75 = 600
. What if 5 students enrolled? 5-12 x 75 = -525
5. Based on the original
eak-even with SP at £125 and VC at £25. Mo and Jo have received an offer from a school to send 8 students on the course but they will only pay £80 per student. Should Mo& Jo accept this offer?
8x25 = 200
640 – 200 = 440
Accept
6. Draw a
eak-even chart.
INVESTMENT APPRAISAL TASKS
1. ACCOUNTING RATE OF RETURN (ARR)
Looks at the return on investment and compares this with a predetermined target level. ARR is based on accounting results rather than cash flows, =
ARR = Estimated average profits x 100%
XXXXXXXXXXCost of the investment
Problem
CK is contemplating the purchase of a new machine and is looking at 2 alternatives:-
Machine A Machine B
Cost £50,000 £90,000
Estimated scrap value £10,000 £30,000
Estimated life 5 years 5 years
Estimated future cash flows(profits)
Year 1 £12,000 £ 2,000
Year 2 £18,000 £ 3,000
Year 3 £30,000 £15,000
Year 4 £25,000 £51,000
Year 5 £ 5,000 £ 35,000
Which machine should CK purchase?
Solution:-
A B
£ £
Total cash flows 90,000
Value of initial investment 50,000
90,000 / 5 = 18,000 / 50,000 x 100 = 36%
Machine A: ARR = 18,000 / 50,000 = 36%
Machine B?
2. PAYBACK
Machine C Machine D
£ £
Cost 10,000 10,000
Cash inflows year 1 1,000 5,000
Cash inflows year 2 2,000 5,000
Cash inflows year 3 6,000 1,000
Cash inflows year 4 7,000 500
Cash inflows year 5 8,000 500
24,000 12,000
What is the payback period?
Machine C - not until early in year 4
Machine D?
Which overall generates greater return?
3. Net Present Value Method
A project would cost £39,500 and would earn £10,000 per year for the first 3 years and then £8,000 per year for the next 3 years.
The cost of capital is 10%.
Complete the table
Should we invest?
Year Cash flow Discount factor Present Value
£ 10% £
0 (39,500) 1.00 (39,500)
1 10,000 0.909 9,090
2
3
4
5
6
4. INTERNAL RATE OF RETURN
If a project earns a higher rate of return than the cost of capital, it will be worth undertaking (and its NPV will be positive).
If it earns a lower rate of return it is not worthwhile (NPV would be negative)
If the project earns a return exactly equal to its cost of capital, its NPV will be 0 and it will only just be acceptable.
This method involves trial and e
or.
Example:
A project cost is £20,000 and the annual net cash flows are as follows:-
Year Cash Flow
£
1 8,000
2 10,000
3 6,000
4 4,000
IRR is a rate of interest at which NPV is 0 and the discounted present value of benefits adds up to £20,000
Need to find out what interest rate would give you an NPV = 0
Try 15% and 20%
Complete the 20% column
Discount Present Discount Present
Factor 15% Value Factor 20% Value
Year Cash Flow
0 (20,000) 1.000 (20,000) 1.000 (20,000)
1 8,000 0.870 6,960
2 10,000 0.756 7,560
3 6,000 0.658 3,948
4 4,000 0.572 2,288
NPV 756 (994)
IRR is more than 15 but less than 20%
We can work out the fall from 15% to 20% XXXXXXXXXX) = 1750 / 20-15% = £350 p.a for every 1% increase in discount rate
Answer 17 .2 %
INVESTMENT APPRAISAL METHODS
PAYBACK METHOD
ADVANTAGES
DRAWBACKS
ACCOUNTING RATE OF RETURN
ADVANTAGES
DRAWBACKS
NET PRESENT VALUE
ADVANTAGES
DRAWBACKS
INTERNAL RATE OF RETURN
ADVANTAGES
DRAWBACKS
INVESTMENT APPRAISAL TASKS
1. ACCOUNTING RATE OF RETURN (ARR)
Looks at the return on investment and compares this with a predetermined target level. ARR is based on accounting results rather than cash flows, =
ARR = Estimated average profits x 100%
XXXXXXXXXXAverage cost of the investment
Problem
CK is contemplating the purchase of a new machine and is looking at 3 alternatives:-
Machine A Machine B Machine C
£000s £000s £ 000s
Cost 500 500 500
Estimated scrap value 200 100 300
Estimated life 5 years 5 years 5 years
Straight line depreciation per yr 60 80 40
Estimated future cash flows
(profits)
Year 1 160 190 50
Year 2 160 180 100
Year 3 160 170 150
Year 4 160 160 250
Year 5 160 150 350
Which machine should CK purchase?
Solution:-
Step 1: Deduct depreciation from annual profits
Machine A: Machine B: Machine C:
Profits – depreiation
Year 1 160 –60 = 100 190-80 = 110 50-40 = 10
Year 2 160- 60 = 100 180-80 = 100 100-40 = 60
Year 3 160- 60 = 100 170-80 = 90 150-40 = 110
Year 4 160- 60 = 100 160-80 = 80 250-40 = 210
Year 5 160- 60 = 100 150-80 = 70 350-40 = 310
800 XXXXXXXXXX XXXXXXXXXX 900 700
Step 2: Calculate annual average profits:
Machine A: Profit after depreciation 500 = 100
No of years 5
Machine B: 450/5 = 90
Machine C: 700/5 = 140
Step 3: Calculate average investment
Add together initial cost of investment & resale value of asset and divide by 2
Machine A: XXXXXXXXXX = 700 = 350
2
Machine B: XXXXXXXXXX = 600/2 = 300
Machine C: XXXXXXXXXX = 800/2 = 400
Step 4: Calculate accounting rate of return
ARR = Estimated average profits x 100% (step 2)
XXXXXXXXXXAverage cost of the investment XXXXXXXXXXstep 3)
Machine A: 100 x 100 = 28.57%
350
Machine B: 90x100/300 = 30%
Machine C: 140x100/400 = 35%
2. PAYBACK
Work out the payback period for the 3 machines
Machine A: In year 4 month 2
Machine B: 500 – 190 = 310
XXXXXXXXXX – 180 = 130
2 years