15118654 ACCA CAT Paper T10 Managing Finances Solved Past Papers

Certified Accounting Technician examination

Sample multiple choice questions – June 2009

Paper T10 Managing Finances Section A only All questions are compulsory Note: Section B of the actual exam paper will contain four written questions

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The following questions are typical of those that will appear in Section A of the examination paper from June 2009 onwards. There will be a total of ten questions in section A. All questions in Section A will be worth two marks each.

1

The following statements have been made about the benefits of debt finance compared to equity finance:



Statement 1: Interest payments on debt attract tax relief. Statement 2: Control of the company is diluted.



Which of the above statements is true?



A

Both of them



B

Statement 1 only



C

Statement 2 only.

D Neither of them.

(2 marks)

2

The selling price for a product is $62. It takes 2 hours of skilled labour to make the product and 3 kg of materials. Fixed overheads are $435,000 per annum. The cost of labour is $11 per hour and materials cost $6 per kilogram. Variable overheads are absorbed at the rate of $5 per direct labour hour. The company’s budgeted sales for the product for the next year are 100,000 units.



What is the contribution per unit of the product?



A

$12



B

$22



C

$23

D $17

3

(2 marks)

The break-even sales revenue for a product is $235,000. The selling price of the product is $25 per unit.

If budgeted sales are 10,000 units, what is the margin of safety, in units?

A

400



B

10,000



C

9,400

D 600

(2 marks)

2

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4

Extracts from a company’s accounts show the following balances:

Inventories Trade receivables Cash Trade payables Bank overdraft

$000 114 216 42 180 60



Which of the following is the company’s quick ratio, calculated to the nearest two decimal places?



A

1.55



B

1.08



C

2.07

D 1.43

(2 marks)

5

The following statements have been made about inflation:



Statement 1: Inflation leads to a distribution of income and wealth. Statement 2: If a country has a higher rate of inflation than its partners, its imports become relatively more expensive and its exports become relatively cheaper.



Which of the above statements is true?



A

Both of them



B

Statement 1 only



C

Statement 2 only

D Neither of them

(2 marks)

6

The net present value of a proposed project is $20,000 at a discount rate of 5% and $(28,000) at 10%.



What is the internal rate of return of the project, to the nearest one decimal place?



A

7.1 %



B

7.5 %



C

2.3 %

D 8.6%

(2 marks)

7

A company is considering increasing its credit period to customers from one month to two months. Annual revenue is currently $1,200,000. It is expected that the increased credit period would increase sales by 25% and result in an increase in profit of $45,000, before any INCREASE in finance charges have been taken into account. The company’s cost of capital is 10%.



What is the financial effect of this proposal, after taking into account any increase in finances charges?



A

Increase in profit of $35,000



B

Decrease in profit of $35,000



C

Increase in profit of $30,000

D Decrease in profit of $30,000

(2 marks)

3

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8

Which of the following are assumptions used when calculating the economic order quantity for inventory?



(i) Lead time is constant (ii) Demand is constant (iii) Purchase costs are constant



A

All three



B

i and ii only



C

i and iii only

D ii and iii only

(2 marks)

9

A company is considering undertaking a contract for a new client. The contract requires 100kg of material A. It has 200kg in inventory, which it bought last year at a cost of $10 per kg. The current resale value is $8, although to replace the material today would cost $15 per kg. There is no other use for the material, except as a substitute for material B, which costs $14 per kg.



What is the relevant price per kg of material A?



A

$10



B

$14



C

$8

D $15

(2 marks)

10 A farmer grows carrots, which he currently digs up and sells in 10kg sacks, without washing the carrots or preparing them in any other way. He is considering whether to trim them, wash them and package them up in 1kg cartons instead of continuing to sell them in sacks.

Which of the following are relevant to his decision?



(i) The (ii) The (iii) The (iv) The



A

All of them



B

(i), (iii) & (iv) only



C

(ii), (iii) and (iv) only

cost of growing the carrots sales value of the unprepared sacks of carrots costs of trimming and washing the carrots sales value of the new trimmed cartons of carrots

D (iii) and (iv) only

(2 marks)

End of Sample Questions

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Answers

5

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Sample Multiple Choice Question Paper T10 Managing Finance 1

Answers

B Only statement 1 is true

2 A Contribution per unit: Sales price Labour (2x$11) Materials (3 x $6) Variable overhead(2 x $5) Contribution per unit

$ 62 (22) (18) (10) 12

3 D

Break-even sales in units = 235,000/25 = 9,400. Therefore, M of S = 10,000 – 9,400 = 600.

4 A

(216 + 42)/(180 + 60) = 1.08, to 2 D.P.s

5

Only statement 1 is true.

B

6 A

⎛ 20 ⎞ + [10% – 5%]⎟ IRR = 5% + ⎜ ⎝ 20 + 28 ⎠ ⎛⎛ 20 20 + [10% – 5%]⎞⎞⎞ ⎛⎜ 20 28 + ⎝⎜ 20 + + [10% [10% – – 5%] 5%]⎟⎠⎟⎟⎠ + [Distractors: ⎛⎜⎝⎝ 20 ⎞⎠ 2020 + 28 28 ⎜⎝ 20 – 28 x[10% – 5%]⎟⎠ B ⎛ 20 ⎞ x[10% –– 5%] 5%]⎞⎞⎟ IRR = 5% + ⎛⎛⎜ 20 20 x[10% ⎜⎜⎝⎝ 20 ⎟ – 28 x[10% – 5%] ⎟⎠⎠⎠ ⎛⎝ 20 20 – – 28 28 20 ⎞ 5% + x[10% – 5%] ⎜⎝ 20 – 28 ⎟⎠ C ⎛ 20 ⎞ 5% + 20 5%] ⎛⎜⎛ 5% 20 ⎞⎟⎞ x[10% x[10% ––– 5%] 5%] IRR = 20 –– 28 28 ⎟⎠⎟⎠ x[10% ⎝⎜⎜⎝ 5% + + 20 ⎛⎝ ⎞ 20 – 28 ⎠ ⎜⎝ 5% + 28 x]10% – 5%]⎟⎠ ⎛⎛ 20 D 20 x]10% – 5%]⎞⎞⎞ + ⎛ 5% 5% + + 20 x]10% – 5%]⎟ 28 IRR = 5% + ⎜⎝⎜⎝⎜ 5% 28 x]10% – 5%]⎠⎟⎠⎟⎠ 28 ⎝

7 D Current receivables($1.2/12) New receivables ($1.2 x 1.25/6) Increase Finance cost of increase at 10% Net profit increase

$ 100,000 250,000 150,000 15,000 45,000



Therefore overall increase is $30,000 ($45,000 – $15,000)

8

A

9

B

All three are assumptions for EOQ calculations. The relevant cost is $14 per kg. Since the material has no other use except as a substitute for material B, it would either be used in place of B or sold. As the company would only get $8 per kg from selling it, its best use is as a substitute, therefore saving $14 per kg.

10 C The incremental revenue (iv – ii) should be compared to the incremental costs (iii) of preparing the carrots.

6

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ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL WEDNESDAY 16 JUNE 2004

QUESTION PAPER Time allowed 3 hours ALL FOUR questions are compulsory and MUST be answered

Paper T10

Managing Finances

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ALL FOUR questions are compulsory and MUST be attempted 1

Paradise Ltd is a large company specialising in luxury holidays for the rich and famous. It has recently purchased an uninhabited island, close to the popular resort of Luca, at a cost of £2 million. The company has already spent £1·5 million on preparing the land for construction work. Over the next year it plans to develop the island extensively, with the aim of making it one of the most exclusive holiday locations in the region. An offer has just been made to buy the land for £5 million. Paradise Ltd has therefore decided to reappraise the project in order to decide whether they should still proceed with the project, or should instead accept the offer. If they decide to accept the offer, the sale will take place immediately, incurring legal fees of £20,000. If they reject the offer, development will continue and accommodation will be available for rent in one year’s time. The company’s project accountant has provided estimates of costs and revenues for the next five years as set out below. 1.

Total construction costs for the seven hotels on the island are £37 million. Of the total, £2 million has already been spent in the form of down payments to several construction firms. These down payments are irrecoverable.

2.

Total construction costs for the forty luxury self-catering lodges that will be attached to the hotels are £24 million. A down payment of £4 million is required immediately.

3.

The cost of furnishing the hotels and lodges is estimated at £3·2 million.

4.

Each lodge will have its own private swimming pool. The cost of each pool is expected to be £12,000.

5.

Six restaurants will be built on the island at a cost of £15 million. Paradise Ltd has already had to commit to £3 million of these costs in order to attract the chefs it requires. Although these monies have not yet been paid over, Paradise Ltd is contractually bound to pay them, irrespective of whether the project now proceeds.

6.

A small parade of shops will be developed at a cost of £4 million.

7.

Annual cash overheads are expected to be £2 million for the hotels. Revenues for the hotels are estimated at £13 million per annum.

8.

Maintenance costs for each of the lodges will be £7,000 per annum, compared to rental income of £390,000 per annum, per lodge.

9.

Depreciation totalling £1·5 million per annum will be charged in Paradise Ltd’s accounts for the hotels, lodges, restaurants and shops.

10. The restaurant and shops are expected to generate net income of £4·73 million per annum, in total. 11. Interest on money borrowed to finance the project will be £2·5 million per annum. All the set-up costs will occur within the next year, before the resort is open. The annual revenues and overheads relate to the four years following this. Assume that all cash flows occur at the end of each year, unless otherwise stated, and that there are no terminal values to consider at the end of the four years. The company’s cost of capital is 10% per annum.

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Required: (a) Explain the main principles used to differentiate between relevant and irrelevant costs for investment appraisal, using the information in the question to illustrate your points. (8 marks) (b) Calculate the project’s net present value (NPV) at the company’s required rate of return. Conclude as to whether the company should accept the offer or continue with the project, giving a reason for your conclusion. (16 marks) (c) Calculate the internal rate of return (IRR) for the project, using the discount rates in the tables provided. (4 marks) (d) State three advantages and three disadvantages of using the IRR as a method of project appraisal. (6 marks) (e) Briefly outline each of the following stages involved in evaluating capital projects: (i)

Initial investigation of the proposal;

(ii) Detailed evaluation; (iii) Authorisation; (iv) Implementation; (v) Project monitoring; (vi) Post-completion audit.

(6 marks) (40 marks)

(Workings should be in £’000, to the nearest £’000.) Present Value Table (extract) Periods (n) 1 2 3 4 5

Discount Rates (r) 10% 20% 0·909 0·833 0·826 0·694 0·751 0·579 0·683 0·482 0·621 0·402

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[P.T.O.

This is a blank page. Question 2 begins on page 5.

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2

Chocoholics Ltd sells high quality Belgian chocolates that it buys in ready-made. Its main attraction to customers is that it gift wraps the items and delivers them to an address of the customer’s choice. The company has just expanded its product range to include flowers. You are an accounting technician and have been asked to prepare a cash budget for the next six months, incorporating the sales of the new products. You have been provided with the following table of estimated revenues and their relative costs. Other costs are also included in the notes below. 2004 Sales Purchases of chocolates and flowers Administration expenses Packaging costs Miscellaneous expenses Loan repayments

July £’000 250 125 155 112 116 150

August £’000 266 133 160 113 116 –

September £’000 282 141 162 113 117 –

October £’000 306 153 165 113 117 –

November £’000 320 160 168 114 118 150

December £’000 330 165 170 114 118 –

Notes: 1. Opening stocks of chocolates and flowers will amount to £250,000 at 1 July 2004. Closing stocks at 31 December 2004 are estimated at £170,000. 2. Suppliers allow one month’s credit. Purchases in June will total £60,000. 3. 30% of sales are paid for by cash but the remaining 70% take advantage of the company’s offer of ‘Buy now, pay in one month’. June 2004 sales are expected to be £140,000. 4. Delivery costs are 1% of sales revenue each month, and are paid in the month in which they are incurred. Administration and miscellaneous expenses are also paid as they are incurred. 5. Packaging expenses are paid two months after they are incurred. These costs were £1,000 in May and will be the same in June. 6. The bank charges interest of 1% per month for the overdraft, calculated on the closing bank balance each month, and payable the following month. 7. The bank overdraft at 1 July 2004 is expected to be £155,000. 8. The loan repayments above refer to an interest free loan obtained by the company when they moved their business to a new bank. 9. The business has no depreciable fixed assets. Required: (a) Prepare a monthly cash budget for EACH of the six months to 31 December 2004, showing the cash balance at the end of each month. (13 marks) (b) Prepare a budgeted Profit and Loss account for the six month period ending 31 December 2004. (7 marks) Note: All workings should be shown clearly in order to score maximum marks. Please show workings in £’000, to the nearest £’000. (20 marks)

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[P.T.O.

3

Rant Ltd manufactures and distributes plasma screen televisions to a number of electrical retailers. Due to the increased popularity of these products, growth has been rapid and the Financial Director (FD) of the company is concerned that the company is overtrading. Turnover has increased by 250% over the last year, and fixed assets have increased by 75%. The bank overdraft limit of £3 million has been exceeded on five occasions in the last year, culminating in a recent threat by the bank to withdraw the facility altogether. Rant Ltd is a largely family-owned company, with twelve shareholders in total. Whilst the long-term plan involves making a rights issue in two years’ time, none of the current shareholders are in a position to inject new capital into the company at present. Neither do they wish to issue new shares outside the current group of shareholders, as they do not want to lose their collective control of the company. Some preliminary analysis has revealed that debtors are increasing rapidly and raw material stock days have gone up from 30 days to 55 days. The FD is concerned that these stock levels are so high. He has asked you, an accounting technician, to assist him in reviewing them. One of the key costs of making a plasma television is the screen. These screens are bought in ready-made at a cost of £250 per unit. It costs £150 to place an order for these screens, irrespective of the number of units ordered. At current sales levels, which are expected to stabilise now, 150,000 screens are needed per annum. The cost of holding one screen in stock for one year is £15. Required (a) Define the terms ‘over-capitalisation’ and ‘overtrading’.

(2 marks)

(b) Briefly describe the symptoms of overtrading. Conclude whether Rant Ltd is overtrading, giving reasons for your conclusion. (6 marks) (c) Explain the four main types of costs associated with stock management.

(4 marks)

(d) Explain how the economic order quantity (EOQ) model can assist in reducing stock costs, AND the assumptions it is based upon. (4 marks) (e) Calculate the EOQ for screens AND the number of orders to be placed per annum, using the data contained in the question. (4 marks) (20 marks) Note: The formula for EOQ is

2 Co D Ch

(where Co represents fixed cost of placing one order; D represents annual demand in terms of units; Ch represents cost of holding one unit of stock per annum.)

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4

Clean Lens Ltd is a contact lens manufacturer and distributor producing an extensive range of contact lenses that are distributed direct to customers via the Internet. It is a small company with five shareholders, all of whom are involved in the running of the company. The company is in the preliminary stages of developing a new type of contact lens, made of a unique material that moulds to the shape of the eye, providing revolutionary comfort for the lens wearer. The company’s projections show that profits of £1·3 million per annum are expected over the first five years, once sales commence. In order to proceed with the project, further finance of £1·5 million is required. Clean Lens Ltd expects to fund the project through a mix of debt and equity finance, and is considering approaching venture capital organisations. Required: (a) Briefly explain five factors that Clean Lens Ltd should take into account when deciding on the mix of debt and equity finance. (10 marks) (b) Identify and discuss five factors that a venture capital organisation should take into account when deciding whether or not to invest in Clean Lens Ltd. (10 marks) (20 marks)

End of Question Paper

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances 1

(a)

June 2004 Answers

Relevant costs The following principles should be applied when identifying costs that are relevant to a period. Relevant costs are future costs A relevant cost is a future cost arising as a direct consequence of a decision. A cost which has been incurred in the past is therefore totally irrelevant to any decision that is being made now. Such past costs are called ‘sunk costs’. In Paradise Ltd’s project, the £1·5 million spent preparing the land for construction is a sunk cost, as is the £2 million downpayment to construction firms. These costs should therefore be excluded when calculating the net present value of the project. Relevant costs are cash flows Only those future costs which are in the form of cash should be included. This is because relevant costing works on the assumption that profits earn cash. Therefore, costs which do not reflect cash spending should be ignored for the purpose of decision-making. This means that the depreciation charges of £1·5 million should be ignored in the decision for Paradise Ltd. Relevant costs are incremental costs A relevant cost is the increase in costs which results from making a particular decision. Any costs or benefits arising as a result of a past decision should be ignored. Opportunity costs An opportunity cost is the value of a benefit foregone as a result of choosing a particular course of action. Such a cost will always be a relevant cost. Other non-relevant costs Certain other costs will be irrelevant to decision-making, such as ‘committed costs’. A committed cost is a future cash outflow that will be incurred anyway, regardless of what decision will now be taken. The £3 million restaurant costs represent such committed costs, and these will therefore be ignored for the decision-making process. The interest costs of £2·5 million per annum are also ignored. This is not because they do not meet the above criteria, but because they are taken into account in the discounting process. If these costs were included as relevant they would be double counted.

(b)

Net present value

Net sale proceeds foregone Hotel building costs Lodge building costs Furnishings Swimming pools Restaurants Shops Annual overheads – hotel Annual revenues – hotel Rentals – lodges Lodge overheads Restaurant/shop income Net relevant costs 10% discount factors Discounted cash flow

Years 0 £’000 (4,980) (4,000)

––––––– (8,980) 1·000 ––––––– (8,980) –––––––

1 £’000

2 £’000

3 £’000

4 £’000

(2,000) 13,000 15,600 (280) 4,730 ––––––– 31,050 0·826 ––––––– 25,647 –––––––

(2,000) 13,000 15,600 (280) 4,730 ––––––– 31,050 0·751 ––––––– 23,319 –––––––

(2,000) 13,000 15,600 (280) 4,730 ––––––– 31,050 0·683 ––––––– 21,207 –––––––

5 £’000

(35,000) (20,000) (3,200) (480) (12,000) (4,000)

-–––––– (74,680) 0·909 -–––––– (67,884) -––––––

(2,000) 13,000 15,600 (280) 4,730 ––––––– 31,050 0·621 ––––––– 19,282 –––––––

Total £’000 (4,980) (35,000) (24,000) (3,200) (480) (12,000) (4,000) (8,000) 52,000 62,400 (1,120) 18,920 ––––––– 40,540 ––––––– 12,591 –––––––

Since the net present value of the project is positive at £12·591 million, the company should proceed with it. (Note: An alternative NPV calculation is shown overleaf, using an annuity factor. Where workings are shown clearly for the ‘net cash flow’ figures, full marks should be awarded for this method.)

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Alternative presentation for 1(b) Years Net cash flow £’000 0 (8,980) 1 (74,680) 2–5** 31,050

DF/AF

Present value £’000 (8,980) (67,884) 89,455 –––––––– 12,591 ––––––––

1·000 0·909 2·881

**Annuity factor for T2 – 5 = 0·826 + 0·751 + 0·683 + 0·621. (c)

Internal rate of return a IRR = A + [ –––– x (B–A) ] a–b Where A is the lower rate and B is the higher rate; a is the NPV at the lower rate and b is the NPV at the higher rate. (In this case, 20% has been used as the higher rate.) 12·591 10% + –––––– x (10%) 16·805 = 17% –––– Working 0 1 £’000 £’000 Net relevant costs (8,980) (74,680) 20% discount factors 1·000 0·833 –––––– –––––– Discounted cash flow (8,980) (62,208) –––––– –––––– Net present value at 20% = – £4·214 million

(d)

2 £’000 31,050 0·694 –––––– 21,549 ––––––

Years 3 £’000 31,050 0·579 –––––– 17,978 ––––––

4 £’000 31,050 0·482 –––––– 14,966 ––––––

5 £’000 31,050 0·402 –––––– 12,482 ––––––

Total £’000 40,540 –––––– (4,214) ––––––

Advantages and disadvantages of IRR Advantages include: 1. It takes into account the time value of money, which is a good basis for decision-making. 2. Results are expressed as a simple percentage, and are more easily understood than some other methods. 3. It indicates how sensitive decisions are to a change in interest rates. Disadvantages include: 1. Projects with unconventional cash flows can have either negative or multiple IRRs. This can be confusing to the user. 2. IRR can be confused with ARR or ROCE, since all methods give answers in percentage terms. Hence, a cash-based method can be confused with a profit-based method. 3. It may give conflicting recommendations to NPV. 4. Some managers are unfamiliar with the IRR method. Note: Only 3 advantages and 3 disadvantages were required.

(e)

The stages for project appraisal (i) Initial investigation of the proposal Firstly, a decision must be made as to whether the project is technically feasible and commercially viable. This involves assessing the risks and deciding whether the project is in line with the company’s long-term strategic objectives. (ii)

Detailed evaluation A detailed investigation will take place in order to examine the projected cash flows of the project. Sensitivity analysis is performed and sources of finance will be considered.

(iii) Authorisation For significant projects, authorisation must be sought from the company’s senior management and Board of Directors. This will only take place once such persons are satisfied that a detailed evaluation has been carried out, that the project will contribute to profitability and that the project is consistent with the company strategy. (iv) Implementation At this stage, responsibility for the project is assigned to a project manager or other responsible person. The resources will be made available for implementation and specific targets will be set. (v)

Project monitoring Now the project has started, progress must be monitored and senior management must be kept informed of progress. Costs and benefits may have to be re-assessed if unforeseen events occur.

(vi) Post-completion audit At the end of the project, an audit will be carried out so that lessons can be learned to help future project planning.

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2

(a)

Cash budget for the six months ended 31 December 2004 July August September £’000 £’000 £’000 Cash inflows Sales receipts 173 255 271 –––– –––– –––– 173 255 271 –––– –––– –––– Cash outflows Payments to suppliers 160 125 133 Admin. expenses 155 160 162 Delivery costs 113 113 113 Packaging 1v1 111 112 Misc. expenses 116 116 117 Loan repayments 150 Overdraft interest 112 112 111 –––– –––– –––– 177 197 208 –––– –––– –––– Net cash flow 11(4) 158 163 Opening balance (155) (159) (101) –––– –––– –––– Closing balance (159) (101) 1(38) –––– –––– ––––

October £’000

November £’000

December £’000

Total

289 –––– 289 ––––

310 –––– 310 ––––

323 –––– 323 ––––

1,621 ––––– 1,621 –––––

141 165 113 113 117

153 168 113 113 118 150

160 170 113 113 1v8

–––– 285 –––– 125 132 –––– 157 ––––

–––– 244 –––– 179 157 –––– 136 ––––

1,772 1,380 1,118 1,113 1,142 1,100 1,115 ––––– 1,330 ––––– 1,291 1,(155) ––––– 1,136 –––––

11 –––– 219 –––– 170 1(38) –––– 132 ––––

Workings 1. Sales receipts

Cash: 30% x £250 Credit: 70% x £140

Cash: Credit

30% x £266 70% x £250

July £’000 75 98 –––– 173 ––––

August £’000

September £’000

October November £’000 £’000

December £’000

80 175 –––– 255 ––––

Cash: 30% x £282 Credit: 70% x £266

85 186 –––– 271 ––––

Cash: 30% x £306 Credit: 70% x £282

92 197 –––– 289 ––––

Cash: 30% x £320 Credit: 70% x £306

96 214 –––– 310 ––––

Cash: 30% x £330 Credit: 70% x £320

99 224 –––– 323 ––––

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(b)

Budgeted Profit and Loss Account for the six months ending 31 December 2004 £’000 Sales (w.1) Less cost of sales (w.2) Gross profit Delivery costs (w.3) Administration expenses (w.4) Miscellaneous expenses (w.5) Interest (w.6)

18 380 42 3 –––– (443) ––––– 335 –––––

Net profit Workings 1. Sales:

£’000

(£250,000 + £266,000 + £282,000 + £306,000 + £320,000 + £330,000) 2.

£’000 1,754 (976) ––––– 778

Cost of sales Opening stock Purchases (£125,000 + £133,000 + £141,000 + £153,000 + £160,000 + £165,000) Closing stock Packaging (£2,000 + £3,000 + £3,000 + £3,000 + £4,000 + £4,000)

–––––– 1,754 –––––– £’000 250 877 (170) ––––– 957 19 ––––– 976 –––––

Total

£’000 3.

Delivery costs (£3,000 + £3,000 + £3,000 + £3,000 + £3,000 + £3,000)

––––– 18 –––––

Note: Delivery costs could have been included in COS. 4.

Administration expenses (£55,000 + £60,000 + £62,000 + £65,000 + £68,000 + £70,000)

5.

Miscellaneous expenses (£6,000 + £6,000 + £7,000 + £7,000 + £8,000 + £8,000)

6.

––––– 380 –––––

Interest (£2,000 + £1,000)

––––– 42 ––––– ––––– 3 –––––

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3

(a)

Definitions ‘Over-capitalisation’ means that there is an excessive amount of the business’ money invested in assets. ‘Overtrading’ means that a business’ volume of trade is too large given the level of long-term capital at its disposal.

(b)

Symptoms of Overtrading The symptoms of overtrading are as follows: – A rapid increase in turnover. – A rapid increase in the volume of current assets, and sometimes fixed assets. – A rapid increase in trade creditors and the bank overdraft, with very little increase in equity capital (if any). – A significant reduction in liquidity ratios and an increase in debt ratios. Conclusion for Rant Ltd The first two of these symptoms are present for Rant Ltd, as turnover has increased by 250% and fixed assets have increased by 75%. In addition, the bank overdraft limit has been exceeded on five occasions, suggesting that there has been a rapid increase in bank borrowing. We are also told that current shareholders cannot afford further shares at present, nor do they want new shares to be issued to new shareholders, so the implication is that there has been no injection of additional equity finance recently. Finally, whilst we cannot calculate debt and liquidity ratios from the information, we can deduce, from the information given, that they will have increased and decreased respectively. We can therefore conclude that Rant Ltd is overtrading.

(c)

Stock costs The four main stock costs are as follows: Holding costs The cost of holding stocks includes the following: – Finance cost, since capital is tied up in stocks – Warehouse and handling costs – Deterioration costs – Obsolescence costs – Insurance costs – Pilferage costs. Ordering costs There will be costs for Rant Ltd when placing orders with manufacturers. Such costs will include delivery costs, and also the administrative costs involved in placing order (staff costs, telephone charges, etc.) Shortage costs These may include: – Loss of a sale, and the consequent loss of contribution that would have been earned from that sale. – Additional costs involved in making emergency orders for goods. – The costs of lost production, when stock-outs occur and production lines grind to a halt. Staff will still have to be paid, even if they have no work to do. Stock costs The actual cost of the raw materials from the manufacturers (or goods for resale from the wholesalers).

(d)

Rationale and assumptions The economic order quantity (EOQ) model is used to decide the optimum order size for stocks. This then minimises the total of ordering costs and stockholding costs. Assumptions It is based on the following assumptions: – demand is constant – the lead time is constant or zero (suppliers are reliable) – purchase costs per unit are constant (i.e. no bulk discounts)

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(e)

EOQ calculation The EOQ for Rant Ltd is calculated as follows: 2 Co D Ch

=

2 × £150 × 150,000 £15

=

3, 000, 000

=

1,732.

The number of orders to be placed will therefore be 150,000/1,732 =

4

(a)

86 per annum.

Debt vs equity Factors that should be taken into account when deciding the mix of debt and equity finance are as follows: (i)

Cost The higher the cost of funding, the lower the company’s profit. Equity funding is more expensive as an equity investor is subject to both business and finance risk. The investor will therefore demand a higher return for his increased level of risk.

(ii)

Taxation The tax treatment of the cost of financing needs to be taken into account. Interest on debt is tax deductible, whereas if equity finance is raised, dividends paid to shareholders will not be tax deductible. This fact, combined with the lower risk of debt financing, means that debt tends to be cheaper.

(iii) Control of the business If finance is raised through the issue of shares to new shareholders, those shareholders become joint owners of the business. The percentage of shares held by existing shareholders will therefore decrease. As this percentage decreases, so does the individual shareholders’ voting power. When deciding on the number of shares to be issued, the current shareholders will probably want to retain their voting control. This should therefore be considered when deciding the mix of debt and equity. (iv) The effect on gearing Gearing measures the amount of debt compared to the amount of equity. If too much debt is issued, Clean Lens Ltd’s gearing ratio will increase. Finance providers will then see the company as a high-risk investment, and will expect higher returns to compensate for their increased risk. This may lead to unwillingness, on the part of finance providers, to lend money to Clean Lens Ltd at all. (v)

Current level of debt and maturity of existing borrowings A significant difference between debt and equity finance is that debt has to be repaid, but equity does not. If Clean Lens Ltd already has substantial debt finance, then they will already be making repayments, or they will be committed to making repayments in the future. Therefore, when considering the mix of further debt and equity finance, they should ensure that they do not over-commit themselves to future loan repayments.

(vi) Availability of finance As Clean Lens Ltd is a private limited company, the availability of equity financiers may be limited. This will, to a certain extent, dictate the mix of debt and equity finance. NOTE: Only five factors were required.

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(b)

Venture capital Factors that a venture capital organisation will take into account are as follows: (i)

Level of expertise of the company’s management Venture capitalists will believe that the success of Clean Lens Ltd is highly dependent on the quality of the company’s management team. They will expect Clean Lens Ltd to have a skilled team, who are experienced managers. Management will also be required to show a high level of commitment to the project, and the company. As the owners of the business are all involved in the running of the company, this should be proof of their commitment.

(ii)

Level of expertise in production The venture capitalists will seek assurance that the company has the necessary technical ability to be able to develop and produce the new contact lenses. They will want evidence that the management and staff are technically competent.

(iii) The nature of Clean Lens Ltd’s new product The venture capitalists will consider whether the development and production of the new lens is technically feasible. They will employ experts in the field to examine the idea and assess whether the new lens will actually provide revolutionary comfort. (iv) The market and competition They will seek assurance that there is actually a market for a new contact lens, as there are already so many different products on the market. They will ask to see any market research that the company has carried out. The venture capitalists will also look at the threat posed by new entrants in the contact lens market, and current rival producers. (v)

Future prospects Since the risk involved in investing capital in the company is fairly high, the venture capitalists will seek to ensure that the prospects for future profits compensate for the risk. They will therefore want to see a detailed business plan setting out the future business strategy. Clean Lens Ltd has already prepared profit projections showing a very good margin on the product.

(vi) Risk borne by current owners of Cleans Lens Ltd The venture capitalists will expect to see that the current owners bear a high degree of risk. This will give them assurance that the owners have the sufficient level of commitment to the company, as they themselves will have a lot to lose should the company fail. As there are only five shareholders, it is likely that each of them has invested a significant amount of money. (vii) Exit route The venture capitalists will try to establish a number of exit routes. These may include a sale of shares to the public, following a flotation, a sale of shares to another business, or a sale of shares to the original owners. (viii) Board membership Since the venture capitalists will want to ensure that their investment is protected, they will required a place on the Board of Directors. This will enable them to have their say on all significant matters affecting the business. NOTE: Only five factors were required.

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances

June 2004 Marking Scheme Marks

1

(a)

(b)

(c)

(d)

(e)

Relevant cashflows RC = future cash flow Not sunk costs £1·5m and £2m = sunk cost RC = form of cash Ignore depreciation RC arises as result of decision Committed cost of £3m – ignore Interest costs ignored

1 1 1 1 1 1 1 1 –––– 8 ––––

NPV calculations Opportunity cost Hotel building costs of £35k T1 Lodge costs £4k T0 Lodge costs £20k T1 Furnishings/Swimming pools T1 Restaurants T1 Shops T1 Annual overheads hotel T2–5 Annual revenues hotel T2–5 Annual rentals lodges T2–5 Annual overheads lodges T2–5 Restaurant and shop profits T2–5 Net relevant cost totals Correct 10% DFs Correct discounted CFs Correct conclusion

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 –––– 16 ––––

IRR calculation IRR calculation NPV calculations

2 2 –––– 4 ––––

IRR ads and disads Each advantage Each disadvantage

1 1 –––– 6 ––––

Six stages Each stage

1 –––– 6 –––– 40 ––––

Total Total marks available

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Marks 2

(a)

(b)

Cash flow forecast Sales receipts Purchases Admin expenses Delivery costs Packaging Miscellaneous expenses Loan repayments Overdraft interest Net cash flow Opening balance Closing balance

3 1 1 1 1 1 1 1 1 1 1 –––– 13 ––––

Profit and loss account Sales COS Admin. and misc. expenses Recalculating interest Deriving net profit

1 3 1 1 1 –––– 7 –––– 20 ––––

Total marks available

3

(a)

(b)

(c)

(d)

(e)

Definition Each definition

1 –––– 2 ––––

Overtrading Symptoms Conclusion and reasons

2 4 –––– 6 ––––

Stock costs Each cost explained

1 –––– 4 ––––

EOQ model Explanation of model Each assumption

1 1 –––– 4 ––––

Calculations EOQ calculation Number of orders

3 1 –––– 4 –––– 20 ––––

Total marks available

4

(a)

(b)

Debt and equity For each factor explained

2 –––– 10 ––––

Venture capital For each factor identified and discussed

2 –––– 10 –––– 20 ––––

Total marks available

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ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL WEDNESDAY 15 DECEMBER 2004

QUESTION PAPER Time allowed 3 hours ALL FOUR questions are compulsory and MUST be answered

Paper T10

Managing Finances

Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

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ALL FOUR questions are compulsory and MUST be attempted 1

Tots Ltd specialises in the importation and sale of equipment for children’s indoor play centres. The company was set up two years ago by its joint shareholders, Mr and Mrs Brute. The business has been very successful, expanding rapidly over the last year, and the cash balance in the company’s current account has exceeded £1 million on several occasions recently. Mr and Mrs Brute have asked you, an accounting technician for Tots Ltd, to assist them in managing their cash balances over the next six months. You have been provided with the following information. (i) (ii)

The bank balance on 1 January 2005 is forecast at £1·2 million in credit. Sales for November and December 2004 are £1·3 million per month. They are expected to rise to £1·5 million in January 2005, £1·7 million in February and £1·9 million in March. They will then fall to £1·4 million for each of the following six months. This is due to a downturn in demand as the weather improves. (iii) All sales are made on credit. 2% of debtors do not pay at all, 70% pay one month after sale and the remaining 28% pay two months after sale. (iv) Purchases are made one month prior to sales, and two months’ credit is taken from suppliers. (v) The company’s gross profit margin is 50%. (vi) The cost of employing Tots Ltd’s permanent staff is £150,000 per month. Tots Ltd also employs temporary staff during January, February and March at an additional cost equating to 3% of sales each month. (vii) Tots Ltd uses a courier to despatch the equipment to its customers. The cost of this service is 2% of sales value in January to March, falling to 1% thereafter. (viii) Administration costs are forecast at £30,000 for January. These costs are directly proportional to sales each month. (ix) Mr and Mrs Brute will be attending a conference abroad in July 2005 at a total cost of £5,000. They must complete the booking form and send it off, along with a deposit of £2,000, by the end of January 2005. The final balance is due in June. (x) The company charges depreciation of £45,000 each month. (xi) Tots Ltd also owns two indoor play centres that it rents out at the rate of £3,500 each per month from January to April, falling to £3,000 per month thereafter. All rents are received one month in advance. (xii) The company will invest in a new computer system later in the year. This will be paid for by two equal instalments of £200,000, one in June and one in September. Required: (a) Prepare a monthly cash budget for EACH of the six months to 30 June 2005, showing clearly any necessary workings. NOTE: All workings should be in £000. Unless told otherwise, assume that payments are made in the month in which the costs are incurred. (16 marks) Mr and Mrs Brute are aware that the business is holding too much cash, but are unsure how to invest it safely. They are very risk averse, having each lost a considerable amount of money on the Stock Exchange. They also want to ensure that they retain enough cash to allow the business to meet its debts as they fall due. (b) Briefly explain three motives for holding cash, as identified by Keynes.

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(6 marks)

(c) Define and explain the characteristics of THREE out of the four types of investment below. In light of the characteristics you have identified, conclude as to whether you consider each of the investments you have explained to be an appropriate use of Tots Ltd’s cash surplus. (i) (ii) (iii) (iv)

Certificates of deposit; Gilt-edged securities (gilts); Shares; Bills of exchange.

(18 marks)

Note: Each type of investment carries equal marks. (40 marks)

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[P.T.O.

2

Pooch Ltd makes and sells pet care products. The following projected data for the next year is available. Sales

£2,200,000

Costs as percentage of sales Raw materials Direct labour Variable production overheads Fixed production overheads Other costs

15% 20% 11% 10% 12%

Working capital statistics Average raw material holding period Average Work-in-progress (WIP) holding period Average finished goods holding period Average debtors’ collection period Average creditors’ payment period on: Raw materials Direct labour Variable production overheads Fixed production overheads Other costs

4 2 4 6

weeks weeks weeks weeks

4 weeks 1 week 8 weeks 5 weeks 12 weeks

Other relevant information – All finished goods stock and WIP values include raw materials, direct labour, variable production overheads and apportioned fixed production overhead costs. –

Assume WIP is 75% complete as to materials and 50% complete as to direct labour, variable production overheads and fixed production overheads.

–

Assume there are 52 weeks in one year.

–

Assume that production and sales volumes are the same.

Required: (a) Calculate the estimated average working capital required by Pooch Ltd for the year, showing clearly all necessary workings. NOTE: All workings should be in £. (14 marks) (b) Pooch Ltd is currently in dispute with one of its suppliers, Petcoats Ltd. Pooch Ltd is unsure of its legal obligations regarding an agreement it made with Petcoats Ltd. The Financial Director of Pooch Ltd has asked you, an accounting technician, to explain certain legal terms to him. Define and briefly explain the following legal terms: (i)

‘Offer’;

(2 marks)

(ii) ‘Acceptance’;

(2 marks)

(iii) ‘Consideration’.

(2 marks) (20 marks)

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This is a blank page Question 3 begins on page 6

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[P.T.O.

3

Taxi Ltd is a long established company providing high quality transport for customers. It currently owns and runs 350 cars and has a turnover of £10 million per annum. The current system for allocating jobs to drivers is very inefficient. Taxi Ltd is considering the implementation of a new computerised tracking system called ‘Kwictrac’. This will make the allocation of jobs far more efficient. You are an accounting technician for an accounting firm advising Taxi Ltd. You have been asked to perform some calculations to help Taxi Ltd decide whether Kwictrac should be implemented. The project is being appraised over five years. The costs and benefits of the new system are set out below. (i)

The central tracking system costs £2,100,000 to implement. This amount will be payable in three equal instalments: one immediately, the second in one year’s time, and the third in two years’ time.

(ii) Depreciation on the new system will be provided at £420,000 per annum. (iii) Staff will need to be trained how to use the new system. This will cost Taxi Ltd £425,000 in the first year. (iv) If Kwictrac is implemented, revenues will rise to an estimated £11 million this year, thereafter increasing by 5% per annum (i.e. compounded). Even if Kwictrac is not implemented, revenues will increase by an estimated £200,000 per annum, from their current level of £10 million per annum. (v) Despite increased revenues, Kwictrac will still make overall savings in terms of vehicle running costs. These cost savings are estimated at 1% of the post Kwictrac revenues each year (i.e. the £11 million revenue, rising by 5% thereafter, as referred to in note (iv)). (vi) Six new staff operatives will be recruited to manage the Kwictrac system. Their wages will cost the company £120,000 per annum in the first year, £200,000 in the second year, thereafter increasing by 5% per annum (i.e. compounded). (vii) Taxi Ltd will have to take out a maintenance contract for the Kwictrac system. This will cost £75,000 per annum. (viii) Interest on money borrowed to finance the project will cost £150,000 per annum. (ix) Taxi Ltd’s cost of capital is 10% per annum. Required: (a) Calculate the net present value of the new Kwictrac project to the nearest £000. Use the discount factors provided at the end of the question. (10 marks) (b) Calculate the simple payback period for the project and interpret the result.

(3 marks)

(c) Calculate the discounted payback period for the project and interpret the result.

(3 marks)

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(d) Taxi Ltd wants to ensure that it has enough cash available to pay the second and third instalments for the Kwictrac system, when they fall due. The company has therefore decided to invest the cash on time deposits with its local bank. The rates of interest paid by the bank are as follows: 6 month deposits One year deposits Two year deposits Three year deposits

7% 8% 9% 10%

per per per per

annum annum annum annum

Interest is paid once a year, at the end of the year. Calculate the total amount of cash that Taxi Ltd needs to put on deposit immediately in order to meet the final two instalments for Kwictrac. (4 marks) NOTE: You should assume that all cash flows occur at the end of the year, unless otherwise stated. Present Value table (extract) Periods (n) 1 2 3 4 5

Discount rate (r) 10% 0·909 0·826 0·751 0·683 0·621 (20 marks)

4

Skint Ltd is a small family owned company that makes fuses for electrical plugs. It was set up twenty-five years ago by its main shareholder, Mr Holmes, who is also the Managing Director of the company. The company is facing short-term cash flow difficulties. It is already a highly geared company and Mr Holmes is concerned that the bank will not lend it any more money. He is considering applying for a personal loan or giving a personal guarantee in order to solve the company’s short-term cash flow difficulties. Required: (a) List and explain the general factors that will be taken into account by a bank when deciding whether or not to lend money to a client. (14 marks) (b) Briefly explain three characteristics that any security for a loan should have.

(3 marks)

(c) Briefly describe the following: (i) bullet repayment loan; (ii) balloon repayment loan; (iii) amortising loan (straight repayment loan).

(3 marks) (20 marks)

End of Question Paper

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances

December 2004 Answers

1 – Tots Ltd (a)

Cash Budget

Cash inflows Sales Rental income

Cash outflows Purchases Permanent staff Temporary staff Delivery Administration Conference Computer system Depreciation – ignore

Note

Jan £000

Feb £000

Mar £000

Apr £000

May £000

Jun £000

Total £000

1 2

1,274 7 –––––– 1,281 ––––––

1,414 7 –––––– 1,421 ––––––

1,610 7 –––––– 1,617 ––––––

1,806 6 –––––– 1,812 ––––––

1,512 6 –––––– 1,518 ––––––

1,372 6 –––––– 1,378 ––––––

8,988 39 –––––– 9,027 ––––––

3

650 150 45 30 30 2

750 150 51 34 34

850 150 57 38 38

950 150 0 14 28

700 150 0 14 28

700 150 0 14 28 3 200

4,600 900 153 144 186 5 200

–––––– 907 –––––– 374 1,200 –––––– 1,574 –––––– ––––––

–––––– 1,019 –––––– 402 1,574 –––––– 1,976 –––––– ––––––

–––––– 1,133 –––––– 484 1,976 –––––– 2,460 –––––– ––––––

–––––– 1,142 –––––– 670 2,460 –––––– 3,130 –––––– ––––––

–––––– 892 –––––– 626 3,130 –––––– 3,756 –––––– ––––––

–––––– 1,095 –––––– 283 3,756 –––––– 4,039 –––––– ––––––

–––––– 6,188 –––––– 2,839 1,200 –––––– 4,039 –––––– ––––––

4 5 6

Net cash flow Opening balance Closing balance

(The total column is a useful arithmetic check but not specifically required by the question.) Notes 1. Sales Sales volume Per the question Sales receipts 70% paid in 1 month 28% paid in 2 months

2.

Nov £000

Dec £000

Jan £000

Feb £000

Mar £000

Apr £000

May £000

Jun £000

1,300

1,300

1,500

1,700

1,900

1,400

1,400

1,400

n/a n/a

n/a n/a

910 364 –––––– 1,274 ––––––

1,050 364 –––––– 1,414 ––––––

1,190 420 –––––– 1,610 ––––––

1,330 476 –––––– 1,806 ––––––

980 532 –––––– 1,512 ––––––

980 392 –––––– 1,372 ––––––

Rental income Play Centre 1 and 2 (2 x £3,000/£3,500) Received one month in advance

3.

Feb £000

Mar £000

Apr £000

May £000

Jun £000

Jul £000

7 ––– 7 ––– 7 –––

7 ––– 7 ––– 7 –––

7 ––– 7 ––– 7 –––

7 ––– 6 ––– 6 –––

6 ––– 6 ––– 6 –––

6 ––– 6 ––– 6 –––

6

Purchases Orders are made each month for the following month’s requirements, but 60 days credit is taken. This means that the company is paying for the previous month’s purchase requirements each month.

Sales volume Per the question Purchase requirements at 50% Payments to suppliers 4.

Jan £000

Dec £000

Jan £000

Feb £000

Mar £000

Apr £000

May £000

Jun £000

1,300 650

1,500 750 –––––– 650 ––––––

1,700 850 –––––– 750 ––––––

1,900 950 –––––– 850 ––––––

1,400 700 –––––– 950 ––––––

1,400 700 –––––– 700 ––––––

1,400 700 –––––– 700 ––––––

n/a

Temporary staff (Jan to March only)

Sales levels Temp costs at 3%

Jan £000 1,500 –––––– 45 ––––––

Feb £000 1,700 –––––– 51 ––––––

Mar £000 1,900 –––––– 57 ––––––

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5.

Delivery costs Sales levels Delivery costs at 2%

Jan £000 1,500 –––––– 30 ––––––

Feb £000 1,700 –––––– 34 ––––––

Mar £000 1,900 –––––– 38 ––––––

Delivery costs at 1% 6.

May £000 1,400

Jun £000 1,400

–––––– 14 ––––––

–––––– 14 ––––––

–––––– 14 ––––––

Administration costs Per the question, these costs are directly proportionate to sales. £30,000/£1,500,000 = 2%, therefore calculate these costs as 2% of sales each month.

Sales levels Admin costs at 2% (b)

Apr £000 1,400

Jan £000 1,500 –––––– 30 ––––––

Feb £000 1,700 –––––– 34 ––––––

Mar £000 1,900 –––––– 38 ––––––

Apr £000 1,400 –––––– 28 ––––––

May £000 1,400 –––––– 28 ––––––

Jun £000 1,400 –––––– 28 ––––––

Motives for holding cash The three motives for holding cash, as identified by Keynes, are: (i)

The transactions motive. This means that a business holds cash in order to make the payments that are necessary to keep the business going, such as wages, taxes and payments to suppliers. If the business cannot meet its financial obligations as they arise, it may cease to be a going concern. It is therefore the main motive for holding cash.

(ii)

The precautionary motive. The second motive for holding cash is so that the business does not find itself in financial difficulties should some unforseen expenses arise. In practice, businesses tend to cover themselves against this by arranging overdraft facilitities with their banks. These do not cost businesses anything unless they are used.

(iii) The speculative motive. This refers to businesses holding cash in case an opportunity to invest and earn money arises. Few businesses are likely to do this in practice as they will lose money whilst waiting for an opportunity to arise. (c)

Possible investments (i)

Certificates of deposit (CDs) These are negotiable instruments in bearer form. Title belongs to the holder and can be transferred by delivering the certificate to the buyer. Bank and Building Societies issue these CDs, which will state on them the amount of the deposit and the date of repayment. The deposit amount will usually be at least £100,000 and the repayment date will be anything from one week to five years. Repayment is obtained by presenting the CD to the issuer on the designated date. Alternatively, since CDs are negotiable, they can be sold at any time by the holder. CDs usually offer an attractive rate of interest and a low credit risk. They are useful for investing funds in the short term since they can be sold at any time on the secondary market. Since Tots Ltd has a large amount of cash available over a long period, it does not need instant access to all its cash. It may therefore earn more interest from a money market time deposit, for example, rather than a CD.

(ii)

Gilt-edged securities (gilts) These are marketable British Government securities. The government issues them to finance its spending, but also uses them to control the money supply. Most gilts have a face value of £100 at which the government promises to buy the gilt back on a specific date in the future. Gilts usually have fixed interest rates, although there are also various index-linked gilts. Where they are the index-linked type, both the interest and the redemption value are linked to inflation, ensuring that a decent real return is gained. Gilts may be ‘Shorts’ (repaid in less than five years), ‘Mediums’ (repaid in five to fifteen years), or ‘Longs’ (repaid in more than fifteen years). Some of the older gilts, such as 31/2% War Loans, are irredeemable. If you buy a gilt and hold it until it is repaid by the government, the return you get will be fixed from the outset. As the government will not default on the debt and the interest to be earned is known in advance, this makes it a low risk investment. Gilts are also traded on the stock market, however, where their price can go up or down, depending on what people think will happen with interest rates. When interest rates are expected to fall, the price of the gilt rises, and when interest rates are expected to rise, the gilt price falls. Using gilts in this way makes them a more risky investment, but still relatively safe when compared with buying shares on the stock exchange. Gilts are transferrable on the secondary market in multiples of a penny, but if they are bought from new the minimum investment is £1,000. There is no maximum investment limit. They are easy to transfer and title can even be passed electronically now.

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Given that the Brutes are very risk averse when it comes to investing surplus funds, gilts would be a good choice of investment for Tots Ltd. (iii) Shares There are two main types of shares – ‘ordinary shares’ and ‘preference shares.’ Ordinary shares are issued to the owners of a company. These shareholders have the right to participate in the running of the company through voting. They also share in the profits of the company through increases in the market value of their shares and through the receipt of dividends. Ordinary shareholders have no right to be paid dividends, however. In addition, should the company run into financial difficulties, ordinary shareholders are the last group of people to be paid back from the sale of the company’s assets. In practice, this means that the capital they invested in the company will usually be lost. Ordinary shares are therefore a high risk investment. As Mr and Mrs Brute are very risk averse and have already lost money on the stock exchange before, they should not purchase ordinary shares. Preference shares are shares that have a fixed percentage dividend that is payable in priority to any ordinary dividend. Similarly, preference shareholders will be paid in priority to ordinary shareholders on dissolution of the company. These shareholders will not participate in the affairs of the company in the same way as ordinary shareholders since they do not have the same voting rights. Whilst the income from preference shares is more secure than the income from ordinary shares, the capital is still high risk. Given Mr and Mrs Brutes’ previous experience, preference shares are not a good choice of investment for them. (iv) Bills of exchange A bill of exchange is an unconditional order in writing to pay money. There are two types of bills of exchange. Firstly, ‘sight bills’, whereby the money is payable on demand. Secondly, ‘term bills’, whereby the money is payable at a future date. The maturity of term bills can vary from two weeks to six months. Their maximum value is £500,000 and they can be denominated in any currency. The ‘drawee’ is the party liable to pay the money; the ‘payee’ is the person who receives the money. Banks and non-banking institutions are the main buyers of bills on the secondary market. The buyer makes a profit by purchasing the bill at a discount to its face value, then receiving the full value at maturity, or reselling it before this time. The level of risk attached to bills depends on the credit quality of the drawer. If the drawer is a large company or institution, the risk will be lower than if the drawer is relatively small and unknown. Bills are not really a suitable investment for Tots Ltd as they are not in a good position to start assessing the credit quality of drawers. Bills are more suitable for financial institution investors.

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2 – Pooch Ltd (a)

Working capital Sales for the year:

£2,200,000 –––––––––––

The costs for the year are: Raw materials £2,200,000 x 15% Direct labour £2,200,000 x 20% Variable production overheads £2,200,000 x 11% Fixed production overheads £2,200,000 x 10% Other costs £2,200,000 x 12%

Current assets: Stock Raw materials W-I-P Materials Direct labour Variable and fixed production overheads

£ 330,000 440,000 242,000 220,000 264,000 –––––––––– 1,496,000 –––––––––– –––––––––– £ 4/52 x £330,000 2/52 x £330,000 x 75% 2/52 x £440,000 x 50% 2/52 x (£242,000 + £220,000) x 50%

£ 25,385

9,519 8,462 8,885 26,866

Finished Goods Materials and direct labour Variable and fixed production overheads Total stock value Debtors

4/52 x (£330,000 + £440,000) 4/52 x (£242,000+ £220,000)

59,231 35,538 94,769 –––––––– 147,020 253,846 –––––––– 400,866 ––––––––

6/52 x £2,200,000

Total value of current assets Current liabilites Materials creditor Labour creditor Variable production overhead creditor Fixed production overhead creditor Other costs creditor

4/52 x £330,000 1/52 x £440,000 8/52 x £242,000 5/52 x £220,000 12/52 x £264,000

25,385 8,462 37,231 21,154 60,923 ––––––––

Total value of current liabilities Working capital required (£400,866 – £153,155) (b)

–––––––– 153,155 –––––––– –––––––– 247,711 –––––––– ––––––––

Legal terms Offer An ‘offer’ is a definite promise to be bound on specific terms. It can be made orally or in writing. It can also be implied from a person’s conduct by, for example, despatching goods in response to an offer to buy. It can be revoked at any time before it has been accepted. Acceptance ‘Acceptance’ is the unconditional agreement, by the offeree, to all the terms of the offer. As with an offer, it can also be oral, written or implied from a person’s conduct. A request for information about an offer is not acceptance. Consideration ‘Consideration’ is one party doing something in exchange for another party doing something. Often, there is simply an exchange of promises, for example, Petcoats Ltd promises to supply items to Pooch Ltd and Pooch Ltd promises to pay them. Consideration is often simply the price. For example, when one of Pooch Ltd’s customers buys an item in the shop, their consideration is the amount they pay for the goods.

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3 – Taxi Ltd (a)

Net present value

Implementation costs Training costs Increased revenues (1) Cost savings (2) Operative costs (3) Maintenance costs Net cash flow 10% discount factors Discounted cash flow

0 £’000 –700

Years 3 £’000

4 £’000

5 Net Present £’000 Value

1,150 116 –200 –75 ––––– 291

1,528 121 –210 –75 –––––– 1,364

1,934 127 –221 –75 –––––– 1,765

2,371 134 –232 –75 –––––– 2,198

0·909 ––––– ––––– –373 –––––

0·826 ––––– ––––– 240 –––––

0·751 –––––– –––––– 1,024 ––––––

0·683 –––––– –––––– 1,205 ––––––

0·621 –––––– –––––– 1,365 ––––––

1 £’000 11,000 –10,200 –––––––– 800 –––––––– ––––––––

2 £’000 11,550 –10,400 –––––––– 1,150 –––––––– ––––––––

Years 3 £’000 12,128 –10,600 –––––––– 1,528 –––––––– ––––––––

4 £’000 12,734 –10,800 –––––––– 1,934 –––––––– ––––––––

5 £’000 13,371 –11,000 –––––––– 2,371 –––––––– ––––––––

2 £’000 –700

0 0 0 0 ––––– –700

1 £’000 –700 –425 800 110 –120 –75 ––––– –410

1·000 ––––– ––––– –700 –––––

Notes 1. Increased revenues

Revenues + 5% each year Without Kwictrac Increased revenue 2.

Savings in costs Annual revenues

11,000 11,550 12,128 12,734 13,371 –––––––– –––––––– –––––––– –––––––– –––––––– 110 116 121 127 134 –––––––– –––––––– –––––––– –––––––– –––––––– –––––––– –––––––– –––––––– –––––––– ––––––––

Savings at 1% 3.

Operative costs Additional costs (+ 5% from T3)

(b)

–––––– 2,761 ––––––

–––––––– –––––––– –––––––– –––––––– –––––––– 120 200 210 221 232 –––––––– –––––––– –––––––– –––––––– –––––––– –––––––– –––––––– –––––––– –––––––– ––––––––

4.

Ignore depreciation as not a cash flow.

5.

Ignore interest as this is already taken into account in the discounting process.

Simple Payback Time 0 1 2 3 4 5

Annual cash flows –700 –410 291 1,364 1,765 2,198

Cumulative cash flows –700 –1,110 –819 545 2,310 4,508

The simple payback period for the project is three years. This means that in three years’ time, the project has recovered its costs and is then making a profit. (c)

Discounted Payback Period Time 0 1 2 3 4 5

Annual cash flows –700 –373 240 1,024 1,205 1,365

Cumulative cash flows –700 –1,073 –833 191 1,396 2,761

The discounted payback period for the project is also three years. This means that in three years’ time, the project has recovered its costs and is then making a profit. As this calculation is for the discounted payback period, the time value of money has also been taken into account. (Note: Students will still be awarded full marks where they have not rounded their calculations to the nearest year.)

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(d)

Time deposits First instalment of £700,000: 1 Amount required now = £700,000 × ——— (1·08) Amount required now = £648,148 Second instalment of £700,000: 1 Amount required now = £700,000 × ——— (1·09)2 Amount required now = £589,176 Total deposits = £1,237,324

4 – Skint Ltd (a)

Factors considered by a bank The factors to be considered are set out below. The character of the borrower Before lending money, the bank will need to decide whether the borrower is of good character. This will involve looking at the borrower’s past record and conducting a personal interview with the applicant. If a person is applying for a loan, they will often be credit scored. If a company is making the application, the bank will probably use key ratios to analyse the company’s financial position. The ability to borrow and repay The bank looks at a business customer’s financial performance in order to ascertain their likely future position. If the owner re-invests profits in the business rather than drawing them all out, it shows that he has some confidence in the success of the business. This makes the bank more likely to lend to the business. When dealing with a company that is applying for finance, the bank may check whether the company has the authority to borrow the funds it is requesting. The company’s articles of association provide this information. The margin of profits The bank lends money in order to make money. It needs to ensure that it makes enough of a profit to warrant the risk that it takes by lending. Most banks have lending policies which require them to charge different interest rates to customers depending on the reason for the borrowing. This is because some types of lending are more risky than others. Ultimately, it is the bank’s discretion to charge whatever interest rate it chooses. For risky ventures, the rate will obviously be higher. Purpose of the borrowing The purpose of the borrowing affects not only the interest rate but also the bank’s decision as to whether or not to lend in the first place. A bank will not lend money for an illegal purpose. It will normally lend in order to finance working capital, provided that the company’s liquidity position is still manageable. Lending to finance new business ventures is more risky since many of them fail. The bank will be more cautious in these cases. Amount of the borrowing Firstly, the bank will need to make sure that the applicant is not asking for more money than he needs for the purpose specified. If he is, this casts doubt over his ability to repay. Secondly, the bank needs to be sure that the applicant is asking for enough money. If he is not, the bank may well end up having to lend more in order to safeguard the original loan. Repayment terms The bank must not lend money to a person or company who does not have the ability to repay it, with interest, irrespective of any security available for the loan. Security should only be called upon as a last resort if there is a sudden unexpected inability to pay. A repayment term should be set which is realistic. Overdrafts are repayable on demand and are therefore more risky for the borrower.

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Insurance against the possibility of non-payment When lending large sums of money to an individual or to a company, the bank may well ask for the loan to be secured. This security may take the form of title deeds to property – either property of the company or the individual’s house, depending on who is making the application for finance. A borrower may take out payment protection insurance, so that his repayments are covered even if his financial position deteriorates. (b)

Three characteristics

The three characteristics for security are as follows: (i)

Easy to take This means that the security should be easy to obtain in the first place, for example, title documents to property.

(ii)

Easy to value The security should have a clearly identifiable value which is either stable or increasing, and which fully covers the lending amount and the margin of profit.

(iii) Easy to realise The security should ideally be readily available for sale. This ensures that the bank’s administrative costs are kept to a minimum. Also, the risk of the security deteriorating between the time of default and the time of sale is minimised. (c)

Three terms (i)

Bullet repayment loan None of the principal amount lent is repaid until the end of the loan period. The principal is then repaid in one big lump sum.

(ii)

Balloon repayment loan Some of the principal is repaid during the term of the loan. A final substantial payment is then made at maturity.

(iii) Amortising loan (straight repayment loan) The principal is repaid gradually over the term of the loan, along with the interest payments. Some mortgages are repaid in this way.

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[P.T.O.

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances

1

(a)

Cash sales Rental income Purchases Permanent staff Temporary staff Delivery Administration Conference Ignoring depreciation Computer system Net cash flow/op bal/clos bal

(b)

Each motive discussed

Marks 3 1 2 1 1 1 2 1 1 1 2 ––– 16 ––– 2 ––– 6 –––

Maximum marks (c)

(i)

CDs Negotiable instrument Transfer of title Banks and BSs issue Deposit amount Repayment length Obtaining repayment Attractive interest Low risk Useful for short term Conclusion for Tots Ltd

1 1 1 1 1 1 1 1 1 1 ––– 6 –––

Max marks (ii)

December 2004 Marking Scheme

Gilts Marketable Gov securities Face value usually £100 Fixed interest rates Index-linked Shorts/mediums/longs Low risk if hold until repd Explaining price/int rates rel Higher if on secondary Minimum investment Electronic transfer available Conclusion re Tots Ltd

1 1 1 1 1 1 1 1 1 1 1 ––– 6 –––

Max marks (iii) Shares Two types Ordinary shares: – voting rights – share in profits – no right to dividends – loss of capital – conclusion

1 1 1 1 1 1

Preference shares: – preferential dividends – preference on winding up – lack of participation – conclusion

1 1 1 1 ––– 6 –––

Max marks

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Marks (iv) Bills of exchange Definition Two types Term bill details Drawee and payee Main buyers Making a profit Risk Conclusion re Tots Ltd

1 1 1 1 1 1 1 1 ––– 6 ––– 40 ––– –––

Max marks Total marks

2

(a)

Calculation of each cost for yr

0·5 ––– 2·5 –––

Max marks Calculation of current assets: Raw materials WIP Finished goods Debtors

0·5 4 2 0·5 ––– 7 –––

Calculation of current liabs Materials creditor Labour creditor Variable overheads Fixed overheads Other costs

0·5 0·5 0·5 0·5 0·5 ––– 2·5 ––– 1

Working capital required

(b)

Presentation

1 ––– 14 –––

Definition of offer Orally/in writing/implied Withdrawal

1 1 1 ––– 2 –––

Max marks Definition of acceptance Orally/in writing/implied Request for information

1 1 1 ––– 2 –––

Max marks Definition of consideration Exchange of promises Price

1 1 1 ––– 2 ––– 20 ––– –––

Max marks Total marks

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3

Marks 1 1 3 1 1 1 1 1 ––– 10 –––

(a)

Implementation costs Training costs Increased revenues Decreased costs Operative costs Maintenance costs Ignore depreciation and interest NPV

(b)

Net cashflows Cumulative cashflows Interpretation and result

1 1 1 ––– 3 –––

(c)

Discounted net cashflows Cumulative cashflows Interpretation and result

1 1 1 ––– 3 –––

(d)

One year deposit Two year deposit

2 2 ––– 4 ––– 20 ––– –––

Total marks

4

(a)

Character of borrower Ability to repay Margin of profit Purpose of borrowing Amount of borrowing Repayment terms Insurance

2 2 2 2 2 2 2 ––– 14 –––

(b)

Each characteristic

1 ––– 3 –––

Total (c)

Each explanation

1 ––– 3 ––– 20 ––– –––

Total Total marks

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ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL WEDNESDAY 15 JUNE 2005

QUESTION PAPER Time allowed 3 hours ALL FOUR questions are compulsory and MUST be answered

Paper T10

Managing Finances

Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

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ALL FOUR questions are compulsory and MUST be attempted 1

Seventeen Ltd Sally Sharp is the Managing Director of Seventeen Ltd, a production company responsible for the huge success of the television programme ‘Pop Icon 1’ and ‘Pop Icon 2.’ The programme is just nearing the end of the second series, with only four weeks to go before the public chooses a winner. Sally is in the process of deciding whether to run a ‘Pop Icon’ tour. This would consist of twelve live performances, in twelve different locations, during the month of September. The twelve finalists from the television programme would all take part in the tour. Seventeen Ltd ran a ‘Pop Icon 1’ tour after the first series and this was a big success. Sally is concerned, however, about the effect of the tour on the company’s cash flow, as the company currently has funds tied up in several other projects. You have been provided with the following information: (i)

Seventeen Ltd will open a separate bank account on 1 July 2005 for the tour, with an opening balance of £500,000.

(ii) During the Pop Icon 1 tour, it was calculated that for each thousand votes cast during the final twelve television programmes, one person attended the Pop Icon tour. This ratio is expected to remain the same for the second Pop Icon tour, should it go ahead. During the last eight weeks of Pop Icon 2, the public has cast a total of 180 million votes. This is an average of 22·5 million votes per week. Public interest is expected to increase over the final four weeks and it is therefore estimated that votes for the remaining four weeks will be 100 million in total. (iii) Tickets vary in price according to the seat location within each venue. Ticket information is as follows: Ticket type Premium seats Arena floor Stalls

Price £35 £30 £25

Percentage of total tickets sold 10% 30% 60%

It is expected that 20% of ticket revenues will be received in September, 30% in October, 30% in November and the remainder in December. (iv) At every live performance, a selection of souvenirs will be on sale, from mugs and t-shirts to CDs and DVDs. From the Pop Icon 1 tour it has been calculated that for every ticket sold, an average of £6 is spent on souvenirs. These monies are received by Seventeen Ltd in September. (v) The souvenirs are purchased from two key suppliers – Records Ltd, who produce all the CDs and DVDs (50% of total souvenirs sales), and Junk Ltd who produce everything else (remaining 50% of sales). The gross profit margins for Seventeen Ltd are 25% for CDs and DVDs and 50% for everything else. All orders must be made from both suppliers in August but whereas Records Ltd requires payment at the time of order, Junk Ltd provides one month’s credit. (vi) Each of the twelve performers will be paid £35,000 for his/her participation in the live tour. Of this amount, £5,000 will be paid at the start of the tour at the beginning of September, with the remainder being paid at the beginning of October. (vii) Seventeen Ltd will pay an average of £150,000 to hire each of the twelve venues for the live tour. In order to secure the venues, a deposit of 10% had to be paid in May for each venue out of one of the company’s existing bank accounts. The remaining balances will be paid in August from the Tour bank account. (viii) Seventeen Ltd will need to hire two tour buses in September – one for the performers and one for the crew. The cost of these will be £10,000 each. In addition to these, six heavy vehicles will be required to transport equipment. Each vehicle costs £12,000. All of these transport costs include driver costs and fuel. 75% of the total transport costs (including buses) will be paid in September, with the remainder being paid in October. (ix) For each performer on the tour, five members of crew are required over and above the already existing staff of Seventeen Ltd. The average gross wage of each crewmember is £12,000 per month. Whilst all of these crewmembers are required for the month of September, only half of them are needed for August. All crewmembers are paid at the end of each month that they work.

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(x) The crewmembers are hired through an agency, Hands on Deck Ltd. The agency charges a fee for each member of crew hired through them. The fee is calculated as 10% of the gross monthly wage of each crewmember and is paid for EVERY month that they work. Hands on Deck Ltd allows one month’s credit. (xi) Publicity for the tour is expected to cost a further £2·5 million. Of this amount, 20% will be paid in July and 30% paid in August. Sally has negotiated delaying the remaining payment until November. (xii) Other costs are estimated to be in the region of £240,000 IN TOTAL, incurred evenly through the months of July, August, September and October. They will be paid in the month in which they are incurred. (xiii) All workings should be in £’000, to the nearest £’000. Required: (a) Prepare a monthly cash budget for the Pop Icon 2 Tour for EACH of the six months to 31 December 2005, showing clearly any necessary workings. (30 marks) The following information applies to part (b) only. Sally is concerned that the above calculations rely on the public’s average weekly votes increasing in the final four weeks of the programme. They also rely on the assumption that there will be one ticket sale per thousand votes. Sally is concerned about the effect on profit should these assumptions be wrong, with the second tour proving to be less popular that the first one. She now wants you to assume that voting for the final four weeks of the programme stays at the same average level as the previous eight weeks AND that for every TWO thousand votes only one person attends the tour. (b) Calculate the original profit of the project as per part (a) AND the revised profit/loss after the change in the assumptions. (10 marks) (40 marks)

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[P.T.O.

2

Silly Filly Ltd Silly Filly Ltd is a recently established company specialising in the manufacture of talking toy horses for children. The Silly Filly range currently comprises three key products – all of which are toy horses – plus approximately thirty accessories to complement the range, from stables to grooming kits. The Silly Filly range has been such a success in the last year that the management is considering producing an animated film to accompany the range. This is in accordance with the company’s long-term expansion plans, culminating in a stock exchange flotation in three year’s time. The film will take one year to make. In the year following that, sales of the film will commence. You, an accounting technician for the company, have been asked to assist in appraising the project to decide whether it should go ahead. The following information is relevant to your calculations. (i)

Market research has already been carried out at a cost of £1·2 million.

(ii) The services of a company specialising in animation will be required at a total cost of £520,000. 50% of these costs will be paid immediately with the remainder being paid in one year’s time. (iii) Two producers will be employed throughout the first year of the project. They will each be paid salaries of £120,000. (iv) Other production costs during the year are expected to be £650,000. (v) A film director will be employed immediately on a one-year contract at a cost of £160,000. (vi) The animated film is expected to generate revenues of £1·2 million in the first year of sales, £2·2 million in the second year, and £1·6 million in the third year. (vii) The two producers and the director will each be paid royalties from the film. These will be paid at the rate of 1·5% of gross revenues for EACH of the producers and 2% for the director. They will always be payable one year in arrears. (viii) Specialist equipment will need to be purchased immediately for the film production. This will cost £2·3 million but can be sold at the end of the year for £1·7 million. (ix) A loan for £1 million will be taken out to assist in financing the project. The loan will be repayable in two year’s time, with interest of 8% per annum being payable for its duration. (x) The company’s cost of capital is 10% per annum. (xi) Assume that all cash flows occur at the end of each year, unless otherwise stated. Required: (a) Using the present value tables provided at the end of the question, calculate the project’s net present value (NPV) at the company’s cost of capital. Conclude as to whether the company should proceed with the project, giving a reason for your conclusion. (10 marks) (b) List four costs associated with a new equity issue.

(4 marks)

(c) Explain three reasons why a company may seek a stock exchange listing.

(6 marks)

Present Value table (extract) Periods (n) Discount rate (r) 10% 1 0·909 2 0·826 3 0·751 4 0·683 5 0·621

Discount rate (r) 8% 0·926 0·857 0·794 0·735 0·681 (20 marks)

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3

Duel Fuel Ltd Duel Fuel is an energy company that buys gas in bulk and sells it to the main market providers in the UK. The company’s credit control department is poorly run at present, following the resignation six months ago of the credit controller. Poor credit control has had a serious effect on the company’s overdraft, which currently stands at £5 million, compared to £3 million at the same time last year. This, in turn, is pushing up interest costs. The company is therefore considering factoring its debts to improve its cash flow and reduce costs. Credit sales for the last year totalled £8·5 million, with average debtors of £4·3 million. Next year, sales are expected to be 20% higher, and debtor days are expected to remain the same if the factoring arrangement is NOT entered into. A factoring company has put forward the following proposal to Duel Fuel Ltd: (i) (ii) (iii) (iv)

The factor would immediately advance 70% of the value of sales invoices. The factor will charge interest of 12% per annum on the advances. The factor will charge an administration fee of 1·5% of turnover for the service. Debtor days will be reduced to 60 days, the industry norm, as a result of stricter credit control procedures

Should Duel Fuel Ltd enter into the agreement, it will make both of the credit control staff redundant. They earn salaries of £14,000 per annum each, but they will both be paid a redundancy package of £3,000 each. Current bank overdraft rates are 9% per annum. Required: (a) Calculate for the coming year whether it is financially viable for Duel Fuel Ltd to factor its debts. (10 marks) (b) Identify five advantages of factoring.

(5 marks)

(c) List five functions that a credit control department may undertake.

(5 marks) (20 marks)

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[P.T.O.

4

Gym Jam Ltd Gym Jam Ltd is a well-established company that hires out a range of top quality treadmills to gyms across the country, under operating leases. Over recent months, Gym Jam Ltd’s client base has expanded so rapidly that the company has struggled to finance the level of treadmill purchases required to supply its new clients. The company used a loan from its local bank to assist with its last bulk order of treadmill purchases two years ago. Interest on this loan was variable, being linked to the bank’s base rate, and Gym Jam Ltd saw its interest charges steadily increasing over the two-year period. It is now considering using finance leases (fixed interest) to acquire the next bulk order of treadmills. In the last year, the company’s debtor days have increased from an average of 30 days to 45 days, partly because sales ledger staff could not cope with the increased workload. Currently, all customers are invoiced every three months (quarterly) for the hire of the treadmills, and most of them pay by cheque. Invoices are raised manually and state on them that payment terms are 30 days from invoice date. You are an accounting technician for the company, and have been asked to assist in resolving these problems. Required: (a) Briefly describe three key characteristics of an operating lease.

(3 marks)

(b) Briefly describe five key characteristics of a finance lease.

(5 marks)

(c) Identify four weaknesses in Gym Jam Ltd’s invoicing and credit control system and indicate how they can be rectified. (4 marks) (d) List the factors that affect the rate of interest for a loan.

(6 marks)

(e) Explain why the interest charges on Gym Jam Ltd’s loan kept increasing.

(2 marks) (20 marks)

End of Question Paper

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances 1

(a)

June 2005 Answers

Seventeen Ltd Note Cash inflows Ticket sales Souvenirs sales

Jul £’000

Aug £’000

1 2

Total cash inflows Cash outflows Purchases: Records Ltd Purchases: Junk Ltd Performers Venue costs Transport costs Crew costs Agency fees Publicity costs Other costs

3 3 4 5 6 7 8 9

Total cash outflows Net cash flow Opening balance Closing balance

Sep £’000

Oct £’000

Nov £’000

Dec £’000

Total £’000

1,540 1,680 ––––– 3,220 –––––

2,310

2,310

1,540

––––– 2,310 –––––

––––– 2,310 –––––

––––– 1,540 –––––

7,700 1,680 ––––– 9,380 –––––

––––– 0 ––––– 1,540 1,230 ––––– 2,770 –––––

630 420 420 1,620 92 1,080 108 2,500 240 ––––– 7,110 ––––– 2,270 500 ––––– 2,770 –––––

630 420 60

360

1,620 69 720 36

360 500 60 ––––– 560 ––––– (560) 500 ––––– (60) –––––

750 60 ––––– 3,420 ––––– (3,420) (60) ––––– (3,480) –––––

23 72 1,250

60 ––––– 1,365 ––––– 1,855 (3,480) ––––– (1,625) –––––

60 ––––– 515 ––––– 1,795 (1,625) ––––– 170 –––––

––––– 1,250 ––––– 1,060 170 ––––– 1,230 –––––

Note: The ‘Total’ column above is not required but does provide a useful arithmetic check for accuracy. Note 1 Ticket sales Total votes (180,000,000 + 100,000,000) Estimated ticket sales (280,000,000/1,000) Allocated as follows: Premium seats (280,000 x 10% x £35) Arena floor (280,000 x 30% x £30) Stalls (280,000 x 60% x £25) Total revenues Received in: September (£7,700,000 x 20%) October (£7,700,000 x 30%) November (£7,700,000 x 30%) December (£7,700,000 x 20%)

Note 2: Souvenirs sales Total number of tickets sold Average souvenirs sale each Total souvenirs sales

280,000,000 280,000 £’000 980 2,520 4,200 –––––– 7,700 –––––– 1,540 2,310 2,310 1,540 –––––––– 7,700 –––––––– £’000 280,000 6 1,680 ––––––––

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Note: 3 Souvenirs purchases Total souvenirs sales Split as follows: DVDs/CDs – 50% GPM at 25% Therefore COS at 75% Payable in August to Records Ltd Other souvenirs – 50% GPM at 50% Therefore COS at 50% Payable in September to Junk Ltd Note 4: Performers 12 performers at £35,000 each Split as follows: Due September (12 x £5,000) Due October (12 x 30,000) Note 5: Venue costs 12 venues at £150,000 each Less deposits paid (10% x £1,800,000) Remainder due in August Note 6: Transport costs 2 tour buses (2 x £10,000) 6 heavy goods vehicles (6 x £12,000) Total 75% due September 25% due October Note 7: Crew costs Total number of crew required (12 x 5) Total cost for August (30 x £12,000) Total cost for September (60 x £12,000) Note 8: Agency fees August staff 30 x £12,000 x 10% Due September September staff 60 x £12,000 x 10% Due October Note 9: Publicity costs July: £2,500,000 x 20% Aug: £2,500,000 x 30% Nov: £2,500,000 x 50% Note 10: Other costs July – Oct: £240,000/4

£’000 1,680 840 (210) –––––––– 630 –––––––– 840 (420) –––––––– 420 –––––––– £’000 420 60 360 –––––––– £’000 1,800 (180) –––––––– 1,620 –––––––– £’000 20 72 –––––––– 92 69 –––––––– 23 –––––––– £’000 60 360 –––––––– 720 –––––––– £’000 36 ––––––––

72 –––––––– £’000 500 –––––––– 750 –––––––– 1,250 –––––––– £’000 60

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(b)

Recommended method of calculation Original level of profit per (a) Income Less: expenditure per cash budget Less: venue deposits pd May Profit Revised level of profit/loss Revised income: (£9,380 x 270/280) x 1/2 Less original expenses: Add: original souvenir expenses (£630 + £420) Less revised souvenir expenses: (£1,050 x 270/280) x 1/2 Revised loss Alternative method for calculating revised profit/loss Revised profit/loss Ticket sales (note 1) Souvenirs sales (note 2) Less expenses Per original cash budget Less venue deposits paid May Add back original souvenir expenses Less revised souvenir expenses (note 3)

£’000 9,380 (7,110) (180) ––––––– 2,090 ––––––– £’000 4,523 (7,110) (180) 1,050 (506) ––––––– (2,223) ––––––– £’000 3,713 810 ––––––– (7,110) (180) 1,050 (506) –––––––

Revised loss Note 1: Revised ticket sales Total votes (180,000,000 + 90,000,000) Estimated ticket sales (270,000,000/2,000) Allocated as follows: Premium seats (135,000 x 10% x £35) Arena floor (135,000 x 30% x £30) Stalls (135,000 x 60% x £25)

£’000

4,523

(6,746) –––––––– (2,223) ––––––––

270,000,000 135,000 £’000 473 1,215 2,025 –––––––– 3,713 –––––––– £’000 135,000 6 810 ––––––––

Total revenues Note 2: Revised souvenirs sales Total number of tickets sold Average souvenirs sale each Total souvenirs sales

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Note 3: Revised souvenirs purchases Total souvenirs sales Split as follows: DVDs/CDs – 50% GPM at 25%

£’000 810 405 101 –––––––– 304 –––––––– 405 203 –––––––– 202 –––––––– 506 ––––––––

Therefore COS @ 75% Other souvenirs – 50% GPM at 50% Therefore COS at 50% Total souv. expenses (£304,000 + £202,000)

2

Silly Filly Ltd (a) NPV 0 £’000 Revenues Market research – sunk cost Animation company costs Producers’ salaries Other production costs Director’s salary Royalties (note 1) Specialist equipment Loan interest – irrelevant Net relevant cash flows Discount factor Discounted cash flow

(260)

1 £’000

2 £’000 1,200

3 £’000 2,200

4 £’000 1,600

5 £’000

(260) (240) (650) (160) (60)

(2,300)

1,700

–––––– (2,560) 1 –––––– (2,560) ––––––

–––––– 390 0·909 –––––– 355 ––––––

–––––– 1,200 0·826 –––––– 991 ––––––

–––––– 2,140 0·751 –––––– 1,607 ––––––

(110)

–––––– 1,490 0·683 –––––– 1,018 ––––––

(80)

–––––– (80) 0·621 –––––– (50) ––––––

The project should be undertaken as it has a positive NPV of £1·361 million. Note 1: Royalties 0

1

Revenues Royalties: (2 x 1·5% + 2% = 5%)

(b)

Years 2 3 1,200 2,200 –––––– 60 ––––––

4 1,600 –––––– 110 ––––––

5 –––––– 80 ––––––

Four costs of new equity issues – Underwriting costs – Stock exchange listing fees – Costs of printing and distributing the prospectus – Advertising costs – Issuing house fees – Solicitors’ fees – Public relations consultancy fees – Accountants’ fees (Note: Only four were required.)

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(c)

Reasons for a stock exchange listing Access to wider pool of finance The level of finance available to a private unlisted company is limited. Therefore, if a company needs more finance than is currently available to it, it may seek a stock exchange listing. A stock exchange listing may also improve the company’s credit rating, meaning that more investors are willing to invest in it. Enhancement of the company image A company’s image is generally improved anyway when it becomes listed, as it is perceived as being more financially stable. This may result in increased custom and increased buying power. Increased marketability of shares It is not very easy for a shareholder in a private company to sell his/her shares, and this in itself makes the investment more risky. Once a company is listed on the stock exchange, its shares become far more marketable, thus making them far more attractive. Facilitation of growth by acquisition Should a listed company wish to make an offer to takeover another company, they are in a much better position to do so than an equivalent unlisted company. This is because the terms of the offer will probably include an exchange of the shares in the acquiring company for those of the target company. Transfer of capital by founder owners A stock exchange listing gives founder members more opportunity to sell their shareholding, or part of it, leaving them free to invest in other projects. Note: Only three reasons were required.

3

Duel Fuel Ltd (a) Whether to factor Existing finance cost at 9% New level of debtors = £4,300,000 x 120% Overdraft cost per annum = £5,160,000 x 9%

£5,160,000 £464,400 ––––––––––

Cost of factoring New sales level = £8,500,000 x 120% Debtors reduced to 60 days: £10,200,000 x 60/365 70% advanced by factor at 12%: £1,676,712 x 70% x 12% 30% still financed by overdraft: £1,676,712 x 30% x 9% Admin Fee: £10,200,000 x 1·5% Saved salaries (2 x £14,000) – (2 x £3,000)

£10,200,000 £1,676,712 £ 140,844 45,271 153,000 (22,000) –––––––––– 317,115 –––––––––– 147,285 ––––––––––

Saving = £464,400 – £317,115

Conclusion It is financially viable for Duel Fuel Ltd to factor its debts as a total saving of £147,285 will be made.

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(b)

Advantages of factoring (i) Managers can concentrate on running the business rather than spending time dealing with problems relating to slow paying debtors. (ii)

The factor will run the company’s sales ledger department, hence cutting running costs in this area.

(iii) The company’s cash flow position is improved, such that the company can pay its suppliers promptly and benefit from early payment discounts. (iv) The finance costs of the business are linked to its sales levels and will therefore only increase as sales levels increase. (v)

Expansion can be financed through sales, rather than through increased debt or any injection of capital.

(vi) Optimum stock levels can be maintained, since the cash is readily available for injection. (vii) Insurance against the company’s bad debts is provided, since the factor takes over the risk of these losses if the agreement is a ‘without recourse’ agreement. Note: Only five advantages were required: (c)

4

Roles of credit control department – Keeping the sales ledger up-to-date – Pursuing overdue debts – Investigating customers’ creditworthiness – Dealing with customer queries about their account – Advising customers on payment terms – Giving references to third parties Note: Only five roles were required.

Gym Jam Ltd (a) Operating lease – This is a rental agreement between two parties, whereby the lessor supplies equipment to the lessee. – The lessor usually retains the responsibility for servicing and maintaining the leased equipment. – The period of the lease is usually shorter than the asset’s expected useful economic life. (b)

Finance lease – This is an agreement between the lessor, who provides finance for the asset, and the lessee. – The person supplying the equipment is usually a third party; the lessor just finances the asset. – The lessee is responsible for the service and maintenance of the asset. – The lease has a primary period which covers all/most of the expected useful economic life of the asset. – The lease usually has an indefinite secondary period whereby the lessee continues to lease the asset for a nominal rent.

(c)

Weaknesses and rectifications – Invoices are only raised quarterly, and using an inefficient manual system. A computerised invoicing system should be introduced that automatically raises invoices every month. – Cheques are a slow method of payment, and rely on the customer sending them by post. Direct debits should be set up for customer payments instead. – There are insufficient sales ledger staff to cope with the workload and this is causing a backlog. Additional sales ledger staff should be recruited to assist with the increased workload. – Customers are not penalised for late payment and are therefore paying late. An interest penalty should be imposed on all late payments. Customers should be notified of this on their invoices.

(d)

Factors affecting interest rate on loan – Level of risk – Interest rates in the economy – Status of the borrower – Security offered by the borrower – Amount of the loan – Purpose of the loan – Duration of the loan

(e)

Increase in interest charges Interest charges persisted in increasing because the loan was linked to the Bank’s base rate. A bank’s base rate is based on LIBOR – the London Inter-Bank Offered Rate. LIBOR is the rate at which a bank can borrow money on the Inter-bank market. This LIBOR rate must have gone up, leading to an increase in Gym Jam Ltd’s bank’s base rate, and hence the rate of interest on the loan.

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances

June 2005 Marking Scheme Marks

1

(a)

Cash budget Total votes cast Total tickets bought Premium sales Arena sales Stalls sales Total sales Ticket sales – Sept Ticket sales – Oct Ticket sales – Nov Ticket sales – Dec Souvenirs Sales Souvenirs Purchases – CDs Souvenirs Purchases – Other Performer costs – Sept Performer costs – Oct Venue costs Transport costs – Sept Transport costs – Oct Crew costs – Aug Crew costs – Sept Agency costs – Sept Agency costs – Oct Publicity costs Other costs Net cash flows Opening bank balances Closing balances Presentation

1 1 1 1 1 1 1 1 1 1 1 2 2 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 ––– 30 –––

Total (b)

Profits – recommended method Current profit figure Revised income Original expenses Add back souvenir expenses Revised souvenir expenses Loss figure

3 2 1 1 2 1 ––– 10 ––– 40 –––

Total Total marks

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Marks 2

(a)

NPV Revenues Market research – sunk cost Animation company costs Producers’ salaries Director’s salary Other production costs Royalties Special equipment Loan interest – irrelevant Discounted cash flow Conclusion

1 1 1 0·5 0·5 0·5 1 1 1 1·5 1 ––– 10 –––

Total (b)

Costs of new equity issue For each cost

1 ––– 4 –––

Max marks (c)

Stock exchange listing For each reason explained

2 ––– 6 ––– 20 –––

Max marks Total marks

3

(a)

Whether to factor New sales level Current cost New debtors level Debtors at 60 days Cost of 70% advanced Cost of 30% not advanced Admin fee Saved salaries Factor saving Conclusion

1 1 1 1 1 1 1 1 1 1 ––– 10 –––

Total (b)

Advantages For each advantage

1 ––– 5 –––

Max marks (c)

Roles For each role

1 ––– 5 ––– 20 –––

Max marks Total marks

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Marks 4

(a)

Operating lease For each characteristic

1 ––– 3 –––

Max marks (b)

Finance lease For each characteristic

1 ––– 5 –––

Max marks (c)

(d)

Weaknesses/rectifications Computerised invoicing Changing payment method More staff Interest penalty

1 1 1 1 ––– 4 –––

Interest rate factors Each factor

1 ––– 6 –––

Max marks (e)

Increasing interest Base rate must have increased Base rate based on LIBOR LIBOR explained LIBOR must have increased

1/

2

1/

2

1/

2

1/

2

––– 2 ––– 20 –––

Total marks

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ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL WEDNESDAY 14 DECEMBER 2005

QUESTION PAPER Time allowed 3 hours ALL FOUR questions are compulsory and MUST be answered

Paper T10

Managing Finances

Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

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ALL FOUR questions are compulsory and MUST be attempted 1

Gold Club Ltd is a newly established company that has not yet commenced trading. The two shareholders/directors are planning to set up an Internet business. With the help of finance from venture capitalists, they plan to set up a website through which individuals can join a ‘Gold Club’. Membership of the club will provide members with a range of quality travel services including access to a First Class lounge at airports, travel insurance for an unlimited number of trips and discounted upgrades for seats on flights. It will take one year to set up the business. You are an accounting technician who has been asked to appraise the investment of capital in the project based on a six-year plan (one year to set up the business followed by five years of operation). (i)

Market research has been carried out at a cost of £200,000. This indicates that the number of new members joining the club would be approximately 5,000 each year. Of these new joiners each year, 50% will renew their membership ONCE, in the following year.

(ii) Membership fees for new members joining the club each year will be £500. Members renewing their membership in the subsequent year will benefit from a reduced annual fee of £400. (iii) The – – –

costs of setting up the website are as follows: Design costs: £1,220,000 Administrative costs: £125,000 Legal advice fees: £155,000

25% of these costs will be paid immediately as a deposit, with the remainder being paid in one year’s time. (iv) The costs of the technical support for maintaining the website will be £100,000 for the first year it is in operation. These costs will increase by 20% year-on-year thereafter. (v) All new members will be issued with a club card, with an electronic chip in it. The cost of this card for Gold Club Ltd will be £3 per member. Once the original card is issued, there will be no need to issue a further card for renewal of membership. The supplier will be paid annually in arrears for all cards issued in that year. The first payment is therefore due at the end of the second year. (vi) For every member who uses a First Class lounge at any airport worldwide, a charge of £20 will be made to Gold Club Ltd each time the lounge is used. It is estimated that 40% of members will use it three times a year, 30% of members will use it twice a year, 20% will use it once a year and 10% will not use it at all. (vii) Gold Club Ltd will purchase a travel insurance policy based primarily on the number of members in the scheme. It is assumed that all members will make use of the travel insurance and the supplier will therefore charge Gold Club Ltd £50 per member in the first year, increasing steadily by £2 per member each year after that. Each member will have to e-mail the travel insurers with details of their trip in advance of each trip. Therefore, the insurers will also charge Gold Club Ltd an administrative fee of £2 for every e-mail received. Gold Club Ltd estimates that on average each member will send two e-mails per annum. (viii) Gold Club Ltd will pay ten major airlines £100,000 EACH per annum in order to provide their members with access to discounted seat upgrades. (ix) Overdraft interest will be £5,000 per annum. (x) Assume that all cash flows, including the receipt of membership fees, occur at the end of each year, unless otherwise stated. (xi) The company’s cost of capital is 10% per annum. (xii) Workings should be in £’000, to the nearest £’000.

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Required: (a) Using the discount tables provided at the end of the question, calculate the project’s net present value (NPV) at the company’s cost of capital. Conclude as to whether the company should proceed with the project, giving a reason for your conclusion. (30 marks) (b) Identify and discuss five factors that a venture capital organisation would take into account when deciding whether or not to invest in Gold Club Ltd. (10 marks) Present value table (extract) Periods (n) 1 2 3 4 5 6 7 8 9 10

Discount rates (r) 10% 20% 0·909 0·833 0·826 0·694 0·751 0·579 0·683 0·482 0·621 0·402 0·564 0·335 0·513 0·279 0·467 0·233 0·424 0·194 0·386 0·162 (40 marks)

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[P.T.O.

2

Cleanly Ltd is a manufacturing company producing and selling a range of cleaning products to wholesale customers. It has three suppliers and two customers. Cleanly Ltd relies on its cleared funds forecast to manage its cash. You are an accounting technician for the company and have been asked to prepare a cleared funds forecast for the period Monday 2 January to Friday 6 January 2006 inclusive. You have been provided with the following information: (1) Receipts from customers Customer name Credit terms W Ltd 1 calendar month X Ltd None

Payment method BACS Cheque

2 Jan 2006 sales £150,000 £180,000

2 Dec 2005 sales £130,000 £160,000

(a) Receipt of money by BACS is instantaneous. (b) X Ltd’s cheque will be paid into Cleanly Ltd’s bank account on the same day as the sale is made and will clear on the third day following this (excluding day of payment). (2) Payments to suppliers Supplier Credit name terms A Ltd 1 calendar month B Ltd 2 calendar months C Ltd None

Payment method Standing order Cheque Cheque

2 Jan 2006 purchases £65,000 £85,000 £95,000

2 Dec 2005 purchases £55,000 £80,000 £90,000

2 Nov 2005 purchases £45,000 £75,000 £85,000

(a) Cleanly Ltd has set up a standing order for £45,000 a month to pay for supplies from A Ltd. This will leave Cleanly’s bank account on 2 January. Every few months, an adjustment is made to reflect the actual cost of supplies purchased (you do NOT need to make this adjustment). (b) Cleanly Ltd will send out, by post, cheques to B Ltd and C Ltd on 2 January. The amounts will leave its bank account on the second day following this (excluding the day of posting). (3) Wages and salaries Weekly wages Monthly salaries

December 2005 £12,000 £56,000

January 2006 £13,000 £59,000

(a) Factory workers are paid cash wages (weekly). They will be paid one week’s wages, on 6 January, for the last week’s work done in December (i.e. they work a week in hand). (b) All the office workers are paid salaries (monthly) by BACS. Salaries for December will be paid on 2 January. (4) Other miscellaneous payments (a) Every Monday morning, the petty cashier withdraws £200 from the company bank account for the petty cash tin. The money leaves Cleanly’s bank account straight away. (b) The window cleaner is paid £30 from petty cash every Wednesday morning. (c) Office stationery will be ordered by telephone on Tuesday 3 January to the value of £300. This is paid for by company debit card. Such payments are generally seen to leave the company account on the next working day. (d) Five new computers will be ordered over the Internet on 5 January at a total cost of £6,500. A cheque will be sent out on the same day. The amount will leave Cleanly Ltd’s bank account on the second day following this (excluding the day of posting). (5) Other information The balance on Cleanly’s bank account will be £200,000 on 2 January 2006. This represents both the book balance and the cleared funds. Required: Prepare a cleared funds forecast for the period Monday 2 January to Friday 6 January 2006 inclusive using the information provided. Show clearly the uncleared funds float each day. (20 marks) 4 FOR FREE CAT & ACCA RESOURCES VISIT: http://kaka-pakistani.blogspot.com

3

Fibre Clean Ltd is a small company specialising in the cleaning of upholstery and carpets. All of the company’s current customers are domestic and pay at the time the work is done. Mr Sykes, the owner, is considering undertaking a number of commercial contracts instead of his domestic work because the profit margins are much higher. It is standard practice in this sector to offer 30-day credit terms to customers. Mr Sykes is concerned about a number of issues. Firstly, how he can ensure that he only provides credit to creditworthy customers. Secondly, how he will manage the extra administrative workload and, finally, what the effect of providing credit will be on his cash position. He is already overdrawn at his local bank. A friend of Mr Sykes has suggested that he should obtain ‘trade references’ for his new customers and seek the advice of a ‘credit reference agency’. Required: (a) Describe the following sources of externally generated information and their usefulness in assessing the creditworthiness of Mr Sykes’ new customers: (i) Trade reference; (ii) Credit reference agency.

(6 marks)

(b) Explain the meaning of ‘debt factoring’ and ‘invoice discounting’ to Mr Sykes. Highlight any key differences between the two and suggest which one may be more useful for Mr Sykes. (5 marks) (c) If Mr Sykes changes to commercial contracts, he expects sales for the next year to be £75,000, with customers paying within the 30-day limit set. It would cost him £2,000 per annum to employ someone one day a week to invoice customers and collect debts for him. Alternatively, his local bank has offered to provide a factoring service for him, including the advance of 80% of his sales invoices. They would charge 2% of turnover for the administration and charge interest of 8% per annum on advances. However, the bank would not invoice Mr Sykes’ customers. He would need to employ somebody for half a day a week to do this, at a cost of £1,000 per annum. Mr Sykes pays interest at the rate of 10% per annum on his overdrawn bank account. Mr Sykes thinks that customers will pay within 30 days regardless of which option is selected. Required: Calculate and recommend whether or not Mr Sykes should factor his debts.

(9 marks) (20 marks)

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[P.T.O.

4

(a) Define the term ‘financial intermediary’, distinguishing between a ‘broker’ and a ‘principal’. Give four examples of organisations that act as financial intermediaries. (4 marks) (b) Discuss four main benefits of financial intermediation.

(8 marks)

(c) Briefly describe four main money market instruments.

(4 marks)

(d) Governments use monetary policy to control prices, economic growth and employment levels. Required: Define ‘quantitative’ and ‘qualitative’ controls used by governments.

(4 marks) (20 marks)

End of Question Paper

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances 1

December 2005 Answers

Gold Club Ltd (a)

Time 0 £’000 Market research – ignore Membership fees (notes 1 & 2) Set-up costs (note 3) Maintenance costs (note 4) Club cards (5,000 x £3) First Class lounge (note 5) Travel insurance (note 6) Upgrade costs (10 x £100k) Interest costs – ignore Net cash flow 10% discount factors Discounted cash flow

(375)

1 £’000

2 £’000

3 £’000

4 £’000

5 £’000

6 £’000

2,500

3,500

3,500

3,500

3,500

(100) (15) (200) (270) (1,000)

(120) (15) (300) (420) (1,000)

(144) (15) (300) (435) (1,000)

(173) (15) (300) (450) (1,000)

(208) (15) (300) (465) (1,000)

(1,125)

–––––– (375) –––––– ––––––

–––––– (1,125) –––––– ––––––

–––––– 915 –––––– ––––––

–––––– 1,645 –––––– ––––––

–––––– 1,606 –––––– ––––––

–––––– 1,562 –––––– ––––––

–––––– 1,512 –––––– ––––––

1·000 –––––– (375) ––––––

0·909 –––––– (1,023) ––––––

0·826 –––––– 756 ––––––

0·751 –––––– 1,235 ––––––

0·683 –––––– 1,097 ––––––

0·621 –––––– 970 ––––––

0·564 –––––– 853 ––––––

The net present value of the project is £3·513 million. The project should therefore be undertaken, since the net present value is positive. Note 1: Membership numbers New members Renewals at 50% Total members Of which, new members Renewals Note 2: Fees New members Fee per member £ Total new member fees Renewal member numbers Fee per member £ Total fees from renewals Total fees

Year 1 T2 5,000 –––––– 5,000 –––––– 5,000 –––––– 0 ––––––

Year 2 T3 5,000 2,500 –––––– 7,500 –––––– 5,000 –––––– 2,500 ––––––

Year 3 T4 5,000 2,500 –––––– 7,500 –––––– 5,000 –––––– 2,500 ––––––

Year 4 T5 5,000 2,500 –––––– 7,500 –––––– 5,000 –––––– 2,500 ––––––

Year 5 T6 5,000 2,500 –––––– 7,500 –––––– 5,000 –––––– 2,500 ––––––

Year 1 T2 5,000 500 £’000 2,500 –––––– 0 400 £’000 0 –––––– 2,500 –––––– ––––––

Year 2 T3 5,000 500 £’000 2,500 –––––– 2,500 400 £’000 1,000 –––––– 3,500 –––––– ––––––

Year 3 T4 5,000 500 £’000 2,500 –––––– 2,500 400 £’000 1,000 –––––– 3,500 –––––– ––––––

Year 4 T5 5,000 500 £’000 2,500 –––––– 2,500 400 £’000 1,000 –––––– 3,500 –––––– ––––––

Year 5 T6 5,000 500 £’000 2,500 –––––– 2,500 400 £’000 1,000 –––––– 3,500 –––––– ––––––

Year 2 £’000 T3

Year 3 £’000 T4

Year 4 £’000 T5

Year 5 £’000 T6

120 ––––––

144 ––––––

173 ––––––

208 ––––––

Note 3: Set-up costs Costs = £1,220k + £125k + £155k = £1,500k T0: 25% x £1,500k = £375k T1: 75% x £1,500k = £1,125k Note 4: Maintenance costs

£100k in first year Increasing by 20% each year thereafter

Year 1 £’000 T2 100 ––––––

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Note 5: First Class lounge

Year 1 Year 2 Year 3 T2 T3 T4 Number of members 5,000 7,500 7,500 –––––– –––––– –––––– £’000 £’000 £’000 40% x £20 x 3 120 180 180 30% x £20 x 2 60 90 90 20% x £20 x 1 20 30 30 –––––– –––––– –––––– Total costs 200 300 300 –––––– –––––– –––––– (There is effectively an average of two visits per club member per year.)

Year 4 T5 7,500 –––––– £’000 180 90 30 –––––– 300 ––––––

Year 5 T6 7,500 –––––– £’000 180 90 30 –––––– 300 ––––––

Note 6: Travel insurance costs

Year 4 T5 56 4 –––––– 60 –––––– 7,500 £’000 –––––– 450 –––––– ––––––

Year 5 T6 58 4 –––––– 62 –––––– 7,500 £’000 –––––– 465 –––––– ––––––

Flat rate per member £ E-mail costs: 2 x £2

Total number of members Total costs (b)

Year 1 T2 50 4 –––––– 54 –––––– 5,000 £’000 –––––– 270 –––––– ––––––

Year 2 T3 52 4 –––––– 56 –––––– 7,500 £’000 –––––– 420 –––––– ––––––

Year 3 T4 54 4 –––––– 58 –––––– 7,500 £’000 –––––– 435 –––––– ––––––

Venture capitalists Factors that a venture capitalist organisation will take into account are as follows: (i)

Level of expertise of Gold Club Ltd’s management Venture capitalists will believe that the success of Gold Club Ltd’s membership scheme is dependent on the quality of the two shareholders/directors. They will expect these two key personnel to show a high level of commitment to the project. As both the existing owners of the business are all involved in the running of the company, this should be proof of their commitment. The venture capitalists will also look at the amount of money that the owners themselves have invested in the project in assessing their level of commitment. The venture capitalists will expect a place on Gold Club Ltd’s Board of Directors so that they can have a say in future business strategy.

(ii)

Level of expertise in the area of service The venture capitalists will seek assurance that the directors have the necessary know-how and technical support to be able to run the website properly. In addition, they will need assurance that Gold Club Ltd can really provide the services to its customers.

(iii) The nature of Gold Club Ltd’s product The venture capitalists will consider the feasibility of providing the service at the membership prices proposed. This will involve analysing the cost estimates to ascertain their accuracy and ensuring, for example, that key airlines have agreed to the discounted upgrades and to the use of their First Class lounges. The venture capitalists will need a high level of assurance about the accuracy of the forecast membership numbers. (iv) The market and competition The venture capitalists will seek assurance that there is actually a market for the Club, as there are already some similar memberships available in the market place. They will ask to see the market research that has already been carried out. The venture capitalists will also look at the threat posed by new entrants in the market, and current rival membership schemes. (v)

Future prospects Since the risk involved in investing in a new company is fairly high, the venture capitalists will seek to ensure that the prospects for future profits compensate for the risk. They will therefore want to see a detailed business plan setting out the future business strategy.

(vi) Exit routes The venture capitalists will consider potential exit routes before they invest in the venture. They will not invest money in a share of the business unless they are confident that it can be sold at some point in the future. Note: Only five factors were required.

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2

Cleanly Ltd Cleared Funds Forecast

Receipts W Ltd X Ltd

Payments A Ltd B Ltd C Ltd Wages Salaries Petty Cash Stationery

Cleared excess receipts over payments Cleared balance b/f Cleared balance c/f Uncleared funds float Receipts Payments

Total book balance c/f

3

2 Jan £

3 Jan £

4 Jan £

5 Jan £

6 Jan £

130,000 0 –––––––– 130,000 ––––––––

0 0 –––––––– 0 ––––––––

0 0 –––––––– 0 ––––––––

0 180,000 –––––––– 180,000 ––––––––

0 0 –––––––– 0 ––––––––

45,000 0 0 0 56,000 200 0 –––––––– 101,200 ––––––––

0 0 0 0 0 0 0 –––––––– 0 ––––––––

0 75,000 95,000 0 0 0 300 –––––––– 170,300 ––––––––

0 0 0 0 0 0 0 –––––––– 0 ––––––––

0 0 0 12,000 0 0 0 –––––––– 12,000 ––––––––

28,800 200,000 –––––––– 228,800 ––––––––

0 228,800 –––––––– 228,800 ––––––––

(170,300) 228,800 –––––––– 58,500 ––––––––

180,000 58,500 –––––––– 238,500 ––––––––

(12,000) 238,500 –––––––– 226,500 ––––––––

180,000 (170,000) –––––––– 10,000 –––––––– 238,800 –––––––– ––––––––

180,000 (170,300) –––––––– 9,700 –––––––– 238,500 –––––––– ––––––––

180,000 0 –––––––– 180,000 –––––––– 238,500 –––––––– ––––––––

0 (6,500) –––––––– (6,500) –––––––– 232,000 –––––––– ––––––––

0 (6,500) –––––––– (6,500) –––––––– 220,000 –––––––– ––––––––

Fibre Clean Ltd (a)

(i)

Trade reference A trade reference is a reference received from another business that the potential customer deals with. The trade referee selected should offer similar terms to those now being offered to Mr Sykes’ customers, that is, 30-days terms. A well known company stated as a referee should always be followed up, but if the name given is that of an unknown company, it should be treated with caution. This is because there is an increased likelihood of collusion between Mr Sykes’ new customer and their referee. Mr Sykes should contact the referee himself, enclosing a stamped addressed envelope so that the reply comes direct to him. This prevents possible alteration by the customer. The main problem with obtaining trade references arises from the fact that Mr Sykes’ potential customers are unlikely to provide him with the names of referees who will provide bad references. They will only provide the names of those creditors with whom they have a good credit history. Their usefulness is severely limited by this factor.

(ii)

Credit reference agency These agencies provide information about businesses so that their creditworthiness can be assessed by potential suppliers. The level of information they hold varies. Some merely hold background information, for example, a set of a company’s financial statements. Others hold more up to date information and may offer a credit rating. Some of the main agencies include Equifax, Infolink, CCN, Moody’s and Dunn & Bradstreet. The main restriction on the usefulness of these agencies is that the information is often out of date. They are also of less use for assessing newer businesses which do not have enough history on which to base a credit assessment.

(b)

Debt Factoring and Invoice Discounting Debt Factoring ‘Debt Factoring’ is a service provided by factors whereby the factor collects debts on behalf of their client and often invoices their client’s customers as well. The factor also advances, to its client, a proportion of the money it is due to collect (typically about 80% is advanced). Mr Sykes would find the service useful because he could both receive cash early and reduce administration.

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There are two types of factoring agreements: ‘with recourse’ and ‘without recourse’ agreements. With the first of these agreements, although the factor advances monies, the risk of non-payment of debts stays with the client. If a debtor defaults, the factor has ‘recourse’ to their client for the money. If the agreement is ‘without recourse’ the factor bears the risk of nonpayment. Debt factoring has to be paid for, usually as a percentage of the amounts advanced and as a percentage of turnover. Agreements without recourse to the client obviously cost more. Mr Sykes would have to compare his total costs if he uses a factor to his total costs if he does not use a factor before making a decision. He should also take into account the fact that there is some stigma attached to debt factoring as clients sometimes assume that a business using a factor must be in financial difficulty. Invoice Discounting Invoice discounting is a service whereby a provider (often a factoring company) purchases invoices from a client at a discount. In this case, they are merely advancing cash, rather than providing a debt collection service. Again there will be a charge for discounting, calculated as a percentage of the invoices purchased. Given Mr Sykes’ concerns about his increased workload, a factoring arrangement would be far more suited to his needs. (c)

Cost of factoring Cost of financing debtors Average debtors £75,000 x 30/365 20% financed by overdraft at 10% Average level of factor’s advance: £6,164 x 80% Cost at 8%

£ 6,164

£ 123

4,931 394 –––––– 517

Total cost of financing debtors Sales administration cost 2% x £75,000 Invoicing administrator employed

1,500 1,000 –––––– 3,017 ––––––

Total cost of arrangement Cost of not factoring Cost of financing debtors Average debtors £75,000 x 30/365 Financed by overdraft at 10% Sales administration cost New staff

6,164 616 2,000 –––––– 2,616 ––––––

Total cost of arrangement

The factoring arrangement would cost Mr Sykes £401 per annum more than not factoring. Therefore, he should not enter into the agreement.

4

Financial matters (a)

Financial intermediaries A financial intermediary is an organisation that brings together potential borrowers and potential lenders. Such an intermediary can act as a broker, whereby they handle a transaction on behalf of others. Alternatively, they may act as a principal, whereby they hold money balances of lenders for lending on to borrowers. Examples of financial intermediaries include: – Banks – Building societies – Finance houses – Insurance companies – Pension funds – Unit trusts – Investment trust companies Note: Only four examples were required.

(b)

Benefits of financial intermediation (i)

Lending/borrowing becomes easier The intermediary has a whole range of lenders and a whole range of borrowers. This makes lending and borrowing easier. Both parties know where to go to lend or borrow money since the services of financial intermediaries are well-advertised.

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(ii)

Risk reduction The intermediary helps to spread the risk of lending money to borrowers among the various lenders who deposit money with the intermediary. This clearly benefits the lender. In addition, intermediation reduces risk for the borrower too. For example, an organisation such as a unit trust company invests money in a variety of stocks and shares thereby ensuring diversification. Individuals then buy a small share of such investments, thus benefiting from risk reduction through diversification, but without having to invest large sums of money in numerous investments.

(iii) Aggregation The intermediary is able to aggregate the amount lent by savers into amounts which the borrower may require. This makes the process of borrowing large sums of money much easier for the borrower. For example, if an individual requiring £100,000 to buy a house had to approach numerous different lenders, the process would be time-consuming and expensive. (iv) Maturity transformation The intermediary bridges the gap between the desire of many lenders for liquidity and the need of many borrowers for long-term loans. In order to fulfil this role, it is essential that the intermediary keeps an adequate reserve of liquid assets. (c)

(d)

Financial instruments – Deposits: deposits of money with financial intermediaries such as banks. –

Bills: short-term financial assets which can be converted into cash at short notice by selling them in the discount market.

–

Commercial paper: short-term IOUs issued by large companies. They can either be held until maturity or sold on before then.

–

Certificates of deposit: available to customers who deposit a minimum of £50,000 for fixed terms. They can be held until maturity or sold in the CD market.

Monetary policies Quantitative controls Quantitative controls are those controls introduced by the government to restrict the amount of money lent by the clearing banks. Qualitative controls These are where the government restricts the type of lending that banks can do, rather than the amounts which they can lend. For example, the government may introduce incentives for lending to manufacturing businesses, or create disincentives for lending to individuals.

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances

December 2005 Answers Marks

1

Gold Club Ltd (a)

NPV Ignore market research Membership numbers Membership fees Set-up costs Maintenance costs Club cards First class lounge Travel insurance Upgrade costs Ignore interest costs Net cash flow Correct discount factors Discounted cash flow NPV Conclusion and reason Presentation

2 2 4 2 1 1 4 3 1 1 2 1 2 1 2 1 –––– 30 ––––

Total (b)

Venture capitalists For each factor discussed

2 –––– 10 –––– 40 ––––

Max marks Total marks

2

Cleanly Ltd Receipts: W Ltd X Ltd

1 1

Payments: A Ltd B Ltd C Ltd Wages Salaries Petty Cash Ignore window cleaner Stationery Total

1 1 1 1 1 1 1 1 1

Cleared excess Cleared balance b/f Cleared balance c/f

1 2 1

Uncleared funds float Receipts Payments

1 1

Total book balance c/f Correct presentation

1 2 –––– 20 ––––

Total marks

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Marks 3

Fibre Clean Ltd (a)

References and agencies (i)

Trade reference Definition Similar terms Well known co. vs unheard of Contact directly Limitation

1 1 1 1 1 –––– 3 ––––

Max marks (ii)

Credit reference agency Provide info re suppliers Detail of info varies Main agencies Out of date Not good for new companies

1 1 1 1 1 –––– 3 ––––

Max marks (1 mark each awarded for any useful comments) (b)

Factoring and invoicing Factoring Definition Includes administration With recourse agreements Without recourse agreements Cost

1 1 1 1 1

Invoice discounting Definition Advancing cash Cost Conclusion on most suitable

1 1 1 1 –––– 5 ––––

Max marks (c)

Cost of factoring Factoring Average debtors figure 20% overdraft cost 80% advance figure Cost at 15% Sales admin cost at 2% Invoicer cost

1 1 1 1 1 1

Not factoring Overdraft cost at 100% Administrator cost

1 1

Conclusion

1 –––– 9 –––– 20 ––––

Total Total marks

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Marks 4

Financial matters (a)

Financial intermediaries Definition Broker/principal Examples (0·5 each, max 2 marks)

1 1 2 –––– 4 ––––

Total (b)

Benefits Easier Risk reduction Aggregation Maturity transformation

2 2 2 2 –––– 8 ––––

Total (Award marks for all sensible points) (c)

Financial instruments Each one

1 –––– 4 ––––

Total (d)

Monetary policies Quantitative controls Qualitative controls

2 2 –––– 4 –––– 20 ––––

Total Total marks

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ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL WEDNESDAY 14 JUNE 2006

QUESTION PAPER Time allowed 3 hours ALL FOUR questions are compulsory and MUST be answered

Paper T10

Managing Finances

Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

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ALL FOUR questions are compulsory and MUST be attempted 1

Maybay Hospital is a private hospital. Currently, all cleaning is undertaken by staff employed by the hospital. There are 150 cleaning staff in total, of which half work full-time and half work part-time. Over the last year there has been a serious outbreak of the MRSA bug (a bacterial infection resistant to antibiotics) in the hospital. Cleaning standards have therefore become a key issue. The hospital is currently being sued by a group of patients who are all claiming to have suffered from MRSA following admittance to Maybay. This has caused a significant fall in the number of patient admissions and an increase in the hospital’s insurance costs. The hospital managers are now considering whether they should continue with their existing cleaning staff (Option 1) or contract out the cleaning function to external providers for the next five years (Option 2). The following information has been provided: 1 2 3 4 5

6

7 8

9

10 11 12 13

14 15 16

Full-time cleaning staff work 35 hours a week and are paid £5·70 per hour. Part-time cleaning staff work a 20-hour week and are paid £5·65 per hour. Eight full-time supervisors are also employed, in addition to the cleaning staff, at a salary of £15,000 per annum each. Other staff costs, including pension costs, average £2,625 per annum per full-time employee (including supervisors) and £1,215 per part-time employee. If the cleaning continues to be done by hospital cleaners, it has already been decided that 10 new full-time cleaners will be employed immediately. The hospital will also recruit a further 15 full-time cleaners in one year’s time. Total insurance costs for the whole hospital are currently £6·5 million per annum. The hospital estimates that these will fall immediately by 10% if the cleaning is contracted out to an external provider. They will remain the same if the cleaning is NOT contracted out. Cleaning materials cost £1·44 million per annum. If an external provider is used in the future, they will provide their own cleaning materials. Independent inspectors inspect hospital hygiene standards every six months. Breaches of standards fall into one of two categories: serious breaches, for which a fine of £10,000 per breach is imposed, and minor breaches, for which a fine of £2,000 per breach is imposed. If the hospital does NOT contract out its cleaning, but the new cleaners are employed, it is estimated that serious breaches can be limited to 22 per year and minor breaches can be limited to 74 per year. The external providers expect to restrict these breaches to 17 and 50 respectively in the first year, falling to 8 and 25 respectively per year thereafter. Even with a contracted out cleaning service, the hospital will continue to be responsible for all payments of fines. The hospital has invested heavily in floor polishing machines over recent years, and currently has 150 in total. The external providers have offered to buy these immediately at a price of £4,000 each, should the contracting out go ahead. Adverse publicity resulting from the MRSA bug is costing the hospital £1·2 million per annum in lost contribution. The external cleaning providers’ reputation is such that this amount can be totally eliminated immediately. The external providers have offered to provide cleaning services for a contracted five-year period. The fees will be £4·25 million for each of the first two years, increasing to £4·5 million per annum thereafter. Administration costs are currently £300,000 per annum. They would fall to £270,000 per annum if the cleaning were contracted out. If the hospital decides to contract out the cleaning, it will be with immediate effect. A redundancy package has been put together for current staff. Each full-time employee, including supervisors, will receive an average of £5,000 and each part-time employee will receive an average of £3,000. These amounts will be payable immediately. The hospital managers have spent £60,000 researching and calculating their costs. The hospital’s cost of capital is 10% per annum. Assume that all cash flows occur at the end of each year unless told otherwise.

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Required: (a) Calculate the net present values of the costs of each of the two options above. Recommend whether the hospital should continue with its existing staff (Option 1) or contract out of cleaning for the next five years (Option 2). (30 marks) (b) State four factors, other than cost, that should be taken into account when deciding whether to use the external providers. (4 marks) (c) Explain the main principles used to differentiate between relevant and irrelevant costs for investment appraisal. Include a brief explanation of the treatment of finance costs. (6 marks) NOTE: All workings and answers should be in £’000, to the nearest £’000. Present value table (extract) Periods (n) 1 2 3 4 5 Annuity factor table (extract) Periods (n) 1 2 3 4 5

Discount rate (r) 10% 0·909 0·826 0·751 0·683 0·621

Discount rate (r) 10% 0·909 1·736 2·487 3·170 3·791 (40 marks)

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[P.T.O.

2

You have been provided with the following financial information relating to Health Foods Ltd. Forecast Profit and Loss Account for the year ending 30 June 2007 £’000 20,350 (12,265) ––––––– 8,085 (785) ––––––– 7,300 (2,230) ––––––– 5,070 (2,270) ––––––– 2,800 –––––––

Turnover Operating costs Operating profit Interest payable Profit before tax Tax payable Profit after tax Dividends payable Retained profit

Extract from Historical Balance Sheet as at 30 June 2006 (Actual figures) £’000

£’000

Fixed assets Current assets Stock Debtors Cash Current liabilities Trade creditors Tax payable Dividends payable

£’000 8,000

2,167 2,543 1,264 –––––– 5,974 1,737 1,895 1,542 –––––– (5,174) ––––––

Net current assets

800 –––––– 8,800 –––––– ––––––

Net assets Extract from Forecast Balance Sheet as at 30 June 2007 £’000

£’000

Fixed assets Current assets Stock Debtors Cash Current liabilities Trade creditors Tax payable Dividends payable

£’000 8,300

3,245 3,318 2,984 –––––– 9,547 1,723 2,289 2,235 –––––– (6,247) ––––––

Net current assets

3,300 ––––––– 11,600 ––––––– –––––––

Net assets

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Additional information 1. Operating costs include depreciation of £200,000. 2. The company does not plan to sell any fixed assets over the next year. 3. Fixed assets are all tangible (physical) assets. 4. All finance costs are paid in the year in which they are incurred. Required: (a) Prepare a forecast cash flow statement for Health Foods Ltd for the year ending 30 June 2007 identifying the net cash flow for the business. Note: Accounting standards format is not required. (16 marks) (b) Briefly describe the drawbacks of the Baumol (EOQ) cash management model.

(4 marks) (20 marks)

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[P.T.O.

3

You are an accounting technician working at Shoes for You Ltd, a company that manufactures and distributes a range of fashion shoes. All shoes are made at the company’s factory in the country of Bushai, where materials and labour have historically been very cheap. The shoes are then exported to the UK where they are sold to a number of retail outlets. All costs are incurred in Bushai’s unit of currency. All materials are paid for in cash at the time of purchase. Production staff are paid their wages daily in cash. They have not had a pay increase in the last year. All other overheads, production and sales, are on credit. All sales are to UK customers and are on credit. They are, therefore, invoiced (and amounts are received) in £ sterling. Any finance needed for the business is also obtained from the UK. You have estimated the figures below for the coming year. Sterling has been used for all figures so as to avoid any distortion caused by high inflation in Bushai. Sales Average debtors Materials purchases Production staff wages Other production overheads Sales overheads Net profit margin Average stocks: Finished goods Work in progress (65% complete) Raw materials Average creditors

£2,500,000 £410,000 £630,000 £450,000 £350,000 £320,000 30% £325,000 £195,000 £133,000 £73,000

The economy in Bushai has recently become unstable. This has led to a rapid increase in inflation levels over the last year, from 10% at the beginning of the year to 25% at the end of the year. Interest rates are controlled by Bushai’s central bank. Inflation in the UK has remained stable at about 4% per annum. Required: (10 marks)

(a) Calculate the cash operating cycle. (b) The raw material holding period has doubled over the last year.

State the main financial advantage and main financial disadvantage of this happening, paying attention to the fact that inflation has increased over the year. (4 marks) (c) Discuss BRIEFLY the general problems associated with inflation as listed below and consider how each problem affects Shoes for You Ltd. (i)

(2 marks)

Redistribution of income and wealth;

(ii) The balance of trade (Do NOT discuss exchange rates);

(2 marks)

(iii) Higher interest rates.

(2 marks) (20 marks)

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4

Financial analysts will use ratios to compare performance of companies in the same industry. Lenders will frequently use ratio analysis to help them decide whether to lend to an individual in the first place and whether to continue their financial support. Business owners and managers also use ratios to assess the financial performance of their business. Such ratios may include earnings per share, interest cover, gearing and net profit margin. Required: (a) Outline FOUR sources of finance (short and/or long-term) available to small and medium-sized businesses. Ignore government grants, leasing and factoring. (12 marks) (8 marks)

(b) Discuss four limitations of ratio analysis.

(20 marks)

End of Question Paper

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances 1

June 2006 Answers

Maybay Hospital (a)

Option 1: Continue with existing staff 0 £’000 Full-time staff costs (1) Part-time staff costs (2) Cleaning materials Insurance costs Fines (3) Administration costs Research costs – ignore as sunk Net cash flow 10% discount factors (4) Discounted cash flow

––––– 0 1·000 0 ––––– –––––

Time 1 £’000 1,246 532 1,440 6,500 368 300

2–5 £’000 1,440 532 1,440 6,500 368 300

––––––– 10,386 0·909 9,441 ––––––– –––––––

––––––– 10,580 2·882 30,492 ––––––– –––––––

Total present value of costs of Option 1 over next five years is £39·933 million. 1.

Full-time staff costs Wages: 85/100 staff x 35hrs at £5·70 x 52 weeks Supervisors: 8 x £15,000 Other costs: £2,625 x 93/108

2.

Part-time staff costs Wages:75 staff x 20hrs at £5·65 x 52 weeks Other costs: £1,215 x 75

3.

Fines Serious breaches (22 x £10,000) Minor breaches (74 x £2,000)

4.

T1 £’000 882 120 244 –––––– 1,246 ––––––

T2–5 £’000 1,037 120 283 –––––– 1,440 ––––––

T1–5 441 91 –––– 532 –––– 220 148 –––– 368 ––––

Annuity factor Annuity factor T2 – T5 = 3·791 – 0·909 = 2·882

Option 2: Contracting out

Annual contract fees Revised insurance costs (£6·5m x 90%) Revised fine costs (5) Machine sales (150 x £4000) Saved revenue contribution Administration costs Redundancy costs (6) Net cash flow 10% discount factors (7) Discounted cash flow

Time 0 £’000

1 £’000 4,250 5,850 270

2 £’000 4,250 5,850 130

3–5 £’000 4,500 5,850 130

(1,200) 270

(1,200) 270

(1,200) 270

–––––– 9,440 –––––– –––––– 0·909 –––––– 8,581 –––––– ––––––

–––––– 9,300 –––––– –––––– 0·826 –––––– 7,682 –––––– ––––––

(600)

640 –––––– 40 –––––– –––––– 1·000 –––––– 40 –––––– ––––––

––––––– 9,550 ––––––– ––––––– 2·055 ––––––– 19,625 ––––––– –––––––

Net present value of costs of Option 2 is £35·928 million. The hospital should therefore choose Option 2 and contract out the cleaning since the net present value of the costs is £4·005 million less than for Option 1.

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5.

6.

7.

Yr 1 Revised fines £’000 Serious breaches (17/8 x £10,000) 170 Minor breaches (50/25 x £2,000) 100 –––– 270 –––– Redundancy costs Full-time: 83 x £5,000 Part-time: 75 x £3,000

Yrs 2–5 £’000 80 50 –––– 130 ––––

415 225 –––– 640 ––––

Annuity factor Annuity factor T2 – T5 = 3·791 – 1·736 = 2·055

Note: It is the difference in the NPVs of the two options that is important, rather than the NPVs themselves. (b)

Other factors Other factors to be considered, apart from cost: (i) (ii) (iii) (iv) (v) (vi)

The experience of the external provider’s cleaners in the area of hospital cleaning. The reliability of the cleaners in turning up for work. The quality of the cleaning provided. The effect on morale of remaining hospital staff if work is passed on to an outside provider and redundancies are made. The extent to which reliance can be placed on the external provider’s assertions re reducing fines and lost admissions. The extent to which the cleaning materials used by the contractors are environmentally friendly.

Note: Only four factors were required. Marks will be given for any sensible suggestion. (c)

Relevant costs The following principles should be applied when identifying costs that are relevant to a project. Relevant costs are future costs A relevant cost is a future cost arising as a direct consequence of a decision. A cost which has been incurred in the past is therefore totally irrelevant to any decision that is being made now. Such past costs are called ‘sunk costs’. Relevant costs are cash flows Only those future costs which are in the form of cash should be included. This is because relevant costing works on the assumption that profits earn cash. Therefore, costs which do not reflect cash spending should be ignored for the purpose of decision-making. Relevant costs are incremental costs A relevant cost is the increase in costs which results from making a particular decision. For example, an opportunity cost – the value of a benefit foregone as a result of choosing a particular course of action – will always be a relevant cost. This is because it is a future incremental cost. Any costs or benefits arising as a result of a past decision should be ignored, for example, costs to which the business is already committed. Finance costs Certain other costs will also be irrelevant to decision-making, such as ‘finance costs’. This is because interest has already been taken into account in the discounting process.

2

Health Foods Ltd (a)

Projected cash flow statement Operating profit Depreciation Finance costs Tax paid (w.1) Dividends paid (w.2) Fixed asset purchases (w.3) Increase in stock (w.4) Increase in debtors (w.5) Decrease in trade creditors (w.6) Projected increase in cash over the year

£’000 8,085 200 (785) (1,836) (1,577) (500) (1,078) (775) (14) –––––– 1,720 ––––––

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Reconciled as follows: Cash per BS at 30/06/06 Cash per BS at 30/06/07 Projected increase in cash over the year

£’000 (1,264) 2,984 –––––– 1,720 ––––––

Workings 1.

Tax Tax Tax Tax

paid payable b/f at 01/07/06 charge for y/e 30/06/07 payable c/f at 30/06/07

Therefore cash paid 2.

Dividends paid Dividends payable b/f at 01/07/06 Dividend charge for y/e 30/06/07 Dividends payable c/f at 30/06/07 Therefore cash paid

3.

Fixed asset purchases Fixed assets b/f at 01/07/06 Depr’n charge for y/e 30/06/07 Fixed assets at 30/06/07 Therefore cash paid

4.

Increase in stock Stock as at 30/06/07 Stock as at 30/06/06 Increase

5.

Increase in debtors Debtors as at 30/06/07 Debtors as at 30/06/06 Increase

6.

Decrease in trade creditors Trade creditors as at 30/06/07 Trade creditors as at 30/06/06 Decrease

£’000 (1,895) (2,230) 2,289 –––––– (1,836) –––––– (1,542) (2,270) 2,235 –––––– (1,577) –––––– 8,000 (200) (8,300) –––––– (500) –––––– 3,245 (2,167) –––––– 1,078 –––––– 3,318 (2,543) –––––– 775 –––––– 1,723 (1,737) –––––– (14) ––––––

Note: full marks given for any method of arriving at projected increase in cash over the year. An example of another approach is summarised below £’000 Receipts (20,350 + 2,543 – 3,318) 19,575 Payments for operating expenses (12,265 – 1,723 + 1,737 – 200 + 3,245 – 2,167) (13,157) Interest paid (785) Tax paid (w.1) (1,836) Dividends paid (w.2) (1,577) Fixed asset purchases (w.3) (500) ––––– 1,720 ––––– (b)

Drawbacks of Baumol model 1.

It does not take into account costs associated with running out of cash.

2.

The model only works properly for a firm which uses up cash at a steady rate throughout the year. In practice, most firms are likely to have large inflows or outflows of cash from time to time.

3.

In practice, it will be difficult to predict future cash requirements with certainty.

4.

Future interest rates are difficult to estimate.

5.

It assumes that transaction costs are constant but, in practice, they may vary.

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3

Shoes For You Ltd Days

(a) Raw materials stock period: Raw materials –––––––––––– x 365 Purchases

=

133,000 ––––––––– x 365 630,000

77

Credit taken from suppliers: Creditors ––––––––––––––––––– x 365 Credit overheads (w.1)

=

73,000 ––––––––– x 365 670,000

(40)

=

195,000 –––––––––––––––– x 365 1,430,000 x 65%

77

x 365

=

325,000 –––––––––– x 365 1,430,000

83

Credit allowed to debtors: Debtors –––––– x 365 Sales

=

410,000 –––––––––– x 365 2,500,000

60

Work in progress: Work in progress ––––––––––––––––––––––––––––––––––– Cost of sales (w.2) x degree of completion Finished goods: Finished goods ––––––––––––– Cost of sales

x 365

–––– 257 –––– ––––

The cash operating cycle is therefore approximately 257 days. Working 1: Credit overheads Production overheads Sales overheads Costs on credit Working 2: Cost of sales Materials Wages Production overheads Cost of sales (b)

£ 350,000 320,000 –––––––––– 670,000 –––––––––– 630,000 450,000 350,000 –––––––––– 1,430,000 ––––––––––

Increase in raw material holding period Advantage – Since prices are increasing, it makes sense to buy more raw materials before prices increase even more. Overall purchase costs will therefore be lower. Disadvantage – Stock holding costs will increase. These include the costs of working capital tied up in stock, warehousing costs and deterioration costs.

(c)

The general problems associated with inflation (i)

Redistribution of income and wealth Inflation will lead to a redistribution of income and wealth. This is because debts, for example, lose their real value with inflation. This kind of random redistribution is undesirable as those in positions of economic power tend to gain at the expense of others. In Shoes For You Ltd’s case, however, their income is received in sterling. Since this is a stable currency the value of the company’s debts is not decreasing much in real terms.

(ii)

The balance of trade may suffer If a country has a higher rate of inflation compared to that of the countries it trades with, then its exports become more expensive for its overseas partners and its imports become cheaper for its residents. This affects the balance of trade adversely. In the case of Shoes For You Ltd, the reason the shoes are made in Bushai is because of relatively low materials and labour costs. Whilst production labour costs are not yet increasing because of fixed wages, materials costs are already increasing dramatically and it may soon become cheaper to set up a factory elsewhere. In the long-term, labour costs will have to increase as well otherwise workers will presumably seek employment elsewhere.

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(iii) Higher interest rates The central bank in Bushai may counter inflation by raising interest rates. This makes the cost of borrowing higher and therefore limits investment opportunities. Since all the finance for Shoes For You Ltd is obtained from the UK, this problem will not affect Shoes For You Ltd.

4

Sources of finance (a)

Sources of finance for SMEs Equity When the business is first set up, the first (probably main) source of finance will be equity injected by the owner, and possibly by family and friends. The owner may have to re-mortgage his home to obtain funds. Since the business will have few tangible assets at this stage, it will be difficult to obtain equity from elsewhere. Once the business becomes more established, equity finance will become more readily available. Shares can be sold privately to investors. Since equity owners also have the right to participate in the running of the business, through voting, the initial owner may wish to sell a small number of shares to a number of investors so as to maintain control. Overdrafts An overdraft is a deficit on a bank current account. Overdrafts are suitable for short-term borrowing only. This is because they are usually expensive, both in terms of arrangement fees and in terms of interest charges. Also, they are repayable on demand. This means that the bank can withdraw the facility at any time, usually at a time when the business most needs the cash because of financial difficulties. Although overdrafts are not suitable for long term borrowing, they are often used as a permanent source of finance. Loans If an overdraft appears to be becoming too permanent, the bank may suggest that it is converted into a medium term loan. In this way, the business is forced to start repaying some of it. The bank may also provide loans for the purchase of fixed assets or for expansion of the business. In general terms, overdrafts are more suitable for the financing of working capital and loans are more suitable for longer term assets or projects. Trade credit Trade credit is often used as a source of finance for small and medium-sized enterprises (SMEs), particularly when the business is first starting up. Ironically, this is the time when such finance can be difficult to obtain, due to lack of the business’s reputation and credit history. The cost of trade finance has to be weighed up, taking into account both loss of early payment discounts and loss of supplier goodwill. Business angel financing Business angels may be either individuals or groups of individuals. They are characterised by their wealth! Such forms of financing tends to be informal and it is very much a question of knowing the right people. The informal nature of this type of financing can be both a strength and a weakness. It is a strength because many of the onerous formalities relating to provision of information to financiers are avoided. However, it is a weakness because of the lack of a formal business angel market through which finance can be sought. Venture capital Venture capitalists tend to invest in new businesses and specific expansion schemes. They tend to be attracted to businesses that will eventually be listed on the stock exchange, both because businesses of this size will generate the largest profits and because this also gives them an exit route in the future. Many of the smaller SMEs will simply not be big enough for venture capital finance. Also, venture capitalists will want to become involved in running the business because of their need to protect their investment. Note: Only four sources were required.

(b)

Limitations of ratio analysis –

On their own, ratios do not provide information that can be used to assess a business’s performance. They are only useful when comparative figures are also available, whether these be budgeted figures, prior year figures, or figures for similar companies.

–

Where price inflation has occurred, ratios comparing different time periods will not be directly comparable. The wrong conclusions may therefore be drawn about a business’s performance. In order to rectify this, adjustments would have to be made to allow for price differences.

–

Many of the key ratios used actually have numerous different definitions. For example, there are several ways of defining gearing. It is therefore essential to ensure that the exact same definition is being used before ratio analysis is relied upon.

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–

When the performance of different companies is being compared, ratios are usually calculated from the companies’ financial statements. The problem with this is that these accounts will not have been prepared using exactly the same accounting policies. For example, one company may use the straight line method for depreciation whilst the other uses the reducing balance method. Therefore, once again, inaccurate conclusions may be drawn.

–

Ratio analysis is only useful to the extent that key information is readily available. It may be that a business has changed its management accounting system in the year meaning that comparable information is not available in the required format.

–

The information on which the ratios are based is historical – not current. A lot might have happened between the date that the accounts were prepared and the date when they are being analysed.

NOTE: Only four limitations were required.

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances

June 2006 Marking Scheme Marks

1

Maybay Hospital (a)

NPV of costs Not contracting out: F/T staff costs P/T staff costs Cleaning materials Insurance costs Fines Administration costs Annuity factor calculation Net cash flow DCF Contractors’ research costs ignored Net present value

5 2 1 1 1 1 1 1 2 1 1 ––– 16 –––

Max marks Contracting out Annual contract costs Insurance cost savings Revised fine costs Lost admissions Machine sales Reduced administration costs Redundancy costs Net cash flow DCF Net present value

1 1 2 1 1 1 1 1 2 1 ––– 12 –––

Presentation Conclusion

1 1 ––– 2 ––– 30 –––

Total (b)

Other factors Each factor

1 ––– 4 –––

Max marks (c)

Relevant costs Future costs Cash flows Incremental costs Opportunity costs Committed costs Finance costs

1 1 1 1 1 1 ––– 6 ––– 40 –––

Total marks

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Marks 2

Health Foods Ltd (a)

(b)

Projected cash flow Operating profit Depreciation Interest paid Tax paid Dividends paid Fixed asset purchases Increase in stock Increase in debtors Decrease in trade creditors Projected cash flow

1 1 1 2 2 2 2 2 2 1 ––– 16 –––

Drawbacks of Baumol model Each drawback

1 ––– 4 ––– 20 –––

Max marks Total marks

3

Shoes For You Ltd (a)

(b)

(c)

Cash operating cycle Credit overheads calculation COS calculation RM days Creditor days WIP days FG days Debtor days Length of cycle

1 2 1 1 2 1 1 1 ––– 10 –––

Raw material holding period Advantage Disadvantage

2 2 ––– 4 –––

General problems of inflation Redistribution – max. Balance of trade Higher interest rates

2 2 2 ––– 6 –––

Max marks (1 mark for each sensible comment, subject to the maximum) Total marks

20 –––

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Marks 4

Sources of finance (a)

Sources for SMEs Equity Overdrafts Loans Trade credit Business angels Venture capital

3 3 3 3 3 3 ––– 12 –––

Max marks (b)

Limitations of ratio analysis Each limitation

2 ––– 8 ––– 20 –––

Max marks Total marks

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ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL WEDNESDAY 13 DECEMBER 2006

QUESTION PAPER Time allowed 3 hours ALL FOUR questions are compulsory and MUST be answered

Paper T10

Managing Finances

Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

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ALL FOUR questions are compulsory and MUST be attempted 1

Morello Landscapes is a small business established several years ago. The owner, Mr Morello, designs and landscapes gardens for a range of clients using his team of five employees. The firm works on one job at a time. Mr Morello has just signed a contract with a local building firm to landscape the gardens on a development of thirty executive houses. His designs have already been accepted and he has agreed to complete the work within a six-month period, starting on 1 January 2007. Should he fail to complete the work on time, he will have to pay a penalty. Should the work be completed early, workers can begin working on the next project. Mr Morello understands the importance of careful cash budgeting and wants to prepare the cash budget for the next six months, from January to June 2007. The following information has been obtained: (i)

Opening debtors are forecast to be £2,400, all of which will be received in January.

(ii) A price of £400,000 has been agreed for the contract. The amount will be paid in instalments as follows: January 5% February 15% March 10% April 10% May 10% June 50% (iii) Opening creditors, which will be paid in January, are forecast to be as follows: Materials £6,600 Miscellaneous £2,570 (iv) Five diggers will be hired at the start of the job in January to level the land. They will be hired for the whole month at a cost of £1,200 each. The fee is payable in full on the first day of hire. A deposit of £500 per digger is also payable at this point but this amount is refunded in full on the return of the vehicles on the first day of February. (v) Various materials are needed to complete the work and these will be purchased at different times over the six months. Ace Ltd supplies all the soil and turf and Hardcastle Ltd supplies the sand, cement and bricks/stones. Shrubs and ‘other materials’ are bought from several different companies. Materials have to be kept on the driveways of the properties during the landscaping process. Since space is restricted, the following schedule of purchases has been drawn up: Materials Soil Sand Cement Bricks/stones Turf Shrubs Other materials

Month Purchased January February February March May May Every month

Amount £12,600 £2,200 £3,100 £85,000 £48,000 £16,700 £2,000 per month

Credit terms None One month One month Two months One month None None

The two key suppliers do charge delivery costs but these are already included in the above amounts. Both key suppliers also give a 10% bulk order discount on any individual order that exceeds £40,000 in any given month. Mr Morello has not taken any bulk discounts into account when calculating the above figures. (vi) A waste disposal company has agreed to remove waste throughout the six months at a total cost of £8,500. This must be paid in January. (vii) Each of Mr Morello’s five employees is paid a salary of £21,600 per annum. They are all paid on the last working day of each month for that month’s work. Mr Morello has also agreed to give each worker a bonus of £1,500 in June for completion of the contract within the six-month period. (viii) The firm uses three vans, which the five workers share. These are leased at an annual cost of £3,960 each, payable in equal monthly instalments on the first day of each month.

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(ix) Mr Morello himself uses a business car that has already been fully paid for. He plans to sell the car in April for £3,000 cash, giving rise to an anticipated profit on disposal of £600. His replacement car, to be bought and paid for in the same month, is expected to cost £18,500. He charges depreciation of £300 each month in his accounts for the existing car and will charge £385 per month for the new car. Depreciation is charged in full in the month of acquisition but not at all in the month of disposal. (x) Mr Morello’s business account is expected to be overdrawn by £14,200 at the beginning of January. (xi) The bank charges interest of 1% per month on an overdrawn balance, calculated on the closing bank balance each month, and payable the following month. No interest is credited on positive balances. Required: (a) Prepare a monthly cash budget for each of the six months to 30 June 2007, showing the cash balance at the end of each month. Assume that the contract is completed on time. (24 marks) In the past, Mr Morello has had problems with Hardcastle Ltd delivering the wrong materials or delivering the materials late. Its prices are so good that he does not want to buy from anybody else. However, it has been such a problem that he is considering making all of these purchases at the beginning of January. He feels that it would also be useful to have a basic understanding of the essential elements of a contract so that he knows his position when dealing with problems with suppliers. (b) Discuss the costs and benefits, for Mr Morello, of ordering materials early. No additional calculations are required. (8 marks) (c) Briefly outline two essential elements of a contract. Do not discuss ‘form’ since most contracts do not have to be in any strict legal form. (4 marks) (d) The local building firm that Morello Landscapes has entered into the new contract with has only been in business for five years. Mr Morello therefore had to check on the creditworthiness of the firm. List four external sources of information that Mr Morello may have used to provide assurance about the creditworthiness of the local building firm. (4 marks) (40 marks)

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[P.T.O.

2

‘Nippers’ is a children’s nursery. It is a profitable business and demand for child places always exceeds supply because of the great shortage of local nurseries. It is owned and managed by a lady called Mrs Dibble. All the staff at the nursery are either relatives or good friends of Mrs Dibble’s and even the shortest-serving member of staff has worked at the nursery for ten years. Mrs Dibble is planning on retiring on her sixtieth birthday in six years’ time, at which point she hopes to sell the business to one or some of the existing staff. She wants to work full-time until then since she enjoys working so much. She is currently considering whether to extend the building in order to create more space so that she can meet the demand for nursery places. Mrs Dibble’s brother has offered to do the extension, by himself, at a very competitive price. He is currently unemployed and he faces bankruptcy if he does not find work soon. Mrs Dibble estimates that, with the extension, she would be able to sell the business as a going concern for £600,000 in six years’ time. Without the extension, she would expect to sell it for £500,000 in six years’ time. A local builder has recently approached Mrs Dibble with an unexpected offer to buy the nursery now for £850,000. He hopes to build apartments on the land. Mrs Dibble needs to decide whether to carry on in business without the extension (Option 1), have the extension built (Option 2), or sell to the developer (Option 3). The following information is available. 1.

Mrs Dibble has already obtained preliminary planning permission for the extension at a cost of £1,200.

2.

Mrs Dibble’s building costs are estimated to be £85,000. Of this amount, £45,000 relates to materials and must be paid immediately. The balance of the building costs relates to labour and will be paid on completion of the work. The work would take one year to complete. The nursery would still be open as usual during the year so revenue would be unaffected by the building work.

3.

The nursery currently generates net cash inflows of £98,000 per annum. With the extension, these would rise to £135,000 once the work is complete. Mrs Dibble pays herself a salary, but this amount has already been deducted before arriving at the £98,000.

4.

The nursery’s cost of capital is 10% per annum.

5.

Assume that all cash flows occur at the end of each year, unless otherwise stated.

Required: (a) Using the discount tables provided at the end of the question, calculate the net present value (NPV) of each option at the business’s cost of capital. Based on these calculations, conclude as to which option Mrs Dibble should choose. (16 marks) (b) Outline four non-financial factors that Mrs Dibble should take into account before finally making a decision. (4 marks) Discount factor tables at a discount rate of 10% Time Factor 1 0·909 2 0·826 3 0·751 4 0·683 5 0·621 6 0·564 Annuity factor tables at a discount rate of 10% Time Factor 1 0·909 2 1·736 3 2·487 4 3·170 5 3·791 6 4·355 (20 marks)

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3

Noise Ltd makes and sells sound equipment to a range of clients. Its main supplier, Speak Ltd, has never offered discounts for early payment so Noise Ltd has always taken the full 60 days’ credit allowed by Speak Ltd. Speak Ltd has recently been having problems collecting its debts on time. Following this, a decision has been made to offer customers a 2% discount for all invoices paid within two weeks (14 days) of purchase. Noise Ltd can invest cash to obtain an annual return of 12%. Required: (a) Determine whether it is financially viable for Noise Ltd to take advantage of the early payment discount. (7 marks) (b) From Speak Ltd’s point of view, what might be three benefits of offering such settlement discounts to its customers? (3 marks) (c) Discuss four features of a credit control system that would encourage customers to pay on time. (10 marks) (20 marks)

4

Zimmer plc is a listed company specialising in the manufacture and distribution of mobility aids, ranging from walking sticks to wheelchairs. The company directors are considering branching out into the manufacture and distribution of stair lifts. Such expansion would require considerable capital investment and the company is therefore considering how it could finance the project. Required: Explain: (a) the advantages and disadvantages, to a company, of debt finance over equity finance;

(8 marks)

(b) the reasons why a company may choose to issue preference shares rather than ordinary shares or debt; (4 marks) (c) four factors that will be taken into account by a bank when deciding whether or not to lend money to a client. (8 marks) (20 marks)

End of Question Paper

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances 1

Morello Landscapes (a) Cash budget Cash inflows Opening debtors Contract receipts Returned deposits (5 x £500) Car disposal proceeds

Jan £ 2,400 20,000 ––––––– 22,400 –––––––

Cash outflows Opening creditors: – Materials 6,600 – Miscellaneous 2,570 Digger hire (5 x £1,200) 6,000 Digger deposit (5 x £500) 2,500 Materials: – Soil 12,600 – Turf – Sand – Cement – Bricks/stones – Shrubs – Other materials 2,000 Waste disposal 8,500 Salaries [(£21,600/12) x 5] 9,000 Bonus (5 x £1,500) Van lease payments[(£3,960/12)x3] 990 New car costs Depreciation – ignore (non-cash) ––––––– 50,760 ––––––– Net cash flow (28,360) Opening balance (14,200) Overdraft interest (142) ––––––– Closing balance (42,702) ––––––– (b)

December 2006 Answers

Feb £

Mar £

Apr £

May £

Jun £

60,000 2,500

40,000

40,000

40,000

200,000

––––––– 62,500 –––––––

––––––– 40,000 –––––––

3,000 ––––––– 43,000 –––––––

––––––– 40,000 –––––––

–––––––– 200,000 ––––––––

43,200 2,200 3,100

2,000

2,000

2,000

76,500 16,700 2,000

9,000

9,000

9,000

9,000

990

990

990 18,500

990

––––––– 17,290 ––––––– 22,710 7,381 – ––––––– 30,091 –––––––

––––––– 30,490 ––––––– 12,510 30,091 – ––––––– 42,601 –––––––

––––––– 11,990 ––––––– 50,510 (42,702) (427) ––––––– 7,381 –––––––

––––––– 105,190 ––––––– (65,190) 42,601 – ––––––– (22,589) –––––––

2,000 9,000 7,500 990

–––––––– 62,690 –––––––– 137,310 (22,589) (226) –––––––– 114,495 ––––––––

Benefits Mr Morello will reduce his delivery costs since only one delivery from Hardcastle Ltd will be necessary. He may also reduce his purchase costs by making purchases before any potential price rises come into effect. He will also benefit from an increased bulk purchase discount, since he will now receive a 10% discount on the sand and cement. The materials will also be available as and when required. This means that workers will not have to sit idle waiting for materials to arrive. There will therefore be a greater chance of the contract being completed on time. In turn, this means that the penalty will not be payable. Workers will also be able to start another job earlier should the contract be completed within the six month period. This will bring extra revenue to the business. Costs If more materials are left on driveways for longer, there is an increased risk of stock loss either due to pilferage, weather, or accidents. For example, the sand and cement may get damaged by rain/wind, and the stones/bricks may get cracked. Since there is restricted storage space on the driveways anyway, some materials may need to be stored elsewhere, for which there will be a cost (e.g. local warehouse). Insurance costs will probably rise if greater quantities of stock are to be held at one time. There is also the cost of capital being tied up in stock. Finally, if the customer needs to change his requirements, pre-ordered materials may become surplus, resulting in increased costs for Mr Morello unless the contract states that changes the customer will be responsible for such costs.

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(c)

Contracts Legal intention Both parties to a contract must have intended it to be legally binding. In commercial arrangements such intention is assumed. In domestic or social arrangements such intention may need to be proved. Offer An ‘offer’ is a definite promise to be bound on specific terms. It can be made orally or in writing. It can also be implied from a person’s conduct. An offer can be revoked at any time before it is accepted. Acceptance ‘Acceptance’ is the unconditional agreement, by the offeree, to all the terms of the offer. As with an offer, it can also be oral, written or implied from a person’s conduct. Consideration ‘Consideration’ is one party doing something in exchange for another party doing something. Often, there is just an exchange of promises, or alternatively, consideration may simply be the price. Note: Only two elements were required.

(d)

Sources Bank references Trade references Credit reference agencies The press County Court records Company Registry search Informal conversations with people connected Internet NOTE: Only four sources were required.

2

‘Nippers’ (a) NPV Option 1: No change Net present value = (£98,000 x 4·355) + (£500,000 x 0·564) = £708,790 Option 2: Extending the premises 0 Planning permission (ignore – sunk) Building costs: materials Building costs: – labour Operating cash inflows Sale price Net cash flow Discount factor/Annuity factor Discounted cash flow

Time 1

2–5

6

(40,000) 98,000

135,000

––––––– 58,000 ––––––– 0·909 ––––––– 52,722 –––––––

–––––––– 135,000 –––––––– 2·882 –––––––– 389,070 ––––––––

135,000 600,000 –––––––– 735,000 –––––––– 0·564 –––––––– 414,540 ––––––––

(45,000)

–––––––– (45,000) –––––––– 1 –––––––– (45,000) ––––––––

The NPV of option 2 is £811,332 Working 1 AF for T2 to T5 = 3·791 – 0·909 = 2·882 Option 3: Selling Since the nursery would be sold immediately, the NPV of this option is simply the sale proceeds of £850,000 (applying a discount factor of 1 at T0) Mrs Dibble should sell to the developer (Option 3) since this option produces the highest NPV.

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(b)

Other factors to take into account – If Mrs Dibble extends the nursery she will provide work for her brother and stop him from possibly going bankrupt. –

The extension will also provide much needed additional child care places for local children.

–

The extension will enable Mrs Dibble to carry on working. She may have to look for a new job if she sells up, given that she wishes to work until retirement age.

–

Mrs Dibble's staff will all lose their jobs if she sells to the developer.

–

The shortage of child care in the area will increase further if Mrs Dibble sells to the developer since all the children will lose their places at the nursery.

–

However, the building of the extension is likely to cause some noise and disruption at the nursery.

–

Mrs Dibble may want the building to remain a nursery, in part as a monument to her good work over the years.

Note: Only four factors were required.

3

Noise Ltd (a) Whether to pay within one week Effective interest rate over 46 days is: 2 –– 98

= 2·04%

Compound annual interest rate is: [1·0204 365/46 – 1] x 100 = 17·38%. 365 (Simple annual interest rate is 2·04% x ––– = 16·18%.) 46 Noise Ltd should pay early as the annualised benefit of the discount (17·38%) exceeds the opportunity cost of capital (12%) [Alternative method of calculation Cost of not taking the discount: 365 ⎛ ⎞ ⎜ 100 t –1⎟ × 100 ⎜ 100 – d ⎟ ⎝ ⎠

where d is the size of the discount; t is the reduction in payment period in days which would be necessary to obtain the discount. 365 ⎛ ⎞ ⎜ 100 46 –1⎟ ×100 =17·38%] ⎜ 98 ⎟ ⎝ ⎠

(b)

Benefits of offering settlement discounts –

Customers are encouraged to pay early, which reduces the costs associated with providing trade credit, such as financing costs, and also the administrative costs of chasing debts.

–

The cash flow position of Speak Ltd will be improved, enabling the company to maintain liquidity.

–

Customers may actually buy more from Speak Ltd, as the discount may make their prices appear cheaper than those of competitors.

–

There may be fewer bad debts arising since customers are keen to pay early and benefit from discounts.

Note: Only three benefits were required. (c)

Credit control systems Awareness of supplier’s terms The customer must be fully aware of the supplier’s terms. As well as the terms being clearly printed in bold on the face of every invoice, payment terms should be clearly stated in writing when the order is confirmed. Even before this time, when the customer account is set up, the contract should state that the customer accepts the supplier’s terms. Accurate and prompt invoicing Invoices should be correctly drawn up. They will need to include the customer’s name and address, product details and costs, customer’s authorisation reference, purchase order number and supplier’s details. The invoice should be totalled correctly and it should be clear where payment is to be sent to and by what time. The invoice must be sent out promptly to maximise time for payment.

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Awareness of customer’s systems It is important to understand the payment system at your customer’s business. Some businesses make payments to suppliers only once a month. If this is the case, they will have a cut off point each month by which invoices must be received and processed. Some businesses have an informal policy that suppliers are not to be paid until a reminder or even final reminder is received. Some businesses will only pay out a certain amount each month in order to control their cash flow. Without this knowledge of client’s systems, debts cannot always be collected promptly. System of statements and reminders Your customer should be sent a monthly statement showing, as a minimum, the individual invoices outstanding, the age of the invoices and the total balance outstanding. Late payments should always be followed by the issue of a reminder and perhaps a telephone call. Should the debt still remain unpaid, a final reminder should be issued. If all else fails and it appears that the customer has no intention of paying, the debt should be passed promptly to a debt collection agency.

4

Zimmer plc (a)

Advantages of debt finance –

Debt finance is cheaper than equity finance. This is because, firstly, it is less risky for the lender and, secondly, interest on debt is deductible for tax purposes whereas dividend payments are not.

–

Issuing debt is relatively cheap compared to issuing equity. This is because there is no need to issue a prospectus etc for a debt issue.

–

The issue of debt does not affect ownership and control of the company because debt holders are not owners of the company.

–

It is easier to arrange debt finance than equity finance. The company law requirements and the Stock Exchange rules (if it is a listed company) make the issue of equity quite a lengthy procedure.

Disadvantages of debt finance

(b)

–

As the level of debt increases with each debt issue, the cost of equity will also increase to reflect the increased financial risk of the company.

–

Debt, unlike equity, has to be repaid at the end of its term. This can cause financial difficulty for the company if they have insufficient funds. If a company cannot pay its debts it faces the risk of bankruptcy.

–

Interest MUST be paid on debt whereas dividend payments on ordinary shares are discretionary. Unlike with dividends, if the company is having a bad year it must still pay its interest charges.

–

If the company has borrowed at a floating rate of interest, the company is subject to interest rate risk. This means it risks having to pay increased interest charges if the interest rates go up.

–

Security for the debt may be required by the lender. This can restrict the company’s use of the assets on which the debt is secured.

–

Loan agreements may make the company subject to restrictive covenants. These are effectively promises to keep, e.g., the current ratio at a certain level.

Reasons for issuing preference shares –

Preference shares do not carry voting rights. This means that they do not give the purchaser any control over the decisions made by the company. Hence, the issue of preference shares does not dilute control.

–

Preference share capital is not secured on the assets of the company like debt. It does not therefore restrict the company’s borrowing power or its use of its assets.

–

Preference dividends do not have to be paid if the company cannot afford it, although they will often carry the right to cumulative dividends, i.e. if the dividend is not paid one year, it is carried forward to the next year and so on.

–

Irredeemable preference shares lower the company’s gearing ratio, which is generally seen as a good thing. However, redeemable preference shares are usually treated as debt for the purpose of calculating the gearing ratio, so they WILL increase gearing.

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(c)

Factors considered by a bank The factors to be considered are set out below. The character of the borrower Before lending money, the bank will need to decide whether the borrower is of good character. This will involve looking at the borrower’s past record and conducting a personal interview with the applicant. If a person is applying for a loan, they will often be credit scored. If a company is making the application, the bank will probably use key ratios to analyse the company’s financial position. The ability to borrow and repay The bank looks at a business customer’s financial performance in order to ascertain their likely future position. If the owner re-invests profits in the business rather than drawing them all out, it shows that he has some confidence in the success of the business. This makes the bank more likely to lend to the business. When dealing with a company that is applying for finance, the bank may check whether the company has the authority to borrow the funds it is requesting. The company’s articles of association provide this information. The margin of profits The bank lends money in order to make money. It needs to ensure that it makes enough of a profit to warrant the risk that it takes by lending. Most banks have lending policies which require them to charge different interest rates to customers depending on the reason for the borrowing. This is because some types of lending are more risky than others. Ultimately, it is the bank’s discretion to charge whatever interest rate they choose. For risky ventures, the rate will obviously be higher. Purpose of the borrowing The purpose of the borrowing affects not only the interest rate but also the bank’s decision as to whether or not to lend in the first place. A bank will not lend money for an illegal purpose. It will normally lend in order to finance working capital, provided that the company’s liquidity position is still manageable. Lending to finance new business ventures is more risky since many of them fail. The bank will be more cautious in these cases. Amount of the borrowing Firstly, the bank will need to make sure that the applicant is not asking for more money than he needs for the purpose specified. If he is, this casts doubt over his ability to repay. Secondly, the bank needs to be sure that the applicant is asking for enough money. If he is not, the bank may well end up having to lend more in order to safeguard the original loan. Repayment terms The bank must not lend money to a person or company who does not have the ability to repay it, with interest, irrespective of any security available for the loan. Security should only be called upon as a last resort if there is a sudden unexpected inability to pay. A repayment term should be set which is realistic. Overdrafts are repayable on demand and are therefore more risky for the borrower. Insurance against the possibility of non-payment When lending large sums of money to an individual or to a company, the bank may well ask for the loan to be secured. This security may take the form of title deeds to property – either property of the company or the individual’s house, depending on who is making the application for finance. A borrower may take out payment protection insurance, so that his repayments are covered even if his financial position deteriorates. Note: Only four factors were required.

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances

December 2006 Marking Scheme Marks

1

(a)

(b)

Cash budget Opening debtors Contract receipts Returned deposits Van sales proceeds – correct fig. Opening creditors: – materials – miscellaneous Digger hire Digger deposit Materials: – Soil – Turf – Sand – Cement – Bricks/stones – Shrubs – Other materials Waste disposal Salaries Bonus Van lease payments New van costs Depreciation – ignore Overdraft interest Net cash flow Opening balance Closing balance Presentation

0·5 2 0·5 2 0·5 0·5 0·5 0·5 1 1 1 1 1 1 1 0·5 0·5 0·5 1 0·5 2 1 1 1 1 1 ––– 24 –––

Stock Benefits – delivery costs – bulk order discount – materials readily available – no penalty – increased revenue – avoid price increases

1 1 1 1 1 1

Costs – damage to stock – warehouse cost – insurance cost – capital tied up – materials becoming surplus

1 1 1 1 1 ––– 8 –––

Max. marks (c)

Contracts Each element

2 ––– 4 –––

Max. marks (d)

Creditworthiness Every source

1 ––– 4 ––– 40 –––

Max. marks Total marks

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Marks 2

(a)

NPVs Option 1 Correct relevant cash flows Correct DF/AF Follow-on NPV Option 2 Planning permission (ignore – sunk) Building costs: materials Building costs: – labour Operating cash inflows Sale price Correct DF/AF Net cash flow Discounted cash flow Follow-on NPV Option 3 Correct NPV

1 1 1 1 1 1 2 1 1 1 1 1 1

Use of annuity factors Conclusion Presentation

1 1 1 ––– 16 –––

Max. marks (b)

Factors Each factor

1 ––– 4 ––– 20 –––

Max. marks Total marks

3

(a)

Discount calculation Effective discount Annualised Conclusion

3 3 1 ––– 7 –––

Marks (b)

Benefits of settlement discounts Each benefit

1 ––– 3 –––

Max. marks (c)

Features Supplier’s terms Accurate and prompt invoicing Customer’s systems Statements and reminders

3 3 3 3 ––– 10 ––– 20 –––

Max. marks Total marks

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Marks 4

(a)

Debt For each adv./disadv explained

2 ––– 8 –––

Max. marks (b)

Preference shares Each reason

2 ––– 4 –––

Max. marks (c)

Bank lending Each factor explained

2 ––– 8 ––– 20 –––

Max. marks Total marks

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ACCA CERTIFIED ACCOUNTING TECHNICIAN EXAMINATION ADVANCED LEVEL WEDNESDAY 13 JUNE 2007

QUESTION PAPER Time allowed 3 hours ALL FOUR questions are compulsory and MUST be answered

Paper T10

Managing Finances

Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

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ALL FOUR questions are compulsory and MUST be attempted 1

Go Green Ltd is a small company specialising in the manufacture of a small range of environmentally friendly toiletries and cleaning products. It is considering extending its production lines to include environmentally friendly soap and washing-up liquid. The company’s research and development department has already spent £450,000 developing the products and a further £325,000 on test marketing them. If the company decides to proceed with the project, new machinery will be purchased immediately and production will commence straight away. Notes 1. Forecast sales in ‘000 units, are as follows:

Soap Washing up liquid 2.

1 250 240

Years 3 150 320

2 200 280

4 90 170

5 30 50

Forecasts for the revenues and costs per unit for each of the new products have been made, as detailed below. However, these may need to be revised as per notes (a) to (c) below.

Selling price Direct materials Direct labour (note a) Variable overheads (note b) Allocated fixed overheads (note c) Profit

Soap £ 1·75 (0·15) (0·25) (0·50) (0·65) –––––– £0·20 –––––– ––––––

Washing-up liquid £ 1·60 (0·35) (0·12) (0·24) (0·65) –––––– £0·24 –––––– ––––––

(a) The product cost cards for both products above have been prepared on the basis that each factory worker is paid a standard hourly rate of £6. Further details of labour requirements are as follows: Year one Production of each unit of soap requires 2·5 minutes of one factory worker’s time. However, all workers are currently working to full capacity. Therefore, for the first year’s production of soap, they will have to work overtime, for which they are paid £7·20 per hour. Production of each unit of washing-up liquid requires 1·2 minutes of one factory worker’s time. During the first year, temporary workers provided by an agency will be used to produce the washing-up liquid at a cost to the company of £7 per hour. Years two to five New permanent staff will be recruited to produce both soap and washing-up liquid. They will be paid at the company’s standard hourly rate of £6 per hour. (b) Variable overheads represent factory power costs, which vary according to labour hours worked. (c) Allocated fixed overheads comprise factory rental costs of £0·10 per unit and depreciation of £0·55 per unit. 3.

The company will need to purchase a new piece of machinery immediately costing £500,000 if the project is to proceed. Some modifications will need to be made to the machinery on site. They will take place as soon as the machinery is purchased and will take two days to complete. The cost of these will be £150,000, payable on completion. The machinery will have no scrap value at the end of the project.

4.

There are currently two production lines that are not in use on the top floor of the factory. If the project goes ahead, these two lines will be used for production. If the project does not go ahead the top floor will be rented out immediately to a third party, producing income of £125,000 per annum, receivable annually in arrears.

5.

Go Green Ltd’s cost of capital is 10% per annum.

6.

Assume that all cash flows occur at the end of the year unless otherwise stated.

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7.

All workings should be in £’000 to the nearest £’000.

Required: (a) Using the discount factors provided, calculate the net present value of the proposed project over five years and conclude whether the project should be accepted. (20 marks) (b) Calculate the internal rate of return of the project using the tables provided.

(5 marks)

(c) Calculate the discounted payback period for the project at the company’s cost of capital. If the company only accepted projects with a discounted payback period of three years or less, decide whether the company should accept this project. (4 marks) The company has now decided that the project should be funded using debt finance, but it is unsure which form of debt finance would be best. Required: (d) Discuss three factors that any business should consider when deciding whether a loan or an overdraft is the best way to finance a project. (6 marks) (e) Recommend and briefly explain whether an overdraft or a loan would be the most appropriate form of finance for Go Green Ltd. (3 marks) (f)

What is the UK government’s ‘Loan Guarantee Scheme’ and how might it help Go Green Ltd, if required? (2 marks)

Extracts from discount factor tables Time 1 2 3 4 5

Factor 10% 0·909 0·826 0·751 0·683 0·621

Factor 20% 0·833 0·694 0·579 0·482 0·402 (40 marks)

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[P.T.O.

2

Camp Ltd is a retailer of real wood flooring. It buys and sells 20,000 packs of flooring each year from its supplier, Strong Ltd. The real wood flooring from Strong Ltd costs £35 per pack. There is an order processing charge of £150 per order, irrespective of the quantity of packs ordered, and Strong Ltd takes 10 days to deliver the wood flooring. The average cost of holding one pack of real wood flooring for one year is £9. A new supplier of real wood flooring, Fake Ltd, has offered Camp Ltd wood flooring on slightly different terms. Fake Ltd guarantees that its wood will never arrive damaged since it uses special packaging designed for maximum protection. It charges £34·95 per pack for the flooring. There is an order processing charge of £160 per order, irrespective of the quantity of packs ordered, and Fake Ltd takes 7 days to deliver the goods. The average cost of holding one pack of Fake Ltd’s real wood flooring for one year is £12. This is because the special packaging takes up additional storage space. The economic order quantity, which will minimise costs, is:

EOQ =

2CoD Ch

Where Co = the cost of placing one order D = the annual demand in units Ch = the cost of holding one unit per annum. Required: (a) Under the current arrangement, calculate: (i) the economic order quantity for packs of wood flooring; (ii) the total cost (ordering, purchase and holding cost) of stocking wood flooring for one year.

(5 marks)

(b) For the new supplier calculate: (i) the economic order quantity for packs of wood flooring; (ii) the total cost (ordering, purchase and holding cost) of stocking wood flooring for one year

(5 marks)

Camp Ltd has decided that it is NOT going to change suppliers. It, therefore, contacts Fake Ltd and informs them that it does not wish to change suppliers. Fake Ltd has now offered Camp Ltd a bulk purchase discount of 1% on all single orders for 2,000 or more packs of wood. Required: (c) Calculate and conclude whether it is worth accepting the offer by ordering 2,000 packs at a time from Fake Ltd. (4 marks) (d) Outline three non-financial factors that should be taken into account when deciding whether to change suppliers from Strong Ltd to Fake Ltd. (6 marks) (20 marks)

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3

Porkys Ltd is an ice cream manufacturing company preparing its accounts to 31 May each year. The company’s peak season occurs in the months of July, August and September and it always prepares a profit forecast for this period. The following cash budget has been prepared for the six months ending 30 November 2007.

Receipts from sales Sale of machinery Total receipts Payments Ingredients Labour Sundry expenses Purchase of machinery Loan repayments Total payments Receipts less payments Opening cash balance b/f Interest received Closing cash balance c/f

Jun £’000 1,100 – –––––– 1,100 –––––– ––––––

Jul £’000 1,250 45 –––––– 1,295 –––––– ––––––

Aug £’000 1,400 – –––––– 1,400 –––––– ––––––

Sep £’000 1,800 – –––––– 1,800 –––––– ––––––

Oct £’000 2,200 – –––––– 2,200 –––––– ––––––

Nov £’000 1,700 – –––––– 1,700 –––––– ––––––

250 350 75 – 50 –––––– 725 –––––– ––––––

280 450 85 – – –––––– 815 –––––– ––––––

360 550 95 120 50 –––––– 1,175 –––––– ––––––

440 425 80 – – –––––– 945 –––––– ––––––

340 275 70 60 50 –––––– 795 –––––– ––––––

340 250 65 – – –––––– 655 –––––– ––––––

375 1,400 – –––––– 1,775 –––––– ––––––

480 1,775 – –––––– 2,255 –––––– ––––––

225 2,255 – –––––– 2,480 –––––– ––––––

855 2,480 50 –––––– 3,385 –––––– ––––––

1,405 3,385 – –––––– 4,790 –––––– ––––––

1,045 4,790 – –––––– 5,835 –––––– ––––––

Notes/assumptions made when preparing the cash flow forecast 1 Customers always take two month’s credit. 2 The machinery to be sold for £45,000 will give rise to a profit on disposal of £3,000. 3 Depreciation of £13,000 will accrue during the three months ending 30 September 2007. 4 One month’s credit is always taken from suppliers of ingredients. 5 There are no stocks of raw materials or finished goods maintained. 6 Labour is paid by BACS on the last day of each month, for that month’s work. 7 Sundry expenses are all paid in the month in which they are incurred. 8 The loan repayment relates to an interest free loan obtained from Porkys Ltd’s parent company. 9 Interest is received by Porkys Ltd from the bank twice a year. The interest receivable for the peak season of July, August and September is expected to be £30,000. 10 All workings should be in £’000s to the nearest £’000. Required: (a) Prepare a profit forecast for the three months ending 30 September 2007. Show all workings clearly. Where any items have been excluded from the profit forecast, include a note to justify your treatment of the item. (10 marks) Porkys Ltd’s parent company is considering centralising the treasury function for the whole group. (b) List four roles of a treasury department.

(4 marks)

(c) Describe three advantages of having a centralised treasury department.

(6 marks) (20 marks)

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[P.T.O.

4

Jay Ltd manufactures furniture. It has come under pressure in recent years to reduce prices in order to compete with some larger competitors in the market. The company’s aim has therefore been to maintain sales levels, with the effect that debtor control has been allowed to deteriorate. The company has always had a target of keeping the debtors period at an average of 45 days. Debtors as at 31 May 2007 are £323,654. Sales for the year ending 31 May 2007 were £1,581,743. This figure included £14,250 of cash sales. During this time, debts of £26,784 were written off. All £26,784 relates to sales made in the year ending 31 May 2007. Required: (a) Calculate the current debtors collection period, in days, from the above information.

(3 marks)

(b) How much of the year-end debtors’ balance would have to be immediately recovered in order to reduce the debt collection period to the target level? (2 marks) (c) Calculate the company’s bad debt ratio for the year ended 31 May 2007.

(2 marks)

(d) List five procedures that could be used to pursue the overdue debts.

(5 marks)

Jay Ltd has carried out some of the procedures to collect debts. One of its major debtors is still refusing to pay on the basis that it was not satisfied with the quality of some of the goods it received and had to make refunds to its own customers. Jay Ltd does not want to sue the customer but has heard of ‘arbitration’. (e) Explain what arbitration is, in this context. (f)

(2 marks)

State two advantages and two disadvantages of using arbitration as opposed to taking a case to court. (4 marks)

You have now learnt that arbitration will not be possible since your client informs you that it is actually insolvent. You have heard that creditors can attempt to recover monies owing to them through ‘liquidation’. (g) Briefly explain what happens when a company goes into liquidation.

(2 marks) (20 marks)

End of Question Paper

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finance 1

June 2007 Answers

Go Green Ltd (a)

NPV of the project Product development costs – sunk Test marketing costs – sunk Net cash inflow – soap (w.1) Net cash inflow – iquid (w.1) Fixed overheads (irrelevant) New machinery Modifications Lost top floor income Net cash flow Discount factors at 10% Present value

0 £’000

1 £’000

2 £’000

3 £’000

4 £’000

5 £’000

200 209

170 249

128 285

77 151

26 45

(500) (150) –––––– (650) –––––– –––––– 1·000 –––––– (650) –––––– ––––––

(125) –––––– 284 –––––– –––––– 0·909 –––––– 258 –––––– ––––––

(125) –––––– 294 –––––– –––––– 0·826 –––––– 243 –––––– ––––––

(125) –––––– 288 –––––– –––––– 0·751 –––––– 216 –––––– ––––––

(125) –––––– 103 –––––– –––––– 0·683 –––––– 70 –––––– ––––––

(125) –––––– (54) –––––– –––––– 0·621 –––––– (34) –––––– ––––––

The net present value of the project is approximately £103,000. Since it is positive, the project should be accepted. Working 1: Net cash inflow per unit Soap

Year 1 £ 1·75 –0·15 –0·30 –0·50 ––––– 0·8 ––––– –––––

Year 2–5 £ 1·75 –0·15 –0·25 –0·50 ––––– 0·85 ––––– –––––

£ 1·60 –0·35 –0·14 –0·24 ––––– 0·87 ––––– –––––

£ 1·60 –0·35 –0·12 –0·24 ––––– 0·89 ––––– –––––

1 250 0·80 £’000 200 ––––– –––––

2 200 0·85 £’000 170 ––––– –––––

3 150 0·85 £’000 128 ––––– –––––

4 90 0·85 £’000 77 ––––– –––––

5 30 0·85 £’000 26 ––––– –––––

240 0·87 £’000 209 ––––– –––––

280 0·89 £’000 249 ––––– –––––

320 0·89 £’000 285 ––––– –––––

170 0·89 £’000 151 ––––– –––––

50 0·89 £’000 45 ––––– –––––

Sales price Direct materials Direct labour (£7·20 ÷ 60 x 2·5 for year 1) Variable overheads Net cash inflow per unit Washing up liquid Sales price Direct materials Direct labour (£7 ÷ 60 x 1·2 for year 1) Variable overheads Net cash inflow per unit Working 2: Total net cash inflow per year Soap Sales in units (’000) Net cash inflow per W.1 Total net cash inflow Washing up liquid Sales in units (’000) Net cash inflow per W.1 Total net cash inflow

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Alternatively, the answer may have been presented as follows, although it would have been more time effective to adopt the former approach. 0 £’000 Product development costs (sunk) Test marketing costs (sunk) Sales: soap – washing up liquid Direct materials: soap – washing up liquid Direct labour: soap (w.1) – washing up liquid (w.1) Variable overheads: soap – washing up liquid Fixed overheads (irrelevant) New machinery Modifications Lost top floor income Net cash flow Discount factors at 10% Present value

Year 1 £’000

2 £’000

3 £’000

4 £’000

5 £’000

438 384 (38) (84) (75) (34) (125) (58)

350 448 (30) (98) (50) (34) (100) (67)

263 512 (23) (112) (38) (38) (75) (77)

158 272 (14) (60) (23) (20) (45) (41)

53 80 (5) (18) (8) (6) (15) (12)

(125) –––––– 283 –––––– –––––– 0·909 –––––– 257 –––––– ––––––

(125) –––––– 294 –––––– –––––– 0·826 –––––– 243 –––––– ––––––

(125) –––––– 287 –––––– –––––– 0·751 –––––– 216 –––––– ––––––

(125) –––––– 102 –––––– –––––– 0·683 –––––– 70 –––––– ––––––

(125) –––––– (56) –––––– –––––– 0·621 –––––– (35) –––––– ––––––

(500) (150) –––––– (650) –––––– –––––– 1·000 –––––– (650) –––––– ––––––

The net present value of the project is approximately £101,000. The difference in NPV compared to the former method used arises because of rounding differences.

(b)

Working 1: Direct labour Soap: cost per unit in year 1 = £7·20 ÷ 60 x 2·5 = £0·30 1 Sales in units 250 Cost per unit 0·3 £’000 Annual cost 75 ––––– –––––

2 200 0·25 £’000 50 ––––– –––––

3 150 0·25 £’000 37·5 ––––– –––––

4 90 0·25 £’000 22·5 ––––– –––––

5 30 0·25 £’000 7·5 –––– ––––

Liquid: cost per unit in year 1 = £7 ÷ 60 x 1·2 = £0·14 1 Sales in units 240 Cost per unit 0·14 £’000 Annual cost 33·6 ––––– –––––

2 280 0·12 £’000 33·6 ––––– –––––

3 320 0·12 £’000 38·4 ––––– –––––

4 170 0·12 £’000 20·4 ––––– –––––

5 50 0·12 £’000 6 –––– ––––

2 £ 294 0·694 –––––– 204 –––––– ––––––

3 £ 288 0·579 –––––– 167 –––––– ––––––

4

5

103 0·482 –––––– 50 –––––– ––––––

(54) 0·402 –––––– (22) –––––– ––––––

IRR of the project

Net cash flow Discount factors at 20% Present value

0 £ (650) 1·000 –––––– (650) –––––– ––––––

Time 1 £ 284 0·833 –––––– 237 –––––– ––––––

The net present value of the project at a discount rate of 20% is approximately £(14,000). ⎛ a ⎞ IRR ≈ A + ⎜ × ⎡⎣B – A ⎤⎦ ⎟ ⎝a –b ⎠

Where A is the lower rate and B is the higher rate; a is the NPV at the lower rate and b is the NPV at the higher rate.

⎛ 103 ⎞ IRR ≈ 10 + ⎜ × ⎡20 – 10⎤⎦ ⎟ ⎝ 117 ⎣ ⎠ = 18·655% = 18·803%

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(c)

Discounted payback period Time 0 1 2 3 4 5

Annual discounted cash flows £’000 (650) 258 243 216 70 (34)

Cumulative discounted cash flows £’000 (650) (392) (149) 67 137 104

The discounted payback period for the project is between two and three years. This means that the project will have recovered its capital outlay at this point. Since the company accepts projects with a discounted payback period of three years or less, the company should accept the project. (d)

Factors to consider Purpose of the borrowing If the cash is required to fund temporary shortfalls in cash, it is easier and more appropriate to obtain an overdraft. This is because an overdraft is more flexible and can be increased or decreased (within its limit) on a day-to-day basis. The main purpose of an overdraft is to fund day-to-day shortfalls in cash rather than long-term projects. A loan, on the other hand, is more suitable for a fixed asset investment, the benefits of which will accrue over a number of years. Duration of the borrowing This links in closely with the purpose of the borrowing. If the cash is needed for a long time, a loan should be sought. Conversely, if the cash is only needed for a short time, an overdraft is more appropriate since this can be paid back just as soon as the business can afford it. This means that the business only has to pay interest for as long as the borrowing is really required, rather than interest being payable for the whole term of the loan. Interest rates The interest rates payable on an overdraft are often higher than the interest rates payable on a loan. This is because an overdraft is such a flexible arrangement and that flexibility comes at a cost. A business will want to minimise the interest that it pays out. Security This factor needs to be considered from two angles. Firstly, the bank will probably require security for a medium-term loan. If the business has no security to offer then it may not be able to obtain the loan. An overdraft is more easily obtained without security. This is because the bank can keep a close eye on the business’s cash flows and immediately demand repayment of the overdraft if it has any cause for concern. Secondly, the business may want to be secure in the knowledge that knows exactly how much its repayments will be and when they will be due cash for a number of years. It has this security with a loan, whereas, with an overdraft, the bank can demand repayment at any time. Note: Only three factors were required.

(e)

Finance for Go Green Ltd The main reason why Go Green Ltd needs cash is to purchase the machinery costing £500,000. This is a fixed asset for which the benefits will accrue over a long period of time. This would initially indicate that a medium-term loan would be more appropriate. A loan may be preferred by the bank since the new machinery may provide adequate security for the loan, although this depends on the potential resale value of the machinery. A loan would probably be preferred by Go Green Ltd because, firstly, the interest costs are likely to be lower and, secondly, the bank cannot suddenly demand repayment of the money in full. This is reassuring, especially since the sales levels do not rise really high until the third year of the project.

(f)

Loan Guarantee Scheme This scheme is available to small companies with turnover of £5.6 million per annum or less. Through this scheme, the government facilitates lending to small businesses by providing security for up to 75% of the value of the loan, for loans of a maximum amount of £250,000. Therefore, Go Green Ltd could apply for this assistance if it meets the criteria, in order to obtain a loan to assist with the costs of the machinery. This might be necessary if other security is not available i.e. if, for example, the machinery is not suitable for use as security for the loan. This may be the case if the machinery’s resale value has been affected by the modifications made to it.

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2

Camp Ltd (a)

Current supplier (i)

EOQ

EOQ =

2CoD Ch

Where the Co = the cost of placing one order D = the annual demand in units Ch = the cost of holding one unit per annum. 2 × 150 × 20, 000 9 = 816 Total cost:

EOQ =

(ii)

Holding cost: average stock x unit holding cost = (816 ÷ 2) x £9 = £3,672. Ordering cost = number of orders x £150 Number of orders = annual demand ÷ EOQ = 20,000 ÷ 816 = 24·5 Therefore ordering cost = £3,675 per annum. Purchase cost = 20,000 x £35 = £700,000. Total cost for one year = £3,672 + £3,675 + £700,000 = £707,347 ––––––––– ––––––––– (b)

New supplier (i)

EOQ 2 × 160 × 20, 000 12 = 730 Total cost:

EOQ = (ii)

Holding cost: average stock x unit holding cost = (730 ÷ 2) x £12 = £4,380. Ordering cost = number of orders x £160 Number of orders = annual demand ÷ EOQ = 20,000 ÷ 730 = 27·4 Therefore ordering cost = £4,384 per annum. Purchase cost = 20,000 x £34·95 = £699,000. Total cost for one year = £4,380 + £4,384 + £699,000 = £707,764 ––––––––– ––––––––– (c)

Discount Holding cost = (2,000 ÷ 2) x £12 = £12,000. Ordering cost = (20,000 ÷ 2,000) x £160 = £1,600. Purchase cost = £699,000 x 99% = £692,010. Total cost for one year = £12,000 + £1,600 + £692,010 = £705,610. ––––––––– ––––––––– The discount means that it is worth changing suppliers.

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(d)

Non-financial factors –

Quality of Fake Ltd’s wood. This may not be as good as Strong Ltd’s wood, although it should be as there is very little difference in price. The new wood should be closely inspected to ensure that it is of the same thickness as the current wood.

–

Reliability of Fake Ltd. Fake Ltd appears to have a shorter lead time for orders (seven days instead of 10 days) but if they are not able to send stock consistently on time, Camp Ltd may end up running out of stock. This could mean that customers go elsewhere, leading to lost revenue for the company.

–

Packaging of Fake Ltd’s wood. Fake Ltd’s packaging needs to look attractive, otherwise customers will not buy it. In addition, it needs to protect the wood well, as the guarantee claims.

–

Range. There are many different types of wood, e.g. beech, maple and oak. Camp Ltd need to ensure that all the currently stocked types of wood are on offer from the new supplier.

–

Returns policy. Fake Ltd appear to offer a guaratee that the wood will arrive undamaged but Camp Ltd may still need to make returns. Fake Ltd’s policy would need to be understood and the extent to which they are contactable to deal with problems would be relevant.

Note: Only three factors were required.

3

Porkys Ltd (a)

Profit forecast for the three months ending 30 September 2007 Sales (1) Purchases (2) Labour Depreciation Profit on disposal (3) Interest receivable Sundry expenses Net Profit

£’000 5,700 (1,140) (1,425) (13) 3 30 (260) –––––– 2,895 –––––– ––––––

Workings 1.

Sales = receipts from Sept, Oct and Nov. since the cash is received two months in arrears. £1,800,000 + £2,200,000 + £1,700,000 = £5,700,000.

2.

Purchases – paid one month in arrears so use CFF figures from Aug, Sep, Oct. Ingredients: £’000 (£360,000 + £440,000 + £340,000) 1,140 ––––––

3.

Profit on disposal – it is this revenue figure that is relevant for the profit and loss forecast, rather than the actual sale proceeds of £45,000 since this is a capital disposal.

Notes for items excluded from the profit forecast

(b)

1.

Purchase of machinery – these are capital payments and are only relevant in so far as they are used to calculate depreciation.

2.

Loan repayments – ignored since these are capital in nature, not revenue.

Roles of a treasury department – – – – – – –

banking cash management funding management foreign currency management corporate finance risk management insurance

Note: Only four were required. (c)

Advantages of a centralised treasury department –

higher interest rates may be attainable on investments because the department has larger amounts of cash available for investment.

–

experts can be employed with specialised knowledge, more qualified to make manage risk and make better investment decisions.

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–

foreign currency management becomes easier, since the foreign currency expenditure in one company can be matched with receipts in the same currency in another group company.

–

lower interest rates may be sought for borrowing, since borrowing can be arranged for the group as a whole.

–

the level of cash held for precautionary purposes can be minimised since only one amount will be required for the whole group.

–

the treasury department may be a profit centre in its own right, resulting in an increased likelihood of a profit being made.

Note: Only three advantages were required.

4

(a)

Current debtors collection period Credit sales = £1,581,743 – £14,250 = £1,567,493 Debtor days= debtors/credit sales x 365 = (£323,654 ÷ £1,567,493) x 365 = 75 days.

(b)

Debtors needs to be reduced to: £1,567,493 x 45/365 = £193,253 Debts to be collected immediately = £323,654 – £193,253 = £130,401.

(c)

Bad debt ratio Bad debt ratio = bad debts/credit sales x 100% = £26,784 ÷ £1,567,493 x 100% = 1.7%

(d)

Procedures for collecting debts –

Telephone customers and request that they pay their debts as soon as possible, informing them if they have exceeded their credit period.

–

Write to customers, enclosing a copy of their most recent statement showing all their outstanding invoices.

–

Arrange a personal visit to customers’ premises so that you can discuss the need for payment and any reasons for nonpayment.

–

Freeze customers’ accounts so that they are forced to pay before they can order more goods.

–

Send customers formal warnings or final demands, stating that if their debts are not paid, further action will be taken, and stating what that further action is.

–

Refer the debts to a debt collection agency who will pursue debts on the company’s behalf.

–

Arrange for your solicitor to send your overdue customers a letter stating that if payment is not received within a certain period, legal proceedings will be commenced.

–

Commence legal proceedings i.e. issue a summons or a writ (depending on the amount of the debt).

Note: Only five were required. (e)

Arbitration is the process whereby a debtor and a creditor enter into a written agreement to submit their dispute to a third party who assists in its resolution. The parties produce all relevant documents to the arbitrator and are then examined under oath. The decision of the arbitrator is final.

(f)

Advantages – –

less costly than court action more flexible

Disadvantages – arbitrator’s powers not as extensive as a judge’s powers in court. – arbitrator’s decision not as objective, since case not examined in same level of detail, or according to the rules of evidence in court. (g)

Liquidation The company is dissolved as a legal entity. Its assets are then sold to raise cash, which is used to pay creditors. Any money left over (usually none!) is then given to the shareholders.

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances

June 2007 Marking Scheme

Marks 1

(a)

(b)

(c)

(d)

NPV Ignoring development costs Ignoring test marketing costs Net cash inflow – soap: sales fig. Direct materials Direct labour Variable overheads Net cash inflow – WUL: sales fig. Direct materials Direct labour Variable overheads Fixed overheads – ignore New machinery cost Modifications cost Lost top floor income Net cash flow Present value NPV Conclusion

IRR NPV calculation at 20% Correct IRR formula Correct IRR calculation

Discounted payback Annual cash flows Cumulative cash flows Discounted payback calculation Conclusion

Factors For each factor discussed Total

(e)

(f)

Recommendation Recommendation Reasons

Loan guarantee scheme What it is How it might help.

Total marks

1 1 1 1 2 1 1 1 2 1 1 1 1 1 1 1 1 1 ––– 20 –––

(Alternative method) Ignoring development costs Ignoring test marketing costs Sales: soap – washing up liquid Direct materials: soap – washing up liquid Direct labour: soap – washing up liquid Variable overheads: soap – washing up liquid Fixed overheads – ignore New machinery cost Modifications cost Lost top floor income Net cash flow Present value NPV Conclusion

2 1 2 ––– 5 –––

1 1 1 1 ––– 4 –––

2 ––– 6 –––

1 2 ––– 3 –––

1 1 ––– 2 ––– 40 ––– –––

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1 1 1 1 1 1 2 2 1 1 1 1 1 1 1 1 1 1 ––– 20 –––

Marks 2

(a)

(b)

(c)

(d)

Old supplier EOQ Total costs

New supplier EOQ Total costs

Discount Total costs Conclusion

Factors Each factor Max.

Total marks

3

(a)

(b)

Profit and loss forecast Sales (right figure) Purchases Labour Depreciation Profit on disposal: correct figure Interest receivable Sundries Forecast profit – correct figure Note on mach. purchase Note on loan repayments

Roles of treasury department Each role Max.

(c)

Advantages Each advantage Max.

Total marks

2 3 ––– 5 –––

2 3 ––– 5 –––

3 1 ––– 4 –––

2 ––– 6 ––– 20 ––– –––

1 1 1 1 1 1 1 1 1 1 ––– 10 –––

1 ––– 4 –––

2 ––– 6 ––– 20 ––– –––

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Marks 4

(a)

(b)

(c)

(d)

Debtors collection period Credit sales figure Ratio calculation

Debts collected New debtors figure Collect debtors figure

Bad debts ratio Ratio calculation

Debt collection Each method Max.

(e)

Arbitration Written agreement Under oath Binding Max.

(f)

Advantages/disadvantages Each one Max.

(g)

Liquidation Dissolved Assets sold Cash paid to creditors/SHs Max. marks

Total marks

1 2 ––– 3 –––

1 1 ––– 2 –––

2 ––– 2 –––

1 ––– 5 –––

1 1 1 ––– 2 –––

1 ––– 4 –––

1 1 1 ––– 2 ––– 20 ––– –––

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Managing Finances Wednesday 12 December 2007

Time allowed Reading and planning: Writing:

15 minutes 3 hours

ALL FOUR questions are compulsory and MUST be attempted.

Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor.

Paper T10

Certified Accounting Technician Examination Advanced Level

This question paper must not be removed from the examination hall.

The Association of Chartered Certified Accountants

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ALL FOUR questions are compulsory and MUST be attempted 1

Robo Clean Co is a recently established innovation company. It currently has one product on the market, the ‘Robovac’, a robotic floor cleaner. This has been extremely successful. The company is currently developing a new robotic cleaner called ‘Robomum’ that vacuums, dusts and presses. To date $120,000 has been spent on developing the product. The company has also incurred $250,000 of market research costs, although the invoice for these costs has only just been received and will be paid in January. Since the set-up costs are substantial, a final decision now needs to be made as to whether it is viable to manufacture and sell ‘Robomum’. The following revenues and costs have been estimated: 1.

A new factory, to be used solely for the production of ‘Robomum’, will need to be built. This will take nearly a year to build and is expected to cost $11·75 million in total, payable in two instalments. The first instalment of $6m will be paid at the start of the building work and the second instalment for the remaining balance will be paid when the building work has been completed at the end of the year.

2.

Robo Clean Co will immediately enter into a one-year contract with a project management company, who will oversee the building of the factory. The total cost of this during the year will be $250,000. Two production lines will need to be installed in the factory at a further cost of $1,500,000 payable at the end of the build in one year’s time.

3.

The machinery for the production of ‘Robomum’ also needs to be built-to-order and is expected to cost $2·5m, payable in one year’s time. Its terminal value is nil. Depreciation will be charged as soon as production commences (as soon as the build finishes in one year’s time) at 10% per annum on a straight-line basis. Maintenance costs for the machinery are estimated at $250,000 per annum.

4.

Production and Sales will commence in the year following the build. Sales quantities and prices for ‘Robomum’ are expected to be as follows: Years Sales volume (’000 units) Sales price ($)

1

2

5 1,000

10 800

3&4 5 to 9 (each year) (each year) 30 50 700 500

It is anticipated that by the beginning of year 10, a new robotic helper will have replaced ‘Robomum’, hence there will be no further sales. 5.

Material costs for ‘Robomum’ are estimated at $125 per unit.

6.

Labour costs are estimated at $100 per unit.

7.

Fixed production overheads on the new factory are estimated at $240,000 per annum. Variable production overheads are expected to be $50 per unit.

8.

Head office costs of $4·5m per annum will be allocated to ‘Robomum’ when production commences. Of these costs, only $3·7m is incremental.

9.

The introduction of ‘Robomum’ is expected to adversely affect sales of ‘Robovac’. It is thought that, for every two units of ‘Robomum’ sold, one unit of ‘Robovac’ will be lost. ‘Robovac’ is currently sold for $150 per unit and generates a net cash flow of $50 per unit.

10. The company’s cost of capital is 5%. 11. Assume that all cash flows occur at the end of the year, unless stated otherwise. 12. All workings should be in $’000, to the nearest $’000.

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Required: (a) Using the discount tables provided, calculate the net present value (NPV) of the project at the company’s cost of capital. Conclude as to whether Robo Clean Co should proceed with the project. (22 marks) (b) Explain the main principles to differentiate between relevant and irrelevant costs for investment appraisal. Wherever possible, use the costs of ‘Robomum’ to illustrate your answer. (6 marks) (c) Define and distinguish between capital and revenue expenditure. Explain whether the $250,000 per annum costs of maintaining the machinery for ‘Robomum’ are capital or revenue in nature. (6 marks) (d) Robo Clean Co is considering alternative ways of funding the project. The machinery is one of the largest costs. The company has heard of hire purchase agreements, finance leases and operating leases, but is not sure whether any of these will be suitable, given that the machinery has to be built-to-order. Briefly describe each of the following (i)

Hire purchase agreements;

(2 marks)

(ii) Finance leases;

(2 marks)

(iii) Operating leases.

(2 marks)

Present value table (extract) Periods (n) 1 2 3 4 5 6 7 8 9 10

Discount rate (r) 5% 0·952 0·907 0·864 0·823 0·784 0·746 0·711 0·677 0·645 0·614

Annuity factor table (extract) Periods (n) 1 2 3 4 5 6 7 8 9 10

Discount rate (r) 5% 0·952 1·859 2·723 3·546 4·329 5·076 5·786 6·463 7·108 7·722 (40 marks)

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[P.T.O.

2

All Weather Windows Co manufactures and fits windows for domestic customers. The company needs to forecast its working capital requirements for the year ahead. The following figures are available: Sales revenue

$7,600,000

Costs as percentage of sales revenue Raw materials Direct labour Variable production overheads Apportioned fixed production overheads Other costs

22% 18% 7% 12% 5%

Working capital statistics Average raw material holding period Average work-in-progress (WIP) holding period Average finished goods holding period Average trade receivables’ collection period Average trade payables’ payment period on: Raw materials Direct labour Variable production overheads Fixed production overheads Other costs

6 weeks 3 weeks 5 weeks 2.5 weeks 8 2 4 6 3

weeks weeks weeks weeks weeks

Other relevant information 1. All finished goods inventory and WIP values include raw materials, direct labour, variable production overheads and apportioned fixed production overhead costs. 2.

Assume WIP is 80% complete as to materials; 75% complete as to direct labour; 50% complete as to variable production overheads and fixed production overheads.

3.

Assume there are 52 weeks in one year.

4.

Assume that production and sales volumes are the same.

5.

All workings should be in $’000, to the nearest $’000.

Required: (a) Calculate the estimated average working capital required by All Weather Windows Co for the year, showing all necessary workings. (14 marks)

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(b) All Weather Windows Co approaches its bank to ask for a loan to assist with a new machinery purchase. The bank refuses the loan on the basis that the company is too highly geared and its interest cover is too low. The industry averages for gearing and interest cover are as follows: Industry average

(

)

Prior-charge capital Gearing ––––––––––––––––– x 100% Shareholders’ funds

100%

Interest cover

3 times

The following figures are extracts from All Weather Windows Co’s accounts: Long-term loans Ordinary share capital Reserves Profit before interest Interest (i)

$6million $3 million $1 million $1.2million $500,000

Calculate the company’s level of gearing (also known as leverage) using the same ratio as above, and explain what it means when All Weather Windows Co is said to be ‘highly geared’. (3 marks)

(ii) Calculate the company’s interest cover and explain what it means when All Weather Windows Co is said to have low interest cover. (3 marks) (20 marks)

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[P.T.O.

3

Cool Ski Co is a skiwear retailer operating through its website shop. It is run by its three directors/shareholders who started the business three years ago. Its busiest months of the year are December, January, February and March, with sales for the rest of the year being relatively insignificant. In December the company prepares a cash budget for January, February and March. The following figures from its profit forecast for December 2007 through to March 2008 are currently available. However, they may need to be revised and should be read together with the notes below.

Sales revenue (1) Purchases Staff costs (4) Packaging costs (5) Distribution costs (6) Other costs (7)

Dec $’000 450 See notes 2 and 3 45 7 35 50

Jan $’000 650

Feb $’000 750

Mar $000 350

60 10 50 75

70 12 58 85

30 6 28 55

Notes: 1. The company does not provide any credit to customers. However, customers who join the company’s members’ club are given a 5% discount on all of their purchases. Half of customers are club members. The sales revenue forecasts above have been calculated before any discounts have been taken into account. 2. Purchases represent 40% of gross sales revenue. Sales revenue in November was $95,000. 3. Suppliers allow two months’ credit. 4 All staff are paid at the beginning of the month for the previous month’s work. 5. Packaging costs are paid one month after they are incurred. 6. Distribution costs are paid in the month in which they are incurred. 7. Other costs include depreciation of $12,000 per month. They also include rental costs of $30,000 per month, which are paid quarterly in December, March, June and September. The remainder of ‘other costs’ are paid in the month in which they are incurred. 8. The bank charges interest of 0·5% per month for the overdraft, calculated on the closing bank balance each month, and payable in the following month. 9. The overdraft on Cool Ski Co’s bank account at 31 December 2007 is expected to be $500,000. 10. All workings should be in $’000, to the nearest $’000. Required: (a) Prepare a monthly cash budget for each of the three months to 31 March 2008, showing the cash balance at the end of each month. (10 marks) (b) Cool Ski Co is considering expanding its business. It wants to branch out into the manufacture of its own brand of skiwear, and then expand its customer base to include wholesale customers, such as high street retailers. The three directors/shareholders have produced a business plan and are now considering approaching a venture capital organisation for finance. Identify and discuss five factors that a venture capital organisation would take into account when deciding whether or not to invest in Cool Ski Co. (10 marks) (20 marks)

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4

Waste Co is a waste management company, with one sole shareholder/director, Mr Trusty. It collects two types of waste from businesses – recyclable waste and confidential waste. Since companies have increasingly become aware of both the need for recycling and the need to protect confidential information, Waste Co’s client base has expanded rapidly over the last two years. As the business has expanded Mr Trusty has had less time available to focus on credit control. This has resulted in a steady deterioration in accounts receivable collection and a rapid increase in Mr Trusty’s overdraft, despite high profits. Mr Trusty’s bank has now refused to extend his overdraft any further and has suggested that he either employ a credit controller or factor his accounts receivable. The following information is available: 1. 2. 3.

4. 5.

Credit sales for the year ending 30 November 2007 were $2,550,000 and average accounts receivable days were 60. Sales are expected to increase by 25% over the next year. If Mr Trusty employs a good credit controller, the cost to the business will be $47,000. It is anticipated that the accounts receivable days can then be reduced to 40 days. A local factoring organisation has offered to factor the company’s accounts receivable on the following terms: (i) An advance of 80% of the value sales invoices (which Mr Trusty would fully utilise). (ii) An estimated reduction in accounts receivable days to 35 days. (iii) An annual administration fee of 1·3% of turnover. (iv) Interest charge on advances of 12% per annum. Current overdraft rates are 10% per annum. Assume there are 365 days in a year.

Required: (a) Explain the meaning of ‘debt factoring’ (accounts receivable factoring) to Mr Trusty, distinguishing between ‘with recourse’ and ‘without recourse’ agreements. (4 marks) (b) Explain how debt factoring is different from ‘invoice discounting’.

(2 marks)

(c) Calculate whether it is financially beneficial for Waste Co to factor its accounts receivables for the next year, as compared to employing a credit controller. (10 marks) (d) State four roles that a credit controller may play.

(4 marks) (20 marks)

End of Question Paper

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances 1

(a)

December 2007 Answers

NPV 0 $’000

1 $’000

Market research costs (sunk) Development costs (sunk) – Factory costs (6,000) (5,750) Project management company (250) Machinery costs (2,500) Depreciation (non-cash) – – Maintenance Production lines (1,500) Sales revenue Material costs Labour Fixed overheads (relevant as incremental) Variable overheads Head office costs (incremental element only) Reduced Robovac contribution –––––– ––––––– Net cash flows (6,000) (10,000) –––––– ––––––– Discount factor 1 0·952 Discounted cash flows (6,000) (9,520)

2 $’000

Time 3 $’000

4 $’000

5 $’000

6–10 $’000

– (250)

– (250)

– (250)

– (250)

(250)

5,000 (625) (500) (240) (250) (3,700) (125) –––––– (690) –––––– 0·907 (626)

8,000 (1,250) (1,000) (240) (500) (3,700) (250) –––––– 810 –––––– 0·864 700

21,000 (3,750) (3,000) (240) (1,500) (3,700) (750) –––––– 7,810 –––––– 0·823 6,428

21,000 25,000 (3,750) (6,250) (3,000) (5,000) (240) (240) (1,500) (2,500) (3,700) (3,700) (750) (1,250) –––––– ––––––– 7,810 5,810 –––––– ––––––– 0·784 3·393 6,123 19,713

The net present value of the project is $16·818 m. The company should therefore proceed with it. Workings AF for T6 – 10 = 7·722 – 4·329 = 3·393 (b)

Relevant costs The following principles should be applied when identifying costs that are relevant to a project. Relevant costs are future costs A relevant cost is a future cost arising as a direct consequence of a decision. A cost which has been incurred in the past is therefore totally irrelevant to any decision that is being made now. Such past costs are called ‘sunk costs’. Examples of such past costs are the development costs and the market research costs. Relevant costs are cash flows Only those future costs which are in the form of cash should be included. This is because relevant costing works on the assumption that profits earn cash. Therefore, costs which do not reflect cash spending should be ignored for the purpose of decision-making. An example of such costs for the Robomum is the depreciation on the new machinery. Relevant costs are incremental costs A relevant cost is the increase in costs which results from making a particular decision. For example, an opportunity cost (the value of a benefit foregone as a result of choosing a particular course of action) will always be a relevant cost. This is because it is a future incremental cost. An example of such an opportunity cost for the Robomum is the lost contribution from decreased sales of Robovac. Allocated fixed overheads are not normally incremental. In the case of the Robomum, however, the allocated fixed overheads relate to a factory that is being built entirely for the production of Robomum. The costs are therefore relevant because they are incremental. As regards the allocated head office overheads, only the incremental part of these overheads is relevant i.e. the $3·7m. The remainder of the $4·5m is irrelevant to the NPV calculation since it would have been incurred, irrespective of the emergence of Robomum onto the market. Certain other costs will also be excluded in the NPV calculation, such as ‘finance costs’. This is because interest has already been taken into account in the discounting process.

(c)

Capital and revenue expenditure Capital expenditure is expenditure on the purchase of or improvement to fixed assets. Fixed assets are used in the business to generate income over a number of years. The expenditure on them is therefore charged to the profit and loss account over a number of years through a depreciation charge. Revenue expenditure, on the other hand, is expenditure incurred in relation to sales, for example, materials and labour costs, or overhead costs. It also includes the cost of maintaining, but not improving, fixed assets.

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The maintenance costs of $250,000 per annum for the machinery are therefore revenue costs. This is because they do not enhance the value of the machinery but merely keep it running properly so that production can continue. (d)

(i)

Hire purchase Hire purchase is simply a form of financing an asset through paying in instalments. The supplier of the goods sells them directly to the financier (usually a finance house). The supplier then supplies the customer with the goods. The customer will usually be required to pay a sizeable deposit towards the purchase price of the goods. The goods remain the property of the financier until the end of the agreement, at which point the customer will have paid for the goods in full. The customer makes regular payments throughout the course of the agreement that consist of partly capital repayment and partly interest.

(ii)

Finance leases A finance lease is similar in substance to a hire purchase agreement. The goods are sold to the lessor. The supplier of the goods then supplies the customer with the goods. In return, the customer makes regular payments to the lessor. Over the period of the lease, the lessee will have paid for the full costs of the goods plus an additional amount equivalent to an interest charge. Throughout the lease the lessee is responsible for maintaining the asset. A finance lease usually has a primary period over which these significant payments are made. At the end of this primary period, the lessee then enters a secondary period. During this time, he will pay a notional charge (perhaps as low as $1 per annum) but continue to have full use of the asset. Alternatively, he may sell the asset on behalf of the lessor, usually keeping most of the sale proceeds himself.

(iii) Operating leases This type of lease is very different from a hire purchase agreement or finance lease. The equipment is supplied directly to the lessee by the lessor. The lessee will make regular payments under the lease. The lessor will be responsible for maintaining the asset so the lessee avoids the risks of ownership. The period of the lease is often much shorter than the full life of the asset. Since the machinery for Robo Clean is built-to-order, an operating lease would not be appropriate.

2

All Weather Windows (a)

Working capital requirements Sales revenue for the year: Raw materials costs $7,600,000 x 22% Direct labour costs $7,600,000 x 18% Variable production overheads $7,600,000 x 7% Fixed production overheads $7,600,000 x 12% Other costs $7,600,000 x 5%

$’000 7,600 –––––– 1,672 1,368 532 912 380 –––––– 4,864 –––––– ––––––

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Current assets: Inventory Raw materials W-I-P Materials Direct labour Variable and fixed production overheads

$’000 6/52 x $1·672m 3/52 x $1·672m x 80% 3/52 x $1·368m x 75% 3/52 x ($532k + 912k) x 50%

$’000 193

77 59 42 –––– 178

Finished Goods Materials and direct labour Variable and fixed production overheads

Total inventory value Trade receivables

5/52 x ($1·672m + $1·368m) 5/52 x ($532k + $912k)

292 139 –––– 431 –––––– 802 365 –––––– 1,167 ––––––

2·5/52 x $7,600,000

Total value of current assets Current liabilities Accounts payable: Materials Labour Variable production overheads Fixed production overheads Other costs

8/52 2/52 4/52 6/52 3/52

x x x x x

$1·672m $1·368m $532k $912k $380k

Total value of current liabilities Working capital required (b)

(i)

(257) (53) (41) (105) (22)

–––––– (478) –––––– –––––– 689 –––––– ––––––

Gearing It is calculated as follows: Prior-charge capital ––––––––––––––––– Shareholders’ funds $6m = ––––––––––– $3m + $1m = 150%

x 100% x 100%

All Weather Windows’ gearing is 150% as compared to an industry average of 100%. The company is therefore said to be ‘highly geared’ because its borrowings are simply too high compared to its level of equity. (ii)

Interest cover It is calculated as follows: Profit before interest –––––––––––––––– Interest = $1,200,000 ––––––––––– $500,000 = 2·4 times All Weather Windows’ interest cover is only 2·4 times, meaning that its interest payments are only covered by its profits 2·4 times.The industry average for interest cover is 3 times. Therefore, compared to the industry that the company operates in, its interest cover is deemed to be low, meaning that the profitability of the company is too low given its level of interest.

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3

Cool Ski Ltd (a)

Jan $’000

Feb $’000

Mar $’000

325 309 –––– 634 ––––

375 356 –––– 731 ––––

175 166 –––– 341 ––––

38 45 7 50 33

180 60 10 58 43

–––– 173 –––– 461 (500) (3) –––– (42) ––––

–––– 351 –––– 380 (42) – –––– 338 ––––

260 70 12 28 13 90 –––– 473 –––– (132) 338 – –––– 206 ––––

Nov $’000 95 –––– 38 ––––

Dec $’000 450 –––– 180 ––––

Jan $’000 650 –––– 260 ––––

Each month Jan $’000 75 (12) (30) –––– 33 ––––

Feb $’000 85 (12) (30) –––– 43 ––––

Mar $’000 55 (12) (30) –––– 13 ––––

Cash inflows Sales revenue: non-members Sales revenue: members (5% discount) Cash inflows Cash outflows Purchases (w.1) Staff costs Packaging costs Distribution costs Other costs excl. rent (w.2) Rent (3 x $30k ) Cash outflows Net cash flows Opening balance Overdraft interest Closing balance Workings 1. Purchases Gross sales revenue Purchases at 40% 2.

Other costs

Per question Less depreciation Less rental costs

(b)

Venture capitalists Factors that a venture capitalist organisation will take into account are as follows: (i)

Level of expertise of Cool Ski Co’s management Venture capitalists will believe that the success of Cool Ski Co’s business is dependant on the quality of the management. They will expect the three directors/shareholders to show a high level of commitment to the business. As all of the existing owners of the business are all involved in the running of the company, this should be proof of their commitment. The venture capitalists will also look at the amount of money that the owners themselves have invested in the project in assessing their level of commitment. The venture capitalists will expect a place on Cool Ski Co’s Board of Directors so that they can have a say in future business strategy.

(ii)

Level of expertise in the area of service The venture capitalists will seek assurance that the directors have the necessary know-how and technical support to be able to run the business properly. The fact that the business has been supplying the public direct through its website for the last three years is evidence of the ability of the directors/shareholders to run the company. However, running a manufacturing business is going to be different from simply being a retailer, and dealing with wholesale customers is different from dealing with the public direct. The directors have a lot to prove.

(iii) The nature of Cool Ski Co’s product In order to succeed in manufacturing and selling their own brand of skiwear, the directors need to show that they have excellent designs for a range of skiwear that people will want to buy and wear. The business already has a customer base with members buying skiwear at reduced prices. This should help the directors in persuading the venture capitalists that they have a likeable brand. (iv) The market and competition They will seek assurance that there is actually a market for the ski wear, as there are already some similar memberships available in the market place. They will ask to see the market research that has already been carried out. The venture capitalists will also look at the threat posed by new entrants in the market, and current rival membership schemes.

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(v)

Future prospects Since the risk involved in investing in a new or expanding company is fairly high, the venture capitalists will seek to ensure that the prospects for future profits compensate for the risk. They will therefore want to see the business plan setting out the future business strategy.

(vi) Exit routes The venture capitalists will consider potential exit routes before they invest in the venture. They will not invest money in a share of the business unless they are confident that it can be sold at some point in the future. Note: Only five factors were required.

4

(a)

Debt factoring ‘Debt factoring’ is a service provided by factors whereby the factor collects accounts receivable on behalf of their client and often invoices their client’s customers as well. The factor also advances, to its client, a proportion of the money it is due to collect (typically about 80% is advanced.) Mr Trusty would find the service useful because he could both receive cash early and also delegate the administration of his invoicing, accounting and accounts receivable collection work. There are two types of factoring agreements: ‘with recourse’ and ‘without recourse’ agreements. With the first of these agreements, although the factor advances monies, the risk of non-payment of accounts receivable balances stays with the client. If a balance is not recovered, the factor has ‘recourse’ to their client for the money. If the agreement is ‘without recourse’ the factor bears the risk of non-payment. Debt factoring has to be paid for, usually as a percentage of the amounts advanced and as a percentage of turnover. Agreements without recourse to the client obviously cost more. Mr Trusty would have to compare the cost to those of employing an individual to do his invoicing and obtaining insurance against unpaid accounts receivable balances. In addition, there may be some stigma attached to debt factoring as clients sometimes assume that a business using a factor must be in financial difficulty.

(b)

Difference from invoice discounting Invoice discounting is a service whereby a provider (often a factoring company) purchases invoices from a client at a discount. In this case, they are merely advancing cash, rather than providing an accounts receivable collection service. For this reason, there is no administration fee payable (like there is for factoring), making invoice discounting a cheaper option.

(c)

Whether to factor accounts receivables Cost of factoring New sales level = $2,550,000 x 125% Accounts receivable reduced to 35 days: $3,187,500 x 35/365

$3,187,500 $305,651 $

80% advanced by factor at 12%: $305,651 x 80% x 12% 20% still financed by overdraft: $305,651 x 20% x 10% Admin fee: $3,187,500 x 1·3%

Cost of not factoring but employing new staff Accounts receivable reduced to 40 days: $3,187,500 x 40/365

29,342 6,113 41,438 ––––––– 76,893 ––––––– –––––––

$349,315 $

Overdraft cost $349,315 x 10% Credit controller costs

34,932 47,000 ––––––– 81,932 ––––––– –––––––

Waste Co should use the services of the factor since this will produce a saving, over the next year, of $5,039, compared to employing a credit controller.

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(d)

Roles of a credit controller May include some/all of the following: – – – – – – –

Updating the sales ledger Dealing with customers’ queries Assessing creditworthiness of new customers Establishing/updating payment terms for customers Regular review of the sales ledger Pursuing overdue accounts receivable balances Providing references for customers

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances

December 2007 Marking Scheme Marks

1

(a)

NPV Market research costs ignored Development costs ignored Project management company Factory costs Machinery costs Depreciation ignored Maintenance Production lines Sales revenue Material costs Labour Fixed overheads Variable overheads Head office costs (incremental element) Reduced Robovac profits Net cash flows Discount factors/annuity factors Discounted cash flows NPV Conclusion

1 1 1 1 1 1 1 1 1 1 1 2 1 2 2 0·5 1 0·5 1 1 ––– 22 –––

Total marks (b)

Relevant costs Future costs Ignore sunk Cash flows Depreciation Incremental Opportunity costs Lost contribution from Robovac Fixed overheads Head office Finance costs

1 1 1 1 1 1 1 1 1 1 ––– 6 –––

Max marks (c)

(d)

Capital/revenue costs Capital costs Revenue costs Maintenance costs

2 2 2 ––– 6 –––

HP agreements and leasing HP agreements Finance leases Operating leases Correct mention of Robo Clean

2 2 2 1 ––– 6 ––– 40 ––– –––

Max marks Total marks

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Marks 2

(a)

Working capital requirements Calculation of each cost for year

0·5 ––– 2·5 –––

Max marks Calculation of current assets: Raw materials WIP Finished goods Debtors

1 3 2 1 ––– 7 –––

Calculation of current liabilities Accounts payable: Creditor Labour Variable overheads Fixed overheads Other costs

0·5 0·5 0·5 0·5 0·5 ––– 2·5 ––– 1

Working capital required Presentation

(b)

(i)

(ii)

1 ––– 14 –––

Gearing Ratio calculation Explanation

1 2 ––– 3 –––

Interest cover Ratio calculation Explanation

1 2 ––– 3 ––– 20 ––– –––

Total marks

3

(a)

(b)

Cash budget Sales Purchases Staff costs Packaging costs Distribution costs Other costs (excl. rent) Rent Net cash flows Balance b/f Overdraft interest Balance c/f

2 2 0·5 0·5 0·5 1 1 0·5 0·5 1 0·5 ––– 10 –––

Venture capital Per factor

2 ––– 10 ––– 20 ––– –––

Max marks Total marks

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Marks 4

(a)

Factoring Definition Includes administration With recourse agreements Without recourse agreements Other points

1 1 1 1 1 ––– 4 –––

Max marks (b)

Invoice discounting Advancing cash only No a/cs rec’ble collection service Cheaper

1 1 1 ––– 2 –––

Max marks (c)

Cost of factoring New sales level New accounts receivable 12% factoring charge 10% overdraft charge 1·3% admin fee

1 1 1 1 1

Cost of not factoring New a/cs rec’ble figure Overdraft cost Credit controller cost Logical approach

1 1 1 1

Conclusion/saving

(d)

1 ––– 10 –––

Roles of credit controller Each role

1 ––– 4 ––– 20 ––– –––

Max marks Total marks Total marks for paper

100 –––– ––––

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Managing Finances Wednesday 11 June 2008

Time allowed Reading and planning: Writing:

15 minutes 3 hours

ALL FOUR questions are compulsory and MUST be attempted. Extract from discount factor tables and annuity factor tables are on page 2. Do NOT open this paper until instructed by the supervisor.

Paper T10

Certified Accounting Technician Examination Advanced Level

During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet 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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Extract from discount factor tables at a discount rate of 10% Time 1 2 3 4 5 6 7 8 9 10

Factor 0·909 0·826 0·751 0·683 0·621 0·564 0·513 0·467 0·424 0·386

Extracts from annuity factor tables at a discount rate of 10% Time 1 2 3 4 5 6 7 8 9 10

Factor 0·909 1·736 2·487 3·170 3·791 4·355 4·868 5·335 5·759 6·145

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ALL FOUR questions are compulsory and MUST be attempted 1

Alan Web is a famous musician and composer. He has recently teamed up with a successful producer of musicals, David Daniels. Together, they are going to fund a new musical ‘The Fiesta’. The musical will run in Jamin (the capital of Bundai) for five months. If it is successful, it will then tour the rest of Bundai for a further period. Alan and David are each investing $100,000 in the production. They have opened a business bank account to be used solely for the musical’s income and expenses. The investment cash will be paid into this account on 30 June 2008. Rehearsals will take place throughout the month of July, with the musical’s official opening night taking place on 1 August. Alan and David appreciate the need for cash forecasting and have made the following estimates for income and expenses for the six months from 1 July to 31 December 2008: 1

Tickets for the musical will go on sale on 1 July. Tickets will be sold through an agent who is to be paid commission by Alan and David. The price of tickets will vary according to the seat location. Prices are as follows: Location of seat Stalls Front Rear

Price $30 $20 $15

Ticket sales each month will include not only tickets for that month’s performances but also advance bookings for later months. Sales per month are expected to be as follows: Stalls Front Rear

Jul 10,000 30,000 10,000

Aug 20,000 50,000 30,000

Sep Oct Nov Dec No further stalls seats available 20,000 No further front seats available 40,000 50,000 45,000 35,000

The agent will pay the proceeds of ticket sales into Alan and David’s business account in the same month as the tickets are sold to the public. The agent will then invoice Alan and David for the commission it charges of 6%. This will be payable in the month following the ticket sales. 2

Sales from programmes, CDs and beverages are expected to be $150,000 in August and $175,000 for each month thereafter. All costs relating to the production of these goods will be incurred in July. Costs represent 10% of sales value.

3

All of the staff in notes 4 and 5 below will only receive 50% of their usual monthly salary for the month of rehearsals.

4

The leading lady, who plays the key role in the musical, will be paid a salary of $16,000 per month. The remaining 20 cast members (actors/singers) will be paid a monthly salary of $8,000 each. The leading lady and the cast members will be paid at the end of each month for that month’s work.

5

A live orchestra will also be playing every night. The orchestra also starts rehearsing at the beginning of July. There are 25 musicians in the orchestra, each of whom will be paid a salary of $4,000 per month. Musicians will be paid at the beginning of each month for the previous month’s work.

6

Other production staff members are provided by an independent production company and are expected to cost $80,000 per month in total. They will not be required until the musical opens in August. They will be paid at the beginning of each month for that month’s work. However, in addition to this monthly cost, there will also be a production company administration fee of 5%, payable monthly in arrears.

7

The production company charges a separate amount for the production equipment, also required at the beginning of August. This is expected to be $33,000 per month, payable on the first day of each month.

8

The costumes for the cast will be made in July. A deposit of $50,000 needs to be paid at the beginning of July, with the remaining balance of $25,000 to be paid at the end of that month.

9

The background for the stage is currently being painted by local artists. Its cost of $180,000 will be payable upon its completion at the beginning of July.

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[P.T.O.

10 The musical will be held at the National theatre, which must be hired for $600,000 per month, payable at the beginning of each month. The theatre will be used for rehearsals in July as well. 11 Certain equipment, not supplied by the production company, costing $155,000 will be bought in July for the production. Depreciation for the six-month period will total $31,000. 12 All workings should be in $’000 to the nearest $’000. Required: (a) Prepare a monthly cash budget for the musical for each of the six months to 31 December 2008, showing the cash balance at the end of each month. (18 marks) (b) Alan and David are very aware that their actual cash flow in the six months ending 31 December 2008 could differ greatly if the above estimates prove to be inaccurate. They have heard of ‘sensitivity analysis’ and want to know more about it. Required: Briefly explain sensitivity analysis and discuss how it might best be used to make the cash budget for the musical more useful. Note: no further calculations are required.

(6 marks)

(c) Alan and David are considering whether they should set up their own company for future theatrical productions. They want to know whether, over a ten-year period, it would save money. If they set up the company, they would avoid the following annual costs: (i) Estimated external production staff costs of $900,000. (ii) Estimated administration fees of $45,000. (iii) Estimated production equipment costs of $400,000. However, they would incur the following set-up costs immediately: (i) Legal costs of $4,000. (ii) Company registration costs of $1,000. (iii) Equipment costs of $1,800,000. A further amount of $1·5 million would be payable for the equipment in one year’s time. The following annual costs would arise: (i) (ii) (iii) (iv)

Staff salaries of $500,000. Professional fees of $10,000. Equipment maintenance costs of $75,000. Depreciation costs of $200,000.

Alan and David will need to spend a considerable amount of time setting up the company. They estimate that, as a result of this, their revenue may be $75,000 lower in the first year than it would otherwise have been (ignore agent’s commission). Their cost of capital is 10% per annum. Required: Using the discount tables provided, calculate the net present value (NPV) of the proposal to set up the production company, at the company’s cost of capital. Advise Alan and David whether they should set up the company. Note: show all workings in $’000.

(10 marks)

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(d) Alan and David have been advised that the ‘pay-back period method’ may also be a useful way of assessing whether to set up the production company. They know nothing about this method of project appraisal. Required: (i)

Explain the simple payback period method; Note: calculations are not required.

(2 marks)

(ii) State two differences between the calculation of the simple payback period of a project as compared to the calculation of the net present value of a project; (2 marks) (iii) State two advantages of using the simple payback period method as compared to other methods of project appraisal. (2 marks) (40 marks)

2

Light Co is a privately owned company specialising in the manufacture of lighting equipment. It supplies lighting to customers, who take an average of 30 days to pay. It has an overdraft on its current account of $2m. The compound annual interest rate charged on this account is 12%, with interest being charged to the account daily. In order to reduce its overdraft, Light Co is now considering introducing discounts to customers who pay within seven days. Required: (a) Calculate the maximum discount that Light Co should offer for payment within seven days if it wants to avoid any increase in its overall finance costs and explain the basis of your calculation. (4 marks) (b) Briefly explain the difference between simple and compound interest rates, using Light Co’s overdraft interest as an example. (4 marks) (c) One year later, despite introducing a tempting discount to customers, Light Co has found that very few customers have paid early and taken the discount. In fact, receivables days have increased significantly, as has the company’s overdraft. Light Co is therefore considering factoring its debts in the coming year. Credit sales for the last year totalled $12 million, with average receivables of $2 million. Next year, sales are expected to increase by 10%. Receivables days are expected to increase to 70 days if the factoring arrangement is NOT entered into. A factoring company has put forward the following proposal to Light Co: (i) (ii) (iii) (iv)

Receivables days will be reduced to 28 days as a result of stricter credit control procedures. The factor will charge interest of 13% per annum on the advances. The factor will charge an administration fee of 1·5% of turnover for the service. The factor will advance 80% of the value of sales invoices.

Should Light Co enter into the agreement, it will make its credit controller redundant. She earns a salary of $18,000 per annum. Current bank overdraft rates have remained the same at 12% per annum. Required: Evaluate whether it is financially viable for Light Co to factor its debts in the coming year.

(12 marks) (20 marks)

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[P.T.O.

3

The Kitchen Co is an innovation company set up two years ago by its key shareholder and director, Brian Geek. It currently has a range of about two thousand kitchen products on the market, the most successful of which is a gadget called the ‘Fish Eye’. This is a revolutionary utensil, the size of a kitchen knife, which plugs into the power supply and is used on cooked fish to identify any fish bones that need to be removed prior to serving. The ‘Fish Eye’ exploded onto the market two years ago, as the company’s introductory product, and sales have continued to grow rapidly ever since. One of Brian Geek’s friends has warned him about the high incidence of overtrading for new businesses selling high demand, innovative products. Brian Geek is therefore concerned that The Kitchen Co’s financial position be carefully monitored. Its turnover has increased by 100% over the last year, and its trade receivables and inventories have doubled. The company’s current ratio has fallen over the last year from a ratio of 3:1 to a ratio of 2·5:1. The industry norm is 2:1. The company has a $1 million overdraft facility on its current account from its bank. Whilst the company has never used even half of its limit, it often relies on the overdraft facility to finance its working capital. Required: (a) Explain the term ‘overtrading’.

(2 marks)

(b) Describe the symptoms that MAY be present in a company that is overtrading.

(5 marks)

(c) Briefly discuss whether The Kitchen Co is overtrading.

(5 marks)

(d) One of the key components used to make the ‘Fish Eye’ is component X, which is imported from overseas. Brian Geek wants to manage his inventory levels of component X more efficiently. He wants to make sure that he can meet demand for production and sales whilst at the same time avoiding excessive inventory levels. The following information relates to component X: Cost of component X Usage per day Maximum lead time Minimum lead time Average lead time Cost of ordering Holding costs

$24 per unit 1,000 units 20 days 10 days 15 days $650 per order $2 per unit per annum

Usage per day is always constant. The re-order level is set at the maximum expected requirement in lead time plus 25%. Required: (i)

Calculate the re-order level;

(3 marks)

(ii) Calculate the Economic Order Quantity (EOQ) using the following formula: EOQ =

2Co D CH

Where Co = the cost of placing one order D = the annual demand in units CH = the cost of holding one unit per annum Note: you should assume that there are 48 working weeks in the year and five working days in each of the weeks. (2 marks) (iii) Calculate the maximum inventory level for component X using the information provided.

(3 marks) (20 marks)

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4

Banks and the money markets play an important role in a country’s economy. Required: (a) Explain the difference between retail banks and wholesale banks.

(4 marks)

(b) Describe four functions of a central bank.

(8 marks)

(c) Name the different money markets and briefly explain their role within the economy.

(4 marks)

(d) Briefly describe four money market instruments.

(4 marks) (20 marks)

End of Question Paper

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances 1

(a)

June 2008 Answers

Cash budget

Receipts Ticket sales (1) Other sales (2)

Payments Costs re ‘other sales’ Leading lady’s salary Other cast members Musicians Production company staff Production company fee Production equipment Costumes Stage background Theatre hire Equipment costs Depreciation – ignore Ticket agent’s commission (2) Total payments Net cash flow Opening balance b/f Closing balance c/f

Jul $’000

Aug $’000

Sep $’000

1,050

2,050 150 –––––– 2,200 ––––––

1,000 175 –––––– 1,175 ––––––

750 175 –––––– 925 ––––––

675 175 –––––– 850 ––––––

525 175 –––––– 700 ––––––

16 160 50 80 33

16 160 100 80 4 33

16 160 100 80 4 33

16 160 100 80 4 33

16 160 100 80 4 33

600

600

600

600

600

–––––– 1,183 ––––––

63 –––––– 1,002 ––––––

123 –––––– 1,116 ––––––

60 –––––– 1,053 ––––––

45 –––––– 1,038 ––––––

41 –––––– 1,034 ––––––

(133) 200 –––––– 67 –––––– ––––––

1,198 67 –––––– 1,265 –––––– ––––––

59 1,265 –––––– 1,324 –––––– ––––––

(128) 1,324 –––––– 1,196 –––––– ––––––

(188) 1,196 –––––– 1,008 –––––– ––––––

(334) 1,008 –––––– 674 –––––– ––––––

$’000 300 600 150 –––––– 1,050 ––––––

$’000 600 1,000 450 –––––– 2,050 ––––––

$’000

$’000

$’000

$’000

400 600 –––––– 1,000 ––––––

750 –––––– 750 ––––––

675 –––––– 675 ––––––

525 –––––– 525 ––––––

–––––– 0 ––––––

–––––– 63 ––––––

–––––– 123 ––––––

–––––– 60 ––––––

–––––– 45 ––––––

–––––– 41 ––––––

–––––– 1,050 –––––– 85 8 80

75 180 600 155

Oct $’000

Nov $’000

Dec $’000

Workings (1) Ticket sales Stalls Front Rear Total

(2) Ticket agent’s commission 6% of sales, one month later (b)

Sensitivity analysis In order to prepare a cash budget, many assumptions have to be made. In the case of ‘The Fiesta’ the biggest assumption being made is in relation to ticket sales. Whilst former experience of ticket sales for this type of musical can be used as a basis for the sales estimates, the fact is that it is an unknown variable. This is also the case for ‘other sales’. Certain items in the cash budget can be calculated with more certainty, for example, theatre hire costs, staff costs and production equipment costs. This is because these costs are largely fixed, that is, they will not vary according to ticket sales. Sensitivity analysis is less useful on these items unless there is uncertainty about their actual cost. Sensitivity analysis uses models in order to determine the changes on our cash budget if some of the key variables change. Given that ticket and other sales are the least predictable, sensitivity analysis would be most useful on these items. For example, the cash budget could be reperformed on the assumption that ticket sales and other sales were 10%, 20% and 30% less than estimated. A computerised model could be used to make the calculations easier and the sensitivity analysis more complicated. Using sensitivity analysis in this way would make it easier to ascertain the level of risk attached to the project.

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(c)

Net present value Saved production costs Saved admin fees Saved equipment costs Legal costs Registration costs Equipment Maintenance costs Lost revenue Salaries Professional fees Depreciation – ignore Net cash flow Discount factor/annuity factor* Discounted cash flow

T0 $’000

(4) (1) (1,800)

–––––– (1,805) –––––– 1·000 –––––– (1,805) ––––––

T1 $’000 900 45 400

(1,500) (75) (75) (500) (10) –––––– (815) –––––– 0·909 –––––– (741) ––––––

T2–10 $’000 900 45 400

(75) (500) (10) –––––– 760 –––––– 5·236 –––––– 3,979 ––––––

* Annuity factor for T2–T10 = 6·145 – 0·909 = 5·236 The net present value of setting up the production company, as opposed to carrying on as normal, is $1·433 million. Alan and David should, therefore, set it up. (d)

Payback method (i)

The payback period method assesses the feasibility of a project by ascertaining the length of time it takes for the investment costs of a project to be paid back by the revenues/cost savings. It is therefore the length of time it takes for the total cash inflows to equal the original cash outflows.

(ii)

It is different from the NPV method because firstly, it looks at simple cash flows and not discounted cash flows, thus ignoring the time value of money. Secondly, whilst the NPV method takes into account all the cash flows over the life of the project, the payback method disregards any cash flows arising after the original investment has been paid back.

(iii) – – –

2

(a)

It is easy to calculate and easy to understand. It uses cash flows rather than profits, therefore it is less likely to be distorted by accounting conventions. It helps liquidity by taking into account the timescale rather than the overall cash flows.

Maximum discount Effective interest rate over 23 (30 – 7) days is: (1·1223/365 – 1) x 100 = 0·717% The maximum discount that Light Co should offer, if it does not want to increase its finance costs, is 0·717%. Explanation If customers are to be given a discount for paying within seven days, Light Co is effectively paying to receive the cash 23 (30 – 7) days early. Therefore, in order to calculate the maximum discount that should be offered to customers for paying within seven days, it is necessary to calculate the effective interest rate that Light Co is paying on its overdraft for the 23 day period. This figure should then be the maximum amount that Light Co should offer its customers for early payment.

(b)

Interest rates Light Co has a compound annual interest rate of 12%, with interest being charged to its account daily. This 12% rate therefore takes into account that, on an annual basis, interest is not only being charged on any capital amounts but also on any interest that is debited to the current account each day. Therefore, it is called compound interest because interest is being paid on capital AND interest over the course of the year. A ‘simple’ interest rate, on the other hand, only takes into account the interest payable on any capital amounts. So, in Light Co’s case, it ignores any interest payable that is incurred on the interest that is credited to Light Co’s account each day. (Note: This could be demonstrated using numbers.)

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(c)

Whether to factor Existing finance cost at 12% New sales figure ($12m x 1·1) Receivables ($13,200,000 x 70/365) Overdraft cost per annum at 12% Cost of factoring Sales Receivables reduced to 28 days: $13,200,000 x 28/365 80% advanced by factor at 13%: $1,012,603 x 80% x 13% 20% still financed by overdraft: $1,012,603 x 20% x 12% Admin. Fee: $13,200,000 x 1·5% Saved salary

Additional cost of factoring

$ 13,200,000 2,531,507 303,781 ––––––––––– ––––––––––– 13,200,000 1,012,603 ––––––––––– 105,311 24,302 198,000 (18,000) ––––––––––– 309,613 ––––––––––– ––––––––––– (5,832) ––––––––––– –––––––––––

Conclusion It is not financially viable for Light Co to factor its debts as an additional cost of $5,832 will arise.

3

(a)

Overtrading A company is said to be overtrading when its sales are expanding too quickly for it to finance them. Further explained, this means that the volume of sales is too large given the level of long-term capital at the company’s disposal.

(b)

Symptoms of overtrading – A rapid increase in turnover – A rapid increase in the volume of current assets and sometimes fixed assets – A significant reduction in liquidity ratios – An increase in debt ratios – A rapid increase in trade payables – A rapid increase in bank overdraft

(c)

The Kitchen Co’s turnover has increased by 100% over the last year. However, since this is a new company and the ‘Fish Eye’ is an innovative product for which this company is the sole retailer, one would expect to see a large increase in turnover. Similarly, since sales have increased so much, trade receivables would have been expected to increase proportionately, which they did. Since a 100% increase in turnover is effectively a doubling in turnover, the doubling of trade receivables was to be expected. Again, inventory levels have doubled. This is also linked to the doubling of turnover. Inventory levels would have been increased in order to meet the increase in demand. The company is relying heavily on its overdraft but it is not exceeding it; nor is it uncommon for a new business to rely on this form of short-term finance to fund its working capital. Whilst the current ratio has deteriorated it is still 2·5:1, which is higher than the industry norm. In conclusion then, whilst the company’s financial position needs to be monitored carefully to ensure that sales do not spiral out of control, the company does not currently appear to be overtrading.

(d)

(i)

Re-order level Re-order level = max. lead time x usage x 125% = 20 x 1,000 x 125% = 25,000 units.

(ii)

Economic order quantity EOQ = =

2Co D CH 2 x 650 x 48 x 5 x 1,000 2

= 12,490 units.

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(iii) Maximum inventory level Calculated as follows: Re-order level + re-order quantity – (minimum rate of usage x minimum lead time) = 25,000 + 12,490 – (1000 x 10) = 27,490.

4

(a)

Retail and wholesale banks Retail banks are those banks that specialise in the provision of banking facilities to the public and businesses. The amounts of the deposits and loans that they deal with tend to be relatively small. In the UK, traditional high street banks such as Barclays and LloydsTSB are retail banks. Much of their business is now done over the telephone and internet. Wholesale banks, on the other hand, are banks dealing in larger deposits and loans. They are not in the business of providing household mortgages and small loans to businesses and consumers. They tend to have a small number of large customers and deal extensively in the foreign exchange market. They include merchant banks such as Kleinwort Benson and Hambros, and finance houses.

(b)

Functions of a central bank Banker to the banks It provides a payments system for transactions between banks. Banker to the government The central bank collects tax revenue and disburses government expenditure. Issuance of currency The central bank prints/mints and issues notes and coins for the government, usually backed by holdings of government bonds. Monetary policy function The Central Bank executes monetary policy on behalf of the government. This facilitates the control of inflation, which is damaging to the economy. Reserve management The central bank manages the portfolio of foreign exchange reserves of the country and may buy or sell them to influence the exchange rate. Maintain financial stability The central bank does this through the supervision of other banks. Lender of the last resort A central bank may be called upon to act as lender of the last resort to the banking system. (Government debt management In several countries, central banks issue long term government debt in the market. This is no longer the common practice in most countries today, however.) (Note: Only 4 functions were required)

(c)

Money markets These are markets which trade money for short-term borrowing and lending, in wholesale amounts. They enable financial institutions to cover short-term money shortages or to lend money profitably if they have surplus money. Trading is done either over the telephone or electronically. Money markets include a ‘primary market’ and a ‘secondary market’. The primary market is used by the central bank and other approved banks and securities firms. The central bank uses it to smooth out shortages and surpluses of cash. The – – – – –

(d)

‘secondary market’ includes: the interbank market the eurocurrency market the certificates of deposit market the intercompany market the local authority market.

Money market instruments –

Deposits: deposits of money with financial intermediaries such as banks.

–

Bills: short-term financial assets which can be converted into cash at short notice by selling them in the discount market.

–

Commercial paper: short-term IOUs issued by large companies. They can either be held until maturity or sold on before then.

–

Certificates of deposit: available to customers who deposit a minimum amount for fixed terms. They can be held until maturity or sold in the CD market.

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances

June 2008 Marking Scheme Marks

1

(a)

(b)

(c)

Cash budget Ticket sales Other sales Costs re ‘other sales’ Leading lady’s salary Other cast members Musicians Production company staff Production company fee Production equipment Costumes Background Theatre hire Equipment costs Depreciation – ignore Ticket agent’s commission Net cash flow Opening balance b/f Closing balance c/f

2 1 1 1 1 1 1 1 1 1 0·5 1 1 1 2 0·5 0·5 0·5 ––– 18 –––

Sensitivity analysis Each valid point

1 ––– 6 –––

NPV Saved production costs Saved admin fees Saved equipment costs Legal costs Registration costs Equipment Maintenance costs Lost revenue Salaries Professional fees Depreciation – ignore Net cash flow Discount factors/annuity factor Use of annuity factor Discounted cash flow Follow-on NPV Conclusion Presentation

0·5 0·5 0·5 0·5 0·5 0·5 0·5 2 0·5 0·5 0·5 0·5 0·5 0·5 0·5 0·5 0·5 0·5 ––– 10 –––

Maximum marks (d)

(i)

Payback explained

––– 2 –––

Explanation (ii)

Differences Each difference

1 ––– 2 –––

Max marks (iii) Advantages

––– 1 ––– 2 ––– 40 –––

Each advantage

Overall total

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2

(a)

Calculation Explanation

(b)

Simple/compound interest Each point explained

––– Marks 2 2 ––– 4 –––

1 ––– 4 –––

Max marks (c)

Whether to factor New sales level New receivables level Current cost Receivables at 70 days Cost of 80% advanced Cost of 20% not advanced Admin fee Saved salary Factor cost Conclusion

1 1 1 1 2 2 1 1 1 1 ––– 12 ––– 20 ––– –––

Overall total

3

(a)

Overtrading

––– 2 –––

Explanation (b)

Symptoms Turnover Current assets Fixed assets Liquidity ratios Debt ratios Trade payables Bank overdraft

1 1 1 1 1 1 1 ––– 5 –––

Max marks (c)

Discussion Each point discussed

1 ––– 5 –––

Max marks (d)

Inventory calculations (i)

Re-order level

(ii)

EOQ calculation

––– 3 ––– ––– 2 ––– ––– 3 ––– 20 ––– –––

(iii) Maximum level Overall total

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Marks 4

(a)

(b)

Retail/wholesale banks Retail banks Wholesale banks

2 2 ––– 4 –––

Functions of central bank Each function described

2 ––– 8 –––

Max marks (c)

Money markets Short-term Wholesale amounts Cover shortages Facilitate use of surpluses Primary market Secondary market Interbank market Eurocurrency market Certificates of deposit market Intercompany market Local authority market Any reasonable point

0·5 0·5 0·5 0·5 0·5 0·5 0·5 0·5 0·5 0·5 0·5 0·5/1 ––––– 4 –––––

Max marks (d)

Money market instruments Deposits Bills Commercial papers Certificates of deposit

1 1 1 1 ––––– 4 ––––– 20 ––––– –––––

Overall total

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Managing Finances Wednesday 10 December 2008

Time allowed Reading and planning: Writing:

15 minutes 3 hours

ALL FOUR questions are compulsory and MUST be attempted.

Do NOT open this paper until instructed by the supervisor. During reading and planning time only the question paper may be annotated. You must NOT write in your answer booklet until instructed by the supervisor.

Paper T10

Certified Accounting Technician Examination Advanced Level

This question paper must not be removed from the examination hall.

The Association of Chartered Certified Accountants

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ALL FOUR questions are compulsory and MUST be attempted 1

Wicker Co manufactures chairs. It has recently been approached by one of its customers, Chill Co, a garden furniture retailer, who has asked it to enter into a five-year contract to supply a particular range of chairs. The chairs will form part of Chill Co’s new luxury collection that they plan to start selling in three months’ time. Production would therefore have to commence as soon as possible. There are three types of chairs in the collection – The Recliner (R), The Soother (S) and The Handy (H). Wicker Co has collated the following information: 1

Chill Co estimates that it would purchase the following quantities of R, S and H over the five year period: R S H

Year 1 20,000 25,000 30,000

Year 2 22,000 27,500 33,000

Year 3 24,200 30,250 36,300

Year 4 26,620 33,275 39,930

Year 5 29,282 36,603 43,923

Wicker Co’s intention is not to hold any finished goods inventory at the end of each year. 2

Chill Co will pay $200 for each R purchased, $100 for each S and $70 for each H.

3

Wicker Co will need to use a high-tech machine to make the chairs. This could be purchased immediately at a cost of $200,000 and would have no scrap value at the end of the five years. Alternatively, Wicker Co has another machine on site, for which it no longer has any use, which could be modified at an immediate cost of $75,000. This machine would then be equivalent to the high-tech machine in terms of its capacity to make chairs. This machine was bought two years ago at a cost of $300,000. If it is not used for the Chill Co contract, it will be sold immediately for $100,000. If modified, it would have no scrap value at the end of the five years.

4

Wicker Co would also use some additional existing machinery to carry out the work on the chairs. Depreciation of $45,000 per annum would be allocated to this contract.

5

Materials usage for each of the three chairs are as follows: (m2)

Wood X Fabric (m) 6

R 1 3

S 2 2

H 3 1

Materials costs are as follows: Wood X $14 per m2 Fabric $22 per m Wicker Co already has 160,000m2 of wood X in inventory, which it ordered in error last month. Wood X cost $20 per m2. If Wicker does not use wood X for this contract, it will either be used immediately as a substitute for Wood Y, which currently costs $13 per m2, or sold for $11 per m2. Also, Wicker Co already has 294,000m of fabric in inventory. The fabric cost the company $20 per metre. If it does not use this fabric for the Chill Co contract, the fabric would be sold immediately for $10 per metre since it has no other use for it.

7

Each chair requires the following amount of time from Wicker Co’s skilled and unskilled labour forces: R Skilled (hours) 2 Unskilled (hours) 1

S 2 1

H 2 1

At present, the company’s skilled labour force costs $8 per hour and its unskilled labour force costs $6 per hour. The company’s skilled labour force is working to full capacity, so new staff will need to be recruited if the Chill Co contract is entered into. These will cost $9 per hour and will be needed for the whole period of the contract. However, there is an unexpected surplus capacity of unskilled labour for the first year. It is thought that existing employees can provide 35,000 of the unskilled labour hours required in the first year, at no extra cost to the company. The remainder of the unskilled hours required will be provided by the employment of additional staff at $6 per hour. 8

Variable overheads will be incurred at the rate of $4 per skilled and unskilled labour hour used.

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9

Fixed overheads are expected to be $400,000 per annum. Of these, $220,000 relates to apportionment of factory rent. The factory space that would be used for the contract is currently unused and Wicker Co does not foresee it being used at all in the future unless this contract is entered into. The remainder of the fixed overhead cost relates to a new warehouse that would be rented to cope with the increased storage space required for the Chill Co contract.

10 The company’s cost of capital is 11·5%. Required: (a) Within the context of relevant costing, explain how to determine the relevant cost of the following items for the Chill Co contract: (i) machine costs (note 3) (ii) wood costs (note 6) (iii) fabric costs (note 6) Note: whilst you should explain the correct costs to be used, detailed calculations should be performed in (b) below. (8 marks) (b) Using the discount factors provided below, calculate the net present value of the contract and recommend whether Wicker Co should enter into the contract. Workings should be in $’000, to the nearest $’000. Discount factors Time 1 2 3 4 5

Factor 11·5% 0·897 0·804 0·721 0·647 0·580 (32 marks) (40 marks)

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[P.T.O.

2

Brush Co is a recently established company specialising in the manufacture of a range of drugs for the pharmaceutical industry. Two brothers, Thomas and Gerald Broom, formed the company and have just finished the first year of business. Sales are made to customers on 60-day payment terms and all suppliers offer 30 days’ credit. All of the raw materials purchased by Brush Co only last for a limited time. Therefore, it is the company’s policy that such chemicals are used within 75 days of purchase. Whilst the brothers are experienced in the field of pharmaceuticals, they are finding it difficult to understand some of the financial matters associated with running a company. You are employed in the company as an accounting technician and have collated the following information for the last year. $ 1,500,000

Sales Raw material purchases Direct labour costs Variable production overheads Apportioned fixed production overheads

378,000 240,000 215,000 185,000

Average receivables

356,000

Average inventories: Finished goods Work-in-progress (WIP) Raw materials

210,000 58,000 82,000

Average payables: Materials Variable and fixed overheads Direct labour

45,000 75,000 9,000

Other relevant information 1 All finished goods inventory and WIP values include raw materials, direct labour, variable production overheads and apportioned fixed production overhead costs. 2 Assume WIP is 70% complete. 3 Assume there are 365 days in one year. 4 Assume that production and sales volumes are the same. 5 The length of the average working capital cycle in this type of business is 90 days. Required: (a) Calculate Brush Co’s working capital cycle (cash operating cycle) in days. All workings should be rounded to the nearest complete day. (10 marks) (b) Explain what working capital management is and why it is important.

(4 marks)

(c) From your calculations in part (a), identify possible concerns that Brush Co’s chief accountant may have about the company’s working capital cycle. (6 marks) (20 marks)

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This is a blank page. Question 3 begins on page 6.

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[P.T.O.

3

Print Co is a printing company providing a range of printing services to commercial businesses and the public (noncommercial customers.) It has three main suppliers, which it uses for the majority of its supplies, but also uses a number of smaller suppliers for its sundry purchases. Whilst commercial customers are sometimes provided with a credit facility, non-commercial customers must pay on the day with cash, cheque, debit or credit card. Print Co prepares cleared funds forecasts on a weekly basis. You are an accounting technician for the company and have been asked to prepare a cleared funds forecast for the period Monday 19 January to Friday 23 January 2009 inclusive. You have been provided with the following information: 1

Receipts Commercial customers Customer Credit terms name Anchor Co 2 calendar months Beauty Co 1 calendar month Kent Co 1 calendar month Hut Co None Light Co None Non-commercial customers Payment Mon Tue method 12 13 Jan. Jan. Cash $300 $230 Cheque $220 – Debit card $255 $426 Credit card – –

Wed 14 Jan. – – – –

Month to: 19 Jan. 2009 sales $18,000 $13,000 $20,000 $2,200 $4,500

Payment method Cheque Cheque BACS Cash Cheque Thu 15 Jan. $120 – – –

Fri 16 Jan. – – – –

Mon 19 Jan. – – $170 –

Tue 20 Jan. $220 – $210 –

19 Dec. 2008 sales $24,000 $18,000 $18,000 $5,400 – Wed 21 Jan. $350 – – –

19 Nov. 2008 sales $16,000 $17,000 $15,000 – $2,200 Thu Fri 22 23 Jan. Jan. – $430 – – – – – $3,500

Notes (i) Receipt of money by BACS is instantaneous. (ii) All commercial customers are reliable, as cheques are always received on 19th day of each month. They are banked on the same day and clear on the fourth working day following the date of receipt. (iii) Debit card payments are credited to Print Co’s account on the next working day following the date of sale. They represent cleared funds as soon as they are credited. (iv) Credit card receipts clear in Print Co’s bank account on the fifth working day following the day of sale. (v) A ‘working day’ is a Monday, Tuesday, Wednesday, Thursday or Friday. 2

Payments to suppliers Main suppliers Supplier name Credit terms Ink Co Toner Co Paper Co

1 month 2 months 1 month

Payment method Direct debit Direct debit Direct debit

Jan. 2009 purchases $6,500 $8,500 $7,200

Dec. 2008 purchases $5,500 $8,000 $10,500

Nov. 2008 purchases $4,200 $10,600 $5,400

Notes (i) Print Co’s monthly direct debit payments will leave its account on 23 January. (ii) Print Co pays its sundry suppliers by cheque each month. These total $8,200 for January and will also be sent out on 23 January. 3

Wages and salaries All staff are paid a monthly salary by BACS on the 22nd day of each month. The total salaries cost for January is $9,600. BACS transactions are initiated and paid on the same day.

4

Other payments Every Monday morning, the cashier withdraws $150 from the company bank account to use as petty cash. The money leaves Print Co’s bank account straight away.

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5

Other information The balance on Print Co’s bank account will be $35,000 on 19 January 2009. This represents both the book balance and cleared funds.

Required: Prepare a cleared funds forecast for the period Monday 19 January to Friday 23 January 2009 inclusive using the information provided. Show clearly the uncleared funds float and the total book balance carried forward each day. (20 marks)

4

Slim Jim Co is a five-year old private company specialising in the manufacture of a range of health drinks, foods and supplements aimed at the fitness market. At present, their biggest customers are health food shops and fitness centres. However, now that their brand has become established, the wealthy owners, who also manage the business, are convinced that sales could be increased dramatically through the opening of an internet shop. They are currently considering how best to fund the expansion of the business. Funds would be needed to set up the website, expand manufacturing at the factory, and employ more staff to deal with administration, despatch and delivery of the web orders. It is estimated that $2 million would be needed for the expansion. At present, the market value of the company’s equity is $4 million and the company has loans of $0·5 million, repayable in six months time. The company also has cash built up from retained earnings of $1·3 million. Required: (a) Outline THREE appropriate sources of medium/long-term finance that may be available to Slim Jim Co to finance its expansion. (Presume that government grants and leasing are NOT appropriate.) (5 marks) (b) Discuss FIVE factors that Slim Jim Co should take into account when deciding on the mix of debt and equity finance. (15 marks) (20 marks)

End of Question Paper

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Answers

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances 1

December 2008 Answers

Wicker Co (a)

Relevant costs Machine costs There are two alternatives to consider for the machine. The first is the purchase of the new machine for $200,000. This cost has to be compared to the cost of not purchasing the new machine but instead, converting the old one. The total cost of this latter option would be the conversion cost of $75,000 together with the lost sale proceeds of $100,000. The $75,000 is relevant to the decision since it is an incremental cash flow if this option is chosen. The $100,000 is also relevant since it is the opportunity cost of keeping the old machine. If it is kept, it cannot be sold and these potential sales proceeds are therefore lost. Hence, the total costs of $175,000 ($100,000 + $75,000) must be compared to the cost of buying a new machine, which is $200,000. The assumption is then made within relevant costing that the company chooses the cheaper option which, in this case, is keeping the old machine and converting it. Hence, it is the $175,000 that is relevant to the NPV calculation. Wood X In deciding the relevant cost for wood X, Wicker Co has to firstly decide what it would do with wood X if it did not use it for this contract. It has two choices – either sell wood X for $11 per metre or use it as a substitute for wood Y, saving $13 per metre. The best of these alternatives is to use it as a substitute for wood Y, saving $13 per metre. Next, Wicker Co should compare the value of wood X as a substitute ($13 per m) to the cost of buying new wood for the Chill Co contract ($14 per m). It is clearly better to use the wood for this contract. Therefore, the opportunity cost for wood X is $13 per m2, at T0. $13 x 160,000 = $2·08 million. From T2 onwards, the replacement cost of $14 per metre is the relevant cost. At no point is the $20 historic cost of wood X relevant since it is a sunk cost. Fabric costs With regards to fabric, Wicker Co has two choices: either sell the fabric for $10 per metre or use it for the Chill Co contract. Since the current cost of the fabric is $22 per metre, Wicker Co should use the fabric rather than selling it. The cost is therefore the lost sale proceeds of 294,000 x $10. These lost sales proceeds of $2·94m are all included at T0 since, if it were not to be used for this contract, the fabric would be sold immediately.

(b)

Net present value T0 $’000 Sales (W1) Machine modification Depreciation – ignore Wood (W2) Fabric (W3) Skilled labour (W4) Unskilled labour (W5) Variable overheads (W6) Fixed overheads Net cash flows Discount factors Present value

T1 $’000 8,600

T2 $’000 9,460

T3 $’000 10,406

T4 $’000 11,447

T5 $’000 12,591

– – (1,350) (240) (900) (180) –––––– 5,930 –––––– 0·897 –––––– 5,319 –––––– ––––––

(2,464) – (1,485) (495) (990) (180) ––––––– 3,846 ––––––– 0·804 ––––––– 3,092 ––––––– –––––––

(2,710) (3,727) (1,634) (545) (1,089) (180) ––––––– 521 ––––––– 0·721 ––––––– 376 ––––––– –––––––

(2,981) (4,099) (1,797) (599) (1,198) (180) –––––– 593 –––––– 0·647 –––––– 384 –––––– ––––––

(3,280) (4,509) (1,977) (659) (1,318) (180) ––––––– 668 ––––––– 0·580 ––––––– 387 ––––––– –––––––

(175) (2,080) (2,940)

––––––– (5,195) ––––––– 1 ––––––– (5,195) ––––––– –––––––

The net present value of the contract is $4·363m. Since the net present value is positive, the contract should be entered into. Workings W1: Sales Annual sales levels per question R: S: H: Total sales levels Sales revenue R: at $200 each S: at $100 each H: at $70 each Total sales

T0

T1

T2

T3

T4

20,000 25,000 30,000 ––––––– 75,000 –––––––

22,000 27,500 33,000 ––––––– 82,500 –––––––

24,200 30,250 36,300 ––––––– 90,750 –––––––

26,620 33,275 39,930 ––––––– 99,825 –––––––

29,282 36,603 43,923 ––––––– 109,808 –––––––

$’000 4,000 2,500 2,100 ––––––– 8,600 –––––––

$’000 4,400 2,750 2,310 ––––––– 9,460 –––––––

$’000 4,840 3,025 2,541 ––––––– 10,406 –––––––

$’000 5,324 3,328 2,795 ––––––– 11,447 –––––––

$’000 5,856 3,660 3,075 ––––––– 12,591 –––––––

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T5

W2: Wood R: annual sales level x 1m2 S: annual sales level x 2m2 H: annual sales level x 3m2

T0

Total m required per annum. $’000 2,080 Total cost at $13 per m2 (T0) & ––––––– $14 per m2 at T3 to 5. W3: Fabric R: annual sales level x 3m S: annual sales level x 2m H: annual sales level x 1m Total m required per annum Less: already in inventory Purchase requirements

Total cost at $10 for T0 & T2/$22 T3–5

$’000 2,940 –––––––

W4: Skilled labour Total sales levels x 2 hours each, at $9 per hour. W5: Unskilled labour Total sales levels and hours required Less: available unused hours Hours required

Total cost at $6 per hour W6: Variable overheads Total sales levels Hours required per unit Total hours required

Total cost at $4 per hour

T1 20,000 50,000 90,000 –––––––– 160,000 ––––––––

T2 22,000 55,000 99,000 –––––––– 176,000 ––––––––

T3 24,200 60,500 108,900 –––––––– 193,600 ––––––––

T4 26,620 66,550 119,790 –––––––– 212,960 ––––––––

T5 29,282 73,206 131,769 –––––––– 234,257 ––––––––

$’000 – ––––––––

$’000 2,464 ––––––––

$’000 2,710 ––––––––

$’000 2,981 ––––––––

$’000 3,280 ––––––––

60,000 50,000 30,000 –––––––– 140,000 –140,000 –––––––– 0 ––––––––

66,000 55,000 33,000 –––––––– 154,000 –154,000 –––––––– 0 ––––––––

72,600 60,500 36,300 –––––––– 169,400 0 –––––––– 169,400 ––––––––

79,860 66,550 39,930 –––––––– 186,340 0 –––––––– 186,340 ––––––––

87,846 73,206 43,923 –––––––– 204,975 0 –––––––– 204,975 ––––––––

$’000 – ––––––––

$’000 – ––––––––

$’000 3,727 ––––––––

$’000 4,099 ––––––––

$’000 4,509 ––––––––

75,000

82,500

90,750

99,825

109,808

$’000 1,350 ––––––––

$’000 1,485 ––––––––

$’000 1,634 ––––––––

$’000 1,797 ––––––––

$’000 1,977 ––––––––

75,000 –35,000 –––––––– 40,000 ––––––––

82,500 – –––––––– 82,500 ––––––––

90,750 – –––––––– 90,750 ––––––––

99,825 – –––––––– 99,825 ––––––––

109,808 – –––––––– 109,808 ––––––––

$’000 240 ––––––––

$’000 495 ––––––––

$’000 545 ––––––––

$’000 599 ––––––––

$’000 659 ––––––––

75,000 3 –––––––– 225,000 ––––––––

82,500 3 –––––––– 247,500 ––––––––

90,750 3 –––––––– 272,250 ––––––––

99,825 3 –––––––– 299,475 ––––––––

109,808 3 –––––––– 329,424 ––––––––

$’000 900 ––––––––

$’000 990 ––––––––

$’000 1,089 ––––––––

$’000 1,198 ––––––––

$’000 1,318 ––––––––

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2

Brush Co (a)

Working capital cycle Inventories: Raw materials: Raw materials –––––––––––– Purchases

$ x 365

Work in progress: Work in progress ––––––––––––––––––––––––––––––––––– Cost of sales (w.1) x degree of completion Finished goods: Finished goods ––––––––––––– Cost of sales

x 365

x 365

Credit allowed to customers: Receivables –––––––––– x 365 Sales Credit taken from suppliers: Materials: Payables –––––––––––––––– x 365 Raw materials costs Overheads: Payables –––––––––––––––––––– Variable/fixed overheads Labour: Payables ––––––––––––––– Direct labour costs

x 365

x 365

Working 1: Cost of sales Raw material costs Direct labour Variable production overheads Apportioned fixed production overheads

(b)

Days

=

82,000 –––––––––– x 365 378,000

79

=

58,000 ––––––––––––––––– x 365 1,018,000 x 70%

30

=

210,000 –––––––––– x 365 1,018,000

75

=

356,000 –––––––––– x 365 1,500,000

87

=

45,000 ––––––––– 378,000

x 365

(43)

=

75,000 ––––––––– 400,000

x 365

(68)

=

9,000 –––––––– 240,000

x 365

(14) –––– 146 –––– ––––

$ 378,000 240,000 215,000 185,000 –––––––––– 1,018,000 –––––––––– ––––––––––

Working capital management Working capital management involves: – controlling the overall liquidity position of a business, and – controlling the individual elements of working capital, namely inventories, receivables, cash and payables. The aim of working capital management is to balance having too much working capital with having too little working capital. Too much working capital is costly in terms of lost opportunities and finance charges for cash tied up; too little working capital can lead to the inability to pay debts as they fall due, or necessitate the use of expensive short-term borrowing. It is therefore important to manage it effectively.

(c)

Concerns about Brush Co’s working capital cycle –

The receivables payment period is 87 days. This is too long, given that Brush Co only allows 60 days credit to customers. Also, it is twice as long as the payment period for raw material supplies and overheads.

–

The payment period for raw material supplies is 43 days and for overheads it is much higher, at 68 days. These periods are both longer than the agreed credit period of 30 days. This could lead to interest being charged by suppliers and a deterioration in the relationships with suppliers.

–

Raw materials are held for an average of 79 days. Since it is the company’s policy to use raw materials within 75 days of purchase, these inventories are too high. The company’s policy is being breached, which could lead to substandard drugs being manufactured.

–

Overall, the working capital cycle is too long. At 146 days, it is 56 days longer than comparative companies. This is costing the company money in terms of cash tied up in working capital and lost opportunities elsewhere.

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3

Print Co Cleared Funds Forecast 19 Jan $ Receipts (w 1) Anchor Co Beauty Co Kent Co Hut Co Light Co Non-commercial customers – method: Cash Debit card Credit card

Payments Ink Co Toner Co Paper Co Other cheques Salaries Petty cash

Cleared excess receipts over payments Cleared balance b/f Cleared balance c/f Uncleared funds float Receipts Payments

Total book balance c/f Working 1 Uncleared funds: Receipts Anchor (Nov. sales) Beauty Co (Dec. sales) Light Co (Jan. sales) Debit (DR) card receipts 19 Jan Uncleared receipts 19 Jan Less: cleared DR card receipts from 19 Jan Add: debit card receipts from 20 Jan Uncleared receipts 20 Jan Less: cleared DR card receipts 20 Jan Uncleared receipts 21 and 22 Jan Less: cleared cheques from 19 Jan Add: uncleared credit card receipts Uncleared receipts 23 Jan

20 Jan $

21 Jan $

22 Jan $

23 Jan $ 16,000 18,000

18,000 2,200 4,500

––––––– 20,200 –––––––

220 170

350 210

––––––– 390 –––––––

––––––– 560 –––––––

430 ––––––– 0 –––––––

––––––– 38,930 ––––––– 5,500 10,600 10,500

9,600 150 ––––––– 150 –––––––

––––––– 0 –––––––

––––––– 0 –––––––

––––––– 9,600 –––––––

––––––– 26,600 –––––––

20,050 35,000 ––––––– 55,050 –––––––

390 55,050 ––––––– 55,440 –––––––

560 55,440 ––––––– 56,000 –––––––

(9,600) 56,000 ––––––– 46,400 –––––––

12,330 46,400 ––––––– 58,730 –––––––

38,670

38,710

38,500

38,500

––––––– 38,670 ––––––– 93,720 ––––––– –––––––

––––––– 38,710 ––––––– 94,150 ––––––– –––––––

––––––– 38,500 ––––––– 94,500 ––––––– –––––––

––––––– 38,500 ––––––– 84,900 ––––––– –––––––

3,500 (8,200) ––––––– (4,700) ––––––– 54,030 ––––––– –––––––

$ 16,000 18,000 4,500 170 –––––––– 38,670 –––––––– –170 210 –––––––– 38,710 –––––––– –210 –––––––– 38,500 –––––––– –38,500 3,500 –––––––– 3,500 –––––––– ––––––––

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4

Slim Jim Co (a)

Sources of finance (i)

Retained earnings This is the most obvious source of finance for at least part of the funds required. Slim Jim could use part of the $1·3 million for the investment. However, given that the loan is repayable in six months time, the company must keep $0·5 million back for this. Also, there are often cost overruns on this sort of project so Slim Jim must keep some retained earnings back to cover these.

(ii)

Loan Slim Jim Co could take out a loan from the bank. It is unlikely to have access to any other source of debt provider (such as the international bond market) since it is not a large company.

(iii) Rights issue of shares Presumably, since we know that Slim Jim’s current owners are ‘wealthy’, they could inject more cash into the company in the form of shares. This will prevent any dilution of control by selling shares outside of the company. (iv) New share issue This would have to be to private investors, unless the company were to be floated on the stock exchange. (v)

(b)

Venture capital Slim Jim could approach a venture capital company with a view to obtaining funds for the expansion of the business. However, venture capitalists would want to be closely involved with the new venture, even expecting a place on the board of directors.

Mix of debt and equity Factors that should be taken into account are as follows: (i)

Cost The cost of equity is higher than the cost of debt. This is because an equity investor takes a greater risk. If the company goes into liquidation, an equity investor is the last person to be paid any money. Therefore, an equity investor expects a higher return to reflect the risk he is taking. Also, whereas equity holders receive their return in the form of dividends, lenders receive interest. Whilst interest payments are deductible for tax purposes, dividends are not. This makes the cost of paying $100 in interest, for example, less than the cost of paying $100 in the form of dividends. The tax relief element, combined with the lower risk element of debt, means that debt finance will definitely be cheaper.

(ii)

Control of the business Equity is normally injected into the business through the issue of ordinary shares. These allow the holder to share in the ownership of the business and carry voting rights. Hence, a shareholder can participate in business decisions. The market value of Slim Jim Co’s shares is currently $4 million. If the company issues a further $2 million of shares to private investors, then one would expect the investors to gain about 1/3 of the total number of shares in issue (2:4). This would give them a large degree of control over company decisions. Many resolutions of a company require 75% of the votes and Slim Co would therefore be advised to think carefully before issuing shares giving new shareholders this degree of control.

(iii) Current level of debt and maturity of existing borrowings A significant difference between debt and equity is that debt has to be repaid, whereas equity does not. It is therefore essential to review the level of Slim Jim’s current debt and the time period over which it has to be repaid. At present, the company has $0·5 million of loans to be repaid over the next six months. Cash flow and profit forecasts would need to be prepared in order to decide whether the company could undertake another loan at this point in time. There is not enough information here to decide. (iv) Effect on gearing Gearing can be calculated in many ways but, in simple terms, it measures the amount of debt against the amount of equity in a company. If debt is increased too much relative to equity, potential lenders will then see Slim Jim Co as a high risk investment. They will then expect better returns to reflect their increased level of risk. At worst, they will refuse to lend at all. Since Slim Jim Co has $4 million of equity and only has loans outstanding of $0·5 million (which will have been repaid in six months anyway), gearing will increase substantially if the company issues $2 million of loans. However, given the maturity of existing borrowings in six months, even with a full $2 million of loans, the company is unlikely to be seen as so risky that a lender would not grant a loan. This assumes, of course, that the company can pay the existing borrowings in six months without having to refinance them. (v)

Availability of finance Slim Jim Co is a private company. This means that it cannot sell shares to the general public. Equity finance must come from private investors. As such, the mix of debt and equity finance is restricted by the company’s ability to attract private investors. It is probably going to be much easier for Slim Jim to obtain debt, rather than equity, finance. This is presuming the company can offer some form of security for the loan. Debt finance would be restricted if this was not the case, since the lender would view the debt as more high risk without security. As regards equity finance, the company could consider floating its shares on the stock exchange in order to gain access to a greater pool of investors.

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ACCA Certified Accounting Technician Examination – Paper T10 Managing Finances

December 2008 Marking Scheme Marks

1

(a)

Costs explained One mark per valid point

1 ––– 8 –––

Max. marks (b)

NPV Sales Depreciation ignored Machine – incl. f £100k Machine – incl. £75k Wood – 1 mark per year Fabric – one mark per year Skilled labour Unskilled labour T1 Unskilled labour T2–5 Variable overheads Fixed overheads – ignoring £220k Fixed overheads – including £180k Net cash flow Present values Net present value Conclusion

6 1 1 1 5 5 2 2 2 1 1 1 1 1 1 1 ––– 32 ––– ––– 40 ––– –––

Total marks

2

(a)

(b)

(c)

Working capital cycle Raw materials period Finished goods period WIP period Receivables period Payables period (mats) Payables period (o/heads) Payables period (labour) COS working Total cycle

1 1 2 1 1 1 1 1 1 ––– 10 –––

Working capital management Explanation of WCM Why it is important

2 2 ––– 4 –––

Concerns Each one identified & explained

2 ––– 6 ––– ––– 20 ––– –––

Max. Total marks

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Marks 3

Receipts: Anchor Co Beauty Co Kent Co Hut Co Light Co Non-comm. cash customers Non-comm. DR card customers Total receipts Payments: Ink Co Toner Co Paper Co Salaries Petty cash Total payments Cleared excess Rs over Ps Cleared balance b/f Cleared balance c/f Uncleared funds float Uncleared receipts – 19 Jan Uncleared receipts – 20 Jan Uncleared receipts – 21 & 22 Jan Uncleared receipts – 23 Jan Uncleared payments – 23 Jan Total book balance c/f

0·5 0·5 0·5 0·5 0·5 1 1 1 0·5 0·5 0·5 1 1 1 1 1 1 2 1 1 1 1 1 ––– 20 ––– –––

Total marks

4

(a)

Sources of finance Max. marks for each source

2 ––– 5 –––

Max. overall (b)

Mix of debt and equity Cost Control of the business Current level of debt & maturity Effect on gearing Availability of finance

3 3 3 3 3 ––– 15 ––– ––– 20 ––– –––

Total marks

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