SOLUTIONS Accounting and Finance for Non-Specialists (By Peter Atrill & Eddie McLaney)

Instructor’s Manual Accounting and finance for non-specialists 5th Edition

Peter Atrill Eddie McLaney

For further instructor material please visit:

www.pearsoned.co.uk/atrillmclaney ISBN-13: 978-0-273-70246-7 / ISBN 10: 0-273-70246-7

 Pearson Education Limited 2006 Lecturers adopting the main text are permitted to photocopy the pack as required.

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Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: http://www.pearsoneduc.com ----------------------------------First published in 1999 This second edition 2006 © Pearson Education Limited 2006 The rights of Eddie McLaney and Peter Atrill to be identified as authors of this work has been asserted by them in accordance with the Copyright, Designs and Patent Act 1988. ISBN-13: 978-0-273-70246-7 ISBN-10: 0-273-70246-7 British Library Cataloguing in Publication Data A CIP catalogue record for this book can be obtained from the British Library. All rights reserved. Permission is hereby given for the material in this publication to be reproduced for OHP transparencies and student handouts, without express permission of the Publishers, for educational purposes only. In all other cases, no part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise without either the prior written permission of the Publishers or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London W1P 0LP. This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it is published, without the prior consent of the publishers. Printed and bound in Great Britain

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Contents Section A: Author’s Note to Tutors

4

Section B: Solutions to Exercises

10

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Section A

Authors’ note to tutors

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

Authors’ note to tutors Using the text The text is designed to provide readers with a sound introduction to accounting and finance. It assumes no previous knowledge of these subjects and recognises that students using the text may come from a wide variety of backgrounds. The text, therefore, tries to avoid technical jargon and does not assume a high level of numerical ability from students. The text has been class tested by students on various courses and we have modified and refined the material to take account of their comments. We have also taken account of the comments made by lecturers who used the first four editions of the text. The text aims to encourage an active approach to learning by providing activities and selfassessment questions at appropriate points in the text. This is designed to stimulate thought concerning particular issues and to give the reader the opportunity to test his or her understanding of the principles covered. The text is supplemented by a password-controlled lecturers’ website and a student website available to all readers. The structure of the text allows the tutor to deliver the subject in a number of ways. It can be used as recommended reading for a traditional course based on lectures and tutorials. There are review questions and exercises at the end of each chapter that can be used as the basis for tutorials. It could also provide the basis for a distance learning approach for part-time or off-campus students. For these students, the interactive nature of the text may be extremely useful where access to a tutor is restricted. The text can also be used as the basis for an open learning approach for full-time campus-based students. Accounting ‘surgeries’ may also be provided to give students the opportunity for one-to-one help with any problems they face. The text is appropriate for modules that are designed to be covered in 150 to 200 hours of study. For full-time students, this will often be covered in one academic year. For students taking certain programmes where the time available for accounting and finance is more limited, it may be necessary to adopt a selective approach to the chapters to be studied. The first six chapters deal with the nature and role of financial accounting and give a good grounding in the major financial statements. This would take up much of the time available, however. It may be possible to select further chapters for study from the remaining ones in the text.

PowerPoint slides The diagrams in the text, along with other diagrams and materials, are available as PowerPoint slides. These should help in delivering lectures and tutorials. They can be downloaded from the lecturers’ website.

International Financial Reporting Standards For accounting periods starting on or after 1 January 2005, all Stock Exchange listed companies in EU countries (including the United Kingdom) must prepare their published consolidated financial statements following International Financial Reporting Standards (IFRSs), formulated 5 © Pearson Education Limited 2006

Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

by the International Accounting Standards Board (IASB). This represents a major change for UK listed companies because IFRSs not only supersede UK Financial Reporting Standards, but much of UK company law as well. Given the date of publication of this book, we felt that it was appropriate for us to make the move to IFRS. Though non-listed companies need not make the change immediately, they may do so. It seems very likely that a mandatory adoption of the IASB regime will be applied to non-listed companies before too long. Though we became clear about the effect that the introduction of the IASB regime would have on the rules, we were not sure how companies would behave where they were able to use their discretion. We were eager that the book should reflect practice as well as the rules. Unfortunately, at the time of publication, practice had not had the full opportunity to reveal itself. In view of this, we carried out a survey of a number of practitioners and academics with a particular interest in the accounts of listed companies. We also examined a number of published interim financial statements of listed companies whose accounting year began on or after 1 January 2005. A clear consensus view emerged from our survey of the experts and we have followed this in the examples in the book. There was also considerable consistency in the approach taken by companies in their interims. The position can be summarised as follows: Adoption of the IASB approach The consensus view of the experts is that non-listed companies would tend to follow their listed counterparts fairly rapidly. Terminology Pronouncements of the IASB, including IFRSs, use terminology different from that generally used in the United Kingdom before 2005. These include the following: IASB term

Traditional UK term Profit and loss account

Income statement

Fixed asset

Non-current asset

Tangible fixed asset

Property, plant and equipment

Creditors: amounts falling due within one year

Current liabilities

Creditors: amounts falling due after more than one year

Non-current liabilities

Debtors

Receivables

Trade debtors

Trade receivables

Creditors

Payables

Trade creditors

Trade payables

Stock (in trade)

Inventories

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Our problem with these was the extent that the new terminology would supersede the old, in UK financial statements. The consensus view of the experts was that most of the IASB terms would tend to be used rather than the traditional ones. This was borne out by the published interims where the IASB terms were adopted wholesale in all cases. We have used IASB terms consistently throughout the book, though we have also referred to the traditional terms, at least at the first instance of mentioning the issue concerned and subsequently from time to time. Formats IAS1, Presentation of Financial Statements, shows an example of the format for an income statement and a balance sheet. In both cases, however, these are shown as illustrations, the choice of format being left to the company concerned. Since the IASB regime overrules the equivalent UK company law provisions, this means that the formats specified in the Companies Act 1985 are no longer mandatory. Given the freedom of choice that IAS1 allows, the question is, what will the UK companies do? The consensus view of the experts is that companies will continue to use the same formats that they used before 2005. The most popular formats were Format 1 for both statements, and so we have continued to use these in the book. The published interims show consistent use of Format 1 for the income statement. For the balance sheet, there is less consistency, with a variety of formats being used. Since the Format 1 approach is well represented, we have followed this approach in most of our examples.

Ordering of material The order in which topics are dealt with is clearly a matter of opinion. Our broad approach is to try to build up students’ knowledge and understanding and to seek to avoid situations where reference needs to be made to material appearing later in the text. We have taken the view that financial accounting is a good place to start, partly because students probably know of this aspect of accounting and finance from their background, it tends to be discussed in the news media, and so on. Also, we feel that this aspect is easier to deal with without knowledge of management accounting and finance. Within financial accounting, we have dealt with the balance sheet and income statement, company accounting, the cash flow statement and finally the financial accounting ratios. When dealing with the balance sheet and income statement (in Chapters 2 and 3), we have made no real distinction between companies and unincorporated businesses. This is because we see no great difference between these, except when there is the need to go into detail about the restrictions on withdrawals of capital and this is covered in Chapter 4 on company accounting. We have left cash flow statements until after introducing companies, because these statements usually relate to companies and the problem areas often relate to aspects like dividends and taxation.

Double-entry bookkeeping The text does not cover double-entry bookkeeping, in the sense of ‘T’ accounts. We have taken the view that students can gain a sufficient grasp of both the principles and practice of how transactions are recorded, and their ultimate effect on the balance sheet and income statement, by dealing with them on a ‘plus and minus’ basis. We feel that, for the target readership, the recording process is of limited importance and that the key issues relate to the effect of transactions on the business overall. It may be the case that students’ understanding of this would be

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enhanced by a closer look at the recording process, through ‘T’ accounts, but this will take time that we believe could be better devoted to other aspects. We are aware that not all of our colleagues agree with us on this, so an appendix – ‘Recording financial transactions’ – is available for tutors to download. This can be slotted into the students’ studies, perhaps best, immediately after dealing with the contents of Chapters 2 and 3. This supplement is self-contained. It includes a number of activities and three exercises.

Practice/assessment material The activities, whose solutions immediately follow them, and self-assessment questions, whose solutions are at the end of the text, form an integral part of the text. In addition, there are various other practice/assessment materials. At the end of each chapter, there are four review questions. These are short, narrative questions involving recall, explanation and brief discussion. The solutions to these are also given at the end of the text. At the end of all the chapters, except Chapter 1, there are five exercises. These are questions, many involving calculations, that are similar in nature to exam-style questions. The solutions to three of these are also given at the end of the text and are, therefore, accessible to students. Solutions to the other two are in the following pages of this manual and are not accessible to students. The lecturers’ website contains the following: 1. Supplementary questions, with solutions. There are 11 such questions and these are similar to the end-of-chapter exercises. 2. Tutorial/seminar questions, four for each chapter, with outline solutions. These are questions that can be used as a basis for discussion at tutorial sessions. These are short, narrative questions that are designed to encourage students to think round the issues a bit. 3. Case studies, with solutions. 4. Progress tests, with answers. There are two of these, both including multiple-choice, missing-word, and more traditional exam-style questions. 5. The double-entry bookkeeping appendix, referred to above. None of the material on the lecturers’ website is accessible to students. The student website contains the following: 1. Revision questions, similar in style to the end-of-chapter exercises, with solutions. There are 22 of these. 2. Multiple-choice questions (MCQs). Typically, there are 10 such questions for each chapter. These are intended to be tackled online, where they will be automatically graded. 3. Missing-word questions (MWQs), typically 10 for each chapter. These too can be attempted and graded online. Both MCQs and MWQs are intended to provide students with a quick assessment of their mastery of the material of each chapter. The solutions to all of this material, except to the MCQs and MWQs, are fully annotated in order to give the necessary feedback to students.

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

We intend to expand the number and scope of the practice/assessment materials on a continuing basis. We hope that you and your students will find the text and the website material useful, accessible and interesting. We should much appreciate any suggestions you may have on how the text and supplementary material may be improved. Peter Atrill Eddie McLaney September 2005

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Section B

Solutions to exercises

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

Solutions to exercises 2.3 Joe Conday Balance sheet as at 1 March £ Bank

20,000

£ Capital

20,000

Balance sheet as at 2 March £ Bank (20,000 – 6,000)

14,000

Fixtures and fittings

6,000

Inventories

8,000

£ Capital Payables

28,000

20,000 8,000

28,000

Balance sheet as at 3 March £ Bank (14,000 + 5,000)

19,000

£ Capital

20,000

Fixtures and fittings

6,000

Payables

8,000

Inventories

8,000

Loan

5,000

33,000

33,000

Balance sheet as at 4 March £ Bank (19,000 – 7,200)

11,800

£ Capital

19,800

Fixtures and fittings

6,000

Payables

8,000

Inventories

8,000

Loan

5,000

Motor car

7,000 32,800

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32,800

Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

Balance sheet as at 5 March £

£

Bank (11,800 – 2,500)

9,300

Capital

Fixtures and fittings

6,000

Payables

8,000

Inventories

8,000

Loan

5,000

Motor car

9,000 32,300

19,300

32,300

Balance sheet as at 6 March £ Bank (9,300 + 2,000 – 1,000)

10,300

£ Capital

21,300

Fixtures and fittings

6,000

Payables

8,000

Inventories

8,000

Loan

4,000

Motor car

9,000 33,300

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33,300

Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

2.5

Balance sheet as at the end of the week Assets

£

Freehold premises

Claims

£

145,000 Capital (203,000 + 11,000 – 8,000 + 23,000 – 17,000 + 100,000 + 10,000)

Fixtures and fittings

63,000

322,000

Motor van

10,000 Bank overdraft (43,000 – 11,000 – 18,000 – 100,000 + 13,000)

Inventories

Trade payables

(28,000 – 8,000 – 17,000 + 14,000)

(23,000 + 14,000 – 13,000)

(73,000)

17,000

24,000

38,000

_______

Trade receivables (33,000 + 23,000 – 18,000)

273,000

273,000

Since the bank balance is now positive, we can rewrite this balance sheet as follows: Balance sheet as at the end of the week Assets

£

Claims Capital

£

Freehold premises

145,000

Fixtures and fittings

63,000

Motor van

10,000

Inventories

17,000

Trade receivables

38,000

Cash at bank

73,000

_______

346,000

346,000

Trade payables

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322,000

24,000

Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

3.2 Singh Enterprises

Income statement (extract) for the year ended 31 December 2003 £ Depreciation – machinery

2,000

Balance sheet as at 31 December 2003 £ Machinery at cost

10,000

Less Accumulated depreciation

2,000 8,000

Income statement (extract) for the year ended 31 December 2004 £ Depreciation – machinery (2,000 + 2,500)

4,500

Balance sheet as at 31 December 2004 £ Machinery at cost

25,000

Less Accumulated depreciation (4,000 + 2,500)

6,500 18,500

Income statement (extract) for the year ended 31 December 2005 £ Depreciation – machinery

4,500

Loss on sale of machine (10,000 – 6,000 – 3000)

1,000

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

Balance sheet as at 31 December 2005 £ Machinery at cost

15,000

Less Accumulated depreciation (2 x 2,500)

5,000 10,000

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

3.5 TT Limited

Balance sheet as at 31 December 2006 Assets

£

Delivery van (+9,500 + 13,000 – 5,000)

Claims

17,500 Capital (+76,900 – 20,000 + 37,705)

Inventories

£ 94,605

26,000

(+ 65,000 + 67,000 + 8,000 – 89,000 – 25,000) Trade payables

18,000

(+ 22,000 + 67,000 – 71,000)

Trade receivables

20,600 Accrued expenses

(+19,600 + 179,000 – 178,000)

Cash at bank

1,550

(+ 860 + 690)

49,730

(+750 – 20,000 – 15,000 – 1,300 – 13,000 – 36,700 – 1,820 – 8,000 + 54,000 + 178,000 – 71,000 – 16,200) Prepaid expenses

325

(325) _______ 114,155

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114,155

Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

Income statement for the year ended 31 December 2006 £ Sales revenue (+ 179,000 + 54,000)

£ 233,000

Less: Cost of inventories sold (+ 89,000 + 25,000)

114,000

Gross profit

119,000

Less: Rent (5,000 + 15,000) Rates (300 + 975)

20,000 1,275

Wages (–630 + 36,700 + 860)

36,930

Electricity (–620 + 1,820 + 690)

1,890

van depreciation (2,500 + 2,500)

5,000

van expenses (16,200)

16,200 81,295

Net profit for the year

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37,705

Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

The balance sheet could now be rewritten in a more stylish form as follows:

TT Limited Balance sheet as at 31 December 2006 £

£

£

Non-current assets 17,500

Motor van Current assets 26,000

Inventories Trade receivables

20,600

Prepaid expenses

325

Cash

49,730 96,655

Less: Current liabilities Trade payables

18,000

Accrued expenses

1,550

19,550 77,105 94,605

Capital 50,000

Original Retained profit

44,605 94,605

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

4.3 (a) A dividend is a drawing of capital made by shareholders. Usually, but not necessarily, it is in the form of cash. Often it reflects the level of profit made during the year to which it relates, but it is perfectly legal to pay a dividend out of past retained profits. Broadly, that part of the owners’ claim that can be reduced through payment of a dividend is limited to that that arises from normal realised trading profits and realised gains from disposals of noncurrent assets. (b) A debenture is a long-term loan (evidenced by a deed). Many businesses borrow on a longterm basis where the rate of interest, the interest payment date and the capital repayment date are defined in the contract between the business and the lenders. Debenture loans are usually secured on some assets (typically land and buildings) of the business. (c) A share premium account is a reserve – part of the equity or owners’ claim – that arises from shares being issued at above their par (or nominal) value. This reserve is not part of the owners’ claim that can be reduced by paying a dividend.

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

4.5 Rose Limited

Balance sheet as at 31 March 2006 £000 Non-current assets (2,728 – 74 + 16)

£000 2,670

Current assets Inventories (1,583 – 2)

1,581

Receivables (996 + 34 – 21)

1,009

Cash

26 2,616

Current liabilities Trade payables

(1,118)

Other payables (417 + 16 +1)

(434)

Tax

(415)

Overdraft

(596) (2,563)

Net current assets 53 Non-current liabilities Secured loan (2011) (300) 2,423

Equity Share capital (50p shares, fully paid) Share premium

750

Retained profit

250 1,423 2,423

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

Income statement for the year ended 31 March 2006 £000

£000

Sales revenue (12,080 + 34)

12,114

Cost of sales (6,282 + 2)

(6,284)

Gross profit

5,830

Labour cost (2,658 + 1)

(2,659)

Depreciation (625 + 74)

(699)

Other operating costs (1,003 + (1,030 x 2% = 21))

(1,024) (4,382)

Net profit before interest and tax Interest payable

1,448 (66)

Net profit before tax

1,382

Tax payable (1,382 x 30%)

(415)

Net profit after tax

967

Dividend paid

(300)

Retained profit for the year

667

Retained profit brought forward

756

Retained profit carried forward

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1,423

Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

5.2 Juno plc Net operating profit (for last year)

187

Adjustments for: Depreciation

55 242

Increase in inventories (31 – 27)

(4)

Decrease in trade receivables (24 – 23)

1

Increase in trade payables (17 – 15)

2

Cash generated from operations

241

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

5.4 Chen plc Cash flow statement for the year ended 31 December 2006 £m

£m

Cash flows from operating activities Net profit, after interest, before taxation (see Note 1 below)

25

Adjustments for: Depreciation (10 + 12)

22

Interest expense (Note 2)

4 51

Increase in inventories (25 – 24) Decrease in trade receivables (26 – 25) Decrease in trade payables (37 – 34)

(1) 1 (3)

Cash generated from operations

48

Interest paid

(4)

Corporation tax paid (Note 3)

(11)

Dividend paid

(18)

Net cash from operating activities

15

Cash flows from investing activities Payments to acquire non-current assets (Note 4)

(36)

Net cash used in investing activities

(36)

Cash flows from financing activities Net cash used in financing activities Net decrease in cash and cash equivalents

— (21)

Cash and cash equivalents at 1 January 2006 Cash at bank

19

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

Cash and cash equivalents at 31 December 2006 Bank overdraft

(2)

To see how this relates to the cash of the business at the beginning and end of the year, it may be useful to provide a reconciliation as follows: Analysis of cash and cash equivalents during the year ended 31 December 2006 £m Cash and cash equivalents at 1 January 2006

19

Net cash outflow

(21)

Cash and cash equivalents at 31 December 2006

(2)

Notes: 1. This is simply taken from the income statement for the year. 2. Interest payable expense must be taken out, by adding it back to the profit figure. We subsequently deduct the cash paid for interest payable during the year. In this case, the two figures are identical. 3. Tax is paid by companies at 50% during their accounting year and the other 50% in the following year. Thus, the 2006 payment would have been half the tax on the 2005 profit (that is, the figure that would have appeared in the current liabilities at the end of 2005), plus half of the 2006 tax charge (that is, 8 + (1/2 × 6) = 11). 4. Since there were no disposals, the depreciation charges must be the difference between the non-current asset values at the start and at the end of the year, adjusted by the cost of any additions. £m Book value at 1 January 2006 Add Additions (balancing figure)

172 36 208

Less Depreciation (10 + 12) Book value at 31 December 2006

22 186

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

6.3 Conday and Co. Ltd (a) Return on capital employed Net profit before long-term loan interest and tax x 100% Long-term capital (320 + 24*) x 100% 1,265

27.2%

* interest on debentures. Return on ordinary shareholders’ funds Net profit after tax x 100% Share capital + reserves 225 x 100% 1,065

21.1%

Gross profit margin Gross profit x 100% Sales revenue 37.7%

980 x 100% 2,600 Net profit margin Net profit before interest and tax x 100% Sales revenue 398 x 100% 2,600

15.3%

Sales revenue to capital employed (asset turnover) Sales revenue Total assets employed 2,600 2,410

1.1 times

Average settlement period for receivables Trade receivables x 365 days Credit sales revenue 820 x 365 days 2,600

115 days

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

Inventories turnover period Inventories held x 365 days Cost of sales 600 x 365 days 1,620

135 days

The above ratios reveal that Conday and Co. Ltd is profitable. In particular, the return on ordinary shareholders’ funds and ROCE ratios seem to be high in relation to the returns achieved by more secure forms of investment such as government securities. However, whether this level of return is sufficient in relation to the risks involved is difficult to judge from the information available. The settlement period for receivables seems very high, which may be due to the nature of the business. However, this high ratio, combined with the fact that the bad debts of the company account for more than 6% of the total sales revenue, suggests that some tightening of credit control procedures may be required. The inventories turnover figure also seems high. The business is carrying more than four months’ inventories. This may indicate a need also to improve inventories control procedures. At present, the business has a large bank overdraft and so major improvements in inventories control and credit control procedures may have a significant effect on both the liquidity and the profitability of the business. Given the high level of bank borrowing, it is difficult to understand why such a high proportion of the profits generated for the year was distributed in the form of dividend. This is not a very prudent policy. The ratio of sales revenue to capital employed seems quite low. This is due, at least in part, to the high levels of inventories and receivables that are being carried. (b) Though the business is profitable, there are some doubts as to the quality of its management. The business has high levels of inventories and receivables and a large overdraft. It is possible that better management would not have allowed this situation to arise. It is also possible that better management of existing assets would remove the need for external sources of funds for expansion. It interesting to speculate how £200,000 received from the issue of shares might be used by the managers. Would it be used to finance even higher levels of inventories and receivables without there being a corresponding increase in sales revenue? The share price of £6.40 is much higher than the net asset value of the shares. At present, the net assets (assets less liabilities) are £1,065,000 and there are 700,000 shares in issue. This gives a net asset value per share of £1.52. To justify paying £6.40, the investor would have to be convinced that the business would generate high profits in the future.

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

6.4 Threads Ltd (a)

2005

ROCE

2006

234/756

= 31.0%

(159 + 8*)/845

= 19.5%

Net profit margin

234/1180

= 19.8%

167/1200

= 13.9%

Gross profit margin

500/1180

= 42.4%

450/1200

= 37.5%

Current ratio

253/199

= 1.3:1

396/238

= 1.7:1

Liquidity ratio (Acid test)

105/199

= 0.5:1

160/238

= 0.7:1

(102/1180) x 365

= 32 days

(156/1200) x 365

= 47 days

Days payables

(60/680) x 365

= 32 days

(76/750†) x 365

= 37 days

Inventories turnover

148/680 x 365

= 79 days

236/750 x 365

= 115 days

Days receivables

*Long-term interest only †Credit purchases figure not available (b) A supplier seeking to sell a substantial amount of goods to the business will be concerned with both liquidity and longer-term viability (where there is a continuing relationship) as measured by profitability ratios. The supplier will also be interested in the average time taken by the business to pay its current suppliers. •

The liquidity ratios reveal an apparent improvement over the two years. However, for a manufacturing business, the liquidity ratios seem low and the supplier may feel some concern. The increase in inventories over the period has led to a greater improvement in the current ratio than in the liquid (acid test) ratio. The improvement in the acid test ratio has not been very great and some concern over the business’s liquidity position must remain. 27 © Pearson Education Limited 2006

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•

The average credit period allowed to credit customers has increased substantially in 2006. This may be a deliberate policy. However, if this is the case, the effect of a more liberal credit policy has not proved to be very successful as there has only been a slight increase in sales revenue in 2006. The increase in credit period may be due, on the other hand, to other factors such as poor credit control or particular customers experiencing financial difficulties. The effect of this change in the receivables ratio should be carefully noted by the supplier as the increase in receivables outstanding seems to be partly financed by an increase in the average period taken to pay trade payables.

•

The inventories turnover period has increased significantly in 2006. This might be due to building inventories in anticipation of future sales revenue. However, it might indicate that certain products are not selling as well as expected and are therefore remaining as inventories.

•

The gross profit margin and net profit margin are both lower in 2006. Lower margins have, in turn, led to a lower return on capital employed. The lower profit margins, the increase in the average credit period allowed to trade receivables and the increase in the inventories turnover period may suggest that the business has a product range that is becoming obsolete and therefore more difficult to sell. It might, however, also suggest a more competitive business environment.

The ratios calculated above do not indicate any serious problems for the business. However, it is clear that 2006 proved to be a more difficult year than 2005. Things may well improve in the future though. At this point, however, the supplier would be well advised to be cautious in its dealings with the business. Certainly, the supplier should not rely too heavily on Threads Ltd for future sales revenue.

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7.1 Alpha, Beta and Gamma (a) Firstly, we need to deduce the total contribution for one unit of each service. This will enable us to deduce the contribution per £1 of labour and so the relative profitability of the three services, given a shortage of labour. Strictly, we should use the contribution per hour, but we do not know the number of hours involved. Since all labour is paid at the same rate, using labour cost will give us the same order of priority as using hours. Alpha

Beta

Gamma

£000

£000

£000

Materials

(6)

(4)

(5)

Labour

(9)

(6)

(12)

Expenses

(3)

(2)

(2)

(18)

(12)

(19)

Sales revenue

39

29

33

Contribution

21

17

14

2.333

2.833

1.167

1st

3rd

Variable costs:

Total variable cost

Contribution per £ of labour Order of profitability

2nd

Since 50% of each budget (and, therefore, £13,500 of labour) is committed, only £6,500 (£20,000 – £13,500) of labour is left uncommitted. The £6,500 should be deployed as: £ Beta

3,000

Alpha

3,500 6,500

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Total labour committed to each service and the resultant profit are as follows: Alpha

Beta

Gamma

Total

£

£

£

£

Labour 50% of budget

4,500

3,000

6,000

Allocated above

3,500

3,000

–

Total

8,000

6,000

6,000

Contribution per £ of labour

2.333

2.833

1.167

Contribution per unit of service* 18,664

16,998

7,002

Less Fixed costs

20,000

42,664 33,000

Maximum profit (after rounding)

9,664

*The contribution per £ of labour x total labour for each product. (b) The steps include the following: •

Using all of the surplus labour to render the Beta service (the most efficient user of labour). In other words, could the business sell more than £29,000 of this service? It might be worth reducing the price of the Beta, though still keeping the contribution per £1 of labour above £2.33, in an attempt to expand sales revenue.

•

Dropping the commitment to 50% of budget on each service, in favour of providing the maximum of the higher-yielding services.

•

Finding another source of labour.

•

Subcontracting the labour-intensive part of the work. Some, possibly all, of these approaches may not be practical in the circumstances, but they seem worth considering. Other approaches may also be worth considering.

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7.2 The hotel group (a) The variable element and, by implication, the fixed element of the hotel’s costs can be deduced by comparing any two quarters, for example: Quarter

Sales revenue

Profit (loss)

Total cost

£000

£000

£000

1

400

(280)

680*

2

1,200

360

840*

Difference

800

160*

* This is because: Sales revenue – total costs = profit (or loss) So, Sales revenue – profit (or + loss) = total costs Thus, the variable element of the sales price is 20% (160/800). Now: The fixed costs for quarter 1 = Total costs – variable costs = £680,000 – (20% x 400,000) = £600,000 To check that this calculation is correct and consistent for all four quarters, we can ‘predict’ the total costs for the other three quarters and then check the predicted results against those that can be deduced from the question, as follows: Quarter 2 Total cost = fixed costs – variable costs = £600,000 – (20% x 1,200,000) = £840,000

Agrees with the question

Quarter 3 Total cost = fixed costs – variable costs = £600,000 – (20% x 1,600,000) = £920,000

Agrees with the question

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Quarter 4 Total cost = fixed costs – variable costs = £600,000 – (20% x 800,000) = £760,000

Agrees with the question

Had the fixed and variable elements been deduced graphically, the consistency of the fixed and variable cost elements over the four quarters would have been obvious because the result would have been a straight line. The provisional results for this year are as follows: Total

Per visitor (50,000 visitors)

Sales revenue Variable costs (20% of sales revenue) Contribution

£000

£

4,000

80

(800)

(16)

3,200

64

(2,400)

(48)

Fixed costs (that is, fixed costs for a quarter x 4) Profit

800

16

(b) (i) At the same level of occupancy as for this year and incorporating the increase in variable costs of 10%, the sales revenue for next year should be as follows: £000 Fixed costs Variable costs (800,000 x 110%)

2,400 880

Total costs

3,280

Target profit

1,000

Sales revenue target

4,280

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Hence, the sales revenue per visitor is £4,280,000 = £85.60 50,000

(ii) If the sales revenue per visitor remains at the current rate, the contribution per visitor will be £80 – (£16 x 110%) = £62.40

To cover the fixed costs and the target profit, it would take £2,400,000 + 1000 , ,000 ≈ 54,487 visitors £62.40

(c) The major assumptions of profit–volume analysis are that costs can be divided between those that vary with the volume of activity (and with that factor alone) and those that are totally unaffected by volume changes. Further assumptions are that both variable costs and sales revenue vary at a steady rate (straight-line relationship) with volume. These assumptions are unlikely to be strictly valid in reality. Variable costs are unlikely to vary in a truly straight-line manner relative to volumes. For example, at higher levels of output, there may be economies of scale in purchasing (for example, bulk discounts) or the opportunity to use materials or labour more effectively. On the other hand, the opposite may be the case. At higher levels of output, cost per unit increases because a shortage may be created by the higher output level. Similarly, the business may not be able to sell more without reducing the selling price.

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8.2 Pieman Products Ltd Indirect costs: £ Indirect labour

25,000

Depreciation

8,000

Rent and rates

10,000

Heating, lighting and power

5,000

Indirect materials

2,000

Other indirect costs

1,000

Total indirect costs

51,000

This list does not include the direct costs because we shall deal with the direct costs separately. Probably a direct-labour hour basis of charging overheads to jobs is most logical in this case (see below). The direct-labour hours are given as 16,000. Overhead recovery rate per direct-labour hour: £51,000/16,000 = £3.1875 per direct-labour hour. Full cost of the trailer: £ Direct materials

1,150.00

Direct labour

(250 x (£160,000/16,000))

Indirect costs

(250 x £3.1875)

Full cost

2,500.00 796.88 4,446.88

Direct-labour hours are probably the most logical basis for charging overheads to the job. Those hours probably provide the only measurable thing about the job that is a reasonable assessment of the size/complexity/importance of each job relative to the others undertaken. The work of the business is probably labour intensive; it is probably difficult to introduce to a great extent machine-controlled work into making trailers to individual specifications.

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8.3 Athena Ltd (a)

Budgeted overheads for next year Total

Machining

Fitting

Department £

Department

£

£

Heating and lighting

25,000

12,500

12,500

Machine power

10,000

10,000

-

Indirect labour*

50,000

12,500

37,500

Depreciation

30,000

30,000

115,000

65,000

50,000

* This is divided as 50,000:150,000, that is, in proportion to direct labour. Note that direct labour and materials are not included in this schedule because they are not indirect costs. (b)

Machining Department The machine hour rate = £65,000/20,000 = £3.25 per hour Fitting Department The direct labour hour rate = £50,000/(150,000/10) = £3.33 per hour. (Note that the direct workers are paid £10 an hour, so the hours to be worked are 150,000/10.)

(c)

Job price £ Direct materials

1,200

Direct labour: Machining Department

10 hours x £10

100

Fitting Department

40 hours x £10

400

50 hours x £3.25

163

(to the nearest £)

40 hours x £3.33

133

(to the nearest £)

Overheads

1,996

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Profit loading

20% x £1,996

399 £2,395

Thus the price will be £2,395.

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9.1 (a) A budget is a business plan for a future period, usually expressed in financial terms. A forecast is an assessment/estimation of what is expected to happen in the environment. ‘Plan’ implies an intention to achieve. Thus, a budget is a plan of what management intends to achieve during the period of the budget. Relevant forecasts may well be taken into account when budgets are being prepared, but there is a fundamental difference between budgets and forecasts. Though a year is a popular period for detailed budgets to be drawn up, there is no strong reason in principle why they have to be of this length. (b) The layout described is generally regarded as a useful approach. Budgets are documents exclusively for the use of managers within the business. For this reason, those managers can use whatever layout best suits their purpose and tastes. In fact, there is no legal requirement that budgets should be prepared at all, let alone that they are to be prepared in any particular form. (c) It is probably true to say that any manager worth employing would not want to work for a business that did not have an effective system of budgeting. Without budgeting, the following advantages would be lost: •

Coordination

•

Motivation

•

Focusing on the future

•

Provision of the basis of a system of control

•

Provision of a system of authorisation.

Any good system of budgeting would almost certainly have individual managers participating heavily in the preparation of their own budgets and targets. It would also be providing managers with demanding, but rigorous, targets. This would give good managers plenty of scope to show flair and initiative, yet be part of a business that is organised, in control and potentially successful. (d) Any sensible person would probably start with the budget for the area in which the limiting factor lies – that is, that factor that will, in the end, prevent the business from achieving its objectives to the extent that would have been possible were it not for that factor. It is true that, in practice, sales demand is often the limiting factor. In those cases, the sales budget is the best place to start with. The limiting factor could, however, be a shortage of suitable labour or materials. In this case, the labour or materials budget would be the sensible place to start with. The reason why the starting point is important is simply that it is easier to start with the factor that is expected to limit the other factors and for those other factors to fit in.

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9.2 Daniel Chu Ltd •

The finished goods inventories budget for the six months ending 30 September (in units of production) is as follows: April

May

June

July

Aug

Sept

units

units

units

units

units

units

0

500

600

700

800

900

500

600

700

800

900

900

500

1,100

1,300

1,500

1,700

1,800

Less Sales (note 3)

0

500

600

700

800

900

Closing inventories

500

600

700

800

900

900

Opening inventories (note 1) Production (note 2)

•

The raw materials inventories budget for the six months ending 30 September (in units) is as follows:

April

May

June

July

Aug

Sept

units

units

units

units

units

units

0

600

700

800

900

900

1,100

700

800

900

900

900

1,100

1,300

1,500

1,700

1,800

1,800

Less Production (note 4)

500

600

700

800

900

900

Closing inventories

600

700

800

900

900

900

Opening inventories (note 1) Purchases (note 2)

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•

The raw materials inventories budget for the six months ending 30 September (in financial terms) is as follows: April

May

June

July

Aug

Sept

£000

£000

£000

£000

£000 £000

-

24

28

32

36

36

44

28

32

36

36

36

44

52

60

68

72

72

(note 4)

20

24

28

32

36

36

Closing inventories

24

28

32

36

36

36

Opening inventories (note 1) Purchases (note 2)

Less Production

•

The trade payables budget for the six months ending 30 September is as follows:

April

May

June

July

Aug

Sept

£000

£000

£000

£000

£000

£000

-

44

28

32

36

36

44

28

32

36

36

36

44

72

60

68

72

72

-

44

28

32

36

36

44

28

32

36

36

36

Opening balance (note 1) Purchases (note 5)

Less Cash payment Closing balance

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•

•

The trade receivables budget for the six months ending 30 September is as follows: April

May

June

July

Aug

Sept

£000

£000

£000

£000

£000

£000

Opening balance (note 1)

-

-

50

60

70

80

Sales revenue (note 3)

-

50

60

70

80

90

-

50

110

130

150

170

Less Cash received

-

-

50

60

70

80

Closing balance

-

50

60

70

80

90

The cash budget for the six months ending 30 September is as follows: April

May

June

July

Aug

Sept

£000

£000

£000

£000

£000

£000

-

-

50

60

70

80

300

-

50

60

70

80

-

44

28

32

36

36

10

12

14

16

18

18

17

17

17

17

17

17

10

10

10

10

10

10

Inflows Share issue

300

Receipts – receivables (note 6)

Outflows Payments to payables (note 7) Labour (note 3) Overheads: Production Non-production (note 8) Non-current assets

250

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Total outflows

287

83

69

75

81

81

(outflows)

13

(83)

(19)

(15)

(11)

(1)

Balance c/f

13

(70)

(89)

(104)

(115)

(116)

Net inflows

Notes 1. The opening balance is the same as the closing balance from the previous month. 2. This is a balancing figure. 3. This figure is given in the question. 4. This figure is derived from the finished inventories budget. 5. This figure is derived from the raw materials inventories budget. 6. This figure is derived from the trade receivables budget. 7. This figure is derived from the trade payables budget. 8. This figure is the non-productive overheads less depreciation, which is not a cash expense.

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10.2

C. George (Controls) Ltd

(a) and (b) The potential variable cost savings per unit of the product is as follows: £ Labour

2.10

(that is, £3.30 – £1.20)

Materials

0.45

(that is, £3.65 – £3.20)

Variable overheads

0.18

(that is, £1.58 – £1.40)

2.73 x 50,000 = £136,500 each year Incremental cash flows Year 0

Year 1

Year 2

Year 3

Year 4

£000

£000

£000

£000

£000

136.5

136.5

136.5

136.5

Variable cost savings New equipment

(670.0)

70.0

Old equipment

150.0

(40.0)

Working capital

130.0

____

____

____

(130.0)

(390.0)

136.5

136.5

136.5

36.5

Discount factors

1.000

0.893

0.797

0.712

0.636

Present values

(390.0)

121.9

108.8

97.2

23.2

NPV

(38.9)

(c) Since the NPV is negative, the project would have an adverse effect on the wealth of the shareholders of the business and should not be pursued.

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(d) Cash flows are used rather than profit flows since it is cash which gives command over resources. It is only when the cash is paid or received that the opportunity to deploy it elsewhere is lost or gained respectively. In the long run, profit and cash flows should be equal; however, the timing of the flows will be different.

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10.3

The accountant

(a) Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

£000

£000

£000

£000

£000

£000

Sales revenue

450

470

470

470

470

Working capital recovered

___

___

___

450

470

470

470

650

Materials

126

132

132

132

132

Labour

90

94

94

94

94

Overheads

30

30

30

30

30

180

Working capital

180

New equipment

500

___

___

___

___

___

680

246

256

256

256

256

(680)

204

214

214

214

394

Incremental cash flows Notes: •

Working capital invested in this project at the start will be recovered at the end of the project’s life.

•

The relevant overheads figure is £30,000 per year additional cost that the project is expected to cause.

•

Depreciation is not a cash flow.

•

Interest on the working capital investment, and indeed on other aspects of this investment, is dealt with by discounting.

•

The development cost is not a relevant cost, since it has already been incurred and is not affected by the decision to be made.

•

The cost of the equipment to start this project is the £500,000 that must be spent. The book value of the old machine is not relevant since this does not represent an outlay or an opportunity cash flow.

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(b) (i) Payback period

Incremental cash flows Cumulative incremental cash flows

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

£000

£000

£000

£000

£000

£000

(680)

204

214

214

214

394

(680)

(476)

(262)

(48)

166

560

Thus the payback point occurs in Year 4, that is, after just over 3 years (assuming cash flows accrue evenly over the year). (ii) NPV Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

£000

£000

£000

£000

£000

£000

Incremental cash flows

(680)

204

214

214

214

394

Discount factor

1.000

0.893

0.797

0.712

0.636

0.567

Present values

(680)

182.2

170.6

152.4

136.1

223.4

NPV

184.7

(c) A memo to the board might include the following points: • The fact that the project has a significant positive NPV, which would increase shareholder wealth. •

The fact that the project has a relatively short payback period.

• The figures in the analysis ignore taxation, which should be considered before a final decision is made. •

The question of risk should be considered before a final decision is made.

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11.2

International Electric plc

(a) The approximate equivalent annual percentage cost of allowing 2% discount for receiving cash 40 days earlier is (365/40) x 2% = 18.25% (b) Old scheme

New scheme

£m

£m

0.5 x (£365 m x 30/365)

15.0

15.0

0.5 x (£365 m x 70/365)

35.0

Receivables owing

0.25 x (£365 m x 30/365) 0.25 x (£365 m x 70/365)

7.5 ____

17.5

50.0

40.0

(c) Cost of discounts allowed = (0.75 x £365 m) x 2% = £5,475,000 (d) £ Cost of discounts

£ 5,475,000

Less Interest charges saved ((£50 m – £40 m) @ 12%) Bad debt savings

1,200,000 300,000

Net cost

1,500,000 3,975,000

The calculations reveal that the costs of the discounts scheme heavily outweigh the benefits.

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(e) To manage its receivables, the business should consider doing the following: •

establish clear policies concerning who should receive credit and how long the credit period should be;

•

establish a system for investigating creditworthiness;

•

ensure that customers are invoiced promptly and that statements and reminders are issued at appropriate periods;

•

establish systems for monitoring and controlling receivables, such as ageing schedules, average settlement period ratios, and so on;

•

set up procedures for dealing with slow payers.

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11.3

Sparkrite Ltd

(a) Last year

This year

Inventories turnover period

(160 + 200)/2 x 365

61 days

1,080

(200 + 250)/2 x 365

73 days

1,125

Average settlement period *

375 x 365

76 days

1,800

480 x 365

91 days

1,920 *Year-end receivables figures were used because opening figures were not available for both the years. (b) (i) Ways in which the business can exercise control over inventories levels include the following: •

using sales forecasting methods in order to assess the demand for inventories;

•

using inventories management models in order to determine the economic order quantity;

•

using proper authorisation procedures for ordering inventories;

•

establishing an accurate inventories-recording system;

•

using the just-in-time method, improving supplier lead times, and so on, to minimise inventories holding;

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•

conducting regular physical inventories checks to ensure accuracy of inventories records and to identify slow-moving and obsolete inventories;

•

ensuring levels of inventories monitoring and security are appropriate to the value of the inventories held.

(ii) Ways in which the business can exercise control over receivables’ levels include the following: •

establishing creditworthiness checks on potential customers;

•

establishing credit limits;

•

offering discounts for prompt payment;

•

charging interest on late payment;

•

calculating average settlement periods and preparing ageing schedules of receivables outstanding;

•

invoicing customers promptly and sending reminders and statements at appropriate periods;

•

checking to see where credit limits have been breached;

•

establishing a policy for dealing with late payers;

•

factoring (that is, allowing a finance institution to manage the receivables and obtaining finance on the strength of the debts owing to the business), where appropriate.

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12.4

Gainsborough Fashions Ltd

(a) The major factors that a bank should take into account are as follows: •

Purpose What is the purpose of the overdraft? Is it to help finance a temporary cash shortage? Will the purpose ensure that the overdraft is self-liquidating? If not, how will the overdraft be repaid?

•

Repayment period When will the overdraft be repaid? Has a cash flow forecast been prepared, clearly showing the repayment period and the financing requirements? Are the underlying assumptions of the forecast valid and reliable?

•

Security What assets can be offered as security for the overdraft? Are the assets readily realisable?

•

Financial strength What is the financial position and performance of the business? What are the risks involved in the business in which it is engaged? Can the business cope with a downturn in sales?

•

Directors What are the abilities and characters of the directors? Are they managing the business efficiently? Would they make every effort to repay the overdraft when required?

•

Track record Has the business taken out loans before and, if so, did the business comply with the terms of these loans?

(b) A number of points can be made concerning the request of the business for an overdraft: •

Ability to repay The information available does not indicate how the proposed increase in overdraft might be repaid. In order to reduce the average credit period taken from three months to one month, the finance required will be £108,000 (that is, 2/3 x £162,000). This is more than 4 times the business’s current net profit after taxation. It does not seem likely, therefore, that the overdraft, which is meant to be a short-term form of borrowing, could be repaid out of short-term future profits. As the purpose of the overdraft is to repay trade payables, the overdraft will not generate further cash flows for the business and so will not be self-liquidating.

•

It is interesting to note that the debentures are due for repayment in the near future (one year’s time). Any repayment of the debentures before the overdraft is due for repayment is likely to make it even more difficult for the business to repay the overdraft.

•

Risk The purpose of the overdraft is to replace one form of short-term borrowing with another. This will mean that the financing risks will be transferred from the trade payables to the bank. These financing risks are quite high. If the overdraft is granted for one year, the annual interest payments would increase by approximately £13,000 (that is, £108,000 @ 12%). Assuming profits remain constant, this would reduce the interest cover ratio from 7.6 times (that is, 38/5) to 2.1 times (that is, 38/(5 + 13)). The total debt to total asset ratio would remain unchanged by the new financing arrangements. However, the ratio is already high at 85.1% (that is, (194 + 40)/(74 + 201)) and the new arrangements would increase the bank’s exposure.

•

Security The balance sheet of the business does not reveal any assets that the business is likely to find particularly attractive as security for the loan. Although it is possible that the directors may be able to provide personal guarantees, it should be noted that they already offer personal guarantees in respect of the debentures outstanding. (However, if the debentures are repaid, this would release some debt capacity.)

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

•

Undercapitalisation The main problem with the business appears to be one of undercapitalisation. It really requires an injection of long-term finance in order to provide a more sound financial base. Given the business’s high level of gearing, lenders are likely to expect a significant proportion of any new long-term finance to be raised through the issue of equity shares. At present, the return to equity shareholders is very high at 56.1% (that is, 23/41) and so raising additional equity finance may not be a problem. An issue of equity shares to raise all the necessary finance would mean that, if profit before interest and tax remains constant, the return to equity could still prove attractive to investors.

Overall, the request for an overdraft is unlikely to prove successful. Instead, the business should attempt to improve its long-term financial structure. It should also review its current asset management (for example, average inventories turnover period, average settlement period for receivables, and so on) to see whether there is scope for improvement.

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Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

12.5

Telford Engineers plc

(a) Projected income statement for the year ending 31 December Year 10 Debt

Shares

£m

£m

Profit before interest and tax

21.00

21.00

Interest payable

(7.80) [5 + (20 x 14%)]

(5.00)

Profit before taxation

13.20

16.00

Corporation tax (30%)

(3.96)

(4.80)

Profit after tax

9.24

11.20

Dividends paid

(4.00)

(5.00)

Retained profit

5.24

6.20

Debt

Shares

£m

£m

20.00

25.00

(20 + (20 x 0.25))

15.00

(20 (1.00 – 0.25))

Capital and reserves Share capital 25p shares Share premium Reserves*

Loans

– 48.24

49.20

68.24

89.20

50.00

30.00

118.24

119.20

*The reserves figures are the Year 9 reserves plus the Year 10 retained profit. The Year 9

figures for share capital and reserves was 63, of which 20 (that is, 80 × 0.25) was share capital, leaving 43 as reserves. Add to that the retained profit for Year 10 (that is, 5.24 (debt) or 6.20 (shares)).

52 © Pearson Education Limited 2006

Atrill & McLaney, Accounting and Finance for Non-Specialists, 5th edition, Instructor’s Manual

(b)

Earnings per share Debt (9.24/80)

11.55p

Shares (11.20/100)

11.20p

(c) The debt alternative will raise the gearing ratio and lower the interest cover of the business. This should not provide any real problems for the business as long as profits reach the expected level for Year 9 and remain at that level. However, there is an increased financial risk as a result of higher gearing. Shareholders must carefully consider whether the additional returns expected will compensate for this higher risk. The figures above suggest only a marginal increase in EPS compared with the equity alternative at the expected level of profit for Year 9. The share alternative will have the effect of reducing the gearing ratio and is less risky. However, there may be a danger of dilution of control by existing shareholders under this alternative and it may, therefore, prove unacceptable to them. An issue of equity shares may, however, provide greater opportunity for flexibility in financing future projects. Information concerning current loan repayment terms and the attitude of shareholders and existing lenders towards the alternative financing methods would be useful.

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