FINANCIAL MANAGEMENT & CONTROL

Pearson Ltd., a food manufacturer, is considering purchasing a new machine for £200,000. The annual running costs are expected to be £20,000 plus straight line depreciation charge. The machine is expected to last for 5 years, after which the machine will be scrapped for an estimated amount of 20% of the original cost. The annual revenue is forecasted to be £100,000 and the cost of capital is 10%.

You are required to

(a) Advise the management of Pearson Ltd whether or not it will be economically feasible to invest in the new machine in the light of the four different investment appraisal methods covered in this module. (10%)

(b) Critically comment on the results you obtained in (a) above referring to the pros and cons of each evaluation method. (10%)
“El-Domyati Co.” produces white cheese. Small but steady growth in sales has been achieved by the company over the past few years while selling prices have been increasing. The company is now formulating its plans for the coming year. Presented below is the data used to prepare the actual income statement for the year just ended:

1) The per unit variable costs: £10 milk, £5 other variable costs.
2) The per unit selling price: £35.
3) Actual fixed costs: £300,000.
4) Actual sales: £1,800,000

The maximum available capacity of the company is 75,000 units. Now, all suppliers of milk have announced that they will increase – in the coming year – their selling prices of milk. “El-Domyati Co.” expects that all other costs will remain at the same rates or levels as in the year just ended.

Required

(a) For the year just ended, calculate the breakeven quantity and value, and determine the units and the value of the safety margin. (10%)
(b) What selling price per unit must “El-Domyati Co.” charge in the coming year to cover an expected increase of 5% in the cost of milk and still maintain the last year’s contribution margin ratio? (5%)
(c) Analyze and criticize the assumptions of the breakeven analysis in the light of the reality of today’s business environments. (15%)

Arrowbell Company is a wholesale distributor of professional equipment and supplies. The company is considering expanding its business and comparing between two potential opportunities for investment in either company A or company B.

The president of Arrowbell has asked the controller to prepare a report that summarises the financial aspects of the two potential investees for the last year.

The controller has presented a number of financial ratios that can assist in the identification and interpretation of trends for each investee. The following ratios have been calculated for the year ended 31st December 2012 for each company:

Ratio Company A Company B

Current ratio 2 1.50
Acid-test ratio 1 0.80
Accounts receivable days 60 90
Inventory turnover (times) 4.50 3
Accounts payable days 50 90
Percent of total debt to total assets 30% 50%
Percent of long-term debt to total assets 25% 35%
Gross profit percentage 35% 40%
Operating profit percentage 10% 7%
Return on capital employed 12% 8%
Return on equity 14% 12%
Gearing 30% 40%
Interest cover (times) 8 5
Earnings per share 0.80 1.20
Operating cash flow per share 2.85 2.10
Required

Write a report to the Board of Directors of Arrowbell Company to analyse the performance of companies A and B and to give recommendation as which of those two investment opportunities is better. Your report should include comments on as much performance areas as data allow. (20%)

Part D (30%)

Explain and critically evaluate
a) The main sources of finance available to business and the advantages and disadvantages of such finance (15%)
b) The use of budgets as a means of planning and controlling the various business activities (15%)

 
Notes:

1. To obtain a high mark, you should:
a) Make your report concise, precise and well presented and structured;
b) Draw logical conclusions from accounting information;
c) Synthesise information in a coherent and useful way;
d) Show evidence of key text and background reading;
e) Incorporate your knowledge into an integrated piece of work;
f) Demonstrate critical understanding of financial management.
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