# Financial Management Techniques Assignment Solution

QUESTION

Question 1

Yates Ltd sells tennis racquets for £300 each. The company has budgeted to produce 6,000 units in the upcoming year.

The variable production costs are:

Materials – £60 per unit.

Direct labour – £16.00 per hour. Each bicycle takes 5 hours to assemble.

Variable production overheads are charged at the rate of £12.00 per labour hour.

The company incurs other costs as follows:

[where appropriate work should be presented to ONE decimal place, marks are available for formulae, workings and correct presentation]

Required:

1. Calculate the break-even point expressed in numbers of units sold.

 b) Calculate the sales value required to break even (in £’s).
1. Calculate the margin of safety expressed in units, value and as a percentage figure.

1. Briefly explain the term “margin of safety” and its significance for production management.

[Indicative word count: 150 words]

1. Yates Ltd is keen to expand the business further. Assuming no change in the fixed costs, calculate how many racquets the company would need to sell to achieve an annual profit of £300,000.

1. Explain the concept of Marginal Costing and discuss its application for management decision making.

[Indicative word count: 300 words]

Question 2

 Jeff Gates is keen to attract business clients but would need to upgrade his computer repair equipment at an estimated cost of £35,000. This new computer equipment would have an estimated useful life of just 3 years. It could be sold for scrap £3,500 at the end of the third year. The budgeted net cash flows from the investment are as follows:- £ Year 1 9,000 Year 2 12,000 Year 3 14,000 Years 7% 8% 9% 10% 1 0.9346 0.9259 0.9174 0.9091 2 0.8734 0.8573 0.8417 0.8264 3 0.8163 0.7938 0.7722 0.7513 4 0.7629 0.7350 0.7084 0.6830 Required a) Calculate the payback of the project to the nearest month b) Calculate the Net Present Value of the project if Jeff Gates has a cost of capital of 9% [present your answer to the nearest pound] c) Based on your answer in a) and b), advise Jeff on his planned investment [Indicative word count: 200 words] d) Evaluate the investment appraisal techniques used above, identifying strengths and weaknesses of each, explaining in what circumstance each may be used. [Indicative word count: 500 words]

Question 3

Valerian Ltd makes three different types of machines for a broad range of manufacturing customers, the details for the engines are:

Per unit: Machine 1 Machine 2 Machine 3

Selling price £30 £24 £28

Variable cost £12 £10 £15

Weekly demand 30 units 22 units 33 units

Machine time 5 hours 4 hours 5 hours

Machine time is limited to 166 hours per week.

1. Which combination of products should be manufactured to produce the highest profit?

2. What is the highest weekly contribution achievable?

Question 4:

1. Outline the importance of budgetary control in a business organisation.

[Indicative word count: 550 words]

1. Discuss various behavioural aspects of a budgetary control system.

[Indicative word count 400 words]

# Question 1

 Selling price per tennis racquet £300 Budgeted production 6,000 racquets Time to assemble 1 racquet 5 hours Variable costs Materials £60 per unit Direct labour £16.00 per hour Overheads £12.00 per hour Fixed Costs Fixed manufacturing £165,000 Fixed administration £125,000

Total budget sales = 300*6000 = £1,800,000

Total variable costs per racquet = 60 + 5*(16+12) = 56 + 80 + 60 = £200

Total fixed costs = 165000 + 125000 = £290,000

## a)

Break even = Fixed cost/contribution margin = Fixed cost/(sales price – variable cost)

= 290000/(300-200) = 290000/100

= 2900 units

## b)

Contribution margin Ratio = (sales price – variable cost)/variable cost = 100/300

= 0.33

Break Even Sales = Fixed costs/ Contribution margin Ratio = 290000/0.33

= £870,000

Break even Sales = Break even units* sales price per unit = 2900*300 = £870,000

## c)

Margin of safety units = Total sale units – Break even sale units = 6000 – 2900

= 3100 units

Margin of safety value = Budgeted Sales – Break even Sales

= 1,800,000 – 870,000 = £930,000

Margin of safety percentage = Margin of safety value*100/budgeted sales

= 930,000*100/1800000 = 51.7%

## d)

Margin of Safety: The financial term is the measure of the sales that exceed the break-even point. It can be measured in terms of units exceeding the break-even units, the actual excess of sales on that break-even or as a ratio of the access to the total sales. Margin of safety denotes the revenue or sales that are earned after paying all the fixed costs of production of a company or a product. Thus, as long as margin of safety is a positive value, the company remains in profit. Thus, as the name of the term suggests as long as there is a margin above the break even the company is safe and will have an operating profit. In case of a negative margin, the company books an operating loss.

The significance of the term lies in judging a product or a department for probable losses and possible profits.

## e)

Total Fixed Costs = £290,000

Required Annual Profit = £300,000

Required Sales = 290,000 + 300,000 = £590,000

Contribution Margin = £100

Number of units sold = 590,000/100 = 5,900 units

## f)

Marginal cost is the cost incurred in increasing the production by one unit of a product. The same amount will be saved if one less unit is produced. Mathematically,

Marginal Cost = Change in cost/change in production quantity

Generally marginal cost is fixed only for a very small range of production. It starts out very high for producing low number of units, then it reaches a minimum value as we increase the production quantity and finally it again starts increasing. Initially as the number of products produced increases the operations benefit from higher produce, decreasing the cost in forms like automation, mass purchase discounts etc. But as the production increases beyond a point then the costs increases again in terms of storage costs, overcapacity etc. The change in marginal cost is different for every industry and its relevance also changes accordingly. In some industries marginal cost is relatively stable while in others it fluctuates highly and is the key deciding factor in deciding the profits of an organisation. Though, in all industries it is necessary for any company to keep its marginal cost below a certain level.

Thus, the job of a manager is to produce an optimal number of units where the selling price of the product is still higher than the marginal cost of the product so that the company keeps on booking a profit. As the marginal cost increase the manager should stop accepting production orders.

# Question 2

Estimated Cost = £35,000 Scrap value = £3,500

## a)

 Yearly Cashflow Cumulative Cash Flow Year 1 £9,000 £9,000 Year 2 £12,000 £21,000 Year 3 £14,000 £35,000 Scrap Year 3 End £3,500 £38,500

As the cumulative cash flows equal the initial investment at the end of 3 years thus, the payback period is 3 years.

## b)

Present value from any year = Cash flow of that year*PV factor

We will use the values for 9%

 Year Cash Flow Factor Present Value 0 -35,000 1 -£35,000.00 1 9,000 0.9174 £8,256.60 2 12,000 0.8417 £10,100.40 3 14,000 0.7722 £10,810.80 3 3,500 0.7722 £2,702.70

NPV = -£35,000.00 + £8,256.60 + £10,100.40 + £10,810.80 + £2,702.70 = £3,129.5

## c)

Jeff should not invest in the project based on the results of either a or b. We can see that the payback period of the project is equal to the total duration of the project and thus, the money will not be released in cash terms till the project is completed. At the same time with the cost of capital of the project being 9% the NPV of the project is negative and thus, Jeff will lose money in nominal terms instead of gaining money. It will be a much better option for Jeff to invest the money with a return of 9% at least so that the nominal value of the money remain the same. Currently, for the perspective of both, the net payback period and net present value this investment seems to be a lost cause and Jeff should stay away from the project.

## d)

Two techniques have been used for the appraisal of the investment in the case above, namely:

• Pay-back period

• Net present value

Payback period gives the time taken to get the money back of the investment in real terms. Following are the advantages of using the payback period technique:

• It is very easy to implement [9]

• It accounts for the liquidity issues in a project, and a project with shorter payback period is generally more liquid, earning the invested money quicker that the other

• The payback periods of two projects can be compared to see which project is better and everything else kept constant the project with a shorter payback period is better [10]

• Payback period does not account for the time value of money thus, it can happen that a project with longer payback period is better if cost of capital is lower for the project

• The technique also disregards the cashflows generated after the payback period which might be just as significant as the cashflows before the payback period [11]

We use the technique when we have a low investment to consider where the cost of capital is not important. It is also used when the liquidity position of a project is an important criterion.

The net present value technique discounts the cashflows of the project to the present date and checks of the project gives positive returns or negative considering the cost of capital of the project. As we increase the discount rate of the project (the cos of capital) the NPV of the project decreases. The same effect occurs when the cashflows of the project are dispersed further into the future as the PV factor gets lower and lower for future cashflows. Following are its advantages and disadvantages:

• It accounts for the time value of money and we should choose a project only if the NPV of the project is positive [6]

• The calculations associated with the technique are more complex when compared to the payback period method

• The technique accounts for all the cashflows of the project unlike the payback period method [7]

• We cannot compare the NPV of two projects as it does not account for the size of investment of the project [8]

• The technique gives a higher NPV for shorter projects

The technique is used when the cost of capital is a major concern and the duration of the project is immaterial. We also choose the technique when the size of the investment is not as important as the fact that the project should finally be profitable to the investors.

# Question 3

 Per Unit Machine 1 Machine 2 Machine 3 Selling price £30 £24 £28 Variable cost £12 £10 £15 Contribution £18 £14 £13 Weekly demand 30 units 22 units 33 units Machine time 5 hours 4 hours 5 hours

## a)

The machine yielding highest contribution per hour should be given priority

 Machine Machine 1 Machine 2 Machine 3 Contribution per hour 18/5 = £3.6 14/4 = £3.5 13/5 = £2.6 Preference Order 1 2 3

The production is based on the preference order. First, we fulfil the orders for Machine 1

Total machine ours for Machine 1 = 30*5 = 150 hours

Remaining hours = 166 – 150 = 16 hours

Machine 2 is made for remaining time

Number of units of Machine 2 = 16/4 = 4 units

Optimal Combination

Machine 1: 30 units

Machine 2: 4 units

Machine 3: 0 units

## b)

Highest weekly contribution achievable is at the optimal combination

 Item Machine 1 Machine 2 Machine 3 Contribution per unit £18 £14 £13 Production 30 units 4 units 0 units Net Contribution 30*18 = £540 14*4 = £56 £0

Highest possible contribution = 540 + 56 = £596

# Question 4

## a)

Budgetary control plays a pivotal role in the finances of an organisation. It is important for any company to manage the day to day expenses and also the cost of production of goods. It needs to set estimates of the sales and plan the productions accordingly. Such practices maximise the profits of the company and that is exactly what budgetary control is. In simpler terms budgetary control is setting targets and limits to expenses and production of products of a company. It is sometimes also used as a method or tool for controlling costs.

The budgetary control is the limits and instructions that the senior management creates to limit the losses of the company in case of financial or economic disasters. These losses could also be from theft or just human error. The budget sets the limits on the expenditures of a department thereby limiting the final produce of the department as well. The spending limits in the budgetary control are rechecked at the end of every quarter/year. The actual spending are also verified with the set budgets to understand the mistakes in the budgets made.

There are a few aspects that play in important role from the budgetary control perspective. First, we have the management accounting function, which gives the data about the cost structure of the company and the estimated expenditures of the various heads. It accounts for the operational costs of the company. Next comes the income statement of the company. Through it the revenue and comparative expenses are monitored. It gives an overview of the cashflows and how much of the budgetary expectations actually materialise.

A budgetary control is a mechanism that helps senior managers ensure that spending limits are adequate. This control is important because spending excesses have an unfavourable impact on corporate profits. If we do not apply controls, then there can be excessive losses. This can even lead to bankruptcy. It is the budget only that helps the firm to make sure that the cashflows are maintained properly, like repayment of debt and credit recovery. It also limits the amount of credit that a company gives.

## b)

Budgets are a piece of the management control intended to increase the proficient utilization of assets and offering help for other basic operations [1]. The degree to which any budget is fruitful is particularly dependant on its acceptance and the frames of mind of employees towards it. Over and over again, companies will in general anticipate results from budgetary control and neglect to perceive that most issues of budgeting are causing [2]. Where there is cause for useless reasons, decisions made prompting doubt, threatening vibe and activities unfavourable to the long-haul prospects of the company. Consequently, every budgeting framework must be customized, and its prosperity ought to be estimated by the degree to which it gives the inspiration to people to make their top-level input to the accomplishment of company objectives. The board members must perceive that bookkeeping strategies and human relations are inseparable bound with one another.

A broken practice related with open budgeting is the “spend it or lose it disorder” where organizations will in general participate in superfluous spending to go through their full budget before the financial year closes as a result of dread of decreased allotment later on [3]. Another component of open segment budgeting in Trinidad and Tobago is the way that operations do not seem, by all accounts, to be a focal piece of the budget procedure [4]. For instance, different budget focuses are assessed based on having overspent or under-spent budgets as opposed to on effectiveness of operations. There is by all accounts no worked in impetus framework to spur organizations/bodies to accomplish past their objectives.

The conduct parts of budgeting are noteworthy, and the administration bookkeeper has an obligation to limit the social issues inside the bookkeeping frameworks for control [5]. It pursues that administration members should work all the more intimately with social researchers to pick up a comprehension of the fundamental job that human conduct plays in fruitful budget use.

REFERNCES

1. Bar-Haim Aviad (2002), Participation Programs in Work Organizations: past, present and scenarios for the future, first edition, Greenwood Publishing Group Inc., Westport, Connecticut.

2. Bonner E. Sarah (2008), Judgment and Decision Making in Accounting, Pearson Education Inc., Upper Saddle River, New Jersey.

3. Campbell, Ian J. (1985). “Budgeting is it a Technical or Behavioural Process?” Management Accounting, 66-70.

4. Chiesa, V., & Fratini, F. (2009). Evaluation and performance measurement of research and development: techniques and perspectives for multi-level analysis. Cheltenham: Edward Elgar.

5. Gailly, B. (2011). Developing innovative organizations: a roadmap to boost your innovation potential. Houndmills, Basingstoke, Hampshire: Palgrave Macmillan.

6. Ryan, P.A., & Ryan, G.P. (2002). Capital budgeting practise of the fortune 1000: How Have Things Changed. Journal of Business and Management, 8, 389-419.

7. Don Dayananda et al. (2002). Capital Budgeting: Financial Appraisal of Investment Projects

8. MJ du Toit and A Pienaar (2005). A review of the capital budgeting behavior of large South African firms. Meditari Accountancy Research Vol.13 No 1; pp19-27

9. Numminen Emil, (2008). Software Investments under Uncertainty, Pg 26 – 27

10. Stefan Yard (1999). Developments of the payback method Int. J. Production Economics 67 (2000) 155 – 167

11. Segelod E. (1995), Resource Allocation in Divisionalized Groups, Ashgate, Avebury.

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