(a) Decision to Make or Buy the Tubes: Variable overhead cost per box: Rs. per Box

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Tamsyn Freeman
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1 Question No. 1 SUGGESTED SOLUTIONS/ ANSWERS SPRING 2018 EXAMINATIONS 1 of 8 (a) Decision to Make or Buy the Tubes: Variable overhead cost per box: Rs. per Box Total manufacturing overhead cost per box of tooth paste 100 Less: Fixed portion (4,000,000 80,000) (50) 0.5 Variable overhead cost per box The total variable cost of producing one box of tooth paste would be: Rs. per Box Direct materials 200 Direct labour 100 Variable manufacturing overhead 50 Total variable cost per box If the tubes for the tooth paste are purchased from the outside supplier, then the variable cost per box of tooth paste would be: Rs. per Box Direct materials (200 x 0.85) Direct labour (100 x 0.75) Variable manufacturing overhead (50 x 0.80) of tubes from outside. 75 Total variable cost per box A savings of Rs.10 per box of tooth paste will be realized by producing the tubes internally. Therefore, the company should reject the outside supplier s offer. 1.0 (b) The company will be indifferent towards the decision at a price of Rs.65 per box. 1.0 (c) Decision to Make or Buy the Tubes with Revised Estimate: The computations are: of making (100,000 boxes x Rs.65 per box) 6,500, Rental cost of equipment. 2,000,000 Total cost 8,500, of buying (100,000 boxes x Rs.75 per box) 7,500, At a volume of 100,000 boxes, the company should buy the tubes as the cost of buying is lower than cost of making internally. 0.5 (d) Decision to Make or Buy the Tubes, with an Order of Any Size: Under these circumstances, the company should make the 80,000 boxes of tubes and purchase the remaining 20,000 boxes from the outside supplier. The costs would: of making (80,000 boxes x Rs.65 per box) 5,200, of buying (20,000 boxes x Rs.65 per box) 1,500, Total cost 6,700,

2 SUGGESTED SOLUTIONS/ ANSWERS SPRING 2018 EXAMINATIONS 2 of 8 (e) Qualitative Factors for Make or Buy Decision: 5.0 The management should take into account at least the following additional factors: The ability of the supplier to meet required delivery schedules. The quality of the tubes purchased from the supplier. Alternative uses of the capacity that would be used to make the tubes. The ability of the supplier to supply tubes, if volume increases in future years. The problem of finding an alternative source of supply, if the supplier proves to be undependable. Question No. 2 Feasibility for Investment, using Net Present Value (NPV) Analysis: Nominal rate = (1 + Real rate) x (1 + Inflation) 1 = (1.080) x (1.0555) 1 = 14% 1.0 Depreciation: Year Acquisition Initial Normal Total Written Down Value (WDV) Tax Shield on Depreciation 0 250, ,500 28,125 90, ,375 27, ,906 23, ,469 7, ,320 20, ,149 6, ,272 17,272 97,877 5, ,877 97,877 29, Year Savings After-Tax Savings Tax Shield on Depreciation Total Cash Saving flow Present Value Factor [@ 14%] Present Value 1 150, ,000 27, , , ,000 87,500 7,172 94, , ,000 73,500 6,096 79, , ,000 63,000 5,182 68, , ,000 56,000 29,363 85, , ,126 Initial investment (250,000) 0.5 Net present value (NPV) 77,126 Investment is feasible due to positive NPV. 0.5

3 Question No. 3 SUGGESTED SOLUTIONS/ ANSWERS SPRING 2018 EXAMINATIONS 3 of 8 (a) Calculation of Weighted Average of Capital (WACC): of equity = {4% + (7% 4%) x 0.9} = 6.70% 0.5 of debt = {6.95% x (1 30%)} = 4.87% 0.5 Value () Share WACC Equity (10,000,000 x 96) 960,000, % 6.70% 4.12% 1.0 Debt 600,000, % 4.87% 1.87% 0.5 1,560,000, % 6% 0.5 (b) Net Terminal Value (NTV): Year Acquisition Saving Initial Dep. [25%] Normal Dep. [15%] Total Taxable Income Tax [30%] Net Cash Flow 0 (10,000) (10,000) 1 5,000 2,500 1,125 3,625 1,375 (413) 4, , ,044 (913) 3, , ,187 (656) 2, ,000 4,606* 4,606 (2,606) 782 2, *Balancing figure Initial investment (10,000) Interest in Year-1 (600) 0.5 Cash inflow in Year-1 4,587 Balance (6,013) 0.5 Interest in Year-2 (361) 0.5 Cash inflow in Year-2 3,087 Balance (3,287) 0.5 Interest in Year-3 (197) 0.5 Cash inflow in Year-3 2,344 Balance (1,140) 0.5 Interest in Year-4 (68) 0.5 Cash inflow in Year-4 2,782 Balance [net terminal value (NTV)] 1, (c) Modified Internal Rate of Return (MIRR): Year Net Cash Flow Interest Rate Multiplier Future Value 1 4, , , , , , , , ,

4 SUGGESTED SOLUTIONS/ ANSWERS SPRING 2018 EXAMINATIONS 4 of 8 Total return = 14,200 10,000 = Rs MIRR = 14, or , = 9.16% 0.5 Question No. 4 (a) Examples of Non-financial Considerations: [Any four (4)] 2.0 Impact on employee morale Impact on the community Impact on the environment Ethical issues Learning (b) (i) Financial Feasibility: Contribution margin (CM) per tile [Rs.{1,590 ( )}] Volume 180,000 CM before tax (Rs.250 x Rs.180,000) 45,000, Tax (@ 29%) (13,050,000) 1.0 CM after tax 31,950, Present value factor for an annuity [PVIFA (10%, 5)] Present value (Rs.31,950,000 x 3.791) 121,122, Initial investment Net of tax relief (99,900,000) Net present value (NPV) 21,222, At internal rate of return (IRR), the present value (PV) factor should be: Initial investment net of tax relief 99,900,000 After tax annual cash flow 31,950,000 PV factor By looking in cumulative PV factor table, the value falls under 18% column. 1.0 As NPV is positive and IRR is more than the cost of capital, therefore, the investment is feasible. 1.0

5 (ii) SUGGESTED SOLUTIONS/ ANSWERS SPRING 2018 EXAMINATIONS 5 of 8 Value of Price and Volume for a Zero NPV: Let, Price = P that at zero NPV 180,000 x (P Rs.1,340) x (1 29%) x PV factor Rs.99,900,000 = ,000 x 71% x x (P Rs.1,340) = Rs.99,900, , x (P Rs.1,340) = Rs.99,900, ,489.80P Rs.649,216,332 = Rs.99,900, P = Rs.1, Drop by (2.75%) 1.0 Let, Volume = V that at zero NPV V x Rs.250 x 71% x Rs.99,900,000 = Rs x V = Rs.99,900, V = 148,461 Drop by 31,539 (17.52%) 1.0 (iii) The results suggest that the NPV of the project is more sensitive to price variations than changes in volume. The company, therefore, should review the estimated price to ensure that it is confident that prices will not decline by more than 2.75%. If prices decline by more than 2.75%, and the other variables remain unchanged, the project will yield a negative NPV. 3.0 Question No. 5 (a) -plus Pricing: 3.0 -plus pricing has following three major limitations: First, demand is ignored. Second, the approach requires that some assumption be made about future volume prior to ascertaining the cost and calculating the cost-plus selling prices. This can lead to an increase in the derived cost-plus selling price when demand is falling and vice-versa. Third, there is no guarantee that total sales revenue will be in excess of total costs even when each product is priced above cost.

6 SUGGESTED SOLUTIONS/ ANSWERS SPRING 2018 EXAMINATIONS 6 of 8 (b) Variable per Motorcycle: Motorcycles 70 cc 100 cc Direct material 40,000 44,000 Direct labour 20,000 25,000 Sets up 1,000 1, Materials handling 2,500 3, Inspection 2,000 2, Machining 4,250 8, ,750 84, Profit at Various Price Levels of Motorcycle 70 cc: Price Demand Contribution per Motorcycle Total Contribution 75, ,000 5, ,500, , ,000 16,500 2,145,000, , ,000 20,250 2,025,000, ,500 70,000 27,750 1,942,500, Therefore, profit maximising price is Rs.86,250 at output level of 130,000 motorcycles. 1.0 Profit at Various Price Levels of Motorcycle 100 cc: Price Demand Contribution per Motorcycle Total Contribution 86, ,000 2, ,000, , ,000 9,500 1,140,000, ,500 90,000 13,250 1,192,500, ,500 70,000 28,250 1,977,500, Therefore, profit maximising price is Rs.112,500 at output level of 70,000 Motorcycles. 1.0 Question No. 6 Workings: Products FD301 FD302 FD303 Total W-1: Hours Required to Meet Maximum Demand: External sales (Units) 1,600 1, Labour hours required per unit in FD Hours required to meet maximum demand 4,800 4,000 1,200 10, W-2: Per Hour Contribution: Selling price () 2,400 2,300 2,000 Less: Variable cost per unit () (1,650) (1,200) (1,400) Per unit contribution () [A] 750 1, Labour hours required per unit [B] Per hour contribution () [A B] Ranking

7 (a) SUGGESTED SOLUTIONS/ ANSWERS SPRING 2018 EXAMINATIONS 7 of 8 Minimum Transfer Price if only 7,600 Hours are Available: Products FD301 FD302 FD303 Total Production (units) 800 1, Hours required 2,400 4,000 1,200 7, Transfer Price: Rs. per Unit Variable cost of FD302 1,200 Opportunity cost* (4 x Rs.250 [W-2]) 1, (b) Minimum Transfer Price if only 11,200 hours are Available: Hours available 11,200 Less: Hours required to meet maximum external demand [W-1] (10,000) 2, Balance hours available 1, FD302 can be produced from available hours (1,200 4) (Units) Total variable cost (Rs.1,200 x 600) () 720, Opportunity cost*: Internal demand (Units) 600 FD302 can be produced from available hours (Units) (300) Balance to be produced (Units) Opportunity cost per units of FD302 (300 x Rs.1,000) () 300, Total cost () 1,020, Average transfer price (Rs.1,020, ) (Rs. per Unit) 1, *Contribution relating to FD301 forgone for producing additional units of FD302 Question No. 7 (a) Actual and Budgeted Selling Prices and Variable s: Rs. per Unit (i) Actual selling price (Rs.2,860 million 260,000) 11, Budgeted selling price (Rs.1,680 million 240,000) 7, (ii) Actual variable cost per unit (Rs.2,060 million 260,000) 7, Budgeted variable cost / unit (Rs.960 million 240,000) 4,

8 (b) Performance Report: SUGGESTED SOLUTIONS/ ANSWERS SPRING 2018 EXAMINATIONS 8 of 8 Flexible Budget Working: Revenue = 260,000 x Rs.7,000 per unit = Rs.1,820 Variable cost = 260,000 x Rs.4,000 per unit = Rs.1,040 Actual Results Flexible Budget Variances Flexible Budget Sales Volume Variances Rs. in million Static Budget Unit sold 260, , ,000 Revenue 2,860 1,040 F 1, F 1, Less: Variable cost (2,060) (1,020) U (1,040) (80) U (960) 1.25 Contribution margin (CM) F F Less: Fixed costs (560) (80) U (480) (480) 1.0 Operating Income 240 (60) U F Note: F means favourable and U means unfavourable (c) Analysis of Performance Report: 2.0 A closer look at the variance components reveals some major deviations from plan. Actual variable costs increased from Rs.4,000 to Rs.7,923 per compressor causing an unfavourable flexible budget variable cost variance of Rs.1,020 million. Such an increase could be a result of a jump in direct material prices. Opel Appliances (Pvt.) Limited was able to pass most of the increase in costs onto their customers actual selling price increased by 57% [(Rs.11,000 Rs.7,000) Rs.7,000], bringing about an offsetting favourable flexible budget revenue variance in the amount of Rs.1,040 million. An increase in the actual number of units sold also contributed to more favourable results. The company should examine why the units sold increased despite an increase in direct material prices. THE END

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