Analysing cost and revenues

Osborne Books Tutor Zone Analysing cost and revenues Chapter activities Osborne Books Limited, 2013

2 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 1 An introduction to cost accounting 1.1 The following table shows explanations of some terms used in costing. Select the correct term from the list to match each explanation. Explanation A cost which remains unchanged over a range of output levels A cost that cannot be identified with each unit of output A unit of output to which costs can be charged A cost which is neither a material cost nor a labour cost A cost which varies directly with output The total of all direct costs Term Select term from: Semi-variable cost Prime cost Fixed cost Cost unit Direct cost Indirect cost Cost centre Expense Variable cost 1.2 Analyse the following examples of costs for a manufacturing business into those that behave as fixed costs and those that behave as variable costs, by ticking the appropriate column. Examples of costs Fixed Cost Variable Cost (c) (d) (e) (f) (g) Materials used in production Business rates of factory premises Salary of Production Manager Royalties paid for each unit produced Packaging costs Factory building insurance Direct labour paid by piece-work

c h a p t e r a c t i v i t i e s 3 1.3 From the following list of statements, select those that are true. True (c) (d) (e) (f) (g) (h) Cost centres, profit centres and investment centres are all examples of responsibility centres A cost centre is a section of a business to which costs can be charged, revenue can be identified and profit can be calculated Costs can be classified by element, nature, function and behaviour Classification of costs by nature involves analysing the costs into direct costs and indirect costs Classification of costs by function means dividing them into materials, labour and expenses The total cost of a unit of output can be calculated by dividing the total of the direct and indirect costs for a period by the number of units of output for that period Indirect costs are also known as overheads Direct costs always behave as fixed costs

4 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 1.4 You work for a company that manufactures a range of office furniture. The following list of costs has been compiled from the company records. You have been asked to classify these costs into a table to illustrate to a new trainee how the company costing system works. List of costs: Factory rent Wages of employee who assembles desks (c) Steel used to make desk legs (d) Costs of advertising (e) Wages of factory maintenance employee (f) Royalties paid to designer of office chair (g) Bank loan interest (h) Repair to photocopier in administration department (i) Wages of warehouse employee (j) Machinery oil for use in the factory (k) Wages of employee in administration department (l) Stationery used in administration (m) Fuel for fork lift truck in warehouse Complete the table below by inserting all the costs on the above list in the appropriate place. Materials Production ( factory ) costs Non-production ( warehouse & office ) costs Direct Costs Indirect Costs Administration Selling and Finance (overheads) Indirect Costs Distribution Indirect Costs (overheads) Indirect Costs (overheads) (overheads) Labour Expenses

c h a p t e r a c t i v i t i e s 5 2 Materials costs 2.1 The following is an extract from a stores record card relating to pigment bought for making paint by a paint manufacturer. It has been completed correctly according to the inventory valuation method used by the company. State the method of inventory valuation that has been used. Receipts Issues Balance kilos cost per kilo total cost kilos cost per kilo total cost kilos total cost 350 3,650 200 12 2,400 550 6,050 100 12 1,200 450 4,850 2.2 The following information is available for plastic grade RX3: Annual demand 225,000 kilograms Annual holding cost per kilogram 0.50 Fixed ordering cost 2.50 The Economic Order Quantity (EOQ) for RX3 is: kg The inventory record shown on the next page for plastic grade RX3 for the month of November has only been fully completed for the first three weeks of the month. (c) Complete the entries in the inventory record for the two receipts on 21 and 25 November that were ordered using the EOQ method. Complete all entries in the inventory record for the two issues in the month and for the closing balance at the end of November using the AVCO method of issuing inventory. Show the costs per kilogram (kg) in to three decimal places, and the total costs in whole.

6 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e Inventory record for plastic grade RX3 Receipts Issues Balance Date Qty Cost per kg Total cost Qty Cost per kg Total cost Qty Total cost (kg) (kg) (kg) Balance 20 Nov 150 240 21 Nov 1.616 22 Nov 1,000 25 Nov 1.620 30 Nov 1,800

c h a p t e r a c t i v i t i e s 7 2.3 Complete the following inventory record for material KZ90. The company policy is to use the first in first out (FIFO) method of inventory valuation. (Cost per kilogram entries should be completed in to three decimal places.) Receipts Issues Balance Date Qty Cost per kg Total cost Qty Cost per kg Total cost Qty Total cost (kg) (kg) (kg) Balance 1 Sept 480 2,400 2 Sept 500 5.120 4 Sept 1,500 5.100 5 Sept 400 7 Sept 1,000 2.4 A company orders a specific material that has a lead time of 10 days. The daily usage of the material is 50 kg. The company wishes to keep at least 150 kg in stock at all times. The company policy is to order 2,000 kg at a time. Complete the following table. kg Re-order level Maximum inventory level Average inventory level

8 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 3 Labour costs 3.1 A company employs 10 direct labour staff making production units, each working a 40 hour week. Employees are paid 10.00 per hour basic pay, with a 5.00 per hour premium for overtime hours worked. During the 4 weeks ending 28 November, the staff worked 1,600 normal hours, and 300 overtime hours, and made 1,600 units. Calculate the cost of direct labour for the 4 weeks, assuming that the overtime premium is charged to direct labour, that the overtime premium is charged to overheads. (c) Assuming that the overtime premium is charged to overheads, complete the following journal entry for the 4 weeks to 28 November. Debit Credit Work in Progress Overheads Wages Control Account (d) Assuming that the overtime premium is charged to overheads, calculate the direct labour cost per unit of production for the period (to three decimal places).

c h a p t e r a c t i v i t i e s 9 3.2 The following table gives pay data for four employees who work in a factory. Employee Number Hours Worked Units Produced 1 41 425 2 37 400 3 38 300 4 40 410 Calculate the gross pay for each employee based on each of the following alternative pay methods. Set out your answers in the table below. (c) Basic rate of 12.00 per hour for 37 hour week, with any overtime paid at one and a third times the basic rate. Piecework at 1.05 per unit produced. Time rate of 10.00 per hour for all hours worked, plus a bonus of 1.50 for each unit produced in excess of 8 per hour. Employee Number Payment methods (c) 1 2 3 4

1 0 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 3.3 Below is a weekly timesheet for one of Butterworth Ltd s employees, who is paid as follows: For a basic seven-hour shift every day from Monday to Friday basic pay. For any overtime in excess of the basic seven hours, on any day from Monday to Friday the extra hours are paid at time-and-a-half (basic pay plus an overtime premium equal to half of basic pay). For two contracted hours each Saturday morning basic pay. For any hours in excess of two hours on Saturday the extra hours are paid at double time (basic pay plus an overtime premium equal to basic pay). For any hours worked on Sunday paid at double time (basic pay plus an overtime premium equal to basic pay). Complete the columns headed Basic rate, Overtime premium and Total pay. Employee: P. Boyd Profit Centre: Plastic extrusion Employee number: K089 Basic pay per hour: 15.00 Hours spent Hours worked Notes Basic rate Overtime Total pay on production on indirect work premium Monday 7 Tuesday 3 4 9am 1pm setting up equipment Wednesday 8 Thursday 6 2 10 12am cleaning of machinery Friday 6 1 3 4pm weekly meeting Saturday 4 Sunday 2 Total 36 7

c h a p t e r a c t i v i t i e s 1 1 4 Expenses 4.1 Analyse the costs shown in the following table into their cost behaviour by ticking the appropriate column. (c) (d) (e) (f) (g) Raw materials Employees paid a flat rate plus a production based bonus Factory rates Repairs to factory building Royalties paid per unit produced Packing materials Supervisor s salary Fixed Variable Semi-variable 4.2 A company wishes to estimate how its expenses behave when production volumes change. Complete the following table, and by using the high-low method calculate the expected variable costs (per unit) and fixed costs (per month). Cost per month Output per month (units) Data provided 65,000 11,500 Difference 95,000 19,000 Variable cost per unit Fixed cost per month Using the information calculated in part, complete the following table to show the breakdown of estimated costs at a monthly production level of 12,800 units. Variable costs Fixed costs Total costs

1 2 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 4.3 From the following list of statements, select those that are true. True (c) (d) (e) (f) (g) Capital expenditure relates to expenditure on assets that will benefit the organisation for more than one accounting period All direct costs behave as variable costs Costs of the installation of non-current assets are treated as capital expenditure Semi-variable costs contain both a fixed element and a variable element Fixed costs may change from time to time due to factors other than output levels Variable costs per unit of output do not alter when volumes change Total fixed costs change when the volume of output changes

c h a p t e r a c t i v i t i e s 1 3 4.4 Butterworth Ltd has prepared a forecast for the next quarter for one of its small components, KF36. This component is produced in batches and the forecast is based on selling and producing 3,200 batches. One of the customers of Butterworth Ltd has indicated that it may be significantly increasing its order level for component KF36 for the next quarter and it appears that activity levels of 3,500 batches and 4,000 batches are feasible. The semi-variable costs should be calculated using the high-low method. If 5,000 batches are sold the total semi-variable cost will be 20,500, and there is a constant unit variable cost up to this volume. Complete the table below and calculate the estimated profit per batch of KF36 at the different activity levels. Batches produced and sold 3,200 3,500 4,000 Sales revenue 64,000 Variable costs: Direct materials 12,800 Direct labour 16,000 Overheads 9,600 Semi-variable costs: 17,800 Variable element Fixed element Total cost 56,200 Total profit 7,800 Profit per batch (to three decimal places) 2.438

1 4 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 5 Overheads 5.1 Zed Limited has three cost centres: Manufacturing, Finishing, and Stores. The budgeted fixed overheads for the four weeks ending 28 November were as follows: Rent 4,000 Indirect Labour: Manufacturing 2,500 Finishing 1,500 Stores 3,400 Depreciation of non-current assets 1,200 Other property overheads 2,400 15,000 The following data is available: Floor space NBV non-current assets Manufacturing 800 sq mts 30,000 Finishing 400 sq mts 10,000 Stores 400 sq mts 20,000 Overheads are allocated and apportioned using the most appropriate method. The stores overheads are then reapportioned on the basis of the cost centres that benefit from the stores department. Records show that 75% of the stores activity benefits the manufacturing cost centre, whilst the other 25% benefits the finishing cost centre. Complete the following table relating to the allocation and apportionment of the budgeted fixed overheads.

c h a p t e r a c t i v i t i e s 1 5 Overhead Basis Total Manufacturing Finishing Stores Rent 4,000 Indirect Labour 7,400 Depreciation 1,200 Other Property o/h 2,400 Sub Total Stores Reapportioned Totals 15,000 The budgeted direct labour hours for the manufacturing cost centre for the four weeks ended 28 November was 1,600 hours. The company policy is to absorb fixed overheads using a budgeted rate per direct labour hour (calculated to the nearest penny). Calculate the fixed overhead absorption rate for the manufacture cost centre for the four weeks to 28 November. (c) The actual fixed overheads allocated/apportioned to the manufacturing cost centre for the four weeks to 28 November were 11,000. During this period 1,900 direct labour hours were worked in the manufacturing cost centre. Calculate the amount of fixed overhead under or over absorbed in the manufacturing cost centre. under / over absorbed

1 6 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 5.2 Select the best basis for apportioning the overheads shown in the following table by ticking the appropriate column. Staff canteen costs Buildings insurance Power for plant Heating and lighting Staff uniform costs Maintenance of plant Rent and rates Net book Number of Area of Power value of plant employees cost centres consumption of plant 5.3 Buccaneer Ltd s budgeted overheads for the next financial year are: Depreciation of plant and equipment 235,450 Power for production machinery 401,200 Rent and rates 98,500 Light and heat 43,560 Indirect labour costs: Maintenance 67,400 Stores 55,300 Administration 151,650 Total indirect labour cost 274,350 The following information is also available:

c h a p t e r a c t i v i t i e s 1 7 Department Net book value Production machinery Floor space Number of of plant and power usage employees equipment (KwH) (square metres) Production centres: Assembly 981,000 1,900,000 40,000 15 Finishing 519,000 600,000 29,000 9 Support cost centres: Maintenance 16,000 5 Stores 9,600 3 Administration 5,400 8 Total 1,500,000 2,500,000 100,000 40 Overheads are allocated or apportioned on the most appropriate basis. The total overheads of the support cost centres are then reapportioned to the two production centres using the direct method. 85% of the maintenance cost centre s time is spent maintaining production machinery in the assembly production centre and the remainder in the finishing production centre. The stores cost centre makes 65% of its issues to the assembly production centre, and 35% to the finishing production centre. General administration supports assembly 60% and finishing 40%. There is no reciprocal servicing between the three support cost centres. Complete the apportionment table on the next page. Show amounts rounded to the nearest where appropriate.

1 8 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e Basis Assembly Finishing Maint ce Stores Admin Totals Depreciation of plant and equipment Power for production machinery Rent and rates Light and heat Indirect labour Totals Reapportion Maintenance Reapportion Stores Reapportion General Admin Total overheads to production centres

c h a p t e r a c t i v i t i e s 1 9 5.4 Which of the following statements shows the correct calculation of the overhead absorption rate when based on direct labour hours? (c) (d) (e) (f) (g) Actual overhead costs divided by budgeted direct labour hours Budgeted direct labour hours divided by budgeted overhead costs Actual overhead costs divided by actual direct labour hours Actual direct labour hours divided by actual overhead costs Budgeted overhead costs divided by actual direct labour hours Actual direct labour hours divided by budgeted overhead costs Budgeted overhead costs divided by budgeted direct labour hours

2 0 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 6 Methods of costing 6.1 Select the most appropriate method of costing for the following activities by ticking the relevant column. Job Batch Service Process Costing Costing Costing Costing (c) (d) (e) (f) (g) Manufacturing paper clips Manufacturing fire engines to individual specifications Running a nursing home Manufacturing cleaning chemicals Rewiring commercial buildings Printing text books Operating an oil refinery 6.2 Complete the following table by ticking the relevant columns to show both the debit and credit entry for each process costing transaction listed. Normal loss (with scrap value) Abnormal gain Abnormal loss Process Account Normal Loss Abnormal Loss Account or Gain Account Debit Credit Debit Credit Debit Credit

c h a p t e r a c t i v i t i e s 2 1 6.3 A company operates a process in which the normal loss is 10% of the input. This normal loss has a scrap value of 1.30 per kg. During November 120,000 kg were input into the process. The total process costs were 604,200 (materials, labour and overheads). The actual output of the process was 109,000 kg finished product and 11,000 kg scrap. Calculate the data used in the process account to complete the following table. Weight (kg) Value per kg Total Value Normal Loss Abnormal Gain Finished Product If the amount received from the actual 11,000 kg scrap is 1.30 per kg, the balance in the abnormal gain account will be a debit / credit of

2 2 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 6.4 A company uses process costing for some of its products. The process account for October for one particular process has been partly completed but the following information is also relevant: Three employees worked on this process during October. Each employee worked 40 hours per week for 4 weeks and was paid 12 per hour. Overheads are absorbed on the basis of 17 per labour hour. The company expects a normal loss of 5% during this process, which it then sells for scrap at 1 per kg. Complete the process account below for October. Description kg Unit Total Description kg Unit Total cost cost cost cost Material AH1 700 1.30 Normal loss 1.00 Material AH3 500 1.60 Output 1,425 Material AH5 300 0.40 Labour Overheads

c h a p t e r a c t i v i t i e s 2 3 7 Marginal and absorption costing 7.1 Analyse the following features based on whether they apply to marginal costing or absorption costing by ticking the appropriate column in the table. Feature Marginal Absorption Costing Costing (c) (d) (e) (f) Uses just the variable costs to value a unit of production Complies with standard IAS 2 for inventory valuation Is often used in conjunction with the preparation of a manufacturing account Can be used in conjunction with break-even analysis It does not consider cost behaviour when classifying costs It uses the idea of contribution to help with short-term decision making

2 4 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 7.2 Execo Ltd makes one product, with the following costs: Variable direct materials Variable direct labour Fixed overheads 12 per unit 15 per unit 120,000 per year During the last year the company made 20,000 units and sold 15,000 units for 50 each. There was no inventory at the start of the year. Use the following tables to show how the Statements of Profit or Loss would appear under absorption costing and marginal costing. Statement of Profit or Loss Absorption Costing Sales Direct Materials Direct Labour Fixed Overheads Total Cost of Production Less Closing Inventory Cost of Sales Profit Statement of Profit or Loss Marginal Costing Sales Variable Materials Variable Labour Variable Cost of Production Less Closing Inventory Variable Cost of Sales Fixed Costs Profit

c h a p t e r a c t i v i t i e s 2 5 7.3 Place the following headings and amounts into the correct format of a manufacturing account on the right side of the table, making sure that the arithmetic of your account is accurate. Prime (Direct) Cost 146,000 Opening inventory of raw materials 20,000 Closing inventory of work in progress 38,000 Direct labour 60,000 Opening inventory of work in progress 20,000 Factory cost 188,000 Closing inventory of raw materials 22,000 Manufacturing overheads 42,000 Raw materials used in manufacture 86,000 Purchases of raw materials 88,000 Factory cost of goods manufactured 170,000

2 6 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 7.4 Wyeco Ltd makes one product, with the following costs: Variable direct materials Variable direct labour Fixed overheads 18 per unit 12 per unit 180,000 per year During the last year the company made 15,000 units and sold 20,000 units for 50 each. There were 5,000 finished units in inventory at the start of the year. The costs for the previous year were the same as above, and have been used to value the opening inventory. 15,000 units were made last year. Use the following tables to show how the Statements of Profit or Loss would appear under absorption costing and marginal costing. Statement of Profit or Loss Absorption Costing Sales Opening Inventory 210,000 Direct Materials Direct Labour Fixed Overheads Cost of Sales Profit Statement of Profit or Loss Marginal Costing Sales Opening Inventory 150,000 Variable Materials Variable Labour Variable Cost of Sales Fixed Costs Profit

c h a p t e r a c t i v i t i e s 2 7 8 Aspects of budgeting 8.1 Greene Ltd has produced a performance report detailing budgeted and actual revenue and costs for last month. The actual volume of production and sales was in line with the budgets. Calculate the amount of the variance for each budget and then determine whether it is adverse (A) or favourable (F) by putting a tick in the relevant column of the table below. Budget Budget Actual Variance A F Sales 155,000 149,500 Direct Materials 34,200 36,200 Direct Labour 41,200 42,100 Production Overheads 25,600 25,500 Administration Overheads 10,200 10,450 Selling and Distribution Overheads 18,800 20,100 8.2 Complete the following table to show flexible budgets based on both 75% and 120% of the original budgeted level of activity. Direct materials and direct labour both behave as variable costs. Overheads are a fixed cost. Original Budget Budget Flexed at Budget Flexed at 75% Activity level 120% Activity level Number of Units 120,000 Sales 4,920,000 Direct Materials 1,320,000 Direct Labour 1,800,000 Overheads 1,300,000 Profit from operations 500,000

2 8 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 8.3 From the following list of statements, select those that are true. True (c) (d) (e) (f) (g) To prepare a flexible budget statement, the actual costs must be flexed to the activity level of the budget When the actual sales revenue is greater than the sales revenue shown in the flexed budget, the result is a favourable variance A sales revenue variance is impossible when comparing actual revenue with a flexed budget, as they are both based on the same sales volume Variances produced by comparing actual costs with a fixed budget are meaningless if the actual activity level is significantly different from that of the budget Fixed budgets are useful for planning purposes or for when the activity level is unlikely to change A sales revenue variance based on a flexed budget can arise when goods are not always sold at budgeted prices When actual costs are greater than those shown in the flexed budget, the result is a favourable variance

c h a p t e r a c t i v i t i e s 2 9 8.4 Buccaneer Ltd has the following original budget for product LK9 for the year ending 31 December. Budget Volume sold 200,000 000 Sales revenue 1,200 Less costs: Direct materials 300 Direct labour 480 Overheads 210 Profit from operations 210 Both direct materials and direct labour are variable costs, but the overheads are fixed. Complete the table below to show a flexed budget and the resulting variances against this budget for the year. Show the actual variance amount, for sales and each cost, in the column headed Variance and indicate whether this is Favourable or Adverse by entering F or V in the final column. If neither F nor V, enter 0. Flexed Budget Actual Variance (F), (A) or 0 Volume sold 194,000 Sales revenue 1,160,000 Less costs: Direct materials 290,000 Direct labour 450,000 Overheads 218,000 Profit from operations 202,000

3 0 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 9 Short-term decisions 9.1 The following table shows how to calculate various information that is useful for short term decision making. Select the appropriate performance indicator description from the list supplied and match it with its calculation method. Calculation method Fixed costs divided by contribution per unit Performance indicator Selling price per unit minus variable costs per unit Sales volume minus break-even sales volume (Fixed costs plus target profit) divided by CS ratio (Sales minus variable costs) divided by sales Select from: (c) (d) (e) (f) (g) (h) Contribution per unit Turnover to reach target profit CS ratio Total contribution per period Break-even point in units Sales units to reach target profit Margin of safety Break-even point in sales value

c h a p t e r a c t i v i t i e s 3 1 9.2 A milkman buys milk for 0.40 per bottle and sells it for 0.50 per bottle. This is the only product that he sells, and the milk itself forms the only variable cost. The fixed costs of the business are 150 per week. Calculate the break-even point in numbers of bottles of milk per week. bottles of milk Calculate the Contribution / Sales (CS) ratio as a percentage % and use it to calculate the break-even point in sales value. (c) Complete the following table to show income, costs and profit at the two sales levels of 2,000 bottles and 3,000 bottles per week. Sales (bottles) 2,000 per week 3,000 per week Sales Income Variable Costs Fixed Costs Profit (d) Calculate the volume of sales required to generate a profit of 250 per week. bottles of milk

3 2 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 9.3 A small general shop produced the following Statement of Profit or Loss for last month: Sales 25,000 less cost of goods sold (15,000) less fixed overheads ( 4,000) Profit 6,000 The costs of goods sold are variable costs. Calculate the Contribution / Sales (CS) ratio as a percentage % and use it to calculate the monthly break-even point in sales value. Calculate the margin of safety for the last month, in terms of the percentage of the month s sales value. % (c) Complete the following table to show income, costs and profit at the two sales levels of 20,000 and 30,000 per month. Sales Income 20,000 30,000 Variable Costs Fixed Costs Profit (d) Calculate the amount of monthly sales value required to generate a profit of 10,000 per month.

c h a p t e r a c t i v i t i e s 3 3 9.4 A company currently makes tables and chairs with monthly data as follows: Tables Chairs Unit Selling Price 200 80 Unit Material Cost 40 20 Unit Labour Cost 60 30 Monthly Sales Units 200 400 Both materials and labour are variable costs. The fixed costs of the business are 25,000 per month, and do not relate to any specific product. Complete the following Statement of Profit or Loss based on a typical month: Tables Chairs Total Sales Income less variable costs Contribution less fixed costs Profit If, in the future, the company decided to make and sell only tables, calculate: The contribution per table The break-even point in numbers of tables per month The number of tables that would need to be made and sold to achieve the current profit level tables per month

3 4 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 10 Long-term decisions 10.1 The following table describes various information that is useful for long-term decision making. Select the key term from the list supplied, and match it with its description. Description Name of Key Term The length of time that it would take to get back the initial investment in a project The difference between the present value of the total cash inflows and total cash outflows of a project The system that converts cash flows that occur at various points in time to their present value by taking account of the time value of money The rate which when used to discount the cash flows in a project results in a net present value of zero The result of comparing the present value of the total cash inflows and total cash outflows of a project when the outflows are greater than the inflows Select from: (c) (d) (e) Net present cost Internal rate of return Payback period Discounted cash flow Net present value

c h a p t e r a c t i v i t i e s 3 5 10.2 A company is considering investing a capital sum of 90,000 in one of two possible projects. The company s cost of capital is 10%. Each project would have the same initial capital cost, but the remaining cashflows would differ as follows: Year 0 Year 1 Year 2 Year 3 Year 4 000 000 000 000 000 Project A: Cash Inflows 0 110 130 140 0 Project A: Cash Outflows 90 70 70 86 0 Project B: Cash Inflows 0 180 180 180 180 Project B: Cash Outflows 90 150 150 150 150 PV Factors (10%) 1.000 0.909 0.826 0.751 0.683 Complete the following table to calculate the NPV of project A. Year 0 Year 1 Year 2 Year 3 Year 4 000 000 000 000 000 Net Cashflows PV Factors 1.000 0.909 0.826 0.751 0.683 Present Values (to nearest 000) Net Present Value (to nearest 000) Complete the following table to calculate the NPV of project B. Year 0 Year 1 Year 2 Year 3 Year 4 000 000 000 000 000 Net Cashflows PV Factors 1.000 0.909 0.826 0.751 0.683 Present Values (to nearest 000) Net Present Value (to nearest 000) continued

3 6 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e (c) The project which is better in terms of net present value is project A / project B. (d) Calculate the payback period for each project in years and months. Partial months must be rounded up to the next month. Project A year(s) month(s) Project B year(s) month(s) (e) The project which is better in terms of payback period is project A / project B.

c h a p t e r a c t i v i t i e s 3 7 10.3 John Greene is considering installing additional insulation in his offices to reduce his energy bills. The insulation will cost 1,750 to purchase and install, and will result in an annual saving of 500 in energy costs. The office lease expires in 5 years, so no savings after that point need be considered. John s cost of capital is 10%, and this rate has been used for the discount factors in the table shown below. Complete the following table to calculate the net present value of the additional insulation. Year Detail Cash Flow Discount Factor Present Value 0 Purchase and Installation 1.000 1 Savings 0.909 2 0.826 3 0.751 4 0.683 5 0.621 Net Present Value Calculate the payback period for the project in years and months. Partial months must be rounded up to the next month. year(s) month(s)

3 8 a n a l y s i n g c o s t s a n d r e v e n u e s t u t o r z o n e 10.4 One of the extrusion machines in the production department is nearing the end of its working life and Butterworth Ltd is considering purchasing a replacement machine. Estimates have been made for the initial capital cost, sales income and operating costs of the replacement machine, which is expected to have a working life of three years: Year 0 Year 1 Year 2 Year 3 000 000 000 000 Capital expenditure 1,170 Other cash flows: Sales income 650 760 790 Operating costs 110 130 140 The company appraises capital investment projects using a 15% cost of capital. Complete the table below and calculate the net present value of the proposed replacement machine (to the nearest 000). Year 0 Year 1 Year 2 Year 3 000 000 000 000 Capital expenditure Sales income Operating costs Net cash flows PV factors 1.0000 0.8696 0.7561 0.6575 Discounted cash flows Net present value The net present value is positive / negative. Calculate the payback of the proposed replacement machine in years and months. Partial months must be rounded up to the next month. The payback period is year(s) and month(s).

c h a p t e r a c t i v i t i e s 3 9 10.5 What is meant by the internal rate of return (IRR) of a project? (c) (d) The discount factor that results in a net present value of zero The discount factor that results in a positive net present value The discount factor that results in a negative net present value The discount factor that is closest to the Bank of England s base rate 10.6 Hirani Limited has the following net cash flows for a project: Year 0 Year 1 Year 2 Year 3 000 000 000 000 700 200 300 350 The directors of Hirani Limited ask you to assess the approximate internal rate of return (IRR) against the following percentages: 6% 10% 14% You are to use compound interest calculations to show the internal rate of return of this project.