ACC10707 Accounting And Finance For Business

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04-10-2021

Questions:

Business Analysis and Interpretation

1.The following information relates to a landscaping business. At 30 June 2018, it had a bank balance of $26 500. Provided below are estimates for receipts and payments for the three months ending 30 September 2018.

A.Prepare a monthly cash budget for the three months ending 30 September 2018.

B.The owners were wondering what the effect would be on the cash position if they did not buy the new equipment, but instead took advantage of a new rental arrangement. The equivalent equipment would cost $10 000 per month under the rental arrangement. Redraft the cash budget to show the impact of the rental alternative. Based on the information available, should they lease or buy the equipment?

2.The landscaping business plans to introduce various aged trees to their product range in 2018. They have provided the following information relating to its planned activities.

Required

A.Calculate the break-even point in total units and units per product based on the 2018 data.

B.Calculate the before tax profit (loss) that would be achieved in 2018 based on the above data. This calculation relates to the information from question 2 only.

C.Management is concerned about competition for some of its trees, and wants to increase its sales of 3 years old trees relative to 1 year old trees. This initiative would increase annual fixed costs by $50 000 and alter the sales mix to 30 per cent for 2 years old trees, 30 per cent for 3 years old trees and 40 per cent for 1 year old trees. On the available data, would you recommend the initiative? Show workings.

3.Deciding between two machines

Our landscaping business is now considering the purchase of one of two acceptable pieces of equipment. Each of these two pieces of equipment is expected to have individual advantages. The Office Manager who has calculated the information below is quite conservative and likes to rely on the Accounting Rate of Return (ARR) as the chief decision-support tool. The assistant office manager, on the other hand, is a new business graduate and has worked out the expected Internal Rate of Return (IRR) for the two items of equipment as shown below.

Required

A.What more financial information does the company owner need to make a decision?

B.Would you as the owner rely only on this information to make a decision? If not, why not?

C.If the calculated returns all exceed the entity’s required minimum rate, which design would you recommend to the owner?

Answers:

Question 1

a) Cash Budget of the Landscaping Business for the three months ending September 2018:

	July	August	September
Opening balance	$26,500	-$74,000	$61,800
Add: Cash Receipts
Fees	$1,40,000	$1,60,000	$2,00,000
Proceeds from sale of surplus non-current assets		$1,00,000
Total cash available	$1,66,500	$1,86,000	$2,61,800
Less: Cash payments
Salaries and wages	$70,000	$70,000	$70,000
Supplies	$8,500	$9,200	$12,000
New Equipment	$1,20,000
Purchase of plants	$42,000	$45,000	$61,000
Total payments	$2,40,500	$1,24,200	$1,43,000
Closing cash balance	-$74,000	$61,800	$1,18,800

b) If the owners of the business did not buy the equipment, instead opted to lease it under a rental of $10000, the cash budget would change.

Cash Budget for the rental alternative

	July	August	September
Opening balance	$26,500	$36,000	$1,61,800
Add: Cash Receipts
Fees	$1,40,000	$1,60,000	$2,00,000
Proceeds from sale of surplus non-current assets		$1,00,000
Total cash available	$1,66,500	$2,96,000	$3,61,800
Less: Cash payments
Salaries and wages	$70,000	$70,000	$70,000
Supplies	$8,500	$9,200	$12,000
Monthly rental of equipment	$10,000	$10,000	$10,000
Purchase of plants	$42,000	$45,000	$61,000
Total payments	$1,30,500	$1,34,200	$1,53,000
Closing cash balance	$36,000	$1,61,800	$2,08,800

From the above cash budget we see that the closing cash balance has changed as a result of change in the alternative of renting the equipment instead of buying. If the company decides to buy the equipment, the cash balance in July would be negative as the payment is being made in July. The cash balance for other two months is positive. However, if the company decides to lease the equipment, the closing cash balance for July will become positive. Hence it is recommended that the company should lease the equipment to have a positive cash balance for all the three months.

It is very important for a business to have a positive cash balance for a business to run its operations smoothly. A negative cash balance may arise the need of loan from a bank which will have its own costs in the form of interest (Ross, Hillier, Westerfield, & Jordan, 2012). Another reason for having a cash balance is with respect to the banks. The banks need to be compensated for the banking services provided by them. Thus, a business must always ensure a positive cash balance to finance its operations.

Question 2

a) Break-even point for each product and the total break even points is calculated below:

Break-even point = fixed costs / contribution margin per unit

Fixed costs = $402,800

Contribution margin

	1 year old	2 year old	3 year old	Total
Selling price	$20	$28	$45	$93
Variable cost per unit	$12	$18	$27	$57
Contribution margin per unit	$8	$10	$18	$36

Break-even point in total units

1 year old tree = 402800 / 36

= 11189 units

The break even points in units per product can be divided on the basis of the selling mix.

	1 year old	2 year old	3 year old	Total
Selling mix	125000	75000	50000	$2,50,000
Percentage share	50%	30%	20%	100%

The break even units of 11189 units should be divided on the above mix basis. Hence, the break-even point units for the three products are:

1 year old = 11189*50% = 5594 units

2 year old = 11189*30% = 3357 units

2 year old = 11189*50% = 2238 units

b) The profit (loss) before tax that would be achieved by the Landscaping business is given below:

	1 year old	2 year old	3 year old	Total
Selling mix	1,25,000	75,000	50,000	2,50,000
Selling price	$20	$28	$45
Sales revenue	$25,00,000	$21,00,000	$22,50,000	$68,50,000
Variable cost per unit	$12	$18	$27
Variable cost	$15,00,000	$13,50,000	$13,50,000	$42,00,000
Contribution margin	$10,00,000	$7,50,000	$9,00,000	$26,50,000
Fixed costs				$4,02,800
Profit before tax				$22,47,200

c) The new sales mix as per the initiative to increase the sale of old tress would be:

Total sales = 250000 units

	1 year old	2 year old	3 year old	Total
Sales mix	40%	30%	30%	100%
Selling units	100,000	75,000	75,000	250,000

The fixed costs would increase by $50,000.

The new profit (loss) before tax after the initiative is given below:

	1 year old	2 year old	3 year old	Total
Selling mix	1,00,000	75,000	75,000	2,50,000
Selling price	$20	$28	$45
Sales revenue	$20,00,000	$21,00,000	$33,75,000	$74,75,000
Variable cost per unit	$12	$18	$27
Variable cost	$12,00,000	$13,50,000	$20,25,000	$45,75,000
Contribution margin	$8,00,000	$7,50,000	$13,50,000	$29,00,000
Fixed costs				$4,52,800
Profit before tax				$24,47,200

From the above, we see that the total profit before tax has increased by $200,000 ($2447200 - $2247200). Hence, it is recommended that the company should go ahead with changing sales mix to increase the sale of its 3 years old trees as compared to 1 year old trees.

Question 3

a) When deciding on a purchase of equipment or any other capital investment, it is necessary to do a capital budgeting analysis. The analysis requires an estimation of the future cash inflows, the total outflows, and a discount rate to discount the cash flows to the present. One of the most important tools of capital budgeting is Net Present Value (NPV) which is the difference of the discounted cash inflows and the cash outflows. An investment having a positive NPV is considered feasible and a company should go ahead with the investment only if the NPV is positive, thereafter other capital budgeting techniques like IRR and ARR should be considered (Houston & Brigham, 2016)

b) As an owner of the business, we cannot rely on this information because both ARR and IRR do not take into consideration the time value of money which is very important for an investment analysis because all the cash flows are for a future period. Considering the risk of the investment and the inflation rates, it is important to discount the cash flows to account for the risk. ARR does not consider the time value of money; it also does not consider the cash flows and the terminal value of the investment. IRR gives the decision in a relative form unlike NPV which measures the absolute profitability. IRR is the rate at which NPV of a project is equal to 0.

c) For a project to be acceptable when ARR is the decision criterion, it is important for ARR to be higher than the target rate. This rate is decided by the management. For IRR, the IRR should be more than the discount rate. If both the above rates exceed the entity’s minimum required rate, then the company should go for the equipment which has a higher IRR which is Equipment B. This is because IRR is a better measure than ARR since it considers the time value of money and in investment decision analysis, it is extremely important to consider cash flows and time value of money (Luckett, 1984) Hence IRR proves to be a better method.