Corporate Governance, Investment Appraisal, Marginal Costing, and Financial Forecasting

Question 1

(a) Critically discuss the ‘comply or explain’ model of corporate governance.

(b) Listed companies must send their financial statements to the authorities that oversee the stock exchange on which their shares are listed. Companies incorporated in the UK file their accounts with both Companies House and the London Stock Exchange.

Identify and explain the characteristics of the approach that is used to the filing of financial statements by plc’s that are incorporated in the UK.

Question 2

Flyers plc operates public transport services in major cities in the United Kingdom (UK). The company uses the accounting rate of return (ARR) and payback methods to support investment decision making. You are a Senior Finance Manager at Flyers plc.

The company intends to bid for new five-year contracts to operate bus services in either Edinburgh, UK, or Newcastle upon Tyne, UK. Both contracts require the successful bidder to pay a franchise fee to secure the contract and to invest in a new fleet of buses. Sufficient funding is available to finance only one of these options.

Assume that all cash flows occur at the end of the respective year. The company’s approach to investment appraisal was discussed at a recent meeting of Flyers plc’s senior executive team. Chang Ying Simmonds, Director of Marketing at Flyers plc, is keen to understand the nature of investment decisions.

Chang Ying has commented:

These decisions appear to have particular characteristics. We need to understand why investment decisions are of importance to the business as this will help us to appreciate if our approach to investment appraisal is appropriate.

Travis van Riemsdyk, Chief Operating Officer at Flyers plc, has highlighted that the internal rate of return (IRR) method can be of use in investment appraisal. Travis has commented:

Like other investment appraisal methods, the IRR has both advantages and disadvantages. I would like to know more about the strengths and weaknesses of the IRR.

(a) Calculate the payback period for both the Edinburgh and Newcastle upon Tyne contracts.

(b) Calculate the accounting rate of return (ARR) for both contracts. Assume that the only difference between cash flow and profit is the depreciation charge.

(c) Critically evaluate the payback technique.

(d) Advise Flyers plc’s senior executive team on the comments made by Chang Ying Simmonds and Travis van Riemsdyk. Your advice should include an explanation of the characteristics of investment appraisal decisions and the advantages and disadvantages of the IRR.

Question 2

Question 3

Marginal costing is a technique that distinguishes between variable costs and fixed costs. In this approach to costing, only the variable costs of production are charged to cost units. Marginal costing and the concept of contribution are fundamental to the breakeven analysis or ‘cost-volume-profit’ (CVP) technique.

(a) Explain the concept of contribution and its importance to the CVP technique.

(b) Describe the nature of each of the ‘dropping a product or service’ and‘special contract’ decisions for which the CVP technique can be useful.

(c) Critically evaluate the CVP technique and explain the limitations of its use in the context of both the different interpretations offered by the economist’s model of CVP and other limitations.

Question 4

A group of friends have formed a new business called Fashion Clothing, an online and mail order clothing business, in which they have invested £200,000 of their own capital. They intend to manufacture and sell quality clothes. They have set the business up and are selling direct to the final consumer, using a combination of aggressive marketing across a range of different media and also with the use of an automated web site that accepts online orders. To support this, they also have a department of telephone sales and support staff ready to help customers. The sales staff work in teams and receive a basic salary plus commission for each successful sale. By the start of July 20X5, they have spent £150,000 on tangible non-current assets, and they currently have the remaining £50,000 in their business bank account.

They provide you with the following forecasted figures for their first 6 months of trading:

They provide you with the following forecasted figures for their first 6 months of trading:

Their projected cash receipts and payments are estimated to be as follows:

In addition to the above, they expect to have to pay a tax bill of £20,000 in December 20X5. All transactions will go through their business bank account.

(a) Prepare an opening statement of financial position at the start of July 20X5.

(b) Prepare a monthly cash flow forecast, showing the bank balance at the end of each of the 6 months and indicating what level of overdraft facilities the friends need to negotiate with their bank manager.

(c) Explain what additional expense they should take into account as a result of needing the financial assistance (overdraft) referred to in (b).