Financial Management and Decision Making: Calculation of Ratios and Variances

University of Bolton REGENT COLLEGE LONDON BSC (H ons ) BUSINESS MANAGEMENT SEMESTER 1, EXAMINATION 2021/22 FINANCIAL MANAGEMENT AND DECISION MAKING MODULE NO: BMP5006 Date: 05 June 2021 Exam Start Time: 10:00 am (Submit by 10:00 pmon 05 June 2021) ANSWER BOOKLET All the pages of the answer booklet should be submitted including blank ones. Please type your answers in the spaces provided. Insert additional pages where required. Student Name ID Number Question 1 (a) Calculation of Payback Period for each product: 2of 12 CUMULATIVE CASH FLOWS Project A Project B Project C £ £ £ Year 1 4000 5000 4000 Year 2 10000 10000 9000 Year 3 17000 14000 12000 Year 4 19600 17000 Year 5 20400 2+ (5000/7000) 3+ (1000/5600) 3years + (3000/5000) Payback Period (years and months) 2years 9 months approx 3years 2 months approx 3years 7 months approx Calculation of Payback Period for each product: Discount Factors Project A Project B Project C CF DCF CF DCF CF DCF 8% £ £ £ £ £ £ Year 1 0.926 £4,000.00 £ 3,704.00 £5,000.00 £ 4,630.00 £4,000.00 £ 3,704.00 Year 2 0.857 £6,000.00 £ 5,142.00 £5,000.00 £ 4,285.00 £5,000.00 £ 4,285.00 Year 3 0.794 £7,000.00 £ 5,558.00 £4,000.00 £ 3,176.00 £3,000.00 £ 2,382.00 Year 4 0.735 £5,600.00 £ 4,116.00 £5,000.00 £ 3,675.00 Year 5 0.681 £3,400.00 £ 2,315.40 Total DCF £14,404.00 £16,207.00 £16,361.40 Initial investment £15,000.00 £15,000.00 £15,000.00 Net present value -£ 596.00 £ 1,207.00 £ 1,361.40 Question 1 (b) 3of 12 In case of payback period method itisrecommended to chose project A as ithas lowest payback period. In case of NPV method itis recommended to make selection of project that highest equivalent annual annuity in either Project B and Project C Project B =(8%*1207.00)/[1-(1+8%)^4] =$364.42 Project C =(8%*1361.40)/[1-(1+8%)^5] =$340.97 On the basis of NPV itis suggested to make selection Project B as ithas highest equivalent annual annuity value. (c) NPV isthe ultimate decision making criteria while making the investment decision. Therefore, itis highly recommended to make selection of Project B as itis highest NPV among all three projects. (d) The major merit of the payback period is that itis regarded as simple method for assessing the feasibility of acapital investment project. It also requires incurring less cost and time as compared to other methods of capita budgeting. The major limitation of the payback period is that does not take into consideration the time value of money and also does not consider the inflow of cash after the realization of the payback period. On the other hand, the major merit of the net present value is that itdoes consider the time value of money unlike the cash on cash returns in the simple payback period. The major limitation of the net present value method in investment appraisal is that itcannot be used for comparing the projects of different sixes. Question 2 (a) Calculation of ratios: 4of 12 (i) Gross Profit Margin == Gross Profit x100 Sales 2019 =192 440 ?100 =43.64% 2020 = 138 330 ?100 =41.82% (ii) Operating profit margin% =Operating profit or EBIT x100 Sales Revenue 2019 = 70 440 ?100 =15.91% 2020 = 50 330 ?100 =15.15% (iii) Expenses to sales = Operating Expenses x100 Sales Revenue 2019 =122 440 ?100 =27.73% 2020 = 88 330 ?100 =26.67% (iv) ROCE = Profit before Interest and Taxation X 100 Capital employed including long-term loans Capital Employed =Total Equity +Long Term Loans 2019 = 70 (350+100) ?100 =15.55% 2020 = 50 (313+100) ?100 =12.11% (v) Assets turnover = Sales Total Assets 2019 = 440 (405+117) =0.84 times 2020 = 330 (361+84) =0.74 times 5of 12 (vi) Non-current asset turnover = Sales Total Non Current Assets 2019 =440 405 =1.09 times 2020 = 330 361 =0.91 times (vii) Current Ratio = Current Assets Current Liabilities 2019 =117 72 =1.625 times 2020 = 84 32 =2.625 times (viii) Quick Ratio = Current Assets Current Liabilities 2019 =117 ?45 72 =1.00 times 2020 = 84?28 32 =1.75 times (ix) Inventory Turnover period in days =Inventory x 365 Cost of Sales 2019 = 45 248 ?365 =66.23 days 2020 = 28 192 ?365 =53.23 days 6of 12 (x) Receivables days = Receivables x 365 Sales 2019 = 65 440 ?365 =53.92 days 2020 = 46 330 ?365 =50.88 days (xi) Payable days= Payables x 365 Cost of Sales 2019 = 72 248 ?365 =105.97 days 2020 = 32 192 ?365 =60.83 days (xii) Interest Cover = EBIT Interest Expenses 2019 =70 10 =7times 2020 = 50 10 =5times (b) Comment on company performance: 7of 12 The profitability analysis of the company can be done through examining the results of gross profit margin, operating profit margin, expenses to sales, return on capital employed ratios. The gross profit margin ratio of the company has decreased from 43.64% to 41.82% over the years 2019-2020. This is mainly because decrease in the sales revenue of the company over the period. The operating profit margin ratio of the company has also depicted aslight decrease from 15.91% to 15.15% which is mainly due to decrease in operating profit of the company over the period 2019-2020. The operating expenses have also decreased from 27.27% to 26.67% over the period 2019-2020 that is mainly due to decrease in operating expenses of the company. The ROCE ratio has decreased from 15.55% to 12.11% over the years 2019-2020 which is mainly due to decline in the EBIT performance. Thus, itcan be said that there is decline in the profitability performance of the company over the financial period 2019-2020. The efficiency position of the company as analyzed from asset turnover ratio has depicted aslight decrease from 0.84 to 0.74 times. The non-current asset turnover has also decreased from 1.09 to 0.91 times over the period and this indicates adecline in the ability of the company to realize sales from the use of asset base. The inventory turnover period has decreased from 66.23 to 56.23 days which means that number of days taken by the company to realize sales from the inventory has been reduced over the period 2019-2020. The receivable days has also been reduced from 53.92 days to 50.88 days wich means that number of days that are taken by the company to collect debt from debtors has been declined which ensure improved position of cash flows. The payable days has been reduced 105.97 to 60.83 days which means that company is meeting the obligations of its suppliers properly. The liquidity performance of the company over the period 2019-2020 can be analyzed in terms of current and quick ratio. The current ratio has been increased from 1.62 to 2.62 over the period 2019-2020 and quick ratio has also been improved from 1.00 to 1.75 times during the financial period. This depicts improved liquidity performance of the company as it the amount of current or liquid assets available to meet the short-term financial obligations has been improved. The interest coverage ratio has depicted adecrease from 7times to 5times over the financial period 2019- 2020 which is due to decline in EBIT position of the company and that has resulted in decreasing the ability to meet the interest expenses over the period. Question 3 Calculation of variances: Sales variances £ Favourable (F)/Adverse (A) Sales price variance: (Actual Price –Budgeted price) *Actual Volume Actual Volume =4850 units, total selling value = £150,350, Actual Price =£150,350/4850 units =$31.00, Budgeted price =$32.00 Sales price variance: ($31.00 –$32.00) *4850 units 4850 Adverse (A) Sales volume variance: (Actual volume –Budgeted Volume) *Budgeted Price Actual Volume =4850 units, Budgeted Volume =5100 units 8of 12 Budgeted price =$32.00 Sales volume variance: (4850 –5100) *$32.00 8000 Adverse (A) Total sales variance 12850 Adverse (A) Direct material variances £ Favourable (F)/Adverse (A) Material price variance: (Standard Price –Actual Price) *Actual Quantity Standard Price =$4.00 per kg, Actual Quantity =2300 Kgs Actual total cost =$9800 Actual Price =$9800/2300kgs =$4.26 Material price variance: ($4.00 –$4.2601) *2300 kgs 600.00 Adverse (A) Material usage variance: (Standard Quantity –Actual Quantity) *Standard Price Actual Quantity =2300 Kgs, Standard Price =$4.00 per kg Standard Quantity per unit =0.5 kg, Standard quantity for 4850 units =4850 *0.5kg =2425 kg Material usage variance: (2425 kgs –2300 kgs) *$4.00 500.00 Favourable (F) Total direct material variance 100.00 Adverse (A) Question 3 Calculation of variances (continued): Direct labour variances £ Favourable (F)/Adverse (A) Labour rate variance: (Standard Rate –Actual rate) *Actual Hours Standard Rate =$8.00 per hour, Actual Hours =8000 hours Actual Rate =$67800 /8000 hours =$8.475 Labour rate variance: ($8.00 –$8.475) *8000 hours 3800 Adverse (A) Labour efficiency variance: (Standard Hours –Actual Hours) *Standard Rate Actual Hours =8000 hours, Standard Rate =$8.00 per hour Standard Hours =2hours per unit *4850 units =9700 hours Labour efficiency variance: (9700 –8000) *$8.00 13600 Favourable (F) Total direct labour variance 9800 Favourable (F) 9of 12 Note =Here actual operating hours has been considered i.e. (8000 hours) not the actual hours paid (8500 hours) Variable overhead variances £ Favourable (F)/Adverse (A) Variable overhead rate variance: (Standard Rate –Actual Rate) *Actual Hours Standard Rate =$0.30 per hour, Actual Hours =8000 hours Actual Rate =$2600 /8000 hours =$0.325 Variable overhead rate variance: ($0.30 –$0.325) *8000 hours 200.00 Adverse (A) Variable overhead efficiency variance: (Standard Hours –Actual Hours) * Standard Rate Actual Hours =8000 hours, Standard Rate =$0.30 per hour Standard Hours =2hours per unit *4850 units =9700 hours Variable overhead efficiency variance: (9700 –8000) *$0.30 510.00 Favourable (F) Total Variable overhead variance 310.00 Favourable (F)/ Question 3 Operating Statement (OP): Standard OP Variances Actual OP £ £ £ £ £ Sales $163200 ($12850.00) £150,350 Direct materials $9700 ($100.00) £9,800 Direct labour $77600 $9800.00 £67,800 Variable overheads $2910 $310.00 £2,600 Total variable expenses $90210 $10010.00 $80200 Contribution $72990 $70150 Standard Sales at 5100 units =5100 units *$32.00 =$163200.00 Standard Direct Material Cost =(4850*0.5kg) *$4.00 =$9700.00 Standard Direct Labour Cost =(2 hours *4850 hours) *$8.00 =$77600.00 Standard Variable overhead cost =(2 hours *4850 hours) *$.30 =$2910.00 10 of 12 Question 4 (a) Breakeven points in units: Contribution per unit: Product A Product B £ £ Selling price per unit $12.00 $17.00 Less: Variable Cost per unit $7.90 $11.20 $4.10 $5.80 £ Contribution from standard mix: 4/7 3/7 57.14% 42.86% $4.10*57.14 % $5.80*42.86 % $2.34 + $2.49 Weighted average contribution per unit: $4.83 Total Fixed Cost: £131,820 Weighted average contribution per unit: $4.83 Breakeven point in units in standard mix Fixed Cost /Weighted Average Contribution per unit Weighted average contribution per unit: 27300 Units Breakeven points in units for each product: Product A (27300 units *57.14%) = 15600 units Product B (27300 units *42.86%) = 11700 units Question 4 (b) Margin of safety in units 11 of 12 Breakeven sales 27300 units Budgeted Sales revenue £398,500.00 Weighted Average selling price $14.14 Budgeted Number of Units Sold 28177 units Margin of safety in units 877 units Calculation of margin of safety: Budgeted Sales revenue =£398,500.00 Budgeted Sales revenue for Product A =£398,500 *57.14% =$227,714.30 Budgeted Sales revenue for Product B =£398,500 *42.86% =$170,785.70 Number of selling units of Product A ==$227,714.30/$12.00 =18976 units Number of selling units of Product B =$227,714.30/$17.00 =10046 units Weighted Average selling price =Product A Selling price *(4/7) *Product B Selling price *(3/7) =$12.00 *(4/7) +($17.00 *(3/7) =$14.14 Number of Units Sold =£398,500.00 /$14.14 =28176.77 or 28177 units Breakeven Sales =27300 units (c) Evaluation of relevance of breakeven analysis in amodern manufacturing environment: The break even analysis is sued for deciding the least number of sales that are required for making profits. Itprovides the business with aclear idea of the units to be manufactured for meeting the cost incurred and avoiding the realization of any type of losses. This is because the determination of break-even point helps in establishing the point at which total cost and revenue for aparticular business venture are equal. The results of such an analysis as such can be regarded as highly important for determining the attractiveness of agiven business opportunity such as investing in anew product or undertaking expansion activities. The determination of break-even point in advance would help the management in taking final decision by analyzing the external factors or obstacle that could restrict the business growth in future context. 12 of 12 Question 5 Significant steps in setting afinancial/cost controlling budget in alarge organisation. The significant steps that are involved in setting a financial or cost controlling budget in a large organization are as follows: ? Establishing actual position: The budget holder need to examine and understanding the given financial information in relation to costs which may require gathering information from different sources. The costs incurred in different business activities such as purchase, production, sales, manpower planning and other are identified for over viewing the complete cost incurred by a company. ? Comparing Actual with the Pre-determined Budget: The information realized need to be compared with the budgeted figures that are established at the beginning of the financial year. The difference between the actual cost incurred and the expenses pre-determined can be used for conducting variance analysis. ? Establishing the Reasons for Variances: The major reason that is responsible for causing the difference between the actual and planned figures need to be established for taking adequate measures to control the deviations. The major reason responsible for causing deviations can be due to occurrence of error, delay in entering the information, poor budgeting, unplanned changes and others. ? Taking Corrective Action: The cost control by budget developed can be done by taking corrective action in response to the variances. The action that can be taken for controlling the cost can be reducing the expenses in areas that are incurring high costs, eliminating the wasteful activities, redefining the objectives, changing the nature of the business activities for minimizing the cost of operations.