Financial Analysis and Decision Making Assessment

You must submit your answers in a single Word or PDF document via the Assignment Submission link provided on 7000ACC â€“ Financial Analysis and Decision Making Virtual Learning Environment page (i.e. AULA) in the AssessmentÂ folder.

		Â	Â	Â	Â	Â	Â	Â	Â
Â	Felco Limited is going into the manufacture of a blue tooth device and has identified two potential machines that could be used to produce it. The Finance Manager has produced for the board the following potential cash flows from operating either machine.
Â	Year	Â	Â	Â	Â Machine	Â	Machine	Â	Â
Â	Â	Â	Â	Â	A	Â	B	Â	Â
Â	Â	Â	Â	Â	Â£'000	Â	Â£'000	Â	Â
Â	0	Capital Outlay		Â	-2800	Â	-3600	Â	Â
Â	1	Cash Inflow		Â	800	Â	900	Â	Â
Â	2	Cash Inflow		Â	800	Â	900	Â	Â
Â	3	Cash Inflow		Â	800	Â	900	Â	Â
Â	4	Cash Inflow		Â	800	Â	900	Â	Â
Â	5	Cash Inflow		Â	800	Â	900	Â	Â
Â	Â	Â	Â	Â	Â	Â	Â	Â	Â
Â	5	Residual Value		Â	400	Â	600	Â	Â
Â	Â	Â	Â	Â	Â	Â	Â	Â	Â
Â	The company has a cost of capital of 13%					Â	Â	Â	Â
Required		Â	Â	Â	Â	Â	Â	Â	Â
a)	Calculate the Payback period for each of the machines and identify which should be invested in and explain why.
Â	Â					Â	Â	Â	3 marks
b)	Calculate Accounting rate of Return for each machine and identify which should be invested in and explain why.								5 marks
c)	Calculate the Net present Value of each machine and identify which should be invested in and explain why.
Â	Â				Â	Â	Â	Â	6 marks
d)	The Marketing Director believes that the production of this new generic drug is more risky and hence believes that the firm should not be discounting at the Cost of Capital but should add a 5% risk factor to it and discount at the Hurdle Rate of 18%. Recalculate the NPV for each product utilising this new hurdle rate and identify which should be invested in and explain why.
Â	Â	Â	Â	Â	Â	Â	Â	Â	6 marks
e)	Critically evaluate each of the three methods					Â	Â	Â	Â
Â	i)	Payback Method		Â	Â	Â	Â	Â	Â
Â	ii)	Accounting Rate of Return			Â	Â	Â	Â	Â
Â	iii)	Net present Value Method			Â	Â	Â	Â	Â
Â	Â	Â	Â	Â	Â	Â	Â	Â	10 marks
f)	As the Finance Manager, write a short memo to the Board to explain whether a hurdle rate should be used when undertaking the Net present value Computation
Â	Â	Â	Â	Â	Â	Â	Â	Â	5 marks
g)	Based on your answers to part e and f, advise the board as to which machine should be invested in, fully justify your recommendation.
Â	Â	Â	Â	Â	Â	Â	Â	Â	5 marks
Â	Â	Â	Â	Â	Â	Â	Â	Total	40 marks

Star Steel produces a range of steel alloy products used in domestic, commercial and industrial premises. Due to the different markets that they operate in they have divisionalised into three autonomous departments, Domestic, Commercial and Industrial. They have just reported their results for the year ended 30th June 2020, which are shown below.

Â Â Â Â Â Â Â Â Â Â Â£â€™000

Division Â Â Â Â Â Â Â Â Â Â Â Â Â Â Domestic Â Â Â Â Â Commercial Â Â Industrial Â Â Â Â Â Â Â Total

Sales Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 1,900 Â Â Â Â Â Â Â Â Â Â Â 1,600 Â Â Â Â Â Â Â Â Â 1,200 Â Â Â Â Â Â Â Â Â Â Â Â 4,700

Operating Profit Â Â Â Â Â Â Â Â Â 600 Â Â Â Â Â Â Â Â Â Â Â Â 300 Â Â Â Â Â Â Â Â Â Â Â Â 200 Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 1,100

Capital Employed Â Â Â Â Â Â Â Â 2,500 Â Â Â Â Â Â Â Â Â 1,200 Â Â Â Â Â Â Â Â 1,800 Â Â Â Â Â Â Â Â Â Â Â Â Â 5,500

The company rewards divisional mangers on the basis of the Return on Capital Employed and has a Cost of Capital of 16%.

You may assume that the company does not pay corporation tax.

Required:

1. For each division calculate

1. The Return on Capital Employed
2. The Operating Profit Margin
3. The Asset Turnover Rate

6 marks

2. Utilising the calculations in (a) comment on the profitability of each of the divisions and identify potential reasons why their results may differ.

5 marks

3. It has been put forward that the domestic division should expand its product range. New Investment would cost Â£500,00 and generate an additional Â£80,00 in profit. As the manager of the Domestic Division would you recommend that this opportunity be invested in.

4 marks

4. Utilising the calculations in part (c) critically appraise the use of Return on Capital Employed as a measure of Divisional Manager performance.

6 marks

5. Using the Companyâ€™s Cost of Capital, calculate the Residual Income of each division and for the additional investment described in part (c).

4 marks

6. Utilising your calculations in part (d) explain why Residual Income may be a superior measure of a Divisional Manager performance.

5 marks

Total 30 marks

Delco Manufacturers is planning to introduce a new product in the next period 2021. It is expected that 12000 units can be sold at a selling price of Â£70.

The production manager has put forward two possible production methods. The following financial information has been prepared for each of the alternatives.

Â	AlternativeÂ A	Alternative B
Capital Expenditure	Â£900,000	Â Â Â Â Â£600,000
Â	Â	Â
Maximum Capacity(units)	Â 16000	Â Â Â 13000
Unit Cost	Â£	Â Â Â£
Â	Â£	Â Â Â£
Direct Materials	14	Â Â 14
Direct Labour	12	Â Â 16
Variable Production Cost	6	Â Â Â 10
Fixed Production Cost	Â Â£800,000	Â Â Â Â Â£200,000
Â	Â	Â

Required

For each of the alternatives determine

i)Â Breakeven point in units

ii)Â Breakeven point in revenue

iii)Â The Margin of Safety

6 marks

Determine the profit made under each alternative

1200 units are produced and sold.

ii)

Output is 15% below forecast i.e. 10200 units

iii)

Output is 15% above forecast i.e. 13800 units

6 marks

Determine the number of units that would have to be produced and sold under each alternative if the company wished to earn a 25% return on its investment.

Â Â Â Â Â Â Â Â Â Â 4 marks

Explain what is meant by operational gearing utilising your answer from part

(b)

6 marks

If you are advised that the company are risk averse, advise the Management as to which of the production methods to adopt, fully justify your answer utilising the calculations from parts (a) to (c).