Financial Management Assessment: Break-Even, Budgeting, Capital Investment Projects

This assessment will test your understanding of financial management methods related to:

(1) Break-even analysis, marginal analysis, budgeting and variance analysis
(2) Appraisal of capital investment projects. 

Answer the following four questions (All questions carry equal marks- marks assigned to different parts of a question are shown in square brackets)

Q1. Lewisham Ltd makes and sells one standard product, the standard costs of which are as follows:
                                                                                                                £
Direct materials: 3 kg at £2.50 per kg                                                   7.50
Direct labour: 15 minutes at £9.00 per hour                                        2.25
Fixed overheads                                                                                   3.60
                                                                                                           13.35
Selling price                                                                                        20.00
Standard profit margin                                                                         6.65

 

The monthly production and sales are planned to be 1,200 units. The actual results for May were as follows:
                                                                                                              £
Sales                                                                                                 18,000
Less: Direct materials                                                                         (7400) (2800 kg used)
         Direct labour                                                                             (2,300) (255 hours used)
         Fixed overheads                                                                        (4100)
Operational profit                                                                               4,200

Overview and Learning Outcomes Assessed

There were no stocks of any description at either the start or end of the month. As a result of poor sales demand during May, the business had reduced the price of all sales by 10%.

Required:  

(1) Draw up the original and flexed budgets alongside the actual results for May.  [5]

 

(2) Calculate the budgeted profit for May and reconcile it to the actual profit through variances (sales, direct material, labour and fixed overhead variances), going into as much details as possible from the information available. [15]

Q2. Darmour Ltd has three products, which require the same production facilities. Information about the production costs for one unit of its product is as follows:

 

All labour and materials are variable costs. Skilled labour is paid a basic rate of £6 an hour and unskilled labour is paid a basic rate of £5 an hour. The labour costs per unit, shown above, are based on basic rates of pay. Skilled labour is scarce, which means that the business could sell more than the maximum that it is able to make of any of the three products. 

 

Product X is sold in a regulated market, and the regulators have set a price of £50 per unit for it. 

Required: 

(a) State, with supporting workings, the price that must be charged for products Y and Z, such that the business would find it equally profitable to make and sell any of the three products. [15]

 

(b) State, with supporting workings, the maximum rate of overtime premium that business would logically be prepared to pay its skilled workers to work beyond the basic time. [5]

 

Q3. D’Arcy (Builders) Ltd is considering three possible investment projects: A, B and C. The expected pattern of cash flows for each project is:

Project cash flows

The business has a cost of finance of 10% and the capital expenditure budget for next year £25 million. 

Required:  

(1) Calculate the NPV of each project. [10]

(2) Which investment project(s) should the business undertake assuming:

a. Each project is divisible
b. Each project is indivisible.  [10]

Q4. Nimby plc is considering two mutually exclusive projects; Delphi and Oracle. The possible NPVs for each project and their associated probabilities are as follows:

 

Required:

(1) Calculate the expected net present value and the standard deviation of NPV associated with each project. [10]

(2) Which project would you select and why? State any assumptions that you have made in coming to your conclusions. [10]