[Solution]Finance: Calculate the ROI and RI for the three departments over the five-year period

Question 1 Conan Engineering has three departments. The company has £1,650,000 available for investments and each department has been asked to identify a project that…

Question 1
Conan Engineering has three departments. The company has £1,650,000 available for investments and each department has been asked to identify a project that is suitable for investment. Only ONE department will be given £1,650,000 to invest.
Project cash flow forecasts. The forecasts are for a 5 year period.

Department Alpha
Department Beta
Department Delta

Year 1
£540,000
£210,000
£940,000

Year 2
£490,000
£230,000
£740,000

Year 3
£490,000
£470,000
£230,000

Year 4
£450,000
£920,000
£120,000

Year 5
£450,000
£940,000
£80,000

NPV
-£6,723
£8,913
-£13,449

For all departments cash flows exclude depreciation. The required rate of return has been estimated at 15%.
The investment base for Return on Investment (ROI) and Residual Income (RI) calculations is net book value (written-down value) of the investment at the beginning of the year. Straight line depreciation is applied at the rate of 20%
Required:

Calculate the ROI and RI for the three departments over the five-year period. Compare the ROI, RI and NPV for the three departments. Which department should be given the £1,650,000 to invest?                                                                                                              (22 marks)

Economic Value Added (EVA) is another technique that Conan Engineering has considered. Discuss why EVA may not be regularly used by companies.               (11⅓ marks)

(Total 33⅓ marks)
Question 2
A department at Venta Technology has prepared the following report for 2020. This department has recently faced severe competitive pressures, which has resulted in falling sales and profits over the last 3 years.
Summarised data from the management accounts
Budgeted profit and loss account for 12 months

£

Sales (80,000 units)
5,600,000

Cost of goods sold (see notes 1 and 2)
4,800,000

Gross profit
800,000

Selling general & administrative overheads (see note 3)
800,000

Profit before tax
0

A new customer has placed an order for 10,000 units at £60 per unit. The current capacity of the factory is 90,000 units.
Note 1. Cost of goods sold includes fixed costs of £500,000. All other costs are variable.
Note 2. If the order is accepted there will be additional fixed costs of £50,000. Staff will receive a bonus of £10,000 if the order is completed on time.
Note 3. Sales commission is 10% of sales and is included in the total cost of £800,000. The sales commission on the new order is only 5%. All other costs are fixed
Required:

Advise managers whether or not the order will increase the department’s profits.

(8 marks)

Calculate the minimum price the company should accept for the order. (6 marks)

Assume that the company will lose 10% of current sales if the order is accepted. What is the lost contribution if the company loses 10% of current sales? (5 marks)

Identify and evaluate what additional information management need about existing and potential customers before finally accepting or rejecting the order. (14⅓ marks)

(Total 33⅓ marks)
Question 3
Gladwell PLC is a large manufacturing company with divisional performance assessed on the basis of profitability. Division North of this company produces a single product. Although there is an external market for this product, currently 100% of the output is transferred within the company to Division South which incorporates this product into another product which is sold externally. Both divisions are currently operating significantly below full capacity.
Division North’s Costs per unit of product are (based on current total output):

 
£s

Direct Materials
500

Direct Labour
500

Manufacturing Overhead
1,700

Total Cost
2,700

Manufacturing overhead includes a fixed element absorbed at a rate of 100% of direct labour cost with the remaining part being variable overhead. Division North’s transfer price for sales to South is £2,800 per unit.
To produce the final product, Division South incurs further direct costs of £700 per unit and overhead of £1,000 per unit (50% of this figure is the fixed overhead per unit at current output level and the remainder is variable overhead).
Division South’s management want to review the transfer price. Both divisions are concerned with maximising profits and Division South argues that a transfer price of £2,300 would be good for total profits of the company.
Estimated demand for the final product produced by Division South is shown below:

Division South
 
 
 

Price
£5,000
£6,000
£7,500

Demand (units)
1,600
850
400

Required:

Calculate the contribution of both divisions and of the company overall both in the current situation and using the new transfer price proposed by Division South                                                                                                                        (17 marks)
Is the total profit for the company changed with the new transfer price? Explain the problem being caused by the transfer pricing system in this specific situation. (8 marks)

Briefly discuss whether it is advisable for central management to act to reduce such problems arising from transfer pricing systems.     (8⅓ marks)

     (Total 33⅓ marks)
Question 4

Pasternak PLC make and sell a product, the Varley. Annual sales in units for 2020 are expected to be 210,000, and standard cost and selling price per unit is:

 
£

Selling price
30

Variable costs:
 

Materials
8

Labour
8

Overheads
2

Annual fixed overheads for 2020 are budgeted at:

Manufacturing:
528,000

Non-manufacturing:
336,000

Actual production and sales for the month of January was 16,000 units. The actual revenue and expenditure for the month of January 2020 was as follows:

Sales revenue
502,000

 
 

Expenditure:
 

Materials
118,500

Labour
125,500

Variable overhead
32,400

Fixed overheads
 

Manufacturing
40,000

Non-manufacturing
35,000

Pasternak PLC divides the annual budget by 12 in order to produce monthly control reports.
Required:

Prepare the monthly control report showing original budget, flexed budget and variances.                                                                                                      (12 marks)

Using your report, give a brief analysis of Pasternak’s performance during the month.                                                                                                                                           (7 marks)

QUESTION CONTINUES ON NEXT PAGE

A balanced scorecard supports the company’s strategy throughout the organization.

Required:

Describe and explain the four perspectives on business performance captured by the Balanced Scorecard.                                                                                                       (8⅓ marks)

Suggest one possible suitable measure for each of the perspectives in a manufacturing company.                                                                                                                       (6 marks)

(Total 33 ⅓ marks)
 

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