Professional Documents
Culture Documents
Accounting Assignment 2 Harilal N
Accounting Assignment 2 Harilal N
Surname Harilal
First Name/s Narisha
Student Number 114023
Subject Accounting for Decision Making
Assignment Number Two (2)
Tutor’s Name Mark Kalkwarf
Examination Venue College of Education at Wits, Johannesburg, South Africa
Date Submitted 25 April 2011
)
Submission ( First Submission Re-submission
17 Glastonbury Avenue
Somerset Park
Postal Address Umhlanga Rocks
Durban
South Africa 4321
E-Mail Narisha.harilal@eskom.co.za
011 800 6642 (Work)
Contact Numbers N/A (Home)
083 788 1516 (Cell)
Course/ Intake MBA Year 2 – January 2010
Declaration by Student
I hereby declare that the assignment submitted is an original piece of work produced by myself
and any sources consulted are adequately acknowledged in the text and listed in the
bibliography.
25 April 2011
Signature Date
Table Of Contents
1. Question One
1.1.1 Production Budget…………………………………………………………. 2
1.1.2 Expected Production Costs……………………………………………….. 3
1.2 Sales Budget……………………………………………………………………. 4
2. Question Two
2.1.1 Ratios………………………………………………………………………… 5
2.2 Earnings Per Share……………………………………………………………... 8
2.3 Dividends Per Share……………………………………………………………. 9
3. Question Three
3.1.1 Break Even Quantity………………………………………………………… 11
3.1.2 Decrease in Price, Increase in Sales……………………………………… 12
3.2 Closing of Department B………………………………………………………… 13
4. Question Four
4.1.1 Pricing Method………………………………………………………………. 16
4.1.2 Position Taken by Manager………………………………………………… 16
4.2 Financial Position………………………………………………………………… 18
5. Question Five
5.1.1 Pay back Period……………………………………………………………… 21
5.1.2 Accounting Rate of Return…………………………………………………… 23
5.1.3 Net Present value…………………………………………………………….. 24
5.1.4 Chosen Project………………………………………………………………… 26
5.2 Internal Rate of Return……………………………………………………………..26
6.Bibliography………………………………………………………………………………. 27
1
1. Question One
2
1.1.2 Expected Production Costs for March 2011
From question 1.1.1, the expected number of units to be produced in March is 1400
units.
The production costs per unit are shown in the table below:
3
1.2 Five External Influences that may impact on the preparation of a
sales budget
• The state of the economy: The state of the economy will dictate demand and
therefore the number of units sold. E.g if the economy is experiencing a
downturn, sales forecast quantities will be lower
• The actions of competitors: The actions of competitors will influence the number
of units sold. E.g. if a competitor reduces its price or introduces an improved
product, sales will be reduced to a loss in market share
• The effect of seasonal fluctuations: The effects of season and cyclical trends
have to be considered as this will influence demand. E.g. The demand for air
conditioners will be greater during the summer season.
• The stability of suppliers: A disruption in supply lines will cause a halt or backlog
in production and therefore a halt or slow in sales.
• The effects of the external market: Both imports and exports will have an effect
on the sale quantities budgeted. If government raised taxes on imports, this will
lower the rates of these imports, and have an effect on a sales budget of a
company that relies on these imports for the production of their finished goods.
4
2. Question Two
2.1.1 Profitability Comparison
Where
5
Therefore,
The operating profit reflected in Table 1.2.1.2 above, is taken from Table 1.2.1.1.
The capital employed is the sum of the owner’s equity and non-current liabilites, and
finally the Return on Capital Employed is calculated as the operating profit divided by
the capital employed multiplied by 100 to get it to a percentage form.
XYZ limited has a higher return on capital employed than ABC limited, showing that the
return earned at XYZ limited is in excess of what could be earned elsewhere compared
with ABC Limited. (Mancosa Study Guide, 2011:95)
Where
Gross Profit = Sales – Cost Of Sales ( taken from Table 2.1.1.1), and
Therefore,
6
ABC Limited XYZ Limited
Gross Profit 990 000 648 000
Sales 3 300 000 1 080 000
Gross Profit Ratio 30% 60%
The Gross Profit Ratio of XYZ Limited is double that of ABC Limited, showing that
operational effectviness is greater at XYZ than at ABC Limited, as this ratio reflects the
value added over cost. Therefore has a higher price margin than ABC Limited.
(Mancosa Study Guide, 2011:88)
Where
Therefore,
This ratio shows the earnings available to shareholders, XYZ Limited shareholders earn
more than ABC Limited Shareholders. (Mancosa Study Guide, 2011:96)
7
2.2 Earnings Per Share for ABC Limited for 2010
Where: Net Profit After Tax is calculated in Table 2. 1.1.1 as R453 600, and
ShareCapital 1000000
No. of Ordinary Shares is = = 500 000
ParValue 2
Therefore Earnings Per Share for ABC Limited for 2010 is:
453600 100
= X
500000 1
= 90 cents.
Earnings per share is an indication of profitability, the EPS has decreased from
115cents in 2009 to 90cents in 2010. This is not a good indication for ABC Limited as
shareholders as well as management consider this indicator very important, as it shows
the shareholders the porfitablility of the company, and it shapes the strategy and future
of the company from the management point of view. ( Mancosa Study Guide, 2011: 98)
8
2.3 Dividend Per Share for XYZ Limited to declare for 2010
Dividends per share should not be greater than earnings per share to maintain wealth
created during the year.
So we need to calculate the earnings per share for XYZ Limited for 2010.
407400 100
= X
250000 1
= 162 cents.
Where Net Profit after tax for XYZ Limited is calculated in Table 2.1.1.1, and,
No. of ordinary shares issued is Share Capital (500000) divided by Par Value of a share
which is R2, giving no. of ordinary shares issued to be 250000.
Therefore dividends per share can not be greater than 162 cents or R1,62.
To calculate the exact amount we consider the fact that Net Profit After Tax if divided
into Retained Earnings and Dividends paid.
9
Since Retained Earnings for XYZ Limited for 2010 is R40000, which is given in the
questions, we can conclude that Dividends paid would be :
Since Number of Shares issued by XYZ Limited for 2010 is 250000, we can calculate
the dividends per share.
(No. of ordinary shares issued is Share Capital (500000) divided by Par Value of a
share which is R2, giving no. of ordinary shares issued to be 250000.)
Therefore,
Dividends Per Share XYZ can declare for year ended 31 December 2010 is:
DividendsPaid
Dividends per share =
No.ofOrdinarySharesIssued
R367400
=
250000
= R 1,47
Therefore the dividends per share that XYZ Limited should declare fro year ended 31
December 2010, should be R1,47. This does not exceed the earnings per share of
R1,62 indicating that some of the wealth created during the year was maintained by the
company.
10
3. Question Three
3.1 .1 Break Even Quantity for January 2011
FixedCosts
Break Even Quantity =
Contribution M arg in / Unit
Therefore,
FixedCosts
Break Even Quantity =
Contribution M arg in / Unit
210000
=
30.04
= 6990 units.
11
3.1 .2 Decrease selling price to increase Sales
To evaluate if a 6% decrease in selling price which would lead to the increase in sales
by 12% would be an overall good decision for Sellrite Enterprises, one would have to
consider the operating profit achieved , and compare this operating profit value with that
of the company before the decrese in selling price and increase in sales numbers.
This was done in Table 3.1.2.1 below, where the present operating profit (Sales -
Costs) of the company was compared to the proposed operating profit (Sales - Costs)
of the company should it choose to decrease its selling price by R6 per unit to increase
its sales numbers by 12% (15000 + 12%(15000) = 16800)
The costs column is made up of Variable costs per unit which is calculated in Table
3.1.2.2, which is then multiplied by the sales volume, and then the fixed costs which are
given in the question are added.
Present Proposed
Sales R990000 R1008000
Present Price per Unit R66 R60
Sales Volume 15000 16800
Costs (R749400) (R808080)
Variable Cost per Unit R35.96 R35.6
Fixed Costs R210000 R210000
Operating Profit R240600 R199920
12
Variable Cost per Unit
Per Unit Present Price Per Unit (R66) Proposed Price Per Unit(R60)
Manufacturing Variable Costs R28 R28
Marketing Variable Costs R3.96 (6% of Sales) R3.6 (6% of Sales)
Administration Variable Costs R4 R4
TOTAL VARIABLE COST
PER UNIT R35.96 R35.6
Table 3.1.2.2 Calculations of present and proposed Variable Costs per Unit
(for use in calculations in Table 3.1.2.1)
From Table 3.1.2.1, its clear that should the sellin price be decreased to R60, in order to
increase the sales volume by 12 %, the operating profit would actually decrease from
R240 600 to R199 920. This is a decrease in operating profit by around 17%.
Therefore it would not be advisable to decrease the selling price by R6 in order to
increase the sales by 12%, as it would lead to an overall decrease in operating profit of
Sellrite Enterprises.
13
3.2 Zambesi Manufacturers Closing of Department B
To establish weather closing department B would be advisable, one needs to consider
the contributions made by each department. This is calculated through the contribution
margin which is the amount contributed to fixed expenses and operating profit. Fixed
expenses include rent, property rates and taxes, depreciation, insurance, salary of
factory managers, etc. These are costs incurred to the firm as a whole, so to get a true
reflection of the performance per department, these fixed expenses are left aside for
now as they actually belong to the whole firm, and the contribution margin per
department was calculated in Table 3.2.1.
Department
A B C D
Sales 150 300 450 600
Variable Costs
Variable Manufacturing Costs (93) (267) (411) (548)
Other Variable Costs (15) (23) (18) (15)
Contribution Margin 42 10 21 37
If one had to look at the contribution margin in isolation, they might consider closing
down Department B and redeploying employees as a good idea, as from Table 3.2.1 ,
the contribution margin for Department B is the lowest.
However on closer evaluation, one needs to consider why this margin is so low, since
Sales – Variable costs give the contribution margin, one needs to look at these factors.
The variable costs on Department B are very high leading to the low contribution
margin, the highest contribution to this high variable costs at Department B is the high
cost of direct labour (112) as compared to the sales output (20% from Table 3.2.1) of
that department when evaluated against other departments. Now should Department B
14
be closed an employee’s be redeployed, these high direct labour costs would just be
transferred to another department, so essentially this closure would not make the
business more efficient, but just move the inefficiencies.
Closing down Department B would not be a good idea, as it would not solve the
problem the business as a whole is experiencing with the high direct labour costs at
department B, as this problem would merely be transferred, and the high fixed costs of
the business (Table 3.2.1) may be reduced by measures such as moving of location, so
as to reduce rent , property rates, etc. These may be lessened without the closure of the
entire department.
Department B contributes 20% to total sales, that’s greater than department A, and
there is no guarantee that there would be an increase in demand for products produced
at the other departments(as we are moving resources to these departments, and that
would most likely result in an increase in production, but demand might not match this
production)
Therefore for all the reasons discussed above it is not a good idea to close down
Department B.
15
4. Question Four
4.1.1 Disadvantages of transfer pricing method
A full cost method is been used at Crimson Enterprises, with the disadvantages of this
method been:
• It can lead to a poor estimation of costs and therefore inaccurate costs been
charged by the supply division.
• There is also no profit margin added to the cost which does not provide an
incentive for the supplying division to transfer services.
The reason she had taken this position was , should she lower the internal price to
match the external agency, she would be required to lower her budget as well, and she
would still see no profit from this effort due to the full cost price method implemented by
the firm. She budgets for the recovery of all costs, with no profit margin considered, so
all her and her teams effort would result in no gain or profit for her department, so with
the lack of incentive resulting from the pricing method implemented, it did not seem
worth her while to reduce the price.
A recommended solution to this situation would be for the company to provide other
types of incentives to the managers of each department, should they reduce overall
costs in their departments, they could receive benefits of a personal nature, such as
better insurance, gym memberships, company hired cars, etc. This would not effect the
pricing method of the company, which might have been chosen for specific reasons, but
would still provide other incentives to the departments to reduce costs, even if they don’t
see traditional profits.
16
Another reason B.Lara took the position of not reducing prices is that, budgeted costs
are 75% fixed. So on a R15 per hour rate that’s R11.25 which forms the fixed portion.
The external agencies price is R10.50, therefore should Lara reduce the internal rate,
they would not even cover the fixed costs (e.g. rent, rates and taxes) incurred to the
company for this service. Since the price strategy dictates covering only full cost with no
meat as profits, this possible decrease in price will see the section running at a loss.
A recommendation to solve this problem would be to either try to lower the fixed costs of
the department, or alternatively motivate to the company heads to change the pricing
strategy to one of either a Market-based transfer price, where the company would need
to evaluate the market, and set prices according to this. In this way, the typing
department would be more competitive to the outside agencies, and would not be in a
position to take a comfort zone approach. Been forced to compete with external prices,
the department may even force themselves to work more efficiently, and find ways to
reduce their fixed costs.
Another pricing method they may recommend to the executives of the company would
be the Cost-plus a mark-up transfer price method. This mark-up that the department
would be allowed to add to their price, would provide incentive to the department to
work harder or more efficiently, thereby cutting down costs, fixed and variable. This
profit would also provide as a buffer, so they department will have a lower chance at
running at a loss.
17
4.2 Beta Limited’s Financial Position
In order for possible lenders and creditors to evaluate the success of a company, to
decided which company they should fund the needs of, they need to consider the
negative consequences of default and liquidation as well as access the risk involved in
recovering the funds lent, as well as a margin of safety in the assets held by the
company. The ratios used to evaluate these aspects include the Liquidity Ratio(Current
Ratio) and the Financial Leverage Ratios (Debt to Assets, and Debt to Equity). These
ratios would be evaluated to determine the Financial Position of Beta Limited. (Mancosa
Study Guide, 2011:103)
From the information given in the question the following was calculated:
2010 2009
Current Assets R398000 R286000
Current Liabilities R108000 R104000
Current Ratio 3,68:1 2,75:1
This ratio shows the relationship between current assests and current liabilities, and it
shows the safety of current debt holders claims in the case of default. The incline in the
current ratio of Beta Limited from 2,75:1 to 3,68:1 is due largely to the increase in the
current assets from 2009 (R286 000) to 2010 (R398 000).
This high current ratio or increase in current ratio is favorable from a debt holders point
of view as it shows that the business would have a cushion against losses in the event
of a business failure. A very high current ratio however from a management point of
18
view may seem that the company has idle cash or high inventory levels that could be
invested in more profitable ways, or it might even indicate that the company has poor
credit management as its has excessive accounts receivable. The norm is 2:1, Beta
Limited is at 3,68:1, which is much higher than norm, and reflects well to debt holders,
but could point out problems from the managers point of view. (Mancosa Study Guide,
2011:103)
The next ratios to evaluate are the Financial Leverage Ratios, such as the Debt to
Assets Ratio:
Total Debt 100
Debt to Assets = x
Total Assets 1
From the information given in the question the following was calculated:
2010 2009
Total Debt R988000 R802000
Total Assets R920000 R858000
Debt to Assets 107,4% 93,5%
The greater the debt to assests ratio the greater the risk, as it reflects the claim of debts
against assets of the company. This increase from 93,5% to 107,4% is a poor reflection
of Beta Limited, as it indicates that in 2009 93,5% of the companies assets ‘belong’ to a
creditor. In 2010 Betas Debt to Assets ratio rose to an high of 107,4% showing that the
company is running completely on the backs of the creditors, and would be a very poor
investment choice on prospective lenders. (Mancosa Study Guide, 2011:105)
19
The last Financial Leverage Ratio to evaluate is the Debt to Equity Ratio:
From the information given in the question the following was calculated:
2010 2009
Non-Current Debt R880000 R698000
Owners Equity (R68000) R56000
Debt to Assets 1:-0.08 1:0,08
This ratio shows the relative non-current creditor claims to ownership claims, which
essentially measures debt exposure. In 2009 for ever 100cents invested by the long
term creditor, 8cents was invested by the owners of Beta Limited. However in 2010, for
every 100cents invested by the long term creditors of the company, not only did the only
invest 0cents, but they actually used 8cents of the creditors, this is reflected by the
negative in the Debt to Assets ratio for 2010 in the table above. This is a very poor
reflection of Beta Limited. They have more debt than assets, resulting in an extremely
high debt exposure. (Mancosa Study Guide, 2011:106)
Therefore from the above ratio analyses from the point of view of lenders and creditors,
Beta Limited is not an attractive company to invest in. The decline of the company from
2009 to 2010 shows that although the company was doing poorly in 2009, in 2010 they
did worse, with increasing their debt exposure, with more debt than assets. There was
no sign of recovery and Beta Limited will not attract any more investors.
20
5. Question Five
5.1.1 Payback Period
Before doing the calculation, the cash flow for each year needs to be calculated from
the profit for each year given. Since Profit = Cash Flow – Depreciation, therefore
21
Therefore the payback periods for Project A and B are:
R75000
= 0.789 x 12months = 9,5months
R95000
R 42000
= 0.388 x 12months = 4,7months
R108000
22
5.1.2 Accounting Rate of Return for Project B
Average Annual Pr ofit 100
Accounting Rate of Return= x
Average Investment 1
Average Annual Profit is the sum of the Profits from year 1 to year 4 of Project B,
Project B
Year 1 Profit R70500
Year 2 Profit R70500
Year 3 Profit R70500
Year 4 Profit R70500
Average Annual Profit R70500
Average Investment is :
R150000 + R0
=
2
= R 75 000
Therefore,
R70500 100
= x
R75000 1
= 94%
23
5.1.3 Net Present Value of Project A and Project B
The Net Present Value for Project A is calculated in the Table below:
PROJECT A
Year Cash Inflow (R) Discount Factor(12%) Present Value(R)
1 64000 0.8929 57146
2 77000 0.7972 61384
3 86000 0.7118 61215
4 95000 0.6355 60373
5 56000 0.5674 31774
5(Scrap Value) 42000 0.5674 23831
Total Present Value 295723
Investment (302000)
Net Present Value
(negative) (6277)
24
Where,
Cash Flow or Net Inflow = Profit (R70500) + Depreciation (calculated below as R37500)
= R108 000
= R37500
25
5.1.4 Which project should be chosen?
Project B should be chosen as it has a Positive Net Present Value as opposed to
Project A which has a negative Net Present value. A positive NPV(Net Present Value)
indicates that a project will be profitable, and a negative NPV indicates that a project will
not be profitable. Hence Project B should be chosen.
The Internal Rate of Return occurs when NPV (Net Present Value) = 0
Therefore NPV is zero between 16% and 17% from table above, to get the exact
position:
R1599
NPV zero at : = = 0,248 + 16% = 16,25%
R6451
26
6. Bibliography
• Anonymous. 2011. MBA Course and Assignment Handbook. Mancosa
• Anonymous. 2011. MBA Year 2 Accounting for Decision-Making. Mancosa
27