MBA-Final Mock Exam

Question 1 (25 marks)

Explain the tools of management accounting which help the financial manager in taking
decisions.

Question 2i (50 Marks)

The directors of Mylo Ltd are currently considering two mutually exclusive investment
projects. Both projects are concerned with the purchase of new plant. The following data
are available for each project:

Project1 (£) Project 2 (£)

Cost (immediate outlay) 100,000 60,000

Expected annual net profit (loss)
Year 1 29,000 18,000
Year 2 (1,000) (2,000)
Year 3 2,000 4,000
Estimated residual value 7,000 6,000

The company has an estimated cost of capital of 10 per cent and employs the straight-line
method of depreciation for all fixed assets when calculating net profit. Neither project
would increase the working capital of the company. The company has sufficient funds
to meet all capital expenditure requirements.

Required

(a) Calculate for each project:

(i) the net present value

(ii) the approximate internal rate of return
(iii) the profitability index
(iv) the payback period

(b) State which, if any, of the two investment projects the directors of Mylo Ltd should
accept, and why.

State, in general terms, which method of investment appraisal you consider to be most
appropriate for evaluating investment projects and why.
Question 3 (25 marks)

The following information relates to Bimmer Ltd

INCOME STATEMENT FOR 2006 $000

Sale 50,000
Cost of sales 30,000
Gross profit 20,000
Administration costs 14,000
Profit before interest and tax 6,000
Interest 300
Profit before tax 5,700
Tax @ 30% 1,710
Profit after tax 3,990
Dividends 2, 394
Retained earnings 1, 596

BALANCE SHEET $000

Non-current assets 20,100

Net –current assets 4,960
12% debenture (redeemable in 6 years) (2500)
22,560
Ordinary shares, par value 25p 2,500
Retained profit and reserve 20,060
22,560

Calculate the following ratios:

ROCE
DPS
EPS
Return on shareholders’ capital / return on equity
Solution

Answer 1

The following are the important tools of management accounting which help the financial
manager in taking decisions:

a) Ratio Analysis: this is tool of management accounting with the help of which
different variables in the financial statements are analyzed. Then the different ratios
are formed with the help of these variables. Comparison can be made with the
ratios within industry and with past performances. There are different categories of
ratio such as

i. Profitability ratios, such as net profit ratio

ii. Working capital and liquidity ratios for example, acid test ratio, current ratio
iii.Capital structure ratios such as debt equity ratio
iv. Assets Turnover ratios such as debtors turnover ratio, shares
v. Dividend related ratios such as price earnings ratios, dividend payout ratios,
etc
b) Cost Profit Volume relationship: Cost is divided into fixed cost and variable cost.
Only variable cost changes in the short run according to a change in volume. With
the help of this tool, the profitability of the project is decided. It also helps in deciding
whether the investment is good or bad.

c) Budgeting and Profit Planning: Normally, different functional departments make

the estimations regarding their activities which are then converted into monetary
terms and called a budget. Actual revenue, cash flow and costs are then compared
with the budgets and any variances are discovered. So this is a very effective tool
for the financial manager.
d) Other analytical tools: are also used by financial manager such as analysis of
coats in order to decide whether to close down the operational or continue.

Answer 2

Mylo plc
(a)

(i) Net present value

Project 1 – Incremental cash flows

Year

0 1 2 3
£ £ £ £
Cash flows* (100,000) 60,000 30,000 40,000
Discount rate 10% 1.0 0.91 0.83 0.75
Present value (100,000) 54,600 24,900 30,000
Net present value 9,500
* Calculated by adding the depreciation charge (i.e. capital outlay less residual value
spread over 3 years) to the profit.

Project 2 – Incremental cash flows

Year
0 1 2 3
£ £ £ £

Cash flows (60,000) 36,000 16,000 28,000

Discount rate 10% 1.0 0.91 0.83 0.75
Present value (60,000) 32,760 13,280 21,000
Net present value 7,040

(ii) Internal rate of return

Project 1 – Incremental cash flows

Year
0 1 2 3
£ £ £ £

Cash flows (100,000) 60,000 30,000 40,000

Discount rate 18% 1.0 0.85 0.72 0.61
Present value (100,000) 51,000 21,600 24,400
Net present value 3,000

Net present value at 10% 9,500

Net present value at18% (3,000)
Difference 12,500

By interpolation the internal rate of return is 10% + (8% × (9,500/12,500)) = 16%

Project 2 – Incremental cash flows

Year

0 1 2 3
£ £ £ £
Cash flows (60,000) 36,000 16,000 28,000
Discount rate 18% 1.0 0.85 0.72 0.61
Present value (60,000) 30,600 11,520 17,080
Net present value 800

Net present value at 10% 7,040

Net present value at 18% (800)

Difference 7,840

By interpolation the internal rate of return is 10% + (8% × (7,040/7,840)) = 17%

(iii) Profitability index

 Present value
Profitability index = Initial investment
109,500
Project 1 = 100, 000
=1.095

67, 040
Project 2 = 60, 000
= 1.117
(iv) Payback period

Project 1 = 60,000 (Year 1) + 30,000

(Year 2) + 10,000 (Year 3)

= 2.25 years

Project 2 = 36,000 (Year 1) + 16,000

(Year 2) + 8,000 (Year 3)
= 2.29 years

(b) Based on the information given, Project 1 should be chosen in preference to Project 2
as it has a higher positive net present value. Given that the net present value of Project 1
is only slightly higher, it would be useful to undertake some assessment of the degree of
risk associated with each project.

(c) The net present value method is the most appropriate method for evaluating investment
projects because:

(i) It takes account of all relevant information unlike the payback method, for example, that
ignores cash flows beyond the payback period.

(ii) It is directly related to the objective of wealth maximisation which is the assumed goal of
a business enterprise.

(iii) It employs a discount rate based on the cost of capital.

(iv) It takes account of the time value of money by discounting future receipts and
payments.

Answer 3

$4 m
1. ROCE = x 100 = 20%
$ (15+5) m
$ 2.1 m
2. ROSC = x 100 = 14%
$ 15 m
$ 0.8 m
3. DPS = = 4 cents
20 m shares
(Tip: students usually find it useful to calculate the number of share in issue before doing
the main calculation. In this case the number of shares in issue in 20m ($5m/$0.25)
$ 2.10
4. EPS = = 10.5 cents
20 m shares
i
Question 02-page 145