Lama Company has $7,200,000 to invest and wishes to evaluate the following three projects.

Years X ($) Y ($) Z ($)

0 (3,600,000) (3,600,000) (3,600,000)
1 1,200,000 2,160,000 2,400,000
2 1,200,000 480,000 1,040,000
3 1,200,000 960,000 1,200,000
4 1,200,000 1,440,000
cost of capital 14% 14% 14%

Required:
Which project(s) would you recommend using:
a. Payback Period (PP) in nominal and discounted values.
b. Net Present Value (NPV)
c. Profitability Index (PI)
d. The internal rate of return (IRR) (hint: use 10% for X and 20% for the other projects)

[Marks: (6+9+3+7) = 25]

1-a- The nominal PP: (3 marks, 1 mark per project)
- X = 3 years
- Y = 3 years
- Z = 2.133 years (2 + 160,000/1,200,000)
The discounted PP: (3 marks, 1 mark per project)

Year PVX CCFX PVY CCFY PVZ CCFZ

0 -3,600,000 -3,600,000 -3,600,000 -3,600,000 -3,600,000 -3,600,000
1 1,052,632 -2,547,368 1,894,737 -1,705,263 2,105,263 -1,494,737
2 923,361 -1,624,007 369,344 -1,335,919 800,246 -694,491
3 809,966 -814,042 647,973 -687,946 809,966 115,475
4 710,496 -103,545 852,596 164,650 0
PPA = beyond 4 years PPB = 3.80 years PPC = 2.85 years

Rana should invest in Z and either X or Y projects using the nominal PP, while it is
recommended to invest in Z and Y using the discounted cash flows.

Years X ($) Y ($) Z ($) (1+ r)n PVX PVY PVZ

-
0 -3,600,000 -3,600,000 1
3,600,000
1 1,200,000 2,160,000 2,400,000 1.14 1,052,632 1,894,737 2,105,263
2 1,200,000 480,000 1,040,000 1.2996 923,361 369,344 800,246
3 1,200,000 960,000 1,200,000 1.481544 809,966 647,973 809,966
4 1,200,000 1,440,000 1.68896 710,496 852,596 0
r 14% 14% 14% PV = 3,496,455 3,764,650 3,715,475
b - NPV -103,545 164,650 115,475
(9 marks, 3 marks per project)
c - PI 0.9712374 1.045736 1.0320764
 (3marks, 1 mark per project)

According to both NPVs and PIs, Rana should choose projects Y and Z.

d- The NPV at 20% & 10%: (3 marks, 1 mark per project)

Year PVX PVY PVZ
0 -3,600,000 -3,600,000 -3,600,000
1 1,090,909 1,800,000 2,000,000
2 991,736 333,333 722,222
3 901,578 555,556 694,444
4 819,616 694,444 0
PV 3,803,839 3,383,333 3,416,667
NPV
203,839 -216,667 -183,333
@30%

According to the IRRs Rana should choose projects Y and Z: IRRs: (4 marks, 1 mark per project and
1 mark for the recommendation)
X: 14 – 4 * 103,545 / 307,384 = 12.65%
Y: 14 + 6 * 164,650 / 381,316 = 16.59%
Z: 14 + 6 * 115,475 / 298,809 = 16.32%

a. Company KPC has an average trade receivables of $5,500,000 and annual sales of $11.5 million.
It is considering the use of factoring given that this would result in a reduction in credit control costs
of $425,000 per annum. The factoring house charges a fee of 1.2% of sales. It will provide an advance
to the company of 80% of its receivables and will charge interest on this advance of 9 % per annum.
Required: Assess whether it is financially beneficial for company KPC to enter into this factoring
arrangement.

Suggested answer:
The estimated annual costs to the company from the factoring arrangement would be:
Factoring fee = 1.2% × $11.5 million = $138,000
Interest = 80% × $5,500,000 × 9% = $396,000
Total cost = $534,000
Savings on credit control costs = $425,000
Loss to the company = $109,000
It is not beneficial for the company to proceed with factoring.
(10 marks, 2 marks per amount)

b. A Toys Company has 1.8 million shares in issue. The current market price is $40 per share. The
company’s debt is publicly traded on the London Stock Exchange and the most recent quote for its
price was at 94% of face value. The debt has a total face value of $ 9 million and the company’s
 credit risk premium is currently 2.8%. The risk-free rate is 3.5% and the equity market risk premium
is 7.1%. The company’s beta is estimated at 1.2 and its corporate tax rate is 35%.
Required: Calculate the company’s WACC.

Suggested answer:
Current cost of equity = 3.5% + (1.2 x 7.1%) = 12.02% (2 marks)
The current cost of debt = 3.5% + 2.8% = 6.3% (2 marks)
The market value of equity = $40 x 1.8 million = $72 million
The market value of debt = 0.94 x $9 million = $8.46 million
Total debt + equity = $40.46 million
So debt is 10.51% of the total and equity 89.49%. (4 marks, 2 marks each)

WACC = [89.49% x 12.02%] + [10.51% x 6.3% x (1-35%)] = 11.18% (2 marks)

a. Discuss the four techniques for foreign currency exposure management

a. Discuss the Balanced Scorecard (BSC) and its key elements; support your discussion by a
diagram. Elaborate on three of the features of a Good Balanced Scorecard.

b. Discuss the currency risk and elaborate on the three foreign currency risks faced by
companies.

b. Yalla Company makes kids bikes. The profit plan and actual results for the previous
year, 2021, are as follows:
Profit Plan Actual Results
Volume(Q) Pounds$ Volume Pounds
Sales 25,000 500,000 30,000 480,000
Cost of Goods Sold

Raw material (KG) 3,000 96,000 3,600 97,200

Raw material (L) 8,000 200,000 10,000 180,000
Labor (Hours) 6,000 90,000 5,000 80,000
Contribution Margin 114,000 122,800
Other costs
 Energy 14,000 18,000
Maintenance 6,000 8,000
Depreciation 15,000 20,000
Selling expenses 12,000 15,000
Advertising 18,000 12,800
Profit before interest 49,000 49,000
and tax

The plant manager, Rashad, has instructed the plant management accountant to prepare a detailed
report to be sent to corporate headquarters comparing each component’s actual result with the
amounts set forth above in the annual budget.

Required:
Explain the difference between the expected and actual profit, show your workings and
draw the variances tree.
[Marks: (15+35) = 50]

Explaining the difference between the expected and actual profit:

The competitive effectiveness:
a- The impact of the change in sales volume: (4 marks)
The sales (market) variance = (actual volume – planned volume) × planed price
The sales (market) variance = (30,000 – 25,000) × (500,000 ÷ 25,000)
The sales (market) variance = $100,000 (F)

b- The impact of the change in price: (4 marks)

The sales price variance = actual volume × (actual price - planed price)
The sales price variance = 30,000 × [(480,000 ÷ 30,000) - (500,000 ÷ 25,000)]
The sales (market) variance = $120,000 (U)

The operating efficiency:

a- The impact of the change in raw material (KGs):
 The efficiency (quantity) variance = (actual volume - planned volume) × planned price
The efficiency (quantity) variance = (3,600-3,000) × (96,000 ÷ 3,000)
The efficiency (quantity) variance = $19,200 (U) (3 marks)
 The spending variance = (actual price - planned price) × actual volume
The spending variance = [(97,200 ÷ 3,600) - (96,000 ÷ 3,000)] × 3,600 = $18,000 (F) (3
marks)

b- The impact of the change in raw material (Liters):

  The efficiency (quantity) variance = (actual volume - planned volume) × planned price
The efficiency (quantity) variance = (10,000 – 8,000) × (200,000 ÷ 8,000)
The efficiency (quantity) variance = $50,000 (U) (3 marks)
 The spending variance = (actual price - planned price) × actual volume
The spending variance = [(180,000 ÷ 10,000) - (200,000 ÷ 8,000)] × 10,000 = $70,000 (F)
(3 marks)

c- The impact of the change in labor:

 The efficiency (hours) variance = (actual hours - planned hours) × planned labor rate
The efficiency (hours) variance = (5,000 – 6,000) × (90,000 ÷ 6,000)
The efficiency (hours) variance = $15,000 (F) (3 marks)
 The spending variance = (actual labor rate - planned labor rate) × actual hours
The spending variance = [(80,000 ÷ 5,000) - (90,000 ÷ 6,000)] × 5,000 = $5,000 (U) (3
marks)

The impact of the change in other costs: (4 marks)

Actual
Other costs Profit Plan Variance ($)
Results
Energy 14,000 18,000 4,000 (U)
Maintenance 6,000 8,000 2,000 (U)
Depreciation 15,000 20,000 5,000 (U)
Selling expenses 12,000 15,000 3,000 (U)
Advertising 18,000 12,800 5,200 (F)
Total 8,800 (U)
 The tree of variance analysis: (4 marks)

Change in profits
0

Competitive effectiveness Operating efficiency

$20,000 (U) $20,000 (F)

Variance due to Variance due to selling Variance associated Variance associated

market (sales) price with direct costs with other costs
$100,000 (F) $120,000 (U) $28,800 (F) $8,800 (U)

Variance associated
Variance associated Variance associated with with direct labor
with direct material direct material (L) $10,000 (F)
(KG) $1,200 (U) $20,000 (F)

Eff. Var. Spend. var Eff. Var. Eff. Var. Spend. var
Spend. var
$19,200 (U) $18,000 (F) $15,000 (F) $5,000 (U)
$50,000 (U) $70,000 (F)

The Company did not show any changes in profit; which is the result of a $20,000 as an
unfavorable competitiveness effectiveness variance and a $20,000 as a favorable operating
efficiency variance. (1 mark)
Question 2:
The following summary information is available regarding ABD Plc.

ADB Plc.
Profit Plan
For the year ending Dec. 31, 2021
Sales Revenue $900,000
Net Income $171,000
Total Assets $750,000
Operating Assets $350,000
Total Liabilities $250,000
WACC 20%
Tax rate 18%
Return from Project A $132,000
Cost of project A $116,000

Required: Compute and analyze the:

- Return on Investment (ROI) for project A
- Return on Equity (ROE) and its components for the company.
- Residual income (RI)
[Marks: (6+13+6) = 25]

Computing ROI:
Gain from Investment – Cost of Investment
ROI =
Cost of Investment

($132,000-116,000) 0.1379 or
ROI = =
(116,000) 13.79%

The ROI compares the return from an investment with the amount of the investment. In this case,
project A will generate a return of 13.79%

Computing ROE:
Net Income
ROE =
Shareholders’ equity

$171,000 0.342 or
ROE = =
(750,000 – 250,000) 34.2%
 Analyzing ROE:

Net Income Sales Total Assets

ROE = × ×
Sales Total Assets Shareholders’ equity

171,000 900,000 750,000

ROE = × ×
900,000 750,000 500,000

0.19 (or 0.342 or

ROE = × 1.2 t × 1.5 =
19%) 34.2%

Profitability Asset Turnover Financial

ROE = × ×
Ratio Ratio Leverage Ratio

We can see that the company is projected to earn 19% net income on sales with asset turnover of
1.2 times and a leverage ratio of 1.5. The combination of these three indicators yields ROE of
34.2%.

Computing RI:
Residual income (RI) = Operating income – (WACC x Operating assets)
= 208,536.59* - (20% x 350,000) = $138,536.59

*Net Income = Operating Income * (1-Tax Rate)

Operating Income = Net Income / (1-Tax Rate) = 171,000/ (1-18%) = $208,536.59

A residual income approach to measuring performance moves away from calculating a return in
the form of a percentage, as the ROI does, to focus on the return as an absolute monetary amount
the company will generate an RI of $138,536.59.

c. A Company has an average trade receivables of $700,000 and annual sales of $2.8 million. It is
considering the use of factoring given that this would result in a reduction in credit control costs of
$80,000 per annum. The factoring house charges a fee of 1.3% of sales. It will provide an advance
to the company of 85% of its receivables and will charge interest on this advance of 9.6% per annum.
Required: Assess whether it is financially beneficial for the company to enter into this factoring
arrangement.

Suggested answer:
The estimated annual costs to the company from the factoring arrangement would be
 Factoring fee = 1.3% × $2.8 million = $36,400
Interest = 85% × $700,000 × 9.6% = $57,120
Total cost = $93,520
Savings on credit control costs = $80,000
Loss to the company = ($13,520)
It is not beneficial for the company to proceed with factoring.

d. KPL Company has 1.4 million shares in issue. The current market price is $20 per share. The
company’s debt is publicly traded on the London Stock Exchange and the most recent quote
for its price was at 100% of face value. The debt has a total face value of $12 million and the
company’s credit risk premium is currently 3.1%. The risk-free rate is 2.4% and the equity
market risk premium is 6%. The company’s beta is estimated at 0.8 and its corporate tax rate
is 20%.
Required: Calculate the company’s WACC.

Suggested answer:
Current cost of equity = 2.4% + (0.8 x 6%) = 7.2%
The current cost of debt = 2.4% + 3.1% = 5.5%
The market value of equity = $20 x 1.4 million = $28 million
The market value of debt = 1 x $12 million = $12 million
Total debt + equity = $40 million
So debt is 30% of the total and equity 70%.

WACC = [70% x 7.2%] + [30% x 5.5% x (1-20%)] = 6.36%