accounting assignment 2 harilal n

ASSIGNMENT COVER SHEET

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

Umhlanga Rocks

Durban

Postal Address

South Africa 4321

E-Mail [email protected]

011 800 6642 (Work)

N/A (Home) Contact Numbers

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

1

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

2

1. Question One

1.1.1 Production Budget

January February March

Sales Forecast (in units) 1000 1200 1600

Closing Inventory of Finished Goods 500 600 800

Total Budgeted Production Needs 1500 1800 2400

Opening Inventory of Finished Goods

(600)

(800) (1000)

Required Production 900 1000 1400

Table 1.1.1 Production Budget

3

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:

Direct Material cost per unit R24

Direct Labour cost per unit R14

Other Manufacturing Costs per unit R66000/22000units = R3

TOTAL PRODUCTION COST PER UNIT R41

Table 1.1.2 Production Costs per Unit

Therefore the expected production cost for March is

4

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.

5

2. Question Two

2.1.1 Profitability Comparison

ABC Limited XYZ Limited Sales 3 300 000 1 080 000 Cost of Sales (2 310 000) (432 000) Gross Profit 990 000 648 000 Operating Expenses (135 000) (6000) Other Expenses (120 000) (22 500) Operating Profit 735 000 619 500 Other Income 0 0 Profit before interest 735 000 619 500 Interest Expense (87 000) (37 500) Profit before tax 648 000 582 000 Tax (194 400) (174 600)

Net Profit after tax 453 600 407 400

Table 2.1.1.1 Income Statement for year ended 31 December 2010

• Return on Capital Employed

Return on Capital Employed = loyedCapitalEmp

ofitOperating Pr X 1

100

Where

Capital Employed = Owners Equity + Non Current Liabilities, and

Owners Equity = Retained Earnings + Ordinary Share Capital

6

Therefore,

ABC Limited

XYZ Limited

Owners Equity 1 125 000 540 000 Retained Earnings 125 000 40 000 Ordinary Share Capital 1 000 000 500 000 Non Current Liabilities 510 000 240 000 Capital Employed 1 635 000 780 000 Operating Profit 735 000 619 500 Return on Capital Employed 44,9% 79,4%

Table 2.1.1.2 Calculation of Return on Capital Employed

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)

• Gross profit (Gross Margin) Ratio

Gross Profit Ratio = Sales

ofitGross Pr X

1100

Where

Gross Profit = Sales – Cost Of Sales ( taken from Table 2.1.1.1), and

Sales = given in the question ( can be found on Table 2.1.1.1)

Therefore,

7

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)

• Net profit (Profit Margin) Ratio

Net Profit Ratio = Sales

AfterTaxofitNet )(Pr X

1100

Where

Net Profit After Tax = Calculated in Table 2.1.1.1, and

Sales = given in the question ( can be found on Table 2.1.1.1)

Therefore,

ABC Limited XYZ Limited

Net Profit 453 600 407 400

Sales 3 300 000 1 080 000

Net Profit Ratio 13,74% 37,72%

This ratio shows the earnings available to shareholders, XYZ Limited shareholders earn

more than ABC Limited Shareholders. (Mancosa Study Guide, 2011:96)

8

2.2 Earnings Per Share for ABC Limited for 2010

Earnings per share = edSharesIssuofOrdinaryNo

AfterTaxofitNet

.

)(Pr X

1100

Where: Net Profit After Tax is calculated in Table 2. 1.1.1 as R453 600, and

No. of Ordinary Shares is ParValue

alShareCapit =

21000000

= 500 000

Therefore Earnings Per Share for ABC Limited for 2010 is:


AfterTaxofitNet

.

)(Pr X

1100

=

500000453600

X 1

100

= 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)

9

2.3 Dividend Per Share for XYZ Limited to declare f or 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.


AfterTaxofitNet

.

)(Pr X

1100

=

250000407400

X 1

100

= 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.

Figure 2.3 Components of Net Profit After Tax

10

Since Retained Earnings for XYZ Limited for 2010 is R40000, which is given in the

questions, we can conclude that Dividends paid would be :

Dividends Paid = Net Profit After tax – Retained Earnings

= R407400 – R40000

= R 367400

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:

Dividends per share = edSharesIssuofOrdinaryNo

aidDividendsP

.

=

250000367400R

= 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.

11

3. Question Three

3.1 .1 Break Even Quantity for January 2011

Break Even Quantity = UnitinMonContributi

FixedCosts

/arg

Fixed Costs for Jan 2011:

Fixed Manufacturing Costs R160 000

Advertising R8000

Sales Personnel’s Salaries R10000

Salaries (Administration Costs) R24000

Other Office Costs R8000

TOTAL FIXED COSTS R210000

Contribution Margin Per Unit (Sales – Variable Costs) :

Sales R66

Variable Costs (R35.96)

Manufacturing Variable Costs R28

Marketing Variable Costs R3.96

Admin Variable Costs R4

CONTRIBUTION MARGIN PER UNIT R30.04

(Marketing Variable Costs per unit: Selling Price x 6%)

Therefore,

Break Even Quantity =

UnitinMonContributi

FixedCosts

/arg

=

04.30

210000

= 6990 units.

12

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

Table 3.1.2.1 Comparison of Operating Profits

13

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.

14

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 Contribution as a % of Sales 10% 20% 30% 40% Fixed Costs 8 15 8 6

Table 3.2.1 Comparisons of Departments

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

15

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.

16

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.

4.1.2 Disadvantages of transfer pricing method

The manager of the typing cost centre B.Lara would not lower the price set internally of

R15 an hour of typists time, when approached by a manager from one of the operating

departments who could get an external agency to provide the service for R10.50 an

hour.

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.

17

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.

18

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)

The first Liquidity Ratio to analyze is the Current Ratio:

Current Ratio = sLiabilitieCurrent

AssetsCurrent

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

19

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:

Debt to Assets = AssetsTotal

DebtTotal

1100

x


2010 2009 Total Debt R988000 R802000 Total Assets R920000 R858000 Debt to Assets 107,4% 93,5%

Where Total Debt = Non-Current Liabilities + Current Liabilities

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)

20

The last Financial Leverage Ratio to evaluate is the Debt to Equity Ratio :

Debt to Equity= EquityOwners

DebtCurrentNon −

1100

x


2010 2009 Non-Current Debt R880000 R698000 Owners Equity (R68000) R56000 Debt to Assets 1:-0.08 1:0,08

Where Owners Equity= Ordinary Share Capital + Retained Earnings

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.

21

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

Cash Flow = Profit (Given) + Depreciation (calculated)

Depreciation is calculated as:

(Initial cost of Machine – Scrap Value)/ Number of Years in Service

Project A (R) Project B (R) Investment (302000) (150000) Year 1 Cash Flow 64000 108000 Profit 12000 70500 Depreciation 52000 37500 (238000) (42000) Year 2 Cash Flow 77000 108000 Profit 25000 70500 Depreciation 52000 37500 (161000) 66000 Year 3 Cash Flow 86000 108000 Profit 34000 70500 Depreciation 52000 37500 (75000) 174000 Year 4 Cash Flow 95000 108000 Profit 43000 70500 Depreciation 52000 37500 20000 282000 Year 5 Cash Flow 56000 Profit 4000 Depreciation 52000

76000

22

Therefore the payback periods for Project A and B are:

Payback Period for Project A:

monthsmonthsx

R

R5,912789.0

9500075000 ==

Therefore Payback period for Project A is 3years 9,5months

And Payback Period for Project B:

monthsmonthsx

R

R7,412388.0

10800042000 ==

Therefore Payback period for Project B is 1year 4,7months

23

5.1.2 Accounting Rate of Return for Project B

Accounting Rate of Return= InvestmentAverage

ofitAnnualAverage Pr

1100

x

Average Annual Profit is the sum of the Profits from year 1 to year 4 of Project B,

divided by 4 (Number of years), this calculation is shown in the table below.

Project B

Year 1 Profit R70500




Average Annual Profit R70500

Average Investment is :

2ValueScrapMachineOfCost +

20150000 RR +=

= R 75 000

Therefore,

Accounting Rate of Return = InvestmentAverage

ofitAnnualAverage Pr

1100

x

= 7500070500

R

R

1100

x

= 94%

24

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)

The Net Present Value for Project B is:

Net Inflow R108 000

Discount Factor x 3,0373 (for 4 years)

Total Present Value R328 028

Investment - R150 000

Net Present Value R178 028

25

Where,

Cash Flow or Net Inflow = Profit (R70500) + Depreciation (calculated below as R37500)

= R108 000

Depreciation is calculated as:

(Initial cost of Machine – Scrap Value)/ Number of Years in Service

= (R150 000 – 0) / 4years

= R37500

26

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.

5.2 Internal Rate of Return

Year Cash Inflow

(R) Discount

Factor(16%) Present Value(R) Discount

Factor(17%) Present Value(R) 0 (280000) 1 (280000) 1 (280000) 1 86000 0.8621 74141 0.8547 73504 2 86000 0.7432 63915 0.7305 62823 3 86000 0.6407 55100 0.6244 53698 4 86000 0.5523 47498 0.5337 45898 5 86000 0.4761 40945 0.4561 39225

5(Scrap Value) 0 0.4761 0 0.4561 0

Net Present Value (1599) 4852

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:

NPV zero at : %25,16%16248,06451

1599 =+==R

R

Therefore IRR (Internal Rate of Return) = 16,25%

27

6. Bibliography

• Anonymous. 2011. MBA Course and Assignment Handbook. Mancosa

• Anonymous. 2011. MBA Year 2 Accounting for Decision-Making. Mancosa

accounting assignment 2 harilal n

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