Bwembya has invented an electronic executive toy which can be activated to emit various noises on selection of one of six buttons. The toy is pocket-sized and it is anticipated that it will retail for K10. Bwembya is keen to exploit the toy and with the help of his business partner Bwalya, they consider the following possibilities.

• Sell the exclusive rights to the game to a major toy manufacturer for K110,000.
• Sell the rights to the manufacturer for K10,000 but receive an annual payment of K35,000 for the next five years (the payment being made at the end of each).
• Set up a manufacturing and selling operation. The best estimates for the next five years are:
• Initial capital expenditure: K30,000.
• Residual value at the end of year 5: K5,000.
• Net working capital required to start up: K10,000.

Year Sales (units) Sales price/unit Variablecosts/unit Fixed Costs p.a*

1 20,000 K10 K8 K45,000

2 40,000 K10 K8 K45,000

3 100,000 K10 K8 K45,000

4 60,000 K10 K8 K45,000

5 40,000 K10 K8 K45,000

*Note, Including depreciation of K5,000 p.a.

REQUIRED;

• Evaluate the proposals, given that the required rate of return is 20 per cent, and recommend the optimum proposal. Justify the reasons for your selection.
• What factors would influence your choice of a required rate of return?
• Would you advise the use of the cash payback method? Justify your answer with appropriate calculations

QUESTION TWO

Computer Limited was formed three years ago to produce a single product, the Mini. The directors are receiving the financial results of the first three years presented by the company accountant, and are concerned with the decline in profits in the year 20x2

Summarised results are shown below:

20x0 20x1 20x2

Production: Budget (units) 1,000 1,000 1,000

Actual (units 900 1,100 800

Sales (units) 800 800 1,000

Selling price K80 K80 K80

Marginal production cost per unit K10 K10 K10

Fixed production overheads K40,000 K40,000 K40,000

Fixed selling and administrative overheads K20,000 K20,000 K20,000

Net profit nil K8,000 K2,000

Fixed overheads are absorbed on the basis of budgeted annual production. Under or over absorbed overheads are charged to cost of goodssold.

REQUIRED:

• Prepare a statement showing the profir figures derived by the company accountant.
• Prepare an income statement using marginal costing approach.
• Reconcile the profits calculated in parts (a) and (b) above
• Explain the rationale behind the approaches adopted in parts (a) and (b).