1. Pheonix

Pheonix is considering the purchase of a new machine to make wood-burning stoves. They have had a market research survey conducted at a cost of $200,000. This predicts demand of 4,000 stoves per annum at a selling price of $750 per stove for 10 years.

The machine will cost $2,000,000, payable in two instalments as follows.

Depreciation of $180,000 per annum over the next 10 years will be provided to write down the machine to its scrap value.

Use will also be made of some existing equipment which originallycost $150,000, has a book value of $75,000 and would cost $200,000 toreplace.

Pheonix is currently negotiating the sale of this machine for $100,000.

Variable cost per stove will be $600, and in accordance with thenormal policy $250,000 of fixed overheads will be apportioned to the newproduct line per annum.

The machine will require its first service one year after purchase,and from then on will be serviced every year. Each service costs$50,000.

The machine will be brought into use immediately to build upinventory, but the first revenues will not be received until 31 December20X2. Variable costs are payable annually at the same time as therevenues are received.

Required:

Calculate the following:

(a)Return on capital employed on an initial investment basis.

(3 marks)

(b)Return on capital employed on an average investment basis.

(1 mark)

(c)Payback period.

(3 marks)

(d)NPV at the company's cost of capital of 15%.

(5 marks)

(e)Internal rate of return of the project.

(3 marks)

(f)The sensitivity of your advice based on the NPV computed in (d) to errors in the estimates of

(i)the required rate of return

(ii)the selling price per unit

(iii)the level of demand.

Your answer should also include a comment on the sensitivities calculated.

1. Cloud Co

The following financial information related to Cloud Co:

information

(1)Sales for the year to 30 April20X0 were $89m, yielding an operating profit of $8.7m and a profitbefore tax (after finance costs) of $8.2m.

(2)At the beginning of the year to30 April 20X1 the company bought some new manufacturing equipment andrecruited six more sales staff.

(3)Sales for the year to 30 April 20X1 were $131m, with an operating profit of $8.5m, and a profit before tax of $7m.

Required:

(a)Explain the cash conversion cycle (operating cycle) and its significance in determining the working capital needed by a company.

(4 marks)

(b)Calculate the cash operating cycle of Cloud Co for the years ending 30 April 20X0 and 20X1.

(4 marks)

(c)Using additional calculations, together with your results to part (b) discuss whether or not Cloud Co is overtrading.

(8 marks)

(d)Explain the different strategies a firm may follow in order to finance its working capital requirements.

(5 marks)

3. Hexicon

(a)Hexicon Inc manufactures andmarkets automatic washing machines. Among the many hundreds ofcomponents which it purchases each year from external suppliers forassembling into the finished article are drive belts, of which it uses40,000 units pa. It is considering converting its purchasing, deliveryand inventory control of this item to a just-in-time system. This willraise the number of orders placed but lower the administrative and othercosts of placing and receiving orders. If successful, this will providethe model for switching most of its inwards supplies on to this system.Details of actual and expected ordering and carrying costs are given inthe table below.

To implement the new arrangements will require 'one-off'reorganisation costs estimated at $4,000 which will be treated as arevenue item for tax purposes. The rate of corporation tax is 33% andHexicon can obtain finance at 12%. The effective life span of the newsystem can be assumed to be eight years.

Required:

(i)Determine the effect of the new system on the economic order quantity (EOQ).

(ii)Determine whether the new system is worthwhile in financial terms.

(12 marks)

(b)You are required to brieflyexplain the nature and objectives of JIT purchasing agreements concludedbetween components users and suppliers.

(6 marks)

(e)Suggest ways in which Cloud Comight seek to resolve its current funding problems, and avoid the risksassociated with overtrading.

(4 marks)

4.Marton

Marton Co produces a range of specialised components, supplying awide range of customers, all on credit terms. 20% of revenue is sold toone firm. Having used generous credit policies to encourage past growth,Marton Co now has to finance a substantial overdraft and is concernedabout its liquidity.

Marton Co borrows from its bank at 13% pa interest. No furthersales growth in volume or value terms is planned for the next year.

In order to speed up collection from customers, Marton Co is considering two alternative policies:

Option one

Factoring on a non-recourse basis, the factor administering andcollecting payment from Marton Co's customers. This is expected togenerate administrative savings of $200,000 pa and to lower the averagereceivable collection period by 15 days. The factor will make a servicecharge of 1% of Marton Co's revenue and also provide credit insurancefacilities for an annual premium of $80,000.

Option two

Offering discounts to customers who settle their accounts early.The amount of the discount will depend on speed of payment as follows.

Payment within 10 days of despatch of invoices 3%

Payment within 20 days of despatch of invoices 1.5%

It is estimated that customers representing 20% and 30% of MartonCo's sales respectively will take up these offers, the remaindercontinuing to take their present credit period.

Extracts from Marton Co's most recent accounts are given below:

Required:

(a)Calculate the net benefit to the company of taking option 1, the non-recourse factoring arrangement.

(8 marks)

(b)Calculate the net benefit to the company of taking option 2, offering a prompt payment discount to customers.

(10 marks)

(c)Recommend which option is the most financially advantageous policy. Comment on your results.

(7 marks)

5.Thorne

Thorne Co values, advertises and sells residential property onbehalf of its customers. The company has been in business for only ashort time and is preparing a cash budget for the first four months of2006. Expected sales of residential properties are as follows.

The average price of each property is $180,000 and Thorne Cocharges a fee of 3% of the value of each property sold. Thorne Coreceives 1% in the month of sale and the remaining 2% in the month aftersale. The company has nine employees who are paid on a monthly basis.The average salary per employee is $35,000 per year. If more than 20properties are sold in a given month, each employee is paid in thatmonth a bonus of $140 for each additional property sold.

Variable expenses are incurred at the rate of 0.5% of the value ofeach property sold and these expenses are paid in the month of sale.Fixed overheads of $4,300 per month are paid in the month in which theyarise. Thorne Co pays interest every three months on a loan of $200,000at a rate of 6% per year. The last interest payment in each year is paidin December.

An outstanding tax liability of $95,800 is due to be paid in April.In the same month Thorne Co intends to dispose of surplus vehicles,with a net book value of $15,000, for $20,000. The cash balance at thestart of January 2006 is expected to be a deficit of $40,000.

Required:

(a)Set a monthly cash budgetfor the period from January to April 2006. Your budget must clearlyindicate each item of income and expenditure, and the opening andclosing monthly cash balances.

(10 marks)

(b)Discuss the factors to be considered by Thorne Co when planning ways to invest any cash surplus forecast by its cash budgets.

(5 marks)

(c)Discuss the advantages anddisadvantages to Thorne Co of using overdraft finance to fund any cashshortages forecast by its cash budgets.

(5 marks)

(d)Explain how the Baumol model canbe employed to reduce the costs of cash management and discuss whetherthe Baumol cash management model may be of assistance to Thorne Co forthis purpose.