Referring to the following passage and information, I could use some help with answering this ADVANCED MANAGEMENT ACCOUNTING revision question worth 20 MARKS.

Question 3

It is now October 2000 and Brenda, who has become more confident at planning ahead for the business, has produced a budget for the next twelve months' trading to October 2001. This highlights a period of 35 per cent spare capacity from November 2000 to January 2001 inclusive. She has established that for an extra investment of 35,000, she could buy equipment which is more flexible than the newly purchased plant, in that it can be used to produce cog mechanisms of a slightly different design, in addition to the current cog mechanism. These slightly different cog mechanisms are suitable for use in automated waste collection vehicles.

Identify the types of information which Brenda would need to consider in making a decision to purchase the additional equipment, the likely sources of information and any other factors which you feel she should consider.

Endeavour Twoplise Limited is a manufacturing company that was established over 50 years ago by the Twoplise family. It has been owned and managed in recent years by Endeavour Twoplise Junior, the son of the founder. Endeavour has no family to inherit the business and so, due to ill health, he has decided to sell it to Brenda Forthright. Brenda has no experience of the company's manufacturing process, but she is a very astute businesswoman. As a prelude to investing in the business, she has carried out extensive research into the environment in which the company trades and into its commercial operations. Her investigations have given her some interesting information.

The Product

The company produces one product, a metal cog mechanism which is used in ready-mix concrete vehicles to maintain a 'turning' action of the tub whilst the concrete is in transit. This turning action during transit is vital in order to preserve the required consistency of the concrete for tipping directly into customer's prepared locations. The cog mechanism has to meet stringent quality and safety standards and needs regular replacement during the life of a ready-mix concrete vehicle. The tooling of the mechanism requires expensive specialised equipment.

The Competitive Environment

There are only three major manufacturers of the type of vehicle which uses the company's product, but these vehicles are purchased by a substantially larger number of ready-mix concrete suppliers. Endeavour Twoplise Limited is one of only a few manufacturers in the UK who manufacture the cog mechanism. Sales have been fairly constant over the last 4 years, following a downturn in the recessionary period of the late 1980s/early 1990s. Prior to period, this the product was in great demand during the building boom of the 1980s.

The Company's Resources

Endeavour Twoplise Limited owns a large plot of land, part of which has been developed to provide well-maintained factory premises and part of which remains undeveloped. The land was bought and developed in 1977 and no revaluation has taken place since that date. The factory is large and provides room for expansion of production within the existing building. Its location is ideal for distribution of products to consumers and for obtaining raw materials. Brenda feels that the site is likely to be worth considerably more that its balance sheet value.

The company owns a lorry and a delivery van, both of which are in good condition. Unfortunately, the equipment used in the manufacture of the cog mechanism is old and in need of immediate replacement.

Brenda has made extensive enquiries and has established that new equipment would cost 110,000. She would retain the old equipment as a back up, since it has no resale value and there is sufficient factory space to store it. Brenda has a number of business contacts and feels confident that she will have no difficulty in raising the additional funds needed to purchase the new equipment.

The company employs four permanent operatives in the factory and hires temporary labour if required. Samuel is the factory supervisor and he also works on the machines. He has been with the company since he left school and is due to retire in two years' time. He tends to be set in his ways and dislikes change. This was shown when Toby, a young operative who joined the company two years ago, tried to initiate changes to the production process which he felt would improve efficiency. Sam was most indignant and threatened to leave if Endeavour made such changes. Since Sam and Endeavour are long-standing friends, Endeavour backed Sam on that occasion and no changes were made. Toby is still working for the company, but this incident has made him rather frustrated. The only other full time employee is Andy Bucket, an accounts assistant, who was employed six months ago, because of Endeavour's deteriorating health, to take some of the workload from his shoulders.

The company has an overdraft facility to support its cashflow requirements. Brenda has negotiated a 30,000 overdraft facility to be available to the company when she takes over as owner.

The Company's Systems

Andy is quite a bright young man and is keen to use his initiative. He has a friend who, until recently, was studying accounting on a day-release basis at the local college and this friend recommended to Andy that it would be helpful if the company set up a budgeting system. During the six months in which Andy has been with the company, he has managed to construct a budget for the period to 30th June, 2000, with advice from his friend and information from Endeavour and the company records.

Unfortunately, shortly after the budget was completed, Andy's friend decided to change jobs. He moved out of the area and so Andy no longer has his advice to guide him. Consequently, although the budget has been constructed, nothing has been done with it.

The budget identified the levels of production required each month to meet expected demand. The current state of affairs is that production tends to jog along at a steady rate regardless of demand and, in addition, purchases of raw materials tend to be on a 'hit and miss' basis. It is mainly by good luck rather than good management that sufficient raw materials are available. In Endeavour's opinion, if he can see the men working diligently in the factory, he is satisfied that the business is doing okay and so far he has managed to negotiate additional overdraft facilities whenever the company has been short of cash. However, the bank has said that any further borrowing by Endeavour would have to be supported by budgets and monitoring information.

The Future

Based on her analysis, Brenda is optimistic about the company's prospects. She feels that the long awaited upturn in the construction industry is imminent and that demand for the product will increase considerably in the medium to long term. She has thus agreed to buy the business and take over its management in June 2000.

She has already looked carefully at the budget which Andy has produced and is fairly confident that the budgeted balance is a reasonable assessment of the company's assets and liabilities as at 30th June 2000

Brenda has considerable experience of accounting, having worked for a number of years in this field, and has been able to build upon Andy's efforts. Together they have set about the task of gathering information which will be useful in the planning of the final four months' trading up to 31st October 2000.

The results of their labours are as follows:
Estimated Production Data
Estimated selling price per cog mechanism	250
Estimated materials usage per cog mechanism	one kilogram
Estimated cost of materials per kilo	45
Estimated production wages and variable overheads per cog mechanism	65
Estimated fixed overheads per month	3000

	July	Aug	Sept	Oct
Estimated sales of cog mechanisms	110	115	110	80
Estimated production of cog mechanisms	100	120	110	70
Estimated purchases of raw materials (kilos)	100	110	100	60

Purchase of New Equipment

Brenda has decided that the new equipment will be delivered in July and paid for in August. She has made arrangements for the company to issue 10% debentures to the value of 130,000 to be repaid in the year 2007. Interest on the debentures will be paid by two six-monthly installments, in arrears. 130,000 will be credited to the company's bank account on 1st August 2000.

Depreciation July to October

Buildings 333

Machinery 15,200 (includes depreciation on new equipment)

Vehicles 5,400

Credit terms

• All sales are on credit and two months' credit is allowed.
• All purchases of raw materials are on credit and are paid for one month following purchase.
• Wages, variable and fixed overheads are paid in the month in which they are incurred.

Proposed Dividend

Since Brenda will make a considerable investment in purchasing the business, she intends to propose a dividend of 5% in October 2000.