You are employed as an accounting technician by SW& J, a small firm of accountants and registered auditors. One of your clients is G Life plc, a large department store. Grace, the purchasing manager for G Life plc, has gained considerable knowledge about bedding and soft furnishings and is considering acquiring her own business. She has recently written to you requesting a meeting to discuss the possible purchase of DHC Ltd. DHC has one outlet in Asawanse, a Model A 1,620 336,960 Model B 2,160 758,160 Model C 1,620 1,010,880 Turnover 2,106,000 Expenses () Cost of beds 1,620,000 Commission 210,600 Transport 216,000 Rates and insurance 8,450 Light heat and power 10,000 Assistants salaries 40,000 Managers salary 40,000 2,145,050 Loss for year 39,050 small town 100 miles from where Grace works. Enclosed with her letter was DHCs latest profit and loss account. This is reproduced below. DHC Ltd Profit and loss account year to 31 May Sales (units) () Also included in the letter was the following information: 1) DHC sells three types of bed, models A to C inclusive. 2) Selling prices are determined by adding 30 per cent to the cost of beds. 3) Sales assistants receive a commission of 10 per cent of the selling price for each bed sold. 4) The beds are delivered in consignments of 10 beds at a cost of 400 per delivery. This expense is shown as Transport in the profit and loss account. 5) All other expenses are annual amounts. 6) The mix of models sold is likely to remain constant irrespective of overall sales volume. Task 1 In preparation for your meeting with Grace, you are asked to calculate: a. the minimum number of beds to be sold if DHC is to avoid making a loss; b. the minimum turnover required if DHC is to avoid making a loss.

At the meeting, Grace provides you with further information: 1) The purchase price of the business is 300,000. 2) Grace has savings of 300,000 currently earning 5 per cent interest per annum, which she can use to acquire DHC. 3) Her current salary is 36,550. To reduce costs, Grace suggests that she should take over the role of manager as the current one is about to retire. However, she does not want to take a reduction in income. Grace also tells you that she has been carrying out some market research. The results of this are as follows: 1) The number of households in Asawanse is currently 44,880. 2) DHC Ltd is the only outlet selling beds in Asawanse. 3) According to a recent survey, 10 per cent of households change their beds every 9 years, 60 per cent every 10 years and 30 per cent every 11 years. 4) The survey also suggested that there is an average of 2.1 beds per household. Task 2 Write a letter to Grace. Your letter should: a) identify the profit required to compensate for the loss of salary and interest b) show the number of beds to be sold to achieve that profit c) calculate the likely maximum number of beds that DHC would sell in a year d) use your answers in (a) to (c) to justify whether or not Grace should purchase the company and become its manager e) give two possible reasons why your estimate of the maximum annual sales volume may prove inaccurate.

On receiving your letter, Grace decides she would prefer to remain as the purchasing director for G Life plc rather than acquire DHC Ltd. Shortly afterwards, you receive a telephone call from her. Grace explains that G Life plc is redeveloping its premises and that she is concerned about the appropriate sales Model Monthly demand (beds) A 35 B 45 C 20 () () () Unit selling price 240.00 448.00 672.00 Unit cost per bed 130.00 310.00 550.00 Carriage inwards 20.00 20.00 20.00 Staff costs 21.60 40.32 60.48 Department fixed overheads 20.00 20.00 20.00 General fixed overheads 25.20 25.20 25.20 Unit profit 23.20 32.48 (3.68) Storage required per bed (m2) 3 4 5 policy for G Lifes bed department while the redevelopment takes place. Although she has a statement of unit profitability, this had been prepared before the start of the redevelopment and had assumed that there would be in excess of 800 square metres of storage space available to the bed department. Storage space is critical as customers demand immediate delivery and are not prepared to wait until the new stock arrives. The next day, Grace sends you a letter containing a copy of the original statement of profitability. This is reproduced below: In her letter she asks for your help in preparing a marketing plan which will maximize the profitability of Winters bed department while the redevelopment takes place. To help you, she has provided you with the following additional information: 1) Currently storage space available totals 300 square metres. 2) Staff costs represent the salaries of the sales staff in the bed department. Their total cost of 3,780 per month is apportioned to units on the basis of planned turnover. 3) Departmental fixed overhead of 2,000 per month is directly attributable to the department and is apportioned on the number of beds planned to be sold. 4) General fixed overheads of 2,520 are also apportioned on the number of beds planned to be sold. The directors of Winter plc believe this to be a fair apportionment of the stores central fixed overheads. 5) The cost of carriage inwards and the cost of beds vary directly with the number of beds purchased. Task 3 a) Prepare a recommended monthly sales schedule in units which will maximize the profitability of G Life plcs bed department. b) Calculate the profit that will be reported per month if your recommendation is implemented.

Metro Bus has been experiencing a fall in passenger numbers over the past few years as a result of intense competition from Trotro. The company directors are concerned to improve profit and are considering two possible alternatives. Passenger volume last year was 20,000 passengers per day. The average fare was 2 per passenger per day and variable costs per passenger per day were 0.50. If no investment is made the current passenger volume, average fares and variable costs will remain the same on current routes for the next five years. The company operates a full service for 365 days of the year. Project 1 The company hired a management consultant, at a cost of 50,000, to review the companys fare structure. The consultant recommended that the company reduce fares by 10 per cent, which would result in a 20 per cent increase in passenger volume in the first year. In order to maintain this level of passenger numbers, fares would remain at the reduced rate for years 2 to 5. The increase in passenger numbers would result in the need for four new buses costing 250,000 each. The new buses would be depreciated on a straight-line basis over their useful life of five years. They would have no residual value at the end of their useful life. Other annual fixed costs, including advertising costs, would increase by 100,000 in the first year and remain at that level for the life of the project. Variable costs would remain at 0.50 per passenger per day for the life of the project. Project 2 Increase the number of buses to enable new routes to be opened. The new buses are expected to cost 5,000,000 in total and have a useful life of five years with no residual value. Fixed costs, including straight line depreciation, are expected to increase by 3,500,000 in the first year, as a result of opening the new routes. Fixed costs would remain at the higher level for the life of the project. Additional working capital of 1,000,000 would also be required. The passenger numbers for year 1 on the new routes are predicted as follows: Passenger numbers per day Probability 6,000 50% 9,000 30% 12,000 20% It is expected that passenger numbers would increase by 3 per cent per annum for the following four years. The average fare per passenger for year 1 would be 2 and remain at that level for the life of the project. Variable costs would remain at 0.50 per passenger per day for the life of the project. Additional information: Taxation and inflation should be ignored. The company uses a cost of capital of 8 per cent per annum. Required: (a) (i) Advise the management of the company which project should be undertaken based on a financial appraisal of the projects. You should use net present value (NPV) to appraise the projects.

(ii) Explain TWO other major factors that should be considered before a final decision is made.