MI 2021 Prelim Paper 2 Answer Guide

2021 Prelims Paper 2 Suggested Answer Guide 1 (b) Year 0 1 2 3 4 5 Net Present value Initial Cost -500 000 Cash flow from profits (NP+Depn) 160 000+ 90 000 150 000+ 90 000 80 000+ 90 000 60 000+ 90 000 40 000+ 90 000 Sales proceeds 50 000 Total Cash flows -500 000 250 000 240 000 170 000 150 000 180 000 Disc factor 1 0.893 0.797 0.712 0.636 0.567 Present Value -500 000 223 250 191280 121040 95 400 102 060 233 030 / / / / / / [6] Depreciation = (500-50)/5 = 90 (a) Year 0 500 000 1 -250 000 Left to cover 250 000 2 -240 000 Left to cover 10 000 -10 000 10000/170000 x 12 = 1mth 0 Payback period = 2 years 1 month /// [3] (c) Buy P. / - P’s NPV is only slightly lower than Q’s by $6 97 0 [6970/240000 = 3% lower] but its payback period is much shorter than Q’s by 8 months [8 mths/ 33mths = 24% shorter]. // - The cost of Q is also much higher than P by $100 000 but its NPV is only higher by $6 970 and there are opportunity cost of the extra $100 000 cash tied up from being invested elsewhere. / - The earlier payback period for P means that is less risky to invest in P and the funds can be recovered earlier to be reinvested for profits. / - Other relevant points [5] (d) - Projected amount and timing of cash flows may not be accurate. - Difficult to establish an accurate cost of capital - Difficult to determine a suitable acceptable NPV or minimum payback period - Impacts on business such as savings from productivity are difficult to estimate Any 2 [2]

(e) % loan $ loan $ shares Cost of loans Cost of shares Cost of capital 40% 80000 120000 9600 [80000 x 12%] 16800 [120000 x 14%] 26400 // 60% 120000 80000 21600 [120000 x 18%] 12800 [80000 x 16%] 34400 // [4] 2. a July August Sept Sales (units) 20000 26000 28000 + Closing stock 3900 4200 5700 - Opening stock (3000) (3900) (4200) Production (units) 20900 26300 29500 X2 X2 X2 Purchases (units) 41800 / 52600 / 59000 / Purchases ($) 209000 / 263000 295000 / [5] b September / Shortfall = 59000 – 55000 = 4000 units / [2] c To minimise storage costs, he should minimise the stock holding period. Hence he should buy the shortfall in August followed by July. units workings Shortfall 4000 Purchase in August (2400) (55000-52600) 1600 Purchase in July OF (1600) Hence he should buy 2400 units in August and 1600 units in July. [2] d workings $ August’s 2400 units 2400 units x 1 mth x $0.50 1200 / July’s 1600 units 1600 units x 2 mths x $0.50 1600 / OF Storage costs 2800 Purchase costs 4000 units x $5 20000 / OF Total costs 22800 / [4] e. Costs = 4000 units x $6 = $24000 OF [2] f. Option 1 / - It is cheaper by $1200 (24000 - 22800). // - Original supplier so quality is assured However, need to consider the following - Higher risk of loss due to stockholding (e.g. spoilage) - Opportunity costs of cash being tied to stocks purchased before actual need and possible negative impact on cash flow Note: for qualitative factors, always suggest some limitations of the recommended decision to give the answer more ‘balance’ +2 relevant qualitative factors [2]

3 (a) It enables management to anticipate any deficits so that the necessary financial arrangements may be made. / It enables management to decide upon a policy for using any cash surpluses. / [2] (b) Computation of level of bank overdraft needed at end of first year $ $ Projected Receipts (1) Ordinary share capital 250 000 } (2) Mortgage loan 60 000 } / (4) Credit sales (100000 x 10) 1 000 000 / 1 310 000 Less: Projected Payments (2) Mortgage loan repayment (60K/10) 6 000 } (2) Interest on mortgage loan (8% x 60K x 9/12) * 3 600 } / (3) Purchase of equipment 360 0 / (6) Operating overheads (25K x 6 + 30K x 5) 300 0 / (5) Creditors (14 x (100000x0.6) – 1x (100000x0.6) 780 000 / 1 449 600 Bank ( overdraft ) required ( 139 600 ) [6] *More accurate interest calculation = (8% x 60K x 6/12 + (8% x 54K x 3/12) = $3 480 (c) Blue Ltd Forecasted Income statement for the first year $ $ Sales ( 100 000 X 12) 1 200 000 / Less: Cost of Goods Sold (60%) (720 000) Gross profit (40% x Sales) 480 000 / Less: Operating Expenses (25000 x 6 + 30000 x6) 330 000 / Interest on Mortgage loan (8% x 60000 x 9/12) 3 600 / Depreciation on Equipment (360K/5 x 6/12) 36 000 369 600 // Net profit 110 400 [6] (d)Focus on components of working capital cycle to answer this question. Reduce inventory held from 2 months so that cash is not tied up in inventories by ordering in small quantities or just-in-time. Negotiate for longer repayment period with suppliers beyond 1 month or look for suppliers who can offer longer credit terms of more than 1 month Shorten credit period to customers from 2 months so that cash is not tied up with customers. Note: not quite appropriate to suggest improving collection from customers or make better use of credit term by suppliers because the business is new. 3 points with elaboration [6]

4 a. Product Aqua Blue Cyan Total $ $ $ Per unit Selling price 44 24 20 Direct material – material X 18 6 12 Direct labour 10 4 6 Unit contribution margin 16 14 2 X volume 2 000 4 000 1 000 Contribution margin 32 000 56 000 2 000 90 000 /// Less: Fixed cost (2000x6 + 4000x4 + 1000x4) 32 000 / Net Profit 58 000 / [5] b. Breakeven sales (units) = FC/ UCM =(2000x6)/16 =750units Breakeven sales ($) =750 x 44 =$33000 // [2] c. With limited material X Unit contribution margin 16 14 2 Metre of material X per unit [18/3] 6 [6/3] 2 [12/3] 4 Contribution per metre Mat X 2.7 7 0.5 // Rank 2 1 3 / Material X available = 16 200 + 2 000 = 18 200m Allocation (metres) [18 200 -8000] 10 200 [4 000 x 2] 8 000 - } // Units made [10 200/6] 1 700 4 000 - } X Unit Contribution Margin 16 14 Contribution margin 27 200 56 000 83 200 / Less: Fixed cost 32 000 / Net Profit 51 200 / [8] d. Product Blue No of units [18 200/ 2 ] 9 100 / $ UCM [21 – 6 – 4] 11 Contribution Margin [ 9 100x 11] 100 100 // Less : FC 32 000 / Net Profit 68 100 / [5m]

e. Since net profit of $68 100 is higher than that from (b) of $51 200, accept the order. // Other factors: - It will not be able to sell to existing customers all 3 products, who may turn to other suppliers permanently. - It will only be selling to one customer, which is risky should that customer face financial difficulties and cannot repay - Resources will have to be redeployed to make Cyan and there could be hidden costs involved e.g. retraining of workers and adaptation of machines from other product lines to Cyan Note: retrenchment is not likely to occur because the shortage is only for January. +2 factors // [4] f. No as Cyan makes a positive contribution to the business $2 per unit to cover fixed costs. // - Stopping sales of Cyan may affect sales of Aqua and Blue if customers who buy Cyan also buy these products. Reduced product variety for customers. - The resources used to produce Cyan may not be easily transferable to making Aqua and Blue. E.g. workers need to be retrained for other products, incurring costs - Workers making Cyan may need to be retrenched if they can’t be retrained, affecting morale and productivity of workers in Aqua and Blue Note: It is wrong to switch to other products with higher margins because there is a maximum that should be produced for each product depending on the forecast sales. This is true even if there is a limited facto