1. Tables ltd has recently set up in business manufacturing bespoke kitchen furniture. A summary of the transactions for the first year of trading to 31 December 2021 are as follows:
i. Shareholders invested £200,000 into the business.
ii. On 1 January 2021 Tables ltd borrowed £100,000 from the bank. The first loan repayment of £10,000 was paid on 1 January 2022. Interest on the loan is charged at 7% per annum, payable half yearly on 30 June 2021 and on 31 December 2021. The payment due in June 2021 was paid on 30 June 2021 and the payment due on 31 December 2021 was paid on 1 February 2022.
iii. In January 2021 the business purchased and paid for equipment costing £175,000. The equipment is expected to last for five years and have no residual value at the end of five years.
iv. In January 2021 the business purchased and paid for delivery vehicles costing £50,000, to be depreciated 25% per annum reducing balance.
v. Total sales for the year were £950,000 of which £200,000 was still owed from customers at the year end. Following a review of the amounts owed from customers it is considered prudent to provide a bad debt provision of 25% of amounts owing from customers.
vi. Total purchases during the year for direct costs of manufacturing were £545,000 of which £60,000 was still owing to suppliers at the year end.
vii. At 31 December 2021 there was closing inventory costing £100,000.
viii. During the year wages and salaries of £200,000 were paid and annual bonuses for the year ended 31 December 2021 of £30,000 were paid on 31 January 2022.
ix. During the year insurance, energy and other costs of £130,000 were paid. The cost of £130,000 includes a £10,000 insurance payment for the year to 31 December 2022. Energy costs of £5,000 were estimated to be outstanding at 31 December 2021.
x. Corporation tax is estimated at 20% of the net profit for the year and is payable on 30 September 2022.
REQUIRED:
(a) Prepare an Income Statement (Profit and Loss Account) and Statement of Financial Position (Balance Sheet) for the first year of trading. (35 marks)
(b) Using the information from the question and reviewing the reports prepared in part “a”, explain with reasons five issues regarding working capital and liquidity that are concerning. (15 marks) (Total: 50 marks)
2. Hightown ltd is a non league football club and the directors of Hightown ltd are considering the purchase of three mobile catering units to sell hot food and drinks to fans on matchday. The directors of Hightown ltd have asked you to evaluate the proposal and you have been provided with the following information:
i. The three catering units will cost £150,000 in total, payable immediately, and will last for three years. At the end of three years the catering units can be sold for £60,000 in total.
ii. Sales have been forecast at £500,000, £520,000 and £550,000 in years 1, 2 and 3 respectively. Operating costs are estimated to be £300,000, £312,000 and £330,000 in years 1, 2 and 3 respectively. Annual operating fixed costs are estimated to be £150,000, this cost of £150,000 includes straight line depreciation on the three catering units.
iii. Working capital requirements are expected to amount to 5% of the expected annual sales value and 90% of the working capital will be recovered at the end of the contract. Working capital cash outflows are payable at the start of each relevant year and cash inflows at the end of each relevant year.
iv. Corporation taxation is payable annually at a rate of 20% on operating cashflow, where operating cashflow includes relevant sales and operating cost cashflows.
v. Hightown ltd’s required return is 15%.
vi. Unless otherwise indicated, assume all cash flows are payable at the end of the year in which the relevant cashflows arise.
REQUIRED:
(a) Calculate the Net Present Value, (NPV), and based on the NPV advise Hightown ltd, with reasons, whether or not to proceed with the investment. (24 marks)
(b) You have been advised that Hightown ltd requires a payback of no longer than two years. Calculate the Payback Period and based on the Payback Period advise Hightown ltd, with reasons, whether or not to proceed with the investment. (5 marks)
(c) Explain how the Payback Period can be used to manage risk and use your calculations in parts “a” and “b” to illustrate two limitations of using this method to appraise investments. (9 marks)
(d) Explain how the Internal Rate of Return, IRR, of an investment can be used to appraise an investment and explain why, when appraising alternative investment opportunities, NPV is considered to be a superior investment appraisal technique compared to IRR. (6 marks)
(e) Explain two reasons why NPV is considered to be a superior investment appraisal technique when compared to the Accounting Rate of Return, ARR. (6 marks) (Total: 50 marks)
3. Sofa ltd manufactures and sells sofas and is planning to introduce a new range of sofas for the 2023/24 season. The following information has been provided regarding the new sofas, (on a per unit basis)
REQUIRED:
(a) Explain the terms; contribution, shared fixed cost and separable fixed cost. (6 marks)
(b) i. Advise Sofa ltd, with reasons, on which sofas to introduce and calculate the total expected monthly profit. (6 marks)
ii. Had the fixed costs been separable, advise Sofa ltd on which sofas to introduce and calculate the total expected monthly profit. (4 marks)
(c) Assume fixed production costs are separable, not shared, and Sofa ltd has taken an optimistic approach to the sales forecasts, as such there is a high degree of uncertainty as to whether the monthly sales forecasts will be achieved:
i. For each product introduced calculate the expected total monthly profit, breakeven volume, margin of safety, gearing sensitivity and operational gearing. (14 marks)
ii. If Sofa ltd can only introduce one product, using your calculations from ‘i’ to explain, advise which product, if any, Sofa ltd should introduce. (6 marks)
(d) Explain, with reasons, the relationship between Operational Gearing and Profit Sensitivity. (6 marks) (e) Explain what is meant by the terms Incremental and Opportunity
Cashflows and provide an example for each. (8 marks) (Total: 50 marks)
4. Write a 1,000 word essay on EITHER Explain the term finance and evaluate external sources of long-term finance available to businesses. (Total: 50 marks)
OR Explain the term working capital and discuss the measures managers can take to manage working capital. (Total: 50 marks)
OR Explain the aims of budgeting and evaluate how a bottom-up approach to budgeting addresses budget aims. (Total: 50 marks)
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