The Theory and Practice of Corporate Finance - Assignment Example

Question 1 Requirement 1 Total material handling costs = $288,000 Material handling rate by Smith’s predecessors = $0.10 per dollar value of direct material. Requirement 2 Total material handling costs = $288,000 Revised material handling costs = revised material handling rate * number of purchase orders = $13.09*242,000 = $3,168,000 Requirement 3 Purchase orders is a more reliable cost driver since it reflects on the volume of material handled by the business. the more you place orders to purchase material the more of that material will accumulate in your warehouse hence more handling costs will be incurred. If the dollar amount of direct material is used as the cost driver, it means a low volume high dollar material will be allocated higher cost than the high volume low dollar material. This is not reliable since a high volume material generally requires high handling costs which is not advanced by the method of allocation used by Smith’s predecessors. Requirement 4 Government contracts: material handling costs Previous allocation = 2006,000*0.1 = $200,600 New method allocation = 80,000 purchase orders * $1.19 = $95,200 Difference = $200,600 - $95,200 = $105,400 Requirement 5 Government contract's unit Year 1 Year 2 Year 3 Number of purchase orders (A) 80,000 84,000 88,200 Material handling cost per purchase order (B) $1.19 $1.19 $1.19 Material handling department cost C = A*B 95,200 99,960 104,958 Cumulative dollar impact 95,200 195,160 300,118 Therefore, the material handling department costs in relation to Government contract’s unit will have accumulated to $300,118 by the third year. Requirement 6 a) Eloise Smith has an ethical conflict because Jones has asked her to distort her analysis against her findings. This is an ethical conflict because Smith would want to report correct government contracts forecast to the new managing director but at the same time would like to show Jones that she is compliant with his request to make adjustments to her numbers so that the government contracts will be favourable. b) Smith could solve the conflict by explaining to Jones the long term effect of distorting the finds and the wider implication to the business as a whole. He could also report directly and be answerable only to the new managing director. The last step is to ensure that she sticks to her professional codes of ethics no matter the outcome. Question 2 Requirement 1 Standard compound Alternative prices (per box) A Production Cost (per box) B Sales volume (in boxes) C Sales Revenue D=A*C Total Cost E=B*C Profit F = D-E $18 $20 120,000 $2,160,000 $2,400,000 $(240,000) 20 20 100,000 2,000,000 2,000,000 0 21 20 90,000 1,890,000 1,800,000 90,000 22 20 80,000 1,760,000 1,600,000 160,000 23 20 50,000 1,150,000 1,000,000 150,000 Therefore, the management should select a unit selling price of $22 per box of the standard compound. This is the selling price at which the profit is maximized. A selling price below $22 will result to a lower profit due to the high cost of production and a selling price above $22 will cause a reduction in sales volume and a consequent reduction in sales revenue hence a lower profit. Commercial compound Alternative prices (per box) A Production Cost (per box) B Sales volume (in boxes) C Sales Revenue D=A*C Total Cost E=B*C Profit F = D-E $25 $26 175,000 $4,375,000 $4,550,000 $(175,000) 27 26 140,000 3,780,000 3,640,000 140,000 30 26 100,000 3,000,000 2,600,000 400,000 32 26 55,000 1,760,000 1,430,000 330,000 35 26 35,000 1,225,000 910,000 315,000 Therefore, the management should select a unit selling price of $30 per box of the commercial compound. This is the selling price at which the profit is maximized. A selling price below $30 will result to a lower profit due to the high cost of production and a selling price above $30 will cause a reduction in sales volume and a consequent reduction in sales revenue hence a lower profit. Requirement 2 Requirement 2 (a) If remains open If Closed Standard Commercial Total Standard Commercial Total Sales 1,150,000 1,225,000 2,375,000 0 0 0 Cost of goods sold (800,000) (665,000) (1,465,000) (200,000) (175,000) (375,000) Gross profit 350,000 560,000 910,000 (200,000) (175,000) (375,000) selling & administrative expenses (200,000) (245,000) (445,000) 0 0 0 Profit (loss) before taxation 150,000 315,000 465,000 (200,000) (175,000) (375,000) If the Fremantle manufacturing plant remains open until 1st January of the next year it will gain $465,000, but if it closes it will lose $375,000. Therefore, the Fremantle manufacturing plant should definitely remain open as it gains even if a little. This is because the produced sales revenue during the out of season period help the plant to cover some of the fixed manufacturing overhead costs that the plant has to pay even if it remains closed. Requirement 2 (b) Clientele of the business – it is important to note that the client is the most important factor in any business (Graham and Harvey, 2001). Whether the business is out of season or in season the customer would like to get the product when the need arises. This helps to create customer loyalty since they know that a certain product is always available in the business. Therefore, if Fremantle plant is closed down the customers that are loyal to the business will be greatly affected hence there is a likelihood that they will switch to a competitor who is offering these products whenever they need them. Fixed costs – these are costs which are constant and have to be incurred whether the plant is open or not. If this proportion is high then it is wise for the plant to continue operating so that the produced sales revenue during the out of season period (however little) help the plant to cover some of the fixed manufacturing overhead costs that the plant has to pay even if it remains closed. Question 3 Requirement 1 The new membership plan and fee structure will help HLW (Hawthorn Leisure Works) to improve its cash receipts ability. This is because it will receive the cash in advance and hence it can plan accordingly. This is an improvement because the HLW will essentially receive cash even during the off-season because the members will pay for the whole year unlike in the previous plan where there was cash shortage during the off-season due to low court usage. Requirement 2 Previous Plan Membership fee Individual (25%*2,000*$45) $22,500 Student (25%*2,000*$30) 15,000 Family (1,000/4)*100 25,000 Total membership fee 62,500 Court fees Peak season Prime time (5*$12*10*181 108,600 Non-Prime time (7*$8*6*181) 60,816 Off- season All time (12*$6*3*184) 39,744 Total court fees 209,160 Total revenue 271,660 . New Plan Membership fee Individual Advance (45%*70%*1000*$250) 78,750 On October (55%*70%*1000*$300) 115,500 New individuals on October (15%*1000*$300) 45,000 New individuals on April (15%*1000*$150) 22,500 Total annual fees from individuals 261,750 Family Advance (45%*70%*250*$450) 35,438 On October (55%*70%*250*$500) 48,125 New families on October (15%*250*$500) 18,750 New families on April (15%*250*$250) 9,375 Total annual fees from families 111,688 Total annual fees from members 373,438 The revenue has increased by $101,778 under the new plan ($373,438 - $271,660) Assumption A family has been assumed to be comprised of 4 members such that the number of families will be arrived at by dividing 1,000 by 4 to get 250 families. The court usage during peak season at prime time is 100% and hourly court fees is $12 while at non-prime time is 60% and hourly court fees is $8. The daily usage during off-season is 30% (that is three courts in use every hour from 9 am to 9pm) 15% of new individuals and families will join on October whereas another 15% will join in the second half of the year. Requirement 3 Requirement 3 (a) The distribution of income of its existing members – members may be such that they are not economically able to pay the annual membership fee in lump sum as proposed by the new plan. This will force the management to continue with the original plan whereby the members pay for court usage separately. The capacity of tennis courts – when members have paid for court usage in the annual membership fee they are free to turn up at any time of the day when the club is in operations. Chances may be that during the peak season and during the prime time members turning up to use the courts may be higher than the capacity. Requirement 3 (b) HLW should prepare common size analysis in order to make a complete evaluation. This analysis will show the change in every component of sales revenue with respect to total sales revenue and the change in sales revenue from previous plan to proposed plan. Requirement 4 Adoption of proposed membership plan and fee structure will mean that cash flow to the company will change in that all cash will be received at the beginning of the year. Therefore, HLW should invest this cash in short term investments in order to enhance cash flow to the business (Bazerman and Moore, 2009). References Bazerman, M. H., and Moore, D. A., 2009. Judgment in managerial decision making (7th ed.). Hoboken, NJ: Wiley. Graham, J. R. and Harvey, C. R., 2001. The theory and practice of corporate finance: evidence from the field, Journal of Financial Economics, 60, pp. 187 – 243. Read More