JUNE 2012 EXAMINATION. D2. Business Finance. Answer ALL THREE questions. Question 1: 20 marks available. Question 2: 30 marks available

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1 1 JUNE 2012 EXAMINATION D2. Business Finance Instructions to candidates 1. Time allowed is 3 hours and 10 minutes, which includes 10 minutes reading time. 2. This is a closed book examination. 3. Use of a silent, non-programmable calculator, which is NOT part of a mobile phone or any other device capable of communication, is allowed. 4. Put your candidate number on the top of each answer page. 5. Start each new question on a new page. 6. Include any workings. Answer ALL THREE questions Question 1: 20 marks available Question 2: 30 marks available Question 3: 50 marks available

2 2 Question 1 ABC are a small engineering company specialising in a small steel component used in engines in the marine industry. The company are currently the only company in the world that produce the 3BB component part, which they produce and then sell to a medium- sized company, MGT. MGT use the 3BB part in their production process and then eventually sell the engines to large marine companies. The 3BB part requires precise machining. MGT have commented that some of the 3BB parts they have recently purchased from ABC have been of a poor standard. ABC have therefore decided to scrap their old machinery and are investigating the options available to them in financing a new machine. The machine will be of high value and the Finance Manager wants this to be reflected in the non-current assets section of the statement of financial position. The Managing Director at ABC has researched bank loans, hire purchase and leases (operating and finance). They also have the ability to buy the machine outright, using cash generated in the business. (a) In a report to the Managing Director explain briefly each of the finance options that are available and the accounting treatment for each method. You should include notes on the pros and cons of each possible method: using cash, bank loan, hire purchase, operating and finance leases. In your answer you should refer to both the income statement and statement of financial position. You should also provide a conclusion for the Managing Director as to which finance methods would meet ABC s requirements best. (16 marks) ABC decided to finance the new machinery with a bank loan. However, the application for the bank loan was rejected. The Bank Manager stated that ABC s business model provided a high competitive risk. (b) In a brief report explain briefly, using information from the scenario, the Bank Manager s comments and provide an example of how ABC could reduce this risk. (4 marks) (Total 20 marks)

3 3 Question 2 DWD are a medium sized company, suffering from severe cashflow issues. The company formed three years ago with a highly profitable product and a large market to sell to. However, the company did not have the business infrastructure required to sell to such large volumes of customers. This led to DWD s failing to meet customers orders. Product quality was also compromised due to the lack of resources that the company owned. This led to some of their customers not paying, which left DWD unable to pay their suppliers and overheads, which caused their stock levels to reduce. DWD have recently lost a large contract to a competitor caused by insufficient stock levels to meet demand. The following financial information is available for DWD over the last two years: Year ended 31 st March 2011 ($) Year ended 31 st March 2010 ($) Turnover 612, ,000 Cost of sales 374, ,000 Cash (29,000) 23,000 Trade receivables 135, ,000 Bad/Irrecoverable debts written off 31,000 8,000 Trade payables 82,000 64,000 Inventories 14,500 33,000 (a) Calculate the operating cycle (in days) for 2010 and (b) Discuss the changes that have occurred. Your answer should refer to the operating cycle that you have calculated in (a). You are also required to calculate the quick ratio (acid test) for 2010 and (10 marks) DWD have employed a business consultant to help them move their business forward. Having looked at their financial information, she has suggested that DWD have been overtrading. She is also concerned with the amount of debt written off in She thinks this may be due to lack of credit assessment and control at the company. The business consultant stated that all credit customers should be assessed as high, medium or low risk. (c) Briefly explain the term overtrading and suggest a suitable solution to this problem. (4 marks) (d) Explain how DWD should manage customers that fall into each of the three risk categories, and provide an example of a customer type that could fall into each category. (Total 30 marks)

4 4 Question 3 A21 are reviewing their inventory control systems. They are concerned that they are holding too much stock. There is a lack of inventory control. The business is unsure of how much stock to order and how frequently stock should be ordered. The Stores Manager and Purchasing Manager have gathered the following information. Demand is expected to be 60,000 units per month. The company incurs $25 each time an order is placed. It costs $0.50 to hold one unit for a year. (a) In a report to management: (i) Explain the term reorder level. (ii) Explain the term economic order quantity (EOQ). (iii) Calculate the EOQ for A69. (iv) Calculate the number of orders that A21 will place each year. (2 marks) (v) Calculate the inventory cycle (in weeks). (2 marks) The Finance Director has been asked to prepare a presentation for the other directors on the importance of budgeting. (b) Draft some notes for the Finance Director on the objectives of budgeting. Your answer should also refer to the effects on variances calculated at the end of a period.

5 5 The following forecasted information has been provided for the next three months: Budgeted Sales in units (February 450 units, March 470 units, April 465 units) Selling price per unit = $850 (75% of sales are for cash, 15% are received the month after). The remaining debt is never received and is written off in the accounts the month after the sale is made. The company sold 510 units during January. Each unit produced uses 2kg of material. It costs $75 per kilogram of material. There were 80 kilograms in inventory at the beginning of February. Closing Inventory levels are to increase by 10kgs each month A21 pay all their suppliers in cash. The company purchase a new machine in February for $70,000. This will be paid for over 20 months. The machine is depreciated at 10% per annum on a straight line basis. Depreciation is accounted for monthly on a pro-rata basis. Labour costs were $20,000 in January. Due to working regulations, this is currently increasing by 1% each month. A dividend is paid to shareholders in March of $12,000 The opening cash balance at 1 st February is $11,500 overdrawn. Bank Interest of 4% per annum is received monthly and is calculated on the cash figure at the beginning of the month (where there is positive cash balance) Interest on overdrafts is at 7% per annum to be charged on a monthly basis (where applicable) and is calculated on the overdrawn balance at the beginning of the month. (c) Prepare a cash budget for February, March and April. (20 marks) (d) Prepare a budgeted income statement for February and March. (9 marks) (Total 50 marks)