Tag (SQ): variable costs

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  • 16 Marks

FM – L2 – Q68 – Discounted Cash Flow

Calculate the expected NPV of a new product launch for Accra Nova Cosmetics Limited with given cash flows and a 12% cost of capital.

Accra Nova Cosmetics Limited has designed a new product that it would like to introduce to the market. It has spent GH¢250,000 on the design work so far. A market research report has indicated that the product will have a life of four years, and at a selling price of GH¢35 per unit, annual sales would be as follows:

Year Sales (units)
1 40,000
2 60,000
3 60,000
4 20,000

It has been estimated that to produce the new product, annual fixed production costs (all cash flows) will increase by GH¢200,000, and the variable cost per unit will be GH¢10.
Other cash flows for the project will be:

  • Capital expenditure of GH¢1,400,000 at the beginning of the project. There will be a residual value of GH¢600,000 from this investment at the end of Year 4.
  • An investment of GH¢400,000 will be required in working capital. This will be recovered at the end of Year 4.
  • Expenditure on advertising will be required, as follows:

Year Advertising costs
0 800,000
1 600,000
2 400,000
3 200,000

Required
(a) Calculate the expected NPV of the project to launch the new product, if the company’s cost of capital is 12%.

(b) Calculate the target cost for the product that is needed to achieve a return of 12% on investment and calculate the size of the current cost gap.

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  • 20 Marks

MA – L2 – Q70 – Performance analysis

Calculate the impact of three strategies on annual profit for Kumasi Ventures Ltd, each implemented independently.

Kumasi Ventures Ltd manufactures and sells a single product. Its budget for the next financial year is as follows:

Sales (80,000 units at GH₵600 per unit) GH₵000
48,000
Production costs: materials and labour 16,000
Other production costs 8,000
Marketing and distribution costs 12,000
Administration costs 10,000
Total costs 46,000
Profit 2,000

Materials and labour costs in production are 100% variable, and 25% of other production costs are variable. All administration costs are fixed costs and two-thirds of marketing and distribution costs are also fixed.

The directors of Kumasi Ventures Ltd are dissatisfied with the budgeted profit, and believe that annual profits should be at least double the size of the budgeted profit.

Three strategies have been proposed to improve profitability.

(1) Strategy 1. Increase sales by opening a new sales office in a neighbouring country. It is expected that this would increase annual sales by 5,000 units, but would add GH₵1.2 million to annual fixed costs.

(2) Strategy 2. Re-design the product by adding several additional features that should add value for the customer. This would have no effect on annual sales volume in units, but the company would be able to raise the sales price to GH₵625. The additional costs of producing the new product design would be GH₵1.5 million each year (all fixed costs).

(3) Strategy 3. Implement a cost reduction exercise throughout the company. It is expected that the planned exercise would reduce all variable costs by 20%, but would add to annual fixed costs by GH₵3.5 million.

Required:
(a) Calculate the effect of each individual strategy on annual profit, assuming that the strategy is implemented on its own, without the other two strategies.

(b) Show whether the three strategies, if they are all introduced together, will close the profit gap between the budgeted profit and the target profit that the directors would like to achieve.

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  • 20 Marks

MA – L2 – Q52a – Relevant Cost and Revenue

Advise whether Okonku Enterprises should discontinue Double bed production based on contribution and profit impact.

Okonku Enterprises produces Single, Double, and King size beds for sale to hotels in West Africa. Its manufacturing plant is located in Keta and is currently producing at 100% capacity. Below is the annual output and sales for each product and the associated costs.

Product Single bed Double bed King Size
Units sold 5,000 units 3,500 units 4,000 units
Sales GH₵ 2,500,000 GH₵ 2,800,000 GH₵ 3,800,000
Cost
Material cost 750,000 1,400,000 1,520,000
Labour costs 600,000 1,050,000 1,200,000
Manufacturing O’head 200,000 650,000 300,000
Administrative cost 200,000 100,000 200,000
Total cost 1,750,000 3,200,000 3,220,000
Profit /Loss 750,000 (400,000) 580,000

The Director of Okonku is of the view that the product Double bed is not doing well and must not be produced any longer. The following additional information has been provided.
(i) 40% of the labour cost for all bed types are fixed costs.
(ii) 50% of the manufacturing overhead is variable costs for all products.
(iii) 80% of the administrative cost is fixed.

Required:
(a) Advise whether the company should shut down the production of Double beds.

(b) Should the company accept the new order assuming Double beds will still be produced?

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  • 15 Marks

MA – L2 – Q50 – Pricing Strategies

Calculate prices for simplified Product Z using full cost-plus and budgeted profit pricing policies for Nexco Industries.

Nexco Industries Limited makes Product Z in department C. For the year commencing 1 January Year 7, the following budget has been formulated for department C:

GH¢000
Direct costs
Materials 60
Labour 40
100
Production overheads 100
Full production cost 200
Administrative and marketing overheads 50
Full cost of sale 250
Profit 50
Revenue (see note) 300

Note: This revenue is from budgeted sales of 20,000 units.
Production overheads are absorbed on the basis of 100% of direct costs. However, half of these costs are fixed, and the other half are variable. It is assumed that they vary with the cost of materials.
The administrative and marketing overheads are based on 25% of factory costs and do not vary within wide ranges of activity. A profit margin of 20% is applied to the full cost of sale. This also results in a price that appears to be fair to customers.
Halfway through the year to 31 December Year 7, it became clear that actual sales of Product Z would be 25% below budget. At about the same time that this shortfall in sales became evident, a customer asked about buying 5,000 units of a simplified version of Product Z. If Nexco Industries Limited were to produce this simplified model for the customer, the direct material and labour costs would be lower. It is estimated that materials costing GH¢12,000 and direct labour of GH¢8,000 would be required to produce the 5,000 units. As the production could take place within the firm’s existing capacity, fixed costs would not be affected.

Required:
(a) Calculate the prices that Nexco Industries Limited should quote to the customer for each unit of the simplified product, assuming that the following pricing policies are applied:
(i) Full cost plus pricing, on the current basis.
(ii) A price that would enable the company to achieve its original budgeted profit.

(b) Give your advice on the price that should be quoted to the customer.

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  • 15 Marks

MA – L2 – Q48 – Decision Making Techniques

Determine if BHIL should manufacture Zeta internally or buy it, given material constraints and government orders.

Blue Horizon Industries Limited (BHIL) produces and markets three products viz. Alpha, Beta, and Gamma. Following information is available from BHIL’s records for the manufacture of each unit of these products:

Alpha Beta Gamma
Selling price GH₵ 66 GH₵ 106 GH₵ 124
Material-A (GH₵ 4 per kg) GH₵ 8 GH₵ 12 GH₵ 12
Material-B (GH₵ 6 per kg) GH₵ 12 GH₵ 24 GH₵ 24
Direct labour (GH₵ 10 per hour) GH₵ 25 GH₵ 25 GH₵ 30
Variable overhead based on:
– Labour hours GH₵ 1.8 GH₵ 1.5 GH₵ 1.8
– Machine hours GH₵ 1.4 GH₵ 1.2 GH₵ 1.2
Total GH₵ 3.2 GH₵ 2.7 GH₵ 3.0
Other data:
Machine hours 7 6 6
Maximum demand per month (units) 3,000 3,000 5,000

Additional information:
(i) BHIL is also engaged in the trading of a fourth product Zeta, which is very popular in the market and generates a positive contribution. BHIL currently purchases 600 units per month of Zeta from a supplier at a cost of GH₵ 40 per unit. In-house manufacture of Zeta would require: 2.5 kg of material-B, 1 hour of direct labour, and 2 machine hours.
(ii) Materials A and B are purchased from a single supplier who has restricted the supply of these materials to 22,000 kg and 34,000 kg per month respectively. This restriction is likely to continue for the next 8 months.
(iii) BHIL has recently accepted a Government order for the supply of 200 units of Alpha, 300 units of Beta, and 400 units of Gamma each month for the next 8 months. These quantities are in addition to the maximum demand stated above.
(iv) There is no beginning or ending inventory.

Required:
Determine whether BHIL should manufacture Zeta internally or continue to buy from the supplier during the next 8 months.

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  • 15 Marks

MA – L2 – Q47 – Decision Making Techniques

Establish production plan to maximize profit with steel limited to GH₵250,000, prioritizing a major customer's order.

An engineering company has been experiencing problems with restricted availability of resources. The company manufactures a variety of casings. It makes four types of casing. Each casing requires the same bought-in component and some high-grade steel. The standard costs for the four types of casing are as follows:

Casing A B C D
GH₵ GH₵ GH₵ GH₵
Steel 250 500 190 390
Bought-in component 50 50 50 50
Direct labour 60 60 50 100
Variable production costs 40 50 40 50
Fixed production costs 180 240 150 270
Selling and administration costs 145 225 120 215
Profit 35 55 30 55
Selling price 760 1,180 630 1,130

All the selling and administration costs are fixed and the same single component is used for each of the four products. Direct labour is paid GH₵8 per standard hour and each member of the workforce is capable of producing any of the casings.
The company’s main customer has ordered 30 units of Casing A, 20 units of B, 30 units of C, and 20 units of D for production and delivery in the next month. Senior management have agreed that this order should be treated as a priority order and that these casings must be manufactured and delivered to the customer next month. This is necessary to maintain the goodwill of the customer. It is estimated that this order represents 10% of the total demand next month for each type of casing.
The company operates a just-in-time system, and has no inventories of steel, components, or finished goods.
Required:
If the aim is to maximise profit for the month, establish the production and selling plan for the company next month in the following situation:
(a) Situation 1. Supplies of steel are limited to GH₵250,000.

(b) Situation 2. Only 400 bought-in components are available from suppliers.

(c) Situation 3. A labour dispute restricts available productive labour hours in the month to 2,125.

(d) Situation 4. A labour dispute restricts available productive labour hours in the month to 2,125; but the manufacture of any quantities of the four casings could be sub-contracted to an outside supplier. The cost of buying the casings externally would be GH₵475, GH₵705, GH₵380, and GH₵640 for Casing A, Casing B, Casing C, and Casing D respectively. In addition, it should be assumed that the major customer insists that its order is completed by the company itself and the manufacture should not be subcontracted.

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  • 15 Marks

MA – L2 – Q46 – Decision making techniques

Compute Ouluto Limited's net profit for February 20X9 based on the optimum product mix, given resource constraints and cost data.

Ouluto Limited (OUL) is engaged in the manufacture and sale of three products viz. WBA, QPR and SC. The following information is available from OUL’s records for the month of February 20X9:

WBA QPR SC
Sales price per unit (GH₵) 2,300 1,550 2,000
Material cost per Kg. (GH₵) 250 250 250
Labour time per unit (Minutes) 20 30 45
Machine time per unit (Hours) 4 2.5 3
Net weight per unit of finished product (Kg.) 6 4 5
Yield (%) 90 95 92
Estimated demand (Units) 10,000 20,000 9,000

Each worker is paid monthly wages of GH₵15,000 and works a total of 200 hours per month. OUL’s total overheads are estimated at 20% of the material cost.
Fixed overheads are estimated at GH₵5 million per month and are allocated to each product on the basis of machine hours. 100,000 machine hours are estimated to be available in February 20X9.
Required:
Based on optimum product mix, compute OUL’s net profit for the month of February 20X9.

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  • 20 Marks

MA – L2 – Q45 – Decision making techniques

Compute units of each product for Image Solutions to maximize profit and calculate contribution at optimal mix, considering machine hour constraints.

Image Solutions Limited deals in various products. Relevant details of the products are as under:

PW PX PY PZ
Estimated annual demand (units) 5,000 10,000 7,000 8,000
Sales price per unit (GH¢) 150 180 140 175
Material consumption:
R (kg) 2 2.5 1.5 1.75
T (kg) 0.5 0.6 0.4 0.65
Labour hours 2 2.25 1.75 2.5
Variable overheads (based on labour cost) 75% 80% 100% 90%
Fixed overheads per unit (GH¢) (based on 80% capacity utilisation) 10 20 14 16
Machine hours required:
Processing machine hours 5 6 8 10
Packing machine hours 2 3 2 4

Company has a long term contract for purchase of material R and T at a price of GH¢ 15 and GH¢ 20 per kg respectively. Wage rate for 8 hours shift is GH¢ 200.

The estimated overheads given in the above table are exclusive of depreciation expenses. The company provides depreciation on number of hours used basis. The depreciation on each machine based on full capacity utilisation is as follows:

Hours GH¢
Processing machine 150,000 150,000
Packing machine 100,000 50,000

The company has launched an advertising campaign to promote the sale of its products. GH¢ 2 million have been spent on such campaign. This cost is allocated to the products on the basis of sale.

Required:
Compute the number of units of each product that the company should produce in order to maximize the profit and also compute the product wise and total contribution at optimal product mix.

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  • 15 Marks

MA – L2 – Q41 – Cost-volume-profit (CVP) analysis

Calculate breakeven point in units and sales value for Nartey Enterprises based on budgeted profit statement.

Nartey Enterprises, a manufacturing organisation, has a budgeted profit statement for its next financial year, when it is expected to be operating at 75% level of capacity. The budget is given below:

GH₵ GH₵
Sales 9,000 units at GH₵32 288,000
Less:
Direct materials 54,000
Direct wages 72,000
Production overhead:
fixed 36,000
variable 18,000
Administration and distribution costs:
fixed 42,000
variable 27,000 249,000
Profit 39,000

Required:
(a) Calculate the breakeven point in units and in sales value.

  (b) Calculate the contribution/sales ratio.                                                                                                                                                                  (c) Calculate the number of units to be sold to earn a profit of GH₵52,000.

    (d) Calculate the profit that would be expected if the company operated at full capacity.

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  • 15 Marks

MA – L2 – Q40 – Cost-volume-profit (CVP) analysis

Compute break-even point in GH¢ and units for AquaPure Limited at GH¢16 per bottle using budgeted cost data.

AquaPure Limited is planning to produce mineral water. It is contemplating to purchase a plant with a capacity of 100,000 bottles a month. For the first year of operation the company expects to sell between 60,000 to 80,000 bottles. The budgeted costs at each of the two levels are as follows:

Particulars 60,000 bottles 80,000 bottles
Material 360,000 480,000
Labour 200,000 260,000
Factory overheads 120,000 150,000
Administration expenses 100,000 110,000

The production would be sold through retailers who will receive a commission of 8% of sale price.

Required:
(a) Compute the break-even point in GH¢ and units if the company decides to fix the sale price at GH¢16 per bottle.

(b) Compute the break-even point in units if the company offers a discount of 10% on purchase of 20 bottles or more, assuming that 20% of the sales will be to buyers who will avail the discount.

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