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Accounting and finance for non-specialists
(6th edition)
Progress Test 2 Chapters 7–12
This paper is divided into three sections
Answer all questions in each section
Time allowed – 3 hours Total possible marks – 100
Section A – Multiple-choice questions
Each question in this section is worth 2 marks (Total 20 marks)
For each question select the best one of the four options available
1. Let: S = sales revenue per unit, F = fixed costs per unit, V = variable costs per unit, TF =
total fixed costs and BEP = the break-even point (in units).
What is the formula to be used when calculating the break-even point (in units) for a
particular product or service?
A BEP = S/(V – F)
B BEP = F/(S – V)
C BEP = TF/(S – F)
D BEP = TF/(S – V)
2. Pelican Products plc uses a Squidget in one of its products. The Squidget takes one hour to
make the following costs per unit:
£
Variable costs 10
Fixed cost allocation 5
15
If the business decides to purchase the Squidget from an outside source, it can use the
spare capacity in the factory to produce Didgets that have a variable cost of £12 per unit
and which can be sold for £20 per unit. The Didget takes two hours to make.
What is the maximum amount that Pelican Products should be prepared to pay a
supplier for a Squidget?
A £10
B £14
C £18
D £20
3. Consider the following two statements concerning costs.
(1) Direct costs always vary directly with the level of output
(2) Fixed costs always stay the same irrespective of the time period involved.
Which one of the following combinations (true/false) relating to the above statements
is correct?
Statement
1 2
A True True
B True False
C False True
D False False
4. Two businesses produce the same product. Relevant information is as follows:
Hawk Ltd Osprey Ltd
Selling price per unit £20 £20
Variable costs per unit £6 £8
Fixed costs £1,000 £1,000
Planned output (units) 94 108
Which one of the following combinations is true concerning the performance of Hawk
Ltd relative to that of Osprey Ltd?
Break-even point Margin of safety
(in units)
A Higher Higher
B Higher Lower
C Lower Higher
D Lower Lower
5. Consider the following two statements concerning cost–volume–profit analysis.
(1) The contribution per unit is the difference between the sales price per unit and the fixed
costs per unit.
(2) The marginal cost per unit will usually equal the variable cost per unit.
Which one of the following combinations (true/false) relating to the above statements
is correct?
Statement
1 2
A True True
B True False
C False True
D False False
6. Devril plc is considering investing in a project that has an initial cash outlay followed by a
series of net cash inflows. The business applied the NPV and IRR methods to evaluate the
project; but, after the evaluation had been undertaken, it was found that the correct cost of
capital figure was lower than that used in the evaluation.
What will be the effect of correcting for this error on the NPV and IRR figures?
Effect on
NPV IRR
A Decrease Decrease
B Decrease No change
C Increase Increase
D Increase No change
7. Which one of the following statements relating to sources of finance is correct?
A Retained profits are a free source of finance to a business.
B Invoice discounting involves the invoice discounter taking over the management of the
trade receivables of a business.
C Investors normally view loan capital as being more risky than preference shares.
D Finance leases involves the lessee (the user of the assets) taking over substantially all
the risks and rewards of ownership.
8. Dune Ltd is considering a project that will require the use of a crane that cost £600,000
when it was acquired four years ago and which has a current carrying value (written down
value) of £370,000. If the project is not undertaken, the crane could be sold for £180,000 or
it could be used for another project. If it is used for the other project, the business will not
have to purchase another crane for £250,000. The business uses the net present value
(NPV) method to appraise investment projects.
What is the relevant cost of the machine when calculating the NPV of the project?
A £600,000
B £370,000
C £250,000
D £180,000
9. Which one of the following methods of investment appraisal uses annual profits (losses)
rather than annual cash flows when evaluating investment opportunities?
A Net present value
B Accounting rate of return
C Payback period
D Internal rate of return
10. The economic order quantity (EOQ) for inventories can be calculated using the following
equation:
EOQ = √(2WX/Y)
What does Y represent?
A Cost of placing an order
B Annual demand for the item of inventories
C Cost of holding one unit of inventories for one year
D Cost of delivering one unit of inventories to a customer
Section B – Fill in the blanks
Each question in this section is worth 2 marks (Total 20 marks)
For each question, select the best of the four options to fill in the blanks.
1. A(n) _______ cost is always an irrelevant cost when making decisions.
A opportunity
B fixed
C past
D indirect
2. An activity with relatively high fixed costs compared with its variable costs is said to have a
high ______________________________.
A level of financial gearing
B level of operating gearing
C margin of safety
D contribution-to-fixed cost ratio
3. __________ costing is used to describe the way in which we identify the full cost per unit of
output where the units of output differ.
A Batch
B Full
C Job
D Process
4. Activity-based costing sees overheads as ___________________________________.
A being caused by cost units
B rendering a service to cost units
C being unrelated to cost units
D being impossible to control
5. The difference between the original and the flexed budget profit figures is called the
_________________________________.
A sales price variance
B sales volume variance
C operating volume variance
D fixed cost variance
6. _____________________are no longer an important source of new finance for businesses.
A Ordinary shares
B Preference shares
C Finance leases
D Loan notes
7. The ___________________________ system of inventories control is based on the idea of
selective levels of control.
A ABC
B just-in-time
C materials requirement planning
D economic order quantity
8. Under ABC, an overhead cost __________ is established for each type of cost that can be
linked to a cost-driving activity.
A unit
B pool
C centre
D allocator
9. Indirect costs cannot be directly linked to individual cost ____________________.
A centres
B drivers
C units
D pools
10. When considering a break-even chart, the___________ range refers to the level of possible
volumes of activity at which the business might operate.
A forecast
B operating
C planned output
D relevant
Section C
Each question in this section is worth 20 marks (Total 60 marks)
1. On 31 December Year 0, Khan Ltd invested in some machinery and started to manufacture
a new product the ‘gadget’. The decision was based on the machinery being capable of
producing gadgets until the end of Year 6 and sales continuing until that time.
Actual sales of gadgets have not been as buoyant as projected when the investment was
being appraised during Year 0. As a result, the business’s management is considering
abandoning the project at the end of Year 3, the earliest date at which it would be feasible
to do so. You have been asked to prepare calculations and recommend whether to
abandon the project at that time or to continue as originally projected until the end of Year 6.
You have discovered the following:
(1) The machinery was bought on 31 December Year 0 for £420,000. Were production to
be abandoned at the end of Year 3, the machinery would be disposed of for £150,000,
on 31 December Year 3. Should the project continue, the machinery would be disposed
of in late December Year 6, for zero proceeds.
Depreciation of this machinery has been, and if retained will continue to be, charged at
the rate of £70,000 a year.
(2) It has been estimated that the most likely sales levels for the remaining three years of
the project will be as follows:
Number of gadgets
Year 4 2,400
Year 5 2,400
Year 6 1,500
(3) Gadgets are sold for £200 each. This produces a contribution of £80 a gadget.
(4) The variable costs include £90 a gadget for materials. The only other element of variable
operating cost is labour.
(5) The business also has a longstanding product, the ‘widget’, for which the market is very
buoyant. This uses the same manufacturing labour, paid at the same rate, as the
gadgets. As a result of a shortage of this labour, sales of widgets are lost when gadgets
are produced. A higher-than-planned output of widgets has occurred since Year 1, due
to the labour released by the gadget sales shortfalls.
Widgets generate a contribution of £50 each, with a variable labour element of £30.
(6) It is believed that there are no other relevant cash flows associated with the decision.
(7) Given the risk of the project, a cost of capital of 15% per year is considered appropriate.
(8) Assume that all operating cash flows arise on the last day of the accounting year
concerned.
Required
1. Show calculations that indicate, on the basis of net present value at 31 December Year 3,
whether Khan Ltd should abandon gadget production at the end of Year 3 or continue until
Year 6. (20 marks)
2. Peterkin Ltd makes three products, the ‘Gadget’, the ‘Midget’ and the ‘Widget’. Each of the
products requires the use of labour and of materials, including a special material, ‘Material
X’. Manufacturing labour is equally capable of working on all three products.
Demand for all three products has increased strongly over recent months and is expected to
remain high.
Information about the products, relating to the foreseeable future, is as follows:
Gadgets Midgets Widgets
Material X usage (metres per product) 55 25 20
Manufacturing labour (minutes per product) 40 35 50
Selling price (£ per product) 21.00 16.00 20.00
Other materials (£ per product) 1.50 1.00 1.00
Expected demand (units a week) 200 500 200
Manufacturing overheads —————– see below ————–
Material X costs the business £0.10 a metre and the manufacturing workers are paid £8 an
hour. The manufacturing workers are all employed on contracts that guarantee all 12 of
them a 40-hour week (that is, the manufacturing workers are paid £320 a week, irrespective
of the amount of work carried out). There are no other employment costs associated with
the workers. It is not possible to expand the staff by employing other manufacturing
workers and the existing ones are reluctant to work overtime.
Material X is in short supply and only 30,000 metres a week are expected to be
available for the foreseeable future. The business holds no inventories of Material X.
Supplies of it are received at the beginning of each week.
The business incurs manufacturing overheads that are believed to be partially fixed and
partially variable with manufacturing labour time. During two recent consecutive weeks,
these costs totalled £2,700 in week one and £3,010 in week two.
Output for those two weeks was as follows:
Gadgets Midgets Widgets
Week one 150 320 160
Week two 150 380 180
There have not been, nor are there expected to be in the foreseeable future, any price
changes, either of sales prices or of cost elements.
Required
(a) Prepare calculations that indicate whether it is the current level of staffing or the supply of
Material X that will constrain the business from meeting the expected demand for baskets.
(6 marks)
(b) Determine, with clear workings and justification (including assumptions made), the optimal
quantity of each product that the business should produce each week. (8 marks)
(c) Determine:
(i) the maximum amount that the business should be prepared to pay as an overtime rate to
the manufacturing workers, should any of them be prepared to work extra hours; and
(ii) the maximum amount that the business should be prepared to pay for any additional
quantities of Material X.
In each case explain how any additional resources would be deployed, if at all.
(4 marks)
(d) Explain what steps the business might take to improve its profitability in the near future.
(2 marks)
(20 marks)
3. Lee Ltd makes a range of products all of which follow a similar production process and
have the same cost structure. The products are made in batches that are started at the
beginning of the month and are completed and taken into finished goods inventories at the
end. There is no work in progress at the end of any month. The business is considering a
change in its sales prices, volumes and credit terms.
Current position
Sales revenues are £0.3 million a month and produce a contribution of 40p per £1 of sales
revenue. Variable raw material costs account for 20p per £1 of sales revenue. Fixed costs
are £120,000 a month, of which £30,000 is depreciation. The business’s only variable costs
are production costs.
Credit customers take one month to pay, trade payables for raw materials are paid one
month after purchase and the other variable costs are paid during the month of production.
At the end of each month the business has sufficient raw material inventories to meet the
following month’s production and enough finished inventories to meet the following
month’s sales.
Possible future position
Production and sales volumes would be increased by 50%. To generate the increased
demand, selling prices would be reduced by 10% and trade receivables would be allowed to
pay two months after the sale. Since neither the usage, nor the cost per product of raw
materials and other variable costs would be affected by the proposed expansion, the
contribution per £1 of sales revenue would fall to 30p. Apart from the increased trade
receivables payment period, all working capital policies would remain the same as at
present. The changes to sales volume, price and payment period, were they to occur, would
commence with sales made from 1 December this year; but, to meet the business’s working
capital policies there would be effects on cash flows before that time.
The business’s balance at bank at 1 October is expected to be £70,000.
Required
(a) Prepare Lee Ltd’s cash budgets for each of the months of October, November and
December this year and January and February next year, on the assumption that the
proposed expansion of sales goes ahead.
Note: Ignore interest
(b) Discuss the effects of the expansion plans on the business’s working capital levels and
profitability.
(20 marks)
End of question paper
Accounting and finance for non-specialists
(6th edition)
Atrill and McLaney
Supplementary questions
Chapter 2
Sarah started a new business on 1 June. During the first month of her business, the following
transactions took place:
(a) Sarah opened a bank account in the name of her business and transferred £50,000 of her
own money to it.
(b) She borrowed £35,000 from the Commercial Loan Company and paid the money into the
business bank account.
(c) She paid £40,000 for a small business unit (premises).
(d) She paid £3,000 for a second-hand delivery van.
(e) She bought goods for resale (inventories) for £10,000, paying immediately, and further
goods for £20,000, on credit.
(f) She sold goods, which had cost £15,000, for £25,000. £5,000 of this revenue was for cash
and the remaining £20,000 was on credit.
(g) She paid staff wages for June totalling £500.
(h) She paid £100 for petrol for the van, all of which was used during June.
(i) She received £4,000 from trade receivables.
(j) She paid £200 to the Commercial Loan Company as interest on the loan for the month.
Required:
Open a balance sheet for Sarah’s business and show each of these transactions on it as a series
of pluses and minuses to reach the position of the business as at the end of June. Ignore
depreciation of the non-current assets.
Chapter 3
Lee Company, a retail business, has been trading for some time. The balance sheet at 31
December last year was as follows:
Balance sheet as at 31 December last year
£
Non-current assets
Property, plant and equipment
Premises 76,000
Plant – cost 50,000
depreciation (8,000) 42,000
118,000
Current assets
Inventories 23,000
Trade receivables 21,000
Cash at bank 11,000
55,000
Total assets 173,000
£
Equity (or capital)
Balance at 31 December last year 102,000
Non-current liabilities
Borrowings from Commercial
Loan Company 45,000
Current liabilities
Trade payables 26,000
173,000
During this year (ending 31 December) of the business, the following total transactions took
place:
(a) An additional item of plant was bought for £10,000, which was paid immediately.
(b) The owners of the business withdrew £11,000 in cash and inventories that had cost £8,000.
These were for the owners’ personal use.
(c) Sales revenue of £137,000 was made. The inventories sold cost £63,000. £42,000 of this
sales revenue was for cash (immediate settlement) and the remainder was made on credit.
(d) Inventories costing £59,000 were bought, all on credit.
(e) Cash totalling £97,000 was received from trade receivables.
(f) A credit customer who owed £2,000 went bankrupt and it was clear at the end of the year
that no cash would ever be forthcoming from this customer.
(g) Trade payables were paid £61,000.
(h) Electricity bills for the first nine months of the year were paid totalling £3,000. At the end
of the year, the bill for the last three months of the year (£1,000) remained unpaid.
(i) Wages totalling £12,000 was paid.*
(j) Interest of £4,000 was paid on the borrowings from the Commercial Loan Company.*
(k) General expenses of £11,000 were paid.*
* These three payments represented the full expense for the year (that is, there were no
accruals and prepayments).
You are told that the business wishes to depreciate all plant owned at the end of the year by 10%
of its cost value.
Required:
Open a balance sheet for the business and enter the balances from the 31 December last year
balance sheet. Also open an income statement. Show each of the transactions on the two
statements as a series of pluses and minuses and transfer the profit or loss to the balance sheet to
reach the position of the business as at 31 December this year.
Chapter 4
Question 1
You have recently overheard the following statements:
(a) ‘When a company’s shares are traded on the Stock Exchange and the current market price is
above the nominal value of the shares, this excess is recorded by the company in the share
premium account.’
(b) ‘A ‘reserve’, in the context of company accounts, is an amount of cash that can legally be
used to a pay a dividend to shareholders.’
(c) ‘A bonus issue is a way of rewarding shareholders for their long-term loyalty to the
company.’
(d) ‘A public limited company is one that is owned by the government, whereas a private
limited company is one that is owned by the Stock Exchange’
Required:
Comment critically on each of these statements.
Chapter 4
Question 2
You have recently overheard the following statements:
(a) ‘Each company’s own set of rules, the articles and memorandum of association, lays out the
basic rules on what information needs to be included in company accounts.’
(b) ‘International accounting standard 1 (IAS 1) says that companies must set out their income
statement and balance sheet in a particular format and that these statements may contain
only the information specified in that standard.’
(c) ‘IAS 1 imposes an overriding requirement on company directors that they produce financial
statements that are a ‘correct and accurate representation’ ’.
(d) ‘The auditors are appointed by the directors to make sure that the company’s financial
statements are correct and, if not, to correct them.’
(e) ‘The operating and financial review is the collective name given to the annual income
statement, balance sheet and cash flow statement of a UK limited company.’
Required:
Comment critically on each of these statements.
Chapter 5
The following are the financial statements of Colmar Ltd for the last year and this year:
Income statement for the year ended 31 December:
Last year This year
£000 £000
Sales revenue 499 602
Cost of sales (335) (423)
Gross profit 164 179
Operating expenses (127) (148)
Operating profit 37 31
Interest payable (13) (22)
Profit before taxation 24 9
Taxation (8) (4)
Profit for the year 16 5
Balance sheet as at 31 December:
Last year This year
£000 £000 £000 £000
Non-current assets 110 125
Current assets
Inventories 68 83
Trade receivables 80 96
Cash 6 154 2 181
Total assets 264 306
Equity
Ordinary shares of £0.50 each 13 13
Capital reserves 33 33
Retained profit 84 130 84 130
Non-current liabilities
Borrowings – Loan notes 55 60
Current liabilities
Trade payables 75 114
Taxation 4 79 2 116
Total equity and liabilities 264 306
[Included in operating expenses are the following depreciation charges:
Last year £32,000
This year £36,000
There were no disposals of non-current assets in either year.
Dividends were paid of £6,000 and £5,000 during last year and this year respectively.
Required:
Prepare a cash flow statement for this year. Show workings.
Chapter 6
The balance sheet and income statements of Crow Ltd for the current year and previous year are
set out below.
Balance sheet as at 31 December
Previous year Current year
Cost Depr’n CV Cost Depr’n CV
£000 £000 £000 £000 £000 £000
Non-current assets
Property, plant and
equipment
Land and buildings 159 12 147 222 15 207
Plant and equipment 150 30 120 270 33 237
309 42 267 492 48 444
Investments at cost 150 240
417 684
Current assets
Inventories 165 195
Trade receivables 120 150
Bank 9 294 – 345
711 1,029
Equity
£0.50 Ordinary shares 120 150
Share premium 36 39
Revaluation reserve – 63
Retained profit 75 231 75 327
Non-current liabilities
Borrowings – 8% Loan
notes 300 450
Trade payables 180 240
Bank – 180 12 252
711 1,029
Income statement for the year to 31 December
Previous
year
Current year
£000 £000
Sales revenue 600 600
Cost of sales (300) (360)
Gross profit 300 240
Expenses (180) (180)
Profit for the year 120 60
Dividends of £60,000 were paid in respect of both years.
Required:
Using appropriate ratios, evaluate the changes in the financial position and performance of the
business as revealed by the financial statements.
Chapter 7
(a) Rennes Ltd provides a single standard service. The business’s results for the past two
months are as follows:
April May
Sales (units of the service) 500 620
Sales revenue (£) 25,000 31,000
Operating profit (£) 10,000 14,800
There were no changes, of any description, in selling prices or costs over the two months.
Required:
What is the break-even point for the business’s activities?
(b)
Required:
What benefit will it be for the management of Rennes Ltd
(i) to carry out the analysis required in part (a) and
(ii) to know the business’s break-even point?
(c) Lorient plc has three products all of which require the same production facilities. Financial
data on the three products are as follows:
Product X Y Z
£ per unit £ per unit £ per unit
Labour: skilled 10 15 20
unskilled 3 6 3
Materials 9 12 15
Variable overheads 8 12 16
Share of fixed overheads 10 15 20
All three of the products use just one raw material, which is the same material for all three
products. This material costs £12 a kilo and is scarce, such that the amount of all three products
that can be produced falls well below the amounts that the market would take. All labour is a
variable cost.
Product X is sold in a market where the selling price per unit is fixed at £60.
Required:
Show, with workings and explanations, the price at which the business will need to sell products
Y and Z such that it will be equally profitable to produce and sell any one of the three products.
Chapter 8
You have been asked to suggest a method of deducing the full cost of various production orders
of Patel Ltd. This method will be used as a basis for setting prices. The production orders vary
greatly in size and nature from one to the next.
The following information has been taken from the budget for the forthcoming financial year:
Direct labour hours 100,000 hours
Machine hours 90,000 hours
£
Manufacturing costs:
Power 40,000
Direct materials 200,000
Machine maintenance and repairs 38,000
Factory heat and light 4,000
Lubricants and cleaning materials 6,000
Direct labour 600,000
Depreciation: factory buildings 130,000
machinery 402,000
Indirect labour 100,000
1,520,000
The business is not departmentalised for accounting purposes.
All direct labour is paid the same hourly rate.
Required:
(a) Calculate two feasible overhead rates for the year.
(b) Prepare full costing for Order No 101 using each of the rates calculated in (a) (that is, two
separate costings).
The cost sheet for Order No 101 shows the following:
Raw materials £5,000
Direct labour hours 4,000 hours
Machine hours 1,900 hours
(c) State briefly which of the two bases of overheads you prefer and why.
How might you improve on the two possible costs that you derived in (b) by taking a
slightly different approach?
Chapter 9
Seine Products Ltd, a new manufacturing business, started production on 1 January. Sales are
planned to start in February and to be as follows for the rest of the year:
Sales units
February 400
March 500
April 600
May 700
June 800
July 900
August 800
September 800
October 700
November 600
December 500
The selling price per unit will be £100.
All sales will be made on credit. The business plans to offer a cash discount (of 2% of the
amount owed) to those customers who pay by the end of the month of the sale. Customers for
half of all units sold are expected to qualify for the discount. For the remaining half of the units
sold, customers for 95% are expected to pay during the month following the month of the sale.
The remainder is expected to be bad debts.
It is planned that sufficient finished goods inventories for each month’s sales should be
available at the end of the previous month.
Raw material purchases will be such that there will be sufficient raw materials inventories
available at the end of each month precisely to meet the following month’s planned production.
This planned policy will operate from the end of January. Purchases of raw materials will be on
two months’ credit (that is, buy in month 1, pay in month 3). The cost of raw material is £40 per
unit of finished product.
The direct labour cost, which is variable with the level of production, is planned to be £20 per
unit of finished production.
Production overheads are planned to be £20,000 each month, including £3,000 for depreciation.
Non-production overheads are planned to be £11,000 a month of which £1,000 will be
depreciation.
Various fixed assets costing £250,000 will be bought and paid for during January.
Except where specified, assume that all payments take place in the same month as the cost is
incurred.
The business will raise £300,000 in cash from a share issue in January.
Required:
Draw up a cash budget for the six months from I January to 30 June, with a column for each
month. The budget should, among other things, show each end-of-month cash balance.
Show all workings
Chapter 10
The product development department of Dolly plc is contemplating renting a factory building
on a four-year lease from 1 January 2008, investing in some new plant and using it to produce a
new product, code named GS7.
Since there appears to be no possibility of the plant continuing to be economically viable
beyond a four-year life, it has been decided to assess the new product over a four-year
manufacturing and sales life.
Under the lease, the business will pay £100,000 annually in advance on 1 January.
The plant is expected to cost £600,000. This will be bought and paid for on 1 January 2008 and
is expected to be scrapped (zero proceeds) on 31 December 2011. The business will depreciate
this asset, in its accounts, on a straight-line basis (25% each year).
Each unit of GS7 is estimated to give rise to a variable labour cost of £200 and a variable
material cost of £100. GS7 manufacture will be charged with an annual share of the business’s
administrative costs, totalling £150,000 each year. Manufacture and sales of GS7s is expected to
increase total administrative costs by £90,000 each year.
Manufacture and sales of GS7s are expected to be as follows:
Year ending 31 December Year Units of GS7
2008 400
2009 600
2010 500
2011 200
These will be sold for an estimated £1,400 each.
The business will need to support the manufacture and sales of the product with working capital.
This has been estimated at an amount equivalent to £100 per unit of the product sold each year.
This working capital would need to be in place by the beginning of the relevant year of
production and sales and reduced to zero by the end of 2011.
The business’s accounting year end is 31 December each year.
It has been decided, given the level of risk involved with the project to use a discount rate of
15% a year.
Required:
(a) Identify the annual net relevant cash flows and use this information to assess the project on
a net present value basis at 1 January 2008.
(b) Estimate the internal rate of return of the project.
Chapter 11
(a)
Required:
Why do companies make ‘rights’ issues of equity, rather than raising the equity in some other
way?
(b) Memphis plc has issued ordinary shares of 20 million £0.10 shares. On 7 June the Stock
Exchange closing price of the shares was £1.20. Early on the morning of 8 June, the
business publicly announced that it had just secured a new contract to build some hospitals
in the Middle East. To the business, the contract had a net present value of £4 million. On 9
June the business announced its intention to raise the necessary money to finance the work,
totalling £10 million, through a rights issue priced at £0.80 per share.
Required:
Determine for how much, in theory, a shareholder could sell the right to buy one of the new
shares.
Assume that the events described above were the only influence on the share price.
(c) The directors of Memphis plc (see (b) above) are reconsidering their decision on the rights
issue price. They are now contemplating an issue price of £1 per new share. One of their
concerns is the effect that the issue price will have on the wealth of the existing
shareholders. You have been asked to advise on this.
Required:
Calculate the effect on the wealth of a person who owns 200 shares in Memphis plc before the
rights issue assuming in turn a rights issue price of £0.80 and £1.00, in each case both on the
basis that the shareholder takes up the rights and that the shareholder sells the rights.
Taking account of all of the factors, advise the business to do about the rights issue price.
Chapter 12
Magpie Ltd produces a graphite tennis racquet that has been reasonably successful but sales
volumes have remained stable in recent years. Financial data relating to the racquet are as
follows:
£ £
Selling price 40
Variable cost (30)
Fixed cost apportionment (5) (35)
Profit 5
Magpie Ltd has recently been approached by a large supermarket that wishes to buy 30,000
racquets each year but has demanded that four months credit is allowed. Magpie Ltd is
concerned that if the demand is accepted, its other customers, who are allowed only one
month’s credit, will make similar demands. The current level of sales is 120,000 racquets each
year. If the supermarket order is accepted, 10,000 extra racquets will have to be held in
inventories (where inventories are valued at total cost) and trade payables will increase by
£350,000. The business expects a return of 25% on it net investment.
Required:
Assess the acceptability of the offer made by the supermarket to Magpie Ltd on the basis that:
(a) all customers will receive a credit period of four months; and
(b) only the supermarket will receive a four-month credit period.
