2015 Solution 4SSMN135 to MAIN (MAY) exam question

QUESTION 5 GUYS Ltd

Part (a) Cost per unit (ABC costing method) – total 12.5 Marks
Cost driver No of activities Cost driver rate
Machine department £20,860 Machine hours 5,200.00 £4.01 (1 Mark)
Set up costs £10,500 Production runs 42.00 £250.00 (1 Mark)
Stores receiving £7,200 Requisitions raised 80.00 £90.00 (1 Mark)
Inspection £4,200 Production runs 42.00 £100.00 (1 Mark)
Materials handling £9,240 No of orders 84.00 £110.00 (1 Mark)

(1 mark each for cost driver rate, total 5 marks)

A B C D A (as example)
Direct costs £32,640 £28,400 £14,080 £38,880 (240*136=32640)
Machine department £7,702 £4,814 £2,567 £5,777
Set ups £3,000 £2,500 £2,000 £3,000
Stores/receiving £1,800 £1,800 £1,800 £1,800
Inspection £1,200 £1,000 £800 £1,200
Handling £2,640 £2,200 £1,760 £2,640
total £48,982 £40,714 £23,007 £53,297
units 240 200 160 240
Cost per unit £204.09 £203.57 £143.80 £222.07 (1/2 Mark)

Working notes: students produce equivalent calculations of table below get 5 marks
1 mark each : total 5 marks

Final cost per unit : 0.5 mark each, total 2 marks

Format: clear and illustrative format 0.5 mark

No of
activities A B C D
Machine department Mhrs 1920=4.01*1920 1200 640 1440 7720

Set ups Prod. runs 12=250*12 10 8 12 3000

Stores/receiving Requisitions 20=90*20 20 20 20 1800
Inspection Prod. runs 20=100*12 10 8 12 1200
Handling orders 24=110*24 20 16 24 2640
units 240 200 160 240
Cost per unit £204.09 £203.57 £143.80 £222.07

1
QUESTION 6 FRANKLIN Ltd

(a) 12.5 marks total – To make or buy

comparative relevant costs statement (per unit)

£ £

To make To buy

unit purchase price 50

direct material 14

direct labour 12

variable overhead 8

opportunity cost 40

total cost 74 50

saving 24 per unit to buy

NOTES: detailed workings for calculation of opportunity cost if making component 3A:

Direct labour hour is the limiting factor at Franklin plc. Therefore, direct labour used to make
component 3A could otherwise be used to produce product Y. Need to calculate contribution per unit of
limiting factor for Y:

product Y

contribution per unit £130-£50 80

contribution per labour hour £80/8 10

2
4 scare labour hours are required to make component 3A, so opportunity cost to make component 3A is
as follows:

4 hours x £10/per direct labour hour = £40 per unit.

Or alternatively

Product X requires 4DLH x 3000 units = 12,000 DLHs

Product Y can be produced: 12,000/8 = 1500 units

CM of product Y: 130 – (10+ 24+ 16) = £80

Opportunity cost foregone: £80 x 1500 units = £120,000

Conclusion:

Calculations show a net saving of £24 per unit if buying component from outside suppliers. To buy.

Assumptions made in preparing the above comparative relevant costs statement:

(1) direct material and labour represent the additional material and labour costs of producing the
component

(2) Franklin will not incur any additional fixed overheads if the component 3A is made

(b) 4.5 Marks – marks are awarded to students who better illustrated these two terms using (a)

(1) Limiting factors refer to the constrained resources which prevent companies from making or selling
as much as they would desire. In other words, production capacity is not able to fulfil all the demands
for all products. These resource constrains include raw material, labour, supervisor’s time, machine time
etc. Students can make reference to their workings on production plan which utilizes the constrained
resource in the most effective way.

(2) Opportunity costs are monetary benefits foregone from the next best alternative course of action. In
this question (a), because the direct labour hours are limiting factor, therefore opportunity cost per unit
of 3A should be the contribution margin per unit of limiting factor of Y.

3
QUESTION 7 Project appraisals

(a) 8 marks total

(i) Payback period:

Project X: 1.5 years (1+£11,250/£22,500) (1 mark)

Project Y: 2.4 years (2+£7,500/£18,000) (1 mark)

(ii) Net present value

Year Project X Project Y Discount Project Project Y

factor X
Cash Cash PV
@10% PV

Inflows Inflows
(W1) (W1)

£ £

1 26,250 15,000 0.909 23,861 0.5 mark 13,635 0.5 mark

2 22,500 15,000 0.826 18,585 0.5 mark 12,390 0.5 mark

3 18,750 18,000 0.751 14,081 0.5 mark 13,518 0.5 mark

4 15,000 27,000 0.683 10,245 0.5 mark 18,441 0.5 mark

4 7,500 7,500 0.683 5,123 0.5 mark 5,123 0.5 mark

71,895 63,107

Investment (37,500) (37,500)

NPV 34,395 0.5 mark 25,607 0.5 mark

(b) 2.5 marks total

4
Project X is recommended (0.5 mark) because:

(1) It has a higher NPV (1 mark)

(2) It also has a shorter payback period (1 mark)

(c) 6 marks total

NPV adjusts for timing of the project’s expected cash flows; Takes into account time value of money;
Includes all cash flows over the life of the project; Individual projects can be added to see the effect of
accepting a combination of projects; Can be used in situations where the required rate of return varies
over the life of the project; Absolute NPV values can be misleading. (1 mark for each valid point: 3
Marks in total)

IRR takes into account time value of money; Includes all cash flows over the life of the project; If the IRR
is high enough, one may not need to estimate a required rate of return; Percentage may make more
sense to some people; projects with non-conventional cash flows can lead to multiple IRRs; can lead to
wrong decision when projects are mutually exclusive. (1 mark for each valid point: 3 Marks in total)

QUESTION 8 Company A and B

(a) 4 mark

Operating leverage measures the sensitivity of changes in profit to changes in sales.

OL = contribution margin/profit

Company A = 2000/1000=2
Company B = 6000/1000=6

(b) 4 mark

BEP = TFC/CM ratio

Company A = 1000/0.2= 5000 pounds

Company B= 5000/0.6=8333.333 pounds

Company B breakeven point is higher because its fixed costs are higher.
Company A must achieve higher level of sales in order to cover higher level of fixed costs even its
contribution margin ratio is higher

(c) 5.5 marks

revised profit = Operating leverage * incr in profit

Company A = 2 million ( 2*50% =100% so old profit 1 million, new profit 2 million) - 2 mark
Company B = 4 million (6 * 50% = 300%, so old profit 1 million, new profit 4 million) – 2 mark

5
Operating leverage is higher (1.5 mark)

(d) 3 marks

(1) Operating leverage is a measure of how sensitivity profits are to changes in sales. Companies with
higher operating leverage, a small change in sales will cause large change in profit.

(2) margin of safety is the difference between expected sales and break-even sales. This measures how
much sales can fall before a loss will be incurred. Company with higher margin of safety is less risky

(3) indirect cost is a cost that cannot be physically and conveniently traced to a product.