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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
©IFA Business Finance June 2012
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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.
Required:
(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.
Required:
(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)
©IFA Business Finance June 2012
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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:
Turnover
Cost of sales
Cash
Trade receivables
Bad/Irrecoverable debts written off
Trade payables
Inventories
Year ended 31st March
Year ended 31st March
2011 ($)
2010 ($)
612,000
828,000
374,000
434,000
(29,000)
23,000
135,000
120,000
31,000
8,000
82,000
64,000
14,500
33,000
Required:
(a) Calculate the operating cycle (in days) for 2010 and 2011.
(8 marks)
(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 2011.
(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 2011. 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.
Required:
(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.
(8 marks)
(Total 30 marks)
©IFA Business Finance June 2012
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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.
Required:
(a)
In a report to management:
(i) Explain the term ‘reorder level’.
(3 marks)
(ii) Explain the term ‘economic order quantity (EOQ)’.
(3 marks)
(iii) Calculate the EOQ for A69.
(3 marks)
(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.
Required:
(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.
(8 marks)
©IFA Business Finance June 2012
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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.
Required:
(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)
©IFA Business Finance June 2012