Exam 10: Flexible Budgets, Standard Costs and Variance Analysis

Greenwich plc has £1million to invest in new products and has to decide between two alternatives. Both projects have an estimated life of 4 years. The annual sales for Project X have been forecast at 50,000 units and for Project Y only 4,000 units. Recent experience suggests that any new products will face severe competition and it is becoming increasingly difficult for managers to prepare reliable forecasts. Senior managers are therefore very concerned about the sensitivity of revenues and costs for the projects. Details of the proposals Project P roject Y Unit £ Unit £ Selling price 290 890 Costs: Labour 200 40 Material 25 320 Variable Overhead 25 41 The cost of capital for the group is 10% Total fixed costs for project X are forecast at £1,500,000 and this includes £500,000 of head office charges. A residual value has been estimated at £100,000. Total fixed costs for project Y are forecast at £1,250,000 and this includes £300,000 of head office charges. There will be no residual value. Calculate how sensitive Project Y and Project X is to increases in variable overhead costs.

A very useful guide for making investment decisions is: The shorter the payback period, the more profitable the project

The Deta Company is analyzing projects X, Y, and Z as possible investment opportunities. Each of these projects has a useful life of six years. The following information has been obtained: Project X Project Y Project Z Initial investment needed. £260,000 £180,000 £340,000 Present value of future cash inflows. £295,000 £220,000 £390,000 Internal rate of return. 20\% 16\% 18\% - Which project has the highest ranking according to the net present value and the profitability index criteria Net Present Value Protitability Index A. Z Z B. Y X C. X Y D. Z Y

Greenwich plc is considering adding two new products at a subsidiary to improve its overall competitiveness. The new products are enthusiastically supported by the managers responsible and an immediate decision is required. It is normal for the managers to calculate the net present value (NPV) for the projects before it is accepted or rejected. Details of the proposals -Calculate the Present Value of the cash flows for Project B

Calculate the relevant cash flows for year 0

(Ignore income taxes in this problem.) Hamilton Company invested in a two-year project having an internal rate of return of 12%. The project is expected to produce cash flow from operations of £60,000 in the first year and £70,000 in the second year. The cost of the project is closest to

(Ignore income taxes in this problem.) Beaver Company is investigating the purchase of a new threading machine that costs £18,000. The machine would save about £4,000 per year over the present method of threading component parts, and would have a salvage value of about £3,000 in 6 years when the machine would be replaced. The company's required rate of return is 12%. The machine's net present value is

The length of time required to recover the initial cash outlay for a project is determined by using the

In preference decisions, the profitability index and internal rate of return methods may produce conflicting rankings of projects

Under the internal rate of return capital budgeting technique, it is assumed that cash flows are reinvested at the

Calculate the contribution per unit for the new machine

If an investment has cash outflows of Q pounds at the end of each year for three years, then the present value of these cash outflows under a 10% rate of return will be

The calculation of the net present value of an investment project requires that the depreciation tax shield be included at

Greenwich plc is considering adding two new products at a subsidiary to improve its overall competitiveness. The new products are enthusiastically supported by the managers responsible and an immediate decision is required. It is normal for the managers to calculate the net present value (NPV) for the projects before it is accepted or rejected. Details of the proposals -Calculate the Net Present Value of the cash flows for Project A

The profitability index is used to compare the internal rates of return of two companies with different investment amounts

(Ignore income taxes in this problem.) Murdock Company has a chance to make and sell a new plastic five-gallon container. The company estimates that the net cash flows (sales less cash operating expenses) arising from manufacture and sale of the new container would be as follows (numbers in parentheses indicate an outflow): Years 1-10 £85,000 Years 11 £(20,000) Years 12 £95,000 - Murdock would need to purchase production equipment costing £200,000 now to use in the manufacture of the new containers. This equipment would have a 12-year life and a £20,000 salvage value. Murdock Company's required rate of return is 12%. The net present value of all cash flows associated with this investment (rounded to the nearest thousand pounds) is

Greenwich plc is considering adding two new products at a subsidiary to improve its overall competitiveness. The new products are enthusiastically supported by the managers responsible and an immediate decision is required. It is normal for the managers to calculate the net present value (NPV) for the projects before it is accepted or rejected. Details of the proposals -Calculate the Present Value of the cash flows for Project A

Preference decisions attempt to determine which of many alternative investment projects would be the best for the company to accept

Explain why it is important to allow for inflation in a capital budgeting question.

The simple rate of return method places its focus on cash flows instead of on accounting net operating income