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CAT Programme

T10 Managing Finances


Mock Test

Section A – ALL 10 questions are compulsory and MUST be attempted. (20%)


Each question within this section is worth 2 marks.

1) Which of the following ratios is difficult for creditors of a firm to analyze because the data is
usually not available in published financial statements?
a) Operating leverage
b) Average payment period
c) Quick ratio
d) Average age of inventory ( )

2) All of the following are functions of security exchanges EXCEPT


a) Allocating scarce capital.
b) Aiding in new financing.
c) Creating continuous markets.
d) Holding demand deposits. ( )

3) A firm has actual sales in November of $1,000 and projected sales in December and January
of $3,000 and $4,000, respectively. The firm makes 10 percent of its sales for cash, collects 40
percent of its sales one month following the sale, and collects the balance two months following
the sale. What is the firm's total expected cash receipts in January?
a) $700.
b) $2,100.
c) $1,900.
d) Cannot be determined with the information provided. ( )

4) On a purely theoretical basis, the NPV is the better approach to capital budgeting due to all the
following reasons EXCEPT:
a) that it measures the benefits relative to the amount invested.
b) for the reasonableness of the reinvestment rate assumption.
c) that there may be multiple solutions for an IRR computation.
d) that it maximizes shareholder wealth. ( )

5) A firm has an average age of inventory of 101 days, an average collection period of 49 days,
and an average payment period of 60 days. What is the firm's cash conversion cycle?
a) 150 days
b) 90 days
c) 112 days
d) 8 days ( )

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6) Which of the following minimize the risks of outsourcing?
a) The use of short-term contracts that specify price
b) The responsibility for on-time delivery is now the responsibility of the supplier
c) Building close relationships with the supplier
d) All of these answers are correct ( )

7) The Asia Chemical Company uses 150,000 gallons of hydrochloric acid per month. The cost of
carrying the chemical in inventory is 50 cents per gallon per year, and the cost of ordering the
chemical is $150 per order. The firm uses the chemical at a constant rate throughout the year.
It takes 18 days to receive an order once it is placed. What is the reorder point?
a) 7,500 gallons
b) 25,000 gallons
c) 90,000 gallons
d) 105,000 gallons ( )

8) A firm is analyzing a relaxation of credit standards that is expected to increase sales 10


percent. The firm is currently selling 400 units at an average sale price per unit of $575, and
the variable cost per unit is $400 at the current sales volume. The average cost per unit is
$425. What is the additional profit contribution from sales if credit standards are relaxed?
a) $23,000
b) $16,000
c) $6,000
d) $7,000 ( )

9) When evaluating projects using internal rate of return,


a) projects having lower early-year cash flows tend to be preferred at higher discount rates.
b) projects having higher early-year cash flows tend to be preferred at higher discount rates.
c) projects having higher early-year cash flows tend to be preferred at lower discount rates.
d) the discount rate and magnitude of cash flows do not affect internal rate of return. ( )

10) Cooper Limited has a plant capacity of 100,000 units per month. Unit costs at capacity are:
Direct materials $4.00
Direct labor 6.00
Variable overhead 3.00
Fixed overhead 1.00
Marketing — fixed 7.00
Marketing/distribution — variable 3.60

Current monthly sales are 95,000 units at $30.00 each. A regular customer has contacted
Cooper about purchasing 2,000 units at $24.00 each. Current sales would not be affected by
the one-time-only special order. What is Cooper’s change in operating profits if the one-time-
only special order is accepted?
a) $14,800 increase
b) $17,200 increase
c) $22,000 increase
d) $33,200 increase ( )

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Section B – ALL THREE questions are compulsory and MUST be attempted. (80%)

Question 1
Thurbro Ltd makes and sells a single product A. The following information is available for use in
the budgeting process for the year to 31 December 20X2.

(i) Sales at selling price per product unit $20


20X2 20X3
Quarter 1 Quarter 2 Quarter 3 Quarter 4 Quarter 1
Product units 6,000 4,000 3,600 5,600 4,800

(ii) Stock levels


At 31 December 20X1: Finished product A 1,500 units
Raw material X 3,500 kg

Closing stocks of finished product A at the end of each quarter are budgeted as a percentage
of the sales units of the following quarter as follows:
at the end of quarters 1 and 2: 25%.
at the end of quarters 3 and 4: 35%.

Closing stock of raw material X is budgeted to fall by 300 kg at the end of each quarter in order
to reduce holdings by 1,200 kg during 20X2.

(iii) Product A unit data


Material X 4 kg at $1.60 per kg
Direct labour 0.6 hours at $3.50 per hour

(iv) Other quarterly expenditure


20X2
Quarter 1 Quarter 2 Quarter 3 Quarter 4
Fixed overhead ($) 45,000 48,000 47,000 ,000
Capital expenditure ($) 50,000

(v) Forecast balances at 31 December 20X1


$
Receivables 40,000
Bad debts provision 2,000
Bank balance 22,000
Payables: materials 9,600
Non-current assets (at cost) 500,000

(vi) Cash flow timing information


(a) Sales revenue: 60% receivable during the quarter of sale, 38% during the next quarter,
the balance of 2% being bad debts.
(b) Material X purchases: 70% payable during the quarter of purchase, the balance of 30%
during the next quarter.
(c) Direct wages, fixed overhead and capital expenditure: 100% payable during the quarter
in which they are earned or incurred.

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(vii) Non-current assets are depreciated on a straight-line basis of 5% per annum, based on the
total cost of non-current assets held at any point during a year and assuming nil residual value.

(viii) All forecast balances at 31 December 20X1 will be received or paid as relevant during the first
quarter of 20X2.

(ix) Stocks of product X are valued on a marginal cost basis for internal budgeting purposes.

Required
(a) Prepare a cash budget for Thurbro Ltd for each quarter of the year to 31 December
20X2. All relevant working calculations must be shown. (12 marks)

(b) Prepare a budgeted income statement for the year to 31 December 20X2.
(8 marks)

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Question 2
(a) For each of the following scenarios, advise the Finance Director what type of borrowing
would be most suitable and why. (10 marks)

Scenario 1
WJ Patch Ltd, a company which owns a small group of jeweller shops, requires a ‘working
capital line’. This line is to fund the day-to-day requirements of the business and, most
importantly, its highly seasonal cash flows. Jewellery shops typically make two thirds of
their sales in one third of the year, i.e. the three months before Christmas (October to
December) and the following month in the New Year (January) sales.

Scenario 2
St Mirren Tools Ltd, an engineering company, seeks to finance an extensive factory
refurbishment purchasing new machinery with an expected useful life of ten years. This
company’s business is not subject to any seasonal variations.

(b) Leasing is a financing technique that allows a firm to obtain the use of certain assets by
making periodic, contractual payments. Discuss the advantages and disadvantages of
leasing. (10 marks)

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Question 3
(Discount factor table extracts and annuity factor table extracts can be found on the next page)

(a) Mayhew is considering a project requiring investment of $100,000 in equipment with a life of
five years and a residual value of $15,000. Annual cash earnings will be $25,000, $34,000,
$25,000, $15,000 and $8,000 for the five years respectively.

Required
(i) Calculate the ARR based on average investment. (2 marks)
(ii) Calculate the ARR based on initial investment. (2 marks)
(iii) Calculate the payback period. (2 marks)

(b) Durgan has a 25% cost of capital and is considering a project requiring initial investment of
$183,000. Annual savings will be $70,000 for the next 4 years.

Required
(i) Calculate the NPV of the project at 25%. (2 marks)
(ii) Calculate the IRR of the project. (4 marks)

(c) Cooper has recently expanded into new premises which cost $2.5 million and have a current
market value of $2.6 million. Equipment must now be installed, one possibility being to
purchase this for $1 million, another being to transfer Cooper's existing equipment into the new
premises at a cost of $170,000. This existing machinery was bought five years ago for
$700,000 and has a current book value of $150,000. Operations will continue at the original
premises and if equipment is transferred to the new premises then the cost of replacement will
be $660,000.

All equipment has a life of 15 years from now and could generate annual cash returns of
$384,000. At the end of this period the new premises would have an estimated market value of
$1.8 million and all equipment would have negligible scrap values. Cooper’s cost of capital is
10%.

Required
(i) Advise Cooper on the best way of equipping the new premises. (3 marks)
(ii) Advise Cooper whether or not the new premises are worth equipping.
(5 marks)

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Discount factor table extracts  Annuity factor table extracts

Time Factor Time Factor


10% 10%
1 0.909 1 0.909
2 0.826 2 1.736
3 0.751 3 2.487
4 0.683 4 3.170
5 0.621 5 3.791

Time Factor Time Factor


15% 15%
1 0.870 1 0.870
2 0.756 2 1.626
3 0.658 3 2.283
4 0.572 4 2.855
5 0.497 5 3.352

Time Factor Time Factor


20% 20%
1 0.833 1 0.833
2 0.694 2 1.528
3 0.579 3 2.106
4 0.482 4 2.589
5 0.402 5 2.991

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Question 4
Krug Inc. is considering shortening its credit period from 30 days to 20 days and believes, as a
result of this change, its average collection period will decrease from 36 days to 30 days.

The firm is currently selling 300,000 units but believes as a result of the change, sales will decline
to 275,000 units. On 300,000 units, sales revenue is $4,200,000, variable costs total $3,300,000,
and fixed costs are $300,000. The firm pays 15 percent on working capital financing. (Assume a
360-day year)

Required
(a) Evaluate this proposed change and make a recommendation to the firm.
(8 marks)

(b) Discuss the tradeoffs in tightening credit standards. (5 marks)

(c) A good credit control system encourages customers to pay on time. Give Krug some
advice. (7 marks)

- END OF PAPER -

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