91. Business
1.Case Study – Rumpole Ltd
You are employed as the accountant of a manufacturing company called Rumpole Ltd that has been trading successfully for a number years.
The directors are keen to expand their operations and have asked you to advise them financially on various projects/issues that they are considering.
The directors have 3 separate tasks for you to advise them on that require a written response.
Task 1
The directors are considering manufacturing and developing a new product requiring £2million investment. The following are estimates of costs and revenues for the first five years of the products life:
Forecast sales:
Year Quantities sold (units) Selling price £ per Unit
1 5,000 250
2 15,000 230
3 22,000 200
4 15,000 200
5 5,000 200
New machinery will be bought at the start of the project at a cost of £2m. It is expected to have a resale value of £150,000 at the end of 5 years
Labour costs will be £40 per unit in year 1, rising by £2 per unit in each succeeding year.
Materials costs will be £80 per unit for the first two years of production, rising by 10% in year 3, and by a further £6 in each of years 4 and 5.
Other costs will be £25 per unit. These are forecast to remain unchanged over the life of the project.
The cost of capital to the company is 6% per annum
Required
Evaluate the project using investment appraisal technique by calculating the
Net Present Value (5 Marks)
Payback period (3 Marks)
Advise the company whether it should proceed with the new product.
(2 Marks)
The capital for the project will need to be raised by the management, suggest methods of raising this capital using equity and a method of raising the capital required by debt. (10 Marks)
Discuss the advantages and disadvantages of both the equity and debt methods of raising capital to the company. (10 Marks)
Task 2
One of the ways in which the directors are hoping to expand Rumpole Ltd is through acquisitions, One of the directors has suggested a company called Genisis Ltd that they are considering whether to acquire. It has come the attention of the directors that this company is having problems.
Genisis Ltd was incorporated in 2009 and has grown rapidly over the past 4 years. The rapid rate of growth has created problems for the business, which the directors have found difficult to deal with. They recently employed a firm of management consultants to help them overcome the problems.
In a preliminary report to the board of directors, the management consultants state ‘ most of the difficulties faced by the business are symptoms of underlying problem of overtrading’
The most recent financial statements of the business are:
Statement of financial Position as at 31 October 2012
ASSETS £000
Non-Current Assets
Land & Buildings 442
Fixtures & Fittings 116
Motor vans at cost 64
622
Current Assets
Inventories 128
Trade receivables 104
232
Total Assets 854
EQUITY & LIABILITIES
Equity
Ordinary 50p shares 60
general reserve 50
Retained Earnings 74
184
Non-Current Liabilities
Borrowings – 10% Loan Notes 120
Current Liabilities
Trade payables 184
Taxation 8
Short term borrowings(overdraft) 358
550
Total Equity & Liabilities 854
Income Statement for the year ended 31 October 2012
£000 £000
Revenue 1640
Cost of Sales
Opening Inventories 116
Purchases 1260
Closing Inventories (128) (1248)
Gross Profit 392
Selling & Distribution expenses (204)
Administration expenses (92)
Operating Profit 96
Interest Payable (44)
Profit Before taxation 52
Taxation (16)
Profit for the year 36
All Purchases and sales were on credit
A dividend was paid during the year on ordinary shares of £4,000
Required
The directors require an explanation of the term overtrading and how this may arise for a business (10 Marks)
A discussion of the possible problems that overtrading can create for a business and the ways in which a business may overcome the problem of overtrading (10 Marks)
Calculate and discuss five financial ratios that might be used to establish whether the business is overtrading (20 Marks)
Task 3
The production department has highlighted a potential problem with supply of material in the manufacturing department to the directors.
The following information relates to the manufacturing of Rumpole Ltd’s four key products:
Product A B C D
Maximum demand (units 2,000 3,100 2,500 2,750
£ £ £ £
Sales 60 108 40 50
Variable costs
Materials 20 40 12 16
Labour 24 48 10 24
Contribution 16 20 18 10
All four products are produced using the same material that costs £8 per kg. and is currently in short supply. Due to supply difficulties only 20,000 kg is available for the period. Fixed costs are £30,000 for the period.
Required:
Taking into account this limiting factor, determine the optimal production plan, assuming that the company wishes to maximise profits. Show the level of profit that can be achieved (10 marks)
An explanation of the term ‘limiting factor’, also what action might a company take to reduce the chance of experiencing a limiting factor in the production process? (20 marks)
Additional Guidelines
The answers to all three questions need to be written in a professional form an appropriate to the task. A report or memo would be an appropriate format.
Word Count (+/- 10%) 2500
All calculations must be detailed and presented clearly
Use of published work (citing reference) within the text is expected
A full list of references should be presented at the end of the case study
Include the assignment front sheet, which is included in the module guide