Answer to Question 1
- Most profitable preparation
| Particulars | RG40 | RG50 | RG60 |
| Selling Price | 110 | 140 | 100 |
| Less: Variable Costs | | | |
| Total Variable Costs | 64 | 88.4 | 74.6 |
| Contribution | 46 | 51.6 | 25.4 |
| Ranking | 2 | 1 | 3 |
The most profitable use of the machine hours and restricted material quantity is to produce the maximum demanded production of all the three products for a particular week.
In case, the product XG is produced by the entity itself, then the profitability of the entity will be as follows:
| Particulars | RG40 | RG50 | RG60 |
| Selling Price | £ 110.00 | £ 140.00 | £ 100.00 |
| Variable Costs without XG | £ 64.00 | £ 38.40 | £ 74.60 |
| Variable Costs including XG | £ – | £ 31.50 | £ – |
| Total Variable Costs | £ 64.00 | £ 69.90 | £ 74.60 |
| Contribution | £ 46.00 | £ 70.10 | £ 25.40 |
| Ranking | 2 | 1 | 3 |
As the contribution per unit is more, the entity should undertake the production of the good XG by itself rather than outsource it.
Profit foregone by deferring Brook Ltd.
| Particulars | RG40 | RG50 | RG60 |
| Total sales | £ 132,000.00 | £ 168,000.00 | £ 180,000.00 |
| Less: Variable Costs | £ 76,800.00 | £ 83,880.00 | £ 89,520.00 |
| Contribution | £ 55,200.00 | £ 84,120.00 | £ 90,480.00 |
- On the basis of the calculation for the 6 weeks, it can be suggested that the business should produce by the Product XG by itself and do not defer the contract with Brook Ltd. as it adversely impacts the profitability of the business. Similarly, the business should also give more priority to RG50 in terms of production as it would earn more profits.
Answer to Question 2
- Relevant Cash Flow
| Particulars | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 |
| Cash Outflow | -£ 2,500,000.00 | | | | |
| Cash Inflows: | | | | | |
| Sales | | £ 3,125,000.00 | £ 3,750,000.00 | £ 5,000,000.00 | £ 6,250,000.00 |
| Total Costs | | -£ 3,275,000.00 | -£ 4,055,000.00 | -£ 5,180,000.00 | -£ 6,290,000.00 |
| Cash flow from sale of machinery | £ 350,000.00 | | | | £ 400,000.00 |
| Annual Savings in the cost of machinery | | 250000 | 250000 | 250000 | 250000 |
| Fees of marketing consultanats | -£ 110,000 | | | | |
| Cost of Directors | -£ 50,000 | | | | |
| Additional advertising expenditure | -£ 400,000.00 | -£ 80,000.00 | -£ 80,000.00 | -£ 60,000.00 | -£ 60,000.00 |
| Maintenance Costs | | -£ 25,000.00 | -£ 35,000.00 | -£ 49,000.00 | -£ 68,600.00 |
| Replacement of Key Components | | | -£ 65,000.00 | | |
| Relevant Cash Flow | -£ 2,710,000.00 | -£ 5,000.00 | -£ 235,000.00 | -£ 39,000.00 | £ 481,400.00 |
- Net Present Value of the project
| PV Factors | 1 | 0.909 | 0.826 | 0.751 | 0.683 |
| PV of Cash Flow | -£ 2,710,000.00 | -£ 4,545.00 | -£ 194,110.00 | -£ 29,289.00 | £ 328,796.20 |
| NPV of project | -£ 2,609,147.80 | | | | |
- NPV by taking Director’s Concerns
| PV of Cash Flows | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 |
| Net Cash Flows | -£ 2,710,000.00 | -£ 5,000.00 | -£ 235,000.00 | -£ 39,000.00 | £ 481,400.00 |
| Less: Reduction in Sales | | | | | |
| Product W | | -£ 250,000.00 | -£ 200,000.00 | -£ 250,000.00 | -£ 176,000.00 |
| Product G | | -£ 180,000.00 | -£ 140,000.00 | -£ 96,000.00 | -£ 78,000.00 |
| Net Cash Flows | -£ 2,710,000.00 | -£ 435,000.00 | -£ 575,000.00 | -£ 385,000.00 | £ 227,400.00 |
| PV | -£ 2,710,000.00 | -£ 395,415.00 | -£ 474,950.00 | -£ 289,135.00 | £ 155,314.20 |
| NPV | -£ 3,714,185.80 | | | | |
The new project is not worth it due to a significantly negative value of the NPV of the project.
- The short run issues are that the new machine will not be able to generate sufficient profits for the business on an immediate basis. Hence, it may not be wise to sell the machinery without sufficient liquidity. The long term concerns may arise about its efficiency and ability to continuously generate profits for the business.
- The quality of the machine, improvement in the scale and quality of the production, better utilisation of the available resources and generating sufficient resources for the usage of the machinery are some of the important factors to be considered.
Answer to Question 3
- Break-even sales
| Particulars | November | December | January | February | March | April | Total |
| Sales | £ 73,125 | £ 65,625 | £ 7,500,000 | £ 78,750 | £ 91,875 | £ 67,500 | £ 7,876,875 |
| Variable Cost per unit | £ 7 | | | | | | |
| Fixed Costs per month | £ 36,000 | | | | | | |
| | | | | | | | |
| Contribution per unit | £ 18 | | | | | | |
| Breakeven Sales per month | 2000 | | | | | | |
| Annual break-even sales | 24000 | | | | | | |
- Profitability of the business
| Required Profit | £ 300,000 |
| Total Fixed Costs | £ 432,000 |
| Contribution | £ 732,000 |
| Units to be Sold | 40667 |
| Margin of Safety | 69.44% |
| | Proposal 1 | Proposal 2 | Proposal 3 |
| Sales | £ 512,426.25 | £ 493,447.50 | £ 607,320.00 |
| Less: Variable Costs | £ 351,378.00 | £ 129,055.50 | £ 195,210.00 |
| Contribution | £ 161,048.25 | £ 364,392.00 | £ 412,110.00 |
| Total Fixed Costs | £ 432,000.00 | £ 472,000.00 | £ 507,000 |
| Profit | -£ 270,951.75 | -£ 107,608.00 | -£ 94,890.00 |
Based on the three proposals, Proposal 3 is the best one which should be accepted by the business at a given point of time.
- The continuation of the production, ability to sustain the customer levels, continuous quality generated by the business and ability to generate sufficient profits for the business are some of the important factors which need to be taken into consideration by the business before the acceptance of a proposal.
| Answer to Question 3 |
|
| a) | Particulars | November | December | January | February | March | April | Total |
| Sales | £73,125 | £65,625 | £7,500,000 | £78,750 | £91,875 | £67,500 | £7,876,875 |
| Variable Cost per unit | £7 |
| Fixed Costs per month | £36,000 |
|
| Contribution per unit | £18 |
| Breakeven Sales per month | 2000 |
| Annual break-even sales | 24000 |
|
| b) | Required Profit | £300,000 | 18075 | Sales | £451,875 |
| Total Fixed Costs | £432,000 | Less: Variable Costs | £126,525 |
| Contribution | £732,000 | Contribution | £325,350 |
| Units to be Sold | 40667 | Fixed Costs | £432,000 |
| Margin of Safety | 69.44% | Profit | -£106,650 |
|
| c) | Proposal 1 | Proposal 2 | Proposal 3 |
| Sales | £512,426.25 | £493,447.50 | £607,320.00 |
| Less: Variable Costs | £351,378.00 | £129,055.50 | £195,210.00 |
| Contribution | £161,048.25 | £364,392.00 | £412,110.00 |
| Total Fixed Costs | £432,000.00 | £472,000.00 | £507,000 |
| Profit | -£270,951.75 | -£107,608.00 | -£94,890.00 |
|
