Question 1: Costing

i. The variable manufacturing cost per unit, the budgeted fixed manufacturing overhead rate
per unit and the total manufacturing cost per unit using the absorption costing.

Absorption costing refers to a managerial accounting method that captures all the cost
related to manufacturing of particular product. This include both the direct and indirect
costings such as direct labor, rent and insurance.
From the problem statement, the variable manufacturing costing is categorized into the raw
materials and direct labor cost per unit product produced. The number of units budgeted for
were 600 as result the calculations below answers the questions provided.

For a single unit, we therefore have

Variable manufacturing cost
¿ ∑ variable manufacturing cost ( per unit )=£ 16.00+ £ 12.00+ ¿ £ 34 per unit
Although the fixed does not change with the number of units, averagely the fixed
cost incurred in producing one unit is the sum of fixed cost divided by the budged
number of units. This yields the equations shown below
Budgeted fixed manufacturing overhead rate per unit
∑ manufacturing overhead = £ 75000+24000 =£ 16.5 per unit
budgeted units 6000
Total manufacturing cost

¿
∑ manufacturing overhead + variable cost per unit=£ 1 6.5+ £ 34=£ 5 0.5 per unit
budged units
ii.
In order to get the total cost incurred in production, we let the number of units produced be
unknown say x.
From i, it has be established that the fixed cost does not vary with the number of units that
are produced. The variable cost is however dependent on the number of units produced by
the company. As a result, the variable cost is evaluated as shown below
Total variable cost
( Selling∧adminstration variable cost +manufacturing variable cost ) x=(£ 28+ £ 6) x=£ 34 x
The total fixed cost remains the same irrespective of the number of units produced as a
result the total fixed cost incurred
¿ 75000+24000=99000
Hence the total cost of producing x units of the product becomes
£ 75000+ £ 24000+ £ 34 x=£ 99000+£ 34 x
Where x is the number of units produced.

iii. A breakeven point refers to the number of units at which the cost of production is
equivalent to the earnings of the sales of the units produced. Units above this value yield
profit to the company because the fixed cost remains the same.
 The breakeven point and the budgeted safety margin
From the costings, the absorption cost equation is evaluated as

C=£ 99000+ £ 34 x … … . i

Where x is the number of units produced by the company.

The earnings from x units is
E=55 x … … … … … … ii
The earnings form sales is evaluated from the statement. It was stated that each of the
product units costs £ 55.
A break-even point occurs when the earnings is equivalent to the total production cost from
the breakeven condition stated above hence equating equations (i) and (ii) we get
55 x=99000+34 x

Collecting the like terms, we get

55 x−34 x=99000

From which
99000 99000
x= = =4714.29 4715 units
55−34 21
A ltd must produce at least 4715 units of the components to balance the cost of production
and the earnings from the production. Producing units less than this makes it economically
inviable to produce the product because the company will be making losses while producing
units greater than this value results into net profit.

The budgeted safety margin.

Budgeted safety margin refers to the profit realized by company if they produce the
projected number of units. From the problem statement, the budgeted number of units is
6000. From part ii of the problem, the total cost of production equation was established.
The earnings for producing x number of units was also established in part iii of the question.
Using these two formulae with the argument x as 6000 we get the profit margin as shown
below.
For the budgeted plan,
X=6000
The earnings from production
Ebudgeted =55 × 6000=£ 330000

The cost of production

¿ 99000+ ( 34 × 6000 )=£ 303000
Profit safety margin
¿ £ 330000−£ 303000=£ 27000
iv. Profit statement using marginal costing
Marginal costs statements treat fixed variable and costs separately and indicates contribution.
It offers an alternative layout to the traditional income statement that is obtained from the
absorption costing. From the problem statement there were no opening inventory neither were
there closing inventory. As a result, these values are valued at zero in the statement. The
number of units produced from the problem statements was 6300. The fixed and the variable
costs are thus arranged in the income statement as shown below.

Marginal Costing Income Statement

sales revenue 55*6300 346500

marginal cost of sales
Opening inventory (valued @ marginal cost) 0
add cost of production (valued @marginal
cost) 6300(16+12) 176400
less closing inventory (valued @marginal cost) 0 176400 176400
170100
Less variable distribution and administration
cost 6*6300 37800 132300
contribution 0 0 132300
less fixed cost (production, distribution,
administration) 75000+24000 99000 33300
profit for the year 33300

From the income statement, the profit realized by the company is

33300

Question 3: Investment Appraisal.

Accounting rate of returns refers to the ratio of the average after tax profit divided the
average investment. The average investment is equivalent would be equal to the original
investment if it were depreciated uniformly. In this problem, the desired accounting rate of
return is provided as 15%.The cashflows are provided as indicated in the table below. In order
to compute accounting rate of return, the profit earned from investment is computed by
evaluating the difference between capital investment and the total cash flow. The average
annual profit is then computed from by dividing the profit with the number of years as shown.
i. Required accounting rate of return=15%
Profit
cashflow−investment =( 350000+200000+50000 )−500000=100000
Average annual profit
100000
3
Actual accounting rate of return
100000
( 3 ) × 100=6.6667 %
500000
Since actual accounting rate of return< Required accounting rate of return,
the company would not invest.
ii. The payback period is the time taken by the investment to start yielding a profit.
That point when the total cash inflow is equivalent to the capital invested. From the
table shown below, it can be shown that the net cash flow turns positive somewhere
just before the second year.
Net
New machine Cashflows cashflows
Investment -500000 -500000
year1 350000 -150000
year2 200000 50000
year3 50000 100000
Assuming that the cash flow rises linearly within the period, the actual payback
period arises from the relationship
150000
1 year + =1 year 9 months
200000
 iii. Net present value (NPV) refers to the difference between the present value of a
cash flow and the present value of the cash out flow over a given period of time.
From the problem statement, at the beginning of investment, the net present value
is -500000. The subsequent cash flows are characterized by positive cash flows which are
computed using the formula shown below.
(cash flows)
NPV = −C
(1+r )i
Where cash flows= cash flows in the time period
R=Discount rate
i=time period
From excel, the NPV are as shown below
C=investment
Net
New machine Cashflows cashflows NPV
Investment -500000 -500000
year1 350000 -150000 304347.8
year2 200000 50000 151228.7
year3 50000 100000 32875.81
Sum 488452.4
NPV -11547.6

The net present value is negative hence, the company cannot invest. The negative
NPV shows that the company would be running at losses should they decide invest.
iv. Internal rate of return refers to that rate that yields NPV value of zero. It can easily
be computed form NPV values by adjusting the value r in the equation below to yield
an NPV value of 0.
(cash flows)
From iii, the NPV= −C
(1+ r)i

Internal rate of return (IRR) is that value that sets NPV to zero hence
(cash flows)
=C
(1+ r)i
Hence
350000 200000 50000
+ + =500000
( 1+ r) (1+r )2 (1+ r)3
 Using Excel Solver, we set the value of NPV to 0 by changing the variable r while
maintain the other variables. From the Solver results, the value of
r 13.15828682%
The excel procedure used in computing the value of r is as shown in below

Microsoft Excel 16.0 Sensitivity Report

Worksheet: [Book1]Sheet2
Report Created: 12/3/2019 5:31:08 PM

Variable Cells
    Final Reduced
Cell Name Value Gradient
$B$ Discount=15% year 13.1582868
4 0 2 0

Constraints
Lagrang
    Final e
Multipli
Cell Name Value er
$C$ 0.00272479
8 NPV year 1 1 0

v.
Advantages
 NPV considers both the timing of cash flows and the size of the cash flow in
arriving at an appraisal. It therefore reveals whether an investment will
create value for a given organization. In the example above NPV has revealed
viability of the investment.
 NPV considers the time value of money and accounts for money’s
opportunity cost. In every period, the cash flows are discounted by another
period of the capital cost.

Disadvantages
 NPV does not give room for a comparison between two projects. The analysis
is only done for a single project and there is no way of comparing financial
projections of other projects.
 NPV method requires the determination of the rate of return. If higher rate
of return is assumed, it can show false negative NPV and if lower rate of
return is assumed, it will show false profitability of the project resulting into
wrong decision making.