You work for Alphabet Holdings Plc as a junior management accountant.
The board of directors are considering ways to improve the suboptimal performance of an investment in a manufacturing company called DEF products Ltd.
As you can see from the table below the directors are considering closing products Bozon and Carbon in an effort to improve overall profitability.
You spot that marginal costing would show the results differently and may affect the directors’ decision.
i. Use your knowledge of management accounting and marginal costing to calculate the contribution of each product 5 marks
ii. Use your findings from part (a) and appropriate academic references to explain whether the company should stop making product Bozon 2 marks
iii. Use your findings from part (a) and appropriate academic references to explain whether the company should stop making product Carbon 2 marks
iv. Discuss how and why marginal costing calculates contribution to pay overheads and why this is useful in evaluating product value to a firm? 3 marks
v. Do you agree that profitability will improve by ceasing to make Products Bozon and Carbon? What do you suggest the company does to increase profitability? 3 marks
Question 3 300 words
As an Alphabet Holdings Plc junior management accountant, the Finance Director wants your calculations and recommendation regarding an expansion plan the Board is considering, which includes a chain of factory outlet stores.
Below are the figures for the first one that is planned for a central Birmingham location next year.
Company policy dictates that any decision should be based on the results of calculating Net Present Value (NPV) of 3 years of cash flows using a cost of capital of 12%, Payback Period (PBP) must be less than 3 years, and the Internal Rate of Return (IRR) of the project should provide a 5% cushion in case of increases in inflation or interest rates.
The investment consists of £100,000 for the land, building costs of £158,000, and £36,600 for fittings and equipment.
The cash flows in year 1 are expected to be: total sales revenue £600,600; the cost of Axor products sold £165,900; Bozon stock sold £118,860; staff costs £24,780; light & heat £35,196; other overheads £134,904. The cash flows for years 2 and 3 are the same, but are expected to increase by 2% inflation each year.
Requirements for Question 3
Using the information above and in accord with the above stated company policy you are required to calculate:
i. Net Present Value (NPV) 5 marks
ii. Payback period (PBP) and Discounted Payback Period (DPBP) 5 marks
iii. Internal Rate of Return 1 marks
iv. Based on your calculations do you recommend the investment is made and the new outlet store is built? 2 marks
v. Critically discuss the limitations of the above project appraisal techniques used and any other recommendations to the board. 2 marks
