UNIVERSITY OF KWAZULU-NATAL

SCHOOL OF ACCOUNTING
Managerial Accounting and Finance 3
(Codes: MAFM300WY & MAFM300PY)

NOVEMBER EXAMINATION 2007

TOTAL MARKS: 200 DURATION: 3 HOURS

INTERNAL EXAMINERS: Staff of School of Accounting

EXTERNAL EXAMINER: Mrs N Trikamjee, B.Com Hons, PGDip Bus Mgt
CA(SA)

DO NOT TURN THIS PAGE OVER UNTIL INSTRUCTED TO DO SO

INSTRUCTIONS TO CANDIDATES:

1. This paper consists of four (4) questions. Each question is worth 50

marks. The recommended time per question is 45 minutes.

2. There are 12 numbered pages, including this cover sheet. Please check
that your paper is complete.

3. Answer each question in a separate blue answer book. All answer books
must be handed in, even if a question is not attempted.

4. Complete all the details on the front cover of all blue answer books.
Please ensure that your student number and the relevant question number
are legibly recorded.

5. Write your answers in blue or black ink only. Answers, including

workings, submitted in pencil will not be marked.

6. Use both sides of the paper in the answer book.

7. State your assumptions if deemed necessary. Ensure that you provide

suitable workings in support of your answers.

8. The use of non-programmable silent calculators is permitted.

9. Failure to follow the above instructions may result in your answer

being unmarked.

1
 QUESTION 1 (50 MARKS : 45 MINUTES)

You have recently been engaged as management accountant for Incisive

Connections (Pty) Limited a progressive company the produces and distributes a
unique notebook computer.

The company’s product is revolutionary in that the notebooks are extremely

compact, and because of new technology developed by the company, the
notebooks do not require conventional modems in order to connect to the
Internet.

The company anticipates exceptional benefits arising from the use of the new
notebook and the technology will significantly impact the information technology
industry. Unfortunately rapid expansion for the company in the short to medium
term is limited and until the product gains acceptance, Incisive Connections is
faced with a high level of fixed costs.

The company’s plant presently has a maximum capacity of 50 000 units and it is
at this production level that the average cost per notebook is at is at its lowest. At
lesser production levels the average cost per notebook is higher1, the main
reason being the heavy fixed asset base. Consequently, the higher the
production level, the higher the overall profitability of the company.

The board of directors fully appreciate the special situation of the company, but
at the same time they are concerned about medium term profitability. In the light
of this, the managing director suggests you fully analyse the company’s revenue
and cost structure.

Your preliminary investigation reveals the following:

Production volume (units) 20 000 30 000 40 000 50 000

Average cost per unit2 R1000 R750 R625 R550
Current sales and production volume 45 000
(units)
Unit selling price R600

1. The lower the volume level the higher the average cost.
2. Defined as the total of fixed and variable costs, divided by the production
volume

Requirement 1:

1) Determine the amount of Incisive Connections (Pty) Limited’s fixed

costs. (8 marks)

2
 QUESTION 1 CONTINUED

2) Calculate the profit of the company at its current sales volume of

45 000 units. (4 marks)

3) What is the company’s the break-even point in units? (3 marks)

4) Calculate the company’s margin of safety expressed as a percentage

and also indicate the significance of this figure. (3 marks)

5) Advise the managing director of the assumptions underlying cost-

volume-profit analysis. (8 marks)

The board of directors obviously desire the company to operate at full capacity.
At recent meetings they have considered strategies to achieve this goal. Most of
the suggestions proved not to be feasible except for a proposal from the
Marketing Director.

The Marketing Department is able to secure an export order for the remaining
5 000 notebooks to take the company to full capacity. However, mainly because
of global competition the maximum price per unit that the company can expect
from the export order is R325. Most of the directors are not at all happy at the
prospect of selling notebooks overseas at price significantly lower than the local
cost and most of them are of the opinion that the export order should be rejected.

The managing director wants you to investigate the implications if the export
order is accepted at a price of R325 provided the size of the order is increased to
15 000 units.

Requirement 2:

Before responding to the managing director certain groundwork is

necessary and you need to calculate the following:

1) The change in profits from accepting the order for 5 000 units at
R325. (4 marks)

2) The change in profits from accepting an order for 15 000 units at

R325. (6 marks)

3) Briefly explain and justify which proposal, if either, should be

accepted. (4 marks)

4) Identify two non-financial factors that should be taken into account

before making a final decision. (4 marks)

3
QUESTION 1 CONTINUED

Requirement 3:

This part of the question is independent of requirements 1 and 2 above.

Incisive Connections (Pty) Limited makes all the components in the manufacture
of the notebook computer. Control Instruments CC, a local firm making levers
and switches has offered to make all the necessary on/off switches for the
notebook at a price of R37,50. Control Instruments CC has done work for Incisive
Connections (Pty) Limited in the past and is regarded as a reliable supplier.

Incisive Connections (Pty) Limited are presently making the switch at the
following per unit cost:
R
Direct material 20,00
Direct labour 10,00
Variable overhead 5,00
Fixed overhead 9,00
44,00

Required:

1. Should Incisive Connections (Pty) Limited take up the offer of

outsourcing the notebook switch? (3 marks)

2. Would it make any difference if the company is operating at full

capacity making the switch and that if it accepts the outsourcing
offer it could instead make another small product that has a
contribution of R10 per unit? (3 marks)

4
QUESTION 2 (50 MARKS : 45 MINUTES)

Latchet Limited uses a standard absorption costing system. Standards are

based on budgets for the current period. Raw material stocks are kept at
standard prices.

Standard costs for the current period are:-

Material A : R1,20 per unit

Material B : R2,60 per unit
Direct labour : R2,05 per hour

Standard finished product contents for the current period are:-

Product X Product Y
Material A 12 units 12 units
Material B 6 units 8 units
Direct labour 14 hours 20 hours

The budgeted sales for the current period were:-

Total sales value

Product X : 600 units R63 000
Product Y : 150 units R24 000

The budgeted expenses for the current period were:-

R
Direct labour 11 400 hours at R2,05 23 370
Fixed manufacturing costs (Absorbed on the basis of direct
labour hours) 5 700
Variable manufacturing costs (varies with direct labour hours) 17 100
Selling expenses – fixed 4 000
Administration expenses – fixed 7 500

The actual information for the current period is:-

R
Sales: Product X : 500 units 52 700
Product Y : 100 units 16 400
Purchases: Material A : 8 500 units 9 725
Material B : 1 800 units 5 635

Material requisitions: Material A Material B

Actual quantity issued 7 600 units 3 950 units
Returned to stores 75 units -

Actual direct labour hours 10 000 hours

5
QUESTION 2 CONTINUED
R
Wages paid: 500 hours at 2,10
8 000 hours at 2,00
1 500 hours at 1,90

R
Expenses: Manufacturing 21 325 (Note 1)
Selling 3 250
Administrative 6 460

Note 1: (includes fixed manufacturing costs in line with budget)

REQUIRED

a) Calculate the standard unit profit of Product X and Product Y and the
budgeted profit for the period. (8 marks)

b) Calculate the variances listed below, from the information provided, that
would be presented to management.

1) Material price variance for material A.

2) Material usage variance for material B.
3) Labour rate variance
4) Labour effiency variance
5) Variable overhead expenditure variance
6) Variable overhead efficiency variance
7) Fixed overhead expenditure variance
8) Sales margin price variances for Product X
9) Sales margin volume variance for Product Y
10) Fixed overhead volume capacity variance
11) Fixed overhead volume efficiency variance
(28 marks)

c) Provide two reasons why each of the variances referred to in items 1, 2 and
8 above could have arisen indicating clearly whether these variances are
adverse or favourable. (6 marks)

d) Discuss in general, the ways in which variance analysis helps management to

control a business. (Note: there is no need to refer to specific variances.)
(8 marks)

NB. ALL INTERMEDIATE CALCULATIONS ARE TO BE WORKED TO 4

DECIMAL PLACES AND FINAL ANSWERS TO BE ROUNDED OFF TO
THE NEAREST WHOLE NUMBER.

6
QUESTION 3 (50 MARKS : 45 MINUTES)

Your aunt, Mrs Sharp has inherited a large amount of money. She has decided
that she would like to invest in shares on the JSE market. As she knows that you
have been taught invaluable principals in your Manfin 300 course she has asked
for your professional evaluation of her investment options. Her investment broker
has supplied her with all the relevant information on his recommended shares
and the market, which is supplied below:

State of Probability Market return Share A Share B

economy:
Strong 0.25 15% 20% 19%
Moderate 0.60 12% 13% 15%
Weak 0.15 10% 10% 14%

A summary of statistics that you have already calculated is shown below. Do not
recalculate any of these figures given as no marks will be awarded!

Summary Market return Share A Share B

Expected return 12.45% ??? 15.85%
(Re)
Variance 2.648 ??? 3.428
Standard deviation 1.627 ??? 1.852
Covariance with n/a 5,565 2.918
the market
Beta 1 ??? 1.1
CAPM Required 12.45% ??? 12.695%
return
Covariance n/a 6,345
between Share A
and Share B

The R153 Government Bond (considered risk free) is trading at a yield to

maturity of 10%. (Ignore taxation)

You are required to: (all answers to 3 decimal places maximum)

a) For Share A calculate the expected return, variance, standard deviation,

and the beta. (10 marks)

b) What does the standard deviation measure? (2 marks)

c) Using the CAPM formula, determine the required return for Share A.
(4 marks)

7
 QUESTION 3 CONTINUED

d) If you were considering the expected return and the required return of
Share A and Share B individually which share would be a superior
investment? In your explanation draw a diagram of the Security Market
Line and plot the expected and required rates of return for each share.
(8 marks)

e) Explain the difference between the Security Market Line (SML) and the
Capital Market Line (CML) (2 marks)

f) Calculate the probability that the returns will exceed 14,7% for Share B
only. (5 marks)

g) Mrs Sharp is considering mixing a portfolio of 50% of Share A and

50% of Share B. For the new portfolio calculate the:-
a. expected return (2 marks)
b. portfolio beta (2 marks)
c. new required rate of return (2 marks)
d. Correlation Coefficient (3 marks)
e. Standard deviation (4 marks)

h) Explain to Mrs Sharp whether the new portfolio would decrease the risk of
her investments or whether the risk would remain the same.
(2 marks)

i) Briefly explain the difference between systematic risk and unsystematic

risk. Which are investors more concerned about and in what unit of
measurement is this risk typically expressed?
(4 marks)
USEFUL FORMULAE:

COV(A, B)
ρ AB =
σ Aσ B

β p = w β A + (1 − w) β B

COVi , j = ∑ ([ Ri − E ( Ri )] x [ R j − E ( R j )]xPi )
n

i =1

σ COV( Ri , R m )
β i = CORim i Or βi =
σm σ 2m

σp = w A σ A + wB σ B + 2 w A wB COV (A,B)
2 2 2 2

8
QUESTION 3 CONTINUED

EXTRACT: AREAS UNDER THE STANDARDISED NORMAL DISTRIBUTION

Z…. .02
0.3 .1255
0.4 .1628
0.5 .1985
0.6 .2324

9
 QUESTION 4 ( 50 MARKS : 45 MINUTES)

Paperco (Pty) Ltd is a manufacturer in the paper industry. The shares in the
company are held as follows:

No of shares
Mr Mondi 14 000
Mr Sappi 35 000
Ms Pine 35 000
Ms Wattle 16 000
100 000

The shareholders of Paperco (Pty) Ltd entered into an agreement that contains,
inter alia, the following clauses:

1. The company will always declare one third of its after-tax profits as
dividends.

2. On retirement or death of a shareholder, the shares are to be sold as

follows:
(i) the shares will be offered to the remaining shareholders in
proportion to their existing interest in the company;
(ii) if any of the shareholders cannot or do not wish to take up the
shares, the retiring shareholder shall then offer these shares to
the remaining shareholders in proportion to their existing
interest in the company;
(iii) if none of the existing shareholders wish to purchase the
available shares, they may be sold to an outsider;
(iv) the value of the shares will be determined by the auditor of the
company.

The company’s income statements for the past four year is summarized below:

2003 2004 2005 2006

R R R R
Operating income 800 000 800 000 850 000 900 000
Exceptional item (150 000)
Bad debt (60 000)
Net income before taxation 800 000 650 000 790 000 900 000
Taxation 320 000 260 000 316 000 360 000
Net income after taxation 480 000 390 000 474 000 540 000
Dividends 160 000 130 000 158 000 180 000
Retained income for the year 370 000 260 000 316 000 360 000
beginning of year 121 000 441 000 701 000 1 017 000
end of year 441 000 701 000 1 017 000 1 377 000

10
QUESTION 4 CONTINUED

BALANCE SHEET

2006
R
ASSETS
Non-current operating assets 1 200 000

Current assets 800 000

Stock 400 000
Debtors 250 000
Bank 150 000
2 000 000

EQUITY AND LIABILITIES

Share capital 100 000 shares @ R1 each 100 000
Retained earnings 1 393 000
Current liabilities
Creditors 307 000
2 000 000

The exceptional item arose from a failed joint venture with a trucking company.
Paperco (Pty) Ltd withdrew from the joint venture and has not entered into any
other similar business undertakings.

The bad debt written off relates to a debtor raised in 2003.

The directors’ salaries are in total R100 000 less than the ‘going rate’ for senior
management in the paper industry.

Paperco (Pty) Ltd has received an award from an environmental awareness

group for their innovative production methods which have substantially reduced
the pollution associated with the manufacture of paper. The quality of the paper
was maintained at its high standard.

The company does not depend on borrowed money for any long-term capital.

The effective tax rate paid by the company was 40% for all years.

The following information relates to listed companies having the same business
activities:

11
QUESTION 4 CONTINUED

Earnings yield 12%

Dividend yield 6%
Current ratio 2:1
Growth in earnings 12%

The current return on Treasury bills is 10%. The market premium has been
calculated at 8%. Paperco (Pty) Ltd has an estimated beta of 0.5 and this is
consistent with companies in the same industry.

During 2006 Ms Wattle decided that she would like to retire at the end of the
year. As required by the shareholders’ agreement, she offered her shares to the
remaining shareholders. Mr Mondi declined the offer as he is retiring in one
years’ time. Mr Mondi is the technical director with many years of experience in
the paper industry. Ms Pine also declined due to personal financial constraints.
Ms Wattle therefore offered to sell her shares to Mr Sappi who in principle, has
agreed to acquire her shares.

Ms Wattle’s departure will have an impact on the business. Ms Wattle

maintained a close relationship with customers and this has contributed to the
company’s success.

As the auditor of the company you have ascertained the following with regard to
the assets of the company:
• included in the stock value is R50 000 of paper which recently damaged
when a water main burst in the warehouse. The stock has no re-sale
value;
• bad debts are estimated to be 4% of total debtors balances. No
adjustment has been made for this in the debtors’ accounts;
• an independent valuator considers the fixed assets to be over-valued by
R140 000.

REQUIRED:

As the company’s auditor, draft a comprehensive report to the shareholders of

Paperco (Pty) Ltd wherein you derive a value for Ms Wattle’s shares and Mr
Sappi’s shares.

12