CMA DECEMBER-2018 EXAMINATION

OPERATIONAL LEVEL
SUBJECT: P1. PERFORMANCE OPERATIONS

MODEL SOLUTION

SECTION B

Solution to the question No. 2

(a)
The following table is prepared to compute the Economic Order Quantity.
Annual Number of Units per Average Carrying Order Total
Consumption orders p.a. order Inventory cost @ placing annual
Units Tk.4 per and costs
unit on receiving
average cost @
inventory Tk.100 per
order
800 1 800 400 Tk.1600 Tk.100 1700
2 400 200 800 200 1000
3 267 133 532 300 832
4 200 100 400 400 800*
5 160 80 320 500 820
6 133 67 268 600 868

* The total annual cost of Tk.800 is the lowest when number of orders placed are 4 in a year. This
means that the quantity per order of 200 [4 orders per year] is the Economic Order Quantity.

(b)
The following working notes will have to be prepared for computation of variable overhead variances.
A] Standard variable overhead per unit = Tk.10, 000/400 units = Tk.25 per unit
B] Standard variable overhead per hour = Tk.10, 000/8, 000 hrs = Tk.1.25 per hour
C] Recovered variable overhead = Actual output X Standard variable overhead per hour 360 units X
Tk.25 = Tk.9, 000
D] Budgeted variable overheads [Based on actual hours worked] – Actual hours worked X Standard
variable overhead per hour = 7, 000 hrs X Tk.1.25 = Tk.8, 750
E] Standard hours for actual output = Actual output X Standard hours per unit = 360 units X 20 hours
= 7,200 hours
Computation of Variable overhead variances
I] Variable overhead cost variance – Recoverable variable overhead – Actual variable overhead =
Tk.9, 000 – Tk.9, 150 = Tk.150 [A]
II] Variable overhead budget or expenditure variance – Budgeted variable overheads – Actual variable
overhead = Tk.8, 750 – Tk.9, 150 = Tk.400[A]
III] Variable overhead efficiency variance – Standard variable overhead per hour [Standard hours for
actual output – Actual hours] = Tk.9, 000 – Tk.8, 750 = Tk.250[F]

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(c)

Product X (Tk.) Product Y (Tk.)

Selling price 46 62
Material cost (18) (16)
Throughput contribution 28 46
Machine hours per unit 0.5 hours 0.8 hours
Return per machine hour 56 57.50
(ii)
Product X Product Y Total
Return per machine hour Tk. 56 Tk.57.50
Ranking 2 1
Units produced 3,200 8,000
Machine hours 1,600 6,400 8,000
Contribution per machine hour Tk. 56 Tk.57.50
Total contribution Tk. 89,600 Tk.3,68,000 Tk.4,57,600
Factory costs Tk. 248,000
Total profit Tk. 209,600

(d)

Project Investment Net present value Profitability index Ranking

AB 10 4.20 0.4200 2
BC 40 6.10 0.1525 6
CD 20 8.50 0.4250 1
DE 40 13.70 0.3425 3
EF 50 3.80 0.0760 7
FG 20 4.90 0.2450 4
GH 20 4.33 0.2165 5

Project Investment Net present value Ranking

CD 20 8.50 1
AB 10 4.20 2
DE 40 13.70 3
FG 10 2.45 4
80 28.85

The maximum net present value is Tk.28.85 million

(e)

(i) Annual sales revenue = Tk.1,095,000

Factoring fee Tk.1,095,000 x 2.5% = Tk.27,375

Annual interest (90% x Tk.180,000) x 12% = Tk.19,440

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 Tk.46,815

Savings in credit control costs Tk.20,000

Net cost of factoring Tk. 26,815

(ii) The company requires to borrow – Tk.180,000 x 90% =Tk.162,000

The cost of borrowing is therefore – Tk.162,000 x 15% = Tk.24,300

There is therefore no financial benefit in factoring as the cost of borrowing is less than the cost of
factoring.

SECTION C

Solution to the question No. 3

(a)
Year 1 expected sales revenue = Tk. 435m
[(Tk. 450m x 50%) + (Tk. 300m x 30%) + (Tk. 600m x 20%)]
Year 2 sales revenue = Tk. 435m +100m = Tk. 535m
Year 3 sales revenue = Tk. 535m + 100m = Tk. 635m
Year 4 sales revenue = Tk. 635m + 100 = Tk. 735m

Contribution Year 1 = Tk. 435m x 60% = Tk. 261m

Contribution Year 2 = Tk. 535m x 60% = Tk. 321m
Contribution Year 3 = Tk. 635m x 60% = Tk. 381m
Contribution Year 4 = Tk. 735m x 60% = Tk. 441m

Fixed Costs
Depreciation per annum (Tk. 600m - Tk. 400m) / 4 = Tk. 50m
Fixed costs excluding depreciation = Tk. 150m - Tk. 50m = Tk. 100m

Cash Flows
Year 1 (Tk.) Year 2 (Tk.) Year 3 (Tk.) Year 4 (Tk.)
Contribution 261 321 381 441
Fixed Costs (100) (100) (100) (100)
Marketing Costs (50) (50) (50) (50)
Net cash flows 111 171 231 291

Taxation
Year 1 (Tk.) Year 2 (Tk.) Year 3 (Tk.) Year 4 (Tk.)
Net cash flows 111 171 231 291
Tax (150) (113) (84) 147
Depreciation
Taxable profit (39) 58 147 438
Taxation @ 30% 12 (17) (44) (131)

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Net present value

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

(Tk.) (Tk.) (Tk.) (Tk.) (Tk.) (Tk.)
Development and fit out costs (600) 400
Working capital (60) 60
Net cash flows 111 171 231 291
Tax payment 6 (9) (22) (66)
Tax payment 6 (8) (22)
(65)
Net cash flow after tax (660) 117 168 201 663
(65)
Discount factors @ 8% 1.000 0.926 0.857 0.794 0.735
0.681
Present value (660) 108 144 160 487
(44)
Net present value = Tk. 195m
The net present value is positive therefore on this basis the company should go ahead with the
project.

(b) (i)
Year 1 Year 2 Year 3 Year 4 Year 5 Total
(Tk.) (Tk.) (Tk.) (Tk.) (Tk.) (Tk.)
Fixed costs 100 100 100 100
Tax @ 30% 30 30 30 30
Tax payment (15) (30) (30) (30) (15)
Discount factors @ 8% 0.926 0.857 0.794 0.735 0.681
Present value 79 60 56 51 (10) 236
Tk. 195 / Tk. 236 = 82.6%
If fixed costs increase by more than 82.6% the NPV of the project will be negative and the decision
will be to reject the project.

(ii) Sensitivity analysis recognizes the fact that not all cash flows for a project are known with
certainty. Sensitivity analysis enables a company to determine the effect of changes to variables on
the planned outcome. Particular attention can then be paid to those variables that are identified as
being of special significance. In project appraisal, an analysis can be made of all the key input factors
to ascertain by how much each factor would need to change before the net present value (NPV)
reaches zero i.e. the indifference point. Alternatively, specific changes can be calculated to determine
the effect on NPV.

Solution to the question No. 4

Alternative A: (Factoring Cost)
Given that,
Monthly Credit sales=1,25,000
Average collection period= 60 days
Factor charge=2.5%
Compensating balance =(100%-80%)=20%
Interest charge=12%
Save for cost of credit administration=1500 per month
Save for bad debt loss=125,000×2%=2500 per month
So we have to be find out: Usable loan and Effective Interest Rate (EIR)

Average level of A/R= (Annual credit sale× Average collection period)/360 days
={(1,25,000 × 12) ×60}/360
=2,50,000
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Calculation of Usable Loan:
Average level of A/R 2,50,000
Less: Factoring charge (2.5% of 2,50,000) 6,250
Less: Compensating balance (20% of 2,50,000) 50,000
1,93,750
Less: Interest Charges
{(193750×12%)×60/360} 3,875
Usable Loan 1,89,875

Calculation of Net Factoring Cost:

Annual interest charge (3,875×6 times) 23,250
Annual factoring cost (6250×6 times) 37,500
60,750
Less: Save for credit administration (1500×6 9,000
Less: Save for bad debt loss (2500×6) 15,000
Net factoring cost 36,750

We know, EIR= (Net factoring cost ÷ Usable Loan) ×100=19.35%

Alternative B: (Cost of Commercial Paper)

Given that,
Face value (FV)=1,000
Sale Value / Net Value (SV)= 955
Maturity period = 6 months=120 days
So we have to find out: EIR=?
We know,
EIR= {(FV- SV-Floatation cost) ÷ SV} × (360 days ÷ Maturity period)
= {(1000-955-5) ÷ 955}× (360÷120) =15.71%

Alternative C: (Cost of Bank Loan)

(i) Given that,
Granted loan = 2,00,000
Interest rate= 12%
Compensating rate= 20%
So we have to find out: EIR=?

Calculation of Usable Loan:

Granted loan 2,00,000
Less: Compensating charge (20%) 40,000
Usable Loan 1,60,000
We know,
EIR = {(Interest rate × Granted loan) ÷ Usable loan}× 100
={(12% ×2,00,000) ÷ 1,60,000}×100 = 15%

(ii) Given that,

Granted loan = 2,00,000
Interest rate= 14%
Compensating rate= 10%
So we have to find out: EIR=?

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Calculation of Usable Loan:
Granted loan 2,00,000
Less: Compensating charge (10%) 20,000
Usable Loan 1,80,000

We know,
EIR = {(Interest rate × Granted loan) ÷ Usable loan}× 100
={(14% ×2,00,000) ÷ 1,80,000}×100 = 15.56%

Financing Decision

Alternatives A Cost of factoring A/R = 19.35%

Alternatives B Cost of Commercial Paper = 15.71%
Alternatives C(i) Cost of Bank Loan= 15% (Cheapest)
Alternatives C(ii) Cost of Bank Loan=15.56%

So as a finance manager I have to suggest to choose Alternatives C(i).

*End of the Exam Paper*

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