Week 11 - Revision Sessions Flashcards

1
Q

Financial Reporting and Analysis – Week 11 Revision Session

  1. The trial balance of Kay Andrews at 30 June 2017 was as follows:
    Dr Cr
    £ £
    Opening capital 50,850
    Drawings 7,400
    Freehold premises 20,000
    Receivables and payables 9,500 5,350
    Inventory 1 July 2016 10,000
    Wages 3,650
    Office expenses 3,600
    Rates and insurance 2,900
    Purchases and sales 101,100 121,550
    Electricity 1,100
    Advertising 515
    Allowance for doubtful debts
    provision 1,000
    Rent received 800
    Depreciation at 1 July 2016:
    Office equipment 1,200
    Fixtures and fittings 650
    Lighting and heating 1,240
    Office equipment 6,000
    Fixtures and fittings 6,500
    Cash in hand 75
    Balance at bank 7,820
    181,400 181,400

You are also given the following information:

i) Inventory as at 30 June 2017 was valued at £15,500;
ii) Rates prepaid amounted to £400;
iii) It has been decided to increase the allowance for doubtful debts provision to £1,500;
iv) An electricity bill for £500 for the quarter up to June had not been paid;
v) A bad debt of £200 is to be written off;
vi) The office equipment is depreciated at 10% per annum, whereas the fixtures and fittings are depreciated at 5% per annum.

Required
Prepare the Income Statement for the year ended 30 June 2017 and the Statement of Financial Position as at 30 June 2017.

A

Income Statement for Kay Andrews for the year ending 31 December 2017
£ £
Sales 121,550
Cost of Goods Sold
Opening Inventory 10,000
Purchases 101,100
111,100
Less Closing Inventory -15,500 95,600
Gross Profit 25,950
Plus rent received 800
Less Expenses
Wages 3,650
Office expenses 3,600
Advertising 515
Light and heat 1,240
Rates and insurance 2,500
Electricity 1,600
Increase in allowance for DDP 500
Bad debt 200
Depreciation - Office equipment 600
Depreciation - Fixtures & fittings 325 14,730
Net Profit 12,020

Statement of Financial Position for Kay Andrews as at 31 December 2017
£ £ £
Non-Current Assets Cost AccDep WDV
Freehold premises 20,000 - 20,000
Office Equipment 6,000 1,800 4,200
Fixtures and Fittings 6,500 975 5,525
29,725
Current Assets
Inventory 15,500
Trade Receivables 7,800
Prepayment 400
Cash at Bank 7,820
Cash in Hand 75 31,595
Total Assets 61,320
Capital and Reserves
Opening Capital 50,850
Add Profit for the Year 12,020
Less Drawings -7,400 55,470
Current Liabilities
Trade Payables 5,350
Accrual 500 5,850
Total Liabilities 61,320

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2
Q

Financial Reporting and Analysis – Week 11 Revision Session

  1. Shown below are the statements of financial position of Premier Trust plc as at 31 December 2016 and 31 December 2017.
    2016 2017
    £000 £000 £000 £000
    Non-Current assets
    Property, plant & equipment 4,800 9,450
    Long-term investments 1,125 1,880
    5,925 11,330
    Current assets
    Inventory 1,605 2,355
    Trade Receivables 1,875 2,510
    Short-term investments 930 1,695
    Bank 285 0
    4,695 6,560
    Total Assets 10,620 17,890

Capital and reserves
Ordinary share capital 3,000 3,750
Share premium account 0 300
General reserve 900 1,200
Retained earnings 1,554 1,966
5,454 7,216
Non-current liabilities
Long-term loan 3,000 6,750
Current liabilities
Short-term loan 0 1,500
Bank overdraft 0 510
Trade payables 1,641 1,224
Taxation 525 690
2,166 3,924
Total Liabilities 10,620 17,890

The following information is also available:

i) The depreciation charge for 2017 was £600,000.
ii) Non-current assets sold during the year had a net book value of £375,000. Profit on disposal of these assets amounted to £60,000.
iii) The investments compromise shareholdings in other companies. Dividends received (net) and credited to profit and loss were £95,000 for the year.
iv) Interest charged during the year was £450,000.

Required

a) Prepare a cash flow statement for Premier Trust plc for the year ended 31st December 2017.
b) Comment on the state of the company’s trading situation.

A

Statement of Cash Flow for Premier Trust plc for the year ending 31 December 2017
£000 £000
Cash flow from operating activities
Operating profit 712
Plus
Depreciation 600
Interest 450
Taxation 165
Less
Profit on sale 60
Dividends received 95
Increase in trade receivables 635
Increase in inventory 750
Decrease in payables 417
Net cash outflow from operating activities -30

Cash flow from investing activities
Sale of non-current assets 435
Dividends received* 95
Purchase of non-current assets -5,625
Purchase of long-term investments -755
Purchase of short-term investments -765
Net cash outflow from investing activities -6,615

Cash flow from financing activities
Share issue 1,050
Long-term loan 3,750
Short term loan 1,500
Interest paid -450
Net cash inflow from financing activities 5,850
Decrease in cash or cash equivalents -795

Year one - £285,000 in bank and no overdraft
Year two - nothing in bank and £510,00 overdraft
Equals a negative cash flow of £795,000

  • Dividends paid would be a financing activity, whereas dividends received are an investment activity

Analysis
The company is not making a cash profit from its operating activities, which is not a good position to be in.
Whilst the company has paid off some of its payables, its inventory and receivables have both increased,
which could be a sign of problems selling its stock and in getting its debtors to pay. Moreover, it did
not pay any tax in 2017. This could be a sign of cash flow problems.
Whilst it sold some non-current assets at a slight profit, it has made a significant purchase in new
non-current assets. It will be hoped that they increase income in future years.
It has also made some further long-term and short-term investments, which seems surprising given
its overall cash situation.
It has issued more shares and taken on more long-term and short-term debt, moreover it now
has a sizable overdraft. All of which will lead to extra dividend and interest payments next year.
The company seems to have no coherent financial strategy, and should have perhaps cleared some
of its liabilities before taking on further investments.

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3
Q

Financial Reporting and Analysis – Week 11 Revision Session

  1. A company is looking at developing three software products that can aid other organisations in the calculation of their taxes. The company’s financial director has prepared the following financial estimates regarding the three products:
                 Taxfriend      Ezetax      Taxcalc Initial  outlay (£)       60,000      120,000   180,000
Cash flow – 
year 1 (£)       25,000        50,000    95,000
Cash flow –
year 2 (£)      30,000        70,000    80,000
Cash flow –
year 3 (£)      32,000        40,000    58,000

The company has a 10% cost of capital

Required

a) Using each of the following appraisal methods, rank the products in order of investment potential:
a. Net present value;
b. Approximate IRR; and
c. Payback period.
b) If the project were mutually exclusive, which project, if any, would you select and why?
c) Explain why the company’s cost of capital does not necessarily equate to the cost of obtaining finance.

A

The actual and cumulative cash flows of the three products are as follows:

Actual      Taxfriend Ezetax Taxcalc
                       £             £          £
Year 0       -60,000 -120,000 -180,000
Year 1          25,000 50,000 95,000
Year 2         30,000 70,000 80,000
Year 3         32,000 40,000 58,000

Cumulative Taxfriend Ezetax Taxcalc
£ £ £
Year 0 -60,000 -120,000 -180,000
Year 1 -35,000 -70,000 -85,000
Year 2 -5,000 0 -5,000
Year 3 27,000 40,000 53,000

Payback periods Ranking
Taxfriend 2 years and two months 3
Ezetax 2 years 1
Taxcalc 2 years and one month 2

NPV Taxfriend
Outlay Cash flow Net Discount PV
£ £ £ £
Year 0 -60,000 - -60,000 1 -60,000
Year 1 - 25,000 25,000 0.909 22,725
Year 2 - 30,000 30,000 0.826 24,780
Year 3 - 32,000 32,000 0.751 24,032
NPV 11,537

NPV Ezetax
Outlay Cash flow Net Discount PV
£ £ £ £
Year 0 -120,000 - -120,000 1 -120,000
Year 1 - 50,000 50,000 0.909 45,450
Year 2 - 70,000 70,000 0.826 57,820
Year 3 - 40,000 40,000 0.751 30,040
NPV 13,310

NPV Taxcalc
Outlay Cash flow Net Discount PV
£ £ £ £
Year 0 -180,000 - -180,000 1 -180,000
Year 1 - 95,000 95,000 0.909 86,355
Year 2 - 80,000 80,000 0.826 66,080
Year 3 - 58,000 58,000 0.751 43,558
NPV 15,993

NPVs Ranking
Taxfriend 11,537 3
Ezetax 13,310 2
Taxcalc 15,993 1

Taxfriend IRR
Net Discount PV
20% £ £
Year 0 -60,000 1 -60,000
Year 1 25,000 0.833 20,825
Year 2 30,000 0.694 20,820
Year 3 32,000 0.579 18,528
NPV 173

Ezetax IRR
Net Discount PV
20% £ £
Year 0 -120,000 1 -120,000
Year 1 50,000 0.833 41,650
Year 2 70,000 0.694 48,580
Year 3 40,000 0.579 23,160
NPV -6,610

Taxcalc IRR
Net Discount PV
20% £ £
Year 1 95,000 0.833 79,135
Year 2 80,000 0.694 55,520
Year 3 58,000 0.579 33,582
NPV -11,763

NPVs Ranking
Taxfriend Just over 20%* 1
Ezetax 10%+10% * 13,310/19,920= 16.7% 2
Taxcalc 10%+10% * 15,993/27,756= 15.8% 3

*Can’t use the calculation method as there is no negative NPV.
The above calculations show that depending on the method used, all three products are ranked differently.

However, one of the problems with the payback period is that it ignores any cash flow after the payback period, and as can be seen, Taxcalc produces the highest cash flow after this is achieved. Moreover, it has the best NPV, generally seen as the best method to use. Nevertheless, Taxcalc has the lowest IRR, which is normally seen as the project’s yield.

Nevertheless, its IRR is only slightly lower than that of Ezetax, and the product with the highest IRR, Taxfriend, has the lowest NPV and slowest payback period.
Therefore, even though it has the highest outlay, I would choose Taxcalc.

The cost of capital can include factors such as the opportunity cost of not going for another option with regard to spending money and the risk associated with the project. That is why the company’s cost of capital is
much higher than current interest rates.

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4
Q

Financial Reporting and Analysis – Week 11 – 2nd Revision Session

  1. The trial balance of Hallington Ltd at 31 December 2018 was as follows:
    Dr Cr
    £000 £000
    Sales 12,080
    Purchases 7,400
    Inventory 1 January 2016 1,100
    Wages 2,658
    Other operating costs 1,003
    Interest payable 66
    Trade receivables 1,621
    Non-current assets 2,728
    Accumulated depreciation 735
    Trade payables 1,435
    Bank overdraft 596
    Long-term loan 300
    Cash 26
    Share capital 1,000
    Retained earnings 456
    16,602 16,602

You are also given the following information:

i) Inventory as at 31 December 2018 was valued at £1,583,000;
ii) Depreciation has not been charged on the non-current assets, which are depreciated at 5% per annum (to the nearest £000);
iii) Invoices for credit sales on 31 December 2018 amounting to £34,000 have not been included (this does not affect the cost of sales);
iv) A bad debt of £1,000 is to be written off;
v) It has come to light that inventories which had been purchased for £2,000 have been damaged and are thus unsaleable;
vi) Fixtures and fittings costing £16,000 were delivered just before 31 December 2018, but have not been included in the financial statements. These were purchased on credit;
vii) Wages of £3,000 are outstanding; and
viii) Tax is paid at a rate of 20% (to the nearest £000).

Required
Prepare the Income Statement for the year ended 31 December 2018 and the Statement of Financial Position as at 31 December 2018.

A

Income Statement for Hallingdon Ltd for the year ending 31st December 2018
£000 £000
Sales 12,114
Cost of Sales
Opening inventory 1,100
Purchases 7,400
8,500
Less Closing inventory 1,581 6,919
Gross Profit 5,195
Less Expenses
Wages 2,661
Other operating expenses 1,003
Interest payable 66
Bad debt 1
Depreciation 136 3,867
Profit before tax 1,328
Taxation 266
Profit after tax 1,062

Statement of Financial Position for Hallingdon Ltd as at 31st December 2018
£000 £000 £000
Cost AccDep WDV/NBV
Non-current assets 2,744 871 1,873
Current Assets
Inventories 1,581
Trade receivables 1,654
Cash 26 3,261
Total Assets 5,134
Capital and Reserves
Share Capital 1,000
Retained earnings 1,518 2,518
Non-Current Liabilities (Loan) 300
Current Liabilities
Trade payables 1,451
Accruals 3
Taxation 266
Bank overdraft 596 2,316
Total liabilities 5,134

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5
Q

Financial Reporting and Analysis – Week 11 – 2nd Revision Session

  1. Shown below are the statements of financial position of MacParlane plc as at 31 December 2017 and 31 December 2018.
    2017 2018
    £m £m £m £m
    Non-Current assets
    Property, plant and equipment 4,300 7,535
    Intangible assets - 700
    4,300 8,235
    Current assets
    Inventory 1,209 2,410
    Trade Receivables 641 1,173
    Bank 123 0
    1,973 3,583
    Total Assets 6,273 11,818
    Capital and reserves
    Ordinary share capital 1,800 1,800
    Share premium account 600 600
    General reserve 352 352
    Retained earnings 685 1,748
    3,437 4,500
    Non-current liabilities
    Long-term loan 1,800 3,800
    Current liabilities
    Bank overdraft 0 1,816
    Trade payables 931 1,507
    Taxation 105 195
    1,036 3,518
    Total Liabilities 6,273 11,818

The following information is also available:

i) During the year the company disposed of property, plant and equipment that had cost £581m, and had accumulated depreciation of £320m, for £275m
ii) The depreciation charge for 2017 was £645m
iii) The taxation charge for the year was £205m.
iv) Dividends on the company’s ordinary shares amounted to £400m.
v) Interest charged during the year was £300m.

Required

a) Prepare a cash flow statement for MacParlane plc for the year ended 31st December 2018.
b) Comment on the state of the company’s trading situation.

A

Cash Flow Statement for MacParlane plc for the year ending 31st December 2018
£m £m
Cashflow from operating activities
Operating profit for the year 1,063
Add back on Tax charge 205 1,268
Plus
Depreciation 645
Interest payable 300
Dividends paid 400
Increase in Trade payables 576 1921
Less
Increase in inventory 1,201
Increase in Trade Receivables 532
Profit on sale of non-current asset 14
Tax paid 115 1,862
Cash inflow from operating activities 1,327
Cashflow from investing activities
Sale of the non-current asset 275
Purchase of intangible assets -700
Purchase of non-current assets -4141
Cash outflow from investing activities -4,566
Cashflow from financing activities
Increase in long-term loan 2,000
Interest paid -300
Dividends paid -400
Cash inflow from financing activities 1,300
Decrease in cash of cash equivalents -1,939

Reconciliation
Year 1 - bank balance of £123m - year 2 = 0
Year 1 - no overdraft - year 2 = £1816m
This represents a negative cash flow of £1,939m

Analysis
The company is getting a positive cash flow from its operating activities. This figure was higher than the actual profit recorded.

Inventories, trade receivables and trade payables have all gone up. This means that the company is not selling its inventory, is having trouble getting money from its receivables and is delaying payments to its suppliers. This could lead to a loss of goodwill.

The company has made a substantial investment in non-current assets during 2018. This could be responsible for the operating profit this year or will lead to more profit next year.

The company has taken on an extra £2,000m worth of debt. This means it will be paying more interest next year. This loan was taken out to pay part of the non-current assets.

There has been a decrease in cash over the year. The company now has no money in the bank and a substantial overdraft. This will lead to extra payments
next year. The company should not be using short-term finance for long-term assets.

Tax calculation
Tax owed at the end of 2017 = £105m
Plus tax charge for 2018 = £205m
Therefore the company should owe £310m
Less tax owing at the end of 2018 = £195m
£310m - £195m = £115m

Purchase of non-current asset
Non-current asset figure in 2017 was £4,300m
Since that time that amount has been reduced by depreciation and the NBV of the asset that was sold
The net book value of the sold asset = £581m less £320m = £261m
The depreciation charge for the year was £645m
Therefore the net book value of the remaining assets = £3,394m
Therefore the company has purchased £7,535m - £3,394m worth of assets, i.e. £4,141m

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6
Q

Financial Reporting and Analysis – Week 11 – 2nd Revision Session

  1. A company has an empty department in one of its factories that could be used to expand the production of its current products or produce new ones. Four senior personnel have submitted their proposals in relation to using this spare department. Whilst each proposal would fully utilise the empty department, the company can only accept one of them.
    The CFO of the company has received the following information regarding the proposals:
Cash flows     1        2       3       4
(£000)
Year 0        -£120 -£95  -£80  -£160
Year 1           £80   £10    £30    £30
Year 2          £60  £40    £40    £50
Year 3          £40  £40    £30    £90
Year 4          £20  £60    £30    £80
Year 5         -£40  £50    £20    £60
Residual 
value            £0     £5      £0     £40

The cash flows for year 5 include, where applicable, the sale of the non-current assets that were initially purchased in year 0 at their residual value. The company’s cost of capital is 10%.

Required

a) Calculate the payback period, NPV and IRR for each proposal.
b) State which of the proposals you feel should be selected based on your calculations.
c) Explain why the company’s cost of capital is 10% when interest rates are currently much lower.

A

Investment appraisal problem

The actual and cumulative cash flows of the three products are as follows:

Actual
Cash flows     1        2       3       4
(£000)
Year 0        -£120 -£95  -£80  -£160
Year 1           £80   £10    £30    £30
Year 2          £60  £40    £40    £50
Year 3          £40  £40    £30    £90
Year 4          £20  £60    £30    £80
Year 5         -£40  £50    £20    £60

Cumulative
Cash flows 1 2 3 4
(£000)
Year 0 -120 -95 -80 -160
Year 1 -40 -85 -50 -130
Year 2 20 -45 -10 -80
Year 3 60 -5 20 10
Year 4 80 55 50 90
Year 5 40 105 70 150

Payback periods             Ranking
1st Proposal 1.67 years        1
2nd Proposal 3.08 years    4
3rd Proposal 2.33 years      2
4th Proposal 2.89 years      3

Calculations
1st Proposal 1 year + 40/60 (1 year 8 months)
2nd Proposal 3 years + 5/60 (3 years 1 month)
3rd Proposal 2 years + 10/30 (2 years 4 months)
4th Proposal 2 years + 80/90 (2 years 11 months)

NPV 1st Proposal
£000 Discount rate PV
Year 0 -120 1 -120
Year 1 80 0.909 72.72
Year 2 60 0.826 49.56
Year 3 40 0.751 30.04
Year 4 20 0.683 13.66
Year 5 -40 0.621 -24.84
NPV 21.14

NPV 2nd Proposal
£000 Discount rate PV
Year 0 -95 1 -95
Year 1 10 0.909 9.09
Year 2 40 0.826 33.04
Year 3 40 0.751 30.04
Year 4 60 0.683 40.98
Year 5 50 0.621 31.05
NPV 49.20

NPV 3rd Proposal
£000 Discount rate PV
Year 0 -80 1 -80
Year 1 30 0.909 27.27
Year 2 40 0.826 33.04
Year 3 30 0.751 22.53
Year 4 30 0.683 20.49
Year 5 20 0.621 12.42
NPV 35.75

NPV 4th Proposal 
             £000 Discount rate  PV 
Year 0    -160         1               -160
Year 1       30      0.909         27.27
Year 2      50      0.826         41.30
Year 3      90      0.751          67.59
Year 4      80      0.683         54.64
Year 5      60       0.621         37.26
NPV                                       68.06   
NPV                £000  Ranking
1st Proposal     21.14      4
2nd Proposal  49.20     2
3rd Proposal   35.75     3
4th Proposal   68.06      1

IRR
As all proposals are quite a way from 0, use 20% as the second discount rate.

1st Proposal
             £000 Discount rate  PV 
Year 0   -120           1             -120 
Year 1     80        0.833        66.64 
Year 2    60        0.694        41.64 
Year 3    40        0.579         23.16 
Year 4    20        0.482         9.64 
Year 5   -40        0.402       -16.08
NPV                                         5 
2nd Proposal
             £000 Discount rate  PV 
Year 0    -95           1              -95
Year 1      10       0.833          8.33
Year 2    40       0.694         27.76
Year 3    40       0.579         23.16
Year 4    60       0.482        28.92
Year 5    50       0.402         20.1
NPV                                     13.27
3rd Proposal 
             £000 Discount rate  PV 
Year 0    -80            1             -80 
Year 1      30        0.833       24.99 
Year 2     40        0.694        27.76 
Year 3     30        0.579        17.37 
Year 4     30        0.482       14.46 
Year 5     20        0.402       8.04 
NPV                                     12.62 
4th Proposal 
             £000 Discount rate  PV 
Year 0    -160         1             -160
Year 1       30     0.833        24.99
Year 2      50     0.694        34.70
Year 3      90     0.579         52.11
Year 4      80     0.482        38.56
Year 5      60     0.402        24.12
NPV                                     14.48

Given the IRR values above, it is clear that the 1st proposal must have an IRR of just over 20%. The next
highest IRR is proposal 3, followed by proposal 2 and then proposal 4.

NOTE: It is not possible to calculate the IRR as there is no negative NPV.

Whilst the 1st proposal has the best payback period, it has the lowest NPV and IRR. Both of the latter
techniques take the time value of money into account. Moreover, the cash flows for the 1st proposal gradually diminish, being negative in the 5th year.

Proposal 4 has the second longest payback period, but this is not surprising given the high initial outlay.
However, it has the highest NPV and IRR. Therefore, going by the above calculations alone, this
proposal should be accepted. The next best proposal is the 2nd followed by the 3rd. However, the 2nd proposal has the longest payback period, so this might be an issue for the company.

The cost of capital takes a number of factors into consideration, including the return that the company is looking for and how much risk they are willing to take on. It could also include the opportunity cost of not for example subletting the empty department.

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