Question 1: Long Haul Transport
(a) Since the income tax implications have to be ignored, thereby depreciation considerations are ignored as depreciation impacts the cash flows only through taxation. Also, any capital gains tax on potential capital gains on the existing semi- trailer truck is also ignored (Damodaran, 2015).
Potential cost savings owing to the new truck = $ 40,000 per annum for a period of 5 years.
Cash flow – Year 0
Inflow on existing truck sale = $ 62,000
Outflow on new truck (including delivery) = $ 220,000
Net cash outflow = 220000 – 62000 = $ 158,000
Cash flow – Year 1 to Year 4
Cash inflow on account of saving in operating cost = $ 40,000 p.a.
Cash flow – Year 5
Cash inflow on account of saving in operating cost = $ 40,000 p.a.
Cash inflow from sale of new truck = $ 69,000
Hence, total cash inflows = 40000 + 69000 = $ 109,000
The NPV or Net Present value is the sum of present value of future cash flows that arise from a given project during the life of the project (Parrino and Kidwell, 2014).
Present value = Future cash flow * Relevant present value factor
The relevant present value factors have already been provided for 14% discount rate and the same have been used to compute NPV.
NET PRESENT VALUE = -158000 + 40000*0.877 + 40000*0.769 + 40000*0.675 + 40000*0.592 + 109000*0.519 = $15,091
Since the NPV is positive, hence the project would increase the shareholders’ wealth and the company should replace the existing truck with the new truck (Petty et. al., 2015).
(b) The three non-financial considerations are as follows.
- The various safety features considering the security of the vehicle and the driver. It is imperative that these should be atleast as good as the existing truck. Further, no additional risk should be levied on drivers owing to this switch.
- Further, it is imperative that the company should have drivers that could operate the modern trucks or else there would be loss of business for the company.
- The fleet management practices and truck choices being made by competitors must also be considered.
(c) There are other alternative techniques to NPV such as IRR, payback period. One of the key advantages of NPV over the other methods is that it provides reliable and accurate results even where ranking of projects ought to be done. Also, the time value of money is considered which is lacking in payback period. Further, it takes into consideration the cash flows over the entire project period and therefore superior than payback period which uses cash flows till the time of breakeven only (Damodaran, 2015).
However, a key disadvantage of NPV is that it is difficult to understand especially for people from non-financial background which is not the case with payback period. Also, the discount rate plays a crucial role in NPV determination and this can be inaccurate thereby impacting reliability. IRR computation on the other hand does not require discount rate. Besides, the future cash flows need to be estimated accurately which can be potentially difficult and hence time and resources woukl be required (Arnold, 2015).
Question 2: On Time Ltd
The income statement is as indicated below (Drury, 2016).
Explanations
1) Cost of fuel = Opening inventory + Purchases – Closing inventory
2) Other income = Dividend income + Gains from Truck sale
The cash flow statement is as highlighted below.
The respective cash flow statement is indicated below (Petty et. al., 2015).
1) Net change in cash = Cash flow from operating activities + Cash flow from investing activities + Cash flow from financing activities
2) Closing cash balance = Opening cash balance + Net change in cash
(b) One reason is that the income statement is prepared on accrual basis and considers income and expenses even if the relevant cash flows have not taken place. This is in sharp contrast to the cash flow statement which is prepared on cash or receipts basis. Another reason is that in the income statement previous transactions have limited impact but this is not the case in cash flow statements where the cash implications of previous period payments are considered (Arnold, 2015).
(c) The income statement is a true reflection of the financial performance of the company for the given year since it highlights the impact of the transactions which have been enacted in the given year. The cash flow statement is not reflective as the various cash flows may arise from previous year sales or expenses which do not have much relevance in the present year. The accrual accounting tends to consider the income and expense based on the earnings and hence is more accurate reflection (Parrino and Kidwell, 2014).
(a) The accounts receivable days for the company (Comfort Living) has been constantly increasing from 2014-2017. This is a worrisome indication for the company as it reflects that the time taken to collect the money from credit sales is increasing which would increase the cash cycle and heighten the working capital requirement. In comparison the industry average for accounts receivable days has only marginally increased for the given period (Damodaran, 2015).
The inventory days for the company (Comfort Living) has been constantly increasing from 2014-2017. The industry average in this regards has only increased marginally. It is interesting to note that in 2014, the company had the inventory days at the same value as the industry average. But during the period, it has surged tremendously and if inferior to the industry now. This would reflect potential issues in generating sales from inventory which may be a sign of slowing demand for the products of the company (Arnold, 2015).
Question 3: Financial Statements – On Time Ltd
The accounts payable days for the company has increased significantly over 2014-2017. This is in sharp contrast with the industry trend where the accounts payable days have halved in 2017 from corresponding 2014 levels. While a higher value of accounts payable days auger well for the lowering the cash cycle and thereby bringing down working capital requirement (Petty et. al., 2015).
However, considering the opposite trend of the industry, this seems indicative of potential cash crunch owing to which the payments to suppliers are delayed. The growing value of account payables from 2014-2017 when the credit sales have remained same clearly highlighted cash management issues faced by company.
(b) The following measures can be deployed by the company in order to resolve the current working management crisis experienced by the company (Bhimani et. al., 2017).
- The company must provide discounts to the buyers so that the receivables period could come down and thereby allow the company to enhance the cash balance.
- Before ordering any new inventory, the company aim at liquidating the existing inventory (even at loss) so that the cash balance of the company can be strengthened. This is imperative so that a cash crunch can be averted.
- The payment to suppliers should be hastened in a phased manner with careful cash management so that the new suppliers are not blocked which is imperative to continue the business.
- Any possible cash expenses that can be deferred must be postponed including any capacity expansion or capital expenditure. Suitable austerity measures should be introduced so as to enhance the operational margins.
- The budgeting of the company needs significant improvement owing to significant variances between the actual figures and estimated figures. As a result, it is imperative that going forward these variances need to be limited.
(a) Sales revenue from each scenic flight = Price per passenger * Number of passengers = $ 300* 20 = $ 6,000
Variable Costs (Per Flight)
Cost of pilots = 2*500 = $ 1000
Cost of flight attendants = 2*200 = $ 400
Fuel cost per flight = $ 800
Total refreshment cost per flight = 30*20 = $ 600
Hence, total variable cost per scenic flight = 1000 + 400 +800 + 600 = $ 2,800
Contribution margin = Sales – Variable Costs = 6000 – 2800 = $ 3,200
(b) At breakeven, no profit or loss is incurred. The relevant formula for determination of this is indicated as follows.
Breakeven (units) = Fixed cost/Unit contribution margin = 150000/3200 = 46.88 or 47 flights
(c) Current profits = 3200*90 -150,000 = $138,000
Expected profits = 1.4*138000 = $ 193,200
Incremental profits desired = 193,200 – $138,000= $ 55,200
Since the fixed cost would remain the same, hence additional profit generated per flight would be the unit contribution margin or $ 3,200.
Hence, additional flights required = 55200/3200 = 17.25 or 18 flights
(d) The projections is based on the assumption that the fixed costs would not alter even if higher number of flights are operated. Also, the variable cost and price offered to the customer would not alter. A big limitation is that price and costs are assumed to be same (Heisinger, 2014).
(e) (i) Income from each flight = 250*15 = $ 3,750
Variable Costs (Per Flight)
Cost of pilots = 2*250 = $ 500
Cost of flight attendants = 2*100 = $ 200
Question 4: Working Capital Management – Comfort Living Ltd
Fuel cost per flight = $ 450
Total refreshment cost per flight = 50*15 = $ 750
Hence, total variable cost per scenic flight = 500 + 200 +450 + 750 = $ 1,900
Contribution margin = Sales – Variable Costs = 3,750-1,900= $1,850
Fixed costs (annually) = $ 200,000
Hence, number of flights required to break even = 200000/1850 = 108.11 or 109 flights
(ii) Profits (under the shorter duration flights) = Total contribution margin – Annual fixed costs = (1850*190) – 200,000 = $ 151,500
Profits (under the existing 2 hour flight) = $ 138,000
Hence, if the objective is to maximise profits, then the replacement must be done with 1 hour luxury flights.
(f) One of the considerations is the cost taken by pilots and staff who would now have to spend more time owing to the waiting time between the morning and afternoon flights. Additionally, the maintenance cost on the airplanes may increase owing to the higher number of flights even though hours in air may remain same (Emmauel and Otley, 2015).
(a) The depreciation schedule for straight line depreciation is shown below (Damodaran, 2015).
Relevant Explanations
1) Depreciation expense = (110000-11000)/5 = $ 19,800
2) Asset carrying amount = Asset cost – Depreciation expense
3) Accumulated depreciation (time t) = Accumulated depreciation (time t-1) + Depreciation Expense
The depreciation schedule for units of production is shown below (Arnold, 2015).
Relevant Explanations
1) Total units produced over the useful life = 600000+550000+500000+450000+400000 = 2,500,000
Total depreciation on machine = $110,000 – $ 11,000 = $ 99,000
Depreciation per unit = $ 99,000/2,500,000 = $ 0.0396
Depreciation Expense (Year N) = Number of units produced in year N * 0.0396
2) Asset carrying amount = Asset cost – Depreciation expense
3) Accumulated depreciation (time t) = Accumulated depreciation (time t-1) + Depreciation Expense
The depreciation schedule for reducing balance is shown below (Parrino and Kidwell, 2014).
Relevant Explanations
1) Depreciation in year 1= (110000-11000)*0.35
Depreciation in year 2= (75350-11000)*0.35
Depreciation in year 3= (52828-11000)*0.35
Depreciation in year 4 = (38188-11000)*0.35
All the remaining depreciation is charged in year 5 so that the total depreciation charged is $ 99,000.
2) Asset carrying amount = Asset cost – Depreciation expense
3) Accumulated depreciation (time t) = Accumulated depreciation (time t-1) + Depreciation Expense
(b) The considerations for the right choice of the depreciation method are indicated as follows (Drury, 2016).
- The type of asset is a key factor which is related to the pattern of differentiation.
- The pattern of asset usage especially if there is expected higher or lower usage expected at certain time.
- The estimated useful life of the asset is also a key consideration which essentially determines the amount of depreciation charged under various methods and hence decides on the correct choice.
(c) The given statement is false as depreciation is only an accounting entry and does not lead to any cash being set aside for the asset replacement. The only cash impact for the depreciation is in the form of tax savings (Bhimani et. al., 2017).
(d) The book value of the asset at the end of year 5 would be $ 11,000. However the proceeds generated would be $ 15,000 and $ 4,000 would be the gain on sale.
Changes in assets = +15000 (cash) -$11,000 (Disposal of asset) = $ 4,000
Changes in liabilities = No changes
Changes in equity = $ 4000 (Gains on sale of asset)
References
Arnold, G. (2015) Corporate Financial Management. 3rd ed. Sydney: Financial Times Management.
Bhimani, A., Horngren, C.T., Datar, S.M. and Foster, G. (2017), Management and Cost Accounting 4th ed. Harlow: Prentice Hall/Financial Times
Damodaran, A. (2015). Applied corporate finance: A user’s manual 3rd ed. New York: Wiley, John & Sons.
Drury, C. (2016) Cost and Management Accounting: An Introduction. 6th ed. New York: Cengage Learning
Emmauel, R.C. and Otley, T.D. (2015) Accounting for Management Control. 8th ed. London: Cengage Learning.
Heisinger, K.(2014) Essentials of Managerial Accounting 4th ed. London: Cengage Learning.
Parrino, R. & Kidwell, D. (2014) Fundamentals of Corporate Finance, 3rd ed. London: Wiley Publications
Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M., & Nguyen, H. (2015). Financial Management, Principles and Applications, 6th ed.. NSW: Pearson Education, French Forest Australia
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