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Let’s solve the multiple-choice questions.
i) Which of the conventions instructs “The business and its owner(s) are treated as being quite separate and distinct”?
Answer of i): d. Business Entity Convention
ii) According to the Accounting Standards, financial statements should normally cover how many periods of information?
Answer of ii): a. 1-year period
iii) ………………………is an economic benefit from trading in the period, enjoyed by the buyer. It is calculated using the formula: selling price per unit × units sold.
Answer of iii): c. Sales/Revenue
iv) SOFP stands for:
Answer of iv): d. Statement of Financial Position
v) SOFP is:
Answer of v): a. A statement that measures what the entity owns and also what it owes in a set period.
vi) …………………..ratio measures the size of profits relative to capital employed - the return on investment.
Answer of vi): a. Return on Capital Employed
vii) Which of the following is not true regarding Digitisation:
Answer of vii): b. Makes it difficult to disenfranchise vulnerable/non-digital savvy stakeholders.
viii) …………represents an overhead cost-driving activity area. It is important to identify which variable causes the overhead cost.
Answer of viii): d. Cost driver
ix) CLR Ltd makes toy machines with fixed costs of £500 and variable costs of £7.00 per machine (raw material £2.00 and labor £5.00), and a selling price of £11.00.
Calculation:
Break-even point = Fixed Costs / (Selling Price per Unit - Variable
Cost per Unit)
= £500 / (£11 - £7) = £500 / £4 = 125.
Answer of ix): b. 125 Cars
x) Tesla Ltd makes Toy cars with fixed costs of £450, variable production costs of raw materials at £3.00 per car, and labor at £5.00 per car. Selling price is £12.00.
a. Contribution per car: Selling price - Variable costs = £12 - (£3 + £5) = £4.
b. Break-even point in sales: Fixed Costs / Contribution per car = £450 / £4 = 112.5 (or 113 cars to cover all costs).
xi) A vehicle has a purchase price of £20,000, a useful life of four years, and a residual/scrap value of £4,000. Calculate the annual depreciation.
Calculation: Depreciation = (Cost - Residual Value) / Useful Life = (£20,000 - £4,000) / 4 = £4,000.
Answer of xi): a. £4,000
xii) Three months’ rental is paid, but the accounting period ended after two months.
Answer of xii): b. Payment in advance
xiii) Which of the following statements refers to Agency Theory?
Answer of xiii): b. Managers tend to self-serve and put their own wishes and needs ahead of the organization.
xiv) Operating Leases are:
Answer of xiv): b. Short term finances
xv) A secured bond has:
Answer of xv): d. More security and less likelihood of lenders not recovering funding
xvi) If the flex ratio is 0.8 and budgeted fixed costs were £600, what is the flex budget for fixed costs?
Answer of xvi): a. £600 (since fixed costs do not change with output)
xvii) Which of the following is associated with Beyond Budgeting (BB)?
Answer of xvii): b. Market focus, Team focus, and Long term approach
xviii) Average Rate of Return (ARR), investment appraisal technique, uses which of the following variables to calculate:
Answer of xviii): d. Profit
xix) ARR method: if an investment entails £10,000 for a machine with a four-year life and scrap value of £4,000.
Calculation: Average annual investment = (Initial Cost + Residual Value) / 2 = (£10,000 + £4,000) / 2 = £7,000.
Answer of xix): c. £7,000
xx) Blockchain records are more accurate than single ledger systems because:
Answer of xx): a. They use incentives and consensus to promote accuracy
Let’s go through each ratio calculation for Amazon Ltd. based on the information provided.
1. i Ratio Calculations
a. Gross Profit Ratio
The Gross Profit Ratio specifies the percentage of revenue that overdoes the cost of goods sold, which reflects Amazon Ltd’s profitability after its activities.
Gross Profit Ratio=Gross Profit / Revenue×100
Using the values given:
Gross Profit = £25,200.00
Revenue = £42,000.00
Gross Profit Ratio=25,200/42,000×100=60%
b. Net Profit Ratio
The Net Profit Ratio tells the percentage of revenue that remains as profit after all operating expenses are deducted.
Net Profit Ratio=Operating Profit/Revenue×100
Using the values given:
Operating Profit = £13,200
Revenue = £42,000
Net Profit Ratio=13,200/42,000×100=31.43%
c. Current Ratio
The Current Ratio evaluates the company’s ability to pay off its short-term liabilities with its short-term assets.
Current Ratio=Current Assets/Current Liabilities
Using the values given:
Current Assets = £9,300
Current Liabilities = £3,900
Current Ratio=9,300/3,900=2.38
d. Quick Ratio (Acid-Test Ratio)
The Quick Ratio measures the company's immediate liquidity by not including inventory from current assets.
Quick Ratio=Current Assets?Inventory/Current Liabilities ?
Using the values given:
Current Assets = £9,300
Inventory = £1,400
Current Liabilities = £3,900
Quick Ratio=9,300?1,400/3,900 =7,900/3,900 = 2.025
e. Trade Receivable Turnover Ratio
This ratio reflects how professionally the company collects its receivables within the period.
Trade Receivable Turnover Ratio=Revenue Trade / Receivables
Using the values given:
Revenue = £42,000
Trade Receivables = £7,900
Trade Receivable Turnover Ratio=42,000 / 7,900=5.316
f. Trade Payable Ratio
The Trade Payable Ratio indicates the number of times Amazon Ltd. pays off its trade payables in the period.
Trade Payable Ratio=Cost of Sales/Trade Payables
Using the values given:
Cost of Sales = £16,800
Trade Payables = £3,400
Trade Payable Ratio=16,800/3,400=4.94
g. Stock Turnover Ratio
The Stock Turnover Ratio measures how efficiently Amazon Ltd. uses its inventory or the number of times inventory is sold and replaced over a period.
Stock Turnover Ratio = Cost of Sales/Inventory
Using the values given:
Cost of Sales = £16,800
Inventory = £1,400
Stock Turnover Ratio=16,800/1,400=12
1. ii Profitability Analysis
Gross Profit Ratio and Net Profit Ratio
Amazon Ltd's Gross Profit ratio of 60% and Net Profit ratio of 31.43% depict the adequate management of the cost of sales and operating expenses, thus indicating a healthy profit structure. This tells us about better cost control and efficient operations, therefore making Amazon Ltd profitable (Husna and Satria, 2019).
Liquidity Ratios: Current Ratio and Quick Ratio
Amazon Ltd has very good liquidity with both the Current Ratio at 2.38 and the Quick Ratio at 2.03, which is way above the industry benchmark of 1. The company can well afford to satisfy all short-term liabilities without having to sell the inventory to raise money, thus making such financial stability create room for comfort while meeting the short-term liabilities (Rashid, 2018).
Efficiency Ratios: Trade Receivable Turnover, Trade Payable Ratio, and Stock Turnover Ratio
A Trade Receivable Turnover Ratio of 5.32 signifies that the firm is generally collecting its receivables efficiently, with scope for increasing cash flows through accelerating collections. The Trade Payable Ratio stands at 4.94, meaning regular payment practices, build good relationships with suppliers and may result in better terms of payment. At 12, the Stock Turnover Ratio reflected effective inventory management since the inventory has a quick cycle and hence reduces holding costs and the possibility of obsolescence.
Recommendations
Improve Collection of Receivables: Despite the high trade receivable turnover, the collection process can be improved to increase cash flows and maximise working capital. This can be realised through reducing credit terms or through the activation of aggressive follow-up of outstanding payments (Abdulazizovich, 2023).
Optimise Stocking Management: Despite the stock turn ratio being healthy, there will always be a stage where the demand variation leads to overstocking or stockouts and prevents consistent availability of products which is cost-advantageous in terms of inventory management (Warn and Ware, 2019).
Leverage High Liquidity: The strong liquidity in the Amazon Ltd. company means that reinvestment opportunities would be present in growth areas such as the expansion of a company's product lines or entering a new market area. Such action could improve long-term growth by strategically using available cash to back potential future expansion activities.
Here is Amazon Ltd's profitability analysis.
Let’s go through each investment appraisal technique step-by-step for the three proposals.
2.i Investment Appraisal Calculations
For each proposal, we will calculate:
Average Rate of Return (ARR)
Payback Period
Net Present Value (NPV)
Proposal 1
Initial Investment = £120,000
Cash Flows over 5 Years
= £80,000, £60,000, £40,000, £20,000, £40,000
Scrap
Value = £4,000
Cost of Capital = 15%
a. Average Rate of Return (ARR)
The Average Rate of Return (ARR): (average annual profit/initial investment) and expressing it as a percentage.
Depreciation per Year:
Depreciation=Investment?Scrap Value/Useful Life=120,000?4,000/5=23,200
Total Profit over 5 Years: Profit for each year = Cash flow - Depreciation
Year 1: 80,000?23,200=56,800.000
Year 2: 60,000?23,200=36,800.000
Year 3: 40,000?23,200=16,800 .000
Year 4: 20,000?23,200=?3,200.000
Year 5: 40,000?23,200=16,800.000
Total profit over 5 years = 56,800+36,800+16,800?3,200+16,800=124,000
? Average Annual Profit:
(Average Annual Profit=(Total Profit over 5 years /5)
=124,000/5=24,800
? ARR:
ARR=(Average Annual Profit / Initial Investment×100)
= 24,800/120,000×100 =20.667%
b. Payback Period
The Payback Period is the time it takes for the project to recover the initial investment.
Cumulative Cash Flows:
Year 1: £80,000
Year 2: £80,000 + £60,000 = £140,000
The initial investment (£120,000) is recovered during Year 2.
Exact Payback Calculation:
Payback Period=1+Amount Needed to Reach Investment/Cash Flow in Year 2 =1+120,000?80,000 / 60,000
=1+40,000 / 60,000 =1.667 years
c. Net Present Value (NPV)
To calculate NPV, we discount each cash flow at the cost of capital (15%).
NPV Formula:
NPV=(?Cash Flow t / (1+r) t ? Initial Investment)
For each year’s cash flow:
1st Year: 80,000 / (1+0.15)1 = 69,565.22
2nd Year: 60,000 / (1+0.15)2 = 45,368.62
3rd Year: 40,000 / (1+0.15)3 = 26,300.64
4thYear 4: 20,000 / (1+0.15)4 = 11,435.06
5th Year 40,000 + 4,000/ (1+0.15)5= 19887.06
NPV Calculation:
NPV=69,565.22+45,368.62 +26,300.64 +11,435.06 +19887.06?120,000=52556
Proposal 2
Initial Investment = £95,000
Cash Flows over 5 Years = £10,000, £40,000,
£40,000, £60,000, £50,000
Scrap Value =
£5,000
a. Average Rate of Return (ARR)
Depreciation per Year:
Depreciation=Investment?Scrap Value/Useful Life = (95,000?5,000) / 5=18,000
Total Profit over 5 Years: Profit for each year = Cash flow - Depreciation
Year 1: 10,000?18,000=?8,000.000
Year 2: 40,000?18,000=22,000.000
Year 3: 40,000?18,000=22,000.000
Year 4: 60,000?18,000=42,000.000
Year 5: 50,000?18,000=32,000-000
Total profit over 5 years = ?8,000+22,000+22,000+42,000+32,000=110,000.000
? Average Annual Profit:
Average Annual Profit=Total Profit over 5 years/5 = (110,000/5) =22,000
? ARR:
ARR=Average Annual Profit/Initial Investment×100
=22,000/95,000×100=23.15%
b. Payback Period
Cumulative Cash Flows:
Year 1: £10,000
Year 2: £10,000 + £40,000 = £50,000.000
Year 3: £50,000 + £40,000 = £90,000.000
Year 4: £90,000 + £60,000 = £150,000.000
The initial investment (£95,000) is recovered during Year 4.
Exact Payback Calculation:
Payback Period=3+Amount Needed to Reach Investment/Cash Flow in Year 4 =3+95,000?90,000/60,000 =3+5,000/60,000=3.08 years
c. Net Present Value (NPV)
To calculate NPV, we discount each cash flow at the cost of capital (15%).
NPV Formula:
NPV=?Cash Flow t / (1+r) t ? Initial Investment
For each year’s cash flow:
Year 1: 10,000 / (1+0.15)1 = 8,695.65
Year 2: 40,000 / (1+0.15)2 = 30245.75
Year 3: 40,000 / (1+0.15)3 = 26,300.65
Year 4: 60,000 / (1+0.15)4 = 34305.2
Year 5: 50,000 + 5,000/ (1+0.15)5= 27344.72
NPV Calculation:
NPV=8695.65+30245.75+26300.65+34305.2+27344.72=118196.3186
Proposal 3
Initial Investment = £80,000
Cash Flows over 5 Years
= £30,000, £40,000, £30,000, £30,000, £20,000
Scrap
Value = £8,000
Cost of Capital = 15%
a. Average Rate of Return (ARR)
Depreciation per Year:
Depreciation=Investment?Scrap Value/Useful Life=80,000?8,000/5=14,400
Total Profit over 5 Years: Profit for each year = Cash flow - Depreciation
1 Year 30,000?14,400=15,600
2 Year: 40,000?14,400=25,600
3 Year: 30,000?14,400=15,600
4 Year: 30,000?14,400=15,600
5 Year: 20,000?14,400=5,600
Total profit over 5 years = 15,600+25,600+15,600+15,600+5,600 = 78,000
Average Annual Profit:
Average Annual Profit=Total Profit over 5 years / 5= 78,000 / 5 =15,600
ARR:
ARR=Average Annual Profit/Initial Investment×100
=15,600 / 80,000×100 =19.5%
b. Payback Period
Cumulative Cash Flows:
Year 1: £30,000
Year 2: £30,000 + £40,000 = £70,000
Year 3: £70,000 + £30,000 = £100,000
The initial investment (£80,000) is recovered during Year 3.
Exact Payback Calculation:
Payback Period=2+Amount Needed to Reach Investment/Cash Flow in Year 3 =2+80,000?70,000/30,000
=2+10,000/30,000=2.33 years
c. Net Present Value (NPV)
To calculate NPV, we discount each cash flow at the cost of capital (15%).
NPV Formula:
NPV=?Cash Flow t / (1+r) t ? Initial Investment
For each year’s cash flow:
Year 1: 30000/ (1+0.15)1 = 26,086.96
Year 2: 40,000 / (1+0.15)2 = 30245.75
Year 3: 30,000 / (1+0.15)3 = 26,300.65
Year 4: 30,000 / (1+0.15)4 = 17152.6
Year 5: 20,000 + 8,000/ (1+0.15)5= 13920.95
NPV = 26086.96+30245.7467+26300.6493+17152.5998+13920.9499=87619.9457
2. ii Recommendation
Based on the review of ARR, Payback Period, and NPV for all proposals,
Proposal 1 is found to have the highest Net Present Value at £52,556 with, therefore, the strongest rate of return that accounts for the time value of money, thereby making it the most attractive in terms of long-term profitability.
Among all proposals, Proposal 2 has the highest Accounting Rate of Return with a value of 23.16%, which means that an excellent return in relation to the initial investment cost has been achieved.
Proposal 3 has the shortest payback period at 2.33 years, thus quick recovery of investment, hence, lower financial risk exposure.
Recommendation: Proposal 1 appears to be the best financial option for Vipers Ltd, as it is a superior NPV provider and presents the highest potential of value enhancement to its shareholders.
References
Husna, A. and Satria, I., (2019). Effects of return on asset, debt to asset ratio, current ratio, firm size, and dividend payout ratio on firm value. International Journal of Economics and Financial Issues, 9(5), pp.50-54.
Rashid, C.A., (2018). Efficiency of financial ratios analysis for evaluating companies’ liquidity. International Journal of Social Sciences & Educational Studies, 4(4), p.110.
Abdulazizovich, K.U.B., (2023). Improvement Of Information About Accounts Receivable In Current Assets In The Balance Sheet Based On International Standards. Journal of Survey in Fisheries Sciences, 10(2S), pp.2849-2859.
Warn, L. and Ware, J.W., (2019). Optimising stocking rate-the key to increasing pasture utilisation and profit.
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