Question Tag: Cost Analysis

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FM – Nov 2021 – L3 – Q1 – Strategic Cost Management

Analyze costs and investment requirements for Femi Appliances Ltd's new motor vehicle vacuum cleaner product line.

Question

Femi Appliances Limited (FAL) is a Nigerian-based manufacturer of household appliances with many distribution centers across various locations in Nigeria and along the ECOWAS sub-region. FAL is now considering the development of a new motor vehicle vacuum cleaner – VC4.

The product can be introduced quickly and has an expected life of four years, after which it may be replaced with a more efficient model. Costs associated with the product are estimated as follows:

Direct Costs (per unit):

Labour:
- 3.5 skilled labour hours at ₦500 per hour
- 4 unskilled labour hours at ₦300 per hour
Materials:
- 6 kilos of material Z at ₦146 per kilo
- Three units of component P at ₦480 per unit
- One unit of component Q at ₦640
Other variable costs: ₦210 per unit

Indirect Costs:

Apportionment of management salaries: ₦10,500,000 per year
Tax allowable depreciation of machinery: ₦21,000,000 per year
Selling expenses (excluding salaries): ₦16,600,000 per year
Apportionment of head office costs: ₦5,000,000 per year
Rental of buildings: ₦10,000,000 per year
Annual interest charges: ₦10,400,000
Other annual overheads: ₦7,000,000 (includes building rates ₦2,000,000)

If the new product is introduced, it will be manufactured in an existing factory, having no effect on rates payable. The factory could be rented out for ₦12,000,000 per year to another company if the product is not introduced.

New machinery costing ₦86,000,000 will be required, depreciated on a straight-line basis over four years with a salvage value of ₦2,000,000. The machinery will be financed by a four-year fixed-rate bank loan at 12% interest per year. Additional working capital requirements may be ignored.

The new product will require two additional managers at an annual gross cost of ₦2,500,000 each, while one current manager (₦2,000,000) will be transferred and replaced by a deputy manager at ₦1,700,000 per year. Material Z totaling 70,000 kilos is already in inventory, valued at ₦9,900,000.

FAL will utilize the existing advertising campaigns for distribution centers to also market the new product, saving approximately ₦5,000,000 per year in advertising expenses.

The unit price of the product in the first year will be ₦11,000, with projected demand as follows:

Year 1: 12,000 units
Year 2: 17,500 units
Year 3: 18,000 units
Year 4: 18,500 units

An inflation rate of 5% per year is anticipated, with prices rising accordingly. Wage costs are expected to increase by 7% per year, and other costs (including rent) by 5% annually. No price or cost increases are expected in the first year of production.

Income tax is set at 35%, payable in the year the profit occurs. Assume all sales and costs are on a cash basis and occur at the end of the year, except for the initial purchase of machinery, which would take place immediately. No inventory will be held at the end of any year.

Required:

a. Calculate the expected internal rate of return (IRR) associated with the manufacture of VC4. Show all workings to the nearest ₦million. (19 Marks)

b. i. Explain what is meant by an asset beta and how it differs from an equity beta. (2 Marks)
ii. Given the company’s equity beta is 1.2, the market return is 15%, and the risk-free rate is 8%, discuss whether introducing the product is advisable. (4 Marks)

c. The company is concerned about a potential increase in corporate tax rates. Advise the directors by how much that the tax rate would have to change before the project is not financially viable. A discount rate of 17% per year may be assumed for part (c). (5 Marks)

Answer

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Tags: Cost Analysis, Depreciation, Financial strategy, Investment Appraisal, Labour Costs, Material Costs, Overhead Allocation, Product Development, Profitability analysis, Strategic Decision-Making
Level: Level 3

Topic: Strategic Cost Management

FM – Nov 2022 – L3 – Q1 – Mergers and Acquisitions

Evaluating the acquisition of Company K3 in Togo for business expansion purposes.

Question

The following case relates to a business expansion decision for Abayomi Plc (AP):

Abayomi Plc (AP) is a major electrical company in Nigeria. The directors have recently identified Togo as a priority location for business expansion. Togo uses currency T$. Assume today is 30 August 2021.

Company K3, located in Togo, has been identified as a potential acquisition target. AP already manages two business units in Togo, named K1 and K2, and these have shown strong performance under AP’s ownership.

K3 is particularly attractive to AP because it has its own warehouse, distribution, and logistics network, all of which could be used by K1 and K2, if the acquisition goes ahead. Currently, K1 and K2 send goods to customers from AP warehouses located in Ghana. This involves considerable cost and delay in delivery.

K3 is a private company, and 100% of its shares are owned by the family that founded it. Many shareholders are keen to realize their investment by selling the company to AP.

Both companies are working towards an effective date for the sale of K3 to AP on 1 January 2022.

Financial Data for K3 for 2020:

The statement of financial position of K3 as at 31 December 2020 showed the following balances:

T$ Million
Long term borrowings	375
Share capital (T$1 ordinary shares)	90
Total liabilities	465
Net assets	180

Additional Data:

AP aims to maintain the same capital structure as AP. That is, gearing (debt/debt+equity) would be 25% based on market values. AP would guarantee K3’s new debt, which can be assumed to have the same risk profile as AP’s debt.

A proxy company has been identified which is also located in Togo and has a similar business model to K3.

Proxy company data:

P/E ratio of 12.
Equity beta of 1.7 and debt beta of 0.4.
Gearing (debt/debt+equity) based on market values of 35%.

Togo has a risk-free rate of 5% and a market risk premium of 4%.

Financial Data for AP:

Latest data available for AP shows:

P/E ratio of 14.
Equity beta of 1.5 and debt beta of 0.3.
Gearing (debt/debt+equity) based on market values of 25%.
AP pays 6.2% interest on its long-term borrowings.
Tax rate in Nigeria is 30%.

The spot rate for T$ against Naira today is T$7/₦ (i.e., ₦1 = T$7.00) and is not expected to change in the foreseeable future.

Assume that Nigeria has the same risk-free rate and market risk premium as Togo.

Required:
Assume you are the Finance Director of AP.

a. Advise on:
i. The types of synergistic benefit that might arise from the acquisition of K3. (8 Marks)
ii. Possible reasons why both one-off and ongoing synergistic benefits might not be achieved to the extent expected. (4 Marks)

b. Calculate:
i. A Weighted Average Cost of Capital (WACC) for use in valuing K3 based on the proxy company’s business and country risk and AP’s capital structure. (6 Marks)
ii. A range of values for the equity of K3 in T$ as at 1 January 2022 using the following methods:

Asset basis. (2 Marks)
P/E (including bootstrapping). (5 Marks)
DCF (with and without synergistic benefits). (5 Marks)

(Total 30 Marks)

Answer

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Tags: Acquisition valuation, Business Expansion, Cost Analysis, Financial strategy, Foreign Operations, Logistics Integration, Strategic Management, Synergy
Level: Level 3

Topic: Mergers and acquisitions
Series: NOV 2022

PM – Nov 2024 – L2 – Q2 – Cost Management Strategies

Evaluation of Ope-Olu Limited's inventory holding cost and the impact of switching to a JIT production system.

Question

Ope-Olu Limited produces and sells household items. For a particular product, the marketing department has prepared the following quarterly expected demand for next year:

Quarter	Expected Demand (Units)
1	400,000
2	440,000
3	760,000
4	560,000

The existing production facility can only produce 540,000 units per quarter under regular time. However, it is possible to increase output by 40% if working overtime is introduced.

It is the policy of the company to manufacture units using a constant level of production system. This means that although the opening and closing levels of inventory for the year are zero units, there are increases and decreases in the quarterly inventory levels. Based on this policy, the unit selling price, variable production costs, and contribution for next year are expected to be as follows:

Additional Information:

Overtime is paid at 150% of the normal rate, and the unit variable production overhead cost will increase by 25% for those units produced during overtime.
The company incurs a holding cost (based on average inventory) of N25 per unit per quarter for each item that is held in inventory.
The company is considering switching to a Just-in-Time (JIT) production system due to fluctuating sales demand.

Required:

a. Discuss generally, the key conditions that are necessary for the successful implementation of a JIT manufacturing system. (7 Marks)

b. Calculate the cost of holding inventory for each of the quarters and the year in total under the current production system. (6 Marks)

c. Calculate the financial impact of changing to a JIT production system. (7 Marks)

Answer

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Tags: Cost Analysis, Demand forecast, Inventory Holding, JIT, Overtime Production
Level: Level 2

Topic: Cost Management Strategies

PM – May 2015 – L2 – SB – Q4 – Costing Systems and Techniques

Analyze the pricing policy and budget position for Badegy Limited, considering competitor price changes and cost inflation.

Question

BADEGY Limited is a medium-sized company. The company is in the process of deciding its pricing policy for the next period.

The following information is available from its records:

Previous Period:

Revenue: ₦13,000,000
Units Sold: 100,000 at ₦130
Costs: ₦10,000,000
Profit: ₦3,000,000

Current Period:

Revenue: ₦13,780,000
Units Sold: 106,000 at ₦130
Costs: ₦10,774,000
Profit: ₦3,006,000

It was discovered that between the previous and current periods, there was a 4% general cost inflation, and it is forecast that costs will rise further by 6% in the next period. As a matter of policy, the company did not increase the selling price in the current period, although competitors raised their prices by 4% to allow for the increased costs.

A survey by a team of management consultants found that the demand for the product is elastic with an estimated price elasticity of demand of 1.5. This means that volume falls by 1.5 times the rate of real price increase. Various options are to be considered by the Board.

Required: a. Show the budgeted position of the company if it maintains the ₦130 selling price for the next period when it is expected that competitors will increase their prices by 6%. (15 Marks)
b. What would the budgeted position be if the company also raises its price by 6%? (5 Marks)

Answer

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Tags: Budget Position, Competitor Pricing, Cost Analysis, Demand Elasticity, Pricing Policy
Level: Level 2

Topic: Costing Systems and Techniques
Series: MAY 2015

PM – May 2017 – L2 – SA – Q3 – Cost Management Strategies

Calculate relevant cost for engine production for Tadex and factors influencing component opportunity cost.

Question

Tadex Nigeria Limited is an engineering company specializing in building engines for grinding machines. One of the components for building these engines is sourced from Toka Nigeria Limited, a company in the same group as Tadex Nigeria Limited. Each component is transferred to Tadex, taking into account Toka’s opportunity cost of the component. The variable cost for Toka is N280 per component.
A prospective customer has approached Tadex to submit a quotation for a contract to build a new engine. This is a new customer for Tadex, but the directors of Tadex are keen on winning this contract, as they believe it may lead to more contracts in the future. As a result, they intend to price the contract using relevant costs.

The following cost data is provided for the contract:

(i) Production Director’s Salary: Annual salary equivalent to N15,000 per 8-hour day.

(ii) Materials for the Contract:
- Material A: 110 square meters needed, with 200 square meters in stock, bought at N120 per square meter. Resale value: N105 per square meter; Replacement cost: N125 per square meter.
- Material B: 30 liters needed, must purchase a minimum of 40 liters at N90 per liter, with no future use after the contract.
- Components from Toka: 60 units at N500 per unit.
(iii) Direct Labor Hours: 240 hours required; 75 hours available as spare capacity. Additional hours are sourced at overtime cost of N140/hour or temporary staff at N120/hour (10 hours supervision by an existing supervisor at N180/hour).

(iv) Machine Hours: 25 hours needed, with the machine leased weekly at N6,000 and sufficient spare capacity. Running cost: N70 per hour.

(v) Fixed Overhead Absorption Rate: N200 per direct labor hour.

Requirements:

a. Calculate the relevant cost of building the new engine and explain why you have included or excluded any costs in your calculations.
(15 marks)

b. Discuss the factors that would be considered by Toka to determine the opportunity cost of the component.
(5 marks)

Answer

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Tags: Cost Analysis, Opportunity Cost, Project Quotation, Relevant Costing
Level: Level 2

Topic: Cost Management Strategies
Series: MAY 2017

PM – NOV 2016 – L2 – Q4 – Decision-Making Techniques

Question requires analysis of airline operations to determine profitability of different pricing and charter decisions through contribution analysis.

Question

Aghobe Air owns a single aircraft which operates between Lagos and Kano. The normal flight schedule is that flights leave Lagos on Mondays and Thursdays and depart from Kano on Wednesdays and Saturdays. Aghobe Air cannot offer any more flights between Lagos and Kano. The only seat available on the aircraft is economy class.

The following information is available: Seating capacity of the aircraft is 360 passengers. Weekly average number of passengers per flight is as follows:

Additional information:

(i) Food and beverages service cost N1,000 per passenger but at no charge to the passengers;

(ii) Commission to travel agents paid by Aghobe Air (All tickets are booked by travel agents) is 8% of fare;

(iii) Fixed annual leased costs allocated to each flight is N2,650,000 per flight;

(iv) Fixed ground services (maintenance, check in baggage handling, etc.) cost allocated to each flight N350,000 per flight;

(v) Fixed flight crew salaries allocated to each flight is N200,000 per flight; and

(vi) Fuel cost is unaffected by the actual number of passengers on the flight.

Required:

a. Determine the net operating income made by Aghobe Air on each one way flight between Lagos and Kano. (5 Marks)

b. The market research unit of Aghobe Air indicates that lowering the average one way fare to N24,000 will increase the average number of passengers per flight to 212. Should Aghobe Air lower its fare? (5 Marks)

c. A tourist group known as Sea Bird Tour Operator approaches Aghobe Air on the possibility of chartering the aircraft twice each month from Lagos to Kano and back from Kano to Lagos. If Aghobe Air accepts the offer, it will only offer 184 flights in each year. Other terms of the offer include:

For each one way flight, Sea Bird Tour Operator will pay Aghobe Air N3,750,000 which covers cost of charter for one way, use of flight crew and ground service staff. Sea Bird Tour operator will pay for fuel costs, food and beverages.

Should Aghobe Air accept the offer from Sea Bird Tour Operator? (5 Marks)

d. What factors should be taken into consideration in taking the decision in (c) above? (5 Marks)

Answer

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Tags: Airline Operations, Capacity Planning, Cost Analysis, Decision Making, Financial Analysis, Revenue Analysis
Level: Level 2

Topic: Decision-making techniques
Series: NOV 2016

PM – Nov 2016 – Q2 – Cost Management Strategies

Question requires explanation of Life Cycle Costing concepts and calculation of unit costs over 3-year product lifecycle for a CD manufacturer.

Question

Tadesco Limited manufactures Compact Disks. It is planning to introduce a new model and production will begin very soon. It expects the new product to have a life cycle of three years and the following costs have been estimated.

You are required to:
a. Explain Life Cycle Costing and state what distinguishes it from traditional costing technique. (10 Marks)
b. Calculate the cost per unit over the whole life cycle and comment on the price to be charged. (10 Marks)

Answer

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Tags: Cost Analysis, Life Cycle Costing, Manufacturing Costs, Product Life Cycle, Traditional Costing
Level: Level 2

Topic: Cost Management Strategies
Series: NOV 2016

PM – May 2022 – L2 – SA – Q5 – Cost-Volume-Profit (CVP) Analysis

Analysis of Abayomi Plc's financial data to determine break-even sales and evaluate budget adjustments.

Question

Abayomi Plc produces and sells two major products, A and B. The budgeted income statement for the year to December 31, 2022 is given below:

The budgeted selling prices of the products are:

A: ₦120
B: ₦180

Required:
a. Determine the breakeven sales in units for each of the products, using the budgeted data. (6 Marks)

Now assume that the following changes are made to the budget:
(i) Unit selling price of product B is reduced to ₦160.
(ii) Direct material cost is expected to drop by 10% for product A and 20% for product B.
(iii) Direct labour costs for each product will increase by 10%.
(iv) Additional ₦456,000 will be spent on advertising.
(v) 80% of total revenue will be derived from product B.

Answer

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Tags: Break-even Sales, Cost Analysis, Product pricing, Profitability
Level: Level 2

Topic: Cost-Volume-Profit (CVP) Analysis
Series: MAY 2022

QTB – Nov 2014 – L1 – SA – Q15 – Mathematics of Business Finance

Determines the smallest number of units to produce for break-even.

Question

Assume that the standard selling price of a medium-size detergent produced by BICU Nigeria Limited is N250 per unit. If the total fixed cost is N85,000 and the cost of producing each unit is N130, what is the smallest number of units which the company should produce in order to break even?
A. 709
B. 708
C. 707
D. 706
E. 700

Answer

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Tags: Break-Even Point, Cost Analysis, Production
Level: Level 1

Topic: Mathematics of Business Finance
Series: NOV 2014

QTB – May 2016 – L1 – SB – Q1b – Mathematics

Draw cost graph, estimate production units, deduce fixed costs and cost equation for an aluminum manufacturing company.

Question

An aluminum manufacturing company in Lagos incurs a daily total cost of N5,000 for one unit of production. To produce 4 units, the company spends N30,000 as its total cost.

Required:

i. Draw a graph to depict the above information.
(3 marks)

ii. Use your graph above to estimate the number of units to be produced to incur a total cost of N70,000.
(2 marks)

iii. Deduce

The daily fixed costs of the company from the graph above (1 mark)
From the above, obtain the equation representing the company’s activity (3 marks)

iv. Comment on the results obtained in (iii) above.
(1 mark)

Answer

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Tags: Cost Analysis, Cost Functions, Fixed Costs, Graphing
Level: Level 1

Topic: Mathematics
Series: MAY 2016

FM – Nov 2021 – L3 – Q1 – Strategic Cost Management

Analyze costs and investment requirements for Femi Appliances Ltd's new motor vehicle vacuum cleaner product line.

Question

The product can be introduced quickly and has an expected life of four years, after which it may be replaced with a more efficient model. Costs associated with the product are estimated as follows: