Question Tag: Profitability 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

CR – Nov 2023 – L3 – SB – Q2 – Consolidated Financial Statements (IFRS 10)

Analyze the profitability, cash flow, and investor ratios of Mama-Kitchen PLC and discuss dividend policy and EPS limitations.

Question

Mama-Kitchen PLC owns a number of subsidiaries that operate standard fast-food eateries in all the six geopolitical zones of the country. You are the financial analyst of your Bank (Pam-Pam Bank Nigeria Limited) which owns 10% of the issued share capital of Mama-Kitchen PLC.

You are provided with the following financial and background information on Mama-Kitchen PLC.

Mama-Kitchen PLC

Consolidated statement of profit or loss for the year ended September 30

	2023	2022
Revenue	188,900	145,850
Cost of sales	(141,700)	(110,400)
Gross profit	47,200	35,450
Admin expenses	(31,200)	(22,400)
Profit from operations	16,000	13,050
Finance cost	(2,050)	(2,100)
Profit before taxation	13,950	10,950
Income tax expense	(3,050)	(2,300)
Profit for the year	10,900	8,650
Earnings per share – basic	26.8k	21.3k
Earnings per share – diluted	21.2k	19.2k

Mama-Kitchen PLC

Consolidated statement of cash flows for the year ended September 30

	2023	2022
Cash flows from operating activities:
Profit before taxation	13,950	10,950
Finance cost	2,050	2,100
Depreciation and amortisation	15,300	11,050
Loss on disposal of PPE	150	50
(Increase)/decrease in inventories	(200)	50
Increase/decrease in receivables	(1,250)	(100)
Increase in trade payables	2,250	650
Total	32,250	24,750
Interest paid	(2,050)	(2,200)
Tax paid	(1,600)	(1,300)
Net cash flows from operating activities	28,600	21,250
Cash flows from investing activities:
Purchase of PPE	(29,850)	(28,950)
Proceed from sale of PPE	100	150
Net cash used in investing activities	(29,750)	(28,800)
Cash flows from financing activities:
Proceeds from issues of shares	1,200	100
Borrowings	3,250	10,000
Net cash flow from financing activities	4,450	10,100
Net increase in cash and cash equivalents	3,300	2,550
Cash and cash equivalents at beginning	12,400	9,850
Cash and cash equivalents at year end	15,700	12,400

Details of revenue, fast food outlets profits, and new fast food outlets openings for the year ended September 30

	2023	2022
Revenue per fast food outlets:
At September 30	1,770	1,715
Opened in the current financial year	1,290	–
Gross profit per outlet opened
At September 30	435	415
In the current financial year	345

Note:

30 new outlets were opened during the year ended September 30, 2023, bringing the total to 115 fast food outlets.

Additional financial information

	2023	2022
Gross profit margin	25%	24.3%
Debt equity ratio	35.2%	44.4%
Current ratio	0.56:1	0.48:1
Trade payables payment period	86 days	103 days
Return on capital employed	20%	19.1%
Cash return on capital employed	40.2%	36.3%
Earnings before Interest, tax, depreciation and amortisation (N‟m)	31,300	24,100
Non-current assets turnover	1.68 times	1.49 times
Share price (at September 30)	302k	290k

Background information

i. Mama-Kitchen PLC has a reputation of depreciating its assets more slowly than others in the industry.

ii. The strategy of the group is to fund new fast food outlets capital expenditure from existing operating cash flows without needing to raise new borrowings.

iii. Revenue growth in the industry is estimated at 4.1% per annum.

iv. It is the company’s policy to increase promotional and advertising spending on new outlets to encourage strong initial sales.

v. The board has accused the management of concentrating on new outlet openings to the detriment of existing outlets.

vi. One of your colleagues, a financial analyst, stated that the company has not been able to pay dividends because of the debit balance on its consolidated retained earnings.

Required:

a. Draft a report addressed to the Managing Director of Pam-Pam Bank Limited analyzing the profitability, cash flows, and investor ratios of Mama-Kitchen PLC. You should also identify and justify matters that you consider will require further investigations.
(13 Marks)

b. Explain the validity or otherwise of your colleague financial analyst’s statement that Mama-Kitchen PLC was unable to pay dividends because of the debit balance on consolidated retained earnings.
(4 Marks)

c. Explain the usefulness and limitations of diluted earnings per share information to investors.
(3 Marks)

Answer

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Tags: Cash Flow, Dividend Policy, Earnings Per Share, Financial Ratios, Investor Ratios, Profitability analysis
Level: Level 3

Topic: Consolidated Financial Statements (IFRS 10)
Series: NOV 2023

PM – May 2017 – L2 – SA – Q1 – Working Capital Management

Calculate KPIs for Kardex’s products, perform a PEST analysis, and comment on KPI effectiveness in external conditions.

Question

Kardex Industries Nigeria Limited is a subsidiary of a large manufacturing company based in China (Kardex International). The company manufactures washing machines, table gas cookers, and refrigerators which are being sold by the subsidiary in Nigeria. Demand for the company’s product is growing, especially among the growing middle-class population, until recently when the company started experiencing some hiccups due to the economic recession and stiff competition.
- The company currently sells two types of washing machines in Nigeria:
  - Wash Up: A basic product comparable to local competitors.
  - Perfect Wash: A premium product similar to Kardex’s offerings in developed countries.
- The competitive environment in Nigeria is evolving quickly. Apart from Kardex, two other companies offer similar machines in the market. One competitor produces machines similar to “Wash Up” locally with tax incentives, while the other is planning to set up a plant for specialized washing machines akin to Kardex’s “Perfect Wash.”
- Kardex International’s mission is to be the “industry leader.” The Kardex Board has identified critical success factors (CSFs) for the Nigerian subsidiary:
  - Market leadership.
  - Profit maximization and shareholder wealth within acceptable risk.
  - Brand image maintenance as a top-of-the-range product.
- The Board suggests using the following KPIs for each product:
  - Total profit, average sales price per unit, contribution per unit, market share, margin of safety, return on capital employed (ROCE), and total quality costs.

Appendix 1
Financial Year Data for Nigerian Subsidiary:

Requirements:

a. Calculate the Key Performance Indicators (KPIs) for Kardex, including:

Total Profit
Average Sales Price per Unit
Contribution per Unit
Market Share
Margin of Safety
Return on Capital Employed (ROCE)
Quality Costs (20 Marks)

b. Use a PEST Analysis to identify external environmental issues affecting Kardex and discuss the effectiveness of the KPIs in addressing these issues.

Answer

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Tags: KPI, Margin of Safety, Market Share, Profitability analysis, Quality Costs, ROCE
Level: Level 2

Topic: Working Capital Management
Series: MAY 2017

FR – May 2024 – L2 – SB – Q1 – Statement of Cash Flows

Prepare a statement of cash flows for Badary Plc using the direct method and discuss profitability, gearing, and investor's stake in Badary Plc.

Question

Additional Information:

(i) During the year ended March 31, 2021, plant and equipment with a carrying amount of N40,000,000 were sold for N55,000,000. The profit or loss on disposal was charged to distribution expenses.
(ii) Dividend of 2 kobo per share was paid in the year ended March 31, 2021, and there were also bonus issues.
(iii) Depreciation charged for the year was N10,000,000 on furniture and N30,000,000 on plant and equipment.
(iv) During the year, an investment that cost N12,500,000 some years ago was disposed of for N20,000,000. The profit or loss on disposal was charged to administrative expenses.
(v) Dividends received were from investments in shares and the immediate disposal of rights issues from the investment in a blue-chip company.

You are required to:
a. Prepare the statement of cash flows of Badary Plc for the year ended March 31, 2021, using the direct method in accordance with IAS 7. (20 Marks)
b. Discuss the profitability, gearing, and investor’s stake in Badary Plc and recommend strategies for improving or sustaining them. (10 Marks)

Answer

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Tags: Cash Flow, Financial Reporting, Gearing, IAS 7, Investor's Stake, Profitability analysis, Statement of Cash Flows
Level: Level 2

Topic: Statement of Cash Flows (IAS 7)
Series: MAY 2024

CR – Nov 2020 – L3 – Q5d – Performance Analysis

Report on the performance and state of the business using calculated ratios from the viewpoint of shareholders and lenders.

Question

Report on the performance and state of the business from the viewpoint of a potential shareholder and lender using the ratios calculated above and explain any weaknesses in these ratios.

Answer

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Tags: Business performance, Financial Performance, Profitability analysis, Ratio Analysis
Level: Level 3

Topic: Analysis and Interpretation of Financial Statements
Series: NOV 2020

PM – Mar/Jul 2020 – L2 – Q4 – PM – Mar/Jul 2020 – L2 – Q4 – Economic Value Added (EVA) and Regulatory ROCE for Ibok Power Nigeria Limited

Evaluate the performance of Ibok Power Nigeria Limited using EVA and regulatory ROCE, discussing impacts on performance management.

Question

Ibok Power Nigeria Limited (IPN) is a power utility company providing power distribution services to the public and businesses of Southern Nigeria. The company was formed when the government-owned Power Holding Company of Nigeria was broken up into regional utility companies (one of which was IPN) and sold into private ownership over four years ago.

As a vital utility for the economy of Nigeria, power services are a government-regulated industry. The regulator is principally concerned that IPN does not abuse its monopoly position in the regional market to unjustifiably increase prices. The majority of services (80%) are controlled by the regulator, who sets an acceptable return on capital employed (ROCE) level and ensures that the pricing of IPN within these areas does not breach this level. The remaining services, such as the provision of meters and contract repair services, are unregulated, and IPN can charge a market rate for these. The regulator calculates its ROCE figure based on its own valuation of the capital assets being used in regulated services and the operating profit from those regulated services.

The target pre-tax ROCE set by the regulator is 6%. If IPN were to breach this figure, then the regulator could fine the company. In the past, other such companies have paid fines amounting to millions of naira.

The board of IPN is trying to drive the performance for the benefit of shareholders. This is a new experience for many at IPN, who left the public sector four years ago. In order to better communicate the objective of maximising shareholders’ wealth, the board has decided to introduce economic value added (EVA) as the key performance indicator.

The finance director has provided the following financial information for the year ending September 30, 2018:
Ibok Power Services

Notes:
(i)
(ii) Economic depreciation is assessed to be N41.5bn in 2018. In previous years, economic and accounting depreciation were assumed to be the same.
(iii) Tax is the cash paid in the current year (N4.5bn) and includes an adjustment of N0.25bn for deferred tax provisions. No deferred tax balance existed before 2018.
(iv) The provision for doubtful debts was N2.25bn in 2018.
(v) The research and development project is not capitalised and is expected to benefit the company in the long-term. 2018 is the first year of this project.
(vi) IPN’s cost of capital is as follows:
Equity: 16%
Debt (pre-tax): 5%
(vii) Capital structure: 40% equity, 60% debt.

Required:
(a) Evaluate the performance of IPN using EVA. (13 Marks)
(b) Assess whether IPN meets its regulatory ROCE target and comment on the impact of such a constraint on performance management at IPN. (7 Marks)

Answer

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Tags: Economic Value Added, Finance, Performance Measurement, Profitability analysis, Regulated Industries, ROCE, Utility Company
Level: Level 2

MA – April 2022 – L2 – Q2b – Advanced variance analysis

Calculate and comment on the Throughput Accounting Ratios of three products for Drogo.

Question

Drogo uses the Throughput Accounting technique for efficient allocation of scarce resources. In the second quarter of 2021, the throughput per bottleneck resource for its three products were given as follows:

Product A: GH¢4
Product B: GH¢6
Product C: GH¢9

The total factory cost was GH¢67,500, and the bottleneck resource was 15,000 machine hours.

Required:

Calculate and comment on the Throughput Accounting Ratios of the three products. (3 marks)

Answer

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Tags: Bottleneck Resources, Profitability analysis, Throughput Accounting
Level: Level 2

Topic: Advanced variance analysis
Series: APR 2023

FM – May 2020 – L2 – Q5b – Working Capital Management

Evaluate the impact of introducing credit sales on total profit before tax for a company and provide management advice.

Question

Innovate Ghana Ltd is a dealer in household consumables in Ghana. It currently sells on a cash-only basis. The company’s current annual sales are GH¢10 million. The operating cost structure is as follows:

Cost of sales: 55% of sales
Staff cost: 10% of sales
Marketing and distribution cost: 15% of sales

Management in a meeting concluded that introducing credit sales will help boost sales in the light of the current tightness in liquidity in the market, the drive by other competitors, and pressure from the sales team.

It is projected that total sales will grow by 50% solely from the credit sales. The customers are offered 1-month credit, and a new credit department is set up to assess and monitor these credit sales. The monthly cost of running this credit department is GH¢20,000, and bad debts are expected to be 4% of the credit sales.

To finance this credit, Innovate Ghana Ltd will borrow at an interest rate of 25% per annum.

Required:

i) Calculate the total profit before tax before the introduction of the new policy.
(4 marks)

ii) Calculate the total profit before tax after the introduction of the new policy.
(6 marks)

iii) Advise management whether the initiative should be undertaken.
(3 marks)

Answer

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Tags: Credit Policy, Profitability analysis, Receivables Management, Working Capital Management
Level: Level 2

Topic: Working Capital Management
Series: MAY 2020

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: