Advanced Business Calculations Level 3

Model Answers Series 4 2006 (Code 3003)

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Advanced Business Calculations Level 3 Series 4 2006

How to use this booklet

Model Answers have been developed by Education Development International plc (EDI) to offer additional information and guidance to Centres, teachers and candidates as they prepare for LCCI International Qualifications. The contents of this booklet are divided into 3 elements: (1) Questions – reproduced from the printed examination paper (2) Model Answers – summary of the main points that the Chief Examiner expected to

see in the answers to each question in the examination paper, plus a fully worked example or sample answer (where applicable)

(3) Helpful Hints – where appropriate, additional guidance relating to individual

questions or to examination technique Teachers and candidates should find this booklet an invaluable teaching tool and an aid to success. EDI provides Model Answers to help candidates gain a general understanding of the standard required. The general standard of model answers is one that would achieve a Distinction grade. EDI accepts that candidates may offer other answers that could be equally valid.

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3002/4/06/MA 3

Advanced Business Calculations Level 3 Series 4 2006 QUESTION 1 (a) A bank tenders for a £500,000 Treasury bill that runs for 6 months and is to be redeemed at par. The bank calculates that it will earn 4% per annum simple interest on its investment. Calculate the amount the bank will pay for the Treasury bill. Give your answer to the nearest £100. (5 marks) (b) An investment account of £650,000 attracts 4.65% compound interest per annum, compounded six-monthly. (i) How much will be in the account after 5½ years? (5 marks) (ii) How much of this is interest? (1 mark)

(iii) How much interest will be earned in the first six months? (2 marks)

(Total 13 marks)

3002/4/06/MA 4

MODEL ANSWER TO QUESTION 1 (a) Percentage interest for the 6 month period = 2% Par value represents 102% of the initial investment Bank tenders £500,000 ÷ 102% = £490,196 = £490,200

(b) (i) Interest rate per six month period = 4.65% ÷ 2 = 2.325% Number of time periods = 5½ x 2 = 11 Amount after 5½ years = A = P(1 + R) T

100 = £650,000 (1.02325) 11 = £836,975.30

(ii) Interest = £836.975.30 − £650,000 = £186,975.30

(iii) Initial six month interest = £650,000 x 4.65% ÷ 2 = £15,112.50

3003/4/06/MA 5

QUESTION 2 An investor bought 20,000 Ordinary Shares (nominal value £5.00) at 410 pence each. After 2 years, the shares were sold for 432 pence. The investor paid a total of £65 broker’s commission. (a) Calculate the capital gain from the purchase and sale of the shares.

(4 marks) The dividends declared on the nominal value of the ordinary shares were: Year 1 Year 2 3% 8.5% (b) Calculate the total dividends received by the investor.

(4 marks) The investor could instead have invested £80,000 in a Unit Trust, buying the units at £5 each and selling them after two years at £5.99 each. Assume that the units are accumulative, that is, the price Includes the dividend. (c) Compare the two investment options.

(7 marks)

(Total 15 marks) MODEL ANSWER TO QUESTION 2 (a) Cost of the shares = 20,000 x £4.10 = £82,000 Income from sale = 20,000 x £4.32 = £86,400 Capital gain = £86,400 - £82,000 - £65 = £4,335

(b) Total percentage dividend = (3 + 8.5)% = 11.5% Nominal value of shares = 20,000 x £5.00 = £100,000 Total dividend = £100,000 x 11.5% = £11,500 (c) Net income from shares = £4,335 + £11,500 = £15,835 Number of units purchased = £80,000 ÷ £5.00 = 16,000 Net income from one unit = £5.99 - £5.00 = £0.99 Net income from units = 16,000 x £0.99 = £15,840 The income from the units would have been £5 more The investment in the units would have been £2,000 less The unit trust would have been a marginally better investment

3003/4/06/MA 6

QUESTION 3 A factory manufactures two products. (a) Product A may be manufactured by two methods of production. Using Method X, fixed costs

are £1,500,000 per period and variable costs are £215 per unit of product. Using Method Y, fixed costs are £2,250,000 per period and variable costs are £175 per unit of product. (i) Calculate the level of output per period for which the total costs are the same.

(3 marks) (ii) Compare the costs of Method X and Method Y for an output of 50,000 units of product per period.

(3 marks) (b) Product B has unit costs of production during a trading period as follows: £ Components 195 Labour 460 Production overheads 145 Distribution expenses 80 The cost of components varies directly with the number of units produced. 65% of the labour costs vary directly with the number of units produced. The production overheads do not vary irrespective of how many units are produced. 70% of the distribution expenses vary directly with the number of units produced. Calculate, for the trading period, the variable cost as a percentage of the total cost of production.

(5 marks)

(Total 11 marks)

3003/4/06/MA 7

MODEL ANSWER TO QUESTION 3 (a) (i) For an output of Q units Cost for Method X = £1,500,000 + £215Q Cost for Method Y = £2,250,000 + £175Q Total costs are equal when Cost X = Cost Y 1,500,000 + 215Q = 2,250,000 + 175Q 40Q = 750,000 Output = Q = 18,750 units per period (ii) At the required output: Total cost for method X = £1,500,000 + £215 x 50,000 = £12,250,000 Total costs for method Y = £2,250,000 + £175 x 50,000 = £11,000,000 Method Y is cheaper The difference is £1,250,000 (b) Variable element of labour costs = 65% x £460 = £299 Variable element of distribution expenses = 70% x £80 = £56 Total unit variable cost = £195 + £299 + £56 = £550 Total unit cost = £195 + £460 + £145 + £80 = £880 Variable cost percent = £550 x 100% = 62.5% £880

3003/4/06/MA 8

QUESTION 4 The following information relates to a retailer’s business at the end of the first year of trading. £ Net sales 350,000 Cost of goods sold 200,200 Initial stock value 19,100 Final stock value 17,300 Overhead expenses 104,300 Calculate: (a) the overhead expenses as a percentage of net sales (2 marks) (b) gross profit as a percentage of net sales (3 marks) (c) net profit as a percentage of net sales (3 marks) (d) net purchases (2 marks) (e) rate of stockturn (3 marks)

(Total 13 marks)

MODEL ANSWER TO QUESTION 4 Net sales 350,000 Cost of Goods Sold 200,200 Initial stock value 19,100 Final stock value 17,300 Overhead expenses 104,300 (a) Expense ratio = Overhead expenses x 100% = £104,300 x 100% = 29.8% Net sales £350,000

(b) Gross profit = Net sales – cost of goods sold = £350,000 - £200,200 = £149,800 Gross profit percent = Gross profit x 100% = £149,800 x 100% = 42.8% Net sales £350,000 (c) Net profit = Gross profit – overheads = £149,800 - £104,300 = £45,500 Net profit percent = Net profit x 100% = £45,500 x 100% = 13% Net sales £350,000 (d) Net purchases = Cost of goods sold – Initial stock value + final stock value = £200,200 - £19,100 + £17,300 = £198,400 (e) Average stock = ½ (Initial stock value + final stock value) = ½ (£19,100 + £17,300) = £18,200 Rate of stockturn = Cost of goods sold = £200,200 = 11 times Average stock £18,200

3003/4/06/MA 9

QUESTION 5 (a) An investor estimates the following figures for investment project A:

Initial cost of project £4,600,000 Expected life of project 5 years Total return before allowing for repairs and maintenance £7,000,000 Average cost per annum of repairs and maintenance £250,000 Estimate the average rate of return of project A.

(4 marks) (b) An investor estimates the costs and returns for investment project B as follows: £ Initial cost 4,000,000 Year 1 net cash inflow 1,500,000 Year 2 net cash inflow 1,500,000 Year 3 net cash inflow 1,500,000

(i) Using a discount rate of 13%, and the following table, calculate the net present value of project B. (4 marks)

Year Discount factor (13%) Year 1 0,885 Year 2 0.783 Year 3 0.693 The investor believes that project B can also provide cash inflow in year 4. She now estimates that the NPV will be positive with a value of £31,900. The discount factor for year 4 is 0.613. (ii) Calculate the estimated net cash inflow for year 4.

(3 marks)

(Total 11 marks)

3003/4/06/MA 10

MODEL ANSWER TO QUESTION 5 (a) Average return per annum = £7,000,000 ÷ 5 = £1,400,000 Net of repairs &c = £1,400,000 - £250,000 = £1,150,000 Average rate of return = £1,150,000 ÷ £4,600,000 = 0.25 = 25%

(b) Discount (i) £ Factor NPV Initial cost 4,000,000 (4,000,000) Year 1 net cash inflow 1,500,000 0.885 1,327,500 Year 2 net cash inflow 1,500,000 0.783 1,174,500 Year 3 net cash inflow 1,500,000 0.693 1,039,500 (458,500)

(ii) Contribution to NPV from year 4 = £31,900 – (£458,500) = £490,400 Net cash inflow in year 4 = £490,400 ÷ 0.613 = £800,000

3003/4/06/MA 11

QUESTION 6 In each of the following two bankruptcies calculate the rate in the pound paid to unsecured creditors and the amount received by an unsecured creditor who is owed £10,000. (a) Bankruptcy A: An unsecured creditor who is owed £6,500 is paid £2,080 (4 marks) (b) Bankruptcy B: The total liabilities are £550,000, of which £340,000 is owed to secured creditors. The total assets available for creditors are £394,600.

(6 marks)

(Total 10 marks)

MODEL ANSWER TO QUESTION 6 (a) Bankruptcy A: Rate in the pound paid to unsecured creditors = £2080 x £1 = £0.32 £6,500 Received by an unsecured creditor who is owed £10,000 = 0.32 x £10,000 = £3,200 (b) Bankruptcy B: Amount owed to unsecured creditors = £550,000 - £340,000 = £210,000 Amount available for unsecured creditors = £394,600 - £340,000 = £54,600 Rate in the pound paid to unsecured creditors = £54,600 x £1 = £0.26 £210,000 Received by an unsecured creditor who is owed £10,000 = 0.26 x £10,000 = £2,600

3003/4/06/MA 12

QUESTION 7 A factory buys two machines. Machine A costs £575,000 and is estimated to have a life of 5 years and a scrap value of £25,000. Using the equal installment method: (a) Calculate: (i) the percentage of the cost which must be written off in total (3 marks) (ii) the percentage of the cost to be written off each year (1 mark) (b) Prepare a depreciation schedule that shows: (i) the annual depreciation for each year (ii) the accumulated depreciation for each year (iii) the book value at the end of each year

(5 marks) Machine B is depreciated by the equal installment method over 6 years. It has the same scrap value as machine A. It also has the same book value at the end of one year as machine A. (c) Calculate the original cost of machine B.

(5 marks)

(Total 14 marks)

3003/4/06/MA 13

MODEL ANSWER TO QUESTION 7 (a) (i) Amount to be written off in five years = £575,000 - £25,000 = £550,000 % of cost to be written off in five years = £550,000 x 100% = 95.65% £575,000

(ii) % of cost to be written off each year = 95.65% ÷ 5 = 19.1%

(b) Annual depreciation = £550,000 ÷ 5 = £110,000 Depreciation schedule (£) Annual Accumulated Book End of Year Depreciation Depreciation Value Purchase value, start of year 1 575,000 1 110,000 110,000 465,000 2 110,000 220,000 355,000 3 110,000 330,000 245,000 4 110,000 550,000 25,000

(c) Machine B: end of year 1 to end of year 6 is five years Depreciation in 5 years = £465,000 - £25,000 = £440,000 Annual depreciation = £440,000 ÷ 5 = £88,000 Original cost of machine B = £465,000 + £88,000 = £553,000

3003/4/06/MA 14 © Education Development International plc 2006

QUESTION 8 Company A sells Product P with the following prices

Year 2002 2003 2004 2005

Price (£) 10.24 12.80 15.20 17.10

(a) Calculate the prices of Product P for years 2003 to 2005 as a chain base index.

(5 marks) (b) Giving your answers correct to four significant figures, calculate the index of prices for Product P for the years 2002 to 2005 with year 2002 as the base year.

(6 marks) (c) The price relative for year 2002 with 2001 as the base year is 1.28. Calculate the selling price of Product P in year 2001.

(2 marks)

(Total 13 marks) MODEL ANSWER TO QUESTION 8 (a) 2003: Chain base index = 100 x 12.80/10.24 = 125 2004: Chain base index = 100 x 15.20/12.80 = 118.75 2005: Chain base index = 100 x 17.10/15.20 = 112.5

(b) 2002: Price index = 100.0 2003: Price index = 100 x 12.80/10.24 = 125.0 2004: Price index = 100 x 15.20/10.24 = 148.4 2005: Price index = 100 x 17.10/10.24 = 167.0

(c) Selling price in year 2001 = £10.24 ÷ 1.28 = £8