Finance Question – Budgeting And Variances

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PROBLEM 9-43

 

FreshPak Corporation manufactures two types of cardboard boxes used in shipping canned food, fruit,

and vegetables. The canned food box (type C) and the perishable food box (type P) have the following

material and labor requirements.

Type of Box

C P

Direct material required per 100 boxes:

Paperboard ($.20 per pound) …………………………………………………………………………….. 30 pounds 70 pounds

Corrugating medium ($.10 per pound) ………………………………………………………………… 20 pounds 30 pounds

Direct labor required per 100 boxes ($12.00 per hour) ……………………………………………….. .25 hour .50 hour

The following manufacturing-overhead costs are anticipated for the next year. The predetermined

overhead rate is based on a production volume of 495,000 units for each type of box. Manufacturing

overhead is applied on the basis of direct-labor hours.

Indirect material ……………………………………………………………………………………………………………………… $ 10,500

Indirect labor …………………………………………………………………………………………………………………………….. 50,000

Utilities …………………………………………………………………………………………………………………………………….. 25,000

Property taxes …………………………………………………………………………………………………………………………… 18,000

Insurance ………………………………………………………………………………………………………………………………….. 16,000

Depreciation ……………………………………………………………………………………………………………………………… 29,000

Total …………………………………………………………………………………………………………………………………….. $148,500

The following selling and administrative expenses are anticipated for the next year.

Salaries and fringe benefits of sales personnel ……………………………………………………………………………….. $ 75,000

Advertising ………………………………………………………………………………………………………………………………. 15,000

Management salaries and fringe benefits …………………………………………………………………………………………. 90,000

Clerical wages and fringe benefits ………………………………………………………………………………………………….. 26,000

Miscellaneous administrative expenses ……………………………………………………………………………………………… 4,000

Total …………………………………………………………………………………………………………………………………….. $210,000

The sales forecast for the next year is as follows:

Sales Volume Sales Price

Box type C …………………………………………………………………………….. 500,000 boxes $ 90.00 per hundred boxes

Box type P …………………………………………………………………………….. 500,000 boxes 130.00 per hundred boxes

The following inventory information is available for the next year. The unit production costs for

each product are expected to be the same this year and next year.

Expected Inventory

January 1

Desired Ending Inventory

December 31

Finished goods:

Box type C …………………………………………………………………….. 10,000 boxes 5,000 boxes

Box type P ……………………………………………………………………… 20,000 boxes 15,000 boxes

Raw material:

Paperboard …………………………………………………………………… 15,000 pounds 5,000 pounds

Corrugating medium ……………………………………………………….. 5,000 pounds 10,000 pounds

Required: Prepare a master budget for FreshPak Corporation for the next year. Assume an income tax rate of 40 percent. Include the following schedules.

1. Sales budget.

2. Production budget.

3. Direct-material budget.

4. Direct-labor budget.

5. Manufacturing-overhead budget.

6. Selling and administrative expense budget.

7. Budgeted income statement. ( Hint: To determine cost of goods sold, first compute the manufacturing cost per unit for each type of box. Include applied manufacturing overhead in the cost.)

 

EXERCISE 11-26

The following data are the actual results for Marvelous Marshmallow Company for October.

Actual output ………………………………………………………………………………………………………………… 9,000 cases

Actual variable overhead …………………………………………………………………………………………………. $405,000

Actual fixed overhead ……………………………………………………………………………………………………… $122,000

Actual machine time ………………………………………………………………………………………………… 40,500 machine hours

Standard cost and budget information for Marvelous Marshmallow Company follows:

Standard variable-overhead rate ………………………………………………………………………… $9.00 per machine hour

Standard quantity of machine hours ……………………………………………………………. 4 hours per case of marshmallows

Budgeted fixed overhead ………………………………………………………………………………….. $120,000 per month

Budgeted output …………………………………………………………………………………………….. 10,000 cases per month

Required:

1. Use any of the methods explained in the chapter to compute the following variances. Indicate whether each variance is favorable or unfavorable, where appropriate.

a. Variable-overhead spending variance.

b. Variable-overhead efficiency variance.

 

2. Build a spreadsheet: Construct an Excel spreadsheet to solve the preceding requirement. Show how the solution will change if the following information changes: actual output was 9,100 cases, and actual variable overhead was $395,000.

Finance Assignment – Corporate Finance

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Individual Assignmnet Corporate Finance

 

Tenyearsago,in 2003,GeorgeReebyfoundeda smallmail-­‐order companysellinghigh-­‐ qualitysportsequipment.SincethoseearlydaysReebySportshas grownsteadilyand been consistently profitable.

 

The companyhas issued2millionshares,all of whichareownedbyGeorgeReebyand his five children.Thecompanydoesnot useanydebtin its capitalstructure.Forsomemonths George has beenwonderingwhetherthetimehas cometo takethecompanypublic.This wouldallowhimto cashin on partof his investmentand wouldmakeit easierforthefirmto raise capital should it wish to expand in the future.

 

But how much are the shares worth? George’s first instinct is to look at the firm’s balance

sheet, which shows that the book value of the equity is $26.34 million, or $13.17 per share.

A share price of 13.17 would put the stock on a P/E ratio of 6.6. That is quite a bit lower than

the 13.1 P/E ratio of Reeby’s larger the rival, Molly Sports.

 

Georgesuspectsthat bookvalueis not necessarilya goodguideto a share’smarketvalue. Hethinksof his daughterJenny,whoworksin an investmentbank.Shewouldundoubtedly knowwhatthesharesareworth.Hedecidesto phoneheraftershefinishesworkthat evening at 9 o’clock or before she starts the next day at 6.00 a.m.

 

Beforephoning,Georgejots downsomebasicdata on thecompany’sprofitability.After recoveringfromits earlylosses,thecompanyhas earneda returnthat is higherthan its estimated10%costof capital.Georgeis fairlyconfidentthat thecompanycouldcontinueto growsteadilyforthenextthreeto fiveyears.In fact,hefeelsthat thecompany’sgrowthhas beensomewhatheldbackin thelast fewyearsbythedemandsfromtwoof thechildrenfor the company to make large dividend payments. Perhaps, if the company went public, it

could hold back on dividends and plow more money back into the business.

 

Therearesomecloudson thehorizon.Competitionis increasingand onlythat morning MollySportsannouncedplans to forma mail-­‐order division.Georgeis worriedthat beyond thenextthreeorso yearsit mightbecomedifficultto find worthwhileinvestment opportunities.

GeorgerealizesthatJennywillneedto knowmuchmoreabouttheprospectsforthe businessbeforeshecanputa final figureon thevalueof ReebySports,buthehopesthat

theinformationbelowis sufficientforherto givea preliminaryindicationof thevalueof the

shares.

 

 

Column1 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E
earningsper share,$  

-­‐0.70

  

-­‐0.23

  

0.81

  

1.10

  

1.30

  

1.52

  

1.64

  

2.00

  

2.03

  

2.33

  

2.68
Dividend,$ 0.00 0.00 0.20 0.20 0.30 0.30 0.60 0.60 0.80 0.80 1.00
Bookvalue pershare,$  

7.70

  

7.00

  

7.61

  

8.51

  

9.51

  

10.73

  

11.77

  

13.17

  

14.40

  

15.93

  

17.62
ROE,% -­‐7.14 -­‐2.99 11.57 14.45 15.28 15.98 15.28 16.99 15.41 16.21 16.85

 

a)      HelpJennyto forecastdividendpaymentsforReebySportsand to estimatethevalue of thestock.You do notneedto providea singlefigure.Forexample,youmaywishto calculatetwofigures,oneon theassumptionthattheopportunityforfurther profitableinvestmentis reducedin year3and anotheron theassumptionthatitis reducedin year5.You canassumea costof equityof 12%forthecalculation.

(21points)

 

 

OnceReebyoperatesas a marketlistedfirm,Georgewillhaveto justifythefirm’scapital structuretowardsshareholders.Hehas heardfromhis daughterthatmostfirmsshould use atleastsomedegreeof debtif thegoalis themaximizationof shareholdervalue.Jenny mentioneda “debttax shield”as thereasonforherclaim.George,on theotherhand is worriedabouttheincreasedriskthatdebtmightbringforequityholders.

 

 

b)      Brieflyexplaintheleverageeffectand howitis relatedto theexpectedriskfor shareholders.Also,explainthebalancing(ortrade-­‐off) theoryof capitalstructure. Whatarethetwoeffectsthatneedto bebalancedand whatdoesthetheoryimplyfor thedebt/equitychoiceof Reeby?(13points)

 

 

 

Georgeis increasinglyconfidentto takethefirmpublic.However,therearestill someissues aroundtheIPOprocessthathehas notyetfiguredout. Hehas writtendownthesequestions and asksforyourhelp:

 

c)       Pleaseexplainwhata „Greenshoeoption“ is and underwhatcircumstancesitis used.

(4points)

d)      WithintheIPOprocessunderwritersplayan importantrole.Definetheterms underwriterand syndicateand explaintheirrole/purpose.(4points)

 

e)      In 2003,prosecutorschargedseveralinvestmentbankersforwhatis called“spinning”.

Brieflyexplaintheunderlyingprincipleand rationalizetheuseof spinningby investmentbanks.(8points)

 

Finance Question – Exchange Rate

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Tiffany Case

 

1.            In what way(s) is Tiffany exposed to exchange-rate risk subsequent to its new distribution agreement with Mitsukoshi?  How serious are these risks?

 

2.            Should Tiffany actively manage its yen-dollar exchange-rate risk?  Why or why not?

 

3.            If Tiffany were to manage exchange-rate risk activity, what should be the objectives of such a program?  Specifically, what exposures should be actively managed? How much of these exposures should be covered, and for how long?

 

4.            As instruments for risk management, what are the chief differences of foreign-exchange options and forward and futures contracts?  What are the advantages and disadvantages of each? Which, if either, of these types of instruments would be most appropriate for Tiffany to use if it chose to manage exchange-rate risk?

 

5.            How should Tiffany organize itself to manage its exchange-rate risk?  Who should be responsible for executing its hedges? Who should have oversight responsibility for this activity?  What controls should  be put in place?

Finance Assignment – DESTROYA PEST CONTROL INC

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DESTROYA PEST CONTROL, INC.

 

 

 

Desmond Troya, CEO of DESTROYA Pest Control, Inc. is weighing the purchase of new equipment, based on heat sensing technology, for termite inspections.  The equipment will cost $156,000 including delivery and setup.  It is expected to have a useful life of 5 years and will be depreciated using the MACRS percentages for a seven-year class life.  After five years, the estimated disposal value of the equipment would be $15,600.

 

 

 

Adoption of the new inspection technology would require an investment in Net Working Capital equal to 15% of the following year’s revenue from inspection services.  For purposes of analysis, Mr. Troya assumes that this investment will occur at the beginning of each year (at t0 for yr 1, t1 for year 2, etc.).  Falling sales would result in a positive cash flow from the partial liquidation of working capital.  All net working capital will be recovered at the end of the project (year 5).  DESTROYA estimates its average cost of capital (discount rate) at 10.5% and its marginal tax rate at 34%.

 

 

 

Most likely scenario:

 

Mr. Troya believes the equipment would be used to perform 960 inspections the first year.  Customers would be charged $150 for an inspection.  Labor, supplies and other direct, cash costs per inspection would be $75.  DESTROYA would also have $20,000 per year in fixed costs directly associated with this project.  Fixed costs would stay the same throughout the five years.  Troya believes that the number of inspections would probably increase by 5% per year; the price of an inspection and direct, variable costs would also increase by 5% per year.

 

 

 

Best case scenario:

 

Same as the most likely scenario except that 1050 inspections are performed in the first year and the number of inspections performed increases at the rate of 10% per year for the remaining four years.

 

 

 

Worst case scenario:

 

 

 

960 inspections are performed in the first year, but competitors purchase the same technology causing unit sales and price to fall by 5% per year.   Direct variable costs, on the other hand, still rise at the rate of 5% per year.

 

 

 

Required:

 

 

 

1.  Compute a separate schedule of cash flows (investment, operating and terminal, if any) for each scenario of the expansion project.

 

 

 

2.  For each scenario, compute payback, net present value, and internal rate of return.

 

 

 

 

3.  Make a recommendation whether or not to go ahead with the project.   Consider all three scenarios.  You have subjectively estimated the probability of the best and worst case scenarios at 25% and 50% for most likely case.  Explain your decision.  Keep in mind that scenarios happen, they cannot be chosen in advance.