a. Define the following
Variable production costs
Fixed charges
Plant overhead costs
b. List at least three groups of fixed charges that must be considered when deciding whether to invest money for a proposed project. [3]
c. Trade Kings Limited produces 300 metric tonnes of Boom washing powder per year. The production cost per kg of washing powder is K15.00. The average annual depreciation is calculated to be K180,000.00. The sum of annual fixed charges overhead cost and general expenses is K3,000,000.00. The taxes are payable at 30% gross. The washing powder sells at K40 per kg. Assuming the plant runs at full capacity and that all the washing powder produced is sold, determine the annual net profit of the plant.
- Determine the annual cash flow resulting from the process operations. [2]
Briefly explain how the net profit can be improved.
The Correct Answer and Explanation is:
b. List at least three groups of fixed charges that must be considered when deciding whether to invest money for a proposed project. [3]
c. Trade Kings Limited produces 300 metric tonnes of Boom washing powder per year. The production cost per kg of washing powder is K15.00. The average annual depreciation is calculated to be K180,000.00. The sum of annual fixed charges overhead cost and general expenses is K3,000,000.00. The taxes are payable at 30% gross. The washing powder sells at K40 per kg. Assuming the plant runs at full capacity and that all the washing powder produced is sold, determine the annual net profit of the plant.
7. Determine the annual cash flow resulting from the process operations. [2]
Briefly explain how the net profit can be improved.
a. Definitions
- Variable Production Costs: These are costs that vary directly with the level of production. As more units are produced, the total variable cost increases. Examples include raw materials, direct labor, and utility costs directly tied to production.
- Fixed Charges: These are costs that remain constant regardless of the level of production or sales. Examples include rent, insurance, depreciation, and salaries of permanent staff.
- Plant Overhead Costs: These refer to all the indirect costs associated with operating a production facility. This includes utilities, maintenance, factory supplies, indirect labor, and depreciation of machinery not directly traceable to a specific product.
b. Three Groups of Fixed Charges to Consider in Investment Decisions
- Depreciation Expenses – The reduction in value of fixed assets over time due to usage and wear and tear.
- Insurance and Property Taxes – Costs related to asset protection and compliance with local tax regulations.
- Salaries of Administrative and Maintenance Staff – Payments to personnel whose compensation does not vary with production volume.
c. Annual Net Profit Calculation
- Production Volume: 300 metric tonnes = 300,000 kg
- Selling Price per kg: K40
- Total Revenue = 300,000 kg × K40 = K12,000,000
- Variable Production Cost = 300,000 kg × K15 = K4,500,000
- Fixed Charges + Overhead + General Expenses = K3,000,000
- Depreciation = K180,000
- Total Costs (before tax) = K4,500,000 + K3,000,000 + K180,000 = K7,680,000
- Earnings Before Tax (EBT) = K12,000,000 − K7,680,000 = K4,320,000
- Tax (30%) = 30% of K4,320,000 = K1,296,000
- Net Profit = K4,320,000 − K1,296,000 = K3,024,000
7. Annual Cash Flow from Operations
To calculate cash flow, we add back non-cash expenses (depreciation) to net profit:
- Cash Flow = Net Profit + Depreciation
- Cash Flow = K3,024,000 + K180,000 = K3,204,000
How Net Profit Can Be Improved
To enhance net profit, Trade Kings Limited can implement several strategies:
- Reduce Variable Production Costs: By sourcing cheaper raw materials or improving production efficiency (e.g., minimizing waste or automating processes), the company can reduce the K15 per kg cost, increasing margins.
- Optimize Fixed Costs: Though fixed, these costs can often be reduced through lease renegotiations, energy audits to reduce utility bills, or downsizing underutilized resources.
- Increase Selling Price Strategically: If market demand is strong and the product quality justifies it, a slight increase in the selling price of Boom washing powder can significantly boost profit without raising costs.
- Expand Production and Sales Volume: Since the plant is at full capacity, expanding plant capacity or outsourcing additional production can increase total revenue if market demand supports it.
- Tax Planning: Legal tax reduction strategies (like investment in tax-deductible activities or optimized depreciation methods) can decrease tax liability and increase after-tax profit.
- Product Diversification: Offering variants or related products can share overhead costs across more items, improving overall profitability.
By applying these improvements, the business can ensure better financial health, more robust cash flows, and sustainable long-term growth.
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