Instructors Manual - Financial Management for Decision Makers Eighth...

Instructor’s Manual Financial Management for Decision Makers Eighth Edition Peter Atrill 1 / 4

Atrill, Financial Management for Decision Makers, 8 th edition, Instructor’s Manual on the web 7 © Pearson Education Limited 2017

CHAPTER 2

Solution to Exercise 2.2 Davis Travel Ltd (a) (i) Projected cash flow statement for the six months to 31 March Year 5 Oct Nov Dec Jan Feb Mar Receipts £000 £000 £000 £000 £000 £000 Deposits 30 90 90 90 – – Final balance –

– 270 810 810 810

30 90 360 900 810 810

Payments Payables 180 Non-current assets 50 Loan repayment 20 Loan interest 10 Admin 60 60 60 60 60 60 Commission - 30 90 90 90 - Other variable costs - - 20 80 60 40 Hotels - - 100 400 300 200 Flights - - 50 200 150 100 Promotion 100

150 150 50 - -

340 240 470 880 660 480

Cash flow (310) (150) (110) 20 150 330 Opening balance 30 (280) (430) (540) (520) (370) Closing balance (280 ) (430) (540) (520) (370) ( 40) (ii) Projected income statement for the six months to 31 March Year 5 £000 Sales revenue 3,000 Flights (500) Promotion costs (450) Hotels (1,000) Admin costs (360) Other variable costs (200) Commission (300) Depreciation

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) Operating profit 148 Interest charges ( 10) Profit for the period 138 2 / 4

Atrill, Financial Management for Decision Makers, 8 th edition, Instructor’s Manual on the web 8 © Pearson Education Limited 2017 (iii) Projected statement of financial position as at 31 March Year 5 £000

ASSETS

Non-current assets (560 + 50 − 42) 568 Current assets –

Total assets 568

EQUITY AND LIABILITIES

Equity Share capital 100 Retained earnings 338 438 Non-current liabilities Borrowings − loans (110 − 20) 90 Current liabilities Bank overdraft 40

Total equity and liabilities 568 (b) A major problem facing the business is the heavy cancellation charges that will have to be borne if sales do not meet expectations. Given the low profit margins and weak cash flows of the business, this obligation can provide a real threat to the viability of the business.A further problem facing the business is the pattern of receipts and expenditures that it has.The business must pay large amounts out at the beginning of the season for advertising. As bookings have not been received at this point, the business is reliant on a large overdraft to meet these obligations. In the event that the bank withdraws its support the business would be in grave difficulties. It would be advisable to seek an injection of long-term funds to put the business on a sounder footing.The profit is small in relation to the sales revenue and expenses of the business. A slight increase in expenses, without a corresponding increase in sales, could wipe out the projected profits.Solution to Exercise 2.3 Fowler Ltd (a) Projected income statement for the year ending 31 October Year 8 £000 Sales revenue (1.8m × £1.20) 2,160 Variable expenses (1.8m × £0.35) (630) Fixed expenses (420 + 150) (570 ) Operating profit 960 Interest payable (Note 1) (380) Profit before taxation 580 3 / 4

Atrill, Financial Management for Decision Makers, 8 th edition, Instructor’s Manual on the web 9 © Pearson Education Limited 2017 Tax (30%) (174 ) Profit for the year 406 Note 1 Loan notes with a nominal value of £2.5m will be required to raise the cost of the new bottling line. Total interest payable is, therefore, [(£2.5m + £1.3m) × 10%] = £380,000 (b) (i) Earnings per share (EPS) EPS = Profit available to ordinary shareholders

Ordinary shares in issue Year 7 Year 8 £350

2,000 £406

2,000 17.5p 20.3p (ii) Degree of operating gearing DOG = Sales − Variable costs Operating profit Year 7 Year 8

£ (1,800 − 750)

£630

£ (2,160 − 630)

× 100%

£960 1.67 1.59 (iii) Degree of financial gearing DFG = Operating profit Operating profit - Interest payable Year 7 Year 8 £630

£500 £960 £580

1.26 1.66

(iv) Degree of combined gearing

DCG = DOG × DFG

Year 7 Year 8

1.67 × 1.26 1.59 × 1.66

2.10 2.64

(c) Investing in the new bottling line will increase profit for the year by 16 per cent and boost earnings per share by the same amount. Although variable costs are reduced, fixed expenses are increased, thereby increasing operating gearing. Other things being equal, this would increase the degree of operating gearing. However, as sales increased by 20 per cent, the degree of operating gearing has reduced slightly. This is because the impact of operating gearing becomes less pronounced the further away from the point at which sales (less variable costs) equal the fixed costs.

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