Part-1
Greentown Industries sells its transport services at a range of prices to 5 different customer groups. The company has fixed costs of £150,000 per year. The average variable costs for each transport service, irrespective of customer group, is £7. The Table below display the prices charged to each customer group and the quantity of transport services that are currently sold at that price.
|
Customer group
|
Selling price
|
Quantity
|
|
Multinational
|
£19
|
13,000
|
|
Corporate
|
£20
|
12,500
|
|
Small business
|
£21
|
12,000
|
|
Government
|
£22
|
11,000
|
|
Private
|
£23
|
10,000
|
a. If the average selling price is £21, Evaluate the breakeven point in quantity and money terms and draw a rough sketch of a cost-volume-profit (CVP) graph that shows the relationships between the elements of CVP.
b. Ignoring any market demand or capacity limitations, Evaluate the optimum selling price for Greentown Industries and identify which customer group is most profitable.
Use the subsequent information to answer part (c)
Assume that the maximum market demand for each customer group is 20,000 transport services at the same price as currently charged (see Table above).
Also assume that Greentown's capacity limitation is 60,000 transport services.
- Based on the evaluation of optimum selling prices in (b) above but with the capacity and demand assumptions taken into consideration, calculate the maximum profits that Greentown can earn and the customer mix and quantity by which that profit can be achieved.
Part-2
Phonic Solutions PLC is considering creating a new division which will need an investment in computer and telecommunications equipment of £10 million. The company has a cost of capital of 12%.
The sales department has forecast sales for each of the next five years as follows:
Year 1 £4 million
Year 2 £6 million
Year 3 £8 million
Year 4 £6 million
Year 5 £4 million
Operations staff have predicted the cost of sales as 30% of revenue. Rent and office expenses are £300,000 each year. Selling and administration salaries will be £400,000 in the first year increasing each year by 5%. Repairs and maintenance will be £100,000 in each of years 1 and 2, £200,000 in each of years 3 and 4, and £300,000 in year 5. The company depreciates its equipment over 4 years.
a. Produce a
i. Profit budget for each of the five years, showing both gross profit and operating profit;
ii. Cash flow for each of the five years, and
iii. Apply a discounted cash flow technique and use this to recommend whether the new division and capital investment should proceed.
b. What does theory tell us about the strengths and limitations of budgeting and the discounted cash flow technique?