Certificate in Accounting and Finance Stage Examination

ARTT Business School 10 June 2024

Fellow RAET of the ICAP 2.25 hours – 70 Marks
Prepared by Ahmed Raza Mir, FCA Additional reading time – 15 minutes

Managerial and Financial Analysis

Q1 Zee Limited has been importing a product named Sigma from Indonesia for several years. The company is
now considering producing the product locally by obtaining the production formula from the Indonesian
manufacturer and agreeing to pay a royalty of 3% of sales. Below are the details pertaining to importation
and production:

Import option
1 Last year, the company imported 6,000 units. The manufacturer has agreed to increase the supply by
5% per annum. The current demand for the product is 14,500 units per year, expected to remain
constant over the next five years.
2 The current selling price per unit is Rs 138, inclusive of a 15% adjustable sales tax. This price is
expected to increase by 10% per annum due to inflation specific to imported products.
3 The purchase price per unit last year was Rs 90. A withholding income tax of 10% is applied at the
time of import on the purchase price, considered final with no further income tax levied on the
company's income.
4 A customs duty of 7.5% is levied on the cost plus withholding tax. An additional sales tax of Rs 8 per
unit is paid at import but is subsequently adjustable.

Production-Related Data:
1 The company needs to purchase machinery costing Rs 2 million. Tax authorities will allow an initial
allowance of 30% of the cost and depreciation of 50% of the cost over five years. Normal depreciation
will be allowed on 10% on WDV. Any gain or loss on disposal is non-tax deductible or chargeable.
2 Tax depreciation is charged at 10% on a reducing balance method.
3 The residual value of the machinery at the end of five years will be 25% of the cost.
4 First-year production will be 10,000 units, with an annual increase of 10% subject to maximum
demand.
5 The first-year selling price per unit for the produced product will be Rs 149.50 (inclusive of 15% sales tax
adjustable ), adjusting in line with general inflation thereafter.
6 Variable production costs include:
a. Direct material: Rs 23 per unit, inclusive of 15% adjustable sales tax.
b. Direct labor: Rs 20 per unit. Labor hours will be reallocated from discontinuing a smaller
product with a contribution margin of Rs 5 per unit. Two units of the smaller product will
be forgone to produce one unit of Sigma.
c. Variable overhead: Rs 6 per unit.

General Information:
1 The applicable tax rate is 30%, except for imported goods where the tax paid is the withholding tax on
import.
2 Applicable dicount rate to the case is 16% p.a.
3 The inflation rate in Pakistan is 5%, and in Indonesia, it is 8%, applicable from the relevant year.
4 Last year's office rent was Rs 25,000 per year. If the company opts for production, factory rent will be
 Rs 65,000 per year for the first year.

Required:

Using the Net Present Value (NPV) technique and a time horizon of five years, advise Zee Limited on
whether to continue importing the product or start producing it locally in Pakistan. (17)

Q2 Shahzad limited is in all equity company and is consulting to expand its operations by setting up a new
plant. Following are the credentials of the company at 31 December 2023

1 Ordinary shares with a par value of Rs 10 in issue are 25,000

2 Dividend for the last 4 years:
Year Dividend / Share (Rs)
2023 24.50
2022 23.01
2021 21.50
2020 20.00
3 Beta equity of the company is 1.24
4 Market return observed is 16% where as risk free rate is 9%

The expansion project

The project would be needing Rs 2,000,000. The project will result in the following cash flows in
perpetuity:
----Rs----
Annual Sales 950,000
Cost of sales 380,000
Operating cost 142,500
This project will not affect the cost of equity (WACC)

Required
1 Calculate the current WACC of the company (04)
2 Calculate the market value of the company after accepting the project (05)

Q3 In the manufacture of a company's range of products, the processes give rise to two main types of waste
material.

Type A is the outcome of the company's original processes. This waste is sold at Rs.2 per tonne, but this
amount is treated as sundry income and no allowance for this is made in calculating product costs.

Type B is the outcome of newer processes in the company's manufacturing activity. It is classified as
hazardous, has needed one employee costing Rs.9,000 per year specially employed to organize its handling
in the factory, and has required special containers whose current resale value is assessed at Rs.18,000. At
present the company pays a contractor Rs.14 per tonne for its collection and disposal.

Company management has been concerned with both types of waste and after much research has
developed the following proposals.

Type A waste

This could be further processed by installing plant and equipment costing Rs.20 000 and incurring extra
direct costs of Rs.2.50 per tonne and extra fixed costs of Rs.10,000 per annum.
 Extra space would be needed, but this could be obtained by taking up some of the space currently used as a
free car park for employees. The apportioned rental cost of that land is Rs.2,500 per annum and a
compensation payment totaling Rs.500 per annum would need to be paid to those employees who would
lose their car-parking facilities.

The selling price of the processed waste would be Rs.12.50 per tonne and the quantity available would be
2000 tonnes per annum.

Type B
Using brand-new technology, this could be further processed into a non-hazardous product by install-ling a
plant costing Rs.120,000 on existing factory space whose apportioned rental cost is Rs.12,500 per annum.

This plant cost includes a pipeline that would eliminate any special handling of the hazardous waste. Extra
direct costs would be Rs.13.50 per tonne and extra fixed costs of Rs.20,000 per annum would be incurred

The new product would be saleable to a limited number of customers only, but the company has been able
to get the option of a contract for two years' sales renewable for a further two years. This would be at a price
of Rs.11 per tonne and the output over the next few years is expected to be 4,000 tonnes per year.

For Type A waste project, the board wants to achieve an 8% DCF return over four years. For Type B waste
project, it wants a 15% DCF return over six years.

Required
Recommend whether the company should invest in either or both of the two projects. (15)

Q4 Following is the movement in loan amount of Sultan Limited:

2022 2023
Opening Balance 650,000 665,000
Interest at effective rate (10%) 65,000 66,500
Cash Payment (50,000) (50,000)
Closing Balance 665,000 681,500
Today is 1 October 2023.

The company is scheduled to repay the above loan amount on 31st December 2023. However, it lacks the
necessary financial support or funds to settle this obligation until 31st May 2024. The company is expected
to receive a government grant of Rs 700,000 on 31st May, which would be sufficient to cover the loan
repayment.

To bridge this gap, the company requires an intermediate loan for five months. The current KIBOR
(Karachi Interbank Offered Rate) is at its lowest, at 12% per annum. The company anticipates a substantial
increase in these rates over the next three to four months, potentially resulting in a more expensive loan to
refinance the existing debt.

To mitigate the risk of adverse interest rate movements by 31st December 2023, the company is considering
the following hedging instruments:

1 Forward Rate Agreement (FRA)

A 3 x 5 FRA at 13.25% - 13.50%
A 3 x 8 FRA at 13.45% - 14.15%

Interest Rate Futures

A 3-month January interest rate futures contract with a contract size of Rs 31,250 is available at 85.5.
 The basis will diminish uniformly.

Borrower's Option
An over-the-counter interest rate option for a five-month loan at 13.65% with a premium of 1.25%,
payable on a notional amount with a Rs 62,500 contract size.

Required:
Assuming an expected spot rate of 17.55% on 31st December 2023 and that the company obtains a loan at
KIBOR + 1.3% for a period of five months, calculate the actual borrowing cost considering all the above
hedging instruments. (14)

Q5 ABC limited has managed to produce the following profit and loss statement for the year just concluded:

-----Rs----
Sales (40,000 units @ Rs 50) 2,000,000
Variable Cost of Goods Sold (1,540,000)
Fixed cost of goods (250,000)
Gross profit 210,000

Further information
1 Cost of goods manufactured was determined to be 96% of cost of goods sold
2 Raw material consumed is 56% of cost of goods manufactured

Next year the company is considering to ease the credit period for customers by 14 further days. This will
bring the following changes:

1 Sales volume will increase by 10,000 units

2 Due to economies of scales variable cost per unit will go down by 6%.
3 Selling price and all costs will increase by 7% on account of expected inflation
4 Bad debts will increase from 2% of sales to 3% of sales
5 Raw material consumption will increase inline with the change in volume and inflation and cost
reduction

Working capital policies (Existing)

1 The company allows 30 days to debtors to settle their account

2 Production time is 10 days
3 The company keeps raw material and finished goods stock for 2 and 3 weeks
4 Creditors allow 3 weeks to the company to settle their balance

Working capital finance is hard to arrange and current cost of finance is 18%. Any increase would be
arranged at 4% above rate

Required
Calculate the increase in profit over last year after incorporating all changes above including inflation (15)
Question

Importing the product

- 1 2 3 4 5
Sales 756,000 873,180 1,008,523 1,164,844 1,345,395
Purchase cost (724,116) (821,147) (931,181) (1,055,959) (1,197,458)
Office rent cost (26,250) (27,563) (28,941) (30,388) (31,907)
Net cash 5,634 24,470 48,401 78,497 116,030
PV at 16% 4,857 18,185 31,009 43,353 55,243
NPV of import option 152,648

Working 1 2 3 4 5
Sales units (growth 5%) 6,300 6,615 6,946 7,293 7,658
Selling price (inf 10%) 120.00 132.00 145.20 159.72 175.69
Purchase price (Inf 8%) 114.94 124.13 134.06 144.79 156.37

Purchase price 90.00

Withholding tax 9.00
99.00
Custom duty 7.43
106.43 inflated for first year 114.94

Production decsion 132.25

- 1 2 3 4 5
Sales 1,300,000 1,501,500 1,734,233 2,003,039 2,291,229
Production cost (560,000) (646,800) (747,054) (862,847) (986,991)
Depreciation - IA (600,000) I/A 600,000
Depreciation - Normal (140,000) (126,000) (113,400) (102,060) (518,540) Max Dep 1,000,000
Royalti (39,000) (45,045) (52,027) (60,091) (68,737)
Fixed Cost (91,250) (95,813) (100,603) (105,633) (110,915) 1,600,000
(130,250) 587,843 721,148 872,407 606,046 Four yrs (1,081,460)
Tax @ 30% 39,075 (176,353) (216,345) (261,722) (181,814) 518,540
Depreciation 740,000 126,000 113,400 102,060 518,540
I/O (2,000,000) 500,000
Net Cash Flows (2,000,000) 648,825 537,490 618,204 712,745 1,442,772
NPV at 16% (2,000,000) 559,332 399,442 396,057 393,643 686,923
435,397

Working 1 2 3 4 5
Sales units (growth 10%) 10,000 11,000 12,100 13,310 14,500
Selling price (inf 5%) 130.00 136.50 143.33 150.49 158.02
Variable production cost (5% inf) 56.00 58.80 61.74 64.83 68.07
Fixed Costs - Factory 65,000 68,250 71,663 75,246 79,008
Fixed Costs - Office 26,250 27,563 28,941 30,388 31,907

Material 20 46 / 1.15
Labour 20
Opertunity Cost 10
VOH 6
56.00
Solution

Dividend details
Dividend per share 24.50
Oldest dividend per share 20.00
Time 3 years
Dividend growth rate 7.00%
Dividend current yr 24.50

Cost of equity
Risk free rate 9.00%
Market return 16.00%
Beta equity 1.24
Cost of equity (Ke) 17.68%

Market value per share 245.4674

Total Market Value 6,136,685
Solution

Laon amount 681,500

FRA
A 3x8 FRA is to be obtained

Amount Rate Interest

Loan from bank 681,500 18.85% 53,526 Five months interest
PV of Kickback (8,997) 9655 / (1+17.55% x 5/12)
Net interest cost 44,529

Kickback from FRA 681,500 3.40% 9,655 Five months interest

Interest rate futures

Amount required 681,500

Month 5.00
Month avaiable in future 3.00
Amount adjusted 1,135,833 681,500 / 3 x 5
Contract size 31,250
Contracts 36.35
Rounded to 36.00
Converage 1,125,000

Future rate for Jan 85.50 14.50

Spot rate now 12.00
Bais difference 2.50
Months 4
Closing at 31 Dec (months left) 1
Basis left 0.6250 2.5/4x1

Spot rate at 31 Dec 17.55%

Future basis left 0.625%
Future rate on 31 Dec for Jan 18.175%
In future terms 81.825

Futuer market operations

Future sell 85.5000
Future buy 81.8250
Gain on future 3.6750

Amount Rate Months Interest

Loan from bank 681,500 18.85% 5 53,526
Future gains 1,125,000 3.675% 3 (10,336)
Net interest cost 43,190
Interest rate Options

Loan from market 17.55%

Options lock in rate 13.65%
Gain on options 3.900%

Contracts 681,500
Contract size 62,500
Contracts 10.90
Rounded off to 11.00
Converage 687,500

Amount Rate Months Interest

Loan from bank 681,500 18.85% 5 53,526
Options gain 687,500 3.900% 5 (11,172)
Premium paid 687,500 1.250% 5 3,581
Net interest cost 45,935

Hedging instruments Effective Borrowing cost

Forward rate agreement 44,529
Interest rate futures 43,190 Proved to be the best
Interest rate options 45,935
Type A

Annual Cash Flows

CF DF PV
Outlay (20,000) 1 (20,000)
Extra processing cost (5,000) 3.3121 (16,561)
Fixed Cost (10,000) 3.3121 (33,121)
Compensation (500) 3.3121 (1,656)
Additional Sales 21,000 3.3121 69,555
Net Present Value (1,783)

Since the NPV is negative the company should not process Type A waste

Type B

Annual Cash Flows

CF DF PV
Outlay (102,000) 1.0000 (102,000)
Extra direct cost (54,000) 3.7845 (204,362)
Additional Fixed Cost (20,000) 3.7845 (75,690)
Savings in employee cost 9,000 3.7845 34,060
Savings in Fixed Costs 56,000 3.7845 211,931
Sales 44,000 3.7845 166,517
Net Present Value 30,457

Since the NPV is possitive the company should further process Type B waste material.
Solution

Profit last year 115,981

Profit for next year 294,566
Additional profit 178,585
The company should go ahead with the new policy

Working capital balance for last year

Cost of goods Sold (Total) 1,790,000

Cost of goods manufactured 1,718,400
Raw Material consumed 962,304

Base Days Balance

Receivables 2,000,000 30 166,667
Raw Material 962,304 14 37,423
Work in Process 1,718,400 10 47,733
Finished Goods 1,790,000 21 104,417
Creditors 962,304 21 (56,134)
Working capital (Average) 300,105

Interest for the year (at 18%) 54,019

Last year profit

Gross profit 210,000
Bad debts (40,000)
Finance cost (54,019)
Net profit 115,981

Next year financial information

Sales (50,000 units@ Rs 50x1.07) 2,675,000

Variable Cost of goods sold (1,936,165) 1.54 mil / 40k x 50k x 1.07 x .94
Fixed Cost of goods sold (267,500)
Gross profit 471,335
Finance cost (96,519)
Bad debts (80,250)
Net profit 294,566

Base Days Balance

Receivables 2,675,000 44 326,944 160,278
Raw Material 1,209,857 14 47,050 9,627
Work in Process 2,227,795 10 61,883 14,150
Finished Goods 2,203,665 21 128,547 24,130
Creditors 1,219,484 21 (71,137) (15,002)
Working capital (Average) 493,288
Previous working capital balance 300,105
Additional working capital 193,183
 Interest cost 54,019 300,105 x 18%
Further interest cost 42,500 193,183x 22%
96,519

Finished Goods
Op 104,417 COGS 2,203,665
COGM 2,227,795

Closing 128,547

Raw material consuption last year 962,304

Adjusted for three aspects 1,209,857 962,304/40k x 50k x 1.07 x 94%

Raw Material
Op 37,423 Consumed 1,209,857
Purchase 1,219,484

Closing 47,050