Download N1DM01 - The University of Nottingham

N1DM01
Nottingham University Business School
MASTER OF BUSINESS ADMINISTRATION
Examinations JANUARY 2003
ACCOUNTING AND FINANCE
Time allowed TWO hours
Candidates must NOT start writing their answers until told to do so
Answer a total of THREE QUESTIONS
Answer Question One in SECTION A and any two questions in SECTION B
If more than TWO questions are answered for Section B, marks will be awarded for the first two
answers only.
Only silent, self contained calculators with a Single-Line Display, or Dual-Line Display are permitted
in this examination.
Dictionaries are not allowed with one exception. Those whose first language is not English may use a
dictionary to translate between that language and English provided that neither language is the subject
of this examination. No electronic devices capable of storing and retrieving text may be used.
DO NOT turn examination paper over until instructed to do so
Turn Over
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SECTION A - This question is compulsory.
COMPULSORY
1. The Board of Directors of Rainall plc is reviewing the company’s operations. There is concern about the
performance of the furniture division, and the board is considering the divestment of the division. Rainall has
received an informal offer of £8 million for the division.
Divisional profits are estimated after the allocation by head office of some central costs and a depreciation
charge. The losses for the last year for the furniture division are shown below:
£000
2002
12,900
9,600
2,400
800
500
_______
(400)
(120)
Turnover
Direct costs of production
Allocated central overhead
Finance charge
Depreciation charge
Loss before tax
Imputed tax (tax reduction elsewhere in
Rainall)
_______
(280)
Loss after tax
Balance Sheet summaries of the furniture division
£000
2002
Land and Buildings
2,100
Plant and machinery (net)
3,650
Current assets:
Stock
Debtors
Cash
2,550
1,900
20
Less: Current liabilities
Trade creditors
Other creditors
(3,750)
(600)
______
5,870
Finance provided by Rainall’s central
treasury
5,870
The division’s accountant estimates that 65% of the allocated central overhead has actually been incurred on
behalf of the division and would be saved if the division closed. The depreciation charge is currently believed
to be at a realistic level relative to the division’s investments, and is expected to remain at approximately this
level. Depreciation for tax purposes is the same as the accounting depreciation charge. All finance is provided
by Rainall’s central treasury, and is charged at a composite rate linked to Rainall’s estimated weighted
average cost of capital. Rainall’s capital structure is 70% equity, 30% debt by market values, and 50% equity,
50% debt by book values. The company’s equity beta is 1.2, and medium term bonds may be issued at an
interest rate of 8%. The risk free rate is 4% and the market return 12%. The furniture division is believed to
be more risky that Rainall’s average operations; this extra risk would justify adding 3% per year to Rainall’s
cost of capital. Turnover of the furniture division is expected to increase by 5% per year, direct costs by 7%
per year, and central overhead by 8% per year. The central finance charge will remain approximately
constant.
At the end of five years the furniture division is estimated to have a net of tax disposal value at least equal to
the 2007 market value of land and buildings, plus £2 million. Land and buildings have an estimated current
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market value 70% above their book value, and plant and machinery 25% below their book value. Land and
buildings are expected to increase in value by 8% per year. If divestment was to take place Rainall would be
responsible for immediate redundancy payments, with an estimated pre tax cost of £2.5 million. Corporate
tax is at the rate of 30% per year, payable in the year that it arises.
Assume that it is now 1 January 2003. Turnover and operating costs may be assumed to be on a cash basis.
Required:
a) Using present value analysis, evaluate whether or not Rainall should accept the £8 million offer for the
furniture division. State clearly any assumptions that you make.
(28 marks)
b) Discuss other factors that might influence this decision.
(12 marks)
(40 marks)
SECTION B
Answer TWO questions only from this section.
2.
Given below are two extracts from the notes to the financial statements of Microsoft for the year ended
30th June 2002
“Research and development
Technological feasibility for Microsoft's software products is reached shortly before the product
is released to manufacturing. Costs incurred after technological feasibility is established are not
significant and accordingly, the Company expenses all research and development costs when
incurred”
“Unearned revenue
…The percentage of revenue recognized rateably for undelivered elements ranges from
approximately 20% to 25% for Windows XP Home, approximately 10% to 15% for Windows
XP Professional, and approximately 10% to 15% for desktop applications, depending on the
terms and conditions of the license and prices of the elements. Product life cycles are currently
estimated at three years for Windows operating systems and 18 months for desktop applications.”
(a) Explain the effect on Microsoft’s reported profits and net assets if the company decided to (i)
capitalise some of its development costs, which would then be amortised over the life of the
product line; and (ii) lower the percentage of revenue recognized rateably to 10% and then use a
product life cycle of five years for the subsequent recognition of the unearned revenue.
(10 marks)
(b) What factors may explain the decisions of the directors of Microsoft to avoid the capitalisation of
software development costs and to delay the recognition of revenue to future accounting periods?
(10 marks)
(c) Discuss the view that the accounting policies adopted by Microsoft are inappropriate and are a
form of accounting manipulation no different to the accounting abuses perpetrated by Enron and
Worldcom.
(10 marks)
(Total of 30 marks)
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3.
Roncon PLC is a large listed construction company, with its headquarters in London. It has a number of
projects in progress including the construction of a large hotel for the Novotel chain. The following
financial statements have been drafted, prior to being audited and published, by the accountant of Roncon
PLC:
Profit and loss account for the year ended 30 June 2002
2002
£M
Turnover
277
Cost of sales
220
Gross profit
57
Distribution costs
22
Administration expenses
20
Operating profit
15
Profit on disposal of fixed assets
5
Profit before interest and tax
20
Income from fixed asset investments
4
Interest payable and similar charges
2
Profit on ordinary activities before tax
22
Tax on profit on ordinary activities
6
Profit on ordinary activities after tax
16
Dividends
7
Retained profit for the year
9
Group balance sheet as at 30 June 2002
2002
£M
£M
Fixed assets
Intangible assets
Tangible assets
Investments
2001
£M
250
203
47
20
19
8
8
2
3
7
2
3
2
1
2001
£M
3
44
27
74
Current assets
Stock
Debtors
Cash at bank and in hand
34
26
11
71
Creditors falling due within one year
Creditors
Net current assets
Total assets less current liabilities
Creditors falling due after more than one year
Debentures
4
3
30
27
60
20
20
9
49
33
Capital and reserves
Called up share capital
Share premium account
Revaluation reserve
Profit and loss account
£M
14
38
112
35
95
20
92
20
75
42
8
3
39
92
40
2
3
30
75
The following information is relevant to the financial statements:
(i) The investment relates to the acquisition of a 10% stake in the equity share capital in another construction
company. The investment was made many years ago. At present the investment is carried at original cost.
The current market value of this stake – the shares are quoted – is £50million.
(ii) Soon after 30 June 2002 a debtor of Roncon, Sabena BV entered liquidation. Sabena owes Roncon
£10million. Roncon’s accountant has decided to be prudent and provided for the entire amount owed. This
£10 million provision is included in administrative expenses.
(iii) During the year the company conducted a valuation of its headquarters property. It was found to have a
current market value of £60million. The company, however, continues to carry this property at cost of
£40million in its balance sheet. This property is being depreciated over thirty years.
(iv) The stock relates to several incomplete construction projects. The company’s policy is to record no revenue
and profit until such projects are finished. The Novotel project is 95% complete. On completion it is expected
that the contract price of £40million will be settled and that the company will make £10million profit.
The company’s directors are coming under increased pressure to outperform its competitors in terms of both
profitability and risk. For this reason the directors have approached you, a freelance accountant, to advise on
ways to improve two key performance parameters, namely return on equity (ROE) and financial gearing (debt to
equity). You are to suggest changes to accounting policies and accounting estimates which can be implemented
with immediate effect. The company then plans to redraft the financial statements shown above. The directors
stress that they do not want to violate UK or International Accounting Standards.
Required:
Outline the accounting changes that Roncon PLC could make to boost ROE and reduce debt-to-equity for the
current year. You should attempt to explain how each change would impact upon the financial statements and, in
turn, the given ratios. You are NOT required to redraft the financial statements.
(Total of 30 marks)
4.
Evaluate the many criticisms that have been made about budgeting as a management and accounting
technique and suggest why, given this level of criticism, the technique remains widely used.
(Total of 30 marks)
5.
Where overheads are high and plants produce a range of items with significantly different volumes and
complexity, traditional volume-based systems tend to over-cost high volume lines and send out the wrong
signals about pricing (Rutherford, 2000). Activity-based costing (ABC) is often put forward as a solution
to these difficulties, but its adoption by large UK companies has levelled out (Innes et al, 2000).
Evaluate the potential benefits of ABC for cost-management within businesses and suggest why these
potential benefits will not always be realised.
(Total of 30 marks)
6.
EITHER:
'The capital asset pricing model relies on market efficiency, beta being the correct measure of risk and, if
used as the basis for the discount rate, may lead to underinvestment.'
Explain whether or not you agree with this statement, and discuss the advantages and disadvantages of
portfolio theory and the capital asset pricing model for financial managers.
[30 marks]
OR:
"The search for optimal capital structure is like the search for Truth or Wisdom: you will never
completely attain either goal." S.C. Myers.
Discuss alternative views on the influence of capital structure to the value of a company and the
importance of capital structure in financial decision-making.
[30 marks]
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END
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