MA 663 – 303



MB 663

Managerial Accounting

June 20, 2009

Penson

Final Examination

NAME: ___ANSWER KEY_______________

This examination consists of eight questions. Please read each question carefully. Avoid giving extraneous information (i.e., “filler”). Use graphs whenever possible to help tell your story. Use the back of the page if necessary. Good luck!

Question 1 _____ of 15 points

Question 2 _____ of 25 points

Question 3 _____ of 25 points

Question 4 _____ of 25 points

Question 5 _____ of 20 points

Question 6 _____ of 25 points

Question 7 _____ of 35 points

Question 8 _____ of 30 points

TOTAL _____ of 200 points

1. Assume you are going to a real estate auction. Please describe fully the process you would determine the maximum bid price you can pay for a particular tract of land in which you have an investment interest. (15 points)

When participating in an auction or simply offering to purchase real estate in a one-on-one negotiation, it is important to know what the maximum value you can afford to pay for a tract of real estate. This value can be found by merely rearranging the terms in the NPV equation to solve for the original purchase price which results in a net present value of zero. The present value is given by:

PV = NCFE(EPIFR,N) + {V0 ÷ PIFG,N}(PIFR,N)

– [tCG({V0 ÷ PIFG,N} – V0)](PIFR,N)

where V0 represents the asking price. You can justify making this investment as long as the net present value of this project is greater than zero (NPV = PV – C = $0). This suggests that the maximum you can bid for this tract of land on a per acre basis, or C, is also $2,125, or that:

$0 = PV – C

Transposing C to the left-hand side, we see that the maximum bid price is equal to PV above.

2. Please define and contrast the following accounting terms. Use the back of this page if necessary. (25 points)

a. Monthly cash position versus ending cash balance

The cash position is a line item in the cash flow statement while the cash balance is the first entry in a year-end balance sheet. The cash position in December’s monthly cash flow statement is identical to the cash balance in the year-end balance sheet.

b. Debt ratio versus leverage ratio

The debt ratio is the ratio of total debt to total assets. The leverage ratio is the ratio of total debt to equity. When the debt ratio is equal to 0.5, the leverage ratio is equal to 1.0.

c. Explicit versus implicit cost of capital

The explicit cost of capital is the interest stated on the loan contract or agreement. The implicit cost is the additional internal cost you assess the cost of debt capital as you use up your firm’s credit capacity.

d. Economic versus engineering capacity

Economic capacity refers to the level of output where MC=MR irregardless of whether the firm is perfectly or imperfectly competitive. Engineering capacity refers to the level of output where the MC curve becomes perfectly inelastic.

e. Process versus job order cost accounting

Process cost accounting involves assessing costs and productivity for key production process or cost centers as a product moves through the firm’s supply chain. There are multiple job cost reports analyzed by management. Job order cost accounting on the other hand is associated with unique custom orders and there is only one cost report.

3. Suppose a firm is considering undertaking one of the two projects. Project A generates an annual net cash flow of $8,000 annually over the three-year life of the project and requires an initial net capital outlay of $15,000. Project B generates an annual net cash flow of $7,000 over the six-year life of the project and requires an initial capital outlay of $25,000. Assume the cost of the assets acquired by these two projects grows at a 3% rate annually over time. (25 points)

Which project would you rank highest? Why? Assume the firm requires a 9% rate of return.

(SHOW ALL WORK FOR FULL CREDIT)

Project A:

NPV = 8,000(EPIF.09,6) – 15,000 – [15,000/(PIF.03,3)](PIF.09,3)

= 8,000(4.486) – 15,000 – (15,000/.915)(.7722)

= 8,000(4.486) – 15,000 – (16,393)(.7722)

= 35,888 – 15,000 – 12,659

= $8,229

Project B:

NPV = 7,000(EPIF.09,6) – 25,000

= 7,000(4.486) – 25,000

= 31,402 – 25,000

= $6,402

Prefer project A over project B since its NPV is greater.

4. Suppose your goal is to achieve a 10 percent rate of return on equity in your firm this year. Assume the annual cost of debt capital is 9 percent, your firm is in the 30 percent tax bracket and you plan to withdraw 10 percent of net income for other uses. Further assume your total debt outstanding is $75,000 and your total assets are worth $200,000. (25 points)

a. What rate of return on assets would your firm have to achieve to hit this target?

L = $75,000/($200,000 - $75,000) = $75,000/$125,000 = 0.60

ROE = [(ROA – i)L + ROA](1 – ty)(1 – w)

.10 = [(ROA – .09)0.60 + ROA](1 – .30)(1 – .10)

.10 = [1.6(ROA) – .054](.63)

.10 = 1.008(ROA) – .034

.134 = 1.008(ROA)

ROA = .1329 or 13.29 percent

Check:

Y = .1329(200,000) - .09(75,000) = 26,587.3 – 6,750 = 19,837.3

ROE = (19,837.3/125,000)(1-.30)(1-.10) = .0999 or 10 percent

b. Suppose the government raised the rate at which your income is taxed to 40 percent instead of 30 percent. What rate of return on assets would your firm now have to make to achieve your ROE goal?

.10 = [(ROA – .09)0.60 + ROA](1 – .40)(1 – .10)

.10 = [1.6(ROA) – .054](.54)

.10 = .864(ROA) - .0292

.1292 = .864(ROA)

ROA = .1495 or 14.95 percent

Check:

Y = .1495(200,000) - .09(75,000) = 29,907.4 – 6,750 = 23,157.4

ROE = (23,157.4/125,000)(1-.40)(1-.10) = 10 percent

5. The DuPont model approach to analyzing the profitability of a firm allows you to determine factors that may be limiting the firm’s economic performance. Please discuss the DuPont model, its linkages to the firm’s financial statements, and the specific manner in which it helps you analyze the factors affecting profit. (20 points)

The relationship between the financial statements and the ROA is explained by the DuPont model as shown below:

A firm is said to be in a sound financial condition if:

1. It has a high profit margin, which signals strong operating management. If not, seek ways to raise prices and lower costs.

2. It has a high total asset turnover ratio, which signals strong asset management. If not, seek ways to eliminate redundant or idle assets and increase productivity.

3. It has a low equity multiplier, which signals strong capital management in the presence of low and stable cost of debt capital.

6. Suppose you are considering investing in a $75,000 depreciable asset for your business that has an economic life of 10 years. Assume further that you plan to sell this asset 5 years from now. If the expected net cash flows generated by this asset are $15,000 annually and you require an 8% rate of return, would you make this investment if: (25 points)

a. The market value of the depreciable asset was only $15,000 five years from now?

b. What would this market value have to be 5 years from now before you would be indifferent about making this investment?

(SHOW ALL WORK FOR FULL CREDIT)

a. NPV = NCF(EPIF.08,5) – C + T(PIF.08,5)

= 15,000(3.993) – 75,000 + 15,000(.681)

= 59,895 – 75,000 +10,215

= - $4,890 ( NO

b. Set equation in part (a) equal to zero and solve for T

T = [C – NCF(EPIF.08,5)]/ (PIF.08,5)

= [75,000 – 59,895]/.681

= 15,105/.681

= $22,181

Check your answer:

NPV = 59,895 – 75,000 +22,181(.681)

= 59,895 – 75,000 + 15,105

= $0.00

7. Assume a firm produces two products (product A and product B). Assume further that the firm has three activities (setups, assembly and shipping). Given the following information, answer the questions listed below this data. (35 points)

Driver Activity Distribution

Overhead Activity Product A Product B

Setups $300,000 1,500 500 1,000

Assembly $500,000 50,000 30,000 20,000

Shipping $100,000 2,000 500 1,500

Unit Production Costs

Product A Product B

Direct materials $40 $30

Direct labor 12 12

a. If the firm produces 10,000 units of Product A and 20,000 units of Product B, please determine the total unit costs of production for each product using activity based cost accounting.

b. How does differ from the total unit costs of production for each product if activity based cost accounting was not used?

(SHOW ALL WORK FOR FULL CREDIT)

Overhead activity per driver

Setups $300,000/1,500 = $200

Assembly $500,000/50,000 = $100

Shipping $100,000/2,000 = $50

Product A Overhead Product B Overhead

Setups $200(500) = $100,000 $200(1,000) = $200,000

Assembly $100(30,000) = $300,000 $100(20,000) = $200,000

Shipping $50(500) = $25,000 $50(1,500) = $75,000

Total $425,000 $475,000

Per unit charge using ABC

Product A = 425,000/10,000 = $42.50

Product B = 475,000/20,000 = $23.75

Per unit charge without ABC

All products = 900,000/30,000 = $30.00

Total unit costs with ABC accounting

Unit Production Costs

Product A Product B

Direct materials $40.00 $30.00

Direct labor 12.00 12.00

Overhead 42.50 23.75

Total $94.50 $65.75

Total unit costs without ABC accounting

Unit Production Costs

Product A Product B

Direct materials $40.00 $30.00

Direct labor 12.00 12.00

Overhead 30.00 30.00

Total $82.00 $72.00

Thus, ABC accounting more accurately highlights the true costs of both products and helps in making enterprise decisions.

8. Suppose land is currently selling for $3,000 an acre and that you expect land prices to go up at an annual rate of 8 percent over the next 10 years. Further assume that you expect this land to generate annual net cash flows of $750 an acre over this 10-year period. (30 points)

a. What is the after-tax capital gain associated with this investment in year 10 if capital gains are taxed at a 20 percent rate?

b. Can you justify purchasing this land if your required rate of return is 10 percent?

c. What would this investment be feasible if the annual net cash flows were only $100 an acre?

(SHOW ALL WORK FOR FULL CREDIT)

NPV = NCFE(EPIFR,N) – C + T(PIFR,N) – tCG[(C/(PIFG,N))-C ]

where:

T = C/(PIFG,N)

T = $3,000/(PIF.08,10) = $3,000/.463 = $6,480

a. After tax capital gains calculation:

= [0.20[($6,480 - $3,000]

= .20[$6,480 - $3,000]

= 0.20($3,480)

= $696

Therefore the after tax capital gain is = $6,480 – $3,000 – $696 = $2,784

b. Net present value calculation:

NPV = $750(EPIF.10,10) - $3,000 + $6,480(PIF.10,10) - $696(PIF.10,10)

= $750(6.145) – $3,000 + ($6,480)(.386) - $696(.386)

= $4,609 - $3,000 + $2,501 - $269

= $3,841

Yes, I can justify purchasing this land since NPV > 0.

c. Revised terminal value

NPV = $100(EPIF.10,10) - $3,000 + $1,621 - $269

= $615 - $3,000 + $2,501 - $269

= - $153

No, I cannot justify purchasing this land since NPV < 0.

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