Tax Shield Education Centre.

Cost Accounting - 1

Decision Making --- D.C.F.

1. A public company responsible for the supply of domestic gas has been approached by several prospective customers in a rural area adjacent to a high-pressure main. As a condition of its license to operate as a utility, the company is obliged to respond positively to current needs provided the financial viability of the company is not put at risk. New customers are charged Rs. 250 each for connection to the system. Once a meter is installed, a standing charge of Rs.10 per quarter is billed. Charges for gas are levied at Rs.400 per 1,000 metered units. A postal survey of the area containing, according to the rating authority, 5,000 domestic units, elicited a 40% response rate. 95% of those who responded confirmed that they wished to become gas users and expressed their willingness to pay the connection charge. Although it is recognised that a small percentage of those willing to pay for connection may not actually choose to use gas, it is expected that the average household will burn 50 metered units per month. There will be some seasonal differences. The companys marginal cost of capital is 17% pa and supplies of bulk gas cost the company Rs.0.065 per metered unit. Wastage of 15% has to be allowed for Determine what the maximum capital project cost can be to allow the company to provide the service required. 2. A Limited Company is manufacturing a product Hindon with the help of a group of machines having a book value of Rs. 65,000 after deducting depreciation on straight line basis. The company is considering the replacement of these machines by new ones. The new machines would cost Rs. 1,00,000 while the old machines could be sold only for Rs. 45,000. The new machines would have a life of four years. The existing machines could also be kept in operation for four more years provided it would be economical to do so. The scrap values of both the new and old machines would be zero after four years. The current costs per unit of manufacturing Hindon on the existing and new machine would be as under : Materials Rs. Labour (32 hours @ Rs.1.25) Overhead(32 hours @ Re.0.60) Total cost Existing Machines 22.00 40.00 19.20 81.20 New Machines Rs. 20.00 (16 hrs.@Rs.1.25) 20.00 (16 hrs@Rs.1.80) 28.80 68.80

Overheads are charged to products on the basis of direct labour hour rate method comprising : Variable Overhead Fixed OHD(including depreciation) Existing Machine Re. 0.25 0.35 New Machine Re. 0.625 Rs. 1.175

The present sales of Hindon are 1,000 units per annum @ Rs. 90 each. In the event of new machines being purchased, the output would increase to 1,200 units and selling price would stand reduced to Rs. 80. A Limited requires a minimum rate of return on investment at 20% per annum ( ignore tax) in money terms. materials costs, overhead costs and selling prices will increase at the rate of 15% per annum. Labour costs would increase by 20% per annum. it may be assumed that receipts and payments would accrue at the end of each year. Advise .

Tax Shield Education Centre.

Cost Accounting - 2

3.

GFM produces two products-a main product Cp and a co-product Dg. For their main product Cp there is a 100% buy-back arrangement with their foreign collaborators. Recently GFM doubled their capacity and with this their production capacity for the co-product Dg increased to 10,000 MT .a. Fortunately there was an unprecedented increase in decrease in demand for Dg and price too has increased significantly to Rs.1,000 per tonne. However, with delicensing and liberalization more and more units for manufacturing CP and Dg are being set up in the country. GFM, therefore, anticipates stiff competition for Dg from next financial year. For maintaining sales at current level (i.e. 10,000 MT per year GFM will have to drop the price by Rs.50 per MT every year for the next 5 years when prices are likely to stabilise at pre-boom level of Rs.750 per MT. The Vice-President (Marketing) who, sensing this situation, has just completed a market study, suggests that the Company revive an earlier project for converting Dg into Dp grade and starting with 1,000 MT from next year increase production of Dp in stages of 1,000 MT every year by correspondingly reducing Dg. The Production Manager estimates that the additional variable cost for Dp will be Rs.200 per MT. V.P. (Marketing) feels that Dp can be sold at Rs.1,500 per Mt but in the first two years a discounted price of Rs.1,400 in tear 1 and Rs.1,450 in year 2 will have to be fixed. With partial conversion into Dp, the drop in price of Dg can also be contained at Rs.25 per MT instead of Rs.50 envisaged. Production facilities for Dp involves a capital outlay of Rs.50 lakhs. Present the projected sales volume and price of products Dg and Dp for the next 5 years under two alternatives. If GFM normally appraises investment @ 12% p.a. and if cash beyond 5 years from investment are ignored advise whether Dp should be produced.

4.

A theaters, with some surplus accommodation, proposes to extend its catering facilities to provide light meals to its patrons. The management is prepared to make the initial funds available to cover the capital costs. It requires that these be repaid over a period of five years at a rate of interest of 14% per annum. The capital costs are estimated at Rs. 60,000 for equipment that will have a life of 5 years and no residual value. Running costs of staff etc. will be Rs. 20,000 in the first year, increasing by Rs. 2,000 in each subsequent year. The management proposes to charge Rs. 5,000 per annum for electricity and other expenses and wants a nominal Rs. 2,500 per annum to cover any unforeseen contingencies. Apart from this, the management is not looking for any profit as such from the extension of these facilities because it believes that these will enable more tickets to be sold for the cinema shows at the theaters. It is proposed that costs should be recovered by setting prices for the food at double the direct cost. It is not expected that the full sales level will be reached until year 3. The proportion of that level reached in year 1 and 2 are 35% and 65% respectively. You are required to calculate the sales that need to be achieved in each of the five years to meet the managements targets. Ignore inflation and taxation.