Financial Management

You are a Corporate Finance Manager at Quebec plc, a large manufacturing
company that is listed on the New York Stock Exchange.
Quebec plc is considering a major investment in a new production facility. Senior
managers at the company have identified two options for the new production facility,
project A and project B. According to company policy at Quebec plc, proposed
investments must be evaluated using the following techniques:
• Payback period
• Accounting rate of return
• Net present value
Each project has an expected life of five years. Sufficient funding is available to finance
only one of the projects.
Project A Project B
$ $
Initial cost (year 0) 30,250,000 30,260,000
Scrap value (year 5) 3,310,000 3,325,000
Forecast net cash inflows
Year 1 3,390,000 3,420,000
Year 2 3,380,000 3,390,000
Year 3 3,375,000 3,380,000
Year 4 3,360,000 3,350,000
Year 5 3,355,000 3,350,000
Quebec plc has a cost of capital of 16%.
Assume that all cash flows occur at the end of the respective year.
The new production facility will be used to produce two new products, product Y and
product Z. The following information has been gathered in respect of these two
products:
The following information has been extracted in respect of these two products:
Quebec plc Product Y Product Z
Labour hours per product 1.5 1.0
Machine hours per product 1.0 3.0
Direct labour cost per hour ($) 6.00 6.00
Machine hour overhead recovery rate – per machine hour ($) 28.00 28.00
Direct material costs per product ($) 12.00 25.00
Production volume (products) 1,250 7,000

Fixed overheads for a typical production period are $623,000.
The company uses both absorption costing and marginal costing techniques in the
course of its business. Senior managers would like to explore the use of activity
based costing as an approach to the calculation of production costs.
Required:
Prepare a business plan for the proposed investment in a new production facility.
Your business plan should include responses to the following requirements:
Question 1

Calculate the payback period for project A and project B.
(8 marks)
Question 2

Calculate the accounting rate of return for project A and project B. Assume that the
only difference between cash flow and profit is the depreciation charge.
(10 marks)
Question 3

Calculate the net present value for project A and project B. Use Quebec plc’s cost of
capital as the discount rate.
(8 marks)
Question 4

Explain which project should be accepted. Support your explanation with the results of
your calculations in question 2 and question 3.
(4 marks)
Question 5

Explain the qualitative factors that the managers of Quebec plc might also need to
consider, in addition to the results of the capital investment appraisal, before making
a decision on in which project the company should invest

 

Question 6
Critically evaluate the use of payback, accounting rate of return and net present
value as investment appraisal techniques.
(20 marks)

Question 7
Calculate the forecast unit costs of product Y and product Z using absorption costing
and marginal costing.
(10 marks)

Question 9
Critically evaluate the use of absorption costing and marginal costing as approaches
to the calculation of production costs.
(10 marks)

Question 10
Critically evaluate the use of activity based costing as an approach to the calculation
of product costs. As part of your critical evaluation, explain the information that
Quebec plc will need to produce in order to apply the activity based costing
technique to the calculation of product costs for product Y and product Z.
(20 marks)