AMAC – Revision Answers 7

Question 1
What are the stages of the product lifecycle?

Development, Introduction, Growth, Maturity and Decline.

Question 2

Complete the following table to calculate the Net present value

Year 0 Year 1 Year 2 Year 3

Revenue 0 1,520,000 1,840,000 2,120,000

Operating costs 0 -912,000 -1,084,000 -1,224,000

Capital expenditure -1,200,000 0 0 0

Net cash flows -1,200,000 608,000 756,000 896,000

Discount factor 1 0.877 0.769 0.675

Discounted cash flow -1,200,000 533,216 581,364 604,800

NPV 519,380

Country Farms Ltd should / should not invest in the new product.

This is because the NPV is positive and therefore will generate cash into the business.

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Question 3
a) Calculate the discounted lifecycle cost of purchasing the machines based upon the
following information:

If there are nil cashflows then these should be entered as ‘0’ in the appropriate box.
Net cashflows must be shown as positive figures and net cash inflows as negative
figures (use a minus sign). Round your answers to the nearest whole £.

Year 0 1 2 3 4 5

Cash flow 400,000 50,000 52,500 55,125 55,125 20,125

Discount factor 1 0.952 0.907 0.864 0.823 0.784

Present value 400,000 47,600 47,618 47,628 45,368 15,778

Net present cost 603,992

b) Calculate the discounted lifecycle cost of leasing the machine for 5 years based
upon annual costs of £140,000 paid annually in advanced.

If there is nil cashflows then these should be entered as ‘0’ in the appropriate box. Net
cashflows must be shown as positive figures and net cash inflows as negative figures
(use a minus sign). Round your answers to the nearest whole £.

Year 0 1 2 3 4 5

Cash flow 140,000 140,000 140,000 140,000 140,000 0

Discount factor 1 0.952 0.907 0.864 0.823 0.784

Present value 140,000 133,280 126,980 120,960 115,220 0

Net present cost 636,440

c) Using the information from above, answer the following questions.

Simms Ltd should purchase / lease the machine. This would save £32,448.

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Question 4
A junior member of staff has asked what the difference is between lifecycle costing and
discounted lifecycle costing. Write a note briefly describing what they are, the
difference and how it can be a useful tool.

Lifecycle costing aims to trace all the costs relating to a product, project, customer,
or service over its complete lifecycle from design or purchase through to cessation
with a view to maximise the return over its total life whilst at the same time minimising
the costs.

For example, lifecycle costing of a product would therefore consider all the costs
that will be incurred from start to finish and compares these costs to the revenue
that is expected to be generated from selling the product and at different target
prices throughout the products life.

To calculate the lifecycle costs there may be present costs and future costs. Future
costs may need to be discounted to take in to account the time value of cash (money
will be worth less in the future than it is today due to inflation/interest rates). This will
then give a clear view of the true costs and this allows us to calculate the net present
value.
The net present value therefore is the sum of discounted cash flows which shows
the cash increase or decrease caused by the product or project in terms of todays
value.

There are many benefits to using the lifecycle costing concept however the main
ones are the assistance and improvement it can bring to the decision-making
process and cost control.

Lifecycle costing can show a clearer picture of all the costs and cost increases as a
total rather than for just one period and therefore aids decision making process.

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Question 5
The company uses a discount rate of 10% to appraise all capital projects.

Enter all your answers to the nearest whole £.

Year 0 1 2 3 4
Net cash flow £ (40,000) 15,000 13,500 12,150 10,935
Discount factor 1 0.909 0.826 0.751 0.683
Present value £ (40,000) 13,635 11,151 9,125 7,469
Net present value £ 1,380

Should the new machine be purchased?

Yes

Explain how calculating the net present value of the project can help to decide whether
the proposal of the new machine should be accepted.

The calculations show a positive net present value of £1,380. This means that the
proposal of purchasing the new machine should be accepted.

The net present value of a project is made up of positive and negative cashflows
which are expected to occur as a result from the project, after adjusting for their
time-value. Time value is the assumption that cashflows in the future are worth
less than if we received them today due to inflation and interest rates.

To calculate time-value we multiplying each period’s actual net cashflow by a

discount factor based on a predicted interest rate – this is often the same as the
company’s cost of capital. You can see that the further into the future a projects
cashflow continues a greater discount is applied.

If a higher interest rate is assumed, the discount factor will be greater for each
period. This will reduce the impact of both positive and negative cashflows that occur
further into the future.

For this project, the future cashflows are all positive, and so applying a higher
interest rate would reduce their impact and therefore reduce the positive amount of
the net present value. This would have a negative effect on the feasibility of this
project.

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Question 6
Briefly describe target costing:

It is a method by which a company uses a set or given market price for a

product. The target cost is calculated by taking the market price and
deducting the required profit margin leaving a target cost.

Question 7
Calculate the target cost per kilogram.

Selling price 20.00

Profit margin 8.00

Total costs 12.00

Fixed cost per unit 4.00

Labour cost per unit 2.50

Maximum material cost per unit 5.50

Target cost per kilogram 22.00

The supplier of the material has quoted a price of £25.00 per kilogram. However, the
purchasing manager has managed to negotiate a discount of 5%.

Should the discount be accepted? Yes / No

What is the price per kilogram after the discount is deducted? £23.75

Is this above or below the target cost? Above / Below

What is the minimum percentage discount needed to achieve the target cost? 12%

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Question 8
a) You have been asked to complete the following table using the Activity Based
Costing concept.

Cost driver £ Workings

Per material requisition 4,000 3,600,000 / 900

Per production set-up 6,000 1,800,000 / 300

Product A1 (£) Product B1 (£)

Total materials handling cost 640,000 2,960,000

Total production set up cost 360,000 1,440,000

Total 1,000,000 4,400,000

b) Calculate the total fixed overheads using a budgeted labour hour basis.

Budgeted labour hours 600,000

Overhead absorption rate £ 9.00

Product A1 Product B1

Overheads per unit 36 13.50

Total overheads absorbed 3,780,000 1,620,000

c) Using the information from above calculate the following. Round your answer
to 2 decimal places.

Product A1 Product B1

Total unit cost using Absorption costing 91.20 43.50

Total unit cost using ABC 64.72 66.67

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d) Explain whether traditional absorption costing or activity-based costing would
provide the most useful information. List the advantages and disadvantages of activity-
based costing in your answer.

Traditional absorption costing by absorbing the fixed overheads on a budgeted

labour basis could give illogical or misleading calculations of information. This could
be because the labour hours may not be what has caused the overhead costs.
We can see from the information that if we calculate the costs based on traditional
absorption costing, we have very different figures to the costs under ABC.
ABC looks at the causes of group overheads called cost pools and uses these
activities to distribute the overheads to the product more fairly. Using this method
means that the product that uses more will be charged more of the cost. This then
provides a more accurate view of the costs for each product that can assist in the
decision-making process for example, pricing, withdrawal of products and
scheduling of production.
Advantages:
More accurate cost per unit
Better view of what causes overhead costs
Overhead costs can be managed better looking at the cost drivers. Useful in more
complicated or complex business industries.
Can be used in service-based industries.

Disadvantages:
Less useful in business with proportionally small overhead costs in comparison to
the overall costs.
Can not allocate all overhead costs to specific activities or groups. More complex.
Can be time consuming and expensive, meaning the costs may outweigh the
benefits.

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