Thursday 5 June 2008
WEDNESDAY 13 JUNE 2007
Time allowed 3 hours
This paper is divided into two sections
Section A This ONE question is compulsory and MUST be
Section B TWO questions ONLY to be answered
Formulae Sheet, Present Value and Annuity Tables are on
pages 7, 8 and 9.
Do not open this paper until instructed by the supervisor
Section A – This ONE question is compulsory and MUST be attempted
1 The finance director of GTK plc is preparing its capital budget for the forthcoming period and is examining a number
of capital investment proposals that have been received from its subsidiaries. Details of these proposals are as follows:
Division A has requested that it be allowed to invest ￡500,000 in solar panels, which would be fitted to the roof of
its production facility, in order to reduce its dependency on oil as an energy source. The solar panels would save
energy costs of ￡700 per day but only on sunny days. The Division has estimated the following probabilities of sunny
days in each year.
Number of sunny days Probability
Scenario 1 100 0·3
Scenario 2 125 0·6
Scenario 3 150 0·1
Each scenario is expected to persist indefinitely, i.e. if there are 100 sunny days in the first year, there will be 100
sunny days in every subsequent year. Maintenance costs for the solar panels are expected to be ￡2,000 per month
for labour and replacement parts, irrespective of the number of sunny days per year. The solar panels are expected to
be used indefinitely.
Division B has asked for permission to buy a computer-controlled machine with a production capacity of 60,000 units
per year. The machine would cost ￡221,000 and have a useful life of four years, after which it would be sold for
￡50,000 and replaced with a more up-to-date model. Demand in the first year for the machine’s output would be
30,000 units and this demand is expected to grow by 30% per year in each subsequent year of production. Standard
cost and selling price information for these units, in current price terms, is as follows:
￡/unit Annual inflation
Selling price 12 4%
Variable production cost 4 5%
Fixed production overhead cost 6 3%
Fixed production overhead cost is based on expected first-year demand.
Division C has requested approval and funding for a new product which it has been secretly developing, Product RPG.
Product development and market research costs of ￡350,000 have already been incurred and are now due for
payment. ￡300,000 is needed for new machinery, which will be a full scale version of the current pilot plant.
Advertising takes place in the first year only and would cost ￡100,000. Annual cash inflow of ￡100,000, net of all
production costs but before taking account of advertising costs, is expected to be generated for a five-year period. After
five years Product RPG would be retired and replaced with a more technologically advanced model. The machinery
used for producing Product RPG would be sold for ￡30,000 at that time.
GTK plc is a profitable, listed company with several million pounds of shareholders’ funds, a small overdraft and no
long-term debt. For profit calculation purposes, GTK plc depreciates assets on a straight-line basis over their useful
economic life. The company can claim writing down allowances on machinery on a 25% reducing balance basis and
pays tax on profit at an annual rate of 30% in the year in which the liability arises. GTK plc has a before-tax cost of
capital of 10%, an after-tax cost of capital of 8% and a target return on capital employed of 15%.