Fowler Ltd produces ‘Vitex’, a vitamin supplement drink that is sold for £1.20 per bottle. At present the business’s bottling plant is operating at full capacity and it is not possible to expand sales beyond the current level unless there is further investment in plant and machinery. The most recent income statement for the business is as follows: Income statement for the year ending 31 October Year 7 £000 Sales revenue (1.5m bottles) 1,800 Variable expenses (750) Fixed expenses (420) Operating profit 630 Interest payable (130) Profit before taxation 500 Tax (30%) (150) Profit for the year 350 The statement of financial position of the business revealed that 2 million £1 ordinary shares are in issue as well as 10 per cent loan notes with a nominal value of £1.3 million. There are no reserves as all profits have been distributed as dividends. lt is believed that output can be increased by 20 per cent if the existing bottling line was replaced. The cost of the new line would be £2 million, which could be financed by the issue of 10 per cent loan notes at £ 80 per £.100 nominal value. The new bottling line would reduce variable costs by £0.15 per botle but would increase fixed costs by £150.000 per year. Installation of the new line can occur immediately after a decision is made. Required: Assume that the business decides to install the bottling line at the beginning of Year 8 and all the increased output can be sold Prepare a projected income statement for the year to 31 October Year 8. Calculate for Year 7 and Year 8 the: earnings per share degree of operating gearing degree of financial gearing degree of combined gearing. Briefly evaluate the information produced in your answers to Parts (a) and (b) above. Calculate the sales revenue required in Year 8 to maintain existing earnings per share.
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Fowler Ltd produces ‘Vitex’, a vitamin supplement drink that is sold for £1.20 per bottle. At present the business’s bottling plant is operating at full capacity and it is not possible to expand sales beyond the current level unless there is further investment in plant and machinery. The most recent income statement for the business is as follows:
Income statement for the year ending 31 October Year 7
|
|
£000 |
|
Sales revenue (1.5m bottles) |
1,800 |
|
Variable expenses |
(750) |
|
Fixed expenses |
(420) |
|
Operating profit |
630 |
|
Interest payable |
(130) |
|
Profit before |
500 |
|
Tax (30%) |
(150) |
|
Profit for the year |
350 |
|
|
|
The
lt is believed that output can be increased by 20 per cent if the existing bottling line was replaced. The cost of the new line would be £2 million, which could be financed by the issue of 10 per cent loan notes at £ 80 per £.100 nominal value. The new bottling line would reduce variable costs by £0.15 per botle but would increase fixed costs by £150.000 per year. Installation of the new line can occur immediately after a decision is made.
Required:
Assume that the business decides to install the bottling line at the beginning of Year 8 and all the increased output can be sold
- Prepare a
projected income statement for the year to 31 October Year 8. - Calculate for Year 7 and Year 8 the:
-
- earnings per share
- degree of operating gearing
- degree of financial gearing
- degree of combined gearing.
- Briefly evaluate the information produced in your answers to Parts (a) and (b) above.
- Calculate the sales revenue required in Year 8 to maintain existing earnings per share.
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