Business finance : theory and practice

Problems
Based on an estimated constant annual demand of 10,000 hair dryers, the unit cost
of a hair dryer has been determined by one of the business’s employees as follows:
Labour: 2.5 hours at £10/hour 25.00
Plastic: 2.5 kg at £10/kg 25.00
Supervision 3.00
Various bought-in parts 12.70
Loan interest 5.00
Depreciation 12.50
Electrical power 2.20
Apportionment of company-wide fixed overheads 23.80
109.20
£
The supervision cost refers to the salary of an existing employee, who would be
moved from her present work to manage production and sales of the hair dryer. This
person’s existing work will be undertaken by someone employed on a four-year contract
at an annual salary of £25,000.
It is considered that manufacturing and selling the hair dryers would not have any
net effect on the amount of working capital required by the business. Assume that all
operating cash flows occur at the end of the relevant year.
The business’s accounting year is to 31 December and its corporation tax rate is
30 per cent. Assume that tax cash flows occur on 31 December of the year in which the
events giving rise to them occur.
Identify the minimum price per hair dryer that the business will need to charge in order
for manufacturing and selling the hair dryers to meet the target of increasing the shareholders’
wealth by £200,000. Ignore inflation.
5.8 Penney Products plc has a manufacturing plant devoted exclusively to production of
one of the business’s products, a toy known as Zapper. The product is produced only
at this factory. Recently demand has declined owing, managers believe, to the product’s
rather old-fashioned image.
The lease on the factory is due to expire on 31 December 20X8, and the company’s
management has identified two possible courses of action:
l Cease production of the Zapper and close the factory on 31 December 20X6.
l Keep up production of the Zapper until 31 December 20X8 and close the factory on
that date.
You have been asked to make an assessment of the relative merits of the two
possible closure dates. Your investigations have revealed the following:
1 Annual sales revenue of Zappers is estimated at £5m for 20X7 and £4m for 20X8.
Both of these amounts are stated at 1 January 20X7 prices, but are expected to
increase at the general rate of inflation. Variable manufacturing and distribution
costs average 40 per cent of sales revenue value. Zapper production will be charged
an allocation of head office costs at an estimated £1 million for each of the two
years.
2 The annual rent of the factory premises is £0.9 million, payable annually in advance.
If the factory were to be closed in 20X6, it appears that the landowner would be
prepared to accept just one payment of £0.9 million on 31 December 20X6 to terminate
the lease. ‘
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