Managing Finance and Budgets Lecture 5 Activities & Solutions

Activity One A garage has an old car standing around which it bought several months ago for £3,000. The car needs a replacement engine before it can be sold. It is possible to buy a reconditioned engine for £300. It would take a mechanic (who paid is £8 per hour) 7 hours to fit the engine. At present the garage is short of work, but the owners are reluctant to lay off any mechanics or even to cut down their basic working week because skilled labour is difficult to find and an upturn in repair work is expected soon. Without the engine the car could be sold for an estimated £3,500. Identify the following: Historic cost of the car Outlay cost if the car is to be repaired Opportunity cost of the car and sunk cost of the car Relevant costs to consider in deciding whether or not to repair the car What is the minimum price to sell the car for to justify carrying out the work? How would the minimum price change if the garage were busy at the moment, and the mechanic’s time could be charged to other customers at £12 per hour.

Activity One Solution (1) Historic cost £3,000 What we paid for the car originally Outlay cost (to repair) £300 NB We disregard labour costs of £8 x 7 = £56 because the mechanics are already paid, but not employed. Opportunity cost £3,500 What we think we can sell the car for now Sunk cost£3,000 What we have currently spent on the car to date Relevant costs to consider : Opportunity Costs + Outlay Costs = £ £300 = £3800 £3,800 is the minimum price that the garage will sell the car for in order to justify carrying out the work.

Activity One Solution (2) If the garage were busy, with the mechanic’s time charged at £12 per hour. Historic cost 3,000 What we paid for the car originally Outlay costs (to repair)Engine £300 Labour Costs £12 x 7 = £84 £384 Relevant costs to consider : Opportunity Costs + Outlay Costs = £ £384 = £3884 £3,884 is the minimum price that the garage will sell the car for in order to justify carrying out the work. NB: What we could charge for their labour, rather than what it costs us.

Activity Two Identify a range of Fixed and a range of Variable Costs for each of the following types of organisation: Manufacturing company Hotel Supermarket

Activity Two Solution Fixed CostsVariable Costs ManufacturingRent/Rates Cleaning Raw Materials Transport HotelRates/Mortgage Cleaning Food, Laundry SupermarketRates/Lease Admin Salaries Goods, Some wages

Activity Three Company ACompany B FIXED COSTS £ 10,000 £ 54,000 UNIT SALES PRICE £ 20 £ 20 VARIABLE COSTS PER UNIT £ 10 £ 2 PLANNED SALES 2000 units 5000 units Calculate the following for each Company: Contribution per Unit Break-even point and Margin of safety Profit at planned sales, twice planned sales and 1/2 x planned sales Which company has the higher operating gearing and what effect does this have?

Activity Three: Company A Solution Company A FIXED COSTS £ 10,000 UNIT SALES PRICE £ 20 VARIABLE COSTS PER UNIT £ 10 PLANNED SALES 2000 units Contribution per Unit: £20 -£10= £10 Break-even point:£10000/£10= 1000 Margin of safety:(2000 –1000) x £10= £10,000 Profit atplanned sales= £10,000 twice planned sales = £30,000 1/2 x planned sales= NIL

Activity Three: Company B Solution Company B FIXED COSTS £ 54,000 UNIT SALES PRICE £ 20 VARIABLE COSTS PER UNIT £ 2 PLANNED SALES 5000 units Contribution per Unit: £20 -£2= £18 Break-even point:£54000/£18= 3000 Margin of safety:(5000 –3000) x £10= £20,000 Profit atplanned sales= £20,000 twice planned sales = £110,000 1/2 x planned sales= £9,000 Loss

Activity Four Calculate the COST of producing 5,000 pints of bitter and 2,300 pints of lager in 1 month using the Direct Costs & the three methods of allocating overheads shown below. DIRECT COSTSBitterLager Ingredients10p per pint25p per pint Labour20p per pint10p per pint Fuel 5p per pint10p per pint Brewery/Depreciation£500Overheads £ 5,000 Method 1: Allocate overheads according to pints produced Method 2: Allocate overheads according to % of labour cost Method 3: Allocate overheads according to overall direct cost of production

Activity Four Solution Method 1

Activity Four Solution Method 2

Activity Four Solution Method 3

Activity Five “The full cost of pursuing an objective is effectively the long-run break-even selling price.” What does this mean?

Activity Five - Solution “The full cost of pursuing an objective is effectively the long-run break-even selling price.” If the analysis has been performed correctly, then selling the item for its full cost, should do just that, precisely recover the cost of producing it. This is just another way of saying we would neither make a profit or a loss, but just “break even”

Activity Six You work in the costing department of a budget airline. What items need to be taken into account when trying to calculate the unit cost of transporting a passenger from one destination to another?

Activity Six - Solution What items need to be taken into account when trying to calculate the unit cost of transporting a passenger? This is not an exhaustive list: Airport Service/Tax Charges Air Traffic Control Charges Maintenance & Replacement (Labour & Parts) Cleaning Depreciation of Aircraft Fuel & other running costs Food costs Baggage handling costs Staff salaries (cabin and ground) Admin Costs (booking, travel agent commission etc.)