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Homework answers / question archive / Shaft Mining Ltd is a mining contractor with ten autonomous divisions operating in various copper mines in Copperbelt and North-Western provinces of Zambia

Shaft Mining Ltd is a mining contractor with ten autonomous divisions operating in various copper mines in Copperbelt and North-Western provinces of Zambia

Accounting

Shaft Mining Ltd is a mining contractor with ten autonomous divisions operating in various copper mines in Copperbelt and North-Western provinces of Zambia. The cost of capital for the group is 12% per annum and is currently earning 15% on its capital employed.
In the ROCE calculation, return is equated with net profit and capital employed figure at the beginning of the financial year. All fixed assets are depreciated on a straight-line basis. Investments in new projects include incremental working capital. Projects sold or withdrawn from operation are treated as consisting of fixed assets only.
If no new expenditure transactions take place the position of four of the divisions would be:
 
Division
Capital employed as at 1 January 2019
 
Net profit
Budgeted for 2019 Sales
 
$'000
$'000
$'000
Kitwe
3,200
   800
  8,000
Solwezi
4,500
1,500
14,000
Chingola
2,800
   840
  7,000
Mufulira
2,000
   260
  2,000
 
The following transactions were proposed:
Kitwe Division         
Investment of $1,000,000 to yield sales of $1,500,000 per annum and net profit of $200,000 per annum.
Solwezi Division       
Sale for $750, 000 of a projected that is budgeted to yield a net profit of $150,000 in 2019. The original equipment cost $6,000,000 seven years ago with an expected life of eight years.
Chingola Division    
(a) Sale of product line at book value. The original equipment cost $600,000 two years ago     with an expected life of three year. This line is budgeted to yield a net of $200,000 in 2019; combined with
(b) Replacement  of (a) above by investing $1,000,000 in a new product to yield $300,000 per annum.
Mufulira Division     
Investment of $800,000 in a project to yield sales of $360,000 per annum and a net profit of $112,000 per annum.
(Note. In connection with each of the above transactions, you are to assume that the sale and/or investment would be completed by 1 January 2019 so as to be included in the relevant ROCE calculations for the year 2019. Ignore taxation and inflation considerations and assume that actual results are as budgeted.)
Required
A. On the assumption that each transaction goes ahead:
(i) Calculate the new ROCE for each division for the year ending 31 December 2019.                                              (7 Marks)
(ii)Identify those divisional managers whose bonuses will be higher if they receive annual bonuses directly related to the level of their respective ROCE.                                                                                                                                                        (8 Marks)
(iii) State, in respect of each division, whether the group's interest will be favorably or adversely affected by the proposed transactions. Explain briefly why in each case.                                                                                                             (7 Marks)
 
B. Identify, with brief reasons, which proposals the group would approve if its new capital expenditure were limited to $2,000,000 for the four divisions.                                                                                                                                                        (7 Marks)
 
C. Compare the old results for  Kitwe Division and Mufulira Division, and briefly advise the divisional manager of Mufulira Division how he might improve his performance based on the data concerning Kitwe Division.    (4 Marks)
 
D. Comment briefly on how the new project for Mufulira Division fits in with the advice given in (c) above. (4 Marks)
 
E. Calculate the lowest price at which the equipment should be sold by Solwezi Division if the transaction proposed is to break even financially for the group.                                                                                                                                              (7 Marks)
 
F. Explain briefly the concept of residual income in the context of performance evaluation.                                    (6 Marks) 
 
QUESTION TWO
A. In what situations should the transfer price be the external market price?                                                               (10 Marks)
B. How should the transfer price be established when there are diseconomies of scale and prices have to be lowered to increase sales volume?                                                                                                                                                           (10 Marks)
C. What is the ideal transfer price?                                                                                                                                                             (5 Marks)
D. In what circumstances should the transfer price be standard variable cost plus opportunity cost of making the transfer?                                                                                                                                                                                                                 (10 Marks)
E. Discuss the advantages and disadvantages of Market Price Based Transfer Prices and Cost Based Transfer Prices. Further, outline the main variants that exist under each method.              

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