Strategic Cost Management
December 2021 Examination
1. The equity shares of a firm in the current stock market have been traded at Rs60 per
share. The price-earnings ratio is 10 times. The Dividend payout ratio is 75%.
The total number of shares issued and outstanding as of date is 100000 equity shares of
Rs10 each. The book value of each Share is Rs40.
Describe and Compute - Earnings per Share, return on equity (10 Marks)
Introduction:
Calculating return on equity (ROE) is a simple process that involves dividing net income by
shareholders' equity. Because shareholders' equity, also known as net assets, is equal to the assets
of a company minus its debt, return on equity is similarly referred to as net assets. In order to
fulfill the shareholders' fairness requirements, ROE is taken into account by analysts as a
measure of profitability of an organization. Typically net income is divided by the outstanding
stock of a company's standard inventory to arrive at an earnings per share (EPS) amount that is
consistent with the company's profits. A discernment derived from the ensuing discernment is
indicative of whether an organization is profitable or not. Most businesses publish EPS adjusted
for unusual activities and ability proportion dilution.
Concept and application:
The number of shares available is multiplied by the net income (also known as profits or
earnings), and the result is a revenue stream that is proportional to the share value (EPS).
Similarly, refinement includes adjusting numerators and denominators for claims generated
through alternatives, convertible debts, or warrants. As a result, converting the equation's
numerator for ongoing activities makes it more relevant. About a business enterprise's
profitability, the greater its earnings in step with share are. While earnings according to share
(EPS) are growing, claims observe suit. While it is declining, shares generally tend to lessen due
to it. A commercial enterprise's share price is heavily encouraged by its profits in line with share
(EPS) fashion, which market analysts actively display and estimate earlier than the firm issues its
actual earnings file.
Earnings Per Share = (Net Income – Preferred Dividends) / Equity Shares Outstanding.
For each firm with astounding internet profits as well as fairness, ROE can be computed.
Dividends to everyday shareholders and favored shareholders are subtracted from internet
income before interest to creditors. To position it every other manner, internet profits divided by
using shareholders' equity instead of stocks first-rate is similar to earnings in line with share.
Handiest annual results are used for computation, with the overall profits divided by the ordinary
shareholders' fairness. In line with the balance sheet, shareholders' equity is identical to the entire
property, less the total liabilities.
Return On Equity = Net Income / Shareholder’s Equity
Return on Equity (ROE) Vs. Earnings Per Share (EPS)
The return on equity, even though it is not the same as essential profitability in proportion to
revenues (EPS), is an important indicator in estimating an organization's efficiency in using its
resources. More returns on equity (ROE) mean extra unique wealth creation for shareholders and
a better return on their investment. Comparing an organization's ROE with its competitors and
different organizations in the same industry is a higher manner of deciding whether or no longer
its shares are overvalued or undervalued.
There are essential profitability ratios: the return on equity and the earnings according to
percentage. Shareholder return on equity (ROE) quantifies the return that buyers get hold of on
their investments. Income consistent with proportion (EPS) quantifies the internet income
because of every percentage of stock. Ordinarily, organizations submit their quarterly and yearly
earnings per percentage (EPS) and different ratios of their reports.
Significance of ROE and EPS
For each rupee of typical inventory funding, ROE measures control's ability to create a return.
Income in line with percentage (EPS) is a measure of the recovery in line with rate. Marketplace
dominance and pricing strength are commonly related to a high ROE, whereas a low ROE is
typically associated with a mixture of competitive pressures and subpar performance. P/E is the
ratio of the current stock charge to the trailing 12-month EPS. PE multiples for organizations
with constantly increasing EPS ratios are regularly higher than the industry or marketplace
common. As a result, falling or negative EPS ratios are usually indicative of worsening business
basics.
The following formulas are used to calculate the EPS and ROE for the given problem:
Current Market Price = Rs. 60
Price to Earnings Ratio = 10 times
Dividend Payout Ratio = 75%
Total Number of Shares Outstanding = 1,00,000 shares
Face Value = Rs. 10
Book Value = Rs. 40
Price to Earnings Ratio = Share Price / Earnings Per Share
10 = 60 / EPS
EPS = 60 / 10
Earnings Per Share = Rs. 6
Workings:
Annual Dividend Per Share = EPS * Dividend Payout Ratio
Annual Dividend Per Share = 6 * 75%
Annual Dividend Per Share = 4.5 per share
Total Dividend Paid = 4.5 * 1,00,000
Total Dividend Paid = 4,50,000
EPS = Net Income – Dividends / Equity Shares Outstanding
6 = (Net Income – 4,50,000) / 1,00,000
6,00,000 = Net Income – 4,50,000
Net Income = 10,50,000
Shareholder Equity = Book Value of Shares * Number of Shares Outstanding
Shareholder Equity = 40 * 1,00,000
Shareholder Equity = 40,00,000
Return on Equity = Net Income / Shareholder’s Equity
Return on Equity = 10,50,000 / 40,00,000
Return on Equity = 26.25%
Conclusion:
ROE and EPS may be affected by performance in the investment and finance operations of the
company. If, for example, a company issues stocks to raise cash as a way of raising cash, its
ROE and earnings per share may erode as a result. If a company issued bonds to repurchase its
common stock, then its ROE and earnings per share (EPS) might improve as the amount of
equity from common shareholders and their proportion count could be reduced. If either scenario
occurs, both of the scenarios do not affect the net earnings or the incomes capacity of the
corporation.
2. Subway is selling a good number of veggie patty Burgers daily. The production house
offers a proposal to get the Veggie Patty manufactured by one of the suppler named Vishnu
LLP. However, the administration wants to take the outsourcing decision, also called as
make or buy decision, by evaluating the various essential factors contributing to the
decision
Discuss the primary considerations for evaluating the make or buy decisions
(10 Marks)
Introduction:
The decision to manufacture in-house or purchase products from an outside issuer is to be made
by the person creating or purchasing the product. This desire, also known as outsourcing,
compares the costs and benefits of producing an important product or service internally with the
charges and advantages of engaging an external service provider. It is crucial for companies to
consider all of the aspects, from how much it will cost to collect and store an object to how much
it will cost to create it internally, before deciding between the two. Some of the factors that might
influence a firm's choice to manufacture an item internally or outsource it include labor charges,
lack of expertise, storage costs, contracts with service providers, and inadequate reach.
Quantitative analysis is used by companies to evaluate whether manufacturing or buying is the
most value-effective strategy.
Concept and application:
Comparing the costs and advantages of manufacturing internally vs. shopping for it outside is
made in make-or-buy picks, as is the case with outsourcing decisions.
At both the strategic and operational ranges, a make-or-buy evaluation is performed. Strategic is
more lengthy-variety than tactical. At the strategic degree, variables which include destiny and
the existing surroundings, are taken under consideration. Regulation, competition, and
marketplace trends all influence the decision to buy or no longer shop for. Companies should, of
course, provide matters that support or are aligned with their core capabilities. These are the
regions where the corporation excels and has an aggressive part.
Subcontracting prices and benefits are in comparison to the make-or-purchase desire.
Management has to weigh the advantages of acquiring expert expertise towards the edges of
cultivating equal expertise in-house.
• While contemplating in-house manufacturing, managers must consider aspects in in-
residence production prices. A product's or provider's transaction fees are blanketed.
Additionally, it'd encompass the cost of additional production employees, tracking and storage
needs, and waste product disposal costs.
• Additionally, when contemplating outsourcing from doors suppliers, companies ought to
examine the production and transaction costs. Among different matters, the product's rate, sales
tax, and transport expenses need to be considered. Inventory conserving charges, which
encompass warehousing and handling prices and danger and order fees, should also be included.
• In a few instances, the selection to make or purchase is viewed as a financial or
accounting selection. Performing a value-benefit analysis is vital. However, it is even greater
critical to understand the reasoning at the back of the choice.
• For this reason, corporations should not forget the strategic implications in their
purchase-or-make decisions because they affect the enterprise's profitability and economic
health. They could extensively affect the business method, key competencies, cost shape,
customer service, and agility.
Making or buying a decision triggers the following:
The fundamental competency of an organization is what determines whether or not to
manufacture or purchase a product. The process of making or purchasing a product is generally
dictated by the combination of production costs and special issues, as well as other variables that
determine government movements and long-term business techniques, the current operations
sample.
Even historical policy selections might lead a corporation to explore in-source vs. outsource
alternatives. The move toward in-sourcing can be because of extra satisfactory manipulate, idle
production potential, or the lousy overall performance of external companies. Even companies
with limited sources would benefit from such trends when buying specific offerings from out of
doors providers.
On the opposite, elements of the need for numerous sources, loss of internal understanding, fee
discount, and reduced danger exposure may cause an organization to outsource an item rather
than create it in-residence. A firm with a robust track files of outsourcing services can appear on
the subject of lengthy-term relationships.
Make or buy decision criteria:
Incorporating a universally applicable "make-or-purchase" technique might be an assignment. In
component, that is because businesses have fantastic behavior styles and operate in numerous
business contexts. Then again, cost accounting stays the essential thing in determining whether
to provide or acquire a product.
Employers verify if they could reduce contemporary overhead fees by using new assets through
outsourcing. Other concerns, including strategic, technological, and middle competence
problems, risks, and connections, are also considered as an outsourcing choice.
End: there are numerous sophisticated alternatives available to a company to consider various
variables associated with outsourcing. Advantages of Make or buy decision:
1. Lower cost and higher Capital Investments: Whether you favor fabricating substances
in-house or getting them from a 3rd-celebration dealer, a company's bottom line will advantage
from a make-or-purchase choice strategy. It can lower charges and improve capital investments.
2. Source of competitive advantage: As an advantage, an entire make or purchase
assessment may provide you with a competitive edge over your competition. Customers and
shareholders can advantage from multiplied costs delivered with the aid of an company's middle
services and know-how. A make-or-buy desire method also can be used to keep flexibility. So,
this type of firm might be more resilient in the face of a market slump. The inner and outside
environments wherein organizations perform need to be considered to gain rewards. Choices and
their execution may be inspired by using the lifestyle wherein they may be made and the
schedule of the parties concerned.
Conclusion:
Furthermore, we will say that when trying to make a final decision on whether or not to make or
purchase a product, an organization will use a price-benefit analysis to decide whether to
manufacture it in-house or to buy it from an outside vendor. In addition to a declining inventory
of goods produced by a company, there may be logistical problems with the existing suppliers, or
an economic demand for trade-ins may exist.
3. Following particulars have been shared with you. If fixed cost is Rs500000, selling price
is Rs60, and Variable cost is Rs20
a. Calculate and describe -Breakeven point (5 Marks)
Introduction:
Calculating a trade's or investment's breakeven point is as simple as comparing the market price
of an asset with the original cost of that asset. It can be derived in accounting that the breakeven
point can be calculated by dividing the constant costs associated with manufacturing by the unit
cost of manufacturing minus variable production costs. While a product reaches its breakeven
factor, the prices of manufacturing fit the sales. If you're investing, the breakeven point is when
the marketplace rate of an asset equals its initial value.
Concept and application:
Divide the fixed costs which are involved in manufacturing via revenue less the variable costs
per unit in order to determine the break-even point in company accounting. Fixe prices are those
that don't fluctuate with the number of units sold in this example. In different phrases, the
breakeven factor is the production level at which general revenues for a product are identical to
general expenses for a similar outcome.
Break-Even Point (in Units) = Fixed Costs / (Sales Price per unit – Variable Cost per unit)
In the given case,
Fixed Cost = 5,00,000
Selling Price per unit = Rs. 60
Variable Cost per unit = Rs. 20
So, Break Even Point (in units) = 5,00,000 / (60 - 20)
Break Even Point (in units) =5,00,000 / 40
Break Even Point (in units) = 12,500 units
Consequently, if the company produces 12,500 units, it will not profit, it will not lose anything.
A company's total cost of production and total revenue are the same in this case.
If an employer's sales suit its costs, it has reached breakeven. When calculating a breakeven
point, there are two alternatives: one is to estimate how many unit incomes are wished, and the
opposite is to determine how an awful lot of money wishes to change arms. With the breakeven
threshold, organizations can decide whether or not or no longer will they be worthwhile in the
future. Unprofitable is an organization whose profits are underneath the breakeven factor. This
means the employer is getting cash if it is within the top 5.
Conclusion:
This means that breakeven points are able to be used across a wide range of situations. The
breakeven factor for a property is the amount of cash the property owner would have to
contribute from a sale in order to have the net purchase charge, taking into account final prices
and all other expenses (including loan interest), exactly offset by any proceeds of the sale. As a
result, if the home owner paid that amount of money, they would break even, which isn't money
they make or money they lose.
b. What could be the sales number to earn a profit of Rs 50000, at a Fixed Cost Rs 200000,
Variable Cost Rs30 per unit, Selling Price Rs 60 per unit (5 Marks)
Introduction:
Target Profit is a term used in fiscal analysis to indicate income that a controlling economic
entity hopes can be completed by the end of an accounting period to be selected by the
controller. By comparing projected earnings against real earnings, which is usually determined
by determining a budget, one can derive a profit assertion. As a management accountant, it is
crucial that we grasp the difference between sales and earnings in order to properly manage the
business. For a firm, not all sales translate into income. For plenty of items, the value of
production outweighs their gain. Those items are losing money because their expenditures
exceed their income.
Concept and application:
Accounting staff are going to report a discrepancy in the actual profit figures versus the target
profit figures. As a matter of fact, budgets are notoriously wrong and become worse with time,
since they are most likely going to be wrong anyway. As a result, a rolling forecast, where the
purpose statistics are updated periodically based on a company's quick-term projections for the
next few months, tends to be more accurate in estimating the target income. It is therefore
generally true that there is a very modest difference between the goal and the actual earnings.
It may be required to assess the method used to calculate the aim profit and expand a more
careful budgeting process if there is a sizeable destructive version among the goal and actual
earnings. When adjusted to approximate cash flow, the target profit concept is beneficial for
planning cash flow, designing performance-based total bonuses, and disclosing projected
outcomes to investors and lenders. For traders, the worst-case situation is liberating unduly
optimistic target income again and again because they regularly lose consider in control's
competencies to satisfy their predictions.
In the given case,
Fixed Cost = Rs. 2, 00,000
Desired Profit = Rs. 50,000
Variable Cost per unit = Rs. 30
Selling Price per unit = Rs. 60
Sales (in Units) = Fixed Cost + Desired Profit / Contribution per unit
Contribution per unit = Sales per Unit – Variable Cost per Unit
Contribution per unit = 60 – 30
Contribution per unit = Rs. 30 per unit
Sales (in units) = (2, 00,000 + 50,000) / 30
Sales (in units) = 8,333 units
Therefore, to have a desired profit of Rs. 50,000, the company should sell 8,333 units of
products.
Conclusion:
A cost-volume-earnings analysis (CVP) is a method of figuring out a firm's profits purely based
on changes in variable and glued charges. There are cases in which an organization may appoint
a CVP in order to gain a certain profit margin, for instance to break even (cover all prices). Some
assumptions are used in the CVP analysis, consisting of the income rate, constant price according
to the unit, and variable price in keeping with the unit can be the same for all teams.
