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Dear John,
I was working through Qn 1 from June 2015 but couldn’t understand how the model answers got the Contribution from parts sold from Imoni Co to Yilandwe. To quote from the question;
“The parts needed to assemble into the components in Yilandwe will be sent from the USA by Imoni Co at a cost of $200 per component unit, from which Imoni Co would currently earn a pre-tax contribution of $40 for each component unit. However, Imoni Co feels that it can negotiate with Yilandwe’s government and increase the transfer price to $280 per component unit”.
The model answer further states that;
“It is assumed that the increase in the transfer price of the parts sent from the USA directly increases the contribution which Imoni Co earns from the transfer”.
Based on the information above, I would have assumed that the proposed increase in the transfer price would increase proportionally with the contribution from $40 to $56 (80/200 x 40) per component. Factoring in the inflation rate in the US, the contribution for year 1 would amount to $8,652 ($56 x 1.03 x 150units). However, the model answer has $120 + inflation per unit, giving $18,540 for year one.
I don’t understand how the $120 was arrived at. Given the proposed increase in transfer price, the percentage increase will only be 40%, but the model answer seems to have used a 300% increase.
I’ll be most grateful for your clarification.
Sorry, but the ACCA is (yet again!) having problems with their website which means I cannot look at the question (and therefore give you an answer).
The announcement says that it will be all OK tomorrow morning, so assuming that turns out to be correct I will answer you tomorrow 🙂
Now I have managed to get on to the ACCA website 🙂
At the current transfer price of 200, they earn a contribution of 40 which means that cost must be 160.
If they increase the price to 280 (and the cost stays at the current 160) then it means that the contribution will be 280 – 160 = 120.
Hope that helps 🙂
Hi John – Also looking at this Q
Inflation is causing me confusion with the question wordingCan I assume that the wording “from year one onwards” ALWAYS means to allowed for in year 1 and does not mean after year 1 ?
“from year 1” includes year 1.
However, if ever you are unsure about anything then state your assumption and you will still get most (if not all) of the marks.
There is rarely just one correct answer in P4 questions – it depends on your assumptions (just as would be the case in real life). The marks are mainly for your approach and not for the final answer.
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hello sir. is it possible to upload the online video solution of this question yilandwe just like the other past exam question 1’s? it would be really help full
Hi sir,
Woulc like to ask about the discount rate of 9% and 12%. Does the examiner just want us to use 12% as what the finance director feels, or we have to consider the change in business risk first…?
By the way no change in business risk right…?
He wants you to use 12% because that is given as the project-specific discount rate i.e. it takes into account the business risk of the new project (which is clearly different from the existing business risk because the current WACC is only 9%).
Hi John,
I was going through the answers of Q1 part (b) of June 2015. My question is in making the cash flows as per the suggested answer we are taking contribution earned on part sales as a cash inflow for the parent.
My understanding was as this is a group and they have a transfer price on it. Is it really a cash inflow for Parent i.e Imoni Co.? The reason i can come up with is because Yalandwe has taken it as a outflow for tax calculation we have to reverse the contribution part.
Let me know if my understanding is correct or i messed it up.
What it is is as follows:
Imoni will buy the goods and then send them to Yilandwe. At the moment they are charging 200 and making a contribution of 40, which means that the cost to Imoni must be 160 per unit.
Imoni think that they will be able to increase the price to 280, which means they will earn a contribution of 280 – 160 = 120.
So….the actual cash flows will be:
In Yilandwe an outflow of 280 (the cash paid to Imoni)
In Imoni’s home country, an inflow of 280 (from Yilandwe) and an outflow of 120 (to buy the goods).
Obviously they have to be kept separate in the two countries because of the foreign exchange conversion and the tax.
I hope that makes sense of it 🙂
(It is a nasty one 🙁 )Hi Sir,
How do we derive the exchange rates of 101.4 for Year 0? As well the following years, why is it calculated based on the forecast future rates of YR/$1?
Thank you.
But you are not required to derive the exchange rate for time 0 (or for the following years) – they are all given in the question! (I assume you are looking at the actual exam question?)
Hi sir. First of all, i would like to thank you for your continued support. My doubt is they say other calculations are acceptable if assumptions are stated. So if i assume that contribution of 20% willremain same all throughout, and now the contribution is 56 per unit (280*20%), will i be right?
Also, once they take forward the tax loss to the 3rd year, why are they adding it back???
And why do they not account for redundancy costs as opportunity costs for Imoni?…
Thanks in advance.You cannot assume that the contribution will remain at 20%. The question says specifically what the cost is, and also says specifically that they will negotiate a higher transfer price.
The tax loss has been subtracted for the purpose of calculating the tax payable. However the tax loss itself is not a cash flow and that is why it has been added back.
The lost contribution and redundancy costs should have been taken into account, but as the examiner states (at the end of appendix 1) the effect is only small and amount to a reduction of approximately $0.1M in the NPV).
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