Incremental Fixed costs Q 33 of the Pre-Sep 2023 Mock Exam

Hi Tutor

The question is long :

This scenario relates to 4 requirments

Lottrechio Co has several subsidiaries operating in foreign countries and these subsidiaries look after their own financial affairs.

Lottrechio Co has recently experienced cash flow shortages in some months and cash flow surpluses in other months. The company is therefore keen to improve its cash management. Lottrechio Co is preparing cash flow forecasts for September, October and November. Due to their financial independence, the forecasts will ignore the cash flows of the foreign subsidiaries. Forecast income and expenditure information has been prepared, as follows:

  June July August September October November December
  $’000 $’000 $’000 $’000 $’000 $’000 $’000
Sales 3,000 2,250 3,400 2,900 3,300 2,800 3,100
Labour 680 500 705 690 735 305 600
Fixed costs 375 480 505 480 595 476 550
Depreciation 300 300 300 300 300 300 300
 

All sales are on credit and 40% of trade receivables pay after one month, 50%
after 2 months’ with the remaining paying after three months.

All purchases are on two months’ credit. Purchases are made one month in advance of sales, the average margin achieved is 60%. Fixed costs are paid in the month in which they are incurred. 80% of labour costs, are paid in the month, while the remaining 20% are paid after one month.

Lottrechio Co must make an interest payment of $0·6m in October and will receive a loan of $0·5m in November. A new machine costing $0.8m will be purchased for cash in October.

Lottrechio Co currently has no short-term investments and has a policy of not investing short-term cash surpluses. The company expects to begin September with an overdraft of $0·2m.

Required:

(a) Prepare cash flow forecasts for September, October and November.

(7 marks)

(b) Calculate the forecast Quick Ratio at the end of the three month period.

Thanks,

Hi Tutor,

Yes, that’s why I wonder why they did not say the fixed cost is incremental.

So in this case the flow of fixed cost is ok to deal with ,

Am I right .

Thanks for clarification.