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(ii) Following on from your answer to (i), evaluate the two purchase proposals, and advise Bill and Ben

which course of action will result in the highest amount of after tax cash being received by the

shareholders if the disposal takes place on 31 March 2006. (4 marks)

4 The Better Agriculture Group (BAG), which has a divisional structure, produces a range of products for the farming

industry. Divisions B and C are two of its divisions. Division B sells a fertiliser product (BF) to customers external to

BAG. Division C produces a chemical (CC) which it could transfer to Division B for use in the manufacture of its

product BF. However, Division C could also sell some of its output of chemical CC to external customers of BAG.

An independent external supplier to The Better Agriculture Group has offered to supply Division B with a chemical

which is equivalent to component CC. The independent supplier has a maximum spare capacity of 60,000 kilograms

of the chemical which it is willing to make available (in total or in part) to Division B at a special price of $55 per

kilogram.

Forecast information for the forthcoming period is as follows:

Division B:

Production and sales of 360,000 litres of BF at a selling price of $120 per litre.

Variable conversion costs of BF will amount to $15 per litre.

Fixed costs are estimated at $18,000,000.

Chemical (CC) is used at the rate of 1 kilogram of CC per 4 litres of product BF.

Division C:

Total production capacity of 100,000 kilograms of chemical CC.

Variable costs will be $50 per kilogram of CC.

Fixed costs are estimated at $2,000,000.

Market research suggests that external customers of BAG are willing to take up sales of 40,000 kilograms of CC at a

price of $105 per kilogram. The remaining 60,000 kilograms of CC could be transferred to Division B for use in

product BF. Currently no other market external to BAG is available for the 60,000 kilograms of CC.

Required:

(a) (i) State the price/prices per kilogram at which Division C should offer to transfer chemical CC to Division

B in order that the maximisation of BAG profit would occur if Division B management implement rational

sourcing decisions based on purely financial grounds.

Note: you should explain the basis on which Division B would make its decision using the information

available, incorporating details of all relevant calculations. (6 marks)

(d) The management of Wonderland plc have become concerned about the increased level of operating costs

associated with its petrol-driven ferries and have made a strategic decision to dispose of these. They are now

considering entering into a contract with the Newman Steamship Company (NSC), a shipping organisation based

in Robynland. The contract would entail NSC providing transport to and from Cinola Island for all visitors to the

zoo and circus.

As a result of negotiations with NSC, the directors of Wonderland plc are considering two options whereby NSC

will become responsible for the transportation of visitors to and from Cinola Island with effect from 1 December

2007 or 1 December 2008.

Additional information is available as follows:

(1) NSC would require Wonderland plc to pay for the necessary modifications to their steamships in order that

they would satisfy marine regulations with regard to passenger transportation. The only firm which could

undertake this work is currently working to full capacity and would require a payment of ￡2,450,000 in

order to undertake the work necessary so that the ferries could be in operation by 1 December 2007. The

same firm would require a payment of ￡1,725,000 in order to make the necessary modifications so that

the ferries could be in operation by 1 December 2008. The government of Robynland would be willing to

pay a grant of 8% towards the cost of getting the ferries into operation by 1 December 2007, but would not

be willing to pay a grant in respect of any later date.

(2) On 1 December 2002 Wonderland plc paid ￡500,000 to the Port Licencing Authority of Robynland. This

payment was for a licence which entitles Wonderland plc to use all harbour facilities in Robynland during

the five-year period ending 30 November 2007. The licence could be renewed on 1 December 2007 at a

cost of ￡150,000 per annum.

(3) Redundancy payments would need to be paid in respect of loss of employment. These would amount to

￡1,200,000 if the contract with NSC commenced on 1 December 2007. This amount would reduce to

￡750,000 if the contract commenced on 1 December 2008.

(4) Wonderland plc has a contract for the provision of petrol for its ferries which is due to expire on 30 November

2008. Early termination of the contract would incur a penalty charge of ￡76,000. An emergency reserve

stock of petrol held by Wonderland plc, which cannot be used after 30 November 2007 due to marine

regulations regarding the age of fuel, could be sold for ￡55,000 on 1 December 2007 but not on any date

thereafter.

(5) The ferries could be sold for ￡3,300,000 on 1 December 2007. If retained after 1 December 2007 the

ferries would require servicing during the year ending 30 November 2008 which would incur costs

amounting to ￡150,000. The resale value of the ferries on 1 December 2008 would be ￡2,900,000.

(6) Stock of consumable items which originally cost ￡150,000 could be sold on 1 December 2007 for

￡110,000 and on 1 December 2008 for ￡50,000.

Required:

(i) On purely financial grounds, advise whether the management of Wonderland plc should enter into a

contract with NSC with effect from 1 December 2007 or 1 December 2008. You may ignore the time

value of money. (9 marks)