Reference no: EM133002671

Question - Lee Ltd makes a range of products all of which follow a similar production process and have the same cost structure. The products are made in batches that are started at the beginning of the month and are completed and taken into finished goods inventories at the end. There is no work in progress at the end of any month. The business is considering a change in its sales prices, volumes and credit terms. Current position Sales revenues are £0.3 million a month and produce a contribution of 40p per £1 of sales revenue. Variable raw material costs account for 20p per £1 of sales revenue. Fixed costs are £120,000 a month, of which £30,000 is depreciation.

The business's only variable costs are production costs. Credit customers take one month to pay, trade payables for raw materials are paid one month after purchase and the other variable costs are paid during the month of production. At the end of each month the business has sufficient raw material inventories to meet the following month's production and enough finished inventories to meet the following month's sales. Possible future position Production and sales volumes would be increased by 50 per cent. To generate an increase in demand, selling prices would be reduced by 10 per cent and trade receivables would be allowed to pay two months after the sale. Since neither the usage nor the cost per product of raw materials and other variable costs would be affected by the proposed expansion, the contribution per £1 of sales revenue would fall to 30p. Apart from the increased trade receivables payment period, all working capital policies would remain the same as at present. The changes to sales volume, price and payment period, were they to occur, would commence with sales made from 1 December this year, but to meet the business's working capital policies there would be effects on cash flows before that time.

The business's balance at bank at 1 October is expected to be £70,000.

Required -

(i) Prepare Lee Ltd's cash budgets for each of the months of October, November and December this year and January and February next year, on the assumption that the proposed expansion of sales goes ahead. Note: Ignore interest.

(ii) Discuss the effects of the expansion plans on the business's working capital levels and profitability (Current position and possible future position).