MGTA04 - INTRODUCTION TO MANAGEMENT (II)
Saturday, 27 October, 2012
SHORT ANSWER QUESTIONS - Model Answers
1a. Explain what is meant by the term “productivity” 2 marks
Productivity is a ratio. It describes the relationship between “inputs” (e.g. hours
of labour, $$ of capital, pounds of natural resources) and “outputs” (finished
goods and services).
The higher the “productivity” the greater the value of products or services relative
to the time, money or raw materials that went into producing those goods.
1b. Identify whether productivity is higher in the United States or 2 marks
in Canada, and provide evidence to support your answer
Although the two countires are similar in many ways, GDP per capita (i.e the
value of goods and services prodcued per citizen) is about 20% high in the US
than it is in Canada.
Because they are producing more with the same resources, or producing the same
with fewer resources (either will produce higher produtivity) Americans are
richer, on average, than canadians
1c. Provide two ways by which a nation could increase its productivity 2 marks
A nation could improve its productivity by investing more in the education of its
population (better educated people tend to be able to be more productive).
A nation’s businesses could invest in more on the job training
A nation’s businesses could invest in more and better technology for its workers
and for its factories.
Page 1of12 A nation’s government could invest in more and better transportation and
communication infrastructure, to help businesses produce more goods and service
s more quickly, cheaply or easily.
Part I – Questions About Leverage and the Financing of the Business
Joe decided he wanted to go into business as a car mechanic. He did his research and asked
a number of friends and acquaintances who had been in the auto mechanic business for
years. They advised him that he would need $200,000 to fully equip and outfit a garage (i.e.
purchase the fixed assets like tools and equipment, as well as the opening inventory of parts
Joe’s life savings were $40,000. That could be his initial equity. In order to come up with the
rest of the necessary capital, Joe thought he would take out a bank loan.
Calculate the debt to equity ratio that Joe would have if he borrowed 1 mark
the balance of the money necessary to outfit “Joe’s Garage”.
If Joe needs $200,000 to outfit the garage and he only has $40,000 in equity he
will need to borrow $160,000.
That would produce a debt to equity ratio of $160,000/$40,000 or 4:1
Joe went to see his bank manager. His bank manager was friendly and sympathetic, but he
advised Joe that it was the bank’s policy not to allow small business customers to have a debt
to equity ratio of more than 3:1
Why would the bank want to limit on a borrower's debt to equity ratio? 3 marks
Banks will want to limit the amount that they lend to any borrower because they
want to ensure that the borrower will have the profitabiltiy to be able to repay the
debt, plus interest.
The more that a business borrows, the higher will be its interest expense, and the
lower will be its profit.
Page 2of12 Also, lenders want to know that the owners of the business are committing some
of their own resources into the business.
Page3 of12 Question 2c)
What would be the maximum amount of money that the bank would lend 1 mark
to Joe, to outfit a $200,000 garage, and not violate its lending policies?
To finance $200,000 but to keep the debt to equity ratio at no more than 3:1, the
bank would be willing to lend as much as $150,000 in addition to $50,000 in
Part II – Questions About Liquidity and the Balance Sheet
On the first day of trading (i.e. the day the Joe’s Garage opened its doors for business), the
balance sheet looked like this:
Joe’s Garage Inc.
Balance Sheet on 1 April, 2011
Assets - Current Liabilities - Current
Cash 4,000 Accounts Payable 00
Accts. Receivable 00
Parts 26,000 Liabilities - Term
5 year term loan 150,000
Assets - Fixed
Tools & Equipment 170,000 Equity
Share capital 50,000
Question 2d) Calculate Joe’s Garage’s working capital 1 mark
Working capital = Current Assets – Current liabilities
$30,000 - $0 = $30,000
Question 2e) What is the purpose of calculating a business’ 1 mark
One calculates a business’ working capital to see if the value of the assets to be
converted into cash in the short term (less than 1 year) are sufficient to cover any
debts that will need to be covered in the short term (less than 1 year)
Page4 o12 Part III – Questions About Profitability and The Income Statement
In the first year of its operations Joe’s garage did $248,000 worth of business. One of Joe’s
customers, who owed the garage $8,000 died, without paying his bill. Although Joe tried
to contact the customer’s family, it appears as though the customer died without a will, and
without any money. Joe therefore wrote off the outstanding receivable.
Joe’s direct expenses were:
Parts and supplies $ 80,000
Wages to Joe’s assistant 40,000
Administrative expenses were:
Depreciation of the equipment 20,000
Electricity and other utilities 8,000
Newspaper advertising 3,000
Stationery and office supplies 2,000
Cleaning supplies 1,000
In addition, “Joe’s Garage” paid Joe a salary of $2,500 per month ($30,000 for the year) to
work full time as the General Manager.
The interest on the bank loan was 8% on the original full princip