Question 1: Capital Budgeting (12 + 4 + 4 = 20 marks) | | Forgone Rent | Fitout | Equipment | Operating Expense | Advertising | Revenue | Net Cash Flow | Time Factor | Present Value | Y0 | | -150,000 | -120,000 | | | | -270000 | 1 | -270000 | Y1 | -60,000 | | | -180,000 | -40,000 | 400,000 | 120000 | 0.917 | 110040 | Y2 | -60,000 | | | -180,000 | -40,000 | 400,000 | 120000 | 0.842 | 101040 | Y3 | -60,000 | | 36,000 | -180,000 | -40,000 | 400,000 | 156000 | 0.772 | 120432 | Y4 | -60,000 | | -130,000 | -180,000 | -40,000 | 450,000 | 40000 | 0.708 | 28320 | Y5 | -60,000 | | | -180,000 | -15,000 | 450,000 | 195000 | 0.650 | 126750 | Y6 | -60,000 | 10,000 | 39,000 | -180,000 | -15,000 | 450,000 | 244000 | 0.596 | 145424 | | | | | | | | | At 9% | | | | | | | | | | NPV | 362006 | | 1 mark | 2 marks | 2 marks | 1 mark | 1 mark | 1 mark | 1 mark | 1 mark | 2 marks | | | | | | | | | | | a. Calculate the NPV for the proposed investment [12 marks as indicated in table above] | | | 1. Current rent 5,000 per month ($5000*12 = 60,000) | 2. Café fit-out 150,000; Residual value is 10,000 after 6 years | 3. Computer equipment 120,000; residual value 36,000 after 3 years; new computers purchased at beginning of Year 4 at 130,000; residual at end of Year 6 is 39,000 | | 4. Operating expense - 180,000 all six years | | | 5. Advertising 40,000 in first 4 years and 15,000 in the 2 years after that | | | | | 6. Revenue first 3 year 400,000 and following years as 450,000 | | | | | 7. Discount rate 9% | b. In your opinion, should Tyrone stay with the restaurant lease or should he start his new internet café? Identity and describe two (2) factors might influence this decision. [4 Marks]The NPV is positive, and is going to accumulate $326,006 over 6 years. Tyrone would most likely accept the investment in his new café. He needs to consider the extent to which his desire to start his own business has contributed to overly ambitious figures and needs to consider the salary he will forgo to take on this position. Are his estimates and underlying assumptions accurate? Can he afford to take a lower salary to keep the business running? What are his personal outgoings? He should conduct sensitivity analysis to ensure worse case scenarios. What would a small reduction in sales or increase in salary do to the NPV? If he didn’t make the investment, he must also take into account the long-term viability of rental potential and the need to maintain the building. He might still need funds to renovate for future tenants, regardless of whether he is operating the business or not. Tyrone should also consider the long-term potential of the internet café. What is the impact of competitors in the area? Does he want to derive personal satisfaction from this venture? Students might offer equally valuable factors to this solution. Award 1 marks for each factor raised and 1 mark for quality of discussion (total 2 marks per factor) c. What investment would this be classified as? Does the proposed NPV methodology suit this investment type? Explain why or why not. [4 Marks] This could be classified as a strategic investment decision, in which strategy prevails and is far different from the existing operations, requiring new management expertise than previously required to oversee the tenants of a restaurant. In this case the proposed methodology might not capture all the strategic benefits and risks associated with the proposal. Cash flows that occur later might be penalised by the use of NPV methodology. In this case, there is only 6 yrs of calculation and Tyrone might be considering this investment more on a longer-term personal basis, in which he is happy to forgo profits in the short-run. Students could also classify this as an operational investment, in which the business itself is more operational and less strategic in nature. Students could argue that a lot of the investment is based around upgrading the business with new décor and computer equipment. That Tyrone has the experience in running IT businesses and this decision is not really strategic in nature. In this case the NPV methodology would be appropriate. The students might also mention the occupational health and safety and regulatory aspects required as part of this investment (i.e. a large proportion of the capital investment is in equipment and decoration which must meet regulatory standards), however should not argue that this is only a regulatory investment. I would suggest it is the first, a strategic investment but award marks for the logic of their argument. Award 2.5 marks for investment classification and 1.5 mark for the NPV methodology.Question 2: Variance analysis (8 + (2 + 2 + 2) + 4 + 4 = 22 Marks) a). note students only need to provide the shaded FB and variances (volume column and price/efficiency columns) |

b) – e) See marks within the solution table provided below. Note b) – d) 2 marks each and e) 4 marks for price x 1;efficiency measures x 2; and 1 mark for overall totals | Net Profit – Profit Plan 2013 | | 825,000 | | Volume Effects | | | | Additional Sales Volume Contributed | 1,060,750 | | Explained by: | | | | Market growth (size) | 118,000F | 2 marks (b) | See below | Loss in market share | 147,500U | 2 marks (c) | | Product mix effect | 40,250F | 2 marks (d) | | | | | | Price Effects | | | | Selling prices | | 840,000U | 1 mark | Variable costs | 256,100 | | 1 mark | Fixed costs | 60,000 | | 1 mark | | | | | Total variances | | 513,150U | | | | | | Net Profit – Actual 2014 | | 311,850 | |
Budgeted market size = 2,500/.015 = 16,667 (given Actual Market Size = 18,000)
Actual market share = 2,450/18,000 = 0.1361 (13.61%) (given Budgeted Market Share = 15%)
b. Market Size (growth) Variance = (18,000 – 16,667) * 0.15 * (1,475,000/2,500) = 118,000 F (2 marks)
c. Market Share Variance = 18,000 * (0.1361-0.15) *(1,475,000/2,500) = 147,500 U (2 marks)
d. Product Mix Variance = (1,485,750/2,450) – (1,475,000/2,500) * 2,450 = 40,250 F (2 marks)
e) 1 mark for each sales price, fixed and variable cost variances and 1 mark for overall; if they make an errors in b, c, d calculations, students will recognise they have made a mistake as the numbers will not balance, so the total variances will not add – you can deduct 1 mark if they do not recognise the mistake they have made.
f) Big Travella lost $513,150 in overall profits. This was mainly because the sales prices were not as expected and they lost $840,000 due to lower selling prices. While they gained some advantage in the mix effect ($40,250) with the overall America study tour contributing greater contribution margin than budgeted, this did not make up the shortfall in pricing impacts. The contribution margin from the China study tour was actually negative which meant for every tour they sold, they lost money (to a total of 57,500). Perhaps this was due to reducing the selling price to improve market share as Shae had misread the market and they lost some of the market to their competitors ($147,500). They were not the preferred travel agent and Shae needs to look into this in more detail. In particular as the market for student study tours had grown ($118,000) meaning there were more customers demanding this type of product in the region. The profits that could be achieved because of market growth were not received by Big Travella as customers went to their competitors instead. They had a favourable variance on the variable costs, perhaps indicating that they had scrimped on airfares and hotel quality meaning they might not have been attentive to their customer needs and the market competition. Fixed costs were also favourable, possibly meaning that they did not offer the same customer service. Students might also suggest that the selling price reduction was because the sales people were trying to meet competitor pricing and needed to drop prices to keep market share. This would be an example of a reactionary response to misread market conditions. Award marks on the quality of the response [4 marks in all]. Award 0.5 marks for each well-argued comment around market size; share; product mix; selling price, fixed and variable variances plus 1 mark for linking the factors.

Question 3 a. Drawing on your knowledge of value chain analysis, discuss the approach Rio Tinto has taken. In your discussion, highlight the type of financial analysis that you would have expected the management team would undertake to guide the restructuring [5 Marks]

Rio Tinto has elected to simplify its corporate structure. That is, to save costs they are moving away from more complex decentralised structures to combined business unit structures. They have not totally centralised but enables a bit more sharing of value chain activities amongst groups that previously had their own separate value chains functions. At the same time the support activities have been streamlined to reduce corporate overheads.

They would have analysed the value chain performance of each of the business units to determine profitability, asset turnover and return on assets to see where money is spent and assets are required. In particular they would have looked at ways to share assets to generate more income and ways to reduce costs throughout the value chain. Certain budgeting techniques such as activity based budgeting (ABB) might assist them with this analysis – where they can focus on activities and associated activity cost pools and cost drivers. They would look at maximising their structural and executional cost drivers across all value chains.

Award marks for the extent to which they argue their viewpoint. For example, give 5 marks for a well written. Adjust depending on level of conviction. This is a tough question designed to draw out the HD students.

b. Using your knowledge of the risk management topic and drawing on the information about Blade Runner’s operations; provide an overview of the types of risks faced by the company. [5 Marks]

The risks faced by Rio Tinto include: * Strategic risks – competitor product offerings and reduced consumer demand may impact Rio Tinto in the future. For example popularity of certain products, such as coal can wane overtime – as new forms of energy are increasingly available. Demand for these resources depend on the global economy and when production is slowing, so will the demand for inputs such as aluminium, coal and iron ore. Financial risk – the company might have cash flow issues that need to be maintained from time to time with back-up overdraft or credit facilities. Given they operate in a dynamic environment, cash flow could be an issue. They are a large corporation so will tend to cut workforce and reduce production output to minimise financial exposure. They may not pay dividends to shareholders and if the share price drops because of lower demand, this can also expose the company somewhat. * Legal and Regulatory risk – this is always an issue for Rio Tinto, particularly with rules and regulations associated with health and wellbeing of the planet and safety of their workforce operating in the mines. Deaths can be very damaging to corporate reputation. Individual country laws must be attended to, and, operations need to comply with local standards. This is particularly important when it comes to managing environmental sustainability impacts due to mining. * Operational risk – these are many and varied and are to do with anything that damages the ability for Rio Tinto to provide their commodity products to customers. It could be unintentional or an accident that results in mining disasters and Rio Tinto management need to be aware of all risks. Operational risk can be deliberate fraud within a company (i.e. a supply manager ordering poor quality products because he/she is getting a kickback from a dodgy supplier, or negligent mining inspections). Mining organisations such as Rio Tinto are very strict with risk management procedures to prevent any disastrous incidents (such as those experienced at Bhopal Union Carbide gas disaster or BHP oil spill). All risks will present as strategic risks if not well managed. Award 1 mark for each point raised and discussed. Add an additional mark for addressing the solution in context.

c. Using the risk calculator, provide an overview of the level of risk for Rio Tinto’s management team. While you will not have details of all components of the risk calculator, provide discussion on four (4) components of the risk calculator. [8 Marks]

Responses might address any of the 9 points mentioned in the table, above. The could talk about growth, in general - that they are a very large organisation operating in a global context. Because they are listed they have pressure for performance from shareholders and in particular, institutional investors. Inexperienced employees are very risky for a mining organisation and Rio would be careful to make sure both corporate and operational employees are well trained. Culture - Managers might be under pressure to perform and could be benchmarked against each other – particularly in the shake-up of divisions some managers might have lost their positions. Students could highlight issues around competition for bonuses or between different regional managers. Information management plays an important role. Because of the size of the company, transaction complexity and velocity is going to be high. There are multiple orders in different currencies happening at the same time. There is certainly a high level of decentralised decision making indicated by the geographical split and mines operating in different global regions. As a result of the decentralised structure, there could be gaps in diagnostic performance measures and management accounting information will help to close the gaps.
Award 2 marks for each of the points raised and discussed. Note the students responses might not be as clear cut as the solution. This is designed to be a tough question to draw out insights from the more informed students. The better-read student will perform better here. You might find generic memorised solutions. Discretion is required when marking - only award half points or less for ‘memorised solutions.’