CAP 2 SFMA Assessment - May 2011

aorourke23

Hi, I notice that for the January assessment there was a thread for discussion of the SFMA assessment and wondered would anyone be interested in doing the same this time?

I have just attached it now so ill post my thoughts when I get a chance to look at it..

mano79

Excellent was hoping there would be a thread for this. I was sick for the January one so missed it. Hoping to get most of the work done on this over Easter weekend. Hopefully a few will join the thread so that we can share workings etc :cool:

aorourke23

Oh thats brilliant, was beginning to think that I was the only person sitting this assessment in May. I will be working on it this week and next week as I would like to have it almost together before Easter so can enjoy easter hols besides studying.

I believe that the main focus is on Relevant Cosing and Investment Appraisal and perhaps a theory question on Target Costing. Just finding it hard to start, but anything I put together I will post up on this so hopefully we will get a good grade between us all.

Happy studying. Keep you posted :eek:

Diagnostics

Great im in the same boat too..

Ive done a small bit of work on it today.. It looks to me like there is two parts to this case study - job costing and investment decision. On the day they will get back to us with the following questions, i reckon:
1) Perform a new tender for the Scratch Plc job - focusing on reducing the cost of the project using target costing.
2) Should the company go ahead with bringing the licence into ireland?

Thats the way im thinking so far.....

aorourke23

I have uploaded a rough draft of my workings on relevant costing and job costing for Scratch Ltd. Some of these solutions may be incorrect but just thought id post my workings to make a start with this trend.

Perhaps if you could post your suggestions or any changes you would make to my solution or put up your suggested solutions so by the end of this we will have the correct solution for the exam.

I have also uploaded some theory notes on Relevant Costing and target Costing.

I will be working on investment appraisal later this evening and hopefully by the end of next week we will be in good shape for the exam.

Diagnostics

Good work on that stuff.
Im busy with work today and Tomorrow. I Will focus on doing some more on the assessment on friday. Ill do my own workings first, then post it and then review it against yours and we can see what varainces there are between our work.

aorourke23

Hello all
Just working through the case study again and I think I may have discovered some important information on page 8of9.
"Freestyle Incorporated has carried out a detailed analysis of the rate at which the system demonstrations are converted into sales. Sandy White is expecting an email from their Marketing Associate, Mrs Susan Lovett, confirming these critical details in the next few days"
Perhaps this is the further information that we will receive on the day so maybe we should work on some calculations for this????:)

Diagnostics

yeah definately.. Apparently what you get in terms of additional information on the day is pretty much what the student expects - and this email is pretty key in putting the whole profitability of the licence deal together.

Ill perform a similar exercise in looking at the sunk relevant costs etc in section 1 and then calculate the expenses that are possible for the second part..

In terms of calculating the number of licences sold i was thinking along the lines of some form of probability tree starting from
mailshot - demonstration - coverted to sales (o/s) - licences purchased .... Any thoughts on best way to go about this?

aorourke23

Ya I was thinking along the lines of probability alright but no idea what way to approach it. But I will look into it in more detail this evening and hopefully put something together. Any one else have any ideas or are we going in the right direction, any bit of help will be great

Diagnostics

Hi,
Attached are my workings for the Job in part 1 of the case study.
I didnt look at your work - aorourke - so i have some differences in the figures i came up with. Have a look and see what you think.

Question for you:
The notes you posted and used regarding relevant costs, future etc. Where did u get them from? I looked in the management accounting book for CAP 1 (Managerial Accounting Peter Clarke) and in the section 'Relevant costs for Decision Making' they only mention sunk and incremental costs. I didnt see anything regarding future or oppotunity costs, which i know are right i just cant see them!

toobeyshaw

Hi,

I did the assessment in January but I know the group work really helped me. What we did was go through the whole case study, underline any term that could be used as a question (even a small one) and made sure we had some info/relevant formulas on it so that we had to look nothing up in the book on the day because the time just flew by. My advice would be to have a very organised folder with summaries of the info you need as you won't have time to read through pages and pages of stuff.

BlueApple

Hi guys,

Glad to see this thread is up and running. I'd been involved in group work for the January sitting (unfortunately wasn't able to take the assessment on the day), and it certainly took a lot of the sting out of it.

In terms of what's coming up, I'd obviously agree with the two questions outlined thus far (i.e. redetermine a quote for the Scratch plc tender using relevant costing; and appraise the investment in the license agreement).

However, these assessments have usually had 3 questions at a minimum, so I think there will be at least one more. I would imagine that there will be a question in relation to how Purple finances itself. There's quite a lot of info provided at the start of the case relating to its equity/debt structure. It would seem strange that this has been included for no reason.

Anyone got any ideas on what this might involve?

Diagnostics

I was thinking that all that information could be used in some other part of the question where they ask us to comment on the companys financial position, its strategy and performance etc. We might have to bring in some ratios on the gearing of the company and tie their high amount of debt into the importance of licencing / scratch job.

Im going to work on the other major part of the question tonight - ieis calculating the expense etc for the licencing job.
Is anyone else doing this soon so we can compare work?

Also did anyone have any thoughts on the work uploaded by aorourke and myself in terms of the scratch job?

I think we should try and get these two main sections nailed first and then go back and see what other important areas there are in the case study we need to focus on....

BlueApple

Yeah, that's exactly what I was thinking, Diagnostics. The bulk of the marks will be split between the Scratch question and the License question, but there's room for another more general question, probably in relation to their high level of gearing and/or their weird strategy of employing people to do unsuitable tasks (e.g. the project manager working on costings).

I think there's also a good chance of a quick theory q on Target Costing, in which case the word doc uploaded by aorourke is very useful.

Lastly, I think the info provided on the day will include both the item that aorourke has highlighted (email from marketing assoc) and also a clarification on the following: "Freestyle Incorporated has agreed to supply Purple PLC with any quantity of technical information packs on the software, but is yet to confirm whether or not there will be a charge for this literature, and if so how much this will be." I'm guessing there will be some nominal charge for this technical info, which will have to be factored into the total cost of the project.

As regards what you guys have uploaded for Scratch, I had a quick look there and both seemed to be pretty good. There are obviously a couple of small differences (e.g. treatment of the plant expenditure) and it would be worth ironing these out.

I'm going to try to to get an outline together for the License question either tonight or tomorrow. It looks pretty messy, so would be helpful if a few people did it as it's unlikely one person will catch everything.

Diagnostics

Good work blue apple.

Ill have mine work on the licence job up by tomorrow morning.

With regards your differences to our work in the scratch project, could you upload something detailing why you think certain costs should be treated differently that we have included by mistake / omitted. Ill review and then we can upload a final combination of all the work on this project.

BlueApple

Diagnostics, by "differences", I actually meant differences between the two uploads, e.g. aorourke had factored no cost in relation to the plant acquisition (i.e. just adjusted for the incorrectly included depreciation cost), whereas you had included the full 400k figure (which I think is correct as there's no residual value).

Similarly, you have treated the screens on hand differently (again, I think your treatment is correct, Diagnostics - there's a saving on disposal costs rather than a foregone scrap value).

I'll probably work through the licensing stuff first, but I'll have a proper look at the Scratch plc Q after that. I need to re-read the area in the book to make sure I'd have it all down; it's a good while since I looked at that kinda stuff!

BlueApple

Attached are my workings for the Freestyle License investment appraisal question.

I worked off the following assumptions:

(a) Freestyle decide to charge for the literature provided. I included this as a base cost of 100k.

(b) The rate at which sales are converted from demos is 60% (i.e. the information we will receive from the marketing associate on the day)

Using 60% and a discount rate of 12% (case study dictates that min IRR acceptable is 12%) gives an NPV of about 3.5m. I'd imagine that the rate given on the day will be much lower. If you play around with the sheet, you can see that a 21% conversion rate just about allows for an IRR of 12%.

It might be a rate low enough so that the requirement of payback over 3 years is met, but the minimum IRR of 12% is not. This looks likely, as there's a significant drop in revenue in years 3 and 4 as a result of the 2-year contracts coming to an end.

Please let me know of any thoughts you might have. It's a pretty lengthy calc, so there will definitely be some errors in it. I haven't given a detailed explanation of where every figure comes from, but if you look in the formula, it should be fairly straightforward.

Diagnostics

Nice Work!
I just completed my answer and ran the numbers for 60% conversion and it matched your work except for the sales commission amount.

You seem to be calculating sales commission for each year. I assumed all the sales were made in year 1, and therefore there is only one sales commission payment to be made in the first year. Our total sales commission figures are the same, i just have it as one payment made in year one. (one mailshot - one batch of sales)

I cant see anything else wrong with your calc.

Just thinking about going into the exam. I was planning on going through all the possibilities ie 5%, 10% ..... 95% conversion so id have them all prepared. But i was forgetting about the other vairable ie the literature costs. Is our best bet to go in with just one answer or should we try and figure out a way to perform all the calcs prior?

Diagnostics

Just thinking and throwing out ideas!

If we assume the literature costs are nil for the moment, and then go through the process of putting in every percentage, and therefore have 99% of the work done and ready before the exam, all we will have to change on the day is Yo amount (ie the initial costs).

BlueApple

Cheers!

Yeah, wasn't too sure how to treat the sales comms, as I would have thought they all just arise in the first year b/c all they're selling is a 2 or 4 year license; it's not like it's a recurring sale each year. But then in the question they say "...payable in the year in which the sales are achieved", so wasn't sure what they were getting at. I think your conclusion is right though - all sales in the one year, so just one year of comms.

(It's strange actually that they even keep the two technical sales reps employed for the 4 years rather than just the first, as surely their role is defunct after year one. If they don't have another mail shot in a later year, then there's not much for them to do bar after-sales support).

I think you could definitely go through each possible percentage so that you have every working ready to go, it's just a bit time consuming and involves bringing in a lot of stuff with you. It's certainly an option though. The initial cost for the literature isn't a big factor I don't think, as it's just one input figure at Y0.

Also, had a better look at what you did for the Scratch Q. Think it's 100% spot on. There's kind of a vagueness in how they phrase the keyboard section. I'm taking it to mean that it's either sell the whole lot for 25k or only sell 1000 of them for 10k, i.e. the person willing to pay a fiver for each one wants all of them or none. I suppose though, in theory, you might be able to sell the first 1k of them at a tenner and the remaining 4k at a fiver and make 30k. I'm going to go with 25k in the exam anyway though.

Diagnostics

Nice work.

That point you raised regarding the technical sales team could be an issue maybe to raise in terms of reducing unnecessary costs or improving on the quote etc.. ie another question...

With regards the 25k keyboards, i reckon as long as we write down our assumption they shouldnt be able to dock us marks here.


The other two issues i think that are left are:
1. the payback period - ill look into this tonight
2. some of the debentures expire in 2013 - will this affect the question? - ie what will happen in year 4 if the this lump sum is called on..
Maybe they want us to to advise on what to do - ie regnetotiate debentures , additional forms of other finance as the licence deal will not create enought profit to pay the 20m redeemable debentures.

i performed a quick calculation of the gearing of the company - the company is very highly geared at 87%...

BlueApple

Yeah, I think the payback side of it is relatively straightforward. Again you just have to play around with the rate of sales conversions, and then you can see how quickly the net cash flows pay back the initial outlay (be it 600k or a bit more, depending on the price of the literature).

Regarding the debentures maturing, I'd also think that that will be the crux of a short question. I'd presume you'd have to present some alternative financing methods to try to lower the gearing ratio (e.g. convertibles).

One other thing I just noticed on the Scratch question:

Processors: the 5% rebate that applies when you buy 5,000-10,000 units applies to all purchases, i.e. I think that means that they will actually get a rebate on the first 5,000 units bought too (not just the units in the 5k-10k bracket). This is also what happens in the example in the textbook (see treatment of packaging materials on pp. 322-323).

You then get the following cost: (9,000*950) - (4,000*1,000) = 4,550,000

This could also be calculated by taking a 5% discount on the first 5,000 units: 5,000*1,000*5% = 250,000 => 4,800,000-4,550,000 = 250,000

Diagnostics

Ye the payback does look handy allright. As long as the literature costs arent crazy and they achieve a bit over 30% conversion itll be paid back in a year.

Also good spot re the Scratch question, i would of never thought to look at it that way. I was just looking at it like 4000 have been purchased and paid for and delivered etc but they are only ordered, makes sense now.

Well i think thats the main two parts of the case study done now. Unless other people have some input or ideas....

Now we need to focus on recommendations and analysis i think to get the bonus marks..

BlueApple

Yeah, I think that should cover off the two long questions anyway. I think if there's any theory stuff thrown in with those, then it will probably be Target Costing with Scratch, and the advans/disadvans of Payback, IRR and maybe NPV with Freestyle. Obviously then it's a matter of trying to tie these into the case study itself, i.e. recommendations.

I think one thing to look out for is that they mention the Tax rate of 20%. I'm hoping this is just a reference to why they've taken on so much debt (i.e. the Tax Shield effect), but if they gave us info on the day in relation to Capital Allowances, then there'd probably be a positive cash inflow each year in relation to the acquisition of the plant for 400k (see question 13.9 on p.441 of the book).

That reminds me, can you tell me how you calculated 87% for the gearing? I'm not too sure what approach to take with that. I'm assuming they're counting the pref shares as debt, so I'd have (D/D+E) calced as about 76% based on the balance sheet figures. Alternatively, taking the market value of the equity, where share price is 0.024, I get (D/D+E) to be about 99%.

Diagnostics

Apologies 76% is correct,I incorrectly used 20m as capital instead of 40m. Ill be doing some more work on the case study tomorrow, and ill focus on recommendations etc now that we have the spade work out of the way

Diagnostics

Just wondering does anyone want to do anymore work together in preparing for this assessment? Just in terms of some of the big theory issues, we could try and have prepared answers for. I think some of the potential qs are:

1) advans/disadvans of Payback, IRR and maybe NPV with Freestyle (as mentioned by Blue apple)
2) Benefits of target costing and what it is ( i know aaorourke already posted good notes on this, but maybe we should tailor them to the question in particular)
3) The company is clearly highly geared - recommendations as to how to improve / change their capital structure?
(While always trying to tie back to question as much as possible)
and if anyone has any other qs we should focus on....

We could get a list of what we think are the most likely areas to come up and then divide up between whoever is interested in sharing the work and each person put in time into preparing detailed case study relevant answers..

If people are interested wb otherwise best of luck in the case study i suppose!

aorourke23

Good Work all

Ya it would be great to work a bot more on the theory side and bring the info that I gave in the word document more detail in relation to the case study to gain higher marks, but it is looking good so far. Only a few more days so Ill look into the theory more and see if can put it all together before Saturday.:)

mano79

Good stuff lads. Doesn't look like many are sitting the assess on sat so nice to have some info. Does anyone think wacc could come up for purple plc. They give the shares and debt and the Corp rate we would need to work out cost of debts. We would have to be given figures like dividend, growth rate etc on the day but was wondering does anyone else think it might come up.

Just looking at past papers for this. It seems to vary from 3 to 5 questions. They always give five marks for presentation tho so have to make sure to lay out whatever they ask for ie briefing paper or report and start with to from date etc

mano79

Few theory bits for Saturday

Possible theory questions:

- Write a memo to Ron outlining the Target Costing concept
- Advantages & disadvantages/limitations of IRR and payback

Any new ideas??

Diagnostics

Just thinking in calculating out NPV we havent considered inflation, risk and tax (tax rate is given to us at the start of the case study)..

Do we need to adjust for these areas or is what we have ok as is?

aorourke23

Hi All

I have been working on the WACC calculations, we are missing the market prices but may be given this information on the day as we are given alot of info about the sources of finance at the beginning of the question.

I have implemented some market prices but can be adjusted on the day but at least will know where to start if it comes up and hopefully we wont have any surprises.

Our paper could be very similar to the January 2010 paper with relevant costing and WACC and they ask both practical aspects and theory aspects, so we really need to start working on the theory side as the marks are generated evenly between theory and practical.

HAs anyone worked on the theory and applied it to the case study?

I will look into the payback period this evening and some theory but feel free to upload any info if you have any extra.

Plus feel free to discuss any errors in the WACC if you do not agree with any of the figures.

Only 2 more days.:eek:

Diagnostics

Do you have the 2010 January paper? or where did you get it? I checked the chartered accountants website and they only have the May one up...

mano79

Its in the past papers tab in student centre but ive attached it here anyway:o

aorourke23

Oh god. only one more day..... Did anyonje get a chance to look at the WACC question that I attached?

Is there anything else we need to cover?

Diagnostics

On our Licence fee calculation - we have not budgeted in any cash flows for corporation tax. SHould we put this 20% in as a cash outflow?

BlueApple

Hi all,

Two issues:

(a) Calculating WACC as a discount rate: I'd be really surprised if this was the case. They've already told us that the acceptable IRR is 12%, so this strongly suggests that we should be using 12% as the discount rate, and testing whether this gives a positive NPV. To put it this way, what if you calced the WACC at 15%. Then you do the cashflow calc and you get a negative NPV. That doesn't tell you whether the IRR is less/more than 12%. It could still be anywhere between 12% and 14.99%.

Also, there's a lot of leg work involved in the appraisal question already, without having to calculate a WACC just to begin it.

I think if they had WACC in mind, they would have clearly flagged Ke. It's unlikely a company in that position would be paying a dividend, so we probably wouldn't be able to calc it from a Div Growth Model anyway.

(AORourke, had a quick look at your calc. The market value of the equity is given at 0.024. I think you've confused this as a dividend in calculating Ke. We weren't given a dividend figure).

I think it's far more likely that they've included the Capital Structure of the company so as to ask a specific short question on this, presumably in relation to their high gearing.

(b) Diagnostics - regarding the tax element of the appraisal question: I've never seen a question of this type (i.e. NPV/IRR/Payback etc) where you need to deduct tax payments on the net cashflows each year. I suppose, when you think about it, tax won't be charged specifically on these flows - it will be charged on the firm's entire profit for that year (could make a loss and then no tax would be charged).

Previously in the thread, I flagged how capital allowances could result in net cashflows which relate to tax, but obviously I was confusing the two questions (i.e. I was thinking of the plant acquisition in the Scratch question).

odonogj3

Has anyone done any work on the payback period?

Diagnostics

Im with you Blueapple. There is already two large sections of the case study that we have to re-gurgatate on the day, i dont know how we would have time to calculate the WACC on top of this, as well as potential theory questions.

I think you are right about the tax issue. Reading your comment reminded me that you dont tax cash flows, corp tax is based on companys profits. Phew.

With regards their high gearing; what do people think about this. Is it an issue, assuming they have just raised all their debt they dont need to be able to borrow more, so is it important that they are highly geared?

Re: the payback issue - this is a simple calc, which we will calculate when we get all the other information on the day. eg initial outlay 700k. receive 500k in year 1 and 700k in year 2. Means it takes us 1.28 years to payback out initial investment.

aorourke23

Good work

Has anyone any theory information that they would like to share. Im trying to put some of it together and relate it to the case study.

I have attached some info on the relevant costing theory and giving a board report. If anyone onle like to share their info so we can all try and piece as much info together as possible.

BlueApple

Aorourke - haven't done out any theory stuff specifically. I'm planning on bringing in your target costing piece - which I think is ideal for that question - and also just tabbing the books for the other theory pieces I think could come up (advans/disadvans of the various appraisal methods, and also some capital structure theory). I'll then try to tie them into the individual questions, depending on exactly what they ask.

Diagnostics - yeah, had another look at how long that WACC question would take and I just can't see it happening. When you look at Kd on the redeemable debs alone, that could take ages as you have to calc it by interpolation. Then you've got to calc the cost and market value of 3 more types of debt and also the cost of equity. You could be 45 mins doing that.

Regarding their gearing: yeah, I wouldn't think it's an issue right now as long as they can meet the repayments on the debs. They'll have to redeem those debs in 2013 though, so I would assume that they'll look to change their financing structure after that. They can't keep taking on those levels of debt or all the equity investors will just pull out, and they'll also create liquidity problems for themselves by paying those coupons every year.

Lastly, debentures are usually secured against something (maybe their premises if they own it outright), so that's got to be a worry.

aorourke23

Quick question, how exactly do you calculate the gearing, i have a memory blank at the minute?

odonogj3

Debt over debt plus equity

130 million over 170 million

Diagnostics

Anyone any idea of when we will get the results for this?? im itching to just to find out so i can completly forget about it and move on!

I know it took a good six weeks for the jan one, but surely it cant take that long fo rthis one there was only 10 of us !