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1 / 3

MOCK EXAM 01

Section A- This ONE question is compulsory and MUST be attempted

 

QUESTION 1- FLASH

Company information and mission

Flash Supermarkets (Flash) is a multinational listed business operating in several developing countries. The business is divided into two divisions: Metro, which runs smaller stores in the densely populated centres of cities, and Hyper, which runs the large supermarkets situated on the edges of cities. Flash sells food, clothing and some other household goods.

Competition between supermarkets is intense in all of Flash's markets and so there is a constant need to review and improve their management and operations.

Flash mission is to be: 'the first choice for customers by providing the right balance of quality and service at a competitive price. We will achieve this through acting in the long-term interests of our stakeholders: earning customer loyalty, utilising all our resources and serving our shareholders' interests.'

 

Performance report

You are a performance management expert working for Flash, and the Chief Executive Officer (CEO) wants your views on the company's performance report and whether it is fit for the purpose of achieving the company's mission. The CEO has provided you with a copy of the company's most recent report as an example (Appendix 1).

This report is used at Flash's board level for the annual review of the company's performance. The divisional boards have their own reports.

The CEO has mentioned to you that there has been criticism of the board of Flash in the financial press, saying that the board is 'short-termist'.

Therefore, the CEO has asked you to evaluate the performance report to see if it is fit for the purpose of achieving the company's mission. However, the CEO also wants your evaluation of the performance report to include comments in relation to the criticism that the board is short-termist.

 

Performance measures

The board is considering introducing two new performance measures to address the objective of 'utilising all our resources'. These are revenue per square metre, and operating profit per square metre. The CEO wants an evaluation of these two measures, explaining: how they might address the objective, what those ratios currently are, and how they could be used to manage business performance. The CEO told you that the information in the board report (Appendix 1) will assist in this work.

There have been disagreements between Flash's divisional management about capital allocation. The divisions have had capital made available to them. Both sets of divisional managers always seem to want more capital in order to open more stores but historically have been reluctant to invest in refurbishing existing stores. The board is unsure of capital spending priorities given that the press comments about Flash included criticism of the 'run-down' look of a number of its stores.

The CEO has asked you to assess the effectiveness of the current divisional performance measure of divisional operating profit and the possibility of replacing this with residual income, in the light of these problems. The CEO has told you that you are not required to calculate the current values.

 

New stores

As the company is opening many new stores, the board also wants an assessment of the use of expected return on capital employed (ROCE) as a tool for deciding on new store openings. You have been given data for a new store proposal (Appendix 2), as an example to use when making your assessment.

The CEO has told you that the board wants the focus of your comments to be on the use of an expected value, not on the use of ROCE, as this is widely used and understood in the retail industry.

With this in mind, the CEO asked you to calculate the expected ROCE for the new store, and assess its use as a tool for decision making at Flash.

 

Information system

The CEO has proposed to the board that a new information system be introduced. She wishes to spend $100 million on creating a loyalty card programme with a data warehouse collecting information from customers' cards regarding their purchases. Her plan is to use this information to target advertising, product range choices and price offers more efficiently than at present.

The CEO has asked you to include in your report an explanation of how the proposed new information system can help to improve business performance at Flash.

 

Required

Write a report to the board of Flash, in response to the CEO's instructions for work on the following areas:

 

i. Evaluation of Flash's performance report

(14 marks)

 

ii. Evaluation of the new performance measures (revenue and operating profit per square metre)

(8 marks)

 

iii. Changing the divisional performance measure

(8 marks)

 

iv. The use of expected ROCE

(8 marks)

 

v. proposed new information system

(8 marks)

Professional marks will be awarded for the format, style and structure of the discussion of your answer.

(4 marks)

(Total = 50 marks)

 

Appendix 1

Board's performance report

FLASH YEAR TO 31 MARCH

  Metro budget 20X6

$'000

Metro actual 20X6

$'000

Hyper budget 20X6

$'000

Hyper actual 20X6

$'000

Flash budget 20X6

$'000

Flash actual 20X6

$'000

Flash actual 20X5

$'000

Change on PY
Revenue  
Food 1,093,521 1,104,567 5,431,277 5,542,119 6,524,798 6,646,686 6,513,752 2.04%
Clothes 765,465 773,197 3,801,894 3,879,483 4,567,359 4,652,680 4,536,363 2.56%
Other goods 328,056 331,370 1,629,383 1,662,636 1,957,439 1,994,006 1,964,096 1.52%
Total 2,187,042 2,209,134 10,862,554 11,084,238 13,049,596 13,293,372 13,014,211 2.15%
Cost of sales 1,994,583 2,014,730 10,199,937 10,408,099 12,194,520 12,422,829 12,186,796 1.94%
Gross profit 192,459 194,404 662,617 676,139 855,076 870,543 827,415 5.21%
Gross margins   8.80%   6.10%   6.55%    
Other operating costs 34,993 35,346 173,801 177,348 208,794 212,694 208,227  
Operating profit 157,466 159,058 488,816 498,791 646,282 657,849 619,188 6.24%
Operating margins   7.20%   4.50%   4.95%    
Finance costs         76,993 79,760 75,482  
Group profit before tax         569,289 578,089 543,706 6.32%
Tax         142,322 144,522 135,926  
Group profit after tax         426,967 433,567 407,780 6.32%
Total shareholder return           3.10% 2.70%  
Return on capital employed 13.2% 13.3% 13.2% 13.5% 13.2% 13.4% 13.2%  
Number of stores   533   208        
Total square metres   161,227   841,967        

 

Appendix 2

New store

The following data has been forecast by the Marketing Department for the new store based on Flash's existing experience. There are three possible scenarios:

 

Demand scenarios Low Medium High
Revenue ($m) 12.5 13.0 13.5
Probability (%) 20 50 30
Forecast operating margin (%) 4.1 4.3 4.4

 

The new store is expected to cost $4.2m to buy, fit out and stock. The target ROCE for Flash has been set at 13%.

2 / 3

Section B – BOTH questions are compulsory and MUST be attempted

 

QUESTION 2- TULIP

 Joint venture: T&R

Tulip Aerodynamics (Tulip) has formed a joint venture (JV) with Rosy Generators (Rosy) in order to design and manufacture high-performance wind turbines which generate electricity. The JV is called T&R with each party owning 50%. Tulip will design and build the pylons, housing and turbine blades while Rosy will supply the generators to be fitted inside the housing.

 

Tulip

Tulip is a medium-sized firm known for its blade design skills. It is owned by three venture capital firms (VCs) (each holding 30% of the shares), with the remaining 10% being given to management to motivate them. The VCs each have a large portfolio of business investments and accept that some of these investments may fail provided that some of their investments show large gains. Management is an ambitious group who enjoys the business and technical challenges of introducing new products.

 

Rosy

On the other hand, Rosy is a large, family-owned company working in the highly competitive electricity generator sector. The shareholders of Rosy see the business as mature and want it to offer a stable, long-term return on capital. However, recently, Rosy had to seek emergency refinancing (debt and equity) due to its thin profit margins and tough competition, both of which are forecast to continue. As a result, Rosy's shareholders and management are concerned for the survival of the business and see T&R as a way to generate some additional cash flow. Unlike at Tulip, the management of Rosy does not own significant shareholdings in the company which has preferred to pay fixed salaries. W]

 

Choice of design for the turbines

T&R is run by a group of managers made up from each of the JV partners. They are currently faced with a decision about the design of the product. There are three design choices depending on the power which the wind turbines can generate (measured in megawatts (MW)):

Design Description
8 MV A large8 MW unit
3 MW A 3 MW unit
1 MW A basic 1 MW unit

 

The engineering for the 1 MW and 3 MW units is well understood and so design is much simpler than for the 8 MW unit which would be world leading if completed.

The demand for the different types of units will depend on government subsidies of the electricity price charged by the electricity generating companies which will buy the wind turbines and the planning regulations for building such large structures. It is believed that there will be orders for either 1,000, 1,500 or 2,000 units but there is no clear picture yet of which demand level is more likely than the others.

The estimated costs and prices for the units are:

Type Variable cost per unit $m Fixed costs

$m

Price per unit

$m

8 MW 10.4 7,500.0 20.8
3 MW 4.8 820.0 9.6
1 MW 1.15 360.0 4.6

 

Notes

  1. The fixed costs cover the initial design, development and testing of the units.
  2. The costs and prices are in real terms with the 8 MW unit likely to take more years to develop than the others.

 

Required

 

a. Assess the risk appetites of the two firms in the JV and provide a justified recommendation for each firm of an appropriate method of decision making under uncertainty to assess the different types of wind turbines.

(9 marks)

 

b. Evaluate the choice of turbine design types using your recommended methods from part (a) above.

(8 marks)

 

c. Discuss the problems encountered in managing performance in a JV such as T&R.

 (8 marks)

 (Total = 25 marks)

3 / 3

QUESTION 3- PLUTO

Company background and objectives

Pluto manufactures electronic components for export worldwide, from factories in Camomile, for use in smartphones and handheld gaming devices. These two markets are supplied with similar components by two divisions, Phones Division (P) and Gaming Division (G). Each division has its own selling, purchasing, IT and research and development (R&D) functions, but separate IT systems. Some manufacturing facilities, however, are shared between the two divisions.

Pluto's corporate objective is to maximise shareholder wealth through innovation and continuous technological improvement in its products. The manufacturers of smartphones and gaming devices, who use Pluto's components, update their products frequently and constantly compete with each other to launch models which are technically superior.

 

Budgeting process

Pluto has a well-established incremental budgeting process. Divisional managers forecast sales volumes and costs months in advance of the budget year. These divisional budgets are then scrutinised by the main board, and revised significantly by them in line with targets they have set for the business. The finalised budgets are often approved after the start of the accounting year. Under pressure to deliver consistent returns to institutional shareholders, the board does not tolerate failure by either division to achieve the planned net profit for the year once the budget is approved. Last year's results were poor compared to the annual budget. Divisional managers, who are appraised on the financial performance of their own division, have complained about the length of time that the budgeting process takes and that the performance of their divisions could have been better but was constrained by the budgets which were set for them.

In P Division, managers had failed to anticipate the high popularity of a new smartphone model incorporating a large screen designed for playing games, and had not made the necessary technical modifications to the division's own components. This was due to the high costs of doing so, which had not been budgeted for. Based on the original sales forecast, P Division had already committed to manufacturing large quantities of the existing version of the component and so had to heavily discount these in order to achieve the planned sales volumes.

A critical material in the manufacture of Pluto's products is silver, which is a commodity which changes materially in price according to worldwide supply and demand. During the year supplies of silver were reduced significantly for a short period of time and G Division paid high prices to ensure continued supply. Managers of G Division were unaware that P Division held large inventories of silver which they had purchased when the price was much lower.

Initially, G Division accurately forecasted demand for its components based on the previous years' sales volumes plus the historic annual growth rate of 5%. However, overall sales volumes were much lower than budgeted. This was due to a fire at the factory of their main customer, which was then closed for part of the year. Reacting to this news, managers at G Division took action to reduce costs, including closing one of the three R&D facilities in the division.

However, when the customer's factory reopened, G Division was unwilling to recruit extra staff to cope with increased demand; nor would P Division reallocate shared manufacturing facilities to them, in case demand increased for its own products later in the year. As a result, Pluto lost the prestigious preferred supplier status from its main customer who was unhappy with G Division's failure to effectively respond to the additional demand. The customer had been forced to purchase a more expensive, though technically superior, component from an alternative manufacturer.

The institutional shareholders' representative, recently appointed to the board, has asked you as a performance management expert for your advice. 'We need to know whether Pluto's budgeting process is appropriate for the business, and how this contributed to last year's poor performance.'

However, the shareholder representative did also acknowledge that external factors had contributed to Pluto's poor performance in the last year, and suggested that it would be useful if Pluto's performance reports distinguished between variances which had resulted from its own operational performance as opposed to external circumstances which could not have been anticipated when the budgets were produced. You noted that many organisations address this issue by analysing variances into planning and operational elements.

 

Required

 

a. Evaluate the weaknesses in Pluto's current budgeting system and whether it is suitable for the environment in which Pluto operates.

(14 marks)

 

b. Evaluate the extent to which Pluto's poor performance for the last year can be attributed to external factors.

(6 marks)

 

c. Discuss the potential benefits to Pluto of analysing variances into planning and operational elements.

(5 marks)

(Total = 25 marks)

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