CIMA MCS N23F24 - Solutions Activity B

CORE ACTIVITY B: IMPLEMENT SENIOR MANAGEMENT DECISIONS
ANSWERS
EXERCISE 1 – Project constraints (linked to core activity B1)
Example answer:
Project constraints
Time – Time relates to the time to deadline for completion of the project. The deadline may be
imposed – for instance a car manufacturer may only offer a new franchise if the expansion and
opening of the franchise sites needs to be achieved by a particular date. Or it may be down to
senior management, who may also allow for some contingency if the project encounters
unexpected delays, such as being unable to find suitable new dealership sites quickly enough.
Cost – This relates to the budget allocated to the project and will be set by senior management.
The initial budget may be based on past experience – e.g. for a project to expand into another 20
sites, past data on the cost of new site openings may be used to prepare the budget. There may
also be a contingency built in for unexpected costs, such as unplanned inflationary rises in the
costs of salaries or fixtures and fittings.
Quality – There may be imposed quality standards that have to be met. For instance, car
manufacturers have certain presentation standards they require in order for dealerships to retain
a franchise. Cuppcar also has its own presentation standards, which may exceed those set by car
manufacturers. Failure to achieve appropriate quality levels could lead to lost franchises or lost
business, meaning that quality may be the most important constraint in some cases.
Note that these constraints interact with each other. For example, if a project has a short
timescale for completion, it may need more resources which will cost more and the quality may
be compromised through less time for checking that quality levels have been achieved.
EXERCISE 2 – Project management phases (linked to core activity B1)
Example answer:
Need – This phase involves the identification of a need that only a discrete project will be able to
resolve. The need for refurbishment will be triggered by interaction with the car manufacturer,
perhaps at the time of renegotiation of the franchise agreements.
A feasibility study will be prepared, covering the potential benefits of the project (retaining or
winning a franchise) and the potential solutions for achieving it, along with their costs.
In this phase, the company decides whether to proceed with the project or not and, if so,
produces a project initiation document to define the project, its justification and scope, as well as
provide a base document against which to measure progress.
Solution – This phase involves the development of a proposed solution. For the refurbishment
project, there may be various different contractors to choose from to do the work, or it may be
managed internally. Each potential solution is evaluated and judged and the most appropriate
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solution to satisfy the need is selected. Investment appraisal calculations will form part of this
phase.
Implementation – This phase relates to the actual performance of the project, involving more
detailed planning and implementation of the plans. Monitoring of the project against plan will be
undertaken. For example, there may be a schedule and deadline for each site to be refurbished,
with a budget for each site and for each type of expenditure. It is important to monitor and track
progress against such targets so that timely action can be taken if their achievement starts to slip.
Completion – Once the project is complete, confirmation is needed that the project goals have
been achieved. For instance, failure to achieve the correct quality levels required by the car
manufacturer would represent a significant failure of the project and will detrimentally impact
future revenues and profits. It is also important to conduct a post completion review, so that any
lessons learned from the project can be carried forward to future ones.
EXERCISE 3 – Risk and uncertainty in capital projects (linked to core
activity B3)
Example answer:
Sensitivity analysis
Sensitivity analysis looks at the effect of changing individual variables in an investment appraisal
on the overall value of the project. It can be used to assess which variables are most critical to the
success of the project – the ones that the project result is most sensitive to.
It can be used to analyse how far such variables can change before the project becomes
financially non-viable.
For a project to launch dealerships for a new car brand, variables such as sales volumes will be
especially important to perform a sensitivity analysis on, as the potential for sales will be
unknown in comparison to established brands.
Scenario planning
This allows discrete potential project scenarios to be evaluated separately. Each scenario can have
multiple different variables in relation to the other scenarios, which means that a more realistic
picture of the effect of changing variables, which are often interdependent, can be seen that with
a sensitivity analysis.
For instance, NPVs could be produced under different scenarios such as the new brand being an
immediate success, or gaining market share slowly, or not being successful, could be produced
and evaluated in order to evaluate the risks being faced.
Stress testing
A stress test is a way of analysing a business to consider how well it could cope in difficult
conditions. It would involve, for this project, assessing how well the project can withstand
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hypothetical detrimental events, such as an unexpected downturn in the market or negative
publicity about the car brand just before the dealerships open. In this context, it would be similar
to scenario planning for negative outcomes.
PRACTICE TASK B1 – Project management (linked to core activity B1)
SUGGESTED SOLUTION
To: Pavarit Chotisin
From: Financial Manager
Date: Today
Subject: Finance project
Need phase
The initial step is to determine the project’s goals and scope. For example, should the finance
company be in a position to provide financing for all car sales at the completion of the project, or
is the intention to start on a smaller scale and build up from that?
Then, a feasibility study will need to be produced, covering Cuppcar’s ability to undertake the
project. This will highlight areas where we may be lacking, such as in financing expertise and
appropriate software.
If the project is considered to be feasible, the project team should be selected such that all
necessary skills are available. As this project is so far removed from our current operations, there
will be a need to source external expertise to be involved with the project team. In fact, the
majority of the project team may need to be experts on financing, as it is such a highly regulated
area. There is no way that the project could be completed without such expertise. A decision will
need to be made whether such people should be contracted or employed to do the work.
The team must be briefed on the project’s goals and priorities. Understanding the objectives will
allow the team to appropriately compare the various options that are open to them in terms of
how to undertake the project.
A project initiation document should be prepared, including such elements as project purpose and
scope, the deliverables, initial budgets, etc. This will give the team something to work to, although
flexibility from these initial parameters will be necessary as the project progresses.
Solution phase
The next stage is to develop a suitable project plan that satisfies the Board’s vision for the project.
The various alternatives that are discussed must be considered in the light of the key deliverables
that have been identified by the Board and all must be fulfilled.
There may be many ways of achieving the Board’s vision for the finance project – for instance,
purchasing an already established finance company or recruiting skilled staff who are able to set
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one up from scratch. Each potential solution should be evaluated on both a financial and nonfinancial
basis. Investment appraisals will be produced.
A decision will be made as to which solution to move forward with.
Implementation phase
Once the appropriate solution has been identified, the implementation phase is where it is put
into place. This may involve adaptations to the project team, resources used, budget, etc. as the
project plans become more detailed.
For instance, if it is decided to start a finance company from scratch, more expert staff will need
to be employed who ideally have experience of doing this. If the decision is to purchase a finance
company, the expert staff will already be part of that company and the whole nature and
resourcing needs of the project will change, as well as the budget.
Project management is important at this stage to ensure that the project is progressing to plan
and to highlight areas that are falling behind or that need extra resource allocated to them. It will
also help to monitor the progress of the expenditure on the project and whether extra money
needs to be signed off by the Board in order to complete the project.
Completion phase
At completion, we should implement a post completion review. This will help to ensure that all
deliverables have been achieved, by returning to the goals of the project and checking that they
have been met.
The review will also consider how the project was run and whether there are any lessons that can
be learned from it to use on future projects.
The finance company that has been set up should be integrated into the business. This will require
training of sales staff in particular, so that they understand how to sell the services of the
company.
Financial Manager
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Trait
Project
management
phases
Level Descriptor Marks
No rewardable material 0
Level 1
Level 2
Level 3
Defines the project phases and gives generic discussion of the
need for management of each, with little reference to the specific
scenario
Defines the project phases and discusses the need for
management at each stage, with some reference to the specific
scenario
Defines the project phases and discusses the need for
management at each stage, with good, justified reference to the
specific scenario
1-5
6-10
11-15
PRACTICE TASK B2 – Risk and uncertainty in capital projects (linked to core
activity B3)
SUGGESTED SOLUTION
To: Pavarit Chotisin
From: Financial manager
Date: Today
Subject: Electric vehicles project evaluation
Expected net present value
Net present values (NPVs) represent the monetary value that would be added to the business if
the project goes ahead and progresses as expected. They tell us the effect on shareholder wealth.
The bigger the NPV, the better the project. On this basis, both projects are financially viable but
the Southshire project would be preferred.
Expected NPVs are NPVs that have been prepared using expected values in the calculations. This
means that estimates of future outcomes have been made, along with the anticipated
probabilities of them happening and then a long-term average figure for the outcome has been
calculated. In these calculations, an expected level of sales volumes has been used.
The use of EVs takes risk into account, in that it uses all possible outcomes in its calculation, but it
hides the level of risk that is faced by showing only an average figure. For instance, we cannot see
the values for the lowest and highest level of cars sold for each project, which would give us an
idea of the possible spread of potential NPVs and therefore the risk we face.
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The results are highly dependent on the assumptions and the probabilities used in the
calculations. There needs to be a reasonable basis for the figures used to give the results meaning.
The use of expected values is most appropriate when a decision is repeated over and again, so the
overall results tend towards the average. For a one-off decision, they may not be appropriate. For
this situation, if the initial project is successful, it may indeed be repeated across other counties in
Welland. This means that the use of EVs may be appropriate, although it does not take into
account regional differences if the project is replicated across the country.
Standard deviation of expected NPV
The standard deviation of expected NPV does give us an indication of risk. Standard deviations tell
us how far on average the possible outcomes of the project are from the mean, or expected NPV.
They therefore give us an indication of the spread of outcomes and therefore the risk.
We can see that the standard deviation for the Southshire project is much bigger than that of the
Northshire one. This means that the Northshire project is likely (approximately a 68% chance if
the results are normally distributed) to give an NPV of between W$200 and W$220 million,
whereas the Southshire project is likely to give a spread of W$200 to W$300 million. The
Northshire project is therefore less risky, but given that the low end of the spread for the
Southshire project is the same as the Northshire project, the higher risk of the Southshire project
should not unduly worry the Board. Both projects are still likely to produce highly positive NPVs
after the risk as illustrated by the standard deviation has been taken into account.
Sensitivity figures
Sensitivity analysis tells us how far a variable in question would need to change before we would
change our mind about going ahead with a project. In other words, the presented figures show us
by how far the sales price, capital investment costs and sales volumes would need to individually
change before the projects became financially non-viable.
The lower the sensitivity figure for a variable, the more sensitive the project outcome is to a
change in that variable.
We can see that the capital investment would have to increase by 15.3% for the Northshire
project and 12.5% for the Southshire one before each project is no longer beneficial to undertake.
These figures are relatively large and should not cause us much concern, unless we feel that
changes of this size are possible.
The sales price sensitivity figures are similarly quite high and should not cause us much concern.
The sales volume sensitivity figures are lower and therefore a little more concerning, more so for
the Southshire project where volumes only have to fall by 3.4% before the project becomes nonfinancially
viable.
This factor is made even more concerning when we consider that the sales volumes used in the
appraisals are expected value figures, meaning that there is a genuine potential for sales volumes
to be lower than the value used in the appraisals. Sales volume figures represent the main area of
risk in relation to both projects.
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Further investigation should be made in relation to sales volumes, in order to further evaluate the
project risk levels before a decision is made.
Financial Manager
Note: the detail of normal distribution probabilities is not necessary, but a general understanding
of standard deviations may be useful, in that the lower the number, the closer the potential
individual outcomes are to the expected value.
Trait
Project
evaluation
Level Descriptor Marks
No rewardable material 0
Level 1
Level 2
Level 3
Offers generic discussion of the figures and minimal reference to
risk, with little application to the specific Cuppcar scenario.
Offers good discussion of the figures with some reference to
risk, with good reference to the specific Cuppcar scenario.
Offers full discussion of the figures and refers to risk throughout.
Discussion is centred on the specific Cuppcar scenario.
1-5
6-10
11-15
PRACTICE TASK B3 – Financing sources (linked to core activity B4)
SUGGESTED SOLUTION
To: Pavarit Chotisin
From: Financial Manager
Date: Today
Subject: Financing of flagship dealership
Hi Pavarit,
Bond finance
The fixed rate bond offers lenders security, which should result in a relatively low cost. In the
event of insolvency, bondholders would rank ahead of equity shareholders for repayment of their
investment. Also, the finance cost is a predicable cash outflow and is a tax-deductible expense
against profits. Cuppcar also has ownership of dealership premises around the country, the value
of which significantly outweighs the current loan balance, so these premises could be used as
security for the finance raised.
Only the coupon (interest) is payable each year and the principal (the amount borrowed) is not
due to be repaid until 2026. Therefore, from a cash flow point of view, it gives time for the
investment to start earning returns before we need to repay the amount borrowed. However, we
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need to clarify the expected payback period and compare this with expected cash inflows arising
from the investment. Cash flow issues may occur if the investment hasn’t yet paid back the
amount invested in it by the time we need to pay back the debt.
Cuppcar’s gearing will increase with the issue of the bond. This increases the financial risk of
Cuppcar because it will run into difficulties if it cannot service the bond’s cash flows. Given that
the current level of gearing is approximately 22%, it is unlikely to adversely impact on the group’s
ability to obtain additional finance.
Rights issue
Rights issues are generally an attractive means of raising equity. Shareholders can either increase
their shareholding or sell their rights. Shares will normally be issued at a premium, but at less than
their current market value to encourage existing shareholders to take up the rights issue.
A rights issue will decrease financial risk by raising equity and therefore reducing gearing,
although it will not significantly affect the ratio in this case.
The amount required in this case is relatively small and so it may not be cost-effective to make a
rights issue. There are significant expenses associated with making a rights issue, such as
professional fees, particularly for a quoted company. Those expenses bear little relationship to
the amount being raised.
The potential for the need for future investment would also make a rights issue less suitable. If
the flagship dealership is viewed as a success by Barto Motors, they will likely wish to repeat it
across other dealerships. To repeat the time and disproportionate expense of issuing new shares
for multiple similar projects would not be an efficient way of raising finance. The repeated request
for investment may therefore be viewed negatively, particularly by our shareholders.
Financial manager
Trait
Bond and
rights issue
advantages and
disadvantages.
Level Descriptor Max Marks
Level 1
Level 2
Level 3
No rewardable material 0
Identifies some advantages and disadvantages, with
little application to the specific scenario.
Offers a clear discussion of the advantages and
disadvantages of the bond issue and rights issue,
with some application to the specific scenario.
Offers a clear and comprehensive discussion of
using the advantages and disadvantages of the
bond and rights issue, with the discussion fully
applied to the specific scenario.
1-5
6-10
11-15
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