FEEDBACK TUTORIAL LETTER 1 st SEMESTER 2017 ASSIGNMENT 2 MANAGEMENT ACCOUNTING 310 GMA711S 1
COURSE: MANAGEMENT ACCOUNTING 310 COURSE CODE: GMA711S TUTORIAL LETTER: 02/2017 DATE: 04/ 2017 Dear Student I hope you have received your first assignment back as well as the feedback tutorial letter for the first assignment. If you have not received these, please call your student support officer at COLL. This tutorial letter is to give feedback on Assignment 2 of Management Accounting 310. Assure yourself of all the correct answers and pay attention to the remarks of the marker-tutor. Feel free to call me if you need assistance. Use the time that you have available up to the end of the semester to do revision and prepare yourself for examination. Good Luck with the examinations! Regards, Mr. H Namwandi Tel. 061 207 2767 Email: hnamwandi@nust.na 2
ASSIGNMENT 2 Question 1 (15 Marks) The maximum amount that should be paid to the market research company is computed as the difference between the expected value of the selected project (s) with and without the information from the market research company. Step 1: (7 marks) Compute the expected value of the three projects without any information from the market research company. Next select the best project based on expected value numbers. Customer demand Probability Project A Project B Project C Mark Above average 0.2 400 000 300 000 800 000 1.5 Average 0.45 500 000 400 000 600 000 1.5 Below average 0.35 700 000 600 000 300 000 1.5 Expected Value (EV) 550 000 450 000 535 000 1.5 The best project out of the three based on expected value number is project A with EV = N$550 000. ( = 1 mark) Step 2: (6 marks) Compute the expected value of projects assuming we get information from the market research company. To compute this we select the highest NPVs assuming each of the demand conditions materialize. Thus If there is above average demand, project C with NPV of 800 000 will be selected. If there is above average, again project C with NPV of 600 000 will be selected. If there is below average demand, project A with NPV of 700 000 will be selected. The probability values will be assumed the same i.e. the market research company will forecast perfectly above average demand to be 20%, average demand to be 45% and below average demand to be 35%. Then the expected value will be = 0.2*800,000 + 0.45*600,000 + 0.35*700,000 = 675 000 Step 3: (2 marks) Take the difference of step 2 and 1 i.e. 675,000-550,000 = 125,000. This is the maximum amount that should be paid to the market research company. ( = 1 mark) Question 2 (15 Marks) High (30%) EV Profit: N$11 000 000 1 980 000 3
Medium (30%) Oil found (60% Profit: N$7 000 000 1 260 000 Drilling cost Low (40%) N$1 000 000 Loss:N$500 000-120 000 No oil (40%) -1 000 000 Do not drill 2 120 000 N$0 - Recommendation: they should drill because expected profit will be N$2 120 000 Marks I mark for each shape 1 mark for each branch 1 mark for each EV calculated 1 mark for recommendation Total = (15 marks) Alternative EV calculation Outcome Probability Net cash inflow EV 1. Oil found and high demand 0.18 11 000 000-1 000 000 = 10 000 000 1 800 000 2. Oil found and medium demand 0.18 7 000 000-1 000 000 = 6 000 000 1 080 000 3. Oil found and low demand 0.24-500 000-1 000 000 = -1 500 000-360 000 4. No oil found 0.4-1 000 000-400 000 Total 1 2 120 000 Question 3 (20 Marks) 4
a) Assume no capital rationing (5 marks) First compute the NPV of the three projects. Project A: (50 000)*1.000 + (20 000)*0.909 + 20 000*0.826 + 40 000*0.751 + 40 000*0.683 =5 700 The PV of future cash flows = NPV + Initial Investment (II) = 5 700+50 000 = 55 700 Project B: (28 000)*1.000 + (50 000)*0.909 + 40 000*0.826 + 40 000*0.751 + 20 000*0.683 = 3 290 The PV of future cash flows = NPV + II = 3 290+28 000 = 31 290 Project C: (30 000)*1.000 + (30 000)*0.909 + 30 000*0.826 + 40 000*0.751 + 10 000*0.683 = 4,380 The PV of future cash flows = NPV + II = 4 380+30 000 = 34 380 Decision: Because all the three projects have positive NPV, they should be accepted if there is no capital rationing. b) Assume there is capital rationing (10 marks with 6 marks for the ranking of the projects based on PI and 4 marks for the actual amount invested in each project) If there is capital rationing, we have to rank projects. But before that we need to compute profitability index (PI) PI = PV of cash flows/ Initial investment For project A: PI = 55 700/50 000 = 1.114 For project B: PI = 31 290/28 000 = 1.1175 For project C: PI = 34 380/30 000 = 1.146 Project Initial investment PV Future CFs of NPV PI Ranking based NPV A 50 000 57 000 5 700 1.114 1 3 B 28 000 31 290 3 290 1.1175 3 2 C 30 000 34 380 4 380 1.146 2 1 on Ranking based on PI Selection based on NPV Selection based on PI Project Initial NPV Project Initial NPV investment investment A 50 000 5 700 C 30 000 4 380 C 10 000 + 1 460 * B 28 000 3 290 Total 60 000 7 160 A 2 000 # 228 @ 5
Total 60 000 7 898 ( = 1 mark) Notes + Out the 60 000 capital constraint only 10 000 is left to be invested in project C # Out of 60 000 capital constraint, only 2 000 is left to be invested in project A *The NPV of Project C will be proportionate to the amount of capital invested. From the 30 000 full project cost, only 10 000 is invested. Thus the NPV of the partial investment will be 1/3 of the full NPV i.e. 10 000/30 000 *4 380 = 1 085.70 @ *The NPV of Project A will be proportionate to the amount of capital invested. From the 50 000 full project cost, only 2 000 is invested. Thus the NPV of the partial investment will be 2 000/50 000 (4%) of the full NPV i.e. 4% *5 700 = 228 Decision: If there is capital rationing of 60 000 we have to rank projects by PI to maximize the total NPV from the limited funds. As a result project C and A are selected. Project C is fully accepted whereas project A is partially accepted to the amount of 60%. In this the total NPV of 7 800 will increase when we rank by NPV criteria with the total NPV value of 6 785.70. Meaning of capital rationing and its type (5 marks) Capital rationing is a situation where there is insufficient funds to undertake all positive NPV projects. (2 marks) There are two types of capital rationing Soft capital rationing: occurs when the firm internally imposes a budget ceiling on the amount of capital expenditure (1.5 marks) Hard capital rationing: occurs when the amount of capital investment is restricted because of external constraints such as inability to obtain funds from the financial markets. (1.5 marks) THE END 6
7