General Comments Performance on this paper was reasonably good with the pass rate above average for the 2010 syllabus. Many candidates scored very highly and there were fewer marginal scripts. However there were a number of low scoring scripts suggesting that candidates had attempted the paper without being adequately prepared. Candidates scored fairly badly in the multiple choice questions and question 1 as a whole was not particularly well done. It was however pleasing to see good scores being achieved in question 2 and especially in the narrative questions. Whilst question 3 was reasonably well done it was clear from some scripts that some candidates had not practised using past papers and had not mastered the core areas of Section A of the syllabus i.e. activity based costing and standard costing. Part a) of the question was either very well done, with many candidates scoring full marks, or very poorly done with candidates clearly not understanding the principles behind activity based costing. In part b) many candidates were able to calculate a sales mix variance but few were able to calculate a sales quantity variance with many calculating a sales volume variance instead. Some of the candidates who struggled to calculate the sales mix variance offered a sales price variance instead which suggest a lack of understanding of the purpose of calculating these variances. This was clearly highlighted in part c) where few candidates, including those who calculated the mix variance correctly, were able to provide a reasonable answer. Part a) of question 4 was generally well done but the answers to part b) were generally very weak with many candidates failing to attempt an answer. The answers to part c) were better but they were not as good as in previous diets when this area of the syllabus was examined. There was clear evidence of poor time management with many candidates spending too long answering question 2. Candidates should try to discipline themselves to spend no more than the allocated time on each question. There is no need to write two pages to answer a five mark question. Where candidates are unsure how to do a computational element of a question it is good exam technique to move on to the next question rather than spending time performing meaningless calculations. It is always possible to go back to a question at the end if time allows. The Chartered Institute of Management Accountants 2014 Page 1
Section A 20 marks ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION Question 1.1 1.1 In finance, a bond is described as: A B C D A negotiable instrument offering a fixed rate of interest over a fixed period of time and with a fixed redemption value. A negotiable instrument which provides evidence of a fixed term deposit with a bank. Maturity is normally within 90 days but can be longer. A document which sets out a commitment to pay a sum of money at a specified point in time. An unsecured short term loan note issued by companies and generally maturing within a period of up to one year. (2 marks) The correct answer is A. Question 1.2 1.2 A Treasury bill with a face value of $1,000 and 91 days to maturity has an issue price of $985.04. The discount yield for the Treasury bill, assuming there are 365 days in the year, is: A 1.50% B 6.09% C 6.00% D 1.52% (2 marks) Workings The discount for 91 days = $1,000 - $985.04 = $14.96 The annual discount = $14.96 / 91 x 365 = $60 $60 / $1,000 = 6% The correct answer is C. The Chartered Institute of Management Accountants 2014 Page 2
The following information is given for sub-questions 1.3 and 1.4 below A company manufactures Product Y using a single raw material which is used exclusively in the manufacture of Product Y. It operates a JIT purchasing system and there is no inventory of raw materials. The following data relate to the production of Product Y for April. Budgeted production Standard material cost per unit Actual production Material purchased and used 11,000 units 3kg per unit @ $4 per kg 10,000 units 32,000 kg @ $4.80 per kg It has now been decided that the standard price for the raw material should have been $5 per kg. Question 1.3 1.3 The material price planning variance for April is: A B C D $6,000 Adverse $30,000 Adverse $32,000 Adverse $33,000 Adverse (2 marks) Workings (10,000 units x 3 kg) x ($4 - $5) = $30,000 A The correct answer is B. The Chartered Institute of Management Accountants 2014 Page 3
Question 1.4 The material price operational variance for April is: A B C D $6,000 Favourable $30,000 Adverse $6,400 Favourable $32,000 Adverse (2 marks) Workings 32,000 kg x ($5 - $4.80) = $6,400 F The correct answer is C. Question 1.5 The table below shows the output, total costs and the cost inflation index for a business in two periods. Cost behaviour patterns were the same in both periods. A $1.56 B $1.45 C $1.50 D $1.62 Output level Total cost Inflation index 12,000 units $21,000 1.05 16,000 units $26,780 1.03 The variable cost per unit at an inflation index of 1.08 will be: (2 marks) Workings If inflation is removed from the costs $21,000 / 1.05 = $20,000 $26,780 / 1.03 = $26,000 The variable cost per unit = ($26,000 - $20,000) / (16,000 12,000) = $1.50 At an inflation index of 1.08 = $1.50 x 1.08 = $1.62 The correct answer is D. The Chartered Institute of Management Accountants 2014 Page 4
Question 1.6 A company is considering the launch of a new product which it estimates has a 75% chance of success if no marketing is undertaken. The company believes that if it undertakes a marketing campaign costing $50,000 the probability of success of the product will increase to 90%. If successful, the product will make a profit of $300,000, before marketing costs. However, if it is unsuccessful, the product will make a loss of $80,000 before marketing costs. Required: Calculate whether it is worthwhile for the company to undertake the marketing campaign. (3 marks) Workings Expected value of profit with marketing campaign ($300,000 x 0.90) + (-$80,000 x 0.1) = $262,000 - $50,000 = $212,000 Expected value of profit without marketing campaign ($300,000 x 0.75) + (-$80,000 x 0.25) = $205,000 It is therefore worthwhile for the company to undertake the marketing campaign as the increase in the expected value of profit is $7,000 The Chartered Institute of Management Accountants 2014 Page 5
Question 1.7 A company is planning to launch a new product. The price at which it will sell the product will be determined by the level of competition in the market which is currently uncertain. The possible selling prices and variable costs and their respective associated probabilities are as follows: Required: Selling price per unit Variable cost per unit $ Probability $ Probability 60 0 30 20 0 25 64 0 25 24 0 40 68 0 45 26 0 35 Selling price and variable cost per unit are independent of each other. Calculate the probability of the contribution per unit being equal to or greater than $40. (3 marks) Workings $60 - $20 = $40 Joint probability is 0.30 x 0.25 = 0.0750 $64 - $20 = $44 Joint probability is 0.25 x 0.25 = 0.0625 $64 - $24 = $40 Joint probability is 0.25 x 0.40 = 0.1000 $68 - $20 = $48 Joint probability is 0.45 x 0.25 = 0.1125 $68 - $24 = $44 Joint probability is 0.45 x 0.40 = 0.1800 $68 - $26 = $42 Joint probability is 0.45 x 0.35 = 0.1575 0.6875 Alternatively:- $60 - $20 = $40 Joint probability is 0.30 x 0.25 = 0.0750 $64 - $20 = $44 Joint probability is 0.25 x 0.25 = 0.0625 $64 - $24 = $40 Joint probability is 0.25 x 0.40 = 0.1000 At a selling price of $68, the contribution per unit under all three alternatives is greater than $40 therefore probability is = 0.4500 0.6875 The Chartered Institute of Management Accountants 2014 Page 6
Question 1.8 A project requires an initial investment of $150,000 and has an expected life of five years. The required rate of return on the project is 12% per annum. The project s estimated cash flows each year are as follows: $000 Sales revenue 101 Variable costs 30 Incremental fixed costs 5 The selling price, costs and activity levels are expected to remain the same for each year of the project. Ignore taxation and inflation. Required: Calculate the percentage change in the selling price that would result in the project being rejected. (4 marks) Workings Net cash flows per annum = $101,000 - $30,000 - $5,000 = $66,000 PV of net cash flows = $66,000 x 3.605 = $237,930 Net present value = $237,930 - $150,000 = $87,930 The PV of the sales revenue = $101,000 x 3.605 = $364,105 The percentage change in the selling price that will result in the project being rejected is: $87,930 / $364,105 = 24.15% The Chartered Institute of Management Accountants 2014 Page 7
Section B 30 marks ANSWER ALL SIX SUB-QUESTIONS. YOU SHOULD SHOW YOUR WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE Question 2(a) A company uses a top-down approach to budgeting. Budgets are imposed by senior management and budget holders are not given the opportunity to participate in the budget setting process. Required: Explain ONE advantage and TWO disadvantages to the company of using this top-down budgeting approach. (5 marks) Rationale The question assesses learning outcome B3(b) apply alternative approaches to budgeting. It examines candidates ability to explain the advantages and disadvantages of a top-down approach to budgeting. Suggested Approach Candidates should clearly explain one advantage and two disadvantages of a top-down approach to budgeting. Marking Guide Explanation of one advantage of top-down budgeting Explanation of two disadvantages of top-down budgeting Marks per valid point Up to 2 marks per advantage / disadvantage Maximum marks awarded 5 marks The Chartered Institute of Management Accountants 2014 Page 8
Examiner s comments This was a straightforward question which was generally well answered with most candidates achieving three or four marks. Most candidates were able to identify one advantage and two disadvantages. The difference in marks achieved came down to whether candidates could gain the second available mark for the point made. Some of the weaker candidates gave a general answer about incremental budgeting whilst others thought that top-down budgeting meant starting with revenue and then determining the cost budgets to achieve the revenue. Common errors 1. Failing to expand the points made. 2. Providing answers that did not address the question that was asked. The Chartered Institute of Management Accountants 2014 Page 9
Question 2(b) XY has developed two new products, Product X and Product Y, but has insufficient resources to launch both products. The success of the products will depend on the extent of competitor reaction. There is a 20% chance that competitors will take no action, a 50% chance that they will launch a similar product and a 30% chance that they will launch a better product. The profit/loss that will be earned by each of the products depending on the extent of competitor reaction is as follows: Competitor reaction Product X Product Y No action $540,000 $620,000 Launch a similar product $320,000 $380,000 Launch a better product ($150,000) ($200,000) Another option for XY would be to launch neither product. If it chooses this course of action there is a 60% chance that competitors will take no action and there will be no effect on the company s profit. There is a 40% chance that competitors will launch a new product and company profits will reduce by $100,000. Required: Demonstrate, using a decision tree and based on expected value, the best course of action for the company. (5 marks) Rationale The question assesses learning outcome D1(f) apply decision trees. It examines candidates ability to use decision trees to evaluate a decision where there is uncertainty regarding expected cash flows. Suggested Approach Candidates should firstly draw the decision tree and then using the profit/loss and probabilities given for each branch of the tree work back to calculate the expected profit/loss at each node. They should then clearly indicate the most profitable decision. Marking Guide Expected value of Product X Expected value of Product Y Expected value of no product launch Format Decision Maximum marks awarded Marks 5 marks The Chartered Institute of Management Accountants 2014 Page 10
Examiner s comments There were many correct answers to this question but there were also too many candidates who did not make an attempt at the question. If candidates went wrong it tended to be because they only had two initial branches i.e. launch and don't launch, or alternatively three branches with no action, launch a similar product and launch a better product. Common errors 1. Assuming the decision was whether to launch a product or not to launch a product. 2. Assuming the decision was whether to take no action, launch a similar product or launch a better product. 3. Forgetting to multiply the $100,000 reduction in profits by 40%. The Chartered Institute of Management Accountants 2014 Page 11
Question 2(c) Discuss the potential benefits for a company from using a just-in-time (JIT) purchasing system. (5 marks) Rationale The question assesses learning outcome E1(g) analyse the impacts of alternative policies for stock management. It examines candidates ability to discuss the potential benefits for a company from using a JIT purchasing system. Suggested Approach Candidates should explain how a JIT purchasing system operates and the potential benefits that may arise from the use of the system. Candidates should also consider the pre-requisites for achieving the benefits from a JIT purchasing system. Marking Guide Discussion of the benefits of JIT purchasing Maximum marks awarded Marks per valid point 5 marks Examiner s comments Most candidates seemed to be familiar with the concept of JIT but the difference in the marks awarded related to whether candidates focused their answer correctly on JIT purchasing or included details on JIT production. In some cases those candidates who focused on JIT purchasing could say little more than it reduced holding costs although they gave many examples of the types of holding costs. Unfortunately this answer was capped at one mark. Overall it was clear that the candidates knew the topic area but their answers were either too narrowly focused or moved away from the question requirement. Common errors 1. Answers that were limited to discussion of the types of holding costs that JIT purchasing would reduce. 2. Answers that discussed JIT production rather than JIT purchasing. The Chartered Institute of Management Accountants 2014 Page 12
Question 2(d) JS has decided to purchase t-shirts and print them with a logo to commemorate a major international sporting event. Sales The commemorative t-shirts will be sold for $10 each and predicted sales are as follows: July August September 9,000 t-shirts 18,000 t-shirts 22,500 t-shirts One third of sales will be for cash. The remainder will be on credit with the customer paying the month after sale. Purchases The t-shirts will cost $6 each and will be purchased in the month prior to sale. It is expected that 10% of the t-shirts purchased will be damaged during the printing process and will not be suitable for sale. The supplier has offered two months credit. Capital investment To print the t-shirts with the logo of the sporting event will require the purchase of a machine costing $30,000. The machine will be bought at the start of the project and paid for in August. The machine will have a five-year useful life but no expected residual value. The machine will be used elsewhere in the business at the end of this project. Expenses Expenses, excluding advertising, of $20,000 per month will be incurred each month and paid in the month incurred. Advertising costs of $5,000 per month will be incurred in each of the months July, August and September and will be paid one month in arrears. Required: Produce a cash budget for the project for each of the three months July, August and September. (5 marks) Rationale The question assesses learning outcome B3(a) prepare a budget for any account in the master budget, based on projections/forecasts and managerial targets. It examines candidates ability to prepare a cash budget based on information given about the timing of cash flows. Suggested Approach Candidates should firstly prepare a format for the cash budget with months along the top and receipts and payments down the side. They should then work out the timing of the cash flows for each of the items. The cash receipts and cash payments should be totalled and the net cash flow for each month should be calculated. The opening cash balance and closing cash balance for each month can then be calculated. The Chartered Institute of Management Accountants 2014 Page 13
Marking Guide Sales receipts Payment for purchases Payment for machinery Payment for expenses Payment for advertising Net cash flow Format Maximum marks awarded Marks ½ mark ½ mark ½ mark ½ mark 5 marks Examiner s comments This question was not as well done as might have been expected for a cash budget question although most candidates scored two to three marks. Very few candidates were able to calculate the correct cash outflows for the purchase of the t-shirts; in particular they were unable to deal correctly with the ten per cent damaged items. The timing of the purchasing cash flows was also an issue for some candidates. Few candidates used the correct format and hardly any candidates produced the opening and closing figures for the cash budget. More worryingly, some candidates did not appreciate that depreciation is not a cash flow and included depreciation as well as the $30,000 machine cost! Common errors 1. Failing to include opening and closing balances. 2. Including advertising costs in July. 3. Poor labelling of figures. 4. Accounting for the damages by multiplying the purchases by 1.1. 5. Including depreciation as a cash outflow. The Chartered Institute of Management Accountants 2014 Page 14
Question 2(e) (i) Explain why it is important for a business to prepare a cash budget. (2 marks) (ii) State THREE ways, other than borrowing, of improving the cash flow position of a business. (3 marks) (Total for sub-question (e) = 5 marks) Rationale Part (i) of the question assesses learning outcomes E1(a) explain the importance of cash flow and working capital management. Part (ii) assesses learning outcome E1(d) discuss measures to improve a cash forecast situation. Part (i) examines candidates ability to explain why it is important for a business to prepare a cash budget. Part (ii) requires candidates to state three ways of improving the cash flow position of a business. Suggested Approach In part (i) candidates should clearly explain the benefits to the company of cash budgeting. In part (ii) candidates should state three methods that could be used to improve the cash flow position of a business. Marking Guide Part (i) Explanation of the importance of preparing a cash budget Part (ii) Three ways of improving the cash flow position of a business Maximum marks awarded Marks per valid point per method 5 marks Examiner s comments This question was generally well answered although a number of candidates did not get beyond liquidity in answer to part (i). Some of the weaker candidates talked about projects being profitable rather than cash budgets. Part (ii) was fairly well answered but some candidates did not read the requirement fully as they included options such as issuing shares or taking out loans and overdrafts. Common errors 1. Failure to read the question properly. 2. Failure to develop the answer to part (i). The Chartered Institute of Management Accountants 2014 Page 15
Question 2(f) A company has a highly seasonal business with the result that its borrowing requirement fluctuates significantly throughout the year. There are two alternative ways of funding its short-term borrowing requirement as follows: 1) The company s bank has offered a $400,000 overdraft facility at an annual interest rate of 12% per annum. 2) The company can take a $400,000 one year loan at an interest rate of 10% per annum. The loan would be taken out on 1 st January. Any surplus funds can be deposited to earn 4% per annum. The monthly borrowing requirements for the forthcoming year are as follows: Month Jan Feb March Apr May Jun Jul Aug Sep Oct Nov Dec $000 280 370 0 370 400 0 280 280 0 370 400 400 The borrowing requirement will apply for the whole of each month. Required: (i) Calculate the net cost of each alternative for the forthcoming year. You should assume that each month is of equal length and that there are no fees payable. (3 marks) (ii) State TWO advantages of using an overdraft to fund short-term cash deficits. (2 marks) (Total for sub-question (f) = 5 marks) Rationale Part (i) of the question assesses learning outcome E2(d) illustrate numerically the financial impact of short-term funding and investment methods. Part (ii) assesses learning outcome E2(a) identify sources of short-term funding. Part (i) examines candidates ability to calculate the cost of two alternative methods of funding a company s short-term borrowing requirement. Part (ii) requires candidates to state two advantages of using an overdraft to fund short-term cash deficits. Suggested Approach In part (i) candidates should calculate the cost of the overdraft based on the balance outstanding each month. They should then calculate the annual interest cost of the loan net of the interest receivable on the unused portion. In part (ii) candidates should clearly state two advantages of using an overdraft to fund short-term cash deficits. The Chartered Institute of Management Accountants 2014 Page 16
Marking Guide Part (i) Interest on the overdraft Interest on the loan Interest receivable Part (ii) Two advantages of using an overdraft Maximum marks awarded Marks ½ mark 1 ½ marks each advantage 5 marks Examiner s comments This question was not particularly well answered with quite a large proportion of candidates omitting it entirely and others spending a significant amount of time performing invalid calculations. Part (i) was slightly different than seen before but required the application of very basic principles and could have been answered by someone without any accounting knowledge. Part (ii) was fairly well answered with many candidates discussing flexibility and ease of arrangement. Common errors 1. Calculating the overdraft interest as $400,000 x 12% = $48,000. 2. Inability to calculate the interest received on the surplus funds. 3. Stating that overdrafts did not require security. 4. Stating that overdrafts were interest free. The Chartered Institute of Management Accountants 2014 Page 17
Section C 50 marks ANSWER BOTH QUESTIONS Question 3 (a) Calculate for each product: (i) (ii) the total fixed production overhead costs using the current absorption costing system; (2 marks) the total gross profit using the proposed activity based costing system. (13 marks) The management accountant is reviewing the company s performance for the last quarter of this year. The budgeted standard costs for this year differ from those given in the scenario above for next year. Budget and actual data for the last quarter of this year include: Anti-ageing Cream Facial Masks Collagen Fillers Budget Actual Budget Actual Budget Actual Sales (units) 240,000 250,000 280,000 260,000 120,000 140,000 Gross profit per unit $34.00 $33.20 $20.00 $20.60 $22.00 $20.20 (b) Calculate the following variances for the last quarter: (i) Sales mix gross profit variance (ii) Sales quantity gross profit variance (3 marks) (2 marks) (c) Explain the meaning of the sales mix gross profit variance and why its calculation provides useful information for the company. You should use the figures calculated in part (b) to illustrate your answer. (5 marks) (Total for Question Three = 25 marks) The Chartered Institute of Management Accountants 2014 Page 18
Rationale The question assesses a number of learning outcomes. Part (a) of the question assesses learning outcome A1(c) discuss activity-based costing as compared with traditional marginal and absorption costing methods, including its relative advantages and disadvantages as a system of cost accounting. It examines candidates ability to calculate the cost of a product using both traditional absorption costing and activity based costing. Part (b) assesses learning outcome A1(d) apply standard costing methods, within costing systems, including the reconciliation of budgeted and actual profit margins. It examines candidates ability to calculate a sales mix gross profit variance and a sales quantity gross profit variance. Part (c) assesses learning outcome A1(f) interpret material, labour, variable overhead, fixed overhead and sales variances, distinguishing between planning and operational variances. It examines candidates ability to explain the meaning of a sales mix gross profit variance and why it is useful to calculate the variance. Suggested Approach In part (a)(i) candidates should identify the direct material costs for each product and then calculate the overhead absorption rate. This rate can then be applied to each product and the total overhead cost calculated. In part (a)(ii) candidates need to calculate a cost driver rate for each of the activities and then apply this cost driver rate to calculate the overhead cost for each activity per product. The gross profit for each product can then be recalculated. In part (b)(i) candidates should calculate the sales mix gross profit variance by comparing the actual sales quantity at the budgeted mix with the actual sales quantity at the actual mix. The variance calculated in units for each of the products should then be multiplied by the standard gross profit per unit to calculate the variance for each product. These should then be added together to calculate the total mix variance. In part (b)(ii) the budgeted sales quantity should be compared to the actual sales quantity at the budgeted mix. The resultant variance in units should be multiplied by the standard gross profit per unit to calculate the sales quantity gross profit variance for each product. These should then be added together to calculate the total sales quantity gross profit variance. In part (c) candidates should clearly explain the meaning of the sales mix gross profit variance and why it is useful for a company to calculate this variance. The Chartered Institute of Management Accountants 2014 Page 19
Marking Guide Part (a)(i) Fixed production overhead absorption rate Overhead costs for each product Part (a)(ii) Cost driver rates Application of cost driver rates Sales, direct materials and direct labour Gross profit per product Part (b) Sales mix variance Sales quantity variance Part (c) Explanation of sales mix variance Maximum marks awarded Marks ½ mark 1 ½ marks 8 ½ marks 2 ½ marks 3 marks 2 marks per valid point 25 marks Examiner s comments Part a)(i) was usually correctly answered. If candidates had the wrong answer it was because they had apportioned the overhead using sales value or production/sales units. For part a) (ii) there were many completely correct answers but also many candidates who failed to calculate any of the cost driver rates correctly. Candidates often simply added the data provided in the question, for example machine set-ups 3 + 3 + 4 = 10 as the basis for the apportionment of the machine set-up costs. Where candidates calculated some of the cost driver rates correctly, the calculation of the number of batches was especially a problem with many candidates using batch size instead. However, where these mistakes had been made, most candidates did manage to ensure that the apportionment of the cost across the three products added back to the total cost. However some of the weakest candidates did not check that they had apportioned the total cost which showed no understanding of the basic principles. Part b) was generally not answered well with many candidates calculating the sales price or sales volume gross profit variances instead or simply having little idea of how to calculate sales variances at all. As always with such questions, incorrect variance signs and unreasonable rounding were also evidenced. Part c) was very poorly answered. Few candidates were able to explain the sales mix variance or why the information may be useful. Many candidates explained the sales volume variance or confused the sales mix variance with the materials mix variance. Common errors Part (a)(i) 1. Apportioning costs by sales value or production/sales units. Part (a) (ii) 1. Incorrect calculation of number of cost drivers. 2. Using batch size rather than number of batches to calculate total cost drivers. 3. Failure to check that the total of costs for each product added back to the total cost. Part (b) 1. Calculating the sales mix and sales quantity variance using actual costs per unit. 2. Unreasonable rounding when calculating the actual sales at budgeted mix. 3. Calculating a sales price variance rather than a sales mix variance. 4. Calculating a sales volume variance rather than a sales quantity variance. The Chartered Institute of Management Accountants 2014 Page 20
Part (c) 1. Confusing the sales mix variance with a materials mix variance. 2. Discussing a sales price variance. 3. Discussing information that could be obtained from a sales volume variance. The Chartered Institute of Management Accountants 2014 Page 21
Question 4 (a) (b) Evaluate whether QR should go ahead with the investment. You should use net present value as the basis of your evaluation. Your workings should be rounded to the nearest $ million. (13 marks) Explain why discounted cash flow techniques should be used when evaluating a long-term investment project. (6 marks) (c) Explain the benefits of carrying out a post completion audit of a long-term investment project. (6 marks) (Total for Question Four = 25 marks) Rationale Part (a) assesses learning outcomes C1(b) apply the principles of relevant cash flow analysis to long-run projects that continue for several years and C2(a) evaluate project proposals using the techniques of investment appraisal. It examines candidates ability to identify the relevant costs of a project and then apply discounted cash flow analysis to calculate the net present value of the project. Part (b) assesses learning outcome C1(e) explain the financial consequences of dealing with long-run projects, in particular the importance of accounting for the time value of money. It examines candidates ability to explain why discounted cash flow techniques should be used when evaluating a long-term investment project. Part (c) assesses learning outcome C1(a) explain the processes involved in making long-term decisions. It examines candidates ability to explain the benefits of carrying out a post-completion audit of a long-term investment project. Suggested Approach In part (a) candidates should firstly calculate the number of units sold and the contribution that would be earned from the product in each year. They should then deduct the fixed costs after adjusting for depreciation. The tax depreciation and tax payments should then be calculated. The total cost of the investment and the residual value should then be added to the net cash flows. The net cash flows after tax should then be discounted at the discount rate of 12% to calculate the net present value of the project. In part (b) candidates should clearly explain why it is necessary to adjust cash flows to account for the time value of money. In part (c) candidates should clearly explain the potential benefits to a company of carrying out a post-completion audit of a long-term investment project. Marking Guide Part (a) Depreciation Fixed costs excluding depreciation Contribution Years 1-5 Advertising costs Tax depreciation Tax payments Initial investment/residual value Working capital Present value of cash flows Marks 2 marks ½ mark 2 marks 2 marks The Chartered Institute of Management Accountants 2014 Page 22
Net present value of cash flows Investment decision Part (b) Explanation of why discounted cash flow techniques are used in evaluating long term investment projects Part (c) Explanation of the benefits of carrying out a post completion audit Maximum marks awarded ½ mark per valid point per valid point 25 marks Examiner s comments The performance on part a) was very good with most candidates able to do enough to achieve at least a pass in this part of the question. In part b) many candidates referred to the time value of money and could explain it in general terms. However they were then unable to expand on the concept in relation to the discounted cash flow techniques. Part c) was reasonably well answered with most candidates stating that the audit would provide information for future projects and that it would be a useful learning exercise. Most candidates however discussed the audit's use in terms of the future and did not appear to realise that the information could be used to make changes to a current project or to take a decision to abandon a project. Some of the better answers also discussed the information in terms of motivating staff and for staff appraisals. Common errors Part (a) 1. Incorrect calculation of depreciation. 2. Failure to exclude depreciation from fixed costs. 3. Failure to multiply by the market share. 4. Failure to multiply by the market growth rate. 5. Treating the $25m sunk costs as a relevant cost. 6. Treating the tax depreciation figures as a cash flow. 7. Failure to calculate the correct balancing allowance for Year 5. 8. Failure to extend the tax payments into Year 6. 9. Failure to state a decision about the investment. 10. Including the residual value in Year 6. 11. Including the working capital recovery in Year 6. Part (b) 1. Failure to answer the question asked. 2. Lack of sufficient detail in answers given. 3. Very general answers given. Part (c) 1. Failure to answer the question asked. 2. Lack of sufficient detail in answers given. 3. Very general answers given. The Chartered Institute of Management Accountants 2014 Page 23