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Final Exam

ACCT 502

Spring A 2023

Instructions:

This open book examination consists of five problems.  The problems can be worked in any order.  Please show all calculations.  Record your answers in any way in which you wish – on the exam, on a separate sheet of paper, in excel, in word, etc.  You will, however be required to submit the exam as a pdf file.  I will be grading them on a screen, so please keep your answers as much “together” as you can (I won’t easily be able to flip back and forth between pages).  You may use whatever books, notes or computers you wish.  This exam is measuring individual ability – please do NOT discuss it with anyone other than me (Tom Fields).  If you have questions, please email me at [email protected].

There are 11 pages to this exam including the cover.  The suggested time is just that – a suggestion; you may take as long as you like to complete the exam, so long as you submit it before the deadline.

Points Suggested

Points Assigned and Suggested Times Assigned   Times  

Problem I:  Kelton Medical Devices, Inc. 30 30 minutes

Problem II: SCG Consulting 25 20 minutes

Problem III:  Lackawanna Products 20 15 minutes

Problem IV:  Nuevo Banco Comercial 25 25 minutes

Problem V:  Montpelier Co. 20 30 minutes

Review           60 minutes 

120   180 minutes

Problem I:  Kelton Medical Devices, Inc.

Kelton Medical Devices produces a wide range of medical products which are sold to hospitals throughout the United States and Canada.  Due to market and regulatory differences, each of the seven main product lines has its own separate sales team, headed by a divisional sales manager.     Both the sales manager and the rest of the sales team are paid primarily through a fixed salary, though both also participate in a small commission scheme, based on a percentage of the gross margin of products sold (by the individual sales people and, for the sales manager, by the entire sales team).

Once per quarter, Kelton’s corporate strategy group creates sales targets for each division.  While there is some input from the sales manager to the strategy group, these targets are primarily based on the strategy group’s assessment of changes in the market for medical products, incorporating actions by customers, competitors and regulators.

At the end of each quarter, the seven divisional sales managers are ranked based on their actual sales compared to their target sales, and an all-day meeting is held at corporate in which the divisional sales managers explain their performance for the quarter.  Successful sales managers are praised by top managers, while unsuccessful sales managers are made very aware that they have “let down” the company.  Sales managers who fail to make their targets in three or four quarters of a given year rarely remain at Kelton for long thereafter.

Describe one possible drawback (from Kelton’s perspective) of their current system for motivating divisional sales managers.  What types of control systems could Kelton use to prevent or at least mitigate this problem?  Briefly (two paragraphs) describe and evaluate two different potential solutions to the identified drawback.

Problem II: SCG Consulting

Susan is a project manager at a SCG Consulting, a strategic consulting firm.  In a given year, Susan manages approximately a dozen different teams, each working on a project which might last between two and ten months.  Susan has no particular expertise regarding the projects, her job is to manage the experts on each team.  Specifically, her goal is to ensure that everyone on the team is clear about their role, has the information and support needed to perform that role, and coordinates with other team members to ensure that tasks are completed in the most efficient manner, with no duplication of effort or downtime (as one team member waits for another to complete their portion of the project).

SCG is in the process of designing a new compensation system for all of their employees, including project managers such as Susan.  They have narrowed down the list of possible measures to the following:

Measure 1:  For each project, compute the ratio of the total labor hours taken to complete the job divided by the hours budgeted for the job.  SCG would then average this ratio over the jobs completed during the year by each project manager.

Measure 2:  At the completion of each job, have all team members fill out an evaluation of Susan’s performance.  Each team member will rate Susan, on a scale of one to five, regarding a number of goals.  These range from the very general, such as “The project manager added value to the team”, to the more specific, such as “The project manager made sure that I was always aware of what other team members were working on and how it related to my own tasks” or “The project manager ensured that I always had the support I needed to accomplish my tasks”.  SCG would then compute the average rating over all questions, all team members, and all teams, for each project manager.

Briefly evaluate these two performance measures based on the criteria used in class, and provide a recommendation to SCG as to which measure to use (or if you wish to use both, be specific about how to combine them).  Justify your recommendation.  You should be able to do this in a couple of paragraphs.   

Problem III:  Lackawanna Products

Lackawanna Products is evaluating a major upgrade to its information technology systems.  The chief financial officer (CFO) of Lackawanna has talked to many other companies, and has come to the following conclusions about the project.

It is believed that the value of the upgrade will be $24 million, which for simplicity, we will assume is received one year from today.  Depending on how well implementation goes, the cost implementing the new system will be:

$10 million with probability 40%

$15 million with probability 30%

$25 million with probability 30%

Assume for simplicity that all costs will be incurred immediately if the firm decides to pursue the project.  Lackawanna faces a cost of capital of 20%, and the CFO cannot observe (now or later) the actual cost of implementation.  The firm’s CIO, on the other hand, is already aware of the cost of implementation, but cannot credibly convey this information to the CFO.  If the project is overfunded, the CIO is able to benefit from the additional funding.

Assuming that all participants are risk neutral, and that the CFO can announce a policy of accepting only projects with an expected internal rate of return greater than a give hurdle rate, what hurdle rate will maximize Lackawanna’s expected net present value?  Why is that?  Be sure to explain the economics of your answer, not just the mathematics.  Note: There is actually a range of correct answers to this question.  

Problem IV:  Nuevo Banco Comercial

Nuevo Banco Comercial (NBC) is a Uruguayan retail bank that pays an average interest rate of 5% on deposits (note that you can think of this as the cost of raising funds, at the margin, for NBC).  NBC has recently created a subsidiary in Brazil which is making car loans to Brazilian customers.  The Brazilian subsidiary does not yet have regulatory approval to take deposits, so all funds for the car loans must come from the Uruguayan retail portion of the bank.  To keep things simple (banking is actually slightly more complex than this) assume that for every dollar (or peso or real) that the Brazilian subsidiary loans out, they must borrow one dollar (or peso or real) from the Uruguayan bank.  

The Brazilian subsidiary can make loans at an interest rate of 9%, while the Uruguayan bank earns only 7% on loans that they make (to Uruguayan car buyers).  The Brazilian bank has a marginal tax rate of 20% on pre-tax net income and the Uruguayan bank faces a marginal tax rate of 30% on pre-tax net income.  In addition, the Uruguayan Central Bank charges a 1% financial levy on any money loaned to foreign entities (and NBC’s Brazilian subsidiary counts as a foreign entity).  The financial levy is paid by the lending bank, is imposed before any income tax and is tax deductible.

Hint:  Based on the above information, and in the absence of taxes or financial levies, loaning Uruguayan deposits to Brazilian car buyers earns NBC a net profit of 4% (9% received from the Brazilian car buyers less the 5% paid to Uruguayan depositors).

1.  If the transfer price between the two divisions of NBC is 8%, that is if the Brazilian subsidiary pays 8% interest on any funds borrowed from the Uruguayan retail bank, what is the net after-tax profit from the transaction, for NBC as a whole (expressed as a percentage)?

2.  Assume that international agreements between the two countries require that the transfer price between the two divisions must be no lower than 6% and no higher than 9% (i.e., so that neither division can operate at a loss).  If NBC is a centralized organization, what transfer price maximizes NBC’s net, after-tax profit, and what is that profit (expressed as a percentage)?

3.  If NBC is a decentralized organization (i.e., each division has the right to refuse to cooperate with the other division), will your answer in 2 be feasible?  Why or why not?

4.  Assume NBC is a decentralized organization, and wants to set a transfer price which meets the government regulations (see question 2), and which is goal congruent (i.e., everyone agrees to transfer funds from Uruguay to Brazil).  What transfer price should NBC set, within these constraints, to maximize their net, after-tax profit?  What is the cost of goal congruence (expressed as a percentage)?

Problem V:  Montpelier Co.

Montpelier Co. produces hand-made wood furniture.  It sells its products on-line and offers varying amounts of customization on different products.  Montpelier has four main products, tables, chairs, bookshelves and china cabinets.  Information about the products is provided on the next page.  Montpelier has historically been able to charge high prices (and earn high margins) because their partially customizable and high quality products were clearly superior to mass produced furniture.  However, over time, their competitors have increased the quality and range of options, which has put serious pressure on Montpelier’s prices.

In response to this, Montpelier has decided to move their products further up-market.  By improving designs, improving quality and offering a greater degree of customizability in their products, they hope to be able to charge higher prices for their products without losing volume, thus increasing profitability.  Montpelier recognizes that in order to do this, they will have to improve the quality of their workforce, by changing their hiring practices, paying higher wages, and increasing employee training.

See the following page for a number of performance measures that Montpelier has collected, covering the four product lines, both before and after implementation of the new strategy.

1.   Draw a simple strategy map for Montpelier, using, as much as possible, goals that can be measured by the metrics provided on the following page.  Your strategy map should cover all four of the standard perspectives, and should focus on the metrics that would help to measure Montpelier’s new strategy.  Briefly discuss the logic behind your strategy map.  For each objective on the strategy map, suggest one performance measure which you might use to measure it (most, if not all, should come from the list on the following page).

(a) Total cost of producing one unit of output

(b) Based on on-line surveys of customers (1 = very unsatisfied; 10 = very satisfied)

(c) Average number of customized requests per order

(d) Average design complexity of uncustomized products.  This number is determined internally by the head of design for each product (1 = very simple; 10 = very complex)

(e) Based on surveys of employees (1 = very unhappy; 10 = very happy)

(f) Proportion of new hires with prior experience in custom wood working or design

(g) Revenue equals sales price times sales volume

(h) Average number of training hours per employee during the month

2. By comparing this year’s numbers (with the new strategy) to last year’s numbers, what can you conclude about the effectiveness of Montpelier’s new strategy?  Be as specific as you can as to what part or parts of the strategy are effective or ineffective.  With only four products, you should be able to do this without any formal statistics.