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BMAN21040

INTERMEDIATE MANAGEMENT ACCOUNTING

May 2021

SECTION A

Answer BOTH questions from this section (30 marks per question)

Question 1

A firm that designs highly specialized cameras for the manufacture of semiconductor devices is assessing the viability of a new product.   One phase in its development process involves assessing whether a proposed new product meets a required target- cost before its design is finalized and approved for manufacture.

The following estimates have been assembled for the new camera product, which is expected to have an effective sales cycle of only three years:

 

Year 1

Year 2

Year 3

Estimated unit sales:          Anticipated unit sales price:

100 £225,000

200 £200,000

300 £200,000

R&D costs of camera design:

£ 8 million

£8 million

£8 million

Variable   (material   purchase)

cost per unit:

£120,000

£100,000

£90,000

Variable  (processing) cost  per batch:

Units per batch:

£90,000 5

£80,000 8

£80,000 15

Fixed    (production    capacity)

costs:

£5 million

£5 million

£5 million

Fixed (marketing) costs:

Fixed (warehouse) costs:

£1.5 million £0.5 million

£1.5 million £1million

£1.5 million £1.5 million

The firm’s policy is that a new product should realize a target net operating income of ~14% of sales revenue during the three-year period.  It is a target based on past levels of achievement by the firm itself and on benchmarks of performance throughout the industry. In general, failure to meet the target will indicate a need to re-design the product and/or the means of producing and marketing it.

Half of the variable (material purchase) cost per unit relates to generic materials that are commodities bought on world markets, and the remainder to specialized components made by selected suppliers.  All of the variable (processing) cost per batch relates to proprietary manufacturing techniques that are crucial to the effectiveness of the camera product  as judged  by  the  end  customers.    The  fixed  production,  marketing  and warehouse costs comprise shares of the total cost of providing these resources that are attributed to the new product.

REQUIRED:

a.  Establish whether the proposed camera product will meet the required target income of around 14%. You should clearly show all of your workings.                  (15 marks)

b.  Discuss the limitations of a data-driven approach, alone, in the capital budging context.                                                                                                    (15 marks)

(Total 30 marks)

Question 2

ChipCo designs and produces logic devices that are built into smart phones, tablet devices, personal computers, and enterprise servers.   Because it is a very large company with a dominant market share, it expands primarily through seeking ways to increase the total size of the world markets for logic devices.  This involves investing selectively  in  an  ecosystem”  of downstream firms  that  make  software  and  that develop internet and other mobile infrastructures.  It is these kinds of complementary products that may result in an expanding market for ChipCo’s logic devices.

One of the regions in which Chi Co invests is one that it terms South Central Europe. This  is  a  region  comprising  countries  including  Slovenia,  Croatia,  Bosnia   Herzegovina,  Serbia  and  Montenegro,  among  others.    Chip  Co  has  established contact with a set of software companies in these countries, and is now evaluating the feasibility  of  investing  in  some  of  them.    The  idea  is  to  make  minority  equity investments in the software firms to enable them to develop their products more quickly and effectively for local markets, thus boosting sales of ChipCo’s logic devices in the South Central Europe region.

ChipCo envisages a total cash investment in the software firms of US$400 million as of January 1st  2022.  This would be in return for minority shareholdings in the firms. ChipCo’s general policy is to seek to sell the investments to private equity firms or other buyers after a period of about 5 years.  From extensive analysis of the prospects of the individual software firms, ChipCo’s conservative estimate is that its investments in the software firms will be valued at about $450 million as of December 31st 2026. In addition, Chip Co expects to receive dividends on its investments totaling ~$2m annually, received at the end of each year from 2022 to 2026 inclusive.

If the software firms are successful, then a most-likely estimate is that total sales of logic devices in the South Central Europe region will increase so as to yield the following results for ChipCo and its competitors:

Forecast Incremental Volumes & Profitability for All Logic Device Sales:

South Central Europe Market.

For ease of calculation, you may assume that financial numbers in the table arise

at the ends of the relevant years.

 

2022

2023

2024

2025

2026

Volume    increase    (thousands/

units):

~385

~500

~636

~591

~568

Average selling price/unit ($):

$260

$240

$220

$220

$220

 

 

 

 

 

 

Total revenues ($ million):

$~100

$~120

$~140

$~130

$~125

Variable    production    costs    ($

million):

$40

$50

$62

$57

$55

 

 

 

 

 

 

Contribution ($ million):

As % of total revenues:

$60

60%

$70

58%

$78

56%

$73

56%

$70

56%

 

 

 

 

 

 

Fixed  production  +  sales  costs ($m):

$38

$46

$50

$50

$48

 

 

 

 

 

 

Operating income ($ million):

As % of total revenues:

$22

22%

$24

20%

$28

20%

$23

18%

$22

18%

The fixed production and sales costs in the table (above) are allocations based on the costing system of Chip Co.  It is not expected that ChipCo will need to increase its production or distribution capacity to  meet  incremental demand  in  South  Central Europe between 2022 and 2026.  The data for selling prices and variable production costs are expected averages for Chip Co and its competitors in the region.

Chip Co currently holds ~70% of the logic device market in Europe generally, and it is expected that this percentage may decline by roughly one percentage point per year for each year from 2022 to 2028.  By investing in software developers for the South Central Europe region, ChipCo unavoidably helps its competitors insofar as they too may gain in sales of logic devices.  But ChipCo’s rationale, as explained by the CFO, is as follows:

“Quite a few years back, we came to the conclusion that, given our high market share, it wouldn’t do us much good to try to take more market

 

share from our competitors.  Instead, we have found it better to invest to expand the market overall, on the assumption that we can compete to take a sizeable share of that increase.  Of course, our competitors  may gain from our investments to strengthen the overall software       ecosystem, but that’s a price we may pay so long as the net benefit to us is sufficient” .

The cost of capital rate used by Chip Co is 10% per annum and the relevant discount rates are as follows:

Discount Factor at 10% per annum

Years       10%

0.9091

0.8264

0.7513

0.6830

0.6209

REQUIRED:

a)  Compute the Net Present Value of the estimated direct returns from the minority equity investments. Your computations should show clearly how you arrive at your answer.                                                                                                     (7 marks)

And:

b)  Compute the Net Present Value of the combined direct returns from the minority equity investments and the indirect returns of making the investments in software firms. Your computations should show clearly how you arrive at your answer.

(8 marks)

And:

c)  Where individual firms are highly specialized, a need may arise to coordinate the investment  decisions  of  any  one  firm  with  those  of  others  in  a  network  or “ecosystem” .   Discuss why such collaborative development can be expected to arise.                                                                                                        (15 marks)

(Total: 30 Marks)

 

SECTION B

Answer BOTH questions in this section (20 marks per question)

QUESTION 3

Discuss how accounting can help organizations align themselves to environmental, social and economic (ESG) objectives.  Critically explain if and why you favor rules or

principles for environmental reporting.                                                          (20 marks)

QUESTION 4

In  some  advanced  technology  industries,  products  are  developed  collaboratively across networks of organisations. Critically discuss how they may support