Step-by-step explanations of the calculations alongside literature with sources to back up answers provided

Strategic and Financial Decision Making

Task 1

 The directors of Digitech plc need to increase capacity in order to meet demand for a new component (Product X) which is to be used in the manufacture of a new generation of tablet computers. Product X cannot be manufactured on existing machinery. The directors have obtained tenders on two machines which can manufacture Product X. One tender is from a French supplier and the other from a German supplier. Both machines have the same capacity of 60,000 units per year.

The following data applies to the machines:

French Machine

The machine will cost £477,700 and will last for four years, at the end of which time it will have zero scrap value. Maintenance costs will be £20,000 in the first year of operation, increasing by £6,000 per year for each year of operation.

German Machine

The machine will cost £430,000 and will last for four years, at the end on which time it will have zero scrap value. Maintenance costs will be £20,000 in the first year of operation, increasing by £10,000 per year for each year of operation.

Digitech plc expects demand for Product X to be 30,000 units per year in the first year, and to increase by a further 10,000 units per year in each subsequent year. Selling price is expected to be £20.00 per unit and the marginal cost of production is expected to be £15.60 per unit. Incremental fixed production overheads of £20,000 per year will be incurred. Selling price and costs are all in current terms.

The company has forecast the following annual inflation rates relevant to their circumstances:

General rate of inflation in UK                      2.8%

Selling Price of Product X                            4.0%

Marginal cost of production             4.0%

Maintenance Costs                                       5.0%

Fixed production overheads                        6.0%

The investors in Digitech plc expect a real rate of return on investments of 8% and the company has a target Average Accounting Rate of Return of 25%.

Required:    

1. a) Calculate the Net Present Value (NPV) arising out of the incremental cash flows for each machine and recommend whether the company should buy the French or German machine. You should also provide a brief           interpretation of your answer.                                                                                                                                                                                                                                  (15 marks)

1. b) Calculate the Average Accounting Rate of Return for each machine and briefly comment on your findings.

(10 marks)

1. c) Digitech’s Production Manager is heard to say, “Let’s base our decision on the Average Accounting Rate of Return outcome as this measurement is linked to Return on Capital Employed with which we are familiar. I don’t understand the meaning of NPV.”

You should provide a response to the Production Manager which will   recommend a method to use and compare and contrast the two appraisal        methods in question.

(15 marks)

(Total 40 marks)

Task 2

The assistant finance manager of Digitech is interested in your capital investment appraisal calculations and mentions that when she was a student she can remember using the Capital Asset Pricing Module in order to calculate a suitable cost of capital for use in determining an appropriate discount factor. She also remembers that the cost of capital for a corporation relies upon the size of the company’s beta factor.

With this in mind she says to you, “I am rather confused by beta as it seems to be rather random. If I look at the beta for two well-known UK registered organisations such as Severn Trent plc and Easy Jet plc, they are 0.30 and 2.56 respectively (https://uk.finance.yahoo.com/quote/,acccessed 07/07/21). How can it be possible that two such companies can have such different betas?”

You are required to provide a response discussing explicitly why the betas of the two companies (Severn Trent and Easy Jet) may have such different beta factors and considering the implications of this difference. You may wish to also take account of the fact that the current risk-free rate of return is identified as 2.5% and the average return on the market is taken as 12%.

(25 marks)

Task 3

Digitech plc, as a small quoted company, could finance the purchase of the machinery by long term debt or by issuing more equity. Provide a consideration of the practical factors that may make one source of capital more attractive than another to Digitech’s management team.

(20 marks)

Task 4                                                                                                           

As Digitech plc is expanding quite rapidly it is considering future growth strategies. The marketing director favours acquiring a competitor, whereas the CEO says, “it would be far more sensible to grow organically and carefully.”

You are required to prepare a brief report for the management team providing a critical analysis of the above suggested strategies for growth.

(15 marks)

(Total 100 marks)   

Further Information

You are required to present well-structured answers of no more than 3,500 words in total (excluding calculations).

Assignments will be graded according to the following criteria (as well as the generic postgraduate assessment criteria:

• Evidence of critical judgement in selecting, ordering and analysing content in order to present a sound argument.

• The demonstration and understanding of relevant concepts and models.

• The demonstration of insight and originality in responding to the assignment.

• The extent and level of research undertaken and the degree to which this research is appropriately referenced.

All of the usual University regulations will apply with regard to the late submission of work and plagiarism.

Work should be submitted via Turnitin on the SFDM (ACFI5022) BlackBoard site

Hand in date:     20th August 2021

How to succeed in Phil’s assignments!

• Ultimately this depends on to what extent you want to achieve a good grade! Those students who put time and diligence into their assignments are generally rewarded for their efforts.

Important specific points to remember

• Think about the question and the structure of your answer – you need a clearly defined structure which addresses the specific issues of the assignment. Therefore, PLAN you response very carefully before beginning to write. Think to yourself:

• What is the question asking me to do?
• Is what I am writing focussed on the question – is it relevant – or am I just including it because I found it!!?

• Make sure that you read all articles which are referred to in the assignment

• Never write anything in your assignment that you do not understand

• Do not use ‘bullet points’ to any great extent – this tends to preclude analysis and explanation

• Think about presentation

• Contents page
• Page numbers
• Use short sentences
• Use many short paragraphs – a new paragraph for each different idea.
• Do not use too many headings – this tends to prevent the flow of the work
• Where an assignment is divided into parts 1) 2) 3) etc – answer in that format – do not merge answers – it is impossible for the assessor to mark these easily.
• When calculations are involved ALWAYS show full workings

• When referencing
  • NEVER reference to Wikipedia, Investopedia, mbaessays.com, chaeatsrus.com etc – these websites are all unsubstantiated – the material on these can be written by anyone – ALWAYS use academic literature (journal articles, text books etc – these have been refereed by other academics – unless you are looking on reliable websites for data and statistics)
  • If you include a quote in “speech marks” you need to also include the page number from the source as well as the author name and date – no page numbers if there is no quote
  • All the references that appear in the script should appear in your Reference List – it is not a Bibliography
  • The Reference List should be in alphabetical order by author surname (family name)
  • You have has a great deal of training of referencing, therefore, refer to your guidance notes if in doubt.

• Working Practice
  • Discuss with colleagues but type up your work separately.
  • Never give your work to another student in an electronic format – you will be guilty of collusion as well if they use any of it
  • Do not leave your work accessible on a university computer whilst you are not present
  • Never share a file where calculations/spreadsheets are concerned
  • Keep a back-up of your work – computer problems are not a reason for an extension
  • Print the work leaving yourself plenty of time.
  • Never sub-contract your work to a third party – it is generally easy to identify