Scenario focused on evaluating and justifying the choice between two potential investment projects that a company wants to undertake, using the adjusted present value method and duration.

Part (a) required discussion why a company may prefer to use the adjusted present value (APV) method, rather than the net present value (NPV) method.

This question part was not done as well as expected.

A number of candidates described how the APV method is carried out, not why it is preferred to the NPV method.

There is also the misconception by some candidates that the cost of debt is not accounted for under the NPV method.

Candidates did well when they discussed that the APV method separates out investment from financing cash flows and applies a specific discount rate to the appropriate cash flow to determine the value added or destroyed, whereas the NPV method uses a single rate (the weighted average cost of capital) to discount all the cash flows arising from the potential investment project.

Part (b) (i) required estimate of minimum amount of debt borrowing after allowing for the proceeds from a sale of a factory located abroad.

This part was done well, with the majority of candidates scoring high marks.

However, errors include borrowing the full amount instead of an amount sufficient to allow for the expected sale receipt, and using wrong exchange rate in converting.

Candidates should understand that financial institutions invariably offer a customer an exchange rate which ensures the customer is worse off when converting a foreign currency receivable or payable.

Part (b) (ii) estimate two potential investment projects’ APV and their duration.

Many candidates did well on calculating the projects’ APV and scored high marks.

In determining base case NPV, surprising number of candidates did not compound the inflation rates of sales revenues and production costs correctly. Many candidates did not read carefully the question which allowed tax relief on operating losses to be claimed in the same year against other profits. Instead their answers mistakenly carried forward operating loss to be claimed in future years.

It was surprising to see many candidates unable to calculate the balancing allowance.

The balancing allowance should take into account any disposal value at end of investment period.

Equally surprising was how often candidates’ timings and amount of incremental working capital cash flows were incorrect.

Unless stated otherwise, all cash flows are assumed to occur at the end of the respective time periods.

Therefore, the working capital required at the start of the first year, should be shown under Year 0 column (i.e the end of Year 0 is effectively the start of Year 1), not under Year 1 column (which is the end of Year 1).

The amount of incremental working capital for each year is the increase or decrease in working capital, not the difference between the increase or decrease in working capital.

Other common errors include using the same spot exchange rate every year to convert the foreign component cost into the home currency; not compounding inflation rates for each successive year (for example, a 10% yearly inflation rate would be 10% in year 1 and 21% in year 2); or incorrectly applying the interest rate differentials when forecasting exchange rates. Some candidates showed figures on their cash flow statements without supporting workings, making it difficult to award marks if markers cannot determine where the figures came from.

In determining the project’s APV, many candidates correctly calculated the financing side effects or were given OFR marks based on the method applied. Some candidates mistakenly discounted the financing cash flows using the all equity cost of capital, instead of using the company’s normal borrowing rate.

Determining the project’s duration was done well by most candidates. However, a number of candidates erroneously used the project’s cost instead of its total present value as the denominator in calculating the project’s duration.

Part (b) (iii), required to evaluate and justify choice between the two potential investment projects with a discussion of the assumptions made.

This part of the question was done well by candidates who articulated their arguments with reference to their calculations.

However, very few marks were earned when evaluations did not go beyond merely restatements of the calculation results.

Some candidates however, did not choose one of the two potential projects, which was required in their discussion.

The duration concept was mistakenly discussed as the payback technique by some candidates.

A significant number of candidates did not provide an evaluation as well as a discussion of the set of assumptions made, resulting in scoring low marks.

Candidates who write a list of assumptions without discussing whether they are reasonable or valid, earn very few marks as they did not address this question requirement.

Professional marks in part (b) were awarded for the format, structure and presentation of the report. While many candidates presented their answers in a report format as required thereby gaining the majority or all the professional marks, a significant minority of candidates did not address this requirement fully or not at all. These relatively easy marks to obtain could make the difference between a pass or a fail for some candidates.

Part (c) required to discuss why a company may be exposed to economic risk and how it may be managed.

This part of the question was poorly attempted by most candidates.

Often, candidates did not seem to understand what economic risk (economic exposure) is and were unable to provide a clear definition.

Many candidates misunderstood economic risk to be caused only by interest rate changes when it is the impact on a company’s cash flows caused by a set of long-term macroeconomic factors that can produce a permanent shift in parity conditions (including interest rates).

Most candidates did not recognize this long-term dimension and the problems of managing it appropriately.

Instead they incorrectly focused on managing it using short-term hedging techniques.

In part (d), candidates were required to discuss how the risks categorized may be managed.

This part of the question was generally not done well.

Candidates often did not discuss beyond the TARA definitions and few candidates suggested practical measures other than insurance.

Some candidates mixed up the TARA model, others made vague suggestions on how to manage each risk.

A significant number of candidates suggested risks that were not severe and not frequent should be ignored, but this is not the same as accepting these risks.

Some candidates misinterpreted the question requirement and mistakenly described different types of risks such as transaction, foreign exchange or interest rate risks.

This question required to assess how characteristics of a service business may create problems in the performance measurement and management of quality of service and resource utilisation and, to use the Fitzgerald and Moon building block model to evaluate whether a proposed reward scheme would encourage set standards to be achieved.nPart a) worth 10 marksu00a0tested candidatesu2019 knowledge on the specifics of the applicability of intangibility, heterogeneity, perishability and simultaneity in relation to organisation which provided cosmetic procedures to customers.nMost candidates could offer definitions, with an example appropriate to the scenario, of the terms, though it was also clear that some candidates had not undertaken any revision in this area and were unclear as to any of the meanings of the characteristics.nMost candidates narrowly failed this part of the question.nOther candidates erred in assuming that a term such as heterogeneity related to the different types of cosmetic procedure the company undertook, rather than the fact that no two procedures are exactly the same.nMost candidates did not address the main demands of question with regard to discussing quality of service and resource utilisation. Instead of discussing the implications with regard to quality of how unlikely the procedures would be performed to exactly the same standard on different occasions, candidates who correctly defined heterogeneity tended to only indicate that this state existed and then moved on to defining the next characteristic.nThere was also little discussion or analysis of resource utilisation, which would have been particularly appropriate to perishability when there is unpredictable demand.nCandidates tended to indicate that the organisation could not keep inventory but did not address the problems of having resources available when there is increased demand.nCandidates also repeated themselves in this question to significant extent, perhaps because they did not develop analysis to level required. Comments would end, in discussion of each of the characteristics, with observations on how it was very hard to have a consistent standard and how no two procedures were the same. Whereas such comments are certainly relevant, the repetition of them throughout the response should have acted as a prompt to candidates that further analysis was required.n

Part b) worth 15 marks tested applicability of the rewards part of the Fitzgerald & Moon building block model.nMost candidates scored less than half marks on this part.nThis question provided a very clear example as to why candidates must address the specifics of the question asked. The focus of the question was the reward system, not the dimensions and standards. nHowever, many candidates discussed the applicability of the dimensions and the standards, areas which it was very clear were not part of the requirement, as well as the rewards. Such answers were doubly disadvantaged as valuable time was wasted discussing areas that were not asked about and candidates were inevitably left with less time left to spend addressing the requirement of the question.nThis is something that can be learned as exam technique, perhaps through looking at past examination questions with model solutions.nThis approach tended to mean that most answers did not address the rewards in the depth that was required. For example, candidates might highlight that being rewarded on net profit was potentially unfair to the staff, as it contained factors outside of their control but candidates then ended not to evaluate what these factors were or point to the relevant areas detailed in the scenario.nConcerning, also, was that a significant minority of candidates were not aware of the three areas of controllability, motivation and clarity that the building block model highlights are necessary for the reward system to operate effectively.nPerhaps of more significance with regard to responses lacking the necessary depth, most candidates did not address the potential conflict between, and the effect on behaviour of, the three measures. In a desire to increase the number of customers seen per day), for example, there must be a significant risk of a fall in quality of the service provided and a resultant fall in profitability. The desire to increase net profit may also lead to staff to rush the procedure and affect the quality of the provision and reputation of the company.nThese are the kind of key examples of conflict that the examination team hoped that candidates, using the building block model framework, would refer to and discuss but such a level of analysis was not very noticeable.n

Scenario focused on evaluating whether a clothing retailer should change its budgeting system to an activity based one and then to complete some figure work for an activity based budget, offering an explanation for any variances.

Consideration of advantages & disadvantages of both current system (incremental) and activity based budgeting (ABB) before offering a justified conclusion as to what company should do

worth 13 marks

Candidates generally performed well in this part, if not in all parts of the evaluation.

Candidates would rarely undertake all of these requirements: some, for example, would focus exclusively on ABB and not refer in any detail or level of analysis to the current system whereas others might suggest disadvantages of the current system without explaining the advantages.

It was evident from the scenario that advantages must have existed as the company had been successful over the 18 years it had used the current budget method.

Most frequent of all, however, was the lack of any conclusion or, alternatively, the suggestion of a conclusion the company should adopt ABB, for example, without any justification offered.

This highlights an area where candidates should be more prepared. The use of the word  evaluate , as has been highlighted in previous Examiner Reports for this examination, means that candidates should assess the strengths and weaknesses of the arguments that arise, in relation to the scenario that is detailed, before coming to a justified conclusion as to what the company should do. Seen in that light, this should have been a question where most candidates were scoring at least ten marks.

Both budgeting methods would have been well known to from Performance Management and the issues that arose from them were very clear from the scenario.

One other area where candidates did not score as well was in offering definitions of terms such as incremental budgeting and, in particular, on ABB without directing the comments that they made towards answering the questions requirement. It is always worthwhile offering a very brief definition of any technique or technical term to demonstrate comprehension but candidates should be aware that such comments are not worthy of many, if any, marks and that it is evaluation of those techniques with regard to the specifics of the scenario that the examining team wish to see.nCandidates also tended to bring in other techniques that were not relevant to requirement here and such practice is generally to be avoided as examining team has focused candidatesu2019 attention on specific areas that they wish to examine.nIn this part of the question, for example, candidates frequently commented on zero-based budgeting (ZBB) or rolling budgeting. An analysis of such techniques may have been relevant had the question requirement been more open u2013 u201cevaluate whether the company should change its current budgeting systemu201d, but the requirement in this case was to evaluate a prospective change from the current system to ABB.nIn terms of examination technique, candidates should focus their responses on what they have specifically been asked to address and, in this case, discussion of any other budgeting technique is irrelevant and represents a waste of time which candidates could have deployed better elsewhere.n

Part b) worth 12 marksnIt was not well done with many candidates not undertaking it at all.nThose candidates that did undertake it tended to score most of the calculation marks.nCandidates who did not score well did not appear to realise that they had to work out how many manual workers were needed to be employed by the company. It was perhaps an inability to calculate this figure that confused some candidates as the rest of the calculations, as with the one above, were straightforward.nMost candidates gained comment marks for the insights they offered even if their initial calculations were incorrect.nCandidates also tended to err with regard to the heating and lighting costs in this part, not realising that the proposal for an increase in cost in an environment of zero inflation should not be accepted in an activity based budget. This was a key part of demonstrating the difference between the inefficiencies that the traditional system would allow to be carried forward from year to year and the new system which required justification for the figures used.n