5BUSS001W: BUSINESS DECISION MAKING: EXAMINATION PAPER SEMESTER ONE JANUARY 2019: All Solutions

SECTION A

Answer all THREE questions in this section.

Question 1

Zenith Sporting Goods Company (ZSGC) is trying to decide which of four possible locations it should select for its new ‘mega-store’; the choice is between Aldershot, Brighton, Canterbury and Dover. It has asked you, as one of new business analysts, to undertake a multi-criteria analysis (MCA).  The company has identified three key criteria: Average Incomes, Transport Links and Investment Cost. You have used a range of sources to help determine the weighting given to each criterion, together with the rating assigned to each option (where 5 indicates the best and 1 the worst). The information that have provided is summarised in the decision matrix, below:

Location

Average Incomes

(Weight = 0.35)

Score

Transport Links

(Weight = 0.35)

Score

Investment Cost

(Weight = 0.3)

Score

Aldershot

2

4

4

Brighton

5

1

2

Canterbury

4

2

1

Dover

2

3

3

Required:

a)            Copy the decision matrix above. Use a MCA to advise ZSGC on the location it should choose, based on the information provided.

Location

Average Incomes

(Weight = 0.35)

Score

Transport Links

(Weight = 0.35)

Score

Investment Cost

(Weight = 0.3)

Score

Weighted score

Aldershot

2*0.35

4*0.35

4*0.3

3.3*

Brighton

5*0.35

1*0.35

2*0.3

2.7

Canterbury

4*0.35

2*0.35

1*0.3

2.4

Dover

2*0.35

3*0.35

3*0.3

2.65

 Aldershot is the preferred location. Up to 6 marks for workings; 2 marks for correct choice.  (8 marks)

b)           Give two limitations of multi-criteria analysis as a decision-making technique.

 (2 marks)

                                                                                                                        (10 marks)

Question 2

ZSGC is considering two possible marketing campaigns to increase company turnover (celebrity endorsement or social media adverts). Celebrity endorsement would cost £100,000 (whether the company decides to go with Lewis Hamilton or Johanna Konta), while social media adverts would cost the company £50,000. The decision tree, below, sets out the probabilities and payoffs (profit contribution in £000s) associated with the two marketing options under conditions of high and low growth, but it is incomplete:

Required:

Copy and complete the decision tree (shown over page) by adding any missing elements. Use it to advise ZSGC which option to choose, assuming the company wishes to maximize expected profits from the marketing campaigns.

                                                                                                                        (10 marks)

Question 3

The management team at ZSGC has been offered a new credit control system and would like you to determine whether it will generate an accounting rate of return (ARR) that exceeds the company’s benchmark of 25%.  The system costs £180,000 and has a 10-year life. The system is expected to generate incremental revenues of £120,000 and will have incremental expenses of £66,000 including depreciation.

Required:

a)   Calculate the accounting rate of return (ARR) on the investment project.

 (8 marks)

b) For the benefit of the ZSGC management team highlight two limitations of ARR as an investment appraisal technique.

 (2 marks)

                                                                                                                        (10 marks)

Section B starts on the next page

SECTION B

Answer only TWO questions from this section.

Question 4

ZSGC has long believed that demand for its sporting goods is sensitive to the overall weather conditions in any year. In 2018, for instance, the hot, dry spring and summer weather in the UK boosted sales of water sports wear and equipment, while reducing sales of its hiking gear. The market research consultancy hired by ZSGC has produced forecasts of sales of four of the company’s best-selling products over the next year, based on three alternative weather forecasts for 2019 (relative to long term average conditions). It has summarised these as: Cool & Wet, Warm & Variable or Hot & Dry. This information is summarised in the following pay-off matrix (with sales volumes in £000s).   

Weather Conditions

Sporting Good

Cool & Wet

Warm & Dry

Hot & Dry

Mountain Bikes

400

330

200

Surfboards

-150

150

550

Tennis racquets

-100

300

450

Running shoes

300

300

300

a)            Explain the difference between a situation of risk and one of uncertainty.

 (3 marks)

b)           What is the preferred option according to each of the following criteria and what attitude to risk do they represent?

c)            Construct a potential regret matrix and use it to determine the best choice of sporting good according to the minimax regret criterion.

         (8 marks)

Opp Loss Matrix

Weather Conditions

Sporting Good

Cool & Wet

Warm & Dry

Hot & Dry

MAX

Mountain Bikes

0

0

350

350

Surfboards

550

180

0

550

Tennis racquets

500

30

100

500

Running shoes

100

30

250

250*

d)           The market research consultancy has obtained weather forecasts from the Meteorological Office for the coming year and using these has estimated the following probabilities for the different weather conditions: Cool & Wet (25%), Warm & Dry (55%), and Hot & Dry (20%). Which sporting good looks the best choice according to the expected monetary value (EMV) criterion?

EV

Weather Conditions

Sporting Good

Cool & Wet (0.25)

Warm & Dry (0.55)

Hot & Dry (0.20)

EV

Mountain Bikes

400*0.25

330*0.55

200*0.2

321.5*

Surfboards

-150

150

550

155

Tennis racquets

-100

300

450

230

Running shoes

300

300

300

300

 (8 marks)

e)            ZSGC has now been contacted by a private weather agency that has offered to provide infallible forecasts of next year’s weather conditions. What is the maximum that ZSGC should be prepared to pay the weather agency for this information (in other words what is the value of perfect information concerning next year’s weather conditions in the UK)?

.

(8 marks)

(Total: 35 marks)

Question 5

ZSGC has so far operated as a merchandising company, but would like to move into the manufacture of some ‘own-brand’ sporting goods in its own workshop. Initially, it has plans to produce a high quality badminton racquet made from lightweight, high performance materials. The fixed costs of operating the workshop for a month amount to £16,000. Each racquet will require £120 of material and will take 2 hours of direct labour at an hourly rate of £20. The racquet will be sold at its stores for £240. The company expects to sell 300 racquets each month.

a)    Calculate the company’s annual profit.

 (6 marks)

b)   Calculate the break-even point both in terms of number of racquets and in terms of sales revenue.

 (6 marks)

c)    Calculate the ‘margin of safety’ as a percentage of the expected level of sales and briefly explain what the ‘margin of safety’ means.

 (5 marks)

d)   Would it be worthwhile to increase the selling price of each racquet by £40 from its current level if it leads to a decrease of 20% in demand for the racquet? Estimate the new annual profit if the price reduction was implemented.

(6 marks)

e)    Use the information from d) to calculate the price elasticity of demand for the racquet and the optimal mark-up (on variable costs).

(6 marks)

f)     What price should the company sell each racquet for if it wishes to make an annual profit of £120,000?

(6 marks)

 (Total: 35 marks)

Question 6

ZSGC would like you to appraise two possible designs for its new workshop, which it has code-named Alpha and Omega. The following table presents the annual net cash flows of these two designs; assume that both would have an eight-year life, at the end of which there would be no scrap value.

Year

Alpha

Omega

£

£

Initial investment

(100,000)

(180,000)

1

10,000

10,000

2

20,000

20,000

3

20,000

20,000

4

30,000

30,000

5

40,000

40,000

6

30,000

50,000

7

30,000

60,000

8

20,000

70,000

a)    Calculate the payback period for each of the designs and suggest which of them (if any) is worthwhile if it is the company’s policy not to take on a project with a payback period longer than 4 years.

 (8 marks)

b)   Briefly discuss the main reasons why, despite its numerous drawbacks, payback still remains a widely used technique for investment appraisal.

 (5 marks) 

c)    Calculate the Net Present Value (NPV) for both Alpha and Omega, using a cost of capital of 9%. Recommend which design should be chosen (if any).

14 marks)

d)   You are told that at a discount rate of 20% the NPV of Alpha is –£12,593 and that of Omega is –£65,900. Using this information calculate the internal rate of return (IRR) of each option and indicate which should be preferred according to this criterion.

                                                                                                                  (8 marks)

 (Total: 35 marks)

Question 7

ZSGC buys the component parts for two types of bicycle, a road bike and a mountain bike, which it them assembles, tests and packs under its own brand name. It has a small facility attached to its mega-store in Slough which it uses for this operation.  The table, below, shows the hours required for each stage of the operation and the total hours available each month.

Road Bike

Mountain Bike

Total hours available

Assembly

2

10

8,000

Testing

4

5

5,500

Packing

6

5

6,000

Profit Contribution

£400/unit

£250/unit

Required:

a)     Formulate as a linear programming problem, where the objective is to maximise the total profit from the two products.

 (6 marks)

b)     Solve the problem graphically to determine the optimal number of Road Bikes and Mountain Bikes to produce each month. Confirm the solution algebraically.

So the optimum solution should be:

X1=250; X2=900

And 7c: £325,000?

(14 marks)

c)     What is the maximum achievable monthly profit?

 (4 marks)

d)     What is meant by the shadow price of a constraint? Using the information provided in the Excel Sensitivity Report shown below, advise ZSGC on the benefits to be gained from increasing the hours available at each stage (Assembly, Testing and Packing).

 (5 marks)

Microsoft Excel Sensitivity Report

Adjustable Cells

Objective

Allowable

Allowable

Cell

Name

Coefficient

Increase

Decrease

$D$5

Quantity produced Road Bike

400

100

200

$E$5

Quantity produced Mountain

250

250

50

Constraints

Shadow

Constraint

Allowable

Allowable

Cell

Name

Price

R.H. Side

Increase

Decrease

$C$8

Assembly Amount used

0

8000

Infinity

1500

$C$9

Testing Amount used

1.67

5500

500

1500

$C$10

Packing Amount used

5.56

6000

2250

900

e)            Briefly explain how Scenario Analysis and the Monte Carlo Simulation technique differ from Sensitivity Analysis. How could they could be helpful to ZSGC when dealing with risky decisions?

 (6 marks)

                                                                                                            (Total: 35 marks)

End of Examination

Present Value of £1

Period

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

(after n years)

1

0.9901

0.9804

0.9709

0.9615

0.9524

0.9434

0.9346

0.9259

0.9174

0.9091

2

0.9803

0.9612

0.9426

0.9246

0.9070

0.8900

0.8734

0.8573

0.8417

0.8264

3

0.9706

0.9423

0.9151

0.8890

0.8638

0.8396

0.8163

0.7938

0.7722

0.7513

4

0.9610

0.9238

0.8885

0.8548

0.8227

0.7921

0.7629

0.7350

0.7084

0.6830

5

0.9515

0.9057

0.8626

0.8219

0.7835

0.7473

0.7130

0.6806

0.6499

0.6209

6

0.9420

0.8880

0.8375

0.7903

0.7462

0.7050

0.6663

0.6302

0.5963

0.5645

7

0.9327

0.8706

0.8131

0.7599

0.7107

0.6651

0.6227

0.5835

0.5470

0.5132

8

0.9235

0.8535

0.7894

0.7307

0.6768

0.6274

0.5820

0.5403

0.5019

0.4665

9

0.9143

0.8368

0.7664

0.7026

0.6446

0.5919

0.5439

0.5002

0.4604

0.4241

10

0.9053

0.8203

0.7441

0.6756

0.6139

0.5584

0.5083

0.4632

0.4224

0.3855

11

0.8963

0.8043

0.7224

0.6496

0.5847

0.5268

0.4751

0.4289

0.3875

0.3505

12

0.8874

0.7885

0.7014

0.6246

0.5568

0.4970

0.4440

0.3971

0.3555

0.3186

13

0.8787

0.7730

0.6810

0.6006

0.5303

0.4688

0.4150

0.3677

0.3262

0.2897

14

0.8700

0.7579

0.6611

0.5775

0.5051

0.4423

0.3878

0.3405

0.2992

0.2633

15

0.8613

0.7430

0.6419

0.5553

0.4810

0.4173

0.3624

0.3152

0.2745

0.2394

16

0.8528

0.7284

0.6232

0.5339

0.4581

0.3936

0.3387

0.2919

0.2519

0.2176

17

0.8444

0.7142

0.6050

0.5134

0.4363

0.3714

0.3166

0.2703

0.2311

0.1978

18

0.8360

0.7002

0.5874

0.4936

0.4155

0.3503

0.2959

0.2502

0.2120

0.1799

19

0.8277

0.6864

0.5703

0.4746

0.3957

0.3305

0.2765

0.2317

0.1945

0.1635

20

0.8195

0.6730

0.5537

0.4564

0.3769

0.3118

0.2584

0.2145

0.1784

0.1486

21

0.8114

0.6598

0.5375

0.4388

0.3589

0.2942

0.2415

0.1987

0.1637

0.1351