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T4 – Part B Case Study Examination

Wednesday 27 August 2014

Instructions to candidates

You are allowed three hours to answer this question paper.

You are allowed 20 minutes reading time before the examination begins during which you should read the question paper and, if you wish, make annotations on the question paper. However, you will not be allowed, under any circumstances, to begin using your computer to produce your answer or to use your calculator during the reading time.

This booklet contains the examination question and both the pre-seen and unseen elements of the case material.

Answer the question on page 19, which is detachable for ease of reference. The Case Study Assessment Criteria, which your script will be marked against, is included on page 19.

Maths Tables and Formulae are provided on pages 27 to 30.

Your computer will contain two blank files – a Word and an Excel file. Please ensure that you check that the file names for these two documents correspond with your candidate number.

Contents of this booklet:

Page

G

Pre-seen material – The EL Car

2 - 12

Pre-seen Appendices 13 - 18

Question Requirement 19

Case Study Assessment Criteria

19

Unseen Material 21 - 25

Maths Tables and Formulae 27 - 30

September 2014 2 T4 Part B Case Study

The EL Car Company (EL)

The EL Car Company (EL) The focus of this case is the EL Car Company (EL) which is involved in the design, development, manufacture, marketing, and selling of cars. EL’s head office is located in City P of Country X which lies in Asia. When it was created in the late 1940’s, EL found itself operating in a war ravaged country. The economy of Country X was still primarily agricultural and its industrial base was virtually non-existent. EL’s initial business was based on the purchase, renovation and sale of damaged jeeps and light trucks abandoned in Country X at the end of World War Two. Parts used by EL in the renovation process had to be sourced from the second hand market, hand crafted from metallic debris left by troops during the war or imported at considerable expense. Knowledge of renovation and manufacture was gained by trial and error and by the use of the most elementary kind of reverse engineering. In short EL lacked almost every resource except that of cheap labour, abandoned war vehicles and local ingenuity. Role of government Fortunately, EL like other manufacturing firms benefitted from the infant industry status that Country X gave to selected industries to assist in the country’s industrialisation programme. Under this programme, the Government of Country X prevented the importation of many manufactured goods until its domestic firms were sufficiently strong to compete with potential new entrants from foreign multinationals. It also prevented the acquisition of its fledgling manufacturing companies by foreign investors but allowed a few joint ventures that enabled companies like EL to gain access to required technical knowledge. The Government also offered subsidised loans to encourage exports, access to foreign currency and invested heavily in Country X’s education system to provide engineers and other workers with the necessary knowledge and skills to build up the Country’s manufacturing industries. Growth of EL With the decline in the number of ex-military vehicles available for renovation during the 1950’s, EL turned its attention to the assembly of cars from imported semi-knock down kits (SKD) supplied by a major foreign manufacturer. SKD describes a car that is imported in a set of parts that have been partly put together, and which are then all assembled for sale to customers. In 1973, under the initiative of Mr A Tan the newly appointed CEO and advice from experienced international specialists in car production, EL began the manufacture of a car designed and produced by EL itself. The car was a basic economy model specially developed and priced for first time buyers in its domestic market. In addition to being modestly priced, the car had the virtue of low running costs and quickly found favour amongst financially constrained motorists in foreign markets. Under the guiding hand of the ambitious Mr Tan, EL began the first stage in the internationalisation of its business by setting up a small number of dealerships in closely adjacent countries. Success in this venture encouraged EL to expand into other foreign markets and its next move was to begin the export of its cars to the affluent markets of the USA and Western Europe. Structure, strategy and leadership Success followed on success and since the late 1970’s EL has established seven full scale manufacturing/assembly plants: one in its home Country X along with its head office and divisional headquarters, two in other parts of Asia, one in North America, one in Eastern Europe, one in Western Europe and one in South America. It has also established a network of suppliers, distributors and dealerships in 152 countries to ensure efficient parts supplies and the distribution, sales and servicing of its cars. Recognising the need for


innovation, EL has also set up R&D facilities. These have been strategically placed to assist in the development of new products and processes around the world. As EL has grown, the structure of the Company has undergone a number of changes. Starting from a single product structure in its early days it developed a multiple product structure as it added new models to its portfolio. As it set up operations in more and more countries around the world however, it found it necessary to adopt a global product structure. This is a structure in which the product divisions are further broken down into geographic regions such as Asia, North America, and Europe and, as far as possible, produce models that suit the requirements of consumers within a particular geographic region. When models produced in one region are demanded in other regions/ countries of the world, arrangements are made to ship them to these other regions. EL’s organisation chart is shown at Appendix 1. This growth and distribution of EL’s divisions across the world is something that EL’s management is proud of, but managing these facilities at a distance is not without its problems. Communication becomes less easy and ensuring the right balance between adequate control on the one hand and an opportunity for participation on the other is a balancing act requiring good leadership. Such growth also requires highly developed IT systems, not only to provide good communication but also to ensure efficient delivery of supplies on a Just in Time basis and to coordinate all the activities involved in the development, design, production, marketing, shipping, selling and distribution of cars in the various regions of its global operations. Any breakdown in IT systems can result in lost production and late delivery of cars to customers with consequential damage to the Company’s brand. Today, EL employs 45,000 people world-wide and is forecast to generate annual revenue of X$ 26 billion in 2014. It has 4% of the world market, and 12% of its own home market. Although not yet amongst the giants of the car manufacturers, it is catching up fast and looks set to achieve the distinction of being amongst the top ten players in car production very soon.

EL’s product range encompasses all major segments from small compact to large/mid-sized sedans, sports utility vehicles (SUV’s) and more recently the premium and luxury segment.

EL’s strategy is perhaps best described as multi-domestic in the sense that it tries to achieve maximum local responsiveness by customising both its product offering and marketing strategy to match different conditions in the various markets in which it operates. Production, marketing and R&D activities have been established in each regional market where business is done. This is in marked contrast to companies like Ford which, with its ‘One Ford’ strategy has adopted what might be called a global strategy. This is a strategy which involves building one product for multiple markets rather than a number of different ones tailored to national or regional tastes. The intention of such a global strategy is to spread development and other costs over one huge global market and so reduce unit costs. The Tan family are the majority shareholders, with 55% of the shares, the remainder being held by several large institutional investors in Country X. EL's corporate governance structure includes a nine-member board of directors, a remuneration committee, an audit committee and an ethics committee. Like all the major car companies, EL has a stated commitment to operate as a socially responsible company and continually demonstrates this commitment by producing cars with low emission levels and by charitable work such as its earthquake relief programmes. The driving force of EL’s successful expansion over the last 40 years has been Mr A Tan, a charismatic and now revered CEO whose forceful leadership and sure-footed strategy has proven its worth. Sadly, during late 2013 Mr A Tan suffered a stroke and this has effectively made him unfit to continue active oversight of the Company. It appears that while Mr A Tan might have been revered, he was also feared and even the most senior managers were reluctant to question his judgement. This authoritarian style of leadership worked well when Mr A Tan was in charge but control from the centre makes for difficulties in a globally dispersed divisional structure unless it is directed by a gifted


leader. The legacy of Mr A Tan’s leadership style does not help in this context, as a culture of authoritarian leadership is difficult to change overnight. His son, Mr B Tan, who has been groomed for the leadership of EL, is a competent vice president of manufacturing but it is generally agreed by ‘insiders’ that he does not have the grasp of the business or the strategic insight that had been possessed by his father and that more generally he is not yet ready for the top job. Despite the misgivings of some senior personnel, however, Mr B Tan has been appointed to the post of CEO. Recognising his own limitations, Mr B Tan is advised by a select group of four executive directors. This is shown as the Advisory Committee for the CEO in Appendix 1. Mr B Tan has the benefit of taking up the reins in a successful business. As the Finance Director’s report (Appendix 3) makes clear, on almost any measure EL is performing well. That said however, Mr B Tan and his advisers have many concerns. The manufacture and sale of cars takes place in a very competitive environment and EL faces many problems. The list of problems is formidable and includes changes in both the competitive and the broader macroeconomic environments. Before considering these challenges however, it is useful to look briefly at EL’s operations. EL’s Operations Supply Cars are produced from many different parts; an estimated 20,000 of them. Some of these are manufactured by the car companies themselves but many parts are bought in from suppliers. EL has developed something of a reputation for its arms-length approach to its parts suppliers and is well known as a tough negotiator. Where possible it sources its car parts from low cost Asian countries but still relies on imported car parts from other sources around the world. More recently, in an attempt to improve its relationships with its most important suppliers it has introduced a programme of Guest Engineering in which engineers from its supplier firms work with EL’s own engineers in joint research projects. That said however, its attitude to its suppliers is an ambiguous one, sometimes shifting from supplier to supplier in an attempt to get the lowest price; at other times developing close cooperative relationships. Technological innovation In recent years EL has demonstrated a determination to be among the big investors in R&D even continuing with an annual investment of 5 per cent of its sales value during recessionary times. This determination has proved to be worthwhile for EL as measured both by the number of patent applications accepted in Country X and in terms of the Company’s growing reputation for innovation. It has also expanded its global R&D network over the years so that by early 2014 the Company was maintaining six R&D centres and associated proving grounds (test facilities) across its main geographic regions. One of the main advantages of these regional R&D facilities is that they are close to customers and this enables EL to develop and adjust their key technologies and products to local market preferences. Another advantage is that it allows EL to share findings across its global regions to the mutual benefit of all.


EL is also making a bid to become one of the recognised champions of the environment and is investing considerable resources into the development of cars which make a minimal addition to greenhouse gas emissions via its development of electric cars. Further research is continuing in the Company’s efforts to maximise the fuel efficiency of its internal combustion engines by downsizing engines and using lighter materials in car assembly. With the growth of electronic systems becoming ever more important as part of car technology, EL has found it expedient to form a number of joint-ventures with high tech electronics companies that specialise in this field. Overall, because of its late entry into the car manufacturing business, EL still lags behind in some technologies but is quickly catching up. New Product Development Managers in the regional centres do their best to respond rapidly to changing customer preferences by speedily revamping the product line-up when customer feedback suggests it is demanded. However sometimes their decisions have been over-ruled by headquarters and this has been known to cause enormous frustration to the regional managers involved. In recent years EL has been making efforts to move up market by developing its luxury sedan cars which are intended to challenge the premium brands of Mercedes, Lexus and BMW. One notable feature of its product development is the move from a sequential to a cross functional approach in which members from various departments work simultaneously on a model and so speed up development and time to market. EL has also sought out and recruited some of Europe’s top designers as a means of ensuring that EL has unique designs. Manufacture EL was a latecomer to the car manufacturing business but has benefitted from the ingenuity and the efforts of the pioneers in the business. The first cars were hand-built in late 19th Century Europe by engineers and craftsmen but it was in the early 20th Century United States that the mass production of cars got under way. The credit for this goes to Henry Ford who used a modified assembly system and standard parts to produce the Model T Ford, a car that was affordable to a large number of American families. Not surprisingly, Ford’s assembly line system was quickly copied across the world; first adopted in the industrialised countries of Europe and Japan, and then later on, in the emerging economies of Asia and other regions of the globe. EL’s cars are manufactured like all other mass-produced cars, on the assembly line. In this process the body of the car moves through a series of work stations with parts progressively added by workers until the car is complete. In other respects however, substantial change has taken place. Many of the more strenuous and dangerous jobs such as welding and painting have been taken over by robots, while hydraulic lifts are used to enable the car body to be lifted or tilted at angles to allow easy access for workers in the fitting of parts. The efficiency of car production has also been improved following a series of innovations by Japanese manufacturers. These include the process of continuous improvement (Kaizen), the development of Just In Time (JIT) that allows the reduction of inventory costs, the use of quality circles to help in the motivation of the workforce, the implementation of continuous quality control with a ‘right first time’ culture and more generally, the elimination of waste of all kinds by lean production methods. The ability of car companies to meet the varying needs and wants of consumers has also been much improved by what is known as platform sharing. In technical terms a platform in the car industry refers


to the under-body and suspension with axles (where the under-body consists of the front floor, under-floor, engine compartment and reinforced frame). It is important to note that the term, ‘platform-sharing’ also refers to a way of working that tries to share as many parts as possible among different models in order to maximise economies of scale. When platform-sharing is combined with advanced and flexible-manufacturing technology, car producers are able to sharply reduce product development and change-over times. In addition, modular design and assembly allow the building of a greater variety of models from one basic set of engineered components. EL has recently improved the capability of its own production system by reducing its number of platforms and at the same time increasing the number of different models per platform. Whereas in 2002 it produced 30 models from 23 platform types, in 2013 it produced 42 models from 7 platform types. The modern assembly line adopted by all the major players including EL is quite a complex operation but the main stages are as follows: The main body panels arrive in the assembly plant from the ‘Press Shop’ where they have been pressed out into the required shape from sheet steel and/or increasingly from lighter materials like aluminium alloys. As the car body moves along the assembly line track, stopping briefly at each work station, components such as the doors, the trunk lid (boot) and the hood (bonnet) are added to the car body. This is followed by painting the body with several coats using robotic spraying machines and baking each coat prior to the application of the next coat.

The ‘general assembly’ stage then follows with the ‘nuts and bolts’ assembly carried out primarily by workers assisted with the use of power tools. General assembly incorporates carpets, windshields, door glass, heating/air conditioning systems, pedals, headliners, lighting, instrument panels, steering columns and seats. EL has adopted the Japanese practice of removing the doors before this assembly stage commences so as to allow ease of access into the car for the assembly process.

The next important stage is the installation of the power-train; this is comprised of the engine with transmission, drive shaft and suspension. The whole power-train is then fitted into the car body by use of hydraulic jacks. The final assembly stage is where the wiring is connected, the fuel tank and radiator installed with connecting hoses, the fluids added, the wheels installed and the bumpers, grill and external lights assembled. The car is then started and tested to check acceleration, transmission function and brakes. The steering alignment is later done on rollers with the engine spinning the wheels. After final inspection, the car is then ready for shipping to dealers and customers.

Encouraged by its success to date EL plans to increase its total productive capacity to take advantage of the opportunities presented by the increasing number of affluent consumers in emerging markets. EL now has a network of production plants in emerging markets including Eastern Europe where labour costs are low and where access to markets is relatively easy. This global network is also advantageous in that it helps minimise EL’s exposure to exchange rate fluctuations.

There is however, an ongoing problem with industrial relations in some of EL’s assembly line plants which from time to time results in strike action and lost production. One of the reasons for this seems to have to do with the way that EL manages its front line staff.

While EL’s production-line system is the same in almost every respect to that of most of its competitors, it does differ significantly in its man-management system from its leading Japanese competitors. Whereas Japanese car manufacturers have made a significant investment in the training of their front line assembly line employees, EL has invested instead in the engineering design of the assembly line system. The result of this is that EL’s assembly line workers have fewer skills and have less discretion than their Japanese counterparts. Another important difference is that while most of


the assembly line employees in competitor companies are represented by independent trade unions, the employees in EL are represented by the Company Union. This form of union representation, which is organised by the Company rather than a separate organisation, is an ongoing source of grievance on the part of the more militant members of the workforce.

Marketing and Sales

The late start of EL into the car manufacturing industry has meant that it has a great deal of catching up to do to establish its brand. In recent years therefore it has spent millions of dollars in high profile advertising on bill boards, TV commercials and sponsorship of major sporting events. To improve its social image, EL has also increased its contribution to good causes such as providing relief support to communities afflicted by natural disasters around the world.

These investments have paid off in the sense that they have enabled EL to move up the world rankings of the best global brands.

Another associated success for EL has been in the world quality rankings surveys in which EL has been highly rated, being surpassed only by the likes of Porsche, Cadillac and Lexus.

EL has also enhanced its dealership facilities and services and extended its warranties so as to put them at the forefront of almost all other car manufacturers in this kind of cover. It has also matched other leading companies by offering several years of free roadside breakdown assistance on all its cars.

This has improved the selling experience significantly with the result that EL has been able to increase its overall market share in the last few years.

Challenges facing EL

As already indicated, EL operates in a fiercely competitive global environment. This presents EL with a range of challenges. Some of these derive from changes within the industry but others stem from challenges in the wider macroeconomic environment.

Excess Capacity and Competition In the competitive environment the most immediate threat comes from its other global competitors. These are an ever-shrinking group as fierce competition has eliminated some of the weaker companies and others have been absorbed in a series of mergers and acquisitions. One of the driving forces behind the ferocity of the competition is that the car industry suffers from excess production capacity. This has been estimated at 20 million units, or the equivalent of the combined manufacturing capacity in all of Western Europe. The reason for the overcapacity has a lot to do with the fact that governments encourage, through use of subsidies, the building of new car assembly plants so as to create employment, and when demand drops, political pressure is often exerted to delay closure. Car companies have been aware of this problem for some time and have attempted to resolve the situation through mergers and alliances. By such alliances, the partners hope to improve their competitiveness in two main ways, firstly by combining to increase their scale of operations and in so doing, bring down unit costs and secondly by benefitting from sharing each other’s core competences and resources. Many of these alliances have been less than successful however. In some cases the culture of the alliance partners has proved incompatible, in others there has been a lack of synergy because the capabilities of the partners turn out not to be complementary. In any event, these mergers have rarely resulted in any significant reduction in overall capacity. That said, however, some mergers have been successful and collaboration in research and development has resulted in some outstandingly good engines that have been installed in a wide range of models.


Another reason why this excess capacity in the industry is unlikely to disappear is that the emerging economies such as China and India are gearing up their capacity to meet demand from their domestic population, and when this is satisfied, the likelihood is that they will use this capacity to export to the rest of the world. The main outcome of the overcapacity in the industry is that manufacturers, in their quest to keep their own capacity utilisation high, produce growing inventories of unsold cars and then seek to solve the problem of excess inventory by the use of sales incentives, such as discounts, high trade-in prices, free upgrades, extended warranties and other means to maintain their market share. Most manufacturers drive their production by long-term sales forecasts, and then hope to sell their cars from dealer stock. This strategy worked when demand exceeded supply but in the current situation in which there is excess supply, it is difficult to see how this strategy can be sustained. Some manufacturers of prestige cars build to order and thus avoid the problem of excess stock. To date however, the volume producers are either unable to build to order within a reasonable time frame or are reluctant to do so because of the coordination and scheduling problems involved. Until now, EL has managed to avoid the more damaging consequences of surplus capacity by virtue of its superior product offering, but how long it can maintain this competitive edge depends on a wide range of factors, some of which may be beyond its control. Competing via Differentiation In the current situation of over-supply, the ability of car companies to differentiate their products from those of others is increasingly important. Differentiation in the car industry tends to be measured in terms of quality, cost/value and speed in the development of new models. How consumers rate these attributes varies across regional markets. For example in Europe with its many old winding roads and streets and relatively short driving distances, manoeuvrability and fuel efficiency are more important than in the North American continent where roads are straighter, driving distances potentially longer and fuel less expensive. In emerging economies, where incomes are generally lower, affordability is a key differentiator. These differences necessarily have implications for demand in terms of car design, size and type of power-trains preferred. That said, the influence of foreign travel, global television coverage, the internet and other global media has resulted in a degree of homogeneity in consumer tastes across the world. In quality terms the most visible means of differentiation, has been and seems likely to continue to be, car design. In the search for new designs, car manufacturers look to the past as well as to the future. In this respect they seek to appeal to customers by offering models that include ‘heritage’ styling that conjures up images of popular models of the past. Currently the rising cost of fuel and the global recession has meant that small cars are in demand in both advanced and emerging economies. In recent years, the demand for sports utility models has also become popular. Another important means of quality differentiation is the building of quality into a car. This can take a measurably quantitative form or be of a more subjective nature. Objective and quantifiable aspects of quality include such things as reliability and durability. These have become key elements as have differences in control, the fit and finish of the vehicle and the amount of noise and vibration when in motion. Important also are more subjective, experiential differences such as that of ‘ride’ and ‘handling’ of a car. Other quality differences are those related to safety, such as the ease of braking and electronic warnings related to the cars’ performance and road handling in external environmental conditions such as the risk of sliding due to icy conditions. These quality features have been much enhanced by developments in the field of electronics such as in Antilock Braking Systems (ABS), Electronic Stability Programmes (ESP) and Electronic Brake Distribution systems (EBD).


Power-trains also represent a basis for differentiation. Following Japanese pioneers in this field, most of the big players have developed or are in the process of developing hybrid gasoline/electric power-trains to propel their cars. At the same time, the producers of high quality cars have adopted a strategy of using supercharging to provide high (500) plus horse power cars for the upper part of their market range. Though few of these are sold, companies producing them gain publicity and prestige which helps boost their sales in the rest of their range. Finally in their attempt to differentiate themselves in terms of quality, some car makers are using customer handling as their unique selling point. Important in this respect are differences in the length of warranty offered and offerings like free roadside assistance. The means of offering the best value for money has become ever more important as a differentiator because fierce competitor forces have driven selling prices down in real terms. The use of the internet has made for widespread access to up-to-date accurate information on retail prices, special deals, trade-in values and financing rates. This has resulted in an increasing number of dealers offering their cars for sale online. There is also a trend to reduce service and maintenance costs by designing power-trains so as to extend the length of time between the services required for the car. Speed of development is also of great value in that it serves to differentiate the car maker which can bring a new model to market quicker than others and thus gain first mover advantage. Savings can be made on the cost of product development because resources are more focused for a shorter time period. Furthermore, being first to market means that such models require fewer incentives to attract buyers and so margins are easier to maintain. Given the importance of competitor information to EL on how it should differentiate its product, it follows that car producers like EL need to pay particular attention to competitor information and analysis.

Changes and challenges in the industry supply chain

The design, development, assembly, marketing and sale of the car is the manufacturer’s area of responsibility but suppliers play a very important part in this industry. In recent years, the car manufacturing supply chain has undergone significant change and these changes present EL with both threats and opportunities.

EL’s supply chain copies in most respects the supply chain of the other major players in the industry. The parts that make up the modern car are purchased from a wide range of suppliers and can account for as much as 60% of the overall cost of the car.

In the car industry these suppliers are traditionally classified into tiers according to their relative importance to the manufacturer assembler. A tier one supplier is the most important member of the supply chain; supplying components directly to the car manufacturer that set up the chain. In a typical supply chain, tier two companies supply companies in tier one; tier three supplies tier two, and so on. Tier one companies are generally the largest or the most technically-capable companies in the supply chain. They have the skills and resources to supply the critical components that the car manufacturer needs and they have established processes for managing suppliers in the tiers below them. Some of these suppliers have evolved into global mega-suppliers. Typically they supply complete functions (systems, sub-assemblies or modules) rather than individual components. A first-tier supplier is increasingly responsible for the assembly of parts into complete units (dashboards, brake-axle-suspension, seats and so on). The ‘aftermarket’ is a further important segment of the car value chain and is the market for replacement parts. Nowadays, there is an international trade in aftermarket products. Firms in this category compete predominantly on price. Access to cheaper raw materials and process engineering skills is important. Innovation is not required because designs are copied from the existing


components, but reverse engineering capability and competence to translate designs into detailed drawings are important. The relationship between the manufacturers and their suppliers has been constantly evolving and in recent years a number of significant changes have taken place which influenced the present relationship between manufacturers and suppliers. With the increasing importance of Just In Time production systems and quality assurance, even simple tasks became more critical for the overall efficiency of the operations. The manufacturer has, therefore, found it necessary to invest in its relationships with suppliers. In particular, some car manufacturers have felt it prudent to develop longer-term relationships with fewer suppliers. The move by manufacturers to new locations as they seek to reduce costs and be closer to customers also produces problems for both the manufacturers and their suppliers. Ideally the sources of supply should be geographically close so as to minimise transportation costs and to allow use of Just In Time delivery as a means of keeping inventory costs down. The problem, for both car manufacturers and suppliers, is that when manufacturers relocate, their established suppliers will need to move also, or both parties will be forced to find new partners. The social relationship between car manufacturers and their suppliers has also varied over the years between the traditional price-driven transactional form of relationship and the kind of close relationships practised most successfully by Japanese car companies. Car manufacturers favouring the traditional price-driven form of relationship have also tended to opt for multiple-sourcing while those preferring close relationships with suppliers have opted for single-sourcing. In the past EL has shifted back and forth between the two approaches: sometimes developing close relationships with its suppliers but at other times adopting a more traditional price-driven relationship with them. Relocation of production The shift of manufacturing plants to low cost locations has been going on for some time. The established players from the USA, Europe and Japan have for many years located their manufacturing plants in the low cost areas of emerging economies. As for manufacturers from the emerging economies, they have less need to seek out low cost labour since they have this in abundance. What they need is access to US and European technology and to their markets. The desire to move into these established markets, however, is not as strong as it used to be because demand for cars in more mature economies seems to be in relative decline. As the population of the USA, Europe and Japan is ageing and older people are less likely to buy cars than younger people, demand has moderated in these markets. It is in the emerging economies that demand is seen to be strongest. As emerging economies industrialise and consumers increase their earnings, there is a large unsatisfied demand for cars. Consumers in the emerging economies want what people in the more mature economies have had for years, a car of their own. The location of production in the car industry is therefore driven mainly by two considerations; the first is the search for low-cost labour and the second for access to markets. Regional concentration has also been favoured as a result of a number of other factors. Related factors driving the shift to regional centres include high exchange rate volatility, rising transport costs and importantly, the growing influence of regional trading blocs. For example, the North American Free Trade Agreement (NAFTA), the European Union (EU), the Association of Southeast Asian Nations (ASEAN) and the Mercado Comun del Cono Sur (MERCOSUR). The advantage for manufacturers within these trading blocs is that they enable companies to sell their products without having to pay the tariffs charged to those without the privilege of membership. The overall effect of such changes is that fewer cars will be imported from outside a trade bloc. In this context however, it is important to note that through the efforts of the World Trade Organisation (WTO) there has been significant trade liberalisation across the world. In the case of Country X, for


instance, as for other Asian countries, the WTO has required it to reduce tariffs on its imports so as to facilitate free trade and thus greater competition in the car market and other markets. For EL, as for its competitors, these global pressures to seek out low cost locations to be close to markets and to have the advantage of trading tariff-free within the world’s trading blocs goes a long way to explaining the current distribution of its manufacturing plants. This whole relocation process, however, brings new problems for car companies. In the case of EL for instance, both the growth and the dispersal of its units across the world has been significant. This means that production, some R&D, marketing and sales may be thousands of miles away from headquarters but this is not a cause for concern given the advantages of modern internet and tele-communications. Monitoring can be carried on around the clock and video communication means that all critical functions can be on view all day, every day. Some things however, are not easily monitored as for example employees’ feelings, beliefs and attitudes. In recent years there have been a number of companies in which employees have felt unable to report bad news to their superiors because they feared that to do so would jeopardise their promotion prospects or even their job. The most prominent cases are where millions of dollars have been wasted in the cost of recalls of faulty cars because of a lack of participation and communication by employees about faults that could have been rectified if appropriate forms of management had been employed. These are only cases that have come to light. It follows that in the nature of things, there are many other problems left unresolved because of the use of inappropriate forms of organisational structure, type of leadership and management style. Industrial Relations The car industry has in the past, and is sometimes today, notorious for its industrial relations problems. One of the main reasons for this is that the production line system, developed by Henry Ford in the early twentieth century, produces an unrelenting pressure for employees to keep up with the speed of the assembly line. Because the car under construction must be fitted with parts in sequence as it passes the worker on the line, it follows that each employee’s task of fitting a particular part must be completed before the car moves on to allow the next worker on the line to add another component to the car. One of the problems in the past has been that management, in an attempt to raise production in such plants, has speeded up the line and this has often produced ‘sweat shop’ conditions in which some workers have been unable to keep pace. In the early days of car production, frequent strikes occurred as workers downed tools or even sabotaged the line because of its excessive speed and the resultant pressure on workers to work ever faster and harder. In most countries trade unions were organised by worker groups to negotiate working conditions with management and to take industrial action if necessary to try to enforce their demands for better working conditions and better wages. As a result, many millions of worker days were lost in this industry because of industrial relations problems. Over time however, conditions in car plants have improved, partly as a result of pressure from trade unions, partly as result of the intervention of government and partly as a result of management farsightedness in coming to appreciate that good treatment of a workforce can pay dividends in workforce cooperation and commitment and ultimately in higher productivity. Unfortunately however, these improvements in working conditions are not universal and industrial conflict continues to surface in car assembly plants across the world as lessons from the past are forgotten. A particular problem in a minority of countries is that the principle of freedom of association and the right to free collective bargaining advocated by the International Labour Organisation (ILO) to promote workers’ interests have not been adopted. In such countries, the workers are not free to join a trade union and in others, management of the car companies themselves form workers’ unions to represent the interests of their workforces. This latter arrangement however, is of only limited value to the workforce in that a company union is not independent of the company and so unable to truly represent workers’ interests. Such arrangements may be a source of disagreement between workers


and management and are in contradiction with the guidelines set out by the ILO and its parent body, the United Nations. Studies have shown that labour unrest in the car industry moved from North America in the 1930s and 1940s, to Western Europe in the 1960s and 1970s, and to developing countries in Latin America and East Asia in the 1990s and beyond. Country X has experienced a number of industrial disputes in its car manufacturing sector in recent years. Environmental challenges and consequences Other challenges facing the car industry that have been evident for some time include environmental pollution. The damage to the environment caused by emissions from the burning of fossil fuels like oil has been identified as a major cause of global warming and legislation to reduce emissions from cars and other vehicles has been passed by several governments to reduce this threat. The threat to the car industry was highlighted in 2013 when pollution levels in several Chinese cities reached such dangerous levels that its government announced stringent limits on car and other vehicle emissions and the value of car company shares around the world fell 5 per cent overnight. The environmental problems combined with the perception that oil reserves are perceived to be running low has forced car companies to search for an alternative form of fuel. The main alternative has been to produce battery powered cars. This technology has been available for some time but has required huge investment in R&D to produce batteries light and powerful enough to enable cars to drive a reasonable distance before having to recharge. Batteries need to be frequently charged and this requires investment in a country’s infrastructure to ensure charging can take place conveniently and economically. To date, the electrically powered cars of this kind are not yet seen as competitors to those powered by petrol or diesel. Hybrid cars that allow the driver to switch from electric power to petrol or diesel power as required are available but are more expensive to produce, and buy, than those powered only by an oil-based fuel. An alternative form of power supply is the use of fuel-cell technology but this is yet in the early stages of development. The problem for car companies, is which technology they should invest in for the future? Should they opt to develop lightweight more efficient petrol or diesel powered engines or should they put their R&D investment into battery technology or go for some compromise solution such as the hybrid car? Such choices involve considerable risks since the investment in one or the other form of technology will be enormously costly if the wrong choice is made. In addition to the concern about depletion of oil reserves and the threat to the environment from the burning of fossil fuels, concerns have also been raised about depletion of the earth’s resources and of potential pollution from waste products produced from the millions of cars scrapped each year. Several governments have introduced legislation in recent years governing the disposal of hazardous wastes and in many countries the recycling of cars and vehicles of all kinds is a billion dollar industry. Financial and economic crisis The financial crisis beginning in late 2007 marked the onset of the deepest financial and economic crisis the world has seen since the Great Depression of the 1930s. Economic growth in the traditional markets of Japan, Europe and the USA ground to a halt and sometimes resulted in negative growth. The car industry was particularly badly hit at this time and sales of cars fell 20 to 40 per cent depending on the type of car involved. In the main producing countries of the USA, Europe and Japan, plants were temporarily closed down and employees laid-off. In the USA, an unprecedented bail-out of some of its largest car manufacturers was undertaken to prevent them going into bankruptcy and in Europe a scrappage system was set up using government subsidies to force older cars off the road and to encourage the purchase of new vehicles. The impact of the economic crisis was felt less in emerging economies but given that the demand for cars is a global one, this necessarily had a negative effect on export sales from countries like Country X to markets in the developed economies.


EL Organisation Chart

Note on organisational structure: EL has a complex global product structure. In this structure the Product Divisions are further broken down into geographical regions such as Asia, North America and Europe and, as far as possible, produce models that suit the requirements of consumers within a particular geographic region. When models produced in one region are demanded in other regions/countries of the world, arrangements are made to ship them to these other regions.

Appendix 1

EL Head Office Board of Directors

Advisory Committee for CEO

R&D

Finance

Quality

Engineering

Marketing & Sales

Production

HR

IT

Product Division F: Sales Marketing R&D Production (Luxury models)

Product Division E: Sales Marketing R&D Production (Premium models)

Product Division D: Sales Marketing R&D Production (Mid and large size sedan models)

Product Division B: Sales Marketing R&D Production (Sports utility models)

Product Division C: Sales Marketing R&D Production (Premium & luxury models)

Product Division A: Sales Marketing R&D Production (Compact & mid-sized sedan models)


Appendix 2

Summary Financial Overview of EL

Extract from Published Statement of Profit or Loss for EL for the year ended 31 December

2013

X$ million

2012

X$ million

Revenue 23,828 21,285

Cost of sales 18,005 16,331

Gross profit 5,823 4,954

Selling Expenses 2,388 2,193

Administrative expenses 1,152 1,035

Profit from operations 2,283 1,726

Finance costs 77 94

Profit before tax 2,206 1,632

Tax 551 408

Profit for the year 1,655 1,224


Statement of Financial Position of EL as at:

31 December 2013 31 December 2012 Note X$ million X$ million Assets Non-current assets

Property, plant and equipment Intangible assets

1 2

4,790 751

4,526 747

5,541 5,273 Current assets Inventories 3 2,081 2,120 Trade and other receivables 1,165 1,286 Cash and cash equivalents 2,572 1,006 5,818 4,412 Total assets 11,359 9,685 Equity and liabilities Ordinary share capital issued 1,054 1,054 Retained earnings 6,082 4,546 Total equity 7,136 5,600

582.6

525.0 Non-current liabilities Loans and borrowings 4 1,209 1,222 Total non-current liabilities 1,209 1,222 Current liabilities Trade and other payables 2,463 2,455 Tax payable 5 551 408

412.3 Total current liabilities 3,014 2,863 Total equity and liabilities 11,359 9,685

Note: 1. Assets are at net values after charging depreciation. 2. Intangibles consist of component development costs and in-house software development. 3. Consists of items held for resale and work in progress. 4. Represents the outstanding balance on bond issues. 5. The corporation tax rate is 25%.

Statement of Changes in Equity For the year ended 31 December 2013

Share capital

Share premium

Retained earnings

Total

X$ million X$ million X$ million X$ million

Balance at 31 December 2012 1,054 - 4,546 5,600

Profit for the year - - 1,655 1,655

Dividends paid - - (119) (119)

Balance at 31 December 2013 1,054 - 6,082 7,136

The share capital consists of 1,054 million shares of X$ 1


Statement of Cash Flows for EL for year ended 31 December 2013

X$ million X$ million Cash flows from operating activities

Profit before tax 2,206 Adjustments Depreciation 370 Finance costs 77 447 Movements in working capital (Increase)/decrease in inventories 39 (Increase)/decrease in trade receivables 121 Increase/(decrease) in trade payables 8 168 Cash generated from operations 2,821 Finance costs (net paid) (77) Tax paid (408) (485) Net cash from operating activities 2,336 Cash flows from investing activities Purchase of non-current assets (638) (638) Cash flows from financing activities Dividend paid (119) Decrease in loans and borrowings (13) (132) (Decrease)/increase in cash and cash equivalents 1,566 Cash and cash equivalents at the beginning of the year 1,006 Cash and cash equivalents at the end of the year 2,572


Appendix 3

Finance Director’s report to the Board for the year ended 31 December 2013

The business has experienced a year of sound results building on the position of previous years.

Revenue has increased by X$ 2,543 million over the previous year to X$ 23,828 million for 2013 a 12% increase on 2012 (X$ 21,285 million)

Direct production costs of X$ 18,005 million represent 75.6% of revenue, an improvement on the 76.7% for 2012 (X$ 16,331 million) which has been achieved by improving throughput volumes in existing facilities and favourable changes in the product mix.

This has produced a gross profit of X$ 5,823 million, which after selling expenses of X$ 2,388 million (2012 X$ 2,193 million) and administrative expenses X$ 1,152 million (2012 X$ 1,035 million) resulted in a profit from operations of X$ 2,283 million an improvement of X$ 557 million over 2012 (X$ 1,726 million). R&D costs are included in selling expenses.

Car sales have increased from a volume of 1,419,000 to 1,537,290, an improvement of 118,290, an increase of 8.3% at an average selling price of X$ 15,500 which is an increase of X$ 500 per car, 3.3% over the average price for 2012.

Financing costs have reduced by X$ 17 million to X$ 77 million in 2013 as a result of reorganisation of bond issues, and are expected to be maintained at around this level for the foreseeable future. The cash position of the company continues to be sound; X$ 2,572 million at the end of the year, and is considered adequate to fulfil the capital investment requirements of the business going forward.

For 2014 revenue is forecast to increase by X$ 2,172 million, slightly over 9% to X$ 26,000 million as global economic and market conditions improve. Profit is expected to improve as increased volumes are produced from existing facilities and sales mix improves. Volumes are forecast to improve to 1,565,834 cars and average selling price per car to improve to X$ 16,605. Forecast profit from operations is predicted to be 10% of revenue, X$ 2,600 million. A detailed profit forecast is attached as Appendix 4.

Further performance improvements and the ability to take advantage of demand improvements, particularly in the home market are dependent on continued investment in new plant and production techniques.


Appendix 4

Forecast Statement of Profit or Loss for EL for the year ended 31 December

Forecast 2014 X$ million

Actual 2013 X$ million

Revenue 26,000 23,828

Cost of sales 19,500 18,005

Gross profit 6,500 5,823

Selling Expenses 2,600 2,388

Administrative expenses 1,300 1,152

Profit from operations 2,600 2,283

Finance costs 80 77

Profit before tax 2,520 2,206

Tax 630 551

Profit for the year 1,890 1,655

The above forecast has been prepared using the following volume and price assumptions. Executive

Range Mid Range Compact

Range Total

Units (Cars) 313,334 940,000 312,500 1,565,834

Average Price (X$) 30,000 15,000 8,000

Sales Value (X$M) 9,400 14,100 2,500 26,000

Average Gross Margin (%) 40 35 10

Total Gross Margin (X$M) 3,760 4,935 250 8,945

Direct Factory Overheads (X$M) 625 1,400 420 2,445

Gross Profit (X$M) 3,135 3,535 (170) 6,500


The EL Car Company (EL) – Unseen material provided on examination day

Additional (unseen) information relating to the case is given on pages 21 to 25. Read all of the additional material before you answer the question.

ANSWER THE FOLLOWING QUESTION

You are the Management Accountant of EL

The Finance Director, has asked you to provide advice and recommendations on the issues facing EL. Question 1 part (a)

Prepare a report that prioritises, analyses and evaluates the issues facing EL and makes appropriate recommendations.

(Total marks for Question 1 part (a) = 90 Marks) Question 1 part (b)

Write an e-mail to the FD explaining the strategic and financial importance to EL of accurately forecasting its future levels of profit. You should include reference to your analysis of Plan 10/10+, including your financial conclusions as to whether it is achievable or not. Your email should clearly set out the points you wish to make in no more than 10 short sentences which you may present as bullet points.

(Total marks for Question 1 part (b) = 10 Marks)

Your script will be marked against the T4 Part B Case Study Assessment Criteria shown below. Assessment Criteria

Criterion Maximum marks

available

Analysis of issues (25 marks)

Technical 5

Application 15

Diversity 5

Strategic choices (35 marks)

Focus 5

Prioritisation 5

Judgement 20

Ethics 5

Recommendations (40 marks)

Logic 30

Integration 5

Ethics 5

Total 100


This page is blank


The EL Car Company (EL) – Unseen material provided on examination day Read this information before you answer the question.

Plan10/10+

Plan 10/10+ is being promoted to shareholders by the Chief Executive Officer (CEO) and involves using the forecast for 2014 as a base for the years 2015 and 2016. It involves increasing the sales revenue by 10% over the 2014 forecast and achieving an operating profit of at least 10% of sales revenue per year. It is not anticipated that the selling price of each model of car will increase over the 2014 selling price. The FD is confident that the actual results for 2014 will turn out as forecast.

It is now predicted that for the trading year 2015 the less fuel efficient executive range of cars will show a decline of 10% in sales volume from forecast, but that the mid-range more fuel efficient family models and small compact models will each increase their sales volumes by 10% over forecast.

Anticipated increases in the price of steel are expected to increase the direct cost of sales on average by 2% per car above its forecast cost, for the executive models and 1% per car above its forecast cost, for the midrange and smaller compact range models.

For the year 2015 it is anticipated that direct factory overheads and selling and administrative expenses will be maintained at their current 2014 forecast levels.

Mr B Tan is soon due to give a press conference to the business community emphasising the success of the Company to date and highlighting plan 10/10+ as the Company’s medium term strategy.

Before holding the press conference and as a result of the recent economic developments Mr B Tan held a meeting with his Advisory Committee to discuss the future performance of the Company. He is concerned that the large institutional investors are demanding an improvement in the short term results, together with increases in sales volumes and profit, whereas the Tan family shareholders are prepared to take a longer term view.

The meeting was inconclusive in that it produced a number of conflicting views as follows:

The Marketing Director proposed a further increase in the advertising and promotion budget for 2015 and beyond, with promotional campaigns emphasising the fuel efficiency of the compact model range.

The Production Director indicated that cost savings may be achieved by using lean production techniques which in the short term would require further investment to achieve long term savings and also said that material cost savings may be possible to offset price increases. In addition he stated that it may be possible to reduce labour costs by situating new production plants in low labour cost areas of the world, but this would require considerable capital investment and take time to implement, incur increased transport costs and result in fewer employees in existing plants.

The R & D director indicated that whilst research on new engine types was well underway, the finished product, a new fuel efficient engine, would not be available for some time, although further investment would speed up development.

The Finance Director (FD) stated that with regard to the product range the smaller cars, although less profitable, were a valuable part of the product mix in promoting the Company’s low carbon image. He went on to suggest that as a control measure, any required investment would have to be funded from cash generated by trading. He advised an urgent revision of the 2015 forecast and proposed to produce an outline report of the relative benefits and disadvantages of the actions proposed by his board colleagues.


The FD has asked you to include in your report:

(i) A revision of the operating profit forecast for 2015, taking the 2014 forecast as a base, revising it for the expected changes in the trading environment as set out above and indicate whether Plan 10/10+ is still achievable.

(ii) A commentary on the various proposals discussed at Mr B Tan’s meeting with his Advisory Committee on the implications of their suggestions for Plan 10/10+ in both the short and long term.

Industrial Relations in Country X

EL’s employees enjoy relatively good working conditions and wages compared with many employees in Country X. However work on the Company’s production line(s) can be very pressurised and stressful. The air conditioning in the manufacturing plant where the assembly of cars is undertaken is satisfactory when it is working but the system frequently breaks down. The underlying cause of these breakdowns is the lack of investment to repair the plant and equipment. The production line supervisor has repeatedly asked senior plant management to repair the air conditioning system but the request has always been turned down on cost grounds. Company policy is that repairs must pay for themselves within a year. The senior plant management insist that this is not possible and that it is not worthwhile to repair the system.

There is an agreement between EL and the trade union representing the work force, relating to working conditions. This includes a clause to the effect that humidity and temperature levels must be within certain set limits otherwise the production line should be temporarily shut down until the temperature and humidity levels return to the specified limits. In Country X there is no legal regulation of temperature and humidity levels within car assembly plants.

The senior plant management are, however, reluctant to close the assembly line down for temporary breakdowns because it makes the achievement of production efficiency targets difficult and reduces the potential bonuses which the plant managers earn under the performance related payment system.

When one man on the assembly line recently fainted with heat exhaustion, his work colleagues stopped work and refused to continue when ordered to do so by a line manager. The manager then threatened them with dismissal at which point they walked off the job. News of the dispute quickly spread through the plant and a mass meeting of workers gathered at the factory gate. Union negotiators quickly came on the scene to try to negotiate a settlement but an unofficial spokesperson for the workforce told them to leave, because they did not actually represent the workers’ interests. The spokesperson went on to remind the workers that the trade union had been set up by EL and its aim was to benefit the Company’s management and shareholders rather than the workforce.

Such stoppages in the plant are known to cause a loss of 2% of annual production on the assembly line which assembles Goliath (Gol) cars. The cost of repairing the air conditioning system which is the only way to avoid future breakdowns has been estimated at X$6 million with 2 full working days of production being lost due to the closure of the line while the system is repaired. The factory is presently operating 260 days a year with a planned annual production of 53,000 units of the Gol, which is a top of the range executive car selling for X$ 30,000 per unit and generating a gross margin of 50% of selling price.

The FD has agreed to provide an assessment of the financial implications of closing the assembly plant while the air conditioning system is repaired. He has also agreed to prepare a short report for a meeting of senior plant managers and HR personnel to discuss the implications of the recent industrial action.

He has asked you, as management accountant, to assist him in this task by advising him whether the repair to the air conditioning system will pay for itself within one year.

He has also asked you to recommend ways in which relations with the workforce in the plant may be improved as this will be the main topic likely to arise in the discussion with senior plant managers and HR personnel.


Decentralisation

In late 2013, EL was forced to recall 459,000 of its family sized cars in order to carry out inspections of their fuel tanks. This recall occurred because three of these cars had caught fire after leakage of fuel from their tanks. Aside from the damage to EL’s safety reputation, the cost of the recall ran into many millions of X$.

In early 2014, news leaked out from an internal investigation within EL that the cause of the problem and the need for the recall was due to a communication blockage arising from the over-centralisation of decision-making combined with an authoritarian management style.

EL’s management style left little scope for participation by plant management and personnel and resulted in a lack of feedback about potential faults arising during the assembly of the cars. According to those interviewed in the plant responsible for assembly, instructions came down from EL’s Company Headquarters but rarely were staff members in the production plant asked for their comments and opinions. When attention had been drawn to potential problems in the past, the staff reporting them found they were frequently ignored by senior management and so ceased to raise them. This is apparently what had happened in the case of the faulty fuel tanks; employees had reported potential problems but first line management did not take any further action because their reports had been ignored in the past.

Further organisational issues are that the Company has been slow to respond to market trends, relying on traditional manufacturing methods and an increasingly outdated model range. Feedback from the car market takes time to be discussed by the various head office committees. Purchasing and procurement processes have tended to be very traditional with little attempt to expand the supplier base and investigate the possibility of alternative suppliers.

The collating and transfer of production and financial information has also become slow. The reporting of monthly results for management purposes is a lengthy process and this has led to a system of adjusted estimates being produced. This has led to difficulty in making decisions with regard to production scheduling and stock holdings. A tendency has developed to hold more stock than necessary to ensure sales demand can be met.

The financial reports have been found to be inaccurate and local managers have become reluctant to base decisions on the information they contain. Institutional investors have made known to the Board their concern at the slow production of the annual report.

News of the product recall details were a cause for great concern to one of Mr B Tan’s senior managers. Given the seriousness of the recent recall problem he voiced the opinion in one of the senior management meetings that EL should seek to decentralise its organisation structure, thereby ensuring greater delegation of authority and encourage greater participation amongst the workforce.

Whilst this view did get some support from other senior managers, there was much opposition from those who pointed to the success EL had achieved under Mr A Tan’s centralised structure.

Given the divided opinion amongst his managers, Mr B Tan has asked for a report comparing the present structure and control system with that of a more decentralised and participative structure as had been proposed at the meeting.

Amongst the other costs of such a change will be the enhancement of the reward packages to the divisional managers.

The FD is working on the financial impact himself, which is highly confidential, but has asked you to produce a working paper on the advantages of a shift to a decentralised structure as compared with the present centralised structure.

Competitor Analysis

Reviewing the Annual Report of EL for 2013 and forecast for 2014 at a recent board meeting, Mr B Tan expressed satisfaction with EL’s progress and thanked board members for their outstanding efforts in contributing to the Company’s success. Having completed these preliminaries he went on to warn against any complacency emphasising that competition was intensifying.


In order for EL to survive, he pointed out the need for constant awareness of the competition. EL, he noted, was performing well in comparison with its competitors at the moment, but was faced with significant threats. In particular he noted the resurgence of the US car industry following the recent recession. He also drew attention to the massive investment that Chinese car companies had undertaken in recent years as well as the continued investment made by companies in Europe and South America.

As a response to these competitive threats he asserted the need for a more systematic form of competitor analysis that would provide on-going information about potential threats to EL from its competitors.

Turning to the FD, he asked him to set up a permanent in-house team that would conduct competitor analysis.

After the board meeting, the FD asked you to produce a working paper which will assist him at the first meeting of the competitor analysis team.

In particular, he has asked you to recommend with reasons the type of information to be collected, the best sources of and methods for collecting competitor information and how best to organise and analyse this information to enable EL to compete in the market place.

Braking system

The sales of EL’s latest family car are going well; the motoring press having tested the car have given it high praise for its performance and safety features. More recently, the car has won the prestigious, ‘Best Designed Car of the Year Award’, adding to other awards won in recent years by EL.

It was thus a matter of great concern, when the Company having sold 90,000 cars had six cars returned by customers with claims that the braking system was faulty. On investigation, EL’s Safety team found that under certain very high temperature conditions the brakes of the car did not function as well as they should. One engineer also noted that some of the components of the braking system had been sourced from a new supplier on cost grounds.

Although the test engineers clearly stated the limitations of the braking system, senior marketing people and others ignored this on the grounds that a recall of the cars would present a negative message for what was a top selling car.

The CEO, Mr B Tan, has been informed of these developments and has asked the advice of the FD on what action EL should take bearing in mind the financial consequences for EL.

The FD has asked you for your opinion on the matter before he responds to the CEO’s request.


Appendix 5

Forecast for 2014 reproduced from Appendix 4 of the pre-seen:

Executive Range

Mid Range Compact Range

Total

Units (Cars) 313,334 940,000 312,500 1,565,834

Average Price (X$) 30,000 15,000 8,000

Sales Value (X$M) 9,400 14,100 2,500 26,000

Average Gross Margin (%) 40 35 10

Total Gross Margin (X$M) 3,760 4,935 250 8,945

Direct Factory Overheads (X$M) 625 1,400 420 2,445

Gross Profit (X$M) 3,135 3,535 (170) 6,500

End of unseen material


This page is blank


APPLICABLE MATHS TABLES AND FORMULAE Present value table

Present value of 1.00 unit of currency, that is (1 + r)

-n where r = interest rate; n = number of periods until payment

or receipt.

Periods

(n) Interest rates (r)

1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909

2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826

3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751

4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683

5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621

6 0.942 0.888 0.837 0.790 0.746 0705 0.666 0.630 0.596 0.564

7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513

8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467

9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424

10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386

11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350

12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319

13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290

14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263

15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239

16 0.853 0.728 0.623 0.534 0.458 0.394 0.339 0.292 0.252 0.218

17 0.844 0.714 0.605 0.513 0.436 0.371 0.317 0.270 0.231 0.198

18 0.836 0.700 0.587 0.494 0.416 0.350 0.296 0.250 0.212 0.180

19 0.828 0.686 0.570 0.475 0.396 0.331 0.277 0.232 0.194 0.164

20 0.820 0.673 0.554 0.456 0.377 0.312 0.258 0.215 0.178 0.149

Periods


11% 12% 13% 14% 15% 16% 17% 18% 19% 20%

1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833

2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694

3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579

4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482

5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402

6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335

7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279

8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233

9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194

10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162

11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135

12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112

13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093

14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078

15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.079 0.065

16 0.188 0.163 0.141 0.123 0.107 0.093 0.081 0.071 0.062 0.054

17 0.170 0.146 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.045

18 0.153 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.038

19 0.138 0.116 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031

20 0.124 0.104 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026


Cumulative present value of 1.00 unit of currency per annum, Receivable or Payable at the end of each

year for n years

r

r n)(11

Periods


1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909

2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736

3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487

4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170

5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791

6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355

7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868

8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335

9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759

10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145

11 10.368 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495

12 11.255 10.575 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814

13 12.134 11.348 10.635 9.986 9.394 8.853 8.358 7.904 7.487 7.103

14 13.004 12.106 11.296 10.563 9.899 9.295 8.745 8.244 7.786 7.367

15 13.865 12.849 11.938 11.118 10.380 9.712 9.108 8.559 8.061 7.606

16 14.718 13.578 12.561 11.652 10.838 10.106 9.447 8.851 8.313 7.824

17 15.562 14.292 13.166 12.166 11.274 10.477 9.763 9.122 8.544 8.022

18 16.398 14.992 13.754 12.659 11.690 10.828 10.059 9.372 8.756 8.201

19 17.226 15.679 14.324 13.134 12.085 11.158 10.336 9.604 8.950 8.365

20 18.046 16.351 14.878 13.590 12.462 11.470 10.594 9.818 9.129 8.514

Periods (n)

Interest rates (r)

11% 12% 13% 14% 15% 16% 17% 18% 19% 20%

1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833

2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528

3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106

4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589

5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991

6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326

7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605

8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837

9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031

10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192

11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327

12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 4.793 4.611 4.439

13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533

14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611

15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675

16 7.379 6.974 6.604 6.265 5.954 5.668 5.405 5.162 4.938 4.730

17 7.549 7.120 6.729 6.373 6.047 5.749 5.475 5.222 4.990 4.775

18 7.702 7.250 6.840 6.467 6.128 5.818 5.534 5.273 5.033 4.812

19 7.839 7.366 6.938 6.550 6.198 5.877 5.584 5.316 5.070 4.843

20 7.963 7.469 7.025 6.623 6.259 5.929 5.628 5.353 5.101 4.870


FORMULAE

Valuation Models

(i) Irredeemable preference share, paying a constant annual dividend, d, in perpetuity, where P0 is

the ex-div value:

P0 =

prefk

d

(ii) Ordinary (Equity) share, paying a constant annual dividend, d, in perpetuity, where P0 is the ex-div value:

P0 =

ek

d

(iii) Ordinary (Equity) share, paying an annual dividend, d, growing in perpetuity at a constant rate, g, where P0 is the ex-div value:

P0 =

gk

d

-e

1

or P0 =

gk

g

e

0][1d

(iv) Irredeemable (Undated) debt, paying annual after tax interest, i (1-t), in perpetuity, where P0 is the ex-interest value:

P0 =

net

][1

dk

ti

or, without tax:

P0 =

dk

i

(v) Future value of S, of a sum X, invested for n periods, compounded at r% interest:

S = X[1 + r]n

(vi) Present value of £1 payable or receivable in n years, discounted at r% per annum:

PV = n

r ][1

1

(vii) Present value of an annuity of £1 per annum, receivable or payable for n years, commencing in one year, discounted at r% per annum:

PV =

n

rr ][1

11

1

(viii) Present value of £1 per annum, payable or receivable in perpetuity, commencing in one year, discounted at r% per annum:

PV =

r

1


(ix) Present value of £1 per annum, receivable or payable, commencing in one year, growing in perpetuity at a constant rate of g% per annum, discounted at r% per annum:

PV = gr

1

Cost of Capital

(i) Cost of irredeemable preference capital, paying an annual dividend, d, in perpetuity, and having

a current ex-div price P0:

kpref =

0P

d

(ii) Cost of irredeemable debt capital, paying annual net interest, i (1 – t), and having a current ex-interest price P0:

kdnet =

0

][1

P

ti

(iii) Cost of ordinary (equity) share capital, paying an annual dividend, d, in perpetuity, and having a current ex-div price P0:

ke =

0P

d

(iv) Cost of ordinary (equity) share capital, having a current ex-div price, P0, having just paid a dividend, d0, with the dividend growing in perpetuity by a constant g% per annum:

ke = g

P

d

0

1 or ke = g

P

gd

0

]1[0

(v) Cost of ordinary (equity) share capital, using the CAPM:

ke = Rf + [Rm – Rf]ß

(vi) Weighted average cost of capital, k0:

k0 = ke

DE

D

d

D

E

VV

Vk

V

V

EV


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T4 – Test of Professional Competence - Part B Case Study

Examination

September 2014

Documents

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