• Read the following instructions carefully before answering the assignment, as failure to act upon them will result in loss of marks.
• Your assignment should be typed (12 font, 1.5 spacing)
• Include the following: cover sheet, index, glossary of terms, list of references and proof of research.
• If a student is found guilty of plagiarism, the achieved results will be disregarded and the student will be failed.
• Use the Harvard system of referencing. You must consult at least 3 different textbooks and preferably journals for adequate referencing
• You are expected to communicate your own thoughts. Long theoretical arguments and quotes from the textbook will be penalised.
• Technical requirements for assignments: assignments must be presented in the correct format. Marks will be awarded in conjunction with content for overall presentation (introduction and conclusion, content page, bibliography)
• Failure to adhere to the above will result in a loss of marks. No group work may be done on an individual assignment. Plagiarism and copying will result in the default mark of 0% being awarded.
All calculations are to be shown in the appendices. The document to be emailed must be an MSWord document. Excel spreadsheets must be pasted into the document.
By applying the concepts, principles and theoretical concepts learned in the FMD module, conduct a systematic and critical appraisal, evaluation and examination of the following case study with the view to advise the owner on issues that would help improve on the efficiency and performance of the business.
Nippers is a small company that manufactures high-quality gardening
products and also offers gardening
services to a number of hotels and country clubs in the city. It is a profitable business and demand for certain of its products always exceeds supply because they are one of the few companies which sell quality products at such competitive prices.
The company is owned and managed by Mrs. Dibsa. Most of the staff members at the company are either relatives or good friends of Mrs. Dibsa, and even the shortest-serving member of staff has worked at Nippers for ten years. Mrs. Dibsa is planning on retiring on her 60th birthday in 6 years time, since she enjoys working so much.
She currently considers extending the building to create more space, so that she can meet the demand for certain products that are in high demand. Mrs. Dibsa’s brother has offered to do the extensions at very competitive price. He is currently unemployed and faces bankruptcy if he does not find work soon. Mrs. Dibsa estimates that, with the extensions, she would be able to sell the business as a going concern for R6 000 000 in six years time. Without the extension, she would expect to sell it for R5 000 000 in six years time.
A local builder has recently approached Mrs. Dibsa with an unexpected offer to buy the business immediately for R8 500 000. He hopes to build apartments on the land.
Mrs. Dibsa needs to decide whether she will carry on the business without the extension (option 1), have the extension built (option 2), or sell to the developer (option 3). The following is available:
• Mrs Dibsa has already obtained preliminary planning permission for the extension at a cost of R12 000
• Mrs Dibsa’s building costs are estimated to be R850 000. Of this amount, R450 00 relates to materials and must be paid immediately. The work would take one year to complete. The business would still be open as usual during the year, so that revenue would be unaffected by the building work.
• The company currently generates net cash inflows of R980 000 per annum. With the extension, these would rise to R1 350 000 once the work is complete. Mrs Dibsa pays herself a salary, but this amount has already been deducted before arriving at the R980 000.
• The business’s cost of capital is 10% per annum
• Assume that all cash flows occur at the end of each year, unless otherwise stated.
Nippers is also launching a new product, called 3-in-1 Lawnmowers next year, and is currently considering its pricing strategy for this. The product will be unlike any other product that is currently available and will considerably improve the efficiency of gardening
services. This unique position in the market place is expected to remain for only 6 months before one of the company’s competition develops a similar product.
The prototype required a substantial amount of time to develop and, as a result, the company is keen to recover its considerable research and development cost as soon as possible. The company has now developed its manufacturing process for this product and consequently the time taken to produce each unit is much less than was required for the first few units. This time reduction is expected to continue for a short period of time, once mass production has started, but from then onwards a constant time requirement per unit is anticipated.
Nippers also consider having a once-off contract drawn up. Mrs. Dibsa has asked her inexperienced accountant to advise her on the costs likely to be incurred, so that she can price at a profit. The following schedule has been prepared:
Costs per special order Notes Rand
Direct wages 1 285 000
Supervisor costs 2 115 000
General overheads 3 40 000
Machine depreciation 4 23 000
Machine overheads 5 180 000
Materials 6 340 000
1. Direct wages comprise the wages of two employees, particularly skilled in the labour process for the job. They could be transferred from another department to undertake the work on special order. They are fully occupied in their usual department and sub-contracting staff would have to be brought in to undertake the work left behind. Sub-contracting cost would be R320 000 for the period of the work. Other sub-contractors, skilled in the special order technique, are also available to work on the special order. The costs associated with this would amount to R313 000.
2. A supervisor would have to work on the special order. The cost of R115 000 is made up of R80 000 normal payment plus R35 000 additional bonus for working on the special order. Normal payments refer to fixed salary of the supervisor. In addition, the supervisor would lose incentive payments in his normal work amounting to R25 000. It is not anticipated that any replacement costs relating to the supervisor’s work on other jobs would arise.
3. General overheads comprise an apportionment of R30 000 plus an estimate of R10 000 incremental overheads.
4. Machine depreciation represents the normal period cost, based on the duration of the contract. It is anticipated that R5 000 will be incurred in additional machine costs.
5. Machine overheads (for running costs such as electricity) are charged at R30 per hour. It is estimated that 6 000 hours will be needed for the special order. The machine has 4 000 hours available capacity. The further 2 000 hours required will mean an existing job is taken off the machine resulting in a lost contribution of R20 per hour (before overheads are charged)
6. Materials represent the purchase costs of 7 500 kilograms bought some time ago. The materials are no longer used and are unlikely to be in demand in the future, except for the special order. The complete stock of materials (amounting to 10 000 kilograms), or part therefore, could be sold for R42 per kilogram. The replacement cost of material used would be R333 750.
Because the business does not have adequate funds to finance the special order, a bank overdraft of R200 000 would be required for the project duration of 3 months. The overdraft would be repaid at the end of the period. The company uses a cost of capital of 20% to appraise projects. The banks overdraft rate is 18%. Mrs Dibsa has heard that for special orders such as this one, relevant costing should be used that also incorporates opportunity costs. She has approached you to create a revised costing schedule based on relevant costing.
You should structure your report under the following heading/basis of appraisal:
Executive summary not more than 2 pages, summarising the key findings/conclusions and recommendations supported by, and referenced to a well written and developed detailed report covering the following:
1. Calculate the Net Present Value (NPV) of each option at the business’s cost of capital with regards to extending the building. Based on these calculations, conclude as to which option Mrs. Dibsa should choose.
2. Discus the non-financial factors that Mrs. Dibsa should take into account before finally making a decision about the NPV calculated above.
3. Explain the alternative pricing strategies that may be adopted when launching the new product, 3-in-1 Lawnmowers.
4. Recommend a pricing strategy to the company for its new product and explain how the adoption of your chosen strategy would affect the sales revenue, costs and profits of this product over its life cycle.
5. Explain absorption and marginal cost approaches to pricing and state which one will best suit Nippers.
6. Produce a revised costing schedule for the once-off contract based on relevant costing principles. Fully explain and justify each of the costs included in the costing schedule.
7. Explain how the use of relevant cost as the basis of setting a selling price may be appropriate in the short-term pricing decision, but may be inappropriate for long-term pricing decision
8. Explain the importance of break-even analysis to a business like Nippers.
9. Comment on any limitations of using break-even analysis at Nippers for decision making purposes.
10. List of References (Harvard Style) and overall quality and presentation of report.
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Berman, K., Knight, J., Case, J., 2006, Financial Intelligence: A Manager's Guide to Knowing what the Numbers Really Mean, Harvard Business Press
Bolander, S.F., Gooding, C.W., Mister, W.G., 1999, Transfer Pricing Strategies and Lot Sizing Decisions, Journal of Managerial Issues, Vol. 11
Drudy, C., 2004, Management and Cost Accounting, 6th Edition, Cengage Learning EMEA
Goetz, Jr., J.F., 1985, the Pricing Decision: A Service Industry's Experience, Journal of Small Business Management, Vol. 23
Hilton, R.W., Swieringa, R.J., Turner, M.J., 1988, Product Pricing, Accounting Costs and Use of Product-Costing Systems, the Accounting Review, Vol. 63, No. 2
Kurtz, D.L., 2008, Contemporary Marketing, 13th Edition, Cengage Learning
2009, Break-Even Analysis, Financial Calculators from KJE Computer Solutions, http://www.dinkytown.net/java/BreakEven.html last accessed on August 28, 2009
Marginal Costing and Absorption Costing, BPP Professional Education, http://www.bpp.com/accandtax/studyguides/CIMA/CMP1ST07%20-%20Ch01-02.pdf last accessed on August 27, 2009