Assessment Task

You are working in the management accounting department of Southampton Electronic Technology (SET) Limited which manufactures tablet computers for the UK market. Your manager has asked you to write a paper which addresses issues relating to capital investment decisions.

1. The current approach used by the company is to estimate the net present value of proposed projects using a company-wide discount rate in order to make investment decisions. The department initiating the project is required to present an investment proposal to the board which make the final decision on whether to provide the finance required. This proposal incorporates their estimates of the costs and benefits of the project and the results of the financial appraisal. However, the directors of the company have recently raised the question of whether changes should be made to the decision-making process to make it more robust. They are also concerned that the fast-moving industry in which the company operates means that it is particularly important to consider risk and uncertainty in making decisions.

You are required to discuss the following in your paper:

• The importance of the capital investment decision to the company.

• A critical appraisal of a range of alternative investment appraisal techniques.

• A recommendation for a robust approach to the investment appraisal and management process which would ensure that the wider aspects of the investment decision are considered.

• The importance of considering risk and uncertainty on investment decision making, including a discussion of how this can be taken into account in the decision-making process.

1. You have also been asked to review proposals for one specific product. Information about this project is given on the next page. Your manager feels that there are a number of areas of uncertainty affecting this project and this particular project should be examined more closely.

You are required to:

• Based on the data below, carry out an analysis which includes:

• A financial appraisal of the project.
• The impact on the appraisal of changes in any of the variables in the project.

• Within your paper, present an analysis of the results of your financial appraisal in an appropriate format. This analysis should include an assessment of the impact of changes in key variables.

• Provide a full commentary on your analysis, with reference to points made in part a). Your discussion of the analysis should indicate the decision you believe the company should make on this project, including a discussion of the potential impact of changes to variables and how this affects your conclusion.

Note: you should use a spreadsheet for the calculations which underpin the analysis presented in the paper. Your spreadsheet should be submitted to support your paper.

Assessment criteria

(10%)  Discussion of the importance of the capital investment decision.

(15%)  Identification and discussion of an appropriate range of investment appraisal techniques.

(20%)  A recommendation for a robust decision-making process.

(10%)  Discussion of the importance of considering risk and uncertainty and how it can be taken into account

(25%)  Commentary on analysis of project and presentation and discussion of results.

(10%)  Effective communication and appropriate style of presentation.

(10%)  Use and presentation of academic research to support arguments.

Information on project

The market for the company’s products has shown considerable growth over the last few years. This is expected to continue, and the product development department is now proposing to launch a new high-performance notebook laptop within the next 12 months called the Excel. The new notebook has been designed to appeal to a different segment of the market from the company’s existing products, which are generally of a lower specification and cost. The company is therefore anticipating that the impact on the sales of the existing products will be limited.

The company has already spent £3 million developing and testing the new notebook but a further investment of £25 million will be required to set up manufacturing facilities. This will be bought and paid for before production commences and is expected to have a residual value of £5 million at the end of the life of the product. The business will depreciate this asset in its accounts on a straight-line basis.

The expected selling price of the notebook will be £500 per unit in the first year, reducing to £400 in the second year and £350 for the last two years of its life. The total variable cost per notebook is estimated to be at a constant level of £220 per unit for the life of the product. This estimate includes material, labour and variable overhead costs. The increase in the company’s fixed overheads due to this product is expected to be £2.5 million per year, excluding depreciation.

The company currently charges fixed overheads to each product based on machine hours, using a fixed overhead rate of £100 per hour. Each Excel unit is expected to take 2 machine hours to produce.

Additional working capital of £3 million will be required at the start of the project.

Manufacture and sales of Excel are expected to be as follows:

The company currently uses a discount rate of 10% a year when carrying out investment appraisals.

No allowance has been made for inflation in the data above.