T4 – Part B Case Study Examination docs/2010...Part B C ase Study Examination. T4 – Part B Case...

© The Chartered Institute of Management Accountants 2011

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T4 – Part B Case Study Examination Thursday 26 May 2011

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 open your answer book and start writing 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 13, which is detachable for ease of reference. The Case Study Assessment Criteria, which your script will be marked against, is included on page 14.

Maths Tables and Formulae are provided on pages 19 to 22.

Write your full examination number, paper number and the examination subject title in the spaces provided on the front of the examination answer book. Also write your contact ID and name in the space provided in the right hand margin and close to seal.

Contents of this booklet:

Page

Pre-seen material – BZCS construction case 2

Pre-Seen Appendices 1- 4

9

Question Requirement Case Study Assessment Criteria

13

14

Unseen Material 15 - 18

Maths Tables and Formulae

19 - 22

T4 Part B Case Study 2 May 2011

BeeZed Construction Services (BZCS) case Construction industry background Due to the current economic climate, the demand for building work in Europe has fallen overall by over 10% from 2008 levels. Furthermore, it is forecasted that the volume of construction work will not increase until the start of 2011. Many companies in the construction industry have suffered falls in profits as a direct result of the slowdown in new contracts being awarded. Many European construction companies are involved in a large range of projects in many countries worldwide. Few large construction companies (except some house building companies) operate only within their national boundaries. Most construction companies have established a range of expertise in specific types of project, such as construction of office buildings, hospitals, airports, roads or schools. This expertise allows the construction companies to use their skills and reputation to bid for, and win, further projects in Europe and in other countries around the world. Many large construction projects are financed using Private Finance Initiatives (PFI). PFI is defined as private finance being used to fund public infrastructure work. Private finance is defined as finance provided mainly by banks, institutional investors and pension funds. The Private Finance Initiative (PFI) is a way of creating Public Private Partnerships (PPP). PPP is defined as agreements between public bodies or central governments and private construction companies to deliver the agreed projects. Examples of public infrastructure works are road building and construction of new schools. PFI projects also involve the private sector construction company taking on responsibility for providing an on-going service. This typically includes maintaining and managing the project over the life of the building or for a fixed term of 20 years or longer. Therefore, PFI projects generate revenue streams for the construction company for the initial construction project as well as for long-term maintenance and management of the asset. PFI projects involve the private construction company as a partner in the project and this has generated favourable outcomes in respect of the percentage of projects completed on time and completed to the agreed budget. In the construction industry there are 3 main types of contract, which are:

1. Fixed price contracts – this is where the revenue for the private construction company is fixed at the contract stage, subject to changes in specifications agreed during construction.

2. “Cost plus” contracts – this is where the revenue for the private construction company

will comprise all of the actual costs of the project plus an agreed profit element.

3. Long-term PFI projects – this is where the revenue for the private construction company will include the contracted construction revenue as well as revenues for on-going maintenance and property management for a long-term project, typically 20+ years.

The process for private construction companies to win a new contract for a large construction project is summarised in the following steps:

1. A company or government body will invite tenders 2. The construction company will tender for the contract by preparing a detailed bid 3. A company or government body will select its “preferred contractor” 4. The bid price and the contract details will be negotiated and agreed 5. Contracts are then signed 6. Selection and appointment by the construction company of suppliers for manpower

resources (sub-contractors), as well as for materials 7. Work commences

May 2011 3 T4 Part B Case Study

It should be noted that during construction work, there are often many requests for changes to the original contract specifications or design which are submitted to the construction company. These changes usually affect costs and manpower. All of these change requests have to be negotiated and additional revenues agreed before the changes can be made. BeeZed BeeZed is a construction and property management company listed on a European stock exchange. BeeZed has 3 wholly owned subsidiary companies which are:

• BeeZed Construction Services (BZCS) – concerned with a wide range of construction projects

• BeeZed Professional Services (BZPS) – concerned with offering consultancy services

• BeeZed Building Support Services (BZBSS) – concerned with property management

and maintenance services. In respect of PFI projects, the parent company, BeeZed, will sign the overall contract for the project. BZCS will be involved only with the construction work and BZBSS will manage the ongoing maintenance and property management work. When a PFI contract is signed, the parent company, BeeZed, will agree on how the revenues will be split between BZCS and BZBSS. This case study is concerned ONLY with BeeZed Construction Services (BZCS). BZCS BZCS has many construction projects around the world, ranging from road building, construction of public sector buildings, including hospitals, schools and university buildings to commercial contracts for office buildings. Some of the construction projects that BeeZed is involved with are financed by PFI. However, only the revenue related to the construction project is allocated to BZCS. The revenue relating to the ongoing maintenance and property management work is allocated to BZBSS and is not

included in this case study. BZCS has a good reputation in this industry for quality and safety as well as its ability to deliver projects on time. These are all critical success factors for keeping its existing customers content and for providing a basis for winning future business.

BZCS has 6 divisions, which are:

1. Office Buildings Division – includes building bespoke office buildings for specific company orders, as well as speculative construction of office buildings in city centres or on business park complexes.

2. Sports Facilities Division – includes the construction of large sports stadiums as well as

the construction of small regional sports facilities. 3. Environmental Projects Division – includes the construction of water treatment facilities,

the construction of sophisticated waste management facilities and marine projects, including the construction of container terminals and marinas.

4. Infrastructure Projects Division – includes road building and airport construction.

5. Community Projects Division – includes the construction of hospitals and smaller

healthcare facilities as well as schools and university facilities.

6. Energy Projects Division – includes the construction of gas storage facilities and power stations.


Each of these 6 divisions is headed by a Commercial Director who is responsible for all of the projects undertaken by that division. A summary of the organisational structure for BZCS, effective from 1 January 2011, is shown in Appendix 1 on page 9. In the year ended 30 September 2010, BZCS generated total revenues of €1,267 million and operating profit of €34.7 million. BZCS is a wholly owned subsidiary of BeeZed. An extract from the accounts for BZCS is shown in Appendix 2 on page 10. All of the non-current liabilities represent inter-company long-term loans from its parent company, BeeZed. BeeZed has a range of non-current liabilities with several external bodies including bank loans. BZCS’s cash flow statement for the year ended 30 September 2010 is shown in Appendix 3 on page 11. Geographical analysis of revenues BZCS currently has construction projects operational throughout Europe, the USA, the Middle East and in some other countries, mainly in Asia. The geographical analysis of the total construction services revenue of €1,267 million for the year ended 30 September 2010 was as follows:

Analysis of revenues and operating profit by division The revenues and operating profit for each of BZCS’s 6 divisions for the year ended 30 September 2010 are shown in a table on the next page:

Europe €690 m

USA €369 m

Middle East €110 m

Rest of World €98 m


Revenue

Operating profit

Office buildings

€ million

220.0

€ million

8.5

Sports facilities 145.2 3.4

Environmental projects 193.1 4.2

Infrastructure projects 365.2 16.8

Community projects 213.6 1.3

Energy projects 129.9 0.5

Total

1,267.0

34.7

Financials The operating profit margins achieved by BZCS are low, as is the norm for this industry. However, for some of BZCS’s PFI construction projects, BZBSS, which is part of the BeeZed group, earns additional revenues for a further 10 to 30 years for the ongoing maintenance and property management of the PFI projects. Whilst BZCS prepares annual financial accounts, all of the accounting for each construction project is accounted for on a project basis. All direct costs are allocated to the respective project, including salary and associated costs for all of BZCS’s employees working on each project as well as sub-contractor costs. All non-project based overhead costs are allocated to projects using activity based costing techniques based on appropriate cost drivers. The monthly management accounts show the following information for all on-going operational construction projects:

• Contract revenues and costs • Approved change requests to contracts and amended revenues and costs • Cumulative costs to date for the project (spanning current and past financial years) • Forecast of costs for the remainder of the project (which are split between costs to be

incurred in the current financial year and costs to be incurred in future financial years) BZCS uses a project management system called BZPM. Each Project Manager is responsible for all direct costs incurred on the project for which he / she is responsible. Each Project Manager is responsible for presenting the projects’ financial and operational issues that have occurred for each project on a monthly basis. These presentations are to senior management groups chaired by the Commercial Director for the relevant division of BZCS. These presentations cover all aspects of the project, including safety issues, forecasts for the delivery of the project against plan and any significant operational problems or successes. If there is a significant problem, the Project Manager will be expected to travel to BZCS’s Head Office to present the information to the BZCS Board. Where there are no operational or financial concerns, the Project Manager conducts his monthly presentation by video conferencing. Order book At 30 September 2010 BZCS had an order book valued at over €2,400 million. This is 30% higher than the level of BZCS’s order book at the 30 September 2009. The order book represents the value of contracts signed which have either not yet been commenced or are currently in progress.


Project Management BZCS uses a project management system to plan each project, called BZPM. The contract details and agreed key stages are set up in BZPM when the contract is signed for each new construction project. A Project Manager is appointed for each project. He or she is responsible for controlling all stages of the project using BZPM. This includes control of resources, both BZCS employees and outsourced sub-contractors, timings for each stage of the project, project planning and managing contract change requests. The Project Manager is also responsible for control and reporting of costs against the original contract and the updated budget for the project. The finance system interfaces directly with BZPM allowing data on payments for materials and sub-contractors, payroll costs and revenues to be directly allocated to each stage of the relevant project. The Project Manager and his team, assisted by the Finance Department, prepare monthly accruals based on activities undertaken in the month, which have not been invoiced. BZPM is able to generate reports on all aspects of each project, including forecast timings for all activities and costs, by the end of day 3 after each month end. Corporate Social Responsibility BZCS takes its Corporate Social Responsibility (CSR) very seriously. The BZCS Board is committed to safety on all projects and also to the reduction of waste from sites and the reduction of carbon emissions. It is also very aware of environmental concerns and works closely with the communities in which it operates. BZCS’s commitment to health and safety and environmental issues is shown below. Health and Safety Health and safety is a top priority for BZCS. BZCS continues to enhance its culture of safety throughout the company and its supply chain, to ensure that its employees, sub-contractors and the public are safe. BZCS also ensures that environmental safety is adhered to, so as to try to ensure that the communities in which it operates are not damaged or polluted. BZCS, like all construction companies, adheres to all Health and Safety legislation and BZCS goes beyond what is required by law. It trains all of its employees to ensure their competency and full understanding of what and why safety is so important in all aspects of the company. This training covers all aspects of health and safety, from construction work at building sites to transportation of materials and disposal of waste. BZCS continues to measure its performance against a range of key Health and Safety indicators. BZCS’s annual accident frequency rate has fallen over the last 7 years and is currently 0.16 accidents per 100,000 work hours. This is the lowest accident rate ever achieved by BZCS and is amongst the lowest of the top construction companies globally. 20,000 person days of Health and Safety training has been provided by BZCS during the last financial year ended 30 September 2010. BZCS recognises that it is also important that its supply chain is fundamental to the safe delivery of all construction projects and it works closely with the companies in its supply chain. It tries to ensure that best practice is promoted and that a positive safety culture is created. BZCS provides Health and Safety awareness training to its key suppliers to ensure that they meet BZCS’s challenging Health and Safety requirements. BZCS also conducts audits of its suppliers. Recently some suppliers’ contracts were not renewed as they did not meet the criteria set by BZCS for Health and Safety standards. Environmental issues BZCS is committed to complying with a European Union (EU) wide programme to reduce the volume of waste that goes to landfill sites. Where possible waste from construction sites is sorted by category of material (such as earth, packaging or materials which can be recycled) and is recycled or disposed of in a safe way. BZCS has a range of waste management contractors which manage the safe disposal of site waste. They have demonstrated their


abilities to divert waste from landfill sites. Last year, ended 30 September 2010, BZCS’s target was to dispose of, or recycle, 60% of site waste that would otherwise have ended up in landfill sites. BZCS exceeded this target and disposed of, or recycled, 62% of its waste from its construction sites. BZCS is committed to reducing its carbon footprint and to minimising its impact on the environment. BZCS uses the latest technology on its construction projects so that new buildings are able to operate in an environmentally responsible way and utilise efficient electrical fittings. Many of the buildings contracted by European government departments, such as schools and hospitals, use renewable energy sources and BZCS works closely with the architects to ensure that the buildings will help to deliver planned reductions in carbon emissions. BZCS’s Mission Statement and CSR initiatives are shown in Appendix 4 on page 12. Contracts BZCS is continuously working on bids for possible new contracts. It has specialised teams headed up by Bid Managers in each of BZCS’s 6 divisions. When a bid has been won and a contract signed, then a Project Manager is appointed to manage the project. Sometimes, on a particularly complicated project, the initial Bid Manager will become the Project Manager. Each of BZCS’s 6 divisions usually has between 1 and 5 projects in progress at any point in time. Furthermore, each of the 6 divisions is usually involved in the bid preparation and the bidding process for several other proposed projects. Whilst BZCS has been the preferred supplier for some European government departments in the past for infrastructure projects and community projects, these large customers are now imposing increasingly strict criteria for suppliers to meet. Bids need to be competitive in the current challenging economic climate. Therefore, BZCS, like many other construction companies, is not successful in winning all of the projects for which it bids for. In order to balance the risk of relying on specific construction sectors and a relatively small customer base, BZCS tries to win contracts from a wide selection of organisations. These include government and private sector customers. BZCS also undertakes a wide range of different types of construction project. BZCS has secured some construction projects for the London 2012 Olympic Games. At any point in time BZCS usually has between 12 and 20 projects in progress, with bid preparations taking place for a further 10 or more projects. The bid value of a contract varies greatly, ranging from €5 million to over €800 million for individual contracts. Contract duration often spans more than 2 years. As at the end of December 2010, BZCS has 14 projects currently operational, of which 10 are due for completion during 2011 and the remaining 4 are due to be completed in 2012. Bid tendering process In the UK, the Government’s regulator, the Office of Fair Trading (OFT) has been undertaking investigations of “bid-rigging” in the construction industry. The OFT has established that there is widespread evidence of construction companies which have been involved in manipulating the bidding process. This has allowed specific companies to win Government awarded construction projects at higher prices than could be achieved through a fair competitive bidding process. This on-going investigation has involved the OFT accessing paperwork for over 100 contracts from 20 construction companies. It will also impact on the ways that construction companies, including BZCS, bid for new projects in the future. In order to be treated leniently, BZCS has advised the OFT that it did have discussions with some other construction companies concerning the level of its bid for a UK hospital construction project that it won the contract for in 2008. The project is proceeding on time and it is forecast that it will not over-run the agreed fixed price budget.


BZCS is waiting to hear the outcome of the OFT’s investigation into this specific contract. BZCS has included a provision for a contingent liability, for a possible fine, in the accounts for the current financial year ending 30 September 2011. Re-structuring of BZCS During 2009 and the early part of 2010, BZCS underwent a re-structuring process to enable it to become more competitive following the downturn in construction projects due to the current economic environment. The Board of BZCS recognised the need to become more flexible and to sub-contract a greater volume of its core construction work. Following a Board decision in March 2009, BZCS reduced the number of its employees by 1,800 within 1 year. At the end of September 2010, BZCS had 10,100 employees. Many of BZCS’s ex-employees have joined some of BZCS’s supply chain companies, which are BZCS’s sub-contractors. Therefore some of these people work on the same project as previously but now are employed by sub-contractors or have become short-term freelance contractors to BZCS. BZCS has also focused on winning a wider range of private construction projects as many European governments have cut the budgets on public sector projects and bidding is more competitive than ever. A summary of the organisational structure for BZCS, effective from 1 January 2011, is shown in Appendix 1 on page 9. Within each division, the Commercial Director has responsibility for each of the Project Managers who are each responsible for one operational project. Projects that are operational are defined as a project in which the contracts have been signed but construction is not complete. Each division also has Bid Managers responsible for preparing bids or tenders for new projects and Sales and Marketing Managers for selling to, and liaising with, customers. Additionally there is a Post Completion Manager responsible for all projects that have ongoing problems or require minor rectification work after the project has been completed. Re-structuring of the Procurement Department Before the re-structuring of BZCS, each division was responsible for the procurement for each of the projects under its control. Effective from 1 January 2011, there is a new central Procurement Department for the whole of BZCS. This is under the direct control of an experienced Procurement Director, who reports directly to BZCS’s Managing Director. The new Procurement Director was recruited from a rival construction company and joined BZCS in October 2010. The employees who worked in the procurement departments within each of BZCS’s 6 divisions have been brought together in one centralised Procurement Department, based in Europe. This should help to facilitate better control over purchases and achieve higher bulk discounts, especially for some raw materials. On an operational level, all of BZCS’s Project Managers at construction sites in each country will now make all purchases through the new centralised Procurement Department. They will be given limited authority to purchase goods locally where no global contract is in place for particular materials. The new centralised Procurement Department is in the process of selecting “preferred suppliers” within each country in which it operates. Where possible, the preferred supplier will be another large international company that can provide materials to BZCS in many of the countries in which BZCS has on-going construction projects. The Finance Department is working closely with the Procurement Director in the selection and appointment of new and existing suppliers. The re-structuring of BZCS’s Procurement Department has resulted in an overall reduction in headcount in procurement employees. The new centralised Procurement Department will help meet BZCS’s target for Head Office cost savings.

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Appendix 2

Extracts from BZCS’s Statement of Comprehensive Income, Statement of Financial Position and Statement of Changes in Equity

Statement of Comprehensive Income

Year ended 30 September 2010


€ million

€ million

Sales revenue 1,267.0 1,280.0 Cost of sales 1,210.3 1,222.0 Gross profit 56.7 58.0 Administrative expenses 22.0 22.8 Operating profit

34.7

35.2

Finance income 0.2 0.3 Finance expense 7.5 8.7 Profit before tax 27.4 26.8 Tax expense (effective tax rate is 20%) 5.5 5.4 Profit for the period

21.9

21.4

As at Statement of Financial Position 30 September 2010

As at 30 September 2009

€ million

€ million

€ million

€ million

Non-current assets (net)

241.0 234.0

Current assets Inventory 3.1 3.4 Trade receivables 167.0 167.8 Cash and cash equivalents 23.4 31.2 193.5 202.4 Total assets 434.5 436.4 Equity and liabilities

Equity Share capital 10.0 10.0 Retained earnings 176.0 154.1 186.0 164.1 Non-current liabilities Inter-company loan (provided by parent company BeeZed)

125.0

145.0 Current liabilities Trade payables 118.0 121.9 Tax payables 5.5 5.4 123.5 127.3 Total equity and liabilities 434.5 436.4

Note: Paid in share capital represents 10 million shares of €1.00 each at 30 September 2010 which are 100% owned by parent company BeeZed

Share Statement of Changes in Equity Capital

Share premium

Retained earnings

Total

€ million

€ million

€ million

€ million

Balance at 30 September 2009 10.0 - 154.1 164.1 Profit - - 21.9 21.9 Dividends paid - - - - Balance at 30 September 2010 10.0 - 176.0 186.0


Appendix 3

Cash Flow Statement


€ million

€ million

Cash flows from operating activities: Profit before taxation (after Finance costs (net)) 27.4 Adjustments: Depreciation 88.0 Finance costs (net) 7.3 95.3 (Increase) / decrease in inventories 0.3 (Increase) / decrease in trade receivables 0.8 Increase / (decrease) in trade payables (excluding taxation)

(3.9)

(2.8) Cash generated from operations 119.9 Finance costs (net) paid (7.3) Tax paid (5.4) (12.7) Cash generated from operating activities 107.2 Cash flows from investing activities:

Purchase of non-current assets (95.0) Cash used in investing activities

(95.0)

Cash flows from financing activities: Repayment of inter-company loans (20.0) Cash flows from financing activities

(20.0)

Net decrease in cash and cash equivalents

(7.8)

Cash and cash equivalents at 30 September 2009 31.2 Cash and cash equivalents at 30 September 2010

23.4


Appendix 4

BZCS’s Mission Statement and CSR initiatives

BZCS’s mission statement is: “To be the preferred supplier for quality construction projects and to strive to implement a long-term relationship with our customers based on safety, quality and a timely service” BZCS has the following CSR initiatives: Prudent use of natural resources:

• Reducing waste • Improving design • Improving the use of resources • Improving its supply chain • Increasing the use of locally sourced resources

Environmental issues:

• Reducing water pollution • Reducing emissions into the atmosphere • Reducing waste going to landfill sites

Social issues:

• Improving Health and Safety for our employees and sub-contractors • Supporting our employees • Giving due consideration to the communities in which we work • Developing the skills of our employees

Economic growth

• Investing in the communities in which we operate • Rewarding our shareholders • Satisfying our customers • Managing our risks

End of pre-seen material


BZCS - Construction company case – Unseen material provided on examination day Additional (unseen) information relating to the case is given on pages 15 to 18. Read all of the additional material before you answer the question. ANSWER THE FOLLOWING QUESTION You are the Management Accountant of BZCS.

The Finance Director has asked you to provide advice and recommendations on the issues facing BZCS. Question 1 part (a) Prepare a report that prioritises, analyses and evaluates the issues facing BZCS and makes appropriate recommendations.

(Total marks for Question 1 part (a) = 90 Marks) Question 1 part (b) In addition to your analysis in your report for part (a), the Finance Director has asked you to prepare an email to be sent to non-financial managers in the Office Buildings Division of BZCS explaining the principles and the meaning of NPV calculations in general, together with your recommendation on the office building proposal. Your email should contain no more than 10 short sentences.

(Total marks for Question 1 part (b) = 10 Marks) Your script will be marked against the T4 Part B Case Study Assessment Criteria shown on the next page.


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


BZCS - Construction company case – unseen material provided on examination day Read this information before you answer the question Waste materials Charlie Rix is a junior procurement manager for BZCS. In the course of his work he came across some documents concerning the collection of waste materials from a site where BZCS is constructing a new water treatment plant. On investigation, Charlie Rix has found that the collected waste has not been sent to specialist waste disposal sites, but instead has been delivered to a local landfill site. Charlie Rix is concerned that some of the site waste could contain toxic chemicals. In your role as Management Accountant you had been asked to provide an analysis of the volumes of waste handled by all of BZCS’s waste material sub-contractors and the levels of materials recycled. You had a meeting with Charlie Rix last week to discuss gathering this information. However, when you met with him, he showed you the documents he has found concerning the disposal of this waste material which has been sent to a landfill site. Unfinished sports club BZCS signed a contract in August 2010 to construct 2 sports clubs for a small chain of private sports clubs called EXX Sports (ES) to be completed by December 2011. The contract was for a fixed price of €25 million for each of the 2 sports club buildings. All construction work would use BZCS employees and very few sub-contractors, as BZCS had employees immediately available to work on this project. BZCS planned to complete the first sports club before work started on the second, and this was acceptable to ES. An initial payment of €5 million for the first building was paid by ES when contracts were signed. Work commenced on the first of these 2 sports clubs in November 2010, but work was suspended temporarily when ES did not make the first stage payment of €5 million due in December 2010. Payment was made in late January 2011 and work was re-started. The next stage payment for another €5 million, became due at the end of April 2011, but was not paid on time. BZCS was informed that payment would be made in 10 days time and work continued. Following media speculation concerning ES’s cash problems, ES was put into liquidation on Friday 13 May 2011. All work on site was suspended that day. The 50 BZCS employees working on this project have not yet been allocated to other projects. To date ES has only paid €10 million. BZCS has applied to the liquidator to be added to the list of creditors. BZCS is claiming the contract revenue of €25 million for the first sports club which is partially completed, less the €10 million already paid, as well as the loss of profit of €3 million for the second sports club which has not been started. BZCS’s total claim is for €18 million. The liquidator is not optimistic and has indicated that all creditors may receive only around 10% of their claims. Alternatively, BZCS is considering a proposal to contact ES’s liquidator with an offer to pay €3 million to take on legal ownership of the unfinished sports club. If BZCS were to take legal ownership of the sports club, it considers that the maximum it could realise from the sale of the completed building would be €20 million, due to current depressed market conditions. BZCS has spent €14 million so far on the partially completed sports club. It is forecast that BZCS would need to spend a further €8 million to complete it. The Finance Director has asked you, as Management Accountant, to advise on whether BZCS should pursue the proposal to try to take ownership of the incomplete sports club. You should also advise on what would be the maximum that BZCS should pay to take on the unfinished sports club, if BZCS’s offer of €3 million is not accepted.


Office building proposal BZCS has worked with a leading international architect, Ben Bleur, on many projects previously. All of the projects were commercially successful and some building designs have won awards. BZCS has recently been asked by Ben Bleur to be the developer of, and to construct, an innovatively designed 50 floor office building in a European capital city. The project would utilise the latest environmentally sound technology to recycle heat and reduce carbon emissions. Ben Bleur’s building design has just received planning permission to proceed. He is now selecting a company to develop and construct the office building and has been approached by several interested competitors of BZCS. The deadline for BZCS to make a decision is 31 May 2011. The Commercial Director of BZCS’s Office Buildings Division is very confident that the proposed building design and the association with Ben Bleur will attract corporate buyers of prestige office space. This would be the first city centre large office building that BZCS has considered constructing without first identifying customers to buy the completed office space. Therefore, if BZCS decided to proceed with the development it would bear all of the commercial risk of this proposal, including the purchase of the land at €50 million. BZCS’s parent company has confirmed that it could secure sufficient external financing for this proposed development. If BZCS decided to proceed with this proposal, then it would need to generate publicity in order to secure sales of the office space. As is usual with the construction of such an office building, the actual construction work would not commence until a certain specified level of sales of office space had been made. BZCS would commence a sales campaign to sell whole floors in the building to customers “off plan”. An “off plan” sale is defined as a contracted sale of office space (usually a specified floor or several floors) before building work has even commenced. The “off plan” sales would be subject to BZCS selling a specified percentage of the building by a certain date. The Sales and Marketing Manager for the Office Buildings Division of BZCS has proposed that the percentage that should be sold before building work commences should be set at 30% by 31 December 2011. Usually, when a building is under construction, sales are easier to achieve as potential customers can see the style of the building under construction and are often attracted by the media interest it generates. However, if the 30% target for off-plan sales were not achieved, then BZCS could sell the undeveloped city centre building plot, although it may receive less than the €50 million that it would have paid for it. BZCS’s civil engineers have forecast that this project would use around 900 employees each year, as well as specialised sub-contractors. It is forecast that the total cost of the building would be €525 million (based on 2011 prices) over 4 years, including the cost of the land. It is forecast that the sale of all office space will be achieved over 4 years and will generate sales revenue of €700 million (based on 2011 prices). It is forecast that all office space will be sold within 1 year of the planned completion of the building in September 2014. The Finance Director recognises the need to secure sales of office space and you have been asked to discuss what actions the Office Buildings Division of BZCS should take in order to secure the sales of office space in order to generate the forecast cash inflows shown in the table on the next page. A sale of part, or all, of the building is sometimes made to a property management company rather than a corporate customer. The forecast cash inflows from sales shown in the table on the next page include all sales, irrespective of whether it represents the end customer or not. Following preliminary discussions with corporate customers looking for new office premises, DJ, a global insurance company, has expressed a serious interest in purchasing 25 floors of the building, which represents 50% of the office space. However, DJ has stated that the maximum price it is prepared to pay is €300 million, spread over 3 years, a discount of €50 million. However, an early sale of a significant proportion of the office building will also help attract other corporate customers.


Note: All figures shown below are based on 2011 prices

Year ended: 30 Sept 2011

30 Sept 2012

30 Sept 2013

30 Sept 2014

30 Sept 2015

Totals

All figures pre-tax € million

€ million

€ million

€ million

€ million

€ million

Cash outflows 50 180 170 125 0 525 Cash inflows: Without sale to DJ 0 120 150 180 250 700 With sale of 25 floors to DJ 0 140 170 200 140 650

The pre-tax cash flows are summarised in the table above. You should assume that the effective tax rate is 20% and that tax is paid, or refunded, 1 year in arrears. It should be assumed all cash flows shown in the table above are eligible for tax relief. The Finance Director has stated that the relevant post-tax discount rate is 15%, which includes a premium for the risk of this project. Problems with BZPM BZCS uses a project management system called BZPM. It is an off-the-shelf project management system which is widely used. BZCS pays an annual software licence fee to the software company, EAG. This IT system is used by all of BZCS’s Project Managers for each project to help them plan and monitor the progress, costs and resources for each project. This system is key to the day to day management of all projects and holds details of all current contracts and forecast cost details, as well as manpower resource planning details. The BZPM system interfaces with other BZCS IT systems. This allows the transfer of data electronically into BZPM in respect of payroll costs, supplier and sub-contractor invoices, all of which are charged to each activity within each individual project. The IT department installed the recently released upgraded software for BZPM last weekend, after all users had been informed that BZPM would be unavailable for the weekend. The upgraded BZPM was then tested and the IT department issued an email to all users on Monday morning of this week, informing them that the upgraded system was operational again. The IT department reminded all users about the new features of the upgraded BZPM and asked for any queries to be directed to the IT Manager, Nicos Talli. By the end of Tuesday of this week, 2 days after the upgrade was installed, Nicos Talli had received over 80 emails with queries from almost all of the Project Managers and their administrative staff. Nicos Talli is totally overwhelmed by the volume of emails with queries and problems raised by users throughout all of the divisions of BZCS. He has chased, by phone and by emails, his contact person at the software company, EAG, which has now admitted that it has other customers who are also experiencing some problems with the new software release. Nicos Talli has suggested that BZPM is closed down for 2 days whilst he investigates the problems. However, the Finance Director is under pressure to keep BZPM operational. He has asked Nicos Talli to check the integrity of the data contained in BZPM and to investigate what data has been corrupted, as some Project Managers have stated that dates have been changed within a project. He has also asked Nicos Talli to propose what actions should be taken. One of the Project Managers has suggested to Nicos Talli that the last backed-up version of BZPM from last Friday night, before the software update was installed, should be re-installed. However, there has been 3 days of new input of data, as well as transfers of data from other BZCS IT systems, since the last backed-up version of all the operational projects in BZCS. The Finance Director has asked you, as Management Accountant, to work with Nicos Talli to establish what actions are necessary in order to make BZPM fully operational and reliable.


Safety checks BZCS has a very good track record on safety issues and training and this is an important issue for its construction site workforce. At one of the government funded road building projects which BZCS is under pressure to complete in 3 weeks’ time, the required weekly safety checks on site machinery have not been completed for the last 2 weeks. The Project Manager is concerned that an accident could occur. He has repeatedly phoned and emailed BZCS’s Head Office every day for the last week. He has now stated that unless the safety checks are carried out by 5 pm tomorrow, work on site will completely stop. The cost of all employees and sub-contractors is €80,000 per day. BZCS’s Head Office has instructed the Project Manager to continue working on site. The Project Manager has been told by BZCS’s Head Office that a new contractor, TT, was appointed 2 weeks ago to carry out BZCS’s safety checks in this European country. BZCS’s Head Office has advised that this delay is just a one-off effect of the transfer to TT. However, on further investigation, TT has now admitted that it cannot undertake the safety checks at this site, as well as some other BZCS sites, for a further 4 weeks due to insufficient staffing. The Project Manager at the road building site has identified a suitable local safety management company, which has quoted a premium rate of €20,000 per week for all safety checks to be performed immediately for the road building site only. However, the contract is for a minimum period of 12 weeks.

End of unseen material


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

−+−

rr 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


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 7.793 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 = gP

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

Dd

D

E

VV

Vk

V

V

EV


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T4 – Test of Professional Competence - Part B Case Study

Examination

May 2011

Present value tablePresent value of 1.00 unit of currency, that is (1 + r)-n where r = interest rate; n = number of periods until payment or receipt.Cumulative present value of 1.00 unit of currency per annum, Receivable or Payable at the end of each year for n yearsFORMULAEValuation ModelsCost of Capital

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