ACCA APM Past Exam Rewritten - Q: Daldorn - Risks

ACCA Director Author

ACCA APM Past Exam Rewritten - Q: Daldorn - Risks

Q: DALDORN (SEPT/DEC 19) Managing Risk and Uncertainty in Strategic Planning, and Risk Appetites

Dive deeper, conquer those exams, and truly make your mark by grabbing your spot in our ACCA online course today at www.globalapc.com – let’s crush this together!

Exhibit 1 – Company information

Daldorn is a manufacturer of heavy steel items. It is funded by a venture capitalist organization (VC). Following a period of poor performance, the VC has expressed concern that Daldorn’s board members are focusing too much on their own interests, while neglecting to adequately measure and manage company performance in respect of other stakeholder groups. The company has experienced severe cash flow difficulties due to financial losses made on the sale of several new products. These difficulties have been attributed to poor pricing decisions, which were the responsibility of the board and have resulted in many employees losing their jobs.

Exhibit 2 – Key stakeholder groups

The VC has identified three key stakeholder groups at Daldorn:

The board: The VC is concerned that due to the past losses made on several new products, the board has become too cautious in their attitude towards potential new projects and, in particular, to the pricing of new products. Given the importance of the board to the success of Daldorn, the VC has recently implemented a new bonus scheme. This is an attempt by the VC to revise the board’s appetite for risk and encourage them to take more risks, for example, in deciding on the price of new products. Board members will now receive a very large annual performance-related bonus for Daldorn’s achievement of challenging targets set on the financial performance measure of return on capital employed (ROCE).

Employees: The manufacturing process at Daldorn does not require employees to have a high level of skill, and so most of the manufacturing employees are relatively low-skilled. Other employees in other departments have roles which can require specific skills and qualifications. There is a high level of unemployment in the region where Daldorn is based.

Government and regulators: Daldorn operates in a strict regulatory environment. Daldorn has a good record of compliance, but recently its own scientists have discovered high concentrations of a toxic pollutant, which is a waste product from its own manufacturing processes, in the soil near to its factory.

The VC has asked for your advice on whether Daldorn’s existing measures shown in Appendix 1 adequately measure the company’s performance in managing the concerns of each of these three key stakeholder groups. You may justify the use of alternative measures, but the VC wants only one measure for each stakeholder group and is not concerned about the potential conflict between measures at this stage. As part of this work, the VC expects you to briefly comment on the power and interest of the three stakeholder groups.

Exhibit 3 – Pricing decision

Daldorn is about to launch a new product and needs to determine an appropriate price to charge. The variable cost of each product is uncertain, and hence, there are three possibilities for each demand level. The total contribution of the products at the three possible anticipated levels of demand is shown in Appendix 2. You have been asked to evaluate which price the board would choose for the new product based on the board’s revised attitude to risk and briefly comment on the drawbacks of the decision rule used.

Exhibit 4 – Investment projects

Two new mutually exclusive manufacturing projects, which are totally unconnected to Daldorn, have become available for the VC to invest in. The VC has undertaken many similar investments before and is an almost entirely risk-neutral investor. Two important exogenous (external) variables affecting the net present value (NPV) of the new projects, A and B, are the worldwide demand for steel products and the level of tariffs applied to the import of a key raw material. The probabilities of these two variables are independent. The VC has estimated the probabilities of there being low, medium, or high levels of these two variables in Appendix 3, together with an estimate of the expected NPV for project A for each level of demand and tariff and an estimated overall expected NPV for project A. An analyst has already calculated that the overall expected value of project B is $1,347 million.

As a final requirement, you have been asked to advise the VC which of the two new investment projects it should undertake, including an evaluation of the appropriateness of the numerical technique used.

Exhibit 5 – Appendix 1:

Exhibit 6 – Appendix 2: Demand, selling price, and variable cost for the new product

Exhibit 7 – Appendix 3:

Project A – Expected NPV ($ million) for each possible demand level and tariff level combination

Project A – Joint probabilities for each possible demand level and tariff level combination

Project A – Overall expected NPV calculation

*Assuming the probabilities of the two variables are independent.

Notes:

1. The standard deviation of the outcomes for project A has been correctly calculated to be 103, and the standard deviation of the outcomes for project B has been correctly calculated to be 106.
2. An analyst has already calculated that the overall expected value of project B is $1,347 million.

Required:

(a) Assessment of the performance measures in relation to the stakeholder groups as required by the venture capitalist organization (VC) (9 marks)

(b) The price of the new product and the drawbacks of the decision rule used (5 marks)

(c) The investment project to undertake and the appropriateness of the numerical technique used (6 marks)

Professional marks will be awarded for the demonstration of skill in analysis and evaluation, scepticism, and commercial acumen in your answer. (5 marks)

(Total: 25 marks)

Answer:

(a)

Board (9 marks)

Stakeholders - Power/Interest Commentary:

1. Board members possess substantial power and interest. Their comprehension and endorsement of Daldorn's strategy are fundamental. (1 mark)

Advice on Performance Measures:
2. Their motivation is essential for Daldorn's performance, necessitating a suitable reward system. The VC's performance-linked bonus anchored to ROCE is a recent addition. (1 mark)

1. While ROCE is familiar, it can discourage new asset investments, presenting drawbacks. (1 mark)
2. Alternatives like EVATM might counteract ROCE's limitations, offering a more rounded measure. (1 mark)

Employees (9 marks)

Stakeholders - Power/Interest Commentary:

1. Employees, amidst high regional unemployment, have profound interest but minimal power given their replaceability. However, the stringent regulatory landscape could enhance their power via legal rights. (1 mark)

Advice on Performance Measures:
2. Ensuring they're informed prevents alignment with potent entities like trade unions or regulators. (1 mark)

1. For the predominantly low-skilled workforce, assessing training costs might be unsuitable. Instead, monitoring productivity can enhance job security. (1 mark)
2. For certain skilled roles, training cost metrics are apt. Yet, the mere cost might not signify efficacy. A measure like the percentage achieving relevant skills could be more telling. (1 mark)

Government and Regulators (9 marks)

Stakeholders - Power/Interest Commentary:

1. Despite their potent influence and mild interest, there's an absence of metrics related to government and regulators, particularly in a strict regulatory climate. (1 mark)

Advice on Performance Measures:
2. Ensuring satisfaction can preempt them becoming pivotal stakeholders. Instituting metrics around environmental aspects, such as toxic soil pollutant levels near Daldorn's establishment, can be strategic. This permits timely actions should pollutant levels verge on breaching norms. (1 mark)

(b) The board's bonuses and decision-making approach (5 marks)

1. With substantial performance-tied bonuses, the board's risk attitude leans towards seeking. They'd favor the 'maximax' method. (1 mark)
2. By this rule, the optimal price is $95,000, yielding a peak contribution of $55,100,000. (1 mark)
3. A significant limitation of this decision rule is the potential encouragement of excessive risks. It disregards outcome probabilities, which can be intricate to determine. (1 mark)

(c) The VC's decision-making perspective (6 marks)

1. The VC, largely risk-neutral, will favor the project with the premier expected NPV through the EV method. (1 mark)
2. EV's typical pitfall is its long-term averaging, unsuitable for unique decisions, and may not reflect a project's real outcome. Despite these limitations, the VC's experience in such projects makes EV fitting. Yet, estimations can be subjective and potentially flawed. (1 mark)
3. Both projects exhibit an identical NPV of $1,347 million, leaving the VC neutral. Project A, having a slightly lower deviation, implies reduced risk. Given identical NPVs, further analysis, including sensitivity or PEST evaluations, could guide the VC's choice. (1 mark)

Marking scheme:

Categories: : Advanced Performance Management (APM)