Assessing the development and launch of My-Mate

Category: Accounting

Assessing the development and launch of My-Mate

Z-Tel is a company manufacturing high-profile equipment for customer premises, in the telecom industry in Sri Lanka. Although it is not the market leader, it produces high-quality reliable products for highly demanding customers. The following scenario relates to the development and launch of a new product called My- Mate.

January 2004

In early January 2004, Z-Tel Ltd considered making a new product called My-Mate. Up to that

time, Rs.75.0 million had been spent on researching to develop the product.

The company expects that it would take two further years to develop the product to the point of

production and by that time it would probably have a lead of 18 months over its primary

st

competitors. Z-Tel expected to launch the product on 1 January 2006 and to produce and sell

100,000 units in the first year if Rs.150.0 million was spent on pre-launch advertising. During the

first year of production Z-Tel planned to spend Rs.75.0 million on advertising; and this level of

expenditure would be maintained each year.

From the second year onwards, the market was expected to increase between 160,000 units and

200,000 units. Once a competitor entered the market, it was thought that the competitor would

win 50% market share very quickly because of their reputation.

The development and engineering costs of My-Mate were estimated to be Rs.600.0 million,

Rs.200.0 million of which would be incurred in the first year of development, 2004. A special

piece of equipment costing Rs.50.0 million would be required for the production and this was to

be installed at the commencement of production.

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Professional II Stage - Strategic Management Accounting (SMA)

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Z-Tel planned to set a price of Rs.24, 900 a unit on the basis of variable manufacturing and

distribution costs, expected to be Rs.12, 200 per unit. The company normally sets selling prices

so that the contribution/sales ratio is 50% or slightly higher. The fixed costs relating to the

product were estimated to be Rs.750.0 million per annum. It was also estimated that working

capital of Rs.250.0 million would be needed at the start of production in January 2006.

The product was expected to have a life span of about five years at which time the equipment

would be scrapped as having no value.

January 2007

Development of My-Mate took six months longer than planned. This was mainly due to delay in

recruiting two engineers who are specialist in the product.

The engineering department did not have a budget for this in year 1 (2004) and therefore the

employment was delayed until the start of the second year, January 2005, when the budgets for

extra funds have been approved. This caused the planned expenditure on development for year 2

to be spread over the 18-month period from the start of the second year to the middle of year 3.

The two new members of staff were employed at a salary of Rs.4.50 million each and the

employment costs were estimated to be 100% of the first year salary. As a result, production

started six months late in June 2006 and only 55,000 units were sold in 2006.

As expected, a competitor has decided to enter the market and is launching its rival product

ULTRA-MATE in January 2007.

Z-Tel now predicts the market for 2007 to be 150,000 units and its share to be 50%. Thereafter

the market size will be as forecasted previously, which is between 160,000 and 200,000 units

each year, and the product life cycle will stop at the same date as planned previously. The

monetary value of all expenditure and revenues to date has been very close to the estimates and

there is no reason to revise future forecasts in this respect.

Other information

The company's cost of capital is 12% after tax. The equipment will be entitled for capital

allowances at 25% on a straight line basis. The tax rate is 30%. The tax will be paid/ (received) in

the same year in which revenues and costs were earned/ (incurred).

..

You are required to:

(a) Calculate the net present value of the project as perceived at the beginning of January 2004,

when Z-Tel decided to make My-Mate. State clearly any assumptions you make.

(17 Marks)

(b) Calculate the revised net present value of the project as perceived at the beginning of

January 2007. (11 Marks)

(c) Using the above scenario as an example, explain how each of the following could be

incorporated to the project appraisal.

(i) Learning and experience curve benefits.

(ii) Life-Cycle costing

(iii) Target-costing (04 x 03 = 12 Marks)

(Total 40 Marks)

End of Section A

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Professional II Stage - Strategic Management Accounting (SMA)

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Section B

Answer any two (2) questions

Question No: 2 (20 Marks)

F Ltd is a mechanical engineering company specializing in the manufacture of brass valves using

general purpose lathes. Its cost of capital is 12%.

A number of lathes have reached the end of their useful lives and F Ltd is in the process of

replacing the lathes.

Currently, two alternative models are being considered for replacement. The cost details of the

two models are given below:

Model Useful Purchase Maintenance cost per year

life price 1-5 6-10 11-15

Rs. Rs. Rs. Rs.

A 15 years 6,000,000 200,000 280,000 390,000

B 10 years 4,500,000 310,000 530,000 -

The residual value of a lathe drops by one-third of its purchase price during the first year of its

ownership and thereafter declines by 4% of purchase price of model A and 6% of purchase price

of model B, per year.

Model B can also be rented on the following terms:

f Annual rentals (including maintenance costs) paid in advance is Rs.1,020,000 (for the first

year), Rs.1,025,000 (for subsequent four years) and Rs.1,099,500 (for final five years); the

lathes are returned to the hirer at the end of ten years.

f The rental may be terminated at any time on payment of a penalty of Rs.1, 000,000, declining

by Rs.100, 000 per year with each year of the rental agreement completed.

You are required to advice on suitable replacement strategies as follows:

(a) Which option (purchase A, purchase B, rent B) is most economical assuming the brass valve

production continues for at least 20 years. (09 Marks)

(b) Advice which option (purchase A, purchase B, rent B) is most economical assuming the brass

valve production continues for five years. (07 Marks)

(c) Explain the non-financial factors that might be relevant to the decision making? (04 Marks)

(Total 20 Marks)

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Question No: 3 (20 Marks)

F Ltd is considering launching a new monthly magazine at a selling price of Rs.100.00 per copy.

Sales of the magazines are expected to be 500,000 copies per month. However, it is possible that

actual sales could differ significantly from this estimate.

Two different methods of producing the magazines are being considered and neither method

would involve any additional capital expenditure. The estimated production costs for each of the

two methods of manufacture, together with additional marketing and distribution costs of selling

the new magazine are given below:

Method A Method B

Variable costs Rs.55.00 per copy Rs.50.00 per copy

Specific fixed costs Rs.8.0 million per month Rs.8.0 million per month

Semi-variable costs

- 350,000 copies Rs.5.50 million per month Rs.4.75 million per month

- 450,000 copies Rs.6.50 million per month Rs.5.25 million per month

- 650,000 copies Rs.8.50 million per month. Rs.6.25 million per month

It may be assumed that the fixed cost content of the semi-variable cost will remain constant

throughout the range of activities shown above.

The company currently sells a magazine covering related topics to those who will be included in

the new publication and consequently it is anticipated that the sales of the existing magazine will

be adversely affected. It is estimated that for every ten copies of the new magazine, sales of the

existing magazine will be reduced by one copy.

Sales and costs of the existing magazines are shown below:

Sales - 220,000 copies

Selling price - Rs.85.00 per copy

Variable costs - Rs.35.00 per copy.

Specific fixed costs - Rs.8.0 million per month

You are required to:

(a) Calculate for each production method, the net increase in the company profits which will

result from the introduction of the new magazine, at each of the following levels of activities:

- 500,000 copies

- 400,000 copies

- 600,000 copies (12 Marks)

(b) Calculate, for each production method, the amount by which sales volume of the new

magazine could decline from the anticipated 500,000 copies per month, before the company

makes no additional profit from the introduction of the new publication. (08 Marks)

(Total 20 Marks)

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Question No: 4 (20 Marks)

STAR is a high- quality perishable product which cannot be stored and is produced in one

department of EFP Ltd. Because of its high-quality, STAR is sold at a premium price in the

market.

The department is fully engaged in making of STAR and employs only one grade of labour. At

present there are 105 operatives in the department, all working a 40-hour week and overtime is

not permitted. The operatives are paid Rs.300 per hour with a guaranteed wage of Rs.12, 000 per

week. The production capacity of the department is frequently restricted because additional

operatives of the required skills cannot be recruited.

Demand for STAR is variable, the minimum weekly demand is 6,000 units and the maximum is

9,000 units per week.

The estimated production costs, selling price and the consequent profit per unit of STAR are

given below:

Rs. Rs.

Selling price 500.00

Material 100.00

Labour (0.6 hours * Rs.300) 180.00

Variable overhead 60.00

Fixed overhead 90.00 430.00

Profit 70.00

Variable overhead vary with the units produced, the fixed overhead absorption rate is based upon

an activity level of 7,000 units per week.

The department manager was rather puzzled by a recent remark made by the accountant. The

accountant has been referring to the cost of machine breakdowns which had resulted in operatives

being idle for 210 hours in two successive weeks. In the first week, when demand for STAR had

been 6,500 units, the accountant claimed that the cost of the 210 hours idle time was zero. In the

second week, when the demand for STAR had been 7,500 units, the accountant claimed that the

cost of the idle time had been Rs.119, 000.00.

You are required to:

(a) Carefully explain to the department manager how the accountant has calculated the cost of

idle time for each of the two weeks described above. (10 Marks)

The department manager is considering two alternative proposals for extending the capacity, to

satisfy potential demand for STAR. These are:

(i) Introduce an incentive scheme, for all STAR produced in the department. Operatives would

be paid Rs.200.00 for each unit produced. The manufacturing time would be reduced to 0.50

hours per unit and the guaranteed weekly wage would be withdrawn.

(ii) When demand exceeds current capacity, purchase frozen STAR from another supplier at

Rs.400.00 per unit. Hence further processing would not be required and the product could, be

sold to the customers under its own label.

You are required to:

(b) Calculate the profitability on each of the schemes suggested and recommended by the

department Manager. Which scheme is suitable? (06 Marks)

(c) Comment on any other factors to be considered before a final decision is to be made?

(04 Marks)

(Total 20 Marks)

End of Section B

Society of Certified Management Accountants of Sri Lanka 5

Professional II Stage - Strategic Management Accounting (SMA)

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Section C

Answer only one (1) question

Question No: 5 (20 Marks) (Use the information from the scenario in question 1 to answer this

question)

(a) Explain the concept of the life-cycle costing and give reasons why it may be important to

use it. (05 Marks)

(b) Using the figures from the proposal made in January 2004, draw a life cycle chart for

�My-Mate�. (Precision is not required) (03 Marks)

(c) Discuss the importance or otherwise of a post-project audit, to the successful use of life-

cycle costing techniques. (07 Marks)

(d) Discuss the difficulties of using life-cycle costing techniques in an organization with a

heavy reliance on periodic reporting. (05 Marks)

(Total 20 Marks)

Question No: 6 (20 Marks)

(a) Identify and discuss the circumstances that have brought about the proposition that

traditional management accounting control systems have lost their relevance to today's

manufacturing and organizational environment. (5 Marks)

(b) Evaluate strategic cost management initiatives which may be used in order to restore the

relevance of management accounting control systems in today's manufacturing and

organizational environment. (15 Marks)

(Total 20 Marks)

End of Section C

End of Question Paper