Peng Zhan, a Chinese born Global Business Management graduate of Central Lancashire University has had twenty years experience working in large mining projects at a senior level of big companies in Cameroon and Niger. His long term friend and mining entrepreneur, Abigail Jallow, who has made a fortune mining copper has contacted him about a new opportunity.
The proposition is that he could set up his own company and take over a proposed gold mining opportunity in Ghana. At present the opportunity is in its early exploration stages. It was an opportunity Abigail came across while prospecting for copper but she does not feel she has the time to take it further.
So far the current indicated mineral resource discovered from test drill holes in a remote area of Ghana is estimated at 11,000 ounces of gold. There are a number of test areas still to evaluate.
At present Peng has been delaying giving an answer to Abigail while he evaluates the results. He can finance it as he has just inherited his father’s estate, which includes shares in a major publicly listed UK chemical company valued at over £6 million, which he could sell.
He has engaged you, an old UCLAN friend, to evaluate the project during March 2016. At present his best assessment of the costs and revenues are as follows:
- Payment to Abigail of £3.26m at the commencement of the project (1 April 2016) for exploration work to date and the rights to mine in the area for a period up to and including 2021 conferred by the Ghana central office of mining to Abigail.
- Payment of £2.5 million for further exploration drill holes in 2016.
- Based on the expected quality he expects to receive about a £1,000 an ounce for his gold, the expected quantity mined and operational cost to mine is estimated as follows:
|Year||Ounces||Operational Mining Costs|
- The mining license granted by the Ghanaian government requires the operator of the mine to clear and environmentally improve the area on completion. He estimates this will involve a £0.815 m cost at the end of the license in 2021.
He has asked you to use a cost of capital of 12.5% p.a. With the exception of the payment to Abigail assume all costs and revenues arise at the end of each year.
- Evaluate the net present value of the project at a cost of capital of 12.5% p.a
- Write a short report to Peng Zhan outlining the associated risks of the project.
Part B – 18 total marks
Jon and Matt Ltd, experts in the field of ladies’ handbags, is proposing to manufacture an exclusive range of ladies handbags, the Beck bag, sponsored by Victoria, a well know female celebrity and the Roo bag sponsored by Coleen, another well known female celebrity.
In order to make these intricate handbags, new machines would have to be bought. The bags are expected to be made for 5 years and they will then be replaced by new styles of bags. In both cases after five years the expected scrap value of the machine is zero.
The cash flows can be assumed to approximate with the profits (except they do not take account of annual depreciation).
The cost and the expected additional cash flows for the two different models are currently shown below:
|Expected cash flows||37000||43,000||43,000||25,000||12,000|
|Expected cash flows||43,000||43,000||37,000||37,000||37,000|
- Calculate the payback period for the two machines
- Calculate the accounting rate of return
- Discuss two drawbacks with using payback in investment appraisal
- Discuss two drawbacks with using accounting rate of return in investment appraisal
- When using net present value, costs such as market research incurred before a product decision is made are ignored in investment appraisal calculations. Why is this?
Part C – 19 total marks
- Your colleagues in the sales department have asked you to explain to them the various types of cost. You are required to draft an appropriate response to them and include an explanation of the benefits of such classification.
- The board of directors have asked you to explain to them which costs would be more relevant to Financial accounting, Management accounting and Financial Management.
Part D – 20 total marks
Dewhurst & Park plc. recognises the large increase in demand that has resulted from the new Government tariffs to encourage renewable energy. In an attempt to tap into this market it is determined to bring back manufacturing to the UK. However it recognises that due to lack of investment in UK manufacturing, which has occurred in the past, there is a lack of skilled labour able to manufacture these panels.
There are three types of solar panels the company could manufacture:
- The D&P One, a very high performance panel which converts 20% of the sunlight into energy.
- The D&P Two, a less expensive which converts 17% of the sunlight into energy;
- The D&P Three, which converts 15% of the sunlight into energy.
The costs provided by Dewhurst & Park plc are as follows:
1 2 3
Materials 98 72 60
Labour 56 48 40
Labour costs are £8 per hour.
Demand has been estimated as follows:
- 10,000 per annum at a selling price of £350.
- 8,000 per annum at a selling price of £240
- 6,000 per annum at a selling price of £220
The manufacturing capacity available in the factory for this work is only 106,000 labour hours per annum with the fixed costs being £800,000 per annum.
- You have been asked to determine the most profitable product or products to manufacture showing the actual amounts to be manufactured.
- Produce a profit statement for the proposed demand.
- What products or products should be subcontracted (if any) and, if so, how many? How much extra profit would be generated?
Note: If there is a shortage, sub contracts can be placed with a Chinese firm.
The Chinese firm would buy the materials, pay its own labour and produce and deliver the goods to Dewhurst & Park plc’s factory at the following prices: D&P One at £200 each, D&P Two at £170 each and D&P Three at £160.00 each.
Part E – 10 total marks
The Lancashire Hills Hotel has 150 (the maximum capacity is 150 guests) rooms and the owner have hired your strategic management consultancy to analyse hotel costs to determine the break-even point and the profit the hotel makes at various levels of occupancy. The owner has given you the following information to assist you in the project:
Staff salaries 2,000
The direct costs of providing accommodation for each guest, such as food, linen and cleaning are £100 per week. The remaining overheads are semi-variable though the data isn’t completely clear.
The last four weeks have shown
Occupancy Other overheads
3 84 £8,500
4 75 £7,600
5 61 £6,800
6 57 £6,000
The average price per stay at the hotel is £218 per week.
You are required to
- Calculate the average number of guests needed each week to break even.
- Calculate what the weekly profit/loss of the hotel would be if the occupancy levels were:
In memo format, advise the board of a cash rich company, where you are an employee in the financial management department, about the importance of the three main components of financial management.