Examiners' report - June 2004
Module B, Paper DB2 (project)
Incorporating subject areas:
- Financial Strategy
- Risk Management.
Overall, the performance of candidates in the project was satisfactory. In some cases, the standard of the projects submitted was very high indeed, which reflected well on the efforts made by some candidates. In a minority of cases, however, it was clear that candidates had not reached the point in their studies where they were able to undertake the project with any real chance of success.
General comments
The project concerned a company that operated a dry-ski slope and which was examining a proposal to build a new slope in order to exploit the growing popularity of snowboarding.
Many of the projects were well-researched and well-argued and some were a pleasure to read. The general standard of presentation was high with candidates making good use of tables and diagrams to illustrate key points. The project required a large number of calculations to be made and it was particularly important for candidates to state any assumptions made and to show workings clearly. Unfortunately, this was not always done and so, for some candidates, the opportunity to gain higher marks was lost.
Questions
Part (a) of the project carried 36 marks out of a total of 100 marks and required candidates to evaluate the investment proposal using both the payback method and net present value method of investment appraisal. It also required candidates to use scenario analysis in order to help assess the riskiness of the project. Most candidates managed to achieve a pass standard in this part and there were some excellent answers provided.
A common error in the answers submitted, however, was to ignore the benefits that continued to flow to the company when the slope was closed after eight years. The project stated that 5,000 extra visitors would visit the main slope over a five-year period following the closure of the snowboarding slope. These extra visitors were expected to migrate to the main slope following closure of the snowboarding slope and the benefits that this brought arose as a direct result of the snowboarding slope.
Another common error was to ignore the requirement that the evaluation date was 1 February 2004 and so all inflows and outflows occurring after this date had to be discounted.
In a few cases, candidates failed to gain marks because they did not appear to read the instructions given. Some projects contained an evaluation based only on the most likely scenario while others failed to provide workings showing how the key figures were derived.
Part (b) carried eight marks and required candidates to discuss the parent company’s existing approach to evaluating investment proposals and to make recommendations for improvement. The standard of answers for this part was generally satisfactory but there were only a few very good answers. Many candidates set out the strengths and weaknesses of the payback and NPV methods but offered few ideas for improvements.
Where recommendations were offered, it was often for additional appraisal methods, such as discounted payback and IRR. However, given the stated objective of the company of profit maximisation, the NPV method was entirely suitable and it was not always made clear how employing multiple methods of appraisal would represent an improvement. The use of the payback period was questionable, except perhaps as a partial measure of risk, but this point was rarely made.
Some answers mentioned the value of sensitivity analysis and the use of probabilities to help assess risk, for which credit was given. Part (c) carried 20 marks and required candidates to identify the key risks associated with the proposal and to suggest ways in which these could be managed. The standard of answers for this part was, again, generally high. However, there was often a tendency to focus on financial risks and to deal less fully with the operational risks associated with the proposal. In some cases, risks were identified but ways of managing the risks were not discussed.
Part (d) carried 12 marks and required candidates to identify further information that the parent company was likely to require concerning the planning, monitoring and control of the project. This attracted a wide variety of answers and most candidates managed to make sufficient valid points to obtain a good mark.
Part (e) carried 15 marks and required candidates to prepare a projected profit and loss account and cash flow statement for the forthcoming year under the most likely, optimistic and pessimistic scenarios. This part was often done poorly. Many struggled to prepare a profit and loss account.
To provide an accurate answer a distinction had to be made between the future variable costs and future fixed costs of the business. In addition, the projected cash flow statements were often poorly presented and did not show clearly the amount of external funding that was needed.
Part (f) carried nine marks and required a discussion of the factors to be considered when choosing between loan capital and preference share capital. The answers to this part were generally satisfactory. However, a number of candidates failed to identify the tax benefits of loan capital, which can be a decisive factor in financing decisions.
In addition, a number of candidates suggested the issue of convertible preference share capital, even though the case study made it clear that the parent company would not sanction the issue of equity shares - and presumably preference shares that may ultimately be converted to equity shares.