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Dear Mr Moffat,
I was going through the above mentioned question and I encountered some controversial issues. In the question the examiner writes “This investment will increase production capacity by 9000 units PER YEAR”. This clearly means that in year 1 we will have 9000 and in year 2 we will have 9000*2 and in the final year, year 4, we will have 9000*4 = 36000. However, in the suggested answers of ACCA all years have the same units – 9000. This just doesn’t make sense! It’s 9000 units per year (increasing) so it’s cumulative. However, then I read the examiner’s report and he said that students who analysed the situation as I did will not be penalised.
Now my query to you is, obviously as my answers didn’t exactly correspond to the answers of the examiner, I am wondering what’s the “right” analysis. What do you think? Can you please clarify this situation for me? According to you what’s the correct approach and why? Also, in June 2013 candidates weren’t penalised for analysis as above but what if in June 2014 a similar situation is encountered and I analyse as I did above, then will I be penalised (as in June 2013 exam report he hasn’t mentioned anywhere that future candidates taking a similar approach will be penalised). I fear I might do the wrong thing and get penalised.
Another controversial issue is that of working capital. First of all, I have never really understood how working capital links with investment appraisal and why is working capital an outflow in year “0” and an inflow in the “final” year of the project. Why is it so – why is there this discrepancy? Again, in the exam report of June 2013, he mentioned that he wouldn’t penalise students that assumed that working capital was recovered in the final year of the project, although in his own answer, he says that “as the machine will be replaced” then working capital will not be recovered and works out working capital on an incremental inflationary basis. I took the opposite approach to this. I just showed an outflow of working capital in year 0 of 500 and an inflow in year 4 of 1.074^4*500= 600.84 and didn’t show any accounting for working capital in between. I took this approach, so is it correct? Is it the same approach that the examiner referred to in his report that would be ” not penalised”. Again, if in June 2014 a similar ambiguity in working capital arises and I take the “second best” approach then will I be penalised on the grounds that such a point came up in June 2013 and the examiner explained his approach then?
What’s the right approach of working capital for you, in this particular question, and why do you take such an approach?
Very sorry for the long query for this particular question has so much ambiguity and the examiner didn’t penalise candidates in June 2013 so I’m just wondering whether if I take alternative approaches in this June 2014 exam, then I fear he may penalise the alternative approaches that I take, on the grounds that he already mentioned his preferences in earlier marking schemes and exam reports.
Thanks,
Gabriel.
With regard to the 9,000 per year, the wording of the question was actually OK. If you are paid a salary of 10,000 a year, and I tell you that I am going to increase it by 1,000 a year, then I think you would expect to get 11,000 a year (not automatically 11,000 then 12,000 then 13,000 and so on). It would be a very strange machine that would not only increase production by 9,000 a year, but would then increase it by an extra 9,000 each year as well! What sort of machine could do that? 🙂
However, there are regular meetings between the examiner and the markers while exams are being marked. As you point out, he realised the language problem and students were not penalised. It means that in future he will make it more clear to avoid any problem.
With regard to working capital, the reason for it is that if there is a new project then it will need (for example) the purchase of more inventory of raw materials at the start of the project. It is that sort of thing that creates the need for an extra cash outflow at the start of the project. When the project is finished, there is no longer the need to hold extra inventories etc which is why we usually assume that the cash comes back at the end of the project.
In this question it was clear that the project would in fact continue, which is why the working capital was not brought back at the end. However, most people did bring it back – and again the examiner said that they would not be penalised.
The examiner is very fair indeed – in both cases he would have been justified in marking people down because the question was not actually ambiguous at all, but he understood the problem and did not penalise.
Also, remember, that every figure is marked separately – the final answer counts for nothing – and that even if you do read something incorrectly it will only be the loss of maybe one mark.Do let me know if any of the above does not make sense 🙂
Dear Mr Moffat,
Please explain the calculation of incremental fixed costs because the calculations of fixed cost are not shown in the answer of june 2013 answers.
Thanks,
The fixed costs are 250,000 a year at current prices, inflating at 5% per annum.
So at time 1 they are 250,000 x 1.05 = 262,500.
At time 2 they are 250,000 x (1.05)^2 = 275,625
and so on (the examiner has obviously rounded to the nearest thousand).I do suggest that you watch our free lecture on investment appraisal with inflation.
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