ACCOUNTING FOR NON-FINANCIAL MANAGERS

OBJECTIVES OF THE ASSIGNMENT

1. To introduce the students to academic literature and essay writing.
2. To test the student’s knowledge of investment appraisal techniques.
3. To introduce the student to financial case study material and financial management report writing.

REQUIRED

You are a Senior Financial Manager in the recently privatised Sodor Railway Engineering Corporation Plc (SREC).

(a) Subsequent to privatisation the Chief Executive Officer of SREC feels that the organisation needs to clarify its mission and objective. In order to achieve this he has asked you to review relevant academic literature and discuss the relative benefits of competing objectives of the firm.

This review of the literature should be written as an essay and refer to academic books and journal articles to support your discussion. It is expected that the essay should be approximately 1,000 words in length.

(b) For the attached case study you are required to produce a report for the CEO, which discusses the viability of the proposed project. This report should:

i. describe the meaning and relevance of the time value of money.

ii. find out the Net Present Value of the project, as specified in the project proposal.

iii. Discuss the viability of the project if, during the course of the final negotiations, changes are made in terms of:

• Sir Hatt asks for a discount;
• The payment schedule is revised;
• The estimated level of costs proves to be inaccurate;
• The provisional cost of capital is incorrect.

iv. Justify assumptions made and describe the relevance of the calculations performed;

v. Include appropriate figures and tables to support your report

The report should be produced in a format appropriate to present to the CEO and should be approximately 1,000 words in length (excluding tables and figures).

THE SREC CASE

On 1 October 2011 you were notified that after a lengthy discussions and a bidding process SREC had successfully won a contract to build a new track for FC Railway. The CEO is to hold final negotiations and sign the contract with Sir Hatt, the CEO of FC Railway, over the next few weeks. It is hoped that the final contract will be signed early in December 2011. From previous experience you know that before the contract is signed Sir Hatt may well come up with last minute changes to the proposal or that SREC will discover some unexpected difficulties that could lead to higher costs.

The project is described in below.

Project description

Long-distance track connecting Tidmouth with Ditmouth for FC Railway. It is expected that work will commence on 1 January 2012 and that the track will take two years to complete. In addition SREC will maintain the track for the first ten years of operation (1/1/14- 31/12/23). To date costs incurred in the bidding process are €0.5million.
The payment schedule

An advance on start of work (expected 1 January 2012) = €4.4million.

Two instalments (expected 1 January 2013 and 1 January 2014) = €7.6million each.
A retention to be repaid in two equal amounts (expected 1 January 2015 and 1 January 2016) = €1.1million each.
The maintenance contract of €1.6million will be paid annually in advance. The first payment is due on 1/1/14 and the tenth and last payment on 1/1/23.

Projected costs

Track and electrical cables: €6.9million, this will be ordered immediately on signing the contract and will be paid for on 1 January 2012.
Maintenance and testing equipment: €4.7million, this will be bought in the second year of work and is expected to be paid for in two instalments: 1 January 2013 €2.8million; 1 January 2014 €1.9million.

Labour and material costs: In 2012 = €6.1million; 2013 = €3.1million; 2014-2023 = €1.4million per annum. These costs include €0.3million each year for time spent on this project by existing employees. It is believed that these existing employees have sufficient capacity to undertake this project work in conjunction with their present jobs and if the project does not proceed they will remain in their present jobs.

Overhead costs: These have been estimated at €1.0million for 2012 and 2013 and fall to €0.5million for 2014-2023. 60% of these overheads is an allocation of existing company fixed overheads and 40% represents the overheads incrementally incurred on this project. In addition office space that SREC owns will be required for this project. If the project does not go ahead the office space will be rented out and SREC would receive €0.1million per annum in rental income.

You may assume that cash flows related to relevant labour, material and overhead costs and rental income occur on 1 January of the year to which they relate.

The Island of Sodor is a tax haven and as such SREC will not be required to pay any tax.

Finance costs: The project will be financed by both debt and equity. Interest and dividend payments will total €0.3million per annum.

You may assume that there is no inflation and that the cost of capital for SREC has been provisionally set at 9%.