Question
Refer to the Ducal Aspirateurs case study (DA) (SL/HL paper 1 Nov 2020).
DA’s board must make two major decisions.
Decision 1: DA needs to reduce employment costs. A new system of pay and benefits is under consideration. This includes:
changing from an annual salary to low basic wages with profit-related bonuses
reducing social benefits for employees, such as paying market rents for the housing in Ville d’Ablet and having to pay for the use of the leisure facilities
offering generous compensation payments to employees who are prepared to leave the business.
Decision 2: The three options from DA directors (lines 105–143) must be considered.
Immediately prior to the board meeting, Mia withdrew her proposal (Option C).
There is now additional information available on the remaining options.
Option A: Louise’s proposal – market development
Louise plans to target the mass market and proposes using the brand name DuLow for the redesigned products. She is planning for DA to outsource production to Star Electrics (SE). SE uses mass production together with some customization of products. SE keeps costs low by importing cheap raw materials and paying low wages.
Ben, the human resource management director, is concerned about the impact this change would have on DA’s employees.
Option B: Salah’s proposal – product development
Salah’s plan requires new production lines, one for each product. Salah proposes using cellular manufacturing. The investment cost is estimated to be €500 million. Salah estimates the following net cash inflows (excluding the initial investment cost).
Table 1: Forecast financial information for Option B (figures in € millions)
Louise thinks the option is expensive. Dodi, the finance director, thinks that the investment is too large and he believes that some shareholders are also concerned about the size of future dividends. Salah believes that shareholders will be pleased about the revenues that this investment will generate. Mia is worried that the products would be expensive to produce and that demand might fall in five to seven years.
a. Define the term retained profit.
b.i. Using Table 1, calculate for Option B the average rate of return (ARR) (show all your working).
b.ii.Using Table 1, calculate for Option B the payback period (no working required).
c. Explain one advantage and one disadvantage for DA of replacing the current pay system and benefits with the proposed employment package (Decision 1).
d. Using the Ducal Aspirateurs case study and additional information, recommend whether DA should choose Option A or Option B (Decision 2). [10]
▶️Answer/Explanation
Ans:
a. Profit made by the business, calculated after all deductions, including dividends. It is reinvested into the business as an internal source of finance.
Award [1] for a partial definition and [2] for a full, clear definition. This answer does not need to be in context and can be worded differently to the above.
b.i.
$$
\begin{aligned}
& \text { Average rate of return }(\mathrm{ARR})=\frac{\frac{\text { (total returns-capital cost) }}{\text { years of use }}}{\text { captital cost }} \times 100 \\
& \mathrm{ARR}=\frac{\frac{((50+150+200+300+400)-500)}{5}}{500} \times 100=24 \%
\end{aligned}
$$
Award [3] for a correct answer which must include %.
Award [2] if there are no, or incorrect, units.
Award [1] if the working is not shown.
c. After 3 years $400m paid back so needs 4 more months
So payback = 3 years 4 months
Accept alternative formats such as “40 months” or “3 and 1/3 years” or “month 4 of year 4”
Award [1] for correct answer
Advantages include:
More motivated workforce as a result of bonuses, higher productivity (possible link to Taylorism)
Generous redundancy can encourage workers who are thinking about moving out of the village of Ville d’Ablet
Accept any other valid advantage.
Disadvantages include:
Less certainty for employees in terms of pay, which may affect motivation
Loss of current benefits will affect morale (possible link to Herzberg or Maslow)
Likely increase in staff turnover, reduced staff retention and more difficult to recruit staff.
Accept any other valid disadvantage.
Award [1] for each relevant advantage identified and [1] for a description of how that advantage relates to DA. Award [1] for each relevant disadvantage identified and [1] for a description of how that disadvantage relates to DA.
d.
Refer to Paper 1 markbands for May 2016 forward, available under the “Your tests” tab > supplemental materials.
Option A
Advantages include:
Much larger market
Some customization of products
Lower investment cost
Brand widely recognized so maybe strong market
Disadvantages include:
May impact on DA’s upmarket brands.
Cheaper raw materials, lower wages, issues with outsourcing.
DA employees may feel insecure
Ben, Salah, Mia do not like idea
Option B
Advantages include:
Good return (24 %) and 3 years 4 months payback and is likely to be longer than Option A payback.
Innovative
Increases sales, strengthens brand loyalty
New income stream – important because of low profits
Easy for customers and likely to be popular.
Disadvantages include:
High investment costs
Limited sources of finance
Sales benefits may not last
Only extends product life cycle – not a new product
Marks should be allocated according to the paper 1 markbands for May 2016 forward section B.
Theoretical answer or context limited to naming the business or lack of development max [4].
Discussion of only one option marks limited to [5].
Discussion but no clear balance [6].
Options considered, good use of evidence, particularly from section B, but no effective conclusion award a maximum of [8].
For [10] the answer needs to be clearly relevant to DA with good use of context and a clear and supported recommendation.