Question
Refer to the Megamin Mining case study
MM uses just-in-time (JIT) production in its Oil Production Division.
The long-term demand for oil is usually predictable, and production is reliable unless major problems occur. In 2020, however, there was an unexpected decrease in demand for oil. Uncertainties in the world economy and responses to climate change now make predictions more difficult.
MM has prepared a sales forecast for its oil production for 2022 and 2023 (Table 2).
Table 2: Sales forecast for oil production for 2022 and 2023 (millions of barrels)
† calculated by comparing actual sales with a four-quarter moving average
- A catastrophic fire occurred at one of its oilfields.
- The gold mine in Egypt collapsed, trapping 23 miners.
- It experienced a cyber-attack on its computer network.
- An earthquake in Chile damaged the country’s transport system.
In response to these problems, $M M$ had to rely on its contingency planning and its crisis management procedures.
JG Mining (JG) wants to buy MM’s tar sands mining operation for $\$ 50$ million, but the board of directors are divided. MM recently invested $\$ 15$ million in their tar sands operation in addition to the original $\$ 30$ million set-up cost in 1986 . Production is at designed capacity, and, although the long-term average rate of return (ARR) for the tar sands operation is below those of most of $M M$ ‘s other investments, it provides a reliable source of income. However, $M M$ has difficulty selling sulphur, a by-product of tar sands production.
Employees at the tar sands operation are against selling the operation to JG. However, the income from the sale would help $M M$ finance other investments, such as lithium mining, and the sale could help improve $M M$ ‘s corporate image. MM’s Finance Director, Ethan, estimates that the net present value (NPV) of the tar sands operation is $\$ 46$ million.
a. Define the term just-in-time (JIT) production.
b. With reference to Table 2, explain one benefit and one limitation for $M M$ of using sales forecasting.
c. With reference to $M M$, explain the difference between crisis management and contingency planning.
d. Using information from the case study and additional information above, discuss whether MM should sell its tar sands mining operation to JG. [10]
▶️Answer/Explanation
Ans:
Candidates can answer in terms of JIT production where the focus is on processes that reduce the time within production systems (work-in-progress) and response times with suppliers/customers. The mention of lean production (of which JIT is a part) is useful.
Candidates can also answer in respect of managing stocks (raw materials, work-in-progress, finished products) so that these are available exactly when needed and not before. Award a max of [1] if the answer is only related to JIT stock control.
Candidates can use ‘inventories’ rather than ‘stocks’.
Award [2] for a complete definition.
Award [1] for some understanding of JIT e.g., it mentions ‘lean production’ or ‘stocks’ but not the idea of reducing to a minimum.
Award a max of [1] if the answer is only related to JIT stock control.
Benefits
- Businesses need to plan so forecasts are important
- Oil industry has been predictable so suitable for the sales forecasting technique and helpful to MM
- trend is clearly downward, and MM need to plan for this
- Energy demand is clearly seasonal so broad trends not enough
- Better workforce planning: planning staff required
- Better cash flow management: considering “cyclical and seasonal variation” factors
- Increased efficiency, assisting production department in knowing the number of goods to produce and when to produce them
- Better tracking and finding problematic issues (deviations), etc.
Limitations
- Assumes future is same as past – clearly not the case with unexpected decrease in demand and that long-term predictions are more difficult (economic change and global warming)
- Major problems can affect predictions e.g., strikes
Award [1] for one benefit or one limitation, up to a total of [2].
Award [1] for putting each benefit/limitation into context, i.e., reference MM/ Table 2 up to a total of [2].
i.e Award [3] for answers that put a benefit and/or limitation into context but does not make use of Table 2 in relation to sales forecasting for MM.
Only award [4] for answers that make explicit use of Table 2 in relation to sales forecasting for MM.
Contingency planning; Planning how to respond to unlikely events that are a threat to a business
- Forward looking
- MM are likely to have plans for broad issues such as strikes, fires, floods, earthquakes, failure of IT systems
- Will have gathered relevant information
- Decide which problems are disruptive and which are critical
- Plan likely to be tested and will involve training
- Contingency planning can be used to help improve crisis management
Crisis management: The process by which a business deals with a major event that has happened and poses a threat to the business
- Dealing with an actual not a possible threat
- Information will be available as to the extent of the crisis. e.g., MM may not have planned for so many miners to be trapped underground in Egypt, nor the extent of the Chilean earthquake and the response of the Chilean government
- The plan for an oilfield fire may not have been so extreme as catastrophic
- Actual events can help future contingency planning
Accept any other relevant difference.
Context comes from issues identified in the case and the nature of the business.
Award [4] for a clear distinction between the two with effective use of the context.
Award [3] if both crisis management and contingency planning are understood in context, but there is no clear distinction made.
Award [2] if there is clear understanding of contingency planning and crisis management but no context is shown.
Award [1] for limited understanding.
Refer to Paper 1 markbands for May 2016 forward, available under the “Your tests” tab > supplemental materials.
Arguments for the sale:
- It provides finance for expansion into Lithium mining which looks very positive
- There are local issues with First Nation Canadians which does not fit in with MM‘s ethical values and could bring bad publicity. Selling could improve corporate image
- Is $50 million enough if they have already spent $45 million?
- Lower than average ARR
- MM has difficulty selling Sulphur, a by-product of tar sands production
- How about NPV ($46m); is $50m enough?
Arguments against the sale:
- Production at capacity and has no major issues, more so than other operations
- It provides a reliable source of income – important if other commodities have fluctuating prices
- They have invested $15 million, and the mine is possibly worth more than $45million so is $50 million enough?
- Employees at the tar sands operation are against selling the operation to JG
Judgement/evaluation
- Depends on whether they need the money
- Is the return strong enough?
- Can they afford to upset the workforce?
- Who will ultimately make the decision? What are their views?
- If the business is doing well, why sell it?
Final judgement should relate to points raised.
Candidates can use information from Section A and Section B.
Candidates who attempt to make use of Section B information may not write with the same level of depth but should be rewarded positively.
Accept reasonable alternative answers.
Marks should be allocated according to the paper 1 markbands for May 2016 forward section B.
Award a maximum of [4] for a purely theoretical answer or with no effective use of the case (e.g., only repeating case material without development).
Award a maximum of [5] for a one-sided answer.
Award a maximum of [6] if options are considered but there is limited use of data or if there is good analysis of data with limited consideration of issues.
Award a maximum of [8] if options are considered and there is good use of data but there are no significant judgements.
Question
AFA was at a critical point. Sam and Finn had not fully resolved their disagreements. They seemed to be constantly arguing but Sam could also see that new issues were emerging. At their most recent meeting in early 2018, Finn provided the following financial information to illustrate the declining trend in gross profit margin.
Table 1: Selected financial information for AFA
In addition, the recruitment of new staff was becoming a problem, as the wages that $A F A$ offered were much lower than fair trade competitors. In a meeting between Sam and Finn, they argued over the best way to financially reward and motivate newly recruited workers, given the lower wages paid by $A F A$.
Finn argued for a reward system based on fringe payments (perks), as this was being offered by AFA’s main competitors, the supermarkets. Sam countered that AFA should form a cooperative involving all physical stores. He argued that creating a worker cooperative could give all members a sense of community and fulfillment and motivate them so that all members of the cooperative would benefit. There would also be additional stakeholder benefits. Finn argued that a worker cooperative was too difficult to organize and operate and would not solve the problem of recruiting staff.
In the meantime, AFA was continuing to attract a good deal of publicity. Sam had appeared on a national television show about young, innovative entrepreneurs. After the television show ended, one very large international retailer with a strong online presence contacted Sam about the possibility of a takeover. Sam initially refused, but as the details of the takeover became clear he started to seriously consider the opportunity. By selling the business Sam would have enough fresh capital to start new, innovative businesses and make some of his other visions and ideas into reality. In addition to the corporate social responsibility (CSR) AFA was generating, the takeover would give $A F A$ access to other intangible assets. However, the international retailer had indicated that it could not guarantee keeping all existing and newly recruited employees and managers. Finn and Kim were both very worried that Sam would even contemplate the takeover, which they felt was an act of betrayal to all the stakeholders of AFA.
a. Refer to the As Fair As case study .[2]
Define the term intangible asset.
b.i. Refer to the As Fair As case study .
Calculate the gross profit margin of $A F A$ for 2016 and 2017.
b.ii Refer to the As Fair As case study.[2]
Explain one possible reason for the trend in gross profit margin for AFA between 2016 and 2017.
c. Refer to the As Fair As case study .
Explain one benefit and one cost to AFA of using fringe payments (perks) to financially reward staff.
d. Refer to the As Fair As case study in the supplemental material.$[10]$
▶️Answer/Explanation
Ans:
a. An intangible asset is an asset that lacks physical substance and usually is very hard to evaluate, but it can add value to the business. It includes patents, copyrights, franchises, goodwill, trademarks and brand names with links to product positioning of a good or service that a business may offer.
The definition does not need to be worded exactly as above.
Award [1] for a basic definition that conveys partial knowledge and understanding.
Award [2] for a full definition that conveys knowledge and understanding similar to the answer above.
NOTE: Some candidates may write their definition in the context of AFA; in such cases, the main examples of intangible assets would be brand image (due to ethical behaviour and CSR leading to competitive advantage, customer loyalty, positive word-of-mouth) and goodwill.
b.i. GPM $2016=\frac{142888}{2164486} \times \frac{100}{1}=6.6 \%$
GPM $2017=\frac{124211}{2400625} \times \frac{100}{1}=5.17 \%$
Award [1] for each correct answer which includes the \% (percentage) sign.
NOTE: candidates are not asked to show their working. Candidates may round up the results of their calculations for example, $5.1 \%$ or $5.2 \%$ instead of $5.17 \%$.
b.ii.Given that sales revenues have increased, the likely cause of the decrease in gross profit margin is that direct costs have risen faster. There is evidence of diseconomies of scale being experienced by $A F A$ and this calculation backs this up.
Another possible reason is fluctuation/increase of foreign currency exchange rates (as AFA works with “wholesalers that import products from many parts of the globe”, line 46).
Another possible reason is the increase of the cost of goods sold, which could be linked to the fact that price of fair trade goods may fluctuate/increase.
Award [1] for a possible reason for the trend in gross profit margin, with an additional mark for application to AFA.
c. Example of explanation of a benefit:
- For AFA, given the low wages, it is likely that fringe payments will act as an incentive to existing and new staff. Private health care, for example, would allow Sam and AFA to demonstrate a commitment to the well-being of its employees in the same spirit that the fair trade movement does for its suppliers. Motivation could improve and address some of the issues raised by the mystery shopper that Finn employed.
Example of explanation of a cost:
- The cost to AFA is that even with considerable revenue growth, fringe payments will increase direct costs, which will put further pressure on gross margins. Sam and Finn would also need to draw up new contracts of work,
clearly stating how the new fringe benefits would be calculated and distributed. There are additional managers who may be attracted to this rewards scheme and this may create some jealousy if they are not fairly applied. One key question is whether the fringe payments will apply to all staff.
Award [1] for each benefit and cost identified, with an additional [1] per cost/benefit with direct application to AFA.
d.Refer to Paper 1 markbands for May 2016 forward, available under the “Your tests” tab > supplemental materials.
There is considerable evidence from the stimulus that Sam and Finn’s relationship is on the verge of breaking down. The mystery shopper incident has fuelled suspicion on both sides and a lack of trust and cooperation is evident. It would appear that Sam does not wish to involve himself in the day-to-day running of the business and instead focus on “big picture” thinking. This offer from the international retailer coming at this time would be very tempting. Entrepreneurs such as Sam sometimes do sell a business looking for new opportunities as they may have achieved their own personal goals in setting up a new sustainable business. The goodwill offered by the purchaser would easily allow Sam to put his entrepreneurial qualities to good use in new markets. There is considerable evidence from research that some serial entrepreneurs enjoy setting up new enterprises as an exciting challenge and when the final goal is achieved move on. Sam does seem to be restless and bored easily and the current tensions/conflicts may force his hand.
However, whilst the positive publicity from the reality television show has lifted Sam, it could be easily taken away if the takeover occurs. “Temperton sells out” headlines would not help Sam or AFA and could impact on the brand value of the business. There is also the hypocrisy from Sam (given that he wanted to help internal and external stakeholders in the best way that he could) that the sale of AFA would create. Can he afford to tarnish his image?
Finn and Kip provide the conscientious voice against the sale. AFA is doing well and its position in the market is established. There is, however, still much to do. Why quit now when the actual goal has not been fully achieved?
There is conflict at AFA and this is to be expected. It would be a great shame for all the hard work carried out if Sam were to accept the offer. However, Sam and Finn appear to be drifting apart. Perhaps a change at the top is needed to bring fresh thinking to AFA at a time of expansion as long as Kim and Finn remain loyal to AFA.
Mark according to the paper 1 markbands for May 2016 forward, section B.