Question 1
Hexagon Sounds is a small music recording and publishing company based in
Shoreditch, London which was established in 2016. It is owned and run by two brothers
(Steve and Tony Sherwood). It is now facing a major increase in business rates and
needs to find alternative premises. This will also open-up the possibility of future
growth. The management team has narrowed down the choice to a shortlist of three
locations: Hoxton, Hounslow or Hastings.
Using the decision matrix below, undertake a Multi-Criteria Analysis (MCA) to evaluate
the three locations, based on the following criteria: Cost, Transport Links and
Riskiness. Cost has been most heavily weighted (at 0.5), with Transport Links and
Riskiness equally weighted. The expert ratings for each of these categories is given in
the table below. It uses a scale that runs from 1 (worst) to 4 (best).
MCA: Relocation Decision
Cost Transport Links Riskiness
Hoxton 1 3 3
Hounslow 2 3 2
Hastings 4 1 2
Required:
a) Using the assumptions and information set out above, which location would you
advise Hexagon Sounds to choose?
(6 marks)
b) Highlight the shortcomings of the MCA as a decision-making technique to the
management team, outlining how you would address these.
(4 marks)
Question 2
Hexagon Sounds has estimated the unit costs of publishing in-house its first collection
of musical scores in book form. These are set out in the table, below:
Cost Category Cost per unit (£)
Direct materials 5
Direct labour 3
Variable overhead 1
Supervisory salaries 2
Equipment depreciation 1
Allocated general fixed overhead 4
Total unit cost 16
The equipment to be used to manufacture the book has no resale value and none of
the allocated general fixed overhead could be avoided. The £16 total unit cost is based
on 5,000 books produced each year. Hexagon has found an outside supplier willing to
provide the 5,000 books at a cost of £14 per unit.
Module Code: 5BUSS001W Page 2 of 9
Required:
a) Identify the relevant costs in this decision and determine the additional costs or
savings for Hexagon if it purchased the books from the outside supplier, showing all
calculations. Would you advise Hexagon to accept the offer?
(4 marks)
b) Assume now that if Hexagon accepts the offer to purchase the books from the outside
supplier, the facilities now being used to make the book in-house could be switched to
printing 2,000 album covers, each of which would generate a contribution of £5. Given
this new information, what is the total additional cost or saving of purchasing 5,000
books from the outside supplier, rather than making them in-house.
(6 marks)
(Total: 10 marks)
Question 3
Steve and Tony Sherwood last year decided to branch into the production of portable
record players, which Hexagon assembles from imported components. There are
currently two models of record player (Ruby and Diamond) with slightly different
features and parts. The unit profit from a Ruby model is £40, and from a Diamond
model, £50. There are three constraints (the assembly time available per week from
three employees, A, B and C, in minutes). Steve and Tony used the Excel Solver tool
to determine the optimal combination of record players to produce and have generated
the following Excel Sensitivity Report, which they would like you to help interpret:
Adjustable Cells
Objective Allowable Allowable
Cell Name Coefficient Increase Decrease
$D$5 Quantity produced Ruby 40 10 23.3
$E$5 Quantity produced Diamond 50 70 10
Constraints
Shado
w Constraint Allowable Allowable
Cell Name Price R.H. Side Increase Decrease
$C$8 A Amount used 0 2400 Infinity 240
$C$9 B Amount used 7 1200 109.1 400
$C$10 C Amount used 1 2400 1200 1200
Required:
a) Which of the constraints are binding? Explain how you know.
(4 marks)
Module Code: 5BUSS001W Page 3 of 9
b) Advise the Sherwood brothers on how much the unit profit of each of the two models
(Ruby and Diamond) could vary before the solution they have found no longer holds.
Explain your reasoning.
(6 marks)
(10 marks)
SECTION B: Answer only TWO questions from this section.
Question 4
Hexagon Sounds is looking at three possible ‘campaigns’ for launching a new record
from its star band The Tussauds: a high-quality video featuring the band; a print-based
advertising campaign in music magazines; or, a two-month tour of major UK cities. The
marketing team has produced the following forecasts of the additional sales revenues
in £000s (net of campaign costs) that would be generated by each of the three launch
methods over the first three months, which will depend on general consumer
confidence (which could be Poor, Medium or Good), as shown in the table, below.
Launching the Album (three-month increase in sales revenue)
Consumer Confidence
Poor Medium Good
Video -17,400 -4,800 45,600
Music Magazines 5,200 17,800 30,400
Tour 22,800 22,800 22,800
a) Briefly discuss the impact of risk and uncertainty on business decision making.
Illustrate with relevant examples.
(4 marks)
b) What is the preferred option according to each of the following criteria (and what
attitude to risk does each represent)?
i) Maximin
(2 marks)
ii) Maximax
(2 marks)
c) Construct a potential regret matrix and use it to determine the preferred campaign
according to the minimax regret criterion. What attitude to risk does this represent?
(7 marks)
d) Hexagon Sounds has used published forecasts from the government to calculate
the probability of each the levels of consumer confidence occurring: Poor is
predicted to be 10% likely, Medium 50% likely, while Good has a probability of 40%.
What campaign represents the risk neutral decision for the company?
(7 marks)
e) What is the maximum amount that Hexagon Sounds should offer for information that
tells it with absolute certainty the level of consumer confidence over the next three
months?
(4 marks)
Module Code: 5BUSS001W Page 4 of 9
f) Hexagon Sounds is aware that a rival music company is also considering the launch
of a band, likely to appeal to the same target demographic. Focusing now just on
advertising in Music Magazines, the decision tree below shows the estimated
impact that a rival would have on sales revenues under the different levels of
consumer confidence (in effect the entry of the rival will cut revenues by a half under
each state of nature). The advertising campaign is assumed to cost £20,000.
Calculate the values at nodes W, X, Y and Z. Should Hexagon Sounds implement
an advertising campaign in Music Magazines under this scenario? Explain your
reasoning.
(9 marks)
(Total: 35 marks)
Question 5
Hexagon Sounds owns a shop in London adjacent to its office in Shoreditch which
it uses as an outlet for its vinyl LP records (it sells many more on-line). The shop
carries a wide range of LP records that are all sold at the same price. Sales
personnel in the shops are paid a substantial commission on each LP sold (in
addition to a small basic salary) to encourage them to be aggressive in their sales
efforts. Hexagon has estimated the following cost and revenue data for the shop:
Per LP record
Sales price £30
Variable expenses:
Direct material £10
Direct labor 3.5
Sales commission 4.5
Total variable expenses £18
Annual
Module Code: 5BUSS001W Page 5 of 9
Fixed expenses:
Manufacturing overhead £50,000
Salaries of sales staff 20,000
Advertising 30,000
Total fixed expenses £100,000
Tony Sherwood is anxious to improve the company’s profit performance and has asked
for several items of information.
a) Assume that the company produced and sold 10,000 LP records over the last year.
Calculate the following:
i) Contribution margin per unit and Contribution margin ratio.
(2 marks)
ii) Total profit or loss.
(3 marks)
b) Calculate the annual break-even point in units and in pound sales for the shop
and the margin of safety in percentage terms based on last year’s sales
volume.
(6 marks)
c) Assume that next year management wants the shop to earn a profit of £66,000.
How many LP records will have to be sold to meet this target profit figure?
(4 marks)
d) Tony Sherwood believes that the current sales commission arrangement is not
working and thinks that an increase in the basic salary might be better for profits (as
well as staff motivation) in the coming year. Assuming sales next year of 12,000 LPs
calculate whether a one-third increase in the sales commission per unit or a
doubling of basic salaries would lead to higher profits. What advice would you give
to Tony?
(8 marks)
e) Tony vaguely recalls from his Business Management degree that the concept of
price elasticity of demand can help to determine the optimal size of the mark-up to
apply when determining the price for a product. He temporarily reduces the price of
an LP from £30 to £24 and finds that the quantity sold rises by 30%. Using this
information, calculate the profit-maximising price for an LP. Explain to Tony the
potential issues with using this approach to pricing.
(8 marks)
f) On-line sales of LPs have increased in importance for Hexagon Sounds. Assuming
that on-line sales eliminate the need for sales commissions and sales staff salaries
entirely, but double the advertising cost, what price would be needed to generate a
profit of £80,000?
(4 marks)
(Total: 35 marks)
Module Code: 5BUSS001W Page 6 of 9
Question 6
Hexagon Sounds has identified specific premises in the three locations (Hoxton,
Hounslow or Hastings) it is considering as part of its expansion plans. The premises
have different upfront costs and associated cashflows (as shown in Table 1, below).
Estimated Annual Cash Flows from Relocation
Hoxton Hounslow Hastings
Year 0 (£250,000) (£500,000) (£300,000)
Year 1 £150,000 (£50,000) £55,000
Year 2 £150,000 £50,000 £140,000
Year 3 £75,000 £100,000 £80,000
Year 4 £55,000 £150,000 £100,000
Year 5 £30,000 £200,000 £120,000
Year 6 £20,000 £300,000 £180,000
a) Calculate the payback period for each relocation option and suggest which of them
(if any) is worthwhile if it is the company’s policy not to accept any option with a
payback period longer than 4 years.
(7 marks)
b) Suggest why it would be unadvisable for Hexagon Sounds to base the ‘go-ahead’
decision purely on the payback period method.
(2 marks)
Hexagon Sounds now asks you to undertake a financial appraisal of the three location
options. The planning period for the appraisal is six years; assume no salvage value at
the end of that period. The MCA in Question 1 indicates that Hoxton is a less risky
choice than either Hounslow or Hasting. On this basis, Steve Sherwood believes that
Hexagon Sounds should use a discount rate of 9% for Hoxton, but 10% for the other
two options.
c) Is varying the discount rate a legitimate way of dealing with risk in this case? What
other ways might there be?
(3 marks)
d) Calculate the Net Present Value (NPV) for each of the models (use the Present
Value table provided on page 11). Which location would you advise according to
this technique? Explain your reasoning.
(12 marks)
e) Estimate the Internal Rate of Return (IRR) of the preferred option from d), using the
formula approach. Show your workings.
(4 marks)
Module Code: 5BUSS001W Page 7 of 9
f) Write a brief report (of about 100 words) for Hexagon Sounds summarising your
advice on which option it should choose. Give reasons for your advice and identify
any concerns you have about the different appraisal methods.
(5 marks)
(Total: 35 marks)
Question 7
Part A
Steve Sherwood is planning a celebration event to mark the fifth anniversary of the
company’s establishment. He has derived probability distributions for the cost of the
venue, entertainment costs and number of guests buying (the heavily discounted)
tickets. He has decided to charge £35 for tickets.
Venue
Cost
Probability Entertainment
Cost
Probability Tickets
purchased
Probability
£4,000 0.20 £1,000 0.10 150 0.40
£5,000 0.45 £1,500 0.30 200 0.23
£6,000 0.35 £2,000 0.50 250 0.37
£2,500 0.10
a) Calculate the expected value of the ticket revenue, venue cost and entertainment
cost and use this to estimate the expected surplus (or loss) from the celebration.
(7 marks)
b) Steve wants you to undertake a scenario analysis to determine the surplus or loss
made by the celebration event under each of the following scenarios: ‘base case’,
‘best case’ and ‘worst case’. What advice would you offer to Steve?
(6 marks)
Part B
Tony and Steve Sherwood have approached Investment Analysis, a brokerage firm, to
help them manage a £160,000 investment portfolio. As an initial investment strategy,
the Sherwood brothers want to restrict the portfolio to a mix of the following two shares:
Share Share Price Annual Return
per Share
Risk Index of
Share
Alpha £50 £3 0.50
Omega £100 £5 0.25
The risk index of the share is a rating of the relative risk of the two investment
alternatives. From the data given, Alpha is seen as the riskier investment. By limiting
the total risk of the portfolio, the brokerage firm will avoid placing excessive amounts of
the portfolio in potentially high-risk, high-return investments. For the current portfolio,
an upper limit of 700 has been set for the total risk of all investments. The firm also has
an upper limit of 1,000 shares for the riskier Alpha share.
c) Formulate as a linear programming problem, where the aim is to maximise the total
annual return from the portfolio (of two shares).
Module Code: 5BUSS001W Page 8 of 9
(5 marks)
d) Solve the problem graphically indicating the optimum combination of shares to
purchase and the maximum annual return.
(10 marks)
e) Confirm the solution algebraically.
(3 marks)
f) Explain the difference between ‘constrained resource analysis’ and linear
programming and the limitations of each.
(4 marks)
(Total: 35 marks)
[END OF ONLINE TIMED ASSESSMENT]
Present Value of £1
Perio
d
(Yrs) 3% 4% 5% 6% 7% 8% 9% 10%
15% 20%
1 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.8696 0.8333
2 0.9426 0.9246 0.9070 0.8900 0.8734 0.8573 0.8417 0.8264 0.7561 0.6944
3 0.9151 0.8890 0.8638 0.8396 0.8163 0.7938 0.7722 0.7513 0.6575 0.5787
4 0.8885 0.8548 0.8227 0.7921 0.7629 0.7350 0.7084 0.6830 0.5718 0.4823
5 0.8626 0.8219 0.7835 0.7473 0.7130 0.6806 0.6499 0.6209 0.4972 0.4019
6 0.8375 0.7903 0.7462 0.7050 0.6663 0.6302 0.5963 0.5645 0.4323 0.3349
7 0.8131 0.7599 0.7107 0.6651 0.6227 0.5835 0.5470 0.5132 0.3759 0.2791
8 0.7894 0.7307 0.6768 0.6274 0.5820 0.5403 0.5019 0.4665 0.3269 0.2326
9 0.7664 0.7026 0.6446 0.5919 0.5439 0.5002 0.4604 0.4241 0.2843 0.1938
10 0.7441 0.6756 0.6139 0.5584 0.5083 0.4632 0.4224 0.3855 0.2472 0.1615