ACF314 assessed coursework 2017

Tavistock HiFi
You have recently been appointed the management accountant for Tavistock HiFi
Limited (Tavistock). Your brief is to implement any strategies chosen by the board of
directors, and your specialist knowledge and relevant industry experience were key
to you being given the job. The board have made it clear that they wish you to
suggest anything that will make the company perform better.

The company was started in 1996 by Paul Dennis, and it has remained a family run
business ever since. In recent years the founder, Paul, has been looking at
succession planning, and this resulted in the appointment of his son, Mark, as Chief
Operating Officer (COO) two years ago. Paul remains as Chairman, but he is no
longer involved in the day to day operations. The role of Chairman enables Paul to
exert influence on strategic decisions. In October 2016 Paul sold shares to the
Victory Hedge Fund (Victory) and the shareholding now is as follows:

%
Chairman (Paul) 40
COO (Mark) 10
Victory Hedge Fund 50

From the earliest days, the company has manufactured high quality hi-fi amplifiers.
These have been sold via a select band of enthusiastic dealers to discerning
audiophiles, many of whom are attracted by the “designed and made in the UK”
nature of the products, as well as the high-end audio quality of the amplifiers.
Reliability and service are key strengths of the offering to the customer: in the very
rare event of any problem occurring with a Tavistock amplifier, a dealer will ensure
that a replacement is provided with two working days. As a result of the exacting
construction standards at the company’s factory, located in Devon, the warranty
costs incurred by Tavistock have been negligible. It has been very rare for any
customer to make a warranty claim during the class-leading ten year warranty
period.

Paul Dennis did not run Tavistock in a way to maximise profits. His passion was
creating amplifiers that were highly respected by customers and hi-fi journalists, and
during the nineteen years that he ran the company he was happy for growth to be
slow. Profits were sufficient for Paul to enjoy his life, and he never saw the need to
develop the sales of the company outside the UK.

He sold 50% of the shares to the Victory Hedge Fund in the hope that he would have
sufficient funds for his retirement. In Paul’s ideal world, he would not have sold
these shares to a bunch of “city kids”, but Mark did not have sufficient funds to
enable all the shares to remain in the family. Paul had hoped that Mark, under
Paul’s guidance, will continue running the company with little change. However, Paul
is increasingly aware that he needs to maximise the amount he can receive for his
remaining shares in order that he might have sufficient money to live on in his old
age. He plans to sell his remaining shares within the next two years.

ACF314 2017 Coursework Page 1 of 6

In his first year as COO Mark started to develop a new amplifier that both he and
Paul consider will maintain the strong reputation of the company. It was this new
product that attracted the investment from Victory Hedge Fund. The fund’s
managers have high expectations that this amplifier could lead to an enormous
growth in sales, with the prospect of new sales throughout Europe leading to a
massive jump in profits. The Fund hopes that, within five years from now, 90% of
the sales will be outside the UK, all within the EU. Victory have ambitions to grow
outside the EU after the five year period, and their business model is that they intend
to dispose of the shareholding in Tavistock after five years, with a high valuation
based on future sales growth giving the Fund a massive gain on disposal.

Mark Dennis finds himself caught between two large shareholders with significantly
different aspirations for the future of the company. He has appointed you to help him
to decide how to proceed. He is aware that it might be hard to please both of the
main shareholders, and he needs your expertise to consider the future options.

The new amplifier is now fully developed. It is a design of which the industry experts
have very high expectations, being a combination of modern digital streaming
technology and the warm sound of a classic valve amplifier. This new product, to be
called the Oscar, is ready for production. However, Mark has not yet decided where
manufacturing should take place, although he has identified two main options:

OPTION 1
Production can be continued at the company’s existing factory in Devon. It is to be
assumed that there will be no start-up costs by using the existing factory, and it is
also to be assumed that all of the existing staff can be transferred to making the
Oscar without any need for any training costs. If staff are transferred, the production
of the existing amplifier, the Classic, will cease immediately. Currently, 600 Classics
are made and sold each year. This is not expected to change in future years. For
every one Oscar that will be produced, production of one Classic will be lost. The
production costs of one Classic are £260, advertising and delivery costs are £80 per
unit and the mark-up by the dealer is £100 before they sell each Classic for £500.

OPTION 2
Production of the new Oscar could be undertaken by a manufacturer in Shenzhen,
Guangdong Province, China. This would require a shipping delay of six weeks, but
would give lower costs. A suitable manufacturer has been identified who, at today’s
exchange rate, can make the Oscar for:
£
Components 370
Labour (10 hours at £3.20) 32
Supplier’s profit 40
Total cost from manufacturer 442

This compares favourably with the estimated cost if Tavistock were to make the
Oscar. Tavistock’s costs would be:
£
Components 410
Labour (10 hours at £10.00) 100
Tavistock’s total manufacturing cost 510

ACF314 2017 Coursework Page 2 of 6

Under both options, Tavistock would incur overhead costs. Fixed overheads would
be £60 per unit for advertising (based on the estimated sales level of 1,000 Oscars in
2018). Variable overheads would include the cost of delivery within the UK at £20
per unit plus shipping to the UK from China at £30 per unit. If Tavistock were to
make the Oscar it would also incur packaging costs of £10 per unit.

The only difference in construction of the Oscar between the locations is that the
Chinese manufacturer would utilise a different type of valve when making each
Oscar. Whilst Tavistock would use a valve that had been cryogenically treated, the
valves available in China would not be treated and so would be more fragile. A
proportion of these valves would be expected to break during the transit from China
to the UK. Consequently, the estimated warranty costs if manufacturing were
located in China would be twice the estimated £30 per unit for UK construction.

Tavistock estimates a sales level for Oscars for 2018 of 1,000 units, which will
increase by 20% per annum thereafter. The sales price will be £860 per Oscar in
2018, and is expected to increase at 5% per annum. The company is looking at a 10
year life for the Oscar amplifier. The profit margin of the Chinese subcontractor is
expected to increase by 5% per annum, this being in effect a form of profit-sharing
between the two companies.

During your initial discussion with the Victory Hedge Fund, the fund manager pointed
out that wages in Shenzhen are increasing rapidly (from 2011 to 2016 averaging 9%
per annum), so much so that some of the other companies in which they own shares
are bringing production back to the UK. Wage increases for Tavistock’s employees
in the UK are currently only 2.2%. Victory ask you to consider the expected future
wage rates in your financial analysis of the next 10 years. Victory also ask you to
consider wage levels in Bangladesh, which has the lowest wage levels of South East
Asia – perhaps production should be moved there instead of Shenzhen?

It is expected that, over the next ten years:

 The sales prices of both products will increase at 5% per annum;
 UK labour costs will increase at 3% per annum;
 The cost of components will increase at 3% per annum, as will UK production
related costs;
 Delivery costs within the UK, and shipping costs to the UK, will increase at 7% per
annum;
 The profit taken by dealers will not increase with inflation;
 Advertising expenditures will decrease by 5% per annum;
 Warranty costs for UK production would remain constant throughout the ten year
period;
 Warranty costs for items made in China are expected to rise by 4% per annum;
 Labour costs in China will increase at 8% per annum.

ACF314 2017 Coursework Page 3 of 6

Requirement:

This assessment is to be prepared in groups of 3. See below for more on the

membership of each group. You are to prepare a report for the owners of Tavistock
HiFi Limited, with separate sections for the Dennis family and the Victory Hedge
Fund.

This report must contain:

 An estimate of future profits over the next 10 years, showing the financial
implications of your recommendations. Full workings are to be provided in an
appendix, and these are to be calculated using Excel.
 A list of any key assumptions that you have made, together with any
supporting evidence that you have relied on.
 A full discussion of the risks and opportunities applying to all options that are
open to the company.
 Your recommendations to the main parties (Paul Dennis, Mark Dennis and
the Victory Hedge Fund) of the option that would most be in their interest.
 An appendix showing how you wish to allocate the group mark between the
members of the group (see Appendix 1 below).

You are to ignore all forms of Taxation in your report. Your recommendations are to
be the result of careful research. If your research leads you to conclude that the
assumptions above are not realistic, you should use your assumptions and make
clear your sources.
All of your sources are to be shown in an appendix and you are to use the Harvard
referencing system, so that the readers of the report can check your evidence for
accuracy.

The report will be of a maximum of 5,000 words, plus appendices. It will be

submitted on Moodle by 12.00 on Thursday 14th December at the latest. Earlier
submission is possible, but you can only submit once. A maximum of two files can
be submitted, which will be your report (a Word File) and your Excel spreadsheet.

Marks will be awarded as follows:

%
Calculation of expected 10 year profits 40
Discussion of risks and opportunities,
with the impact on each party 30
Recommendations for each party 20
Report 10
100

ACF314 2017 Coursework Page 4 of 6

Group composition
It is expected that each group will comprise members of the same tutorial group.
This will enable you to prepare the report with people that you work with in class. It
will also enable you to meet with your module leader for a 15 minute preliminary
feedback meeting, which can be held during the timetabled tutorial slots of the weeks
from 13th November onwards.

You must sign up to a group on Moodle by 17:00 on Friday 20th October. It is

your responsibility to join a group. If you do not join a group, then I will assign you to
one after 17:00 on 20th October.
Please agree a group of 3 before signing up together as this will help to prevent
problems. Note that if you sign up as a group of 1 or 2 then I may add more
student(s) to your group after 20th October. Being in a group of 3 is the only way to
ensure this does not happen.
All students are expected to contribute to their group's work equally.
However, the form in Appendix 1 is to be submitted with your report. This can be
used by you to clarify how the group marks should be allocated between you. This
should encourage all members of a group to work hard, and will enable your group to
re-allocate marks if anyone fails to work hard.

Preliminary Feedback meeting

So that your group can be confident about your approach, you can meet me for a 15
minute meeting. At this meeting you will give a 10 minute (maximum) presentation
detailing the main points that you plan to include in your report. This must include
your expected profits each year for each option:
Option 1: production remains in the UK;
Option 2: the production of Oscars will occur in China
and a summary of any key assumptions and recommendations that you plan to
include in your report.

A maximum of 4 feedback points will be given to you shortly after the meeting.

This meeting is to be arranged with me by your group. It is up to you to contact me to

request the meeting. When you email me to arrange the meeting please make sure
that you identify your group number. It is likely that it will be held during a scheduled
tutorial session. Your group will have only one meeting with me.

Your meeting will take place at some stage from 13th November onwards.

ACF314 2017 Coursework Page 5 of 6

Appendix 1

Allocation of your group mark.

Please show how you want your group mark to be allocated.

GROUP Number.................

PRINT YOUR NAMES SIGNATURES % of Group mark (Note 1)

Note 1 – If you wish to split the mark equally, you will put 33% in each box here.

ACF314 2017 Coursework Page 6 of 6