Management Decision Making Assignment

Management Decision Making Assignment

This is solution of Management Decision Making Assignment, fact full discussion of financial activity of MiPie Org.

Task 1

If we look from the financial perspective, the proposal of A2Globe was definitely a better option for MiPie. MiPie would have definitely earned more from the same business due to the outsourcing of the production activity. The benefit of outsourcing over in-house production was clearly evident from a look at the financials of both the options. The net profit earned from the business in case of outsourcing of activity is £ 16 millionas compared to the profit from status quo activity, which is £ 12 million.This gives an increase of 33 % over the ongoing in-house production. Also, when we look at one more crucial indicator of financial performance, we see that the Net Profit Margin of the company will change from 20%to 25% if it shifts from in house production to outsourcing of the production function. A sudden increase of 5% in profit margin is a phenomenal growth which any company would crave to achieve.

Financial cost of Mi-pie to help decision making

The Board had rejected the offer. There can be various reasons why the Board had rejected the offer. Some of the possible reasons are highlighted below:

  • Huge Increase in Fixed Costs:The shift of production from in house to outsource will decrease the variable cost of production, but it will lead to an increase in the fixed costs of production from £ 10 million to £ 14 million,which is an increase of 40% in one year. Although the increase in revenue is just around 9%, but the fixed costs is increasing by 40 %.
  • Contribution Margin:This profit of 16 million is based on the  activity based assumption that the quantity of products sold will be the same as last year. If the number of products sold is lesser than that of the previous year, the contribution margin will go for a toss, and likewise the net profit will take a pounding. This is because of the high fixed costs to be incurred in case of a change of production process.
  • Extra dependence on the Supplier: By outsourcing the entire production activity, the company will be over dependent upon the supplier. Any problematic situation with the supplier will bring the entire business to a stand-still.

The marketing perspective would say that it is not a good choice to be outsourcing the core competency of the company. MiPie had a competitive edge in producing the cookies and by outsourcing this, they would lose out on this front. Also, the company had always focused on innovation to be the main driver of the business. They had used continuous innovation to enable the brand to deliver both variety and quality. By outsourcing their production process, they will lose out on the innovation part as it will be on the supplier company to use the process as it likes.

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TASK 2

First Part:

The company is planning to set up an alternative energy system for meeting its internal requirements for the production process. They have used the basic investment appraisal techniques used in the capital budgeting exercise. The project would involve setting up of two mini-projects. The payback period for both the projects is on the higher side; the ARR for both the projects is very low as compared to the ongoing business performance.

Payback period for wind turbines3 Year 8 months
Payback period for lagoon4 Year 1 month
ARR for wind turbines8.60%
ARR for lagoon6.60%
NPV for wind turbines0.17 million
IRR for wind turbines12.00%

The high payback period shows that the business needs a longer time of gestation before it breaks-even on the cost side. The NPV for the project is just 0.17 million which is very low for an investment of such a huge size.

One critical factor that needs to be considered is that the above investment appraisal has been done on the basis of the forecasted cash inflows which can vary from the actual cash inflows. A small deviation of the actual cash inflows from the forecasted numbers will result in the NPV of the project becoming negative.

The IRR is also on the lower side and it is considerably lower than the profit margin of the company which is 20%. An investment in these projects clearly shows that it will not be as beneficial as investing in the continuing business finance.

Second Part:

The NPV calculated in the investment appraisal process is not correct. They have made the following mistakes:

  • They have stated that they have used 10% as the discount rate but by mistake they have used the discount rate as 12%.
  • Not only have they used a different discount rate, but they have also stated wrong NPV. The stated NPV of 0.17 million is an error. The NPV at discount rate 12% is 0.17 million and 0.42 million for the project wind turbine and lagoon respectively.
  • Both the projects have a similar NPV if the discount rate is taken to be 10%. The NPV will be 0.72 million and 0.71 million respectively.
NPV for wind turbines @ 12 % Discount rate
 Year 0Year 1Year 2Year 3Year 4Year 5
Cash Outflows100.10.10.10.20.2
Cash Inflows02.62.833.23.4
Total CashFlows-102.52.72.933.2
Discount Rate12%   
NPV$0.17     
NPV for Lagoon @ 12 % Discount  rate
 Year 0Year 1Year 2Year 3Year 4Year 5
Cash Outflows50.050.050.10.10.1
Cash Inflows01.371.391.61.81.9
Total CashFlows-51.321.341.51.71.8
Discount Rate12%   
NPV$0.42     
NPV for wind turbines @ 10 % Discount rate
 Year 0Year 1Year 2Year 3Year 4Year 5
Cash Outflows100.10.10.10.20.2
Cash Inflows02.62.833.23.4
Total CashFlows-102.52.72.933.2
Discount Rate10%   
NPV$0.72     
NPV for Lagoon @ 10 % Discount  rate
 Year 0Year 1Year 2Year 3Year 4Year 5
Cash Outflows50.050.050.10.10.1
Cash Inflows01.371.391.61.81.9
Total CashFlows-51.321.341.51.71.8
Discount Rate10%   
NPV$0.71     

Recommendation:The company should go for the project as it will break-even in the next 4 years which is pretty good for a capital intensive project like this energy plant. One more reason that favors this project is that after the 5th year, this project will start to generate positive cash-flows for the company, which will add to the company’s bottom-line.

TASK 3

Management Accounting has evolved over the years. But, if we take a closer look at the details of the process of management accounting, we can find many things which we might feel are not truly representative of a transparent and correct process, which has to be the prerogative of any managerial accountingprocess.

If we look at any other quantitative processes, there is a prescribed definition for any variables, but this is not the case for accounting definitions.  Each of the several purposes in accounting requires a different accounting approach. The argument here is that as these different numbers may superficially resemble one another, a person who is not aware of these, may be easily confused or might problems dealing with it. The most common item where confusion prevails is the word ‘cost’. There are so many terminologies related to costs in management accounting. They might synonymous to our ears, but the actual meaning and accounting treatment is quite different.

A simple and largely overlooked argument against management accounting is that in case of estimation of values of a lot of accounting items, there is a heavy reliance on approximation of numbers, due to which the degree of genuineness of the work is diluted (F. Pomeranz, 1984). We can see some amount of approximation in dealing with cash balances and likewise we can see very high degree of approximation in case of projections for planning purposes, and this is because they are always estimates of what will happen in the future. But this increases the amount of chances of deviations from the actual.

Data sufficiency has always been a problem with management accounting. In a management problem, the manager does not ever have the amount of information needed to take a calculated decision (Joao A. Ribeiro et.al. 2006). The personnel are expected to take a right decision among such data insufficiency. And above all, there is such a lot at stake. The point of contention here is that how can this be done with perfection every other time. Also, at times there is information overload and one has to find the relevant information from an abundance of information available to him.

The problem here is that at times, management decisions are so crucial that we cannot delay the decision and so we have to take decisions based on the limited information available (B.G. Carruthers, 1995). The argument here is that a decision should never be taken if we see that some important piece of information is missing from the information puzzle. Any piece of information that is missing could also be the defining information technology that could completely change the outlook of the decision maker. So, it is better not to take a decision under information constraints.

Accounting evidence is only partial evidence and there is always a larger picture than it is able to portray (John Blake, et.al. 2003). There are very few management problems which can be tackled just by a mere collection and analysis of data. Generally, management decisions are influenced by a lot of other factors which cannot be quantifiable. Although it seems that management decisions are taken based on management accounting information, but the truth is that the management decisions are largely taken by involving the external factors.

The next argument is that people and not numbers are the main force of any organization but management accounting is focused only on numbers. The irony is that although management accounting system is largely focused on numbers, but there has to be a human involvement to be able to process it. However sound the management accounting system may have been designed, but the success of implementation depends upon the people who operate and access it.

One argument is that relating to the rules and regulations related to management accounting practice. These rules are created by government officials and a company has to comply with although it may be not acceptable. This is a dark side of governance that also has its control over the management practices.

Although management accounting is being used by each and every country, but there is no professional body other than in United Kingdom, which is fully dedicated to management accounting. The presence of such an organization will be helpful to the business community. This organization will be involved in making the rules, providing training and knowledge about the subject and above all, it will be a representative of the management accounting practice. The absence of such an organization has not been a favorable situation for the industry.

The world has become a global village and today everything is standardized across the globe. This has created a platform where the company practices are same across countries and any difference in processes are not welcome. But, if we look at the management accounting practices, they vary from country to country (M. Granlund, 2001). This variation is due to a lot of external factors which are beyond the organization’s control. These factors are taxation law, government policies and regulations. Any organization going in for a cross-border acquisition has to make the necessary changes and act accordingly.

The management accounting is done for managerial use in decision making process. The argument here is that of conflict of interest (A. Bhimani, 1996). The manager’s decision can only be focused on his personal benefits, which is not the desirable case. Any decision taken by the management has to be focused on the maxim “shareholder’s wealth maximization”. All the decisions of the management should be beneficial for all the stakeholders of the organization.

The last and final argument against management accounting is that of manipulative accounting or creative accounting as it has been famously called. The managers are interested in getting the approval of the major shareholders for any project. And to be able to do this, they project all rosy pictures and get the approval. This is both legally and ethically wrong and managers should avoid it as it reduces the credibility of the entire system. Also, there are cases of accounting operations and information manipulation because of the differences in the management accounting practices employed in different countries. The difference in policies gives rise to the possibility of any manipulations to be done by the managers.

REFERENCES:

  1. Blake, John et.al. 2003. The dimensions of, and factors giving rise to, variations in national management accounting. European Business Review. Volume 15. Number 3. 2003.
  2. Bhimani A, 1996. Management Accounting: European Perspectives. Oxford University Press.
  3. Pomeranz, F. 1984. International Accounting organizations. Holzer, H.P. International Accounting, Harper and Row, New York.