ACC3602 Managerial Planning and Control (S2, 2014/15)

Tutorial 5
For the week beginning March 2, 2015

Problem 1
Washington Countys Board of Representatives is considering the construction of a longer
runway at the county airport. Currently, the airport can handle only private aircraft and small
commuter jets. A new, long runway would enable the airport to handle the midsize jets used on
many domestic flights. Data pertinent to the boards decision appear below.
Cost of acquiring additional land for runway
$70,000
Cost of runway construction
200,000
Cost of extending perimeter fence
29,840
Cost of runway lights
39,600
Annual cost of maintaining new runway
28,000
Annual incremental revenue from landing fees
40,000
In addition to the preceding data, two other facts are relevant to the decision. First, a longer
runway will require a new snowplow, which will cost $100,000. The old snowplow could be sold
now for $10,000. The new, larger plow will cost $12,000 more in annual operating costs. Second,
the County Board of Representatives believes that the proposed long runway, and the major jet
service it will bring to the county, will increase economic activity in the community. The board
projects that the increased economic activity will result in $64,000 per year in additional tax
revenue for the county.
Required:
1. Determine the IRR on the proposed long runway. Should it be built?
2. Prepare a NPV analysis for the proposed long runway. Should the County Board of
Representatives approve the runway? Which of the data used in the analysis are likely to
be most uncertain? Least uncertain? Why?
3. The County Board of Representatives believes that if the county conducts a promotional
effort costing $20,000 per year, the proposed long runway will result in substantially
greater economic development than was projected originally. However, the board is
uncertain about the actual increase in county tax revenue that will result. Suppose the
board builds the long runway and conducts the promotional campaign. What would the
increase in the countys annual tax revenue need to be in order for the proposed runways
internal rate of return to equal the countys hurdle rate of 12 percent?

Problem 2
The chief ranger of the states Department of Natural Resources is considering a new plan for
fighting forest fires in the states forest lands. The current plan uses eight fire-control stations,
which are scattered throughout the interior of the state forest. Each station has a four-person staff,
whose annual compensation totals $200,000. Other costs of operating each base amount to
$100,000 per year. The equipment at each base has a current salvage value of $120,000. The
buildings at these interior stations have no other use. To demolish them would cost $10,000 each.
The chief ranger is considering an alternative plan, which involves four fire-control stations
located on the perimeter of the state forest. Each station would require a six-person staff, with
annual compensation costs of $300,000. Other operating costs would be $110,000 per base.
Building each perimeter station would cost $200,000. The perimeter bases would need
helicopters and other equipment costing $500,000 per station. Half of the equipment from the
interior stations could be used at the perimeter stations. Therefore, only half of the equipment at
the interior stations would be sold if the perimeter stations were built.
The state uses a 10 percent hurdle rate for all capital projects.
Required:
1. Use the total-cost approach to prepare a NVP analysis of the chief rangers two firecontrol plans. Assume that the interior fire-control stations will be demolished if the
perimeter plan is selected. The chief ranger has decided to use a 10-year time period for
the analysis.
2. Use the incremental-cost approach to prepare a NVP analysis of the chief rangers
decision between the interior fire-control plan and the perimeter fire-control plan.
3. What qualitative factors would the chief ranger be likely to consider in making the
decision?

Problem 3
Saxon Products, Inc., is investigating the purchase of a robot for use on the companys assembly
line. Selected data relating to the robot are provided below.
Cost of the robot
Installation and software
Annual savings in labor costs
Annual savings in inventory carrying costs
Monthly increase in power and maintenance costs
Salvage value in 10 years
Useful life

$1,800,000
$900,000
?
$210,000
$2,500
$70,000
10 years

Engineering studies suggest that use of the robot will result in a savings of 25,000 direct labor
hours each year. The labor rate is $16 per hour. Also, the smoother work flow made possible by
the use of automation will allow the company to reduce the amount of inventory on hand by
$400,000. This inventory reduction will take place at the end of the first year of operation; the
released funds will be available for use elsewhere in the company. Saxon Products has a 20%
required rate of return.
Shelly Martins, the controller, has noted that all of Saxons competitors are automating their
plants. She is pessimistic, however, about whether Saxons management will allow it to automate.
In preparing the proposal for the robot, she stated to a colleague, Lets just hope that reduced
labor and inventory costs can justify the purchase of this automated equipment. Otherwise, well
never get it. You know how the president feels about equipment paying for itself out of reduced
costs.
Required: (Ignore income taxes.)
1. Determine the annual net cost savings if the robot is purchased. (Do not include the
$400,000 inventory reduction or the salvage value in this computation.)
2. Compute the NPV of the proposed investment in the robot. Based on these data, would
you recommend that the robot be purchased? Explain.
3. Assume that the robot is purchased. At the end of the first year, Shelly Martins has found
that some items didnt work out as planned. Due to unforeseen problems, software and
installation costs were $75,000 more than estimated and direct labor has been reduced by
only 22,500 hours per year, rather than 25,000 hours. Assuming that all other cost data
were accurate, does it appear that the company made a wise investment? Show
computations.
4. Upon seeing your analysis in (3) above, Saxons president stated, That robot is the worst
investment weve ever made. And now well be stuck with it for years.
a. Explain to the president what benefits other than cost savings might accrue from
using the new automated equipment.
b. Compute for the president the dollar amount of cash inflow that would be needed
each year from the benefits in (a) above for the automated equipment to yield a 20%
rate of return.

Problem 4
The Fore Corporation is an integrated food processing company that has operations in over two
dozen countries. Fores corporate headquarters is in Chicago, and the companys executives
frequently travel to visit Fores foreign and domestic facilities.

Fore has a fleet of aircraft that consists of two business jets with international range and six
smaller turboprop aircraft that are used on shorter flights. Company policy is to assign aircraft to
trips on the basis of minimizing cost, but the practice is to assign the aircraft based on the
organizational rank of the traveler. Fore offers its aircraft for short-term lease or for charter by
other organizations whenever Fore itself does not plan to use the aircraft. Fore surveys the
market often in order to keep its lease and charter rates competitive.
William Earle, Fores vice president of finance, has claimed that a third business jet can be
justified financially. However, some people in the controllers office have surmised that the real
reason for a third business jet was to upgrade the aircraft used by Earle. Presently, the people
outranking Earle keep the two business jets busy with the result that Earle usually flies in smaller
turboprop aircraft.
The third business jet would cost $11 million. A capital expenditure of this magnitude requires a
formal proposal with projected cash flows and net present value computations using Fores
minimum required rate of return. If Fores president and the finance committee of the board of
directors approve the proposal, it will be submitted to the full board of directors. The board has
final approval on capital expenditures exceeding $5 million and has established a firm policy of
rejecting any discretionary proposal that has a negative net present value.
Earle asked Rachel Arnett, assistant corporate controller, to prepare a proposal on a third
business jet. When Earle reviewed Arnetts completed proposal and saw the large negative net
present value figure, he returned the proposal to Arnett. With a glare, Earle commented, You
must have made an error. The proposal should look better than that.
Feeling some pressure, Arnett went back and checked her computations; she found no errors.
However, Earles message was clear. Arnett discarded her projections that she believed were
reasonable and replaced them with figures that had a remote chance of actually occurring but
were more favorable to the proposal. For example, she used first-class airfares to refigure the
avoidable commercial airfare costs, even though company policy was to fly coach. She found
revising the proposal to be distressing.
The revised proposal still had a negative net present value. Earles anger was evident as he told
Arnett to revise the proposal again, and to start with a $100,000 positive net present value and
work backwards to compute supporting projections.
Required:
1. Explain whether Arnetts revision of the proposal was in violation of management
accountants ethical and professional standards.
2. Identify specific controls that Fore Corporation could implement to prevent unethical
behavior on the part of the vice president of finance.