T4 May 2011

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The Chartered Institute of Management Accountants 2011

T4

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T4 Part B Case Study ExaminationThursday 26 May 2011

Instructions to candidates

You are allowed three hours to answer this question paper.

You are allowed 20 minutes reading time before the examination beginsduring which you should read the question paper and, if you wish, makeannotations on the question paper. However, you will not be allowed, underany circumstances,to open your answer book and start writing or to useyour calculator during the reading time.

This booklet contains the examination question and both the pre-seen andunseen elements of the case material.

Answer the question on page 13, which is detachable for ease of reference.The Case Study Assessment Criteria, which your script will be markedagainst, is included on page 14.

Maths Tables and Formulae are provided on pages 19to 22.

Write your full examination number, paper number and the examinationsubject title in the spaces provided on the front of the examination answerbook. Also write your contact ID and name in the space provided in the righthand margin and close to seal.

Contents of this booklet:

Page

Pre-seen material BZCS construction case 2

Pre-Seen Appendices 1- 4 9

Question Requirement

Case Study Assessment Criteria

13

14

Unseen Material 15 - 18

Maths Tables and Formulae 19 - 22

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T4 Part B Case Study 2 May 2011

BeeZed Construction Services (BZCS) case

Construction industry background

Due to the current economic climate, the demand for building work in Europe has fallen overallby over 10% from 2008 levels. Furthermore, it is forecasted that the volume of construction workwill not increase until the start of 2011. Many companies in the construction industry havesuffered falls in profits as a direct result of the slowdown in new contracts being awarded.

Many European construction companies are involved in a large range of projects in manycountries worldwide. Few large construction companies (except some house buildingcompanies) operate only within their national boundaries. Most construction companies haveestablished a range of expertise in specific types of project, such as construction of officebuildings, hospitals, airports, roads or schools. This expertise allows the construction companiesto use their skills and reputation to bid for, and win, further projects in Europe and in othercountries around the world.

Many large construction projects are financed using Private Finance Initiatives (PFI). PFI isdefined as private finance being used to fund public infrastructure work. Private finance isdefined as finance provided mainly by banks, institutional investors and pension funds. ThePrivate Finance Initiative (PFI) is a way of creating Public Private Partnerships (PPP). PPP isdefined as agreements between public bodies or central governments and private constructioncompanies to deliver the agreed projects. Examples of public infrastructure works are roadbuilding and construction of new schools. PFI projects also involve the private sectorconstruction company taking on responsibility for providing an on-going service. This typicallyincludes maintaining and managing the project over the life of the building or for a fixed term of20 years or longer. Therefore, PFI projects generate revenue streams for the constructioncompany for the initial construction project as well as for long-term maintenance and

management of the asset. PFI projects involve the private construction company as a partner inthe project and this has generated favourable outcomes in respect of the percentage of projectscompleted on time and completed to the agreed budget.

In the construction industry there are 3 main types of contract, which are:

1. Fixed price contracts this is where the revenue for the private construction company isfixed at the contract stage, subject to changes in specifications agreed duringconstruction.

2. Cost plus contracts this is where the revenue for the private construction companywill comprise all of the actual costs of the project plus an agreed profit element.

3. Long-term PFI projects this is where the revenue for the private construction companywill include the contracted construction revenue as well as revenues for on-goingmaintenance and property management for a long-term project, typically 20+ years.

The process for private construction companies to win a new contract for a large constructionproject is summarised in the following steps:

1. A company or government body will invite tenders2. The construction company will tender for the contract by preparing a detailed bid3. A company or government body will select its preferred contractor4. The bid price and the contract details will be negotiated and agreed5. Contracts are then signed6. Selection and appointment by the construction company of suppliers for manpower

resources (sub-contractors), as well as for materials7. Work commences

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May 2011 3 T4 Part B Case Study

It should be noted that during construction work, there are often many requests for changes tothe original contract specifications or design which are submitted to the construction company.These changes usually affect costs and manpower. All of these change requests have to benegotiated and additional revenues agreed before the changes can be made.

BeeZed

BeeZed is a construction and property management company listed on a European stockexchange.

BeeZed has 3 wholly owned subsidiary companies which are:

BeeZed Construction Services (BZCS) concerned with a wide range of constructionprojects

BeeZed Professional Services (BZPS) concerned with offering consultancy services

BeeZed Building Support Services (BZBSS) concerned with property managementand maintenance services.

In respect of PFI projects, the parent company, BeeZed, will sign the overall contract for theproject. BZCS will be involved only with the construction work and BZBSS will manage theongoing maintenance and property management work. When a PFI contract is signed, theparent company, BeeZed, will agree on how the revenues will be split between BZCS andBZBSS.

This case study is concerned ONLY with BeeZed Construction Services (BZCS).

BZCS

BZCS has many construction projects around the world, ranging from road building, constructionof public sector buildings, including hospitals, schools and university buildings to commercialcontracts for office buildings. Some of the construction projects that BeeZed is involved with arefinanced by PFI. However, only the revenue related to the construction project is allocated toBZCS. The revenue relating to the ongoing maintenance and property management work isallocated to BZBSS and is not

included in this case study. BZCS has a good reputation in thisindustry for quality and safety as well as its ability to deliver projects on time. These are allcritical success factors for keeping its existing customers content and for providing a basis forwinning future business.

BZCS has 6 divisions, which are:

1. Office Buildings Division includes building bespoke office buildings for specificcompany orders, as well as speculative construction of office buildings in city centres oron business park complexes.

2. Sports Facilities Division includes the construction of large sports stadiums as well asthe construction of small regional sports facilities.

3. Environmental Projects Division includes the construction of water treatment facilities,the construction of sophisticated waste management facilities and marine projects,including the construction of container terminals and marinas.

4. Infrastructure Projects Division includes road building and airport construction.

5. Community Projects Division includes the construction of hospitals and smallerhealthcare facilities as well as schools and university facilities.

6. Energy Projects Division includes the construction of gas storage facilities and powerstations.

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Each of these 6 divisions is headed by a Commercial Director who is responsible for all of theprojects undertaken by that division.

A summary of the organisational structure for BZCS, effective from 1 January 2011, is shown inAppendix 1 on page 9.

In the year ended 30 September 2010, BZCS generated total revenues of 1,267 million andoperating profit of 34.7 million.

BZCS is a wholly owned subsidiary of BeeZed. An extract from the accounts for BZCS is shownin Appendix 2 on page 10.

All of the non-current liabilities represent inter-company long-term loans from its parentcompany, BeeZed. BeeZed has a range of non-current liabilities with several external bodiesincluding bank loans.

BZCSs cash flow statement for the year ended 30 September 2010 is shown in Appendix 3 onpage 11.

Geographical analysis of revenues

BZCS currently has construction projects operational throughout Europe, the USA, the MiddleEast and in some other countries, mainly in Asia.

The geographical analysis of the total construction services revenue of 1,267 million for theyear ended 30 September 2010 was as follows:

Analysis of revenues and operating profit by division

The revenues and operating profit for each of BZCSs 6 divisions for the year ended 30September 2010 are shown in a table on the next page:

Europe 690 m

USA 369 m

Middle East 110 m

Rest of World 98 m

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Revenue Operatingprofit

Office buildings

million

220.0

million

8.5

Sports facilities 145.2 3.4

Environmental projects 193.1 4.2

Infrastructure projects 365.2 16.8

Community projects 213.6 1.3

Energy projects 129.9 0.5

Total 1,267.0 34.7

Financials

The operating profit margins achieved by BZCS are low, as is the norm for this industry.However, for some of BZCSs PFI construction projects, BZBSS, which is part of the BeeZedgroup, earns additional revenues for a further 10 to 30 years for the ongoing maintenance andproperty management of the PFI projects.

Whilst BZCS prepares annual financial accounts, all of the accounting for each constructionproject is accounted for on a project basis. All direct costs are allocated to the respective project,including salary and associated costs for all of BZCSs employees working on each project aswell as sub-contractor costs. All non-project based overhead costs are allocated to projectsusing activity based costing techniques based on appropriate cost drivers.

The monthly management accounts show the following information for all on-going operationalconstruction projects:

Contract revenues and costs

Approved change requests to contracts and amended revenues and costs

Cumulative costs to date for the project (spanning current and past financial years)

Forecast of costs for the remainder of the project (which are split between costs to beincurred in the current financial year and costs to be incurred in future financial years)

BZCS uses a project management system called BZPM. Each Project Manager is responsiblefor all direct costs incurred on the project for which he / she is responsible.

Each Project Manager is responsible for presenting the projects financial and operational issuesthat have occurred for each project on a monthly basis. These presentations are to seniormanagement groups chaired by the Commercial Director for the relevant division of BZCS.These presentations cover all aspects of the project, including safety issues, forecasts for thedelivery of the project against plan and any significant operational problems or successes. Ifthere is a significant problem, the Project Manager will be expected to travel to BZCSs HeadOffice to present the information to the BZCS Board. Where there are no operational or financialconcerns, the Project Manager conducts his monthly presentation by video conferencing.

Order book

At 30 September 2010 BZCS had an order book valued at over 2,400 million. This is 30%higher than the level of BZCSs order book at the 30 September 2009. The order book

represents the value of contracts signed which have either not yet been commenced or arecurrently in progress.

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Project Management

BZCS uses a project management system to plan each project, called BZPM. The contractdetails and agreed key stages are set up in BZPM when the contract is signed for each newconstruction project. A Project Manager is appointed for each project. He or she is responsiblefor controlling all stages of the project using BZPM. This includes control of resources, both

BZCS employees and outsourced sub-contractors, timings for each stage of the project, projectplanning and managing contract change requests. The Project Manager is also responsible forcontrol and reporting of costs against the original contract and the updated budget for theproject.

The finance system interfaces directly with BZPM allowing data on payments for materials andsub-contractors, payroll costs and revenues to be directly allocated to each stage of the relevantproject. The Project Manager and his team, assisted by the Finance Department, preparemonthly accruals based on activities undertaken in the month, which have not been invoiced.BZPM is able to generate reports on all aspects of each project, including forecast timings for allactivities and costs, by the end of day 3 after each month end.

Corporate Social Responsibility

BZCS takes its Corporate Social Responsibility (CSR) very seriously. The BZCS Board iscommitted to safety on all projects and also to the reduction of waste from sites and thereduction of carbon emissions. It is also very aware of environmental concerns and worksclosely with the communities in which it operates.

BZCSs commitment to health and safety and environmental issues is shown below.

Health and SafetyHealth and safety is a top priority for BZCS. BZCS continues to enhance its culture of safetythroughout the company and its supply chain, to ensure that its employees, sub-contractors andthe public are safe. BZCS also ensures that environmental safety is adhered to, so as to try toensure that the communities in which it operates are not damaged or polluted.

BZCS, like all construction companies, adheres to all Health and Safety legislation and BZCSgoes beyond what is required by law. It trains all of its employees to ensure their competencyand full understanding of what and why safety is so important in all aspects of the company.This training covers all aspects of health and safety, from construction work at building sites totransportation of materials and disposal of waste. BZCS continues to measure its performanceagainst a range of key Health and Safety indicators.

BZCSs annual accident frequency rate has fallen over the last 7 years and is currently 0.16accidents per 100,000 work hours. This is the lowest accident rate ever achieved by BZCS andis amongst the lowest of the top construction companies globally. 20,000 person days of Healthand Safety training has been provided by BZCS during the last financial year ended 30September 2010.

BZCS recognises that it is also important that its supply chain is fundamental to the safe deliveryof all construction projects and it works closely with the companies in its supply chain. It tries toensure that best practice is promoted and that a positive safety culture is created. BZCSprovides Health and Safety awareness training to its key suppliers to ensure that they meetBZCSs challenging Health and Safety requirements. BZCS also conducts audits of its suppliers.Recently some suppliers contracts were not renewed as they did not meet the criteria set byBZCS for Health and Safety standards.

Environmental issuesBZCS is committed to complying with a European Union (EU) wide programme to reduce thevolume of waste that goes to landfill sites. Where possible waste from construction sites issorted by category of material (such as earth, packaging or materials which can be recycled)and is recycled or disposed of in a safe way. BZCS has a range of waste managementcontractors which manage the safe disposal of site waste. They have demonstrated their

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abilities to divert waste from landfill sites. Last year, ended 30 September 2010, BZCSs targetwas to dispose of, or recycle, 60% of site waste that would otherwise have ended up in landfillsites. BZCS exceeded this target and disposed of, or recycled, 62% of its waste from itsconstruction sites.

BZCS is committed to reducing its carbon footprint and to minimising its impact on the

environment. BZCS uses the latest technology on its construction projects so that new buildingsare able to operate in an environmentally responsible way and utilise efficient electrical fittings.Many of the buildings contracted by European government departments, such as schools andhospitals, use renewable energy sources and BZCS works closely with the architects to ensurethat the buildings will help to deliver planned reductions in carbon emissions.

BZCSs Mission Statement and CSR initiatives are shown in Appendix 4 on page 12.

Contracts

BZCS is continuously working on bids for possible new contracts. It has specialised teamsheaded up by Bid Managers in each of BZCSs 6 divisions. When a bid has been won and acontract signed, then a Project Manager is appointed to manage the project. Sometimes, on a

particularly complicated project, the initial Bid Manager will become the Project Manager.

Each of BZCSs 6 divisions usually has between 1 and 5 projects in progress at any point intime. Furthermore, each of the 6 divisions is usually involved in the bid preparation and thebidding process for several other proposed projects. Whilst BZCS has been the preferredsupplier for some European government departments in the past for infrastructure projects andcommunity projects, these large customers are now imposing increasingly strict criteria forsuppliers to meet. Bids need to be competitive in the current challenging economic climate.Therefore, BZCS, like many other construction companies, is not successful in winning all of theprojects for which it bids for.

In order to balance the risk of relying on specific construction sectors and a relatively smallcustomer base, BZCS tries to win contracts from a wide selection of organisations. These

include government and private sector customers. BZCS also undertakes a wide range ofdifferent types of construction project.

BZCS has secured some construction projects for the London 2012 Olympic Games.

At any point in time BZCS usually has between 12 and 20 projects in progress, with bidpreparations taking place for a further 10 or more projects. The bid value of a contract variesgreatly, ranging from 5 million to over 800 million for individual contracts. Contract durationoften spans more than 2 years.

As at the end of December 2010, BZCS has 14 projects currently operational, of which 10 aredue for completion during 2011 and the remaining 4 are due to be completed in 2012.

Bid tendering process

In the UK, the Governments regulator, the Office of Fair Trading (OFT) has been undertakinginvestigations of bid-rigging in the construction industry. The OFT has established that there iswidespread evidence of construction companies which have been involved in manipulating thebidding process. This has allowed specific companies to win Government awarded constructionprojects at higher prices than could be achieved through a fair competitive bidding process. Thison-going investigation has involved the OFT accessing paperwork for over 100 contracts from20 construction companies. It will also impact on the ways that construction companies,including BZCS, bid for new projects in the future.

In order to be treated leniently, BZCS has advised the OFT that it did have discussions with

some other construction companies concerning the level of its bid for a UK hospital constructionproject that it won the contract for in 2008. The project is proceeding on time and it is forecastthat it will not over-run the agreed fixed price budget.

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BZCS is waiting to hear the outcome of the OFTs investigation into this specific contract. BZCShas included a provision for a contingent liability, for a possible fine, in the accounts for thecurrent financial year ending 30 September 2011.

Re-structuring of BZCS

During 2009 and the early part of 2010, BZCS underwent a re-structuring process to enable it tobecome more competitive following the downturn in construction projects due to the currenteconomic environment. The Board of BZCS recognised the need to become more flexible and tosub-contract a greater volume of its core construction work. Following a Board decision in March2009, BZCS reduced the number of its employees by 1,800 within 1 year. At the end ofSeptember 2010, BZCS had 10,100 employees. Many of BZCSs ex-employees have joinedsome of BZCSs supply chain companies, which are BZCSs sub-contractors. Therefore some ofthese people work on the same project as previously but now are employed by sub-contractorsor have become short-term freelance contractors to BZCS.

BZCS has also focused on winning a wider range of private construction projects as manyEuropean governments have cut the budgets on public sector projects and bidding is more

competitive than ever.

A summary of the organisational structure for BZCS, effective from 1 January 2011, is shown inAppendix 1 on page 9.

Within each division, the Commercial Director has responsibility for each of the ProjectManagers who are each responsible for one operational project. Projects that are operationalare defined as a project in which the contracts have been signed but construction is notcomplete. Each division also has Bid Managers responsible for preparing bids or tenders fornew projects and Sales and Marketing Managers for selling to, and liaising with, customers.Additionally there is a Post Completion Manager responsible for all projects that have ongoingproblems or require minor rectification work after the project has been completed.

Re-structuring of the Procurement DepartmentBefore the re-structuring of BZCS, each division was responsible for the procurement for each ofthe projects under its control. Effective from 1 January 2011, there is a new central ProcurementDepartment for the whole of BZCS. This is under the direct control of an experiencedProcurement Director, who reports directly to BZCSs Managing Director. The new ProcurementDirector was recruited from a rival construction company and joined BZCS in October 2010.

The employees who worked in the procurement departments within each of BZCSs 6 divisionshave been brought together in one centralised Procurement Department, based in Europe. Thisshould help to facilitate better control over purchases and achieve higher bulk discounts,especially for some raw materials. On an operational level, all of BZCSs Project Managers atconstruction sites in each country will now make all purchases through the new centralisedProcurement Department. They will be given limited authority to purchase goods locally where

no global contract is in place for particular materials.

The new centralised Procurement Department is in the process of selecting preferred supplierswithin each country in which it operates. Where possible, the preferred supplier will be anotherlarge international company that can provide materials to BZCS in many of the countries inwhich BZCS has on-going construction projects. The Finance Department is working closelywith the Procurement Director in the selection and appointment of new and existing suppliers.The re-structuring of BZCSs Procurement Department has resulted in an overall reduction inheadcount in procurement employees. The new centralised Procurement Department will helpmeet BZCSs target for Head Office cost savings.

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Appendix 2

Extracts from BZCSs Statement of Comprehensive Income,Statement of Financial Position and Statement of Changes in Equity

Statement of Comprehensive Income

Year ended

30 September 2010

Year ended

30 September 2009

million million

Sales revenue 1,267.0 1,280.0Cost of sales 1,210.3 1,222.0Gross profit 56.7 58.0Administrative expenses 22.0 22.8

Operating profit 34.7 35.2

Finance income 0.2 0.3Finance expense 7.5 8.7Profit before tax 27.4 26.8

Tax expense (effective tax rate is 20%) 5.5 5.4

Profit for the period 21.9 21.4

As atStatement of Financial Position 30 September 2010

As at30 September 2009

million million million million

Non-current assets (net) 241.0 234.0

Current assetsInventory 3.1 3.4Trade receivables 167.0 167.8

Cash and cash equivalents 23.4 31.2193.5 202.4Total assets 434.5 436.4

Equity and liabilitiesEquity

Share capital 10.0 10.0Retained earnings 176.0 154.1

186.0 164.1Non-current liabilitiesInter-company loan(provided by parent company BeeZed) 125.0 145.0

Current liabilitiesTrade payables 118.0 121.9Tax payables 5.5 5.4

123.5 127.3

Total equity and liabilities 434.5 436.4

Note: Paid in share capital represents 10 million shares of 1.00 each at 30 September 2010 which are100% owned by parent company BeeZed

ShareStatement of Changes in Equity Capital

Sharepremium

Retainedearnings

Total

million million million million

Balance at 30 September 2009 10.0 - 154.1 164.1Profit - - 21.9 21.9

Dividends paid - - - -Balance at 30 September 2010 10.0 - 176.0 186.0

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Appendix 3

Cash Flow Statement

Year ended30 September 2010

million millionCash flows from operating activities:

Profit before taxation (after Finance costs (net)) 27.4

Adjustments:Depreciation 88.0Finance costs (net) 7.3

95.3

(Increase) / decrease in inventories 0.3(Increase) / decrease in trade receivables 0.8Increase / (decrease) in trade payables

(excluding taxation) (3.9)(2.8)

Cash generated from operations 119.9

Finance costs (net) paid (7.3)Tax paid (5.4)

(12.7)

Cash generated from operating activities 107.2

Cash flows from investing activities:

Purchase of non-current assets (95.0)

Cash used in investing activities (95.0)

Cash flows from financing activities:Repayment of inter-company loans (20.0)

Cash flows from financing activities (20.0)

Net decrease in cash and cash equivalents (7.8)

Cash and cash equivalents at 30 September 2009 31.2

Cash and cash equivalents at 30 September 2010 23.4

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Appendix 4

BZCSs Mission Statement and CSR initiatives

BZCSs mission statement is:

To be the preferred supplier for quality construction projects and to strive to implement along-term relationship with our customers based on safety, quality and a timely service

BZCS has the following CSR initiatives:

Prudent use of natural resources:

Reducing waste

Improving design

Improving the use of resources

Improving its supply chain

Increasing the use of locally sourced resources

Environmental issues:

Reducing water pollution

Reducing emissions into the atmosphere

Reducing waste going to landfill sites

Social issues:

Improving Health and Safety for our employees and sub-contractors

Supporting our employees

Giving due consideration to the communities in which we work

Developing the skills of our employees

Economic growth Investing in the communities in which we operate

Rewarding our shareholders

Satisfying our customers

Managing our risks

End of pre-seen material

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BZCS - Construction company case Unseen material provided on examination day

Additional (unseen) information relating to the case is given on pages 15 to 18.

Read all of the additional material before you answer the question.

ANSWER THE FOLLOWING QUESTION

You are the Management Accountant of BZCS.

The Finance Director has asked you to provide advice and recommendations on theissues facing BZCS.

Question 1 part (a)Prepare a report that prioritises, analyses and evaluates the issues facing BZCS andmakes appropriate recommendations.

(Total marks for Question 1 part (a) = 90 Marks)

Question 1 part (b)

In addition to your analysis in your report for part (a), the Finance Director has askedyou to prepare an email to be sent to non-financial managers in the Office BuildingsDivision of BZCS explaining the principles and the meaning of NPV calculations ingeneral, together with your recommendation on the office building proposal.

Your email should contain no more than 10 short sentences.

(Total marks for Question 1 part (b) = 10 Marks)

Your script will be marked against the T4 Part B Case Study Assessment Criteriashown on the next page.

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Assessment Criteria

Criterion Maximummarks

availableAnalysis of issues (25 marks)

Technical 5

Application 15

Diversity 5

Strategic choices (35 marks)

Focus 5

Prioritisation 5

Judgement 20

Ethics 5Recommendations (40 marks)

Logic 30

Integration 5

Ethics 5

Total 100

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BZCS - Construction company case unseen material provided on examination day

Read this information before you answer the question

Waste materials

Charlie Rix is a junior procurement manager for BZCS. In the course of his work he cameacross some documents concerning the collection of waste materials from a site where BZCS isconstructing a new water treatment plant. On investigation, Charlie Rix has found that thecollected waste has not been sent to specialist waste disposal sites, but instead has beendelivered to a local landfill site. Charlie Rix is concerned that some of the site waste couldcontain toxic chemicals.

In your role as Management Accountant you had been asked to provide an analysis of thevolumes of waste handled by all of BZCSs waste material sub-contractors and the levels ofmaterials recycled. You had a meeting with Charlie Rix last week to discuss gathering thisinformation. However, when you met with him, he showed you the documents he has foundconcerning the disposal of this waste material which has been sent to a landfill site.

Unfinished sports club

BZCS signed a contract in August 2010 to construct 2 sports clubs for a small chain of privatesports clubs called EXX Sports (ES) to be completed by December 2011. The contract was for afixed price of 25 million for each of the 2 sports club buildings. All construction work would useBZCS employees and very few sub-contractors, as BZCS had employees immediately availableto work on this project. BZCS planned to complete the first sports club before work started onthe second, and this was acceptable to ES.

An initial payment of 5 million for the first building was paid by ES when contracts were signed.Work commenced on the first of these 2 sports clubs in November 2010, but work was

suspended temporarily when ES did not make the first stage payment of 5 million due inDecember 2010. Payment was made in late January 2011 and work was re-started. The nextstage payment for another 5 million, became due at the end of April 2011, but was not paid ontime. BZCS was informed that payment would be made in 10 days time and work continued.

Following media speculation concerning ESs cash problems, ES was put into liquidation onFriday 13 May 2011. All work on site was suspended that day. The 50 BZCS employees workingon this project have not yet been allocated to other projects. To date ES has only paid 10million.

BZCS has applied to the liquidator to be added to the list of creditors. BZCS is claiming thecontract revenue of 25 million for the first sports club which is partially completed, less the 10million already paid, as well as the loss of profit of 3 million for the second sports club which

has not been started. BZCSs total claim is for 18 million. The liquidator is not optimistic andhas indicated that all creditors may receive only around 10% of their claims.

Alternatively, BZCS is considering a proposal to contact ESs liquidator with an offer to pay3 million to take on legal ownership of the unfinished sports club. If BZCS were to take legalownership of the sports club, it considers that the maximum it could realise from the sale of thecompleted building would be 20 million, due to current depressed market conditions. BZCS hasspent 14 million so far on the partially completed sports club. It is forecast that BZCS wouldneed to spend a further 8 million to complete it.

The Finance Director has asked you, as Management Accountant, to advise on whether BZCSshould pursue the proposal to try to take ownership of the incomplete sports club. You shouldalso advise on what would be the maximum that BZCS should pay to take on the unfinished

sports club, if BZCSs offer of 3 million is not accepted.

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Office building proposal

BZCS has worked with a leading international architect, Ben Bleur, on many projects previously.All of the projects were commercially successful and some building designs have won awards.BZCS has recently been asked by Ben Bleur to be the developer of, and to construct, aninnovatively designed 50 floor office building in a European capital city. The project would utilise

the latest environmentally sound technology to recycle heat and reduce carbon emissions. BenBleurs building design has just received planning permission to proceed. He is now selecting acompany to develop and construct the office building and has been approached by severalinterested competitors of BZCS. The deadline for BZCS to make a decision is 31 May 2011.

The Commercial Director of BZCSs Office Buildings Division is very confident that the proposedbuilding design and the association with Ben Bleur will attract corporate buyers of prestige officespace. This would be the first city centre large office building that BZCS has consideredconstructing without first identifying customers to buy the completed office space. Therefore, ifBZCS decided to proceed with the development it would bear all of the commercial risk of thisproposal, including the purchase of the land at 50 million. BZCSs parent company hasconfirmed that it could secure sufficient external financing for this proposed development.

If BZCS decided to proceed with this proposal, then it would need to generate publicity in orderto secure sales of the office space. As is usual with the construction of such an office building,the actual construction work would not commence until a certain specified level of sales of officespace had been made. BZCS would commence a sales campaign to sell whole floors in thebuilding to customers off plan. An off plan sale is defined as a contracted sale of office space(usually a specified floor or several floors) before building work has even commenced.

The off plan sales would be subject to BZCS selling a specified percentage of the building by acertain date. The Sales and Marketing Manager for the Office Buildings Division of BZCS hasproposed that the percentage that should be sold before building work commences should beset at 30% by 31 December 2011. Usually, when a building is under construction, sales areeasier to achieve as potential customers can see the style of the building under construction andare often attracted by the media interest it generates. However, if the 30% target for off-plan

sales were not achieved, then BZCS could sell the undeveloped city centre building plot,although it may receive less than the 50 million that it would have paid for it.

BZCSs civil engineers have forecast that this project would use around 900 employees eachyear, as well as specialised sub-contractors. It is forecast that the total cost of the building wouldbe 525 million (based on 2011 prices) over 4 years, including the cost of the land.

It is forecast that the sale of all office space will be achieved over 4 years and will generatesales revenue of 700 million (based on 2011 prices). It is forecast that all office space will besold within 1 year of the planned completion of the building in September 2014.

The Finance Director recognises the need to secure sales of office space and you have beenasked to discuss what actions the Office Buildings Division of BZCS should take in order to

secure the sales of office space in order to generate the forecast cash inflows shown in the tableon the next page.

A sale of part, or all, of the building is sometimes made to a property management companyrather than a corporate customer. The forecast cash inflows from sales shown in the table onthe next page include all sales, irrespective of whether it represents the end customer or not.

Following preliminary discussions with corporate customers looking for new office premises, DJ,a global insurance company, has expressed a serious interest in purchasing 25 floors of thebuilding, which represents 50% of the office space. However, DJ has stated that the maximumprice it is prepared to pay is 300 million, spread over 3 years, a discount of 50 million.However, an early sale of a significant proportion of the office building will also help attract othercorporate customers.

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Note: All figures shown below are based on 2011 prices

Year ended: 30 Sept2011

30 Sept2012

30 Sept2013

30 Sept2014

30 Sept2015

Totals

All figures pre-tax million million million million million million

Cash outflows 50 180 170 125 0 525

Cash inflows:Without sale to DJ 0 120 150 180 250 700

With sale of 25 floors to DJ 0 140 170 200 140 650

The pre-tax cash flows are summarised in the table above. You should assume that the effectivetax rate is 20% and that tax is paid, or refunded, 1 year in arrears. It should be assumed all cashflows shown in the table above are eligible for tax relief. The Finance Director has stated that therelevant post-tax discount rate is 15%, which includes a premium for the risk of this project.

Problems with BZPM

BZCS uses a project management system called BZPM. It is an off-the-shelf projectmanagement system which is widely used. BZCS pays an annual software licence fee to thesoftware company, EAG. This IT system is used by all of BZCSs Project Managers for eachproject to help them plan and monitor the progress, costs and resources for each project. Thissystem is key to the day to day management of all projects and holds details of all currentcontracts and forecast cost details, as well as manpower resource planning details. The BZPMsystem interfaces with other BZCS IT systems. This allows the transfer of data electronically intoBZPM in respect of payroll costs, supplier and sub-contractor invoices, all of which are chargedto each activity within each individual project.

The IT department installed the recently released upgraded software for BZPM last weekend,

after all users had been informed that BZPM would be unavailable for the weekend. Theupgraded BZPM was then tested and the IT department issued an email to all users on Mondaymorning of this week, informing them that the upgraded system was operational again. The ITdepartment reminded all users about the new features of the upgraded BZPM and asked for anyqueries to be directed to the IT Manager, Nicos Talli.

By the end of Tuesday of this week, 2 days after the upgrade was installed, Nicos Talli hadreceived over 80 emails with queries from almost all of the Project Managers and theiradministrative staff. Nicos Talli is totally overwhelmed by the volume of emails with queries andproblems raised by users throughout all of the divisions of BZCS. He has chased, by phone andby emails, his contact person at the software company, EAG, which has now admitted that it hasother customers who are also experiencing some problems with the new software release.

Nicos Talli has suggested that BZPM is closed down for 2 days whilst he investigates theproblems. However, the Finance Director is under pressure to keep BZPM operational. He hasasked Nicos Talli to check the integrity of the data contained in BZPM and to investigate whatdata has been corrupted, as some Project Managers have stated that dates have been changedwithin a project. He has also asked Nicos Talli to propose what actions should be taken.

One of the Project Managers has suggested to Nicos Talli that the last backed-up version ofBZPM from last Friday night, before the software update was installed, should be re-installed.However, there has been 3 days of new input of data, as well as transfers of data from otherBZCS IT systems, since the last backed-up version of all the operational projects in BZCS.

The Finance Director has asked you, as Management Accountant, to work with Nicos Talli toestablish what actions are necessary in order to make BZPM fully operational and reliable.

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Safety checks

BZCS has a very good track record on safety issues and training and this is an important issuefor its construction site workforce. At one of the government funded road building projects whichBZCS is under pressure to complete in 3 weeks time, the required weekly safety checks on sitemachinery have not been completed for the last 2 weeks. The Project Manager is concerned

that an accident could occur. He has repeatedly phoned and emailed BZCSs Head Office everyday for the last week. He has now stated that unless the safety checks are carried out by 5 pmtomorrow, work on site will completely stop. The cost of all employees and sub-contractors is80,000 per day. BZCSs Head Office has instructed the Project Manager to continue workingon site.

The Project Manager has been told by BZCSs Head Office that a new contractor, TT, wasappointed 2 weeks ago to carry out BZCSs safety checks in this European country. BZCSsHead Office has advised that this delay is just a one-off effect of the transfer to TT. However, onfurther investigation, TT has now admitted that it cannot undertake the safety checks at this site,as well as some other BZCS sites, for a further 4 weeks due to insufficient staffing.

The Project Manager at the road building site has identified a suitable local safety management

company, which has quoted a premium rate of 20,000 per week for all safety checks to beperformed immediately for the road building site only. However, the contract is for a minimumperiod of 12 weeks.

End of unseen material

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APPLICABLE MATHS TABLES AND FORMULAE

Present value table

Present value of 1.00 unit of currency, that is (1 + r)-n

where r= interest rate; n= number of periods untilpayment or receipt.

Periods(n)

Interest rates (r)

1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.9092 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.8263 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.7514 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.6835 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.6216 0.942 0.888 0.837 0.790 0.746 0705 0.666 0.630 0.596 0.5647 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.5138 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467

9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.42410 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.38611 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.35012 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.31913 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.29014 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.26315 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.23916 0.853 0.728 0.623 0.534 0.458 0.394 0.339 0.292 0.252 0.21817 0.844 0.714 0.605 0.513 0.436 0.371 0.317 0.270 0.231 0.19818 0.836 0.700 0.587 0.494 0.416 0.350 0.296 0.250 0.212 0.18019 0.828 0.686 0.570 0.475 0.396 0.331 0.277 0.232 0.194 0.16420 0.820 0.673 0.554 0.456 0.377 0.312 0.258 0.215 0.178 0.149

Periods

(n)

Interest rates (r)

11% 12% 13% 14% 15% 16% 17% 18% 19% 20%1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.8332 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.6943 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.5794 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.4825 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.4026 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.3357 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.2798 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.2339 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194

10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.16211 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.13512 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.11213 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.09314 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.07815 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.079 0.065

16 0.188 0.163 0.141 0.123 0.107 0.093 0.081 0.071 0.062 0.05417 0.170 0.146 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.04518 0.153 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.03819 0.138 0.116 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.03120 0.124 0.104 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026

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Cumulative present value of 1.00 unit of currency per annum, Receivable or Payable at the end of

each year for nyears

+

r

r n)(11

Periods(n)

Interest rates (r)

1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.9092 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.7363 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.4874 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.1705 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791

6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.3557 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.8688 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.3359 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759

10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145

11 10.368 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.49512 11.255 10.575 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.81413 12.134 11.348 10.635 9.986 9.394 8.853 8.358 7.904 7.487 7.10314 13.004 12.106 11.296 10.563 9.899 9.295 8.745 8.244 7.786 7.36715 13.865 12.849 11.938 11.118 10.380 9.712 9.108 8.559 8.061 7.606

16 14.718 13.578 12.561 11.652 10.838 10.106 9.447 8.851 8.313 7.82417 15.562 14.292 13.166 12.166 11.274 10.477 9.763 9.122 8.544 8.02218 16.398 14.992 13.754 12.659 11.690 10.828 10.059 9.372 8.756 8.20119 17.226 15.679 14.324 13.134 12.085 11.158 10.336 9.604 8.950 8.36520 18.046 16.351 14.878 13.590 12.462 11.470 10.594 9.818 9.129 8.514

Periods(n)

Interest rates (r)11% 12% 13% 14% 15% 16% 17% 18% 19% 20%

1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.8332 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.5283 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.1064 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.5895 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991

6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.3267 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605

8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.8379 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.03110 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192

11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.32712 6.492 6.194 5.918 5.660 5.421 5.197 4.988 7.793 4.611 4.43913 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.53314 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.61115 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675

16 7.379 6.974 6.604 6.265 5.954 5.668 5.405 5.162 4.938 4.73017 7.549 7.120 6.729 6.373 6.047 5.749 5.475 5.222 4.990 4.77518 7.702 7.250 6.840 6.467 6.128 5.818 5.534 5.273 5.033 4.81219 7.839 7.366 6.938 6.550 6.198 5.877 5.584 5.316 5.070 4.84320 7.963 7.469 7.025 6.623 6.259 5.929 5.628 5.353 5.101 4.870

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FORMULAE

Valuation Models

(i) Irredeemable preference share, paying a constant annual dividend, d, in perpetuity,where P0 is the ex-div value:

P0 =

prefk

d

(ii) Ordinary (Equity) share, paying a constant annual dividend, d, in perpetuity, where P0 isthe ex-div value:

P0 =

ek

d

(iii) Ordinary (Equity) share, paying an annual dividend, d, growing in perpetuity at a constantrate, g, where P0 is the ex-div value:

P0 =

gk

d

-e

1

or P0 =

gk

g

+

e

0 ][1d

(iv) Irredeemable (Undated) debt, paying annual after tax interest, i(1-t), in perpetuity, whereP0 is the ex-interest value:

P0 =

net

][1

dk

ti

or, without tax:

P0 =

dk

i

(v) Future value of S, of a sum X, invested for nperiods, compounded at r% interest:

S = X[1 + r]n

(vi) Present value of 1 payable or receivable in nyears, discounted at r% per annum:

PV=n

r][1

1

+

(vii) Present value of an annuity of 1 per annum, receivable or payable for nyears,commencing in one year, discounted at r% per annum:

PV=

+

nrr ][1

11

1

(viii) Present value of 1 per annum, payable or receivable in perpetuity, commencing in oneyear, discounted at r% per annum:

PV=

r

1

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(ix) Present value of 1 per annum, receivable or payable, commencing in one year, growingin perpetuity at a constant rate of g% per annum, discounted at r% per annum:

PV=

gr

1

Cost of Capital

(i) Cost of irredeemable preference capital, paying an annual dividend, d, in perpetuity, andhaving a current ex-div price P0:

kpref=

0P

d

(ii) Cost of irredeemable debt capital, paying annual net interest, i(1 t), and having acurrent ex-interest price P0:

kdnet

=

0

][1

P

ti

(iii) Cost of ordinary (equity) share capital, paying an annual dividend, d, in perpetuity, andhaving a current ex-div price P0:

ke =

0P

d

(iv) Cost of ordinary (equity) share capital, having a current ex-div price, P0, having just paid adividend, d0, with the dividend growing in perpetuity by a constant g% per annum:

ke = g

P

d+

0

1

or ke = g

P

gd+

+

0

]1[0

(v) Cost of ordinary (equity) share capital, using the CAPM:

ke = Rf+[Rm Rf]

(vi) Weighted average cost of capital, k0:

k0 = ke

++

+DE

D

d

D

E

VV

Vk

V

V

EV

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T4 May 2011

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