A2 1 Business Studies — Questions/Answers

June 2015 Question 1

1) Explain two benefits to Reachit Ltd of having a mission statement. [4]
A mission statement is a description of Reachit Ltd's key business objectives. Reachit Ltd's mission statement is "Striving to reach new heights in everything we do". By having a mission statement Reachit Ltd will be able to motivate their staff because if Reachit's staff believe in what the company is doing they'll be more productive because they'll believe what they're doing is worthwhile. Another benefit of Reachit Ltd's mission statement is that it enables the management team to communicate effectively to all key stakeholders. This means that Reachit Ltd's mission statement will show their customers the high standards Reachit employ when manufacturing their ladders. This should increase sales for Reachit.
2) Analyse two possible objectives that the employees of Reachit Ltd might have. [6]
One key objective that employees of Reachit Ltd will have is high wages. This means Reachit Ltd will have to pay generous wages to their staff compared to their competition. By doing so, this means Reachit Ltd will have a highly motivated, productive workforce which could help Reachit Ltd pay for the high wages because their production costs could be reduced due to the increased productivity of their employees.
Another objective of the employees at Reachit would be career progression. This means Reachit Ltd would have to promote their own staff instead of hiring outsiders. For example, when producing the Flexi 2.4m, an employee could progress from physically operating the machines to become a production supervisor. This means that employees can be ambitious which can make Reachit Ltd more efficient because employees will be competing to be the best to get the promotions.
3) Evaluate Payback as a method of investment appraisal for an organisation such as Reachit Ltd. [15]
One advantage of the Payback method of investment appraisal is that it is very easy to calculate. Based solely on the payback period the machine Reachit Ltd should buy is the Dynamo XZ. This means that Reachit Ltd won't need specialists to carry out the investment appraisal and they are unlikely to make a mistake with the calculation. This means that since the payback period is easy to understand, that it should be easy to communicate the reason for purchasing the Dynamo XZ to Reachit Ltd's stakeholders. However, the payback period doesn't take into account the qualitative factors that must be considered, such as the amount of staff training needed to get full use out of the machine.
Another advantage of the Payback method is that it is useful for businesses that have liquidity problems. Reachit Ltd has a current ratio of 1.4:1, this is below the optimal level of 2:1 which means Reachit could suffer from liquidity problems. This means that the length of time it takes for the machine to pay for itself could be very important to Reachit. This means that the Payback method could be the most relevant for Reachit as the payback period could be more important than any other factor. However, the Payback method doesn't consider the time-value of money. That £1 today won't be worth £1 in 3 years time which is the Payback period for the Dynamo XZ. This means that Reachit should use other methods of investment appraisal alongside the Payback method, such as NPV, which does consider the time-value of money.
One disadvantage of the Payback method is that it ignores that cash flow generated by the machine after the Payback period. This means by only using the Payback method Reachit Ltd will be taking a big risk because they won't know how healthy the cash flows of the Dynamo XZ are in years after the Payback period. This means that Reachit Ltd shouldn't just rely on the Payback method since they should be concerned about improving their liquidity and they should use a method of investment appraisal that considers the cash flows generated by the machine throughout its entire life. However, if Reachit Ltd look at the qualitative factors alongside the Payback method they could reduce the risk they're taking because the

June 2015 Question 3

3) Evaluate Payback as a method of investment appraisal for an organisation such as Reachit Ltd. [15]
Investment Appraisal attempts to assist Reachit Ltd with the evaluation of the financial position of projects. More specifically Payback shows Reachit Ltd how long it will take for them to be repaid by the net cashflows generated from the new production machine. This means that Reachit Ltd will be able to see how long it will take for the machine to pay for itself and what cash flows it will generate for Reachit Ltd during this time. This means that Reachit Ltd can look at the predicted cash flows over this time to see if the machine is a worthwhile investment. However, the cash flows used in the Payback method of investment appraisal are only predictions and if Reachit Ltd incorrectly predict the cash flows the new machine will generate, they could end suffer from cash flow problems if it doesn't generate enough.
One advantage of the payback method of investment appraisal is that it is easy to calculate and simple to understand. This means that the payback method could be useful for communicating whether or not to purchase the Energo 100 or the Dynamo ZX to all stakeholders. This means that it could be a useful tool for communicating with Reachit Ltd's shareholders who may not have a background in finance. Based off of the Payback period of 3 years for the Dynamo ZX Reachit Ltd should purchase that machine instead of the Energo 100. However, using the payback method, it is difficult to compare machines that cost different amounts.
One disadvantages of Payback as a method of investment appraisal is that it doesn't consider the cash flows generated after the machine has been paid back. This means that if the total net cash flows throughout the life the the Energo 100 where larger then Reachit Ltd may consider buying it instead, even with the longer payback period. This means that Reachit Ltd still have to use other methods of investment appraisal, such as Net Present Value, because Payback doesn't tell them all the information the need. However, Payback doesn't give any guidance to managers as to what a satisfactory payback is.
To conclude, I believe that Payback as a method of investment appraisal could be useful to Reachit Ltd but its use is limited by the fact that it doesn't account for cash flows occurring after the payback period. I believe that when used in conjunction with other methods of investment appraisal, such as Net Present Value, the Payback method could be useful for Reachit Ltd.

June 2015 Question 5

5)  Evaluate profit maximisation as a business objective for Reachit Ltd. [20]
Profit Maximisation for Reachit Ltd means that Reachit Ltd will achieve the largest possible profit they can. This means they will most likely have to sacrifice other objectives in the process. For example, employee welfare for Reachit Ltd's 64 workers is expensive and will reduce their profits. Employee welfare means high wages and good working conditions for workers. This means Reachit Ltd could achieve profit maximisation by not giving pay rises to their workers. However, this could cause Reachit Ltd's workers to become less productive which could cost Reachit Ltd money as the labour cost of producing each Flexi 2.4m will increase and directly work against them in their effort to achieve profit maximisation.
Profit Maximisation for Reachit Ltd can be achieved by reducing costs of employees and the costs of materials. This means that by sourcing the materials for their products, such as the Flexi 2.4m, from cheaper suppliers Reachit Ltd can increase their profits. This means Reachit will be able to reduce their manufacturing costs without angering their employees. However, since Reachit Ltd's new supplier is cheaper, it could be less reliable with deliveries and the new supplier could produce lesser quality materials which could anger Reachit's customers since they will be paying the same price for what they view is a lesser quality product which will hurt Reachit's reputation.
Profit Maximisation will be a key objective for the shareholders of Reachit Ltd because they will want to receive a high dividend since they have just come out of recession. Reachit Ltd will also have more money to invest in the new production machinery which could increase the productivity of their production lines. This means that Reachit won't have to go to a bank and pay interest on borrowed money for the machine and the increased productivity of the production line could also make up for the cost of the machine over time. However, since the new machine requires lots of staff training in order to maximise the productivity Reachit achieves from it, the benefits of the machine won't be realised straight away which could make stakeholders of Reachit question if achieving profit maximisation was worth the sacrifices made to other objectives.
Pursuing the goal of Profit Maximisation will force Reachit Ltd become more efficient and less wasteful. This means that Reachit Ltd could become more competitive if they reduce the number of managers because its decision making process will be faster if there aren't as many people to consult. This means that can reduce its wages bill which will help it in its goal to achieve profit maximisation. However, maximising short term profits at the expense of long term investment in the future of Reachit means they are missing an opportunity to allow Reachit to grow organically and increase the size of its business. Investing in the Flexi 2.4m instead of distributing profits to shareholders could be more beneficial to the company in the long term as they could turn their 'Problem Child' into a 'Star'.
To conclude, I believe profit maximisation is good for Reachit Ltd because it will encourage Reachit to be more efficient. It could also be good for Reachit if it can increase their productivity. However, Reachit will have to ensure the means they use to achieve profit maximisation don't hurt their reputation or anger their employees.

June 2015 Question 6

6) Evaluate the financial performance of Reachit Ltd using the information given in the case study. [20]
Reachit seems to have performed well during the year as they achieved a net profit of £1.4 million. They where also able to increase their Gross Profit Margin from 20% in 2013 to 25% in 2014. This means that Reachit have been able to reduce their reduce their cost of sales. Most probably the price they are paying to purchase materials from their suppliers.

Jan 2014 Question 1

1) Explain what is meant by stakeholder objectives using an example from the case study to illustrate your answer. [4]
Stakeholder objectives are the goals, priorities or aims that different groups have in Grandstandings Ltd. An example of a stakeholder objective is high wages for employees. By paying generous wages Grandstandings Ltd will have a more motivated and productive workforce. Grandstandings Ltd has had to recruit a more high skilled and flexible workforce, this means these new employees will expect high wages and Grandstandings Ltd will have to comply if they want to prevent high levels of labour turnover.

Jan 2014 Question 2

2) Analyse the benefits of decision trees as a tool for decision-making in Grandstandings Ltd. [6]
Decision Tree's are a graphical presentation of the decision making process in a business which aims to highlight the most cost-effective decision. One benefit of using Decision Tree's for Grandstandings Ltd is that it is visual. Decision Tree's could also show Grandstandings Ltd courses of action not previously considered by management. This means that it will be easily understood by all stakeholders in Grandstandings Ltd. For example, the shareholders may not have a background in finance but will be able to understand the reason for a decision if a decision tree is used.
Another benefit of decision trees is that they require numerical values to be placed beside each possible outcome. This means that the outcomes of the decisions will be quantifiable in money terms which could make the decision making process easier for Grandstandings Ltd. Decision tree's could be used to help Grandstandings identify whether to buy the £500,000 site in Birmingham or the £300,000 site in Liverpool. This means Decision Tree's could give Grandstandings Ltd a competitive advantage because they will be able to make decisions more quickly and effectively than their competition.