I’m studying for my Accounting class and need an explanation.
CASE STUDY: Brown Limited
BROWN limited is a UK subsidiary of the Australian MMC Group. The company has been operating in the UK for the past 9 years. BROWN provides financial services to a number of organisations which include SME’s, property developers and investment property funds in the UK and Australia. For the past 9 years, BROWN has been a profit-making firm as it has retained its previous clients, in addition to capturing an increasing share of the market. However, the finance director of BROWN has recently got in touch with your professional consulting firm and has engaged your firm with the mandate to provide them with an explanation of the cash flow problem that BROWN Limited had been facing. The company is also dependent on the parent based in Australia for funds, as and when required.
In the past month there has been a number of meetings in London and Australia where it has been agreed that BROWN Limited should do their best to expand the business and raise the required capital in the UK, or perhaps in Europe, so as not to depend so much on cash coming from the parent company all the time. Consequently, the management of BROWN is considering the following projects:
The current product that BROWN Limited has to offer mostly to specialist developers and investment funds companies is outdated. The company is looking to invest in a new product and there are two proposals on offer. The details of these two proposals are outlined below.
All of the above estimates have been prepared in terms of present-day cost and prices. Assume that cash flows arise at the end of each period. In addition
Specialist Developer 1 (SD1): Will be paid £120 per hour and expected number of hours for SD1 are 1,400hrs. The rate paid is expected to rise in line with inflation at 4% per year from year 2 and the number of hours is expected to reduce by 3% per year, every year from year 2 onwards.
Specialist Developer 2 (SD2): Will be paid £110 per hour and expected number of hours for SD2 are 1,200hrs. The rate paid is expected to go up in line with inflation at 4% per year from year 2 and the number of hours is expected to reduce by 3% per year, every year from year 2 onwards.
If BROWN Limited invests in Advanced Suite, then the discount rate that would be required to assess the NPV would be 10%. The table above shows the estimated outgoings and inflows for the project.
General Suite is the second of two proposals, the expected life of this software will also be 5 years and the cost of the new software, expected revenue, Modules costs and overheads are as follows:
All of the above estimates have been prepared in terms of present-day costs and prices. Assume that cash flows arise at the end of each period. In addition, you need to take into account the costs of Specialist Developers, inflation and the rise in the revenue, and overheads consideration, which are the same for the Advanced Suite. The discount will also be the same as with General Suite.
If BROWN Limited invests in General Suite, then the discount rate that would be required to assess the NPV would be 10%.
The manager in charge of sales has just informed your company that they plan to open a centre in the Midlands, and it is hoped that this centre will be opened for business on 1 November 2020. You have also been informed that to start with, the company will only sell 2 software packages, that of Standard Package (SP) and the Expert Package (EP). This will be done to test the market and see if the business will break-even in the same period. These two popular packages will be offered at £310 for SP and £400 for EP.
The company has provided you with the following information regarding the costs and estimated sales for the three-month period, starting from 1 November.
BROWN Limited plan to put in £5,500 as start-up capital and plan to sell a total of 1200 (combined) of SP and EP for the same period. They are not sure which of the two products will produce the most profits for BROWN.
Total budgeted sales for each month are as follows: November 400, December 400 and January 400, of which 30% of each month will be for EP. You will be required to assess the best product combination of sales for the period.
To help with the setup of the store, the company has just concluded a deal to get a bank loan of £24,000 on the 1 November. The interest on this loan will be paid every month. The company will be required to make 12 equal payments to repay the loan starting end of December.
As mentioned above the company plans to sell a total of 1200 product packages during these three months. The fixed costs for the period are as below:
From their costs estimates, the variable costs of the services are £180 for the SP and £210 for the EP. The fixed costs are for the whole period, so they are not affected by the level of service. However, the variable costs will increase with services output (ie sales output multiplied with variable cost per product).
Revenue from the sale of SP and EP will be on the basis of 40% cash in the same month, and the remaining 60% credit to be paid the following month.
You are required to write a management report to the management of BROWN limited directors in which the following points should be discussed.
The rubric by which your report will be assessed is posted separately. It is important that prior to you submitting your work, you read this and objectively assess your response against the rubric. This will ensure that you have done enough to attain the marks you wish to achieve.
Your work should be word processed in accordance with the following:
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