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Paper P1 Performance Operations

Post Exam Guide


September 2010 Exam

General Comments
This was the second sitting of the new P1 syllabus and candidate performance was generally
better than that achieved in the May diet. There were however still core areas of the syllabus
where candidates demonstrated a lack of understanding and preparation. It is essential that
candidates revise the entire syllabus rather than relying on particular topic areas being
included in the paper. As stated in the May 2010 Post Exam Guide, an integral part of the
revision process should be practising questions from past P1, P2 and P7 papers, including a
comparison of the candidates answer to the examiners suggested answers. It was apparent
however that many candidates had not taken this advice, even to the extent of reviewing the
May 2010 exam paper, the examiners answers and Post Exam Guide. The answers given by
many candidates in this sitting continued to demonstrate poor exam preparation, particularly
for those topics from the new areas of the syllabus.
The layouts for numerical answers once again fell short of the standard required. Candidates
place themselves at a disadvantage if they do not provide a clear layout for their workings in
numeric questions.
The quality of answers to discursive questions varied considerably between questions. Many
candidates demonstrated a clear understanding of zero based budgeting but few appeared
to understand what backflush cost accounting involves and were therefore unable to explain
why this system would be more appropriate in a JIT environment. In some questions
candidates did not provide sufficiently detailed explanations of points made; however in other
questions full explanations were given even though candidates were asked to state rather
than explain. It is essential that candidates consider the verb used in the question. The list of
verbs and their definitions is printed in every CIMA examination paper.
Candidates are again reminded of the importance of time management. The exam allows 1.8
minutes per mark and candidates should relate the time they spend on each question to the
marks available. Spending a disproportionate amount of time on sections A and B to the
detriment of section C is not effective time management. Full use should be made of the 20
minutes reading time at the beginning of the examination.

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September 2010 Exam

Section A 20 marks
ANSWER ALL EIGHT SUB-QUESTIONS IN THIS SECTION

Question 1.1
Which ONE of the following is NOT considered to be a cost of holding inventory?
A

Loss of goodwill as a result of being unable to complete customer orders due to lack of inventory

Insurance cost of inventory

Storage cost of inventory

Interest on cash invested in inventory


(2 marks)
The correct answer is A

Question 1.2
The following information has been calculated for a business:
Trade receivables collection period
Trade payables payment period

54 days
67 days

If the working capital cycle is 102 days, the inventory turnover period is
A

19 days

115 days

89 days

13 days
(2 marks)
The correct answer is B

Workings
(102 + 67 - 54) = 115 days

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September 2010 Exam

Question 1.3
A project requires an initial investment of $200,000. It has a life of five years and generates net cash
inflows in each of the five years of $55,000. The net present value of the project when discounted at the
companys cost of capital of 8% is $19,615.
The sensitivity of the investment decision to a change in the annual net cash inflow is:
A

35.7%

25.0%

9.8%

8.9%

(2 marks)
The correct answer is D

Workings
$19,615/$219,615 = 8.9%

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September 2010 Exam

The following data are given for sub-questions 1.4 and 1.5 below
A company can choose from four mutually exclusive investment projects. The net present
value of the projects will depend on market conditions.
The table below details the net present value for each possible outcome:
Market
conditions

Projects
A

Poor

$400,000

$700,000

$450,000

$360,000

Average

$470,000

$550,000

$500,000

$400,000

Good

$600,000

$300,000

$800,000

$550,000

Question 1.4
If the company applies the maximin rule it will invest in:

Project A

Project B

Project C

Project D
(2 marks)
The correct answer is C

Workings
If the maximin rule is applied, the highest of the worst profit for each of the three projects is $450,000 i.e.
project C.

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September 2010 Exam

Question 1.5
If the company applies the minimax regret rule it will invest in:

Project A

Project B

Project C

Project D
(2 marks)
The correct answer is C

Workings
Minimax Regret Table
Market Conditions

Projects
A

Poor

($300,000)

($250,000)

($340,000)

Average

($80,000)

($50,000)

($150,000)

Good

($200,000)

($500,000)

($250,000)

The maximum regret for Project A is $300,000


The maximum regret for Project B is $500,000
The maximum regret for Project C is $250,000
The maximum regret for Project D is $340,000
Therefore if the company wants to minimise the maximum regret it will invest in project C.

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September 2010 Exam

Question 1.6
PJ sells goods to customers on credit. It is forecast that credit sales for July will be $36,000 and that sales
will increase by $2,000 per month for the next six months. Based on past experience PJ expects 50% of
customers to pay in the month after sale, 25% of customers to pay 2 months after sale and the remainder
to pay 3 months after sale.
PJ has a trade receivables balance outstanding at the beginning of July of $65,000.
Calculate the cash that PJ will receive from credit customers during the six month period to the end of
December.
(3 marks)

Workings

Credit
sales

July
36,000

Aug
38,000

Sept
40,000

Oct
42,000

Nov
44,000

Dec
46,000

Total
246,000

Cash Collected:
Outstanding receivables June
Credit sales

$
65,000
246,000
311,000

Less receivables at 31 December

100% December credit sales


50% November credit sales
25% October credit sales
Total cash collected

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(46,000)
(22,000)
(10,500)
232,500

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September 2010 Exam

Question 1.7
The estimated production volume of a new product for the first year is 2,000 units. The management
accountant has produced the following table showing the possible production costs and their associated
probabilities at this level of output.
The probabilities of the different levels of fixed production costs and variable production costs are totally
independent.
Total fixed production costs
$
Probability
80,000
0.40
130,000
0.45
160,000
(i)
(ii)

0.15

Total variable production costs


$
Probability
30,000
0.25
40,000
0.35
0.40
50,000

Calculate the expected value of total production costs for the production of 2,000 units.
Calculate the probability of total production costs for 2,000 units being $180,000 or greater.
(4 marks)

Workings
(i)
The expected value of fixed costs is:
($80,000 x 0.40) + ($130,000 x 0.45) + ($160,000 x 0.15) = $114,500
The expected value of variable costs is:
($30,000 x 0.25) + ($40,000 x 0.35) + ($50,000 x 0.40) = $41,500
The expected value of total costs is therefore $114,500 + $41,500 = $156,000
(ii)
$
130,000 +
160,000 +
160,000 +
160,000 +

$
50,000 =
30,000 =
40,000 =
50,000 =

$
180,000
190,000
200,000
210,000

Joint probability is (0.45 x 0.40) =


Joint probability is (0.15 x 0.25) =
Joint probability is (0.15 x 0.35) =
Joint probability is (0.15 x 0.40) =

0.1800
0.0375
0.0525
0.0600
0.3300

Alternatively:
$130,000 + $50,000 = $180,000
Joint probability is (0.45 x 0.40) =
At fixed costs of $160,000, total costs are all greater than $180,000
therefore probability is =

0.1800
0.1500
0.3300

The probability is 33%.

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September 2010 Exam

Question 1.8
A $1,000 bond has a coupon rate of 10% per annum and will repay its face value in five years time.
Similar bonds have a yield to maturity of 8% per annum.
Calculate the current expected market value of the bond.
(3 marks)
(Total for Section A = 20 marks)

Workings
Yield to maturity of similar bonds is 8%, therefore use 8% as the discount rate.

Year 1-5
Year 5
PV

Cashflows
$
100
1,000

Discount rate @ 8%
3.993
0.681

PV of cashflows
$
399.30
681.00
1,080.30

The expected market value of the bond is therefore $1,080.30

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September 2010 Exam

Section B 30 marks
ANSWER ALL SIX SUB-QUESTIONS.
YOU SHOULD SHOW YOUR
WORKINGS AS MARKS ARE AVAILABLE FOR THE METHOD YOU USE
Question 2(a)
JP has been offered credit terms by a supplier that will allow JP to claim a cash discount of 2.5% if
payment is made within 15 days of the date of the invoice or to pay on normal credit terms within 45 days
of the date of the invoice.
Required:
(i)

Calculate, to the nearest 0.1%, the effective annual interest rate offered to JP from accepting the
cash discount and paying within 15 days. You should assume a 365 day year and use compound
interest methodology.
(3 marks)

(ii)

State TWO other methods that the supplier could use to reduce its level of outstanding trade
receivables.
(2 marks)
(Total for sub-question (a) = 5 marks)

Rationale
The question examines the candidates ability to calculate the effective rate of interest of accepting a cash
discount and paying an invoice early. It also examines the ability to identify other methods that a supplier
could use to reduce the level of outstanding trade receivables.

Suggested Approach

Identify the number of days earlier that the debt will be paid. This will then be used as the
compound factor in calculating the effective rate of interest being offered by the supplier.
Recognise that the cost of the discount is 2.5% of the amount paid i.e. 97.5%.
Suggest two other methods that could be used to reduce the level of trade receivables.

Marking Guide
(i) Number of compounding periods

Marks
1 mark

1.00/0.975 or 1 + (0.025/0.975)

1 mark

Application of formula to derive percentage annual interest rate to 0.1%

1 mark

(ii) 1 mark per valid method


Maximum marks awarded

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2 marks
5 marks

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Paper P1 Performance Operations


Post Exam Guide
September 2010 Exam

Examiners comments
This question was reasonably well answered with many candidates receiving full marks. In part (b) most
candidates managed to state two other methods of reducing outstanding trade receivables however a
number failed to note the word other in the question and suggested offering an early payment discount.
Common errors
1. Failure to follow the instructions to calculate to the nearest 0.1%
2. Calculation of the number of compounding periods as 365/15

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September 2010 Exam

Question 2(b)
BB manufactures a range of electronic products. The supplier of component Y has informed BB that it will
offer a quantity discount of 1.0% if BB places an order of 10,000 components or more at any one time.
Details of component Y are as follows:
Cost per component before discount
Annual purchases
Ordering costs
Holding costs

$2.00
150,000 components
$360 per order
$3.00 per component per annum

Required:
(i)

Calculate the total annual cost of holding and ordering inventory of component Y using the
economic order quantity and ignoring the quantity discount.
(2 marks)

(ii)

Calculate whether there is a financial benefit to BB from increasing the order size to 10,000
components in order to qualify for the 1.0% quantity discount.
(3 marks)
(Total for sub-question (b) = 5 marks)

Rationale
The question examines candidates ability to apply the EOQ formula and to calculate the cost of holding
and ordering the suggested level of inventory. The question then requires candidates to consider whether
it is worth accepting a bulk quantity discount for placing an order greater than the EOQ.

Suggested Approach

Calculate the EOQ and then apply this figure to calculate the cost of holding and ordering
inventory.
Calculate the cost of holding and ordering inventory at the higher order level
Compare the incremental cost to the incremental benefit from the quantity discount.

Marking Guide
(i)
EOQ
Holding costs
Ordering costs

Marks
1 mark
mark
mark

(ii)

mark
mark
1 mark
1 mark

Holding costs
Ordering costs
Value of discount
Evaluation of financial benefit

Maximum marks awarded


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5 marks
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September 2010 Exam

Examiners comments
Overall the answers to this question were good. Part (i) was well done although many candidates could
not calculate holding costs and did not seem to notice that a holding cost of $450,000 was more than the
cost of the components. Many candidates struggled with part (ii), using the EOQ in this part of the answer
and failing to calculate the financial benefit.

Common errors
1. Lack of recognition that the EOQ will result in equal values for holding and ordering costs.
2. Calculating holding cost as $450,000 or $18,000.
3. Using the EOQ in part ii).
4. Careless arithmetical errors.
5. Failure to calculate the financial benefit.

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September 2010 Exam

Question 2(c)
Explain why a backflush cost accounting system may be considered more appropriate than a traditional
cost accounting system, in a company that operates a just-in-time production and purchasing system.

(5 marks)

Rationale

The question examines candidates ability to explain the benefits of using backflush cost accounting
compared to a traditional cost accounting system in a company that operates just in time production and
purchasing.

Suggested Approach

Explain how a traditional cost accounting system operates.


Explain what a backflush cost accounting system is and how it operates.
Explain the benefits of using backflush cost accounting when just in time purchasing and
production is being used

A good answer will clearly identify and explain why a backflush cost accounting system is more
appropriate than a traditional cost accounting system where JIT purchasing and production is being used.
A weak answer will explain backflush costing but will not explain how this differs from a traditional costing
system and why it would be preferable where JIT purchasing and production is in operation.

Marking Guide
Up to 2 marks per valid point

Marks
Max 5 marks

Maximum marks awarded

5 marks

Examiners comments
This question was particularly badly answered. Many candidates explained what a JIT environment
involves but were unable to explain backflush cost accounting and why it would be more appropriate than
a traditional costing system in a JIT environment.
Common errors
1. Failure to answer the question that was asked.
2. Providing general statements rather than explaining specific points.

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September 2010 Exam

Question 2(d)
XY, a not-for-profit charity organisation which is funded by public donations, is concerned that it is not
making the best use of its available funds. It has carried out a review of its budgeting system and is
considering replacing the current system with a zero-based budgeting system.
Explain the potential advantages AND disadvantages for the charity of a zero-based budgeting system.
(5 marks)

Rationale
The question examines candidates ability to identify and explain the advantages and disadvantages of
zero based budgeting.

Suggested Approach
A good answer will clearly identify and explain why zero based budgeting results in a more accurate
budget while recognising the difficulties inherent in a zero based budgeting system. A weak answer will
not clearly identify the advantages of zero based budgeting and/or not recognise the difficulties in its
implementation.

Marking Guide
Up to 2 marks per valid point
Maximum marks awarded

Marks
Max 5 marks
5 marks

Examiners comments
This question was fairly straight forward and was well answered with many candidates achieving full
marks.
Common errors
1. Providing general statements rather than explaining specific points.
2. Lack of detail in the answers.
3. Repetition of the same point a number of times.

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September 2010 Exam

Question 2(e)
QR uses an activity based budgeting (ABB) system to budget product costs. It manufactures two products,
product Q and product R. The budget details for these two products for the forthcoming period are as
follows:

Budgeted production (units)


Number of machine set ups per batch
Batch size (units)

Product Q
80,000

Product R
120,000

4
5,000

2
4,000

The total budgeted cost of setting up the machines is $74,400.


Required:
(i) Calculate the budgeted machine set up cost per unit of product Q.
(3 marks)
(ii) State TWO potential benefits of using an activity based budgeting system.
(2 marks)
(Total for sub-question (e) = 5 marks)

Rationale
The question examines candidates ability to apply activity based budgeting to calculate budgeted product
costs.

Suggested Approach
Calculate the cost driver rate i.e. the budgeted cost per set up.
Apply this rate to product Q to calculate the total set up cost for product Q.
Calculate the set up costs per unit by dividing the total set up cost for product Q by the number of
units of product Q.

Marking Guide
(i)
Number of batches for each product
Total number of set ups
Budgeted cost per set up
Total budgeted set up costs
Budget set up costs per unit

Marks

(ii) 1 mark for each valid benefit


Maximum marks awarded

2 marks
5 marks

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mark
mark
mark
mark
1 mark

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September 2010 Exam

Examiners comments
The performance in this question was particularly poor. Activity based costing is a core part of the P1
syllabus and the failure of many candidates to demonstrate the ability to apply activity based costing
techniques to a simple budgeting question was very concerning. In part (i) candidates failed to recognise the
need to calculate the cost driver rate for the whole company and then apply this to product Q. In part (ii) most
candidates related their answer to activity based costing.
Common errors
1. Calculation of cost driver rate using either the number of batches or the number of set ups per batch.
2. Calculation of budgeted set up costs per batch rather than per unit.
3. Failure to calculate the cost driver rate for the whole company.
4. Poor layout of workings.
5. Relating the answer to ABC rather than ABB.

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September 2010 Exam

Question 2(f)

(f)

A university is trying to decide whether or not to advertise a new post-graduate degree


programme. The number of students starting the programme is dependent on economic
conditions. If conditions are poor it is expected that the programme will attract 40 students
without advertising. There is a 60% chance that economic conditions will be poor. If
economic conditions are good it is expected that the programme will attract only 20 students
without advertising. There is a 40% chance that economic conditions will be good.
If the programme is advertised and economic conditions are poor, there is a 65% chance
that the advertising will stimulate further demand and student numbers will increase to 50. If
economic conditions are good there is a 25% chance the advertising will stimulate further
demand and numbers will increase to 25 students.
The profit expected, before deducting the cost of advertising, at different levels of student
numbers are as follows:
Number
of students
15
20
25
30
35
40
45
50

Profit
$
(10,000)
15,000
40,000
65,000
90,000
115,000
140,000
165,000

The cost of advertising the programme will be $15,000.

Required:
Demonstrate, using a decision tree, whether the programme should be advertised.

(5 marks)

Rationale
The question examines candidates ability to use decision trees to evaluate a decision where there is
uncertainty regarding expected cash flows.

Suggested Approach

Establish the decision that has to be made


Draw the decision tree showing each of the possible outcomes.
Calculate the expected value of each of the possible outcomes.

A good answer will provide a clearly constructed decision tree showing the expected payoffs for each
possible outcome.

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Post Exam Guide
September 2010 Exam

Marking Guide
mark per payoff
Decision tree format
Decision

Marks
3 marks
1 mark
1 mark

Maximum marks awarded

5 marks

Examiners comments
This question clearly separated those candidates who had worked on the May exam paper from those
who had not. The question was very similar to the one asked in May and yet it was badly answered by
many candidates and a large number omitted it altogether. Many candidates seemed to think that the
decision was what the economic conditions were going to be. Other candidates misread the question and
ended up with a decision tree with only five branches instead of six and wrote a note to the examiner that
the question was incorrect. Some candidates drew the decision tree but did not calculate any figures.

Common errors
1. Drawing the decision tree on the basis that the decision was to determine the economic conditions.
2. Producing a decision tree with four or five branches rather than six.
3. Giving no figures for the decision tree.
4. Failing to state the final decision.
5. Making computational errors.

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September 2010 Exam

Section C 50 marks
ANSWER BOTH THE TWO QUESTIONS

Question 3

(a)

Produce a statement that reconciles the budgeted and actual gross profit for product
RG for July showing the variances in as much detail as possible.
(13 marks)

(b)

Calculate the following materials variances for August:


(i) The total materials cost variance.
(ii) The planning variance for materials price.
(iii) The operational variances for materials price and materials usage.
(6 marks)

(c)

Discuss THREE advantages of using a standard costing system that identifies both
planning and operational variances.
(6 marks)
(Total for Question Three = 25 marks)

Rationale
The question examines candidates ability to calculate variances including both planning and operational
variances and to prepare a statement reconciling the budget and actual gross profit. The advantages of
identifying both planning and operational variances are also examined.

Suggested Approach

Calculate each of the individual variances, clearly identifying whether they are adverse or
favourable
Calculate the actual profit for the period.
Produce a statement showing the budgeted profit and the individual variances reconciling to the
actual profit.
Calculate the planning and operational variances in part (b)
Explain the benefits of calculating these figures in part (c).

A good answer will calculate the variances and actual profit correctly and will produce a clear
reconciliation statement. A weak answer will contain errors in the calculation of variances, will not identify
correctly whether the variances are adverse or favourable, will not calculate the actual profit separately
and will not produce a clear reconciliation statement.

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September 2010 Exam

Marking Guide
Part (a)

Marks

Budgeted gross profit


Sales variances
Material variances
Labour variances
Variable overhead variances
Fixed overhead variances
Actual gross profit

1 mark
3 marks
2 marks
2 marks
1 mark
3 marks
1 marks

Part (b)
(i) Materials cost variance
(ii) Material price planning variance
(iii) Material price operational variance
Material usage operational variance

1 mark
2 marks
1 mark
2 marks

Part (c)
Up to 2 marks per reason
Maximum marks awarded

6 marks
25 marks

Examiners comments
Part (a)
Candidates performed fairly well in this part of the question. The variances which caused difficulty were
the sales volume profit variance and the fixed overhead volume variance. Some candidates provided the
total fixed overhead variance rather than analysing this further to show the expenditure variance and the
volume variance.
Part (b)
This part was less well answered. Few candidates were able to calculate a materials cost variance and
many calculated a price variance instead. The planning variance was seldom calculated correctly and the
operational usage variance caused a lot of difficulty. Overall there was evidence of a lack of knowledge in
this area.
Part (c)
This part was poorly answered. Most candidates discussed standard costing systems without reference to
planning and operational variances. When planning and operational variances were considered there was
a lack of detail in the points made.
Common errors
Part (a)
1. Incorrect labelling of variances.
2. Confusion over the calculation and labelling of the fixed overhead variances.
3. Use of incorrect variance signs (adverse/favourable) for the direction of variances, especially with the
fixed overhead variances.
4. Incorrect calculation of the sales volume profit variance.
5. Not providing a reconciliation statement.
Part (b)
1. Calculation of a material price variance rather than a materials cost variance.
2. Calculation of the material planning variance using actual quantity.
3. Incorrect calculation of the material usage variance.
Part (c)
1. Not answering the question that was asked.
Lack of detail in the answers.
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September 2010 Exam

Question 4

(a) Calculate the net present value (NPV) of the gymnasium and spa project.
(16 marks)

(b)

Calculate the post-tax money cost of capital at which the hotel would be indifferent to
accepting / rejecting the project.
(4 marks)

(c)

Discuss an alternative method for the treatment of inflation that would result in the
same NPV.
Your answer should consider the potential difficulties in using this method when
taxation is involved in the project appraisal.
(5 marks)

(Total for Question Four = 25 marks)

Rationale
Part (a) of the question examines candidates ability to calculate the net present value of a project
involving the identification of relevant costs and the calculation of the effect of inflation and taxation. Part
(b) examines candidates ability to calculate the IRR of a project. Part (c) examines the candidates
understanding of the treatment of inflation in investment appraisal.

Suggested Approach

In part (a) firstly identify the incremental cash flows of the project then calculate the tax effect of
the cash flows taking account of the timing of the tax payments.
Discount the resultant net cash flows at the companys cost of capital.
In part (b) calculate the IRR of the project.
In part (c) calculate the real discount rate which could be applied to cash flows that were not
adjusted for inflation.
Also demonstrate appreciation of the problem involved with this approach where there are tax
implications of the appraisal.

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September 2010 Exam

Marking Guide
Part (a)

Marks

Current revenue
Future projected revenue
Incremental revenue
Employee costs
Overhead costs
Adjusting net cash flows for inflation
Residual value
Tax calculations and phasing of cash flows
Discounting cash flows

3 marks
2 marks
1 mark
1 mark
1 mark
1 mark
1 mark
4 marks
2 marks

Part (b)
Recognising need for an IRR calculation
Calculating NPV at higher/lower discount rate
Calculating IRR

1 mark
2 marks
1 mark

Part (c)
Explanation of alternative approach
Formula to calculate real cost of capital
Calculation of real cost of capital
Explanation of problems where taxation is involved

1 mark
1 mark
1 mark
Up to 2 marks

Examiners comments
Part (a)
This part of the question was reasonably well answered although many candidates did not seem to
recognise that only the incremental revenue was relevant. Similarly many candidates included the
absorbed fixed overheads as a relevant cash flow. Most candidates were able to calculate the tax
depreciation for years 1-3 but often calculated the balancing figure for year 4 incorrectly.
Part (b)
Candidates that recognised the need for an IRR calculation scored well in this part of the question but
many candidates did not understand what was required. Some candidates gave the answer to part c)
instead.
Part (c)
This part of the question was omitted by many candidates. Those who did attempt it were usually able to
give the formula to calculate the real cost of capital but many did not then go on to calculate it.
Explanations given for the difficulties in using this method when taxation is involved were vague and did
not demonstrate any clear understanding.
Common errors
Part (a)
1. Failure to calculate incremental revenue.
2. Inclusion of non-relevant costs in the cash flows.
3. Omission of the residual value from the cash flows.
4. Use of 365 days in the calculation of revenue.
5. Incorrect calculation of Year 4 tax depreciation.
6. Incorrect phasing of the benefit from the tax depreciation.
Part (b)
1. Failure to recognise the need to calculate the project IRR.

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September 2010 Exam
Part (c)
1. Lack of knowledge of the topic area.
2. General statements that did not demonstrate a clear understanding.

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