T4- Part B Case Study BZCS Construction company case May 2011 REPORT

To: Finance Director BZCS From: Management Accountant Date: 26 May 2011

Review of issues facing BZCS

Contents 1.0 2.0 3.0 4.0 5.0 6.0 7.0 Introduction Terms of reference Prioritisation of the issues facing BZCS Discussion of the issues facing BZCS Ethical issues and recommendations on ethical issues Recommendations Conclusions

Appendices Appendix 1 Appendix 2 Appendix 3 Appendix 4 Appendix 5 Appendix 6 SWOT analysis for BZCS PEST analysis Extract from Mendelows analysis for BZCS NPV analysis of the office building proposal Analysis of costs for the ES sports club Email to non-financial managers in the Office Buildings Division of BZCS, explaining the principles and the meaning of the NPV calculations in general and a recommendation on the office building proposal.

1.0 Introduction
BZCS is a wholly owned subsidiary of BeeZed, a listed company. BZCS is a construction company, and had revenues of 1,267 million in the financial year ended 30 September 2010. Profit after tax and finance costs was 21.9 million, providing a return on revenues of only 1.73%. Although BZCS had a good order book at the end of its latest financial year, the market is getting much tougher. European governments have cut the budgets on public sector projects, and bidding is more competitive than ever. As Europe accounted for around 54% of BZCSs sales revenue in the last financial year, then it is important that the company maintains its good reputation in the industry for both quality and the ability to deliver projects on time. It would seem necessary therefore, for BZCS to secure as much private sector work as possible. For such a competitive market BZCSs operating profit margins also do not leave much room for manoeuvre at 2.74% in the last financial year. The Office Building Divisions operating profit margin for the latest financial year was a little better at 3.86%. However, it should be noted that other large construction companies are also only achieving similarly low profit margins. For example the Costains operating profit margin was only 2.0% in 2009, and Balfour Beattys profit margin has dropped from 2.0% to 1.5% in the first half of 2010.

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So the whole industry is currently struggling with low margins and also reduced demand for building work.

2.0 Terms of reference

I have been appointed to write a report to the Finance Director which prioritises, analyses and evaluates the issues facing BZCS and makes appropriate recommendations. I have also been asked to draft an email to you, the Finance Director, which will be sent to nonfinancial managers in the Office Buildings Division of BZCS explaining the principles and the meaning of the NPV calculations in general and a recommendation on the office building proposal. This is included in Appendix 6 to this report.

3.0 Prioritisation of the issues facing BZCS

3.1 Top priority Safety checks The top priority is the safety checks on site machinery that have not taken place for 2 weeks due to the appointment of a new sub-contractor, TT. Safety checks is not a procedure that should be taken lightly and if not addressed quickly could result in work on some sites stopping or indeed if the matter were to escalate the H & S Executive, sites could be shut down until the H & S Executive is satisfied that safety checks had been performed. Apart from the ethical aspect of Head Office stating that work should continue, this could have a large impact on the whole of BZCS if an accident were to occur. 3.2 Second priority Problems with BZPM This is considered to be the second priority as BZPM is used extensively throughout the company and the Project Managers need to have confidence in the integrity of the data. Clearly the upgrade was not adequately tested and immediate action needs to be taken. 3.3 Third priority Office building proposal The third priority is considered to be the office building proposal. This is a huge project even by BZCS standards with a forecast project cost of 525 million. It could be very successful and generate much publicity and future office proposals or it could turn out to be a large risk with potentially unsold office space. 3.4 Fourth priority Unfinished sports club for ES BZCS needs to decide whether to offer to pay the liquidator 3 million to take on legal ownership of the incomplete sports club in lieu of the debt that ES owes to BZCS or whether to accept the forecast payout of only 10% of the claim for 18 m. There is also the risk that the uncompleted sports club cannot be sold at the forecast 20 million.

A SWOT analysis summarising the strengths, weaknesses, opportunities and threats is shown in Appendix 1. A PEST analysis is shown in Appendix 2. An extract from Mendelows analysis for BZCS is shown in Appendix 3.

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4.0 Discussion of the issues facing BZCS

4.1 Overview BZCS is a profitable construction company involved with a large range of projects. The company has recently had one of its customers go into liquidation and all work on site has stopped. BZCS has the opportunity to construct a large office building which could generate significant revenues and profits, but at a high commercial risk. It also has 2 immediate concerns which are site safety, due to a delay in safety checks, and also the urgent problem following a software upgrade resulting in concerns over the integrity of data in BZPM. It is not unusual for construction companies to be involved in projects that span several years, such as the office building proposal. Balfour Beattys Railway division has recently won a 5-year contract to renew parts of the London Underground rail network. 4.2 Safety checks This is an urgent issue as safety should not be compromised on construction sites and BZCSs good reputation over many years is based on its good safety record. A poor decision now could result in an accident which could have long term implications for the entire company. The Project Manager was unaware that a new safety checks contractor had been appointed and BZCSs Head Office has allowed construction work to continue despite the lack of weekly safety checks. The new contractor, TT, has stated that it cannot perform the safety checks for all of the sites for which it has contracted to undertake. TT has forecast a further 4-week delay due to insufficient staffing. In order not to damage BZCSs safety reputation work should be stopped immediately until the safety checks have been made. The Procurement Director needs to meet with TT and establish why TT signed a contract to deliver the site safety work and now is admitting that it cannot handle the volume of work it agreed to. The Procurement Director should also contact the previous safety contractor, to see if it could carry on until TT can handle the work. Is this a possible option or had the previous contractor withdrawn its services to BZCS? BZCSs Procurement Department must immediately find and appoint a safety contractor that can meet the needs of all of the affected construction sites. The road building Project Manager should not need to find safety contractors. However, clearly he has found a company that can undertake the work, but it will cost 240 K (12 weeks @ 20 K per week). The Procurement Director should check to ensure that this is a competitive price, taking into account the urgency. The road building Project Manager must liaise closely with the Procurement Director to ensure that the Procurement Department finds a suitable company which can start the safety checks immediately. The cost of this short contract is 240 K. However, this should be compared to the daily cost of lost work at 80 K per day. So if the delay in finding a cheaper contractor takes more than 3 days (3 days @ 80 K / day = 240 K), then this will cost the company more and the completion of the road building contract will be extended by this delay. Additionally, there may be financial penalties to pay to the government for failing to deliver the road building project on time. Furthermore, safety should not be compromised, as the road building site could be shut down by Health & Safety executive. The lack of safety checks could result in accidents. Any damage to

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BZCSs reputation could have far reaching implications for the company. It has taken years to build a good reputation but all could be undone by just 1 accident due to faulty machinery. The potential risk of an accident or knowledge of the lack of safety checks could have far reaching effect on investors and BZCSs reputation and even the success of the possible office building project, and this issue must be addressed urgently.

4.3 - Problems with BZPM This is a potentially huge problem as BZPM is used throughout the company on all projects. The data contained in BZPM must be accurate and sound as Project Managers are reliant on BZPM to monitor and control all construction projects. The integrity of such a crucial IT system must not be compromised. The problem with BZPM is that there seem to be concerns over changes in some data and the integrity of the information contained in BZPM following the software upgrade 3 days ago. The software company, EAG, has now admitted that it is experiencing problems with the new software release which has affected BZCS as well as some of EAGs other customers. BZCS has 3 alternative actions: 1. Nicos Tallis suggestion: Close down BZPM for 2 days and undertake an assessment and investigation into the scale of the problem and to determine what data has changed or been corrupted. This investigation should determine whether it is a minor problem or widespread across many projects. 2. A suggestion from one of the Project Managers is to re-install the old BZPM software and transfer all new data for the last 3 days, either electronically or manually. 3. Do nothing and carry on with the new upgraded system and identify the faults over the next few weeks. Assuming the EAG software has faults, it would be dangerous to carry on using it. The cautious approach (proposed by a Project Manager) of re-installing the backed up version from 3 days ago would be the safest and more conservative option. However, this means closing down this crucial system immediately and identifying and re-inputting (electronically or manually) all data for the last 3 days. There is a need to identify and reconcile all of the data that would need to be transferred or reinput to the re-installed backed up version of the BZPM. The IT and Finance departments would need to be actively involved to ensure all data for the last 3 days has been captured and transferred accurately and completely so that the BZPM is running using the old software release and contains accurate and complete data. As this is a key IT system for all 6 divisions of BZCS for each of its operational projects, this is a massive task and could cause concern for the Project Managers who are trying to manage the construction projects under their control. However, the downside of carrying on using BZPM also has risks. There is a need for improved control and more thorough testing of any new software releases in the future for BZPM (or any other IT system) before live use. 4.4 Office building proposal This is a very large project with forecast sales of between 650 million and 700 million over a 4 year period. The average sales revenue is nearly 170 million per year (for 4 years) and this represents around 13% of the total company sales revenue. So this is a very large project, with potentially high profits.

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The total sales revenue for the Office Buildings Division in the financial year ended 30 September 2010 was 220 million. Therefore this represents a huge proportion of this divisions sales revenue on a single project. It is therefore very important that BZCS ensures that it can manage this size of project and deliver it on budget. This project will be analysed using the Johnson and Scholes model, as follows: Suitability It should be asked whether BZCS should undertake this development at all, as there is a risk of not selling office space due to economic environment. The project is suitable for BZCS to take on as it possesses the skills and expertise to build such an office building. BZCS has been approached by Ben Bleur to take on the project and this architect has worked with BZCS before on other successful projects. Acceptability The financial returns for the companys shareholders should be assessed as to whether the returns are justifiable given the risk. The NPV of the project, without the sale of 25 floors to DJ, is 51.1 million with the high discount rate of 15%. However, much depends on the accuracy of the value and timing of future cash flows. There is always the risk of cost over-runs and also the risk of unknown problems with a large building of this size resulting in delays or adverse publicity. Feasibility BZCSs parent company, BeeZed, has stated that it could secure sufficient external financing for this proposed development. BZCS has the technical skills to construct the building. It should be questioned whether BZCS has sufficient manpower to construct the building as it is stated that 900 employees as well as specialised sub-contractors would be required. However, BZCS has many other projects coming to an end during 2011 and 2012, so this would be a suitable project to deploy them on. In addition, BZCSs Office Buildings Division needs to reach a decision as to whether it should accept the interest from the global insurance company DJ. DJ has stated that it is interested in purchasing 50% of the office space. This immediately overcomes the problems of achieving off plan sales of over 30%. It is possible that if BZCS accepts the purchase from DJ, then this could attract other corporate buyers or investment companies With the London Gherkin building, Swiss Re (a global reinsurance company) was the primary occupant and this attracted other corporate customers. The building was sold to a range of investment companies during construction (for over 600 million). There are a range of risks that BZCS will need to identify and decide what actions it should take to minimise them. These risks include possible accidents on site as well as the risk of design problems. The case material stated that the building would utilise the latest environmentally sound technology to recycle heat and reduce carbon emissions. The use of new technology could result in cost escalation and unforeseen problems. There is also the additional risk that a prestigious new building could be a terrorist target. The financial results for the 2 alternative sales proposals are good and both result in high positive NPVs even at the risk adjusted discount rate of 15%. The NPVs for the office building proposal are shown in Appendix 4.

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In respect of the proposal to sell 25 floors to DJ, which is 50% of the building, the discount of 50m that DJ is requesting is not unreasonable for such an early purchase. Whilst the total sales value falls from 700 million to 650 million, the profile over the 4 years of sales revenue results in a NPV which is only 14.2 million lower after taking account of tax, the time value of money and the risk adjusted discount rate. The NPV, after tax, with the early sale to DJ is 36.9 million. The early sale to DJ would also attract other companies to this project and therefore reduces the risk of unsold office space. This would be the preferred and lower risk option. If BZCS were to reject the DJ offer, it may have difficulty in securing other early sales and potentially not achieve its planned 30% sales off plan. This would result in abandoning the project and this could result in a loss, if BZCS could not re-sell the undeveloped land at 50 million or more. If BZCS were to reject DJs proposal to purchase 50 floors, then the NPV, after tax, of the sale of the building would be 51.1 million. However, it must be questioned whether any other earlier purchasers of office space, bought off plan, would also seek to gain a discount? Perhaps other purchasers may request a greater discount than DJ. The 50 million discount that DJ is seeking is only around 14% (50.0 million / 350.0 million). Actions to be taken in order to secure sales In respect of what actions BZCS should take to ensure the forecast cash inflows occur as planned, the following actions could be taken. Even though accepting DJs offer results in a lower overall profit there is significantly less risk involved. The sale to DJ of 50% of the office space would also help BZCS with its marketing to corporate customers for the remaining 50%, or perhaps even to a property management company which may be interested in purchasing a development property which is already 50% sold. As construction work on the site develops, this in itself will provide excellent marketing for BZCS through the use of advertising on facia hoardings. A 50 floor office building in a European capital city will get significant footfall around the site, and is likely to trigger interest amongst organisations whose leases may be coming up for renewal. The Sales and Marketing Manager for the Office Buildings Division should also work with BZCSs Public Relations and Marketing Director and the IT manager to include publicity material on BZCSs Internet home page. Included in such publicity material should be the association with Ben Bleur, with his international reputation. BZCS should publicise the use of the new technology in this building and the effect of reduced carbon emissions and this could gain much media interest. Other suitable initiatives would be for large scale advertising in both local and national newspapers as construction work progresses, in order to make prospective customers aware of the office development. BZCS should also contact local and national commercial property agents who may be, or who may become, aware of organisations requiring office space in the capital city. BZCS could also launch a marketing campaign to property investment companies and Middle East investors (as part of the Gherkin building in London is owned as an investment by the Abu Dhabi royal family). There is a need to develop and promote an agreed phased payment schedule for when customers are identified, involving a deposit, stage payments and final payment when a company moves into the premises.

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4.5 Unfinished sports club for ES This project appears to have been badly managed and the risk of ES being put into liquidation on Friday 13 May 2011 should have been considered or foreseen. As a principle, BZCS is operating to make a profit and work should not have continued on this site, or indeed any project, if the customer does not pay the agreed stage payments on time. There is clearly a need for better communication between the Finance Director and the Project Managers. Now that ES has been put into liquidation, BZCS has a choice of 2 alternative actions: 1. Leave the sports club unfinished and await the payout from ESs liquidator, which would only be around 10% of the outstanding debt. This would be around 1.8 million (10% of the debt of 18 million). 2. Offer to buy the incomplete sports club building from the liquidator and take ownership of it. Then BZCS could finish it and sell it to another sports club chain or to the local government as a local sports facility for the area. Appendix 5 shows the financial effect of these alternative actions. At present BZCS has spent 14 million and only received revenues of 10 million, resulting in a book loss to date of 4 million. The costs incurred to date of 14 million are sunk costs and do not affect the decision to be made in the future. If BZCS awaited the liquidators possible payout, which would take some time, it could expect only 10% of its claim of 18 million, which is 1.8 million. This is lower than the loss incurred to date, resulting in an overall loss on this contract of 2.2 million. There is also the cost of BZCSs employees who may not be able to be deployed to other construction projects straight away. Additionally, there may be sub-contractors who need to be paid for the duration of the contracts despite the sudden termination of the project. Alternatively, BZCS could offer to buy the uncompleted sports club from the liquidator. BZCS is considering an initial offer of only 3 million, which seems low given that 14 million worth of work has already been incurred on the construction of this sports club. However, the liquidator would be looking to gain cash inflows for ESs assets in order to settle ESs debts. Therefore BZCS could be in a good negotiating position. If BZCS were able to acquire the incomplete sports club for 3 million, it would then need to spend a further 8 million on completing it. If it were able to achieve the forecast sales revenue of 20 million, then this would result in a profit of 9 million. Together with the loss to date of 4 million, this alternative action would result in an overall profit of 5 million. However, there is a risk of completing the sports club and not finding a buyer. There is also a risk of cost over-runs in the completion of the sports club. Therefore BZCS has a choice as to whether to accept the loss now or to spend a further 11 million (3 million for building and 8 million to finish it). ESs liquidator may not accept BZCSs offer of 3 million to acquire the incomplete sports club. BZCS could increase its offer and the absolute maximum that it could offer, that would result in the same financial effect of accepting the 10% liquidators payment, would be 10.2 million. However, this is a maximum price that should be paid as this would result in BZCS only achieving a profit on completion of the sport club of 1.8 million. However, as BZCS would be taking on all of the risk of finishing the sports club and finding a buyer, it would be expected that the offer could be between its initial offer of 3 million and 10.2 million, say around 5 to 6 million, which is just under the midway point. If BZCS did not have any other projects to which it could deploy its employees who are currently allocated to this project, then finishing the sports club would be a good use of BZCSs employee time.

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5.0 Ethical issues and recommendations on ethical issues

5.1 Range of ethical issues facing BZCS There is a range of ethical issues that will be discussed and recommendations made, including the following: 1. Safety checks that have not happened due to the delay by TT 2. Waste materials going to landfill sites 5.2 Safety checks that have not happened due to delay by TT 5.2.1 Why this is an ethical issue BZCSs Head Office should not be instructing the Project Manager to continue working on site without the required weekly safety checks for site machinery that are overdue. BZCS owes a duty of care to all employees. The lack of safety checks on site machinery is putting commercial pressures (to finish the contract) ahead of site safety. This is poor business ethics. Safety should not be compromised in any way. Both Maslow and Herzberg would argue that safety is a basic fundamental level of security that the work-force is entitled to. Also, to ignore potential safety issues would also go against BZCSs Corporate Social Responsibility, to which the Board is clearly committed, of improving health and safety. 5.2.2 Recommendations for this ethical issue It is recommended that work should stop immediately at the road building site and all other sites which have not had the site machinery checked since TT took over the contract 2 weeks ago. It is imperative that the site machinery that has not had the required safety checks should not be used. An alternative contractor needs to be located and appointed in the interim to perform the site machinery safety checks. The contract with TT should be reviewed and a penalty imposed for delays and to compensate BZCS for having to appoint an alternative safety contractor temporarily. The road building Project Manager should be given immediate authority to appoint the local safety management company at a cost of 20,000 per week for a 12 week contract so that work on site is not disrupted. 5.3 Waste materials going to landfill sites 5.3.1 Why this is an ethical issue A colleague in BZCS has found some documents concerning the disposal of waste at landfill sites rather than to specialised waste disposal sites. This is an ethical issue for 2 separate reasons, which are: 1. BZCS has a duty of care to dispose of all construction site material in a safe and legal way and to show consideration for the environment and the communities in which BZCS operates. 2. My colleague, Charlie Rix, does not know what to do with this information or who to approach about the information he has. There appears not to be any official whistle

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blowing procedure for BZCSs employees to report incidents like this. Charlie Rix may be concerned that his knowledge of this site waste disposal may put him in an awkward position in his department or be used against him. Having passed the information to me, as Management Accountant, I have a duty to act upon this information. My colleague is concerned that somebody within BZCS may actually know about this problem but appears to be ignoring it. Obviously to condone such action by BZCSs sub-contractors would also go against BZCSs Corporate Social Responsibility, to which the Board is clearly committed, of reducing any activities in the company that would damage the environment. The ethical dilemma now, for BZCS and for my colleague, Charlie Rix, who informed me, as Management Accountant, is what to do about the documents. 5.3.2 Recommendations for this ethical issue I have been told of this potential problem (the Management Accountant) and having been given the documents, I must escalate this possible incorrect disposal of site waste immediately. As my line manager is the Finance Director, I am highlighting this problem in this report and will also speak to the Finance Director and show him the documents that I have been given. It would also be useful to show the documents to the Procurement Director as well. I will ask them to investigate the documents which infer that site waste is not being correctly disposed of. The Procurement Department will have access to all of the contracts with the site waste contractor and the contractors duty to dispose of waste safely. It is recommended that there should be a high level internal investigation and any BZCS manager who has allowed this site waste to be incorrectly disposed of should be given a written warning. The HR Director should be involved in any disciplinary action. The site waste contractor should be contacted to ascertain its version of the events and to confirm where the waste has been disposed. BZCS should establish a whistle blowing procedure whereby all staff or contractors can have a safe way to disclose information about procedures or site occurrences that they are concerned about, with no fear of the effect on their jobs.

6.0 Recommendations
6.1 Safety checks 6.1.1 Recommendation It is recommended that work on the road building project should stop immediately. It is further recommended that work should be stopped on all other sites which have not had the site machinery checked as required by BZCSs internal safety standards. Until TT can start to perform the safety checks it is recommended that another safety contractor (or several safety contractors) should be appointed to cover all sites affected in this European country. 6.1.2 Justification Safety must not be compromised. Machinery at all sites must not be used with immediate effect until safety checks have been performed by a suitable contractor. BZCSs reputation, built up over many years, could be severely damaged if an accident occurred.

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6.1.3 Actions to be taken Work at all affected sites, including the road building site, should be stopped immediately. All employees and sub-contractors should continue to be paid. The Procurement Director, working with all of the Project Managers of the sites affected by the delay in safety checks, must identify and appoint safety contractors which can start safety checks immediately. The Procurement Director must urgently contact TT and review the contract with it and seek compensation for failure to carry out this critical role. The Procurement Director should also review why TT was selected when it clearly is not adequately staffed to take on this contract. The Procurement Director should ask when TT can start to handle all of the contracted safety check work. The Procurement Director should also contact BZCSs previous safety contractor, and establish if it is able and willing to carry on with safety checks of site machinery until TT can handle the work. Is this contractor available to be re-appointed? The contractor that the Project Manager of the road building project has identified should be appointed immediately at a cost of 240 K. This cost is reasonable and is less than the cost of the site being closed down for more than 3 days. The Procurement Director should conduct audits on the standard and timeliness of work carried out for all newly appointed contractors in future. 6.2 Problems with BZPM 6.2.1 Recommendations It is recommended that the cautious approach of re-installing the old software system and the backed up version of BZPM from last Friday night is chosen. The new software release is not safe to use until the software company, EAG, has removed all of the faults. It would be necessary to immediately close down input into BZPM. The IT department should block access to all users of BZPM while the backed up version is re-installed, except for read only access. It is recommended that the IT manager re-installs the backed up version from last Friday, and that with help from the Finance Department and each of the Project Managers, identifies and transfers of all data for the last 3 days. All users should be advised which data is being transferred electronically and which data needs to be re-input manually. There is a need for the reconciliations of data transfers to be made by IT and Finance departments. Finally, it is recommended that the re-installed backed up version is tested to ensure that the data held is accurate. The IT Manager should request that each of the Project Managers should check the integrity and completeness of data for his / her projects. 6.2.2 Justification BZPM is too important to compromise the risk of damage to the integrity of the data contained in it and to risk the loss of confidence by its users. It is recommended that the backed up version from last Friday using the previous software should be used as there is too great a risk using the new software release which the software company, EAG, admits has possible bugs and that its other customers are experiencing problems with.

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6.2.3 Actions to be taken The IT department should immediately close down BZPM and advise all users of what is happening and when the re-installed backed-up system will be available. It is advised that BZPM should still be available on a read only basis temporarily to allow management of projects to continue. All users should be advised that the backed up version from 3 days ago is being re-installed and that all new data input or transferred into BZPM will be electronically transferred or re-input. An agreed deadline and responsibilities for the re-input of data need to be agreed between the IT department and each of the Project Managers. The IT department and Finance department need to reconcile all of the data transfers. Finance Department should draw up a list of the data to be manually input for each project and responsibility for input of data assigned (Project Management staff or IT department). BZPM should go live when the data has been transferred or re-input and the system tested for integrity. The Finance Director (a key stakeholder in Mendelows analysis) together with the IT Manager should contact EAG, the provider of the BZPM software, in order to gain compensation for the inconvenience caused by the release of faulty software. In future, all new software releases should be tested much more extensively before going live. 6.3 Office building proposal 6.3.1 Recommendation It is recommended that BZCS does undertake this large office building proposal. BZCSs Commercial Director of the Office Buildings Division should contact Ben Bleur immediately to say that the company would like to accept his proposal and to work with him on this project. Therefore it is recommended that the land be purchased at a cost of 50 million and any funding is requested from the parent company. It is recommended that BZCS does accept the early sale to DJ at a sales value of 300 million, a discount of 50 million. It is recommended that BZCS should undertake a range of actions to try to secure further sales as early as possible. 6.3.2 Justification The construction of this office building could generate a high level of sales and a positive NPV of 36.9m, even with the discount to DJ of 50 million. The early sale of office space to DJ will allow the project to commence and eliminates the commercial risk of not achieving the 30% off plan sales target. The funding requirements are lower with the sale to DJ, as the forecast profile of sales revenue would occur earlier. There is a need to undertake a range of sales and marketing initiatives in order to attract commercial buyers of office space as early as possible. 6.3.3 Actions to be taken

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BZCSs Commercial Director of the Office Buildings Division should negotiate what level of discount it could offer to DJ, to try to reduce the 50 million. However, the sale to DJ should be accepted. BZCSs Sales and Marketing Director, together with the Commercial Director of the Office Buildings Division should plan a range of sales and marketing events in order to gain other corporate customers or investors in the building and to gain media interest in the new office building. BZCSs Finance Director should work with BZCSs civil engineers to check and understand the project costings. The Finance Director should prepare a schedule of the funding requirements for this large project and confirm that BeeZed, the parent company has access to adequate funds for this project. In order to help marketing of the office building it is also recommended that: Large advertising boards are placed around the site as construction work gets underway. Publicity material should be prominently placed on BZCSs home page on the internet, including the association with Ben Bleur. Large scale advertising in both local and national newspapers should be undertaken, both now and as construction work progresses, and BZCS should also contact local and national commercial property agents to make them aware of the project. The purpose of such initiatives is to trigger interest amongst organisations whose leases may be coming up for renewal in the city, as well as other organisations that may be looking to relocate to the European capital city. Furthermore, an experienced Project Manager should be appointed to manage this project and a detailed project plan should be prepared.

6.4 Unfinished sports club for ES 6.4.1 Recommendation It is recommended that BZCS should offer to pay 3 million for the unfinished sports club to liquidator. If this is declined, the offer could be increased to around 5 to 6 million. The maximum that should be paid is 10.2 million. It is recommended that BZCS should complete the sports club and locate a buyer at the forecast sales revenue of 20 million. It is recommended that BZCS should review its project procedures to ensure that work on projects does not continue if contracted stage payments are not met. 6.4.2 Justification The expected payout ratio from ESs liquidator is very low and will result in a loss of 2.2 million. If BZCS were to pay 3 million to the liquidator (which is usually welcome as a reasonable payment for assets) then BZCS could make a profit from a future sale of 9 million, resulting in an overall profit of 5 million (after the loss to date of 4 million is included). BZCS could afford to pay the liquidator a little more to secure the sale of the incomplete sports club. BZCS bears the risk of finishing the sports club and incurring a further 8 million in costs to complete it, but this would allow BZCSs employees to continue to work on this project, as there

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may not be other projects that require extra manpower. BZCS will also will bear the risk of perhaps not being able to sell it or not achieving the forecast sales revenue of 20 million.

6.4.3 Actions to be taken BZCSs Commercial Director of the Sports Facilities Division, together with the Finance Director, should negotiate with the liquidator to buy the incomplete sports club, and its opening offer should be 3 million and the absolute maximum purchase price is 10.2 m, and negotiable around the 6 million level. If the offer to acquire the incomplete sports club is accepted then BZCSs Sales and Marketing Manager for the Sports Facilities Division should try to locate a customer for the finished sports club for the forecast sales revenue of 20 million. The Finance Director needs to tighten up procedures to ensure that work on any project is stopped if a stage payment is not made on time. The Finance Director should also investigate nd why did work did continue on this project when ES missed paying the 2 stage payment. Additionally, there is a need for the Finance Department to carry out regular checks on the financial stability of its customer. BZCS has few customers as it usually operates around 12 20 projects at any point. Therefore, it should be investigated why BZCSs Finance Department did not foresee that ES had liquidity issues and perhaps should have more closely monitored this contract. There is also a need for the Finance Department to regularly review all of BZCSs customers to try to protect BZCS from the commercial risk of any of its customers going into liquidation.

7.0 Conclusions
BZCS is a successful construction company but it must not become complacent in todays challenging business environment. Good management supported by strong IT solutions are necessary to ensure contracts are delivered on time and to budget.

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Appendix 1 SWOT analysis for BZCS

Strengths
Profitable company Support and funding from parent company BeeZed Good reputation for quality construction Strong safety culture and CSR ethic Order book at 30 September 2010 was 30% higher than the previous year BZCS exceeded its target for reduced volumes of waste going to landfill sites Comprehensive CSR statement of initiatives

Weaknesses
BZPM has faults and its integrity is being questioned following a software upgrade Poor control over waste material subcontractor Poor management of ES sports club contract Waste materials wrongly going to landfill sites

Opportunities
To acquire ES sports club so that it can be completed and sold Office buildings project with Ben Bleur To accept DJs offer to purchase 25 floors of proposed new office building project off plan

Threats
Risk of accidents at the road building project due to safety checks not being carried out on site machinery Loss of control of projects due to faults in BZPM following software upgrade Risk of delay in completion of road building contract if work on site were to be stopped due to the lack of safety checks Low payout to BZCS by ESs liquidator Will BZCS be able to sell the office space in this large project as planned Low sales of proposed office building and possible threat to have to re-sell undeveloped land if 30% sales target is not achieved Threat of cost over-runs on the office building project BZCS being investigated for bidrigging in UK and threat of loss of future contracts Risk of other customers going into liquidation

Note: The above SWOT analysis is detailed for teaching purposes. However, in exam conditions a SWOT containing fewer bullet points, which cover the main issues from the case and the unseen material, is expected.

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Page No: 14

Appendix 2 PEST analysis

Political/Legal Investigation by UK government body due to admission of bid-rigging Reduction in government funded projects as a result of government cuts Safety checks not carried out could be investigated by H& S executive New EU laws on recycling of waste materials and reduction of waste going to landfill sites Economic The current economic environment has resulted in lower levels of construction work and more price competition to win contracts Other BZCS customers going into liquidation (like ES) BZCSs new buildings are more energy efficient Recession has hit all of the construction industry Will BZCS find corporate buyers or a property management company for all 50 floors of the proposed office building Social New buildings enhance the quality of life for users (from hospital patients to office workers) Technological New office building utilising the latest technology to recycle heat and reduce carbon emissions New construction methods to reduce costs BZPM has developed faults following the recent software upgrade which will hamper BZCSs control of its construction projects

The Chartered Institute of Management Accountants 2011

Page No: 15

Appendix 3 Extract from Mendelows analysis for BZCS

High power and high interest (the key players) Ben Bleur who is selecting a company to develop the office building, should BZCS decide to proceed with this proposal. Competitors, for example Costain plc, which is similar to BZCS, struggling with low profit margins and at a time of recession in the construction industry. Supplier TT and the potential impact of it failing to resolve safety issues. Supplier EAG which supplies the crucial BZPM software system. BZCSs Project Managers and their relationship with the Commercial Directors for each Division of BZCS, and the IT Manager. In particular the role of Project Manager is crucial to the effectiveness of BZCS. Finance Director plays an important role, together with BZCS Boards members, in the approval of new proposals.

The Chartered Institute of Management Accountants 2011

Page No: 16

Appendix 4 (Page 1) NPV analysis of the office building proposal

NPV calculations without the sale to DJ:
Year 0 Year ended 30 Sept 2011 million Pre-tax cash outflows Pre-tax forecast sales Pre-tax net cash flows Tax at 20% 1 year in arrears Post-tax cash flows Post-tax discount rate 15% Discounted cash flows Cumulative discounted cash flows 50.0 0 (50.0) Year 1 Year ended 30 Sept 2012 million 180.0 120.0 (60.0) Year 2 Year ended 30 Sept 2013 million 170.0 150.0 (20.0) Year 3 Year ended 30 Sept 2014 million 125.0 180.0 55.0 Year 4 Year ended 30 Sept 2015 million 0 250.0 250.0 Year 5 Year ended 30 Sept 2016 million 0 0 0 Totals

million 525.0 700.0 175.0

0 (50.0) 1.000 (50.0)

10.0 (50.0) 0.870 (43.5)

12.0 (8.0) 0.756 (6.0)

4.0 59.0 0.658 38.8

(11.0) 239.0 0.572 136.7

(50.0) (50.0) 0.497 (24.9)

(35.0) 140.0

(50.0)

(93.5)

(99.5)

(60.7)

76.0

51.1

NPV NPV calculations with the sale of 25 floors to DJ:

Year 0 Year ended 30 Sept 2011 million Pre-tax cash outflows Pre-tax forecast sales Pre-tax net cash flows Tax at 20% 1 year in arrears Post-tax cash flows Post-tax discount rate 15% Discounted cash flows Cumulative discounted cash flows 50.0 0 (50.0) Year 1 Year ended 30 Sept 2012 million 180.0 140.0 (40.0) Year 2 Year ended 30 Sept 2013 million 170.0 170.0 0 Year 3 Year ended 30 Sept 2014 million 125.0 200.0 75.0 Year 4 Year ended 30 Sept 2015 million 0 140.0 140.0 Year 5 Year ended 30 Sept 2016 million 0 0 0

51.1

Totals

million 525.0 650.0 125.0

0 (50.0) 1.000 (50.0)

10.0 (30.0) 0.870 (26.1)

8.0 8.0 0.756 6.0

0 75.0 0.658 49.4

(15.0) 125.0 0.572 71.5

(28.0) (28.0) 0.497 (13.9)

(25.0) 100.0

(50.0)

(76.1)

(70.1)

(20.7)

50.8

36.9

NPV With the sale of 25 floors to DJ, the difference in the NPVs is (14.2) million lower.

36.9

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Page No: 17

Appendix 4 (Page 2) Alternative format for the NPV analysis of the office building proposal
NPV calculations without the sale to DJ (as before):
Year 0 Year ended 30 Sept 2011 million Pre-tax cash outflows Pre-tax forecast sales Pre-tax net cash flows Tax at 20% 1 year in arrears Post-tax cash flows Post-tax discount rate 15% Discounted cash flows Cumulative discounted cash flows 50.0 0 (50.0) Year 1 Year ended 30 Sept 2012 million 180.0 120.0 (60.0) Year 2 Year ended 30 Sept 2013 million 170.0 150.0 (20.0) Year 3 Year ended 30 Sept 2014 million 125.0 180.0 55.0 Year 4 Year ended 30 Sept 2015 million 0 250.0 250.0 Year 5 Year ended 30 Sept 2016 million 0 0 0 Totals

million 525.0 700.0 175.0

0 (50.0) 1.000

10.0 (50.0) 0.870

12.0 (8.0) 0.756

4.0 59.0 0.658

(11.0) 239.0 0.572

(50.0) (50.0) 0.497

(35.0) 140.0

(50.0) (50.0)

(43.5) (93.5)

(6.0) (99.5)

38.8 (60.7)

136.7 76.0

(24.9) 51.1

NPV Differential calculations with the sale of 25 floors to DJ:

Year 0 Year ended 30 Sept 2011 million Differential pre-tax forecast sales Tax at 20% 1 year in arrears Post-tax differential cash flows Post-tax discount rate 15% Discounted cash flows Cumulative discounted cash flows 0 Year 1 Year ended 30 Sept 2012 million 20.0 Year 2 Year ended 30 Sept 2013 million 20.0 Year 3 Year ended 30 Sept 2014 million 20.0 Year 4 Year ended 30 Sept 2015 million (110.0) Year 5 Year ended 30 Sept 2016 million 0

51.1

Totals

million (50.0)

0 0 1.000 0

0 20.0 0.870 17.4

(4.0) 16.0 0.756 12.1

(4.0) 16.0 0.658 10.5

(4.0) (114.0) 0.572 (65.2)

22.0 22.0 0.497 10.9

10.0 (40.0)

17.4

29.5

40.0

(25.2)

(14.3)

Differential NPV

(14.3)

Note: The differential NPV of (14.3) million is slightly different to the difference between the 2 NPVs shown in Appendix 4 page 1 due to roundings.

The Chartered Institute of Management Accountants 2011

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Appendix 5 Analysis of costs for the ES sports club

Costs incurred to date Paid by ES to date Book loss million 14 10 4

Costs incurred to date are sunk costs and are irrelevant to the future decision. Alternatives are: Claim from the liquidator Payout ratio 10% Forecast payment from liquidator

18

1.8m

Overall loss = 2.2 million loss (4 million loss less 1.8 million possible payout from liquidator) OR Accept ownership of the part completed sports club Proposed payment to liquidator for partially completed building Forecast costs to complete Forecast sales revenue Possible future profit million 3 8 20 9

Together with loss to date of 4 million = overall profit of 5 million Difference between these 2 alternatives is 7.2 million (2.2 million loss and 5.0 million profit)

Maximum that BZCS could pay to buy the uncompleted sports club is the same as accepting the payout from the liquidator = 20 million sales less 8 million to complete = 12 million less the alternative of a payment from the liquidator of 1.8 million = 10.2 million maximum.

Alternatives figures which include the loss to date are: Wait for payout by liquidator = 2.2 million loss overall Or Buy incomplete sports club to finish and then sell = 5.0 million profit overall.

The Chartered Institute of Management Accountants 2011

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Appendix 6 Email to non-financial managers in the Office Buildings Division of BZCS explaining the principles and the meaning of NPV calculations in general and a recommendation on the office building proposal
To: Finance Director (To be sent to BZCSs non-financial managers in the Office Buildings Division) From: Management Accountant Date: 26 May 2011 Re: NPV calculations for the office building proposal 1. The purpose of a Net Present Value (NPV) calculation is to evaluate the cash flows ONLY and to adjust them to take into account the time value of money and the risk of the project. 2. The time value of money attempts to take into account inflation and put the value of cash flows in future years into what they would be worth this year. 3. The discount rate (also known as the hurdle rate) should represent the companys cost of capital and is the return that the company could achieve if it invested the funds in other projects or invested the money. 4. It is not the cost of the specific finance used for a project but should represent the weighted average cost of capital for the whole company. 5. The discount rate can also be adjusted to take account of the risk profile of the specific project. 6. An NPV is NOT the accounting profit of the project as it is the added value of the project based on cash flows only and therefore omits non-cash items such as depreciation. 7. In theory a company should accept all positive NPV projects as this increases shareholder wealth but in practice a company does not have the resources (financial or manpower) to undertake every positive NPV project. 8. An NPV is only as accurate as the underlying assumptions, such as the discount rate used and the forecast of the timings of future cash inflows and outflows, as the further in the future the greater the degree of uncertainty that surround these assumptions. 9. If sales revenue were overstated, or was delayed to later years, then the NPV would reduce, as 1.0 million cash inflow next year is worth 0.870 million (at 15% post-tax risk adjusted discount rate) compared to only 0.572 million in 4 years time. 10. It is recommended that BZCS proceeds with the construction of this building and accepts the sale to DJ at 300 million (a discount of 50 million).

Regards Management Accountant

Note: The above 10 sentences are slightly more detailed for teaching purposes and in exam conditions brief sentences are expected.

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