Page 6 - CIMA OCS Workbook February 2019 - Day 2 Suggested Solutions

CIMA FEBRUARY 2019 – OPERATIONAL CASE STUDY

Unfortunately the consultants have not provided any probabilities so we don’t know how likely it
is that demand will fall that low. To fully assess risk we need both impact and probability. It might
be worth suggesting asking the consultants if they have any probabilities to work with.
Break-even and margin of safety

The break-even revenue shows how much revenue is required to make neither a profit nor loss.
In this case it is F$300,000 in each year. This allows you to discuss how certain you feel that sales
will exceed this. The expected revenue of F$350,000 in year 1 can therefore drop by 14% before a
loss is made. (Note: This is what is meant by the ‘margin of safety’).

The initial impression is that this does not seem to give much room for error, so it may be worth
reviewing where the estimates have come from and whether or not it is worth spending extra
money on market research to get greater assurances on this figure. The market for indoor activity
toys such as climbing frames is an untried proposition..
Standard deviation

The standard deviation is a statistical measure that gives an idea of the average spread of possible
outcomes around the expected volume.

Thus, if you could see all possible revenue figures in year 2, then on average they are 38% away
from the expected figure of F$400,000.
Initial impression is that this represents a significant risk but further work would be necessary to
assess whether it is acceptable or not when compared with the potential return.
Sensitivity analysis
Sensitivity analysis is best viewed as a more general form of break-even analysis.

In this case we are told that the selling price could fall by 10% in year one before a loss results.
In the same way that we discussed margin of safety above, the Board would need to assess how
certain they are of the projected prices and, in particular, whether they could be 10% lower.

3. Preliminary recommendations
The predicted revenue and profit figures are fairly immaterial in terms of the bigger picture –
expected revenue in 2019 would increase over 2019 forecasts by just over 1.7% (350/20,940).
However, I am concerned that the risks are worryingly high:
1. This is a new venture and it may be that our estimates on sales revenue are over optimistic,
particularly as it is a new concept.
2. Whether the new product sales would displace sales of existing outdoor equipment.

Given this, it may best to design a narrower range of indoor frames initially and view the proposal
as a pilot to gauge success before extending the range further.

62 KAPLAN PUBLISHING