Page 9 - CIMA OCS August 2018 Day 1 Suggested Solutions

SUGGESTED SOLUTIONS

EXERCISE 4 – RISK AND UNCERTAINTY
Exercise 4(a) – Key Risks

Question Your response

Identify four • Stagnation / erosion of demand due to lack of investment in new
significant areas products
of risk for • Failure to identify and respond quickly enough to changes in consumer
Thomas Fine taste
Teas. • Powerful customers (supermarkets) may demand lower prices as they
only make small margins
• Very dependent on experienced tasters / buyers / blenders – if there
was a problem with them (e.g. lack of motivation, disputes over pay),
then could be very serious
• Damage to brand due to quality problems – e.g. increase in pests /
pesticides
• Tea bought at auction, so risk re quality, quantity and price of supply

Exercise 4(b) – Expected Values

Response
• EV = 0.6 × 500 + 0.3 × 120 - 0.1 × 250 = + D$310,000 > 0
• Using EV, this would suggest the project is acceptable as the EV is positive.
• Furthermore
o There is a 10% chance of a loss of D$250,000 being incurred for the new
product.
o This is 1.7% of Thomas Fine Teas’ overall 2018 profits of D$14,820k, so the
Board should be willing to take such a risk, especially if viewed as a pilot / loss
leader.
• Concerns over usefulness of EVs
o EV is a long run average when the project is a one-off decision
o EV cannot happen
o Difficult to estimate probabilities with any certainty
o EV ignores risk profile (see above).

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