Practice Case- Matobo Breweries- managerial accounting PDF

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CPA MOCK Evaluation

Core 2 Module

MATOBO BREWERIES

Page 1 Suggested Time (60 minutes)

Matobo Breweries Ltd. (MBL) produces highly popular beers in one large production plant in a semi-rural part of Ontario. It has a wide distribution base within Canada and has also begun exporting its beers to the U.S. MBL’s mission is to enhance the well-being and lifestyles of its consumers as well as to provide meaningful and continued employment for its staff. MBL is known for manufacturing high-quality alcohol through a proprietary process that has been perfected over the past ten years. Only a portion of the alcohol manufactured by MBL is used to produce beer. The excess is sold to other manufacturers to be used as inputs for products such as kerosene and mouthwash. Those manufacturers can often choose from multiple alcohol suppliers but have consistently supported and have remained loyal to MBL for many years so demand is expected to remain stable for the long-term. You, CPA, recently began working for MBL as its CFO. It is now November 3, 2021, and you are meeting with the CEO, Richard Kinsella. As the meeting begins, Kinsella tells you, “I am considering an opportunity to process our excess alcohol further into hand sanitizer instead of selling it to other manufacturers (Appendix I). I don’t want to miss out on the evolution in hand hygiene that has already resulted in a substantial increase in demand for hand sanitizer over the past year that I expect to continue for at least the next five years and maybe even longer. You need to determine whether it makes sense, quantitatively and qualitatively, to pursue this opportunity. “As you know, grain is an important input in producing alcohol and rising prices have a significant impact on our profitability. I would like you to identify the steps involved in hedging our risk with regards to grain prices using futures contracts, and consider any advantages or concerns you may have with using futures contracts. Furthermore, our sales contracts with our U.S. customers generally require payment in U.S. dollars so the potential depreciation of the U.S. dollar relative to the Canadian dollar would lower our profits. Since the Canadian dollar has been outperforming many currencies, including the U.S. dollar, you should also identify the steps involved in hedging our foreign exchange risk using forward contracts. Again, be sure to consider any advantages or concerns you may have with using forward contracts. “I need you to analyze an order that we have received from an important customer (Appendix II) and provide a supported recommendation on whether the order should be accepted.” As the meeting wraps us, Kinsella gives you a final request, “We have $500,000 of extra cash that we have always maintained for emergency purposes and it is earning less than 1% in our bank account. With the annual inflation rate expected to be 2%, I have sought out ways to invest that cash to earn a higher return and have narrowed down the search to three alternatives (Appendix III). I would like you to analyze the alternatives and provide a supported recommendation for the one MBL should select.”

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CPA MOCK Evaluation

Core 2 Module

Page 2

APPENDIX I HAND SANITIZER OPPORTUNITY MBL’s all-inclusive cost to produce one litre of alcohol is $4 up to the point where it can be sold to other manufacturers, used to produce beer, or used to produce hand sanitizer. MBL’s current sale price of alcohol to other manufacturers is $8 per litre with annual sales of 200,000 litres. As MBL’s production facility is operating at capacity and its first priority is to produce alcohol for its beers, only 200,000 litres of excess alcohol are available. The expected sale price of a one litre bottle of hand sanitizer produced by MBL is $7 per litre. Kinsella is certain that the demand for hand sanitizer will continue to exceed supply so that MBL will be able to sell all the bottles of hand sanitizer that it produces for the next five years. The main ingredient in hand sanitizer is alcohol and each one litre bottle of hand sanitizer requires 0.6 litres of alcohol. Bottling, packaging, labeling, and other costs amount to $0.50 per one litre bottle. Advertising, marketing, and promotion costs are estimated to be $140,000 per year. The purchase of specialized manufacturing equipment, other start-up costs, and one-time employee training costs are expected to total $750,000. The amount will be incurred upfront and will need to be financed with a bank loan at an annual interest rate of 4% since Kinsella does not want to use the $500,000 in extra cash. Loan payments are on an interest-only basis with interest payable at the end of each year and the full principal to be repaid at the end of five years. MBL does not have any existing debt on its balance sheet due to Kinsella’s aversion to debt. If existing sales to other manufacturers are discontinued in favour of producing hand sanitizer, one of MBL’s managers earning an annual salary of $80,000 will be redeployed from the existing operations to the proposed hand sanitizer operations. The existing employees not involved in beer production will require training and a period of transition into the hand sanitizer operations. An additional chemist will need to be hired for $90,000 per year to provide full-time technical support. To be authorized to sell hand sanitizer in Canada, MBL would be required to obtain approval from Health Canada. Health Canada will perform random and periodic checks on hand sanitizer producers to ensure that they continue to meet the required standards. Recently, some companies were removed from Health Canada’s list of approved manufacturers because the alcohol in their products was of insufficient quality. The investment time horizon is medium-term because Kinsella feels that the hand sanitizer market will either be extremely saturated with competitors or the demand will have stabilized by the end of five years. At that point, sales prices may need to be lowered, which will reduce profits to a level where exit from the market would be desirable. There has already been a noticeable increase in the number of new hand sanitizer producers in the past year due to the sudden increased demand.

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CPA MOCK Evaluation

Core 2 Module

Page 3

APPENDIX II CUSTOM ORDER MBL has been approached by an important customer who would like to have custom limitededition beer produced and bottled for the customer’s upcoming wedding. The customer requires one bottle of beer to be provided to each of the 600 wedding guests. As MBL is operating at capacity, these 600 bottles will replace sales of MBL’s regular bottles. MBL will not be able to sell the limited-edition beer to regular customers; however, the customer has informed MBL that if the beer be a hit that the customer will be re-ordering the beer on wedding anniversaries. The customer has offered to pay $7,000 for the order. It is expected that two test batches will be prepared at a cost of $1,000 each. The brew master is paid an annual salary $60,000 and works 50 weeks a year. It is expected that the brew master will devote two weeks to creating and producing the limited-edition beer. The following costs will be incurred for the limited-edition beer on a per bottle basis: • Labour $0.15 • Ingredients $0.40 • Bottle $0.10 • Depreciation $0.10 • Overhead costs $0.23 The specialty labels and packaging will be custom designed at a cost of $500 and each label will cost $1.25, while packaging will cost $0.75. MBL sells a 6-pack of beer for $15 and earns a contribution margin of 40%.

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CPA MOCK Evaluation

Core 2 Module

Page 4

APPENDIX III INVESTMENT ALTERNATIVES Alternative 1 Investment in Province of Ontario bonds for a five-year term with an annual interest rate of 3% and guaranteed by the Ontario government. Alternative 2 Investment in a large parcel of vacant land that is currently zoned for agricultural use only. Since local authorities are seeing the financial benefits of having commercial production facilities in semi-rural areas of Ontario, there is some hope that the land might be re-zoned for manufacturing use. The current best estimate is that the likelihood of rezoning to manufacturing use in five years is about 70%. If that were to happen, the land could be sold for about $800,000 net of costs and prior to taxes. Alternative 3 Investment in a precious metals exchange-traded fund (ETF) with exposures to both gold and silver. The expected annual return is 20%. The annualized volatility (standard deviation) of returns is 30%. The average equity ETF has an annual return of 9% and a standard deviation of returns of 7%.

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