Q 51

Grab (Ghana) Ltd is a company that is engaged in site clearance and site preparation work. Information about its operations is as follows:

1) It is Grab (Ghana) Ltd's policy to hire all the plant and machinery it needs, rather than to purchase its own plant and machinery.

2) Grab (Ghana) Ltd will enter into an advance hire agreement contract for the coming year at one of three levels - high, medium or low - which correspond to the requirement of a high, medium or low level of orders obtained.

3) The level of orders obtained will not be known when the advance hire agreement contract is entered into. Probabilities have been estimated by management as to the likelihood of the orders being at a high, medium or low level.

4) Where the advance hire agreement entered into is lower than that required for the level of orders actually obtained, a premium rate must be paid to obtained the additional plant and machinery required.

5) No refund is obtained where the advance hire agreement for plant and machinery is at a level in excess of that required to satisfy the site clearance and preparation orders actually obtained.

A summary of the information relating to the above points is as follows:

Levels of orders Sales revenue Probability Plant and machinery hire cost

Advance Hire Conversion Premium

GHS'000 GHS'000 GHS'000

High 15,000 0.25 2,300

Medium 8,500 0.45 1,500

Low 4,000 0.30 1,000

Low to medium 850

Medium to high 1,300

Low to high 2,150

Variable cost (as a percentage of turnover) 70%

Required

a) Prepare a summary which shows the forecast net margin earned by Grab (Ghana) Ltd for the coming year for each possible outcome.

b) On the basis of maximising expected value, advise Grab (Ghana) Ltd whether the advance contract for the hire of plant and machinery should be at the low. medium or high level.

c) Explain how the risk preferences of the management responsible for the choice of advance plant and machinery hire contract may alter the decision reached in (b) above