"The directors have been looking at the draft budget for the new PEXECO production facility for the four-month period September to December 2020. Ben Thakar, Sales and Marketing Director believes that there is real scope to increase the volume of PEXECO sales by decreasing selling prices. He is optimistic about this and believes that if selling prices were reduced by 5%, sales volumes would increase by 15% and if selling prices were reduced by 10%, sales volumes would increase by 30%. Mia Schmied, Managing Director, is far less confident that sales would increase as much as Ben believes She has requested that we perform sensitivity analysis and also consider expected values. I prefer what if to sensitivity analysis and have produced profit estimates based on Ben's assumptions I think that there is likely to be an increase in fixed costs when volumes increase by more than 20% so my profit estimates also include the effect of this. I have also estimated probabilities so that I could calculate expected values. There has also been some discussion amongst the directors about the fixed production overheads included in the budget for the new production facility. Whilst some overhead expenditures, such as depreciation have been easy to predict, other overheads, such as machinery maintenance are more difficult. Within the new facility it is planned that each piece of machinery will have a routine service three times a year to ensure that it is in optimal condition. In addition, maintenance employees will be required to make repairs as and when the need arises. Diane Rechnung, Finance Director, has suggested the use of activity-based budgeting as a different approach for establishing some of the overhead expenditure budgets. She has asked for me to look into this. I have included the what-f analysis and the expected value tables in a schedule I will give to you shortly. I would like you to prepare a briefing paper for the senior management team which explains The revised profit figures shown in Table 1 of my schedule and why what if analysis is more appropriate than sensitivity analysis in this situation (sub-task (a) = 36% The figures shown in Table 2 and Table 3 and how our attitude to risk will affect our decision about which reduction in selling price would potentially give us the best result (sub-task (b) - 32% How the budget for the maintenance employee cost in the new production facility could be established using an activity-based budgeting approach (sub-task (c) = 32% WHAT - IF ANALYSIS ON THE PEXECO BUDGET FOR THE FOUR MONTHS SEPTEMBER TO DECEMBER 2020 Table 1: Assumption Assumption Assumption Assumption A A B B Original Revised % change Revised % change budget budget budget G$000 G$000 G$000 Revenue 4,860 5,310 + 9% 5,686 +17% Variable costs (1347) (1.550) + 15% (1.751) +30% Contribution 3,513 3,760 +7% 3,935 +12% Fixed costs (1.120) (1.120) 0% (1176) 5% Profit 2,393 2.640 +10% 2.759 +15% Notes: Assumption A is that a 5% reduction in average selling price will lead to a 15% increase in volumes sold. Assumption B is that a 10% reduction in average selling price will lead to a 30% increase in volumes sold and a 5% increase in fixed costs. The % change under each assumption is from the original budget. IMPACT OF CHANGING SELLING PRICES USING EXPECTED VALUES Table 2: If decrease average selling prices by 5%: Change in sales Budgeted profit Expected value volume Probability G$000 G$000 No change 0.2 2.150 430 +7.5% 0.5 2 395 1.198 +15% 0.3 2,640 792 2,420 Table 3: If decrease average selling prices by 10%: Change in sales Budgeted profit volume Probability G$000 No change 0.1 1907 +15% 0.8 2.361 +30% 0.1 2.759 Expected value G$000 191 1.889 276 2.356 "The directors have been looking at the draft budget for the new PEXECO production facility for the four-month period September to December 2020. Ben Thakar, Sales and Marketing Director believes that there is real scope to increase the volume of PEXECO sales by decreasing selling prices. He is optimistic about this and believes that if selling prices were reduced by 5%, sales volumes would increase by 15% and if selling prices were reduced by 10%, sales volumes would increase by 30%. Mia Schmied, Managing Director, is far less confident that sales would increase as much as Ben believes She has requested that we perform sensitivity analysis and also consider expected values. I prefer what if to sensitivity analysis and have produced profit estimates based on Ben's assumptions I think that there is likely to be an increase in fixed costs when volumes increase by more than 20% so my profit estimates also include the effect of this. I have also estimated probabilities so that I could calculate expected values. There has also been some discussion amongst the directors about the fixed production overheads included in the budget for the new production facility. Whilst some overhead expenditures, such as depreciation have been easy to predict, other overheads, such as machinery maintenance are more difficult. Within the new facility it is planned that each piece of machinery will have a routine service three times a year to ensure that it is in optimal condition. In addition, maintenance employees will be required to make repairs as and when the need arises. Diane Rechnung, Finance Director, has suggested the use of activity-based budgeting as a different approach for establishing some of the overhead expenditure budgets. She has asked for me to look into this. I have included the what-f analysis and the expected value tables in a schedule I will give to you shortly. I would like you to prepare a briefing paper for the senior management team which explains The revised profit figures shown in Table 1 of my schedule and why what if analysis is more appropriate than sensitivity analysis in this situation (sub-task (a) = 36% The figures shown in Table 2 and Table 3 and how our attitude to risk will affect our decision about which reduction in selling price would potentially give us the best result (sub-task (b) - 32% How the budget for the maintenance employee cost in the new production facility could be established using an activity-based budgeting approach (sub-task (c) = 32% WHAT - IF ANALYSIS ON THE PEXECO BUDGET FOR THE FOUR MONTHS SEPTEMBER TO DECEMBER 2020 Table 1: Assumption Assumption Assumption Assumption A A B B Original Revised % change Revised % change budget budget budget G$000 G$000 G$000 Revenue 4,860 5,310 + 9% 5,686 +17% Variable costs (1347) (1.550) + 15% (1.751) +30% Contribution 3,513 3,760 +7% 3,935 +12% Fixed costs (1.120) (1.120) 0% (1176) 5% Profit 2,393 2.640 +10% 2.759 +15% Notes: Assumption A is that a 5% reduction in average selling price will lead to a 15% increase in volumes sold. Assumption B is that a 10% reduction in average selling price will lead to a 30% increase in volumes sold and a 5% increase in fixed costs. The % change under each assumption is from the original budget. IMPACT OF CHANGING SELLING PRICES USING EXPECTED VALUES Table 2: If decrease average selling prices by 5%: Change in sales Budgeted profit Expected value volume Probability G$000 G$000 No change 0.2 2.150 430 +7.5% 0.5 2 395 1.198 +15% 0.3 2,640 792 2,420 Table 3: If decrease average selling prices by 10%: Change in sales Budgeted profit volume Probability G$000 No change 0.1 1907 +15% 0.8 2.361 +30% 0.1 2.759 Expected value G$000 191 1.889 276 2.356