Core 2 — Integrated Problem 4

Solution
The following solution is a “best” response, demonstrating a level much higher than
competent. However, there may be additional acceptable and reasonable points that
are not reflected in this response.

In addition, candidates are not expected to prepare a response of this level given the
time constraints involved and, if applicable, page limits / word counts provided.

Memo

To: CEO, Glo Inc.

From: CPA
Subject: Product line expansion

I have analyzed the expansion of the plant and product lines and summarized my
results here.

Assessment Opportunity #1

The candidate calculates Glo’s weighted average cost of capital (WACC), identifies the
funding alternative with the lowest cost of capital, and discusses qualitative
considerations.

The candidate demonstrates competence in Finance.

CPA Map Competencies:

5.2.5 Evaluates the entity’s cost of capital (Core – Level B)

I have calculated the WACC of each funding alternative in Exhibit I.

Based on my calculations, the bank loan would provide Glo with a WACC of 11.87%.
However, the bank loan also carries conditions with it. It requires the building to be held
as security and will also require Glo maintain a minimum working capital ratio. Neither of
these conditions is unreasonable, but they may further constrain the company’s ability
to meet its inventory demands. We should consider if there are any concerns with
meeting the conditions and how this could impact future operations.

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2023-08-24
Core 2 — Integrated Problem 4 Solution

Should Glo proceed with the preferred shares, the WACC would be 13.92%. The
preferred shares come at a higher cost but do not restrict Glo in any way.

I recommend the bank loan option as it has the lowest cost of capital. The conditions
are not cumbersome and will allow Glo to generate a better return on investment by
lowering the overall cost of capital.

Assessment Opportunity #2

The candidate calculates the net present value (NPV) of the machinery options and
identifies the most cost-effective option.

The candidate demonstrates competence in Finance.

CPA Map Competencies:

5.3.1 Develops or evaluates capital budgeting processes and decisions (Core –

Level B)

Glo is considering two options for machinery: the Xpress300 and the D-Lux550. The
Xpress300 must be purchased and has higher repair and maintenance costs, whereas
the D-Lux 550 is an annual lease payment.

Per Exhibit II, the NPV analysis of both options is:

Xpress300 ($450,464)
D-Lux550 ($397,281)

Both options return negative NPVs as there is no incremental cash flow information
available at this time. Based on this limited information, the quantitative analysis
indicates the D-Lux550 is the most cost-effective alternative.

2/5
Core 2 — Integrated Problem 4 Solution

Assessment Opportunity #3

The candidate discusses the machinery options and provides a recommendation for the
CEO’s consideration.

The candidate demonstrates competence in Strategy and Governance.

CPA Map Competencies:

2.3.2 Evaluates the entity’s internal and external environment and its impact on strategy
development (Core – Level B)

In addition to the quantitative analysis, we should also consider qualitative factors.

There are pros and cons to consider for both machines.

Xpress300

Pros:
• The manufacturer has produced machinery for the cosmetic industry for a long time;
therefore, we can expect that this product can be relied on.
• We have experience working with the manufacturer. This means Glo is familiar with
the customer service experience and likely has good working relationships with the
manufacturer.
• We may have economies of scale in training given we use their machinery now,
resulting in lower training costs.

Cons:
• Training is intensive and may require some additional time as employees learn how
to use the equipment, which has not been accounted for in the cost. If the time
needed for training employees exceeds the estimates, the NPV will be impacted.
• A warranty is only provided for 30% of the life of the machine (3 years/10-year useful
life). The repairs and maintenance costs included are an estimate and have
historically been increasing. Actuals may differ from what is included in the analysis.
This can result in volatility to both cash flow and the income statement.

D-Lux550

Pros:
• Repairs and maintenance are included, so expenses are easier to forecast.
• Should production increase, the equipment is capable of handling 20% more units in
a year, which would increase its value to Glo.

3/5
Core 2 — Integrated Problem 4 Solution

Cons:
• The manufacturer is new to the cosmetics space. While it does have experience in
the food space, that doesn’t mean there will be a seamless transition. There is
higher risk that the equipment may fail or the service may not match the cosmetic
space expectations.

My recommendation, based on the quantitative and qualitative information, is to

proceed with the Xpress300. Despite the Xpress300 being the costlier option, there are
many unknowns about the provider of the D-Lux550, which could negatively impact
production and increase costs. Glo is focused on quality; thus, the good working
relationship Glo has with the makers of the Xpress300 as well as the reputation of the
Xpress300 manufacturer, make this is the preferred option.

Assessment Opportunity #4

The candidate calculates the NPV of the new product line.

The candidate demonstrates competence in Finance.

CPA Map Competencies:

5.1.2 Develops or evaluates financial proposals and financing plans (Core – Level B)

One of Glo’s initiatives is to introduce a men’s product line, which is quantitatively

assessed in Exhibit III. The analysis includes the expected sales and expenses, uses
the expected WACC as the discount rate over a five-year period, and assumes the
facility expansion and new machinery cash flows would occur regardless of this
decision. Taking all of this into account, the initiative returns a positive NPV of
$383,404.

Assessment Opportunity #5

The candidate discusses the new product line.

The candidate demonstrates competence in Strategy and Governance.

CPA Map Competencies:

2.3.2 Evaluates the entity’s internal and external environment and its impact on strategy
development (Core – Level B)

While the quantitative information shows the men’s product line is a financially beneficial
initiative based on the positive NPV, we also need to consider the qualitative aspects of
the plan.

4/5
Core 2 — Integrated Problem 4 Solution

Pros:
• Part of Glo’s strategic plan is to capture underserved markets. Introducing beauty
products to men is consistent with this strategic plan.
• The focus group research showed that men liked how the beauty products made
them feel, which shows that there is a market for this type of product.
• Glo already has a male partner for promotion, which should help sales figures.
• Given that Glo is planning to expand its production capacity, production should not
be a concern, and it will be able to accommodate the increased sales volume.

Cons:
• Per the focus group findings, men prefer to not be seen buying beauty products.
This could negatively affect in-store sales.
• Per the focus group findings, men prefer to shop for all beauty products in one
location; therefore, the current plan of introducing one product per year could cause
Glo to lose some of the market, as customers may prefer stores that offer a full
men’s line.
• The focus group showed that men like immediate results. This may be problematic,
as products often take time to be effective, which could negatively impact the
projected sales forecast.

Given the positive NPV and the consistency with the strategic plan to capture
underserved markets, I recommend that Glo proceed with its plans to introduce the
men’s line.

However, I also recommend that Glo make a few changes to the implementation to
ensure success:
• Offer all the products at once, as the market participants prefer to get all of their
products in one visit. The drawback is that this may delay introduction of this entire
new product line to the market. Even with this drawback, Glo is committed to offering
quality products, so an initial delay to offer more products at the quality level your
female customers are used to would be better than rushing to market quickly with
inferior products. Any changes to the product rollout will change the results of the
NPV.
• Offer the products online, given that men prefer not to be seen in-store.
• Consider whether the planned product line will align with the market’s need to see
immediate results, to ensure that it is launching effective products for this market.

5/5