XAT Decision Making – Principles for Solving Financial Decision Questions

Monday, December 16th, 2019


Financial Decision Questions

Decision Making (DM) is an important part of the XAT since one entire section is devoted to it and fully 21 of the 72 questions in Part A of the XAT examination in 2018 and in 2019 were Decision Making questions. Since these questions are completely unfamiliar to test takers from all streams, most test takers dread this section and thus prepare inadequately. Unlike, other sections, this section is not really a test of theoretical knowledge but challenges the basic assumptions of a test taker’s thinking and whether or not the test taker is able to understand real-world problems that are presented as cases in these questions.

In other words, they are application based questions. One cannot simply apply a theoretical principle or formula to the question and arrive at the answer. However, although there are no theoretical concepts for solving these questions, there are some guiding principles a test taker should make use of as this will help the test taker to maximize the number of correct attempts of this question type.

Decision making questions can be broadly divided into four types – Ethical decisions, Financial decisions, Managerial issues and Logic Reasoning or Arithmetic decisions. Out of these, the Financial Decision questions are relatively easier to solve as compared to Ethical or Managerial Decision questions. Very often, there is a clear cut correct answer to these question types, and with the help of some guiding principles, a test taker should look to maximize his or her scoring opportunities in these question types.

Although, the number of Financial Decision making questions are quite small – only around 3-7 questions for each XAT since 2015 – these are questions which present good scoring opportunities for a test taker and he or she should look to improve his or her percentile by attempting all the questions of this type with a high degree of accuracy.

 

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Reasons why a test taker should attempt all or most of the Financial Decision Questions

  • Very often there is a clear cut and definitive answer
  • These questions are not very time consuming
  • No lengthy arithmetic calculations are required

Guiding Principles for Financial Decision Making Questions:

The following aspects need to be considered before taking decisions:

  1. Company’s financial health comes first – You as a decision maker must always arrive at a decision which will not negatively impact on the company’s profitability, sales or financial growth.
  2. Company’s laws and norms are not to be violated. Legal contracts are to be honoured from both sides – the company as well as the entity the company has entered into an agreement with.
  3. All financial decisions should be taken from an ethical perspective – In other words, no short cuts or bypassing the country’s laws in order to make a profit.
  4. Focus on the end result – In a question where more than one answer seems to have merit, the correct answer will be the one which deals directly with the company’s financial objectives.

Example of a typical Financial Decision question:

ABC Pvt. Ltd., a major footwear company, has entered into a 10-year contract with a major supplier who will supply tanned leather. The contract has 5 years remaining on its term but the supplier has now asked you, the General Manager of ABC Ltd., to renegotiate the price because their labour costs and the price of raw materials such as leather have risen more than expected. If you agree to a price increase, it will have a substantial negative impact on your company’s profitability.  What would you do?

A. I will refuse to negotiate the price and hold the supplier liable to ‘breach of contract’ if supplies are affected.

B. I will discontinue the supplier who asked for the increase in the contract period and develop new suppliers.

C. I will increase the price, on the condition that there would be no further increase granted during the contract period.

D. I will negotiate the price and try to limit the increase to a minimum so that my company’s profitability is not significantly affected.

E. I will refuse to negotiate the price, sue the supplier for breach of contract and black list the supplier.

Answer: Option A.

Options B and E are too extreme to be considered for the time being.

Option C will be caving in to the supplier’s demands. Your first duty is to safeguard your company’s interests or Principle 1.

Option D can be eliminated for the same reason as option C.

Since the company and supplier have entered into a legal contract with no clause for renegotiation, the contract is to be honoured in full by the supplier. This satisfies Principle 2.

Questions that involve taking a decision that may have an impact on a company’s profitability, revenues, prospective financial growth etc. are Financial Decision questions.

Example 1:

Bijoy Ghosh has owned a sweet and samosa shop in the seaside town of Puri for over 20 years.  He is now 60 years of age and wishes to hand over his business to his two sons, Supratik and Arindam. The two sons, therefore, start learning the trade by sitting in the shop in the evenings after their college is over. Bijoy’s younger son, Arindam, soon discovered that his father sold sweets and samosas to 10% of his customers at prices fixed 10 years ago. These prices were significantly lower than current prices. On asking the reason, Bijoy told his son, ‘These customers are regular customers who have been buying from my shop for many years now. They are responsible for my shop’s success. Therefore, they deserve this privilege.’ Arindam refuted his father’s argument by citing the following information.

  1. None of these customers have ever visited them at their house.
  2. None of them recognizes or greets Bijoy at the shop or anywhere else.
  3. These customers form the top 10% of the income bracket of the city.
  4. These customers frequently purchase sweets and samosas from other shops at market prices.
  5. These customers actually buy sweets and samosas from Bijoy’s shop for others who do not get this privileged pricing.

Which of the following combination of the above will MOST LIKELY convince Bijoy to charge market prices to all?

A.4 and 5

B. 3 and 4

C. 2 and 4

D. 1 and 2

E. 2 and 5

 

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Answer: The fact that these customers have not visited Bijoy’s home does not take away the fact that they are regular customers. Thus, statement 1 can be negated. Similarly, 2 can also be eliminated since it is not important that these customers recognize and greet Bijoy at his shop. They happen to be regular customers. The income bracket of these regular customers is irrelevant to the decision by Bijoy of offering them discounted prices. Eliminate statement 3. If these customers are buying sweets and samosas from other shops as well at market prices this argument may convince Bijoy to charge them market prices. Therefore, statement 4 is a convincing statement. Statement 5 is definitely a convincing argument to make. If these regular customers are buying sweets and samosas from Bijoy’s shop at discounted prices and giving them to others then this practice of discounted pricing may have to be stopped. Thus both statements 4 and 5 are likely to convince Bijoy to charge market prices.

Therefore, option A is the correct answer.

Example 2:

Ms Anjali Bharadwaj has just returned from acquiring a diploma in ‘Retail Management’ from a university in the UK. She wishes to start her own organic foods boutique in Mumbai. She has zeroed in on three areas, namely Bandra, Kurla and Vashi. Out of these three areas she feels Bandra is the best bet for her boutique since the suburb is populated with educated and affluent young people. Vashi is a residential area while Kurla is a lower-middle income area where shop rentals would be much cheaper as compared to the first two areas.

What could be the most likely reason for Anjali opting for Bandra?

  1. High percentage of health conscious people who go to gyms regularly.
  2. High density of population in both Kurla and Vashi.
  3. High real estate prices in Bandra.
  4. No organic outlet is likely to come up in Kurla in the near future.
  5. She felt that the educated and affluent young population would be excited about organic foods.

Answer: The passage mentions that Anjali feels the best bet for her boutique would be Bandra – because of the educated and affluent population living there. Therefore, she feels that the educated and affluent population is most likely to purchase organic foods.

Therefore, option E is the correct answer.

Note: Option A is a diversionary option since from the realms of real world knowledge many test takers would probably have assumed that option A has merit. But since organic foods has not been linked to health but to educated, affluent populations in the passage this option is eliminated.

What is the most important decision criterion for Anjali to consider in such a business situation?

  1. Availability of space in the premium areas of Bandra.
  2. Attracting customers through big discounts in the initial phase of business.
  3. The range and variety of organic foods.
  4. Consistent increase in the number of customers in future.
  5. Availability of bank loans at low interest rates in order to set up her boutique in Bandra.

Answer: The principal aim of a business should be to attract customers in a consistent manner. Therefore, option D satisfies Principle 4. The end result is the financial health of the new company.

All other options A,B,C and E are probable means to attaining this important objective.

Therefore, option D is the correct answer.

XAT Decision Making Section – Principles for Solving Managerial Issue Questions

 

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