SBM Questions

Merson, Shiplock and Brown LLP
The ethical principles which are relevant to Kate's request are those of confidentiality and integrity - or, more specitically, tran
to have with HH's staff.
Confidentiality - Although Kate has asked for "complete confidentiality", she appears to be using the concept of confidentialit
with her, rather than with any other members of statt or the board ot HH. This seems to be a diterent interpretation of the pri
requires an accountant not to disclose information acquired in the course of a protessional engagement to third parties witho
professional duty to do so.
However, Kate's interpretation also raises the question of who MsB's client actually is in this situation, and therefore to whom
of the board or the staff of HH could only be considered as third parties' it MSB's duty is to Kate as an individual.)
MSB's contractual duty is to HH as a legal entity, though.

The board normally has the power to represent the entity in any dealings with an accountant acting in the capacity as busines
charged with governance.
The CEO (Kate) should not be acting in a single personal capacity unless empowered to do so by the board.
Constraints which Iimit dealings to certain people may be within the power of the CEO and, as MSB's appointment is not a sta
acceptable. Ihe issue of dissemination to the board will be one for the CEO to deal with, providing she has capacity to engage
Confidentiality from executive directors may be within the powers of the CEO but to substantiate the powers of confidentiality
From a practical perspective it might not be possible to hide the activities required of MSB from HH's staff. If MSB tries to do s
enquiries being made of statt, then this lack of transparency could represent a threat to the principle of integrity.
Other issues which MSB should consider before accepting the engagement
It is not clear who would authorise the engagement letter if only the chief executive had knowledge of our intended remit. In
executive has this within her sole and legitimate capacity to act.
Actions might be to enquire of the chief executive the reasons for the contidentiality trom the board and her authority for den
board.
Perhaps seek permission of the CEO to approach the chairman to substantiate that the CEO has the capacity and is not acting
accepting the engagement unless the CEO can otherwise demonstrate her capacity to act.
ity - or, more specitically, transparency in relation to any potential dealings MSB needs
g the concept of confidentiality to mean that MSB should discuss its findings solely
erent interpretation of the principle than that used in ICAEW's Code of Ethics which
gement to third parties without specific authority, unless there is a legal or
ation, and therefore to whom its ethical duties are owed: to Kate, or to HH. (Members
as an individual.)
ting in the capacity as business adviser or assurance practitioner or alternatively those
MSB's appointment is not a statutory appointment such as an audit, this may be

ng she has capacity to engage her own advisers without reference to the board.
e the powers of confidentiality may itself be a breach of confidentiality.

HH's staff. If MSB tries to do s0, or misleads HH's staff about the reason for any
ciple of integrity.
dge of our intended remit. In particular, we should consider whether the chief
oard and her authority for denying legitimate intormation about the company to the
the capacity and is not acting ultra vires. It this is refused, then consider not
Describe the functions central treasury department.
Management of cash
The central treasury department will have the responsibility for the management of the Megatrade group's cash flows and bo
required to submit the cash to the treasury department, and subSidiaries needing cash will borrow it from the treasury depart
Borrowing
Central treasury will be given the responsibility for borrowing on behalt of the Megatrade group. If a subsidiary needs capital
money required, and lend it on to the subsidiary. The subsidiary will be responsible for paying interest and repaying the capit
responsible for the interest and capital payments to the original lenders.
Risk management
Another function of the treasury department will be to manage the financial risk of the Megatrade group, such as currency ris
treasurer might have authority to decide on the balance between fixed rate and floating rate borrowing and to use swaps to a
responsible for arranging forward exchange contracts and other hedging transactions.
Taxation
The central treasury department could be responsible for the tax affairs of the Megatrade group, and an objective would be t
etftectively, the treasury must have authority to manage transfer prices between subsidiaries in the group, as a means of tran
countries.
Describe the information that the treasury department needs, from inside and outside to perform its functions.
The treasury function needs information from within and outside Megatrade to carry out its tasks.
(1) From each subsidiary within the group, it will need figures for future cash receipts and payments, making a distinction bet
amounts. Ihis information about cash tloWs will be used to forecast the cash flows of the group, and identity any future borro
medium-term requirements. Figures should be provided regularly, possibly on a daily basis.
(2) Information will also be required about capital expenditure requirements, so that long-term capital can be made available
(3) Subsidiary finance managers should be encouraged to submit information to the treasury department about local market
change in the value of the local currency, or a change in interest rates.
(4) From outside the group, the treasury will need a range of information about current market prices, such as exchange rate
oftering those prices. Large treasury departments will often have a link to one or more information systems such as Reuters an
(5) The treasury department should be alert to any favourable market opportunities for raising new debt capital. The treasure
banks, and expect to be kept intormed of opportunities as they arise.
(6) Where the treasury is responsible for the group's tax affairs, information will be needed about tax regulations in each coun
those regulations.
ade group's cash flows and borrowings. Subsidiaries with surplus cash will be
ow it from the treasury department, not from an external bank.
p. If a subsidiary needs capital to invest, the treasury department will borrow the
nterest and repaying the capital to the treasury department which will, in turn, be
ade group, such as currency risk and interest rate risk. Within broad guidelines, the
rrowing and to use swaps to adjust the balance. The department would also be
p, and an objective would be to minimise the overall tax bill. To accomplish this
n the group, as a means of transferring profits from high-tax countries to lower-tax
orm its functions.
ents, making a distinction between definite amounts and estimates of future

, and identity any future borrowing needs, particularly short-term and
capital can be made available to fund it.
epartment about local market and business conditions, such as prospects for a
prices, such as exchange rates and interest rates, and about which banks are
on systems such as Reuters and Bloomberg.
new debt capital. The treasurer should maintain regular contact with several
ut tax regulations in each country where the group operates, and changes in
Purchase components £ 116,000.00 3m
Sale of fin goods $ 197,000.00 3m
Purchase of fin goods $ 447,000.00 6m
$/£
Spot 1.7106 1.714
3m forward 0.82 0.77 cents premium
6m forward 1.39 1.34 cents premium
Interest rates Borrow Lending

sterling 12.50% 9.50%
dollar 9.00% 6
contract size $12,500
Exercise price
Calls
$ Mar Jun Sep Mar
1.6 15.2
1.7 5.65 7.75
1.8 1.7 3.6 7.9
Now is December with 3 months to expire of March contracts
If forward foregin markets

$/£
Spot 1.7106 1.7140
3m forward 1.70240 1.70630 just less say 0.82/100 off the spot rate
6m forward 1.69670 1.70060
Net three months £

116,000
Sale 197,00/1.7063030 - 115,454.49 higher rate as sale
546
Net six months

Purchase $ 447,000.00
Sale $ -154,000.00
$ 293,000.00
Rate 1.69670 £ 172,688.16 lower rate as purchase

If money markets
Net three months
this amount is going to be received in 3 m so borrow it NOW
Interest rates Borrow
dollar 9.00%
= $ 192,665.04
The number of dollars we need is 192,665 and need to find out how much that it gives us now so we can borrow )
so divide by the spot rate (higher
= 1.7140
The amount of sterling after 3m given by mutiplying by sterling lending rate
= (3/12 x 9.5%) +1
Purchase components £ 116,000.00

Cost of borrow $ -192,665.04
Rate divide 1.7140
-£ 112,406.67
Lending ra mutiply 1.02375
-£ 115,076.33
£ 923.67
Net six months

Purchase $ 447,000.00
Sale $ -154,000.00
$ 293,000.00
Must pay this amount in 6 months
so borrow, need loan in sterling then convert to dollar
sterling payment in 6 months will be principle less interest
cost of borrow $ 293,000.00

rate 6%
6 months 1.03 $ 284,466.02
the amount in £ today 1.7106 $ 166,296.05
sterling lending rate 12.50% 1.0625 £ 176,689.55
if the actual spot rate in six months' time turned out to be exactly the present siX-month forward rate,
better to have hedged - foreign currency option
sale sterling is being sold be PUT
cost $ 1.70 costs 3.45 cents per £
and at $ 1.80 costs 9.45 cents per £
Using $1.70
293,000/1.7 £ 172,352.94
number of contract 12,500 £ 13.79 rounded 14
cost of option 14 x 12,500 x 3.45 cents $ 6,037.50

14 contract will provide 14 x 12,500 £ 175,000.00
and at rate $1.70 $ 297,500.00
Overall cost £ 175,000.00

cost of dollars $ 293,000.00
$ 6,037.50
$ -297,500.00
$ 1,537.50
Rate 1.69670 £ 906.17
of 6m forward - divid by forward lower £ 175,906.17
as the use of foregin exchange market above £ 172,688.16

this is at a disadvatnage
using 1.80 options

Using $1.70
293,000/1.8 £ 162,777.78
number of contract 12,500 £ 13.02 rounded 14

cost of option 14 x 12,500 x 9.32 cents $ 16,310.00
14 contract will provide 14 x 12,500 £ 175,000.00

and at rate $1.80 $ 315,000.00
Overall cost £ 175,000.00

cost of dollars $ 293,000.00
$ 16,310.00
$ -315,000.00
$ -5,690.00
Rate 1.70060 -£ 3,345.88
of 6m forward - divid by forward higher £ 171,654.12
figures $1.70 £ 175,906.17

foregin exchange market £ 172,688.16
$1.80 £ 171,654.12
Use the lowest at 1.80 preferable
Fair value hedge

protection in fall in oil prices and hedge the value of inventory
Inv cost $ 2,600,000 1 July X2

26 barrels at $100,000
Loss recognised PL $ -350,000
March X3 futures $ 27.50

Market price oil Dec X2 $ 22.50
Price at Dex X2 of March future $ 23.25
Gain to be made on futures contract

The company has a contract to sell 100,000 barrels on 31 March 20X3 at $27.50
A contract entered into at the year end would sell these barrels at $23.25 on 31 March 20x3
Gain (= the value the contract could be sold on for toa third party)
DEBIT Future contract asset $425,000

CREDIT Profit or loss $425,000
The net effect on profit or loss is a gain of $75,000 (5425,000 less $350,000)
whereas without the hedging contract there would have been a loss of $350,000.
Sterling option contracts of £31,250 contracts (cents per £) Asume 1 June

Exercise price Calls
S/£ September December December
1.5000 5.55 7.95 0.42
1.5500 2.75 3.85 4.15
1.6000 0.25 1.55 9.4
Prices are quoted in cents per £.

September £ futures $/£ 1.5390 (contract size £62,500)
current spot exchange rate $1.5404 $1.5425
Sale £ 3,750,000
Using futures
contract size 3.75m / 62.5k 60.000
receipts using lower rate $1.5404 $ 5,776,500
60 contracts at 1.5390
which is 1.5404 - 1.5490 - 0.0014 below the spot rate
Scenario 1 2 3
Spot at Sept 1.48 1.57 1.62
Sell 60 at 1.539 1.539 1.539
Buy 60 at spot - 0.0014 1.4786 1.5686 1.6186
Gain/loss 0.0604 -0.0296 -0.0796
value of gain $ 226,500 $ -111,000 $ -298,500

3.75m sold at spot $ 5,550,000 $ 5,887,500 $ 6,075,000
$ 5,776,500 $ 5,776,500 $ 5,776,500
Using options
contract size 3.75m / 31.25k 120.000
these purchase 120 thus PUT and prem cost vary
Exercise price Cost

1.5000 120 x 0.42/100x 31,250 15,750 15750
1.5500 120 x 4.15/100x 31,250 155,625 155625
1.6000 120x 9.40/100 x 31,250 352,500 352500
at rate 1.48 As 1.48 is less than the option we would excerise options
Selling price at £3.75m
Exercise price Cash received Prem cost Net
1.5000 $ 5,625,000 $ -15,750 $ 5,609,250
1.5500 $ 5,812,500 $ -155,625 $ 5,656,875 Best result
1.6000 $ 6,000,000 $ -352,500 $ 5,647,500
at rate 1.57 As 1.57 is more than 2 of them would not use them and use 1.6 a
Exercise price Excerise option Rate used Cash received Prem cost
1.5000 NO 1.57 $ 5,887,500 $ -15,750
1.5500 NO 1.57 $ 5,887,500 $ -155,625
1.6000 Yes 1.60 $ 6,000,000 $ -352,500
at rate 1.62
as 1.62 is best rate than all 1.5,1.55 and 1.6 abandon all
cash 1.62 x 3.75m £ 6,075,000.0
Exercise price Excerise option Rate used Cash received Prem cost
1.5000 NO 1.62 $ 6,075,000 $ -15,750
1.5500 NO 1.62 $ 6,075,000 $ -155,625
1.6000 NO 1.62 $ 6,075,000 $ -352,500
Summary. The futures hedge achieves the target exactly.

The options give a range of possible results around the target.
When the option IS exercised, it does not give as good a result
as the future. However, when the option is allowed to lapse because of a
favourable movement in the exchange rate, it allows the company to make a gain over the target.
Puts
Jun Sep
2.75
3.45 6.4
9.32 15.35
less say 0.82/100 off the spot rate
er rate as sale
er rate as purchase
us now so we can borrow )
nth forward rate,

$ 2,750,000
$ 2,325,000
$ 425,000
Puts
September
1.95
6.3
11.2
ntract size £62,500)

ption we would excerise options
them would not use them and use 1.6 as best

Net
$ 5,871,750 Best result
$ 5,731,875
$ 5,647,500
Net
$ 6,059,250 Best result
$ 5,919,375
$ 5,722,500
the target.
Investment Appraisal
Self test question 3 from chapter 17
Life Years 4
Variable cost X Material Other
labour £ 30.00
Material of X £ 1.64
Y units £ 12.60
Other VC £ 4.40
£ 1.64 £ 47.00
Indirect costs Op cost 135000]

Head salary 118,000
Building occ 168,000 Year Cost Benefits
Other Salary 34,000 1 1.1 0.9
Other Salary 30,000 2 1.3 0.8
Replacement S 27,000 3 1.4 0.7
Inventory of X £98,400 4 1.5 0.6
Kg of X 60,000
Number of uni 10000 Opp cost 50,000 of X
Unit price 125
Discount rate 14%
Year 0 Year 1 Year 2 Year 3 Year 4

Sales 10,000 18,000 18,000 19,000
Benefits 0.90 0.80 0.70 0.60
Sales £ 1,125,000 1,800,000 1,575,000 1,425,000
Costs 1.1 1.3 1.4 1.5

Material X 50,000.00 230,256.00 247,968.00 280,440.00
Other 517,000.00 1,099,800.00 1,184,400.00 1,339,500.00
Managers Salary 34k+27k 67,100.00 79,300.00 85,400.00 91,500.00
Opp cost of rent - 135,000.00 135,000.00
634,100.00 1,409,356.00 1,517,768.00 1,711,440.00
Net cash 490,900.00 390,644.00 57,232.00 - 286,440.00
NPV -£600,236.40
No accept
Self test question 4 from chapter 17

Units Cost total cost
Vans 100 8,000 £ 800,000.00
Trucks 20 20000 £ 400,000.00
EE's 180 13000 £ 2,340,000.00
Mangers 5 20,000 £ 100,000.00 ingored as would already be working
Cost
Letters 0.525
Parcels 5.25
Running van 2000 £ 200,000.00
Running truck 1000 £ 20,000.00
Captial Rate 12%

Depn years 5.00 tax allowable
Op cost of cap 14%
tax rate 30% 500,000 under profit
tax rate 40% 500,000 over profit
tax payable 1 year arrear
Undertan cost £ 50,000.00 ignore as sunk cost
Year 1 Year 2 Year 3 Year 4

Demand
Letters 3,900,000.00 5,200,000.00 5,200,000.00 5,200,000.00
Parcels 130,000.00 195,000.00 195,000.00 195,000.00
Adversting cost £ 1,300,000.00 £ 263,000.00 £ - £ -
Premises £ 150,000.00
Inflation on costs/revenue 5% 5% 5% 5%

Sales
Letters 2,047,500.00 2,866,500.00 3,009,825.00 3,160,316.25
Parcels 682,500.00 1,074,937.50 1,128,684.38 1,185,118.59
2,730,000.00 3,941,437.50 4,138,509.38 4,345,434.84
Expenes
Staff #NAME? #NAME? #NAME? #NAME?
Premises £ 150,000.00 £ 157,500.00 £ 165,375.00 £ 173,643.75
Vechile maience
Vans £ 200,000.00 £ 250,000.00 £ 312,500.00 £ 390,625.00
Trucks £ 20,000.00 £ 25,000.00 £ 31,250.00 £ 39,062.50
Adversting cost £ 1,300,000.00 £ 263,000.00 £ - £ -
Depn £ 240,000.00 £ 240,000.00 £ 240,000.00 £ 240,000.00
£ 4,250,000.00 £ 3,392,500.00 £ 3,328,975.00 £ 3,552,173.75
Revenue less exp - 1,520,000.00 548,937.50 809,534.38 793,261.09

Tax - 608,000.00 219,575.00 323,813.75 317,304.44
- 912,000.00 329,362.50 485,720.63 475,956.66
Profit 834,431.77
Average 5 year 166,886.35
Averag inv 1,160m/2 580000

Revenue less exp -£ 1,520,000.00 £ 548,937.50 £ 809,534.38
add depn £ 240,000.00 £ 240,000.00 £ 240,000.00
tax £ 608,000.00 -£ 219,575.00
Initial inv -£ 1,160,000.00
Cash flow -£ 1,160,000.00 -£ 1,280,000.00 £ 1,396,937.50 £ 829,959.38
NPV 14% T1-6 £1,148,070.48 NPV(.14,CH year1-year6

Investment -£ 1,160,000.00
-£11,929.52 Do no accept
Introduction
This report considers whether the proposed new service will meet the two targets of a return on investment of at least 5%
tactors which may be relevant. Calculations are set out in the Appendix.
Recommendation
The proposed new service has an annual average return on average investment of 30%, but it has a negative net present v
be acceptable, it is recommended that the service is not provided. However, this is subject to the further factors considere
Non financial factors
Although it has a small negative net present value, the proposed service might well be of great value to the public. It shoul
lf the postal service's other projects have large positive net present values, it might be possible to net them oft against the
overall result. This is, of course, tantamount to cross-subsidisation.
It may be that charges could be increased and/or costs reduced, so that the net present value could become positive.
Before any final decision is taken, the reliability of all forecasts should be reviewed, and a sensitivity analysis should be car
Worked example Sensortex from chapter 20

65,000
5,925,000
y be working
Year 5
5,200,000.00
195,000.00
£ -
Year 5 Year 6
3,318,332.06 5% increase
1,244,374.52 5% increase
4,562,706.59
#NAME? 5% increase
£ 182,325.94 5% increase
£ 488,281.25 5 years divid 1.25

£ 48,828.13 5 years divid 1.25
£ -
£ 240,000.00
£ 3,803,719.94
758,986.65
303,594.66
455,391.99
Year 4 Year 5 Year 6

£ 793,261.09 £ 758,986.65
£ 240,000.00 £ 240,000.00
-£ 323,813.75 -£ 317,304.44 -£ 303,594.66
£ 709,447.34 £ 681,682.21 -£ 303,594.66
n on investment of at least 5% and a non-negative net present value. It also considers other
it has a negative net present value ($24,000). Because projects must meet both targets to
o the further factors considered below.
eat value to the public. It should perhaps be provided on that ground alone.
ble to net them oft against the negative net present value here, to give an acceptable
e could become positive.

nsitivity analysis should be carried out.
Oversea expansion strategy
Before getting involved overseas, Upowerit must consider both strategic and operational issues.
Strategic
Mission
Most importantly, does overseas expansion 'fit' with the overall mission and objectives of the company?
Internal resources
Upowerit needs to make sure that it has the internal resources to expand overseas. These will be chietly financial, but it w
the services to an overseas country will be a significant project, and one which the company has not undertaken betore.
Market entry
Upowerit needs to decide what African markets to enter, and what its level of involvement will be. It is advisable to start o
the costs of entry and market communications, but also the likely number of competitors. I he choice of market is obvious
demand to make the market attractive, but Upowerit must assess its comparatīve advantage in that market. The risk assoc
include political stability, economic intrastructure and other external intluences.
Long-term objectives
The longer-term objectives for the overseas venture need to be established. Is it merelya way of getting through what cou
going to be a full commitment to overseas expansion? Ihis will necessitate some organisational changes for Upowerit, both
Method of investment
The form of involvement needs to be considered. Unless the subsidary route is chosen,
, Upowerit will have to relinquish some control, which it may not be prepared to do.
Operational
These are more short-term needs than the strategic issues presented above. Sales levels, protitability, cash tlows, market s
forecast and planned in detail. In order to be able to do this, the following issues need to be considered.
Features of market
The needs and preferences of the foreign target market need to be established. This can only be achieved via an extensive
demand and establish levels of competition. Dealing with likely foreign competitor responses to the presence of Upowerit
Local culture
The cultural implications of doing business in a foreign country must never be underestimated. Upowerit has no experienc
requires sensitive handling and stafting. Market share will sutter if local preterences are not taken into account.
Local regulations
Regulations overseas are almost certain to be different in some respects, and it is imperative that local knowledge and exp
complied with.
Cost issues
The costs of doing business overseas will be affected by factors such as foreign tax regimes, access to technology and avail
Management skills
Management skills will be vital, both for staffing and the level of control over the operation. This will have implications for
from the home country may need to be seconded to the overseas market to help local staff.
Advantages of JV
Exploit opportunities
Joint ventures (JVs) are often used to enable companies to exploit an opportunity which it would be difficult for any one of
JVs are often used as a means of entering markets which are either closed to foreign companies or ditticult for them to en
of entering a specific foreign country.
Pooling skills and competences
AJV can allow the partners to bring together different skills and competencies. For example, one partner might have exten
market knowledge.
Risks and rewards
Because the JV involves two or more partners, the risks and rewards involved are shared between the various partners. JV
between the venture partners, so they can bea very useftul way of undertaking expensive technology projects.
Assurance service carried to set up JV

Initial investigations
Review Vagreement (in combination with legal advisers) for onerous, ambiguous or omitted clauses.
Ensure that the purpose of the JV is clear and the respective rights of partners are established in the initial contractual arra
Ensure that the scope of the JV is clear so there is separation of the other operations of each company from those faling w
Review tax status of JV entity including remittance of funds.
Review governance procedures including shared management, control, rights over assets and key decision-making process
appropriate level of control over key decisions that may damage its interests.
Establish that initial capital has been contributed in accordance with the agreement.
Establish the creditwothiness, going concern and reputation of JV partner, based on local enquiries from stakeholders and
in the public domain.
Ensure the terms of the disengagement and residual rights are clear in the initial agreement so there is a transparent and l
Where assets that are to be used in the JV are already held by either partner, then they would normally be transferred nom
Clarity revenue-sharing agreement with respect to existing sales in progress.
Health and safety responsibility needs to be established and liability sharing agreed.
Continuing assurance
Audit rights and access to intormation need to be established in the contract, as this will attect the scope of the audit.
Ensure that the operations of the JV are within the terms of the JV agreement.
Ensure that internal controls and accounting systems are being applied and are eftective.
Assess whether the accounting systems for a Ventity will be capable of recording accurately and completely the costs bein
If permitted within the terms of the contract, audit access to the accounting records of the partner would provide addition
Dissolution of the agreement creates additional assurance problems in terms of disengagement, return/sale of assets, inte
access.
The level of assurance needs to be determined (reasonable or limited).
There may be a requirement for a separate audit for a JV entity.
Setting up oversea
LexLand
Now Year 1 Year 2 Year 3
Land 2,300 -
Building 1,600 6,200
Machinary - 6,400
Working capital - 11,500
Tax allow depn 25%

Inflation 5%
Tax rate 40%
LFR/D£ 2.3140 2.3210
Sale at Year 6 16,200,000
Variable cost 2000 2500

Sales 2000
Sales price 20,000
Variable cost 11,000
Margin 9,000
Fixed cost £ 750,000.00 £ 750,000.00
1 2 3
Prod/Sales 2,000 2,500
Margin 9,923 10,419
In LRF'000
Total contro 19,845,000 26,046,563
Fixed (x ex rate) 1,806,000 1,841,000
Operating CF 18,039,000 24,205,563
Tax 40% - 7,215,600
Tax saving by depn W2 1,120,000
Land - 2,300,000
Buildibg - 1,600,000 - 6,200,000
Machinary - 6,400,000
After tax Realsiable value
Working cap W3 - 11,500,000 - 575,000 - 603,750
Cash remitted - 3,900,000 - 24,100,000 17,464,000 17,506,213
Ex rate W4 2.3175 2.3625 2.4084 2.4551
- 1,682,848 - 10,201,058 7,251,366 7,130,438
Royality received £ 750,000.00 £ 750,000.00
Tax on royality 33% -£ 247,500.00
Net cash - 1,682,848 - 10,201,058 8,001,366 7,632,938
PV 14% 7 year -£8,948,296.67 £6,156,791.39 £5,152,015.98
£16,467,182.11
- 1,682,848
14,784,334
W2 Year 1 Year 2 Year 3

Asset value 6,400,000 4,800,000 3,600,000
Depn 25% - 1,600,000 - 1,200,000 - 900,000
Tax saved 40% - 1,120,000
Calc is say 900 x 0.4 and first year is year 1 and year 2
W3
Year Year 1 Year 2 Year 3
Total WC 11,500,000 12,075,000.00 12,678,750.00
Investment in WC - 11,500,000 - 575,000.00 - 603,750.00
5% inflation increase
W4
Spot rate FLR
Spot rate for LFr = (2.3140+2.3210)/2 = 2.3175 Inlation rate exchange rate
Spot rate for JS to D (1.5160 + 1.5210)/2=1.5185
W5
Because both investment alternatives represent an expansion of the exIsting business, the company's existing weighted av
The debt is borrowed in Dinoville where interest will save tax at the rate of 33%. Its after-tax cost is 10% (1 -0.33) = 6.7%.
Market values should be used as weights.
WACC = 0.7 x 17% + 0.3 x 6.7% = 13.91%, say 14%
1 2
LFR 2.3175 2.3625 2.4084
JS to D£ 1.5185 1.5627 1.6082
Jibrovia
Jibrovia in J$ Year 1 Year 2
Cost of Inv 8-10m
Plant 2000 2000 3000
Work cap 4000
Pre tax CF 2 3
Inflation 6%
Tax 33%
Borrow funds 10%

Cost of Eq 17%
Gearing book val 50:50:00
Gearing MV 30:70
1 2
Pre cash flow 2,120 3,371
tax 30% - 636
cost of aq - 10,000
machinery - 2,000
after tax value
Working capital - 4,000 - 240 - 254
Cash remitted - 16,000 1,880 2,480
EX RATE 1.5185 1.5627 1.6082
£ VALUE - 10,537 1,203 1,542
additonal tax 3% W7 - 40.70
- 10,537 1,203 1,502
PV £1,055.28 £1,155.44
Sum £9,876.14
Initial inv - 10,537
-£660.58
Working cap
Year Year 0 Year 1 Year 2
Total WC - 4,000 - 4,240.00 - 4,494.40
Investment in WC 4,000 240.00 254.40
5% inflation increase
additonal tax 3% W7
Additional tax of 3% (33%- 30%) is suttered in Dinoville on Jibrovia taxable protits. This is computed by converting the pre-
multiplying by 3%, eg, Year 1: 2,120 + 1.5627 x 3% = 40.69, rounded to 41.
The net present value of the Jibrovia investment is negative D£658,000 if the investment cost is the maximum J$10 million
If the cost is only J$8 million, the NPV is increased by J$2m/1.5185 = Df1.317m, giving a positive NPV of D£659,000.
ie the cash flow at the start x the exchange rate x 3%
Purchase US Company $ 72,000

NCA $ 8,000
5 years
Ex rate Spot One year forward

$/£ 1.7985 1.8008 1.7726
Swiss/£ 2.256 2.298 2.189
G SOFP
Non-current assets 117.8
Investments 8.1
Current assets 98.1
Current payables
Loans and other borr -38
Other payables -48.6
137.4
Non-current payables
Medium- and long-ter 30
8% bond 20x9 (par va 18
48
Capital and reserves
Ordinary shares (25 p 20
Reserves 69.4
137.4
Book value debt 50%
Dividends per share 0.222
Dividends growth 4%
Current share price 3.02
Corp tax 28%

issue cost and fee not tax allowable
Answer
Finance requried $ 80,000

Ex rate 1.7985
Amount £ 44,481.51
If all debt, 38+30+18+44.48 / 117.8 + 8.1+ 98.1 + 44.48

48.6%
Rights issue
1 for 4 right issue
Price 2.8
cost underwrite 5%
Amont raised ( 80 / 4 x 2.80) x 0.95 53.2m

𝑲𝒆 = 𝑫𝟎(𝟏 + 𝒈) 𝑷𝟎 + g 22.2(1.04)/2
(.222(1.04))/3.02 +4
11.65%
Advantages
(1) The proposed rights issue would comfortably exceed the amount required.
(2) The company's gearing, and thus financial risk, would decrease.
(3) There would be no change in control if the current shareholders took up the rights issue.
(4) Gordon would not have a commitment to make interest payments.
(5) Gordon would not face exchange risk on payments to providers of finance.
Disadvantages
(1) The arrangement costs are higher than for some of the other alternatives.
(2) A rights issue is likely to take longer to arrange than the other alternatives.
(3) The cost of equity is higher than the cost of debt because of the greater risk to equity shareholders and the company d
(4) The exchange risk on the income from the US investment remains, as it cannot be matched against the payments to fin
Fixed Rate Sterling Loan

5 year 7% bank loan B5 =RATE(B1,B2,B3,B4)
Loan 50,000 Nper = the number of periods
fee 1% Pmt the amount (of interest) paid in
Pval = the present value of the asset
Amount raised 44.48 x 100/099 44.93m Fval-the future value (the amount pa
Rate 7.26%
Yield to maturity 7.30%
Post-tax cost of loan = .3%(1 -0.28) = 5.3%
Advantages
(1) Cost is lower than some of the other options.
(2) There is a further facility available which has not been drawn.
Disadvantages
(1) Because the loan is in sterling, there will be foreign exchange risk as the finance is not matched with the dollar income.
(2) Conditions may be attached to the security that impose restrictions over and above the debt limit.
Commercial paper
commerical paper 1 y 15,000
SONIA 1.50%
Renew annually
Addiontal 1%
Cost 0.72 (3.0 +1.5 +0.5) 3.6%
Advantages
(1) Gordon will be able to take advantage of short-term falls in interest rates.
(2) The cost looks low compared with other sources.
Disadvantages
(1) The commercial paper provides less than 20% of the finance required.
(2) The maturity is wrong for the majority of the requirement; commercial paper is a short-term source to finance a long-t
(3) There are likely to be some issuing costs.
4) The floating rate is not attractive if interest rates are expected to rise.
Oversea loan BS-RATE(B1,82,83,84)

Swss franc 80,000 Nper the number of periods
5 year loan Pmt= the amount (of interest) paid in
fixed rate 2.50% Pval= the present value of the asset (
Swapped rate 2.30% Fval = the future value (the amount p
Upfront fee 3% Yield to maturity
Amount raised = 80 (1-0.03/2.298 £33.77m
Cost of loan
Rate 5.659%
p val 77,600 this is 80k less 3%
Post tax cost of loan 5.5%(1-0.28) = 4.0%

Advantages
(1) The cost of finance is still low even after the swap fees.
(2) Gordon can pay interest in the currency in which it is obtaining returns, and thus reduce exchange risk by gearing.
Disadvantages
(1) The loan will not be enough to cover the whole US investment; approximately f10 million further finance will be require
(2) Gordon would still be exposed to foreign exchange risk on the Swiss franc loan itself as against sterling.
(3) Gordon may be subject to counterparty risk, although this will be minimal if it uses an intermediary such as a bank.
Recommendation
It there are concerns about gearing levels and directors are prepared to accept a much higher cost of finance than is likely
should be used.
Of the longer-term sources of finance, the Swiss franc loan offers the lowest rate. However, the loan is insufficient to cove
extra finance from elsewhere. The fixed-rate sterling loan covers the entire US investment with funds to spare. Both loans
Factors in purchase an oversea subsidary

Foreign exchange risk
It is possible to reduce foreign exchange risk by matching; using one of the dollar finance options to set against the dollar r
Cost of finance
This covers not only any annual interest payment costs, but also arrangement fees, issue costs and so on.
Availability
If the purchase is to take place rapidly, the finance should be available quickly, or (expensive?) short-term bridging finance
Flexibility
f the directors are expecting to use different sources of finance, they will prefer to use sources that can be changed withou
Period of investment
The length of time the finance is available should match the length of the investment period.
Tax
The tax consequences of the ditferent sources of tinance must be considered, as these may signiticantly attect costs.
Desired debt-equity finance mix
The maximum amount of debt is limited by a covenant in any event, but the directors may have their own views about the
finance risk. It will be determined by whether they believe that there is an optimal level of gearing, at which the company'
Signaling
By issuing the maximum amount of debt, the directors may wish to demonstrate to the stock market the ir confidence in t
Interest rate expectations

The directors will prefer floating rate finance if interest rates are expected to go down, fixed rate finance if interest rates a
Maturity of debt
Directors will be concerned about when the debt is due to mature, and Gordon's likely cash position around that date.
Security
Directors will be concerned about the amount of security required, also how any restrictions over assets secured might lim
finance in the future.
Other sources
Other sources of finance such as convertible and deep-discount bonds may be appropriate.
e chietly financial, but it will also require a lot of time and staff etfort. Marketing
not undertaken betore.
be. It is advisable to start off with only a few markets at the most, to limit not only
hoice of market is obviously very important. Not only must there be an accessible
that market. The risk associated with the market must also be assessed. This will
getting through what could be a temporary domestic slowdown, or is there

changes for Upowerit, both in structure and management
ability, cash tlows, market share and capital expenditure requirements need to be
e achieved via an extensive programme of market research to forecast likely

the presence of Upowerit must be planned in advance.
Upowerit has no experience of conducting business overseas and this often

en into account.
at local knowledge and expertise is employed to make sure that the rules are
ess to technology and availability of physical resources.
s will have implications for the organisation structure. For example, expatriate staff
d be difficult for any one of them to take advantage of individually.

or ditticult for them to enter. Therefore, Upowerit might see aJVas a good way
partner might have extensive technical expertise, while another may have local
en the various partners. JVs allow risks and capital commitment to be shared
ology projects.
the initial contractual arrangements.

mpany from those faling within the JV.
ey decision-making processes to ensure that Upowerit's management has an
ies from stakeholders and a review of internal documentation as well as that
here is a transparent and legitimate exit route

ormally be transferred nominally at fair value. This needs to be established.
he scope of the audit.
completely the costs being incurred and the assets held by the entity.
ner would provide additional assurance.
return/sale of assets, intellectual property rights, rights to future customer

2500 2500 2500
£ 750,000.00 £ 750,000.00 £ 750,000.00
4 5 6 7
2,500 2,500 2,500
10,940 11,487 12,061
27,348,891 28,716,335 30,152,152

1,877,000 1,914,000 1,951,000
25,471,891 26,802,335 28,201,152
- 9,682,225 - 10,188,756 - 10,720,934 - 11,280,461
360,000 270,000 202,500 151,875
16,200,000
- 633,938 - 665,634 - 698,916 14,677,238
15,515,728 16,217,945 33,183,802 3,548,652
2.5028 2.5514 2.6010 2.6515
6,199,321 6,356,466 12,758,334 1,338,379
£ 750,000.00 £ 750,000.00 £ 750,000.00 £ -
-£ 247,500.00 -£ 247,500.00 -£ 247,500.00 £ -
6,701,821 6,858,966 13,260,834 1,338,379
£3,968,016.00 £3,562,331.76 £6,041,457.37 £534,866.27

2,700,000 2,025,000 1,518,750
- 675,000 - 506,250 - 379,688
- 360,000 - 270,000 - 202,500 - 151,875

13,312,687.50 13,978,321.88 14,677,237.97
- 633,937.50 - 665,634.38 - 698,916.09 14,677,237.97
1.05/1.03 1.01941747572816
1.06/1.03 1.02912621359223
pany's existing weighted average cost of capital can be used as a discount rate.
st is 10% (1 -0.33) = 6.7%.
3 4 5 6 7
2.4551 2.5028 2.5514 2.6010 2.6515
1.6551 1.7033 1.7529 1.8040 1.8565
3 4 5 6 7
3,573 3,787 4,015 4,256
- 1,011 - 1,072 - 1,136 - 1,204 - 1,277
14,500
- 270 - 286 - 303 - 321 5,674
2,292 2,430 2,575 17,230 4,397
1.6551 1.7033 1.7529 1.8040 1.8565
1,385 1,426 1,469 9,551 2,369
- 62.88 - 64.76 - 66.71 - 68.71 - 70.77
1,322 1,362 1,403 9,482 2,298
£892.33 £806.23 £728.44 £4,320.10 £918.32

- 4,764.06 - 5,049.91 - 5,352.90 - 5,674.08
269.66 285.84 302.99 321.17 - 5,674.08
ted by converting the pre-tax cash tlow at the exchange rate for the year and then
the maximum J$10 million.

NPV of D£659,000.
One year forward

1.7746
2.205
olders and the company does not obtain the benefit of tax relief.
gainst the payments to finance providers.
B1,B2,B3,B4)
number of periods 5
mount (of interest) paid in any sing 3.15
present value of the asset (its mark -44.48
ture value (the amount paid at mat 44.93
ed with the dollar income.
source to finance a long-term requirement of $72 million.
umber of periods 5
amount (of interest) paid in any single period 3.84
present value of the asset (its market price net of issue co -77.6
future value (the amount paid at maturity). 80
0.055
hange risk by gearing.
ther finance will be required.
ediary such as a bank.

ost of finance than is likely for any of the loan finance, then the rights issue
loan is insufficient to cover the entire US investment, which would mean seeking
funds to spare. Both loans will expose Gordon to foreign exchange risk.
s to set against the dollar receipts.
hort-term bridging finance will be required.
hat can be changed without significant cost.
iticantly attect costs.
their own views about the desired balance and hence the desired level of
ng, at which the company's weighted average cost of capital will be at its lowest.
arket the ir confidence in the future.
e finance if interest rates are expected to increase.
tion around that date.
er assets secured might limit business decisions, including the ability to raise loan
Equity owned 30%
2015 2016 2017 2018 2019
PAIT 18 21 30 33 48
Invest or c 0 30 0 45 0
Dividends 9 6 15 6 24
Procedure for obtaining a listing on an International Stock Exchange- Paper prepared for the Board of Multimedia Comp
This paper describes the necessary procedures for obtaining a listing on an international stock exchange.
Obtaining a listing on an international stock exchange such as the London or New York Stock Exchange consists of satisfyin
registration, listing and admission to trading.
In the UK, a firm seeking a listing must first register as a public limited company to ensure that it is entitled to issue shares
company's memorandum and articles of association agreed by the existing shareholders at a special meeting convened for
The company must meet the regulatory requirements of the Listing Authority which is part of the Financial Conduct Autho
minimum size restrictions on a company and other conditions concerning length of time trading (normally audited accoun
particular concern here is that the CEO has a controlling interest in the business - this will have to be addressed. Once thes
an offticial list and is allowed to make an initial public oftering of its shares.
Once the company is on the official list it must then seek approval from the stock exchange to allow its shares to be traded
impose strict requirements which invariably mean that the applicant company will need the services of a sponsoring firm s
the London Stock Exchange include:
compliance with corporate governance regulations (for example, 50% of the board should be independent non-executive d
quality and experience of the executive directors and the business plan, all of which must be carefully laid out in a prospec
This tends to be costly and therefore prohibitive for all but the larger companies. The restrictions (and costs) of obtaining a
lower.
Briefing note prepared for Martin Pickie, CEO

Subject-Advantages and disadvantages of a stock market listing for a medium-sized company
Following on from our discussion regarding a stock market listing for the company, I have detailed below the main advanta
company of our size.
For a medium-sized firm, the principal advantage of obtaining a public listing is the additional sources of finance available.
capital from both institutional and private investors, and the sums that can be raised are usually much greater than throug
firm as a limited company on a major exchange such as the London Stock Exchange enhances the credibility of the firm bo
has opened itself to a much greater degree of public scrutiny than a privately financed firm.
The disadvantages are significant; the distributed shareholding places the firm in the market for investors seeking corpora
firm will be subject to a takeover bid. The higher degree ot public scrutiny imposes a signiticant regulatory burden on the fi
requirements and financial accounts must be prepared in accordance with relevant accounting standards. In the UK, this m
as well as the Companies Acts. Under the rules of the London Stock Exchange, companies must also comply with the gover
Code and have an effective and ongoing business planning process in place. The requirement to comply or explain can imp
the company to critical comment.
Finance required 3,000,000
New factory 2,500,000

New machinery 1,000,000
Raw material 250,000
Adversting 500,000
4,250,000
The main factors to be considered when deciding on the appropriate mix ot short, medium- or long-term debt finance to
The term should be appropriate to the asset being acquired. As a general rule, long-term assets should be financed from lo
should finance short-term requirements, such as tluctuations in the level of working capital.
Flexibility
Short-term debt is a more flexible source of finance. There may be penalties for repaying long-term debt early. If the comp
will tind itselt locked into untavourable terms.
Repayment terms
The company must have sufficient funds to be able to meet repayment schedules laid down in loan agreements and to cov
terms of repayment laid down tor short-term debt, it may possibly be repayable on demand, so it may be risky to finance l
Costs
The interest rate on short-term debt is usually less than on long-term debt. However, if short-term debt has to be renewed
significantly.
Availability
It may be difficut to renew short-term finance in the future if the company's position or economic conditions change adve
Effect on gearing
Certain types of short-term debt (such as bank overdrafts and increased credit from suppliers) will not be included in geari
geared, lenders may be unwilling to lend money, or judge that the high risk of detaulit must be compensated by higher int
The practical considerations which could be factors in restricting the amount of debt which Ella could raise
Previous record or company
f the company (or possibly ts directors or even shareholders) has a low credit rating with credit reference agencies, investo
Banks may be intluenced by this, and also by their own experiences of the company asa customer (especially if the compan
basis)
Restrictions in Articles of Associations
The company should examine the legal documents caretully to see it they place any restrictions on what the company can
Restrictions of current borrowing
The terms of any loans to the company that are currently outstanding may contain restrictions about further borrowing th
Uncertainty over project
The project is a signiticant one. Presumably the interest and ultimately repayment that lenders obtain may be dependent
uncertain, lenders may not be willing to take the risk.
Security
The company may be unwilling to provide the security that lenders require, particularly if it is faced with restrictions on wh
Alternatively, it may have insufficient assets to provide the necessary security.
There should be sutticient finance to cover the costs of the new tactory, starting the new business unit and working capita
After the directors have decided how the project should be financed, they will attend a meeting with the audit partner f
There should be sutficient finance to cover the costs of the new tactory, starting the new business unit and working capita
Questions
(1) Will the new venture be financed entirely by new debt or is Ella also advancing any capital? This is to establish whether
(2) Who prepared the forecasts? This is to establish whether they have been prepared by someone with experience of pre
whether the budgets are reasonable.
(3) Are figures in the forecasts supported by evidence such as quotations for machinery or building work? This is to see the
(4) Has the cost of finance been included in the forecasts?
(5) How long before the products can be sold and begin to fund themselves? The budget does not contain any contingency
production schedule is and whether it is realistic.
(6) Have all construction costs been included in the cost projection - for example, the costs of electricity and the cost of em
(7) What is the timescale for the construction? Does the projection take account of inflation, if necessary?
(8) Does the projection contain budgets for all raw materials required?
(9) What are the advertising costs based on? These must be appropriate to the specific product, so if they are based on the
company, they may not be suficient
(10) What is the commercial viability of the new product? The accountant should look at market research because ability t
bank.
Division
Construction and building 50
Engineering and machinery 20
Real estate 30
Group 100
Industry
Construction and building 8
Engineering and machinery 13
Real estate 23
JMR is currently valued on the stock market t £1,000 million, and proposed/current dividends are approximately halt those
Group Stratergy
Disposal of real estate division
The real estate division currently contributes 30% of the Group's earnings, and is the fastest growing of the divisions (over
management team expects this rate of growth to be sustained.
The real estate market sector also has the highest P/E ratio, suggesting the sector affords good growth prospects, and supp
forecasts.
In terms oft JMR's overall porttolio, the real estate division appears to offer better growth prospects than either the constr
engineering division is likely to have relatively secure earnings by virtue of its contracts with government departments. No
does not appear to be a good strategic move.
The engineering and machinery division looks a more suitable candidate tor disposal, despite its government contracts. It m
has a lower growth rate than the real estate division.
Although the construction and building division has the lowest growth rate, it generates 50% of the Group's earnings and J
division which contributes such a large proportion of earnings.
Moreover, we should also consider the institutional investor's potential motives in recommending the sale of the real esta
which suggests a short-term strategy. In this respect, it is likely that JMR could sell the real estate division for a much highe
generating more cash to pay a dividend. However, that is unlikely to be in the Group's longerterm strategic interests.
Relocating Group headquarters

The Group headquarters are quite luxurious' and located in the capital which suggests that they are quite expensive. There
relocating to one ot the divisional headquarters. Ihere may be reasons why the oftices need to be located in the capital (to
case the board need to explain this to the investors.
Equally, there may not be space in any of the divisional headquarters to relocate all the Group staff (50) there, in which ca
where overhead costs will be lower. This could also be a good opportunity to review whether the Group really needs 50 st
Methods of disposal
Sale as a going concern to another business
This would represent, in effect, the reverse of the transaction by which JMR acquired the real estate division. The division
either cash or shares in the acquiring company. All the responsibilities and costs of running the division would pass to the a
If the sale were made for cash, it could provide JMR with an inflow of cash to meet the shareholders' demands for a large,
However, it would mean that JMR loses 30% of its earnings, and any future earnings growth which the real estate division
Group's subsequent ability to pay dividends in future years is reduced. Moreover, stripping out the division with the highe
turn reducing the value of the remaining Group, and possibly again laying the board open to a charge of 'destroying value.
Finally, the sale of a division would mean that the Group overhead costs have to be apportioned over only two divisions ra
unless signiticant overhead savings were made.
Demerger
A demerger would mean that instead of simply being a division of JMR Group, the real estate operation becomes a separa
of JMR Group are likely to receive shares in the new company in proportion to their existing holding in JMR.
The logic behind a demerger is usually that the existing formation is creating negative synergies, and the new company wil
rather than being part of the Group. Given the suggestion that JMR is currently 'destroying value', this could well be the ca
However, from JMR's perspective a demerger is less attractive. As with a cash sale, JMR Group would lose 30% of its earnin
generate a cash inflow into the business.
Therefore this option would not provide for a one-off dividend to the shareholders, because it is a non-cash option. If shar
generate it themselves by selling their shares in the newly demerged company.
However, one advantage of this approach from the shareholders' perspective is that they have shares in both companies.
Group, they could elect to sell their shares in it, and just retain their shares in the new real estate company.
Liquidation of assets
The real estate division could be closed, its staff made redundant (or redeployed elsewhere in the Group) and its assets so
However, given that the real estate is a profitable and growing business, this is unlikely to be a desirable option; not least b
prices than the sale of the business as a going concern.
A liquidation of assets would be a cash sale, and so would provide a cash inflow to underwrite a one-off dividend payment
losing 30% of its Group earnings, it is likely that it would prefer the option which generates more cash in return.
Moreover, there is likely to be negative publicity surrounding the closure of the division, and any associated redundancies,
Group's performance.
MBO
In an MBO, the management of the real estate division would buy the division from JMR, with the intention of driving forw
However, an importat issue here is the price which the managers would agree to pay for the division. On the one hand, it i
capitalists to support their own capital in the purchase, so they will want to keep the purchase price as lOw as possible to m
On the other hand, the divisional managers are likely to know more about the business and its prospects than the Group m
These two factors together are likely to mean that the price an MBO team offer for the sale is likely to be lower than the p
of the business as a going concern.
Again, the Group needs to remember that after the buyout the real estate will be a separate entity so Group earnings will
sale price which is too low, particularly if it intends to make a one-off dividend payment to the institutional investors.
However, an MBO may be considered the most attractive option from a public relations perspective. The Group could pres
management positively- emphasising the way they are being given the opportunity to control the division's strategy and it
Management buy in
This approach, in effect, combines aspects of an MBO and a sale of the business as a going concern. Like an MBO, a group
unlike an MBO, the purchasers come from outside the company. So atter a management buy-in the real estate division wO
From JMR's perspective, the management buy-in is another option which could generate a cash inflow, and so would prov
one-off dividend. Depending on the extent of the purchasers' knowledge of the business, JMR may be able to earn a highe
an MBO.
However, a management bUy-in does not aftord the same pOSitive aspects in terms of public relations.
Recommendation
JMR could either look at the disposal as a means of maximising value from the Group, or raising cash to pay a one-off divid
maximise value, but it will not generate cash. However, an MBO will generate cash proceeds and, by allowing the division
should allow its capabilities to be exploited fully. Although the new entity will be outside the Group, the public relations as
than an open market sale.
Therefore, JMR would be advised to sell the real estate division through an MBO.
oard of Multimedia Company
hange consists of satisfying requirements in three broad areas: namely
is entitled to issue shares to the public. This will require a change to the
ecial meeting convened for the express purpose of agreeing this change.
e Financial Conduct Authority in the UK. These regulatory requirements impose

(normally audited accounts must exist for a three-year period). An issue of
o be addressed. Once these requirements are satisfied the company is placed on
low its shares to be traded. Exchanges such as the London Stock Exchange
vices of a sponsoring firm specialising in this area. The regulatory requirements of
dependent non-executive directors)

efully laid out in a prospectus
s (and costs) of obtaining a listing on a junior market (eg, AlIM in the UK) may be
ed below the main advantages and disadvantages of taking such a step for a
urces of finance available. A listed company would have access to equity

much greater than through private equity sources. In addition, the presence of
e credibility of the firm both to potential investors and to the general public as
investors seeking corporate control and also increases the likelihood that the
regulatory burden on the firm, as it must comply with a range of disclosure
tandards. In the UK, this means in accordance with IFRS and the relevant GAAP
also comply with the governance requirements of the UK Corporate Governan
comply or explain can impose a signiticant regulatory burden and can expose
long-term debt finance tor Ella
should be financed from long-term finance sources. Cheaper short-term funds
erm debt early. If the company takes out long-term debt and interest rates fall, it
oan agreements and to cover interest costs. Although there may be no specitic
it may be risky to finance long-term capital investments in this way.
rm debt has to be renewed frequently, issue expenses may raise its cost
ic conditions change adversely
ill not be included in gearing calculations. if a company is seen as too highly

ompensated by higher interest rates or restrictive covenants.
a could raise
eference agencies, investors may be unwilling to subscribe for debentures.

er (especially if the company exceeded overdraft limits in the past on a regular
on what the company can borrow, and for what purposes.
bout further borrowing that can be taken out.
obtain may be dependent on the success of the project. It the results are
ced with restrictions on what it can do with the assets secured.
ss unit and working capital requirements to begin production.
g with the audit partner for Ella at your firm.

ss unit and working capital requirements to begin production.
his is to establish whether the business plan is complete.

one with experience of preparing such budgets, as this will give assurance as to
ng work? This is to see the degree of estimation included in the plans.
ot contain any contingency and it is important to discover how tight the
ectricity and the cost of employees not being used in their usual roles.
so if they are based on the costs associated with other products of the
research because ability to pay the loan back will be an important factor for the
e approximately halt those of analysts' expectations.
wing of the divisions (over 20% per year in the last three years). The divisional
rowth prospects, and supporting the divisional management team's optimistic
ects than either the construction or engineering divisions, although the

ernment departments. Nonetheless, disposing of the real estate department
government contracts. It makes the lowest contribution to Group earnings, and
the Group's earnings and JMR would be unlikely to want to dispose of a
ng the sale of the real estate division. It is looking for a large one-off dividend,
e division for a much higher price than the engineering division, thereby
m strategic interests.
are quite expensive. Theretore, it is likely that cost savings could be made, by
e located in the capital (tor example, being close to the stock market) in which
taff (50) there, in which case the Group could still look at finding new offices
e Group really needs 50 staft or whether the team can be streamlined.
tate division. The division would be sold to another company, in exchange for
division would pass to the acquiring company, as would all future protits.
ders' demands for a large, one-off dividend payment.
ch the real estate division would have generated. This could mean that the
he division with the highest P/E ratio would cause JMR's share price to tall; in
harge of 'destroying value.
over only two divisions rather than three, again reducing the Group profitability
eration becomes a separate company in its own right. The existing shareholders
ding in JMR.
and the new company will generate greater earnings operating independently
e', this could well be the case.
would lose 30% of its earnings. But unlike the cash sale, the demerger would not
a non-cash option. If shareholders want a one-off cash boost they will have to
hares in both companies. If they remain dissatisfied with the performance of JMR
e company.
he Group) and its assets sold off at market price.

esirable option; not least because a sale of assets is likely to command lower
one-off dividend payment. However, given that both options would lead to JMR
e cash in return.
y associated redundancies, which may have a further negative impact on the
he intention of driving forward its growth and increasing its profitability.

sion. On the one hand, it is likely they will have to obtain funding from venture
rice as lOw as possible to minimise their debt and future interest charges.
rospects than the Group managers, and also any extermal purchasers.
ely to be lower than the price which could be earned from an open market sale
tity so Group earnings will be reduced by 30%. Theretore it should not accept a
nstitutional investors.
tive. The Group could present the sale of a successful division to its
e division's strategy and its tuture.
ern. Like an MBO, a group of people collectively buy the division. However,
the real estate division wOuld become a privately owned real estate company.
inflow, and so would provide the funds to satisfy the investors' demands for a
ay be able to earn a higher selling price froma management buy-in than from
cash to pay a one-off dividend. A demerger is probably the option which would
d, by allowing the divisional management full control of the real estate division
oup, the public relations aspect of a sale to management will be more positive
Profed City tutors
Issued shares (million) 4 10
NAVs (Em) 7.2 15
EPS (pence) 35 20
Dividend per share (pence) 20 18
Debt: equity ratio 1:07 0.086111
Share price (pence) 0 362
Expected rate of growth in earnings/dividends 9% 7.50%
Reauirements
Net assets
Building valuation 1,500,000
Inventory NRV lower cost 100,000
Bad debts 750,000
Discount rate 15%
Range of valuations of Porfed

Net assets
£'000
Net assets at book value 7,200
Add increased valuation of buildings 1,500
Less decreased value of inventory and receivables -850
7,850
Net asset value of equity
Value per share = £1.96 1.9625
P/E Ratio
Profed City Tutors
Issued shares (million) 10
Share price (pence) 362
Market value (£m) 36.2
Earnings per share (pence) 0.35 0.2 181
P/E ratio (share price , EPS) 18.1
The P/E for a similar quoted company is 18.1. This will take account of factors - such as marketability of shares, status of co
Proted. Profed's growth rate has been estimated as higher than that of City Tutors, possibly because it is a younger, develo
be questionable.
All other things being equal, the P/E ratio for an unquoted company should be taken as between one-half to two-thirds of
generous, in view of the possible higher growth prospects of Profed, we might estimate an appropriate P/E ratio of around
This will value Profed at 12 x £0.35= £4.20 per share, a total valuation of £16.8 million.
Dividends Yield
Next year dividends / cost of equity less growuth
which assumes dividends being paid into perpetuity, and growth at a constant rate.
For Profed, next year's dividend = £0.20 x 1.09 = £0.218 per share
While we are given a discount rate of 15% as being traditionally used by the directors of Proted for investment appraisal, t
instead use the intormation for City Tutors to estimate a cost ot equity for Profed. This is assuming the business risks are s
ratio.
For City Tutors, cost of equity=

£0.18x 1.075 /3.62 + 0.075
12.84%
Using, say, 13% as a cost of equity for Profed (it could be argued that this should be higher since Profed is unquoted so risk
Share price 0.218 / 0.13-0.09
= £5.45
valuing the whole of the share capital at £21.8 million.
Range for valuation

The three methods used have thus come up with a range of values of Profed as follows:
Value per Total valuation

Net assets 1.96 7.9
P/E ratio 4.2 16.8
Dividend valuation 5.45 21.8
Asset-based valuation
Valuing a company on the basis of its asset values alone is rarely appropriate if it is to be sold on a going concern basis. Exc
companies and investment trusts, the market values of the assets of which will bear a close relationship to their earning ca
Profed is typical of many service companies, a large part of whose value lies in the skill, knowledge and reputation of its pe
and renders this method quite inappropriate. A potential purchaser of Profed will generally value its intangible assets such
relationships and brands more highly than those that can be measured in accounting terms.
Knowledge of the net asset value (NAV) of a company will, however, be important as a floor value tor a company in financ
will be reluctant to sell for less than the NAV even if future prospects are poor.
P/E ratio valuation

The P/E ratio measures the mutiple of the current year's earnings that is retlected in the market price ofa share. It is thus a
company trom a market point of view. Provided the marketing is etticient, it is likely to give the most meaningtul basis tor
The market price of a share at any point in time is determined by supply and demand forces prevalent during small transac
addition to a realistic appraisal of future prospects.
A downturn in the market, and economic and political changes can all aftect the day to day price of a share, and thus its pr
price given for City Tutors was taken on one particular day, or was some sort of average over a period. The latter would pe
applicable P/E ratio.
Even if the P/E ratio of City lutors can be taken to be indicative of its true worth, using it as a basis to value a smaller, unqu
problematic.
The status and marketability of shares in a quoted company have tangible etfects on value but these are ditticult to measu
The P/E ratio will also be affected by growth prospects-the higher the growth expected, the higher the ratio. The growth ra
probably based on a more rational approach than that used by Proted.
If the growth prospects of Profed, as perceived by the market, did not coincide with those of Profed's management it is diffi
relative levels of growth. However, the earnings yield method of valuation could be useful here.
In the valuation in (a) a crude adjustment has been made to City Tutors's P/E ratio to arrive at a ratio to value Profed's earn
has not been taken of all the differences involved.
Dividend-based valuation
The dividend valuation model (DVM) is a cash flow based approach, which values the dividends that the shareholders expe
at their required rate of return. It is perhaps more appropriate for valuinga minority shareholding where the holder has no
for valuing a whole company, where the total cash flows will be of greater relevance.
The practical problems with the DVM lie mainly in its assumptions. Even accepting that the required pertect capital marke
reality, the tormula used in (a) assumes constant growth rates and constant required rates of return in perpetuity
Determination of an appropriate cost of equity is particularly difficult for an unquoted company, and the use of an 'equiva
drawbacks as discussed above. Similar problems arise in estimating future growth rates, and the results from the model ar
It is also highly dependent on the current year's dividend being a representative base from which to start.
The dividend valuation model valuation provided in (a) results in a higher valuation than that under the P/E ratio approach
The share price for City Tutors may be currently depressed below its normal level, resulting in an inappropriately low P/E r
The adjustment to get to an appropriate P/E ratio for Profed may have been too harsh, particularly in light of its apparentl
The cost of equity used in the DVM was that of City Tutors. The validity of this will largely depend on the relative levels of r
operate the same type of business, the fact that City Tutors sells its material externally means it is perhaps less reliant on a
Even if business risks and gearing risk may be thought to be comparable, a prospective buyer of Profed may consider inves
greater personal risk. His required return may thus be higher than that envisaged in the DVM, reducing the valuation.
operate the same type of business, the fact that City Tutors sells its material externally means it is perhaps less reliant on a
Even if business risks and gearing risk may be thought to be comparable, a prospective buyer of Profed may consider inves
greater personal risk. His required return may thus be higher than that envisaged in the DVM, reducing the valuation.
20X6 20X5 20X7

£'000 £'000 £'000
PAT 280 260 410
Dividends -150 -160 -185
Retained profit 130 100 225
Statement of financial position as at 31 December

Non-current assets 1,405 1,560 1,365
Working capital 810 870 940
2,215 2,430 2,305
Share capital 100 100 100

Retained earnings 875 975 1,200
10% debentures 20Y2 1,200 1,200 1,200
2,175 2,275 2,500
Net assets
£'000
Net assets at book value 100
Coupon yield 11%
P/E ratio 15
gross dividends yield 11%
B of sector 0.8
Return on the market 21%
Methods of valution
P/E ratio
The earnings-based valuation would be based on applying the P/E ratio tor similar quoted companies to Chris Limited's ear
15 x £410,000 £6,150,000
This value would be the approximate value of a quoted company in the sector. Research has indicated the acquisitions of p
to 40% to the quoted sector P/E. This discount probably reflects the lack of marketability of the private company shares co
discount of 40%, the value of Chris Limited would be:
£6,150,000 x 60% = £3,690,000
This is the value of the earnings stream. On top of this, it should be possible to sell the unused property without affecting t
valuation of £3,790,000.
Limitations of the calculation

The sector P/E is an average for the sector. It is not clear whether Chris Limited is an average company or whether it is in a
identify specific companies in exactly the same class of business as Chris Limited.
The sector P/E retlects the expected growth in earnings in the sector. It may be that Chris Limited's expected growth rate i
different P/E ratio would be more appropriate.
The sector P/E reflects the risk of the sector in general, including business and gearing risk. If Chris Limited has a different l
business risk is slightly different, then a different P/E ratio would be appropriate.
The calculation has assumed that Wilkinson plc acquires a controlling interest and forces the sale of the unused property.
When the calculation is useful

Use of earnings to value a company implies that the investor has control of the earnings and can dictate dividend policy, fo
aimina to aet control of the company
Dividend-based valuation - Dividend valuation model

In order to use the dividend valuation model, the cost of equity of the company must first be estimated. This can be done
Where: k the company's cost of equity
the risk-free rate (estimated as the yield on gilts)
mthe return on the market
Ke 11 +0.8(21-11) = 19%
The market value (MV) of the company is given by the formula MV = D,/ (ke - g) where D, is the prospective dividend (estim
expected growth rate in dividends. The value of g can be estimated from extrapolating the dividend growth of Chris Limite
MV=185 x 1.11/ (0.19 -0.11) = £2,567,000
Since this valuation relies on the b of quoted companies and would give the value of a quoted company's dividend stream,
£2,567,000 x 60% = £1,540,000
Adjusting for the value of the unused property, the value of the business would be around £1,640,000.
As with the earnings estimate, use of the sector b implies that Chris Limited has comparable gearing and business risk to th
The assumption that past dividend growth of 11% will continue in the future may not be valid.
thas been assumed the company will dispose of the unused property even if ilkinson plc only obtains a minority holding.
When the calculation would be useful

A minority investor who only receives dividends from the company will find this most useful and therefore it may be releva
Dividend-based valuation - Dividend yield
Dividend-based valuation - Dividend yield

185 x 1/0.11 =1,682
Discount for lack of marketability:
1,682 x 60% = 1,009,000
Including the proceeds from the assumed sale of the unused property, the valuation of Chris Limited would be £1,109,000

As with the above methods, it assumes that Chris Limited is similar to the sector in terms of gearing and business risk.
It has been assumed that the company will dispose of the unused property, even if Wilkinson plc does not acquirea contro

As with the dividend valuation model, it is most useful for a minority investor who will only receive a dividend flow from th
Asset-based valuation
Net realisable value of assets
The net book value of the company's assets is f2,500,000. To establish the value available to equity investors, the market v
of the loan stock's future cash tlows, discounted at the investors' required rate of return. The best indication ot required re
with the same coupon in the question. A risk premium must be added on to the yield on the gilts to compensate for the ad
yield (11%+ 3% = 14%) needs to be altered to a semi-annual rate of return of 6.8% W1.14- 1) since the coupon is semi-ann
Note: The precise calculation here using the square root is probably over the top and gives a spurious level of accuracy. A s
Time Cash flow Discount faPV

£ 6.80%
1 to 10 60,000 7.09 425,400
10 1,200,000 1/1.068^1 621,539
£ 1,046,939
The total value of the company's equity is therefore £2,500,000 -£1,047,000 =-£1,453,000.

The only data available is net book value, which may not represent realisable value due to potetial revaluations, obsolesce
The contents of each category of asset and liability are not known. For example, non-current assets may include intangible
The value of intangibles such as brands and goodwill may not be included in the above valuation.
The required yield on the loan stock has been estimated and the 14% may not be appropriate

Net realisable value assumes the company's assets can be sold ott.
This will only be appropriate if Wilkinson plc acquires a 75% interest and can force a compulsory liquidation. Alternatively,
force the disposal of any surplus assets.
Replacement cost of assets may be appropriate to use for a purchaser who is considering starting up an equivalent busine
of replacing intangible assets such as goodwill and brands.
Reasons for differences between the valuations

The earnings-based valuation is based on an earnings figure that has grown dramatically in the final year. Ihe very high ear
subsequent years the earnings may tall back to a level similar to earlier years. Alternatively, it the earnings are going to gro
is likely to be the most appropriate of all the above.
The dividends of Chris Limited, by contrast, have grown at a reasonably constant rate over the three-year period regardles
at a much slower rate than earnings, this explains the much lower valuations using dividend-based methods.
The dividend policy may give a clue as to the directors' expectations for future protitability and sustainable dividend growt
Iikely to give the most appropriate valuations.
The asset-based valuation is the lowest of the four figures. Ihis is probably because the company derives its value not from
Additional information required

Market value of assets
Existence and value of intangibles
Analysis of profits between ordinary recurring items and exceptional one-off items, which may have distorted the profits in
Details of costs or income that may be avoided or lost if the company is acquired, such as very high directors' remuneratio
Details on growth prospects
More specific details on the company's business, its business risk and gearing risk and similar information for closely comp
The shareholding Wilkinson plc intends to buy
The possibilities for synergies
Cash flow details, to obtain a more fundamental cash-based valuation
Details of any comparable deals executed in the recent past
Profit or loss statement and dividend data

20X1 20x2
Sales 995 1,180
Pre-tax accounting profit 204 258
Taxation 49 62
Profit after tax 155 196
Dividends 50 60
Retained earnings 105 136
Non-current assets 370 480

Net current assets 400 500
770 980
Financed by:
Shareholders' funds 595 720
Medium- and long-term bank loans 175 260
770 980
Depn 95 105
Interest 13 18
Non cash expenses 32 26
Lease non capitlised 35 35
Tax rate 24% 24%

Cost of debt 7% 8%
cost of equity 14% 16%
Capital emploed 695.00
Debt 75%
Equity 25%
EVA
Profit after tax 155 196
Non cash expenses 32 36
Interest after tax (1-.24% 9.88 13.68
NOPAT 196.88 245.68
Capital empolyed
20X1
capital eployed and lease 730.00
20X2
BV of sharehold funds + Bank Loan + Lease 805
WACC
20X1
0.75 x 14% + 0.24 x (7% x (1-.24) 11.8%
20X2
0.75 x 16% + 0.24 x (8% x (1-.24) 13.5%
EVA
20X1
196.88 - (11.8% x 730) 110.8
20X2
245.68 - (13.5% x 805) 137
bility of shares, status of company, growth potential - that will differ from those for
ause it is a younger, developing company, although the basis for the estimate may
n one-half to two-thirds of that of an equivalent quoted company. Being

opriate P/E ratio of around 12, assuming Profed is to remain a private company.
for investment appraisal, there appears to be no rational basis for this. We can
ing the business risks are similar, and ignores the small ditterence in their gearing
e Profed is unquoted so riskier than the quoted City Tutors):
n a going concern basis. Exceptions would include property investment

tionship to their earning capacities.
dge and reputation of its personnel. This is not reflected in the net asset values,
e its intangible assets such as knowledge, expertise, customer/supplier
ue tor a company in financial ditticulties or subject to a takeover bid. Shareholders
price ofa share. It is thus a method that retlects the earnings potential of a
most meaningtul basis tor valuation.
valent during small transactions, and will be dependent on a lot of factors in
e of a share, and thus its prevailing P/E ratio. It is not known whether the share
period. The latter would perhaps give a sounder basis from which to compute an
sis to value a smaller, unquoted company in the same industry can be
hese are ditticult to measure.

her the ratio. The growth rate incorporated by the shareholders of City Tutors is
ofed's management it is difficult to see how the P/E ratio should be adjusted for
ratio to value Profed's earnings. This can lead to a very inaccurate result if account
that the shareholders expect to receive from the company by discounting them
ng where the holder has no intluence over the level ot dividends to be paid than
uired pertect capital market' assumptions may be satistied to some extent, in

turn in perpetuity
, and the use of an 'equivalent' quoted company's data carries the same
e results from the model are highly sensitive to changes in both these inputs.
der the P/E ratio approach. Reasons tor this may be as tollows:
n inappropriately low P/E ratio.
arly in light of its apparently better growth prospects.
d on the relative levels of risk of the two companies. Although they both
is perhaps less reliant on a fixed customer base.
Profed may consider investment in a younger, unquoted company to carry

educing the valuation.
is perhaps less reliant on a fixed customer base.
Profed may consider investment in a younger, unquoted company to carry
educing the valuation.
anies to Chris Limited's earnings.
dicated the acquisitions of private companies are typically priced at a discount of 30%
private company shares compared to those of its quoted counterparts. Using a
roperty without affecting the earnings stream for around £100,000, giving a total
mpany or whether it is in a more or less attractive part of the sector. It may be better to
ed's expected growth rate is better or worse than the sector average, meaning that a
ris Limited has a different level of gearing or is in a part of the sector where the
e of the unused property.
n dictate dividend policy, for example. It would therefore be suitable if Wilkinson plc is
timated. This can be done with the capital asset pricing model: ke =r+ P, (m)
prospective dividend (estimated as Do x {1 + g}), ke is the cost of equity andg is the

end growth of Chris Limited over the last few years and is 11% ({185/150}- 1).
ompany's dividend stream, this value should be discounted.

aring and business risk to the sector averagge.
tains a minority holding.
d therefore it may be relevant if Wilkinson plc only intends to take a minority stake.
mited would be £1,109,000.
ring and business risk.

c does not acquirea controlling shareholding.
ive a dividend flow from the company.
uity investors, the market value of the loan stock must be deducted. This will be the PV
est indication ot required returns is given by the details on gilts for the same maturity
s to compensate for the additional risk of Chris Limited, say 3%. The resultant annual
ce the coupon is semi-annual.
urious level of accuracy. A six-monthly factor ot 7% would be just as good.
tial revaluations, obsolescent inventories, costs of disposal, and so on.

sets may include intangibles which could not easily be sold at book value.
y liquidation. Alternatively, the company must obtain at the very least 50% to be able to
ng up an equivalent business from scratch. The problem will be in identifying the cost
final year. Ihe very high earnings of t410,000 may not be representative and in
he earnings are going to grow trom the current base, then the earnings-based valuation
hree-year period regardless ot earnings pertormance. Since the dividends have grown
sed methods.
sustainable dividend growth. f this is the case, then the dividend-based methods are
y derives its value not from its assets base but from its earnings stream and cash flows.
have distorted the profits in individual years

igh directors' remuneration
ormation for closely comparable quoted companies

15.3%
- 10,000.00 - 6,300.00 3,700.00 11,100.00 11,100.00 10%
TYU 3 - Page 49
METHOD 1 0 1 2 3 4 5
T0 T1 T2 T3 T4 T5
Operating cashflow
pre tax net CF € 800.00 € 800.00 € 800.00 € 800.00 € 800.00
TAX 40% -€ 320.00 -€ 320.00 -€ 320.00 -€ 320.00 -€ 320.00
€ 480.00 € 480.00 € 480.00 € 480.00 € 480.00
Assets
Purchase SV -€ 1,250.00 € -
Bfwd
Tax relief WDA € 100.00 € 100.00 € 100.00 € 100.00 € 100.00
-€ 1,250.00 € 100.00 € 100.00 € 100.00 € 100.00 € 100.00
Working capital
Incriminal Amount -€ 500.00 € 500.00
Net CF -€ 1,750.00 € 580.00 € 580.00 € 580.00 € 580.00 € 1,080.00
Fx rate @ 1.16 1.16 1.14 1.11 1.09 1.07 1.05
Net CFs -£ 1,508.62 £ 510.00 £ 520.20 £ 530.60 £ 541.22 £ 1,027.94
DF 10% -£ 1,508.62 £ 463.64 £ 429.92 £ 398.65 £ 369.66 £ 638.27
PV £ 791.51
NPV fomula
PV T1 - T5 £2,300.13 NPV(0.1,C26:G26,)
T0 -£ 1,508.62
£ 791.51
METHOD 2
Net CF -€ 1,750.00 € 580.00 € 580.00 € 580.00 € 580.00 € 1,080.00
DF 1.000 0.928 0.861 0.798 0.740 0.687
DF convert -€ 1,750.00 € 538.03 € 499.10 € 462.99 € 429.49 € 741.87
PV Euro € 921.49
At today FX rate 1.16
£ 794.39
NPV fomula
PV T1 - T5 € 2,671.49 NPV(0.1,C26:G26,)
T0 -€ 1,750.00
€ 921.49
1.16
£ 794.39
PV working
Convert 1.160 T0
1.137 T1 1.16 x 0.98
r 10% FX t1 / FX t0 x 1+r
PV 1.078 used the NPV formala rather than 10% its 7.8%
As % 0.08
2% apprication
T0 value -97.25
T1 Interst 5
T2 Interest 5
T3 Interes 105
IRR 6.0%
Rate 6% Nper 3 years
PMT 5%
PV -97.25
FV 100
TYU1
Bond rate 3% T0 value - 96.00

Amout 25000000 T1 Interst 3.00
Years 4 T2 Interest 3.00
Premium 20% T3 3.00
MV £96 T4 Interes 123.00
IRR 8.62%
Rate
Debenture 10%
Sale proceeds
Property 2500
Plant 400
Motor 300
Current assets 700
3900
Proceeds 3,900
Liquidator cost - 300
Fixed Charge Debenture - 2,500 10% on 2500
1,100
- 1,100 TP + Overdraft split
- 1100/1600 = 69%
68.75p per £ outstanding
Refinancing scheme
New shares 1500
Exisiting loan 1800
15% debentures 270
Plus New ord shares 800k at £1 800
Debt holders
Loan 2.5m down to 1.8m
but int + shares v liquadiation 2.5m
replacing at new lower amount of dates
orgianlly fo 10% at 2.5m = 250k now they get 15% on 1.8m = 270k
a 20k increase in come and lower repayment on redemption date
Bank
OD at 69% or 100%
they are swapping the overdraft into a short term loan, which provides them with some
security over the amount. However if the overdraft is still to remain it could be seen as risky.
TP
Trade payables at 69% or 100%
If they go liquation get 69%. If contue then should receive the full amount but depends
on cash flow back to the company as if contiue then payable receive future income from company
Shareholders
Get 0% or
Put more money into the company but if they don’t put more money
in then they will receive nothing
With the new shareholding they will be control of 56.6%
ie current shareholding is 3000
plus the 800 new issue and 1.5m new shares - 3000/5300 = 56.6%
Have to pay 1.5m turns the business round
External perfomance affects orgnaistions performance
‘Opportunities and threats - ZTC needs to ensure that it understand the ways in which it is affected by the environment in
(which could be highlighted by ‘PEST’ analysis) as well as any factors that relate more specifically to the telecommunication
‘The most significant recent environmental influence on ZTC’s performance is likely to have come from a political factor - t
Impact of deregulation - Historically, ZTC held a monopoly position in the telecommunications market in Zeeland. Howeve
‘eroded when new competitors enter the market. Consequently, it seems likely that ZTC will suffer a fall in revenue, at leas
New entrants - Itis not clear how many competitors have entered the market so far, but another threat ZTC needs to be aw
Zeeland in the future, and potentially reducing its market share further.
Telephone networks - It is likely that ZTC’s monopoly was of the fixed line network in Zeeland, rather than mobile telecom
mobile phone companies.
In this respect, developments in technology (for example, 4G networks) could also boost the performance of mobile phon
‘Overall market growth - The scenario does not indicate whether the telecommunications market overall in Zeeland is grow
However, this will also have an effect on ZTC’s performance. For example, if the market is growing rapidly, this could help
Similarly, if the global market is growing significantly, this could provide opportunities for revenue growth. It appears that
competitively internationally, and so the state of the global market is likely to be important for its future performance.
‘Customer bargaining power - Another consequence of the deregulation is that customers in Zeeland now have increased
‘customers had little or no ability to influence price or service. However, now that there is increased choice in the market,
competitive against other providers, or its standards of customer service are poor, customers will be able to switch to one
Employees - The deregulation of the market could also affect ZTC’s relationship with its employees. In effect, it could incre
Zeeland could only work for ZTC; but itis likely that in future there will be a choice of companies they could work for. There
its best staff.
Asa State monopoly, ZTC’s role was expressed in terms of its service to the nation as a whole. Its focus was on the public s
market discipline and its finances were controlled by government. The lack of market input and the highly technical nature
‘competence, rather than customer interests. However, the Government, as principal stakeholder, imposed requirements
Shareholders as new stakeholders
ZTC now has a new and important class of stakeholder: its shareholders. They will have firm ideas about their requirement
Importance of customers
‘The company faces a deregulated market where competition will intensify. It will need to pay great attention to the views
influence than previously, since they will be able to choose new suppliers when new providers of telecommunications serv
Impact on objectives
‘These influences will affect objectives at all levels in the organisation and will require a significant realignment of attitudes
products; and to improve customer service, particularly in the matter of installing new equipment and dealing with faults.
‘The respective requirements of shareholders and customers also highlight a potential conflict that will need to be address
Shareholders will want to maximise profitability, which may be achieved by raising prices. But customers will seek the lowe
Although the Government is no longer the main external stakeholder, it will still be interested in ZTC’s performance. The c
major employer and taxpayer; it also has the potential to develop as a major centre of technological excellence.
While the Government will step back from direct involvement in the running of ZTC, itis likely that it will retain an interest
promotion of technological development and overseas expansion which, if successful, could increase ZTC’s tax liability to t
Corporate governance
A final influence on the strategic objectives of the privatised company will arise in the field of corporate governance. As a l
laid down by its quoting stock exchange. It may also be subject to special government regulation designed to prevent it fro
influences are also likely to have a marked effect on the directors’ attitudes and practices.
Overall, the objectives of ZTC will need to change to focus on profitability and shareholder reward, as well as customer sati
Alongside this, the directors will need to ensure the business's controls and governance are adequate to comply with its ne
_x000C_
4.1
Market leader
Rev 19,517 5,541 32,322 57,380 180,000
COS - 3,767 - 2,638 - 13,975 - 20,380 56,000
15,750 2,903 18,347 37,000 124,000
Operating costs 31,394 101,500
Operating proft 5,606 22,500
Shop 40 130
T Ltd market leader
Revenue per shop 1,434.50 4,500
Gross margin 64.5% 68.9%
Gross margin per shop 925 953.85
Operating profit margin 9.8% 12.5%
Loyalty cards for brand awareness for business performance

Competitive market Ihe high number of branded coffee shops in leeland suggests that the market there is likely to be com
their coffee. In this respect, branding, and the loyalty card scheme, could be valuable to CFE IT it encourages customers to
Customer loyalty - By creating customer loyalty, a strong brand identity is a way of increasing or maintaining sales; for exam
Is the logic benind the loyalty cards being proposed by the marketing director.
However, while increasing sales will allow CFE to increase its profits overall, it may not, by itselt, have as much impact as th
Importantly, CFE currently generates more revenue per shop than the market leader, although its profit margins are signifi
HOWever, atnougn tnere appears to be more important factors affecting CE s performance thnan ts company prove, Bran
Brand awareness - Brand awareness would be an indicator of CFE's position in the coffee shop market, and would indicate
customerS, Tor example as offering higher-quality products and service. lf customers don t assoCiate ES products as being
ingredients and service statt Is effectively being wasted.
Quality and trust - One of the key attributes of a successtul brand is that it conveys a sense of qualty and trust to potential
preterence to a rival product.
Quality seems to be very important to CFE: it uses high-quality ingredients for its food and drinks, and seeks to ensure cust
average).
External information of price increase

4.2 Demand for the product-when deciding wnether or not to increase the price of its coffee products, CFE needs to consid
Therefore, market research will be important to assess how demand (and consequently revenue) will be affected by any ch
t seems that CFE'S Customers are not particularly price sensitive, which should increase the chances of the finance directo
implementng it.
In this respect, it would also be useful for CFE to gauge the strength of any brand loyalty towards it.
Amount of increase-Equally, market research will give CHE an insight into what price customers are willing to pay tor their
enable it to charge higher prices than its customers to an extent and still retain its customers. However, if CFE increases its
higher-quality coffee and service than its competitors.
Competitors pricing policies- Currently, CFE'S prices are largely the same as those charged by the multinational competitor
Competitors" plans - Currently, CFE seems to serve a higher proportion of 'Fair Trade' products than its competitors, and th
example, if CFE's competitors increase their prices, that could give CFE greater scope to increase its prices.
to use more Fair Irade coftee, or increase the quality of otner ingredients, this would reduce the basis of direrentiation bet
its competitors' plans, before it changed its prices, would be useful.
Input prices - The finance director's suggestion is designed to help CEE increase margins. However, if the price of coffee be
Equally, if costs, such as the rents CFE has to pay for its premises, rise, this may also increase the pressure on CFE to increa
Market leader
market there is likely to be competitive, because customers will have a high degree of choice about where to buy
E IT it encourages customers to keep returning to CFE shops to buy their coffee, rather than going to rival shops.
ng or maintaining sales; for example, by improving customer retention rates and encouraging repeat purchases. This
tselt, have as much impact as the marketing director might hope.

ugh its profit margins are significantly lower.
thnan ts company prove, Branding could still nave a positive impact on its performance.
op market, and would indicate whether customers or potential customers do actually differentiate CFE from its
assoCiate ES products as being higher quality than the competitors, then the money spent on higher-quality
of qualty and trust to potential customers, thereby encouraging them to buy the product or service in question in
drinks, and seeks to ensure customers receive a high standard of service (by paying its staff wages above the industry
e products, CFE needs to consider wnat impact the changes in price are likely to have on customer demand for them.
enue) will be affected by any change in Price
chances of the finance director's proposal. However, CFE should still research its reaction to any change before
mers are willing to pay tor their coffee. CFE's competitive strategy (of differentiation based around quality) might
rs. However, if CFE increases its prices too much, it is unlikely that the customers will remain loyal to it, even if it offers
by the multinational competitors. Howeve, these competitors might also be planning to change their prices. For
ucts than its competitors, and this might help it justify its higher prices. However, if its competitors are also planning
rease its prices.
e the basis of direrentiation between ChE and its competitors. In this respect, any insights which CFE Could gain into
owever, if the price of coffee beans rises, it might need to increase prices in order to maintain its current margins.
e the pressure on CFE to increase its prices in order to maintain its profit margins.
Assets
Non-current assets Revenue 20,000
Property, plant and equipment 2,000 Cost of sales -16,000
Intangible assets 6,100 Gross profit 4,000
8,100 Administrative expenses -2,500
Current assets Finance cost -300
Inventories 100 Profit before tax 1,200
Trade receivables 900 income tax expense -50
Cash and cash equivalents 200 Protit for the year 1,150
1200
Total assets 9,300

Calculation
Equity and liabilities PBIT 1,500
Equty ROCE 18.2%
Share capital 5,700 GPM 20.0%
Retained earnings 50 NPM 7.5%
Total equity 5,750 Current Ratio 1.14
Quick ratio 1.047619
Non-current liabilities Gearing 30.3%
Long-term borrowings 2,500 Interest cover -5
Current liabilities
Trade payables 1,000
Current tax payable 50
1,050
Total Liabilties 3,550
Total equity and liabilities 9,300
Advantages
The Ambion market (where Swift currently operates) is mature and highly compettive, and the government is hostile to road t
Acquiring EVM would provide Swift with access to a new market (ECuria) in which demand is growing, competition is immatur
Acquiring EVM will increase the overall size of the group, allowing increased economies of scale to be exploited in relation to p
Swift's capabilities in logistics should enable it to increase EVM's profitability post-acquisition.
Disadvantages
The benefits from the acquisition may be reduced in light of any potential culture clashes that may arise between the two com
Swift has no experience of operating or acquiring toreign companies.
Swift has no experience of trading in Ecuria.
Although EVM is now a private company, the mindset may still be that of the government organisation it once was. Changing
could lead to reputation-damaging labour disputes. Ihis may be unavoidable ir Switt attempts to force the Ambion-style worki
Financial considerations
EVM delivers a return on capital employed (ROCE) of 18.2%. Ihis is very similar to the ROCE of Swift Iransport and appears to b
The gross profit margin at 20% is higher than that of Swift. However, its net profit margin of 7.5% is lower. This may raise conc
costs from its State-owned days. However, it is possible that Swift will be able to improve the profit margin through economie
prospect more acceptable.
Liquidity (as demonstrated by the current ratio of 1.14 and the acid test ratio of 1.05) is much lower than that of Swift. Swift w
liquidity and cash flow as well as profit
Gearing (30.3%) is much lower for EVM than for Switt. Ihis may indicate a more conservative approach to long-term lending.
Ihe interest cover ratio (5) is only 60% of Swift's. Ihis could indicate lower profitability, but it could also mean that EVM's intere
raising finance. However, Swift could look at renegotiating EVM's finances post acquisition
PBIT/ Equity + Long Term Borrowing
PBIT / Revenue
Current asset - Inventory / Current Liab

Long term borrowing/ Equity + longterm borriwing
PBIT/Interest
overnment is hostile to road transport.

wing, competition is immature and the Government is investing in road transportation.
to be exploited in relation to purchasing trucks and other equipment.
ay arise between the two companies involved:
sation it once was. Changing these practices, aithough potentially leading to higher profts, may be complex and
force the Ambion-style working practices on them, and may lead to contlicts that could be impossible to resolve.
wift Iransport and appears to be a strong performance for the sector.

% is lower. This may raise concerns over suitability. The low net profit margin may be due to EVM still carrying high
ofit margin through economies of scale and by implementing competences gained at Albion. This would make the
wer than that of Swift. Swift will have to determine why this is the case, but it is important to consider the business's
roach to long-term lending.

d also mean that EVM's interest charges are relatively high, due to the problems the Ecurian investors had in
Restrcuted to comply with principles of good coporate governance
Split of role of chaiman and CEO

Governance reports recommend that the roles of CEO and chairman should be split between different individuals, to avoid the
At present, the CEO is able to manipulate the information the board receives, to protect his position. It seems best for one of t
that the two jobs are distinct, with the CEO running the charity and the chairman running the board. I he chairman can ensure
has enough information to exercise oversight of the CEO.
Appointment of secretary
The board's functioning would be better if someone acted as company secretary. The secretary could undertake a number of t
in advance ot meetings and briefing board members in relation to each agenda team. Ihis would free up the time of the CEO o
and shouia, necessary, nave the independence to come into connect with the CEO if the secretary believes t is in the interest o
More executive directors

Governance reports typically suggest that at least halt the board should be independent, non-executive directors-to ensure an
of seven directors are non-executives, which does not appear to be an appropriate balance. I he UK Higgs report commented t
in the management contribution, when there is only one, or a very small number, of executives on the board. GFE should cons
director. Ihis would also help with succession planning, and lead to a greater emphasis on risk management and operational co
Audit committee
Appointing a separate audit committee will enable the main board to concentrate more on strategic and operational matters,
part of current board meetings. Ihe audit committee should also be responsible for the appointment of auditors and for liaison
auditors' ability to exercise independent scrutiny could be questioned, since they have been appointed by the CEO. Governanc
financial expertise to contribute effectively, and that one member should have relevant and recent financial experience. New
members receive training
Nomination committee
A nomination committee of NEDs would oversee the appointment of the new directors that GFE's board appears to need. Ihe
not been considered recently, such as
the balance between executives and NEDs
whether there are gaps between the skills, knowledge and experience possessed by the current board and what the board ide
the need to attract board members from a variety of backgrounds
whether GFE will need to pay some NEDs to attract the right candidates
Independent NEDs
Governance reports recommend that at least half the b0ard are independent NEDs, without business or financial connections
SFE as it is a charity, and stakeholders will rely on NEDS to provide unbiased scrutiny of how the executive directors are condu
independent, since they have all been appointed on the basis of previous business connections.
Expert NEDs
NEDS with experience of the charity sector need to be appointed. Ihe reason given for not discussing operational matters, tha
NEDs have insufficient expertise at present. The CEO's belief that the executive management team is more than capable of ma
should scrutinise, and if necessary challenge, the way the CEO is running operations, drawing on their own experience.
Stakeholder representation
There appears to be a lack of stakeholder representation on the board, with fund providers, volunteer helpers and users of GF
board would mean that the board received direct feedback on the effectiveness of the charity's activities. Stakeholder represe
on the reasoning behind board decisions and GFE's current strategy.
Changes in board membership

It seems that new NEDs need to be appointed to provide the expertise and independence the board is currently lacking. Corpo
large as to be unwieldy; therefore, some of the new board members may have to replace existing board members.
fferent individuals, to avoid there being an excessive concentration of power in the hands of one individual.
tion. It seems best for one of the existing NEDs to be appointed as chairman. Splitting the roles emphasises
ard. I he chairman can ensure the CEO iS accountable tor his actions by, for example, ensuring the board
could undertake a number of tasks currently undertaken by the CEO, including distributing board minutes
free up the time of the CEO or chairman. The secretary should be accountable to the board collectively,
ry believes t is in the interest of GFE.
ecutive directors-to ensure an appropriate balance between executive and non-executive directors. At GFE five out
UK Higgs report commented that there is a greater risk of distortion or withholding of information, or lack of balance
on the board. GFE should consider appointing one or two more executive directors, tor example, an operations
anagement and operational control at board level.
egic and operational matters, leaving the audit committee to undertake the detailed financial review that is a major
ment of auditors and for liaison with them about further work, including a review of controls. At present, the
ointed by the CEO. Governance reports recommend that all members of the committee should have sufficient
ent financial experience. New directors may therefore need to be recruited to fufil this requirement or existing
's board appears to need. Ihe committee would also review other important issues of board functioning that have
board and what the board ideally should have
iness or financial connections, who face re-election regularly. Independent NEDs will be particularly important for
executive directors are conducting its aftairs. It is possible that none of the current NEDs can be classed as
ssing operational matters, that these are outside the directors experience, indicates that as a body, the
am is more than capable of managing the delivery of the in-home care services misses the point. NEDs
their own experience.
unteer helpers and users of GFE's services not being represented. Having a user representative on the
activities. Stakeholder representatives could also provide feedback to the stakeholders they represent
oard is currently lacking. Corporate governance reports recommend that the board should not be so
g board members.
Risks
operational risks
These are risks relating to the business's day to day operations.
Accounting irregularities
The unexplained fall in gross profit in some stores may be indicative of fraud or other accounting irregularities. Low gross profi
sale income. Incorrect stock levels, in turn, can be caused by incorect inventory counting or theft of inventory by employees. S
employees fraudulently removing cash from the business rather than recording it as a sale.
Systems
Technical risks relate to the technology being used by the company to run its business.
Backup
Transferring data to head oftice at the end of each day will be inadequate for backup purposes. Failure of computer systems d
Delays in inventory ordering
Although stock information is collected using the EPOS system, reordering ot inventory takes a significant amount of time. Iran
some discounts on purchase. However, the average 10 days betore inventory is received at the store could result in the compa
Non-business risks
These are risks that arise for reasons beyond the normal operations of the company or the business environment within which
Event
HOOD may be vulnerable to losses in a warehouse fire.
Business Risks
External risks relate to the business; they are essentially uncontrollable by the company.
Macroeconomic risk
The company Is dependent on one market sector and vulnerable to competition in that sector
Product demand
The most important social change is probably a change in fashion. HOOD has not changed its product designs for four years, in
tend to change more frequently than every four years, HOOD may experience falling sales as customers seek new designs for
variations in demand.
Corporate reputation
Risks in this category relate to the overall perception of HOOD in the marketplace as a supplier of (hopefully) good-quality clot
with the manutacturing process and a consequent high level of returns.
Profiling
By identifying and profiling the effects of the risks, HOOD can assess what the consequences might be, and hence what steps (
Each risk on organisation and impact of risk being minimised
Operational risks
Accounting irregularities
The potential effect on HoOD is loss of income, either from inventory not being available for sale or cash not being recorded. T
employees would be concerned about being caught stealing.
The risk can be minimised by introducing additional controls, including the necessity of producing a receipt for each sale and t
the shop manager. Loss of inventory may be identified by more frequent inventory checks in the stores or closed-circuit televi
Systems
Backup
The potential effect on HOOD is relatively minor; details of one shop's sales could be lost for part of one day. However, the cas
actual loss.
Additional procedures could be implemented to back up transactions as they occur, using online links to head office. The relati
likelihood of error occurring, will help HOD decide whether to implement this solution.
Delays in inventory ordering
The potential effect on HOOD is immediate loss of sales, as customers cannot purchase the garments that they require. In the
customers may not visit the store because they believe goods will not be available.
The risk can be minimised by letting the stores order goods directly from the manufacturer, using an extension of the EPOS sys
internet access for the shops and a possible increase in cost of goods supplied. However, this may be acceptable compared to
Non-business risks
Event
The main effects of a warehouse fire will be a loss of inventory and the incurring of costs to replace it. There will also be a loss
customer demand, and perhaps also a loss of subsequent sales as customers continue to shop elsewhere.
Potential losses of sales could be avoided by holding contingency inventory elsewhere, and losses trom the tire could be reduc
External risks
Macroeconomic risk
The potential effect on HOOD largely depends on HOOD's ability to provide an appropriate selection of clothes. It is unlikely th
sales will be expected. However, an increase in competition may result in falling sales and, without some diversification, this w
HOOD can minimise the risk by diversifying into other areas. Given that the company sells outdoor clothes, commencing sales
equipment, may be one way of diversitying risk. It can also look to reduce operational gearing, fixed cost as a proportion of tu
Product demand
Again, the risk of loss of demand and business to competitors may undermine HOOD's ability to continue in business.
This risk can be minimised by having a broad strategy to maintain and develop the brand of HOOD. Not updating the product r
may be devalued if products do not satisty the changing tastes of customers.
The board must therefore allocate appropriate investment funds to updating the products and introduce new products to ma
Corporate reputation
As well as immediate losses of contribution from products that have been returned, HoOD faces the consequence of loss of fu
products no longer offer quality. Other clothing retailers have found this to be very serious; a reputation for quality, once lost,
The potential effect of a drop in overall corporate reputation will be falling sales for HOOD, resulting eventually in a going conc
HoOD can guard against this loss of reputation by enhancing quality control procedures, and introducing processes such as tot
Pa
g irregularities. Low gross profit in itself may be caused by incorrect inventory values or loss of
ft of inventory by employees. Similarly., loss of sales income could result from accounting errors or
Failure of computer systems during the day will still result in loss of that day's transaction data.
ignificant amount of time. Iransterring data to head oftice for central purchasing may result in
store could result in the company running out of inventory.
ness environment within which it operates.
oduct designs for four years, indicating some lack of investment in this area. Given that fashions
stomers seek new designs for their outdoor clothing. HOOD may also be vulnerable to seasonal
of (hopefully) good-quality clothing. However, this reputation could be damaged by problems
ght be, and hence what steps (if any) are desirable to mitigate or avoid the consequences.
e or cash not being recorded. The overall amount is unlikely to be significant, as
g a receipt for each sale and the agreement of cash received to the till roll by
stores or closed-circuit television.
t of one day. However, the cash from sales would still be available, limiting the
links to head office. The relative cost of providing these links, compared to the
ments that they require. In the longer term, if stock-outs become more trequent,
g an extension of the EPOS system. Costs incurred relate to the provision of

ay be acceptable compared to overall loss of reputation.
ace it. There will also be a loss of sales as the inventory is not there to fultil
es trom the tire could be reduced by insurance
tion of clothes. It is unlikely that demand for coats etc will fall to zero, so some
out some diversification, this will automatically affect the overall sales of HOOD.
or clothes, commencing sales of other outdoor goods, such as camping
xed cost as a proportion of turnover.
continue in business.
OD. Not updating the product range would appear to be a mistake, as the brand
ntroduce new products to maintain the company's image.
the consequence of loss of future sales from customers who believe its
putation for quality, once lost, undoubtedly cannot easily be regained.
ting eventually in a going concern problem.
roducing processes such as total quality management
Exhibit 3: Financial and operating information – prepared by FC management accountant
Management accounts – Statement of profit or loss for years ended 30 June
20x4 20x3
Revenue £m £m
Passenger tickets 2,925 3,040
‘Paid for’ on-board activities and excursions 920 909
Total revenue 3,845 3,949
Operating costs
Fuel 425 378
Staff costs 435 431
Food 240 241
Depreciation 381 380
Other ship operating costs (Note 1) 1,239 1,398
Selling and administration 430 429
3400 3479
Operating profit 445 470
Gain on fuel derivatives 25 0
Gain on foreign currency derivatives 45 0
Earnings before interest and taxes 515 470
Number of passengers in year 2,460,000 2,390,000

Occupancy (% of capacity utilised) 90% 92%
Total passenger capacity of fleet per night (at 30 June) 62,000 59,000
Number of staff 22,500 22,500
Number of ships in fleet at 30 June 24 23
Carrying amount of fleet at 30 June (£m) 5,190 4,940
Fair value of fleet at 30 June (£m) 7,000 6,500
Fuel consumption (000’s tonnes) 839 849
Adjusting the data

Gains on fuel and currency derivatives are likey to be not years increase
can be random time of year
While operating profit has fallen by 5.3% EBITA has increased by 9.6%
Two revenue streams

We have seen a fall in the passger tickets by 3.8% but paid for ticket
have increased by 1.2%
Overall there has been 2.6% fall
670 687
Operating margin 72.8% 75.6%
We have seen a rise in the paid for costs by 12.6%
Operating margin have fallen by 2.8%
When stripping out the paid for and passger ticket we can view the following
Passenger tickets 2,925 3,040
Fuel 425 378

Staff costs 435 431
Food 240 241
Depreciation 381 380
Other ship operating costs (Note 1) 1,239 1,398
Selling and administration 430 429
3150 3257
Loss/profit -225 -217
Operating margin loss -8% -7%
We can seee that a fall in revenue is inline with a fall in costs 3.8% and 3.3%
But overall the operating loss has increased by 1%
Losses of course business have increased by 3.7%
The two revenue streams should be reviewed independent and depending on

how the company manages the overheads then the results could be different
Need to attract passgers to cruises to succedd
Revenue
Occupancy (% of capacity utilised) 90% 92%
Passangers per night 55800 54,280

62k x 90% 92% x 59k
Passengers nights per year 365 day 20,367,000 19,812,200
Global revenue 19,200

Global fleet 250
total global capacity 410,000
Biggest capacity 5,400
Market is growning 0
Revenue split
Passanger tickets 75%
Paid for 25%
% of total ships
% of capcity per night 10% 9%
The main decline is getting passengers on board!

examinable
revenue has fallen cost and seek
and industry has reduce -
growth enhance ship
utilisation
Profit declined
global issue and seek more
control with FC effectively
Fuel price rised bulk buy
Occupancy fallen
revenue per pass has fallen
market share fallen
Fuel
Fuel 425 378
Fuel consumption (000’s tonnes) 839 849
Staff costs
Staff costs 435 431
Number of staff 22,500 22,500
Food
Food 240 241
Decline in market share

Over the last 12 months the industy haas witnessed modest growth of 3.5% which is
in contrast to the delcien in revenue of FC. This may be explained by the increased competition in the sector
thought the issue is the
Part 2
Receive Pay
UK France 2.40
France US 1.80
US UK 6.40
US France 3.60
Step 2 PAY
Receive UK France
UK 2.40
France
US 4.00 2.25
Total to pay - 4.00 - 4.65
Total Receipt 2.40 1.50
Net Position Payment - 1.60 - 3.15
Step 3 - Instruct
UK must pay US - 1.60

France must pay US - 3.15
- 4.75
The use of deriviates

They are only useful for large sums of main currency
They receve cash 4 months in advance and some FOREX movements between
contract date and receipt date therefore limited transaction risk and no
cost between the period
Long term risk is economic risk FX exposure. This might reduce competitivess
PV of future money might advesely affect by FX movements
deriviates are short term and unlikely to mitgiate long term risk
The exchange rates fluct of euro dollar agaisnt £ affect consol FS

any strengthn of £ against will decrease value of £ reporting for revenues and expenes
By using forwards and options other instru like swaps and FX debt obligations and foregin currency balances
ex rate can be maanged by locking in rates and avoiding future flucations
As revenue is advance then derivates are not desirable
Interdivisional sterling settlement

Mutli national net off of 3 divisions and arragenegd should co ordanted by centeral treasury
Need a base currency for all inter co transactions
Has advantage for FC to reduce the transactions and costs and les loss of interest
that money in transit
But strcict controls proedures for treasurey
server restrction and net of means of tax avoidance legal costs
UK must pay US - 1.60

France must pay US - 3.15
- 4.75
1. Reduce transaction that reduce transactions costs

2. Less loss of interest through money in transit
3. Avoids need for more sophisticated hedging technique
4. Reduce the work load and easy to perform task as centeralised
5. Prevents regions from deferring payment in the hope that FX rate is improves
6. Reduce exposure to adverse effects
7. Improves liquidity amongst the regions as payments accelerated when
Ship building
Amount
Rate
£
Final Payment for the ship in € (mill)
0.92 Cost £'s per €1

£ 248.40
If the £ devlaues
Max Paid
FC would exercise the option and protecting the
Difference in Floor & Ceiling

£ 21.60
Acquistion of Ltd company Coastal

$m
CA of NA Dec X3 32
FV of NA Dex X3 30
Loss after tax Dec X4 4
Loss after tax Dec X3 2
Forecast revenue X3 20
Forecast revenue X4 19
Acq date 30 Sept X4

Considartion 25
Exchange rate 1.6
Losses 4m x 9/12 3
FV at Acq
FV of NA Dex X3 30
Losses 4m x 9/12 -3
FV of NA at Sept X4 27
Ac price 25
Negative goodwill -2
Rate 1.6
-1.25
Benefits due diligence for Coastal

FC staff perform
Independent advisor
Areas to be
investigated
Hotel valuation as
we run cruise ships
and not hotel
Financially check
the accuracy of
info
Understatement of
losses and
liabilities
Accounting
estimates could be
manipluated
Legal due diligence

will establish rights
over a brand
Valuation of the
target company –
e.g. hidden
liabilities, uncertain
rights, onerous
contractual
obligations
Commerical-
Hotels Industry &
competition
Financial and
forecasts
Legal
Tax in the US
Accuracy as we did
not do the audit
IT system
HR
Hotel industry
Hotel operation
Data category Outcome
Number of visits 32,869,754
Number of unique visits 12,965,982

39%
Number of page views 97,878,296
Hits (Downloads from site) 1,157,974,936
Average duration of a visit 14.3 minutes
Most popular referral site TripAdvisor
Most popular source of hits – by country:

UK 41%
US 28%
Other – Europe 22%
Other 9%
Most popular pages (by hits):

Cruises 34%
Ships 33%
Facilities 15%
On-board activities and excursions 11%
Booking and payment 7%
Emails received from website 578,397
Advertising campaigns were run in April and December in the UK.

Monthly Visits Millions
July 3 9.1%
August 2 6.1%
September 2 6.1%
October 1 3.0%
November 1 3.0%
December 5 15.2%
January 4 12.1%
February 2 6.1%
March 1 3.0%
April 6 18.2%
May 4 12.1%
June 2 6.1%
33
New system was used to capture data

Hard to do you year on year comparision
More info
Actual number of booking made direct on website
number of booking where payment made or not completed as loss sale
booking where people are located and what curises they are booking
visits from same address
by FC management accountant
£m % change
-115 -3.8%
11 1.2%
-104 -2.6%
47 12.4%
4 0.9%
-1 -0.4%
28 12.6%
1 0.3%
-159 -11.4%
1 0.2%
-79 -2.3%
-25 -5.3%
25
45
45 9.6%
70,000 2.9%
0 -2.2%
3,000 5.1%
0 0.0%
1 4.3%
250 5.1%
500 7.7%
-10 -1.2%
1.2%
12.6%
-2.5%
-3.8%
-3.3%
3.7%
70,000 2.9%
Profit per passanger as costs
are fixed ish
47 12.4%
-10 -1.2%
4.00 0.9%
- 0.0%
- 1.00 -0.4%
70,000.00 2.9%
3,000.00 5.1%
creased competition in the sector
Step 1
Currency Rate per £ Converted
£ 1 2.40
€ 1.2 1.50
$ 1.6 4.00
$ 1.6 2.25
PAY
US Total Receipt
2.40
1.50 1.50
6.25
- 1.50
6.25
4.75 -
and expenes
ons and foregin currency balances
centeral treasury
€ 500,000 € 500,000
1.25 1.15
£ 400,000.00 £ 434,782.61
inal Payment for the ship in € (mill) € 270.00

Ceiling Floor
0.85 0.82 0.8 0.77 0.7
£ 229.50 £ 221.40 £ 216.00 £ 207.90 £ 189.00
the £ devlaues If the £ strenghten

Min Paid
C would exercise the option and protecting the limit 3rd party would exercise the option
ifference in Floor & Ceiling
Gain on bargain purchase

Who should undertake the
investigation
Independs valuation by
experts
experts
experts
experts
Staff could do Fin controller

but not expert. Could
independent for property
experts
US tax expert and Legal
representative
Independents and our

auditors
IT expert and Staff could
review this
Employing new staff and
20X4
Number of
passengers 2,460,000
19,903,772 61% number of people revisit in year
average view of pages 5.270724
19.0%
short term and long term vistis target to long term 7.5%
focus market attention with this site and patnership 2.977762
35.22919
Currency used
which are gives the most hits and ex rate flux could impact the global marketing
how dominate they are in other markets compared to leaders target Germany and Swit
Other could be broken down more Austria and canada - not
How is the currrent marketing in the UK and US different to other areas
marketing on other areas and how to sell other products and services
Hotels link with recent acquisiton
How this can be changed 75% upfront

email most popular and could be used to targe with follow up emails
Seasonal
what number then go onto book
booking per month
what areas are these booking taken place
and how long did they take before booking
Adversiting campgain April and Decemeber

taget UK and US as areas of most interest
Use hits and change time of adversting
Dont make a booking and target them ie over average
Averstie and referal and bonus paid to them
Are they english destinations and alternative language
Removed unused pages and declutter websites
number of visits does not make booking
Passangers to unqiue visits
Number of passgers to visits
Pages view per hit
average hits per page
target Germany and Switz could be land locked courty

Austria and canada - not land locked
32,869,754 Asssumed viewing

2,300,883 Assumed booking via website
Number of
2,460,000 passengers
in year
159,117 Other like travel agent
Requirement 1 - 16 marks - 40 marks
Proposal 1 - Stay with Sole supplier Gootle
Price £100
Discuss
Reliable
No FX risk
Struggling to keep pace with expansiion

could limit the company growth and sales
Switching supplier could limit quality as high end supplier
G is trusted and known can deliver quality
Gives confident to invest in new equipment
new facotry increase capacity
Easily to monitor and control and building relationsjop
More Eco of scale by G therefore could lower price
IT systems can communicate easier or use the same
Collab easier and development of new products
Greater awareness of eachtoher strategic goals
Prouduction issues and can they meet cap which reduce landax goals
may need to hold inventory for the future
variation of demand can mean they are not met in short term
G can control prices and increase will be passed stragight to them due to long term contract
maintained the promise
local and therefore low inventoy JIT system
Enviorment and local therefore SCR
risk of quality/ cost cutting so suppliers can compete
Proposal 2 - mutilple suppliers
Can have a limit of variation in quality

Supply chain issue with parts
Global competiton could achieve better price
Exchange rate risks
How do we ensure the quality is maintend by ICV
Price £90
Transport cost £3
£93
Contracts renewed annually can mean prices vary
but can be competitve
Exchange rate 1: 2 depn at 2%
or could be more forgein currency for every £ ie 2 x 1.02 then year on year
or can dividend by 0.98
Options 2 gives the lowest present value for cost therefore cheapest
Discuss
How accurate is the depn at 2% per year
Assumptions will need to be checked
the payment each year is getting cheaper each year as £ is getting stronger
Contracts can change and how sure are we that will remain at 93
Price can be driven down year on year contract
switching supplier can have quality issue
invovation can be mutli company and new ideas and methods is promising
if we switch suppliers then lack of commient to development
finding the suppliers and they can change
reduce Eco of scale
wont invest in new equipment like G
upfront cost and uncertaily around this
Geographical issues
lead time and delivery time issues
cross boarder suplly chain isues
exchange rate risk and thereofre increase finance risk
may need money market to ensure exchange rate and fixed price if large flux
Contracts reneable annually so have more bargaining power with regards to price as there is more competition between 3
It means that Landex is not reliant on one supplier
ICV currency expected to depreciate so costs will get smaller as the years go on
Capitlity is the issue and now 3 and no longer 1 supplier
Propsosal 3 - Moldiva set up
Build factory $ 40,000,000

VC $ 40
Fixed cost $ 25,000,000
Sell after 4 years $ 20,000,000
Exchange rate
$2 to 1 but increase 5%
Exchage rate 2
Dividend by 1.05 it /1.05
or we can times by 0.95
Sale after year 4 so negative in year 4
as appricate then this is bad for payment as £ is weaking
Discuss
We will have full control and therefore no lack in quality
But have we operated in there before
risk of langauge barrier
we need to find skilled staff as watches are made by staff
we could keep the factory running for after 4 years
with increase in demand and ensure quality this could be best
for the long term
the currency value is falling therefore costs are increasing

costing more £ as the fall in exchange rate we arent getting $ value
wee will have contrl over product and delivery

if demand increase then VC lower and profit risk
prie negatition and renogation are avoided prices are interal transfer
control over invation as they have same goals
risk of fixed costs increasing

staff finding and re location
Vertical diversification so therefore have more control over costs
additional costs in recruiting and training staff
no current expertise in Moldovia and no knowledge of tax, may need an expert
Significant investment is required and significant set up costs therefore we are essentially committee to this strategy as th
but good exit costs selling equipment
Lowest annual running costs but would still take ~20-40 years to pay back investment
Cannot negotiate prices as we own the operation, even if service is available someowhere cheaper, we cannot move acros
we used to be watch manufactor but this was 10 years ago
time and traning of skilled staff
After 4 years
Lowest variable cost and then longer term soluation if say 10 years
if we looked over 20 to 40 then long term solutin
Advice
Stick with google, trusted quality and reliable
Landex should opt for option 3 and bring their manufacturing in house. This provides strong quality and volume control an
Considering the demand is expecte to continue growing, proposal 3 would be the most appropriate solution because costs
Proposal 2 - as the business is growing at a fast rate, it is inevitable that multiple suppliers will be required to keep up with
The current supplier has provided reliable and good quality services. This suggests that Gootle is a good option, negotiatio
Question 2
Amorisated cost after 4 years
However, the functional curre
A - zero coupon bond from its current level of M$2 =
Build factory $ 40,000,000 to be £1= M$1.645405 (i.e. M
Prem 17%
The annual cost of debt in $ terms is [(117/100)^1/4 – 1] = As a consequence, in £ sterling
4.00%
Rate 2; 1
2/1.05^4 1.64540495
$40 x 1.17/1.655
£ 28,442,846.25
£ 20,000,000.00
9.20% (28.4428/20)1/4 —1] = 9.203%
Option 2
£20m 5% coupond bond 20,000,000
charge 2%
Interest 1,000,000
MV less 2% 19,600,000.00
0.8 / 19.6 + 20/19.6 ^1/4 -1
5.10% 0.8 / 19.6 rate function 5.57%

0.51% 20/19.6 ^(1/4) -1
5.61%
Advice
Not only is the 5% sterling bond lower cost, but it is also lower risk.
There is a risk with the zero coupon bond that the M$ may appreciate
even more than the 5% pa expected.
Also the M$ bond adds to the operating foreign exchange risk rather
than hedging it, as it adds even more costs in M$.
The clear advice is therefore to issue the 5% sterling bond. V 9.2% rate
Financial reporting
Opening balanInterest 4% Closing balance FX rate Closing ba

20.00
20X5 40.0000 1.6000 41.6000 1.905 21.840
20X6 41.6000 1.6640 43.2640 1.814 23.849
20X7 43.2640 1.7306 44.9946 1.728 26.043
20X8 44.9946 1.7998 46.7943 1.645 28.439
REDEMPTION 46.7943424
Alternative 2 – £20m, 5% bond

Opening balanInterest 5.57% Cash Closing balance
20X5 19,600,000 1,092,020 - 1,000,000 19,692,020
20X6 19,692,020 1,097,147 - 1,000,000 19,789,167
20X7 19,789,167 1,102,559 - 1,000,000 19,891,726
20X8 19,891,726 1,108,274 - 1,000,000 20,000,000
Q3
Ethics of using G
Ceasing to use G
What is the entition of the chairman and use as 10 years ago to hour statement or to mslead
to gain short term advantage and reduce reduancy cost. He needs to be honest with
Is the 10 years binding and does it make sense to keep them as supplier as overwhelmig ethical obligation
the staff have had a job for 10 years though so more than redundancy pay would be
Brother sits on the board at G

conflict of interest and contract awared to Rotblat as favourable terms would be available
on an arms length basis to other suppliers
Safegaurds would be be clear and transparent with the board

disclosure on the relationship
2 other alternative prososal for FD to consider
intemidation threat as feels pressureed
Coperate governance
The board of directors is a key stakeholder and is fundamental to
corporate governance. In this case a key member of the board, the finance director, has potential influence over two key d
 Whether to have Rotblat as a supplier.

 If Rotblat becomes a supplier, the terms on which the contract is made and manner in which the service monitored
FD is key member of board and can influence decision for personal interest
there irsk the contract is not in best interest for the company
One safegaurde FD to exlcude himself from the deceision on supplier choice
No vote on the matter
Reporting on the matter

If the contract is a related party nte IAS 24
the FD as member of board is key personal and related
close family memebrs to key mangement are RP if they may expect to influence company
if it is likely that the brother will influcence her and with contract a safe underlin assumption
is that she will have an influence
as she reports she is keen with Robtlat rather than netaurl
Will need full disclosure in FS as related due to nature of contract

the amount transation, the balance, commitment and gaurentees and bad debts disclosed
1 2
20X5 20X6
Sales Vol 200,000 220,000
Price 100 100
£ 20,000,000 £ 22,000,000
DF 10% 0.91 0.83
PV £ 18,181,818 £ 18,181,818
NPV £ 70,753,364
1 2
20X5 20X6
Sales Vol 200,000 220,000
Price $ 93.00 $ 93.00
18,600,000 20,460,000
Exchange rate 1 0.98
£ £ 18,600,000 £ 20,050,800
DF 10% 0.91 0.83
PV £ 16,909,091 £ 16,570,909
NPV £ 63,897,018
is more competition between 3 suppliers
Method 1 0 1 2
20X4 20X5 20X6
Sales Vol 200,000 220,000
Build facto $ 40,000,000
Sell after 4 years
VC $ 8,000,000 $ 8,800,000
FC $ 25,000,000 $ 25,000,000
Total $ 40,000,000 $ 33,000,000 $ 33,800,000
Exchange r 2.000 1.905 1.814
£ value 20,000,000 17,325,000 18,632,250
DF 1 0.91 0.83
PV £ 20,000,000 £ 15,750,000 £ 15,398,554
NPV £ 72,251,628
Method 2
Total $ 40,000,000 $ 33,000,000 $ 33,800,000
DF 4.5% 1 0.957 0.916
PV £ 40,000,000 £ 31,578,947 £ 30,951,672
NPV £ 145,085,931
As it 2:1 2 dividend by 2
£ 72,542,965.39
Project T0 is Jan X5
T1 1 Jan X5
it was $2 then increase 5% a
but prop 2 it was 2 then 2% from T1
they told use t1 rate and not T0
ommittee to this strategy as there are significant exit costs
cheaper, we cannot move across

g quality and volume control and allows them to rebuild skills and expertise in the case manufacturing process. This is a longer term op
ropriate solution because costs should become lower over time
will be required to keep up with demand. Supplier competition will also drive prices down.
otle is a good option, negotiations may be required on the price to try and negotiate on lower prices. The option of alternative supplier
However, the functional currency of Landex is the £ and the M$ is forecast to appreciate against the £ over the 4–year term of the bo
from its current level of M$2 = £1. As a result, the exchange rate on 31 December 20X8, when the bond is due to be redeemed, is exp
to be £1= M$1.645405 (i.e. M$2/1.054).
As a consequence, in £ sterling terms, the bond generates £20m when issued and requires £28.4428m (i.e. M$40m × 1.17/1.645405)
(28.4428/20)1/4 —1] = 9.203%

Movement
1.840
2.009
2.194
2.396
movement to PL
hical obligation
tential influence over two key decisions:
hich the service monitored

3 4
20X7 20X8
235,000 245,000
100 100
£ 23,500,000 £ 24,500,000
0.75 0.68
£ 17,655,898 £ 16,733,830
3 4
20X7 20X8
235,000 245,000
$ 93.00 $ 93.00
21,855,000 22,785,000
0.96 0.94
£ 20,989,542 £ 21,445,060
0.75 0.68
£ 15,769,754 £ 14,647,264
3 4
20X7 20X8
235,000 245,000
$ -20,000,000
$ 9,400,000 $ 9,800,000
$ 25,000,000 $ 25,000,000
$ 34,400,000 $ 14,800,000
1.728 1.645
19,911,150 8,994,746
0.75 0.68
£ 14,959,542 £ 6,143,533
$ 34,400,000 $ 14,800,000
0.876 0.839 1.9/2* 1.1
£ 30,144,603 £ 12,410,708
uring process. This is a longer term option and, whilst expensive, provides the highest upside to rising demand.
ces. The option of alternative suppliers can be used as a negotiation tool for prices
t the £ over the 4–year term of the bond

he bond is due to be redeemed, is expected
4428m (i.e. M$40m × 1.17/1.645405) to redeem it.

Margin 40% large stores negotiate lower price
Mark up 50%
Variable production cost 1

Packaging 3.3
Allocated fixed production cost 4.8
Full production cost 3.2
Margin for KHC 8
Price to retailer 4
Retailer mark-up 12
Large stores selling price £8
Revenue 16,400
Gross profit 6,200
Operating profit 650
Net cash flow from operations 1,380
Property, plant and equipment 2,420
Net assets 5,800
Working capital at 30 June 20X6
Inventories 3,100
Receivables 2,200
Cash 680
Current liabilities 2,600
US price 25% increase
Managing exchange rate risk from foreign currency operating cash flows prepared by
Rachel Ridd
The board has asked me to consider foreign currency risks relevant to KHC's first six months of US
operations. I have set out specific illustrative information below.
US operating cash flows- information to illustrate exchange rate risk
Cash outflows on 31 March 20X7 -£435,000 -£ 435,000.00

Cash inflows on 31 March 20X7 $ 640,000.00 1.5208 £ 420,831.14
-£ 14,168.86
Cash outflows on 30 June 20X7 $ -720,000.00
Cash intlows on 30 June 20X7 $ 400,000.00
$ -320,000.00 1.5112 -£ 211,752.25
Spot ($/£) 1.5240 - 1.5275 1.524

3-months forward 0.72-0.67 cents premium 0.72
6-months forward 1.28-1.22 cents premium 1.28
Borrowing Lending
Sterling (£) 6.50% 4.50%
US Dollars (S) 5.00% 3.00%
(a) Currency risks of the US operating cash flows

By entering the US market, KHC will suffer economic foreign currency risk. This XE "Economic
risk" reters to the effect of exchange rate movements on international competitiveness. For
example, KHC uses raw materials which are priced in sterling as manufacturing is in the UK.
However, it exports products to the US so revenues are in S. A depreciation of the dollar against
sterling would erode the competitiveness of the company compared to local Us producers.
Techniques for protecting against the risk of adverse foreign exchange movements include the
tollowing:
KHC could invoice in £, thus transferring all risks to suppliers and customers. However, this
seems implausible in the circumstances as KHC is small, perhaps dealing with large
wholesalers and retailers in an advanced economy with a stable currency.
KHC could enter into forward contracts, under which an agreed amount of $ will be bought
or sold at an agreed rate at some fixed future date or, under a forward option contract, at
some date in a fixed tuture period. where there are many transactions it would be
inappropriate to hedge each one but hedging the net cash flow exposure would be
reasonable. However these are only short term measures. (See illustrative example below.)
KHC could buy foreign currency options, under which the buyer acquires the right to buy
(call options) or sell (Put options) a certain amount of a currency at a fixed rate at some future
date. If rates move out-of-the- money, the option is simply allowed to lapse.
KHC could buy foreign currency futures on a financial futures exchange. Futures are
effectively forward contracts, in standard sizes and with fixed maturity dates. Their prices
move in response to exchange rate movements, and they are usually sold before maturity,
the profit or loss on sale corresponding approximately to the exchange loss or profit on the
currency transaction they were intended to hedge.
KHC could enter into a money market hedge. One currency is borrowed and converted into
another, which is then invested until the funds are required or funds are received to repay the
original loan. The early conversion protects against adverse exchange rate movements, but
at a cost equal to the difference between the cost of borrowing in one currency and the
return available on investment in the other currency. (See illustrative example below.)
Where there are many transactions it would be inappropriate to hedge each one but
hedging the net cash flow exposure would be reasonable. However, these are still only short
term measures and would not manage a risk of a drift of £/S exchange rates over a longer
period.
Cash outflows on 31 March 20X7 -£14,169

Cash intlows on 30 June 20X7 -£211,752
3 months transactions
Receipt $ 640,000.00
What need to be borrowed now at 5% for 3 months / 1+ ( .05 x 3/12
$ need now $ 632,098.77
Net sterling amount 1.5275 413,812.61
Intrest rate £ .54% for 3 months x 1+ ( .04 x 3/12)
£ 418,468.00
Net cash payment -£435,000
- 16,532.00
$640,000 will be received 3 months hence, so $632,098 ($640,000/(1 + (0.05 x 3/12)) may be
borrowed now and converted into sterling, the dollar loan to be repaid from the receipts.
The net sterling payment 3 months hence is:
£435,000-{[S640,000/(1+(0.05x 3/12)1/ 1.5275 x[1 + (0.045 x 3/12)])- £16,532
The equation for the $640,000 receipt in three months is to calculate the amount of dollars to
borrow now (divide by the dollar borrowing rate) and then to tind out how much that will give
now in sterling (divide by the exchange rate). The final amount of sterling after three months is
given by multiplying by the steling lending rate.
6 months transactions
Cash outflows on 30 June 20X7 $ -720,000.00
Cash intlows on 30 June 20X7 $ 400,000.00
$ -320,000.00 1.5112 -£ 211,752.25
What needs to be lend now 3% for 6 months / 1+ ( .03 x 6/12

Dollars need to put in bank now $ -315,270.94
Net sterling amount 1.5240 -£ 206,870.69
Intrest rate £ 6.5% for 6 months x 1+ ( .065 x 6/12)
Sterling payment in 6 months -£ 213,593.99
$320,000 net ($720,000 - $400,000) must be paid 6 months hence. We can borrow sterling now
and convert it into dollars, such that the fund in 6 months will equal $320,000. The sterling
payment in six months' time will be the principal and the interest thereon. A similar logic applies
as for the equation above except that the situation is one of making a final payment rather than
a receipt.
The sterling payment six months hence is therefore:
I$320,000/(1 + (0.03 x 6/12)//1.5240 x (1 +(0.065 x 6/12)]- £213,594
An alternative approach
The intertemporal nature of the $ cash flows can be recognised as a $ inflow of $640,000
OCcurring after 3 months and a net $ outflow of $320,000 after 6 months.
Unless the $ cash inflows need to be converted to fs for use in the UK, some of the $640,000
inflows could be maintained in $ and be put on deposit in $ in the US for the three to six-month
period, rather than converted to £s. The amount invested would be $317,618 (ie, $320,000/(1+
(0.03 x 3/12)) such that it would accumulate to $320,000 after three months. This amount could
then be used to settle the net $ outflow of $320,000 ($720,000- $400,000) after six months. This
Would avoid the need for hedging the six-month $ net cash outiow by a torward or money
market hedge.
6 months transactions $ -320,000.00

Interest rate 3% for 3/12 - 317,617.87
warehouse distribution centre $ 3,000,000.00 1 July 20X7
Niche market
net cash inflow $ 400,000.00 2 years
net cash inflow £100,000 indenfiatly
Wider market
net cash inflow $ 350,000.00 30 June X8
net cash inflow £100,000 indenfiatly
Growth 4%
WACC 10%
Probaility of niche market 40%
Wider market 60%
1 July X7 £1: $1.5
Niche market
400k / 1.485 / 0.1-.001 £ 2,992,891.88
100k / 0.1 -£ 1,000,000.00
PV £ 1,992,891.88
Probaility of niche market 40%
£ 797,156.75
Wider market
4500k / 1.485 / 0.1-.005 £ 4,713,804.71
100k / 0.1 - 0.04 -£ 1,666,666.67
£ 3,047,138.05
Wider market 60%
£ 1,828,282.83
Total £ 2,625,439.58
Less 3m / 1.5 -£ 2,000,000.00
£ 625,439.58
*£1 = $1.5 at 1 July 20X7 moves to f1 = $1.485 at 30 June 20X8 with 1% appreciation of the $
**5% reflects 1% ongoing exchange rate appreciation and 4% $ cash flow growth (more
precisely should be 5.049% (1.04 x 1.01).
The outlay in sterling will be $3m/1.5 £2m
NPV = (0.4 x £1,992,892) + (0.6 x £3,047, 138) - £2m - £625,440
Recommendation
While there is an expected positive NPV, there is also a 40% probability of a negative NPV (ie, if
there is a niche market the PV is less than the outlay of £2 million). Even these figures are
dependent on the accuracy of the underlying assumptions.
Nevertheless, based on these assumptions, for which the test marketing exercise has given
some assurance, there is a significant positive NPV. Also the downside loss in terms of the
negative NPV for a niche market outcome is relatively smal.
A tentative recommendation is therefore to invest in the warehouse but any commitment should
be delayed as long as possible to gain the maximum amount of information from market entry.
(6) Raising finance

The financing need of $3 million is substantial when measured against the company's net assets
of E5.8 million. However, brands are internally generated and represent a signiticant
unrecognised asset.
Leasing
It should not be assumed that debt is the only alternative when equity finance is not available.
Leasing may be a useful choice that would restrict the US financial commitment depending on
the term of the lease. A lease may be an alternative to borrowing, but it may, in commercial
terms, amount to a similar commitment with similar characteristics. Local advice on the tax
implications of a lease and debt may be needed.
The currency in which the debt is denominated

In financing operations overseas, there may be a currency (foreign exchange) risk for KHC XE
Foreign exchange risk" arising trom the method of ftinancing used. For example, it KHC decides
to acquire the distribution centre in the US, using a sterling denominated loan, the investment
will provide returns in S, while the bank will want interest and capital paid in sterling. If the $ falls
in value against sterling, the sterling value of the project's returns will also fall, but the financial
commitment to the bank will remain unatfected.
To reduce this currency risk, KHC might finance it with funds borrowed in the same currency as
the investment ie, in dollars.
The advantages of borrowing in the same currency as an investment are that:
assets and liabilities in the same currency can be matched, thus avoiding exchange losses on
conversion in the Group's ftinancial statements (see Section (3) below).
revenues in S can be used to repay borrowings in the same currency, thus reducing losses
due to tluctuating exchange rates.
KHC therefore has three options when financing the US project:
Borrowing in the same currency as the inflows from the project (ie, in $). This can be done in
the US or using KHC's UK bank.
Raising finance in the UK, denominated in sterling, with a hedge in place.
Raising finance in the UK denominated in sterling, but without hedging the currency risk. This
exposes KHC to exchange rate risk that can substantially change the profitability of Us
Operations,
The type of debt

A bank loan would be the obvious type of borrowing as this scale is far too small for a bond
ISSue.
Fixed or floating rate
Fixed rate loans are where the coupon rate of interest paid on the loan is at a set level for the
entire life of the loan. If the loan is held to maturity, this gives certainty over the cash flows of
interest and principal that will need to be paid by KHC in terms of the local currency. Iif it is a $
denominated loan, the sterling equivalents will not be certain, but there is scope for currency
matching as noted above.
The risk with fixed rate loans is that if market interest rates rise, then the fair value of the
instrument will fall as yields increase (and vice versa).
Variable rate, or tloating rate, loans are where the coupon rate varies according to market
interest rates (eg. LIBOR). Rates are reset periodically. Foras loan, KHC Would have the variation
in cash interest paid according to US market interest rates and for a sterling loan according too
UK market rates.
The term of any loan
Careful consideration needs to be given to the term or period of any loan.
A long term, fixed rate agreement would give certainty of cash flows for many years. A variable
rate agreement would mean KHC would be subject to variations in short term interest rates over
time.
In either case, the risk of refinancing a long term loan would be deferred for many years
providing liquidity advantages during the period KHC is trying to become established in the US
market.
A downside to a long term S denominated loan would be that if the US venture tailed, then KHC
Would be locked into making S interest and capital repayments for many years with no
corresponding S revenues. Additional hedging arrangements would be needed if this became
the case
(0) Financial reporting issues

Foreign currency- assets and financing
Under this strategy, the division is part of KHC for accounting purposes so its results, assets and
liabilities are treated as those of the KHC parent company.
The foreign currency translation issues relating to the division therefore relate to transactions
and balances being translated into the functional currency of KHC (most likely the £). The issue
of presentation currency does not arise as there is no issue of consolidation.
Assuming that the KHC functional currency is the £, then the US revenues are required to be
recognised in £s at the spot exchange rate at the date on which the transaction took place. The
date of the transaction is the date on which the transaction first satisfied the relevant recognition
criterla.
If there is a high volume of transactions in foreign currencies by the division, translating each
transaction may be an onerous task, so an average rate may be used.
The new warehouse distribution centre would represent PPE as a foreign currency asset which is
a non-monetary asset. This would be depreciated over its useful life.
Non-monetary items such as the warehouse will not require retranslation so the warehouse
distribution centre when acquired on 1 July 20X7 will be translated at the assumed spot rate on
that date of f1 = $1.5 and would not be retranslated. Depreciation on this cost would theretore
also be based on the same historic exchange rate. The value in the statement ot financial
position of KHC would not therefore be affected by subsequent exchange rate fluctuations.
Receivables arising from US sales represent another foreign currency asset but they are a
monetary asset. These assets will need to be translated into fs as KHCs functional currency at
each reporting date.
Monetary assets and liabilities would therefore be affected by subsequent exchange rate
ffuctuations and resulting exchange gains or losses impact on profit. Exchange gains/losses on
monetary operating items (eg, receivables) would be recognised in operating costs. Exchange
gains/losses on monetary finance items (eg, a $ loan) would be recognised in finance costs.
Hedging
The investment in the US and its financing cannot be designated as a net investment in a foreign
operation in accordance with lAS 21, The Effects of Changes in Foreign Exchange Rates as this
rule applies only to consolidated financial statements and KHC does not prepare these as the
US operations are only a division, not a subsidiary.
Also, a foreign currency borrowing in USS cannot be designated as a fair value hedge of the US
assets purchased in S (eg, a warehouse) because these assets are non-monetary. AS such, they
are not subsequentiy remeasured under IAS 21 and therefore they do not contain any
separately measurable foreign currency risk.
fa future sale of the warehouse is highly probable, then it could be designated as a cash flow
hedge, but this seems unlikely as it has not yet been purchased.
Where the S denominated revenues and costs are highly probable, as seems the case, and they
are to be hedged with a forwardor a money market hedge (hedge instruments) then, if the
hedge accounting conditions of IFRS 9, Financial Instruments are met, this may be treated as a
cash flow hedge. That is:
the portion of gain or loss on the hedging instrument that is determined to be an effective
hedge should be recognised in other comprehensive income; and
any excess in the cumulative gain or loss on the hedging instrument over the movement in
the hedged item is recognised immediately in profit or loss
The gain or loss on the hedging instrument that has been recognised in other comprehensive
income should be reclassified to profit or loss on receipt/payment of the related operating cash
flow.
Leasing
f leasing is to be used to finance the warehuse IFRS 16, Leases will apply. Under IFRS 16, all
leases will be recognised in the lessee's statement of financial position as a lease liability and a
right-of-use asset with the effective interest expense recognised in profit or losS.
(a) Distribution and warehousing

The decision to builda warehouse distribution centre in the US is partly an issue of cost and partly
an issue of distribution strategy.
In terms of cost there is a greater fixed cost (both initially and annually) in having a warehouse
distribution facility in the US, compared with supplying each retailer, directly from the UK.
AUS warehouse distribution centre would need to be justified in terms of sales volumes as
although fixed costs would be higher, the variable costs could be reduced by more efficient local
distribution to the US and within the US. As an example an agreement with a US wholesaler might
reduce distribution costs and widen access to US retailers.
At the moment, it seems clear that KHC's scale in the US is not sufticient to justify a warehouse
distribution centre. Moreover, it a warehouse distribution centre was set up and the US operations
subsequently tailed, then there are likely to be more signiticant exit costs.
As KHC grows in the US, the arguments, based on costs, about whether to have a warehouse
distribution centre may become more finely balanced. If export volumes rise signiticantly, then
demand may exceed the warehouse capacity in the UK, and a US warehouse could become more
cost effective than a new UK one if labour and property prices are lower. The impact on
distribution strategy may then become the major tactor.
Distribution is part of the downstream supply chain and the management of all supply activities
through to delivery to customers is an important part of becoming successtul in the Us.
Distribution is theretore part of demand chain management, XE "Demand chain management
retlecting the idea that the customers' requirements and downstream orders should drive activity
of end-to-end business (e2e).
The distribution channel comprises a number of stakeholders including: manufacturer (KHC);
wholesalers; retailers and consumers. The local holding of inventory in the US enables the
distribution channel to be shortened in some cases, but there may still be signiticant delays in
supplying from the UK (particularly if supplied by ship rather than by air) unless demand is stable
or significant inventories are held at the US warehouse.
Supplying directly from the UK might result in more significant delays for consumers unless
wholesalers and retailers are prepared to hold significant inventories and suffer the costs of doing
so in order to make sales of KHC products.
Benefits of a US warehouse distribution centre

The lead times and uncertainty of delivery times are greater if supplied from the UK as the
geographical distances are larger. Inventory can be held locally in the US with a warehouse
distribution centre to meet surges in demand more quickly and with less uncertainty for
customers than by supplying directly from production output in the UK.
As a consequence, this strategy is driven by customer need, which is central to the end-to-end
business model. The US presence means that KHC is closer to the customers and could
perhaps better understand their needs.
Presence in the US, rather than delivery directly from the UK, means more local employees with
local knowledge can be used.
Reputation with customers may improve it they know they are being supplied locally (ie, their
supply chain becomes within the US to a greater extent).
Managing customer service from the UK becomes more difficult as US sales volumes grow and
a distribution tacility will, at some point, in the growth curve be a minimum response to satisty
the needs of the US market.
Amore substantial response to US sales growth would be to have a US production facility.
However, having a distribution tacility holding inventory is a much cheaper alternative than a
second manutacturing site in the US which would increase fixed costs and would need an
appropriate skills base without any history of production in the Us.
Having more costs in the US will mean more costs incurred in $ which would be a natural
hedge against the $ revenues that will be earned as a partial protection against currency risks.
Risks
Mere location within the US still leaves a large geographical distance between the warehouse
distribution centre and much ot the US population. A Single distribution centre may therefore
only be a partial solution to the need to improve customer service. A network of multiple
distribution facilities may be warranted at a later date itf and when sales grow more
substantially.
The fixed production facility increases fixed costs and therefore increases risk from operating
gearing if US sales are volatile. Exit costs are also increase if the US venture fails.
High risk of a stock out. May need higher inventory levels than would be the case for an
equivalent level of UK sales, as there is only one warehouse and there is a risk that there may
be inventories in the UK which cannot quickly be used to supply the US market.
Recommendation
Initially, for market entry, sales volumes are likely to be low and supplying from the UK directly to
retailers located across the US is likely to be the most efficient means of distribution while there
are few economies of scope. As sales grow a little, the use of wholesalers may facilitate wider
distribution but there may be a sacrifice of some margin to achieve this, as there would be an
extra step in the supply chain.
Over time, if conditions change and sales expand, a larger number of customers geographically
dispersed across the US may be more eficiently suPplied, with shorter lead times and therefore
better customer service, from a US warehouse distribution centre. If sales expand further, then
multiple US warehouse distribution centres serving different regions of the US may become
appropriate.
(6) Pricing strategy

It is important for the Kiera Healyo brand to gain a foothold in the US market in terms of
recognition and reputation.
The pricing policies used in Ne York (price penetration) and Boston (price skimming) represent
two extremes.
Price penetration can help to gain market share by setting low price initially to enter the
market and get the brand name known amongst as many consumers as possible. Price
penetration may also help in obtaining economies of scale which could render KHC's US
operations more viable as a long-term strategy.
Price penetration is a temporary policy, as prices need to be increased later to generate proft if
sales are being made at full cost price as in New York. It may be ditfticult however, to increase the
price once this lower price has been established.
The low initial prices may also damage the brand name, particularly for toiletries products where
quality is not easily observable, and it may be ditticult to establish a quality brand image later.
Price skimming is where the initial price is set high for new products launched into a market and
a smaller market share is normally gained but at a greater margin. This policy was intended by
KHC in Boston.
Typically a price skimming policy will involve a company charging high prices when a product is
first launched; then spend heavily on advertising and sales promotion to win customers. The
company may later lower its prices in order to attract more price-elastic segments of the market;
however, these price reductions will be gradual.
For KHC, the Boston price model has been successful in generating a higher sales volume at a
nigher price.
One possible reason is that the price is a signal of the quality and image of the product and it
has become successtul in this area partly because of, rather than despite, the price. Another
consideration however is that it was non-price factors that caused the difference in sales
volumes(eg, difterences in culture between the two cities, ditferences in retailers selected or
locations within the cities).
There are significant questions whether the price skimming model is either sustainable within
Boston or extendable to other regions of the US.
Perhaps a more sustainable pricing model would be based on market research including what
similar products are selling for in the US market and what the target market group is willing to
pay. This group may ditter from the females aged 25 to 40 applying in the UK market.
Branding issue
Licensing the brand
A licence grants a third-party organisation (the licensee) the rights to exploit an asset belonging
to the licensor.
Licences over brand rights are common. The licensee, Mooton, would pay an agreed amount (in
this case f5 per bag), to KHC, as licensor, relating to the sales generated on licensed products
for the right to exploit the Kiera Healye brand for its Attude range of products in the specitied
geographical area of the UK.
The total annual payment from Mooton would be £150,000 per annum (30,000 x £5). In
perpetuity (assuming that the four year contract was constantily renewed or replaced)
discounted at the WACC this would give a value of £1.5 million.
This compares favourably with the f2.5 million offered by Buckingham for the brand rights to all
fts products (except cosmetics). Ihere may be some annual monitoring costs to be incurred
which will reduce the PV but these are not likely to be significant.
Licence agreements will vary considerably in the constraints placed on the licensee. Some will
dictate branding, pricing and marketing issues. Others will leave these decisions to the licensee.
Licensing can be a method of financing rapid growth without having to make an initial
investment, as KHC would need to do to exploit ditferent product markets itselt. Mooton will
also bring core competences in handbag manufacture that KHC does not have and may find
difficult to acquire.
There needs to be some incentive for the companies involved to purchase the licence but as
Mooton has already approached KHC presumably it believes it will benefit from the licensingg
agreement
From KHC's perspective, the financial risk is low as there is a low risk new revenue stream with
no operating costs to be incurred other than setting up and monitoring the arrangement. There
is however a potential reputational risk.
A key issue is whether Mooton will enhance, damage or have neutral effect on the Kiera Healy
brand.
The licensing arrangement may enhance recognition of the Kiera Healy brand name and
stimulate sales of toiletries. Alternatively, it may damage the brand name it Mooton's product or
customer service is not of the same quality as KHC. Contractual protection against this could be
built into the licensing agreement to protect against this risk. This might involve control over
production quality, service quality and controls over the advertising image presented.
Also in order to manage risks:

a break-date or exit route from the contract needs to be established in case the relationship
fails within the contract period.
controls measuring sales volumes are needed so Mooton does not exploit the contract and
underpay on the licence royalities. A clear cut-off date needs to be established in the contract
as triggering a royalty payment (eg, date of production, date of sale to retailer, date of sale to
consumer.
Selling the brand

The decision to sell the brand would depend fundamentally on the price that could be
obtained. Three ways of determining the brand value are:
The market basis - this uses market price and other market transactions. Given the nature of aa
brand is unique this would be difticult to use (note, the offer of f2.5 million from Buckinghamn
plc was not appropriate but, had it been for the entire global rights, serious consideration could
have been given to this method of valuation, although as the ofter was rejected the valuation
itself seems too low).
The income basis - This would consider the present value of the incremental income generated
by the brand. No price premium is obtained by the Kiera Healy brand, but additional sales
volume is obtained.
The cost basis - this is the current replacement cost of the brand which is the PV of the
advertising expenditure of f3.5 million. The basis on which this value was determined would
need to be considered, including allowance tor risk and how the expenditure could replicate
the brand in varying market conditions.
Aside from the valuation there are adverse strategic factors which are as follows:
The ability for KHC to leverage the brand in future in order to expand is lost permanently
While the brand sale invoves a cause to retain an exclusive and pemanent right to
continue to use, without charge, the "Kiera Healy brand for toiletries globally' the use of
the brand by other companies may damage the brand for KHC (eg, if the other companies
used it for downmarket products).
On the positive side, larger companies could leverage the brand more efficiently than KHC and
Kiera may obtain a higher price in expectation of this. As a stand-alone company, KHC may take
many years to be of sufficient size to explot the brand as effectively.
Minimum price
The minimum price is likely to be higher than the f2.5 million as: this price was rejected; it only
related to non-toiletry products; and the company has developed since the offer was made.
The f1.5 million for licensing to Mooton just for handbags seems indicative of the value of the
brand it it can be spun out to other types of product.
Cost basis of f3.5 million has no element of added value above cost so a minimum of around
t4 million to f5 million may seem appropriate.
lgnoring tax this would give a P/E ratio of around 6.2 to about 7.7.
PHM engagement
Agreed-upon procedures
In an agreed-upon procedures (AUP) engagement, PHM would provide a report of factual
findings from the procedures and tests performed, which need to be agreed with both KHC and
Mooton. The procedures and tests required should be sufticiently detailed so as to be clear and
unambiguous, and discussed and agreed in advance with both KHC and Mooton, so that the
factual findings are useful and appropriate to the licensing contract.
When performing an AUP engagement on historical financial information, PHM, as practitioners,
are required, as a minimum, to comply with International Standards on Related Services (ISRs)
4400, Engagements to Perform Agreed-upon Procedures Regarding Financial lnformation.
Our report for an AUP will not express a conclusion and, therefore, it is not an assurance
engagement. It will not provide recommendations based on the findings.
We would request that KHC and Mooton review the procedures and findings in our report and
use the intormation to draw their own conclusions.
A key guide to the procedures that PHM would carry out would be related to the contractual
terms of the licensing agreement. For example, the number of bags sold; the number of
customer complaints about product quality; and the number of customer complaints about
service quality.
The value of an AUP comes from PHM, as practitioners, objectively carrying out procedures and
tests with relevant expertise thus avoiding the need for KHC to carry Out the procedures and
tests themselves and theretore it protects confidentiality for Mooton.
AUP are most effective in situations such as this where there is a clear matter to focus on in the
form of the licensing contract.
The benefit to KHC of agreed-upon procedures is therefore that it provides evidence for the
board that Mooton is complying with the terms of the licensing contract in identitying,
measuring and attributing all sales of the Attitude range and is fully stating the royaity payments
to KHC. Ihis prevents understating of royalty payments by Mooton and the monitoring of other
contractual terms in amanner that is inconsistent with the licence contract. Aspects of quality
control could also be monitored (eg, customer complaints) to restrict any reputational damage.
Mooton may be more likely to allow PHM to carry out this task as a professional accountant than
perhaps they would with KHC staff, due to the commercial sensitivity of other information that
may be obtained in the process. In this cotext ISRS 4400 requires compliance with the
applicable requirements of the Code of Ethics for Professional AccoOuntants.
1.5275
0.67
1.22
Q PLC
Listed on AIM in 4 years
Directors Rem increased 10% Year on year but profits not grown
3 months to
3 months to 30 31 3 months to
September December 31 March 3 months to
20X5 20X5 20X6 30 June 20X6 Total
Revenue by customer type:
Individual customers 4,805 3,914 4,766 6,975 20,460
Stores 1,395 1,136 1,384 2,025 5,940
Revenue by product type
Home products 4,200 4,550 4,900 5,250 18,900
Garden products 2,000 500 1,250 3,750 7,500
Cost of sales by product type:
Home products 2,940 3,185 3,430 3,675 13,230
Garden products 1,200 300 750 2,250 4,500
Number of items sold

Home products 120,000 130,000 140,000 150,000 540,000
Garden products 50,000 10,000 25,000 75,000 160,000
Number of items returned by all 8,500 7,000 8,250 11,250 35,000
Number of different types of pro 480 380 420 560
Analyisis of data
3 months to
3 months to 30 31 3 months to
September December 31 March 3 months to
20X5 20X5 20X6 30 June 20X6
Home products 4,200 4,550 4,900 5,250 18,900
Home products 2,940 3,185 3,430 3,675 13,230
1,260 1,365 1,470 1,575 5,670
GPM 30% 30% 30% 30% 30%
Home products 120,000 130,000 140,000 150,000 540,000

Price 0.035 0.035 0.035 0.035 0.035

Garden products 2,000 500 1,250 3,750 7,500
Garden products 1,200 300 750 2,250 4,500
800 200 500 1,500 3,000
GPM 40% 40% 40% 40% 40%
Garden products 50,000 10,000 25,000 75,000 160,000
Price 0.04 0.05 0.05 0.05 0.046875
Total revenue 6,200 5,050 6,150 9,000 26,400

Total COS 4,140 3,485 4,180 5,925 17,730
2,060 1,565 1,970 3,075 8,670
GPM 33.2% 18.3% 19.1% 20.6% 19.6%
Revenue per product type 12,917 13,289 14,643 16,071
Board level data

The types of data made available to the board needs to be commensurate with the types of decisions being made at board
relevance to enable them to control the company and its operations.
Too much detailed data at board level may cause data overload and therefore the inability to comprehend and evaluate th
(indicated by the data in Exhibit 3) the data appear to be too aggregated to be useful.
Sales and customer management

It would appear that data is held on a database of each customer's characteristics and transaction history. The comment b
detailed data to be useful to us' needs to be treated with a degree of professional scepticism.
While this may be a large data set, companies are increasingly using big data analytics to analyse unstructured data to iden
ldentitying such patterns could enable target marketing by Quinter according to the type and frequency of historic purcha
pricing and bespoke customer service.
Sales are only available by product type (household and garden) rather than by product line (where there are over 560 diff
Showing revenue and gross profit for all 560 difterent items may be too much information for board level decisions. Howe
line or support further sales of a successful product line would be the type of decision appropriate to board level. Product
size: best selling down to worst sell ing). Alternatively, management by exception could be used by reporting to the board
product lines.
Sales return information is also poor. The returns need to be analysed between faulty returns and 14 day returns from a ch
then be identified with relevant suppliers so the board can decide whether contract terms have been fultilled (ie, do not p
e the supplier relationship in future.
Certain types of customer may also have a higher propensity to return goods within the 14 day period. Once identified, sal
marketing staff.
Inventory management data

Better data, and better analysis of existing data, can help identify how much inventory is needed and when it is needed. M
quantities to meet customer needs on a timely basis, can reduce inventory costs. These may include: storage costs; damag
A key issue is predicting the timing of demand and ensuring that sufficient goods are ordered to arrive on time, after allow
uncertainty of lead time may mean a buffer inventory needs to be held to prevent shortages which could mean customer n
Key tactors would be analysing historic data to identity the timing of Surges in demand or dropping off in demand (eg, seas
captured in historic data such as an advertising campaign, a tavourable review tor a product in the press or a sudden spell
Data need to be constantly monitored, updated and analysed and compared to inventory levels which should be measured
Relationships with suppliers also need to be part of the data management eg, linking Quinter's IT systems with those of lar
be resupplied at the earliest opportunity.
(3) Financial reporting - inventory

A significant amount of inventory as suggested by Mike Fisher (Exhibit 4) creates the risk that there is scope for material m
and the statement ot profit or loSS.
However, it is not merely the amount of the inventory that creates the risk of misstatement. It is also the nature of the goo
some items likely to be held in inventory for far longer than the average turnover period.
IAS 2, Inventories, requires that inventories should be stated at the lower of cost and net realisable value. There is a risk th
obsolescent, (or at least only capable of being sold at reduced prices) if held in inventory for an extended period. This may
but may also apply to many other electrical items.
Poor information systems, or poor managerial controls in appropriately using these systems, means that old inventories or
(eg, from the introduction of an ageing analysis of inventories) in order to be able to make the appropriate write down.
Inventories are non monetary assets in accordance with IAS 21, The Etfects of Changes in Foreign Exchange Rates. As such
date of purchase and not normally retranslated thereafter. The fact of the inventories being purchased in a foreign curren
long as the original purchase price is recorded.
However, where there is an impairment, or other fair value adjustment, the values of inventories are retranslated at the cu
and reliable continuous inventory records in order to be able to do this.
(4) Corporate governance

A number of aspects of corporate governance need to be reviewed.
Non-executive directors with the right skills and experience need to be appointed (eg, IT skills as Quinter is an internet bas
monitor and manage their pertormance at an operational level.
Subcommittees need to be set up.
Establishing an audit committee seems key to monitor internal performance and information flows (not just dealing with e
controls would be enhanced by an internal audit function reporting to the audit committee. The audit commíttee would co
the performance of the company and its executive directors. As chairman, it may be suitable tor Mike to also chair the aud
A remuneration committee seems appropriate to ensure that, as part of pertormance management for the executive direc
package for promoting the performance of the company. At the moment, without any non-executive directors other than
awarding the executive directors a 10% annual pay rise. If it was the directors themselves, then there may be a contlict of
New executive members of the board may be appropriate as, at four, the board is small and may not have the full spectru
would be useful to do this.
(5) Sustainability
Sustainability is about ensuring that development meets the needs of the present without compromising the ability of futu
The idea of recycling is consistent with sustainability, in that an organisation should only use resources at a rate that allow
will continue to be available). At the same time, waste should be confined to levels that do not exceed the capacity of the
recycling policy attempts to reuse some resources and reduces waste.
However, recycling is only one aspect of sustainability. Wider social, environmental and economic issues also need to be a
responsiblty in promoting sustainability as a listed company acting in the public interest.
Sustainability reporting is an important issue. The ICAEW publication Outside Insights: Beyond Accounting highlights a num
sustainability reporting to be effective and these are relevant to Quinter's decision to report its sustainability policy in the
be indicated. These include the following
Who reports are tor
Links to corporate/business strategy
Materiality of issues reported
Validity of indicators
Objectivity of reporting
Transparency of information
Comparability of information
Balance of information
Understandability of the report
Audit/assurance of the report and performance
External stakeholder engagement
Integration with financial reporting
Addressing true sustainability
An integrated report should explain how the organisation creates value, using both quantitative and qualitative informatio
One aspect of this is natural capital, including the impact that Quinter's activities are having on air, water, land, minerals a
this.
The benetfit to Quinter of such disclosures is that it presents the image of corporate responsibility in formal communicatio
policy.
Publishing the sustainability policy in the annual report also makes environmental assurance more teasible to order to atte
effectively.
Additional management data

While the primary purpose of Quinter's recycling is to demonstrate a policy of sustainability, and therefore corporate resp
information which may give rise to a range of business opportunities. Ihese may include the following:
Information that the customer will no longer be using the product previously purchased and therefore that there may be a
Customer. The purchase of new product is a necessary condition of the collection policy. This may be an opportunity to se
policy as being more about commerciality than sustainability.
t provides a reason to contact customers periodically when it is possible that the average life of a past purchase has expire
recycle their old goods but also to persuade them to buy a new item from the company.
Provides general marketing data about the probable life cycle of Quinter products.
78%
23%
72%
28%
75%
25%
77%
23%
5%
ecisions being made at board level. This should be of sufficient detail and
comprehend and evaluate the key issues within that data. As it stands, however,
tion history. The comment by a member of staff that 'there is just too much
yse unstructured data to identify trends and extract insights to improve decisions.
frequency of historic purchases and customer characteristics, enabling tlexible
where there are over 560 different types of individual product).

board level decisions. However, whether to discontinue a poorly selling product
riate to board level. Product line data could theretore be analysed (eg, in order of
ed by reporting to the board only the outliers of the best and worst pertorming
and 14 day returns from a change in the customer's mind. The faulty returns can
ve been fultilled (ie, do not pay the supplier) and whether Quinter wants to continu
y period. Once identified, sales to these customers may not be encouraged by
ed and when it is needed. Minimising inventory, while still having suficient

nclude: storage costs; damage; obsolescence; insurance.
to arrive on time, after allowing for the lead time. Uncertainty of demand and
which could mean customer needs would not be satisfied on a timely basis.
pping off in demand (eg, seasonality of garden goods). Other factors may not be
n the press or a sudden spell of good weather to encourage garden purchases.
els which should be measured continually (continuous inventory measurement).
s IT systems with those of large key suppliers so forecast inventory shortages can
there is scope for material misstatement in both the statement of financial position
t is also the nature of the goods and that the average inventory turnover is high, with
sable value. There is a risk that some electrical goods are likely to become
n extended period. This may be particularly the case with computer equipment,
means that old inventories or damaged inventories may not be readily identifiable
e appropriate write down.
eign Exchange Rates. As such, they will be translated at the exchange rate on the
urchased in a foreign currency is not therefore a major financial statement risk so
ries are retranslated at the current date and therefore it is necessary to have detailed
as Quinter is an internet based company) to advise executive directors and to
flows (not just dealing with external auditors). Information flows and management
he audit commíttee would consist of non-executive directors who would monitor
or Mike to also chair the audit committee.
ement for the executive directors, they are motivated by their remuneration
ecutive directors other than the chairman, it is difficult to see who has been
n there may be a contlict of interest, a selt-review threat and a self-interest threat.
may not have the full spectrum of skills necessary. An appointment committee
mpromising the ability of future generations to meet their own needs.

esources at a rate that allows them to be replenished (in order to ensure that they
t exceed the capacity of the environment to absorb them. Quinter's proposed
omic issues also need to be addressed for Quinter to demonstrate corporate
Accounting highlights a number of issues that must be addressed for

s sustainability policy in the annual report in terms of the level of detail that should
ve and qualitative information.
n air, water, land, minerals and forests. Recycling would be one element addressing
bility in formal communication by indicating the proposed (it limited) ustainability
more teasible to order to attest that the claimed policies are being implemented
nd therefore corporate responsibility, it will also generate additional management
herefore that there may be a sales opportunity to sell new goods to the
may be an opportunity to sell more goods. However it also casts doubt on the
of a past purchase has expired. Quinter sales staff can then market to them to
Jan X4 90%
Consideration 432
10% 21
share options veted 31 Dec X7
Obtain AIM listing
Production
20m invested to increat automation
redudant of staff
20X5 20X6
Sales 3600 3600
Factory Assembley
Capacity 3600 5200
Staff 300 900
Sales
Sports car 70%
6 months wait on delovery
Sales and production occur evenly over the year. In 20X5, the geographical distribution of total sales revenue was:
%
US 25
UK 40
Eurozone countries 30
Other regions 5
20X3 20X4 20X5 20X6

(estimated)
Revenue 240,000 270,600 309,600 313,200
Gross profit 60,000 85,800 104,400 104,400
Operating (loss/profit -20,000 800 14,400 13,400
(Loss/profit before tax -23,000 -2,700 10,400 9,400
(Loss/profit after tax -18,400 -2,160 8,320 7,520
Property, plant and equipment 80,000 88,000 96,000 95,000
Net current assets 30,000 29,840 40,160 48,680
Non-current liabilities 60,000 70,000 80,000 80,000
Equity 50,000 47,840 56,160 63,680
Operating data for the years to 31 December are as follows:
(estimated)
20X3 20X4 20X5 20X6
Number of cars produced and sold 3,000 3,300 3,600 3,600
Number of employees 1,500 1,350 1,200 1,200
ales revenue was:
(estimated)
(estimated)

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Merson, Shiplock and Brown LLP

MSB's contractual duty is to HH as a legal entity, though.

ting in the capacity as business adviser or assurance practitioner or alternatively those

MSB's appointment is not a statutory appointment such as an audit, this may be

e the powers of confidentiality may itself be a breach of confidentiality.

orm its functions.

ents, making a distinction between definite amounts and estimates of future

capital can be made available to fund it.

Interest rates Borrow Lending

contract size $12,500

Now is December with 3 months to expire of March contracts

If forward foregin markets

Net three months £

Net six months

Rate 1.69670 £ 172,688.16 lower rate as purchase

Purchase components £ 116,000.00

Net six months

cost of borrow $ 293,000.00

the amount in £ today 1.7106 $ 166,296.05

sterling lending rate 12.50% 1.0625 £ 176,689.55

number of contract 12,500 £ 13.79 rounded 14

cost of option 14 x 12,500 x 3.45 cents $ 6,037.50

Overall cost £ 175,000.00

as the use of foregin exchange market above £ 172,688.16

using 1.80 options

number of contract 12,500 £ 13.02 rounded 14

14 contract will provide 14 x 12,500 £ 175,000.00

Overall cost £ 175,000.00

figures $1.70 £ 175,906.17

Use the lowest at 1.80 preferable

Fair value hedge

Inv cost $ 2,600,000 1 July X2

March X3 futures $ 27.50

Gain to be made on futures contract

DEBIT Future contract asset $425,000

Sterling option contracts of £31,250 contracts (cents per £) Asume 1 June

Prices are quoted in cents per £.

receipts using lower rate $1.5404 $ 5,776,500

value of gain $ 226,500 $ -111,000 $ -298,500

Exercise price Cost

Summary. The futures hedge achieves the target exactly.

less say 0.82/100 off the spot rate

nth forward rate,

ntract size £62,500)

them would not use them and use 1.6 as best

Indirect costs Op cost 135000]

Year 0 Year 1 Year 2 Year 3 Year 4

Costs 1.1 1.3 1.4 1.5

Self test question 4 from chapter 17

Captial Rate 12%

Undertan cost £ 50,000.00 ignore as sunk cost

Year 1 Year 2 Year 3 Year 4

Year 1 Year 2 Year 3 Year 4

Revenue less exp - 1,520,000.00 548,937.50 809,534.38 793,261.09

Year 0 Year 1 Year 2 Year 3

NPV 14% T1-6 £1,148,070.48 NPV(.14,CH year1-year6

Worked example Sensortex from chapter 20

£ 488,281.25 5 years divid 1.25

Year 4 Year 5 Year 6