BUSINESS ANALYSIS Time allowed – 3 hours Total marks ... - ICAB

BUSINESS ANALYSIS
Time allowed – 3 hours
Total marks – 100
[N.B. – The figures in the margin indicate full marks. Question must be answered in English. Examiner will
take account of the quality of language and of the way in which the answers are presented. Different
parts, if any, of the same question must be answered in one place in order of sequence]
Marks
1. The Passion, one of the leading supermarket chains in Bangladesh, which has stores in all the major
district towns, adopted the policy of disclosing its key risk issues in the Operating and Financial
Review section of their published annual report.
Requirements:
a. Using your knowledge of super market chains in general, list and comment on the main risks
that Passion faces. 8
b. What method of risk management and internal control are likely to be most appropriate for
Passion in the light of your answer to (a)? 7
2. Happy Products Limited was purchased as part of management buy‐out in 2006 by the existing
management Ahmed and Ali. The company buys cosmetic products from variety of suppliers in
order to supply retailers. Ahmed was the Sales Director and Ali was the Finance Director.
Ali organized the finance by mortgaging both of their houses and borrowing from the banks. He has
continued to deal with the financial and administrative areas of the company whereas Ahmed is
totally involved with the suppliers and customers.
Ahmed was always an excellent sales person and his commitment to customers is next to none.
Most deals are personally done by him and he always maintains excellent relationship with his
customers.
Ahmed has also similar commitment to his suppliers. At the beginning he tried to limit the number
of suppliers, but as the company has grown he has forced to deal with a growing number of
suppliers. Most of the purchases are from China or India. Initial concentration on few major
suppliers has ensured that Happy Products has been able to have exclusive access to some products.
The company buys its products from variety of manufacturers but markets them in its own brand
name. This allows the company to charge premium prices for these products as result of having
created a trusted brand.
The company has gone into strength to strength in the years since the management buy‐out with
revenue increasing on average by over 20% per annum. This has lead to increased number of
suppliers and employee strength from 100 of 2006 to 200. The company has also expanded
physically by taking new head office, new warehouses, investing in computer system to take care of
growing inventories and accounting.
Ahmed is committed to even further expansion but Ali was concerned that the company’s system
and finances cannot keep up with the rate of sales growth and would prefer a period of
consolidation. As an finance person, Ali was happy with the financial controls and performance
measures that has been built into the system, but is concerned that other non‐financial measures
might be just as important, particularly as the company continues to expand.
Requirements:
a. Explain the Ahmed the most common reasons why companies may fail and suggest ways in
which Happy Products could avoid them. 10
b. Using the balance scorecard approached, suggest other non‐financial performance indicators
that Happy Products could use to monitor its overall performance as it continues to expand. 10
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3. D Ltd. operates in a mature, low‐risk industry and has had a stable level of profit for many years.
Profits after tax for the current year were Tk.120 million and this level of profit is expected to
continue in the future providing the current dividend/retention policy is maintained. The company
adopts a dividend policy based on a dividend payout ratio of 80% and it has just paid a dividend for
the year that has recently ended. However, a newly‐appointed Chief Executive is considering three
new investment strategies will have the same initial investment, they will require different levels of
future investment but will lead to different future growth rates.
The Board of Directors has agreed that if any one of the three new strategies is decided upon the
future investment required will be financed entirely from retained earnings rather than any new
issue of equity. This will entail a reduction in future dividends. Alternatively, the business can
continue its current strategy of high dividend and no growth.
The Board has arranged to meet again in the near future to decide whether to support one of the
proposed strategies or whether to continue with existing strategy of high dividend payments and no
growth. The following figures, which relate to the proposed strategies, will be presented to the
Board at this meeting:
Strategy Dividend payment ratio Growth rate in profits Required return by shareholders
% % %
1 10 8 12
2 30 5 10
3 60 3 9
Requirements:
(a) State, with supporting calculations, what recommendation you would make concerning the
proposed strategies. 8
(b) Explain why the proposed change in dividend policy is likely to be regarded as important by
shareholders. 8
(c) Briefly explain why a company may prefer to fund investment projects by the use of retained
profits rather than by the issue of new equity shares. 4
4. P Ltd. is a wholly‐owned subsidiary of M plc. Although the subsidiary has provided satisfactory levels
of performance, M plc is considering the sale of the subsidiary to another conglomerate. M plc is
experiencing trading problems in other parts of its operations and needs to sell P Ltd. in order to
raise much‐needed finance. The most recent balance sheet of P Ltd. is as follows:
Balance sheet as at 30 November 2009
Fixed assets Tkm Tkm Tk m
Freehold land and buildings at cost 58.5
Less Accumulated depreciation 10.2 48.3
Fixtures and fittings at 8.6
Less Accumulated depreciation 2.9 5.7
Motor vehicles at cost 3.2
Less Accumulated deprecation 1.4 1.8
55.8
Current assets
Stock at cost 49.5
Trade debtors 23.4
Cash at bank 21.5 94.4
Less Creditors: amounts falling due within one year
Trade creditors 25.9
Corporation tax 5.4 31.3 63.1
118.9
Less Creditors: amounts falling due after one year
Debentures 49.0
69.9
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Capital and reserves
Ordinary Tk.0.50 shares 25.0
Retained profit 44.9
69.9
Extracts from the profit and loss account for the year ended 30 December 2009 are as follows:
Tk. m
Net profit after taxation 10.7
Dividend proposed and paid 3.3
A bid of Tk.3.50 per share for the shares in P Ltd. has been received from L plc. The agreed price
would be paid in shares in the bidding company.
The following details were taken from a financial newspaper concerning the shares of T plc, a similar
business operating in the same industry that is listed on the Stock Exchange and L plc, the
conglomerate company that has made the bid:
2008‐2009
High Low Stock Price ± Dividend (net) Cover (times) Yield (gross) P/E (times)
Tk. 6.40 Tk.5.80 T Tk. 6.15 +5p 12.0p 2.5 2.2 20.5
Tk.10.89 Tk.5.30 L Tk.10.89 +2p 15.0p 3.0 1.5 24.2
An independent valuer has recently estimated the current realizable value of the company’s assets
as follows:
Tk. m
Freehold land and buildings 104.2
Fixtures and fittings 3.5
Motor vehicles 0.4
Stocks 58.0
The balance sheet values of the remaining assets were considered to reflect their net realizable
values. Tax on dividends is at the lower rate of income tax of 10%.
Requirements:
(a) Calculate the value per share of P Ltd. using the following valuation methods: 10
(i) net assets (liquidation) basis;
(ii) dividend yield basis; and
(iii) price/earnings ratio basis.
(b) Briefly evaluate the strengths and weaknesses of each of the share valuation methods set out in
(a) above. 5
(c) Comment on the bid that has been received from L plc and state whether or not the bid should
be accepted. 5
5. A Ltd. (Healthcare) has invested Tk.220,000 over the past two years in the development of a
personal stress‐monitoring device (PSMD). The device is designed for busy individuals wishing to
check their stress levels. Market research that was commissioned earlier in the year at a cost of
Tk.45,000 suggests that the price for the PSMD should be Tk.22 per unit and that the expected
product life cycle of the device is four years.
In order to produce the device, the business must purchase immediately specialist machinery and
equipment at a cost of Tk.300,000. This machinery and equipment has an expected life of four years and
will have no residual value at the end of this period. The machinery and equipment can produce a
maximum of 15,000 PSMDs per year over four years. To ensure that the maximum output is achieved,
the business will spend Tk.50,000 per year in advertising the device over the next four years.
Based on the maximum output of 15,000 units per year, the PSMD has the following expected costs
per unit (excluding the advertising costs above):
Notes Tk.
Materials (1) 6.50
Labour (2) 5.50
Overheads (3) 8.50
20.50
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Notes:
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(1) The materials figure above includes a charge of Tk.2 for a polymer that is currently in stock and
can be used for this project. Each PSMD requires 200 grams of the polymer and the charge is
based on the original cost of Tk.1 per 100 grams for the polymer. It is a material that is currently
used in other areas of the business and the cost of replacing the polymer is Tk.1.50 per 100
grams. The polymer could easily be sold at a price of Tk.1.25 per 100 grams.
(2) The labour costs relate to payments made to employees that will be directly involved in
producing the PSMD. These employees have no work at present and, if the PSMD is not
produced, they will be made redundant immediately at a cost of Tk.230,000. If, however, the
PSMD is produced, the employees are likely to be found other work at the end of the four‐year
period and so no redundancy costs will be incurred.
(3) The figure includes a depreciation charge for the new machinery and equipment. The policy of
the business is to depreciate fixed assets in equal installments over their expected life. All other
overheads included in the above figure are incurred in production of the new device.
The business has a target capital structure of 50% equity and 50% loan capital. The market cost of
equity is 12% and the market cost of loan capital is 8%. The PSMD project has the same level of risk
as that of other projects undertaken and the level of investment required is very small compared to
the size of the business. If the project is accepted, it will be financed entirely by equity.
Ignore taxation.
Requirements:
(a) Calculate the net present value of the project. 15
(b) Calculate the required reduction in annual net cash flows from operations before the project
becomes unprofitable. 5
(c) Comment on your findings in (a) and (b) above. 5
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