SBM Questions 2

Ethics Page 1
Merson, Shiplock and Brown LLP

The ethical principles which are relevant to Kate's request are those of confidentiality and integrity - or, more specitically, transparency in relation to any potential dealings MSB needs
to have with HH's staff.
Confidentiality - Although Kate has asked for "complete confidentiality", she appears to be using the concept of confidentiality to mean that MSB should discuss its findings solely
with her, rather than with any other members of statt or the board ot HH. This seems to be a diterent interpretation of the principle than that used in ICAEW's Code of Ethics which
requires an accountant not to disclose information acquired in the course of a protessional engagement to third parties without specific authority, unless there is a legal or
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 its ethical duties are owed: to Kate, or to HH. (Members
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 business adviser or assurance practitioner or alternatively those
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 statutory appointment such as an audit, this may be
acceptable. Ihe issue of dissemination to the board will be one for the CEO to deal with, providing she has capacity to engage her own advisers without reference to the board.
Confidentiality from executive directors may be within the powers of the CEO but to substantiate the powers of confidentiality may itself be a breach 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 s0, or misleads HH's staff about the reason for any
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 particular, we should consider whether the chief
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 denying legitimate intormation about the company to the
board.
Perhaps seek permission of the CEO to approach the chairman to substantiate that the CEO has the capacity and is not acting ultra vires. It this is refused, then consider not
accepting the engagement unless the CEO can otherwise demonstrate her capacity to act.
Ethics Page 1
Treasury Page 2
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 borrowings. Subsidiaries with surplus cash will be
required to submit the cash to the treasury department, and subSidiaries needing cash will borrow it from the treasury department, not from an external bank.
Borrowing
Central treasury will be given the responsibility for borrowing on behalt of the Megatrade group. If a subsidiary needs capital to invest, the treasury department will borrow the
money required, and lend it on to the subsidiary. The subsidiary will be responsible for paying interest and repaying the capital to the treasury department which will, in turn, be
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 risk and interest rate risk. Within broad guidelines, the
treasurer might have authority to decide on the balance between fixed rate and floating rate borrowing and to use swaps to adjust the balance. The department would also be
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 to minimise the overall tax bill. To accomplish this
etftectively, the treasury must have authority to manage transfer prices between subsidiaries in the group, as a means of transferring profits from high-tax countries to lower-tax
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 between definite amounts and estimates of future
amounts. Ihis information about cash tloWs will be used to forecast the cash flows of the group, and identity any future borrowing needs, particularly short-term and
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 to fund it.
(3) Subsidiary finance managers should be encouraged to submit information to the treasury department about local market and business conditions, such as prospects for a
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 rates and interest rates, and about which banks are
oftering those prices. Large treasury departments will often have a link to one or more information systems such as Reuters and Bloomberg.
(5) The treasury department should be alert to any favourable market opportunities for raising new debt capital. The treasurer should maintain regular contact with several
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 country where the group operates, and changes in
those regulations.
Financial Risk Management Page 3
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 Puts
$ Mar Jun Sep Mar Jun Sep
1.6 15.2 2.75
1.7 5.65 7.75 3.45 6.4
1.8 1.7 3.6 7.9 9.32 15.35
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 ramutiply 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 $ 2,750,000
A contract entered into at the year end would sell these barrels at $23.25 on 31 March 20x3 $ 2,325,000
Gain (= the value the contract could be sold on for toa third party) $ 425,000
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 Puts
S/£ September December December September
1.5000 5.55 7.95 0.42 1.95
1.5500 2.75 3.85 4.15 6.3
1.6000 0.25 1.55 9.4 11.2
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 as best
Exercise price Excerise option Rate used Cash received Prem cost Net
1.5000 NO 1.57 $ 5,887,500 $ -15,750 $ 5,871,750 Best result
1.5500 NO 1.57 $ 5,887,500 $ -155,625 $ 5,731,875
1.6000 Yes 1.60 $ 6,000,000 $ -352,500 $ 5,647,500
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 Net
1.5000 NO 1.62 $ 6,075,000 $ -15,750 $ 6,059,250 Best result
1.5500 NO 1.62 $ 6,075,000 $ -155,625 $ 5,919,375
1.6000 NO 1.62 $ 6,075,000 $ -352,500 $ 5,722,500
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.
Investment Appraisal Page 6
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 Sa 27,000 3 1.4 0.7
Inventory of X £98,400 4 1.5 0.6
Kg of X 60,000
Number of unit 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 65,000
Benefits 0.90 0.80 0.70 0.60
Sales £ 1,125,000 1,800,000 1,575,000 1,425,000 5,925,000
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 Year 5

Demand
Letters 3,900,000.00 5,200,000.00 5,200,000.00 5,200,000.00 5,200,000.00
Parcels 130,000.00 195,000.00 195,000.00 195,000.00 195,000.00
Adversting cost £ 1,300,000.00 £ 263,000.00 £ - £ - £ -
Premises £ 150,000.00
Inflation on costs/revenue 5% 5% 5% 5%
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Sales
Letters 2,047,500.00 2,866,500.00 3,009,825.00 3,160,316.25 3,318,332.06 5% increase
Parcels 682,500.00 1,074,937.50 1,128,684.38 1,185,118.59 1,244,374.52 5% increase
2,730,000.00 3,941,437.50 4,138,509.38 4,345,434.84 4,562,706.59
Expenes
Staff #NAME? #NAME? #NAME? #NAME? #NAME? 5% increase
Premises £ 150,000.00 £ 157,500.00 £ 165,375.00 £ 173,643.75 £ 182,325.94 5% increase
Vechile maience
Vans £ 200,000.00 £ 250,000.00 £ 312,500.00 £ 390,625.00 £ 488,281.25 5 years divid 1.25
Trucks £ 20,000.00 £ 25,000.00 £ 31,250.00 £ 39,062.50 £ 48,828.13 5 years divid 1.25
Adversting cost £ 1,300,000.00 £ 263,000.00 £ - £ - £ -
Depn £ 240,000.00 £ 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 £ 3,803,719.94
Revenue less exp - 1,520,000.00 548,937.50 809,534.38 793,261.09 758,986.65

Tax - 608,000.00 219,575.00 323,813.75 317,304.44 303,594.66
- 912,000.00 329,362.50 485,720.63 475,956.66 455,391.99
Profit 834,431.77
Average 5 year 166,886.35
Averag inv 1,160m/2 580000
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Revenue less exp -£ 1,520,000.00 £ 548,937.50 £ 809,534.38 £ 793,261.09 £ 758,986.65
add depn £ 240,000.00 £ 240,000.00 £ 240,000.00 £ 240,000.00 £ 240,000.00
tax £ 608,000.00 -£ 219,575.00 -£ 323,813.75 -£ 317,304.44 -£ 303,594.66
Initial inv -£ 1,160,000.00
Cash flow -£ 1,160,000.00 -£ 1,280,000.00 £ 1,396,937.50 £ 829,959.38 £ 709,447.34 £ 681,682.21 -£ 303,594.66
NPV 14% T1-6 £1,148,070.48 NPV(.14,CH year1-year6

Investment -£ 1,160,000.00
-£11,929.52 Do no accept
Investment Appraisal Page 7
Introduction
This report considers whether the proposed new service will meet the two targets of a return on investment of at least 5% and a non-negative net present value. It also considers other
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 value ($24,000). Because projects must meet both targets to
be acceptable, it is recommended that the service is not provided. However, this is subject to the further factors considered below.
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 should perhaps be provided on that ground alone.
lf the postal service's other projects have large positive net present values, it might be possible to net them oft against the negative net present value here, to give an acceptable
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 carried out.
Worked example Sensortex from chapter 20

International Financial Managem Page 8
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 will also require a lot of time and staff etfort. Marketing
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 off with only a few markets at the most, to limit not only
the costs of entry and market communications, but also the likely number of competitors. I he choice of market is obviously very important. Not only must there be an accessible
demand to make the market attractive, but Upowerit must assess its comparatīve advantage in that market. The risk associated with the market must also be assessed. This will
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 could be a temporary domestic slowdown, or is there
going to be a full commitment to overseas expansion? Ihis will necessitate some organisational changes for Upowerit, both in structure and management
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 share and capital expenditure requirements need to be
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 programme of market research to forecast likely
demand and establish levels of competition. Dealing with likely foreign competitor responses to the presence of Upowerit must be planned in advance.
Local culture
The cultural implications of doing business in a foreign country must never be underestimated. Upowerit has no experience of conducting business overseas and this often
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 expertise is employed to make sure that the rules are
complied with.
Cost issues
The costs of doing business overseas will be affected by factors such as foreign tax regimes, access to technology and availability of physical resources.
Management skills
Management skills will be vital, both for staffing and the level of control over the operation. This will have implications for the organisation structure. For example, expatriate staff
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 them to take advantage of individually.
JVs are often used as a means of entering markets which are either closed to foreign companies or ditticult for them to enter. Therefore, Upowerit might see aJVas a good way
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 extensive technical expertise, while another may have local
market knowledge.
Risks and rewards
Because the JV involves two or more partners, the risks and rewards involved are shared between the various partners. JVs allow risks and capital commitment to be shared
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 arrangements.
Ensure that the scope of the JV is clear so there is separation of the other operations of each company from those faling within the JV.
Review tax status of JV entity including remittance of funds.
Review governance procedures including shared management, control, rights over assets and key decision-making processes to ensure that Upowerit's management has an
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 a review of internal documentation as well as that
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 legitimate exit route
Where assets that are to be used in the JV are already held by either partner, then they would normally be transferred nominally at fair value. This needs to be established.
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 being incurred and the assets held by the entity.
If permitted within the terms of the contract, audit access to the accounting records of the partner would provide additional assurance.
Dissolution of the agreement creates additional assurance problems in terms of disengagement, return/sale of assets, intellectual property rights, rights to future customer
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 Year 4 Year 5 Year 6 Year 7
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 2500 2500 2500

Sales 2000
Sales price 20,000
Variable cost 11,000
Margin 9,000
Fixed cost £ 750,000.00 £ 750,000.00 £ 750,000.00 £ 750,000.00 £ 750,000.00
1 2 3 4 5 6 7
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Prod/Sales 2,000 2,500 2,500 2,500 2,500
Margin 9,923 10,419 10,940 11,487 12,061
In LRF'000
Total contro 19,845,000 26,046,563 27,348,891 28,716,335 30,152,152
Fixed (x ex rate) 1,806,000 1,841,000 1,877,000 1,914,000 1,951,000
Operating CF 18,039,000 24,205,563 25,471,891 26,802,335 28,201,152
Tax 40% - 7,215,600 - 9,682,225 - 10,188,756 - 10,720,934 - 11,280,461
Tax saving by depn W2 1,120,000 360,000 270,000 202,500 151,875
Land - 2,300,000
Buildibg - 1,600,000 - 6,200,000
Machinary - 6,400,000
After tax Realsiable value 16,200,000
Working cap W3 - 11,500,000 - 575,000 - 603,750 - 633,938 - 665,634 - 698,916 14,677,238
Cash remitted - 3,900,000 - 24,100,000 17,464,000 17,506,213 15,515,728 16,217,945 33,183,802 3,548,652
Ex rate W4 2.3175 2.3625 2.4084 2.4551 2.5028 2.5514 2.6010 2.6515
- 1,682,848 - 10,201,058 7,251,366 7,130,438 6,199,321 6,356,466 12,758,334 1,338,379
Royality received £ 750,000.00 £ 750,000.00 £ 750,000.00 £ 750,000.00 £ 750,000.00 £ -
Tax on royality 33% -£ 247,500.00 -£ 247,500.00 -£ 247,500.00 -£ 247,500.00 £ -

Net cash - 1,682,848 - 10,201,058 8,001,366 7,632,938 6,701,821 6,858,966 13,260,834 1,338,379
PV 14% 7 year -£8,948,296.67 £6,156,791.39 £5,152,015.98 £3,968,016.00 £3,562,331.76 £6,041,457.37 £534,866.27
£16,467,182.11
- 1,682,848
14,784,334
W2 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

Asset value 6,400,000 4,800,000 3,600,000 2,700,000 2,025,000 1,518,750
Depn 25% - 1,600,000 - 1,200,000 - 900,000 - 675,000 - 506,250 - 379,688
Tax saved 40% - 1,120,000 - 360,000 - 270,000 - 202,500 - 151,875
Calc is say 900 x 0.4 and first year is year 1 and year 2
W3
Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Total WC 11,500,000 12,075,000.00 12,678,750.00 13,312,687.50 13,978,321.88 14,677,237.97
Investment in WC - 11,500,000 - 575,000.00 - 603,750.00 - 633,937.50 - 665,634.38 - 698,916.09 14,677,237.97
5% inflation increase
W4
Spot rate FLR
Spot rate for LFr = (2.3140+2.3210)/2 = 2.3175 Inlation rate exchange rate 1.05/1.03 1.01941747572816
Spot rate for JS to D (1.5160 + 1.5210)/2=1.5185 1.06/1.03 1.02912621359223
W5
Because both investment alternatives represent an expansion of the exIsting business, the company's existing weighted average cost of capital can be used as a discount rate.
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 3 4 5 6 7
LFR 2.3175 2.3625 2.4084 2.4551 2.5028 2.5514 2.6010 2.6515
JS to D£ 1.5185 1.5627 1.6082 1.6551 1.7033 1.7529 1.8040 1.8565
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 3 4 5 6 7
Pre cash flow 2,120 3,371 3,573 3,787 4,015 4,256
tax 30% - 636 - 1,011 - 1,072 - 1,136 - 1,204 - 1,277
cost of aq - 10,000
machinery - 2,000
after tax value 14,500
Working capital - 4,000 - 240 - 254 - 270 - 286 - 303 - 321 5,674
Cash remitted - 16,000 1,880 2,480 2,292 2,430 2,575 17,230 4,397
EX RATE 1.5185 1.5627 1.6082 1.6551 1.7033 1.7529 1.8040 1.8565
£ VALUE - 10,537 1,203 1,542 1,385 1,426 1,469 9,551 2,369
additonal tax 3% W7 - 40.70 - 62.88 - 64.76 - 66.71 - 68.71 - 70.77
- 10,537 1,203 1,502 1,322 1,362 1,403 9,482 2,298
PV £1,055.28 £1,155.44 £892.33 £806.23 £728.44 £4,320.10 £918.32

Sum £9,876.14
Initial inv - 10,537
-£660.58
Working cap
Year Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Total WC - 4,000 - 4,240.00 - 4,494.40 - 4,764.06 - 5,049.91 - 5,352.90 - 5,674.08
Investment in WC 4,000 240.00 254.40 269.66 285.84 302.99 321.17 - 5,674.08
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-tax cash tlow at the exchange rate for the year and then
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 1.7746
Swiss/£ 2.256 2.298 2.189 2.205
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 does not obtain the benefit of tax relief.
(4) The exchange risk on the income from the US investment remains, as it cannot be matched against the payments to finance providers.
Fixed Rate Sterling Loan

5 year 7% bank loan B5 =RATE(B1,B2,B3,B4)
Loan 50,000 Nper = the number of periods 5
fee 1% Pmt the amount (of interest) paid in any sing 3.15
Pval = the present value of the asset (its mark -44.48
Amount raised 44.48 x 100/099 44.93m Fval-the future value (the amount paid at mat 44.93
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-term requirement of $72 million.
(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
5 year loan Pmt= the amount (of interest) paid in any single period 3.84
fixed rate 2.50% Pval= the present value of the asset (its market price net of issue co -77.6
Swapped rate 2.30% Fval = the future value (the amount paid at maturity). 80
Upfront fee 3% Yield to maturity 0.055
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 required.
(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 for any of the loan finance, then the rights issue
should be used.
Of the longer-term sources of finance, the Swiss franc loan offers the lowest rate. However, the loan is insufficient to cover the entire US investment, which would mean seeking
extra finance from elsewhere. The fixed-rate sterling loan covers the entire US investment with funds to spare. Both loans will expose Gordon to foreign exchange risk.
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 receipts.
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 will be required.
Flexibility
f the directors are expecting to use different sources of finance, they will prefer to use sources that can be changed without significant cost.
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 desired balance and hence the desired level of
finance risk. It will be determined by whether they believe that there is an optimal level of gearing, at which the company's weighted average cost of capital will be at its lowest.
Signaling
By issuing the maximum amount of debt, the directors may wish to demonstrate to the stock market the ir confidence in the future.
Interest rate expectations

The directors will prefer floating rate finance if interest rates are expected to go down, fixed rate finance if interest rates are expected to increase.
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 limit business decisions, including the ability to raise loan
finance in the future.
Other sources
Other sources of finance such as convertible and deep-discount bonds may be appropriate.
Finance Page 12
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 Company
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 satisfying requirements in three broad areas: namely
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 to the public. This will require a change to the
company's memorandum and articles of association agreed by the existing shareholders at a special meeting convened for the express purpose of agreeing this change.
The company must meet the regulatory requirements of the Listing Authority which is part of the Financial Conduct Authority in the UK. These regulatory requirements impose
minimum size restrictions on a company and other conditions concerning length of time trading (normally audited accounts must exist for a three-year period). An issue of
particular concern here is that the CEO has a controlling interest in the business - this will have to be addressed. Once these requirements are satisfied the company is placed on
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. Exchanges such as the London Stock Exchange
impose strict requirements which invariably mean that the applicant company will need the services of a sponsoring firm specialising in this area. The regulatory requirements of
the London Stock Exchange include:
compliance with corporate governance regulations (for example, 50% of the board should be independent non-executive directors)
quality and experience of the executive directors and the business plan, all of which must be carefully laid out in a prospectus
This tends to be costly and therefore prohibitive for all but the larger companies. The restrictions (and costs) of obtaining a listing on a junior market (eg, AlIM in the UK) may be
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 advantages and disadvantages of taking such a step for a
company of our size.
For a medium-sized firm, the principal advantage of obtaining a public listing is the additional sources of finance available. A listed company would have access to equity
capital from both institutional and private investors, and the sums that can be raised are usually much greater than through private equity sources. In addition, the presence of
firm as a limited company on a major exchange such as the London Stock Exchange enhances the credibility of the firm both to potential investors and to the general public as
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 corporate control and also increases the likelihood that the
firm will be subject to a takeover bid. The higher degree ot public scrutiny imposes a signiticant regulatory burden on the firm, as it must comply with a range of disclosure
requirements and financial accounts must be prepared in accordance with relevant accounting standards. In the UK, this means in accordance with IFRS and the relevant GAAP
as well as the Companies Acts. Under the rules of the London Stock Exchange, companies must also comply with the governance requirements of the UK Corporate Governan
Code and have an effective and ongoing business planning process in place. The requirement to comply or explain can impose a signiticant regulatory burden and can expose
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 tor Ella
The term should be appropriate to the asset being acquired. As a general rule, long-term assets should be financed from long-term finance sources. Cheaper short-term funds
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 company takes out long-term debt and interest rates fall, it
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 cover interest costs. Although there may be no specitic
terms of repayment laid down tor short-term debt, it may possibly be repayable on demand, so it may be risky to finance long-term capital investments in this way.
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 frequently, issue expenses may raise its cost
significantly.
Availability
It may be difficut to renew short-term finance in the future if the company's position or economic conditions change adversely
Effect on gearing
Certain types of short-term debt (such as bank overdrafts and increased credit from suppliers) will not be included in gearing calculations. if a company is seen as too highly
geared, lenders may be unwilling to lend money, or judge that the high risk of detaulit must be compensated by higher interest rates or restrictive covenants.
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, investors may be unwilling to subscribe for debentures.
Banks may be intluenced by this, and also by their own experiences of the company asa customer (especially if the company exceeded overdraft limits in the past on a regular
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 borrow, and for what purposes.
Restrictions of current borrowing
The terms of any loans to the company that are currently outstanding may contain restrictions about further borrowing that can be taken out.
Uncertainty over project
The project is a signiticant one. Presumably the interest and ultimately repayment that lenders obtain may be dependent on the success of the project. It the results are
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 what it can do with the assets secured.
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 capital requirements to begin production.
After the directors have decided how the project should be financed, they will attend a meeting with the audit partner for Ella at your firm.
There should be sutficient finance to cover the costs of the new tactory, starting the new business unit and working capital requirements to begin production.
Questions
(1) Will the new venture be financed entirely by new debt or is Ella also advancing any capital? This is to establish whether the business plan is complete.
(2) Who prepared the forecasts? This is to establish whether they have been prepared by someone with experience of preparing such budgets, as this will give assurance as to
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 degree of estimation included in the plans.
(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 and it is important to discover how tight the
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 employees not being used in their usual roles.
(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 costs associated with other products of 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 to pay the loan back will be an important factor for the
Finance Page 13
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 of analysts' expectations.
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 20% per year in the last three years). The divisional
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 supporting the divisional management team's optimistic
forecasts.
In terms oft JMR's overall porttolio, the real estate division appears to offer better growth prospects than either the construction or engineering divisions, although the
engineering division is likely to have relatively secure earnings by virtue of its contracts with government departments. Nonetheless, disposing of the real estate department
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 makes the lowest contribution to Group earnings, and
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 JMR would be unlikely to want to dispose of a
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 estate division. It is looking for a large one-off dividend,
which suggests a short-term strategy. In this respect, it is likely that JMR could sell the real estate division for a much higher price than the engineering division, thereby
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. Theretore, it is likely that cost savings could be made, by
relocating to one ot the divisional headquarters. Ihere may be reasons why the oftices need to be located in the capital (tor example, being close to the stock market) in which
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 case the Group could still look at finding new offices
where overhead costs will be lower. This could also be a good opportunity to review whether the Group really needs 50 staft or whether the team can be streamlined.
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 would be sold to another company, in exchange for
either cash or shares in the acquiring company. All the responsibilities and costs of running the division would pass to the acquiring company, as would all future protits.
If the sale were made for cash, it could provide JMR with an inflow of cash to meet the shareholders' demands for a large, one-off dividend payment.
However, it would mean that JMR loses 30% of its earnings, and any future earnings growth which the real estate division would have generated. This could mean that the
Group's subsequent ability to pay dividends in future years is reduced. Moreover, stripping out the division with the highest P/E ratio would cause JMR's share price to tall; in
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 rather than three, again reducing the Group profitability
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 separate company in its own right. The existing shareholders
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 will generate greater earnings operating independently
rather than being part of the Group. Given the suggestion that JMR is currently 'destroying value', this could well be the case.
However, from JMR's perspective a demerger is less attractive. As with a cash sale, JMR Group would lose 30% of its earnings. But unlike the cash sale, the demerger would not
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 shareholders want a one-off cash boost they will have to
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. If they remain dissatisfied with the performance of JMR
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 sold off at market price.
However, given that the real estate is a profitable and growing business, this is unlikely to be a desirable option; not least because a sale of assets is likely to command lower
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. However, given that both options would lead to JMR
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, which may have a further negative impact on the
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 forward its growth and increasing its profitability.
However, an importat issue here is the price which the managers would agree to pay for the division. On the one hand, it is likely they will have to obtain funding from venture
capitalists to support their own capital in the purchase, so they will want to keep the purchase price as lOw as possible to minimise their debt and future interest charges.
On the other hand, the divisional managers are likely to know more about the business and its prospects than the Group managers, and also any extermal purchasers.
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 price which could be earned from an open market sale
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 be reduced by 30%. Theretore it should not accept a
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 present the sale of a successful division to its
management positively- emphasising the way they are being given the opportunity to control the division's strategy and its tuture.
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 of people collectively buy the division. However,
unlike an MBO, the purchasers come from outside the company. So atter a management buy-in the real estate division wOuld become a privately owned real estate company.
From JMR's perspective, the management buy-in is another option which could generate a cash inflow, and so would provide the funds to satisfy the investors' demands for a
one-off dividend. Depending on the extent of the purchasers' knowledge of the business, JMR may be able to earn a higher selling price froma management buy-in than from
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 dividend. A demerger is probably the option which would
maximise value, but it will not generate cash. However, an MBO will generate cash proceeds and, by allowing the divisional management full control of the real estate division
should allow its capabilities to be exploited fully. Although the new entity will be outside the Group, the public relations aspect of a sale to management will be more positive
than an open market sale.
Therefore, JMR would be advised to sell the real estate division through an MBO.
Business & Securities Valuation Page 14
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 company, growth potential - that will differ from those for
Proted. Profed's growth rate has been estimated as higher than that of City Tutors, possibly because it is a younger, developing company, although the basis for the estimate may
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 that of an equivalent quoted company. Being
generous, in view of the possible higher growth prospects of Profed, we might estimate an appropriate P/E ratio of around 12, assuming Profed is to remain a private company.
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, there appears to be no rational basis for this. We can
instead use the intormation for City Tutors to estimate a cost ot equity for Profed. This is assuming the business risks are similar, and ignores the small ditterence in their gearing
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 riskier than the quoted City Tutors):
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. Exceptions would include property investment
companies and investment trusts, the market values of the assets of which will bear a close relationship to their earning capacities.
Profed is typical of many service companies, a large part of whose value lies in the skill, knowledge and reputation of its personnel. This is not reflected in the net asset values,
and renders this method quite inappropriate. A potential purchaser of Profed will generally value its intangible assets such as knowledge, expertise, customer/supplier
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 financial ditticulties or subject to a takeover bid. Shareholders
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 method that retlects the earnings potential of a
company trom a market point of view. Provided the marketing is etticient, it is likely to give the most meaningtul basis tor valuation.
The market price of a share at any point in time is determined by supply and demand forces prevalent during small transactions, and will be dependent on a lot of factors in
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 prevailing P/E ratio. It is not known whether the share
price given for City Tutors was taken on one particular day, or was some sort of average over a period. The latter would perhaps give a sounder basis from which to compute an
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, unquoted company in the same industry can be
problematic.
The status and marketability of shares in a quoted company have tangible etfects on value but these are ditticult to measure.
The P/E ratio will also be affected by growth prospects-the higher the growth expected, the higher the ratio. The growth rate incorporated by the shareholders of City Tutors is
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 difficult to see how the P/E ratio should be adjusted for
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 earnings. This can lead to a very inaccurate result if account
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 expect to receive from the company by discounting them
at their required rate of return. It is perhaps more appropriate for valuinga minority shareholding where the holder has no intluence over the level ot dividends to be paid than
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 market' assumptions may be satistied to some extent, in
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 'equivalent' quoted company's data carries the same
drawbacks as discussed above. Similar problems arise in estimating future growth rates, and the results from the model are highly sensitive to changes in both these inputs.
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. Reasons tor this may be as tollows:
The share price for City Tutors may be currently depressed below its normal level, resulting in an inappropriately low P/E ratio.
The adjustment to get to an appropriate P/E ratio for Profed may have been too harsh, particularly in light of its apparently better growth prospects.
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 risk of the two companies. Although they both
operate the same type of business, the fact that City Tutors sells its material externally means it is perhaps less reliant on a fixed customer base.
Even if business risks and gearing risk may be thought to be comparable, a prospective buyer of Profed may consider investment in a younger, unquoted company to carry
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 fixed customer base.
Even if business risks and gearing risk may be thought to be comparable, a prospective buyer of Profed may consider investment in a younger, unquoted company to carry
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 earnings.
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 private companies are typically priced at a discount of 30%
to 40% to the quoted sector P/E. This discount probably reflects the lack of marketability of the private company shares compared to those of its quoted counterparts. Using a
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 the earnings stream for around £100,000, giving a total
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 more or less attractive part of the sector. It may be better to
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 is better or worse than the sector average, meaning that a
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 level of gearing or is in a part of the sector where the
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, for example. It would therefore be suitable if Wilkinson plc is
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 with the capital asset pricing model: ke =r+ P, (m)
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 (estimated as Do x {1 + g}), ke is the cost of equity andg is the
expected growth rate in dividends. The value of g can be estimated from extrapolating the dividend growth of Chris Limited over the last few years and is 11% ({185/150}- 1).
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, this value should be discounted.
£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 the sector averagge.
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 relevant if Wilkinson plc only intends to take a minority stake.
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 controlling shareholding.

As with the dividend valuation model, it is most useful for a minority investor who will only receive a dividend flow from the company.
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 value of the loan stock must be deducted. This will be the PV
of the loan stock's future cash tlows, discounted at the investors' required rate of return. The best indication ot required returns is given by the details on gilts for the same maturity
with the same coupon in the question. A risk premium must be added on to the yield on the gilts to compensate for the additional risk of Chris Limited, say 3%. The resultant annual
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-annual.
Note: The precise calculation here using the square root is probably over the top and gives a spurious level of accuracy. A six-monthly factor ot 7% would be just as good.
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, obsolescent inventories, costs of disposal, and so on.
The contents of each category of asset and liability are not known. For example, non-current assets may include intangibles which could not easily be sold at book value.
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, the company must obtain at the very least 50% to be able to
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 business from scratch. The problem will be in identifying the cost
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 earnings of t410,000 may not be representative and in
subsequent years the earnings may tall back to a level similar to earlier years. Alternatively, it the earnings are going to grow trom the current base, then the earnings-based valuation
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 regardless ot earnings pertormance. Since the dividends have grown
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 growth. f this is the case, then the dividend-based methods are
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 its assets base but from its earnings stream and cash flows.
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 individual years
Details of costs or income that may be avoided or lost if the company is acquired, such as very high directors' remuneration
Details on growth prospects
More specific details on the company's business, its business risk and gearing risk and similar information for closely comparable quoted companies
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
TYU 3 - Page 49 FX NPV's Page 18
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 2% apprication
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
IRR & Rate Page 19
T0 value -97.25
T1 Interst 5
T2 Interest 5
T3 Interest + Par Redem 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
TYU3 - Luquidation Page 20
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
ST1 C1 Page 21
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 it operates. In this context, it needs to consider the wider environmental factors
(which could be highlighted by ‘PEST’ analysis) as well as any factors that relate more specifically to the telecommunications industry (which could be highlighted using Porter's five forces model as a guide).
‘The most significant recent environmental influence on ZTC’s performance is likely to have come from a political factor - the deregulation of the telecommunications market in Zeeland.
Impact of deregulation - Historically, ZTC held a monopoly position in the telecommunications market in Zeeland. However, now that the market has been deregulated, ZTC’s market share is likely to be
‘eroded when new competitors enter the market. Consequently, it seems likely that ZTC will suffer a fall in revenue, at least in the short term until it identifies alternative markets which it could enter as well.
New entrants - Itis not clear how many competitors have entered the market so far, but another threat ZTC needs to be aware of is that of additional new entrants entering the telecommunications market in
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 telecommunications networks as well. However, its also likely ZTC will face competition from
mobile phone companies.
In this respect, developments in technology (for example, 4G networks) could also boost the performance of mobile phone companies, and thereby increase the level of competition ZTC is facing.
‘Overall market growth - The scenario does not indicate whether the telecommunications market overall in Zeeland is growing or, if itis, how high the growth rate is.
However, this will also have an effect on ZTC’s performance. For example, if the market is growing rapidly, this could help reduce the impact on ZTC’s revenues of its market share declining.
Similarly, if the global market is growing significantly, this could provide opportunities for revenue growth. It appears that one of the Government's motives behind the deregulation was to make ZTC more
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 bargaining power in relation to ZTC. Previously, as ZTC was the sole supplier,
‘customers had little or no ability to influence price or service. However, now that there is increased choice in the market, customers’ bargaining power has increased significantly, because if ZTC's tariffs are not
competitive against other providers, or its standards of customer service are poor, customers will be able to switch to one of the competitors in the market.
Employees - The deregulation of the market could also affect ZTC’s relationship with its employees. In effect, it could increase their bargaining power as suppliers. Previously, telecommunications engineers in
Zeeland could only work for ZTC; but itis likely that in future there will be a choice of companies they could work for. Therefore, ZTC will need to ensure that its rewards package is competitive so that it retains
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 sector aspirations of efficiency, effectiveness and economy, but it was not subject to
market discipline and its finances were controlled by government. The lack of market input and the highly technical nature of its operations make it likely that its main operational concern was engineering
‘competence, rather than customer interests. However, the Government, as principal stakeholder, imposed requirements around performance and service levels to be achieved.
Shareholders as new stakeholders
ZTC now has a new and important class of stakeholder: its shareholders. They will have firm ideas about their requirements in the form of growth, earnings and dividends.
Importance of customers
‘The company faces a deregulated market where competition will intensify. It will need to pay great attention to the views and needs of its customers: they are a stakeholder group that is likely to wield far more
influence than previously, since they will be able to choose new suppliers when new providers of telecommunications services enter the market, following its deregulation.
Impact on objectives
‘These influences will affect objectives at all levels in the organisation and will require a significant realignment of attitudes. In particular, there will be pressure to reduce costs; to develop new and attractive
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 addressed by the directors when setting the company's objectives.
Shareholders will want to maximise profitability, which may be achieved by raising prices. But customers will seek the lowest price they can get.
Although the Government is no longer the main external stakeholder, it will still be interested in ZTC’s performance. The company will continue to make a large contribution to the economy of Zeeland as a
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 in its overall success, and possibly a closer involvement in such matters as the
promotion of technological development and overseas expansion which, if successful, could increase ZTC’s tax liability to the Government.
Corporate governance
A final influence on the strategic objectives of the privatised company will arise in the field of corporate governance. As a listed company, ZTC will be subject to the normal regulations and codes of practice
laid down by its quoting stock exchange. It may also be subject to special government regulation designed to prevent it from using its size and current dominant position to discourage competitors. These
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 satisfaction, all of which becomes increasingly important in a deregulated market.
Alongside this, the directors will need to ensure the business's controls and governance are adequate to comply with its new regulatory requirements.
_x000C_
ST4 Chp5 Page 22
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 competitive, because customers will have a high degree of choice about where to buy
their coffee. In this respect, branding, and the loyalty card scheme, could be valuable to CFE IT it encourages customers to keep returning to CFE shops to buy their coffee, rather than going to rival shops.
Customer loyalty - By creating customer loyalty, a strong brand identity is a way of increasing or maintaining sales; for example, by improving customer retention rates and encouraging repeat purchases. This
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 the marketing director might hope.
Importantly, CFE currently generates more revenue per shop than the market leader, although its profit margins are significantly lower.
HOWever, atnougn tnere appears to be more important factors affecting CE s performance thnan ts company prove, Branding could still nave a positive impact on its performance.
Brand awareness - Brand awareness would be an indicator of CFE's position in the coffee shop market, and would indicate whether customers or potential customers do actually differentiate CFE from its
customerS, Tor example as offering higher-quality products and service. lf customers don t assoCiate ES products as being higher quality than the competitors, then the money spent on higher-quality
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 customers, thereby encouraging them to buy the product or service in question in
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 customers receive a high standard of service (by paying its staff wages above the industry
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 consider wnat impact the changes in price are likely to have on customer demand for them.
Therefore, market research will be important to assess how demand (and consequently revenue) will be affected by any change in Price
t seems that CFE'S Customers are not particularly price sensitive, which should increase the chances of the finance director's proposal. However, CFE should still research its reaction to any change before
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 coffee. CFE's competitive strategy (of differentiation based around quality) might
enable it to charge higher prices than its customers to an extent and still retain its customers. However, if CFE increases its prices too much, it is unlikely that the customers will remain loyal to it, even if it offers
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 competitors. Howeve, these competitors might also be planning to change their prices. For
Competitors" plans - Currently, CFE seems to serve a higher proportion of 'Fair Trade' products than its competitors, and this might help it justify its higher prices. However, if its competitors are also planning
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 between ChE and its competitors. In this respect, any insights which CFE Could gain into
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 beans rises, it might need to increase prices in order to maintain its current margins.
Equally, if costs, such as the rents CFE has to pay for its premises, rise, this may also increase the pressure on CFE to increase its prices in order to maintain its profit margins.
ST2 Chp2 Page 23
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% PBIT/ Equity + Long Term Borrowing
Share capital 5,700 GPM 20.0%
Retained earnings 50 NPM 7.5% PBIT / Revenue
Total equity 5,750 Current Ratio 1.14
Quick ratio 1.047619 Current asset - Inventory / Current Liab
Non-current liabilities Gearing 30.3% Long term borrowing/ Equity + longterm borriwing
Long-term borrowings 2,500 Interest cover -5 PBIT/Interest
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 transport.
Acquiring EVM would provide Swift with access to a new market (ECuria) in which demand is growing, competition is immature and the Government is investing in road transportation.
Acquiring EVM will increase the overall size of the group, allowing increased economies of scale to be exploited in relation to purchasing trucks and other equipment.
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 companies involved:
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 these practices, aithough potentially leading to higher profts, may be complex and
could lead to reputation-damaging labour disputes. Ihis may be unavoidable ir Switt attempts to force the Ambion-style working practices on them, and may lead to contlicts that could be impossible to resolve.
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 be a strong performance for the sector.
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 concerns over suitability. The low net profit margin may be due to EVM still carrying high
costs from its State-owned days. However, it is possible that Swift will be able to improve the profit margin through economies of scale and by implementing competences gained at Albion. This would make the
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 will have to determine why this is the case, but it is important to consider the business's
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 interest charges are relatively high, due to the problems the Ecurian investors had in
raising finance. However, Swift could look at renegotiating EVM's finances post acquisition
ST2 Chp6 Page 24
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 there being an excessive concentration of power in the hands of one individual.
At present, the CEO is able to manipulate the information the board receives, to protect his position. It seems best for one of the existing NEDs to be appointed as chairman. Splitting the roles emphasises
that the two jobs are distinct, with the CEO running the charity and the chairman running the board. I he chairman can ensure the CEO iS accountable tor his actions by, for example, ensuring the board
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 tasks currently undertaken by the CEO, including distributing board minutes
in advance ot meetings and briefing board members in relation to each agenda team. Ihis would free up the time of the CEO or chairman. The secretary should be accountable to the board collectively,
and shouia, necessary, nave the independence to come into connect with the CEO if the secretary believes t is in the interest of GFE.
More executive directors

Governance reports typically suggest that at least halt the board should be independent, non-executive directors-to ensure an appropriate balance between executive and non-executive directors. At GFE five out
of seven directors are non-executives, which does not appear to be an appropriate balance. I he UK Higgs report commented that there is a greater risk of distortion or withholding of information, or lack of balance
in the management contribution, when there is only one, or a very small number, of executives on the board. GFE should consider appointing one or two more executive directors, tor example, an operations
director. Ihis would also help with succession planning, and lead to a greater emphasis on risk management and operational control at board level.
Audit committee
Appointing a separate audit committee will enable the main board to concentrate more on strategic and operational matters, leaving the audit committee to undertake the detailed financial review that is a major
part of current board meetings. Ihe audit committee should also be responsible for the appointment of auditors and for liaison with them about further work, including a review of controls. At present, the
auditors' ability to exercise independent scrutiny could be questioned, since they have been appointed by the CEO. Governance reports recommend that all members of the committee should have sufficient
financial expertise to contribute effectively, and that one member should have relevant and recent financial experience. New directors may therefore need to be recruited to fufil this requirement or existing
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 committee would also review other important issues of board functioning that have
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 ideally should have
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, who face re-election regularly. Independent NEDs will be particularly important for
SFE as it is a charity, and stakeholders will rely on NEDS to provide unbiased scrutiny of how the executive directors are conducting its aftairs. It is possible that none of the current NEDs can be classed as
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, that these are outside the directors experience, indicates that as a body, the
NEDs have insufficient expertise at present. The CEO's belief that the executive management team is more than capable of managing the delivery of the in-home care services misses the point. NEDs
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 GFE's services not being represented. Having a user representative on the
board would mean that the board received direct feedback on the effectiveness of the charity's activities. Stakeholder representatives could also provide feedback to the stakeholders they represent
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. Corporate governance reports recommend that the board should not be so
large as to be unwieldy; therefore, some of the new board members may have to replace existing board members.
ST2 Chp7 Page 25
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 profit in itself may be caused by incorrect inventory values or loss of
sale income. Incorrect stock levels, in turn, can be caused by incorect inventory counting or theft of inventory by employees. Similarly., loss of sales income could result from accounting errors or
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 during the day will still result in loss of that day's transaction data.
Delays in inventory ordering
Although stock information is collected using the EPOS system, reordering ot inventory takes a significant amount of time. Iransterring data to head oftice for central purchasing may result in
some discounts on purchase. However, the average 10 days betore inventory is received at the store could result in the company running out of inventory.
Non-business risks
These are risks that arise for reasons beyond the normal operations of the company or the business environment within which it operates.
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, indicating some lack of investment in this area. Given that fashions
tend to change more frequently than every four years, HOOD may experience falling sales as customers seek new designs for their outdoor clothing. HOOD may also be vulnerable to seasonal
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 clothing. However, this reputation could be damaged by problems
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 (if any) are desirable to mitigate or avoid the consequences.
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. The overall amount is unlikely to be significant, as
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 the agreement of cash received to the till roll by
the shop manager. Loss of inventory may be identified by more frequent inventory checks in the stores or closed-circuit television.
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 cash from sales would still be available, limiting the
actual loss.
Additional procedures could be implemented to back up transactions as they occur, using online links to head office. The relative cost of providing these links, compared to the
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 longer term, if stock-outs become more trequent,
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 system. Costs incurred relate to the provision of
internet access for the shops and a possible increase in cost of goods supplied. However, this may be acceptable compared to overall loss of reputation.
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 of sales as the inventory is not there to fultil
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 reduced by insurance
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 that demand for coats etc will fall to zero, so some
sales will be expected. However, an increase in competition may result in falling sales and, without some diversification, this will automatically affect the overall sales of HOOD.
HOOD can minimise the risk by diversifying into other areas. Given that the company sells outdoor clothes, commencing sales of other outdoor goods, such as camping
equipment, may be one way of diversitying risk. It can also look to reduce operational gearing, fixed cost as a proportion of turnover.
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 range would appear to be a mistake, as the brand
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 maintain the company's image.
Corporate reputation
As well as immediate losses of contribution from products that have been returned, HoOD faces the consequence of loss of future sales from customers who believe its
products no longer offer quality. Other clothing retailers have found this to be very serious; a reputation for quality, once lost, undoubtedly cannot easily be regained.
The potential effect of a drop in overall corporate reputation will be falling sales for HOOD, resulting eventually in a going concern problem.
HoOD can guard against this loss of reputation by enhancing quality control procedures, and introducing processes such as total quality management
Pa
23 Page 26
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 £m % change

Revenue £m £m
Passenger tickets 2,925 3,040 -115 -3.8%
‘Paid for’ on-board activities and excursions 920 909 11 1.2%
Total revenue 3,845 3,949 -104 -2.6%
Operating costs
Fuel 425 378 47 12.4%
Staff costs 435 431 4 0.9%
Food 240 241 -1 -0.4%
‘Paid for’ on-board activities and excursions 250 222 28 12.6%
Depreciation 381 380 1 0.3%
Other ship operating costs (Note 1) 1,239 1,398 -159 -11.4%
Selling and administration 430 429 1 0.2%
3400 3479 -79 -2.3%
Operating profit 445 470 -25 -5.3%
Gain on fuel derivatives 25 0 25
Gain on foreign currency derivatives 45 0 45
Earnings before interest and taxes 515 470 45 9.6%
Number of passengers in year 2,460,000 2,390,000 70,000 2.9%

Occupancy (% of capacity utilised) 90% 92% 0 -2.2%
Total passenger capacity of fleet per night (at 30 June) 62,000 59,000 3,000 5.1%
Number of staff 22,500 22,500 0 0.0%
Number of ships in fleet at 30 June 24 23 1 4.3%
Carrying amount of fleet at 30 June (£m) 5,190 4,940 250 5.1%
Fair value of fleet at 30 June (£m) 7,000 6,500 500 7.7%
Fuel consumption (000’s tonnes) 839 849 -10 -1.2%
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
‘Paid for’ on-board activities and excursions 920 909 1.2%
‘Paid for’ on-board activities and excursions 250 222 12.6%
670 687 -2.5%
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 -3.8%
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 -3.3%
Loss/profit -225 -217 3.7%
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
Number of passengers in year 2,460,000 2,390,000 70,000 2.9%
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
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 Profit per passanger as costs
and industry has reduce - are fixed ish
growth enhance ship
utilisation
Profit declined
global issue and seek more
effectively
control with FC bulk buy
Fuel price rised
Occupancy fallen
revenue per pass has fallen
market share fallen
Fuel
Fuel 425 378 47 12.4%
Fuel consumption (000’s tonnes) 839 849 -10 -1.2%
Staff costs
Staff costs 435 431 4.00 0.9%
Number of staff 22,500 22,500 - 0.0%
Food
Food 240 241 - 1.00 -0.4%
Number of passengers in year 2,460,000 2,390,000 70,000.00 2.9%
Total passenger capacity of fleet per night (at 30 June) 62,000 59,000 3,000.00 5.1%
23 Page 27
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
Step 1
Receive Pay Currency Rate per £ Converted
UK France 2.40 £ 1 2.40
France US 1.80 € 1.2 1.50
US UK 6.40 $ 1.6 4.00
US France 3.60 $ 1.6 2.25
Step 2 PAY
Receive UK France US Total Receipt
UK 2.40 2.40
France 1.50 1.50
US 4.00 2.25 6.25
Total to pay - 4.00 - 4.65 - 1.50
Total Receipt 2.40 1.50 6.25
Net Position Payment - 1.60 - 3.15 4.75 -
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 € 500,000 € 500,000

Rate 1.25 1.15
£ £ 400,000.00 £ 434,782.61
Final Payment for the ship in € (mill) € 270.00

Ceiling Floor
0.92 Cost £'s per €1 0.85 0.82 0.8 0.77 0.7
£ 248.40 £ 229.50 £ 221.40 £ 216.00 £ 207.90 £ 189.00
If the £ devlaues If the £ strenghten

Max Paid Min Paid
FC would exercise the option and protecting the limit 3rd party would exercise the option
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 Gain on bargain purchase
Rate 1.6
-1.25
Benefits due diligence for Coastal

FC staff perform
Independent advisor
Areas to be Who should undertake the

investigated investigation
Hotel valuation as
we run cruise ships Independs valuation by
and not hotel experts
Financially check
the accuracy of Independs valuation by
info experts
23 Page 28
Understatement of
losses and Independs valuation by
liabilities experts
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 & Independs valuation by
competition experts
Staff could do Fin controller

Financial and but not expert. Could
forecasts independent for property
Independs valuation by
Legal experts
US tax expert and Legal
Tax in the US representative
Accuracy as we did Independents and our

not do the audit auditors
IT expert and Staff could
IT system review this
HR Employing new staff and
Hotel industry
Hotel operation
Data category Outcome

Number of visits 32,869,754 20X4
Number of
Number of unique visits 12,965,982 passengers 2,460,000
39% 19,903,772 61% number of people revisit in year
Number of page views 97,878,296 average view of pages 5.270724 number of visits does not make booking
Hits (Downloads from site) 1,157,974,936 19.0% Passangers to unqiue visits
Average duration of a visit 14.3 minutes short term and long term vistis target to long term 7.5% Number of passgers to visits
Most popular referral site TripAdvisor focus market attention with this site and patnership 2.977762 Pages view per hit
35.22919 average hits per page
Most popular source of hits – by country:
UK 41% Currency used
US 28% which are gives the most hits and ex rate flux could impact the global marketing
Other – Europe 22% how dominate they are in other markets compared to leaders target Germany and Switz could be land locked courty
Other 9% Other could be broken down more Austria and canada - not land locked
How is the currrent marketing in the UK and US different to other areas
Most popular pages (by hits):
Cruises 34% marketing on other areas and how to sell other products and services
Ships 33% Hotels link with recent acquisiton
Facilities 15%
On-board activities and excursions 11%
Booking and payment 7% How this can be changed 75% upfront 32,869,754 Asssumed viewing
Emails received from website 578,397 email most popular and could be used to targe with follow up emails 2,300,883 Assumed booking via website
Number of
2,460,000 passengers
in year
Advertising campaigns were run in April and December in the UK. 159,117 Other like travel agent
Monthly Visits Millions Seasonal
July 3 9.1% what number then go onto book
August 2 6.1% booking per month
September 2 6.1% what areas are these booking taken place
October 1 3.0% and how long did they take before booking
November 1 3.0%
December 5 15.2%
January 4 12.1%
February 2 6.1%
March 1 3.0%
April 6 18.2% Adversiting campgain April and Decemeber
May 4 12.1% taget UK and US as areas of most interest
June 2 6.1% Use hits and change time of adversting
33 Dont make a booking and target them ie over average
Averstie and referal and bonus paid to them
New system was used to capture data Are they english destinations and alternative language
Hard to do you year on year comparision Removed unused pages and declutter websites
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
23 Page 29
24 Page 30
Requirement 1 - 16 marks - 40 marks 1 2 3 4

Proposal 1 - Stay with Sole supplier Gootle 20X5 20X6 20X7 20X8
Sales Vol 200,000 220,000 235,000 245,000
Price £100 Price 100 100 100 100
£ 20,000,000 £ 22,000,000 £ 23,500,000 £ 24,500,000
Discuss DF 10% 0.91 0.83 0.75 0.68
Reliable PV £ 18,181,818 £ 18,181,818 £ 17,655,898 £ 16,733,830
No FX risk NPV £ 70,753,364
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 1 2 3 4

20X5 20X6 20X7 20X8
Can have a limit of variation in quality Sales Vol 200,000 220,000 235,000 245,000
Supply chain issue with parts Price $ 93.00 $ 93.00 $ 93.00 $ 93.00
Global competiton could achieve better price 18,600,000 20,460,000 21,855,000 22,785,000
Exchange rate risks Exchange rate 1 0.98 0.96 0.94
How do we ensure the quality is maintend by ICV £ £ 18,600,000 £ 20,050,800 £ 20,989,542 £ 21,445,060
Price £90 DF 10% 0.91 0.83 0.75 0.68
Transport cost £3 PV £ 16,909,091 £ 16,570,909 £ 15,769,754 £ 14,647,264
£93 NPV £ 63,897,018
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 suppliers
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 Method 1 0 1 2 3 4

20X4 20X5 20X6 20X7 20X8
Build factory $ 40,000,000 Sales Vol 200,000 220,000 235,000 245,000
VC $ 40 Build facto $ 40,000,000
Fixed cost $ 25,000,000 Sell after 4 years $ -20,000,000
Sell after 4 years $ 20,000,000 VC $ 8,000,000 $ 8,800,000 $ 9,400,000 $ 9,800,000
FC $ 25,000,000 $ 25,000,000 $ 25,000,000 $ 25,000,000
Exchange rate Total $ 40,000,000 $ 33,000,000 $ 33,800,000 $ 34,400,000 $ 14,800,000
$2 to 1 but increase 5% Exchange r 2.000 1.905 1.814 1.728 1.645
Exchage rate 2 £ value 20,000,000 17,325,000 18,632,250 19,911,150 8,994,746
Dividend by 1.05 it /1.05 DF 1 0.91 0.83 0.75 0.68
or we can times by 0.95 PV £ 20,000,000 £ 15,750,000 £ 15,398,554 £ 14,959,542 £ 6,143,533
Sale after year 4 so negative in year 4 NPV £ 72,251,628
as appricate then this is bad for payment as £ is weaking Method 2

Total $ 40,000,000 $ 33,000,000 $ 33,800,000 $ 34,400,000 $ 14,800,000
DF 4.5% 1 0.957 0.916 0.876 0.839 1.9/2* 1.1
Discuss PV £ 40,000,000 £ 31,578,947 £ 30,951,672 £ 30,144,603 £ 12,410,708
We will have full control and therefore no lack in quality NPV £ 145,085,931
But have we operated in there before As it 2:1 2 dividend by 2
risk of langauge barrier £ 72,542,965.39
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 Project T0 is Jan X5
for the long term T1 1 Jan X5
it was $2 then increase 5% a
the currency value is falling therefore costs are increasing but prop 2 it was 2 then 2% from T1
costing more £ as the fall in exchange rate we arent getting $ value they told use t1 rate and not T0
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 there are significant exit costs
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 across
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
24 Page 31
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 and allows them to rebuild skills and expertise in the case manufacturing process. This is a longer term option and, whilst expensive, provides the highest upside to rising demand.
Considering the demand is expecte to continue growing, proposal 3 would be the most appropriate solution because costs should become lower over time
Proposal 2 - as the business is growing at a fast rate, it is inevitable that multiple suppliers will be required to keep up with demand. Supplier competition will also drive prices down.
The current supplier has provided reliable and good quality services. This suggests that Gootle is a good option, negotiations may be required on
the price to try and negotiate on lower prices. The option of alternative suppliers can be used as a negotiation tool for prices
Question 2
Amorisated cost after 4 years
However, the functional currency of Landex is the £ and the M$ is forecast to appreciate against the £ over the 4–year term of the bond
A - zero coupon bond 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 expected
Build factory $ 40,000,000 to be £1= M$1.645405 (i.e. M$2/1.054).
Prem 17%
The annual cost of debt in $ terms is [(117/100)^1/4 – 1] = As a consequence, in £ sterling terms, the bond generates £20m when issued and requires £28.4428m (i.e. M$40m × 1.17/1.645405) to redeem it.
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 Movement

20.00
20X5 40.0000 1.6000 41.6000 1.905 21.840 1.840
20X6 41.6000 1.6640 43.2640 1.814 23.849 2.009
20X7 43.2640 1.7306 44.9946 1.728 26.043 2.194
20X8 44.9946 1.7998 46.7943 1.645 28.439 2.396
movement to PL
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 decisions:
 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
31 Page 32
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 1.5275

3-months forward 0.72-0.67 cents premium 0.72 0.67
6-months forward 1.28-1.22 cents premium 1.28 1.22
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
31 Page 33
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 -£ 211,752.25
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
31 Page 34
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 distributi $ 3,000,000 1 July 20X7
Niche market
net cash inflow $ 400,000 2 years
net cash inflow £100,000 indenfiatly
Wider market
net cash inflow $ 350,000 30 June X8
net cash inflow £100,000 indenfiatly
Growth 4%
WACC 10%
Probaility of niche ma 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 $
31 Page 35
**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
31 Page 36
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
31 Page 37
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
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.
31 Page 38
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
31 Page 39
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
31 Page 40
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
31 Page 41
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.
32 Page 42
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 78%
Stores 1,395 1,136 1,384 2,025 5,940 23%
Revenue by product type
Home products 4,200 4,550 4,900 5,250 18,900 72%
Garden products 2,000 500 1,250 3,750 7,500 28%
Cost of sales by product type:
Home products 2,940 3,185 3,430 3,675 13,230 75%
Garden products 1,200 300 750 2,250 4,500 25%
Number of items sold

Home products 120,000 130,000 140,000 150,000 540,000 77%
Garden products 50,000 10,000 25,000 75,000 160,000 23%
Number of items returned by all 8,500 7,000 8,250 11,250 35,000 5%
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 level. This should be of sufficient detail and
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 the key issues within that data. As it stands, however,
(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 by a member of staff that 'there is just too much
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 identify trends and extract insights to improve decisions.
ldentitying such patterns could enable target marketing by Quinter according to the type and frequency of historic purchases and customer characteristics, enabling tlexible
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 different types of individual product).
Showing revenue and gross profit for all 560 difterent items may be too much information for board level decisions. However, whether to discontinue a poorly selling product
line or support further sales of a successful product line would be the type of decision appropriate to board level. Product line data could theretore be analysed (eg, in order of
size: best selling down to worst sell ing). Alternatively, management by exception could be used by reporting to the board only the outliers of the best and worst pertorming
product lines.
Sales return information is also poor. The returns need to be analysed between faulty returns and 14 day returns from a change in the customer's mind. The faulty returns can
then be identified with relevant suppliers so the board can decide whether contract terms have been fultilled (ie, do not pay the supplier) and whether Quinter wants to continu
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, sales to these customers may not be encouraged by
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. Minimising inventory, while still having suficient
quantities to meet customer needs on a timely basis, can reduce inventory costs. These may include: storage costs; damage; obsolescence; insurance.
A key issue is predicting the timing of demand and ensuring that sufficient goods are ordered to arrive on time, after allowing for the lead time. Uncertainty of demand and
uncertainty of lead time may mean a buffer inventory needs to be held to prevent shortages which could mean customer needs would not be satisfied on a timely basis.
Key tactors would be analysing historic data to identity the timing of Surges in demand or dropping off in demand (eg, seasonality of garden goods). Other factors may not be
captured in historic data such as an advertising campaign, a tavourable review tor a product in the press or a sudden spell of good weather to encourage garden purchases.
Data need to be constantly monitored, updated and analysed and compared to inventory levels which should be measured continually (continuous inventory measurement).
Relationships with suppliers also need to be part of the data management eg, linking Quinter's IT systems with those of large key suppliers so forecast inventory shortages can
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 misstatement in both the statement of financial position
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 goods and that the average inventory turnover is high, with
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 that some electrical goods are likely to become
obsolescent, (or at least only capable of being sold at reduced prices) if held in inventory for an extended period. This may be particularly the case with computer equipment,
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 damaged inventories may not be readily identifiable
32 Page 43
(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, they will be translated at the exchange rate on the
date of purchase and not normally retranslated thereafter. The fact of the inventories being purchased in a foreign currency is not therefore a major financial statement risk so
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 current date and therefore it is necessary to have detailed
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 based company) to advise executive directors and to
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 external auditors). Information flows and management
controls would be enhanced by an internal audit function reporting to the audit committee. The audit commíttee would consist of non-executive directors who would monitor
the performance of the company and its executive directors. As chairman, it may be suitable tor Mike to also chair the audit committee.
A remuneration committee seems appropriate to ensure that, as part of pertormance management for the executive directors, they are motivated by their remuneration
package for promoting the performance of the company. At the moment, without any non-executive directors other than the chairman, it is difficult to see who has been
awarding the executive directors a 10% annual pay rise. If it was the directors themselves, then there may be a contlict of interest, a selt-review threat and a self-interest threat.
New executive members of the board may be appropriate as, at four, the board is small and may not have the full spectrum of skills necessary. An appointment committee
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 future generations to meet their own needs.
The idea of recycling is consistent with sustainability, in that an organisation should only use resources at a rate that allows them to be replenished (in order to ensure that they
will continue to be available). At the same time, waste should be confined to levels that do not exceed the capacity of the environment to absorb them. Quinter's proposed
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 addressed for Quinter to demonstrate corporate
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 number of issues that must be addressed for
sustainability reporting to be effective and these are relevant to Quinter's decision to report its sustainability policy in the annual report in terms of the level of detail that should
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 information.
One aspect of this is natural capital, including the impact that Quinter's activities are having on air, water, land, minerals and forests. Recycling would be one element addressing
this.
The benetfit to Quinter of such disclosures is that it presents the image of corporate responsibility in formal communication by indicating the proposed (it limited) ustainability
policy.
Publishing the sustainability policy in the annual report also makes environmental assurance more teasible to order to attest that the claimed policies are being implemented
effectively.
Additional management data

While the primary purpose of Quinter's recycling is to demonstrate a policy of sustainability, and therefore corporate responsibility, it will also generate additional management
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 sales opportunity to sell new goods to the
Customer. The purchase of new product is a necessary condition of the collection policy. This may be an opportunity to sell more goods. However it also casts doubt on the
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 expired. Quinter sales staff can then market to them to
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.
33 Page 44
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 8800
Staff 300 900 1200
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
GP% 25.0% 31.7% 33.7% 33.3%

Op profit % -8.3% 0.3% 4.7% 4.3%
PBT% -9.6% -1.0% 3.4% 3.0%
PAT% -7.7% -0.8% 2.7% 2.4%
ROCE -18.2% 0.7% 10.6% 9.3% - 20k / 60k + 50K
ROE -40% 2% 26% 21%
Cars per employee 2 2.4 3 3
% changes
Revenue 9% 12.8% 14.4% 1.2%
Gross profit % 43.0%
Operating profit % -104.0%
Sales volume 10% 9.10% 0
Sales price 2.50% 4.90% 1.20%
Cost of sales 2.70% 11% 1.80%
Prop 1
Net proceeds 29 million
closure costs 2.5 million
CA assets 22 million
FV of assets 28 million
German supplier
3 years Min Max
engine supplier 3500 4200
Average cost per engine
33 Page 45
Fixed rate 1.5

Discount rate 6%
Controbution per car £45,000
Dec X7 Dec X8 Dec X9
€ 14,000.00 € 15,400.00 € 16,800.00
20X7 20X8 20X9

Demand 3800 4100 4400
Delivery 3800 4100 4200
Cost Euro € 14,000.00 € 15,400.00 € 16,800.00
Exchange rate 1.4 1.4 1.4
Cost £ £ 10,000.00 £ 11,000.00 £ 12,000.00
Direct cost £ 38,000,000 £ 45,100,000 £ 50,400,000
Op cost 9,000,000
Total cost £ 38,000,000 £ 45,100,000 £ 59,400,000
NPV £125,861,281.46
Japanses suppkier
2 year contract
Fixd price 1540000 Yen
Min Max
engine supplier 3800 5500
FX rate 140 Yen
Discount rate 6%
Controbution pe £45,000
Demand
Year Number of cars
20X7 3,800
20X8 4,100
20X9 4,400
20X10 4,400
20X7 20X8
Demand 3800 4100
Delivery 3800 4100
Cost Yen € 1,540,000.00 € 1,540,000.00
Exchange rate 140 140
Cost £ £ 11,000.00 £ 11,000.00
Direct cost £ 41,800,000 £ 45,100,000
Op cost
Total cost £ 41,800,000 £ 45,100,000
NPV £79,572,801.71
Approach (a) - Annual equivalent

Gratz
PV of engine costs (E) 125,861,281
AF 3 years 6% 2.673
Annual equivalent (f) 47,086,149
Shensu
PV of engine costs (E) 79,572,802
AF 2 years 6% 1.833
Annual equivalent (E) 43,411,240
Approach (b) - PV cost per engine

Gratz
PV per engine: f125,861,281/(3,800+4,100 +4,200)- £10,402
Shensu
PV per engine: £79,572,802/(3,800+4,100)- £10,073
Prop 2
Automate and upgrade
new factory 40 million
Bond issue 40 million
10 years at rate 4%
Average varaible cost £6,000
Useful life of machinery 7-10 year
Production capacity 8,000
(3) Proposal 1 compared with Proposal 2

Financial appraisal of Proposal 2
There is significant uncertainty Over the useful life of the new engine tactory equipment.
It would be unreasonable to compare directly the NPV of Proposal 2, re-equipping the engine factory, with the
outsourcing options in Proposal 1, as the periods covered are different, as are the profiles of cash flows. Proposal 2
33 Page 46
has a significant initial outlay, then a lower marginal cost. lo compare the first two or three years' cash flows of
Proposal 2 with the outsourcing options would be unreasonable, as the outlay of Proposal 2 would not expect to
be recovered over this short time period.
One approach is therefore to compare the annualised equivalent PVs of Proposal 2 for a 7-year useful life and a
10-year useful life. Ihis can then be compared with Proposal 1 annualised equivalent PVs. (Note: Other
approaches are acceptable.)
Cost per engine 6000 6000 6000 6000

Engines made (75% in 20X7) 2850 4100 4400 4400
0 1 2 3 4
20X6 20X7 20X8 20X9 20X10
Initial investment 40,000,000
Production cost 17,100,000 24,600,000 26,400,000 26,400,000
Opportunity cost (E45k 950 42,750,000
cars)
Total variable cost 40,000,000 59,850,000 24,600,000 26,400,000 26,400,000
DF
at 6% 1.000 0.943 0.890 0.840 0.840
Annuity factor 4yrs (ie, 7 yr 3.645
life)
life)
PV 7 yr i ife 40,000,000 56,462,264 21,893,912 22,165,949 76,849,840
PV 10 yrlife 40,000,000 56,462,264 21,893,912 22,165,949 123786432
Total PV 7 yrlife 217,371,966
Total PV 10 yr life 264,308,558
Annual equiv PV 7 yr life
AF
5.582 38,941,591.84
Annual equiv PV 10 year life
AF
7.36 35,911,488.81
Useful life
The first ot these is the usetul lite of the new equipment. If the new equipment lasts / years then the annual
equivalet PV is approximately t38.9 million, which S a lower cost than that for erther of the outsourcing
companies. On the other hand it the new equipment lasts 10 years then the annual equivalent PV is approximately
f35.9 million, which is even lower.
The useful lite of the new equipment is therefore a key risk and a key element in the decision that requires further
investigation.
Three months' lost sales
Another key factor is that there will be three months of lost production when re-equipping the engine factory. The
above table assumes that these sales will be lost and never recovered.
An alternative assumption is that customers are willing to defer their purchase and wait until the new factory and
new engines are available. Ihe tactory has an annual capacity ot 8,000 engines, so in the remaining 9 months it
can make 6,000 engines. Similarly, the assembly plant has an annual capacity of 5,200 cars so, in 9 months, it could
make 3,900 which is greater than the annual demand of 3,800 vehicles in 20X7.
If the assumption that all sales in the three months can be recovered then the alternative calculation is:
Internal production without opportunity cost

Cost per engine 6000 6000 6000 6000
Engines made (75% in 20X7) 3800 4100 4400 4400
0 1 2 3 4
20X6 20X7 20X8 20X9 20X10
Initial investment 40,000,000
Production cost 22,800,000 24,600,000 26,400,000 26,400,000
Opportunity cost (E45k 950
cars)
Total variable cost 40,000,000 22,800,000 24,600,000 26,400,000 26,400,000
DF
at 6% 1.000 0.943 0.890 0.840 0.840
life)
life)
PV 7 yr i ife 40,000,000 21,509,434 21,893,912 22,165,949 76,849,840
PV 10 yrlife 40,000,000 21,509,434 21,893,912 22,165,949 123786432
Total PV 7 yrlife 182,419,135
Total PV 10 yr life 229,355,727
Annual equiv PV 7 yr life
AF
5.582 32,679,888.12
Annual equiv PV 10 year life
AF
7.36 31,162,462.97
In this scenario, it the new equipment lasts / years then the annual equivalent PV is approximately £32./ million,
which is tar lower than that for erther of the outsourcing companies. On the other hand, if the new equipment lasts
33 Page 47
10 years then the annual equivalent PV is approximately t31.2 million, which Is now a signiticantly lower annual
cost than that for either of the outsourcing companies.
A balanced view might be that the useful life is somewhere between 7 and 10 years and that some, but not all, of
the potential sales during the 3 months the engine factory is closed will be lost. A series of iterations on these
assumptions would test the sensitivity of the outcomes.
PVof costs per engine
An alternative methodology is the PV of costs per engine (including opportunity costs) as follows.
Number ot engines
7 year life 2,850+4,100 +(4,400 x 5) 28,950 cars
10 year life 2,850 +4,100 +(4,400 x 8) 42,150 cars
PV of costs per car

7 year life £217,338,251/28,950 £7,507
10 year life £264,284,843/ 42,150 £6,270
Operating gearing
The two outsourcing options comprise entirely variable costs. However, the significant investment in the factory
means that, while Proposal 2 has a lower variable cost per engine than outsourcing, there are greater fixed costs.
As a result, operating gearing will be higher under Proposal 2. Therefore there is a risk if sales levels are lower than
indicated by the forecasts.
However, the minimum quantities specified by the outsourcing companies are also a de tacto fixed cost as, if
future sales are low, then these minimum levels must still be ordered and paid for. This is a similar risk to Proposal
2 where the cost of the new equipment is paid irrespective of future demand.
In this respect, the Shensu contract is the greater risk as the minimum order is 3,800 which is equal to the 20X/
level of dermand. So any shortfall of sales volume against forecast would result in excess inventory on the Shensu
contract. The Gratz contract is less risky as the minimum is of 3,00 engines per annum.
In both cases, as sales grow over time, the outsourcing company minima become less of a concern as there is
more headroom on tforecast sales.
Financial gearing
he costs ot outsourcing are incurred gradually over time so no immediate borrowing is needed. Conversely,
Proposal 2 requires f40 million of immediate borrowing. This raises financial gearing and therefore financial risk in
requiring future interest payments and capital to be repaid.
The life of the bond is 10 years, which is the maximum useful life of the new equipment. If the useful life is less than
this, then replacement of this equipment may be needed with associated new finance within the life of the existing
bond.
Wider benefits and risks of outsourcing engine production compared with internal manufactures
Benefits
Outsourcing enables Wooster to draw on the core competences of two market leaders. It is noted that Wooster
engines have become inferior to competitors' engines in cost, efficiency and environmental impact. This may
Suggest that, unless the new engine is a significant improvement, the manutacture of engines is not a core
competence of Wooster. Wooster's core competences may instead be in car assembly and brand development.
A further, and related, point is that both outsourcing companies are major multinational car manufacturing
companies which benefit from economies of scale; particularly in comparison to Wooster, which is relatively small
in the context of the industry. By outsourcing to these companies Wooster may benefit from their scale economies
and from a lower price
Risks
There are a number of key risks.
At the moment, the potential to continue internal manutacture of engines gives Wooster the choice to reject the
outsourcing companies' ofters. This may be helpful in negotiating price. However, if Proposal 1 is selected, the
factory will be sold and key staff for engine manufacture made redundant. As a consequence, it would be
extremely difficult for Wooster to resume internal manufacture in future by bringing production back in-house at
the end of the current outsourcing contracts. While there may be competition amongst outsourcers on contract
renewal, there is capacity for Wooster to be less well positioned in renewal negotiations without an in-house
option than is currenty the case.
Outsourcing may restrict future growth as, it sales increase, the capacity of the current two outsourcing companies
appears to be significantly below that of the production capacity of 8,000 which could be achieved by a re-
equipped engine Tactory.
Internal production would incur costs in ts sterling. Ihis appears to reduce currency risk, as Wooster 's functional
currency is the £, compared to the outsourcing alternatives, which are denominated in foreign currencies.
However, it could be argued that the Gratz contract actually gives lower currency risk than in-house production, as
it gives some natural hedging to euro revenues.
One final issue is the supply chain where a UK engine factory is located in the same location, a short distance from
the assembly plant. It therefore has a short supply chain. It also probably benefits from a common internal
information technology system. This may enable more reliable deliveries and appropriate conditions tor just-in-
time manufacturing.
Analysis
The analysis above (Method 1) determines the acost of supplying engines over the contractual periods for Gratz
and Shensu, which are 3 years and 2 years respectively.
In addition, in 20X9, although demand is for 4,400 engines the maximum capacity of Gratz is 4,200 engines. As a
consequence, given that holding inventories at the beginning of 20X9, by over-ordering in 20X8, is not possible
33 Page 48
due to storage problems, there is a constraint on the number of cars that can be sold. There is therefore an
opportunity cost on the Gratz contract in terms of lost contribution from lower sales of £9 million (200 £45,000)
(Note: Method 2 does not require the opportunity cost as the lost sales of 200 cars are built into the lower NPV.)
It may be that the figure of £9 million overstates the opportunity cost as it may be possible to increase price
slightly, compared with the Shensu contract, in order to reduce demand to the available level of supply. Moreover,
if the forecast demand for 20X9 is over optimistic, then this will aftect Shensu but, at the margin, will not aftect
Gratz and therefore the actual opportunity cost will be lower than expected.
A key comparability problem is the ditference in the length of each contract. It is clear that the total cost of
supplying engines over a 3-year period by Gratz (just over £125 million in PV terms) will be greater than that for
Shensu over 2 years (almost f80 million in PV terms). Some method of averaging is theretfore required.
Moreover, the Gratz contract has significant increases in price over the 3-year period so further averagıng is
needed.
The calculations show an annualised equivalent present value of approximately f47.09 million for Gratz and
f43.41 million for Shensu. This would suggest that the Shensu contract is preferable. However, the figures are very
close so a range of other financial and non-financial tactors need to be considered. In particula, the annuity
method adjusts for the differential time periods of the two contracts but does not adjust for the fact that the
number of engines varies over the contract term and is largest in the final year
An alternative method of adjustment is therefore to divide the PV of the costs by the number of engines produced
which allows tor the different contract periods and the variation in the annual number of engines over that period.
Beyond 20X9
The above financial appraisal only goes up to the end of 20X9. While there is no detailed data for 20Y0 and
beyond, there are a number of indicators of future financial differences between the two contracts. If Wooster
wishes to obtain continuity by continuing with the same supplier when the contract is renewed in 20Y0 then the
data for 20X9 for Gratz (and 20X8 for Shensu) may be an indicator of what might be renegotiated.
A key factor is that the demand for Wooster cars is increasing and in 20x9 is expected to be 4,400 which is greater
than Gratz's capacity to supply Wooster. If the demand for Wooster cars continues to expand beyond 20x9 then
the opportunity cost of using Gratz, rather than Shensu, will continue to grow. It may be that, with the knowledge
of a longer term supply relationship with Wooster, Gratz will invest to expand production from 20Y0 but, at current
engine production capacity, it could become a major barrier to growth for Wooster.
Variation in pricing
Shensu is charging a fixed price of yen 1,540,000 per engine. This is £11,000 per engine at the assumed exchange
rate of f1- yen 140.
Over the term of the contract, Gratz is charging variable prices per engine in euro which in ts is as tollows:
Year euro % increase
20X7 14,000 £10,000 0
20X8 15,400 £11,000 10.09%
20X9 € 16,800 £12,000 9.10%
The increases in price over the term of the Gratz contract gives a cash flow advantage to Wooster as the higher
prices are at a later date. These are also discounted to a greater extent as they occur later.
f the contract is taken with Shensu in 20X7 and then renewed with Shensu we do not know what price will be
charged in 20X9 under the new contract. However, the Gratz price for 20X9 represents a significant increase of
9.1% on the Shensu price and on Gratz's own price for 20X8.
If the Gratz contract is to be renewed in 20Y0, the highest price under the existing contract of £12,000 may form
the basis of renewal negotiations and this would mitigate against renewal of the Gratz contract and therefore the
possibility of supply continuity.
(b) Supply chain

Geographical distance
A key difference between the two contracts is geographical distance. Germany is relatively close to the UK, while
the lead time to supply from Japan is many times longer, particularly as engines are large and are likely to be
transported by ship, rather than by air.
If the costs of transport are to be incurred by the supplier, and deliveries are planned in advance, then this long
lead time may not be a major issue. However, if there is uncertainty of demand or supPply, then it could become a
significant issue, which may result in temporary production closure at Wooster's assermbly plant. This is particularly
the case as there seems to be little capacity to store engines and thus hold a buffer inventory level to prevent
shortag
Frequency of delivery
The frequency of delivery is different, with Gratz delivering weekly and Shensu only monthly.
he limited storage capability is placed under more strain with monthly deliveries, but would leave some spare
storage capacity with weekly deliveries as each order is smaller.
The fact that orders are only monthly with Shensu means if there is a problem with fulfilling any order, there may
be a significant delay before it can be rectified.
The even spread of sales over the year may imply there is stability of demand and this may reduce the uncertainty
in the supply chain, enabling Shensu to provide a good senvice.
(C)Foreign currency
Both supply contracts are in foreign currencies, but different foreign currencies.
A key issue is the correlation of each of the two currencies with the £, which appears to be Wooster's functional
currency. This will depend on the relative growth rates, interest rates and monetary policies of the UK, Germany
and Japan. Forward currency rates may give an indication of short-term market expectations of currency
movements, but expert advice might be needed to assess longer term expectations of relative currency
movements.
Foreign currency risk management needs to consider the wider picture of foreign currency tlows for the company
as a whople.
In 20X7, predicted sales are 3,800 vehicles. Assuming the price per car remains at the 20X6 level of £87,00, then
33 Page 49
this means total revenue in 20X7 will be £330.6 million. If the proportion of sales to eurozone countries remains at
30% then this will give euro revenues of f99.18 million.
In 20X7, the total direct cost of the Gratz contract is estimated to be f38 million. The Gratz contract would
therefore represent a direct natural hedge for over a third of euro revenues. As a consequence, rather than
increasing foreign currency risk, it actually reduces this risk for the company as a whole.
There are currently minimal revenues (if any) in yen and hence there is no direct natural hedging in respect of the
cost of the engines from Shensu. There may be an indirect hedge it movements in the yen are closely correlated
with movements in the USS or the euro but, at best, this is likely to be somewhat less than perfect.
Short term hedging of transactions is possible by using yen/£ forwards, futures and options. Given that contract
prices are fixed and quantities required are stable then reasonably effective hedging should be possible, at a cost
Over the contract term.
Recommendation
The Shensu contract has the lower annualised present value of £43.4 million compared with £47.1 million for the
Gratz contract. On this pure financial basis the Shensu contractis to be preferred by a reasonable margin.
In addition however the Shensu contract is tor two years compared with three years for the Gratz contract. This
may enable renegotiation earlier but this may result in either a favourable or an adverse outcome.
The risk of the Gratz cotract is lower in forex terms, minimum delivery and in reliability of supply chain terms.
In the longer term however the maximum quantities are greater for Shensu and along with the direct financial
benefit this appears to be the best option but based on a close iudgement.
(2) KPls and assurance

In order to deliver a successful outsourcing project, the relationship with the outsourcing company, the products
and the service provided, all need to be monitored and controlled.
Outsourcing makes Wooster dependent on a third party supplier to provide a key element of the car at
appropriate quality and time.
A service level agreement, with specific measures of performance required under contract, enables Wooster to
maintain some control of the key features of the supply arrangement.
In this case the features highlighted include environmental impact and sustainability. Two KPls could be:
(1) CO emissions from the engines not to exceed an agreed maximum level
(2) Proportion of an engine that can be recycled to be specitied at a minimum level
Assurance procedures
Co emissions from the engines not to exceed an agreed maximum level.

Review the governance, culture and competence of Gratz/shensu management for evidence of commitment to
sustainability and controlling environmental impact. Ihis may include a public pronouncement in their annual
reports and the emissions levels achieved by their own cars.
Review the design of the engine and the features that control CO2 emissions within the engines. This may need
the help of an expert who is familiar with emissions engineering. The purpose of this procedure is to ensure
emissions controls are embedded within the engine's design.
Monitor the control procedures in the Gratz or Shensu factory to check for emissions of engines actually being
produced. For example, are the checks independent of production line management; are they rigorous; are they
on every car or on a sample.
Monitor any controls over emissions carried out at the Wooster factory eg, as part of quality control checks.
Monitor compliance with environmental regulations in the UK and in Germany/Japan, investigating any breaches.
If Gratz/Shensu participates in the emissions trading scheme, ensure data processing and measurements comply
with the scheme and appropriate disclosures are made in the annual report.
Proportion of an engine that can be recycled to be specified at a minimum level

Review the design ot the engıne in terms of the composition of parts that are made of materials which can be
recycled. Ihis may need to help of an expert who is tamiliar with engineering materials that can be recycled.
Review the procedures for reclaiming and recycling old vehicles and assess the cost of recycling relative to the
likely benefits/revenues.
Test the Gratz or Shensu recycling arrangements for their own cars and ask for the historic evidence of the
experience of implementing these procedures.
(4) Financial reporting

There are a number ot financial reporting issues arising trom the two proposals.
Factory closure
Factory closure relates only to Proposal 1 and is not applicable if Proposal 2 is decided upon.
Under Proposal 1, the engine factory assets would be disposed of to a rival company, Jadd Motors plc, collectively
under a single contract. They therefore appear to form a 'disposal group' under IFRS5, Non-current Assets Held
for Sale and Discontinued Operations - defined as a group of assets to be disposed of, by sale or otherwise,
together as a group in a single transaction.
Given the information about the planned sale, it seems clear that the disposal group would meet the definition of
held for sale' as at 30 November 20X6. (The disposal group would then be available for immediate sale in its
present condition. lt has been actively marketed at a reasonable price as evidenced by negotiations for a sale
nearing conclusion. The sale would then appear to be virtually certain and will be completed within one year.)
Immediately before the classification of a disposal group as held for sale, the carrying amounts of the assets need
to be reviewed (IFRS 5).
On this basis, evidence of impairment should be assessed on each individual asset (or CGU) immediately prior to
the held for sale date. Atter classification as held for sale, any test for impairment will be based on the disposal
group as a whole.
In the case of the engine tactory, there is no apparent evidence of impairment on the assets but more information
will be required to verify this, particularly if there is any evidence of uncertainty over the fair value of individual
assets.
33 Page 50
An adjustment that will need to be made prior to classitication as held tor sale is in respect ot the depreciation
charge for the 11 months to 30 November 20X6. No further depreciation charge is made after the held for sale
classification date.
The depreciation charge for 11 months to 30 November 20X6 is: (£600,000) x 11/12 - £550,000.
The overal adjustment to the financial statements immediately before reclassification as held for sale is theretore
to reduce the depreciation charge to profit or loss to f550,000 and increase the carrying amount of engine factory
assets to f£22.05 million. (Increase is t600,000 - £550,000.)
On re-classification as held for sale, IFRS 5 requires that a disposal group shall, at the date when reclassified as
held for sale, measure the relevant assets at the lower of:
carrying amount
fair value less costs to sell
As the carrying amount is less than the fair value less costs to sell, there is no impairment charge required upon
reclassification.
Based on the estimated amounts provided, a profit on the sale of the factory of f9.45 million (£31.5 - £22.0Sm)
would be recognised in the statement of profit or loss for the year ended 31 December 20X7. The engine factory
assets would be derecognised on sale. (Note that the £29 million proceeds is net of closure costs whereas it
should be gross at f31.5 million without the closure costs deducted. These should be recognised as a provision in
20X6 (see below).)
Foreign currency movement and management

he functional currency is that of the primary economic environment in which the entity operates. Ihis appears to
be the f tor Wooster, as the UK is the largest revenue generator and most costs are currently incurred in fs.
Wooster should translate the foreign currency purchases from Gratz/Shensu at the spot exchange rate at the date
on which the transaction took place. Given there are weekly or monthly deliveries this may be teasible.
However, if there are many transactions in each delivery, an average rate may be used. This appears reasonable as
Wooster has sales evenly spread over the year.
These purchases give rise to:
Assets (inventories in Proposal 1 and the new equipment in Proposal 2) - which are non-monetary items.
Liabilities (ie, payables to outsourcing companies in Proposal 1 or to Silvez lnc in Proposal 2) - which are
monetary items.
Monetary items are translated on the date of the transaction and re-translated at the year end (ie, if the foreign
currency payable remains outstanding at the year end).
The exchange difference is the difference between initially recording the purchases of engines at the rate ruling at
the date of the transaction and the subsequent retranslation of the monetary item to the rate ruling at the
reporting date. Such exchange differences should be reported as part of Wooster's profit or loss for the year.
Non-monetary items (eg. the inventories of engines) are carried at historical cost and are translated using the
exchange rate at the date of the transaction when the asset or liability arose. Ihey are not subsequenty
retranslated.
Gratz- cost recognition

The cash payment per engine changes over the life of the Gratz contract. However in terms of cost recognition in
the financial statements it could be viewed as a single three-year contract where the engines being delivered are
identical and therefore the cost per engine accrued should be constant, even though the cash payments are
uneven.
On this basis the average cost per engine is:
Provisions
Under Proposal 1 a provision of f2.5 million would need to be made for closure costs of the factory in the year
ended 31 December 20X6. By 30 November 20X6, the contract would be finalised and announced. There is
therefore both a constructive and legal obligation to incur these costs from this date.
Year euro Nuber of engine Cost EURo cover 1.4

20X7 14,000 3800 53200000 38000000
20X8 15,400 4100 63140000 45100000
20X9 € 16,800 4200 70560000 50400000
12100 133500000
Average cost 11033.0578512397
Year Cost per engine Nuber of engine total cost

20X7 11033.0578512397 3800 41925619.8347108
20X8 11033.0578512397 4100 45235537.1900827
20X9 11033.0578512397 4200 46338842.9752066
12100 133500000
(5) Evaluation of the performance of Wooster

Introduction and context
This is an independent evaluation of the performance of Wooster, and its management since the acquisition by
StockFin on 1 January 20X4.
Revenue
There has been a clear increase in sales revenues over the period 20x4 to 20X6 represented by signiticant
increases of 12.8% in 20X4 and 14.4% in 20X5, but a much smaller expected increase of only 1.2% for 20X6.
Sales volumes and price are two possible causes of these increases in sales revenues.
Sales volumes have increased by 10% in 20X4 and by 9.1% in 20X5, so this was a signiticant cause of the increase
in revenues. Sales volumes did not increase again in 20X6, but by this stage there was a binding production
capacity constraint from the engine factory which prevented further growth.
The average price increased by 2.5% in 20X4 and by 4.9% in 20X5, which are additional to the volume increases.
33 Page 51
Being able to sell more cars at a higher price is evidence of good performance by Wooster management.
In trying to identity underlying causal factors, it does not seem that the price increase retlects a quality increase as
product costs have also fallen from a high in 20X3 (see below) so this explanation may lack plausibility.
An alternative explanation is a change in the product mix being sold, witha higher proportion of higher priced
cars being purchased by customers in 20x4 and 20X5 compared with 20X3.
An additional explanation of the high price increase in 20X5 could reflect the fact that the company is operating at
productive capacity in 20X5 and 20X6 and management is increasing price to reduce effective demand to the
level of available supply.
The price increase for 20X6 is much smaller at 1.2%. This may be due to market conditions but it is also cumulative
on top of significant price increases in 20x4 and 20X5 which are unlikely to be sustainable at this rate in the longer
run.
Profit
Since 20X3, the year betore the acquisition, profit has improved from operating losses (also losses betore and after
tax) into profits.
Operating profits were achieved in 20X4 and profits before and after tax by 20X5. This was a rapid and significant
turnaround achieved by management
Percentage increases to turn a loss to a profit are not particularly instructive, so perhaps the best measure of the
improvement in operating performance is seen in the improvement in gross profit. In particular, the increase in
gross protit has outweighed the f£11 million increase in administration costs between 20X3 and 20X6 (compound
average ot 4.39% per annum).
The gross profit margin has increased from 25% in 20X3; to 33.7% in 20X5; before dropping back to an expected
33.3% in 20X6.
This has meant a very significant increase in gross profit in 20X4 of 43%; and a further significant increase in 20X5
21.7%.
of
The main cause of the increase in gross profit has been revenue increases which have been discussed above.
However, there has also been good control over production costs which have fallen from £60,000 per vehicle in
20X3; to £S6,000 per vehicle in 20X4; before rising to f58,000 by 20X6.
A key feature in reducing production costs appears to be labour productivity. Following the reduction of the
labour force in 20X4, and again in 20X5, the annual number of cars produced per employee increased
signiticanty from two to three.
There was no further increase in gross profit in 20X6, compared with 20X5, as although the price per vehicle
increased by £1,000, the production cost per vehicle also increased by £1,000, with no change in sales volume.
Return on capital employed (ROCE)

New capital assets, amounting to £10 million, were added to the assembly plant in each of the years 20X4 and
20X5. Capital employed did not increase by this full amount, due to depreciation on existing assets, but
nevertheless there was a signiticant increase in capital over this period. It would therefore be expected that profits,
in absolute terms, should increase as the scale of the business has increased.
Due to operating losses being made in 20X3, ROCE was negative (at minus 18.29%) in that year. Improving to near
breakeven (at ROCE - 0.79%) in 20X4. There was a reasonable ROCE of 10.6% in 20X5; before falling back to 9.3%
in 20X6. This represents a signiticant improvement in pertormance and a reasonable ROCE in absolute terms.
Return on equity
In terms of the investment pertormance for Stockin in 20X3, return on equity (ROE) was significantly negative (at
minus 13.8%) in that year. Improving in 20X4, ROE was still negative at minus 4.5%. In 20XS it increased to 14.8%,
betore faling back to11.8% in 20Ox6. While this represents a significant improvement in investment pertormance,
it could still be regarded as too low for this type of private equity investment; particularly with respect to the
annual benchmark of 20% expected by StockFin.
The Wooster management performance

While the chief executive was changed on acquisition, the four other executive directors are the same as prior to
the acquisition. The non-executives and the chairman are new. The change in performance may therefore be due
to a partial change in the composition of the board.
It may also be due to the additional pertormance incentives given to management by the share options.
In attempting to distinguish management pertormance from company performance, the factors which
management can control need to be considered compared with matters that are decided at a higher level (eg.
new investment by Stockfin) or exogenous events which may affect Wooster's performance, but are beyond the
control of management.
It is clear that performance has increased in 20X4, and again in 20X5, compared with 20X3. Performance fell back
a little in 20X6. Issues such as pricing, sales volumes achieved and cost control in 20X4 and 20X5 have been
favourable and largely attributable to actions within the control of management
Production capacity was reached in 20X5 and 20X6 so turther growth was difticult. New investment is required too
sustain growth (which is now being considered - see above) but this is not directly within Wooster management's
control.
(6) Summary
in 20x3, the year before StockFin acqured Wooster, pertormance was poor with significant operating losses being
incurred. Performance improved significantly in 20X4 and again in 20X5 and began to turn the company around.
Pertormance fell back a little in 20X6, partly because the engine plant reached capacity output. New plans are in
place to address this Issue. Iherefore the pertormance in the two years tollowing the acquisition has been good
but, for further improvements, and to prevent the stagnation of growth in 20X6 reoccurring, there needs to be
increased efficiency and further investment.
34 Page 52
Route to India
Start 1 Oct X7
Prices
Prem Eco £600
Business class £1,250
Premium Business
economy class
passenger passenger
s s Revenue
Monday £240,000
Tuesday £165,000
Wednesday £165,000
Thursday £165,000
Friday £270,000
Saturday £195,000
Sunday £270,000
£1,470,000
Operate 360 days a year
Yearly £75,600,000
FV of aircraft 25,000,000
Prem Eco seBuss Seats
Configurition 1 180 80
Demand Demand Seat Seat PE pass BC pass Upgrades Price
PE BC PE BC PE BC
Monday 150 120 180 80 150 80 600 1,250 90,000 100,000
Tuesday 150 60 180 80 150 60 600 1,250 90,000 75,000
Wednesday 150 60 180 80 150 60 600 1,250 90,000 75,000
Thursday 150 60 180 80 150 60 600 1,250 90,000 75,000
Friday 200 120 180 80 180 80 600 1,250 108,000 100,000
Saturday 200 60 180 80 180 60 20 600 1,250 120,000 75,000 20 x 600
Sunday 200 120 180 80 180 80 600 1,250 108,000 100,000
696,000 600,000
total weekly 1,296,000
Prem Eco seBuss Seats

Configurition 2 225 60
Demand Demand Seat Seat PE pass BC pass Upgrades Price
PE BC PE BC PE BC
Monday 150 120 225 60 150 60 600 1,250 90,000 75,000
Tuesday 150 60 225 60 150 60 600 1,250 90,000 75,000
Wednesday 150 60 225 60 150 60 600 1,250 90,000 75,000
Thursday 150 60 225 60 150 60 600 1,250 90,000 75,000
Friday 200 120 225 60 200 60 600 1,250 120,000 75,000
Saturday 200 60 225 60 200 60 20 600 1,250 120,000 75,000
Sunday 200 120 225 60 200 60 600 1,250 120,000 75,000
720,000 525,000
total weekly 1,245,000

Reasoned recommendation
Based on the estimates provided, the configuration of 80 Business Class; 180 premium economy generates
revenue per week of £1,296,000 per week, which is f£51,000 greater than the alternative contiguration of 60
Business Class; 225 premium economy. Over a year this would generate f2.62 million (£51,000 a 360/7)
additional revenue, which is signiticant.
The passenger load is identical at 1,620 passengers per week, but with the first contiguration there are 60 more
BC customers and 60 tewer PE passengers. Ihis might mean some additional costs (eg, food, drinks) but this is
likely to be small compared to the additional revenue.
Further, in the second option the BC is always full so if forecasts understate the business class demand there is no
capacity to increase BC revenue
There is more flexibility if forecasts understate the PE demand because there is capacity to increase seat capacity
by upgrading to BC it there is spare capacity there.
At full capacity the revenues generated would be very similar as follows:
(80 x £1,250) + (180 x £600) = £208,000
(60 x £1,250) + (225 x £600) - £210,000
Recommendation
The contiguration of 80 Business Class; 180 premium economy generates more revenue per week but also has
greater flexibility to take on more BC passengers. It may 7%
Revenue £m
Fuel costs 2,815.00
Other operating costs - 942.00
Operating profit - 1,273.00
Finance costs 600.00
Profit before tax - 36.00
Tax 564.00
Profit for the year - 73.00
Other comprehensive income 491.00
Fair value changes in cash flow hedges transferred to fuel costs
Fair value changes in cash flow hedges in the year (fuel commodities) 56.00
Total comprehensive income - 85.00
462.00
Finacing the aircrafts

34 Page 53
Loan 1 Oct X7 DF PV
Purchase 40,000,000 1- 40,000,000
Useful life 10
sale price 15,000,000 1/1.07^10 7,625,239
- 32,374,761
Lease 1 Oct X7
Useful life 10
Lease rental 5,000,000
Penalty if broken 14,000,000 if cancel 30 Sept Y2
PV rentals (paid in advance) £5m x (1 + (AF9yrs 7%)) £5m x (1 +6.515)

NPV (£37.575m)
Leasing- break clause
PV rentals £5m x (1 +(AF4yrs 7%)) = £5mx (1 +3.387) - £21.935m
PV penalty -£14m/(1.07)5 - £9.982m
NPV (£31.917m)
Comparison
The full lease term of 10 years is comparable with the expected useful lite of the asset it it is purchased. Over this
period using the assumed discount rate, purchasing is the lower NPV option and on this basis is to be accepted.
However the decision should not be taken on the basis of NPV alone. There are a range of other factors that
should be taken into account, particularly as the difference in the two NPVs is relatively small and may be sensitive
to changes (eg, in the interest rate or in the tax rate).
Liquidity may be a key consideration. The purchase of aircraft requires an initial payment. This needs to be out of
available cash or the t80 million needs to be financed (eg, by borrowing). It the company does not have the
available cash and is near debt capacity then leasing may be the only available choice, notwithstanding the higher
NPV.
Risk is also a key factor. lf demand for the London to New Delhi route is not popular it may be possible to use the
aircrart on other routes. It however the aircraft are particularly suitable for this route, or if there is a general fall in
demand for PWA flights globally, then the costs of grounding the aircraft for substantial periods or disposing of
the aircraft need to be considered.
In this respect, the break clause offers an exit route after 5 years which gives a lower NPV than ownership.
However, the penaity cost is substantial and the comparison of (a) ownership and (b) a S-year lease using the
break clause, assumes the aircraft are grounded for a full 5 years without use betore being sold, which is
unrealistic. So while the break clause offers some flexibility, it is limted in its application.
The interest rate should be the after tax rate once tax cash flows are included. More information is needed on the
tax consequences of the various options.
Further information is also needed on how the interest rate is calculated and how sensitive the NPVs are toa
change in interest rate. A significant rise in interest rates would make the leasing method more favourable as it
reduces the PV of the lease rentals and also reduces the value of the residual receipt for the purchase method,
while leaving the outlay PV unaffected.
Recommendation
There are benefits to both methods. Unless market research has a high degree of certainty for strong demand, the
purchase of one aircraft and the leasing of the other may give some flexibility in that it is less likely, it both were
leased, that demand would be so low that both aircraft would need to be grounded and the break-clause
exercised on both contracts.
Purchase 40,000,000
Useful life 10
sale price 15,000,000
Depn 2,500,000
Carry amount at 30 Sept Y0 32,500,000 3 years
If the airCraft is to be grounded permanently from 30 September 20Y0 then the value in use would be zero in
respect of operating earnings.
The fair value less costs to sell would be the fair value at the date of impairment which is f25 million. An
impairment of £7.5 million would therefore Bbe recognised in profit or loss for the year ended 30 September 20Yo.
Leasing
Under IFRS 16, Leases the lease would be recognised in the statement of tinancial position as a lease liability and a
right-of-use asset, which would be depreciated over the lease term.
lf the aircraft are to be grounded permanently from 30 September 20Y0, and this is anticipated at the inception of
the lease, the lease liability will be calculated on the basis that the break clause will be exercised. Ihis means that
the penalty of £14 million is included in the present value of the future lease payments. Ihe right-of-use asset will
be depreciated over the expected lease term of tive years and an impairment loss will be recognised in profit or
loss for the year ended 30 September 20Y0, as tor an owned asset.
Managing fuel costs

Risk management note - forward and future contracts Concerns about hedging fuel costs
18 months forcothimign
30 Sept X6 90% cover future fuel for 9 months 30 June X7
60% covered for 9 motnhs after 31 March X8
Hedgeing drrangements
Forward contracts
A torward contract is a binding agreement to acquire a set amount of goods at a future date at a price agreed
today.
A forward contract fixes the rate for a transaction, and these contracts must be setled regardless of whether or not
the oil price at the settlement date is more favourable than the agreed forward price.
The hedge could be for aviation fuel itself, or for oil, which is very closely correlated to the price of aviation fuel.
While PWA uses fuel, it does not need to take physical delivery of the fuel. Instead it could use changes in the
price of the forward contracts where the gains and losses would oftset the movements in fuel purchase prices
which are entirely separate contracts.
5, tor example, PWA may arrange a forwa
contract with its bank. Subsequently, when it needs to purchase
34 Page 54
the Tuel, the bank ill close out the original torward contract, in effect by arranging another torward contract Tor
the same settlement date, to cancel out the original contract. Ihe close-out is then settled with a cash payment by
one party to the other, depending on the difference between the forward prices in the contract and market prices.
Some advantages of forwards over futures are as follows:
they are transacted over the counter, and are not subject to the requirements of a trading exchange.
they can, in theory, be tor any amount.
The length of time for the contract can be tlexible, but contracts are generally tor less than two years.
Some disadvantages of forwards compared with futures are as follows:
PWA would not have the protection that trading on an exchange brings (see below).
there is a risk of detault by the counterparty to the contract.
Futures
A future would be an exchange-traded agreement to buy or sell a standard quantity of oil on a fixed future date at
a price agreed today. They can be described as exchange-traded standardised forward contracts.
There are two parties to a futures contract-a buyer and a seller - whose obligations are as tollows.
The buyer of a future enters into an obligation to buy the specified asset on a specified date.
The seller of a future is under an obligation to sell the specified asset on a future date.
Futures contracts are traded on an exchange with the contract terms clearly specified by the rules of the exchange.
The contracts are of a standardised size with standardised delivery dates (March, June, September and
December). This means that it may not be possible to match the exact exposure that PWA requires for its fuel over
the exact period for which fuel purchases are anticipated to be made.
Futures are traded on margin, meaning that the trader only has to spend a small amount of money, far below the
value of the underlying commodity, to be exposed to the price rise or fall of that commodity. Margin is an amount
of money deposited with the clearing house of the futures exchange, to cover any foreseeable losses on the
futures position. Both buyers and sellers of futures deposit initial margin with the exchange when they make their
transaction, and may subsequently be required to pay additional variation margin if they incur a loss on their
futures position.
Recommendation
In general, the principle of both forward contracts and futures would be to lock PWA into a contractual price tor
fuel to be paid in the future. Gains or losses would offset changes in the underlying prices of fuel purchases, which
s the item being hedged.
The key diference would be if PWA wished to hedge 18 months ahead like the previous FD did, then this would
point towards forward contracts, as futures tend to be within 12 months, and possibly less.
It would be possible to extend hedging up to two years using forward contracts, but it would be difficult beyond
that time frame.
Whether PVWA wishes to hedge all of its fuel purchases or (say) 90% like the previous FD would depend on the risk
appetite of the board. The advantage of not hedging 100% would be that the amount of fuel purchased next year
may be below expectations and therefore result in over-hedging (ie, >100% of actual fuel purchases are hedged),
which would perversely expose PWA to increased risk rather than reduced risk.
In having a lower proportion of longer term fuel purchases hedged (say 60% like the previous FD) it leaves scope
for top-up hedging at a later date and the flexibility to leave open positions while observing trends in fuel prices
over time. Shorter term top up hedging at a later date would enable the use of futures it these had more
favourable terms than forward contracts at this time.
Accounting policy notes

treated as cashflow hedge forceasts

The previous finance director has used fonward contracts for fuel as a cash tlow hedge tor accounting purposes.
The purpose of cash fiow hedging is to enter into a transaction (purchasing the forward contracts as a derivative)
where the derivative's cash flows (the hedged instrument) are expected to move wholly or partly, in an inverse
direction to the cash flow of the position being hedged (the hedged item) which is the future purchases of oil. The
two elements of the hedge (the hedge item and the hedge instrument) are theretore matched and are interrelated
with each other in economic terms.
The policy notes in PWA's accounts state that this matching has been highly ettective in the year ended 30
September 20X6.
Overall, the impact of hedge accounting is to retlect this underlying intention of the matched nature of the hedge
agreement in the financial statements. Hedge accounting therefore aims to ensure that the two elements of the
hedge are treated symmetrically and ofssetting gains and losses (of the hedge item and the hedge instrument) are
reported in profit or loss in the same periods. Normal accounting treatment rules of recognition and measurement
may not achieve this and hence may result in an accounting mismatch and earnings volatility, which would not
reflect the underlying commercial intention or effects of linking the two hedge elements which offset and mitigate
risks. For example, typically, derivatives are measured at fair value through profit or loss; whereas the cash flows
from fuel purchases that they are hedging are measured at cost or are not measured at all in the current period.
Hedge accounting rules are theretore required, subject to satistying hedge accounting conditions as stated in IFRS
9, Financial Instruments.
If the hedge is for physical delivery of fuel (own use) then hedge accounting would not apply.
With hedging, but without hedge accounting, there would be a mismatch if the forward contract was taken out in
the year ended 30 September 20X6 for an anticipated fuel purchase in the year ending 30 September 20X7. A
gain (or loss) on a torward contract derivative would be recognised in the year ended 30 September 20X6 but the
fuel price change it was hedging would be recognised when the fuel Is purchased in the year ending 30
September 20X7.
Cash tlow hedge accounting attempts to reflect the use of the torward rate derivative to hedge against future cash
tlow movements from fuel price changes. lo achieve this, movements in the derivative, in the year ended 30
September 20X6, which would normaly go through profit or loss, are recognised in other comprehensive ncome.
The other comprehensive income balance (including further movements in the year ended 30 September 20X6 in
the forward exchange derivative) is restated/recycled to profit or loss in the same period in which the hedged
highly probable transaction (fuel purchases) affects profit or loss which would mostly be tor the year ending 30
September 20X7.
The financial statements for the year ended 30 September 20X6

Under OCl, the 'Fair value changes in cash flow hedges in the year (fuel commodities) of f85 million represent a
loss on forward rate derivative contracts taken out in the year ended 30 September 20X6 to hedge fuel purchases
after that date. This suggests that in hedging against fuel price increases, the price of fuel has fallen and a loss has
therefore occurred on the forward contract as there is an obligation to deliver fuel at the contract price which is by
30 September 20X6, now above the current market price of fuel.
34 Page 55
Under OCI, the Fair value changes in cash flow hedges transferred to fuel costs of f56 million represent a loss on
forward rate derivative contracts taken out in the year ended 30 September 20X5 (or prior years) to hedge fuel
purchases in the year ended 30 September 20X6 (ie, so gains and losses on the forward contracts can be
recognised in profit or loss in the same period in which the hedged item (fuel purchases) affects profit or loss). As
such, they are recycled to fuel costs in the statement of profit or loss in the year ended 30 September 20X6. The
figure of f56 million is positive in OCl as a negative figure is being removed from OCI. The consequence is that
fuel costs are increased to E942 million. In the year ended 30 September 20X6, the overall effect on total
comprehensive income, of recycling the f56 million is zero, as the extra cost under fuel is cancelled by the positive
figure under OCl.
The underlying cost of fuel was f886 million (E942m - £56m). This would reflect a lower than expected price of
fuel purchases but with an added loss on a hedging arrangement that moved in the wrong direction for PWA. This
loss on hedging increased underlying fuel costs by 6.3%6.
35 Page 56
£'000
Bread market cap 2300000
special bread 170000
Other
Savelow customers Total
£'000 £'000 £'000
Revenue 90,000,000 377,600,000 467,600,000
Wheat used in production -15,600,000 -61,360,000 -76,960,000
Other variable costs -48,000,000 -188,800,000 -236,800,000
Fixed operating costs -120,000,000
Operating profit 33,840,000
Other
Number of loaves sold (million) 120,000,000 472,000,000 592,000,000
Tonnes of wheat used 60,000 236,000 296,000
Loaves produced per tonne of wheat 2,000 2,000
Receivables at 30 June X7 7,500,000 47,000,000 54,500,000
Other VC 0.40 0.40

Cost if wheat per loaf 0.13 0.13
Other Information June X7 Oct X7

Overdraft 12,200 12,200
Interest 8%
Facility limit 23000
Production capacity 610,000 loaves per year
Extend credit period with supplier

Reduced prices for customers by 0.02 per loaf of bread
Current contract 30 days
Demand 90 days 1 Oct X7
Sells increase expected by reduce price 10%
Other
Revised contract Savelow customers Total
Loaves sold 120k x 3/12 + 120k x 9/12 x 1.1 129,000,000 472,000,000 601,000,000
price per load .73 & .75 0.8
Tones of wheat 64500 236,000 300,500
Price per tonne of wheat 260 260
Other VC 0.40 0.40
Loaves produced per tonne of wheat 2,000 2,000
Revenue 94,770,000 377,600,000 472,370,000 (£0.75 x 120k x 3/12)+ (£0.73 x 120k x 9/12x 1.1)
Total wheat cost 16,770,000 61,360,000 -78,130,000 64500 x 260
Other variable costs 51,600,000 188,800,000 -240,400,000 129m x .04
Lost contribution from price reduction

£0.02 x 90m loaves = £1.8m
Increased contribution from increased sales volume
£(0.73 - 0.40 - 0.13) x 9m = £1.8m
Financial evaluation
Price change
There are two elements to SaveLow's proposed revised terms:
A reduction in selling price for BBB of 2p.
An additional credit period of 60 days.
SaveLow claims that, as a consequence of the price reduction, it will pass the reduction on to its own customers
and, as a result, there will be a 10% increase in the sales volume of loaves.
The above tables deal with the price change and the volume change. They show that, from BBB's perspective, the
price and volume changes precisely compensate each other in terms of contribution and protit. As a result,
operating profit is t3.84 million in each case.
However, a degree of professional scepticism needs to be applied. The price reduction is certain if the agreement
is made, whereas the volume increase is only an estimate which is being made by SavelLow which is self-interested
in trying to persuade BBB to accept the new contract conditions. The claim of 10% increase in sales volume may
therefore be exaggerated in order to make the changes look more acceptable to the BBB board.
As a result, whilst the above tables show financial indifference, this is not necessarily the case given the risks
attached to the increase in volumes.
The price reduction lowers contribution per loaf sold from 22p to 20p, which is a significant 9.1% reduction.
Applying professional scepticism, if the 10% increase in volumes does not occur, then the overall contribution
from the SaveLow contract would be:
120m x £(0.73 - 0.40 - 0.13) = f24m
This is a reduction of £2.4 million from the current profit on the SaveLow contract of E26.4 million.
Also, it has been assumed that fixed costs do not change with the 10% increase in volume. This may be a valid
assumption but there may be some semi-tixed costs that follow a stepped function and therefore there may be
some increase due to the 10% volume increase in the SaveLow contract.
Conversely, other variable costs per unit may be reduced as, for example, distribution costs per loaf may be lower
This may be due to economies of scope as more loaves are being delivered to the same number of SaveLow
Supermarkets.
Credit period
Credit period change-financial cost
The proposed change in credit terms from 30 days to 90 days potentially has two effects:
The direct financial etfect is a reduction in cash received by BBB from sales immediately following the
introduction of the new policy which will mean that the overdraft will increase (unless other finance can be
35 Page 57
raised) and therefore overdraft interest costs will increase.

The reduction in cash may create cash flow and liquidity issues. The current receivables days is:
Other customer sales:
(47,000/377,600) x 365 days - 45 days (approximately)
SaveLow sales:
(7,500/90,000) x 365 days-30 days (approximately)
f the SaveLow receivables days changes to 90 days, then receivables will be approximately:
£7.5m x 3- £22.5m
Note: This ignores the impact of the price decrease and possible volume increase in order to isolate the credit
period change effect
This means that, under these assumptions, receivables will increase by £15 million and cash will decrease by £15
million under the new credit policy, compared with the previous credit policy. f this continues to be financed by
overdraft this will represent an additional annual interest cost of f1.2 million (f15m x 8%).
If we deduct this cash interest cost from the lowest of the above figures for contribution from SaveLow (above), this
gives an overall contribution from the SaveLow contract of t25.2 million (t26.4m -£1.2m).
In financial terms, this is still substantially positive and, on this narrow basis, then BBB should retain the SavelLow
contract.
Credit period change- Iiquidity and cash flow

Aside from any financial cost, the impact on liquidity of the proposed change in credit terms needs to be
considered.
In particular, BBB has a significant overdraft (E12.2 million) and there is limited headroom (f10.8 million) above
this amount before it reaches the overdraft limit of £23 million. The impact on the overdraft of the proposed
change in credit terms therefore needs to be considered.
For sales made in October, under the new arrangement there will be no cash inflow from SaveLow until January
20X8, yet production and other costs will still be incurred. Whilst there are operating cash inflows from other
customers, the cash tlow forecast below shows that there are negative operating cash tlows after October 20X7
and until January 20X8 when receipts from SaveLow will resume.
As a consequence, the overdraft will increase until January 2OX8 as follows.
October November December january

Contro 127,400k /12 10,620 10,620 10,620 10,620
Fixed cost 120k /12 - 10,000 - 10,000 - 10,000 - 10,000
Sales to Savelow
Receipts 30 days
Sept Sales 90k .12 7500
Oct sales 94,770k /12 7898
VC 17,160k x 52,800k /12 -5830 -5830 -5830 -5830
Opening overdrarft 2,290 - 5,210 - 5,210 2,688
Closing overdraft - 12,200 - 9,910 - 15,120 - 20,330 limit is 23,000

Closing overdraft - 9,910 - 15,120 - 20,330 - 17,642
It may appear trom the above forecast that BBB will stay within the overdratt limit of £23 million, with a maximum
overdraft of £20.33 million in December 20X7, but the above torecast only includes operating cash flows. t
excludes, for example: tax, interest and investment in PPE.
Overall, there may be serious liquidity issues for BBB if it breaches its overdraft limit, even on a temporary basis. A
more comprehensive cash tlow forecast is needed but, it the SaveLow contract is to be accepted, renegotiation of
the overdraft limit with the bank would be a wise precautionarv prior step.
Operating and strategic issues

BBB IS very near full capacity, so may there be an opportunity cost of losing a new order arising trom accepting the
SaveLow contract with an additional 10% volume. At the price of 80p to other customers this would generate a
higher contribution per loaf than for SaveLow. More generally, f the SaveLow contract volume does increase by
10% there is very little growth potential for BBB in developing new strategies for new products or new markets.
Capacity will be filled at the margin with low contribution products sold to SaveLow.
The additional 10% sales volume is within the annual capacity of BBB as it will make a sales volume total of 604
million loaves, compared with a capacity of 610 million. However, some days are already at capacity and, t the
additional demand from SaveLow arises on these days, it would not be possible to satisty this demand unless
additional bread is baked on the days when production is below capacity and then taken into inventory for
perhaps a day or two. As baked bread is a daily fresh product this may afect quality. This bread from inventory
could be allocated to SaveLow, to other customers or shared between them.
However, there is a contrary view that there is a continuing decline in sales volumes expected for traditional breads
so, over time, the pressure on the capacity constraint for BBB may be lessened.
Also, it may be possible to extend the capacity of the factory by operating on Sundays. This may not be possible
due to the need for machinery downtime for mainternance and perhaps due to human resource considerations.
Nevertheless, as capacity Is approached, unday operations may be worthy of consideration.
There is an existing price ditterential between the price for SaveLow and that for other customers of Sp per loaf
(80p compared with 75p) which is an extra 6./% that other customers pay. If prices to SaveLow are to be reduced
by 2p this widens the price differential to p which is a 9.6% differential. If other customers discover this, then they
may also press BBB for a price reduction, perhaps in order to maintain the previous 5p difterential, or even to
reduce it
If all other customers were to demand a price reduction of 2p to copy SaveLow, then this would reduce
contribution by:
£0.02 x £472m = £9.44m
This would make the overall effective contribution from the Savelow contract: £16.96 million (£26.4m - £9.44m)
f the 10% increase in sales volume does not occur and other customers demand the 2p decrease then this would
give an overall contribution from the SaveLow contract f14.56 million (E24m - £9.44m), before considering the
impact of the change in credit terms.
In financial terms, this would be a significant decrease in contribution from the current situation, but it is still
substantially positive.
Conclusion
Despite the proposed changes adversely affecting BBB, the contract with SaveLow remains profitable under a
range of assumptions. In pure financial terms, there is a significant positive contribution.
In terms of a wider perspective, there are however other concerns, including:
approaching capacity and therefore limiting the production of other products and giving a potential opportunity
cost
* liquidity issue it the bank overdraft facility is exceeded in the short term due to the change in credit terms
increasing the price differential with other customers
Despite SaveLow's assertion that the revised terms are not negotiable, there are such significant concerns to BBB
that some adjustment to moderate the new proposals may be worth tryıng to negotiate. Also, a change in supplier
35 Page 58
of a basic item like bread would not be costless for SaveLow and may generate a reaction from ts customers. In
this respect, there may be some costs from SaveLow changing supplier which BBB could leverage to negotiate.
Even if no revisions of the terms are forthcoming, the SaveLow sales are so fundamental to BBB that the new terms
may be preferable to losing the contract entirely, assuming that the bank overdraft facility can be raised
appropriately. It does however appear to be essential that BBB develops alternative strategies to reduce its
dependency on SaveLow in future in case it returns in a few years with further demands for additional price
reductions or other demands that may adversely affect BBB.
Cost and Risk of buying wheat US $

Whether to hedge wheat costs
Wheat is a reasonably significant cost to BBB making up 17.7% of all its operating costs for the year ended 30
June 20X7. However, it would take a fairly substantial 44% increase in the cost of wheat in order for operating
profit to reach breakeven, assuming other costs remain the same.
Despite this, the cost of wheat is volatile and an increase in price could reduce profit significantly. It is possible that
the price of wheat is volatile annually according to each harvest but, in this respect, it may therefore be unlikely to
rise in price consistently and remain high tor many years. To this extent, hedging may reduce cyclicity in profit
rather than attempt to lock in a price over a long period of years.
BBB's core business is to operate as a bakery, not to speculate in wheat commodity price movements, where it
does not have the relevant core competences. Without hedging, BBB's earnings stream could become volatile
and investors may raise the cost of equity in light of this risk.
A hedging strategy to mitigate the impact of wheat price movements, if not remove it completely, therefore seems
necessaty.
The use of forwards in this strategy means that, in protecting the company trom upwards movements in wheat
prices, it would also prevent the company from benefiting from downwards movements in wheat prices for the
period of the contract. Options would protect the downside and leave upside potential but at the cost of the initial
price of the option.
The price of options

To hedge the price of wheat using options, BBB would need to purchase call options which would give it the right
to buy wheat at a predetermined price (the exercise price) on a predetermined date. BBB would be the option
holder. Ihe counterparty is the option writer.
When initially written, the option could be out-of-the-money (the exercise price > the current market price of
wheat or in-the-money (the exercise price < the current market price of wheat).
tor example the option was initially signiticantiy out-of-the-money and wheat prices were predicted to be very
stable for the period of the option, then there is a low probability that the option will be exercised so the writer is
protected and can charge a low price tor the option contract.
In the same example, if wheat prices were predicted to be volatile (high standard deviation) for the period of the
option, then there is a greater probability that the market price of wheat may rise above the exercise price,
possibly significantly. This would mean the option could be in-the-money and an asset to the holder, BBB, and a
liability to the writer. In accepting this increased risk the writer will charge a higher price for BBB to acquire the
option.
Hedges already undertaken

Both hedges
Both hedges are forward contracts. This is a binding agreement to acquire (in this case) a set amount of wheat or
currency, at a future date at a price agreed at the inception of the contract
A forward contract fixes the rate for a transaction, and these contracts must be settled regardless of whether the
wheat price at the settlement date is more tavourable than the agreed torward price.
While BBB uses wheat, it does not need to take physical delivery of the wheat in Hedge 1. Instead it could use
changes in the price of the forward contracts where the gains and losses would offset the movements in wheat
purchase prices which are entirely separate contracts.
Thus, for example, BBB may arrange a forward contract with its bank. Subsequently, when it needs to purchase the
wheat, the bank will close out the original forward contract, in ettect by arranging another forward contract for the
same settlement date, to cancel out the original contract. Ihe close-out is then settled with a cash payment by one
party to the other, depending on the ditterence between the torward prices in the contract and market prices.
Hedge 1
Purchase wheat 5,000 15 Sept X7
hedge date 22 May X7
Future contract on Zero price
Price of contract $ 400.00
Total cost $ 2,000,000.00
Future contract $ 390.00 30 June X7 would have been new future contract
Total cost $ 1,950,000.00
The risk of this underlying contract is twofold. Firstly, that wheat prices are volatile and in contracting at the spot
price at a future date there is uncertainty what that spot price will be as market prices fluctuate. Secondly, the price
of wheat as a commodity is denominated in USS, whereas the functional currency of BBB is clearly f sterling.
Therefore, even it wheat prices in USS remain constant, there is an additional risk of currency tluctuations in the $/£
exchange rate between the inception date and 15 September 20X/ which may cause fluctuations in the f sterling
amount paid by BBB for wheat.
lo summarise:
lotal price risk = market risk + foreign currency risk
he Hedge 1 contract effectively contracts for the equivalent quantity of wheat as the underiying contract at 5,000
tonnes. It also terminates at the same date as the underlying commitment on 15 September 20X/. However, the
risk that it does not mitigate is the foreign currency risk, as BBB is still exposed to changes in the £/S exchange rate
between 22 May 20XI and 15 September 20X7.
The forward contract derivative also generates counterparty risk, which is the risk that the counterparty in a
derivative contract defaults on derivative settlement obligations.
Over the counter (OTC) derivatives, such as forward contracts, generate counterparty risk. Counterparty risk is
similar to credit risk, as it reflects the counterparty's probability of default and the loss arising from the default. But
it is difficult to measure because the exposure at default is uncertain (although it can be mitigated with the use of
collateral).
Financial reporting treatment

Hedge 1
This is a hedge of a firm commitment in relation to a commodity and therefore should be treated as a tair value
hedge in accordance with IFRS9, Financial Instruments.
Determining fair value for financial reporting purposes is a key issue. Over the counter (OTC) contracts, (such as
forward contracts which are specific to a customer) are traded directly between two parties without going through
an exchange. There is therefore not an observable market price which can be directly used. O1C fair values will
35 Page 59
need to be estimated using internal models and then calibrated against quoted prices of exchange traded futures
contracts. These are likely to be level 2 valuations (or possibly level 3) in accordance with IFRS 13, Fair Value
Measurement. Ihe models require some observable inputs but calculations are then performed to derive the
valuation.
At 22 May 20X7
No entries are required at this date as the firm commitment is unrecognised.
The forward contract is potentially recognised, but it has a zero fair value and there is no related cash transaction
record.
However, the existence of the contract and associated risk would be disclosed from this date in accordance with
IFRS 7, Financial Instruments: Disclosures.
At 30 June 20X7
By 30 June 20X7, the hedge has made a loss of $10 per tonne which amounts to $50,000.
Taking this difference as the assumed fair value and assuming the IFRS 9 conditions for hedge accounting are met
then at 30 June 20X7 this loss is recognised as:
DEBIT Profit or loss $50,000

CREDIT Forward contract- financial liability $50,000
This is to recognise the increase in the fair value of the hedge instrument (which is the forward contract, beinga
derivative financial liability) and to recognise the loss on the forward contract in profit or loss.
DEBIT Firm commitment $50,000

CREDIT Profit or loss S50,000
This is to recognise the loss in ftair value of the hedged item (ie, the previously unrecognised firm commitment) in
relation to changes in forward exchange rates and to recognise a credit entry in profit or loss, which offsets the loss
previously recognised in respect of the derivative financial liability.
Any further profit or loss on settlement is similarly recognised at 15 September 20X7.
Note: All these vear-end entries are to be translated to f sterling using the f/IS spot rate at 30 June 20X7
Hedge 2
Purchase wheat 7,000 8 Oct X7
Fixed price $ 420.00
Total cost $ 2,940,000.00
Forward contract ON 4 June X7
Zero price $3m for £1.9m 19 Oct X7
Price on 19 Oct X7 2m
overheadge $ 60,000.00
gain 100k
The underlying contract is at a fixed price of US$420. As such, the underlying contract locks in this price so BBB is
not at risk of wheat commodity price fluctuations between 4 June 20X7 and 8 October 20X7. However, the
underlying contract is subject to the risk of currency fluctuations in the $/£ exchange rate between 4 June 20X7
and 8 October 20xI.
The Hedge 2 contract addresses the foreign currency risk in terms of amount as the contract amount of $2.94
million (S420 x 7,000) is effectively equal to the Hedge 2 contract amount of $3 million. The slight overhedging of
60,000 does give a small amount of risk, but this is insigniticant as BBB is regularly purchasing wheat. Ihe other
risk exposure is that the date of the underlying contract (8 October 20X7) is not coterminous with the completion
date of the Hedge 2 contract (9October 20x/). As a result, there is some exposure to currency risk variation
between E/$ for an 11 day period. Subject to an unusually signiticant movement in currency markets in this short
period, this is not a substantial risk.

Hedge 2
This is a hedge of a firm commitment in relation to foreign currency and can therefore be treated either as a fair
value hedge or as a cash flow hedge in accordance with IFRS9.
By 30 June 20X7, Hedge 2 has made a profit of f100,000. Assuming it is treated as a fair value hedge and the IFRS
9 conditions for hedge accounting are met then:
At 4 June 20X7
No entries are required at this date as the firm commitment is unrecognised.
The forward contract is potentially recognised, but it has a zero fair value and there is no related cash transaction
to record.
However, the existence of the contract and associated risk would be disclosed from this date in accordance with
IFRS /.
At 30 June 20X7
At 30 June 20X7 the profit is recognised as:
DEBIT Forward contract - Financial asset £100,000
CREDIT Profit or loss £100,000
To recognise the increase in the fair value of the hedge instrument (which is the forward contract, being a
derivative financial asset) and to recognise the gain on the forward contract in profit or loss.
DEBIT Profit or loss £100,000
CREDIT Firm commitment £100,000
To recognise the gain in fair value of the hedged item (ie, the previously unrecognised firm commitment) in
relation to changes in forward exchange rates and to recognise a debit entry in profit or loss, which offsets the
profit previously recognised in respect of the gain on the derivative financial asset.
Any further profit or loss is similarly recognised at 8 October 20X7.
If treated as a cash flow hedge then the increase in the fair value of the hedged item (the firm commitment) is not
recognised in the financial statements.
At 30 June 20X7
To recognise the increase in the fair value of the forward contract (ie, a derivative financial asset) and to recognise
the gain on the forward contract in other comprehensive income the following entries would be made.
DEBIT Forward contract - financial asset £100,000
CREDIT Reserves (through OCI) £100,000
The gain is reclassified from OCI (Other Comprehensive Income) in the next accounting period.
35 Page 60
Sustainability and long term planinng

Probability Sales vol %
June X8 70% -1%
30% -3%
Probability Sales price

June X8 60% -2%
40% -4%
Cost remain June X7

Fixed cost remain
2 year horizion
Other
£'000 £'000 £'000
Revenue 90,000,000 377,600,000 467,600,000
Wheat used in production -15,600,000 -61,360,000 -76,960,000
Other variable costs -48,000,000 -188,800,000 -236,800,000
Probabilti Expected
Volume Price y Revenue X8 Volume change Price change Revnue 20Y0 revenue
0.7 0.6 0.42 467,600,000 0.99^2 0.980 0.98^2 0.960 440,146,288 184,861,441
0.3 0.4 0.12 467,600,000 0.97^2 0.941 0.96^2 0.922 405,471,597 48,656,592
0.3 0.6 0.18 467,600,000 0.97^2 0.941 0.98^2 0.960 422,542,232 76,057,602
0.7 0.4 0.28 467,600,000 0.99^2 0.980 0.96^2 0.922 422,364,451 118,262,046
1 427,837,680
Wheat cost
Probability Wheat cost X9 change Y0 chage Wheat cost Y0 Expected cost

0.7 -76,960,000 0.99^2 0.980 -75,428,496 -52,799,947
0.3 -76,960,000 0.97^2 0.941 -72,411,664 -21,723,499
-74,523,446
Other Variable costs
Other
Probability Variable costs X9 change Y0 chage VC Yo Expected cost `
0.7 -236,800,000 0.99^2 0.980 -232,087,680 -162,461,376
0.3 -236,800,000 0.97^2 0.941 -222,805,120 -66,841,536
-229,302,912
Revenue (see table above) 427,837,680

Wheat used in production -74,523,446
Other variable costs -229,302,912
Total VC (see table above) -303,826,358
Fixed costs -120,000,000
Business sustainability
This questions BBB's business sustainability given its current strategy. It is operating in a declining market of
traditional breads where there is competitive pressure from customers and rivals on price and volume.
The validity of the assumptions can be challenged but, to the extent they broadly reflect a declining market, it may
be only a question of time betore breakeven is reached. Moreover, there is a high probability of profit falling to
break even at, or shortly after, 20YO given current market trends.
Alternative strategies to redress the balance may be guided by Ansoff's matrix in seeking new products and new
markets. Most obviously, speciality breads with higher margins may be an opportunity to expand or alternatively
making non-bread baked items such as pastries or seeking new geographical markets.
Financial reporting
A key issue is that within two accounting years BBB may cease to be a going concern. This raises the more
immediate question of impairment and value in use calculations in accordance with lAS 36, Impairment of Assets,
as the time horizon to forecast cash flows from individual assets or CGUs may be limited if the business is not
sustainable beyond 20Y0.
Even before breakeven is reached, reduced cash flow may question the value in use that can be generated and
indicate impairment.
Provisions may also be needed where, for instance, there may be onerous contracts that are not recovering costs
due to the gradual decline of the business.
In the year ending 30 June 20YO the going concern assumption may no longer be appropriate and assets in
general may need to be written down.
As a listed company, BBB needs to comply with the going concern and liquidity disclosures of the UK Corporate
Governance Code. This sets out the following requirements:
to make disclosures on the going concern basIs of accounting and material uncertainties in their financial
statements; and
disclose principal risks and uncertainties, which may include risks that might impact solvency and liquidity,
within their strategic report
In so doing, directors should:
take a broad view, over the long term, of the risks and uncertainties that go beyond the specific requirements in
accounting standards
xplain tne isk managementand contro processesn place that wi unaepin the assessment and tnat tne
degree of formality of this process is consistent with the size, complexity and the particular circumstances of
BBB
For going concern, the 20Y0 horizon tor BBB is beyond current guidance in accounting standards for going
concern but would fall within the narrative disclosures to take a longer term view of viability.
Also, any doubts over short term viability tor BBB resulting from the change in credit terms should be considered.
36 Page 61
Yachts Price
Sailing 15,000 20,000,000
Motor 30,000 50,000,000
20W7 Issue 400,000 Venture capital company Paloma

Raised 60,000,000
Loan 20-70m 20 year repayable 30 June Y7
1 July W7
Machine 150,000,000 20 year life
10 years 75000000 Carry amount at YE
Interest rate 10%
Board Shareholding (number of

Director/Shareholder role £10 ordinary shares)
Chief
Olan Fagan executive 100,000 67%
Finance
Jane Hooton director 5,000 3%
Manufact
uring
Paul Plumber director 5,000 3%
Paloma (venture capital
company) 40,000 27%
Non-
John Nelson (Paloma executive
representative) director 0%
150,000
20X7 20X6 % change

Summary statement of profit or loss for the years ended 30 June £'000 £'000
Revenue 33,000 35,420 -7%
Cost of sales -23,100 -24,790 -7%
Gross profit 9,900 10,630 -7%
Distribution and administration costs -5,400 -5,200 4%
Operating protit 4,500 5,430 -17%
Net finance costs -7,000 -7,000 0%
Loss before tax -2,500 -1,570 59%
Other data
EBITDA (E'O000) 12,000 12,930
Number of motor yachts sold 44 46
Summary statement of financial position at 30 June 20X7

Non-current assets
Property, plant and equipment
Cost 150,000
Accumulated depreciation -75,000
Current assets
Inventories 7,200
Irade and other receivables 6,000
Cash 1,000
Total assets 89,200
Equity
£10 ordinary shares 1,500
Share premium 59,600
Retained losses -52,200
Non-current liabilities
10% loans- Rochester Bank 70,000
Current liabilities
Trade and other payables 2,400
Payments made in advance by customers 3,000
Interest owing to Rochester Bank 4,900
Assets sold for insolvency

Machinery 39,000
Inventories 5,000
Trade and other receivables 4,000
Cash 1,000
49,000
Asset and Liquaator costs 5,400

Bank Floating charge over assets
Interest cover 1.5
Gearing 70%
Current gearing 53%

Interest cover -1.555556
(2) Current financial position and viability as a going concern

It seems unlikely that MMY is a going concern. t cannot pay its debts as they fall due as it is in arrears on the bank interest. The fact that the bank loan has been renegotiated on a number of occasions
shows that the interest has been unpaid on previous Occasions.
MMY is also in violation of both debt covenants.
In addition, it has negative retained earnings, although it does not have negative equity in the statement of financial position.
The assets have low net realisable values compared to their carrying amounts.
MMY is also making losses before tax hence the position is likely to deteriorate in future with further debts accumulating over time. The lack of cash and borrowing capacity means that the company is
unable to invest in a new strategy for recovery without financial assistance.
he reduction in the number of yachts sold and the reduction in price per yacht indicate that the trading situation is worsening.
Whilst making losses betore tax, the operating profit is positive as is EBITDA. A detailed cash flow forecast is needed but it would seem that the company could be generating operating cash intlows.
However, this position is probably unsustainable as when the current PPE reaches the end of its useful lite it seems unlikely there will be sutticient cash to replace these assets given the loss-making
situation and that depreciation costs are not being covered.
Only Sailing Yachts 1 July X8 Next year

New equip 13000
Free cash flow 25000 30 June X9
Growth 7%
Annuity
WACC/ Rate of return required 20%
Corporate recovery plan

A SIgniticant degree ot protessional scepticism needs to applied to the outiine corpOrate recovery plan and the Tinarncial projections provided by Olan and the other directors.
The limited period of time available is unlikely to have been sufficient to establish evidence to support the projections and therefore assurance would be needed with respect to the underlying
assumptions. Market research would be needed as to the likelihood of the projected sales being achieved. It is some time since MMY made sailing yachts and customers are unlikely to be easily
obtainable. Ihere is also no order book, as there is for motor yachts.
Nevertheless, for the time being, taking the figures at face value using RFl's required rate of return of 20% as the discount factor then this would suggest a value of the entity at 1 July 20X8 of:
£25m * (1.07) / (0.20-0.07) =£205.77m
The initial outlay on equipment is to be deducted of f13 million which would give a NPV of approximately £192.77 million.
Consideration would also need to be given to any loss to be incurred in the year of transition in the year ending 30 June 20X8 in orn
Significant questions over the sustainability of the cash flows and the growth rate would also need to be raised.
36 Page 62
to determine valuation in July 20X7.

he above value is an entity value and relates to the total of the value of debt and the value of equity. However, RFI would hold both of these so considering the total value appears reasonable.
As an entity return the 20% would be a weighted average cost of capital rather than a cost of equity.
Proposal 1 Gain control and new shares

Buy the MMY loan from Rochester Bank for a percentage of its face value.
Make an offer to all existing MMY shareholders to acquire their shares to gain control of the company. The price would give them some value for their investment, but this would be a small amount.
Issue new MMY shares to Olan to provide an incentive for him to remain in the senior management of MMY.
Plan for an AlIM listing of MMY shares within seven years.
Rochester Bank
The nominal debt to Rochester Bank including interest arrears is £74.9 million. However, from the bank's perspective this is impaired as it seems irrecoverable in full under any of the scenarios.
In terms of a break up and liquidation of the business:
Machinery 39,000
Fixed charge -39,000
Inventories 5,000
Cash 1,000
10,000
Luquidation cost -5,400
Net proceeds bank 4,600
Total bank repayment 43,600 4600 + 3900

Out of 74.9 a % 58% recovery rate
Other stakeholders
There would be nothing available to the trade and other payables as unsecured creditors (other than a small amount as the prescribed part).
Shareholders would not receive anything.
Conclusion
IF RFI were to buy the loan from the bank for a slightly more favourable price than the liquidation receipts of £43.6 million, (say) £44 million then the bank would make a small return above liquidation
receipts and would avoid the uncertainty, delay and reputational damage of an insolvency.
The annual interest return on this investment for RFl would be (£70m x 10%/£44m = 15.9% which is a significant return for debt but not near the RFI required return of 20%.
Therefore, RFI must consider acquiring the equity. Given that the equity is worthless under liquidation it could possibly be acquired for a nominal price. However, negotiations with equity holders may
best be completed before purchasing the debt.
If equity can be purchased for a nominal amount (say) £1 million then the company (debt and equity) could be acquired for f45 million.
To the extent that the FD's figures in the recovery plan are correct, this would give a return after the additional outlay of £13 million of
E25m/(E45m + £13m)= 43.1% in 20X8 (increasing by 7% per annum thereafter).
Proposal 2 NewCo - Trade and assets

Buy the MMY loan from Rochester Bank for a percentage of its face value.
Place MMY into administration as the loan covenants have been breached.
Set up a new company (Newco) to acquire all of MMY's trade and asset
Offer Olan some shares in Newco as an incentive for him to be part of the senior management.
. Plan for an AIM listing of Newco shares within seven years.
APproach 2
Purchasing the debt as above and then forcing MMY into liquidation (due to breach of covenants and non-payment of interest) would be a solution it shareholders were refusing to sell or were trying
to negotiate a high price for their shares.
The liquidator would then pay the £43.6 million to RFl as the new debtholder.
RFI would then need to negotiate to buy the trade and assets from the liquidator (or other structuring as a going concern). As a minimum, this would be £49 million for the NRV of the assets but if
other parties were interested in buying the company this may force up the price.
Approach 1 would theretore appear favourable if shareholders were not pressing tor a high price.
The acquisition of the trade and assets in Approach 2 may, however, avoid any liability on the faulty engines as the new company under RFI control would then be a separate entity from the old MMY
that sold the yachts, but legal advice would need to be taken on this issue.
Due diligence
Engine fails Per moth Since Jan X6
June X6 15 750000
June X7 6 300000
Cost repair 50,000
Total repair cost 1050000
2 year guarentee
(1) Preliminary due diligence

Key risks
The fauity engines could potentially aftect all of the yachts sold by MMY since January 20X6 (when it started to use the new type of engine). Assuming that sales occurred evenly throughout 20X6, this
could amount to 67 yachts in total, at a repair cost of f50,000 each, which could be a total repair cost of f3.35 million for yachts already sold at 30 June 20X7.
At the moment, the known cost for 20X6 is 15 engines repaired at f50,000 each, which is £750,000. This is one third of all yachts sold in that year having an engine fault. There are also six known
engine taults from sales to June 20X/, with a total repair cost of £300,000. However, there may be other yachts sold in the the year to June 20X/, with the same tault, but where a claim has not yet
been made. Therefore further claims may still arise in relation to the year to June 20X7. In addition, there may be further yachts sold in July 20X7, work in progress, and inventories of engines, all of
which may have the same tault.
These problems with the engines are also likely to result in reputational damage which may mean reduced future sales.
Due diligence procedures

Ascertain the number of faults claimed by MMY to have occurred.
Examine documentation of customer complaints and the engineering work schedules for the nature of the repairs to gain an understanding of the cause of the faults.
Examine correspondence with the engine manufacturer to gain further evidence of the nature of the dispute and about the cause of the faults.
Examine any legal correspondence concerning the claims by MMY against the engine manufacturer.
Examine any legal correspondence concerning the claims against MMY by customers.
Ascertain how the cost of f50,000 is calculated. Is this the average with a wide dispersion or is it a typical cost? ldentity any unrecognised costs (eg, transporting the boat for repair, payments to
third parties for repairs, additional payments to customers for inconvenience).
Based on existing claims and other evidence above, attempt to extrapolate the future claims experience against MMY within the warranty period where RFL, as a nevw owner, may incur costs in
future.
Examine evidence of faults with the same engine type from other yacht manutacturers (press comment; industry information).
Consider evidence of reputational damage which may affect future sales (eg, widespread adverse press comment; cancellation of orders; reduced sales since fault announced).
Financial reporting
Inventories held at 30 June 20X/ including engines, WIP and tinished goods may need to have an impairment allowance to allow for the cost of repairing the engines. if this is based on intormation
received after the year end this could be an adjusting event after the reporting period in accordance with lAS 10, Events After the keporting Period.
Provisions for repairs for future claims reported but not carried out and also for claims expected but not yet reported. Costs to be incurred in future should be discounted in accordance with IAS 37,
Provisions, Contingent Liabilities and Contingent Assets. Disclosure should be made of the nature and the amount of the provisions.
Contingent asset - claims against the manufacturer, if credible, should be disclosed only as a contingent asset in accordance with IAS 37, but not recognised.
Returns of yachts with major faults by customers may be an issue. Provision would need to be made if this is the case to recognise a loss on resale (second hand values may be relevant to determine
this)
37 Page 63
Work for VC company - holding firms 3 - 5 years and sell for gain
Potential investment in GJ
3 years later
Own 20 Jewellery
Manufactor 10%
Wholesale 90%
Owned by Ultima and wants to sell

High end Jewellery
Management team equity 1000 Management will own 10% of the ordinary share capital in GJ.
Venture capital equity ((CF) 9000 ICF will own 90% of the ordinary share capital in GJ.
Bank senior debt (Farmley Bank) 18000 This debt will carry an annual interest rate of 6% and is repayable on 1 January 20Y1.
This debt will rank equally with the f1.5 million existing loan from GJ's bank, Roatt Bank plc.
Venture capital- subordinated debt (ICF) 10000 This debt will rank below the Farmley Bank and Roatt Bank debt. It will carry an annual interest rate of 9% and is repayable 01/01/09
Deferred consideration 2000 This additional amount needs to be paid to Ultima by GJ shareholders on 31 December 20X8
Total consideration 40000 Total payable to Ultima.
1 Jan X8 4 memebers pay 250,000 Debt not paid out of free cash flow
Average rate of return 35%
3 year plan then sell as AIM 31 vDec Y0
Sale of workshop 3,000 1 Jan X8

Used to upgrade all 20 shops
Selling price increase 5% year on year
Sale and leaseback of retail outlets

It is proposed that, on 1 January 20X8, 5 of the 20 shops will be sold and leased back:
Carrying amount 3200
Fair value 4300
Proceeds 5500
lease period 8 years
Annual rent 5 shops 550 from 31 Dec X8
Rate on lease 10%
Staff cost 600 No inflation increase, high staff turnover, red cost insig
Purchase Jewellery 1400 reduce quality of stones
Cemter service payment to Ultima 1000 removeal of office and use HR marketing and admin
3000
Extracts from forecast statement of profit or loss for the year ending 31 December 20X7
£'000
Revenue 60,000 5 % increase
Operating costs (excluding depreciation) -53,580
Depreciation -500 300 additonal depn 1 Jan X8
Operating profit 5,920
Tax is based on acounting profit and is charged at 20%.

Discount rate 10%
Capital expenditure 50
Refurb 3000

Inventories 1,800
Trade receivables 400
Assets 15,000
5% Roatt Bank plc loan (repayable 20Y5) 1,500
Current liabilities 4,800
Ordinary shares (1) 1,000
Retained earnings 7,700
Liabilities and equity 15,000
Forecast of value of GJ equity

31 Dec X7
31 Dec Y0
Current year
20X7 20X7 20X8 20X9 20Y0
Revenue 60,000 63,000 66,150 69,458 5% growth
Operating cost -53,580 -53,580 -53,580 -53,580
Add back depnn 3000 3000 3000 3000
EBITDA 9,420 12,420 15,570 18,878
Depn 500 x 15/20 * 161 -836 -836 -836 -836
EBITDA 8,584 11,584 14,734 18,042
tax 20% -1716.8 -2316.8 -2946.8 -3608.3
PAT 6,867 9,267 11,787 14,433
Add back depn 836 836 836 836
Less CAPEX -50 -50 -50 -50
Working cap saing 450
leaseback proceeds 5,500
Def con -2,000
Sale of workshop 3,000
Refub cost -3,000
Free cash flow 5,950 8,053 12,573 15,219
Bf balance 0 5,950 14,003 26,576

CF balance 5,950 14,003 26,576 41,796
PV of free cashflow @ 10% X8 - Y0 29,147 NPV (.1, yellow cells)
35,097
Termination value 15,220/0.1 152,200
PV of Term payment x .751 114,302
Enterprice value 149,399
Debt exisitng -1500
Debt bank -18000
Debt ICF -10000
Debt new lease liab -2934
116,965
The free cash flow valuation method

The valuation of an enterprise, based on discounting future free cash flows, determines a total value for equity and debt (enterprise value). From a valuation perspective, the normalised cash tlow and
earnings figures are used together to estimate the free cash tlows of a business. It is the free cash flow that is discounted to deduce an enterprise value for the business before deducting the value of
debt to obtain an equity value
The annual discount rate of 10% is the weighted average cost of capital which is appropriate to the enterprise value as it considers the risk of all cash tlows (ie, flows to equity and debt).
The free cash tlow method of determining the value of the equity is sufficiently flexible to allow for a period of temporary growth, followed by a perpetuity period of EBIT without growth. However, a
concern is the sustainability of the cash flows in perpeturty beyond 20Y0, or indeed beyond a reasonable time horizon where markets may change
37 Page 64
In common with other valuation methods, it is dependent on the forecasts being reliable and the discount rate being appropriate and stable over time. This means that the working assumptions need
to be valid, which is questioned further below.
Revenue
Revenue is assumed to grow at 5% per year. This is a fundamental assumption as it drives much of the increase in value of the equity from the MBO.
The PV of the previous revenue stream (which is assumed to be constant) under Utima is:
£60m/0.1- £600m
The PV of the forecast revenue stream under the MBO (with 5% pa growth) is:
(E63m/1.1) + (£66.15m/1.14) + ((E69.458m/1.1^2/0.1) -£685.97m
Thus, there is a very substantial increase of f85.97 million in the value of the enterprise arising from the forecast increase in the revenue stream over the three-year time horizon.
Cost savings
The cash cost savings further add to the increased valuation at 31 December 20Y0.
These comprise:
Staff cost 600

Purchase Jewellery 1400
Cemter service payment to Ultima 1000
3000
less
Increase in lease payments -550
net cost saving 2450
Therefore, annual operating costs fall by £2.45 million from f53.58 million in 20X7 to £51.13 million in 20X8 and thereafter.
The PV of the costs savings before tax amounts to f24.5 million (f2.45m/0.1) according to the working assumptions.
Enterprise value at 31 December 20YO

The value of the enterprise at 31 December 20Y0 is the discounted sustainable free cash flow beyond 20YO which amounts to:
£15.220m/0.1 = £152.2m
Equity value at 31 December 20YO

Over the three-year period 20X8 to 20Y0, GJ has generated free cash flows of £41.796 million before interest (per the above table) which is used to pay the interest and repay the Farmley Bank debt
and ICF debt at 31 December 20YO as follows:
Interest Annual Interest net or

rate interest tax 3 year CF
Original loan 1500 0.05 75 60 180
Farmley Bank 18000 0.06 1080 864 2592
ICF Loan 10000 0.09 900 720 2160
4932
Cash bal c/f 41796
Cash c/f net of int 36864

Farmley debt -18000
ICF Loan -10000
Surplus cash balance 8864
In addition to the debt noted above, the lease liability and interest over the three-year period 20X8 to 20Y0 will also need to be paid.
3 annual payments of £550,000 £1,650,000 leaving a net surplus cash balance of £7,214,000.
The equity value at 31 December 20Y0 can normally be determined by deducting the remaining net debt value at that date.
However, the cash available of £7.214 million is greater than the Roatt Bank debt of f1.5 million at that date giving a surplus of £5.714 milion.
This gives an equity value of:
Ihis gives an equity value of:

Enterprise value 152.20m
Surplus cash 5.714m
Equity value 157.914m
Benfits and risk to stakeholders

MBO FOR STAKEHOLDERS
A key risk factor for all stakeholders is the reasonableness of the price paid to Ultima.
In terms of a 'satety net' the net asset value is:
Per SFP £8.7m

Fair value uplift (f4.3m - £3.2m) E1.1m
Net assets at fair value £9.8m
There may be some unrecognised asset value in intangibles (eg, brand name) but in the absence of this the £40 million valuation givesa high goodwill figure of £30.2 million (E40m - f9.8m).
As a going concern, the continuing valuation to Ultima (ie, without the MBO induced changes) is:
(E5.186m/0.1)- £1.5 m- £50.36m
The price of f40 million therefore looks favourable compared to this figure of f50.36 million.
With the MBO changes the above table shows PV of free cash flows to give an enterprise value of f149.387 million and after deducting debt of £32.434 million an equity value of f116.953 million. The
suggested deal price looks favourable compared to these values, but these are based on forecasts which may not be achieved. This is considered further below.
Overall, subject to the sustainability and reliability of these forecasts, the f40 million sale price suggested seems reasonable.
a) ICF
The forecasts and working assumptions are valid, then the value of the ICF share of equity at 31 December 20YO is (per workings in (1) above):
£157.914m x 90% - £142.123m
ICF's initial equity investment (per the deal structure in Exhibit 4) is £9 million.
The compound annual return over the 3-year period is therefore (E142.123m/£9m)s 250.9%
While this is significantly in excess of the 35% annual return required by ICF, this is only the equity element of the ICF investment. It also has f10 million of subordinated debt which is at risk if the MBO
tails, and this only earns an annual return of 9%.
The weighted average return is therefore:
(250.9% x (9/19)]+ (9%x 10/19)1 123.5% pa
Therefore, to the extent that the torecasts and working assumptions can be delivered by the management team, the expected return is significantly above ICFs required annual rate of 35%.
In particular, the assumption that the cash flows are indefinite needs to be evaluated as much of the fair value at the AlM flotation date at the end of 20Y0 depends on this long tail of cash flows which
may not be realistic given the short-termist strategy of reducing quality and increasing prices.
Risks
There are a number of key risks which may question the forecasts, the working assumptions and therefore the valuations that can be achieved.
Management team
The GJ management team appears to possess the core skills required, have inside knowledge ot the business and hence are aware of the reliability of the forecasts. However, there are some concerns
which may cause risks for the MBO in general, and for ICF in particular.
Geoff Boyne appears to have some conflict of interest between the MBO and Ultima. This may mean there is a risk he will not negotiate the most favourable terms with Ultima for the management
team and for ICF (eg, the total consideration). Ihe tact that he intends to work part time atter the MBO may be indicative of low commitment to the MBO and the lack of suitable finance expertise tor
the MBO (see S below tor further consideration of this issue, including its ethical implications).
In addition, Sally Bothan is responsible for the workshop, but the MBO strategy intends to cdose this, so it is not clear how a key member of the management team will contribute to the post-MBO
operations and whether she has a skill set that will then be required.
Governance
In order to be at less risk from the management team decisions, ICF may want to appoint at least one member of the GJ board to represent its interests and have access to inside information.
Business strategy
The future business strategy of the management team appears to include reducing the actual quality of the jewellery sold. Ihis includes
lower cost precious metals and gem stones
no longer manufacturing its own jewellery, which were: higher priced items; improved reputation; and met 10% of customer needs
fewer stafi, so possiblya poorer service to customers. In contrast GJ management appears to want to raise perceived quality through:
In contrast GJ management appears to want to raise perceived quality through:
refurbishment of stores to improve appearance
increasing prices by 5% per annum, perhaps where price is signal of perceived quality when it is ditficult for customers, for example, to determine the quality of gem stones.
This is a risky policy, as offering customers less and charging a higher price in a competitive market is unlikely to be sustainable. If customers perceive this and revenues fail to increase, or even fall,
37 Page 65
then, as noted above, the valuations are extremely sensitive to the forecast growth rate and the entire MBO financing structure could be at risk, affecting all stakeholders.
Financial gearing
Financial gearing is high with f28 million of the f40 million consideration being financed by debt, which is 67.5%. This is in addition to the £1.5 million debt already in the statement of financial
position and the new lease liability.
This means that any shortfall in operating profit is magnified significantly by the gearing effect
In addition, annual interest on borrowings is £4.932 million (see above). This amount, along with the interest on the new lease liability needs to be earned before any profit is made and before any cash
flows can be generated to repay debt. Failure to repay debt from operating cash flows leaves a major risk of GJ not being able to repay the Farmley Bank debt or the lCF debt in 20Y0 as they fall due.
If this is the case, then ICF is at risk not just for its £9 million equity but also for its f10 million subordinated debt.
(B) The MBO team

The management team is only investing f250,000 per person.
IF the forecasts and working assumptions are valid, then the value of the management team share of equity at 31 December 20Y0 is (per workings in 1 above):
£153.027m x 10%- £15.3027m (ie, £3.826 million per manager)
The management team's initial total equity investment (per the deal structure in Exhibit 4) is £1 million.
The compound annual return over the 3-year period is therefore (E15.3027m/£1m)s - 148.3%
le, this is the same % return as ICF as the shareholdings are linear.
The low initial investment may question the incentives and commitment of the management team if they do not have enough personal assets at risk if the MBO fails (ie, downside potential).
Also, as their share of equity is a fixed 10% it is questionable whether there are enough incentives for upside potential (eg, share options, or increasing the management team equity share if a target
valuation is achieved in three years' time). Closer alignment of interest between ICF and the management team may reduce the risks from lack of management commitment.
In essense, it is not the absolute amount of the investment of managers in the context of the MBO that matters, but rather the significance to each individual's perception of risk. If, in order to raise the
250,000, it has been necessary to engage in personal borrowing perhaps giving security on their houses, then this may be a sutficient commitment to give reassurance to other investors taking risks
with larger absolute amounts.
(c) Farmley Bank

The bank has senior debt so is at less risk than the ICF debt.
However, if the MBO forecasts turn out to be optimistic then there is limited security available for the Farmley loan to be repaid.
The fair value of the five properties in the sale and leaseback arrangement is f4.3 million. These have been sold, but the fiar value for the remaining 15 shops (given they are equal size and value) is
12.9 million. This is insutficient to cover the Farmley debt and existing debt from Roatt Bank totall ing £19.5 million, so there is a significant risk if operating cash tlows are not sutticient to draw down at
least some of this debt
It is important to ICF therefore that Farmley commits to the MBO (notwithstanding these risks) before ICF itself makes any firm commitment
(3) Due diligence

Financial due diligence
The validity of GJ's free cash flow valuation model depends mainly on the revenue and cost cash flow forecasts and the discount rate.
The forecast revenue growth rate is critical. The financial due diligence would need to validate the underlying assumptions of price increases and cost savings to ascertain whether they are consistent
with the forecasts and sustainable. Ihe credibility of achieving these sales also needs to be assessed under commercial due diligence (see below).
The staff cost savings also need to be evidenced in terms of wage rates and the number of staff reductions needed to achieve the total claimed savings. The impact on staffing for each shop would
also need to be considered under operational due diligence (see below). There is no mention of redundancy costs hence this would also need to be investigated under financial due diligence.
Due diligence procedures would also need to attest the fair value of the shops under the proposed sale and leaseback arrangement and for the 15 remaining shops as an assessment for the security
for the loans.
This information would support the net asset valuation as a base line valuation, although as noted above this is well below the sale price.
The appropriateness of the discount rate will need to be assessed from market interest rates. This can be observed from listed companies by modelling share prices, but adjustment would need to be
made for an unlisted company such as GJ.
As the working assumption is for constant future cash flows indefinitely, the discount rate may be viewed as a real rate, rather than a money rate (ie, it compensates for future inflation). The 10% should
therefore be evaluated against real market rates in this context.
While financial due diligence may provide limited assurance, typically it will not involve the detailed level of testing that would be carried out in a statutory audit. Due diligence procedures could be
extended to cover detailed audit procedures, but this would inevitably cause a delay in completing the MBO. Even if audit procedures were to be carried out, the key issue for valuation and risk is the
validity of the forecasts, where only limited assurance could ever be obtained.
Commercial due diligence

Commercial due diligence work complements that of financial due diligence by considering the markets and the external economic environment. Information may come from the GJ management
team but also other business contacts. Alternatively, it may come from external information sources.
Such information is useful for ICF to understand the appropriate post-acquisition strategy.
Commercial due diligence work should be carried out to test the revenue growth assumption for future periods, to enable ICF to assess whether the GJ growth being forecast by the management
team is credible. The due diligence team should look at likely changes in demand on a shop by shop basis considering: regional growth, changes in local competition, and plans for future advertising.
Customer reactions to the 5% pa price increase should be considered, perhaps reviewing the response at each shop to historic price changes.
Operational due diligence

Operational due diligence considers the operational risks and possible improvements which can be made in GJ. In particular it will:
validate the implications of assumed operational cost savings eg, with staff cost savings can a reasonable service continue to be provided to customers.
identify operational upsides that may increase the value of GJ (eg, the impact of the proposed refurbishing on footfall).
(4) Financial Reporting

Sale of workshop
Unless it had reached the end of its useful life, the workshop should not have been fully depreciated, as IAS 16 requires the useful life of PPE to be reviewed on a regular basis and adjusted as a
change in an accounting estimate in accordance with IAS 8 it the useful lite has changed trom previous expectations.
Given however that the workshop has been fully depreciated, then the proceeds of £3 million should be recognised in full as a profit in the statement of protit or loss in the year of sale.
The workshop may be treated as a discontinued operation per lFRS 5 as it is a separate major line of business, cash flows can be distinguished and it will be disposed as part of a single coordinated
plan.
Refurbishment
To the extent that the refurbishment costs are repairs, these costs should be recognised in profit or loss as incurred. Where the refurbishment is PPE or an improvement they should be capitalised and
depreciated over their usetul lives in accordance with GJ's accounting policy on PPE.
Inventory management
Inventory should continue to be recognised in accordance with IAS 2 at the lower of cost and net realisable value. The reduction in inventory levels has no direct effect on financial reporting but the
process of reviewing inventories may reveal slow moving items which should be written down to their net realisable value.
Sale and leaseback

The transter is a sale in accordance with IFRS 15, Revenue from Contracts with Customers
The fact that the lessor will retain the properties at the end of the lease period indicates that control has passed to the lessor. The performance obligations of IFRS 15 have therefore been satisfied to
make the assessment that the transfer of the properties qualifies as a sale.
GJ should therefore measure the lease asset at an amount equal to the 'right of use' retained, ie, a proportion of the previous carrying amount, and a gain or loss on disposal is calculated based only
on the rights transterred to the lessor.
As the transfer proceeds of f5.5 million exceed the f4.3 million fair value of the properties, there is £1.2 million additional financing provided to GJ.
The interest rate implicit in the lease is 10%, so the present value of the 8 annual payments of £550,000 is £550,000 x 5.335- f2,934,250 (of which £1,200,000 relates to the additional financing, and
£1,/34,250 relates to the lease). GJ will measure the right-ot-use asset arising from the leaseback as the proportion ot the previous carrying amount of the asset that relates to the 'right of use that it
has retained. This is calculated as:
Sale and leaseback of retail outlets
Carrying amount 3,200
Fair value 4,300
Proceeds 5,500
- (£3,200,000 x £1,734,250/ £4,300,000 = £1,290,605 lease period 8 years
Carry Amount 3,200 Annual rent 5 shops 550
FV 4,300 Rate on lease 10% from 31 Dec X8
Discount lease 2,934 10% for 8 years AF = 5.355
Less additonal finance - 1,200
1,734
ROU 1,291
Stage 1: Calculate gain - £4.3m less f3.2m - £1.1m

Carrying amount 3,200
Fair value 4,300
1,100
Stage 2: Calculate gain that relates to rights retained:
Gain x discounted lease paymentsc = Gain relating to rights retained fair value
Gain 1,100
Discount Lease 1,734
37 Page 66
FV 4,300
Discount lease payment 444
Stage 3: Gain relating to rights transterred is the balancing tigure:

Gain on rights transferred - total gain (E1,100,000) less gain on rights retained (f443,645) - f656,355
In summary, at the start of the lease, GJ would account for the transactions as tollowS:
DR Cash 5,500
CR ROU 1,291
CR PPE 3,200
CR FV of lease 2,934
CR PL gain/loss 656
Amortised of lease
Bf Interest 1 RepaymentCf CL
Jan X8 1,734 173.43 -550 1,358 414
Jan X9 1,358 135.77 -550 943 NCL
Jan Y0 943 94.34 -550 488
Therefore the profit or loss charge relating to the lease in each of the three years (depreciation on right-of-use asset plus interest on lease liability) is:
Yle 31 December 20X8: £161,326 + £173,425 - £334,751
Yle 31 December 20X9: £161,326 + £135,763 £297,089
Yle 31 December 20Y0: £161,326 + £94,339 £255,665
38 Page 67
Operating performance
Below expected
Expansion plan
Build in SA
Maunfactors contrustion equipment
Engines imoported US $
Sales mixed and all over countries
Financial data Actual Budget

Revenue: £m £m % change
UK sales 211.20 240.00 -12%
Eurozone sales 712.70 806.40 -12%
923.90 1,046.40 -12%
Cost of sales:
Variable production costs:
Purchase of engines - 156.00 - 153.60 2% incease
Other variable production costs - 257.40 - 345.60 -26%
Fixed production costs - 265.00 - 240.00 10%
Cost of sales - 678.40 - 739.20 -8%
Gross profit 245.50 307.20 -20%
Distribution and administration costs - 170.00 - 175.00 -3%
Operating profit 75.50 132.20 -43%
Other gains and losses:
Loss made from foreign currency hedging - 10.80
Number of units sold:

UK 4,400.00 4,800.00 -8%
Eurozone 11,200.00 14,400.00 -22%
15,600.00 19,200.00 -19%
Average exchange rates for year ended
30 September 20X7:
US Dollars 1.20 1.50
Euro 1.10 1.25
Cost per engine $ 12,000.00 12,000.00
Anaylsis
Revenue per unit
UK sales 0.048 0.05 -4% 48,000.00 50,000.00
Eurozone sales 0.063633928571 0.056 14% 63,633.93 56,000.00
Total 0.059224358974 0.0545 9% 59,224.36 54.50
Operating profit per unit 0.00483974359 0.006885416667 -30% 4,839.74 6,885.42
VC per unit -0.04348717949 -0.0385 - 43,487.18 - 38,500.00
GPM 27% 29%

NPM 8% 13%
Budgeted profit 132.2

W1 Automation (fav) 5.4
w2 Sales volume changes (adv) -105.6
w3 Price (adv) -8.8
W4 Foreign exchange (fav) 54.33
ws Fixed costs (adv) -7
W6 Distribution and admin (fav) 5
Actual 75.53
(1) Automation
FC increase (9/12 x £24m) -18
Variable cost saving (15,600 £2,000) x 9/12) 23.4
5.4
Cost saving (favourable)
(2) Sales volume changes -9.6
UK units
(4,800-4,400) x (£50,000 - £18,000 -($12,000/1.5))
EU units
(14,400-11,200) x (E70,000/1.25)- f18,000-($12,000/1.5)) -96
Total (adverse) -105.6
(3) Price
UK
(E48,000-£50,000) x 4,400 -8.8
EU 0
Total (adverse) -8.8
38 Page 68
(4) Foreign exchange

Euro sales
((E70,000/1.1)- (€70,000/1.25)) x 11,200 85.83
(favourable)
US engines
($12,000/1.5) - ($12,000/1.2) x 15,600 -31.2
(adverse)
Total foreign exchange (favourable) 54.63
(5) Fixed costs (excluding automation)

£(265-240)m - £18m (adverse) - 7.00
(6) Distribution and admin

£175m- £170m (favourable) 5.00
Automation
The impact of automation had a favourable effect of E5.4 million, but only affected 9 months of the year. Given it
was such a substantial project it is not clear why an estimate of its effect could not have been made when the
budget was set in July 20X6, which was only 6 months in advance of implementation.
Sales volume changes

Both the UK sales and the eurozone sales volumes were less than budget, but the shortfall against budget in the
eurozone (22.2%) was much more substantial than in the UK (8.3%). Price may have been a tactor restricting the
volume decline in the Uk as price was reduced from t50,000 to t48,000 hereas, in terms of euro values, the
price was held constant in the eurozone market. As the eurozone market is tar larger than the UK market in
absolute value terms, the ettect of the volume shorttall was f96 million, which was by tar the largest ot all the
tactors atfecting protit. The UK sales volume etfect was much smaller by comparison at £9.6 million, but is
nevertheless a concern
Price
The selling price in euro at E/0,000 was the same as budgeted, hence there was no price etfect for eurozone
sales. Although the f sterling price ditfered from budget, this was due to toreign exchange rate effects. Ihe
average f sterling price fell by f2,000 from f50,000 to £48,000. This meant a shortfall against budget of f8.8
million. Ihere appears to be price discrimination between the eurozone and UK markets which was t6,000 at the
budgeted exchange rate (t56,000- t50,000), but £15,600 at actual prices and actual exchange rates. Ihis may
cause some leakage between markets. (t is asserted that the same sales mix occurs in the UK and the eurozone
and so this has been assumed.)
Foreign exchange
Foreign exchange impacts on both receipts and payments. A high proportion of receipts comes from eurozone
countries where contract prices are set in euro. When the budget was set, the exchange rate was £1 =€1.25.
However, the actual average exchange rate was t1€1.1.As Hayftield generates cash in euro this exchange rate
movement has had a tavourable eftect as revenues generated in euro now have a higher value when converted to
f sterling. The scale of this effect is significant amounting to f85.53 million. There is a converse story when
considering the exchange rate impact on purchases of engines which are denominated in $. The strengthening of
the $ from £l =$1.5 at the time the budget was set, to £l = $1.2 as the average exchange rate for the year, meant
that the cost of engines in t sterling increased, even though the s cost remained constant at s12,000 per engine.
The impact of this was to increase production costs by £31.2 million. Ihe overall effect of the above exchange rate
movements on operating profit was to give a net currency gain over the year of f54.33 million. However, currency
hedging also made a loss of £10.8 million so, net of this eftect, the overall impact of currency movements and
currency risk management was a gain of f43.53 million (E54.33m - £10.8m).
Fixed costs
The overall increase in fixed costs was 25 million. However, part of this was a result of investment in automation
in order to lower variable costs (see above). lgnoring this investment eftect, the residual ettect was an increase in
fixed production costs over budget of £7 million.
Distribution and administrative costs

These costs fell compared with the budgeted figure by £5 million which was a 2.9% reduction. Whilst
administrative costs may largely be fixed, part of the reduction in distribution costs may be explained by the fall in
sales volumes. Ihis is particularly the case with respect to deliveries to eurozone countries where delivery
distances are greater. More information is needed about the scale of distribution costs compared with
administrative costs within this total but, given eurozone sales volumes fell by 22.2% and UK sales by 8.3%, the
modest fall of 2.9% in distribution and administrative costs is not unexpected.
Investment in machine that increase fixed cost 24m

Reduced VC by 2,000 per unt
Saving in VC 31,200,000 38,400,000
Cost 24,000,000 24,000,000
Hedging forwards contracts

Receipts EURO 18th month rolling basis
future payments of engine in $ 6 months on roliing basies
A forward currency contract is a binding agreement to acquire a set amount of a given currency at a future date at
38 Page 69
an exchange rate agreed at the time of the transaction.

A forward currency contract therefore fixes the exchange rate for a transaction, and these contracts must be settled
regardless of whether or not the actual exchange rate at the settlement date is more favourable than the agreed
Torward price.
In respect of euro receipts, Haytield will have entered into forward currency agreements to sell euro at a future
date in order to hedge the risk oft the euro weakening (thereby decreasing the f sterling value of receipts from
sales).
However, if the euro unexpectedly strengthens in this period against the £, then the torward contract derivative will
suffer a fair value loss. Given the euro has strengthened in the year ending 30 September 20X7, compared with the
budgeted level, then the loss on hedging is not unexpected. Ihis is particularly the case as hedging takes place
over the forthcoming period of l8 months.
Conversely, however, in hedging $ payments Hayfield will have entered into forward currency agreements to buy $
at a future date in order to hedge the risk of the $ strengthening (thereby increasing the £ sterling cost of engine
purchases).
Given that the S has strengthened in the year ending 30 September 20X7 against the £, compared with the
budgeted level, then a gain on S hedging would be expected.
Overall it is not unexpected that a net loss on derivative contracts has been made as the euro hedges (generating
losses) are greater than the S hedges (generating gains) as:
The value of eurozone sales (E712.7 million) is much greater than the cost of engine purchases (E156 million) so
the hedging contracts are likely to be greater to mitigate the additional risk.
The euro hedging is over 18 months, compared with S hedging which is only over 6 months so there will be
more euro hedging contracts outstanding. given the longer time period covered.

The hedged transactions of receipts and payments are highly probable forecast transactions rather than firm
commitments as, tor example, the time from order to delivery (and receipt of cash) is months whereas the period
of the hedge is up to 18 months. As a result of being classified as highly probable forecast transactions, the
torward currency contracts must be treated as cash tlow hedges (tair value hedges are not permitted)
The purpose of cash flow hedging is to enter into a transaction (purchasing the forward currency contracts as a
derivative) where the derivative's cash tlows (the hedge instrument) are expected to move wholly or partly, in an
inverse direction to the cash flow of the position being hedged (the hedged item). The two elements of the hedge
(the hedge item and the hedge instrument) are therefore matched and are interelated with each other in
economic terms.
In the case of Hayfield, the management accounts recognise all changes in fair values of forward foreign currency
contracts that have occurred during the year ended 30 September 20X/. Given this is the case, then the overall
balance on the suspense account (E10.8 million) will include:
(1) Hedge contracts taken out in the previous accounting period and realised in the current accounting period
(2) Hedge contracts taken out in the current accounting period and realised in the current accounting period
(3) Hedge contracts ta ken out in the current accounting period and realised in the next accounting period
(4) Hedge contracts taken out in the previous accounting period and realised in the next accounting period (for
euro hedges only that can be up to 18 months)
Cash flow hedge accounting attempts to reflect the use of the forward currency derivative to hedge against future
cash flow movements from exchange rate changes.
Assuming the conditions for hedge accounting defined in IFRS 9, Financial Instruments are met, the hedging
instrument is measured at fair value with the gain or loss being recognised as follows:
The gain or loss on the effective portion of the hedge (ie, up to the value of the opposite loss or gain on the
cash flow hedged item) is recognised in other comprehensive income and transferred to profit or loss when the
cash flow itself is recognised in profit or loss.
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 (as matching is not achieved).
For 1, the gains/losses in hedging instruments from previous periods are recycled from OCl and recognised in
profit or loss, in addition to any further gains/losses in the derivative in the year ended 30 September 20X7.
For 2, there is no recycling as the derivatives do not cross the year end threshold. As a result, all the gains/losses
will be recognised in profit or loss in the year ended 30 September 2OX7.
For 3, movements in the derivative, in the year ended 30 September 20X7, which would normally go through profit
or loss, are recognised in other comprehensive income. Such gains/losses on the derivative will be
restated/recycled to profit or loss in the year ended 30 September 20X8 (ie, in the same period in which the
hedged highly probable transaction affects protit or loss).
For 4, movements in the derivative, in the year ended 30 September 20X7, which would normally go through profit
or loss, are recognised in other comprehensive income and added to the gains/losses in hedging instruments
from the previous period. Such gains/losses on the derivative will be restated/recycled to profit or loss in the year
ended 30 September 20x8 (ie, in the same period in which the hedged highly probable transaction affects profit
or loss).
(3) Two altermative strategies

Expansion plan
Build in SA
Build tractors does not build previous
Lower labour and prod cost
sale at lower price about 25,000
38 Page 70
Joint Venture
CTB is othe JV
Hayfieild buy Eq = 38m
Right of assets
key decision both
profit share equal
Unknown business partner
New subsidary
AMSA
£55 loan
Both strategies ofter the opportunity to enter new geographical markets, with a new product market. This is
'diversification' according to the Ansoff matrix. Whilst offering new opportunities, it combines the significant risks
of both a new geographical area and a new product.
In addition, setting upa new subsidiary adds significant new financial risk by increased borrowing. If the project
succeeds, then all of the benefits will come to Hayfield through its subsidiary, AMSA. However, if the project fails
then it will suffer all the losses. With a lack of local knowledge there may also be an increased probability of failure.
In contrast, the joint arrangement has a number of benefits which would not be experienced by the solely owned
subsidiary, AMSA.
Ihe costs are shared with the joint arrangement partner. As the capital outlay is shared, joint arrangements are
especially attractive to risk-averse firms or, as in this case, where expensive new technologies are being
established. CIB may not bring much new financial capital but the utilisation of the CIB tactory premises appears
to reduce Haytield's outlay from £55 million to around £38 million. I here are also shared operating costs (eg,
labour). Ihese common costs and economies of scale are likely to be a financial benefit to Haytield.
There is also reduced risk from the joint arrangement ina reduction in exit costs if the venture fails, as the set-up
costs are lower.
There may be reputational enhancement as CTB is likely to be a more recognisable brand in South Africa as
Haytield has not previously operated in this area. I he venture parther may theretore bring increased initial
credibility and there may be an opportunity to cross brand to enhance the local reputation.
There are ikely to be synergies. One firm's production expertise can be supplemented by the other's marketing
and distribution facility. For example, there may be economies of scope in distribution of both venturers products
throughout Africa. However, this would not seem to apply to any sales to South Asia or South America.
CIB may also provide local knowledge of South African law, culture, customers and language. Ihis may also
extend to local knowiedge and experience ot suppiy chains.
A joint arrangement may also have a number of problems and risks which would not be experienced by a solely
owned subsidiary.
There may be contlicts of interest between Hayfield and CI8. Ihis may be in terms of prioritisation of the short
term use of resources (eg, use of labour for an urgent delivery). Ihey may also have difterent longer-term
objectives for the joint arrangement -for example, if one is looking tor short-term profits, while the other wants to
invest in longerterm growth.
Disagreements may arise over profit shares, amounts invested, the management of the joint arrangement, and the
marketing strategy. In particula, there needs to be a degree of business trust between the parties requiring
openness and access to information.
There may be a finite life of five years if CTB decides to terminate the arrangement after the minimum period. In
contrast, a subsidiary would have an open-ended life to be determined solely by the interests of Hayfield.
Recommendation
The joint arrangement appears to offer modest and temporary benefits, but major risks, with possibly only a five-
year horizon. The preferred recommendation therefore, despite the higher initial cost, is to set up a subsidiary.

Accounting for joint arrangements
The terms of the contractual arrangement between parties to a joint arrangement are key to deciding whether, for
financial reporting purposes, the arrangement is a joint venture or a joint operation.
The proposed arrangement between Hayfield and CTB does not have a separate entity but falls under a joint
operation (per IFRS 11), whereby the parties that have joint control of the arrangement have rights to the assets
and obligations for the liabilities relating to the arrangement.
The two parties exercise joint control. The contractually agreed sharing of control of an arrangement, which exists
only when decisions about the relevant activities require the consent of the parties sharing control, is clearly the
case.
IFRS 11 requires that a joint operator recognises line by line in its own financial statements the following in relation
to its interest in a joint operation:
Its assets, including its share of any jointly held assets (this would include the plant and machinery in the South
African factory)
Its liabilities, including its share of any jointly incurred liabilities
lts revenue from the sale of its share of the output arising from the joint operation (this would include the sales
of tractors less any amounts attributable to CIB)
Its expenses, including its share of any expenses incurred jointly
38 Page 71
Each of the amounts relating to items in the statement of profit or loss would be translated into the functional
currency of Haytield normally using the average exchange rate.
In respect of assets and liabilities:
Monetary items should be translated and then reported using the closing rate.
Non-monetary items carried at historical cost are translated using the exchange rate at the date of the
transaction when the asset or liability arose.
Separate subsidiary (AMSA)

If AMSA is set up in South Africa as a subsidiary, then it would have a different functional currency to Hayfield.
AMSA would therefore be consolidated in accordance with IAS 21 into the consolidated financial statements of
Hayfield translated into its presentation currency.
The following procedures should be followed to translate AMSA's financial statements from its functional currency
into a presentation currency:
Translate all assets and liabilities (both monetary and non-monetary) in the current statement of financial
position using the closing rate at the reporting date.
Iranslate income and expenditure in the current statement of profit or loss and other comprehensive income
using the exchange rates ruling at the transaction dates. (An approximation to actual rate is normally used,
being the average rate.)
Report the exchange differences which arise on translation as other comprehensive income.
The loan of £55 million from Hayfield to AMSA would be a net investment in a foreign operation. As the loan is in
the functional currency of Hayfield, the parent, then any exchange differences will be recognised in the profit or los
s of AMSA.
(5) Assurance risks

In the proposed joint arrangement between Hayfield and CTB profits are to be shared equally between the two
parties. In this respect, it could be valuable for both of the parties to have assurance that profits have been
calculated correctly in accordance with the terms of the agreement.
While the criteria which define the split of profits in the joint arrangement are in the venture agreement, the profit
allocation still needs clarification with the two parties. Both parties want assurance that the protit allocation has
been calculated properly and in accordance with the agreement in terms of determining the value of underlying
transactions and making full disclosures.
This is likely to require initial due diligence and ongoing monitoring of the joint arrangement (JA) to sustain
assurance.
Initial investigations
Review JA agreement (in combination with legal advisers) for onerous, ambiguous or omitted clauses.
Ensure that the purpose of the JA is clear and the respective rights of Hayfield and CTB are established in the
initial contractual arrangements.
Ensure that the scope of the JA is clear so there is separation of the other operations of each company from
those falling within the JA.
Review tax status of JA entity (if applicable) or Hayfield's operations including remittance of funds. Review
governance procedures including shared management, control, rights over assets, key decision-making
processes to ensure that Haytield management has an appropriate level of control over key decisions that may
damage its interests.
Establish that any initial capital from CIB has been contributed in accordance with the agreement and that legal
ights for Hayfield to use the ClB factory and labour have been established.
Establish the creditworthiness, going concern and reputation of CTB based on local enquiries from
stakeholders and a review of internal documentation as well as that in the public domain.
Ensure the terms of the disengagement and residual rights in five years' time are clear in the initial agreement
so there is a transparent and legitimate exit route.
Where assets that are to be used in the joint arrangement are already held by CTB or Hayfield then they would
normally be transterred nominally at fair value. Ihis needs to be established.
Clarify the revenue sharing agreement with respect to existing sales under construction, or orders contracted
for but not yet commenced.
Health and safety responsibility needs to be established and liability sharing agreed.
Continuing assurance
Audit rights and access to information need to be established in the contract as this will affect the scope of the
audit.
Ensure that the operations of the JA are within the terms of the JA agreement (eg, adequate labour is being
provided by CTB and there are no violations of the contractual agreement).
Ensure that internal controls and accounting systems are being applied and are effective (eg, that the revenue
from sales in Africa relating to the JA is fully recorded and is separated trom other sales that do not form part of
the joint arrangement, such as existing customers within Africa or of other types of equipment outside the
agriculture industry).
The accounting systems tor a JA entity will need to be capable of recording accurately and completely the costs
being incurred and the assets held relating to the JA. However, as the JA is set up as a jointly controlled
operation, the costs will mainly be recorded in the individual accounts of each of the venturers (although there
may be some joint costs met out of revenue). In this case the key audit issue for the JA is that operations and
assets have been supplied in accordance with the contract rather than recording their costs. Risk areas tor
Hayfield may include overhead allocations as CTB is supplying a factory which has multiple uses.
f permitted within the terms of the contract, audit access to the accounting records of CIB would provide
additional assurance. Ihis may mean however that a reciprocal arrangement needs to be made available to the
advisers for CIB, by giving access to the Haytield accounting systems.
The eventual dissolution of the agreement (perhaps in five years) creates additional assurance problems in
38 Page 72
terms of disengagement, return/sale ot assets, intellectual property rights and rights to future customer access.
The level of assurance needs to be determined (reasonable or limited)
39 Page 73
Bussiness Analytics and Medical Analysis team part of
Business Analytics Medical Analytics Total

20X8 20X7 20X7 20X8
£m £m £m £m
Revenue
UK 816 612 192 256 1876
US 0 0 448 336 784
Eurozone 544 408 0 0 952
Operating profit 272 255 64 89 680
Number of
New customers in year 232 122 30 25 409
Customers lost in year 88 192 24 19 323
Customers at 30 June 876 732 246 240 2094
Revenue from ABS's largest 97 112 57 15 281
customer
Total revenue 1,360 1,020 640 592 3,612

Revenue per customer 1.33 1.54 2.54 2.41 1.66
Revenue % of largest 7% 11% 9% 3% 8%
Revenue per division 38% 28% 18% 16% #DIV/0!
Revenue from OS 40% 40% 70% 57%
Operating margin 20% 25% 10% 15% 19%

Operating profit per division 40% 38% 9% 13%
% change
UK 33% -25%
US 33%
Eurozon 33%
operating profit change 7% -28%
Customer change 19.7% 2.5%
Larges customer change -13.4% 280.0%
Cloud tech, data analytics and storage

Use of this and return data to customers
Help customers make decesions
Competion and uncertainty

rapid change and high competitive
loss of customers frequent
legal issue over passing of data
Competition risk
Nature and evaluation of risk
It is a highly competitive and changing market where competitive
advantage is contestable and temporary.
In 20X8, Business Analytics increased customer numbers by 19.7% despite
losing 12% of the customers it had at the end of 20X7.
Medical Analytics only gained 2.5% in customer numbers, but lost 10% of
the customers it had at the end of 20X7. Customer switching is theretore a
major risk.
The fall in operating margins of both divisions reilects the risk of increased
competition on operations as well as on sales.
In 20X8 Business Analytics operating margin fell from 25% to 20% and
Medical's from 15% to10%. If this downtrend continues in future it may
remove operating profit entirely.
Risk mitigation
Anticipate and adapt to changes in technology and markets.
Stay close to existing customers' evolving needs by relationship
marketing and frequent dialogue.
Marketing and market awareness to seek out new customers.
Invest in new technologies and infrastructures.
Expansion of the business may compensate for lower operating profit
margins (as occurred for Business Analytics in 20X8).
Foreign currency risk

Business Analytics Division earned 40% of its revenues in euro in 20X8.
Medical Division earned 70% of its revenues in Uss.
f the £ strengthens then foreign currency earnings would fall in value in f
sterling terms.
Risk mitigation
Hedge operational currencies against sterling.
Consider incurring more costs in euro or USs (eg, borrowing in these
currencies) as a natural hedge.
Widen span of sales.
Consider developing foreign operations.
Invoicing in sterling it acceptable to customers.
Data regulation risk

Increase in government regulation in UK (or US or Eurozone countries)
could increase costs, amendment to business model (eg, on personal data
retention, such as GDPR).
t regulation ditters between jurisdictions there may be a competitive
disadvantage compared with foreign operators.
Risk mitigation
Monitor legal changes, particularly prior to new investment.
Take legal advice on a regular basis.
Consider developing toreign operations.
Intellectual property
Products and services nclude and utilise intellectual property content.
There is a risk that intellectual property rights could be challenged, limited,
invalidated or circumvented, which may impact demand for, and pricing of
products and services. Laws can be subject to legislative changes and
increased judicial scrutiny. This creates uncertainty in protectingg
proprietary rights.
Risk mitigation
Trademark, copyright, patent and other intellectual property laws to
protect proprietary rights in intellectual property.
Subscription contracts with customers to contain restrictions on the use of propreitary content
Brexit and other foreign trade regulations and tariffs

39 Page 74
Changes in international trading regulations (including Brexit) may create

regulatory or tariff barriers to cross-border sales and operations.
Risk mitigation
Monitor developments in regulations.
Where appropriate lobby governments and regulators.
Industry dependence - medical

The Medical Division made up almost one third of sales in 20X8 and is
dependent on a single industry. It is also only diversified across two
countries.
Risk mitigation
Consider expansion of Medical Division into other countries (eg.
Eurozone).
Monitor government policies on medical expenditure.
Large customer dependence

The largest customer provides 7% and 9% of divisional sales for Business
Analytics Division and Medical Division respectively, which is significant.
Risk mitigation
Anticipate and adapt to needs of key customers.
Contingency plan for redeployment of resources if key customers leave.
Cyber security
Our data and systems, and those of our strategic partners and customers,
are susceptible to cyber-attacks where external parties seek unauthorised
access.
Our cyber security measures, and the measures used by our third-party
service providers, may not detect or prevent all attempts to compromise
our systems, which may jeopardise the security of the data we maintain or
may disrupt our systems.
This may cause misappropriation of data, deletion or modification of
stored information or other interruption to business operations.
This may lead to financial loss, reputation loss and regulatory breaches.
Risk mitigation
Data privacy and security programmes with the aim of ensuring that
data is protected and that we comply with relevant legislative,
regulatory and contractual requirements.
Continue to invest in rigorous administrative, technical, and physical
controls.
Monitor third party and customer systems and data, particularly where
they interact with our own systems.
Technology failure
The operations are dependent on electronic platforms and networks for
delivery of products and services. These could be adversely affected if we
experience a significant failure, interruption or security breach.
Risk mitigation
Procedures for the protection of our technology assets.
Business continuity plans, including IT disaster recovery plans and back-
up systems, to reduce business disruption in the event of a major
technology failure.
Acquitions of Data Soultions DS

1 July X5 Acq
Acq 8,000.00 Con 8,000.00
SC 1,000.00 Less
RE - 640.00 NA - 360.00
NA 360.00 Intagible - 5,000.00
Goodwill 2,640.00
Software right Max Software 5,000.00
Life 5.00
CA 2,000.00
Possible disposal of DS
June X8 Loss making
Max software sale 480.00
Ex loss - 1,520.00
OR sale of Shares in DS
At the acquisition date, the major asset of DS was the rights over Max Software.
Share capital was f1,000,000 and with negative retained earnings of f640,000 then recognised net assets were £360,000.
Unrecognised intangibles, specifically Max Software (Max), had a fair value of £5 million so (in the absence of any further unrecognised intangibles):
On 1 July 20X5, the date of the acquisition, whilst the value of Max made up most of the value of the business of f8 million there were clearly other factors. These may have been intellectual property
rights over other programs; the expectation of future earnings despite losses to date; the expectation that DS would contribute to the other activities of ABS to make it worth paying f8 million to
secure the Ds business and its employees.
By 30 June 20X8, it would appear that the acquisition has not beena success for ABS. The key asset of Max is becoming outdated and its sale value of £480,000 is far below its carrying amount of £2
million (E5m - (3 years x £lm amortisation)) at that date.
Whilst E480,000 could be seen as a floor price for the sale of DS shares, there may be other costs in relation to employees being transferred to the buyer, retained or made redundant. However, the
sale of the shares may transfer some of these obligations (subject to legal constraints such as TUPE). Also as the Max Software is becoming outdated, its value may decline from f480,000 by the date
of sale.
The fact that DS is making losses and that Max software is no longer being utilised by the remainder of the ABS business means that any goodwill that existed on acquisition in excess of the Max value
is unlikely to still be significant.
Any other assets held within the DS statement of tinancial position would need to be valued and considered as additional value. Conversely., however, any liabilities or other obligations of DS may
mean that the value of DS shares may be lower than the value of the Max program as liabilities would probably transter With the share sale.
Liabilities and obligations may include contractual conditions relating to the acquisition (eg. to the previous owners and to employees). Legal due diligence would be needed to explore the nature of
any obligations and how these would differ between an asset sale and a share sale.
Overall, subject to there being significant liabilities or new programs or processes under development, the Max Software value plus any other net assets is likely to be close to the DS share value.
Financial reporting
Sale of Max Software asset
Individual financial statements of Ds
Max is an internally developed intangible asset and so would not be recognised in the individual financial statements of DS. Any proceeds on sale would therefore be recognised in full in profit or loss.
ABS group financial statements

On acquisition, Max Software would need to be recognised in the group accounts as a technology based intangible asset (a specitic example in IFRS 3). It should be measured at its fair value on the
acquisition date, assuming this can be ascertained reliably.
AS 38 permits two methods oft measuring intangible assets: the cost model (cost less amortisation) and the revaluation model. Ihe revaluation model seems inappropriate as there is no active market
given the uniqueness of the sotware.
If the Max Sotware intangible has not been previously impaired it needs to be impaired at 30 June 20X8, which would be prior to any sale.
The intangible asset of Max Software currently has a fair value of £480,000. If this is also the recoverable amount, it is below its carrying amount of £2 million (E5m -(3 years x £1m amortisation) at 30
June 20X8. An impairment of £1.52 million would therefore take place. Given the software asset is impaired, the goodwill would also now need to be impaired.
IF Max Software is eventually sold, any excess net disposal proceeds above f480,000 would be deemed as a profit on disposal. To the extent that the net disposal proceeds are below f480,000 this
39 Page 75
would be deemed as a loss on disposal.

Whilst the board has decided to sellI DS, the method of sale is still undecided, and it is not being advertised, so it does not meet the IFRS 5 held for sale criteria.
Upon disposal Max Software would be derecoanised.
Sale of DS shares
ABS parent company financial statements
The shares of DS would initially be recognised as a financial asset (ie, an investment) at their original cost of £8 million in the ABS parent company tinancial statements.
Where there is an indication of impairment (eg, through the potential obsolescence of Max Software) then the financial asset should be impaired to its recoverable amount.
For example, if at 30 June 20X8, the share value is approximately the same as the Max value of £480,000, then the impairment would be £7.52 million (f8m - f480,000) assuming there had been no
previous impairment.
When the DS shares are sold, any excess net disposal proceeds above f480,000 would be deemed as a profit on disposal. To the extent that the net disposal proceeds are below £480,000 this would
be deemed as a loss on disposal.
Upon disposal, DS shares would be derecognised in the ABS parent company financial statements.
ABS group financial statements

The impairment of the DS business will be reflected in the impairment of the goodwill on acquisition of £2.64 million. Based on the above discussion of the value of Max Software, goodwill looks to be
fuly impaired in addition to the impairment of the intangible asset Max as noted above.
The profit or loss on disposal of the DS subsidiary in the group financial statements will be the difference between the sale proceeds and the parent's total investment in the subsidiary (ie, the net
assets of DS as they would appear in the group SoFP immediately prior to disposal).
As the original goodwill of f2.64 million is fully impaired at 30 June 20X8, then this does not need to be considered. As a subsidiary, DS is likely to be a reportable segment and therefore meet the
definition of a discontinued activity in accordance with IFRS5. Appropriate disclosures will theretore be required.
Cyber secuirty issue

Malware infection in hospital
(3) Internal audit - Cyber security
Ihe cyber incident on 28 June 20x8 has illustrated ABS's vulnerability to cyber-attacks from external sources with third party service providers.
As a first step in respect of that data incident, the board needs to establish:
That there has been full data cleansing and systems cleansing such that there is no continued contamination from the breach.
That a similar incident could not occur such that ftiles from third party service providers are in future tested tor malware with a more robust firewall, the same as from non-trusted external
communications.
Ihat the security systems of third paty providers are reviewed on a regular basis as part of any agreement
Whilst the specific causes of the attack and its consequences can be addressed by the above measures the incident highlights the risk from other types of cyber-attack and from other sources
including customer and other third-party service providers.
Integrity of customer data held by ABS is fundamental to the company's business model. This emphasises that the report by the internal audit department is too limited in focusing only on technical
risks rather than also seeing it as a wider business risk where responsibility is throughout the organisation, not just in the sphere of the Il department.
The supply chain is Just one set of external partners from which cyber risk could arise. Other external sources of cyber risks include: customers; business partners; I service providers; and
subcontractors. All these external relationships should be part of a wider assurance engagement, but third-party service providers are the immediate focus of this report.
It may be unproductive and unrealistic to gain assurance over all third-party service providers and therefore a degree of prioritisation is required in any cyber security risk management strategy. It is
important to target eftorts on the greatest risk providers, which may not be the same as the highest value providers. However, ABS should at least require third parties to contirm their security
measures and procedures in terms and conditions of dealing with the company.
Those suppliers with IT systems which are integrated with ABS represent one of the greatest risks. Small companies which do not have a significant IT security budget may also be a significant risk.
Similarly, customers may not have well developed II security systems as this may not be core to their business.
It is also important to make cyber assurance part of an ongoing process, not a one-oft exercise. This is likely to require regularly reviewing processes and procedures over the entire lite cycle of a third-
party service provider s contract.
In the June cyber incident, the attack accessed the Medical data analytics system. Ihis is a key risk as it can potentially have lite threatening consequences for individuals. The Medical Division should
therefore be a key focus in assurance over cyber risks from third-party service providers.
However, to the extent that common platforms, programs and processes are used, the assurance engagement should review for cross contamination into the Business Analytics Division's systems.
Recommendations for action
For selected third-party service providers which have been identified as a significant cyber risk, it is important to consider the nature of any critical business relationships alongside IT security. This may
require building a culture of a common approach to risk and a common risk vocabulary, rather than imposing conditions. Ihis may involve sharing data security across the supply chain, including tier 2
and tier 3 suppliers (ie, suppliers of suppliers). ISO 27000 series could provide a benchmark for required standards and for due diligence.
f cooperation is not forthcoming, the business consequences of losing a third-party service provider may need to be weighed against cyber risks.
Service level agreements with third-party service providers may need to include transparency and access conditions to their files and systems in order to obtain assurance as a condition of doing
business. This will tacilitate ongoing |I due diligence procedures throughout the lite cycle of the supply contract. Service level agreements may also include penalty clauses for cyber breaches in order
to provide incentives for suppliers to comply with conditions and install |I security systems.
Financial risk mangement - FX hedging

Due to pay 1m EURO 30 Oct X8
1 May X8 - borrow 1m for 6 motnhs maturity
today stop converted
£ in deposit account
Borrow Lending
Sterling £ 4% 3%
Euro 3.50% 2%
Spot rates
1 May X8 £1 1.2005 1.2025
30 June X8 £1 1.1855 1.1875 EURO weakens
Loan 1,000,000.00 EURO

Interest 17,500.00 EURO 6 months
Cover £ 831,600.83 Covered at May spot

Interest £ 12,474.01 Earned
Cover £ at YE 842,105.26
Gain/Loss 10,504.43
Loan Amoristed
2 months till year end
Loan value 1.00583333333 1+(0.035*2/12) Borrow rate EURO
Loan 1,000,000.00
YE sport 1.19
YE value 847,017.54 Liability
Despoist amount
Loan value 1.005 1+(0.035*2/12) Lending rate £
Loan 1,000,000.00
Date was taken out 1.20
YE value 835,758.84 Asset
The E1 million receivable isa monetary item and is to be retranslated at the closing bid £/€ spot rate of 1.1875, ie, receivables will be recognised at f842,105 (€1m/1.1875).
At 1 May 20x8 the receivable was stated at £831,601 (€1m/1.2025).
A foreign exchange gain of £10,504 (f842,105- f831,601).
The € loan is stated at amortised cost including accrued interest translated at the closing bid f/€ spot rate of 1.1875, ie,
(E1m x(1+(0.035 x 2/12)y1.1875- £847,018
The sterling deposit is stated as a financial asset with accrued interest, ie,
Elm/1.2025x (1+(0.03x 2/12)-£835,759
(b) Nature and consequences

ABS is exposed to exchange rate risk on the receipt of E1 million. The risk relates to the euro weakening against the f (ie, the f strengthening) as the €l million receipt would then be worth less when
converted to fs at the end of October 20X8.
The treasurer has undertaken a money market hedge by borrowing E so the amount payable after 6 months should be €1 milion.
As a consequence, ABS has a net El million, 6-month liability with a 3.5% interest rate. Therefore, it needs to pay El million x (1 + 0.035/2)=€1,017,500 on 31 October 20X8. It seems to be Claude's
intention that this is to be repaid (largely) trom the euro receipt of €l million. However, there is a (small) currency risk on the €1/,500 element of the loan which cannot be repaid trom the €l million
receipt.
Therefore, whilst the general principle is correct, Claude has not borrowed the appropriate amount (ie, too much) for a money market hedge for precise offsetting with this transaction. It should be
noted, however, that this amount is small, and that there are regular euro receipts such that there is no major exposure from Claude's over-borrowing.
(c) Alternative hedging arrangement

The correct procedure and amounts for a money market hedge would have been as follows:
Loan EURO 1,000,000.00
Lending rate for 6 months 1.0175 1+(0.035x 6/12)
39 Page 76
Spot rate at May 1.2025

Dividend by both 817,298.11
Lending rate for 6 month 1.015 1+(0.035x 6/12)
Balance 829,557.59
€l million will be received six months after the transaction.

As a result €982,801 (Elm/{1 + (0.035 x 6/12)) should have been borrowed on 1 May 20X8 and converted into sterling, with the euro loan to be repaid from the receipts.
The net sterling amount 6 months hence is:
IE1m/(1+ (0.035 x 6/12)/ 1.2025 x [1 + (0.03 x 6/12)]}
-£817,298 x 1.015
-£829,557
The equation for the €l million receipt in 6 months is to calculate the amount of euro to borrow now (divide by the euro borrowing rate) and then to find out how much that will give now in sterling
(divide by the exchange rate). Ihe final amount of sterling after6 months Is given by multiplyıng by the steriing lending rate.
The statement by Claude that a profit has been made on the transaction is not true as the € has strengthened against the f by 30 June and therefore the €1 million receipt would have been worth
more in f sterling terms in the absence ot hedging.
40 Page 77
food and production

Rein Ltd
Poor performance
Poor ROCE
YE 30 JUNE
Owns factory
located 50 Km
given between
60 and 90 days credit to supermarkets
Only small retailers
Meat and fish division profit marking
Contract with Gaint PLC

2 year contract
1 Jan X7
Meat only
90 day credit terms
sale
profit
Meat non G PLc G PLC total meat Fish

Meat processed (kg) 3,600,000 300,000 3,900,000 400,000
Revenue 36,000,000 2,400,000 38,400,000 6,000,000
Operating profit f 1,080,000 48,000 1,128,000 300,000
Operating profit margin 3.0% 2.0% 5.0%
Price (f per kg) 10 8 15.00
Sales volumes and opportunity cost

The Giant contract makes up 7.7% of sales volume for meat and 7% total sales volume. Given the company is at full
capacity for packaging and near full capacity for food processing then the Giant contract consumes a significant
element of productive capacity which could be used in accepting alternative, and possibly more profitable,
contracts. In this sense, it has a potential opportunity cost.
The opportunity cost may be limited by the fact that only small customers have, to date, been rejected due to lack
of capacity. In addition, whatever the retrospective opportunity cost has been, going forward greater operating
efficiency, engendered by the recovery plan, may reduce the future opportunity cost.
Sales price
The data shows that the average price of £8 per kg for the Giant contract is lower than the average for other meat
products which is E10 per
This may be due to larger discounts to Giant than other customers. These might have been offered due to the fact
it is a large contract with economies of scale and scope, however the low margins (see below) do not support this
notion.
Alternatively, the tender may have been underpriced to ensure it was successful.
A further, or alternative, explanation is that the type of meats sold to Giant are dissimilar to those sold to other
customers, being cheaper types of meat or lower quality for Giant.
Costs
Limited intormation is provided on costs, but there may be some benefits of large production runs. As noted
above, this may result in economies of scale. Alternatively, as production nears capacity, there may be
diseconomies of scale resulting from production scheduling difficulties and overcapacity problems at some times
of the day or week.
Margins
The operating profit margin, at 2%, is lower than the other meat contracts at 3% or the fish products at 5%. Whilst
appearing to make an incremental profit, the Giant contract does not appear as profitable as other contracts and
therefore on average it there is a capacity constraint then greater questions over renewals would be raised rather t
than for other contracts.
A note of caution is that the allocation of packaging costs appears arbitrary and may have distorted operating
margins which may not, therefore, provide reliable information for decision making.
Moreover, the costs include fixed costs (both those within the food processing division and those allocated from
packaging). As a result, the contribution margin on the Giant contract is likely to be more significant than the
operating profit margin.
Advice
The renewal of the Giant contract depends largely upon whether other contracts are available which may generate
a greater contribution and whether Rein continues to operate at, or near, full capacity. If this is the case, then there
40 Page 78
may be a significant opportunity cost to renewal and, if only available on current terms, it may be optimal to reject
it in order to take advantage of others from other potential customers.
f however the recovery plan can generate spare capacity then continuing with the Giant contract may generate a
reasonable positive contribution, with reduced opportunity cost.
Such a decision is not however without risks. Renewal on same terms does not mean the same profit will be earned
or the same costs incurred. For example, costs may have risen or be volatile as exchange rates may shift with
increasing costs, whilst the price with Giant is fixed.
Given there appears not to be a tender for the renewal, it may be possible to negotiate better terms with Giant as a
condition of renewal.
(2) (a) Operations, supply chain and distribution activities

Comparing meat and fish - summary of operating differences
Meat Fish
Scale Large Small

Types 7 3
Suppliers Few Many
Order size Large Small
Suppliers Quarter overseas Half overseas
Packaging Trays only Many types
Meat Fish
Amount of food processed (kg) 39,000,000 4,000,000
Types of meat or fish 7 3
Operating cycle stages average days
Time between order and when raw 4.8 6.9
ingredients are received
Time that raw food ingredients are held
in storage 4.2 1.8
Processing time 0.4 0.3
Time for transfer to packaging factory 0.2 0.2
Packaging time 0.2 0.5
Time that products are held in 8 3
inventories
Time between taking out of inventory 1.1 2.2
and delivery to customer
Total 18.9 14.9
Order time
Time between order and when raw 4.8 6.9
ingredients are received
The higher number of smaller suppliers for fish

products is likely to mean there is greater delay in
waiting to obtain full loads before delivery. The delivery
the journey time may also be greater for fish products as
half are from overseas, compared with one quarter for
meat
Despite being a shorter delay for meat products, 4.8
is still significant for foods that have a short
hable life.
Risk is that foods may perish during the delay or
a shorter useful life after arrival with increased
of wastage.
the delay also means that urgent customer orders may

not be able to be satisfied. The fact that some agreed
delivery times have been missed makes this more
uncertain.
Improvements
Contractual agreements with suppliers for more prompt
and more reliable deliveries. Consider a just-in-time
(JIT) approach. Consider using more local suppliers.
Information systems linked with suppliers' information
systems where volumes justify this.
40 Page 79
Food held in storage

Time that raw food ingredients are held
in storage 4.2 1.8
Meat products are held in storage for much longer than

fish products. This may be due to poor production
scheduling on the meat production line which is not
coordinated with deliveries. It may also be that there are
more types of meat, so meat products are held in
storage until the appropriate production run has been
set up for each type of meat.
Improvements
Coordinate the production runs for each type of meat
product with deliveries of that product.
Processing time 0.4 0.3

Short time, but as machines are cleaned between
production runs there is some idle time.
Improvements
Investigate new cleaning methods to reduce machine
down time.
Time for transfer to packaging factory 0.2 0.2
Normally an efticient transfer system.

Improvements
No action.
Packaging time 0.2 0.5

Machinery needs to be reset for each type of packaging
therefore fish may take longer in packaging due to
change-overs.
Improvements
Consider reasons why fish take longer in packaging
than meat. Possibly benchmark against meat.
Held in inventory
Time that products are held in 8 3
inventories
Meat times are high. Products held in inventory are at
risk of perishing, particularly if inventory holding times
are excessive.
Improvements
Consider scheduling production to the timing of
predictable customer orders.
Devliery to customer
Time between taking out of inventory 1.1 2.2
and delivery to customer
Goods are delivered to each geographical area when a
truck can be filled.
Fish times may be longer due to small batch sizes.
The risk is that food may perish during delivery. Also,
customer dissatisfaction arises with delays in delivery.
Improvements
Suitable storage during transportation in controlled
temperatures. Information systems linked with customer
information systems.
(b) Overall assessment

Overall there are significant delays for meat and fish of 18.9 days and 14.9 days respectively. In addition to the
specitic inetficiencies, costs and risks identified at each stage of the operating cycle there are more general risks
and costs. The delays in storing and holding food give rise to costs (storage, chilling. rental space, labour, lost
interest on cash flows, spoilage). Ihese costs are not adding attributes to the product or service valued by
customers and therefore, to the extent they can be reduced or eliminated, costs can be reduced without harming
40 Page 80
the quality of the product. Lower costs can therefore give rise to higher profits as revenues would be unattfected.
Indeed, getting the products to customers more quickly with lower wastage and longer shelt lives may enable Rein
to be seen as a higher quality supplier enabling higher prices to be charged.
In addition, to the extent that the above processes are part of the capacity constraint which limits the output (eg, if
storage space or processing capability is at capacity) more etticient processes may raise capacity and enable
increased sales volumes.
One method of approaching this problem in the recovery plan is through business process re-engineering (BPR.
BPR involves focusing attention inwards to consider how business processes can be redesigned or re-engineered
to improve efficiency. Properly implemented, BPR may help an organisation to reduce costs, improve customer
service, cut down on the complexity of the business and improve internal communication.
Evaluate financing risk and solvency

Revenue 38,400 6,000 44,400
Operating profit 1,128 300 1,428
Interest - 1,100
Profit before tax 328
Summary statement of financial position at 30 June 20X8

Non-current assets
Current assets
Inventories 600
Receivables 10,200
TOTAL ASSETS 27,200
Equity
Share capital (£1 ordinary shares)
Non-current liabilities 4,300
7% Bank loan (repayable 30 June 20Y0) 2,000
Current liabilities
Trade payables, accruals and taxation 3,800
Overdraft (at 9% pa) 600
TOTAL EQUITY AND LIABILITIES 27,200
20X9 20Y0 20Y1 20Y2

Forecast free cash flows: years ending 30 JuneForecast Forecast Forecast Forecast
Free cash flows less interest
(without recovery plan) 1100 1100 1100 1100
Estimated impact of recovery plan 200 400 500 500
Free cash flows less interest
(with recovery plan) 1300 1500 1600 1600
bf balance overdraft -600 700 200 -2200

loan repyment 0 -2000 -4000 -9000
cf balance 700 200 -2200 -9600
Rein is forecast to generate positive free cash flows (after interest) in each of the next four years.
Year ending 30 June 20X9

In 20X9, assuming the forecasts are valid, then the free cash flows of £1.3 million will be sufficient to repay the
overdraft of f600,000 at the end of the financial year. There is a reasonable margin of satety in this case as the free
cash flows without the recovery plan of f1.1 million would also be sutficient to repay the overd raft.
There is a solvency risk if the bank calls in the overdraft during the year before the free cash flows are generated.
However, assuming the free cash flows occur evenly over the year there should be sutticient cash to repay the
overdraft a litle before 31 December 20x8 (ie, 1600/1,300]x 12 months, after 30 June 20X8).
Year ending 30 June 20Y0

In 20Y0, the first of the three loans becomes repayable. This amounts to £2 million. If the forecast is valid, then the
surplus cash from 20X9 (E700,000), together with the free cash tlow for 20YO (E1.5 million), will be sutticient to
repay the loan due on 30 June 20Y0 of £2 million. The margin of safety is 10% so there is some risk if the forecast
enhanced cash flows from the recovery plan are not delivered. If this is the case, thena contingency may be to
ensure there is a continued overdraft facility tfrom the bank.

Assuming that the first loan is repaid in the year ending 30 June 20Y0, then the forecast excess cash at 30 June
40 Page 81
20Y0 is £200,000. With the forecast free cash flow for 20Y1 (£1.6 million), this amounts to a forecast cash balance
of £1.8 million at 30 June 20Y1 which will not be sufticient to repay the second loan of f4 million which is due on
that date. The shortfall of £2.2 million is substantial and is likely to be greater than can be realistically financed by
an overdraft.
There is therefore a need to plan early to approach the bank with the forecasts to explore whether there is a
willingness to refinance the loan with a new loan and, if so, whether it would be on reasonable terms.
Whilst there is a possibility of approaching another bank this would be difficult as it would only have a second
charge over the assets as the relationship bank has the first charge. Sale and leaseback of assets would also be
difficult as covenants from the relationship bank would be very likely to restrict this as it holds a charge over these
assetS.

Even if the bank refinances the second loan in 20Y1, there is a much more substantial loan falling due in 20Y2 of
t9 million. This clearly cannot be financed from free cash flows and the shorttall is significant
In order to roll over the two loans, then the total debt would be £13 million (£4m + £9m) less the cumulative cash
flow, which amounts to £9.6 million.
In terms of eligibility for a new loan, PPE has a carrying amount of £16.4 million and it may be that the fair value is
greater than its carrying amount.
However, the debt capacity is limited and there is a real financial risk of not being able to refinance all the loans.
Summary
If the existing loans repayable in 20Y1 and 20Y2 can be refinanced by the relationship bank, then Rein is
generating sutticient cash flows to service those loans. If however they cannot be refinanced then solvency
becomes an issue. It may be ditfficult to refinance the 20Y1 loan as the relationship bank will continue to hold
charges over assets in respect of its 2072 loan and covenants may not permit a second charge.
If refinancing is a problem, then raising finance through the factoring of receivables may be an alternative solution
at this stage but it has significant limitations (see below).
Debt financaing arrragmeent

New finance - factoring of receivables
Trade rec 10,200,000
30-90 days 7,000,000
1 Aug sold debt factor import
90% paid 6,300,000
Insurance prorection 2% - 140,000
Interest paid - 3months 1.20% - 226,800 on the 6.3m
6,633,200
The nature of debt factoring is addressed by IFRS 9, Financial Instruments, although the standard does not give
specific detailed guidance on the treatment of debt factoring. A key question is whether tactored receivables
should be derecognised as a financial asset
Derecognition (ie, ceasing to recognise the factored debts) is appropriate only where the criteria for derecognition
of a financial asset according to IFRS 9 have been satistied.
Specifically, derecognition should only take place where the seller (Rein) has transferred substantially all the asset's
risks and rewards of the receivables. (Note that if a transter occurs and the seller neither transters nor retains
substantially all the risks and rewards the asset will only be derecognised it control has been lost.)
This is a question of judgement as to whether substantially all the risks and rewards have been transferred. In
respect of the t6.3 million (90% x t/m) that would be immediately received from the factor then it would appear
that there is a strong case that this should be derecognised given that it is non-recourse finance. However, interest
has to be paid until cash is received trom receivables, which gives some slow-moving risk and it is a question of
Judgement as to whether this is substantial in the context of the specitic circumstances.
Rein is ultimately to receive a net total of at least t6,633,200 (see working below) thus the question arises as to
when risk passes with respect to the remaining £333,200 (£6,633,200 - £6,300,000) and thus when derecognition
should occur with respect to this amount. This is again likely to be a question ot judgement as to what is a
'substantial' risk, but it would not exceed three months before derecognition when the tactor assumes
unconditional responsibility.
The £3.2 million of receivables which have not been factored will continue to be recognised.
The f6.3 million received would be shown under cash and cash equivalents in the statement of financial position.
(6) Debt factoring advice

This method of finance seems inappropriate as it Is not incremental finance as the cash would have been receved
anyway from customers within a few months and better management of receivables could have achieved the same
end. It is also very expensive over a three-month period if only £6,633,200 of f£7 million is received. This is 5.24%
over three months which annualises to 22.7%. Unless there is a strong suspicion of high bad debts (which is
unlikely for large supermarkets) this seems inapproprnate in terms of costs and timing9.
There may be some savings in reduced administration. but these seem unlikely to be large given that Rein needs
40 Page 82
to maintain its sales ledger function for receivables which have not been factored. There may also be an adverse
reputational damaae
41 Page 83
Ketch PLC
AIM company
air con units
Large AC
Small AC
UK and Europe
Build in mumbai
£m
Director/Shareholder Board role No £1 SC
Rohit Reed Chief executive 30
Katy Krugman Finance director 30
Catherine Coase Production director 5
Sue Shiller NED 5
Zoe Zimmerman NED 5
Individual shareholders - 25
(each owning less than 1%) 100
Annual dividends 10m

Bonus based on EBITDA
YE 30 Set Share traded Av price
2016 1.15 2.56
2017 1.58 268
2018 1.1 2.33
90,000 shipped
900,000 3rd party
Tranfer price 20%

Av price AC 186
Sells in local currency R
Av india price 120
Sale of Mumbai operation £'000 £'000

Aug-18 Sep-18
Advertised selling price - as a going concern (Note) 30,000 30,000
Selling costs 1620 1620
Carrying amounts of PPE 31000 30,000
Fair value of PPE 28700 28250
Carrying amounts of inventories 500 500
Fair value of inventories 600 600
Mumbai Mumbai
internal external
transfers sales Total
Price 186 120
Number of units sold 90,000 90,000 180,000
Revenue 16740000 10800000 27,540,000
Full costs (internal revenue/1.2) 13950000 13950000 27,900,000
Profit/(loss) 2790000 -3150000 -360,000
The above table shows an overall operating loss of f360,000. Hence, the sale of the Mumbai operations appears
to have a favourable financial effect.
However, the figures used in the table make a number of assumptions. One key assumption is that the full cost per
item transferred internally to the UK factory is the same as an external sale to a customer in India. It may be, for
example, that the distribution costs are greater for the sales to the UK. However, this need not be the case, as the
distribution to the UK is to a single destination and is only made in batches, by ship, once a month. Distribution
within India may be overland and may not benefit from the same economies of scope as the UK distribution
channel.
A further assumption is that the prices charged reflect arm's length market values. A superficial conclusion could
be that because the internal and external prices are dterent they cannot both be market values. However, this is
not necessarily the case as they are being sold into different markets with different price elasticities, so price
discrimination may be applied. However, there is doubt about whether an internal transter price of cost plus 20%
IS a market value. Ihe best benchmark may be the alternative UK suppliers of components being considered once
the Mumbai tactory is sold.
Assuming that the transfer price is equal to, or higher than, a market price then it seems on financial terms that the
sale of the Mumbai operations will have a favourable impact on Ketch's profit, if the current year's performance is
to be typical of future pertormance.
In addition to the pure operating profit effect, the sale of the Mumbai operation will release cash which may be
used elsewhere. Alternative uses of the surplus cash are considered below.
There is a need tor Ketch to acquire the refrigerant components to make air conditioning units. Under the
assumption given, the available alternative source is from a UK third-party supplier. This change from the Mumbai
operations to a UK third-party supplier has a number of financial benefits and risks.
Benefits
Operating gearing will fall, as there will no longer be fixed costs of production in Mumbai, but variable costs are
41 Page 84
likely to be higher in paying the supplier per component.

There is more financial flexibility in having a number of suppliers rather than being dependent orn one source as
with Mumbai.
Currency risk is removed.
Risks
The same components will be available to competitors so there is no competitive advantage in terms of costs.
The best suppliers of retrigerant components may have exclusivity agreements with rivals and there may be a
competitive disadvantage in onily being able to source inferior quality components.
A foothold in the Indian market will be lost.
Exit costs are significant financially and perhaps reputationally.

The assets in the Mumbai Division are being disposed of collectively under a single contract.
They, therefore, appear to form a 'disposal group' under IFRS 5, Non-current Assets Held for Sale and Discontinued
Operations. According to the standard, a disposal group is defined as a group of assets to be disposed of, by sale
or otherwise, together as a group in a single transaction.
The following criteria must be met:
he division must be available for immediate sale in its present condition.
The sale must be 'highly probable, that is:
- Being actively marketed at a reasonable price;
Changes to the plan are unlikely;
Management must be committed to the sale;
There must be an active programme to locate a buyer; and
The sale must be expected to be completed within one year from The date of classification.
Whilst the board's decision seems firm, it is questionable whether the Mumbai division is available for immediate
sale, as Ketch has a consistent requirement for the component. The Ketch board does indicate that it would be
willing to use a short-term supplier it a sale contract for the Mumbai operations can be made quickly but this is
questionable in intent and realisation.
Other than this factor however, given the other information about the planned sale, it seems likely that the disposal
group meets the definition of 'held tor sale' at 1 August 2018.
Immediately before the classification of a disposal group as held for sale, the carrying amounts of the assets need
to be adjusted.
On this basis, evidence of impairment should be assessed on each individual asset (or cash generating unit (CGU))
immediately prior to the held-for-sale date. After classification as held for sale, any test for impairment will be
based on the disposal group as a whole.
Fair value of PPE 28700

Fair value of inventories 600
Selling costs -1620
FV less cost to seell 27680
Carrying amounts of PPE 31000

Carrying amounts of inventories 500
Net assets 31500
Impairment 3,820
An adjustment that will need to be made prior to classification as held tor sale is in respect of any depreciation
charge after the date the assets are classified as held for sale.
On re-classification as held for sale, IFRS 5 requires that a disposal group shall, at the date when reclassified as
held for sale, measure the relevant assets at the lower of:
Carrying amount
Fair value less costs to sell
Any test for impairment will be based on the disposal group as a whole.
The impairment charges will be treated as reductions in the carrying amounts of individual assets (IAS 36,
impairment of Assets).
This impairment loss is allocated to non-current assets in accordance with IFRS. Normally, the first part of the
impairment would relate to goodwill but, as the division was set up trom scratch in India, there appears to be no
goodwill. No impairment charge relates to inventories (per IFRS 5) therefore all the impairment relates to PPE.
One qualitication is that the non-monetary assets such as PPE would normally be measured at the exchange rate at
the date of purchase, and would not be normaly be retranslated. However, where there is an impairment, non-
monetary assets are retranslated at the exchange rate at the date of impairment. As a resuit, the sterling amount of
the net asset value may chnange.
Consideration also needs to be given as to whether the sale is a discontinued operation under IFRS 5.
The Mumbai Division may be a component of the entity as a CGU. lt is revenue generating, it is clearly
distinguishable in financial reporting terms from the rest of the company and it is material. It appears to be a
separate major line of the business as it makes dierent types of product from the rest of the company at a
separate location.
IFRS 5 provides an analysis of the contribution of the discontinued element to the current year's profit ie, the part
that will not be included in future years profits. showing separate information about discontinued operations
allows users of tinancial statements to make relevant future projections of cash tlows, financial position and
earnings-generating capacity.
Between 1 August and 30 September 2018 there is a further reduction of f0.45 million in the fair value of PPE. This
should be recognised as a further impairment in the financial statements tor year ended 30 September 2018.
41 Page 85
Use of surplus of cash

1-Oct-19 to be invested in
Propsal 1 - New UK factory with tech

Cost 50,000,000
Cash saved 5,000,000
1% increase 20 years 1000000
No RV for 20 years
WACC 7%
20 year annuity at 7% 11.53

5 m saved 57.63
Less cost - 50.00
7.63
The new factory would have an initial incremental initial outlay of f50 million which could be financed trom the
available surplus funds (see above).
It would generate incremental free cash tlows of f5 million at 1 October 2019 prices, intlating by 1% per annum
for 20 years. (Assuming year end cash flows)
Propsal 2 - Share buy back

purchase own shares
Offer buy back 20,000,000
Share price 2.8
directors do not want to
Artciles of A 75%
Use 6% ie 7% -1 %
20 year annuity at 6% 11.47
5 m saved 57.35
Less cost - 50.00
7.35
use 6% (7%-1%) as an approximation and then use the cumulative present value tables for simplicity
(this approach will give an estimate although it is not technically correct as the cost saving is an annuity not a
perpetuity)
There are a number of riders to the above calculation.

WACC may not be a suitable discount rate. This is partly because it reflects the average risk of the company, rather
than the risk of this particular project. Also, the WACC is determined at a point in time for a period of time and may
not be applicable over a 20-year time horizon
Similarly sustaining a 1% increase in incremental cash flow over a period of 20 years is unlikely.
The EBITDA figure is likely to be favoured by the factory purchase rather than from buying from a third-party
supplier. This is because a significant element of the factory cost, in accruals terms, is depreciation which is
excluded from EBITDA. Conversely, all the cost of purchasing the components is included in EBlTDA.
Catherine is the production director and so may favour this proposal as it increases the importance of her position
and adds job security for her. Ihe procurement function would be responsible for acquiring the component if it is
purchased from a third party, rather than the production function over which Catherine has control.
In addition, Catherine would benefit from the EBITDA-based director bonus if the factory proposal is
nplemented.
In operational terms the new factory would give more control over operations including production scheduling
and quality. However, the higher fixed costs lead to higher operating gearing.
Outsourcing may provide more flexibility of supply from multiple suppliers. Such suppliers may also have
established production, scale economies and core competences. This is particularly the case compared with Ketch
which has no history of cooling component manufacture in the UK and so may lack core competences.
Conclusion
Overall, in the short term, there is more flexibility in outsourcing so there can be a smoother transition from the
Mumbai operations. An investment in a UK factory may be a good long-term idea, as funds are available, but
sourcing cooling components from established external UK suppliers seems the lowest risk solution currently
available.
Cash available
Sale of Mumbai division 28.38
Exisitng cash per SOFP 21.7
total 50.08
Price 2.3
20% prem 0.2
max affoardable price 2.5
Therefore approximately t50 million is available as surplus cash.

The directors' plan is to repurchase 20 million of Ketch's own shares, which would give a maximum price from
funds available of £2.50 per share.
The current share price is f2.30, but the volume of trading at market prices is small and is unlikely to persuade the
41 Page 86
individuals holding 20 million shares to sell back to Ketch. Indeed, even at the maximum affordable price of £2.50
(a premium of 20p per share or 8.7%) many small shareholders may be passive and not want to sell their shares.
At a high price, any of the benefits of the buy-back to continuing shareholders may not be worth the cost. At a
lower price (say) between f2.30 and £2.50 then the directors' objective of achieving 20 million shares bought
back may not be feasible.
Overall, the buy-back price needs to be high enough to persuade a sufficient number of the individual
shareholders to sell. If they are not willing to do so in sufficient numbers, then the scheme may tail to achieve its
objectives.
Acareful balancing of these factors will be needed.
(b) Benefits and problems of share buy-back for stakeholders

Benefits
t provides a use for surplus cash, which may otherwise be an unproductive asset (but see alternative
proposals).
It gives the opportunity for some shareholders to have their investment returned, to reinvest elsewhere, with
low transaction costs.
It will lead to an increase in EPS through a reduction in the number of shares in issue. I his could lead to a
higher share price than would otherwise be the case.
The company could be able to increase dividend payments per share on the remaining shares in issue. This is
particularly the case if the policy of maintaining the overall dividend payment is carried out.
t may tacilitate Ketch withdrawing from the AlM market and becominga private company again.
EBITDA per share may increase if there are fewer shares. This would benefit the executive directors under the
current scheme as directors' bonuses are aligned to this figure.
Problems
Increase in gearing. Repurchase of Ketch's own shares changes the relative proportion ot debt to equity, so
raising gearing. Ihis incre ases the risks for shareholders and the bank as a lender to Ketch.
It can be difficult to determine a price per share that will be fair both to the vendors and to any shareholders
who are not selling shares to the company and to be acceptable to both.
A repurchase of shares could be seen as an admission that the company cannot make better use of the funds
than the shareholders.
Some shareholders may suffer from being taxed on a capital gain following the purchase of their shares rather
than receiving dividend income.
There may not be 75% of eligible shareholders willing to vote to approve the scheme, so it may not be feasible.
The share price on the AlIM market may change by the time the scheme can be approved and implemented.
Proposal 3 - Invest in corporate bonds

P PLC
Bonds 97.5 145
Interest 3%
Par 4 3.68%
ABB rating
Yield
Par 1.025641026 100/97.5
4 years redeem to the power ^1/4 1.006349525
Less 1 0.006349525
Add 3/97.5 0.030769231 100/97.5^(1/4) - 1 ) + 3/97.5
3.71%
G PLC
Quoted 95
10 years prem at 45% 145 par 100 + 45% 4.319%
Zero coupon bond
BBB rating
Par 1.515789474
power 1/10 1.042470775
Less -1 4.25%
Taking the Ploome plc bond as an example. The annual yield can be estimated as:
((100/97.5)^1/4-1)+ 3/97.5 - 3.71%
Taking the Ghlast plc bond as an example. The annual yield is:
((145/95)10-1)-4.32%
The Ghlast bond earns a higher yield but also has a higher credit risk as the credit rating is lower at BBB.
The return on corporate bonds (including the above two examples) is lower than the WACC. However, this does
not mean it is detrimental to shareholder value as the risk on corporate bonds of a BBB credit rating and above
(investment grade) is likely to be lower than Ketch's WACC which includes the riskier cost of equity.
More generally, the investment in bonds enables Ketch to keep liquidity and hold funds until investment
opportunities arise. In so doing, they keep the real option to delay a current investment decision in the expectation
that a preferable project will arise in the future.
The corporate bonds in which Ketch intends to invest are fixed interest. Whilst the interest cash flows are
reasonably secure (although subject to credit risk) the fair value of the bond is subject to variation particularly as
expected interest rates are likely to change.
However, there are a series of risks to consider.

(1) Credit and default risk - This is the risk of the issuer defaulting on its obligations to pay coupons and repay the
principal to Ketch. The ratings issued by commercial rating companies measure only default risk and can be
used to help assess only this risk.
41 Page 87
(2) Liquidity and marketability risk- This is the ease with which an issue can be sold in the market. Smaller issues
are particularly subject to this risk but purchases in Ploome and Ghlast may avoid this. In certain markets the
volume of trading tends to be concentrated in the "benchmark' stocks, thereby rendering most other issues
illiquid. Other bonds become subject to 'seasoning' as the initial liquidity dries up and the bonds are
purchased by investors who wish to hold them to maturity.
(3) Even if an issuer has a triple A credit rating and is therefore perceived as being at least as secure as the
Government, it will still have to offer a yield above that offered by the Government due to the smaller size
(normally) and the thinner market in the stocks.
(4) Issue specific risk - eg, risk of call. If the company has the right to redeem the bond early, then it will only be
logical for it to do this if it can refinance at a lower cost. What is good for the issuer will be bad for an investor
like Ketch and, thus, the yield will have to be higher to compensate.
(5) Fiscal risk - The risk that taxes will be increased. For foreign bonds, there would also be the risk of the
imposition of capital controls locking your money into the market.
(6) Currency risk- For foreign bonds, there would also be the risk of currency fluctuation, so the sterling
equivalent of the interest paid and the principal may vary over time even though these amounts may be fxed
in local currency terms.
Views of Zoe and Sue

Zoe's view- The advantage of the 4-year maturity is that if the funds are required for investment at the end of this
period there are no transaction costs in realising the cash and there is no issue of liquidity of the corporate bond
market as the bonds are being redeemed.
Sue's view- Sue is correct that the Ghlast bonds give a higher yield. This may be due to the longer maturity but
may also be just compensation for accepting higher credit risk, given the BBB rating. Corporate bond markets are
not as liquid as government bond markets so the market for sale may be thin and a buyer may not be available at
a reasonable price when the cash is required for investment.
(5) Recommendation
The three choices impact upon shareholder groups and other stakeholders in a variety of ways, and the best
option for one stakeholder group may not be the same as tor another.
Issues to consider from the perspective of Ketch as a whole are: return, risk and corporate governance.
The investment in the new factory does not favour a good short-term transition for the Mumbai factory production
and therefore outsourcing may be preferred as noted above.
The purchase of own shares seems more driven by personal interests of some directors and is uncertain in its
delivery given the nature of the current shareholdings. Also, it does not appear to be linked to any clear financial
or business strategy.
The return from bonds may not be the highest of the three choices but, in the short term at least, it is relatively
certain. Moreover, it keeps the real option to invest in a new tactory when an appropriate investment opportunity,
with an acceptable risk-return balance, arises. It also maintains the balance of control in the corporate governance
system and so does not disadvantage any stakeholder in terms of power or influence. It also increases liquidity,
although for a cash generating company this is not a key issue, at the moment.
The decision to invest in bonds is therefore recommended.
2018 2017
Draft
£'000 £'000
Revenue 248,000 242,400
Cost of sales -155,100 -151,900
Gross profit 92,900 90,500
Distribution and administration costs -43,400 -42,900
Operating profit 49,500 47,600
Finance costs -5,500 -5,500
Profit before tax 44,000 42,100
Tax -8,400 -8,000
Profit for the year 35,600 34,100
EBITDA 62,600 60,700

Ordinary dividend paid 10,000 10,000
Non-current assets
Current assets
Inventories 18,200
Cash 21,700
Total assets 398,100
Equity
£1 ordinary shares
Share premium 100,000
Non-current liabilities 123,300
Bank loan (repayable 2026) 140,000
Current liabilities
41 Page 88

42 Page 89
Zeta PLC
Sells sport equipment
manufactor
based in US and europe
Sales
Made 10 retail owned
Online store
Cusomters over 35 and 70% golf and 52% Ski
2017 2017 2018 2018 2017 2018

Skiing Golf Skiing Golf total total
£'000 £'000 £'000 £'000
Revenue:
Stores 8,500 15,700 8,600 13,700 24,200 22,300
Online 2,800 4,300 3,700 4,900 7,100 8,600
11,300 20,000 12,300 18,600 31,300 30,900
Cost of sales - 7,910 - 15,000 - 8,856 - 14,508 - 22,910 - 23,364
3,390 5,000 3,444 4,092 8,390 7,536
(1) The selling price per item is the same for sales through stores and online.
(2) The cost of sales per item is the same for sales through stores and online.
(3) Cost of sales comprises the cost of purchasing products for sale.
GP % 30.0% 25.0% 28.0% 22.0% 26.8% 24.4%

Store rev % 75% 79% 70% 74% 77% 72%
Online rev % 25% 22% 30% 26% 23% 28%
GP
Stores 2,550 3,925 2,408 3,014 6,487 5,439
Online 840 1,075 1,036 1,078 1,903 2,097
3,390 5,000 3,444 4,092 8,390 7,536
% change
Revenue:
Stores 1.2% -12.7% -7.9%
Online 32.1% 14.0% 21.1%
Total 8.8% -7.0% -1.3%
Cost of sales 12.0% -3.3% 2.0%
Gross proft 1.6% -18.2% -10.2%
% of total revenue
Stores 27.20% 50.20% 27.83% 44.34% 77.32% 72.17%
Online 8.90% 13.70% 11.97% 15.86% 22.68% 27.83%
36.10% 63.90% 39.81% 60.19% 100.00% 100.00%
Revenue
The revenue of Zeta has declined from £31.3 million in 2017 to f30.9 million in 2018, a fall of 1.3%. Whilst perhaps
not significant of itselt, it is in an unfavourable direction and contributes toa much larger fall in gross profit (see
below).
The composition of the decrease in revenue points to some trends which can be explored in terms of sales
channel (stores and online) and products (skiing and golf):
Stores and online

Overall, online sales have increased significantly from £7.1 million in 2017 to f8.6 million in 2018, an increase of
21.1%. However, online sales remain smaller than sales from stores in absolute terms making up only 27.8% of
revenue.
The increase in online sales is offset by a decrease in sales from stores of 7.9%. Due to the larger scale of the store
based sales, then this is sutticient for sales to fall for Zeta overall.
Skiing and golf

Skiing sales have increased significantly by 8.8%. However, they remain smaller than sales from golf making up
only 39.8% of revenue in 2018.
Conversely, golf sales have declined by 7% in 2018, although they remain the larger contributor to revenue of the
two product lines at 60.2%% (down from 63.9% in 2017). Nonetheless, the decline in golf sales means that overal
revenue has fallen from 2017 to 2018.
42 Page 90
Gross profit
Note: Information on other operating costs is not provided, but it seems likely that stores' sales incur greater costs
(rents, labour and overheads) than online sales. In this respect, the operating profit is likely to be much lower than
the gross profit. Nevertheless, the relative trend of increasing online sales relative to stores sales is likely to be
favourable for operating profit.
The gross profit of Zeta has declined from £8.39 million in 2017 to £7.536 million in 2018, a fall of 10.2%. This fall
is significant and reflects the 1.3% decrease in revenue noted above, but also a 2% increase in cost of sales.
Stores and online

Using the assumption that cost of sales per item is the same for stores as for online, and extending this to assume
that there is the same product mix for stores as for online, then we can determine gross profit for each sales
channel. This shows that golf has significantly more gross profit in stores in 2017 (due to the relatively higher
absolute sales) but only marginally more in 2018.
Skiing and golf

Skiing has a higher gross profit margin than golf at 28% compared with 22% but the margins for both products
have declined since 2017. The cause of the decline for skiing is that cost of sales rose faster (by 12%) than revenue
(8.8%). The fact that both increased may indicate an increase in sales volumes for skiing. The fact that cost of sales
rose faster than revenue could be poor cost control, difficult markets to increase prices, a change in sales mix, or
an adverse change in exchange rates (f weakening).
Digital marketing and use of data base

use data base to visits, unqiue visits, page views, online transactions
Data analysis on marketing needed
Both buy golf and ski 10%
75% of sales come from 20% of customers
84% sales come from customers prev purchased
Databases and existing customers

Database marketing builds a database of all communications and interactions with existing customers and then
uses individually addressable marketing media and channels to contact them further (for promotional messages,
help and support, or any other relationship-building contacts). Leta's custaomer data held in databases can be
interrogated and manipulated in various ways, through data analytics.
Database marketing can be used by Zeta fora range of relationship marketing projects, including identifying the
most profitable customers, using RFM analysis (Recency of the latest purchase, Frequency of purchases and
Monetary value of all purchases).
In addition, database marketing can be used by Zeta in:
Developing new customers (tor example, by collecting data on prospects, leads and reterrals).
lailoring messages and ofterings, based on customers' purchase protiles. (Actual customer buying preterences
and patterns are a much more reliable guide to their future behaviour than market research, which gathers their
stated preterences.)
Personalising customer service, by providing service statt with relevant customer details.
Eliminating contlicting or contusing communications: presenting a coherent image over time to individual
customers. In this respect, it is important to ditferentiate the message to ditferent customer groups.
Databases and new customers

In an effort to target potential customers more effectively, Zeta can use database marketing to build models of its
target demographic/income group. I hese models then allow it to focus advertising budgets on these target
groups, in the hope that this will result in an improved return on investment (ROI) on its advertising spend.
Big data and marketing

One of the ways Zeta can use big data and big data analytics (tor example, through store loyalty cards) is to
personalise the marketing messages and offers it sends to customers. larget marketing and the insights Zeta can
gain from big data will enable it to target its marketing strategies more precisely. As such, the way Leta uses big
data could influence the success of its digital marketing.
Customer relationship management (CRM) and the use of database technology and ICT systems help an
organisation develop, maintain and optimise long-term, mutually valuable relationships between the organisation
and its customers.
CRM with the use of database technology will:
Enable Leta's marketing department to better predict and manage customer behaviour, by allowing them to
lean and analyse what customers value (eg, about products, services, customer service and web experiences
Segment customers based on their relative profitability or lifetime value to Zeta
Enhance customer satisfaction and retention by facilitating seamless, coherent and consistent customer service
across the full range of communication channels and multiple points of contact between the customer and Leta
staft
A CRM system involves a comprehensive database that can be accessed from any of the points of contact with the
42 Page 91
Customer, including website contacts, stores and order processing Tunctions. intormation can be accessed and
updated from any point, so that participants in customer-facing processes- sales, customer service, marketing-
can coordinate their efforts and give consistent, coherent messages to the customer.
Information can also be analysed (through data analytics) to determine protitability, purchasing trends or web
browsing patterns.
Specific benefits of digital marketing

More effective use of the website and digital marketing can include:
(1) Global reach - A website can reach anyone in the world who has internet access. This may allow Zeta to find
new markets and compete say in Europe with only a small investment required.
(2) Lower cost - A properly planned and effectively targeted digital marketing campaign can reach the right
customers at a much lower cost than traditional marketing methods.
(3) The ability to track and measure results -Marketing by email or banner advertising makes it easier for
companies to establish how eftective their campaigns have been.
(4) 24-hour marketing -with the website customers can find out about Zeta's products even when its physical
shops are closed.
(5) Personalisation - lf the customer database is linked to the website, then whenever someone visits the site, they
can be greeted with targeted oters. Ihe more they buy trom Zeta, the more it can refine the customer protile
and market effectively to them.
(6) One to one marketing - Digital marketing helps to reach people who want to know about the products and
services instantly.
(7) More interesting campaigns - Digital marketing helps to create interactive campaigns using music, graphics
and videos, based on their individual preterences.
(8) Better conversion rate - Customers are only ever a few clicks away from completing a purchase.
However, in order for it to be effective, it is important that Zeta's digital marketing is consistent with its overall
marketing goals and ts existing marketing mix and marketing communications.
Equally, the key strategic decisions for digital marketing are common with strategic decisions for traditional
marketing. Ihese involve identitying target customer groups and deciding how to deliver value to those groups.
Segmentation, targeting, differentiation and positioning are all key elements in effective digital marketing.
Brands and digital marketing

Digital marketing can be used to support the branding message by contributing to the wider marketing of
products and the supporting service. It enables online customer support through 24// services to make customers
feel supported and valued.
In developing a relationship with customers, the use of social media interaction allows brands to be supported by
receiving both positive and negative feedback from customers.
Zeta's customers can potentially post feedback online through social media sources, blogs and websites on their
experience with a product or brand. Leta can encourage these conversations through newly developed social
media channels to have direct contact with the customers and manage the feedback they recerve appropriately.
A social media page would turther increase relation quality between new consumers and existing consumers as
well as consistent brand reintorcement therefore improving brand awareness resuiting in a possible ise in brand
awarenesS. Eftective use of such digital marketing can result in a relatively lower cost compared with traditional
means of marketing. Ihis includes lower external service costs, advertising costs, promotion costs, processingg
costs, intertace design costs and control costs.
Supplier purchase - Ski-Gear Ltd

1) Sale under G brand and consuder sell products
2) not to use brand but use quaiity of goods
3) can purchase just brand and sell prod
Brand valuation
either purchase shares or brand
Due dilgence prod to support valuation
(a) Determining the brand value

Brand value (or brand equity) is a measure of the strength of a brand in the marketplace and its ability to add
tangible value to a company by increasing sales and protits.
Brand valuation is difficult. However, if Zeta is considering an acquisition of Ski Ware, it will need to assess the
value of its brand.
One of the key aspects of branding is that branding and a firm's reputation are linked. The important thing to
remember is that a brand is something which customers value: it exists in the customer's mind. A brand is the link
between a company's activities and the customer s perception.
Brand equity is the asset the marketer builds to ensure continuity of satisfaction for the customer and profit for the
supplier he asset consists of consumer attitudes, distribution and so on. ltis thus the public embodiment of the
organisation's strategic capability.
A key concern in this respect is that Ski-Gear is only breaking even. Unless this situation is temporary it may
42 Page 92
indicate a low value or a zero value of its brand to Ski-Gear. It however Zeta can leverage the Ski-Gear brand better
than Ski-Gear management were able to do, then the Ski-Gear brand may still have value to Zeta.
A strong brand should help to generate future cash intlows and higher profits for a company. Brands can build
market share. Ihey could also be used to support higher prices (by ditterentiation) compared with Zeta's own
branded products.
Unlike many other assets, there is normally no active market for brands that could provide comparable market
values. Almost by definition, one brand should be differentiated from another brand, and thus, the two are not
comparable. Iherefore, a number of ditferent models have been developed to try to provide authoritative brand
values and to measure the pertormance oT brands.
Research-based approaches: These use consumer research into consumer behaviour and attitudes to assess the
relative performance of brands. In particular, these approaches seek to measure how consumers' perceptions
intluence their purchase behaviour. However, such measures do not put a financial value on brands so, unless they
are integrated with other approaches, they are insutticient tor assessing the economic value of brands.
Cost-based approaches: Cost-based approaches define the value of a brand as the aggregation of all the
historical costs incurred to bring the brand to its current state for example, development costs, marketing costs,
advertising and other communication costs.
However, the flaw in such approaches is that there is not necessarily any direct correlation between the costs
incurred and the value added by the brand. Financial investment can be important in building brand value,
provided it is etfectively targeted, but it it isn't, it may have no impact at all. Moreover, the analysis of financial
investment needs to go beyond obvious costs such as advertising and promotion, to include R&D, product
packaging and design, retail design and employee training.
Premium price: Under the premium price method, the value of the brand is calculated as the net present value
(NPV) of the price premiums that a branded product could command over an unbranded or generic equivalent
However, a difficuity with this method comes from finding an unbranded product to compare to. loday, the
majority of products are branded and, in some cases, 'own-branded' products such as Zeta can be as strong as
producer brands, charging similar prices
Economic use approach: This approach combines marketing and financial principles as follows:
Marketing principle - first, brands help to generate customer demand, which translates into revenue
through purchase volume, price and frequency. Second, brands help to retain customer demand in
the longer term, through repurchasing and loyalty.
Financial principles-The brand's future earnings are identified and then discounted to an NPV
using a discount rate which reflects the risk of the earnings being realised.
(b) Financial reporting

It Zeta purchases just the brand it would be acquiring the Ski-Gear which is an intangible asset treated in
accordance with IAs 38, Intangible Assets. It is recognised at fair value which is normally the purchase price and
subsequently amortised and reviewed for impairment on an annual basis.
If Zeta acquires the Ski-Gear company it will be treating the brand as part of the acquisition in accordance with
IFRS 3, Business Combinations. In this case Zeta will also need to apply IFRS 13, Fair Value Measurement, which
contains rules on valuing intangible assets in a business combination as there is no separately observable market
price.
Following the acquisition of Ski-Gear, the fair value of its brand acquired by Zeta can be capitalised and included
in the group accounts, and should subsequently be amortised and reviewed for impairment on an annual basis.
IFRS 13 and brand valuation

If the Ski-Gear brand is acquired, it is included as an asset within Zeta's consolidated statement of financial position,
and needs to be shown at fair value.
IFRS 13 defines fair value as "the price that would be received to sell an asset, or paid to transfer a liability, in an
orderly transaction between market participants at the measurement date". IFRS 13 also requires the tair value to
be determined on the basis of its 'highest and best use' from a market participant's perspective. This needs to
consider what is physically possible, legaly permissible and financially feasible. It also needs to take into account
market conditions at the measurement date.
The reference to the market participant's perspective is important. Even if a company acquires a brand but doesn't
plan to continue using that brand name (because it intends to merge the acquired brand into its own brand), the
acquired brand could still have a value - namely the highest and best use that could be made of it by a market
participant (an alternative buyer of the brand). However, if Zeta intends to use it, then (in the absence of any
market factors to the contrary) the company's use of the brand can be taken to represent the highest and best use
of it
Nevertheless, the post-acquisition strategy of the acquiring company may affect the subsequent value of the
brand. For example, if a brand name becomes tarnished post-acquisition, its commercial value will fall. This would
be dealt With under the rules of IAS 36, impairment of Assets.
Fair value hierarchy

42 Page 93
IFRS 13 requires that entities should maximise the use of relevant observable inputs when determining a fair value,
and minimise the use of unobservable inputs. In relation to this, IFRS 13 uses a fair value hierarchy' which
categories inputs into three levels:
Level 1 inputs - Quoted prices in active markets for identical assets or liabilities that the entity can access at the
measurement date.
Level 2 inputs - Inputs (other than quoted market prices included within Level 1) that are observable for the
asset or liability, either directly or indirectly.
Level 3 inputs - Unobservable inputs for the asset or liability.
t is not nomally possible to identity Level 1 inputs when dealing with brands, due to their unique nature. By
definition, if all brands are ditterent, or have ditferent characteristics, it will not be possible to identity any identical
assets. Therefore, the fair values of brands will have to be determined using the lower two levels of inputs
(althougha possible Level 2 input could be the value of similar brands which have already been valued).
(c) Due diligence

The Ski-Gear brand could possibly be the most significant asset recognised in an acquisition deal.
In this respect, carefully identifying the intangibles being acquired and considering their fair value is a vital step in
determining the consideration to be paid for an acquisition. And obtaining a tair valuation for the intangible assets
being acquired is a crucial part of ensuring that the company making an acquisition pays a fair price for the
company it is acquirnng.
Brand valuation requires significant industry-specitic judgement and expertise to ensure supportable
measurements are carried out, and to avoid audit surprises and the risk of subsequent restatement. Leta has some
of this in the existing supplier relationship with Ski-Gear.
The issue of determining a fair value for a brand is also likely to be a key part of the due diligence process
supporting any acquisition deal.
The due diligence procedures should apply one or more of the three approaches' to brand valuation (market
approach, cost approach or income approach) based on the circumstances of Ski-Gear.
Consequently, in seeking to value the Ski-Gear brand (or seeking to gain assurance over the value already implicit
in the brand) Leta could ether engage a valuation services team at a firm of accountants to carry out this valuation
work for them or else it could engage the experience of a specialist consultancy to undertake the work.
Equally, in the context of acquiring a brand, the company considering the acquisition will need to obtain assurance
over any assumptions which have been made when determining the value-for example, marke
the impact that market conditions could have on future income generated by the brand.
umptions, and
However, the due diligence relating to brands acquired in acquisitions shouldn't be confined to narrow issues
around valuation.
Legal due diligence to establish rights over the Ski-Gear brand are import as well as any existing use of those
rights (eg., licensing) which may reduce their value.
It is also important to recognise the role of the brand in the business logic of the deal; for example, to consider
how the brand will contribute to the group post-acquisition, and how it fits with the group s overall brand strategy.
How will the brand affect the company's ability to achieve its long-term objectives? And what impact will it have on
shareholder value in the future?
If these strategic level issues are not considered in advance of a deal, then the acquirer risks overpaying for assets
that are not used, or which have little value to it. One of the risks attached to brand valuation comes from valuing a
brand in a way which has little or no relation to how a company plans to use it in the post-acquisition business. Ihe
result could be a large asset write-down in Tuture, or an equally significant constraint on Tuture business strateg9y (t
possible future strategic options don't tit with the brand).
In this respect, we can suggest there is a need for some due diligence to take place before the final decision to
acquire a brand is taken.
Therefore the scope of commercial due diligence, in relation to acquiring brands and intangible assets more
generally, needs to cover a number ot areas which are important in strategic marketing.
43 Page 94
In Vechile Systems Division

Vechile Compliance dividsion
R&D
develipment costs
4 year life
Tender pricing
Pricing for Vechile Compliance dividsion
1 July 2019 cost pls method
2 examples of tender propsales YE June 2019
Texas Victoria
£'000 £'000
Bespoke programming costs (including learning time) 1,280 320
Support and maintenance costs 640 160
Total direct costs 1,920 480
Add: SNPRS development costs 9,600 2,400
Total estimated cost 11,520 2,880
Mark-up 15% 1,728 432
Tender price 13,248 3,312
texas need gov bespoke change for data protection laws

contingecny 45%
MVS
four softtware company tendred for T and 2 for V
tender price for T was 20% above price
(1) Tendering and costing methods

Evaluation of cost-plus pricing for tender for MVS
Evaluation of cost-plus pricing for tender for MVS
In settinga tender price there are two issues:
maximising the expected probability of winning the contract
maximising the profit on those contracts awarded
There is clearly uncertainty as the price tendered by rival companies is unknown at the time of the bid.
Nevertheless, prior experience of successes and tailures in tenders against rivals and ex post intformation on
winning tenders (which Is available in this case at least through whatever means) would build managerial
experience of the range of tender prices likely to be successtul.
There remain uncertainties, as every case is unique and rivals may change their behaviour or engage in 'game
playing to impact the future expectations and judgements of competitors management Nevertheless, it seems
the use of managerial judgement to set tender prices has been reasonably successful in the past. This is
considered turther below.
Cost plus pricing is particularly weak in a competitive market as it is rigid and therefore rivals may become able to
predict MvSs tender bids and undercut them. It also tails to consider the varying compettive conditions from
contract to contract.
Cost plus pricing also does not guarantee a profit, as excessive pricing means failure to win bids and so
standardised development costs and other indirect costs cannot be recovered.
Clearly such costs must be covered in the long-term but rival companies will have similar cost structures and will
also be making bids to cover indirect costs.
f would be easy, and true, to say that only incremental costs should be covered, but in an industry where a large
majority of costs are fixed, historic standardised development costs, this is of little help as the tender price needs
to be very signiticantly above incremental cost for the business to be sustainable in the long term.
The manner ot implementation by MVS of the cost-plus formula of determining tender prices in the two examples,
has a number of shortcomings.
Texas
£'000 45% cost
Bespoke programming (£1.28m x (100/145)) 882.7586 100/145 1,280
Learning-extra 45% (£1.28m x (45/145)) 397.2414 extra 45/145 640
Other direct costs (support and maintenance) 640
Total direct costs 1,920
Allocation of development costs (excluding 45% extra) [(882,759 +640,000) x 5] 7613.793 9,600
Total cost 9,534
Profit margin 15% 1,430
Tender price 10,964
Successful tender price (£13.248m/1.2) 11,040
Theretore, if this approach had been used, the tender price would have been the lowest with a strong possibility
that the tender would have been won.
43 Page 95
Victoria contract
Regarding the Victoria contract, it may appear that the cost-plus pricing method has been succeesstul in winning
the contract. However, with only one other bidder, it has not taken account of competitive conditions, resulting in a
bid that was 30% below that of the other tendering company at t4,731,429(t3,312,000/0./). Ihis price therefore
tailed to maximise the protit on the contract. Whilst the precise figure of 30% is only known with hindsight,
information may have been known where a price set on a judgement basis could have been higher, based on
knowledge of the rival's prior bidding behaviour.
Recommendation
The recommendation to internal audit could be to return to the previous judgemental basis but closely monitor
the proportion of successful bids and subsequently monitor the profit made on these contracts. Knowledge of
rival bids and customer expectations would be key factors in making such judgements.
Development costs
1 July 2017 SNPRS
life 4 years
Cost 96,000,000
All number plate recognition tenders 109.4

Successful number plate recognition tenders 36.7
2019 2018
Years ended 30 June 16 12
Number of tenders made 4 6
Number of successful tenders 80 72 £m
Value of tenders made 15 36 £m
Value of successful tenders
(2) Financial reporting implications of development costs

Capitalisation of the initial costs of £96m
Initial SNPRS development costs of £96 million were all capitalised. A breakdown of these cost:s is required as IAS
38, para 96 only permits directly attributable developments costs to be recognised for an internally generated
intangible asset.
Also, these SNPRS development costs were significantly greater than budgeted costs which raises the question of
whether they should all have been capitalised. However, while they were in excess of budget, and theretore may
contain cost inefticiencies, this does not, ot itselt, mean that they cannot be capitalised in tull in accordance with
TAS 38. It may have been that the budget was unduly optimistic in not allowing for normal programming issues.
Even it this were not the case however the key test is whether the directly attributable SNPRS developments costs
are in excess of the expected future economic benetits to be derived by MVS trom this expenditure. If the future
economic benefits expected at the date of launch were in excess of £96 million then the decision to capitalise
them, in full. is appropriate if thev are all directly attributable.
Carrying amount
The initial SNPRS development costs of E96m are being amortised over 4 years and so at 30 June 2019 the
carrying amount was E48m.
The key financial reporting issue at 30 June 2019 is whether, due to the poor tender performance on SNPRS
contracts, an impairment charge should be made in respect of the £48m carrying amount
Impairment
IAS 36 requires intangible assets to be tested for impairment. As the development costs have a finite life, they are
not tested for impairment automatically with annual impairment reviews. However, the low tender success rate is
an indication of impairment in accordance with IAS 36 and an impairment review should therefore take place.
The impairment loss will equal the excess of the carrying amount over the recoverable amount. The recoverable
amount is the greater of: ( the tair value less costs of disposal, and () value in use (present value of future cash
flows).
The allocation of overheads is not acceptable as cash flows in determining the value in use. Moreover, the
development costs are unlikely to generate cash tlows independently of other assets. The impairment review
therefore needs to be carried out at the level of a cash generating unit
Whilst the information is not available to do this exercise, it has been estimated that only £36.7m of SNPRS
development costs has been recovered on successtul number plate recognition tenders in the two years since
launch. lo the extent that this calculation is valid, and if this experience is to continue over the next two years, then
only a further £36./m will be recovered from further use, and these amounts need to be discounted to a present
value to determine value in use. Ihere is therefore a strong indicator of impairment when compared with the
t48m carrying amount.
It is unlikely that the recoverable amount of the development costs would be based on their fair value less costs of
disposal as they are integral to the business and therefore difticult to sell separately from the business.
43 Page 96
Cost reduction strategy 2019 2018

£m £m
Revenue 2,000 2,100
R&D expense (written off in year) -150 -158
R&D amortisation & impairment -160 -165
Other operating costs -1,632 -1,540
Operating profit 58 237
Cash spent on R&D 300 315
Carrying amount of development costs- intangible asset at 30 302 312
Current R&D projects 7 8
Amoristed 4 years
R&D budget was 15% of revenue last year
Each saves 12%
Spend 300 m
saved 36 m ie 12%
(3) Cost reduction strategy

Two methods of reducing R&D costs
R&D is an investment which, like any other investment, is expected to yield a return. In cutting R&D costs there is a
reduction in investment whereby there is likely to be a sacrifice in future returns.
The R&D spend is £300m in the current year, so 12% would be a saving of £36m.
There are seven R&D projects this year, so the average spend is f4.86m (E30Om/7). Iif the new project is at the
average, then this would be more than sufficient to meet the 12% reduction requirement
Alternatively, £5.14m (E36m/7) would need to be cut on average from each project each year, although this need
not be equal for all projects.
The factors to consider in deciding where to reduce these costs include:
Wastage and efficiency savings, if they can be identified, are the most appropriate to reduce expenditure as this
would not impact on return.
Identify the elements of R&D expenditure which are expected to yield the lowest return. If an R&D project is
turning out less successful than expected (eg less effective or overspent) then this may be reduced significantly
while others, with a better predicted return, may be reduced by only a small amount.
Short-term gain. There may be a temptation to reduce R&D expenditure on newer projects as there is a short
term gain in cost savings without an immediate impact on revenue. However, the newer projects, such as for
autonomous cars, may be strategically the most important in the long run in entering new markets.
Similarly, there may be a temptation to reduce R&D expenditure on newer projects as these are more likely to
be research expenditure (rather than development costs which can be capitalised) and so would result in a
short-term increase in profit, more than development costs which are being capitalised. Given about half of
R&D expenditure is being written off there is substantial capacity to do this.
R&D activity is, by its nature, risky as not all projects are likely to be successful. In finding the 12% cost savings
the highest risk projects may therefore be selected.
Overall, the choice will depend on the extent to which the software for autonomous driving project fits into the
MVS strategic plan and whether it falls into the above categories. If, however, it is decided that this project is
strategically essential then cuts elsewhere may need to be found.
lf waste and efficiency savings are not enough, then there is a risk in making broad-based cuts that, rather than
reduce the overall cost of an R&D project, it merely delays its completion by spreading costs over more years. In
this case, there is no effective cost saving over the life of the project and there has been a delay in the launch,
perhaps enabling rivals to gain competitive advantage.
Financial reporting
IAS 36 requires intangible assets not yet ready for use to be tested for impairment annually.
If R&D costs are cut on all projects, then the impact of the cuts on their future value in use needs to be assessed.
This may include any delay in implementation, where delayed cash flows are subject to greater discounting or
there may be questions over future viability of some projects given the reduced investment. Intangible assets not
yet ready for use are subject to significant uncertainty and this should be considered in the impairment review.
If the new project is cancelled, then the costs of development already capitalised (if any) will need to be fully
written of as an impairment loss.
(4) Evaluation of R&D spend

In determining overall R&D spend tor MVS, it needs to consider
expected return
affordability
acceptable risk
Given the useful lives of MVS's software products of about 4 years, their life cycle is short and new products are
needed to maintain competitiveness and for the business to be sustainable.
43 Page 97
The use of 15% of revenue seems an entirely arbitrary way of determining total R&D spend. It does not consider
atfordability as, even where revenue is high, protit and net cash tlow may be low. Neither does it assess the level of
return that can be obtained by RED investment, as it is merely a top-down total figure linked to an unrelated figure
from the financial statements.
Rather, the determination of R&D spend should, like any other investment, be determined by the projects
identified which tit into the company's overall strategy and generate an acceptable return whilst, in total, being
affordable and within the company's risk appetite.
SoftTech 2 development delay

developing software
Cost 22m
no maoirsation
(5) SoftTech lI development delay

Strategic and operational issues
Strategic issues
The delay in SoftTech ll was only discovered very recently and it is substantial at possibly two years. The original
strategy was to have an overlap of one year between Softlech I and Softlech ll and now there is instead a gap of
one year according to the original plan of retiring Soft lech I on 1 July 2020.
The strategic options would appear to be:
extend the life of Softlech I for at least a year
keep the Soft lech l withdrawal at the original date and have no product in the car emissions sotware market tor
a year
f Softlech| is losing its competitiveness, it is not attractive to keep selling it, but it may be a better strategy than
exiting from the market. An upgrade of Softlech I may be possible (eg using a bespoke adjustment for a previous
customer that may have broader appeal) but there is some urgency.
It may be that customers have been promised Soft lech I by 1 July 2019, or shortly after. In this case, it may be
possible to continue to sell Softlech I but, as a marketing strategy, otter a tree update to customers when Soft lech
ll is launched.
All outcomes have reputational damage and a key strategic objective would be to minimise this.
Operational issues
It may not be operationally possible to extend the lite of Softlech I (eg through licences ending or compatibility
with other software).
It may not be possible to retain key staff who write the software, given the uncertainties.
The extra operational resources to complete SoftTech lI may not continue to be available.
Financial reporting
It seems appropriate to impair at least some of the £22 million development costs that have already been
capitalised on SoftTech I. Future benefits have been pushed back two years and there is greater risk of benefits
not being realised. Impairing some or all of the f22m of development costs should theretore be evaluated.
The policy of capitalising future development costs on SoftTech II should be revisited given that problems have
been discovered. MVS should therefore consider writing off future development costs on SoftTech l as incurred as
the future economic benetits are too uncertain.
There is no amortisation of Soft lech lI costs until it is available for use.
It may be that, if Softlech I is to continue in productive use beyond 30 June 2020, then its useful life should be
extended to reflect this, thereby reducing the annual amortisation charge for the years ending 30 June 2019 and
30 June 2020.
Soft Tech I cannot be revalued as, in accordance with IAS 38, there is no active market for development projects,
given their unique nature.
Liquidity issue
poor perofmance
new customer terms and new system
improve the cashflow
Sale of software 2.4m
Maintenance for 3 years annual payment arrears 240,000
per year 80000
Or they can make a single payment of £3m
(6) Evaluation of liquidity and credit terms

If the arrangement is seen as a financing arrangement, then a rate of return could be calculated.
This would be:
£3m- f2.4m 240,000
- AFi 3yrs x £240k 600,000
£600/£240 2.5
AFi 3yrs
43 Page 98
interest -9.70%
This is the implicit interest rate sacritice by MvS and the reward to customers from paying early. I hus, while the
new policy benetits short term liquidity for MVS, there is a profit sacrifice.
However, if MVS if having problems obtaining full price, then this scheme could be a way of reducing the price in
present value terms to make the product more attractive to customers.
While there is a short-term liquidity gain in year 1, by bringing receipts for support services forvward, in steady state
after three years the cash receipts will be lower as the payments for support service that would have been received
under the previous payment arrangements will no longer occur.
44 Page 99
Background
C PLC
Listed entity
Design and make high quality glasses
Needs to raise 15m
Proposal of exansion
A unhedged position whcin entered by treasure
Assurance engagement risk and actions
Gearing and executive options issue
10 years of no growth
NEDs 6 years and chairmain is NED 10 years
No single shreholders
2% EURO zone sales

Increase competition in the UK
New productions site

2019 2018
Summary statement of profit or loss for the year ended 30 June 2019 £'000 £'000
Revenue 63,000 59,600
Cost of sales -43,400 -41,800
Distribution and administration costs -13,400 -12,200
Finance costs -3,500 -3,500
Profit before tax 2,700 2,100
Summary statement of financial position at 30 June 2019

Non-current assets
Cost -20,000
Accumulated depreciation 93,750
Current assets
Inventories 7,200
Cash 500
Total assets 107,450
Equity
Share premium 1,000
49% loan notes 2022 87,500
Current liabilities
Share price 8.32

4% loan secured on fixed charge on property
Interest rate futures contract

Expansion
Loan 15,000
1-Nov-19 3 month interest rise
Hedge on the interest
3 month 1m contract
September 2019 delivery 98.4
December 2019 delivery 98.5
March 2020 delivery 98.6
12 month SONIA rate 1 Aug 19 1.50%
Contata can borrow at SONIA 2.50%
Working assumptions are:

At 1 November 2019:
The price of the December futures contract will be 98.00
The price of the March futures contract will be 98.10
The 12-month SONIA rate at 1 November 2019 will be 2%.
Loan 15,000
SONIA + 2.5% = 1.5 % + 2.5% 4.00%
44 Page 100
9 months of year 0.75 mutiply out

450
No of contracts
Exposure / contract size x Loan period/ length of future contract
Exposure 15
Contract size 1
Loan period 9 9 month contract
length of future contract 3 June to Nov
Contract needed 45
Closing position on 1 Nov 19
Sold futures at 1 August 98.5
Buy future at close on 1 November 98
Gain per contract 0.5
SONIA is assumed to be 2%. Contacta can therefore borrow (at 1 November 2019) only at the higher rate of 4.5%
Interest cost on loan - £15m x 4.5% x 9/12 506,250

Total gain on futures 0.50/400x £45m 56,250
Net interest cost 450,000
Interest rate futures contracts offer a means of hedging against the risk of adverse interest rate movements. If a
company buys an interest rate futures contract, it contains the entitlement to receive interest; it it sells an interest
rate futures contract, it sells the promise to make interest payments. Buying an interest rate futures contract,
therefore, equates to lending, whilst selling an interest rate futures contract equates to borrowing.
Contacta will therefore sell interest rate futures contracts to hedge against an increase in interest rates before it
takes out the loan in three months.
It is necessary to choose the futures contract with delivery on the closest date following the date when it is
intended to close the position. In this case, Contacta should therefore sell December futures on 1 August.
The benchmark expected interest cost on the loan at current rates (assuming they do not change) is:
f15m x (SONIA+2.5%) x 9/12 - £15m x (4%) x 9/12 £450,000
As the loan period is nine months and the futures periods are only three months, it is necessary to take a futures
position three times larger than the loan in order to obtain cover for the full impact of an interest rate change.
Treasurey
Borrow amount of Swiss France CHF at low interest
convert to £
despoisting higher sterling rate to profit
8-Jul-19
Borrow 4,000
Annual interest 0.50%
Matuirty in 6 motnhs 10 interest on 6m
Total liabiltiy 4,010 in CHF
Money market rates at 8 July 2019

6-month sterling deposit rate (annual rate) 0.72%
£/CHF spot exchange rate £1-1.295-1.315
6-month ECHF forward premium 0.0038-0.0033
Working assumption by treasury team:

The £/CHF spot rate in 6 months will be: £1 1.15 -1.325
Conver CHF to £` rate 1.305 3065.1341

Despoit interest 0.72% 11.0345
Relaised 3076.1686
Convert CHF at end 6 month rate 1.315 4045.1617
Borrow 4000
Gain on transaction 45.161686
Forward contract take out

Exchange rate spot rate 1.295
Premium rate 0.0038
1.2912
Total liabiltiy 4,010
Cost 3105.6382
Relaised 3076.1686
Gain and loss -29.46958 loss
Appropriateness of the working assumption

The working assumption, the proposition is that the f will appreciate in terms of the spot rate by over 1.5% in the
Six-month period of the transaction.
Whilst this could occur, this is not the expectation of the currency markets as:
t/CHF has a forward rate premium which means currency markets expect the CHF to appreciate against the t
over this period, not depreciate as is implied in the working assumption.
Interest rate parity would also suggest that, as the CHF interest rate is lower than the f interest rate, then there
44 Page 101
is an expectation that the CHF will appreciate against the £. This is to compensate the holders of CHF for the
lower interest rate obtained by expecting currency gains on the principal relative the f sterling deposit holders.
Financial risks and risk mitigation

Contacta is exposed to the risk of the £/CHF exchange rate moving adversely (ie that the CHF appreciates
significantly against the f over the next 6 months) thereby increasing the sterling value of the CHF liability thereby
reducing or removing any benefit from the interest rate differential.
The risk arises because the CHF position is not hedged.
In order to hedge the short CHF position using forwards, Contacta should immediately buy CHF forwards. These
should be for delivery in 6 months' time at the 6-month forward rate which is: 1.2912 (1.295 - 0.0038).
Contacta should immediately enter into a forward arrangement to buy CHF4,010,000 at the CHF/£ forward rate of
1.2912 for a cost of £3,105,638 (CHF4,010,000/1.2912) to be incurred in 6 months' time.
With 3.076,168 realised from the maturity of the sterling deposit, then a loss on the transaction of f29.470
(£3,105,638- £3,076,168) will be made. This loss will be locked in so there is protection against larger adverse
currency movements which could have arisen on the unhedged position arising from the treasury transactions.
Financial reporting - hedge accounting
If the CHF appreciates significantly against the £, as expected by financial markets, then the f sterling value of the
CHF liability will increase.
However, the short position in the forward contract will have a positive value and is recognised at its fair value as a
financial asset. As a derivative, it would be recognised at fair value through profit or loss.
The increase in the fair value of the forward contract from zero to its fair value as a financial asset in 6 months will
largely oftset the increase in the CHF liability which is recognised as a monetary asset at the closing exchange rate
in accordance with IAS 21, The Etfects of Changes in Foreign Exchange Rates. All movements (both fair values and
currency movements) are therefore recognised through profit or loss and therefore there is no benefit in applying
hedge accounting through IFRS 9.
Conversely, if the CHF depreciates significantly against the £, the fair value movements will be in the opposite
directions, but they are all still recognised through protit or loss and therefore there is still no benefit in applying
hedge accounting.
Risk assurance - Controls

These transactions were authorised by the head of treasury, so t is necessary to introduce controls on treasury.
rather than within treasury.
Controls may include:
The treasury department is a profit centre and this may need to be reconsidered it it is providing the wrong
incentives and too much autonomy. In this case, it appears to be a speculative transaction to make currency gains,
rather than a hedging transaction to reduce current risk. Contacta has little or no CHF sales so this was not an
attempt to hedge any transactions or cover any CHF positions. Making treasury a cost centre would be a radical
move to control its transactions, but it would enable more board control (see below) and would signiticantly affect
the control environment.
Even as a profit centre, it is surprising that treasury could be allowed to engage in a transaction of this size and
type without board authorisation. A key control to introduce would be to require board authorisation ot large
individual transactions. Ihere should also be Board monitoring ot monthly pertormance and treasury activity
overall.
Authorisation would be a preventative control. Monitoring would be a detective control. As noted, treasury
authorisation and control would be improved it treasury were to be made a cost centre.
Improved documentation to leave a better audit trail would assist monitoring and control. The notes are very thin
for a transaction of this size and type. Whilst it is possible that additional documentation exists, which was not
reproduced by internal audit, there should be a review of documentation including: rationale for the transaction;
risk analysis; sensitivity analysis for a range of outcomes; evidence of authorisation and approval at all levels;
segregation of duties where the final implementation of this type of transaction is always outside treasury to
prevent controls being circumvented by treasury staff.
A procedures manual should have constraints on the nature and size of transactions to be undertaken by treasury.
These limits should not be too small, as treasury needs to carry out day to day functions without every transaction
requiring high level approval but, for a transaction of over t3m, constraints should be in place, so the transaction
does not take place entirely within treasury in future.
Gearing
Share premium 1,000
Equity tota 14,200
49% loan notes 2022 87,500
Gearing 86%
MV of Equtiy
Share price 8.32
shares 5,000
41600
68%
Can borrow at 4%
wherease if equity they would require Rate of return 10%
Gearing
By all measures, gearing is high and therefore financial risk is high. Gearing will be increased by the f15m new
44 Page 102
debt in three months' time with the expansion tor contact lenses, but this is short term debt.
The securty provided by PPE IS also limited, in terms of carryıng amounts at least. Ihe carrying amount is only
93.75m whereas the debt is close to this at E87.5m and will exceed the PPE carrying amount with the additional
E15m of borrowing. However, it may be that the fair value of the property is far in excess of its carrying amount.
The level of gearing can also be measured in terms of interest cover
interest cover 2019 6,200/3,500 1.77 times
Interest cover 2018 5,600/3,500 1.60 times
Thus, while interest is covered in both 2019 and 2018, it is less than 2 and significant earnings volatility could lower
this. Ihe new tlbm loan in the 2020 financial year will increase interest costs but should also increase revenue and
profit
Overall, it is fair to say that financial gearing is high and with additional risks such as high operating gearing, which
is typical of manufacturing companies, and market risks with new entrants, then further long term borrowing in
future would add to these risks and may be a matter of concern to stakeholders, including shareholders, existing
lenders and employees. Higher gearing with higher risk may also only be possible at higher interest rates to
compensate lenders for the additional risks.
Catherine's quote
Catherine's argument is flawed. As noted above further borowing is raising gearing further and therefore may
well not be available at historic interest rates of 4%.
Even if borrowing is available at a lower rate than the required return on equity, this does not necessarily make it
cheaper. Raising more debt will raise gearing. Ihis in turn will increase the volatility of the residual returns to equity
holders making them more risky. This in turn will raise the required return on equity. In equilibrium, the increase in
the return to equity, with the cost of new debt, will approximately be equal to the weighted average cost of capital.
Share options and decision making

Jun-17
Each 3 directors
Options of shares 100,000
Share price 8.5
excerise price 8.5
Fair value 1.2
Excerise date Jun-21
Share price currently 8.32
Shares 300000
MV 2550000
Gain on FV 120000
Current MV 2496000
The share options give Contacta directors the right to purchase shares at the specified exercise price of f8.50 on
30 June 2021 if they remain as directors until that date (ie over the vesting period). Ihe options have an exercise
price that was equal to the market price on the grant date of 30 June 201/
The amouts of the share options are substantial with an initial fair value of f120,000 per director and the
potential for this value to rise significantly. Whilst we need to know the detail of the remaining remuneration
package, this option value is potentially significant enough to impact upon the incentives of directors in making
decisions.
Share options can be used to align management and shareholder interests, particularly options held for a long
time when value is dependent on long-term performance
The UK Corporate Governance Code states that shares granted, or other forms of remuneration, should not vest or
be exercisable in less than three years. Ihis is to ensure that incentives are given not just for short-term
performance. Ihese options satisty this condition in having a four-year vesting period to encourage longer term
decision making.
If directors or employees are granted a number of options in one package, these options should not all be able to
be first exercised at the same date. Ihis is because it may promote short-termist behaviour around the exercise
date to manipulate the share price (including financial statement disclosures and measurements) it a large number
of options are due to be exercised. Ihese options are the only ones that the Contacta directors have and so they
have this risk.
Share options may give an incentive to align the risk preferences of directors and shareholders. An investment
opportunity that would attract shareholders, because the returns are high relative to the systematic risk, may be
rejected by directors because they may be exposed to the total risks of an investment failing. Options may
encourage directors to take more risks as there is significant upside potential. However, where options are in-the-
money, directors may become more risk averse as they are afraid of losing these accumulated past gains,
particularly given the volatility of option prices.
Conversely, as in this case, the Contacta options are out-of-the money (underwater) at f8.32 compared with an
exercise price of f8.50. If the share price stays at this level, then the options are worthless. If a risky decision is
made that goes wrong and share price falls, they are still worthless. ITheretore, directors may be incentivised to
make risky decisions as there is then upside potential if they increase share price, rather than low risk decisions
which may, even if modestly successful, keep share price at an out-of-the-money level, still making the options
worthless.
If options become significantly underwater, then they may need to be renegotiated or else they would tail to
provide any relevant incentives for decision making. Ihe Contacta options are not in this position at the moment
with almost two more years betore expiry.
More generally, an increase in volatility according to the Black Scholes Merton model will increase the value of
44 Page 103
options so directors are incentivised to take risky business decisions.
Impact of borrowing on options

In the same way that risky business decisions increase volatility and raise option prices, then increasing risk
through financing decisions will have a similar eftect. As already noted, it Contacta borrows more in future it will
raise the volatility of the residual equity returns. Ihis can be seen in terms of systematic risk in the need to re-gear
the equity beta for increased borrowing. This increased gearing volatility would raise the value of the options per
the Black Scholes Merton model.
Conversely, raising new equity will lower gearing and lower financial risk. Ihis will, all other things being equal,
reduce the volatility and the value of the director options.
It would be wrong to conclude that the executive directors are necessarily motivated by self-interest but the
decision to borrow in tuture, so long as it did not put Contacta under undue financial distress, could well be
alianed with directors' self-interest.
45 Page 104
SSS Ltd makes soup, sauce and spreads

UK market
supermarkets
5 productions line and factory and warehouse
Inventory of raw fresh food need to be kept low
Customer base
within 120km of warehouse 60%
over 500km 10%
greater delivery costs
Director/Shareholder Board role SC

Carol Naylor Chief executive 400,000
Alison Rimmer Finance director 400,000
Craig Naylor Marketing director 200,000 son to craig out voted Alsion
1,000,000
2019 2018
£'000 £'000
Revenue 74,400 76,300
Property, plant and equipment 33,600 32,700

Loans 13,900 12,900
Net assets 18,700 15,700
Working capital:
Inventories 1,800 2,500
Trade receivables 9,200 8,100
Cash 1,600 3,600
Trade payables 12,700 14,700
Large orders 4 days

Small order 7 days
Social media and marketing - website to download receipts and don’t sell direct to customers
Short term forecasting

two TV ads
1) Benefits of analysed sales forecasts

Production scheduling. More accurate alignment of production and demand can be achieved with better
forecasts, to help ensure customer needs can be satisfied on a timely basis. This improves customers relationships
and helps reputation in supplying surges in demand which avoid lost sales. Better staff management will also
result from better production scheduling, particularly if there are flexible labour contracts.
In order to have flexible production scheduling, SSS's supplier relations also need to be considered with
appropriate lead times for delivery of ingredients to SSS. Accurate sales forecasts enable early ordering of
ingredients where there is a long lead timne.
A turther issue is the lack of storage space, so even items that do not perish need to be planned.
Inventory management. Ensuring that SSS is not overproducing and building up inventory by predicting
reductions in demand and thereby enabling reductions in production. This is important as some items may perish,
so particular emphasis is to be placed on these to prevent wastage. High inventory is also tying up cash and
damaging liquidity.
Cash management. Better forecasting of production costs will also lead to better short-term cash management.
(2) Data capture and data analytics

Data to be captured
Information needs to be at the level of each of the 88 different products. It is of little benefit to forecast the correct
overall weekly demand, if the predictions for each type of product are not correct as the products are not likely to
be substitutable for each other.
Particular emphasis needs to be on items that may perish, so daily forecasts within the two week period may be
appropriate for these types of items, so they reach the customers with a significant remaining 'use by' date.
A geographical spread of sales over the week may be important as the lead times for items further away from the
SSS factory will need longer to deliver.
Demand for SSS products is volatile but volatility itself is not a problem if it is regular (eg seasonality) and therefore
it follows predictable patterns.
What is more of a problem is what appears to be unpredictable volatility based on current data availability. For
example, as current sales data does not appear to follow the pattern of historic sales data it cannot therefore be
predicted from historic management information. Thus, despite the annual sales being reasonably stable, the
week by week sales look to move unpredictably given the currentiy available intormation set, which is based on
historic internal data.
Information requirements are very short term rather than attempting to predict longer term trends in sales.
45 Page 105
As noted above, granular information is needed for each type of product and for each geographical area.
Information is needed about demand from both:
Customers of SSS (ie retailers)
Consumers (ie individuals who purchase from the retailers)
Customers
Information about customers is essential in predicting sales and as part of customer relationship management.
Customers will better understand local market conditions and how their own customers (consumers) behave.
Knowledge of how customers price our products to consumers would be useful in predicting demand, particularly
for future price changes.
Consumers
There is a pull demand from consumers which, it predictable, could be communicated to customers to encourage
ordering SSS products on a more timely and efficient basis. Collection of data from the website (eg downloads of
recipes and discount vouchers) may enable better prediction of pull demand from consumers.
Data analytics
Historic data may be useful. eg customers may be willing to release data on SSS product sales collected by their
bar codes. This could then be collected for all customers to establish a big data set, to which data analytics could
be applied to analyse point of sale information on SSS products (timing, amounts purchased, price charged).
More indirectly, data relating to the usage by customers of the SSS website and social media may be usefully
analysed. Increased activity (in terms of the number of hits) may be lead indicator for an increase in future sales.
More specifically, the hits on the web page for each type of product may indicate increased sales for that product
in the near future. Ihere needs to be predictable patterns in the link between the number ot hits and future sales
and the lag between them. Algorithms applied to this big data may be able to discern such patterns to provide
better forecasts of sales.
This internal data could be combined with external data to help predict demand.
The number of hits on the SSS website from individual consumers may give some clues. Retailers could be
informed it demand predictions were to be related to a specific geographical area. Ihe downloading of discount
vouchers may be a particular feature as retailers near where the consumers live could be warned of an increase in
expected demand based on the number of vouchers downloaded in the local area.
SSS could more actively use social media to predict consumer behaviour. For example, their use of blogs, vlogs,
twitter feeds etc. SoCial media analytics allows companies to measure quantitatrve metrics such as the number of
times its Facebook account has been 'liked' but also capture qualitative data. For example, key words posted by
customers about the organisation's products can be used to perform 'sentiment analysis' which would allow SSS
to respond to relevant activty and trends.
More general external data could also be used, such as weather predictions if there is an established link between
types of weather and demand for SsS products. Also any popular cooking programmes on IV may produce a
short term surge in demand which could be analysed based on historic data.
Frecnh market
Expand
Price 20% higher
Min order 60 EURO UK Euro eq 50
Fixed delivery 10 EURO Net price 42
Actual currior cost 18 EURO Net euro 52
4% difference in 50 and 52
Or sale online
Each require 3m in marketing and website expandsion
Arrangement 1
Loan 3,000,000 EURO
Mar-20
zero coupon rate
Reedem in 4 years
At 3,510,000 EURO
Arrangement 2
Loan £ 2,500,000
Swaps arragement
4 years
Interest fixed 3.50%
D will pay 3m EURO
SSS pay £2.5m
on 31 March 224
Spot exchange rates

At 31 March 2020 £1 -€1.20
At 30 September 2020 £1-€1.18
At 31 March 2024 £1-€1.25
Average f/E exchange rates for:
Year to 30 September 2020 £1-€1.21
Six months to 30 September 2020 £1 -€1.19
45 Page 106
Benefits and Risk of entering in France Market

(3) Benefits and risks of entering French market
The issue here is about the market entry mode. There are favourable early signs, but there remains more
uncertainty about the French market than the established UK market.
Exporting relates to products made at home but sold abroad. It is the easiest, cheapest and most commonly used
route into a new foreign market. Exporting has the following advantages for SSS:
It can concentrate production on its single location in the UK, giving economies of scale and consistency of
product quality.
SSs lacks experience of selling outside the UK and can try international marketing on a small scale.
Both the models suggested, fit the above exporting model but they are two different types of exporting.
Online to consumers
Selling through online marketing in France is the direct exporting model.
Direct exporting occurs where the producing organisation itself performs the export tasks rather than using an
intermediary. Sales are made directly to customers overseas who in this case are the final users, rather than
wholesalers or retailers.
SS5 also does not use an intermediary (eg overseas selling agent) but rather a courier which merely provides a
distribution service.
There are high initial marketing costs, but this is also true of any other form of entry into a new market where a
producer has to establish reputation. The difference with the online approach is that marketing is targeted to
individuals, rather than general market advertising to the population as a whole.
An advantage of this approach is that, other than these initial marketing costs, there are few fixed costs, so
withdrawal from the market should have low exist costs and there are tewer financial and reputational risks from
withdrawal.
The distribution network is, in effect, outsourced to international couriers with core competences in international
distribution. The distribution costs would therefore be variable costs and would not suffer unduly from low initial
sales.
In terms of margin, at the minimum order value of E60 in rance and there is a delivery charge to customers of
ET0.The distribution cost for SSS averages E18. So, there is a net price of E52. Ihis compares with the equivalent
UK price for the same goods equivalent to ES0 (using a 20% mark up on UK prices). he net rench price is
therefore 4% higher at €52 than the UK price.
However, the initial costs of £2.5 million will need to be covered.
The UK gross profit margin is 33.87% (£25,200k/£74,400k).
If sales prices are 4% higher in France then this is the equivalent of f2,976k (£74,400k x 0.04).
The French margin is therefore:
(£25,200k + £2,976k/(£74,400k+ £2,976k) - 36.4%
However additional distribution costs will be incurred for French sales.
Network of retailer customers
There are two aspects to this suggestion by the FD:
The sales to consumers are through third party intermediaries (ie French retailers)
The distribution is through SSS owned vans (rather than through third party couriers as with the online model)
For the retailer network, there are the following advantages and disadvantages:
Advantages
Local knowledge provided by French retailers.
Control over distribution by SSS.
Bundle multiple orders in vans tor distribution (not each order separately).
Disadvantages
Retailer margins reduce the price to SSS.
Difficulty finding retailers willing to hold SSS inventory.
Time delay to end user as two stages (i) to retailer (ii) held in inventory before final sale. This may affect
perishable items.
Additional tixed costs in establishing retailer network.
SSS may be less aware of consumers' needs and preferences in a new market as there is no direct contact.
Low levels of sales in the early years may mean there is insufticient volume for a retailer coveringa limited
geographical area (eg it demand is from individuals who are geographically spread)
A key risk of both models is foreign exchange risk. As products are made in the UK, costs are incurred in fs.
However, they are sold in hrance, so revenues are generated in euro. Ihis leads to short-term transaction risk and
longer-term economic risk from long-term shifts in exchange rates which may affect viability.
Arrangement 1
Loan 3,000,000 EURO
Mar-20
zero coupon rate
Reedem in 4 years
At 3,510,000 EURO
Effective interest rate 1.17 3.51/3
Less - 1.00
0.17
Divided by 4 years 4.3%
6 month effecite on terest
45 Page 107
1.043
Dividend by 2 0.52
Less -1 - 0.48
1.98%
Interest 3m loan 59,400.00
Convert rate 1.19 49,915.97 Interest
Liability Carry amount 3,059,400.00

YE rate 1.18 2,592,711.86
Arrangement 2
Loan £ 2,500,000
Swaps arragement
4 years
Interest fixed 3.50%
Effective rate 3.84% 1.0192 -1
D will pay 3m EURO
SSS pay £2.5m
on 31 March 224
Financing arragement
Two types of financing arrangements
Amount- Both loans are for the same amount of €3 million (or f2.5 million at the opening spot rate). This is not an
insignificant amount to S55, but neither is it fundamental.
Interest rate- The annual effective interest rate on the euro denominated loan is 4% (E3.51m/€3m) - 1)1/4
The annual nominal interest rate on the sterling loan with a swap arrangement is 3.8% which is lower than the euro
denominated bond. However, the effective rate is 3.8361% (1.0192-1).
Foreign currency risks - both arrangements are etectively in euro. I his forms a patial currency hedge against the
expected euro denominated revenues from the French project. However, there is a currency risk if the French
project fails within 4 years, and SSS withdraws from the French market. Then there is currency exposure from the
run-off of euro interest payments and repayment of principal. These could however be hedged from the date of
withdrawal.
Swap arrangement
The main benefit of the swap is that SSS can take out a sterling loan, perhaps with its relationship bank, in the
home market on tavourable terms. It can then use a swap to convert the sterling loan into what is, in effect, a loan
in a foreign currency.
Whilst there are some transaction costs tor a swap arrangement, these are typically low as they are over-the-
counter arrangements with a bank and do involve market exposure. However, the transaction costs are likely to be
higher than a straight euro loan.
There is the risk that the counterparty will default on its obligations (eg through insolvency or refusal to pay). This
will then leave SSS exposed to the original sterling loan agreement. The lower interest rate on this arrangement
compared with the euro loan may be regarded as a default risk premium.
The swap is in effect a derivative and will have a fair value depending on how the exchange rates move over time.
If the exchange rates move in line with the working assumption, then the swap will be a liability as the value of the
euro interest payments will be greater than the value of the sterling interest payments made by the counterparty.
The same will be true of the final repayments with the counterparty. However, in compensation tor S55, the value
of the sales of products in France will be greater in sterling terms.
Euro denominated loan-financial reporting treatment
The euro denominated loan has not been designated as part of a hedge arrangement for hedge accounting
purposes.
It is therefore measured in accordance with IFRS 9 as a financial liability which would normally be measured at
amortised cost.
It is a financial item in accordance with IAS 21, so it would be retranslated at the year-end into the SSS functional
currency which is f sterling. Interest would be translated at the average rate over the 6 months of the loan that falls
within the financial year to 30 September 2020.
Euro denominated loan -financial reporting treatment

The euro denominated loan has not been designated as part of a hedge arrangement for hedge accounting
purposes.
It is therefore measured in accordance with lFRS 9 as a financial liability which would normally be measured at
amortised cost.
It is a financial item in accordance with IAS 21, so it would be retranslated at the year-end into the SSS functional
currency which is f sterling. Interest would be translated at the average rate over the 6 months of the loan that falls
within the financial year to 30 September 2020.
Interest
The annual effective rate is 4% (see above).
Therefore the 6-monthly eftective rate is 1.98%(1.041/2-1). Accrued interest is added to the loan as there is a
zero coupon.
Interest is: €3m x 0.0198 - €59,400
This is converted to stering at the average rate for the 6 months to 30 September 2020 of f1 - €1.19
The interest charge for the year ended 30 September 2020 in respect of the euro denominated loan is:
45 Page 108
€59,400/1.19 - £49,916
Liability
The carrying amount of the loan at 30 September is: €3.0594m
This is converted to sterling at the closing rate for the year to 30 September 2020 which is f1 -€1.18
Thus the carrying amount of the loan at 30 September 2020 in sterling is:
€3.0594m/1.18 £2,592,712
Enter in canadian market

Subsidary called CC
Annual purchase $ 4,500,000
Enter in market 1 Oct 2020
Summary forecasts of operating profit for CCare as follows for the years ending 30 September:
2021 2022 onwards
CS'000 CS'000
Revenue 9,000 14,500
Manufacturing costs:
Variable -2,100 -3,300
Fixed -4,950 -5,300
Gross protit 1,950 5,900
Administrative and distribution costs -2,205 -2,500
Operating (loss/profit -255 3,400
WACC 10%
Exchange rate 1.7
Appreciate against £ 1% years
2020 2021 2022 2023 onwards

Cash $ - 34,000.000 - 255.000 3,400.000 3,400.000
Ex rate 1.700 1.700 1.700 1.700
Cash £ - 20,000.000 - 150.000 2,000.000
prep with 1% growth 22,444.440 2000 x 1.01/ (0.1-.001)
Rounded DF 1.000 0.909 0.826 0.826 interest 10% and app 1%
PV - 20,000.000 - 136.365 1,652.800 18,548.085
NPV 64.520
Whilst there is an expected positive NPV, it is very small and a small movement in estimates could generate a
negative NPV. Much will depend upon the accuracy and the validity of the assumptions.
Nevertheless, based on these assumptions, there is a positive NPV.
However, a number of serious concerns are relevant:
There is dependency on one large customer, Flomm, which in steady state makes up one third of sales.
Moreover, the sales to Flomm make a total contribution of f3,400k (£4,500- f1,100). The loss of this contract
would entirely wipe out profits tor the year ending 30 September 2022.
Whilst there is some market research, this needs to be questioned given the pattern of substantial growth
within two years.
There is significant foreign currency risk.
The small NPV is dependent on forecasts to perpetuity and a 1% indefinite annual growth of the CS against the
£. These assumptions need to be questioned as a small variation could create a negative NPV.
There are initial losses predicted. This creates a funding risk but also the risk of slower initial growth which
would afect the small NPV.
Recommendation
Based on: the marginal nature of the NPV of the project; the levels of risk; and the questionable credibility of the
assumptions, the Canadian proposal should be rejected.
Methods
SSS IPO
Raise 20,000,000 DR Cash 20,000,000
Shares 315,000 CR SC 315,000
CR Share Prem 19,685,000
Private investor
Loan 20,000,000 DR Cash 20,000,000
Share ssue 340,000 CR SC 340,000
CR Share Prem 19,660,000
Loan $ 34,000,000
Fixed no repayments
Fixed rate 5%
(6) Share capital methods

An IPO is a stock market launch, taking the form of a public offering of shares (on the junior LSE market of AlM in
this case). New shares are being issued by SSS but also the existing shares will have a market and become more
liquid.
45 Page 109
The issue price per share is f63.49. There are some costs to the issue which would include an underwriter, such as
an investment bank. This will reduce the net proceeds obtained.
There is also some uncertainty. Whilst SSS may wish to obtain a given price, this may not be a reasonable price for
a successtul tloat it the market does not value S55 shares at this level. Moreover, there is a risk that the shares may
not be fully subscribed. The underwriter might take on this risk but if the risk is high it may not be possible to find
an underwriter to act for SSS.
The private equity route would raise the same £20m but would require the issue of 340,000 shares. This values the
SSS shares at f58.82 per share. However, if Cobalt has agreed to this, then the funds are more certain than an IPO.
Corporate governance consequences area key issue for the two share capital issues.
With the private equity the shareholdings would be:
Director/Shareholder Board role SC

Carol Naylor Chief executive 400,000
Alison Rimmer Finance director 400,000
Craig Naylor Marketing director 200,000
Coblot NED 340,000
1,340,000
As a result, Carol and Craig would no longer control the board meeting votes or the shareholder votes. Cobalt and
Alison could out-vote Carol and Craig in a shareholder meeting and they would have equal votes in a board m
eeting.
Whilst the IPO would create 320,000 new shares, they would be dispersed amongst many shareholders so voting
may not be active or concentrated. Ihey would also not require a seat on the board.
A downside of a private equity issue is that the existing shares would not be listed.
Recommendation
f an underwriter can be found for the IPO this would seem to be a preferred route for the company and the major
shareholders.
(7) Financial reporting treatment of financing

Consolidated financial statements
CC is a subsidiary of SS and therefore consolidated financial statements will need to be prepared.
For the preparation of financial statements, CC needs to determine its functional currency which is likely to be the
CS. At the year end, it is necessary tor CC to translate its results into the presentation currency of SSS, which is the
t, in order to be included in S5's consolidated financial statements.
Variations in the £/C$ exchange rate will impact upon the consolidated amounts so, for example, if the C$
depreciates against the £ then the value of CS denominated amounts will fall when expressed in the presentation
currency of the group (ie the £).
Intra group items will need to be adjusted on consolidation. A key intra group item is financing with the C$34
million loan. This is dealt with below.
Foreign currency loan of CS34 million

Under AS 21 the loan, under normal circumstances, is a monetary item where foreign currency differences would
be recognised through SSS's profit or loss.
However, as CC is a subsidiary, it is a foreign operation of SSS and, as the loan is long term, it can be treated as a
hedge instrument as a net investment in a foreign operation in the SSS consolidated financial statements.
The hedged item is the amount of SSS's interest in the net assets of CC.
So, the C$34m foreign currency borrowing can be designated as a hedge of a net investment in the foreign
operation (CC), with the result that any translation gain or loss on the borrowing should be recognised in other
comprehensive income to offset the translation loss or gain on the investment in the SSS consolidated financial
statements.
The amount that SSS may designate as a hedge of its net investment in CC may be all, or a proportion of, its net
investment at the commencement of the reporting period. This is because the exchange rate diterences reported
in equity on consolidation, which form part of a hedging relationship, relate only to the retranslation of the
opening net assets. Profits or losses arising during the period cannot be hedged in the current period. However,
they can be hedged in the following periods, because they will then form part of the net assets which are subject
to translation risk.
Hedges of a net investment in a foreign operation should be accounted in a similar way to cash flow hedges:
the potion of gain or loss on the hedging instrument that is determined to be an effective hedge should be
recognised in other comprehensive income and
the ineffective portion should be recognised in profit or loss.
The gain or loss on the hedging instrument that has been recognised in other comprehensive income should be
reclassitied to protit or loss on disposal of the toreign operation. If only part of an interest in a foreign operation is
disposed of, only the relevant proportion of this gain or loss should be reclassified to profit or loss.
Individual company financial statements

In the individual company financial statements of SSS, exchange differences are treated through profit or loss as
for any normal monetary item. For this treatment the loan is recognised at the closing exchange rate and any
exchange differences recognised through profit or loss in the individual company accounts of SSS. The interest
cost should be translated at the average exchange rate for the year. Ihe loan would normally be treated at
amortised cost.
No exchange differences will arise for CC in its individual company financial statements as the loan is in CS which
is also the functional currency of CC.
45 Page 110
The share issue

(a) Ihe IPO share issue would be by S55, as parent company, which would also be the share capital of the group, at
£l per share issued. Share premium would be recognised as the excess of the proceeds above share capital of £1
(eg as f62.49p per share in the case of the IPO).
46 Page 111
MSL wons and manages PBSA
Average rental per

Number of bed month per bed space
Accommodation type
PBSA- Owned by private sector operators 300,000 £550
University-owned accommodation 300,000 £500
Shared houses - owned by private landlords 400,000 £440
Current PBSA under development 150,000

10 month contracts signed
Shared is 12 months
MSL
Properties 30
Bedds 12,300
MSL generates income from the following sources:

(1) Rentals from students (10 months from 1 September to 30 June).
(2) Summerperiod rentals (2 months from 1 July to 31 August).
3) Changes in the fair value of properties.
Patnership with Unis

Agree 5-10 years but 30% renewed annual basis
secuirt of income and 60% of rent is agreements
2019 2018
Summary statement of profit or loss:
Rental income (1 September to 30 June) 68,603 63,534
Rental income (1 July to 31 August) 4,428 5,053
Fair value increases (Note 1) 43,500 23,000
Operating costs (Note 2) -44,500 -38,000
Profit for period 72,031 53,587
Number of properties 30 28
Number of bed spaces available 12,300 11,200
Occupancy rate
(1 September to 30 June) 97% 99%
Occupancy rate
(1 July to 31 August) 40% 48%
Fair value of properties 1230m 1103m
Borrowings (Note 4) 620m 530m
2 properties Ox and Cam 110m

Brought in Sept 18 and 100% occ
Averate interest rate 3.20%
Matuirty 8 years
Property rental rates 2019 Rental 2018 Rental

1 July -31
1 Sept- 30 June 1 July - 31 Aug 1 Sept- 30 June Aug
590 478 586 465
583 438 576 467
580 441 574 471
567 438 568 474
562 476 569 478
589 442 567 476
561 446 569 473
568 441 575 456
Average 575 450 573 470 2068
Additonal rent
New properties bed space 1100
Months 10
New properties bed space 1100

Months 2
Total 6325000 990000 7315000
Occupancy - volume variacne

2019 (1 September to 30 June)
Total bed monthly rentals:
12,300x 97% x 10 months 119.31
New properties bed rentals:
1,100x 100% x 10 months - 11.00
Bed rentals from existing portfolio 108.31
2018 (1 September to 30 June)
99% x 11,200x 10 months 110.88
2019 (1 July to 31 August)
Total bed monthly rentals:
12,300x 40% x 2 moths 9.84
New properties bed rentals:
1,100x 100% x 2 months - 2.20
Bed rentals from existing portfolio 7.64
2018(1 July to 31 August)
48%x 11,200 x 2 months 10.75
Volume variance
2019(1 September to 30 June)
(108,310-110,880) x £S73 1,472.61 adverse
2019(1 July to 31 August) adverse
(7,640- 10,752) x £470 1,462.64 adverse
Volume variance total 2,935.25
Price variance
September to 30 June
(E575-£573) x 108,310 216,620
1 July to 31 August
(E450-£470) x 7,640 - 152,800
Total ` 63,820
£'000
Operating profit 2018 53,587
lew properties (W2) 7,315
Occupancy variance (W3) -2,935
Rental prices variance (W4) 64
Fair value movements 20,500
Operating costs (44,500-38,000) -6,500
Operatina proft 2019 72,031
Performance methods
Properties 30 28 7.14%
Beds 12,300 11,200 9.82%
Occupancy 10m 0.97 0.99 -2.02%
Occupancy 2m 0.4 0.48 -16.67
46 Page 112
Rental pm 10m 575 573 0.35%

Rental pm 2m 450 470 4.26%
Property - total value £1,230,000,000 £1,102,000,000 11.62%
Property value - average £41,000,000 £38,000,000 7.89%
Change in fair value £43,500,000 £23,000,000 9.13%
Rentals 10m £68,603,250 £63,534,240 7.89%
Rentals 2m £4,428,000 £5,053,440 -12.38%
Rentals total £73,031,250 £68,587,680 6.48%
Total return (rent + FV) £116,531,250 £91,587,680 27.23%
Beds per property 410 400 16%
Rental per bed £5,938 £6,124 -3.04%
Rental per property £2,434,375 £2,449,560 -0.62%
Operating costs £44,500,000 £38,000,000 17.10%
Rental revenues
Overall, rentals have risen by 6.48% which appears to be a good performance. However, much of this increase has been driven by expansion, rather than an increase in underlying like-for-like
earnings. There were two new properties added to the portfolio in 2019. This produced an increase of 1,100 beds compared with 2018. The two new properties generated revenues of £7.315m so,
without this, revenue would have tallen.
Looking at average portfolio rental rates these have remained relatively stable for the period of 1 Sept- 30 June, at f575 per property in 2019 and E573 on average in 2018. However, average rates
have shown a decline for the period from 1 July-31 Aug in 2019 compared to the same period in 2018. Whilst it is expected that average rental rates for this period are lower due to students being on
holiday and returning home, the decline of 4.3% (450-470/470) between 2018 and 2019 is a concern.
The increased expansion was at a cost of E110m which was far greater than the existing average property value. A consequence of this was that the gross rental yield fell from 6.22% to 5.94%. This is
indicative that whilst revenues have increased, this is through expensive expansion rather than increased operating performance.
Revenue per bed has fallen from £6,124 to f5,938. This is largely due to the reduced occupancy, as the new properties are priced at the average rate.
A serious concern is the reduction in the occupancy rates. They have fallen in the 10 months student period and the summer period. However, the like-for-like reductions in occupancy are much
greater than the overall figures as the two new properties had 100% occupancy throughout the year.
Fair value movements
The increase in fair values makes up over 60% of total profit. Whilst this is significant it is only partly driven by management actions. The element of fair value movement driven by market forces is
beyond management control. However, to the extent to which forecast future rentals determine fair value then this could be attributable to managerial performance.
Fair value changes are however unlikely to be sustainable at this level and so should not be expected to contribute, to this extent, to the long-term performance of MSL.
Returns on investment
The net total return (based on the FV of properties) for MSL after FV changes and operating costs is 5.86% (£72,031k/E1,230m) which is an increase on 2018 when it was only 4.86%. This is largely due
to FV movements which, as already noted, are unsustainable.
Interest
The finance director has not included interest in the protit figures to be reconciled, hence interest cannot be one of the reconciling items. However, interest does affect overall performance. In 2018,
interest was £16.96 million (E530x 3.29%) whereas in 2019 it had increased to £19.84m (£620m x 3.2%). This increase of f2.88m in annual interest is due to financing the two new properties.
In 2019, the additional properties generated additional rentals of £7.315m, which more than covers the additional interest. However, there are operating costs to consider and the increased borrowing
means increased financial risk and liquidity risk with an average term to maturity of only 8 years.
Conclusion
Overall, profit has increased to just over £72,031 m from £53,587m, an increase of 43.3%. Nevertheless, there are a number of concerns which creates significant doubt about the quality and
sustainability of pertormance:
Rental pertormance is questionable. Given there are no pipeline developments to continue revenue growth through expansion.
There are questions over declining occupancy, particularly in the summer period.
Fair value gains have boosted headline profit in 2019, but cannot be relied on to do so in future and if property prices decline they will reduce profit
The fair values may be questioned in terms ot their measurement (see below) theretore distorting the measurement of pertormance.
Issue 1
No prepare booking of rental argreemnt for 5 rooms for 2 weeks
Issue 2
Audit exam 10% lower than fair value recognised
12m difference
But they are done by expert valuations
Issue 1
The concern in this case is the completeness of reported rental incomes, with the risk of understatement of revenue. The risk is not only that rental incomes have been understated, but that there has
been misappropriation of assets from rental receipts. If true, this would be fraudulent behaviour.
Given the low levels of occupancy in the summer period there is the opportunity for local management responsible for booking, to rent out apartments and take the money directly for personal use. It
may be dificult for one person to do so, but collusion between a small group of individuals may be possible.
Actions and procedures
Review the formal booking system to establish whether the local manager had any ability to enter or alter booking records.
Obtain a full explanation of why the 'delay' in recording occurred and where is the receipt of cash or other means of payment
Discuss the matter with other local staff (eg housekeeping and clerical staff) to establish if they knew anything about the matter.
Speak to the 'guests' to establish the facts surrounding booking and payment.
Examine housekeeping records of occupancy and cleaning for other cases of understatement of incomne.
Review other bookings for similar omissions.
If there is evidence of fraud, then suspend the manager and contact the police.
Issue 2
There is a concern that the fair values of properties are overstated in the statement of financial position. The profit for the period may also be overstated if the fair values are overstated relative to last
year.
There is also a concern that the matter is material as the claimed overstatement is £12m which is a significant proportion of the FV movement for the year in the financial statements and 10% of the fair
value of the assets concerned. Also this is only on the three properties. I here may be further issues relating to the fair value tor other properties.
Actions and procedures
The methods used by the internal audit team to determine their fair values need to be independently reviewed including assumptions, estimates and other evidence. IFRS 13, Level 3 criteria should
have been applied by internal audit (Level 1 and Level 2 seem unlikely in the circumstances).
Review compliance with IAS 40 which does not require an external valuer.
The external valuer is a management expert and should be reviewed for independence and competence. His/her methods need to be independently reviewed including assumptions, estimates and
other evidence.
If there is not agreement on the method after reviewing both sets of estimates, then a further independent valuer may be used, appointed by the board.
If these three properties have been the only sample items then there may be an issue of overstatement of fair value for all properties. A wider review should be considered.
Inform the external auditor who may wish to use an auditor's expert. It may well be that the audit is currently taking place.
Recent loans have been taken out. If these have been based on false valuations the bank should be informed.
Personal note
The FD is my line manager and has asked for support although he may be at fault in this matter. An implied intimidation threat is noted.
Risk Nature and relative significance of risk Risk mitigation

Competition risk It is a highly competitive and changing market Anticipate and adapt to changes
(increase in supply) with PBSA supply-side expansion and new in markets by varying local
entrants. Competitive advantage can therefore be capacity where there is excessive
contestable and eroded in the medium term. over-supply in the market (ie
As the PBSA sector matures, there will be university specific approach).
increased supply with more beds in the sector. Stay close to existing university
This will put increased pressure on prices and partners to satisfy their evolving
occupancy. needs by building and sustaining
Risk assessment relative significance relationships, reputation building
Competition risk is therefore a significant medium and frequent dialogue.
to long term risk. Strive to build new partnerships
with universities in the target
mid- and upper-tier.
Seek to negotiate extended and
longer terms for nomination
agreements to provide income
security and a barrier to entry for
new rivals to sustain competitive
advantage.
Marketing and market awareness
to seek out new individual
student customers.
Monitor prices against compet
itors.
Market risk Government education and immigration policies Monitor developments in

Reduction in demand may impact demand as well as those of foreign regulations.
governments. For example: Where appropriate, lobby
Policy on tuition fees may influence demand governments and regulators.
Political factors (eg Brexit) may influence Model the impact of changes in
demand from EU students. student numbers (UK and
Economic factors - may also influence demand. overseas) on PBSA (eg scenario
46 Page 113
For example, global recession or strengthening of and sensitivity analysis).

the f. Consider hedging FOREX
Societal factors- the desire for a high proportion exposure if currency volatility is
of young people to become students rather than expected (£ sterling prices could
commence work around the age of 18 may then be reduced for overseas
change. Also the mix of home and international students where appropriate).
students may change through different societal Seek to negotiate extended and
factors. longer terms for nomination
Overseas demand - key overseas countries may agreements with universities to
mature their own universities making fewer of provide income security.
their students seek to study in the UK.
Risk assessment- relative significance
Market risk is a significant risk as the demand for
student bed spaces isa derived demand based
on university student numbers- specifically in the
mid- and upper tier institutions where MSL has
nronertins
University partnerships A reduction in the number or duration of Stay close to existing university
university partnerships is a key risk to income partners to satisfy their evolving
security and future rental incomes. needs by building and sustaining
Specifically, if existing nomination agreements relationships, reputation building
were not to be renewed or renewed on less and frequent dialogue.
favourable terms (eg shorter duration) then a Strive to build new partnerships
barrier to entry is lower and competitive with universities in the target
advantage eroded. mid- and upper-tier.
Currently about 60% of rental income is under Seek to negotiate extended and
nomination agreements, of which 70% are multi- longer terms for nomination
year (ie 42% of rental income is under multi-year agreements to provide incomme
nomination agreements). security and a barrier to entry for
Risk assessment- relative significance new rivals to sustain competitive
University partnerships risk is significant as almost advantage.
half (42%) of all rental income, which is currently
guaranteed by universities, would be at risk.
Property market Increases in the price of property may reduce the attractiveness of further expansion as, Consider leasing some property rather than buying.
price and volatity all other things being equal, it will lower the rental yield. Take expert advice on future property price movements.
Moreover, increases in property prices will lower the rental yield on existing properties Consider investing in a 'land bank' for future investment
therefore lowering a key performance measure. where good value opportunities arise.
Volatility in share prices will cause volatility in reported income as fair value movements
are recognised through profit or loss (IAS 40).
Conversely, increases in property prices may reduce risk by deterring new entrants and
reducing competitiveness in the sector.
Risk assessment- relative significance
Property market risk is significant as property is the major asset and the business model is
asset-driven.
Even relatively minor unfavourable movements in property prices may have significant
effects on MSL given the high value of its property portfolio.
Financial risk MSL is highly borrowed with loan to value on properties of 50.4% in 2019; increased from Maintain good relations with banks.
borrowing and 48.1% in 2018. Negotiate refinancing arrangements early.
cost of borrow Interest cover is 3.6 times in 2019; increased from 3.2 in 2018. However, these figures Monitor cash budgets.
include fair value movements which are not cash generating, unless properties are sold. Monitor the extent to which rentals guaranteed by
Bullet repayments also need to be covered or refinanced. universities cover interest payment obligations.
Risk assessment- relative significance Covenants need to be considered for continued compliance
Financial risk has worsened in 2019 but is like to be only a medium risk given the level of to avoid penalties.
profitability.
Health and Death or injury of an employee or student arising from a property defect or MSL Compliance with statutory obligations for building and fire
Safety operational or management obligation. (eg a fire or building defect). safety.
Risk assessment- relative significance Control building features during the development process as
Health and Safety has low probability but high impact if it occurs. Reputational damage, they are built for purpose.
legal redress and financial consequences would be potentially significant. Insurance.
Work with universities to promote the importance of Health
and Safety and students' own conduct in respect of this.
47 Page 114
BB LISTED
Sells lith battery
2018 2m sold global
2019 3m sold global
2020 8m
2030 125m
Director/Shareholder Board role SC (m)

James Hooth Chief executive 2
Mary Laver Finance director 1
Victor Moore Production director 1
Techlnvest 3
Kim Morris Non-executive director 0
Individual shareholders 3
Capacity 250,000 units
Number of
batteries sold by
Company Revenue (m) BB End date of current contract % revenue % units Rev per unit
Bluchi (italy) £126,000,000 60,000 30-Jun-23 3 years 61% 60% £2,100.00
Eastern (US) £60,000,000 30,000 30-Jun-22 2 years 29% 30% £2,000.00
Whiston (UK) £19,000,000 10,000 30-Jun-21 1 year 9% 10% £1,900.00
£205,000,000 100,000
Bluchi overall wants 20,000 and 20% gwoth 5 years, min 50,000 EURO, Source Aus mining
Eastern only by BB, annual 60,000 and 40% 4 years, min 30,000 US $ keep inventory low
Whiston specialist MV, only BB, no min, £
Q1.1a - Risk relating the future revenue

Business risk
The EC battery industry is still evolving and there are significant uncertainties regarding changing technologies and competition. Future sustainability and expansion of revenues are therefore subject
to signiticant, market-wide uncertainties beyond the contractually protected period of the three existing contracts. Successtul R&D may provide some mitigation of these uncertainties, but that success
is itself uncertain.
Possible loss of customer
BB is dependent on only three customers to generate revenues. Bluchi alone generates 60% of all sales by volume and 61.4% of all sales by value. Loss of any one customer could impact on BBB's
going concern.
Bluchi and Whiston are new to electric vehicles (EV), so this product line may not become established, despite predictions of high growth.
There is some protection from losing a customer as there are contracts in place with minimum order numbers. However, the period to expiry is a maximum of only three years, with the other two
customers only one year and two years.
There is no information regarding replacement of a lost customer with a new customer. Ihis may be because contracts are tying in other motor manutacturers.
Revenue growth or decline
Bluchi and Eastern plan to increase the number of EV produced in future years. However, BB is not the sole supplier to either and so while total EV output (and theretore requirements for EV batteries)
increases, this does not mean that BB will necessarily share in this average rate of growth, which may go disproportionately to other suppliers.
BB is a sole supplier to Whiston, but future demand for EV cars produced by Whiston is uncertain. There is no planned growth and the Whiston contract expires next year.
Price
There may seem some risk mitigation in fixed prices, but there is a risk if cOsts rise in the contract period that revenues will not cover costs. Moreover, it new alternative supPpliers offer lower prices (eg
due to improved lithium-ion technology) then BB may be restricted to minimum volumes whilst lower priced rivals pick up the benefits of expansion of output.
Foreign currency
While prices are fixed in local currencies (Euro/USS) there is a currency risk in that any depreciation in these currencies against the f will reduce the sterling equivalent value of the revenues.
Production dosure - loss of access to raw materials
Production may need to be closed down temporarily or permanently if access to scarce raw materials, such as lithium or cobalt, is interrupted. This may damage short-term revenue streams and
longer-term reputation with customers.
Mitigation of risks
The underlying growth in the EV market is a favourable factor for BB as EV car manutacturers wish to have security of supply for their batteries by securing new contracts. The possibility of rolling over
the contracts with exsting customers at their expiry on appropriate terms may therefore be a reasonable risk mitigation.
Widening the customer base with new customers would mitigate the current dependence risk on only three customers, but this may be difficult to achieve in a competitive market and on reasonable
commercial terms.
The risk of production closure through limited access to scarce raw materials may be mitigated by longer term supply contracts (this is discussed further in section 1.1(6) below).
Although the Eastern contract is in USS, there may be a natural hedge with lithium being a commodity cost which is priced in USS.
Currency hedging can take place to mitigate risks for euro denominated sales.
Q1.1B - Risk relating to acquiring lithium

Prop 1
4 year fixed price with Lilley, price 25% higher than current
Keep in AUS $
Prop 2
Monthly contract and 6 month rollowing forward contract and forward US $
Dependence on one supplier, Lilley, may cause a supply chain security issue. Rivals may contract with Lilley for its available tuture supplies or Lilley's natural resources may run out. Also, continued
scarcty may increase supplier power for Lilley, enabling t to impose increased prices or impose other supply conditions.
BB is particularly vulnerable due to its short-term monthly contracts. I his means there is no security of supply and the price is, in eftect, the spot price which is rising and volatile. BB has fixed prices
with car manutacturer customers, so protit is particularly volatile to raw material price volatility.
Also, the Lilley contract is in AS, and there will therefore be currency risk on top of commodity price risk.
Scarcity of supply globally, and supply chain concentration in few countries, are further market-wide supply risks in obtaining alternative sources of lithium. For example, rivals may lock-in available
lithium supplies with long-term contracts, leaving little residual supply available in open markets.
Further scarcity of supply may lead to more price increases and price volatility over time as natural resources diminish further
EV production globally is increasing rapidly. If it expands more quickly than expected then, with this additional demand, available lithium supply may run out sooner than expected.
Non-market factors present additional risks, with the possibility of governmental and inter-governmental regulations limiting supply chains and distribution channels (eg to protect natural resources).
Overall, the sustainability of the long-term supply of raw materials is a major risk which threatens the continued viability and sustainability of BB if it is restricted to lithium-ion battery production only.
In terms of consequences, lithium-ion batteries cannot be made if no lithium is available for BB. This may mean factory shut-downs, perhaps for significant periods, and then the minimum contractual
requirements for customers may not be met. Ihis could risk loss of reputation and litigation.
Mitigation
Lilley contract
A long-term contract with Lilley would fix the price over the contract term and provide assurance, as tar as possible, over security of supply.
However, there are a number of downside factors:
Four years is a long horizon and beyond that of the current customer contracts. Predicting required amounts (maxima and minima) may be ditticult. Ihere is a possible exposure ot having an excess
of lithium if supply is greater than demand. Storage may be costly or impractical and resale may be difticult.
While the lithium price is fixed, it is at a much higher level than the current price. As prices rise over time this may be of future benetit, but there is a short-term cost.
The contracts are in Australian S and there is therefore a currency risk, even though prices are fixed in the local currency.
In addition to the Lilley contract, further contracts with multiple suppliers, if attainable, might go some way towards mitigating the risk of reliance on one supplier.
Commodity forward contract

A commodity forward contract is a binding agreement to acquire a set amount of a commodity at a future date at a price agreed today.
A forward contract fixes the rate for a transaction, and these contracts must be settled regardless of whether or not the lithium price at the settlement date is more or less favourable than the agreed
torward price.
While BB uses lithium, it does not need to take physical delivery of the product based on the forward contract. Instead, it could use changes in the price of the forward contracts whereby the gains and
losses would offset the movements in the monthly lithium purchase prices which are entirely separate contracts.
Thus, for example, BB may arrange a forward contract with its bank. Subsequently, when it needs to purchase the lithium, the bank will close out the original forward contract, in effect by arranging
another forward contract for the same settlement date, to cancel out the original contract. The close-out is then settled with a cash payment by one party to the other, depending on the difference
between the forward prices in the contract and market prices. Ihis would oftset changes in prices paid by BB for lithium.
A disadvantage of a 6-month forward contract is that it only locks in prices for the next six months. Unlike the 4-year contract with the supplier, Lilley, BB remains exposed to long term shifts in the price
of lithium beyond the 6-month horizon.
The forward contracts are in USS and there may be a currency risk. However, as already noted, there is a natural hedge against Eastern sales in USS.
Recommendation
The contract with the supplier seems a better choice as it gives security of supply as well as price protection and over a much longer period.
Requirement 1.2: Benefits and risks of the R&D project (solid state batteries)
The R&D project has had some early success witha number of process innovations. However, there remain significant uncertainties over the outcomes.
Moreover, the scale ot the R&D project is sutficient to impact materialy the company as a whole it the project tails.
Immediate withdrawal from the R&D project is one possibility to be considered. This would save the loss of further R&D investment if the project fails but there is then dependency on the current
technology of lithium-ion production which is at risk for BB and globally in decline.
The three possible outcomes are:
Outcome 1 (1) R&D project fails - Outcome 1

if failed then going concern issue
25% chance it fail
47 Page 115
The R&D continues with up to £200m of new investment then ultimately fails. This is the worst-case scenario as failure of the R&D may be identified before all the additional £200m costs are spent.
Fixed costs of production, of £150m, are avoided it production does not take place.
Outcome 2
succesulf and commence 1 July 2024
sales 180,000 units
till June 2025 and growth 12.5% per annum unit June 2032
60% likely
Annual growth in revenue is (1.04)X1.125) = 1.17

The annual money discount rate is 17%.
So, the effective discount rate is zero (1.17/1.17)-1)
However, sales in the year end 30 June 2025 are already inflated by 12.5% and therefore needs to be deflated by 12.5% for the effective rate to apply.
There is therefore a base year figure of 180,000/1.125 160,000 units.
The PV over 8 years is therefore: (160,000 x £780 x 8 years)- £200m- £150m - £648.4m
Year Sales Contro

Jun-24 0 160,000 Base year 180k/1.125
Jun-25 1 180,000 146,016,000
Jun-26 2 202,500 170,838,720
Jun-27 3 227,813 199,881,302
Jun-28 4 256,289 233,861,124
Jun-29 5 288,325 273,617,515
Jun-30 6 324,366 320,132,492
Jun-31 7 364,912 374,555,016
Jun-32 8 410,526 438,229,369
PV T1-8 @ 17% 998,400,000 npv(.17, All above
Fixed cost -350,000,000
NPV 648,400,000
Outcome 3
succesulf and commence 1 July 2024 15% likely
Year Sales Contro
Jun-24 0 240,000
Jun-25 1 270,000 219,024,000
Jun-26 2 303,750 256,258,080
Jun-27 3 341,719 299,821,954
Jun-28 4 384,434 350,791,686
Jun-29 5 432,488 410,426,272
Jun-30 6 486,549 480,198,739
Jun-31 7 547,367 561,832,524
Jun-32 9 615,788 683,637,815
PV T1-8 @ 17% 1,505,088,000 npv(.17, All above
Fixed cost -350,000,000
NPV 1,155,088,000
Assumptions
WACC 17%
PV July 2024 200,000,000
fixed cost 8 years 150,000,000
total cost 350,000,000
Expected NPV
NPV July 2024
NPV Likelyhood
Outcome 1 -200,000,000 25% -50,000,000
Outcome 2 648,400,000 60% 389,040,000
Outcome 3 1,155,088,000 15% 173,263,200
512,303,200
Earlier costs incurred on the R&D project are sunk costs and so are not relevant to the decision to continue.
Discussion
The R&D project gives an expected positive NPV of E511.18m. Ihis would suggest that BB should continue with the R&D project in pure tinancial terms.
There are however a number of risks and possible hidden costs.
f failure of the R&D project means failure of the BB company, then there may be significant additional costs from the liquidation, eg the distressed sale of assets and foregoing of existing revenue
streams from lithium-ion battery sales.
Delay in R&D is an additional risk to failure. Even if the R&D project succeeds, BB may be only the second fastest to market (or even later) and the projected benefits to BB may then be much smaller.
Worse still, if the company which is first to market also has a first patent over the technology, then BB may now be legally unable to explort its own development work on a commercial basis. Legal
advice would be needed on the restrictions over BB of any prior patent by another company in the industry.
Ihere may also be a financial risk to delay. Ihe funds raised may be insutticient to tinance an extended delay in R&D activities. Also, with a high discount rate of 1/% pa, a significant delay will cause the
NPV of revenues to be reduced substantially.
Expected values suggest a risk neutral approach. I his is unlikely to be the case. Some of the shareholders, such as the private equity holders, may hold diversified porttolios but are nevertheless likely
to be risk averse. More particularly, the shareholder/directors and individual shareholders are less likely to be diversitied and may therefore be very risk averse, weighting possible downside losses
much more than equvalent potential gains.
The high discount rate of 17% per annum does contain a risk weighting to compensate for risk aversion but it may not be the same for all shareholders and may not consider going concern risks.
A further risk is that the board's estimates of outcomes are too optimistic and, in reality, the cash flows and probable outcomes may be optimistic and not the best estimates currentiy available.
Significant estimation uncertainties are not just in the development of the technology but also the forecast costs and revenues and the speed to market, not just of BB, but also of rival companies. Ihe
time horizon is up to 12 years into the future, which is a substantial period in any industry, but more so in a rapidly changing and developing industry like EV batteries.
Recommendation
There are significant risks in continuing with the solid-state battery R&D project. However, there are also significant risks with discontinuing solid-state R&D and leaving sole dependence on lithium-ion
battery production. Ihe current business model, comprising only lithium-ion battery production, appears to be
unsustainable. I his is partly because of the global scarcity of natural resources required to build lithium-ion EV batteries: and partly because the development ot a solid state battery by some company
globally, is likely to make the lithium-ion battery largely obsolete for EV once solid-state batteries become established as the industry norm.
The fact that BB made signiticant progress last year and has patented a number of process innovations encourages continuation with the R&D project. This does not however necessarily mean
continuation to become ultimately an independent solid-state battery producer (although this is possible). Alternatives exist over the next few years whereby, optimistically, BB could merge or be
acquired by a largerEV producer or EV battery producer, perhaps with a wIsh to acquire the BB patents gained to date and any future BB patents as the R&D continues. Ihis may give significant gains
to BB shareholders. More pessimistically, the R&D project could be subject to continual periodic review and it success becomes unlikely, then withdrawal from the project may be possible before the
£200m funding has al been spent
A recommend ation is theretore to continue with the R&D project, but subject to regular monitoring and review based on key time-based KPls and assessment of competitors projects (eg monitoring
their filed patents).
Financing the sold state battery R&D project

bank refused to led
lack of assets
Offer 1 Equity only
Private equity PrivEqu 200,000,000
Share capital 5,000,000
Share price 40.00
Director/Shareholder SC (m) % Old %

James Hooth 2 13.3% 20.0%
Mary Laver 1 6.7% 10.0%
Victor Moore 1 6.7% 10.0%
Techlnvest 3 20.0% 30.0%
Kim Morris 0 0.0% 0.0%
Individual shareholders 3 20.0% 30.0%
Private equity 5 33.3% one New NED
15
PrivEqu
The full amount of finance of f200m is provided but, at f40, this is the lowest price per share of the three offers, as 5 million new shares are required. This is a substantial increase in share capital,
adding 50% to the 10 million ordinary shares already in issue.
It would also be another private equity investor (in addition to Techlnvest) in the corporate governance structure so there may be common interests and common voting. They would have a combined
shareholding of 8 million ordinary shares, which is 53.33% of shareholder votes. Iheir interests (eg in an early exit route) may not be consistent with the interests of the other shareholders. A
shareholder agreement may control their ability to take certain decisions (eg removal of directors).
In only asking for one director, PrivEqu and Techlnvest would not control the board, but the new director may bring some new expertise.
Offer 2 Equity + customer contract

Pleuron, french manu 200,000,000
47 Page 116
Share capital 4,750,000

Share price 42.11
Mary Laver 1 6.8% 10.0%
French man 4.75 32.2% 4 Neds
14.75 100% 100%
has right to 30,000 options in June 25
wants 30,000 EV price = controbution
Pleuron
Pleuron is asking for less shares than PrivEqu and is providing the same amount of finance. So, at £f42.11, the price per share is higher.
The deal however has a key impact on corporate governance as four new directors are required, giving half the votes in board meetings. It is not clear why this is required, but retaining a casting vote
tor the CEO would retain board control for the existing shareholders, but only if they act together.
The four new directors may bring a range of new types of expertise.
In the year ending 30 June 2025, it is requiring supplies of solid-state batteries at a zero contribution. There may be some uncertainty as to how the contribution is calculated, but it could be that there
is no loss no gain from this one-year arrangement. However, if BB is at, or near, full capacity for solid-state battery production in the year ending 30 June 2025, then there may be an opportunity cost
from lost sales to other customers. This may mean not obtaining a foothold in the wider solid-state market.
In the long term, however, this arrangement may generate additional sales and contribution which might not be attained with the other two finance providers. Pleuron is incentivised to buy from BB as
it benefits the value of its shareholding. Further sales seem probable as the investment by Pleuron in BB is likely to be strategic, rather than just financial.
Offer 3 Equity + options + debt

Lith OX argentinain lithumn minning company
Loan 100,000,000
Provided 100,000,000
SC 2,250,000
Share price 44.44 100/2.25m
Call option 250,000 Dec-30
Ex price £50
Value £12,500,000

Mary Laver 1 8.2% 10.0%
French man 2.25 18.4%
12.25
Lith-Ox
Lith-Ox is offering the highest price per share, at £44.44, and the lowest shareholding. However, the value of this deal depends on whether the options will be exercised.
More information is needed to evaluate the consequences of the £100 million loan, particularly the interest rate that would apply.
The options are currently out-of-the-money, but the long vesting period up to 2030 means that if the R&D and subsequent production are successful, the options are likely to become in-the-money
and exercised. There would then be further dilution of equity. On exercise, Lith-Ox's shareholding would increase by 250,000 shares, to 2.5 million, although an additional f12.5 million (250,000 x £50)
would be raised.
Valuing the options at their fair value (eg using Black Scholes Merton model) would give a better idea of the Lith-Ox proposition.
Overall, this proposition protects Lith-Ox from downside risk by using debt, whilst enabling it to benefit from upside potential with the options.
BB's operational risk is lowered by giving it access to a new supplier of Lithium.
Recommendation
The Lith-Ox proposition seems favourable as: it is least thre atening to corporate governance with the lowest shareholding, it provides the required finance and opens upa new source of supply for
lithium.
Requirement 1.4: Financial reporting disclosures

Going concern disclosures
Note: The new going concern standard, ISA (UK) 570, is not applicable for 2020 exams.
BB is a listed company and thus a PIE (Public Interest Entity) and it therefore needs to comply with the UK Corporate Governance Code and the regulations on going concern disclosure.
The 2018 UK Corporate Governance Code contains a provision requiring a 'viability statement. The BB directors should explain in the annual report how they have assessed the prospects of the
company, over what period they have done so and why they consider that period to be appropriate. he directors should state whether they havea reasonable expectation that the company will be
able to continue in operation and meet its liabilities as they tall due over the period ot their assessment, drawing attention to any qualitications or assumptions as necessary.
The period covered should be significantly longer than twelve months. The length of this period will be for the directors to decide, but it is likely to correlate with the time period of any budgets or
financial forecasts that the company has prepared. The guidance emphasises the importance of identifying those risks that might threaten business sustainability.
Overall, the BB directors would consider the risk of failure of the solid-state R&D project as a material uncertainty as there is an estimated probability of 25% of the project failing which is significant
and that this may directly impact going concern.
The length of period of the assessment will be for the BB board to decide, but it is likely to correlate with any budgets or financial forecasts that the company has prepared. BB's solid-state R&D
planning horizon is cleariy longer than 12 months and extends to the time when the success or tailure of the solid-state R&D project can be determined.
Disclosure should therefore be made by BB in its annual report about the nature and impact of this solid-state R&D uncertainty relating and its impact on BB's ability to continue in operation.
TAS 10 also requires management to make an explicit assessment of the entity's ability to continue asa going concern by considering a number of financial, operating and other indicators.
In accordance with IAS1, going concern should be disclosed as the basis for preparation. IAS 1 also requires that any material uncertainties with respect to going concern should be disclosed. For BB,
this would include the nature, risks and progress of the R&D project and wider market and technological uncertainties.
Environmental impact and sustainability disclosures

Legal requirements and the Strategic Report
In the UK, the Companies Act 2006 (Strategic Report and Directors Report) Regulations 2013 require listed companies, such as BB, to report on environmental matters within the Strategic Report
section of their Annual Report, to the extent that this environmental information is necessary for an understanding of the development, performance or position of the company's business.
The Report should include:
The main trends and factors likely to affect the future development, performance and position of the company's business
Information about environmental matters including the impact of the company's business on the environment.
The Report should also include information about BB's policies in relation to those matters and the effectiveness of those policies.
To help readers to understand the company's business, the Report should contain financial KPls and, where appropriate, analysis using other KPls including information relating to environmental
matters. For BB, this might include the environmental benefits arising from the use of EV, but also those environmental impact issues arising trom the manutacture of EV batteries and the use of scare
natural resources.
Greenhouse gas emissions disclosures

In conjunction with the general requirement for listed companies to include information about environmental matters in their business reviews, the Companies Act 2006 (Strategic Report and
Directors' Report) Regulations 2013 require that listed companies, such as BB, to repot their annual greenhouse gas emissions in the directors' repot.
This mandatory reporting requirement is important in the EV industry as a key tactor for EV is zero emissions. However, the production of EV batteries leaves its own carbon footprint which needs to be
measured and compared against the longer-term emissions saving from use of the batteries in EV. Such disclosures are theretore key evidence in justitying the business model and the existence of the
industry.
Environmental issues are not confined within the normal financial reporting boundaries of an organisation or just to BB's UK production activity. For example, the impact of supply chain operations on
the environment needs to be considered even it outside the UK. For BB, this includes sourcing, for example lithium and cobalt, in the most sustainable way which minimises harm to the environment.
Stakeholder pressure for environmental disclosures

In addition to legal requirements there Is commonly pressure, particularly for listed companies as public interest entities such as BB, to become more soCially responsible. Ihis has come fromn
stakeholder expectations including investors and the media who are paying closer attention to companies' social and environmental performance.
In the EV industry, where environmental responsibility is a key factor, there is also likely to be significant pressure for environmental disclosures from BB's customers.
Integrated reporting -sustainability and the six capitals

A key element of integrated reporting (R) is its focus on business sustainability and the long-term success of businesses. By encouraging organisations to focus on their ability to create and sustain
value over the longer term, IR should help the BB board take decisions which are sustainable and which ensure a more effective allocation of scarce resources.
IR requires an organisation to explain the outcomes of its performance in terms of six categories of capital: financial; manufactured; intellectual; human; social and relationship; and natural.
Using these six categories could provide BB with a more comprehensive tramework tor analysing its pertormance which includes environmental impact, than its current approach, which appears to
focus predominantiy on financial performance.
Natural capitals
The element of natural capitals is relevant to BB in its use of scare natural resources ot lithium and cobalt.
In incorporating the use of natural capitals into its business model BB should use and disclose the following key steps in the valuation process:
Quantity resource use
Understand how the resource use causes changes in the natural environment
Value the impacts on people associated with these changes in the natural environment
UN Sustainable development goals

UN Sustainable Development Goals (SDGs) have become important in measuring the wider performance of businesses. Disclosing timely, reliable and relevant information will be central for achieving
sustainable development goals.
For BB, the key disclosures will relate to the following SDGs:
7. Affordable and clean energy- Ensure access to affordable, reliable, sustainable and
47 Page 117
modern energy for all. Ensure there is heat, light and power for the whole planet, without
destroying the planet. (BB is a key producer of clean power)
11. Sustainable cities and communities - Make cities and human settlements inclusive, safe,
resilient and sustainable (reduction of admissions and reduction of the use of lithium-ion if the R&D solid state project is successful).
13.Climate action - Take urgent action to tackle climate change and its impacts (BB contributes to the production of zero emission vehicles).
The SDGs enable companies to report information on sustainable development performance using common indicators and shared sets of priorities.
The Global Reporting Initiative
The Global Reporting Initiative (GR) is a reporting framework that aims to develop transparency, accountability, reporting and sustainable development. Its vision is that reporting on economic,
environmental and social impact should become as routine and comparable as tinancial reporting. It also seeks to achieve as much standardisation as is possible in sustainability reporting by
organisations. The GRI's G4 Sustainability Reporting Standards, published in 2016, emphasise the need for organisations to disclose their most critical impact on the environment, society and the
economy.
For BB this is likely to mean disclosures relating to the risks of raw material usage (lithium and cobalt) but also the opportunities to reduce CO2 emissions by being an effective element of the supply
chain of its customers who produce zero emission Ev.
48 Page 118
ILA PLC
Listed stock exchange
operates lesuire parks UK, US and India
Visiting number down 5%, UK and US maintain vistome
India expect to grow
(1) Analyse the financial performance and position of lLA and each of its three leisure parks, using the information provided.
Share price fallen from £3.23 to £2.25
2020 2019
Extracts- key financial data at 30 June £m £m
Market value of non-Current assets 610 630
Loans-2.8% bank loans 2028 330 330
Share capital - £1 ordinary shares 80 80
Reserves 185 170
2020 2019
Extracts - statement of profit or loss for the years ended 30 June £m £m Op margin 17.9% 22.7%
Revenue - attractions (entry tickets) 139 145.25 % change -4.3%
Revenue -other 55.6 58.1 -4.3%
Variable costs -16.68 -17.43 -4.3%
Fixed costs -153 -153 0.0%
Operating profit 24.92 32.92 -24.3%
UK US Total
Analysis by leisure park for the year ended 30 June 2020 £m £m £m
Revenue -attractions (entry tickets) 60 63 16 139
Revenue - other 24 25.2 6.4 55.6
Variable costs -7.2 -7.56 -1.92 -16.68
Fixed costs -65 -66 -22 -153
Operating profit/(loss) 11.8 14.64 -1.52 24.92
Other operating data for the year ended 30 June 2020 UK US India
Average price per entry ticket £30 £35 £20
Number of attractions 100 80 50
Market value of non-current assets £220m £250m £140m Decline in number of visitors has reducted profitability and operating cashflow
Number of visitors UK US India Total

Year to 30 June 000s 000s 000s % change
2017 2,200 1,780 600 4580 1.7%
2018 2,150 1,810 700 4660 3.6%
2019 2,120 1,830 880 4830 -4.8%
2020 2,000 1,800 800 4600
Price 30 25 20
Vistors 2,000,000 1,800,000 800,000 4,600,000
Attractions 100 80 50
Revenue -attractions (entry tickets) 60,000,000 63,000,000 16,000,000 139,000,000
Revenue - other 24,000,000 25,200,000 6,400,000 55,600,000
84,000,000 88,200,000 22,400,000 194,600,000
Fixed costs -65,000,000 -66,000,000 -22,000,000 -153,000,000
Variable costs -7,200,000 -7,560,000 -1,920,000 -16,680,000
Operating profit/(loss) 11,800,000 14,640,000 -1,520,000 24,920,000
Fair value of PPE 220,000,000 250,000,000 140,000,000 610,000,000
Operating margin 14% 17% -7% 13%
Rev per attraction 42 49 28 42
Rev per attraction 840,000 1,102,500 448,000
ROCE 5.4% 5.9% -1.1% 4.1% Op marign/PPE
Controbution 76,800,000 80,640,000 20,480,000 177,920,000 fixed cost + operating margin
Strategic and operating performance

There has been a decline in visitor numbers at all three parks in 2020. This resulted in an overall decline in visitor numbers of 4.76% in 2020 compared with 2019. The decline in revenue from
admissions to parks is 4.3%. Although prices were constant, the decline in revenue is not linear with visitor numbers as the ticket prices differ between the leisure parks and the extent of the reduction
in visitor numbers also varied between the parks.
Other revenue' streams (food and drink, retail and hotels) are highly correlated to the numberof visitors and so the risk of all revenue streams is a function of the decline in visitor numbers.
The high fixed costs and low variable costs cause high operating gearing. This means there is increased risk in terms of high volatility of profits in response to changes in revenue. This is illustrated by
the fact that operating profits have decreased by 24.3% (1-(24.92m/32.92m)), even though sales revenues only decreased by 4.3%.
Overall, visitors for ILA rose by 3.65% in 2019 and by 1.75% in 2018. However, there was a decrease in visitor numbers in 2020. Whilst the fall in visitor numbers in 2020 affects all 3 parks and is
therefore concerning, the longer-term pattern is less clear.
The largest fall is the Indian park which had a 9.1% reduction, but visitor numbers have risen in all previous years and the 2020 total is the second highest since it opened in 201/. The Indian park is the
only park to generate an operating loss and it generates the lowest revenue per visitor and per attraction. Ihere are therefore some serious current performance weaknesses and concerning future
trends for the Indian park.
The US park shows no cdear trend over the past four years, with small rises and falls, so the pattern and risks are less clear, unless 2020 is the start of a trend. In terms of 2020 performance, however, the
US park generated the highest operating profit of £14.64m and also the highest operating margin of any park at 17%. In 2020, the US park also generated the highest revenue per visitor and per
attraction.
The UK park has experienced a decline in visitor numbers over the four years of available data. This continued trend is a significant risk, as the UK is one of the two larger parks, and it therefore impacts
signiticantly on the company as a whole. Ihere is a risk that managed decline is the best that can be achieved for the UK park. However, whilst not matching the US park for pertormance in 2020, the
UK park still has the highest visitor numbers. Ihe UK park has a smaller asset base at f220m compared with f25Om for the US park. Nevertheless, the US park had a better ROCE than the UK park,
which allows tor the ditferent value of the asset base.
More needs to be known about pricing in previous years. Flexible pricing may be one response to talling deman
In order to avoid managed decline, it appears from visitor surveys that more investment is needed in new attractions. Ihis however brings its own risks in increased borrowing and more fixed costs.
A particular target for new investment is India which made operating losses in 2020. However, if the Indian venture fails, then this would put increased pressure on the other two sites, as there would
be even less diversification. If some of the fixed costs for India are centrally allocated, then these may need to be covered in future by the UK and US parks. Overall, the risk of failure of the Indian park
could be a risk to the whole company. On a positive note, the Indian venture is making a significant positive contribution, before fixed costs, which would mitigate against closure.
Overall, a clearer idea of why sales have fallen at all three locations in 2020 is key to understanding the risks and reversing the decline.
Industry factors
There are external risks to performance trom the industry. Ihis could be from a decline in the industry in terms of social tastes, in tavour of spending on other types of leisure activity. There is some
diversification of tastes across several differ cultures but there remains risk, even froma decline in one major park. Also, some culture changes may be international.
Conversely industry factors may come from increased competitiveness within the industry. This could be new entrants who may draw demand away from lLA.
Other factors could be increased costs, for example from health and safety regulations for the industry.
Financial position
ILA has high borrowing and the refore high financial gearing in relation to PPE (debt/PPE) at 54% (£330m/£610m) in 2020 and 52% (£330m/£630m) in 2019.
Gearing could also be calculated in market value terms at the debt/equity at 183% (£330m/{80m x £2.25) in 2020.
Alternatively expressed as debt/(debt + equity) at 64.7% (E330m/(80m x £2.25) + £330m)).
If share price falls further when earnings are announced, then market value based gearing will increase to an even higher level.
Interest cover is 2.7 times (f24.92m/(E330m x 2.8%) which appears reasonable based on existing debt levels and interest payments.
The high financial gearing makes profit after interest more volatile and risky. In combination with high operating gearing, profit is very sensitive to changes in revenues, which themselves are becoming
more volatile.
High borrowing also reduces debt capacity for further borrowing. This has already been demonstrated by ILA's inability to raise new debt on reasonable terms in the UK and the US.
The inability to borrow puts a strain on liquidity with the reduction in operating cash flows and the need tor new investment. Ihis reduces financial flexibility.
This may also create insolvency risk if sales continue to decline.
Other concerns include covenants on existing loans, which may restrict new borrowing but also, it breached, may require immediate payment out of cash that LA does not have and may not be able
to access.
Even if covenants are not breached, the existing loans become repayable in 2028, so a clear financial plan is needed if the bank will not roll over these loans.
Foreign exchange movements create a further source of volatility as, even if underlying prices and visitor volumes in the US and Indian parks remain constant, there may still be volatility in £ sterling
values.
(2) Evaluate the proposal to open a new leisure park in Japan, including its financing. Include supporting calculations and reasoned advice.
Japan - Leisure Park
Similar price to UK and US ticekts
1-Jul-22 open park
Pirce 4500 Yen
Initial investment 26,000,000 Yen 1-Apr-21
July 2022 to June 2025 ¥m

Revenue - attractions 10,000
Revenue- other 4,000
48 Page 119
Variable costs -1,200

Incremental fixed costs -8,450
Operating assumptions
Number of attractions 70
Assumed exchange rate £1=Y130
Discount rate required 10% pa
Average price per entry ticket ¥4,500
NPV 2023 2024 2025

Revenue - attractions 10,000 10,000 10,000
Revenue- other 4,000 4,000 4,000
Variable costs -1,200 -1,200 -1,200
Incremental fixed costs -8,450 -8,450 -8,450
4,350 4,350 4,350
Discounted 0.10
43,500.00
Rate 1.1 39,545.45
Less investment - 26,000.00
13,545.45
Strategy
This is a significant positive NPV, but the CEO admits that the torecasts are optimistic rather than neutral.
While the NPVs are positive using the management forecasts, there remain a number of concerns and risks with the Japanese project.
This is a new venture in an unknown geographical market. As such, the riskS and uncertainties relating to the forecasts are high. In this respect, the key risk appears to be the visitor numbers, as this is
the main revenue stream and other revenue streams are dependent on this.
While there is a working assumption that visitor numbers remain constant after the tirst three years, this does not mean that ticket prices or costs will remain the same. Both are likely to rise.
Particular risk issues are:
Validity of market research
Competitor analysis, including response of competitors to the ILA new market entrant
Human resources - new language and culture than existing parks mean may not be able to replicate existing business model. Significant local recruitment is needed.
Cost estimates are also at risk eg cost and/or time over-runs on initial building and FOREX risks.
Borrowing and liquidity risk

The Japanese project is entirely debt finance, with no input of cash from equity or from existing cash balances. The amount borrowed is significant for the scale of the company.
The additional borrowing required for the Japan leisure park increases overall debt and therefore reduces further I LA's already constrained debt capacity. The ability to borrow additional funds in the
foreseeable future seems remote.
Also, the additional debt is borrowings of the company, not of the project, so lLAs financial gearing and tinancial risk increases signiticantly given the scale of the project
In addition to the amount of new debt, the required interest payments with further afect Iiquidity as a draw on cash flows. At the assumed exchange rate, the annual interest payments on the Japanese
leisure park element of the loan are: £5m (¥26,000m x 2.5% /130). This is a significant proportion of operating profit.
Ihe loan is in yen and so is matched against yen receipts. It theretore reduces foreign currency risk but only after the park opens and revenues commence.
Non-financial terms of the loan are likely to create further risks. They will include covenants which may be restrictive and reduce financial flexibility.
The security on the loan does not just relate to assets located in Japan (with a ixed charge) but also ILAs assets elsewhere (with a floating charge). A third strand of security is securitisation over LA's
tuture Japanese revenues. Ihis gives Yokosata rights over the future revenue streams from the Japanese leisure park tor ten years to repay the loan interest and principal.
Conclusion
There is a high positive NPV for the project which suggests acceptance on financial grounds. However, this conclusion is based on the working assumptions which have short-term uncertainty relating
to construction costs, medium-term uncertainty over the first three years' revenues and even greater uncertainty in terms of longer-term projections and business sustainability.
Wider considerations such as liquicdity and risk also need to be considered given the inability of ILA to access finance. This is particularly the case if costs overrun on the construction project
To reduce uncertainty, the robustness of the assumptions need to be stress tested with sensitivity analysis and more market research. Liquidity risk could also be reduced by leaving the excess
¥6,000m borrowing on deposit until the Japanese park construction is completed in case there are over-runs. Only once construction is complete, should it be considered spending the money on
developing the Indian park.
Assuming turther marketing research results giving assurance over the working assumptions, the recommendation is to accept the project.
Financing the project

Loan 32,000 Mill Yen
Investment 26,000 Japan
Investment in India 6000
Term 40 years
Fixed charge over all Japanese leisure park assets.

Securitisation over revenues from entry tickets in first ten years of trading at the Japanese
leisure park.
Floating charge over all other lLA assets.
Yokoste the bank are backed by gov and keen to improve tourism
Assurance on Cashflow
Loan from bank
Review documentation trom the bank and legal documentation to determine the terms of the
loan and the future cash flow interest and principal repayments.
Evaluate whether the amount of the loan should be sutticient to fund the expansion and
permit ILA to pay its other debts as they fall due
Initial cost of project

Assess estimates from builders and other suppliers.
Consider documentation from land and property valuers as to likely costs.
Examine draft contracts in place (assess if a fixed price contract).
Examine costs against recent costs incurred at other parks to the extent they are similar (eg
common global supplier of rides).
Review protessional fees for reasonableness such as architects, lawyers and accountants.
Receipts from visitors tickets

Appraise market research undertaken.
Compare initial attendance at other parks.
Review pricing policy against competitors.
Assess feasibility of future growth against experience elsewhere in other parks (|LA and other
external Japanese parks).
Consider potential for any advanced sales of tickets.
Consider the impact ot seasonality.
Review daily projections of visitors against parks capacity
Starting costs
Review statting cost fore casts tor consistency with projected number of visitors and statting
requirements at other parks.
Review salary increases expected over time based on assumptions of wage increases and
statting numbers. Other parks may provide a benchmark.
Evaluate assumptions by comparing with local employment law, including minimum wage
requirements.
Food costs and prices

Review food cost and price torecasts for consistency with projected number of visitors, prices
in Japan and experience at other parks.
Evaluate assumptions for food and other wastage and ensure that these are reasonable and in
line with other parks, taking into account any Japanese regulations about food storage.
Hotel cost and prices

Review revenue and cost forecasts for consistency with projected number of visitors.
Compare occupancy projections with experience at other parks and normal levels in Japan.
Compare prices with local hotels just outside leisure park.
Review land availability and planning permission for building more hotels just outside leisure
park.
Review for consistency with hotel costs and revenues at other similar parks (ILAs parks and
externally owned parks in Japan).
Other costs
Review whether all other cash costs have been included at reasonable amounts (eg
maintenance, asset replacements, asset disposals, utilities, training, health and safety,.
administration, incremental central costs).
48 Page 120
Tax
Review for consistency with forecast taxable profit and Japanese corporate tax rates.
Sensitivity analysis
Review forecast revenues and costs for sensitivity to changes in key assumptions.
Analytical procedures
Review key margins and ratios tor reasonableness
Review daily, weekly, monthly patterns of forecast visitor numbers against experience and
benchmarks elsewhere (internal and external).
Foregin currency risk

Loan issued at 1 April 2021: ¥32,000 million
Loan to be hedged at 1 April 2021: ¥6,000 million
Exchange rate at 1 April 2021: £1-¥130
Exchange rate at 30 June 2021: £1-¥120
1 April 2021 forward contract taken out
FV of forward £ 3.73 m
Loan value at start 46.15 m

Loan at YE 50 m
Gain/loss - 3.85 FX loss
Hedge at start 3.73

Gain - 0.12
Hedging effectiveness
The currency forward hedge attempts to reduce foreign currency risk arising from ¥6,000m of the yen loan in relation to the f which is the functional currency. In hedging this relationship, it would be
largely efective based on the illustrative data. I he yen has strengthened, increasing the *6,000m element of loan liability by £3.85m (see below) but there has been a corresponding increase in the
fair value of the forward contract which has become a financial asset with a fair value of t3./3m, creating a gain of the same amount. Ihere is an ineftective element of t0.12m, but this is small.
The question arises as to whether the correct currency relationship has been hedged. The ¥6,000m excess element of the loan is being invested in India, not in the UK, so the production director is
arguing that this should be the hedge (yen/rupee). This argument has some merit if we are matching currencies on a transaction by transaction basis (see below).
However, a weakness of the above analysis is that it attempts to hedge individual transactions. A better approach would be to consider the net movements and balances on all ILAs foreign currency
activities and then attempt to hedge these. Given that no previous activities have been in Japan, a no hedging policy would leave open the yen exposure for the full ¥32,000m from the date of
receiving the loan, up to the commencement of expenditure on construction or receipts from revenues.
Production director comment

The argument that a currency forward for ¥6,000m is not necessary has been put forward by the production director
It is reasonable that the currency forward contract is unnecessary as there is a much simpler solution. All that is needed on receipt of the ¥6,000m cash from the loan is to convert to fs (or to rupee)
immediately on receipt.
The production director may also have made the argument on the basis that the expected revenues to be generated in yen would exceed interest costs and so there is natural hedging. This argument
has merit once the park is open and generating revenues, but there is a time gap between taking out the loan and when the park opens, or construction expenditure begins, during which there is a
potential yen exposure on the full ¥52,00m and interest payments without matching yen revenues.

The loan is denominated in yen and is a monetary financial liability that will be retranslated in accordance with IAS 21 at each reporting date using the £/¥ closing exchange rate as follows:
As the f is assumed to have depreciated against the yen during the 3-month period 1 April 2021 to 30 June 2021, the tair value ot the ¥6,000m element of the loan being hedged (expressed in Es)
increased, resulting in a foreign exchange loss of £3.85m.
The fair value of the currency forward contract has increased from nil at inception to an asset of £3.73m (gain)
ILA has constructeda currency hedge by entering into the currency forward agreement and the gains/losses on the forward should oftset the majority of any future losses/gains on the loan from
movemets in the t/yen foreign exchange rate.
ILA measures its loan liability using the closing exchange rate and the currency forward is a derivative measured at fair value through profit or loss (FVTPL). As a result, the fair value movement match
under normal IFRS 9 measurement rule and there is no accounting mismatch. Hedge accounting is not therefore required for the gains and losses on the hedged item and hedged instrument to be
reflected in the statement of profit or loss in the same period.
The journal entries to recognise the currency forward are:
Dr Financial asset £3.73m

Cr Profit or loss - gain in fair value of derivative £3.73m
The hedge is clearly, but not perfectly, effective.
¥26,000m element of the loan

Additionally, there will be a further unhedged foreign currency exchange loss of £16.667m [(¥26,000m)/130) - (¥26,000m/120)]. This will be a foreign exchange loss on monetary liabilities recognised
through profit or loss.
Loan value at start 200.00 m
Loan at YE 216.6666667 m
Gain/loss - 16.67 FX loss
Candidates are required to:
(3) Set out the key assurance procedures to be carried out by Perkins when assessing the reasonableness of each of the torecast cash receipts and payments and the underlying assumptions. lgnore
ethical issues.
(4) In respect of the proposed assurance engagement, including the comments by the chief executive, Harold (Exhibit 4):
Set out any ethical implications for Perkins and Harold.
Recommend actions that Perkins should take.
(5) With respect to the proposed yen loan and currency forward contract (Exhibit 5):
Explain the foreign currency risk on the ¥32,000 million loan. Evaluate the extent to which the forward contract hedges the risk and respond to the comments of the production director.
Using the illustrative data, set out and explain the financial reporting treatment of these transactions in the financial statements of ILA for the year ending 30 June 2021.
48 Inclass Page 121
Share price
Jun-20 3.23
Jun-21 2.25
Tight deadline for release statements
1 13
2 8
3 8
4 7
5 8
44
Extracts - key financial data at 30 June

2020 2019 % change
£m £m diff
Market value of non-current assets 610.0 630.0 - 20.0 -3.2% No captial acqiored nor investment in assets
Loans – 2.8% bank loans 2028 330.0 330.0 - 0.0% this has to be paid 7 years
Share capital – £1 ordinary shares 80.0 80.0 - 0.0%
Reserves 185.0 170.0 15.0 8.8%
Extracts - statement of profit or loss for the years ended 30 June

2020 2019 2020 2019
£m £m Op margin 17.9% 22.7%
Revenue – attractions (entry tickets) 139.0 145.3 - 6.3 -4.3% fall inline with the vistors fall ie 5.46% average
Revenue – other 55.6 58.1 - 2.5 -4.3%
Variable costs - 16.7 - 17.4 0.8 -4.3%
Fixed costs - 153.0 - 153.0 - 0.0%
Operating profit 24.9 32.9 - 8.0 -24.3%
ROCE 4.1% 5.4%
Analysis by leisure park for the year ended 30 June 2020

UK US India UK US India
£m £m £m ROCE 5.4% 5.9% -1.1%
Revenue – attractions (entry tickets) 60 63 16 Op margin 19.7% 23.2% -9.5%
Revenue – other 24 25.2 6.4 Rev per attraction 42.00 49.00 28.00
84 88.2 22.4 Rev per attraction 840,000.00 1,102,500.00 448,000.00
Variable costs -7.2 -7.56 -1.92 Controbution 76.8 80.64 20.48
Fixed costs -65 -66 -22 VC % of total 10% 10% 8%
Operating profit/(loss) 11.8 14.64 -1.52 FC % of total 90% 90% 92%
Revenue – attractions ( 43.2% 45.3% 11.5% 100%

Revenue – other 43.2% 45.3% 11.5% 100%
Variable costs 43.2% 45.3% 11.5% 100%
Fixed costs 42.5% 43.1% 14.4% 100%
Operating profit -46.8% -47.5% -15.8% -110%
Other operating data for the year ended 30 June 2020
UK US India
Average price per entry ticket £ £30 £35 £20
Number of attractions 100 80 50
Market value of noncurrent assets £m 220 250 140 610
Number of visitors - Year to 30 June UK US India

000's 000's 000's
2017 Visitors 2,200 1,780 600
2018 Visitors 2,150 1,810 700 -2.27% 1.69% 16.67%
2019 Visitors 2,120 1,830 880 -1.40% 1.10% 25.71%
2020 Visitors 2,000 1,800 800 -5.66% -1.64% -9.09%
Overall the company sutained a increase in reverses by 88%

this is different to fall in operating profit of 24.3%
The ROCE for UK and US are inline and show the stable market
India however is negative as we made a loss for the year
US seems to be doing better operating margin wise than UK as this is due to smaller fixed costs
A reason behind this could be valid
Variable costs seem to be of simialr split ie 90/10%
Revenue per attaraction is £42 compared to £49 were as the India is hlaf this at 20
revenue per attraction seems to also be signicantly less
As the UK and US are mature makets it is important that they take 10/15 years to do so
ie opeing 2016
£20 price
Attrition revenue not enough in India
Jun-20 Apr-21 2023
Amount per annum
Japan NPV ¥m
Revenue - attractions 10,000
Revenue- other 4,000
Variable costs -1,200
Incremental fixed costs -8,450
4,350
Investment -26,000
PV perp @ 10% 43500
DF 0.91 0.83
- 23,636.36 35,950.41
NPV 12,314.05
48 Inclass Page 122
Number of attractions 70
Assumed exchange rate £1 ¥130
Discount rate required 10% pa
Average price per entry ticket Y4,500
Benefits
generates a sign NPV 12.3bn ten
will appease investory who are concerned at firms poor results
Risk
Figures are optimisic
no certainty of success - culture acceptence
Significant investment requred and exit strategy are issue
Ability to contruct in 15m
Yen devlaution
Fin risk
Interest paybale excesssive 36bn x 2.25% = 6.2m
breach esiting converants
Puntive collerail on assets and revenue and floating charges
Recommediation
additonal nalaysis
produce a more realise appriasla - director not sure
apply stress tests s
Situation analysis and senstivty anaylsis
Unless the value can be veriffed with certainy I would reject due to financial risk
Invest in India through with flexible pricing rather than new Japan
Loan
Yen 32,000
40 years term
Investment in Japan 26,000
Improve India 6,000
Interest 2.25% 720
6m loan
Exchange rate
1-Apr-21 130
30-Jun-21 120
Est fair value of contract 4
Loan value at start 46.15

Loan at YE 50.00
Gain/loss - 3.85
Hedge at start 4
Gain - 0.1162
If we did not hedge we would incurre a loss of 3.85m

But as the fair value is 3,730
Financial asset Dr £3.73m

Profit or loss - gain in fair value of derivative Cr £3.73m
The hedge howeve overs this and only a loss 116 is recognised
The loan is converted to £ from Yen at the year end Rate - IAS 21
As the £ has depreciated agaisnt the Yen by 10 during 3 months the fair value of 6m element is hedged
therefore ex change rate loss 3.85m
The FV of forward from Nil to incept ie 3.73 m
By entering into forward agains the gain.loss on forward offset the loss on the loan
the movements being FX changes
Loan measused YE rate

Forward derivative measured FV rate - PL
Under IFRS 9 they are matches and measurement rule and there is no accounting mismatch
Hedge accounting is not required for gain on loss on hedge as hedge instrsutment to be
reflected in the statement of profit or loss in the same period.
The journal entries to recognise the currency forward are:
26m loan
Loan value at start 200.00
Loan at YE 216.67
Gain/loss - 16.67
Additionally, there will be a further unhedged foreign currency exchange loss of £16.667m
This will be a foreign exchange loss on monetary liabilities recognised
Producton director
Says should be REUPEE's
we would need to see the contracts that would be could be in multiple currencly
45 Inclass Page 123
They have issues forcesast

as they manufactor they don’t know how much to sell
therefore don’t know how much to manufactor
Hinez
Operational Issues
FX Risk
Finance expansion
Exhibit 1
High quailty goods
Fresh goods
Ingreidents are perishable
Soup - 10 days use If we predict this wrong then can be disregarded
Others 1 year life then under product they will miss out on sales
88 Porducts
Don’t make products for anyone else
Don’t sell to UK directly - retailers do this
up market retailers - ie low end could be option
One factory we are Niche products sell in the UK

Inventory to low level
Uses own vans do we want to oursource
60% customers are 120km
10% over 500km
More distance = more discto costs
Min order £250 - free delivery
Director/ShareholderBoard role Shareholding (number of ordinary E1

Carol Naylor CEO 400,000 40%
Alison Rimmer FD 400,000 40%
Craig Naylor MD 200,000 20%
1,000,000
Craig is Carol's son
They out vote Allision
Extracts from SSS financial statements for years ended 30 September

2019 2018
£'000 £'000
Revenue 74,400 76,300 -2%
Gross profit 25,200 26,300 -4%
Operating profit 7,500 8,600 -13%
Property. plant and equipment 33,600 32,700 3%
Loans 13,900 12,900 8%
Net assets 18,700 15,700 19%
Working capital:
Inventories 1,800 2,500 -28%
Trade receivables 9,200 8,100 14% super markets paying late
Cash 1,600 3,600 -56% 2 m used liquidity is an issue
Trade payables 12,700 14,700 -14%
Summary
Niche mani
Seek to expand international and fixed domestic issue
Financial performance and luquidity issues
Benefits of more accurate and detailed analyses of sales forecasts

Sales are weekly and vary in order due to customer, season and location
If we change reports to season can gain more accrurate idea of sales thus changing production accordily
We caputre this data but do not use it and we have an issue of knowing what customers actually want poor feedback
from retailers
We had 1 failed marketing capains and as a result inventory build up but this was wasted
causing a damage of relationship with suppliers therefore could impact our level of sales in the future as we can
lose them as a customers
June was a success as a result we lost out on sales as did not build up level of stock to sell
therefore we can review why march failed and June was a success
this may be due to seasonal nature of the goods
Weather is a key factor but this can be down to seasonsal changed
Popular TV programs we may use to target and use our productrs to increase our sales
If we are forecasting sales for 2 weeks im sure we can review TV program for 2 weeks as well as weather forecasts
this will give use a greater understanding of when we need tobuild inventory and not waste goods
We are also keeping our relationship with retailers happy.
Production schudeling
Inventory management
Prevent wastage. High inventory is also tying up cash
damaging liquidity.
Cash management - Better forecasting of production costs will also lead to better short-term cash management.
(2) Data capture and data analytics

Identify and expalin data SSS captured
Age is useful to see demographic and who to market too
address
Occupation key as we are high end therefore who is buying our goods can predict level of disposable income
45 Inclass Page 124
we can view location to nearest store and work out again more acuratly where are sales are coming form which areas
We should be capturing how many products are purchased and get the most views, clicks or downloaded receipts on the website
we need to look at which 88 products are used and why
if the types of products are not being predicted correcly
then we have issue of substitute for each other
The issue with perishable goods is that they need to be reviewed daily as they need to get to customers intime
so that they can be used before 10 days
A georgpraical spread of sales is importatn as lead times for items away from factory take longer to deliver therefore
may not sell as much fresh perishable goods
Unpredictable volatility based on current data availability is an issue
for eample sales data no follow pattnern on historic
given that yearly sales are similar when we look at weeks no patterns can be viewed and unpredictable
we need information quickly to make judgement calls rather than monthly
need customer ie retailers and cosumers
Historic data does not tell us about future
Customer - ie retailers
What promitions are they running
what other goods simialr to ours are they selling
info from customers as part of CRM
understanding of makret they work in and behave
how they price products simialr to ours and what future prices are like
Consumers
wesbite data, social media and other data explained
For our social media we can run poles for new products
get customers to rank our goods
compare the ages of people using
ask for the reasons why people like our goods
download of receipts and which is more popular
Data analytics
Historic data may be useful. eg customers may be willing to release data on SSS product sales collected by their
bar codes. This could then be collected for all customers to establish a big data set, to which data analytics could
be applied to analyse point of sale information on SSS products (timing, amounts purchased, price charged).
More indirectly, data relating to the usage by customers of the SSS website and social media may be usefully
analysed. Increased activity (in terms of the number of hits) may be lead indicator for an increase in future sales.
More specifically, the hits on the web page for each type of product may indicate increased sales for that product
in the near future. Ihere needs to be predictable patterns in the link between the number ot hits and future sales
and the lag between them. Algorithms applied to this big data may be able to discern such patterns to provide
better forecasts of sales.
This internal data could be combined with external data to help predict demand.
The number of hits on the SSS website from individual consumers may give some clues. Retailers could be
informed it demand predictions were to be related to a specific geographical area. Ihe downloading of discount
vouchers may be a particular feature as retailers near where the consumers live could be warned of an increase in
expected demand based on the number of vouchers downloaded in the local area.
SSS could more actively use social media to predict consumer behaviour. For example, their use of blogs, vlogs,
twitter feeds etc. SoCial media analytics allows companies to measure quantitatrve metrics such as the number of
times its Facebook account has been 'liked' but also capture qualitative data. For example, key words posted by
customers about the organisation's products can be used to perform 'sentiment analysis' which would allow SSS
to respond to relevant activty and trends.
More general external data could also be used, such as weather predictions if there is an established link between
types of weather and demand for SsS products. Also any popular cooking programmes on IV may produce a
short term surge in demand which could be analysed based on historic data.
demand by
perishable goods - correct - no subsitues
demand of non perishable goods
georppahica location
awareness of tastes and consumption
demographics
pages popularity
occupacty do our goods sell do we sell to high end indivualds
externalietes
global demand - stock pile
customer recommedations and codes
weather oullok
seasonlity
France
Sell directly to customers
3rd party couries made in UK
Min order EURO 60
20% higher prices Price 60.00
Fixed delviery 10 EUOR Euro UK price 50.00
Actually cost 18 EURO delivery take /1.2 41.67
gradually building to french retailers add the diverly 8.33
3m EURO investment
Geographical Loss on delivery
Belief is not enough Diff in delivery 8.00
45 Inclass Page 125
How do we identify 1.2 covered 6.67

Small again 1.67
Allison said to sell to retailers

this is what we are good at
Benefits and risk of entering into french market

Selling online to indiviudals
benefis of selling is that we have had good success with a small pilot study we did
we increase our understanding of the french market
we have standing of long term customre which looks promising
the market for high individuals seems to be there with high uptake
We can make a greater margin based on the delviery offset ie 1.67
Save delivery as couire would perform this
Have the capacity to the UK
Wesbite is already up and running just small number of changes needed
No fixed french
can be exporter and can be toe in the water
Risk
We ususlly sell to retailer and have an undestanding relationhip with them
we are not aware of actually what customers want therefore can not
know what how much to produce for the french market
the min order seems high for individuals who want to purchase this and can
be off putting total min spend is 70 euro for suaces and spreads
Was the adversting a success in the magazin
What was the market like
Does the free sampling mean that customers want the goods or is it because it is free
it seems we have not tested and tried to use the above model. We are potentially going to
fast too quickly therefoe failure seems more likely as we don’t know the market as
well as we think we do.
Network of retailers
benefits
We undeerstand retailering and have expertise in this are
Can build a foothold in the market and copy the UK model which has proven to be
successful
large market with potentailly moree customers
Risk
We FX risk this is due to flucations of euro and can impacct our margin
we may expierence longer credit terms
the 10 days perishable goods may not last as long as they could in the UK
this will result in more luqidity issues for the bussiness
as cash is tied up in debtors
gaining the contract with retailer may take longer than expected
losses might arise because of this
We would need to delvier in our vans and this again same issues with the UK market
in terms of georgraphical sales
Recommedaition
Despite the risk of retailers there they seem to be perfered choice and
current operations
Financing product
Arragement 1
Loan EURO € 3,000,000
Mach 2020
zero coupon
redeemable € 3,510,000
Mar-24
4 years
take 3.51/3 ^ -(1/4) 0.9615094003919
Less 1 3.85%
Interest charge € 115,472
6 months payment € 57,736
Average 6 m rate rate 1.19 £ 48,518
Carried forward € 3,057,736

at year end rate 1.18 £2,591,302
Interest paid in euro

Natural hedge euro sales to interest
but this is not till 4 years down the line
Amount - compared to 1.20 per £1 - this is for option 1
4% rate average growth forumla
3.84% compund
cash flow Impact until 2024
commitment to a 4 year loan is dangerous if we exit before then
would pay 57,000 every 6 mnhts
foregin currency risk both natual edge
45 Inclass Page 126
duration acceptable for as long as SS remains active

Advantage is the luqidation is presented as no interest is payable over 4 years
the interest in just added to the loan at the year end
exposed tif poreject curtailed prematurely
Arragement 2
Currencey swap
4 year loan 3.50%
2,500,000
Interest charge 87,500
Cover into today rate 1.2 £3,000,000 1.0192
1.0192
French bank -1.9%
currency swap 3.80% 0.019
3,000,000
Interest charge 114,000
6 months payment x average rate 1.19 95,798
using the forward rate 2024 1.25 2,400,000
£/€ spot exchange rates:

At 31 March 2020 £1 €1.20
At 30 September 2020 £1 €1.18
At 31 March 2024 £1 €1.25
Average £/€ exchange rates for:
Year to 30 September 2020 £1 €1.21
Six months to 30 September 2020 £1 €1.19
the euro was weakned

and this was gone
Counter party risk they might not pay us back
swaps
allow SS to borrow demostic market
direct in france pay higher at 3.8%
provided a garudanted fx rate 1.2
provided a hdege against the interest payment which inline with renue
transaction costs of swap marginally higher than straight debt
default risk with counter parky exposed to £ of loan lower rate of 3.%
Recomndation
Neither should obained until firm is convicend that the project will last 4 years
thus defer acquistion of debt until a time which it becomes cleart
a firm should avoid the swap due to credit risk
as the cost is marginal
EURO demoniation of loan - Financial reporting treatment
Use average rate

we are historic information that is preceise
future predctions
revenue will be 1.21
interest 1.19
the 6 month effeie rate

4 % ^(1/2)-1
1.98%
interest 1.98%
laon 3,000,000
59,400
Canadian Market
Dollar $
new factory 34,000,000
Has relationhip with 300 supermket
Purchase 4,500,000
2021 2022 onwards

C$'000 CS 000
Revenue 9,000 14,500
Manufacturing costs:
Variable -2,100 -3,300
Fixed -4,950 -5,300
Administrative and distribution c -2,205 -2,500
Operating (loss)/profit -255 3,400
WACCC 10%
Exchange rate 1.7
this appreciate against £ 1%
2020 2021 2022 2023+

45 Inclass Page 127
2000 x 1.01/ (0.1-.01)

Cash $ -34,000,000 - 255,000 3,400,000 3,400,000 interest 10% and app 1%
Ex rate 1.7 1.7 1.7 1.7 PURP growth 1% each year
Cash £ - 20,000,000 - 150,000 2,000,000 2,000,000
prep with 1% growth 11.222222222222 as appreciate we get more $ for £
Rounded DF 0.9090909090909 0.8264462809917 0.826
PV - 20,000,000 - 136,363.64 1,652,892.56 18,549,127.64
NPV 65,657
Benefits
Expansion into the new market where population is more receptive to UK brands
Potential follow on oppurtines into US and areas
Logics are no longer an issue with couries
locating in canda will avoid trade barries
Risk
high cost of capital lead to signicant dadmage to firms value if market rejects the new brand
WACC might no be accurate and need to be reviewed
We might be selling the machinery or produce on licence for other firms
We can be over reliant on Flom Inc who indicate they will acqure 4.5m (1/3) of revenue
Recommediation
NPV genraltes no vlaue for investors , I would proceed with opportunity
Financing
20 m needed
IPO
New shares 315,000
Issue 20,000,000
Share price 63
New shares 315,000 24%
1,315,000
Loss of control Carol and Craig now have 45%

They have liquity
Raise the profile
Procedures needed and stock exchange regulations
Private equity
New shares 340,000
Issue 20,000,000
Private equity 340,000 25%
1,340,000
They have right NED
this might be a good thing
Balanced Board
NED bring in different insight
Ethical issues
Transparency issues as not to tell them
£1,800 of goods
Could be a brieb £1,800 of product

49 Page 128
Argoc Inc
Listed NYE stock exchange
Operates in Europe Asia and America
New board Oct 2020
Revenue E&A American

Manu and suppliers $m $m
Farm Vehicles 1,116.00 682 1,798.00 62.1% 37.9% 100.0%
Farm Equipment 669.6 1,500.40 2,170.00 30.9% 69.1% 100.0%
Small componets 446.4 545.6 992.00 45.0% 55.0% 100.0%
2,232.00 2,728.00 4,960.00 45.0% 55.0% 100.0%
Gross profit E&A American

Manu and suppliers $m $m
Farm Vehicles 558.00 341 899.00 62.1% 37.9% 100.0%
Farm Equipment 133.9 300.10 434.00 30.9% 69.1% 100.0%
Small componets 111.6 136.4 248.00 45.0% 55.0% 100.0%
803.50 777.50 1,581.00 50.8% 49.2% 100.0%
GPM
Farm Vehicles 50% 50% 50%
Farm Equipment 20% 20% 20%
Small componets 25% 25% 25%
36% 29% 32%
Relative performance in year to 30 June 2020

In terms of revenues, America is the larger region at 55% of company sales, compared with only 45% for E&A.
However, in terms of gross profit E&A is larger making up 51% of total company gross profit.
Care needs to be exercised in judging performance based on gross profit rather than net profit but qualified conclusions are based on the information provided.
A superticial conclusion would be that the American region is larger in terms of revenue generated, but the E&A region is more efficient as it makes more gross profit from a smaller revenue base.
However, such a conclusion would not be valid on closer inspection of the data.
There are equal margins for each division on all three types of product. However, E&A makes more of the high margin products in the sales mix. This decision of where to locate production could be
managerial choice, history of acquisitions or based on location of sales. However, E&A operations do not appear to be more efficient than American operations given equivalent margins for each
product. The explanation for the difference in productivity therefore lays in the sales mix.
Specifically, for America, equipment sales are dominant, while vehicles sales are dominant for E&A. This is true within divisions and between divisions.
Trends and implications -performance of each product type

E&As superior performance in terms of gross profit generation is dependent on dominance in sales of vehicles which have high margins. However, the graph shows revenue and gross profit from
vehicles has been in decline. If such a trend continues, then E&A will be proportionately affected more than America, although both divisions and the company as a whole would suffer
Sales of equipment have also been in decline, but the rate of decline is much less pronounced than for vehicles. However, gross profit is fairly flat. If the trend of sales decline continues however then
gross profit may be more affected. In this case, America will be proportionately more attected than E&A, although both divisions would sutter.
Sales and gross protits of small components have increased marginally. If such a trend continues, then America will benetit more than E&A, although both divisions and the company as a whole would
also b
Taking all three products together, there looks to be an overall decline for company in sales and (to a lesser extent) gross profit due to the decline in the two largest seling products.
benefit.
Supply chain and production scheduling

Improve effeciency
reduce costs
manage risks
Proposal 1 Centralised management

Benefits
Centralisation of one common system of supply chain operations and management control gives consistency and co-ordination across regions, products and suppliers. I his removes inconsistencies
between devolved management and incompatibility between different intormation systems.
Globally managed functions for production will lead to more consistency in production methods and practices throughout the company. Similarly, globally managed supply chains will lead to more
consistency in internal activities and in relationships with external suppliers throughout the company.
These global functions are more consistent with global management as there is common reporting across geographical regions.
Greater consistency can aid economies of scale and economies of scope leading to reduced costs to suppliers which could be passed on, in part, to Agroc.
There are greater incentives and efficiency in monitoring consistently the quality provided by suppliers.
Risks
There is a risk of slow centralised decision making which responds slowly to changes in conditions
Local knowledge from local decision making may be lost
Differences in geographical conditions and cultures may not be accommodated in a commoncentralised management system.
Proposal 2 Upstream supply chain information system

Benefits
Digitisation can encompass the automation of Agrocs operations and processes. It can extend across all aspects of the supply chain.
Having good information helps Agroc to use its supply chain assets more effectively and to coordinate supply chain flows in order to increase responsIveness and reduce costs. I his helps in
integrating Agrocs systems thereby helping managers coordinate production, resources, procurement, inventory, orders, invoicing and payments.
Integration of Agroc's procurement, inbound logistics and production systems means greater efficiency and reduced costs (eg less inventory, no delays, improved work planning)
Consistent, reliable and prompt data and analysis about facilities, inventory, transportation, costs, prices and customers throughout the supply chain also enables better planning and co-ordination
throughout the supply chain. Information for Agroc is potentially the most important driver in the supply chain because it atfects each of the other drivers.
Linkages with suppliers enable them to predict and plan for future deliveries (anticipate needs) rather than respond to requests as they occur, which may delay deliveries and increase costs.
RFID tags, attached to materials or inventory, enable Agroc to track the movement of inventory between locations more accurately, and to get an exact count of incoming items and items in storage.
Electronic data interchange (EDI) enables Agroc to have instantaneous, paperless purchase orders and invoicing with suppliers.
Inventory management - in order to respond to customer demands, Agroc can hold large amounts on inventory. Alternatively, it can have agile production and delivery to meet changes in customer
demand and this requires an etficient supply chain. The digital plattorm enables anticipation of supply needs and therefore less inventory to be held by Agroc. This lowers inventory holding costs and
reduces stock out risks.
Al improves predictive ability but also learning from experience and enabling constant improvement
Integration of Agroc's procurement, inbound logistics and production systems means greater efficiency and reduced costs (eg less inventory, no delays, improved work planning)
Risks
Cost-there is a risk of greater transport costs of movement of goods internally between locations and externally from suppliers and to customers. This is not just greater geographical distance, but
may also include cross-border taxes, tariffs, duties and regulatory compliance costs.
Disruption - the change in structure and global locations is likely to cause disruption of processes and systems with some temporary loss of output and efficiency.
Increased reliance on each supplier. Greater dependence of suppliers, particularly in sole supplier arrangements, may weaken Agroc's negotiation position.
a key supplier fails, there may be risks of security of supply if alternative suppliers are not available at short notice.
Cyber risks may occur by sharing T systems with external providers such as suppliers.
There is a risk that the IT system will fail to deliver the benefits to cover the costs of installation
Risks of successful installation of a workable system within the budgeted price.
Propsal 3 - Global production of farm vechiles

Benefits
Greater volumes of identical products can generate economies of scale and synergies in production tor Agroc. Ihese come from longer productions runs, high volumes of standardised vehicles with
common parts and the learning curve.
Concentration of production in areas of excellence. The data provided does not suggest a difference in efticiency between regions, but there may be etticiency ditterences within regions where
production can be focussed.
Low cost regions. Agroc may be able to lower costs of production by concentrating production in lower cost regions (eg South America or Asia), rather than spreading production globally to include
higher cost regions (such as the US or Europe).
There may be economies of scope from delivering froma central production source. While the transportation distances may be longer, a more planned distribution system for larger quantities may
enable some cost savings.
Central production may facilitate a refocus on suppliers and inbound logistics where activities are concentrated in one location.
Focussed managerial responsibility under the control of a new global production director provides specialist production expertise anda direct reporting line to the board on production activities.
Currently production is dispersed and under the control of a number of non-specialist regional directors.
Risks
Increased transport costs may be incurred due to greater geographical separation arising from the decrease from 45%6 to 30% in the proportion of Agrocs products being sold in the same country
in which they are manufactured.
Transition costs and disruption from the change to global production need to be considered, particularly if new larger factories are to be built.
In addtion to internal costs ot distribution, there may be increased costs to existing suppliers it the location of production activities moves. Ihis may also extend supply chains with resulting9
uncertainty in lead times.
There may be dificulty in finding new suppliers if changes in suppliers are needed.
Chief executive's suggestion
49 Page 129
The idea of the chief executive enhances the degree of specialisation at the lower level of tractor engines, rather than only at the level of complete vehicles.
This tends to enhance some of the above benefits in, for example, giving greater economies of scale and specialisation in production.
However, it also creates greater costs of transport for internal supply chains.
There are also greater problems of internal communication and co-ordination in making parts to a vehicle in different factories in different locations.
It may be possible to standardise production of engines for different vehicles (eg same engine in a small and mid-size tractor). This could give greater production efticiencies from even longer
production runs for engines.
Chief executive's suggestion

The idea of the chief executive enhances the degree of specialisation at the lower level of tractor engines, rather than only at the level of complete vehicles.
This tends to enhance some of the above benefits in, for example, giving greater economies of scale and specialisation in production.
However, it also creates greater costs of transport for internal supply chains.
There are also greater problems of internal communication and co-ordination in making parts to a vehicle in different factories in different locations.
It may be possible to standardise production of engines for different vehicles (eg same engine in a small and mid-size tractor). This could give greater production efticiencies from even longer
production runs for engines.
Downstream supply chain - customer order mgnt, inventory mgn, outbound logistics and customer service
(a) Level production and sales
Production levelling involves smoothing production output over the year which assists production planning. However, unless there are wide variations in inventory levels (with associated costs) then
demand levelling and distribution levelling in the downstream supply chain need to be co0-ordinated with production levelling.
Where production is global (eg for vehicles) then production levelling can be focussed on perhaps only one factory. Where production of the same product is at several sites (eg for farm equipment
and components) then production levelling will need to be coordinated with demand in each area.
Key benefits from level production include:
Maximising plant utilisation
Facilitating predictability of supply requirements for suppliers
Smoothing labour requirements which may mean lower overtime and fewer short-term stafting premiums being paid.
With ideal co-ordination between production and distribution output will be shipped out to customers on the day of production, thereby minimising inventory held by Agroc.
At the other extreme, if production is not smoothed, then Agroc's factories may reach capacity in trying to meet demand in the peak season. Similarly, there may be unutilised capacity in the low
season. Both of these create inefticient use of Agroc s assets.
f production is level, then requirements for pats and components from suppliers are also likely to be level, meaning there is greater predictability of Agrocs needs from suppliers which is enhanced
by the new technology platform but may reduce the benefits of such a platform given the predictability of the level requirements.
Similarly, requirements for labour are more level, thereby reducing overtime payments in the high season or reduced working hours in the low season. Labour recrurtment is also tacilitated.
However, in the absence of demand levelling the counterpart of production levelling is uneven inventory levels.
Demand levelling involves caretul management of the sales pipeline and good relations with dealer customers. A key problem for Agroc in doing this is that it operates in an industry where demand is
seasonal.
As Agroc operates in both the Northern and Southern hemispheres, there may be a partial offset of seasonality for low and high season demand in the agriculture industry. This may help demand
smoothing a little. Nevertheless, there appears to be a significant seasonality issue.
Incentivising dealer customers to buy out of season is key to success. A key issue for dealer customers is that if delivery of goods is to be made out of season, then the period before sale may be
signiticant. Dealer customers therefore need to be incentivised if inventory holdings are to be shitted down the supply chain.
The finance director's proposal aims to share the inventory holding costs with dealers by Agroc incurring the financial cost of holding inventories through an interest free loan. The marketing director
goes further by proposing that Agroc takes on the risks of unsold inventory by offering a 90-day right of return.
he direct tinancial cost of Agroc making loans to customers is the need to borrow to finance the loans. Unless the terms of the loans taken out by Agroc match those of the loans to dealers (period,
interest rate, fixed/variable, currency) then there is a potential mismatch risk where costs may be greater than expected if financial market conditions change unexpectedly.
For dealers, they still have the cost of inventory storage and risk of damage, but they benefit from having inventories always available to meet their customer needs. Indeed, dealers may in turn
provide incentives to their own customers (tarmers) to make purchases out of season to shift inventory storage costs further down the supply chain.
There is an additional bad debt risk to Agroc from this policy. Most customers are SMEs and if they are holding inventories from Agroc and become insolvent then Agroc may not be able to recover
erther the sums due on the outstanding loans or the products supplied.
Marketing director
The marketing director goes further by proposing that Agroc takes on the risks of unsold inventory by offering a 90-day right of return. This will provide greater incentives for dealer customers to make
more purchases out ot season and enhance the probability of level monthly sales over the year.
However, with the marketing director's suggestion, there may be the incentive for dealers to over-order and hold excessive inventories to offer more choice to their customers. However, this shifts the
costs and risks of returns onto Agroc (eg damaged goods, disputed returns, transport costs).
(b) Loan financing arrangement for dealers - Financial reporting treatment

New propsal - level production and sales
12 months delivery
make interest loan to dealers 12 months to fiance purchases
eg loan finacing incentive for dealer
31-Dec-21 Rate
Sold $ 55,000 1.1 $ 50,000
Cost $ 44,000
Interest fee loan $ 55,000

Repayable date sales or 31 Dec 2022
Finance director's proposal

In accordance with IFRS 15, as there is no right of return, then pertormance obligations have been satistied on physical delivery of the tractor when control of the produet passes to the customer.
However, the contract includes a significant financing compornent (per IFRS 15 para 60-62). The implicit interest rate is 10% pa based on the terms of an arm's length separate financing trarnsaction. This
would give an implicit cash price of $50,000 ($55,000/1.1).
A sale can therefore be recognised on 31 December 2021 with the following entries:
Dr Loan financial asset S50,000

Cr Revenue $50,000
Dr Cost of sales $40,000

Cr Inventories $40,000
If the dealer is unable to sell the tractor before 30 September 2022 then Agroc can take credit for interest up to that date being $50,000 (1.1)9/12- 1)- $3,705
Sold $ 55,000 1.1 $ 50,000 even if interest free would have to record entry
1.1 (rate) x Power 9/12 0.074
$ 3,704.97
Thus, at 30 September 2022 the entries are:
Dr Loan financial asset $3,705
Cr Interest income $3,705
If the dealer is able to sell the tractor before 30 September 2022 then Agroc can take credit for interest income up to the date of that sale. Agroc would also recognise a gain on the settlement of the
loan asset equal to the unaccrued interest income at that date. Ihe total of the interest income recognised and the gain would be $5,000.
Marketing director's proposal

Per IFRS 15IE137, Agroc does not recognise revenue on delivery of the tractor as control of the product has not passed to the customer given the right of return and that there is no historical evidence
given this is a new proposal.
On delivery on 31 December 2021 the following entries take place:
Dr Asset for right to recover tractor $40,000
Cr Inventories $40,000
During the 90-day right of return period, no interest income is recognised as (per IFRS 15 para 65) as no contract asset is recognised.
If the tractor is sold by the dealer or the 90-day period elapses without a return, then the sale and interest income can be recognised as above.
50 Page 130
Zatter PlC
London stock exchange
FFF provided advice and assurance service
Zatter interantional company

HQ in UK
Makes R&D
30-Sep-20 YE
Potentail Acq of Minix Ltd

5 directors each 20% shareholders
Incopr 2017
issue with scaling up for large scale comm production
Free cash flow method to determine value

Incentives 5 directors to work 3 years after acq
Cash offer of 35m for SC early negotations
£'000
Minix- summary statement of profit or loss for year ended 30 September 2020
Revenue 14,000
Cost of sales -4,500
Depreciation and amortisation -500
Other operating costs -4,000
Operating profit 5,000
Finance costs -1,200
Profit before tax 3,800
Taxation 20% -760
Profit after tax 3,040
Summary statement of financial position at 30 September 2020

Property, Plant and equipment 19,100
Development costs and patents 11,300
Current assets
Cash 100
Other current assets 1,400
Total assets 31,900
Equity
Issued capital - £1 shares 500
Total equity
Loan 24,000
Current liabilities 750
Assumptions
Prosal 1 Oct 2021
Depn increase 250,000 per annum then consent after 3 years
Captial expendire 1m Sept 2021 and increase 250 and consent after 3 year
Depn tax allowable
tax rate 20%
WACC 10%
No working capital needed
Propsal 1 -100% Share capital

Founders = Ees
EDITDA of 12% growth 3 years
WACC 10% 1 2 3 3+
Free cash flow 2020 2021 2022 2023 2024+
EBITDA 5,500 5,500 6,160 6,899 7,727
Depn - 500 - 750 - 1,000 - 1,250 - 1,250
5,000 4,750 5,160 5,649 6,477
Tax 20% - 1,032.0 - 1,129.8 - 1,295.4
Pls depn 1,000 1,250 1,250
CAPEX - 1,250 - 1,500 - 1,500
FCF 3,878 4,269 4,932
DF 0.90909091 0.82644628 0.751315
3,525.45 3,528.40 3,705.25 37,052.47 (4,932/0.1)/1.1^3
NPV 47,811.56
Debt -24,000
Equity 23,811.56 value of SC
Proposal 1-100% of Minix's share capital

The acquisition date is 1 October 2021. All cash flows prior to this date are therefore not relevant to the acquisition value.
The financial statements provided are to 30 September 2020. We do not therefore know the EBITDA figure forthe current year ending 30 September 2021 (ie up to the acquisition date). Given that
Minnex is "having problems scaling up its operations" it has been assumed that EBITDA for the year ending 30 September 2021remains at f5.5m (ie as for the year ended 30 September 2020). f
negotiations continue up to the acquisition date, then this assumption can be revisited based on profits actually being achieved in the current year.
Tutorial note:
Aternative stated assumptions are acceptable.
Using the working assumptions, an offer by Zatter for a 100% shareholding in Minix generates a value of £23,812,000 for Minix's entire share capital.
(2) Evaluate the proposals

Proposal 1-a 100% acquisition
Retaining the employment and motivation of the five directors (or most of them) seems critical to the future success of Minix in the next few years. It may be that after three years of working with Zatter
scientists, there will be knowledge transfer and the continued participation of the directors will be less significant.
Whilst Proposal 1 locks in the directors as part of the deal, there seems little to motivate them and a lower growth rate may therefore be plausible.
Using the value of £23,812,000, would give each director about f4.762m which may be sufficient for them not to work for material need again, depending perhaps on their age. This would reduce any
direct financial motivation.
There are risks with this proposal.
The growth rate includes synergy gains. To the extent that these are partly generated by Zatter then any offer based on the full f23,812,000 would allow the Minix directors to capture all the synergy
gains.
The use of Zatter's WACC as the discount rate is likely to be inappropriate as this reflects Zatter's risk rather than that of Minix. Minix's risk is likely to be higher as: it is unquoted with liquidity risk; it is
a new company; and it is fundamentally dependent on R&D projects which have significant uncertainty. A higher discount rate would give a lower value for Minix.
There is a 3% chance of failure of some key research projects which may render Minix's shares worthless. Minix directors will not participate in this loss if they have already received cash for all their
shares. To this extent, the risk appetite of Zatter and the Minix directors are not aligned.
Much of the value for the shares is in the long-term terminal value which is sensitive to changes in technology, markets, interest rates and personnel. Any such valuation is therefore subject to
significant variation - up or down.
The Minix directors have indicated that they would accept an offer of about f35m for the entire ordinary share capital, so an offer of f23,812,000 might not be accepted. However, the f35m may
just have been a bargaining position.
Propsal 2 - 80% share capital

20% remaining would be to the director
no longer directors ee on same salary
if profit at lease 20% per annum over 3 years
10% SC transferred giving them 30%
EDITDA of 20% growth 3 years

1 2 3 3+
Free cash flow 2020 2021 2022 2023 2024+
EBITDA 5,500 5,500 6,600 7,920 9,504
Depn - 500 - 750 - 1,000 - 1,250 - 1,250
5,000 4,750 5,600 6,670 8,254
Tax 20% - 1,120.0 - 1,334.0 - 1,650.8
Pls depn 1,000 1,250 1,250
CAPEX - 1,250 - 1,500 - 1,500
50 Page 131
FCF 4,230 5,086 6,353

DF 0.90909091 0.82644628 0.7513148
3,845.45 4,203.31 4,773.25 47,732.53
NPV 60,554.55 (6,353/0.1)/1.1^3
Debt -24,000
Equity 36,554.55
Proposal 2 -80% of Minix's share capital

Using the working assumptions, an offer by Zatter for an 80% shareholding and 20% remaining with Minix directors provides a 20% growth rate in profit which generates a value of f36,555,000 for
Minix's entire share capital.
The 80% shareholding could be reduced to 70% if profit targets are met but this is not cetain.
Amajority holding gives control, so it has a control premium attached.
A typical discount for a 75%+ majority holding in an unquoted company compared to a 100% holding is 5%. For the 80% shareholding this would give £34.727m (f36,555k x 95%).
A typical discount of a 50% to 75% majority holding in an unquoted company compared to a 100% holding isabout 15% (but perhaps as low as 10%). This would give £31.072m (f36,555k x 85%).
However, neither of these would be entirely credible, as the 80% or 70% holdings would be worth more than the 100% holding due to the incentive effects.
Also, there is significant dependence on the five directors so, despite Zatter's majority control of the shares, the directors maintain significant operating control of the company and can negotiate
valuable contractual terms beyond three years. Ihese may be exercised through control of more than 25%% of shares if the 10%% transfer takes place which would prevent changing articles of
association except by consent.
The initial indication by the Minix directors that they would accept a cash offer of £35m would seem to be high but may have been a starting point in negotiation.
(2) Evaluate the proposals

Proposal 2- an 80%% acquisition
Proposal 2 would give the directors a significant immediate pay-out of about fóm each. It would also give them a remaining shareholding of either 20% or 30% after 3 years.
Whilst the offer of additional shareholding is claimed to motivate the directors and raise the profit growth rate from 12% to 20% this is questionable. This is because the value of a minority
shareholding after three years may be small unless there is protection in a shareholder agreement or unless the continued services of the five directors remain valuable beyond 3 years, despite
Working alongside Zatter scientists for that period and knowledge transfer taking place.
Thus, while the deal may retain the directors, it may not suffticiently motivate them beyond the 100% deal.
Risks include some of the same risks as Proposal 1 namely:
The growth rate allows all the synergy gains to be captured by Minix directors and they may be even greater than proposal 1 as the growth rate is higher.
The use of Zatter's WACC as the discount rate is likely to be similarly inappropriately low.
Much of the value of the shares is in the long-term terminal value which is volatile.
Under Proposal 2, the Minix directors would participate in the loss given a 3% chance of failure but their participation is small as they will have extracted most of their value in the initial sale of their
80% of the shareholding for cash.
Propsal 3 - 15% shareholding

investment in Minix
leaving others with 17%
right to appoint direcot
3 uear contract agreemnt of share price 3,705.25 37,052.47
5 directors cant sell shares
5 directors will contineu to work and 100% bonus profit related 182742.93 1^3(4,932/0.1)/1.
5 directors specic projects
Evalution - Proposal 3-a 15% investment

The relationship between the majority and minority shareholders for Zatter and Minix inverts with Proposal 3compared with the other two proposals.
In this case the five directors not only work for the company but retain control of the board and shareholder control.
The 15% minority shareholding is at risk of leaving Zatter without influence or benefit from its investment.
However, there are two possible sources of influence:
The contractual terms suggested by Holly which gives contractual obligations to Minix and to the five directors.
The shared commercial benefits from the synergy of working with Zatter in scaling up Minix's output for industrial production provides commercial incentives to co-operate.
Risks may include:
The nature of the relationship between Zatter and Minix is questionable beyond the contractual period and theretore so is the value of the 15% shareholding once the contracts have expired.
Lack of control of strategic decisions in Minix either at board level or in shareholder meetings.
This offer is very different from the acquisition being negotiated and, for Minix directors who may be seeking an exit route, it may not meet their needs and therefore may not be acceptable.
Risks may be reduced compared with Proposals 1 and 2 by:
Reduced financial stake if Minix fails.
Less reputational risk if Minix fails.
Less Zatter management time and engagement.
Recommedation
Candidates can recommend any of the three proposals it supported by judgements based on facts from the scenario or likely extensions of those facts (eg the nature of the contractual term
shareholder agreement).

As the shareholding is less than 20% and there is no right to appoint a board member it seems unlikely that Zatter exercises significant influence over Minix. It is therefore likely that the 15% investment
IS a financial asset equity instrument, rather than an associate.
Equity instruments must be measured at fair value. Ihe detault position per IFRS 9 is that fair value movements should be recognised through protit or loss.
However, as the 15% shareholding by Latter in Minix is not held for trading, it can make an irrevocable election at initial recognition to measure it at tair value through other comprehensive income
with any dividend income recognised in profit or loss. In this case, fair value movements (such as the 3% chance of a nil value) would go through OCl. Any profit or loss on disposal would also in effect
go through OCI.
The transaction costs of acquiring the 15% shareholding in Minix would follow the treatment of the equity instrument. If the treatment of the financial asset was AFVTPL then the transaction costs of
acquiring the equity instrument would also go through profit or loss. Conversely, it the treatment of the financial asset was AFV IOCI then the transaction costs of acquiring the equity instrument would
also go through OCl
There could also be measurement issues in determining fair value each year, as Minix is unlisted. This would apply whether the treatment is AFVTPLor AFVTOCI.
IFRS 13, Fair Value Measurement would be used to measure fair values. As Minix is a private company, Levell inputs (quoted prices in active markets) would not apply. Level 2 inputs (eg, based on
quoted prices of identical/similar assets that are observable) are unlikely as no Minix shares have been sold recently, as they are still held by the founders, and the nature of the company is unusual, it
not unique. Level 3 inputs (eg, basedon unobservable inputs using an appropriate valuation technique) would probably need to be used, although there may be some uncertainty in the valuations
produced.
(4) Due diligence

Failure of basic research
This judgement on the success of research projects is likely to be beyond the expertise of FFF. However, with the help of Zatter scientists, or FFF's hiring of scientists (equivalent of an auditor's expert)
then the consequences of those uncertainties for related revenue streams and valuations could be established by FF. Assurance could also be given over the evidence and judgements supporting
those estimates.
Due diligence procedures should include:
FF staff should discuss the technical expert's work with them and confirm that the assumptions used in
their work are reasonable.
Evaluate the relevance of the qualifications, seniority and competence of the Zatter staff on the preliminary due diligence visit.
Confirm with a range of Minix staf that data and evidence provided to the Zatter staff contains all relevant information and, as far as is ascertainable, is free from bias.
Check whether there have been any developments (good or bad) on the research projects since the preliminary due diligence visit in October.
Establishing existence of patents by Minix or by rivals' competitor products.
Assess the data, assumptions and the judgements by which the 3% probability was determined.
Director of Minix with failing health

The fact that the continued involvement and motivation of the five Minix directors is important to the future success of Minix, means the role and influence of this one director needs to be established
and the potential limpact on research projects and revenue streams determined.
Establish the nature of the work and role of the director.
Speak to the director to assess the nature of his/her illness and future plans for retirement in the context of the potential acquisition.
Speak to other directors to confirm the nature and signiticance of the directors role in research projects.
Consider whether alternative arrangements are possible/acceptable for sale of this director's shares.
Assess whether the role or project{s) can be carried out by other directors or employees.
Assess whether other roles, functions and projects may be affected if the director leaves Minix.
Estimate consequences for revenue and profit if roles/projects could be affected by the director leaving.
Assess whether 'key person' insurance is available.
Development costs
The capitalisation of development costs would have consequences for accounting numbers but may also affect the FCF estimates derived from the underlying issues.
It may also question the integrity, judgement and optimism of Minix management if they believe that research/development projects will be successful when the auditors do not. This may call into
question otherfigures in the financial statements and other data (retrospective and prospective) provided by Minix directors into question.
Examine board minutes and correspondence with auditors to understand the nature of the disagreement and the basis on which the auditors believed that the development costs should be written
off to profit or loss.
Ascertain the nature of the development projects and the amounts comprising the f1.1 million in question.
Check whether there have been any changes (good or bad) on the development projects since the audit report was issued.
Check other development projects that have been capitalised in the past and assess whether this has been appropriate with hindsight.
With the agreement of Minix directors, speak to the auditors.
51 Page 132
LPH
London stock exchange
Investment in specialistasset for hire
On 1 July 2022 construction equipment
New head of tech and imprve asset management and revenue feneration
May 2020 new digital info system
7% market sahre
top 5 companies make up 30%
60% is UK generated
Busines model
90% hire contract short term 1 - 3 weeks
Owns equipment 6 years
Maintence cost and damage
early disposal
90% order in 24 hours
180 depots in UK and Euorpe
5 new depost opened YE 30 June 2021 cost 5m
Investment in specialist asset

Cost 30,000
Jul-20
Finance loan 30,000
Interest 4% 10 years
Summary statements of profit or loss for the years ended 30 June 2021 2020
Draft Final
£m £m change % change
Revenue 355 330 25.00 7.6%
Cost of sales -162 -151 - 11.00 7.3%
Gross profit 193 179 14.00 7.8%
Distribution and administration costs -164 -153 - 11.00 7.2%
Operating profit 29 26 3.00 11.5%
Finance costs -4 -2 - 2.00 100.0%
Profit before tax 25 24 1.00 4.2%
Tax -5 -5 - 0.0%
Profit for the year 20 19 1.00 5.3%
Gross profit margin 54.4% 54.2%

Operating profit margin 8.2% 7.9%
Interest cover - 7.25 - 13.00
Gearing D/E 41.9% 31.6% bank loan/ ord share + RE
Gearing D/E (using net debt) 37.6% 29.1% bank loan/ NCA total
Gearing D/(D+E) 29.5% 24.0% bank loan / RE + SC + bank loan
Gearing D/(D+E) (using net debt) 27.4% 22.5% Bank loan / NCA + bank loan
CAPEX (Em) 78.00 45.00 33.00 73.3%
Revenue per customer (£) 14,087.30 13,692.95 394.36 2.9%
Operating profit per customer (f) 1,150.79 1,078.84 71.96 6.7%
Revenue per depot (£) 1,972,222.22 2,062,500.00 - 90,277.78 -4.4%
Profit per depot (E) 161,111.11 162,500.00 - 1,388.89 -0.9%
Summary statements of financial position at 30 June 2021 2020

Draft Final
£m £m
Non-current assets
Equipment for hire 220 196
Other property, plant and equipment 35 31
Current assets
Inventories 28 27
Trade and other receivables 75 53
Cash 10 5
Total assets 368 312
Equity
£1 ordinary shares 23 23
Retained earnings 206 186
Bank loans 96 66
Current liabilities 43 37
Total equity and liabilities 368 312
2021 2020
Other financial data £m £m change % change
EBITDA 70 62 8.00 13%
Depreciation 41 36 5.00 14%
Additions to equipment for hire:
New equipment for expansion
(including specialist assets) 34 6 28.00 467%
Replacement equipment 37 39 - 2.00 -5%
Additions to other PPE (including new depots) 7 0 7.00
Net debt 86 61 25.00 41%
Other operating data 2021 2020

Utilisation rate of equipment for hire 52% 56% - 0.04 -7%
Average age of equipment for hire (months) 33 36 - 3.00 -8%
ROCE 8.90% 9.50% - 0.01 -6%
Net debt as a multiple of EBITDA 1.23 0.98 0.25 26%
Number of customers 25,200 24,100 1,100.00 5%
Number of depots at 30 June 180 175 5.00 3%
Directors comments
success increase in profit new specilist assets
generated extra 5.6m
800 new customers
Financial analysis of company

Revenue
Revenue has increased in 2021 by 7.6% compared with the previous year. Data is not provided on price changes and changes in the volume of hires, but there are other causal factors that can be
identified.
t the operations director is correct, then f5.óm of the increased revenue is due to the acquisition of specialist assets at the beginning of the year. Ihis leaves a more modest increase of about 2% in
like-for-like growth from existing equipment for hire.
Part of the explanation for the increase in revenue has been an expansion in the number of customers by 4.6%. Also, the revenue per customer has risen by 2.9% which could suggest that the new
customers generate more revenue than the longer-term customers. However, this assumes that the average revenue generated by the longer-term customers has not changed signitficantiy from last
yedr.
Another possible casual factor for revenue growth has been the growth in the number of depots by 12.5% compared with last year. This is significant but has also resulted in a fall in the revenue per
depot by 4.4%. Part oft the explanation may be that new depots are in new geographical areas which overlap with existing areas. Ihese may now serve new customers and generate new sales, but
could also service existing customer needs more ettectively and at lower transport cost by being closer to markets (ie closer than existing depots to existing customers' locations).
Profit and costs

Both the overall gross profit margin and the overall operating profit margin have changed very little. This could be indicative that the additional revenue has been generated with similar prices and
costs to existing revenue streams.
However, this overall picture of stability of margins could hide ditterent and compensating trends in sub-sets of the data. Ihus, for instance, the new specialist equipment may have pertormed poorly
(as indicated by the low utilisation rate of 40%) but profit margins on underlying like-for-like hiring revenue from other assets may have improved. This matter is considered further below in discussing
the statement of the operations director.
51 Page 133
At f41m for 2021, depreciation is a key cost of asset ownership and use. This is largely a fixed cost and makes the profit sensitive to changes in the level of activity through operating gearing.
Return on assets
While profit has increased in absolute terms in 2021 compared with 2020, there has been increased investment in more equipment in 2021 and therefore an expansion of the asset base available to
generate revenue.
The total CAPEX in the year was £78m. While some of this amount was tor replacement of assets, there was also new investment in specialised equipment for hire of £30m and new depots of £Sm.
The ROCE decreased from 9.5% to 8.9% showing that, although profit increased, it did not increase by as much as the asset base. The % return on assets therefore fell. It may however be that this
reduction is not a reasonable measure of pertormance as:
it may take time for the new business line relating to specialist equipment to gain traction and generate protit. So, while ROCE may tall initially, it may rise again once the new business line is more
established.
Some of the assets (eg the depots) may have been purchased during the year and so have not had a full 12 months to generate profit. Nevertheless, all these assets would be fully reflected in the
statement of financial position.
ROCE is considered more in the next requirement.
Operations director's statement

The operations director claims that the specialised equipment generated E5.6m in the year. If they have the average useful life of six years, then this is only £33.6m generated against a cost of £30m.
At 10% pa discount rate this revenue only generates a PV of f24.4m (£5.6m x 4.355) which is less than cost
In addition to considering the initial outlay, the revenues attributed to the new specialist equipment are gross and do not include variable costs from their use. It is necessary to deduct the annual
variable costs of maintaining, transporting and storing the equipment, before assessing whether the specialist equipment contributed to profit. It then needs to be assessed whether it made an
adequate return on the initial investment.
In mitigation, as already noted, it may be that this is the first year of use of the specialist equipment and new markets may develop over the six-year life and so the revenue will increase. With a
utilisation rate of only 40% there is certainly capacity tor greater use.
It may also be, as the operations director notes, that hiring revenue from other equipment may have been generated as a result of gaining new customers.
Despite these mitigating tactors there is a requirement tor signiticant improvement betore the specialist equipment is likely to break even and earn a reasonable return on the initial outlay.
Financial position and liquicdity

A loan of f30 million was taken out in July 2020 to finance the new specialist equipment. As a consequence, non-current liabilities increased by 45% and all measures of gearing increased. A breach
of debt covenants expressed in terms of gearing may be a risk if further borrowing is needed for expansion.
There is a significant increase in debt exposure but, due to a low interest rate on the loan at 4%, LPH's ability to service the debt looks to be secure. For example, in 2021 interest cover remains high at
7.25, despite decreasing from 13 in 2020.
In terms of the asset position, there has been some debt financed expansion as already noted. However, of the total CAPEX only £30m has been debt financed. A reduction in the cash balance (from
t10m to tbm) has provided sufficient finance tor the investment in new depots. Operating cash flows and disposal proceeds have financed the new replacement assets.
(2) Metrics suggested by finance director

(a) Three current metrics
(i) ROCE
ROCE is a measure of return on assets employed (total assets less current liabilities) and therefore takes into account all sources of finance (debt and equity)
In the numerator, the profit is operating profit (ie before interest is deducted) and the therefore the amount available as a return to all providers of tinance.
For LPH, it is a measure of the return that its equipment generates from hiring to customers (net of operating costs) relative to the cost of the investment.
This is an important measure of efficiency and performance of the assets as it emphasises not just that assets need to generate positive cash flows but that they need to be sufficient to justity the initial
investment.
This is important, not just in selecting the right type of asset, but also in acquiring the appropriate quantity of each asset. If too many of a given type of asset are purchased then, at the margin, a low
return may be made due to low utilisation (see also utilisation below).
However, whether ROCE is an appropriate way of measuring monthly returns is questionable as this requires monthly measurement of assets.
Moreover, if carrying amounts in the statement of financial position are used to measure assets in the denominator of ROCE than managers might retain assets beyond their useful lives and which are
almost entirely depreciated as they have a low carrying amount and boost ROCE. Ihis may lead to dystunctional behaviour in managers being measured using ROCE as they may retain older assets
tor longer than desirable rather than replace them with newer, and more modern, assets.
(ii) Utilisation
Utilisation is a key measure of the efticiency with which assets are being used which is related to the return they make in terms of ROCE
LPH appears to measure physical utilisation of assets based on time. It could more beneficially be measured in terms of value. ie the revenue that has been generated compared with the revenue that
could have been generated. I his gives a greater weighting to the utilisation of more valuable assets.
Utilisation is however a metric that can be used not just at company level but at all levels down to each depot and even each individual piece of equipment. As such, it is a measure of how far the
business is 'making the assets sweat.
It also provides key management information which is appropriate at a monthly level in a range of key management decisions. Poor utilisation of individual assets may indicate:
a shift in customer demand
an inappropriate purchase
purchase of an excessive quantity of a given asset
the need to sell the asset
wrongly located assets.
Conversely, very high utilisation may suggest that more of a given item of equipment needs to be purchased to ensure it is available to satisty customer demand.
A problem may be that utilisation may depend on a range of factors that are not easily identity (eg over/under pricing). However, it could enable appropriate questions to be asked by the board.
Ameasure of asset utilisation at a granular level (eg per depot or equipment type) is therefore likely to be an appropriate metric to report to the board on a monthly basis.
(ii) Net debt to EBITDA

Net debt to EBITDA is a measure of leverage. It shows how quickly net debt can be repaid using EBITDA as a surrogate tor operating cash flows.
In essence, it measures liquidity and solvency from a measure of the ability and time period over which debt can be repaid.
A weakness is that it does not consider the need to replace equipment and acquire new equipment through CAPEX, without which the current level of EBITDA is unlikely to be sustained.
However, whether net debt to EBITDA is an appropriate as a monthly measure is questionable as it reflects longer term liquidity from annual measures of EBITDA.
(b) Alternative performance measures

Measuring pertormance for the business as a whole may have limited use as it may struggle to identity areas of good and bad pertormance to guide decision making.
Possible suggestions for measuring performance could be:
UK and Overseas
This is a geographical segmentation and if the markets are ditterentiated or managed differently this may be important is assessing which area needs more investment or divestment or a different type
of management. The role of exchange rates could also be considered.
By depot
This is a localised geographical segmentation. However, it can also be used to measure and incentivise the managerial performance of depot managers. Measurement would theretore be linked to
managerial responsibility.
A problem might be in measuring common costs (eg where equipment is transferred between depots) and in servicing larger customers with national operations.
By product type
Measuring the performance of individual assets (eg by utilisation rates; hire charges achieved relative to cost) may provide the board with information on the most productive areas to invest in. It may
also indicate the most profitable types of customer (eg Civil engineering).
The appropriate level at which to capture data is an issue (eg individual type of equipment or classes of equipment types).
Recommendation
Assessing monthly performance depot level seems to be the most appropriate as it links to organisational structure and operational management decision making (depot manager) and therefore
metrics may not only measure and control at board level, but also incentivise at depot level.
Financing new contruction equipment

1-Jul-20 value 40,000
High gearing and high rates
lose breaching restrive covenants
6 years cycels
A 6 year lease
two 3 years lease new equipment end of 3 years
Choice 1 - Purchase a bank loan

Cost 40,000
Interest 5%
repayable 30 June 2028 8 years
RV of equipment sold for 4m
Loan 27,073.57
Loan 59,098.22
Asset
To 30 June Cost Depn Acc depn NBV
2023 40,000,000 6,000,000 6,000,000 34,000,000
2024 40,000,000 6,000,000 12,000,000 28,000,000
2025 40,000,000 6,000,000 18,000,000 22,000,000
2026 40,000,000 6,000,000 24,000,000 16,000,000
2027 40,000,000 6,000,000 30,000,000 10,000,000
2028 40,000,000 6,000,000 36,000,000 4,000,000
Liab (all year) 40,000,000
51 Page 134
SOPL Deppn Interest 5% Total

2023 6,000,000 2,000,000 8,000,000
2024 6,000,000 2,000,000 8,000,000
2025 6,000,000 2,000,000 8,000,000
2026 6,000,000 2,000,000 8,000,000
2027 6,000,000 2,000,000 8,000,000
2028 6,000,000 2,000,000 8,000,000
36,000,000 12,000,000 48,000,000
Lease - by decesion TWDV

0 40,000,000 85% x
1 34,000,000 85% x above
2 28,900,000
3 24,565,000
4 20,880,250
5 17,748,213
6 Disposal 4,000,000
Balance allowance 13,748,213
Value of tax Value of tax

Time Equip relief WDA Value of bal allowance DF 4 % CF PV relief WDA
0 -40,000,000 1.000 -40,000,000 -40,000,000
1 1,200,000 0.962 1,200,000 1,153,846 6m x 20%
2 1,020,000 0.925 1,020,000 943,047 85% of above
3 867,000 0.889 867,000 770,760
4 736,950 0.855 736,950 629,948
5 626,408 0.822 626,408 514,861
6 4,000,000 2,749,632 0.790 6,749,632 5,334,332
4,450,358 NPV of purchase -28,800,011 -30,653,205
Choice 2 - 6 year lease

Rental 8,000
6 years payment
right would lessor
8,000 k x AF5 years + 1
AF % years 4.329 + 1
PVFLP at 5% 42,632 8000k x 5.329
YE 30 June Liab b/f Interest 5% payment

2022 42,632 - 8,000 34,632 Interest paid in arrears
2023 34,632 1,732 - 8,000 28,364
2024 28,364 1,418 - 8,000 21,782
2025 21,782 1,089 - 8,000 14,871
2026 14,871 744 - 8,000 7,614
2027 7,614 381 - 8,000 - 5
2028
SOPL Depn Interest total

2023 7,105 1,732 8,837
2024 7,105 1,418 8,524
2025 7,105 1,089 8,194
2026 7,105 744 7,849
2027 7,105 381 7,486
2028 7,105 - 7,105
42,632 5,363 47,995 48000 check 6 x 800k
Lease-buy decision
Value of tax Value of tax
Time Lease rental releif DF 4 % CF PV relief WDA
0 -8,000 1.000 -8,000 -8,000
1 -8,000 -1,600 0.962 -6,400 -6,154 6m x 20%
2 -8,000 -1,600 0.925 -6,400 -5,917 85% of above
3 -8,000 -1,600 0.889 -6,400 -5,690
4 -8,000 -1,600 0.855 -6,400 -5,471
5 -8,000 -1,600 0.822 -6,400 -5,260
6 0 -1,600 2,749,632 0.790 1,600 1,265
-9,600 NPV of 6 year lease -38,400 -35,227
Choice 3 - two 3 years contracts

1-3 years rental 8,400 1-Jul-22
3 -6 uears rental 9,000 separate 1-Jul-25
Lease 1
PVFLP at 5% 24,015.60 (£8400k x (AF2yrs + 1) AF % yrs =1.859+1 2.859 x 8000
Lease 2
PVFLP at 5% 25,731.00 (£9000k x (AF2yrs + 1) AF % yrs-1.859+1 2.859 x 9000
Liab b/f Interest 5% payment c/f

2022 24,015.60 - 8,400 15,616
2023 15,616 781 - 8,400 7,996
2024 7,996 400 - 8,400 - 4
25,731.00 - 9,000 16,731

2025 16,731 837 - 9,000 8,568
2026 8,568 428 - 9,000 - 4
2027 - 4 - 0 - -
2028 - - - -
SOPL Depn Interest 5%] total

2022
2023 8,005 781 8,786
2024 8,005 400 8,405
2025 8,005 - 8,005
2026 8,577 837 9,414
2027 8,577 428 9,005
2028 8,577 - 0 8,577
49,747 2,445 52,192 3 x 8400 + 3 x 9000 52200
Lease-buy decision
Lease 1 - 8,400
Lease 2 - 9,000
Value of tax
Time Lease rental releif DF 4 % CF PV
0 -8,400 1.0000 -8,400 -8,400
1 -8,400 -1,680 0.9615 -6,720 -6,462
2 -8,400 -1,680 0.9246 -6,720 -6,213
3 -9,000 -1,800 0.8890 -7,200 -6,401
4 -9,000 -1,800 0.8548 -7,200 -6,155
5 -9,000 -1,800 0.8219 -7,200 -5,918
6 0 -1,800 2,749,632 0.7903 1,800 1,423
-10,560 NPV of 2 lease -41,640 -38,125
51 Page 135
Lease-buy decision
Cost 40,000,000
After tax borrowing rate 5%(1-T)-4%
Disposal value 4,000,000
Tax rate 0.2
WDA 0.15
Working assumptions
WACC 10%
Borrow rate 5% discoutned
tax 20% end of period
Depn straight line
Purchase of equip 15% reducing balance capital allowances
except in final year
different TWDV and dispal - balance allowance or balance charge
(a) Financial reporting treatment

Purchase and borrow
The construction equipment will be recognised as PPE. The depreciable amount (£36m) is written off as depreciation over the six-year useful life on a straight-line basis (f6m pa) if periods benefit
equally from the assets' use.
The loan of £40m is recognised as a non-current liability for 5 years, then as a current liability for one year until settled as a bullet repayment on 30 June 2028.
Interest at 5% is recognised each year on the loan (EZm) in profit or loss as a finance charge.
Sixyear lease
Initial recognition of the asset (the right of use of the construction equipment) and the lease liability in accordance with IFRS 16 is the present value of the future lease payments (PVFLP).
The assets are recognised as PPE and the PVFLP is written off as depreciation over shorter of the lease term (six years) and the useful life (also six-years) on a straight-line basis (£7,105,969 pa) if
periods benefit equally from the assets' use.
The liability is amortised using the interest rate implicit in the lease or the incremental borrow rate. LPH has chosen the latter (at 5% pa) as its accounting policy. IFRS 16 requires the total finance
charge to be allocated to each accounting period to give a constant periodic rate of charge.
The lease liability reduces each year by the difference between the lease rental payment and the finance charge.
The SPL is charged with the depreciation on the asset and the finance charge on the liability. Overall, the amount recognised through profit or loss is the same as the sum of the lease rentals of E48m.
Two, 3-year leases

Each of the leases is treated separately
The treatment is as for the six-year lease in accordance with IFRS 16 but as the lease terms are shorter than for the six-year lease arrangement, the lease liability (PVFLP) is smaller at the inception of the
lease and, until the final year, at the end of each accounting period (see calculations above).
(b) Method of financing

The discount rate is the net of tax borrowing rate of 4% (ie 5%(1-). This is because lease rentals are low risk like servicing debt. However, it could be argued that a higher discount rate should apply to
the second tranche of 3-year lease rentals as they are uncertain, unless they have been contractually fixed at the beginning of the project.
The proposed expansion of f40m is significant and there could be elements of the investment where LPH borrows and buys the equipment and other elements where it leases the equipment. A range
of local commercial factors should be considered in individual investments.
Borrow and buy

Owing the equipment is more flexible than leasing. If the useful life is eventually longer than expected, LPH can retain the asset beyond the (say) six years. Alternatively, if customer demand changes,
or technology changes and utilisation is low then LPH can sell the asset without the early termination penalties likely to be in a lease contract. LPH therefore has more discretion with the timing of the
end date when it is buying rather than leasing. Ihis can be important in hiring equipment as the business is cyclical and seasonal so utilisation can vary over the term of expected use.
There may also be more flexibility in using the asset. For example, there may be a restriction on taking some equipment out of the UK to use in LPH's European operations if they are leased. There may
also be restrictions on the extent of use in a lease (ega maximum number of miles travelled in a vehicle being hired aout).
Owning assumes the ability to borrow sutficient funds to purchase the asset. There may be limited debt capacity. Gearing is high for LPH but, more importantly, it is close to the debt covenant
threshold.
Leasing
Leasing will reduce the need to tind the initial f40m cash in July 2022. Ihe cash cost will be spread, enabling the new equipment have time to generate revenue for hiring to customers to help pay the
lease rentals. With leasing, the timing of costs is therefore more closely matched with cash intlows from revenue streams, which aids liquidity.
The implicit rate of interest in the lease may be lower than a bank loan, although this needs to be ascertained.
Similarly, there may be a difference in the tax treatment of a lease, but this may be a benetit or a cost according to the tax jurisdiction.
Lease rentals need to be capitalised in accordance with lFRS 16. However, the amount of the capitalised lease liability is likely to be lower than the borrowing required to purchase the equipment. This
is particularly true for shorter leases. Ihis may be an advantage in avoidinga breach of the debt covenant based on gearing.
The lease contract may include maintenance costs or require the lessee to maintain the asset. If maintenance costs are incurred by the lessor, then the lease rentals will be higher, but it avoids
uncertainty. With LPH's mechanical equipment, this may be an advantage
A key assumption is that the LPH board has already decided to acquire the construction equipment. t is therefore presumably contident that the construction equipment will make a profit irrespective
of the method of finance. Ihe viability of the acquisition of the construction equipment is not therefore in question. Ihe Issue is therefore which of the three methods of ftinancing the construction
equipment is preterable.
Using the net of tax borrowing interest rate as the discount rate, this shows the following present values of financing cash flows.
Purchase and borrow £30,653,197

A six-year lease £35,227,160
Two 3-year leases £38,231,909
In pure financial terms, using the working assumptions, the purchase and borrow decision gives the lowest after tax PV and is therefore preferred if assessed on this basis alone.
However, other tactors need to be considered. It the asset is still serviceable and its condition acceptable to customers after six years, the ownership of the asset can be extended. Extensions of the
lease term may or may not be negotiated with the lessor with the leasing options, but this Is uncertain and is likely to have greater cost than extending ownership
Comparing the 6-year lease with the two 3-year leases, while the 6-year lease has a lower PV cost there are three advantages to the two 3-year leases:
There is an exit route atter three years (unless there is a prior contractual commitment), so it the construction equipment is not hiring out as successtully as expected, then the second lease need not
be entered into.
Ihe second lease is tor brand new construction equipment which may be technologically or aesthetically superior to the construction equipment used in the first three years and in the six-year
lease.
As the two leases are shorter than the six-year lease, the lease liability recognised in the financial statements is lower and so gearing is lower. This may be important for complying with the loan
covenant
New digital information systems

Asset management
Revenue generation
T.Soft is offering SaaS (software as a service) to LPH. SaaS solutions employ internet technology and remote servers, enabling users to access software online from anywhere, using a device with an
internet connection. Ihe sottware does not need to be installed on hardware in the company's offices.
The RFID tracking device enables the assets over £3,000 to be located and their movements recorded providing useful management information to LPH and its customers.
Asset management
Asset management is the process of making best use oft an organisation's assets to promote their efticient use and increase the returns generated from the asset.
The tracking of assets enables equipment meeting customers' specification to be identified and located as soon as a customer order is made. Ihe software and tracking improves logistics, enabling
the most appropriate asset, in the closest location to be delivered to the customer to reduce lead times and transport costs.
Once delivered to the customer, the use and movement of the asset can be traced recording valuable management information about how and where the asset is being used by the customer.
There is also a benefit to the asset management of the customer who can trace the LPH asset during the hire period to make best use it.
Upon completion of the hire period, information about the location of the asset and possibly the next customer to use the asset can be accessed. This can help determine which depot to return the
asset to for storage or whether to transter it directly to the next customer.
Operating efficiencies can therefore be achieved, such as speeding up drop-off and pick-up (ie turnaround times) which may reduce the associated operating costs and improve customer experience.
Inventories of assets and their locations can also be maintained to ensure there is geographical balance of each type of asset to most efficiently meet future customer demands.
There may also be a more general improvement in customer experience in using real time data to enable customers to track hired equipment and reduce the likelihood of equipment being lost or
wrongly located.
Iracking asset usage may also enable maintenance to be carried out by LPH at the time of lowest demand so the impact on utilisation is minimised.
The life-cycle history of each asset can also be ascertained and the decision to replace early or extend useful lives can be informed by evidence.
Revenue generation
For LPH, the use of equipment in terms of utilisation is directly linked to revenue generation. Hire revenues are generated by ensuring the assets are available for customers' use at the right time and
location.
Management information about the location and use of equipment will facilitate awareness of the patterns of availability and use of each type of asset. This will identify under and over stocking of each
type of equipment and help optimise the equipment porttolio to meet customer needs. or example, the number of instances when customer orders cannot be satistied due to lack of availability of
appropriate assets can be minimised.
Having assets in the best locations due to tracking may also shorten lead times to meet urgent customer demands and increase customer satistaction. Ensuring that assets are in the possession of
customers means hiring revenues are being generated.
Cross depot communication may also be improved. Depot managers may have knowledge of local customer needs but may be unaware of revenue generating opportunities outside their
geographical region. Asset availability at the company level can be enhanced by co-operation between depots through sharing information via use of the dashboard. Ihe centralised availability of the
same real time and historic data enables better internal communications and better and more consistent communications with customers.
Administration of revenue is also facilitated by tracking assets' use and location to support invoicing and provide evidence of the cut-off on the asset return date if there is a dispute.
A centralised sales database can be accumulated over time for customer relationship management (CRM) and marketing, based on knowledge of past customer use.
52 Page 136
Tallum PLC
3 subs
make ICM chips
Concerns over cash mg and treasury and mutiple currency operation

FX risk
YE 30-Jun-21
Revenue 6,000 million Similar 2022
Cash 87 million rise 107m for 2022
Subs in germany, UK, Malaysia
UK division - Aerospace industry

German division - Digital communications industry
Malaysian division - Computing industry
Sells 75% of semiconductors external

remained used ICM
USA Invoice $
New treasury 1 July 2020
Net operating cash inflows (per month)
Currency Average Standard deviation
British pounds (f'000) 40,000 19,596
Euro (E000) 27,500 22,000
Malaysian ringgit (RM'000) 75,000 30,000
US dollars (USSO00) 26,000 16,444
Exchange rates at 30 June 2021 were as follows:

British pounds (f'000) 1
Euro (E000) 1.1
Malaysian ringgit (RM'000) 5
US dollars (USSO00) 1.3
(1) Relative risks from net operating cash flows

Currency Average FX £ Per year
British pounds (f'000) 40,000 1 40,000 480,000
Euro (E000) 27,500 1.1 25,000 300,000
Malaysian ringgit (RM'000) 75,000 5 15,000 180,000
US dollars (USSO00) 26,000 1.3 20,000 240,000
100,000 1,200,000
Table 1 above translates the net operating cash inflows provided in the four currencies into t sterling using the
year-end exchange rates provided to bring them to a common currency basis. Ihe year-end exchange rate is not
Ideal as the transactions occurred over the year, but t provides a reasonable apPproximation for management
intormation purposes.
The key issue is that the company generates a signiticant amount of net operating cash tlows at £1,200 million pa.
This is a ratio of 0.20 (operating cash flows divided by revenue) on the revenue of f6,000 million. There are a
number ot payments to be made from these operating net cash intlows including: investment cash tlows (CAPEX;
financing cash flows (interest and repayment of debt), tax, dividends. Nevertheless, there is a substantial surplus
for the year. The cash and cash equivalents balance of f87 million reflects the fact that signiticant net cash inflows
are being generated, but there are substantial outflows.
Nevertheless, whilst there is currently strong growth in the semiconductors industry. there is an historic pattern of
varability and hence there is a need to manage variation in cash flows within years and between years.
This is not just to maintain liquidity, but also to optimise the use of surplus cash to generate returms for
shareholders.
Currency Average Standard deviation Coefficent of variation
British pounds (f'000) 40,000 19,596 0.49
Euro (E000) 25,000 22,000 0.8
Malaysian ringgit (RM'000) 15,000 30,000 0.4
US dollars (USSO00) 20,000 16,444 0.63
100,000
The standard deviations (SD) shown in the table produced by the lallam's data analytics team gives absolute
values. Ihey cannot therefore be directly compared with each other to give a relative assessment of risk, as the
scale of the amounts ditfers. Clearly, they are also in ditferent currencies.
The coefficient of variation relates the SD to its absolute value and is therefore comparable between the divisions
to compare relative risk. Higher values of the coefficient of variation suggest a greater dispersion in the data
adjusting for absolute size.
Once this scaling is considered then Malaysian cash flows have the lowest coefficient of variation and therefore the
lowest relative dispersion.
If the four currencies are translated to fs then the absolute numbers of the means and SDs will change, but this
does not affect the coefficient of variation which shows the relative variability of each division, as it merely scales
the data. This is demonstrated below with the table translated to fs as the common currency:

Currency Average Standard deviation Coefficent of variation
British pounds (f'000) 40,000 19,596 0.49
Euro (E000) 25,000 20,000 0.8
Malaysian ringgit (RM'000) 15,000 6,000 0.4
US dollars (USSO00) 20,000 12,649 0.63
100,000
t can be seen from the above tables that the euro currency cash generation has the highest relative volatility, but
all the divisions are experienCing a reasonable degree of variation in monthly net operating cash flows based on
the SD.
In terms of risk, if the cash flows of each division are approximately normally distributed, then there is a probability
of approximately 16% of them talling more than one SD below the mean in any one month.
However, the above figures are translated at constant year end exchange rates. Currency tluctuations within the
year are an additional source of cash flow uncertainty when the SD in ts equivalent may change over the year from
currency variations within the year. Ihis adds to the variations in the original cash tlows in the underlying
currencies.
The individual divisions' cash flows show fairly high SDs. However, in considering the overall variation for the
company, the covariance between divisional flows needs to be considered. A low, or negative, covariance would
reduce overall volatility of net operating cash tlows tor the company as a whole.
Conversely, it the SDs are highly correlated then there is a significant risk at company-wide level as there is a high
covariance which means they will move together and not be compensated by ditterent random movements or by
movements in opposing directions. The SDs may be highly correlated if there are common factors affecting all
divisions, such as a global recession or a technological change in the semiconductor industry.
For the company as a whole, it is unlikely that the SDs are highly correlated if the movements are random and
independent between divisions and over time.
However, applying professional scepticism to the data, it should be questioned whether the SD of the past is likely
to continue in future. It may be asked, is the data persistent to extrapolate the past to the future '? For example,
what is the probability of an event shifting the distribution of all divisions through a common causal tactor, such a
a recession or technological change.
Irrespective of the nature of the distributions, high volatility, measured by a high SD, is not necessarily a major risk.
In terms of managing the risk, unexpected volatility is the key problem. If the volatility is expected, then plans can
be put in place (eg, extend the overdratt facility) to manage the liquidity risks.
52 Page 137
Despite the high SD, the mean cash flows are all positive, so the company is expected to be cash generative. This
does not mean cash management is not important as surplus cash flows need to be used tavourably (eg invested)
and liquidity needs to be managed in case there are random shocks to cash intlows from revenues.
Overall, with centralised cash management, the central treasury department eftectively acts as the bank tor the
group. Ihe central treasury has the job of managing the volatility and ensuring that individual operating units have
all the funds they need at the right time. For example, a centralised pool of funds can be maintained for
precautionary purposes avoiding the need tor separate management of pools at divisional level.
(2) Interdivisional currency settlements

The multilateral netting ott process involves establishing a base' currency to record all intra-group transactions.
For lallam, this has been determined to be in ts.
In terms of the data provided, multilateral netting off would take place as follows.
Payables
Receivables division UK Germany Malaysia
UK (E'000) 0 £24,000 £18,00 24,000
Germany (EO00) € 5,500 0 £18,000 23,500
Malaysia (RMO00) 35,000 50,000 85,000
40,500 74,000 18,000
Convert to £:
Payables
Receivables division UK Germany Malaysia
UK (E'000) £ - £ 24,000 £ 18,000 42,000
Germany (EO00) £ 5,000 £ - £ 10,000 15,000
Malaysia (RMO00) £ 7,000 £ 10,000 17,000
12,000 34,000 28,000
Tot receiptTot payments

UK 42,000 - 12,000 30,000
Germany 15,000 - 34,000 -19,000
Malaysisa 17,000 - 28,000 -11,000
0
The german division pay 19m to UK

The malaysia division pay 11m to UK
Benefits
This procedure has the advantage for Tallam of reducing the number of settlement transactions and thus
transaction costs, including foreign exchange purchase costs and money transmission costs. Ihere will also be less
loss of interest through having money in transit. However, it requires strict control procedures trom the central
treasury. Ihere may also be other legal and tax issues to consider.
Central treasury function

Multilateral netting of occurs when each of the three divisions of lallam interact with the central treasury
department to net off the outstanding balances arising from internal transactions.
The arrangement is normally most effectively carried out as an internal procedure being co-ordinated by the
centralised treasury as it has access to internal transactions and balances and avoids external transaction costs.
However, the arrangements could alternatively have been operated by lallams relationship bank had the treasury
functions remained at division level.
The group treasurer's claim that "centralisation of the treasury department has made this possible" is not therefore
valid. However, for the reasons above, it would be valid to state that the process has been signiticantly tacilitated at
lower cost by having a central treasury operation.
Linda's notes made on 31 March 2021 - Forward contract with Mooton Bank
Current date: 31 March 2021.
On 30 June 2021, Tallam needs to pay US$4.8 million to a supplier of silicon. 30-Jun-21 $ 4,800.00
On 31 March 2021, the £/US$ market spot rate was:
£1 US$ 1.3110-1.3144
Mooton Bank has offered, on 31 March 2021, the following over-the-counter, forward contract to which I have agreed:
£/USS Three-months forward 0.78-0.72 cents premium
My notes - Alternative available transaction with Kimmel Bank

I have identified the following alternative over-the-counter, forward contract with Kimmel Bank which Linda could have used on 31 March 2021:
E/USS Three-months forward 0.80-0.73 cents premium
Concern 1 Credit risk on freign sales

Receiable 12m term 90 days
Issue 1 Credit risk for foreign sales

Credit risk for Tallam is the risk that credit customers may not pay in full or on time in accordance with the sale
agreement.
While Laser Teck has paid in the past, there is now a clear credit risk that it will not pay some or all of the £12
million outstanding.
As this was a foreign sale, the credit risk is potentially increased by a lower level of direct contact with, and
knowledge of, the customer's business environment. Moreover, the legal tramework cuts across two jurisdictions,
which may make the exercise of legal rights for Tallam to recover the debt a more difficult.
In this case, the long credit term of 90 days may have meant that the creditworthiness of LaserTeck has
deteriorated in this period. The subsequent delay in settlement beyond 90 days may have caused further
deterioration.
Tallam's procedures for granting credit need to be reviewed. There is normally less risk for existing customers, like
LaserTeck, than for new customers. Nevertheless, Tallam should not be blind to changes in creditworthiness,
particularly on a substantial contract for t12 million, that was tar larger than previous contracts with this customer
Bank references, trade reterences and reference to credit agencies could have been considered.
Alternatively, if competitive conditions permit, some advance payment or periodic progress payments procedures
could be considered on such a large contract.
For the future, the following procedures could be considered to manage the credit risk of foreign sales (ie,
exports)
Forfaiting is medium-term export finance. Forfaiting would enable Tallam as an exporter to receive immediate cash
by selling their medium and long-term receivables at a discount through an intermediary. This is achieved by the
purchase of financial instruments such as bills of exchange and letters of credit on a non-recourse basis bya
torfeter. GIven lallams bad debt experience, the discount may however be significant.
Documentary credits This is a risk-free methodof obtaining payment, also a method of obtaining short-term
finance from a bank, for working capital, as a bank might agree to discount or negotiate a letter of credit.
Export credit insurance (ie, trade credit insurance). This is insurance against the risk of non-payment by foreign
customerstor export debts. Export credit insurance is offered by private insurance companies and by government
agencies, often reterred to as export credit agencies (ECAs). However, export credit insurance comes at a cost
which Tallam must weigh against its credit experience. If credit experience has been poor, as indicated by internal
audit, then premiums will also be poor.
Acceptance credits. Short-term financeby a bank agreeing to accept bills oft exchange drawn on itselt.
Concern 2 - transfer rpcing

Average 10% mark up
Sold customer external average mark up 30%
52 Page 138
Issue 2-Transfer prices

Financial reporting issues
Some semiconductors manufactured in one division are transferred to Tallam's other two divisions at an average of
full cost plus 10%. This inter-divisional trading means the value of inventory may contain some unrealised protit in
the consolidated financial statements.
It is important for divisions to ensure that all inter-divisional trading is separately analysed so that any unrealised
profit can be identified. As 10% 1s an average, not universal mark-up, the mark-up on individual internal transters
still in inventory will need to be identified.
Exchange rate movements may alter the impact of the transfer prices. The 10% may apply in the originating
currency but the impact would vary with the recipient company. However, under IAS 21, inventory is a non-
monetary item so normally there is no adjustment between the date of the transaction and the end of the
reporting period.
The interdivisional receivables/payables balances are monetary items in the individual company financial
statement of the subsidiaries. They therefore need to be retranslated at the year end in accordance with 1AS 21.
These intra group balances need to be cancelled in the consolidated financial statements so common exchange
rates need to be used.
As the divisions are subsidiaries, they are related parties of each other. Appropriate disclosures of the related
parties should be made in accordance with IAS 24.
Also, there may be chalenge by tax authorities if transfer pricing regulations in a jurisdiction require that, for tax
purposes, transactions between related parties be priced on a basis that would be comparable to an arm's length
transaction between unrelated parties. Provision for any tax payable based on such a challenge should be made in
the financial statements.
Business issues
The practice of adding an average of only 10%% onto the cost price may cause other divisions to underprice these
products, damaging the gross profit margin of the company as a whole.
More generally, if internally transferred goods are not being recognised at their market value then this may lead to
dysfunctional behaviour in not only pricing decisions but performance measurement and performance
management.
In particular, divisional performance measures will be distorted by transfer prices that are not market values.
Moreover, the policy of centrally set transter prices is contrary to the general policy of autonomy of divisions and
this may have behavioural consequences for managers and by head office towards managers.
)Ethics
There are a number of ethical issues
Confidentiality - opening the group treasurer's desk
Forcing open the group treasurer's desk in her absence could be viewed by the board as a breach of confidentiality committed by the members of the treasury department. This applies in terms of her
personal confidentiality (personal possessions) and corporate confidentiality in terms of accessing potentially sensitive business information. The board has ultimate responsibility, although not
culpability., tor this breach of the treasurer's confidentiality.
While the desk and any business contents are the property of Tallam, the decision to force it open should not have been made at the level of treasury staff. Given the group treasurer is a senior
employee it would be appropriate for the board to authorise forced access and inspection of the documents contained therein if this was deemed legal and necessary. These documents could then
be distributed to appropriate treasury staf.
Depending on the health condition of the group treasurer, permission could have been obtained from her, or at least notification given, to aid transparency of the actions.
Intimidation
There is a possible suggestion in the anonymous letter of an element of intimidation towards the treasury team by the group treasurer in her senior management role. However, this is an accusation,
rather than being established, and needs to be ascertained by the board. Ihe board is responsible for governance and the behaviour of its senior management and, if it ignores the possibility of
intimidation by the treasurer, it could be regarded as complicit
The fact that the whistleblower wrote anonymously may suggest possible intimidation, but there may be alternative explanations such as tear of legal action or disciplinary action for an invalid claim or
a claim with malicious intent
Hedging transactions with Mooton Bank
The ethical issue with the placing of the forward contract with the bank where the group treasurer's brother works may imply conflict between personal family interests and the corporate interests of
Tallam, particularly the group treasurer's duty in respect of those interests.
In particula, the group treasurer's brother was directly responsible for issuing forward contracts at the bank. By processing transactions for Tallam, this may have meant a bonus or at least a better
appraisal for the group treasurer's brother.
Regarding the 'evidence' presented that the group treasurer had deliberately chosen a less favourable contract with her brother's bank Mooton than was available by other banks, the calculations are
set out below:
Mooton Bank
£/S
Payable 4,800,000
Spot rate 1.3032 -1.3072 1.30230
3,685,787
Three months' forward rates

The net payment in three months is:
Three months forward rates Payable 4,800,000
1.3030- 1.3071 1.303 1.303
3,683,807
Not hedged 1,980
From the above it is clear that the Mooton Bank forward contract is actually slightly more favourable to Tallam than the alternative suggested by the whistleblower, as the sterling cost locked-in by the
forward is lower.
Also, the bid-offer spread is greater on the contract with Kimmel Bank suggested by the whistleblower. Kimmel is therefore pricing its risk higher, which is to the disadvantage of Tallam compared with
the Mooton Bank contract.
The difference in quoted torward rates between Mooton and Kimmel may be due to timing. Although they are both on the same day, they may not be at the same time of the same day, so intra-day
exchange rate movements may account tor the difference.
There are also non-financial factors to consider as to which bank offers the better deal. For example, it may include the counterparty risk involved if one of the banks is operating under stressed
conditions.
There is however a question of motives and competence in whether the group treasurer should be entering intoa USS torward contract for settlement of a payment at all. lallam generates significant
revenues in USS and there could be matching and a natural ott-set against these. Some justification may be required trom the group treasurer on her return to work as to why a hedging contract was
needed in these circumstances. Entering into the contract may have been a genuine commercial misjudgement but, alternatively, it questions her motives in entering into an unnecessary transaction
with a related party.
Overall, there appears to be a lack of transparency and accountability for the group treasurer's actions. A number of quotes should have been obtained and a record made of which quote was
selected ith a justification of why this quote was preterred over the others. Authorisation should have been obtained (eg, from the finance director).
Actions
Take legal advice on the actions the board should take with response to whistleblowing and ensure the board's actions responding to the letter comply with legal advice.
The anonymous letter should be discussed at board level.
The whistleblower 's claims of intimidation and the culture of staff working in treasury feeling threatened needs to be investigated.
Discussions should be held with the group treasurer and explanations obtained when she returns to work. This should include the results of investigations if evidence of intimidation is discovered.
It is not appropriate to discover who sent the letter. This may be illegal and it may open the person up to the intimidation feared and may discourage other whistleblowers to come forward in the
future.
An investigation of the circumstances in which it was decided to force open the group treasurers desk, and how this was done, needs to be carried out. Possible disciplinary action may result
Internal controls need to be set up over the group treasurers ability to enter into hedging transactions on her own. An approval process needs to be set up (eg. with approvals by the finance
director) establishing procedures to obtain multiple quotes for hedging and other finance transactions. This should be for all hedges which can impact material risks or have material costs.
On her return to work, the group treasurer needs to explain why she used Mooton Bank and address the concerns, if true, that her brother, as a related party, is processing transactions for the bank
without any disclosure of this relationship.
Establish procedures for disclosure where there may be potential conflicts of interest to facilitate transparency.
Ketch PLC
Not an audit client
financial benefits = calcuations
customers are UK and Europe
Mumbai - Compoents for ac units
Director/Shareholder Board role

Rohit Reed Chief executive 30
Katy Krugman Finance director 30
Catherine Coase Production director 5
Sue Shiller Non-executive director 5
Zoe Zimmerman Non-executive director 5
Individual shareholders 25
Dividends
10m paid each year
AIM markets shares traded (m) Av price % traded % price

2016 1.15 2.56
2017 1.58 2.68 37% 5%
2018 1.1 2.33 -30% -13%
They are going to get a bonus based on the EBITDA
YE 30 Sept 2018
Sale of Mumbai operation
Benefits
Operating gearing will fall, as there will no longer be fixed costs of production in Mumbai, but variable costs are
likely to be higher in paying the supplier per component.
There is more financial flexibility in having a number of suppliers rather than being dependent orn one source as
with Mumbai.
Currency risk is removed.
Loss making and want to increase the EBITDA but this is missleading as boost the groups income
then they can fixed and variable cost are only needed
Risk
Re organise supply chain can cause problems with supplier delay and production issues
this can affect the volume of sales with the lack of ac units being sold due to supplier issues
If a buyer can be found quickly this implies that the sale if likely to be a length time and they have not lined
up a replacement. The third party is a tempory soluation again coming with there supplier issues
this means the business incresae the chance of loss making due to loss of key compotnets and supplier issues.
The same components will be available to competitors so there is no competitive advantage in terms of costs.
The best suppliers of retrigerant components may have exclusivity agreements with rivals and there may be a
competitive disadvantage in onily being able to source inferior quality components.
A foothold in the Indian market will be lost.
Exit costs are significant financially and perhaps reputationally.
Reputation loss
Consulsion
Undertake a compehersive review of ifnancial impact before proceeding with diviestment
disposed then contied to use the factory to supply the firm at a reasonible price
quaility and devliery continity
At 1 August At 30 September 2018

£'000 £'000
Advertised selling price - as a going concern (Note) 30,000 30,000 0
Selling costs 1,620 1,620 0
Carrying amounts of PPE 31,000 30,000 -1,000
Fair value of PPE 28,700 28,250 -450
Carrying amounts of inventories 500 500 0
Fair value of inventories 600 600 0
Units sold 180,000

3rd parties 90,000
UK 90,000
Mumbai
internal Mumbai
transfers external sales
Price 186 120
Mark up 20% 31 20
Cost 155 100
units 90,000 90,000
Revenue 16,740,000 10,800,000
Costs - 13,950,000 - 13,950,000
Profit 2,790,000 - 3,150,000
PPE
CA 30,000
FV 28,250
Impairment 1,750
Price 30,000
cost to sell 1,620
NA -28,250
CA of Inv -500
2,870
From the above we can see that external sales are loss making by 3.15m
this substainaly loss is can be justified to close done the operation and sell the trade as ette
Finacial reporting
The assets can be classed as held for sale
provided they are ready to sold in 12 months
that the are activity looking for seller or seller lined up this is not the case for K PlC
They would also need do disclosure a sperate line as SOPF as assets held for sale
We would also see a sperate line under the SOPL under profit with discounted operations
Inventory is to be held at lower of cost and net relised able value

in this case the CA is less than the FV 500 v 600
so this will be at 500
Propsal 1
New factory
1-Oct-19
Cost of factory 50,000,000
Saving 5,000,000
WACC 7% 20 years 10.59
1% increase per year 11.59
57,950,000
Cost -50,000,000
NPV 7,950,000
Year Cash DF 7% PV
0 -50,000 1.00 -50,000
1 5,050 0.93 4,720
2 5,101 0.87 4,455
3 5,152 0.82 4,205
4 5,203 0.76 3,969
5 5,255 0.71 3,747
6 5,308 0.67 3,537
7 5,361 0.62 3,338
8 5,414 0.58 3,151
9 5,468 0.54 2,974
10 5,523 0.51 2,808
11 5,578 0.48 2,650
12 5,634 0.44 2,502
13 5,690 0.41 2,361
14 5,747 0.39 2,229
15 5,805 0.36 2,104
16 5,863 0.34 1,986
17 5,922 0.32 1,875
18 5,981 0.30 1,769
19 6,041 0.28 1,670
20 6,101 0.26 1,577
NPV 7,627
as the increase 1% cost saving per year add 1 to the WACC
There are a number of riders to the above calculation.
WACC may not be a suitable discount rate. This is partly because it reflects the average risk of the company, rather
than the risk of this particular project.
Also, the WACC is determined at a point in time for a period of time and may
not be applicable over a 20-year time horizon
Similarly sustaining a 1% increase in incremental cash flow over a period of 20 years is unlikely.
The EBITDA figure is likely to be favoured by the factory purchase rather than from buying from a third-party
supplier. This is because a significant element of the factory cost, in accruals terms, is depreciation which is
excluded from EBITDA. Conversely, all the cost of purchasing the components is included in EBlTDA.
Catherine is the production director and favour to her to invest in the new factory
If this was to go to a third party catherin would lose control and perhas job be a risk.
In addition, Catherine would benefit from the EBITDA-based director bonus if the factory proposal is implemented
In operational terms the new factory would give more control over operations including production scheduling
and quality. However, the higher fixed costs lead to higher operating gearing.
Will the factory be under utilied
Use of third party supplier

use of a third party supplier has no been found therefore can not be confident in the price that we
can receive. Given that market they beileve we can do this cost lower than current mumbai factory
Outsourcing may provide more flexibility of supply from multiple suppliers. Such suppliers may also have
established production, scale economies and core competences.
This is particularly the case compared with Ketch

which has no history of cooling component manufacture in the UK and so may lack core competences.
Conclusion
Overall, in the short term, there is more flexibility in outsourcing so there can be a smoother transition from the
Mumbai operations. An investment in a UK factory may be a good long-term idea, as funds are available, but
sourcing cooling components from established external UK suppliers seems the lowest risk solution currently
available.
Share buy back

Buy back 21,700 Price 30000
Proceeds 28,380 cost to sell 1620
50,080 28380
Shares to be repurchased 20,000.000 SOFP

Max price 2.504
Current price 2.3

20% higher - 0.20
Share £1 value 1 100,000

Share premium 1.3 18,400
118,400 0.18 share prem orgianlly
Articles of A require that 75% votes is needed for the buy back
Rohit and Katy are 60% share holders
Offer only to indiviudal share holders
In this case rohit and katy are increasing their share in the business
therefore increase the bonus and 10m dividend granted to themselves
this is clearly acting in there own self interest rather than the own interest of the shareholders
Rohit Reed Chief executive 30 38%

Katy Krugman Finance director 30 38%
Catherine Coase Production director 5 6% they don’t want to sell
Sue Shiller Non-executive director 5 6% they don’t want to sell
Zoe Zimmerman Non-executive director 5 6% they don’t want to sell
Individual 5 6%
80
Do we have the cash and the premium acceptable to the minotity investory
as is 2.5 more than 2.3
they wont 75% approval and they would
Benefits
The control is longer with 1% share holders
Enhances EPS
Potentail to increase DPS above the regualr .10
reduce WACC as expenseive equity finance cancelled
Risk
That increase the control to R and K as they will increase the control of the business to 37.5%
therfore can use the company to their own advantage such as special dividends or increase dividends payments
Investment in bonds
Zoe and Sue NEDS want corporate bonds
Bonds in P PLC IRR
Bond price today 97.5 Y0 -97.5
Interest 3% x £100 3 Y1 3
Years 4 Y2 3
Par 100 Y3 3
rate(4,3,-97.5, 100) 3.684% Y4 103
Add 3% 3.684%
ABB rating
Zero coupon bond Y0 -95

Bond price today 95 Y1 0
Interest 0% x 100 0 Y2 0
Years 10 Y3 0
Par 145 45% premium of par Y4 0
rate(10,0,-95, 145) 4.319% Y5 0
Y6 0
Y7 0
Y8 0
Y9 0
Y10 145
4.32%
Rate(years, interest payment, value now (neg), value in the future ie par)
IRR( values recived in year this has to be negative, guess)
The Ghlast bond earns a higher yield but also has a higher credit risk as the credit rating is lower at BBB.
The return on corporate bonds (including the above two examples) is lower than the WACC. However, this does
not mean it is detrimental to shareholder value as the risk on corporate bonds of a BBB credit rating and above
(investment grade) is likely to be lower than Ketch's WACC which includes the riskier cost of equity.
More generally, the investment in bonds enables Ketch to keep liquidity and hold funds until investment
opportunities arise. In so doing, they keep the real option to delay a current investment decision in the expectation
that a preferable project will arise in the future.
The corporate bonds in which Ketch intends to invest are fixed interest. Whilst the interest cash flows are
reasonably secure (although subject to credit risk) the fair value of the bond is subject to variation particularly as
expected interest rates are likely to change.
Better than doing nothing and share buy back

does create an new income stream
However, there are a series of risks to consider.

(1) Credit and default risk - This is the risk of the issuer defaulting on its obligations to pay coupons and repay the
principal to Ketch. The ratings issued by commercial rating companies measure only default risk and can be
used to help assess only this risk.
(2) Liquidity and marketability risk- This is the ease with which an issue can be sold in the market. Smaller issues
are particularly subject to this risk but purchases in Ploome and Ghlast may avoid this. In certain markets the
volume of trading tends to be concentrated in the "benchmark' stocks, thereby rendering most other issues
illiquid. Other bonds become subject to 'seasoning' as the initial liquidity dries up and the bonds are
purchased by investors who wish to hold them to maturity.
(3) Even if an issuer has a triple A credit rating and is therefore perceived as being at least as secure as the
Government, it will still have to offer a yield above that offered by the Government due to the smaller size
(normally) and the thinner market in the stocks.
(4) Issue specific risk - eg, risk of call. If the company has the right to redeem the bond early, then it will only be
logical for it to do this if it can refinance at a lower cost. What is good for the issuer will be bad for an investor
like Ketch and, thus, the yield will have to be higher to compensate.
(5) Fiscal risk - The risk that taxes will be increased. For foreign bonds, there would also be the risk of the
imposition of capital controls locking your money into the market.
(6) Currency risk- For foreign bonds, there would also be the risk of currency fluctuation, so the sterling
equivalent of the interest paid and the principal may vary over time even though these amounts may be fxed
in local currency terms.
Views of Zoe and Sue

Zoe's view- The advantage of the 4-year maturity is that if the funds are required for investment at the end of this
period there are no transaction costs in realising the cash and there is no issue of liquidity of the corporate bond
market as the bonds are being redeemed.
Sue's view- Sue is correct that the Ghlast bonds give a higher yield. This may be due to the longer maturity but
may also be just compensation for accepting higher credit risk, given the BBB rating. Corporate bond markets are
not as liquid as government bond markets so the market for sale may be thin and a buyer may not be available at
a reasonable price when the cash is required for investment.
Recommedation
share buy back is a no
61% 39%
61% 39%
mpany, rather
mplemented
share prem orgianlly
they don’t want to sell as it’s a bad del
e expectation
Linx
PLC on London stock exchange
Summary statements of profit or loss for the years ended 30 June

2021
Draft
£m
Revenue 355
Cost of sales -162
Gross profit 193
Distribution and administration costs -164
Operating profit 29
Finance costs -4
Tax -5
Profit for the year 20
Summary statements of financial position at 30 June

2021
Draft
£m
Non-current assets
Equipment for hire 220
Other property, plant and equipment 35
Current assets
Inventories 28
Trade and other receivables 75
Cash 10
Total assets 368
Equity
£1 ordinary shares 23
Retained earnings 206
Bank loans 96
Total equity and liabilities 368
Other financial data

2021
EBITDA 70
Depreciation 41
Additions to equipment for hire:
• New equip for expansion (including specialist assets) 34
• Replacement equipment 37
Additions to other PPE (including new depots) 7
Net debt 86
Other operating data

2021
Utilisation rate of equipment for hire 52%
Average age of equipment for hire (months) 33
ROCE 8.90%
Net debt as a multiple of EBITDA 1.23
Number of customers 25,200
Number of depots at 30 June 180
Revenue 355
Revenue per customer 70.9859154929577
Revenue per depost 1.97222222222222
GPM 54.4%
OPM 8.2%
CAPEX 78.00
CAPEX per revenue 22.0%
Revenue
Being that the market is hightly competitvies an increase in revenue of 7.6% shows that they are
able to competie well in the market and able to stay competitve and meet the customers demands. This is a
promising sign as they business looks to grow and expand
Currently has a 7% share of the market

total market 5071.42857142857
therefore the 30% have 1521.42857142857
which shows that the company has growth of 3550
potnetially to take this revneue from competitors
We do not have the information regarding seasonily and econmic cycles therefore could request the information
on a per month bases of sales and what was ordered to gain a better understanding of targeting customers
and there specific wants so we can meet goal of delivery when urgent to customers
Revenue split
UK 213
Euro 142
We can see that if we take the split that there is both growing markets in the UK and Euro markets
with revenues increasing
As maintence is a signicant cost we have seen cost of sales have increased by 7.3% which is inline with renveue growth of
The growth in renvue and sales show that we able to delvier right equipment at right place at the right time
Profit and costs

Cost of sales -162
Gross profit 193
Distribution and administration costs -164
Operating profit 29
Finance costs -4
Which costs have gone up inline with revenue we have seen that disctrubtion and admin costs have increased
this has earn up the increase in sales resulting in a small increase in PBT of 1m comapred to the 25m growth in sales
This shows that even tho we able to meet customers demands we do this at a cost to the business
Return on assets
Utilisation rate of equipment for hire 52%
ROCE 8.90%
Despite an increase in revenue the utilation rate has fallen by 4% showing that customers are not using the products as
much we must maintaine a high rate in order for sale from hiring time to increase
The total CAPEX in the year was £78m. While some of this amount was tor replacement of assets,
there was also new investment in specialised equipment for hire of £30m and new depots of £Sm.
This has fallen but as we have new equipment over time we expect that to grow
Operations director's statement

Profit has increased by extra revenue from specialist machinary 5.6m
New customers are 800 new equipment
We can see that this is not the cash as ROCE has fallen by 6.4^%
Net debt 86
we have taken on the 34 miliion increase in new equioment from a 30 million
loan which as increased our net debt by 41%
As he says profit is the only thing that matters it only matters only increase 1m
profit is based on historic
The increase comes from the revenue in depost

Revenue per depost 1.97222222222222
The 25m only 5.6m and the remaining 19.4m is due to revenue
Financial position and liquicdity

Bank loans 96
Trade and other receivables 75
Cash 10
TR days 128.521126760563
We seem to have a lot of cash tied up in TR as customers are taking

30 more days to pay us in avarage
As a result this means cash we hold in the busiess has grown by5 million
As there is bad debt risk
the bank loan taken out of 30 mili has reduced our liquility in the busess as now we have the bank interest to pay for
Interest cover -7.25
Has fallen by 5.75 and we would need to view if this is inline with bank terms
Gearing 29%
adverse impact on gearing and financial risk
as this has
30million and 6 years is that a good return?

5 and we got 5.6m
this is not the best return only .6m and this is likely to fall in the years to com
Question 2
3 matrix
ROCE
return of captial employed looks Where capital employed = equity + net debt
as the company has taken on increase in the loan amount and as a result increased the net debt of the company
we would expect this to have falen.
We want to ensure that the assets we are investing in a gaining a strong return and being utiliited
for the company and therefore ROU may be best looking at the specilist equipement
this can be measuring the specific customers that used the equipment, the mainitence costs around this
and the type of customers using this equipment
We would not report this as mangerila performacne
if judgment used and not approate and sweat assets and hold them lover book value and
this can lead to short term
Ulitlisation rate of equipment

This has fallen and again we would want a high rate of utlisation. Given that the life of the assets
are 6 years and low we expect a long rate of use given the fact they are also repaired and the main source of income
The longer our equipment is used the better revenue potential give that customers are paying a rate
We can see that the assets are ideal for half a year nearly and raises the question are they in the right place
or is the market for them and should we be investing in these asssets
Are more detailed report into the least used assets and why this is the case it may be only a certain market
Feedback from customers in areas which may need that equipment but currently do not have and georgprahcially too far
may be another reason
We can see that manipled and not alined to revenue and look max revenue based on % and
Net debt as multiple of EBITDA

As profit is not measured perfect and non cash items such as depn and other accounting entries are included
it can be easily maniplated. Once these are taken out then the free cash flow genereated may be postive which
can indicate a vlauton greater than the fair value of the assets.
Cash flow modle may therefore be sued where free cash flows are postive, given that specialist equipment was purchased
we can view the cash flow generated from the hiring of this equpment. Also a rough intial esitmate could be
a mutiple of EBITDA
Need cashflow to meet interest covered by the bank
Benefits of repotting more detailed analys of montly
Seasonal sales and fluxaition
As directors stated we would review the seasonality of the good and potentially reviewing when
assets need to be inplace and pricing around this to target specific customer based
as we are reporting a total figure we can montly breakdown of sales from depoist, new customers
which of this using new special equipment and current
We are also able to review costs monthly and keep them control partialar the maintence costs of
ensuring assets are kept to useable standard
The 24hr needs for customers and delivery of 90% of goods, what they want and when
reporting on the time taken and period held and which type of customer this is can be useful to determin
which assets are worth keeping for future and disposing of
Additonal performance measures

They customer based we operate in and what projects they are opporating in
Review of detailed trade receivebles and likeness of payment from customers
Report on the small and large companies used and breakdwon of which these two can offer insite
into the market we operate in most
reporting the UK and Euro sales again and can look at which sales comes from
whch products in which market areas georgopgical and demograpgic
review of which equipment are repaired the most and does not meet 6 year life and
review the pricing and replacement of these equipment can be useful
By
customer
product what we need and don’t need
deposit where we should and shoudlnt need
Question 3
FR treatment of each choices
Purchase with bank laon

Loan 40,000,000
Interest 5%
Repayment 30 June 2028 6
Equipment sold RV 4,000,000
WACC 10%
Interest 2000000
Tax saved 20% 1600000
Depn and NBV

Year Cost
0
1 2023 36,000,000
2 2024 36,000,000
3 2025 36,000,000
4 2026 36,000,000
5 2027 36,000,000
6 2028 36,000,000
PL charge
Depn
0
1 2023 6,000,000
2 2024 6,000,000
3 2025 6,000,000
4 2026 6,000,000
5 2027 6,000,000
6 2028 6,000,000
0 1
2022 2023
Equipment -40,000,000
Tax saving 1,600,000
Capital allowance 6,000,000
Residual value
- 40,000,000.00 7,600,000.00
DF 5% 1.00 0.95
- 40,000,000.00 7,238,095.24
NPV 935,455.06
Captial allowance 15 % redyce balance

in year of expendutire
Equipement - 40,000,000.00 - 34,000,000.00
85% - 34,000,000.00 - 28,900,000.00
Lease a 6 years
Rental 8,000,000
Annutity 4.329
Annuity to use 5.329
ROU 42632000
Opening
0 2022 42,632,000
1 2023 34,632,000
2 2024 28,363,600
3 2025 21,781,780
4 2026 14,870,869
5 2027 7,614,412
6
ROU
Depn Interest
2022 7,105,333 -
2023 7,105,333 1,731,600
2024 7,105,333 1,418,180
2025 7,105,333 1,089,089
2026 7,105,333 743,543
2027 7,105,333 380,721
42,632,000 5,363,133
Two 3 years lease
1-3 years 8,400,000

Annuity 2.859 5 % annuity for 2 years + 1
ROU 24015600 8005200
4-6 years payment 9,000,000

Anniuty 2.859 WACC ie 10%) x discounted rate on Ye
25,731,000.00 8,577,000.00
Opening
0 2022 24,015,600
1 2023 15,615,600
2 2024 7,996,380
3
4 2025 25,731,000
5 2026 16,731,000
6 2027 8,567,550
Depn Interest
2022 8,005,200 -
2023 8,005,200 780,780
2024 8,005,200 399,819
2025 8,577,000 -
2026 8,577,000 836,550
2027 8,577,000 428,378
Finanancial
Cheaper to go for the purchase
Non financial
Cash position to payment of leease
the penaltiy if the break in lease as the assets are no longer in use
Be business use for the assets in 6 years may change and as lock down in contract unable to
adapt
the loan converence of this amount and interest cover
early repayment charges on repayment of loan
Borrow to buy
More flexible as cash can be used and not tided up
The discount rate is the net of tax borrowing rate of 4% (ie 5%(1-).
This is because lease rentals are low risk like servicing debt. However, it could be argued that a higher discount rate should
of 3-year lease rentals as they are uncertain, unless they have been contractually fixed at the beginning of the project.
expansion of £40m is significant and there could be elements of the investment where Ltd borrows and buys the equipme
A range of local commercial factors should be considered in individual investments.
Borrow and buy Non Financial

Owing the equipment is more flexible than leasing.
If the useful life is eventually longer than expected,
LPH can retain the asset beyond the (say) six years.
Alternatively, if customer demand changes, and low use then sell asset without termination payments
LPH therefore has more discretion with the timing of the end date when it is buying rather than leasign
The hiring of equipment is seasonanl and can vary and there may be more flexibility when owning asset
For example, can not take equipment outside UK to Europe customer
There may be max useual of the lease ie number of miles or life before chasing
However this is limited debt capacity
. Gearing is high for LPH but, more importantly, it is close to the debt covenant threshold.
Leasing Non Financial

Leasing will reduce the need to find the initial f40m cash in July 2022.
Ihe cash cost will be spread, enabling the new equipment have time to generate revenue for hiring to customers to help p
lease rentals.
With leasing, the timing of costs is therefore more closely matched with cash intlows from revenue streams, which aids liq
The implicit rate of interest in the lease may be lower than a bank loan, although this needs to be ascertained.
Similarly, there may be a difference in the tax treatment of a lease, but this may be a benetit or a cost according to the tax
Lease rentals need to be capitalised in accordance with lFRS 16.
However, the amount of the capitalised lease liability is likely to be lower than the borrowing required to purchase the eq
is particularly true for shorter leases. Ihis may be an advantage in avoiding a breach of the debt covenant based on gearing
The lease contract may include maintenance costs or require the lessee to maintain the asset.
If maintenance costs are incurred by the lessor, then the lease rentals will be higher, but it avoids uncertainty.
With LPH's mechanical equipment, this may be an advantage
A key assumption is that the LPH board has already decided to acquire the construction equipment.
It is therefore presumably contident that the construction equipment will make a profit irrespective of the method of finan
New business as the after new techniqual 3 years
TIhe viability of the acquisition of the construction equipment is not therefore in question.
The issue is therefore which of the three methods of ftinancing the construction equipment is preterable.
Using the net of tax borrowing interest rate as the discount rate, this shows the following present values of financing cash
Purchase and borrow

A six-year lease
Two 3-year leases
In pure financial terms, using the working assumptions, the purchase and borrow decision gives the lowest after tax PV an
However, other tactors need to be considered. It the asset is still serviceable and its condition acceptable to customers aft
lease term may or may not be negotiated with the lessor with the leasing options, but this Is uncertain and is likely to have
Comparing the 6-year lease with the two 3-year leases, while the 6-year lease has a lower PV cost there are three advanta
There is an exit route atter three years (unless there is a prior contractual commitment), so it the construction equipment
be entered into.
Ihe second lease is tor brand new construction equipment which may be technologically or aesthetically superior to the co
lease.
As the two leases are shorter than the six-year lease, the lease liability recognised in the financial statements is lower and
covenant
Asset management and asset revenues
Asset management
New IT system will enable us to be sure of where our assets are and when we can expect them back
this enables use to comitt to future lease argreement of customers as we able to advise when they are back in stock and re
and does not book out equipment that is not in stock or returned due to poor asset control
Tracing equopment and maintance of records ensure that assets are not missused or taken for own use by customers
this can mean charges and no longer loss of assets by being stolen and can be used by the business
Can more accurary predict the useful life of assets and the maintence around asset groups
Able to provide a delaited report of which of the wide range of assets are most proift and revenue generating rather than
total balance of revenue
Can gain an inside on assets not utitliised and reasons for this and if they still is a business case to have them in stock
Provide secuiirty that assets are tracked preventing the likelyhood of missuse or stolen
Dashboard provides a clear understanding of where assets are and what they are used for
giving management the clear and can advise if other stores have the assets
Revenue generation
We can track billing and use time by the customers to ensure that revneue per use is manimised and ensure that
we are not under charging the assets
we can track which is used the most and when to give real time information about which assets we need to particualr
area resulting in targetting this areas to increase renveue by large stock of assets they need
the demand is there but we can not meet it is no longer an issue
We can review how the asset is moved from stock to customers and able to meet our target 24hour delivery
Able to view the asset utilisation of each store and which are most popluar to gain understanding of
how seasonal certain types of equipment are
managmenet use there own knowledge and experience but this is subjective and based on past experiene
and can not be used to predict the future and what is expected
June
2020 Change % change
Final
£m
330 25 7.6%
-151 -11 7.3%
179 14 7.8%
-153 -11 7.2%
26 3 11.5%
-2 -2 100.0%
24 1 4.2%
-5 0 0.0%
19 1 5.3%
2020
Final
£m
196 24 12.2%
31 4 12.9%
27 1 3.7%
53 22 41.5%
5 5 100.0%
312 56 17.9%
23 0 0.0%
186 20 10.8%
66 30 45.5%
37 6 16.2%
312 56 17.9%
2020
62 8 12.9%
36 5 13.9%
6 28 466.7%
39 -2 -5.1%
0 7 #DIV/0!
61 25 41.0%
2020
56% -0.04 -7.1%
36 -3 -8.3%
9.50% -0.00600000000000001 -6.3%
0.98 0.25 25.5%
24,100 1100 4.6%
175 5 2.9%
330 25 7.6%
73.0303030303 -2.04438753734529 -2.8%
1.88571428571 0.0865079365079366 4.6%
54.2%
7.9%
45.00 33 73.3%
13.6%
demands. This is a
equest the information

geting customers
198 15 7.6%
132 10 7.6%
is inline with renveue growth of 7.8%
e at the right time

-151 -11 7.3%
179 14 7.8%
-153 -11 7.2%
26 3 11.5%
-2 -2 100.0%
24 1 4.2%
costs have increased

o the 25m growth in sales
56% -0.04 -7.1%

9.50% -0.00600000000000001 -6.3%
are not using the products as
61 25 41.0%
1.88571428571 0.0865079365079366 4.6%
66 30 45.5%
53 22 41.5%
5 5 100.0%
97.702020202 30.8191065585432 31.5%

he bank interest to pay for
-13 5.75 -44.2%
24.40%
t debt of the company
sts around this
the main source of income
in the right place
a certain market
ave and georgprahcially too far
ntries are included

may be postive which
cialist equipment was purchased

esitmate could be
ful to determin
yearsa Jul-22
40 -4 /6 600000
Depn Acc Depn NBV

6,000,000 6,000,000 30,000,000
6,000,000 12,000,000 24,000,000
6,000,000 18,000,000 18,000,000
6,000,000 24,000,000 12,000,000
6,000,000 30,000,000 6,000,000
6,000,000 36,000,000 0
Interest
2,000,000 8,000,000
2,000,000 8,000,000
2,000,000 8,000,000
2,000,000 8,000,000
2,000,000 8,000,000
2,000,000 8,000,000
2 3 4 5 6
2024 2025 2026 2027 2028
1,600,000 1,600,000 1,600,000 1,600,000 1,600,000

5,100,000 4,335,000 3,684,750 3,132,038 13,748,213
4,000,000
6,700,000.00 5,935,000.00 5,284,750.00 4,732,037.50 19,348,212.50
0.91 0.86 0.82 0.78 0.75
6,077,097.51 5,126,876.15 4,347,776.90 3,707,675.20 14,437,934.06
-28,900,000.00 - 24,565,000.00 - 20,880,250.00 - 17,748,212.50 4,000,000

-24,565,000.00 - 20,880,250.00 - 17,748,212.50 - 13,748,212.50 Balance allowance
WACC 5%
5% at 5 years not 5 years + 1
Interst Repayment Closing

- 8,000,000 34,632,000
1,731,600 - 8,000,000 28,363,600
1,418,180 - 8,000,000 21,781,780
1,089,089 - 8,000,000 14,870,869
743,543 - 8,000,000 7,614,412
380,721 - 8,000,000 - 4,867
7,105,333
8,836,933
8,523,513
8,194,422
7,848,877
7,486,054
nnuity for 2 years + 1
24,015.60 (£8400k x (AF2yrs + 1) AF % yrs =1.859+1

25,731.00 (£9000k x (AF2yrs + 1) AF % yrs-1.859+1 2.859
ie 10%) x discounted rate on Year 3 i.e. 1.1^-3
Interst Repayment Closing

- 8,400,000 15,615,600
780,780 - 8,400,000 7,996,380
399,819 - 8,400,000 - 3,801
- 9,000,000 16,731,000
836,550 - 9,000,000 8,567,550
428,378 - 9,000,000 - 4,073
8,005,200
8,785,980
8,405,019
8,577,000
9,413,550
9,005,378
hat a higher discount rate should apply to

the beginning of the project.
d borrows and buys the equipment and other elements where it leases the equipment.
on payments
r than leasign
owning asset
for hiring to customers to help pay the
m revenue streams, which aids liquidity.

ds to be ascertained.
etit or a cost according to the tax jurisdiction.
wing required to purchase the equipment. This
debt covenant based on gearing.
t avoids uncertainty.
respective of the method of finance.
nt is preterable.
present values of financing cash flows.
gives the lowest after tax PV and is therefore preferred if assessed on this basis alone.
tion acceptable to customers after six years, the ownership of the asset can be extended. Extensions of the
Is uncertain and is likely to have greater cost than extending ownership
PV cost there are three advantages to the two 3-year leases:
o it the construction equipment is not hiring out as successtully as expected, then the second lease need not
r aesthetically superior to the construction equipment used in the first three years and in the six-year
nancial statements is lower and so gearing is lower. This may be important for complying with the loan
hen they are back in stock and ready for use
n for own use by customers
revenue generating rather than
case to have them in stock

imised and ensure that
assets we need to particualr
et 24hour delivery
n past experiene
Balance allowance
x 8000
x 9000
TRADITIONAL BUDGET STATEMENT
Actual Budget Variance

£m £m £m
Revenue:
UK sales 211.2 240.0 - 28.8
Eurozone sales 712.7 806.4 - 93.7
Total Revenue 923.9 1,046.4 - 122.5
Cost of sales:
Variable production costs:
Purchase of engines - 156.0 - 153.6 - 2.4
Other variable production costs - 257.4 - 345.6 88.2
Fixed production costs - 265.0 - 240.0 - 25.0
Cost of sales - 678.4 - 739.2 60.8
Gross profit 245.5 307.2 - 61.7
Distribution and administration costs - 170.0 - 175.0 5.0
Operating profit 75.5 132.2 - 56.7
Operating data Actual Budget Variance %

Number of units sold:
UK 4,400 4,800 -400 -8%
Eurozone 11,200 14,400 -3,200 -22%
Total 15,600 19,200
Average exchange rates for year ended 30 September 20X7:

US Dollars per £ 1.2 1.5 $ has strengthen but our co
Euro per £ 1.1 1.25
Cost per engine $ 12,000 12,000
Price Per Unit Sold in £

UK 48,000 50,000 - 2,000
Europe 63,634 56,000 7,634 euro has stregthned to £ a
In Euro € 69,997 70,000 - 3
Cost per Engine 10,000 8,000 -25%

Other Variable Cost 18,000
UK Standard Contribution Per Engine
24,000
Euro Standard Contribution Per Engine
30,000
Profit has fallen in the year
profit not inline with budget
Few major international companies

good reputation and high quality service
techn advantaced machinary
manfuactor heavy equipment above market price
Engine imported from US $ all costs are £

50 different modles and sales mix
1/4 of sales are UK and reset EURO
increase competitive market
New technology
Fixed costs 24,000,000
Saved average 2,000
automation 2 parts - fixed and variable

sales volume UK and Euro splut out
price UK and Euro
foreign exchange Buying in US and Selling Europ
fixed costs (excluding effects from automation) fixed with and without
distribution and administration costs.
notes for the board which explain each of the reconciling factors and a conclusion explaining why the
overall actual operating profit was less than budget operating profit. n
Money Market Hedge

flexiabllity as we acquire the forgein currency today
leading
future contract
bases riks and locking into rate
exchange and standardised
dates and currency are standard might not suit
fixed sizes - futures and options
option we pay the premium

OCT future and pricesion and bring in default risk as single isusttuon
forward rate agreement - securirted and interest variable and fixed

exchange trade futures
swaps last week!

list the advtanges and disvanatages of the aboe
Loss on Euro and not match the benefit

underhedge was delinerate
10.8m loss
Expasion plan
Joint venture or subsidary
Selling price 25,000
JV
We share the profits and losses
Not have 100% control
They wull buy P&M 38,000
5 years contract
Due dilgence will need to be done on new unkwon busienss partner
the key aiea is JV or joint operation
No separate entity but fall under JO per IFRS 11 and both parties have contorl of Rigt to asset and obligation
relating to the arrangement
2 parties have control and shared in agreeemtn which exisit only when dececsions
about the activities of company and neded
JO is recongised in a line in FS
Assets + shares of held assets and Liable + shares of liabilityies
Revenue will also be shared and include sale of tractors less amount attribulted to the joint other party
Expenses will also be joit and items PL transalated at FX using average rates
A+ L - all monetary items will close rate
all non monetary items will histric rate
they specilise in bus's
They are based in SA and have trackion and have distoubtion chan
they have the land and we provide the P&M
Cheaper to use them as set up costs
they are taking 55m - 38m
Subsidary
We take on all profit and loss
Do have a say
Loan 55,000
Loan on consolidation will be elimaited as part of group
As is in South aferica it would have difference domain currency and we would need to cover to £
on consolidation with IAS 21 need presented in presentation currcny
Transalte all monentary and non monetry at closing rate
income and expenses and OCI will exchange rate rules will be the average rate
report fx difference to OCI
Loan 55m will be net investment in forgein operations and PL movedment will be recognsied in the FX home currency
Assurance risk arise from Hayfields and assurance procedures

to help mitagate risks
Providing assurance in respect of forecasts is covered by ISAE 3400, The Examination of Prospective Financial Information.
Prosepctive finacnail informatin based on assumptions about the events and psosible actions by entity
determin the FS and KYC on the
We would gain experts and legal advise on the 5 year contract

the terms and agreement
protection of every eventually
protection on the legal and advise
P&M protectio
they will take the profits for themselves and processed
to identity revenue and costs
we need full disclosure and auditing the FS
the incorperation of any decisions need to be inplace and ensure that this is followed
REQUESTED RECONCILLIATION
Fav Adverse
BUDGETED PROFIT 132.2

Automation Fixed Costs Adverse 18.0
Automation Variable Costs Fav - 23.4
UK Sales Volume 9.6
Euro Sales Volume - 96.0
UK Price Variance Adverse 8.8
Euro FX Variance - 85.5
$ FX Variance 31.2
Fixed costs - 7.0
Distribution Fav 5.0
Total Variance
ACTUAL PROFIT 75.5
Distributi
W6 Distribution and admin (fav)
on and
administr - 170.0
ation
costs
Automation Fixed Costs
$ has strengthen but our costs have increased by 2,000 Automation Variable Costs
W1 Automation (fav)
FC increase (9/12 x £24m)
Variable cost saving (15,600 x £2,000) x
New technology
Fixed costs
euro has stregthned to £ as we get more £ than before Saved average
UK sales volume
Budget
Euro Sales Volume
UK Price Variance
Actual UK sales
Budget price
Buget price v act sales
Actual
Euro FX Variance
Variance
Budget
Fixed
productio - 265.0
n costs
Saved 18m in production
e FX home currency
e Financial Information.
W1 Automation (fav) 5.4
w2 Sales volume changes (adv) -105.6
w3 Price (adv) -8.8
W4 Foreign exchange (fav) 54.33
ws Fixed costs (adv) -7
fixed costs are fixed why are 7m over

we expect saving as we sold less 3,200 units less but we happy to go over budget as we would of sold more
bution and admin (fav) 5

- 175.0 5.0
on Fixed Costs
on Variable Costs
se (9/12 x £24m) 18.0

ost saving (15,600 x £2,000) x 9/12) - 23.4
24,000,000 take in Jan YE Sept = 9/12

2,000
240 Budget sales v price 220.00 20.0
400 x Budget CPU 4000 x 24,000 - 9,600,000
3200 x Budget CPU 3200 x 30,000 - 96,000,000

4,400
50,000
ce v act sales 220.00
211.2
- 8.80
- 2,000
- 240.0
- 25.0
m in production 18
- 7.0
20.00
Nov 2021 Paper
Forecast summary of Dec 21
produced both paper packaging and plastic packagin
Sold plastic division 100m in 1 Jan 2021
(a) Explain and evaluate the benefits and riskS of investing in the new Al machinery
Exhibit 3A). Provide a reasoned recommendation that takes account of relevant
financial and non-financial issues. Show supporting calculations, including the
probability of generating a negative expected NPV.
ignore the possibility of a new market entrant (Exhibit 3B).
new artificial intelligence controlled production machinery (AI machinery) at seven of its paper mills
NPV 3A No new entrant 3B New entrant

have a fiveyear useful life
negligible disposal value because of its specialist nature
Prob Total PV of net CF
optimistic; 0.3 180 54 optimistic;
most likely; 0.5 120 60 most likely;
and pessimistic. 0.2 90 18 and pessimistic.
132
A discount rate of 8% per annum
market risk-free interest rate 2%
Initial investment cost million Initial investment cost

40% 75 30
60% 95 57
87
NPV 45 NPV
Investment
40% 60%
optimistic; 30% 12.00% 18.00% optimistic; 30%
most likely; 50% 20.0% 30.0% most likely; 50%
and pessimisti 20% 8.00% 12.00% and pessimistic. 20%
Investment
Total PV of 75 95 Total PV of
optimistic; 180 105 85 optimistic; 117
most likely; 120 45 25 most likely; 78
and pessimisti 90 15 -5 and pessimistic. 58.5
Benefits of new AI Machinary

packaging market is volatile
eriods of rapid growth
reduced demand in recent years for paper
trend for internet shopping has increased demand for packaging
Single items to consumers require more packaging per item
multiple production lines and uses a variety of machinery.
can be tailored to fit customers’ products
use less raw materials
expected, over time, to enhance production efficiency
improve Demm’s competitive position in the indus
Risk of new machinary

sharp decline
main raw market
material
used is pulp
Legislation and regulation impact the industr
some food products cannot legally be distributed in recycled paper
years of global decline
project team to gather data and evaluate the potential investment
perated separately
How long will it take
AI machinery would need to be reprogrammed
there remain some technical issues to resolve - how bad are they
final adaptations may be needed.
(b)
Explain how your evaluation in 1.(a) would change when Demm becomes aware of
the possibility of Hagg as a new market entrant (Exhibit 3B). Provide reasoned
advice to the directors about the decision they should now take regarding the
investment in the new Al machinery. ShoW revised calculations.
Hagg enntering the market and making it comptetive

PV of net operating cash inflow 35% fall
25% probability of Hagg
Neg NPV 75% does not 12% 0.75 x 0.12 22% Change of Neg NPV
Neg NPV 25% x 50% 0.25 x 0.5
NPV 45 x 75% + 25% x -1.2 33.45 NPV

75% x £45m) + (25% x nil*) = 33.75 delay decsison
(c) Assume that Demm invests in the new Al machinery on 1 January 2022, at a cost
of 295 million and Hagg enters the market in December 2022.
Explain the financial reporting treatment of the Al machinery in Demm's financial
statements for the year ending 31 December 2022. Show supporting calculations.
State any assumptions.
Cost 95
Hag enters in market

optimistic; 0.3 117 35.1
most likely; 0.5 78 39
and pessimistic. 0.2 58.5 11.7
85.8
85.8m/(AF 5 yrs 8% 3.993 21.4876
risk free rate to discount to determine

x AF 4 yrs 2% 3.808 81.82479
Cost 95
NBV after Y1 76
2
Provide reasoned advice to the Demm board regarding which of the two mutually
exclusive sales contracts should be accepted (Exhibit 4). Consider financial and non
financial factors. Show supporting calculations which evaluate returns and risks.
Zambesi Inc US
Nile plc UK
, including shared and integrated information technology
Zambesi Inc
FMCG and is a growing company
global retailers
US customers 50%
nternet sales directly to consumers as B2C sales.
made from recycled pulp
3 year contract
PV for 3 years 3
Prob Std dev

50% 2.5 - 3.5 0.75
50% 2.5 1.25
50% 3.5 1.75
Investment 3.00
New tech every 3 years 2.5m
NPV 0.5
Coeffeint .75/3 0.25
NPV/AF (8% for 3 yrs) 2.577

NPV 0.5
0.194024 m pa
Nile PLC
including foods and FMCG
globally, but
50% of its sales are in Europ
s revenue has been slowly decreasing in recent years
50% of its packaging will be made from recycled pulp and 50% from virgin pul
4 year contract
PV of 4 years 4
Std dev
50% prob 3 - 5m 1.5 e higher risk with a standard deviation
Investment 3.4
4 years renew rech 3.4

NPV 0.6
Coeffeint 1.5/4 0.375
Renew 4 years 8% AF 4 years 3.312

NPV 0.6
0.181159 m pa
3. In respect of Demm's environmental activitiesS
(a) explain the benefits of the proposed environmental audit engagement for Demm;
(b) Identity and justity KPIS for Demm to measure its environmental impact; and
(C) set out assurance procedures that would reliably evidence these KPls.
Majoru marekts
Fast moving cosnumer goods Revenue
online Operating expenses
food compnaies Operating profit
Europe 45% Invoice £ Finance costs
USA 35% Invoice $ Profit before tax
Asia 20% Invoice £
Paper mills Non-current assets

Europe 10% Property, plant and equipme
USA 2% Current assets
Cash
virgin and recycled pulp 40:60 Other current assets
Virgin pulp is supplied by third party forestry companies Total assets
recycling unit at each paper mill Equity
recycling unit at each paper mill Ordinary share capital - £1 sh
Retained earnings
Other reserves
Total equity
Loans
Other
Current liabilities
Total equity and liabilities

0.3 117 35.1
0.5 78 39
0.2 58.5 11.7
85.8
million
40% 75 30
60% 95 57
87
-1.2
Investment
40% 60%
12.00% 18.00%
20.0% 30.0%
8.00% 12.00% 50.00%
Investment
75 95
42 22
3 -17
-16.5 -36.5
Em
4,361
Operating expenses -4,304
Operating profit 57
Finance costs -8
Non-current assets
Property, plant and equipment 935
Current assets
112
Other current assets 372
Total assets 1,419
Ordinary share capital - £1 share 50

Other reserves 246
Total equity
214
239
Total equity and liabilities 1419
Nov-21
Question 2
Rudder plc
Purchase a land
for development
How the land might be fined
Dividends at YE
canceld to provide fiance for land and other same level
Sepecial construction ad building site

6 -8 largge project take 2 - 4 years
owns 4 pieces of land
YE 31 dec 21
market conditions are difficult and worsened in the second half of 2021
Em
Revenue 1476
Operating profit 46
Finance costs (including £11.2m interest on borrowings) -14
Taxation -9
Profit after tax 23
Non-current assets
Property, plant and equipment 305
Current assets
Inventories (including landbank £243m) 587
Cash 8
Other current assetss 172
Total assets 1,072
Equity
Ordinary share capital -£1 shares 100
Other reserves 150
Total equity 497
Borrowings (Note) 351
Other 71
Nominal CA
3.5% Bank loan 190 190 Jun-24 3.5
2.8% Bonds 165 161 May-29 7.5
Shatre price Nov 21 10.03

Same Dec 21
1
(a) Evaluate each method of borrowing by:
calculating the annual effective interest rate (where possible) and explaining
the cost of borrowing
assessing the riskS; and
setting out and explaining the financial reporting treatment in Rudder's financial
statements for the year ending 31 December 2022.
() Recommend and justiy the most appropriate mix of borrowing methods to raise the
£120 million. Selecta mix of two or three of the five available methods of borrowing.
Notes
gnore the possible cancellation of Rudders dividend for the year ending 31 December 2021
(Exhibit 4).
gnore tax.
Use all relevant available information.
.
Land 120
Jan-22
Beileves worth more 120m
Contruction till 2024
Method 1: Loan – Alsopp Bank

Max 40
Fixed rate 4%
Interest 1.6 to the PL
4 years repayment
Interest cover 3 min
Current 4.1071428571
Operating profit 46 46
Finance costs (including £11.2m interest on borrowings) -14 11.2
If below 3 then 4.50%

Interest 1.8
Likelyhood of this being (1.04 / 1.045 )^3) 1/4
Loan will be SOFP 4.38%
Land to land bank
NCL 40
1.6
41.6
-40 x 4%
40.15
Method 2: Loan – Swiss Bank
Method 2: Loan – Swiss Bank
(CHF) Loan 48 Method 1: Loan – Alsopp Bank
Fixed interest 1.20% Method 3: Loan – Carstairs Bank
0.576 Method 4: Bank loan repayable by instalm
Rate 1.2 40 £ Method 5: Corporate bonds
Interest 1.2 0.48 £
4 years repayment
Average rate for interest

Loan will be at historic rate
Then valaued as monetry item at Closing rate
Can use options on the amount as interst paid
exchange rate movement
the CHF weaknes
less CHF for £
Method 3: Loan – Carstairs Bank

Max loan 60
Variable
4 years
10 year bond 0.40%

plus 3% 3%
3.40%
Interest 2.04
Method 4: Bank loan repayable by instalments

Fixed 40
4 equla intereestment
Add interest 11.019
1st Dec 2022 44.076 3.63
Table 4%
Rate function 4.87%
Interest 1.947526524
Method 5: Corporate bonds

Loan 60,000
Par 100 58,800 Start - loan less tran cost
Interest 1% on top of this - 600 Interest
Premium 10% Above par - 600
Premium 66,000 - 600
Transaction cost 2% - 600
Dec-25 4 year - 66,000 Premium + Par
Transaction cost 1,200
Loan start 5880000.00% 3.908% Rate(4,-600,58,800,-66,000)
Provide reasoned advice for the Rudder board on whether the 2021 dividend should be
cancelled (Exhibit 4. In so doing, evaluate the comments of the operations director and
the finance director. Use all relevant available information.
1%
2018 37.64 0.3764
2019 38.8 0.388
2020 40 0.4
2021 40
Directors Five directors own shares in Rudder. Their holdings range from 160,000 shares held by the marketing director to 305
Owned
shareholder and director pressure

share price will fall
Gearing
Net debt 422 46%
Net debt + equity 497
Set out any ethical issues for Rudder and Matt Tarkle, the marketing director, arising from
the matters described by the CEO (Exhibit 5). Recommend the actions that the CEOP
should take, depending on whether Matt is deemed to have acted legally or illegally.
.
Potential insider trading

Buying shares
Tipping off and AML
Risk of losing job
Self interest threat

maniplatution deliberate
volatie of share price
professinalism
Loan Interest miInterest max Interest per £
40 1.600 1.8 25 22.22222
40 0.480 83.33333
60 2.040 29.41176
40 1.948 20.53887 Fixed
60000 0.000 #DIV/0!
40 48000 0.000833
Tran cost 0.8
arketing director to 305,000 shares held by the CEO. 1%

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Ethics Page 1

Merson, Shiplock and Brown LLP

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

Describe the functions central treasury department.

Purchase components £ 116,000.00 3m

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

better to have hedged - foreign currency option

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.

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 5

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Revenue less exp - 1,520,000.00 548,937.50 809,534.38 793,261.09 758,986.65

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

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

Worked example Sensortex from chapter 20

Oversea expansion strategy

Assurance service carried to set up JV

Tax allow depn 25%

Variable cost 2000 2500 2500 2500 2500

Tax on royality 33% -£ 247,500.00 -£ 247,500.00 -£ 247,500.00 -£ 247,500.00 £ -

W2 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

Borrow funds 10%

PV £1,055.28 £1,155.44 £892.33 £806.23 £728.44 £4,320.10 £918.32

Purchase US Company $ 72,000

Ex rate Spot One year forward

Book value debt 50%

Corp tax 28%

Finance requried $ 80,000