FINANCE-ACFI5022 Strategic and Financial Decision Making

ACFI5022 Strategic and Financial Decision Making

Assignment 2013/2014

Pronto plc is a medium-sized manufacturing company, based in the UK, which produces printer cartridges for the computer industry.

The company has been quoted on the stock exchange for 4 years and has no long term debt, although it does have an overdraft. However, as a result of this its interest cover is higher than that of competitors. Its return on capital employed (ROCE), however, is similar to that of other companies within the same business sector (20% before taxation). The company operates from three small production facilities, within the UK, which it owns, along with a small fleet of distribution vehicles, which is also owned.

At the moment Pronto plc is considering an investment in a new machine (at a cost of £2,250,000), in order to manufacture a new printer cartridge. This machine would have a maximum capacity of 180,000 units per annum. The company has employed a market research agency and the agency has established a link between demand and the amount that the company can charge to potential retailers. The agency has suggested two possible sales strategies that could be implemented:

Strategy 1 Strategy 2

Selling price (in current price terms) 12.00 11.50

Sales volume in first year 80,000 95,000

The agency has also predicted that with Strategy 1 sales volume would be expected to increase by 4% per annum and that with Strategy 2 there would be an annual increase in sales volume of 11% per annum.

The market research agency has not yet been paid and Pronto currently owes them £120,000.

The company expects the annual variable cost per cartridge to be £4.50 (in current terms) when 80,000 units per annum are produced. Upon investigation it is discovered that for each additional 10,000 units produced in excess of 80,000 units, there will be a reduction in average variable cost per unit of £0.10. This means that when production is between 90,000 and 99,999 units, the average unit variable cost would be £4.40, and that between 100,000 and 109,999 the cost would be £4.30 per unit, and so on.

Furthermore, the operation of the new machine would cause a rise in fixed costs of £165,000 (in current terms) per annum.

It is anticipated that the machine would have a useful life of 5 years and that upon investigation of economic factors it appears that inflation is expected to increase fixed costs at 4% per year and that annual inflation on the selling price and variable costs could be expected to be 3%. Within the economy as a whole it is expected that the annual Retail Price Index will be 5% per annum.

With regard to financing the new machine the finance executive, Peter Omoteso, is of the opinion that the money should be raised by a new issue of equity. He is also aware that the company’s current shareholders require a real rate of return of about 8½%.

At Board level when the prospective investment is discussed Peter Omoteso says, “I think that we should estimate the Net Present Value in order to decide whether or not to proceed.”

Bob Vickerstaff, the production director, responds, “Net Present Value? Sounds like a load of old accounting jargon to me. Why don’t you just calculate the annual percentage return? Of course I realise that you’d have to make an allowance for the fact that money received in early years is worth more to us. However, I must admit that I do like percentages.”

Beverly Andrikopoulos, the marketing executive, adds to these two comments, “Aren’t you both over-complicating the issue? If we know the current ROCE in our industry why don’t we just see what the ROCE is on this particular project and compare the two?”

Tom Sparkes, the Human Resource manager says, “I’m far from being an expert with numbers so I’ll leave these decisions to you lot. However, I was wondering whether or not there are any better alternatives than going back to the stock exchange in order to raise the finance through more shares. Couldn’t we increase our overdraft or borrow the money?”

At this comment, Andy English, the sales director, joins in. “Whilst we’re discussing spending money, isn’t it about time we bought ourselves more luxurious company cars? My neighbour’s got a lovely car and my family are continuously moaning about mine. I quite fancy a top of the range Mercedes, or something like that. After all we have earned a good return recently. In fact, whilst we’re on the subject, why don’t we make our trips to Spain a bit more bearable when dealing with those large Spanish customers? Perhaps we could buy an apartment in Barcelona. We could then use it for business trips and for long weekends and holidays with our families.”

Peter Omoteso then responds, “Let’s get back to the proposal. I’m not sure how reliable the future forecasts of cash flows will be. Therefore, I propose to undertake some meanvariance analysis on the project.”

This comment was enough for the non-finance managers at the gathering and the meeting soon drifted to a halt!

With these considerations in mind the board decide to appoint a management consultant in order to help them with some of their decisions.

Acting as a management consultant you are required to address the following issues:

1. Determine which of the proposed pricing strategies would be most attractive to Pronto plc, using the following methods of capital investment appraisal:

i) Net Present Value ii) Internal rate of Return

iii) Accounting rate of return, based on average investment

In addition, clearly explain the rationale for your answers and explain upon which methodology you would place most reliance when considering a capital investment project.

(30%)

You are not required to take account of taxation.

2. It would appear to be evident that a decision such as that faced by Pronto plc is characterised by large elements of risk.

You are required to briefly discuss the general sources of this risk (10). Furthermore, you should consider the statement made by Peter Omoteso concerning Mean-variance analysis. As you realise that the non-financial managers are a little confused by his statement you decide to prepare an example which will demonstrate the operation of mean-variance analysis within the context of the above project. You should also provide a brief discussion of the benefits and drawbacks of mean-variance analysis as a risk management tool (15)

(25%)

3. Advise the management of Pronto plc on the matters that they should consider when considering the source of finance for this investment. Your advice should consider both practical factors and those that may be considered to be a matter of academic debate.

(35%)

4. Comment on the views expressed by Andy English, the sales manager, from the shareholders’ point of view. Discuss whether or not they are likely to, or need to, take any action.

(10%)

(Total 100%)

Further Informations:

You are required to present well-structured answers of no more than 3,000 words in total (excluding calculations).

Assignments will be graded according to the following criteria:

Evidence of critical judgement in selecting, ordering and analysing content in order to present a sound argument.

The demonstration and understanding of relevant concepts and models.

The demonstration of insight and originality in responding to the assignment.

The extent and level of research undertaken and the degree to which this research is appropriately referenced.

All of the usual University regulations will apply with regard to the late submission of work and plagiarism.

Work should NOT be submitted in plastic folders or files. It should be simply stapled at the top left hand corner.

Hand in date: 11^th August 2014

How to succeed in Phil’s assignments!

Ultimately this depends on to what extent you want to achieve a good grade! Those students who put time and diligence into their assignments are generally rewarded for their efforts.

Important specific points to remember

Think about the question and the structure of your answer – you need a clearly defined structure which addresses the specific issues of the assignment. Therefore, PLAN your response very carefully before beginning to write. Think to yourself:

o What is the question asking me to do?

o Is what I am writing focussed on the question – is it relevant – or am I just including it because I found it!!?

Make sure that you read all articles which are referred to in the assignment

Never write anything in your assignment that you do not understand

Do not use ‘bullet points’ to any great extent – this tends to preclude analysis and explanation

Think about presentation

o Contents pageo Page numberso Use short sentenceso Use many short paragraphs – a new paragraph for each different idea.

o Do not use too many headings – this tends to prevent the flow of the work

o Where an assignment is divided into parts 1) 2) 3) etc – answer in that format – do not merge answers - it is impossible for the assessor to mark these easily.

When referencingo NEVER reference to Wikipedia, Investopedia, mbaessays.com, chaeatsrus.com etc – these websites are all unsubstantiated – the material on these can be written by anyone – ALWAYSuse academic literature (journal articles, text books etc – these have been refereed by

other academics – unless you are looking on reliable websites for data and statistics)

o If you include a quote in “speech marks” you need to also include the page number from the source as well as the author name and date – no page numbers if there is no quote

o All the references that appear in the script should appear in your

Reference List – it is not a Bibliographyo The Reference List should be in alphabetical order by author surname

(family name)

Working Practiceo Discuss with colleagues but type up your work separately.

o Never give your work to another student in an electronic format – you will be guilty of collusion, as well, if they use any of it

o Do not leave your work accessible on a university computer whilst you are not present

o Never share a file where calculations/spreadsheets are concernedo Keep a back-up of your work – computer problems are not a reason for an extension

o Print the work leaving yourself plenty of time before submissiono Never sub-contract your work to a third party – it is generally easy to identify!