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AF4S31 Strategic Financial Management Assignment Answers

AF4S31 Strategic Financial Management Assignment Report

 

Assignment Detail:

  • Number of Words: 5000

 

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Question 1

Prestige Co specialises in producing engineering components, which are sold throughout the world. The business was set up by two skilled engineers Aled West and Simon Smith.

In 2013 the business was listed in order to finance an expansion into new premises, and very early in 2018 the company invested in a fleet of delivery vehicles proudly carrying their company logo. This investment was mainly funded by the issue of bonds at 9% interest.

The business has continued to grow and Aled, who has taken on the role of Operations Director, and Simon, who is Director of Product Design, continue to operate a very hands-on approach to managing the production aspect of the business.

There is a finance team who manage the day to day accounting transactions and, until recently, Aled and Simon have relied on their school friend Sean Arnold for all aspects of financial strategy and leadership. Unfortunately, though in the last year Sean has not been able to dedicate the time needed to support the business for personal reasons, and Aled and Simon are worried as they do not feel they understand the finances well enough.

This has been brought into focus for two reasons:  firstly, Aled and Simon have arranged to meet with the bank next month about their plans to replace the production line machinery, which they are hoping the bank will help finance; and secondly there is growing pressure from a major shareholder Sir Timothy Long, a well-known and respected environmentalist, to invest in the latest environmentally friendly production machinery. Nicknamed ‘ENGOOD’ this machinery will cost an additional $1,000,000 compared to the next best, but less environmentally friendly, option. Aled and Simon are concerned about the extra cost involved in implementing ENGOOD and the effect this will have on profits and on the market value of the business. In addition they would prefer to be allowed to make what they think is the best decision for the business. Other members of the board are keen to choose ENGOOD as they say “it would reduce Prestige’s carbon emissions to an industry leading low level, which can only be good for the business in the long run”.

You have just been appointed as a management trainee at the company and the directors have asked you to assist them in preparing for the meeting with the bank.

 

The directors have provided you with the following financial information:

 

          2018   2017
         $’000   $’000
Sales 44,900 32,000
Cost of salesGross profitAdmin expenses 1,800 23,000
9,000
1,500
Distribution costs 4,050 2,000
Finance costsProfit before taxationTaxation

Profit after taxation

 

5263,074922

2,152

 

365
5,135
1,541
3,594

 

                                                           2018                       2017 $’000      $’000       $’000          $’000
Non-current assets                                   17,500                      15,300Current assets

Inventory                                   5,500                       2,900

Trade receivables                     5,500                       2,600

11,000                        5,500

Total assets                                               28,500                      20,800

 

Capital and reserves

Share capital 50c shares                            7,200                        7,200

Reserves                                                     6,852                        5,700

14,052                      12,900

Non-current liabilities

9% bonds                                                    3,500                        3,500

 

Current liabilities

Trade payables                         6,648                       2,400

Overdraft                                  4,300                       2,000

10,948                        4,400

Total Equity and liabilities                       28,500                      20,800

 

Dividends of $1,000,000 in 2018 and $1,500,000 in 2017 were distributed to shareholders. The shares of Prestige are currently trading at $3.00 compared to $3.50 this time last year.

 

Required:

1. Prepare a report for Aled and Simon which analyses and evaluates the financial position of Prestige using an appropriate range of financial ratios, commenting on the factors affecting the use of ratio analysis. You should highlight any areas for concern and advise the directors on how they could address these issues.

 

Calculations to support your advice should be included as an appendix to the report.                                                                                                                     

2. “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game” (Milton Friedman, 1970 New York Times).

 

Discuss the roles played by directors Aled and Simon, acting as agents for shareholders of Prestige, and explore whether it is possible for a public limited company to satisfy shareholders needs and adopt a position of corporate social responsibility to other stakeholders.

 

Question 2

The directors of Woodcote Range Co., a listed company, are planning to meet market demand for its products by purchasing new machinery costing $3.5 million. The project name is ‘Growth’.

The machinery would last for five years, at the end of which it would be replaced.  The scrap value of the machinery is expected to be 5% of the initial cost.

Capital allowances would be available on the cost of the machinery on a 25% reducing balance basis, with a balancing allowance or charge claimed in the final year of operation.

This investment will increase production capacity by 10,000 units in the first year, increasing by a further 5% per year for years 2 to 5.

Relevant financial information in current price terms is as follows:

  • Selling price $450 per unit with inflation 3.5% per year.
  • Variable cost $275 per unit with inflation 4% per year.

 

Production departments take a share of existing overheads to the sum of $575,000 per annum and the project will generate incremental overheads of $300,000 per annum both quoted in current prices. Inflation of 6.0% per year applies to overheads.

The machinery will also require the use of warehouse space which is currently being rented out and earning rental income of $120,000 per annum in current terms. The rental income is due to increase by 1.5% per annum. This income will be foregone if the project goes ahead.

There will be working capital requirements of $500,000 at the outset. This amount will be released in full at the end of the project.

Woodcote Range Co. pays tax on profits at the rate of 20% per year, one year in arrears.

The company has a nominal (money terms) after-tax cost of capital of 15% per year.

 

Required

You have been asked to produce a report for the directors of Woodcote Range Co. to include the following:

1. A calculation of:

  1. the net present value of project Growth using a nominal (money terms) approach; and
  2. the payback period for project Growth.

 

A detailed analysis showing how the NPV and payback period have been calculated should be included as an appendix to the report, together with any assumptions and related calculations.

 

2. Advice to the directors of Woodcote Range Co. on the viability of the proposed investment, and a summary of non-financial factors that the directors should consider before finalising their decision. Your advice should include an evaluation of the benefits and disadvantages of the two appraisal methods used.

 

3. A discussion and critical evaluation of the theory that Financial Management involves determining an optimum capital structure. You should refer to relevant models and theories to support your work.

 

The work submitted should use a variety of sources. Marks are available for the presentation of your report including structure, style and the presentation of referencing.

 

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