MCS Themes

Question 1

Acquisition of subsidiary

Answer 1

Areas to consider:

1. Advise the board with reasons whether proposed acquisition is compatible with Piping’s current business model.

> Business model
Defining Value
- Pays attention to needs and wishes of consumers. - Endeavors to obtain feedback from customers.
- Value is in maintain popularity of brands.
- Acquisition will result in access to more consumers which can be used to better meet the needs and wishes of consumers and therefore refining Pipings deifinition of value.

> Creating Value

• Good quality materials for products and packaging.
• Innovation - Packaging (although was external failure as innovation came from customer complaint.)
• Acquisition will enable access to R&D from which we may learn from.

> Delivering Value

• Marketing in clear and relevant manners.
• Would culture require message to be tweaked to account for regional sensibilities.
• Distribution - Will we have efficiency or capacity issues?

> Capturing residual value

• Justify a premium price through quality of materials, value added in production and paying realistic prices.
• A concern here would be if the acquisition operates a low cost model, would this be sustainable?
• Conrols costs through operational efficiencies.
• An opportunity here would be the merging of operational areas and support functions.

2. What factors must we consider when determining the goodwill on acquisition?

> Definition - Consideration less FV of net assets.

> Consideration - how are we paying for it?

• Cash
• Deferred cash - must be discounted back to PV
• Shares - listed company so readily available share price.
• Contingent consideration - ‘earn out’ - depends on future targets, would be based on probabilities and then discounted to PV. Would require judgement and possible independent advice.

> Fair Value of Net Assets

• PPE - use market value
• Property - Surveryor
• Contingent liabilities - would need to be accounted for.
• Intangibles - Brands - What is the plan? to use or discontinue?

> impact of goodwill on the Interpretation of financial statements

• Accounting treatment - non-current asset in intangibles.
• This is likeley to reduce the ROCE
• Gearing will be reduced as equity has increased in relation to debt.
• SPL - Only an impairment would be presented on the SPL. This could be immediately after acquisition or as a part of the annual review.
• Could look at the EBITDA or Cashflows for better analysis on the financial health of Piping.

3. Outline challenges with determining PV of CF of a proposed acquisition. Recommend how to overcome.

> Determining PV of CF

• What is the strategy for the acquired company? to run separately? integrate?
• Incremental costs and revenues
• Are there any synergies? - duplicate departments where cost savings could be made? (R&D, Marketing, HR, IT - Support Functions)
• Other revenue opportunities - cross selling, piping selling to subsidiaries existing contracts?
• Are any customer contracts included in the acquisition?
• Will need a discount rate for the PV calculation - WACC.

> Overcoming challenges

• Need financial information - published stat accounts have limited use, would be more useful to see management accounts/forecasts/budgets
• Approach information with sceptisism on the companies optimism in the numbers.
• Carry out own market research.
• Sound out any customer contracts to see if they are likely to remain with the acquisition.

4. Approach taken when negotiating a share for share takeover.

> Aiming for a win/win situation
- Where would conflict arise? - the price..
- Aim to understand what their position is - getting to know the other party.
- The number of shares - consider the dilution for existing shareholders.
- How will other stakeholders be treated? Staff?
- On ourside:
- What are our limits?
- Where are we willing to be flexible?
-

Post - Acquisition

5. Identify key risks and uncertainties that could impact operational compatibility. recommend ways to manage each.

> Risks
> Supply Chain
- will subsidiaries systems be able to integrate with Pipings existing suppliers.
- Recommendation: Phased approach of moving suppliers.

> > Manufacture

• Will subsidiaries machinery be able to make our products?
• Will there be capacity issues?
• Recommendations: test runs on equipment / forward planning for demand/capacity.

> > Staff

• Culture - will the teams from each company clash?
• Training
• Consultation to raise any concerns.

6. Staffing the project team for
   - In general terms there should be a cross section of staff from a range of levels and in equal parts from Piping and the acquired company.
   - Management should be chosen based on their relevant experience in regard to the objective of the project.
   - Staff members should have a wide range of skills and experiences to provide variety however it should still remain relevant to the project.
7. Types of responsibilities that may cause dysfunctional behavior. Recommend which responsibility centres should be used to discourage this?

> Dysfunctional behaviors

• Outline circumstances this may arise - conflicts over scheduling for production
• Culture differences - Premium brand acquire low cost brand (aggressive cost cutting methods)

> What are they responsible for?

• Branding and marketing? - Cost centre
• Sales and opex - profit center
• Total independence - Investment centre (Dys functional behavior more likely to arise here because of the difference in brand objectives/methods)
• Can it be two responsibility centers? - One for own brand products (Profit), one for manufacturing of Piping branded products (Cost)

8. Benefits of ABM and cost transformation techniques.

> ABM

• Start off by explaining what it is: Managing performance based on the products/services proportion of usage of the drivers that impact costs.
• E.g: Scheduling - production runs from Tea bags to Loose Teas - setup costs (changing tooling and machinery) down time = loss of income (opportunity cost)
• ABM/ABC requires a lot of data and measurements - requires systems that can handle and can be rolled out across subsidiary and new acquisitions.
• Subsidiary is low cost model so unlikely to have significant savings e.g. JIT

> Cost transformation

• Cultural awareness of costs
• HR lead activity through training and leadership.

9. Evaluate the problems associated with conducting an impairment review on the goodwill arising from acquisition of subsidiary. Recommend a response.

> Problems

• Outline why we do it? - IFRS states Intangible assets need to reviewed annually, this is done be comparing the carrying amount with the recoverable amount.
• Recoverable amount = the higher of Value In Use and Sales Value (FV- Cost to Sell)
• Value In Use = NPV Calc based on the future benefits - this is based on judgement
• Indications of impairment - for impairment of tangibles for instance vehicles, its simple to look at the state of the item and market value.
• Intangible goodwill - impaired if subsidiary less profitable than thought.
• Conducting an impairment review soon after acquisition is unlikely to result in a significant impairment. Most likely to be no adj at Y/E.

> Recommendations

• If impaired so soon it would reflect very poorly on the board.
• Could be beneficial to conduct an impairment review - independent valuation / advice
• Review valuation / negotiation techniques to assess how well we are at spotting a bargain or whether our negotiation techniques need improving.

Question 2

New Product range

Answer 2

Areas to consider:

1. Challenges with predicting costs and revenues?
\+ Costs
> Materials
- New ingredients
- New supplier(s), (lead times, prices)
- Lower volumes = no bulk discount
- Wasteage
- Could we reverse engineer competitor products - Competitor analysis.

> Labour

• Volumes - number of staff
• Skills required? - are existing skills transferable? training required? recruitment?
• What are the market rates for these skills?

> Overheads - Machinery

• Do we have capacity
• Do we need new production lines? can we use current production lines?
• need to consider scheduling
• Can we use current machinery? adapt machinery? buy-in new?

+ Revenues

• Volumes - new product
• Will our reputation help with volumes? seen as specialists?
• We are 2nd mover so can’t expect same growth
• Need to complete market research
• Can we compete with 1st mover? usp?
• Price we charge - also compared to competitor?

2. Usefulness of competitors segmental analysis

> description of segmental reporting: How management see the business, each area will have different risks and rewards and is used by management to management business performance.
Say what you see in terms of financial ratio’s, YoY performance.
- Not necessarily directly comparable (segments may be vague, not categories we use)
- Consider proportion new product range of total revenue.
- is growth sustainable? is it based on price or volume?
- Segmental report is historic and we would need forecast data to undertake valuable analysis.
-

3. Engaging product development team

+ Start off by why it is important workers are engaged? consequences of not being engaged?

• Quality of brand is reliant upon workers being engaged. therefore it ties in with the Piping strategy.
• Investigate problem of why workers aren’t engaged - skills/resources/time?
• is the problem culture? one person? whole team? (remove individual, meeting with whole team to air grievances)
• Set the team targets - SMART example
• Incentivise - financial?
• Problem with the team structure? - allocation of work?

4. Transfer pricing challenges

+ The aim of transfer pricing is to avoid dysfunctional behavior. purchasing resources externally that can be provided internally.
> needs to be “Fair” to both parties.
- What type of responsibility center are each party? what will their concerns be?
- Capacity issues?
- Types of transfer pricing? - Marginal cost, Market rate, two-part tariff, Head office recharge.
> The result of the transfer price should also make the purchasing party consider whether the work is really necessary.

5. Debt and Equity

+ Current financial position. -
> The cost of debt vs equity
- debt is cheaper than equity because debt providers take lower risk - paid before tax, paid before shareholder when company is dissolved. debt is also tax deductible.
- Equity has high cost to issue shares - more useful for raising v.large sums of equity.
- Although debt is cheaper the gearing ratio (D/D+E) must be considered.
- Duration: For new plant and machinery it may be efficient to obtain a loan which matches the lifetime of the equipment. (i.e. 15years).
- Duration: Raw materials and Working capital - Overdraft for v.short-term requirements.
> Brief overview of impact on financial ratios: interest cover (if debt route), EPS (if equity)

6. Integrated Reporting

+ What is IR about? - how the company creates value for a wider range of stakeholders not just shareholders.

> Forward looking, but not compulsory.
Capitals
- Financial - Cash/loans - captured in Financial statements as cash/non CL or equity
- Manufactured - PPE/ Inventory - financial capital will be invested into PPE, extra WIP and inventory.
- Intellectual - IP/Knowhow - intangibles, recipes/blends (trademarks)
- Human - Skills/staff - would increase human capital with the recruitment of new staff / new training.
- Social - Relationships with supply chains - improved over time? are we using existing supply chains or new suppliers? We are creating new customers with the new range (also counts as creating relationships), improving relationships with existing customers if they buy the new products.
- Natural - materials we are using up - are we using renewable sources? (Water to grow crops, in areas with people dying of thirst, tea plants, the energy used for production from clean sources?)

7. Management of the project (not project management)

> Who will lead the project?
- If strategy is B2C or B2B will require different skills/makeup of team as customers are different.
B2C - What do consumers want? market research.
- Marketing would be better suited to lead the project. They have data on consumers or can conduct thorough market research on taste, packaging, price.

> B2B - What do retailers want?

• Account managers to lead / or business development team
• Will be able to explain the likely volumes that we epect to sell, the discounts available and rebates, special offers for good positioning of product on shelves.

8. Pricing
   > Two main types for a new product
   - Penetration pricing - low price to gain market share. however could a low price have a negative impact on the brand?
   - Skimming - High price to recover R&D costs and reduce over time to attract new buyers. more applicable for new technology products that have a short life cycle.
   > Should aim to at least match competitor or maybe higher to maintain premium brand.
   - Use discounting or “try me” tables to attract customers.
9. Risks of producing new product range (product / reputation)

> Demand side - might not sell enough which reduces profitability

• Uncertainty of recovering R&D costs, this will impact the future R&D.
• Other competitors entering the market, we may be outcompeted? nice product, cheaper product?
• We are 2nd mover so cannot expect same growth as 1st mover, plus they will spend money to maintain their market share.

> Product side

• May not have the resources to launch.
• feasibility of processes, scheduling, quality control.

> Reputation risk

• How should we promote it? advertising rules around health claims. (lead to fines)
• How are retailers promoting it which could damage our brand?

Question 3

Dysfunctional team

Answer 3

Areas to consider:

1. Risks of a demotivated team / team members and recommendations
   > Risks
   - Tea blenders are key staff that are important to the product and the brand, if they leave what is the risk of the taste of the blend changing?
   - If demotivated staff stay in the business their attitude towards the business may spread among other members making it more of a challenge to change the culture.
   - Demotivated staff may leave for a competitor

> Recommendations

• Consider what the issue may be (may be in the material) and relate to Maslows hierarchy of needs.
• Basic / physiological - food/shelter/clothes (i.e. Money)
• Security - Job security, healthcare, pension, training
• Social - Flexi-time to spend time with family, social events at work
• Ego - Praise, grades or staff/job titles,
• Self actualisation - Variety, challenging work, autonomy, inclusion in management decision.

2. Difference between persuasion and influence. How we exercise to maintain teams support?

> Persuasion
- a deliberate act to get someone to make a specific decision or particular course of action.

> Influence

• More subtle,
• Aims to get the other party to come around to your way of thinking, supporting your interests, being more empathetic towards you.
• Must avoid manipulating, doing something against their will or interests.

> Exercising

• Cialdini
• A method of exercising persuasion is through RECIPROCITY for instance offering more job security for an increase in the scope of their role and responsibilities.
• COMMITEMENT is required,
• It is useful to find areas of COMMON GROUND that you can build upon
• SOCIAL PROOF - if others in the industry are doing something that works and are getting first mover advantage
• LIKING - people like people who are like themselves, charismatic managers that can get greater buy-in
• AUTHORITY - board have bought-in to this and therefore we have to act upon it.
• SCARCITY - fear of missing out or losing what they have (Job security is on the line)

3. How the constraints of Time/Cost/Quality impact on implementation of a project.

> Outline what the Time/Cost/Quality trade offsare

• Improve quality will take longer or cost more.
• Hard deadline will cost more or lower quality (reduce scope)

> Time

• What is the deadline? miniature deadlines / stages / waypoints
• If urgent - may require overtime/extra staff $$$

> Cost

• What is the budget? does it need setting?
• Is it detailed for each area?
• Musn’t comprimise on quality to save minimal costs.

> Quality

• Is the scope /outcomes clear?
• to avoid scope creep / danger of running over budget or time.
• Is it fit for purpose? - to improve brand or customer experience

4. The use of research report data and alternative sources of data.

> Identify concerns about using research report data as a basis for investment appraisal.

• Is the data comparable to the products/geography/economy we have?
• What the research prepared specifically for piping? - could have been created for a different purpose and therefore lead to bad decisions.
• Is the information current or out of date?

> Alternative sources of data

• We should conduct our own research considering segmentation most relevant to use (product segment/geographic)
• Understand the average market prices and features/experiences expected.
• Social media - popularity, feedback,
• This information would form the basis of a more robust cost-benefit analysis and thorough proposal.

5. Recommend an appropriate type of responsibility centre, including why others would not be appropriate.

> Appropriate vs not appropriate

• What is the manager held accountable for?
• Responsible for revenue generation? costs only? Investments?
• Specific costs - premises costs, marketing, staff time-sheeting, part time staff
• reason for recommendation - to be able to measure profitability and assess success required for decision making (expand / shut down)

> Investment centre

• Are there any identifiable assets?
• Will the manager need to make further significant CAPEX?

6. Impact of setting up an overseas base on financial statement ratios and interpretation of financial statements?

> What will we expect to see in terms of Assets / Liabilities / Income / expenses when setting up an overseas base?
- Don’t focus on the FX elements.

> Assets

• Will we be building assets/premesis immediately?
• Capex spend will incur depreciation
• Capex spend will impact (reduce) asset turnover / ROCE
• Any inventory? - More inventory could impact inventory days (possibly negligible)

> Liabilities

• Loan or leases to finance assets?
• Impact on gearing and interest cover.

> Income

• Initially loss making
• Will impact profit margins / earnings per share
• Should improve over time

> Expenses
- FT local staff cheaper than paying for travel and accommodation

> FX - how is the base set up? Branch or division - No separate accounts
- So convert all transactions at spot, will require retranslation of montetary assets at y/e
- FX Gains/Losses to SPL
- If set up as a subsidiary then consolidated accounts would be required.
+ Items to the SPL would be at avg rate.
+ Items to the SFP if monetary then closing rate, non-monetary: historic rate
+ Gains/Loses are presented in SOCIE not SPL.

7. Impact debt finance will have on gearing and WACC

> Gearing

• outline what gearing is (D/D+E) - currently 35%.
• Calculate what it will move to with proposed debt finance and compare to prior years and competitor.
• Gearing will reduce with extra profitability because profits go to equity.

> WACC
- where you given a current figure?
- Factors to consider: Debt is cheaper than equity (lower risk for lenders, no issue costs, tax allowable)
- so would expect cheap cost of debt to reduce WACC
+ However further debt increases financial risk due to the extra interest to pay for which impacts the amount of dividend available.
+ This in turn could increase the cost of equity as shareholders want to be compensated for the extra risk which would increase the WACC.
- So no firm conclusion without further detail.

8. Encouraging team working
   - Keep team small and agile
   - Concentration from too few departments could cause cliques to form. - try to recruit from as many depts as possible.
   - Tasks should be of limited duration to avoid them dragging on.
   - Team members should be there voluntarily
   - Goal and objectives should be clear (SMART)
9. Conflict management

> Aim is to ensure a win-win outcome.

• Discover what the root cause is. - can it be eliminated?
• Is it a serious conflict? will it go away with time?

> Solutions

• Confrontational approach - demand behaviours stop
• Consultants - cost implication
• Arbitration - a series of meetings to air frustrations, to find common ground.
• Board decision - Super ordinated goal.