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Session 2 - SBL Mini Mock Questions Flipbook PDF
Session 2 - SBL Mini Mock Questions
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QUESTION PAPER You are Hoi Lui, a management consultant leading a small team which has been commissioned to prepare a consultancy report for the Data Communications Services (DCS) Company directors to help them plan for the next three years. DCS Company has two product areas. The largest area is the manufacture of data communications components which it mainly sells to original equipment manufacturers (OEM). The other smaller and less developed area is based on supply and support contracts for specialist IT management network systems, mainly to domestic medium-sized enterprises. You are a qualified accountant and your colleagues are Danny Leman, a company researcher, and Freddie Lithium who is a part-qualified finance professional. You and your team have collected and analysed the following information about DCS Company to help you prepare the consultancy report. – – – –
Exhibit 1: A report on DCS Company’s organisational overview, the external environment and the business model sourced and prepared by Danny Leman, your colleague Exhibit 2: Summary of financial and business performance of DCS Company extracted from the Integrated Report (2012–2015) presented to you by the finance director of DCS Company Exhibit 3: The October board report, a recent board meeting notes which include strategic choices facing DCS Company – presented to you by the marketing manager of DCS Company Exhibit 4: An evaluation of alternative future strategies being considered by the DCS Company board, prepared and presented to you by your colleague, Freddie Lithium
Following your findings, you are now starting to prepare the consultancy report and associated tasks for DCS Company. The case requirements are included in the tasks shown below: 1. From the information you have collated, draft a section of the consultancy report for the directors of DCS Company to include the following: (a) An analysis of the industry and market which DCS Company is competing in, using an appropriate model. (15 marks) (b) An evaluation of the overall performance of DCS Company between 2012 and 2015 from an integrated reporting perspective. (9 marks) Professional Skills marks are available for demonstrating evaluation skills relating to DCS Company’s environment and performance. (4 marks) 2.
In the October board report, the executive directors refer to a number of factors affecting DCS Company and the need to choose one of two alternative strategic options. You now need to do the following:
Required: (a) Draft a section of the report to identify and briefly discuss THREE main risks which DCS Company currently faces and plot them on a heat map, recommending appropriate strategies to manage those risks using an appropriate risk management framework. (6 marks)
Professional Skills marks are available for demonstrating commercial acumen in identifying and locating the risks appropriately. (2 marks) (b) You are reviewing the spreadsheet prepared by your colleague Freddie Lithium which evaluates the strategic choices facing DCS Company in the next three years, to ensure its validity in supporting your recommendation in the consultancy report. Required: (i) Critically evaluate the contents of the spreadsheet including any assumption made by the DCS Company board. (5 marks) Professional Skills marks are available for demonstrating scepticism skills in analysing the spreadsheet and any supporting assumptions. (2 marks) (ii)
Prepare some key recommendations for the consultancy report, using appropriate supporting evidence to advise which of the two strategies, re-focus or re-align, DCS Company should implement. (5 marks) Professional Skills marks are available for demonstrating commercial acumen skills in justifying the recommendations. (2 marks)
Exhibit 1 Background report to the DCS Company To: Hoi Lui From: Danny Leman Subject: Organisational overview, the external environment and the DCS business model Date: 20 November 2015 Notes: Organisational overview Data Communications Systems (DCS), a publicly listed company on the small companies’ capitalisation (SmallCap) index of a national stock exchange, used to be a privately owned high technology company established in 1997 by computer engineer, Java Peraya. Due to a rapid expansion over the following years, DCS needed to source additional capital to fund its future growth and was floated on the national stock exchange in 2006. This allowed Java Peraya to realise his majority shareholding in the private company. 30% of the flotation was purchased by institutional investors and DCS also borrowed long-term funds to leverage the newly issued share capital. Before flotation, the company was almost exclusively financed from the founders’ share capital, retained earnings and short-term finance. External environment DCS has its headquarters in Prydain, a prosperous developed nation with a stable and well established political system and which has highly developed labour laws including a national minimum wage and a newly introduced obligatory contributory pension scheme. The government, like many governments worldwide, has invested heavily in a national telecommunications infrastructure which has led to a significant growth in social media and where virtually 75% of the population are connected to the internet through a range of devices including mobile technology. The government is also proposing a new carbon tax which will affect companies which manufacture and provide IT network services such as data communications components and systems. The electronics and IT industry has recently been identified as a sector with an increasing carbon footprint caused by their applications, such as component cooling devices, complex telecommunications network components and cloud computing technology. Although DCS Company can approximately estimate its total carbon footprint from the manufacture and supply of components from its factory, it has not yet developed formal systems and processes to manage its carbon footprint throughout the value chain. Business model DCS has two distinct product/service areas – data communications components manufacture and the supply and maintenance of network management systems, including technical support. The DCS employees are a mixture of technically qualified engineers, working in research and development (R&D), factory staff manufacturing and assembling products and an IT sales and service support team. Since the flotation of the company, 60% of production employees in the data communications components factory joined a major trade union. In 2012 the country suffered an economic downturn which led many companies to postpone technological investment and by then DCS employed 150 full-time employees. The main revenue source for DCS is the high-volume low cost data communications component manufacture part of the business and it has 1% of the total market share, which accounts for approximately 65% of DCS’s total turnover. DCS mainly sells and supplies large volumes of data communications components to original equipment manufacturers (OEMs), 30% of which are based outside Prydain on a continent which has a single currency which is devaluing against the Prydain dollar. Success in the data communications components sector comes from the economies of scale achieved by producing high volumes of reliable components and keeping prices low. DCS Company has achieved this despite producing components in a country where there is significant employment legislation setting minimum wage rates and conditions.
The second product area is much smaller and is based on supply and support contracts for specialist IT management network management systems, mainly to domestic medium-sized enterprises, which currently yields a relatively higher gross profit margin than the data communications component products. A key aspect of this second product area is the installation and support of big data analytics capability along with cloud computing storage, which can be used to replace existing costly IT architectures such as unsophisticated data warehouses to allow business clients to collect and analyse more targeted and timely data about their own customers and purchasing patterns. Much of this can be obtained from data held within social and business networking software.
Exhibit 2 Extracts of the integrated reporting data (2012–2015) from the finance director – Tosh Mondal Financial performance: (all figures in $m) Financial periods: 2015 2014 2013 Sales revenue (domestic and international) 6.95 7.40 6.80 Cost of sales 4.97 4.85 4.25 Gross profit 1.98 2.55 2.55 Overhead expenses 1.12 1.51 1.41 Profit before tax and finance costs 0.86 1.04 1.14 Finance costs 0.69 0.38 0.37 Tax expense 0.02 0.06 0.08 Profit for the year 0.15 0.60 0.69 Other data: Number of employees Staff turnover (%) % of orders delivered late Forward contract order book (number of orders) Customer complaints as a percentage of total orders and existing contracts Employee satisfaction survey score (100% max) Investment in non-current manufacturing equipment as a percentage of sales revenue R&D expenditure as a percentage of sales revenue Carbon emissions in kg per $1,000 sales revenue
2012 4.75 2.62 2.13 1.30 0.83 0.14 0.15 0.54
2015 127 10% 10% 2,500 3.4% 61%
2014 135 7% 8% 3,750 2-4% 65%
2013 143 5% 7% 4,150 2-0% 68%
2012 150 4% 5% 3,505 1.5% 72%
7% 3% 80
8% 5% 75
8% 5% 65
10% 6% 60
Exhibit 3 The October board report for DCS Company To: The Board of Directors – DCS Subject: Strategic overview – DCS Company From: Jules Debrey (marketing director) Date: 12 October 2015 Introduction: This report is based on information obtained from all the executive directors of DCS, under several main headings. The report highlights risks, opportunities and the future outlook for DCS. It also focuses on strategy and resource allocation, highlighting a key strategic decision which the board will need to make in the near future. Risks and opportunities: What are the specific risks and opportunities which affect DCS’s ability to create value over the short, medium and long term, and how is the organisation dealing with them? By 2014, the international market for data communication components started to saturate and decline. For the supply and support of contracts for specialist IT network management systems, we are now finding it increasingly difficult and costly to maintain the required level of network support. It is getting harder to recruit high calibre staff to DCS. The headquarters of DCS, although a modern site, is in a geographical location which is unattractive for key personnel to relocate to. Our specialists in the systems support side of the business are currently overstretched because many key staff have been ‘head hunted’ or taken early retirement. Lenders have until recently been quite willing to lend DCS additional long-term funds at competitive interest rates, but are now tightening their credit lines to the company and placing covenants on us to keep financial gearing within acceptable limits. They are also increasing their interest rates to compensate for the additional financial risk. It is unlikely that any future growth or investment can be financed from further debt and we would need to use our considerable cash reserves or utilise internally generated funds. Currently, DCS has a geared cost of equity capital of 12%. Future outlook: What challenges and uncertainties is DCS likely to encounter in pursuing its strategy, and what are the potential implications for its business model and future performance? DCS currently manufactures approximately 50% of all data communications components used in its own products. The rest of the complete components, including semiconductors and microprocessors, are bought in from two multi-national global suppliers. These suppliers have since 2006 become the key players in the market through a succession of acquisitions and mergers, where previously there were many more suppliers, all with a much smaller market share. Recently, serious production problems have resulted from periodic component shortages from these key suppliers, creating significant delays in manufacturing, assembly and customer deliveries. One of our recently acquired OEM customers accounts for 40% of our sales in this area. Marketing forecasts for 2016 and beyond indicate stronger growth from the supply and sales support for specialised IT management services to currently installed networks in the domestic financial sector, rather than from the manufacture of components to OEMs or for the installation of new networks to large companies. The
other potential growth area is in providing cloud computing and big data analytics capability to the SME sector. Including DCS, there are currently only three companies which provide these specialist services in Prydain. Strategy and resource allocation: Where does DCS want to go and how does it intend to get there? As executive directors, we need an appropriate strategy for the next three to five years. On current trends we are looking at approximately a 10% year on year decline in our revenues for the next three years. At this forthcoming board meeting we need to discuss and decide on the best strategy for us as a company. We need to decide between two strategies. Do we re-align the business to make it less reliant on the high volume, low margin components segment and re-allocate resources from the data communications segment into this higher added-value sector of network management and support? To do this we will need to further exploit technologies such as cloud computing and, in particular, big data analytics which seem to offer lower cost data storage, better understanding of consumer preferences and ability to develop more bespoke products and services. Alternatively, should we re-focus on our core capability in the data communications components manufacturing area, where we have such expertise, experience and where most of our turnover is currently generated? Conclusions: The DCS board should now evaluate the risks and opportunities and take a key decision. DCS also needs to consider how it will implement its chosen strategy and how it will finance it. See further information below. Forecast tangible benefits and costs resulting from various potential scenarios In 2015 we have estimated that the net cash contribution from the data communications components segment of the business is $1·55m and the net cash contribution from the network supply and support is $0·85m. These are after interest and tax. The expectation is that total cash flow contribution will continue to decline by about 10% each year if we do nothing. Re-focus strategy: We can implement this strategy by re-organising our sales and support teams, making manufacturing cost efficiencies and targeting our data communications component customers more effectively. If we are successful, we estimate that we can at least maintain the total cash contribution of DCS at the current level of $2·4m for the next three years. Re-alignment strategy: With a re-alignment of the business towards the network supply and support segment, the net cash contribution from the communications components sector is forecast to decline by 10% per year for the following three years. This is regardless of how the net cash contribution from the network and IT systems support business is expected to grow under any of our assumptions. Forecast annual fixed costs and working capital savings from the decline in the data communications manufacturing area are expected to be $0·35m from general costs and will also result in annual carbon tax cost savings of $0·15m, giving a total saving of $500,000 per annum for the next three years (2016–18). Note that these forecast savings are independent of which growth forecast below emerges. Table 1 below shows the projected growth in the cash flow from the network supply and support segment in the next three years; the additional fixed costs of this investment; and the savings to be made in the data communications division, should the re-alignment and additional investments take place.
Table 1: Alternative growth forecasts for DCS Company under the re-alignment strategy Re-alignment strategy and probabilities for growth Probability of Forecast annual Forecast annual growth increase in cash savings from materializing (%) fixed costs ($m) decline in data communications segment ($m) Additional cash contribution from the network support 60 +0-75 -0.5 business will grow by 25% each year for the next three years from the 2014 level Additional cash contribution from network support 30 +0-45 -0.5 business will grow by 15% each year for the next three years from the 2014 level Additional cash contribution from network support 10 +0-25 -0.5 business will grow by 10% each year for the next three years from the 2014 level
Exhibit 4 An evaluation of strategy choices facing DCS Company You asked your colleague Freddie Lithium to evaluate the alternative strategies based on the information contained in the October board report. Freddie has now given you his work in the spreadsheet below: Strategy evaluation for DCS, using payback method Strategy 1: Re-focus strategy: With total cash contribution maintained: Data communications Network supply and support (1) Total for Strategy 1: Strategy 2: Re-alignment strategy Network supply and support ($0-85m)
2015 $'m 1.55 0.85 2.40 Growth: 25% 15% 10%
(2) Expected value from network growth: (3) Data communications ($l-55m) 10% (4) Total cash contribution from Strategy 2: (2 + 3) (5) Incremental cash contribution (4 - 1):
decline
Additional annual fixed costs based on expected growth: Growth: Network supply and support ($0-85m) 25% 15% 10% (6) Expected value of additional cash fixed costs: (7) Cash fixed cost savings (Data comms) (8) Net additional cash fixed costs: Incremental cash contribution from Strategy 2: (5) Incremental cash fixed costs (8) Incremental net cash contribution from Strategy 2 compared with Strategy 1 Cumulative payback period = 2 years and eleven months
$m 0.75 0.45 0.25
2016 $'m
2017 $'m
2018 $'m
2.40
2.40
2.40
Probability: 0.60 1.063 0.30 0.978 0.10 0.935 1.024 1.55 1.395 2.419 0.019
1.328 1.124 1.029 1.237 1.256 2.492 0.092
1.660 1.293 1.131 1.497 1.130 2.627 0.227
Probability: 0.60 0.450 0.30 0.135 0. 10 0.025 0.610 0.500 0.110
0.450 0.135 0.025 0.610 0.500 0.110
0.450 0.135 0.025 0.610 0.500 0.110
0.092 0.110 -0.018
0.227 0.110 0.117
0-019 0.110 -0.091