Managerial Finance Assignment for MSc

Financial Accountant

Question 1

Prepare a business report for the board of directors which analyses the performance of ARM Holdings Plc over the financial years 2013 to 2015 and recommend any action the board should take.

Your report should utilise key ratios, horizontal and vertical analysis.

Table of Contents INTRODUCTION 6 FINANCIAL RATIO ANALYSIS – PROFITABILITY: 6 FINANCIAL RATIO ANALYSIS – LIQUIDITY: 8 FINANCIAL RATIO ANALYSIS – EFFICIENCY: 9 FINANCIAL RATIO ANALYSIS – GEARING 11 CONCLUSION AND RECOMMENDATIONS: 12 Appendix A - Financial Ratio Analysis for ARM Holding PLC, 2013-2015 – Average and Competition Benchmarks 13 Appendix B - Vertical Analysis Statement of Income for ARM Holdings Plc 2013-2015 14 Appendix C - Vertical Analysis Comprehensive Statement of Position for ARM Holdings Plc 2013-2015 15 Appendix D - Horizontal Analysis Statement of Income for ARM Holdings Plc 2013-2015 16 Appendix E - Horizontal Analysis Comprehensive Statement of Position for ARM Holdings Plc 2013-2015 18 Appendix F - INTEL and AMD Annual Statement – Key Ratios 19 Question 2 - Title Page……………………………………………………………………………………………………………………. 20 Introduction – Part 1 of Question 2 21 Closing Tyseley and Solihull Branch Restaurants Financial Considerations: 21 Marginal Costing: 21 Financial Projections: 21 Timing for Potential Closing – Impact of Rental Contracts T&C’s: 22 Non-Financial Considerations: 22 Conclusion Part 1 of Question 2: 23 Introduction – Part 2 of Question 2 23 New Solihull Restaurant Financial Considerations 23 Profit and Loss Projections: 24 Net Present Value Forecast: 24 Non-Financial Factors for New Solihull Restaurant 24 Financing the Purchase: 24 Equity Funding: 25 Debt Financing: 25 Conclusion – Part 2 of Question 2: 25 Appendix 1 – Marginal Costing for the Company 26 Appendix 2 – Solihull Marginal Costing 5-Year Profit and Loss 5-year Projection 26 Appendix 3 – Tyseley Marginal Costing 5-Year Profit and Loss Projection 27 Appendix 4 – Restaurant Branch Location Closure Scenarios 27 Appendix 5 – Balanced Scorecards for Tyseley and Solihull Closure 29 Appendix 6 – New Solihull Restaurant Projection – Discounted Cash Flow 30 Appendix 7 – New Solihull Restaurant Projection – Net Present Value Calculation 30 Appendix 8 – New Solihull Restaurant Projection – Accounting Rate of Return 31 Question 3 - Title Page……………………………………………………………………………………………………………………. 32 INTRODUCTION 32 Issue More Debentures: 33 Sell Investments: 34 Halving the Receivables Period: 34 Issue More Shares: 34 Conclusion 35 Appendix A – Income Statement 36 APPENDIX B – COMPREHENSIVE BALANCE SHEET 36 APPENDIX C – FINANCIAL RATIO ANALYSIS 37 APPENDIX D – INCOME STATEMENT, DEBENTURE FUNDING ANALYSIS 39 References: 40

To Board of Directors of ARM Holding PLC

From Reporting Accountant

Date 27 March 2017

The report below discusses the financial appraisal for ARM Holding Plc for the three fiscal years 2013-2015, utilising horizontal, vertical as well as ratio analysis of the financial statements as well as comparisons to competitors, INTEL and AMD, financial ratios for the same period. The analysis show ARM is financially sound, with high growth in the profitability ratios including PBIT, Net Profit as well as Asset return and turnover. Excellent liquidity and ARM can easily pay off their debts. Efficiency is shown in the improving cash flows as well as the improving payables, however the high retained cash levels, possibly because of the decrease in R&D spending could indicate indecision while making the company a possible target for takeover or buyout.

MARKERS COMMENTS: good introduction, correct format, excellent presentation

Table 1 – Profitability Ratio’s

(Appendix A)

Net Profit Margin, ROCE and Return on Assets have all doubled in the three-year period assessed reviewed, Table 1 – Profitability Ratio’s, (Appendix A), and this is directly tied to the PBIT which more than doubled during the same period as indicated in Fig 1 and in the vertical analysis of PBIT shown in Appendix B. The increase in PBIT is related to positive increases in sales while controlling costs which have stayed steady or only increased slightly during the same period as the vertical analysis in Appendix B indicates.

Fig 1

The steady rise in ROCE is a good indicator that ARM continues to increase their domination in the market segment of mobile devices, which is 95% in 2014, (Madhu, 2014). The average benchmark ROCE of 18.04% for ARM is more than double the average benchmark ROCE for the two closest competitors, INTEL and AMD. (Appendix A), and while most investors do tend to favor companies with a stable or rising ROCE it can also indicate that capital is not being invested effectively and therefore not generating shareholder return. The comparisons to ARM’s competitors needs to be cautioned as both INTEL and AMD are heavily invested in manufacturing whereas ARM does not employ that level of assets which can result in inaccurate comparisons. The increase in net profit margin seen in Appendix A, is a good indicator that ARM is controlling their expenses year on year as shown in both the vertical and horizontal analysis for cost entries in Appendix B and D. The doubling of ARM’s asset turnover during the 3-year period is indicative of the increase in sales shown in the horizontal analysis in Appendix D however the total asset increase shown in Appendix E is a result of the increase in cash as well as trade receivables rather than in physical assets.

ARM’s asset turnover has remained steady for the 3-year evaluation period with a benchmark which is significantly below that of the competition, however once again we need to keep in mind the different nature of the business models of ARM’s competitors and that their figures might be inflated due to higher depreciations figures given their higher asset levels, (Appendix F). Further study on this would be needed to confirm this analysis.

The gross profit results for ARM shown in Appendix A, have remained steady for the three-year period, again indicating that ARM’s competitors have not encroached on their market share.

Appendix C, vertical analysis of the comprehensive statement of position and Appendix E, horizontal statement of position, both clearly show that research and development investment in the company has fallen quite dramatically during this period. Careful examination of ARM’s product portfolio and especially those products locations within the lifecycle pattern will be required and further investment possibly needed as INTEL looks to finally challenge ARM in the mobile field area, (Hargreaves, 2015).

While the profitability ratios, ROCE, Net Profit and Return on Assets all indicate steady growth and a positive outlook when compared to ARM Holding’s competitors it also shows in the gross profit figures that research and development in the organization is not increasing putting the company at risk of losing market share.

MARKERS COMMENTS: good understanding and referencing

Table 2 – Liquidity Rations

(Appendix A)

The liquidity ratios, Table 2 – Liquidity Ratio’s, and shown in Appendix A indicate a very comfortable financial position for ARM and a low risk to investors and lenders, a company that can easily pay off all debts. ARM’s liquidity benchmarks also continue to outperform the competition for the same period, (Appendix A), however once again all three liquidity ratios compared will be impacted by the competitions significantly larger asset values as shown in Appendix F.

The high liquidity ratio also shows that ARM is not investing their working capital efficiently. 45% of current assets are in short term investments with much of that being in cash, (Appendix C) As Fig 2 below indicates the company would have significant better return reinvesting in the company than they do by collecting interest as per the BOE current interest rates of 0.25%, (Bank of England, 2017).

Fig 2

Besides being inefficient, this high level of cash and low level of company debt does and will make the company a target for possible buyouts or takeovers.

High liquidity ratios which significantly outperform the competition indicate a low risk company in a comfortable financial position which is desirable for potential investors, again however it can also have the effect of targeting the company for possible buyouts or takeovers as well.

MARKERS COMMENTS: good

FINANCIAL RATIO ANALYSIS – EFFICIENCY:

Table 3 – Efficiency Ratio’s

(Appendix A)

ARM Holdings have managed to improve their cash flow, as shown Fig 3 below, from negative in 2013 to positive in 2015 due to increases in the payables payment period combined with a reduction in the inventory turnover period and a steady receivables collection period as seen in Table 3 – Efficiency Ratio’s and in (Appendix A).

Fig 3

The high collection period benchmark for ARM Holdings, which is double their competition is indicative of their business model which is moving towards royalty based payments rather than upfront licensing payments. The royalty payments mean ARM only receive a payment when a product, a chip, with their design in it is sold, rather than the previous royalty license model where they were paid a large fee upfront and then the customer could essentially use whichever ARM product they needed. This could explain the increasing figures seen. During this same period, however the payable payment period has also doubled, and again is twice the competition’s average. This suggests that ARM has been able to secure favorable payment conditions with their suppliers, however management needs to be aware of a possible downside reflected in the increased payable period and that is an increase in pricing by suppliers to cover the extended payment terms. Evidence of this may be reflected in the steady increase in expenses and general administration and accrued expenses seen on the horizontal analysis of the income and comprehensive statement sheets, (Appendix D, E).

The inventory turnover which is decreasing, may also indicate a lack of investment in new products or existing products reaching their end of their life-cycle. This statement is borne out by the 15% reduction in research and development as shown in Appendix B.

Table 4 – Financial Risk Ratios

(Appendix A)

The financial risk ratios, Table 4 above and in Appendix A both indicate a sound, financially strong company. The gearing ratio appears to be low, however as with all ratios we need to look at the benchmarks in the industry and against their peers to understand if this is unusually low or not, (Perks and Leiwy, 2013). Comparisons to the competition benchmarks over the same period, (Intel Company Financial Information, 2017), (Advanced Micro Devices, Inc. Company Financial Information, 2017) show that AMD’s gearing ratio is not significantly low for their industry, outside of AMD’s high rate, which occurred during one year and inflated the competition’s benchmark average. A gearing ratio this low indicates a financially conservative company, financially sound, with low debt. As debt is so low any fluctuations in interest rates will not impact profits. This low of a gearing ratio can indicate that growth is slowing down and that management might be worried about becoming over extended, (Accounting Tools, 2017), or when taken together with a high cash position it could indicate the company is preparing for a merger or possible takeover both of which have been quite active in the technology industry lately, (Fiegerman, 2017). It needs to be understood that low interest borrowing could be achieved, based on this level of financial strength, which would likely be more beneficial to the company either through tax breaks, investment opportunities or using the increased borrowing to increase profits. Whilst this does pose risks if the interest rates were to change greatly, the financial strength of the balance sheets would indicate the risk could be well managed. In the end, the gearing ratio shows that there is currently not a good balance between debt and equity. Management should bear in mind that debt is cheap and tax deductible whereas shareholders, in the end, cost more.

The interest cover ratio benchmark, is significantly higher than the competitors even given AMD’s poor showing in interest coverage ratio have a significant negative effect on average competition benchmark with INTEL, (Appendix F). This shows ARM is financially very healthy and stable, however it also shows that the company is not taking advantage of growing their business through investing their cash reserves into R&D or by increasing debt. The cash reserves combined with a decrease in the companies R&D spend as can be seen in the vertical analysis, (Appendix B), could indicate either a lack of innovation and investment or a lack of an aggressive investment growth approach on the part of management. Trying to understand a company from just one ratio is difficult, however if the high interest coverage ratio, indicating large cash reserves and low debt, are combined with the low gearing ratio some would argue this is what a management team does when it prepares for M&A activity.

CONCLUSION AND RECOMMENDATIONS:

The use of any one financial ratio to critique a company’s performance or to try and plan the company’s future would be a mistake, however by using multiple ratios over several years and benchmarking them against their competition we can see patterns develop which can help us make predictions and suggestions for the future. ARM Holdings PLC is a financially strong and stable company as indicated by the ratio analysis in profitability, efficiency and liquidity, which show ARM benchmarks outperforming their combined competition over the same period. Large cash reserves and low debt combined with stable management and a 95% market share in mobile devices is very attractive to investors. The large cash reserves held by ARM would at first indicate a possible war chest to expand out of their niche market of mobile devices, directly challenging their competitors INTEL and AMD possibly in manufacturing or home based computers, possibly accomplishing this through a merger or acquisition of a competitor. The lack of research and development investment, however, negates this scenario and points to a more troubling scenario of a technology company not keeping pace with technological changes. This may indicate a management team preparing itself to be bought out by another company or it may indicate a company run by somebody other than an experienced manager and financial team.

MARKERS COMMENTS: good

Appendix A - Financial Ratio Analysis for ARM Holding PLC, 2013-2015 – Average and Competition Benchmarks

ACC7012 Managing Financial Performance

B T2 2016/7

Final Assessment

Attn: Professor Jonathan Mills

David J Manderfeld

S16146600

Financial Accountant

Question 2

Part 1 - With consideration of both financial and non-financial factors, advise management on whether or not to close the Tyseley and Solihull restaurants

Part 2 - Advise management whether or not to proceed with the opportunity to open a second restaurant in Solihull. Your answer should include consideration of financial and non-financial information available to you, make use of an investment appraisal technique, explain the limitations of your analysis and analyse potential sources of finance for the investment.

To Management Team – Tuesday’s Restaurants

From Reporting Accountant

Date 27 March 2017

The recommendations regarding the possible closing of the Tyseley and Solihull branch locations has been completed using financial and non-financial analysis information, which has been outlined in Appendix’s 1 – 5 at the end of this report. Financial analysis has included marginal costing for the entire company, based on information provided, as well as conducting five-year profit loss projections for each branch under closure consideration. Four separate location closure cost calculations have been conducted and analysed. In addition, the non-financial implications and factors for closure of each of these locations has been reviewed and discussed in detail.

Initial financial figures, (Appendix 1), would seem to indicate that both the Tyseley and Solihull restaurants should be closed as both branches are showing negative profits, however closer examination of the figures including their individual contribution to the company shows that the Solihull branch actually contributes £4,250.00 to the head office costs, whereas the Tyseley branch is not able to positively contribute to the head office costs as the fixed and variable overhead costs already exceed their revenue by £1,000.00, (Appendix 1). Besides the financial figures, Appendix 1 did also reveal and area of concern with regards to the percentage of contribution in relationship to sales in respect to the Birmingham branch, with a significant decrease in the percentage sales for that branch compared to the other branches. Our recommendation would be to review and investigate this as a possible problem with supplier costs being higher in this area, manager inexperience or as part of inappropriate remuneration or even theft.

Using the revenue and expense expected increased provided we performed a 5-year projection for Solihull, (Appendix 2), and Tyseley, (Appendix 3). These spreadsheets confirm again that Solihull currently has a positive contribution to the head office costs, while Tyseley does not, however due to the expenses, both variable and fixed, increasing at a faster rate than the projected revenue increases, within 5 years Solihull will no longer contribute to the corporate costs in a positive manner. Projections, such as these, are useful for planning purposes, however numerous external factors such as inflation, tax changes, recession or even terrorist attacks can impact projections, even short ones, (Fridson and Alvarez, 2002).

The rent for both Tyseley and Solihull branches in renewable in six month periods so in Appendix 4 we projected the financial impact of closing both restaurants immediately, both in six months, Tyseley closing immediately while leaving Solihull open and finally closing Solihull immediately while leaving Tyseley open. As can clearly been seen by the company overall profit figures, closing both restaurants when their six-month lease periods are due would result in the best financial outcome, with closing Tyseley immediately and leaving Solihull open until the six-month lease period is due the next best financial option. Closing Solihull immediately or closing both immediately will result in the company losing money overall as the remaining branches profit totals will not be able to overcome the additional cost of the leases from closed branches as well as the new distribution of head office costs.

The non-financial factors for closure as discussed in Appendix 5, support the financial data conclusions for each branch office, however internally employee morale will need to be addressed once layoff of the variable staff occur. We would recommend that human resources commence evaluations of all employees with the intention of retaining the highest performing employees if they are willing to travel to different branch locations. Attention should be given to all managers to possibly address the contribution percentage issue at the Birmingham branch, in case the investigation does show negligent manager involvement. Customer interaction as well as innovation and growth are both closely aligned to our findings regarding both areas of operation. Per UK government statistics, (Statistics, 2008), while the Solihull area is one of the most affluent areas of the UK outside of London and the same source lists the Tyseley area is one of the poorer statistical areas, with high unemployment and poor growth potential, (Statistics, 2008)

Our recommendation would be to close the Tyseley branch location when their lease period is up in 6 months prior to which human resources and managers should perform employee evaluations as well as completing the investigation regarding the lower sales percentage figures at the Birmingham branch. The financial contribution for Tyseley is negative and the branch location provides little or no growth potential, (Statistics, 2008), based on sales projections as well as its geographical location in Tyseley. Solihull only being 4.5 miles away from Tyseley does present opportunities for the company to reassure loyal Tyseley customers that another restaurant is near. The Tyseley manager, should, however be evaluated for possible reassignment to the Birmingham branch depending on the outcome of evaluations and the investigation. We recommend, that the Solihull restaurant continues to be allowed to operate, however careful assessment of the finances will need to continue to see if the revenue versus cost comparisons shown in Appendix 2, continues as estimated or if improvements are seen. The UK government lists Solihull is an up and coming area in Birmingham, with considerable growth potential and a growing population with high levels of disposable income, (Statistics 2008). Management should look at marketing options, advertising and internet, promotions to try to reverse the trend of costs increasing faster than revenue, to try and save this branch in a desirable area.

MARKERS COMMENTS: good

Management have requested advise on the financial and non-financial implications of opening a second restaurant in the Solihull area. Utilizing financial projections such as net present value, (Appendix, 7), profit and loss projections, (Appendix, 2), discounted cash flow, (Appendix 6), as well as the accounting rate of return, (Appendix, 8) and the balance scorecard previously mentioned, (Appendix, 5) we would conclude that given the current financial information available, opening another restaurant in the Solihull area would not be a sound decision.

Reviewing again the profit and loss projections over the next 5 years for the Solihull branch, (Appendix, 2), it is evident that this location while currently contributing to the overall company costs, will not contribute positively in 5 years due to costs increasing faster than revenue.

The net present value forecast, (Appendix 7), is equally critical of opening this new restaurant as, despite have a positive figure at the end of 5 years, the only way to show that positive return on the investment would be to sell the building at the end. Fridson and Alvarez (2002), point out the problems with projections, even those as short as 5 years, with inflation, property prices as well as current prediction of revenue and expenses increases all could change given outside factors beyond management’s control. These financial considerations do not consider the fact that the customer base in Solihull is finite, and by opening another branch location, management could split the customer base thus decreasing expected revenue at one or both locations, unless management would close the other branch prior to opening this one. While preserving the customer base in one location marketing and promotion would be needed to ensure customers are willing to change to the new location.

The non-financial balance sheet, (Appendix 5), show no significant problems internally if the company were to open a new restaurant as either new employees would be hired if both Solihull locations remain open or the employees would transfer from the closed location to the new location. Opening the new location, without closing the previous one may have the detrimental effect of splitting the customer base in Solihull which would severely impact the financial predictions made previously. The UK government, (Statistics, 2008), shows that Solihull is an affluent area, with low unemployment and high levels of income which are all positive factors for a new restaurant, however management needs to make sure to stay appraised of the latest trends in food types, diets as well as seemingly non-related economic issues such as the price of fuel, all of which can impact on sales, (Melaniphy, 2007).

Financial resources for funding this purchase would likely be limited to either equity funding or debt financing.

Equity funding would save interest charges associated with debt financing and some investors or venture capitalist might bring valuable outside knowledge to help in managing the business, however management would need to be ready to devote the considerable amount of time required to do this as well as possibly giving up partial control of the company.

Debt financing might be the simpler, although more expensive option due to the interest rates that banks will charge. For either of these options the company will need to produce the financial statements to either potential investors, who given the losses sustained at the current time, might be unwilling to either invest or invest further depending on if this will be a public offering or right to issue The lending institutions will also likely increase the interest charges for any loan or demand further collateral, possibly from the owners private good as the company does not own any substantial assets like buildings or land.

In conclusion, the recommendation would be that without further improvements in financial factors it would not be prudent to open a second branch location in Solihull at this time. All the financial indications that have been completed for this possible purchase, whether they are the current marginal costing figures in Appendix 1 or the 5 year projections in Appendix 2, as well as the net present value figures in Appendix 7, which only show a profit after the sale of the restaurant, clearly indicate that purchasing this building in Solihull for a new location would be a high risk financial decision made more difficult by these same negative financial figures negatively impacting on possible investment sources. The non-financial factors in Appendix 5 as well as the UK government statistics, (Statistics, 2008) all agree however that Solihull is an ideal location for promoting the brand image. Instead of opening another location our recommendation now would be to focus on improving the performance of the current Solihull location using aggressive sales and promotions techniques as well as increasing customer interaction and understand trends on the sales side, improving supplier contracts and negotiations to reduce the lease amounts to address the expense side to reverse the current trends of expenses growing faster than revenue as seen in Appendix 2. Careful reviews should be done to ensure positive sales reactions to any changes, with the timing of these reviews to coincide with the 6-month lease periods so management could follow the possible closure scenario if improvements are not seen. If positive financial trends are seen in the future management would be in a more favourable position both with investors or lenders to further the brand by opening a location in the Solihull area.

MARKERS COMMENTS: good

MARKERS COMMENTS: good

MARKERS COMMENTS: good

MARKERS COMMENTS: good

ACC7012 Managing Financial Performance

B T2 2016/7

Final Assessment

Attn: Professor Jonathan Mills

David J Manderfeld

S16146600

Financial Accountant

Question 3

The directors of Magic Works are seeking funding of £50m to finance a magical institute. Following is the summarised financial information of the company.

The following suggestions have been made for raising the additional finance. Critically explain the effects of each of the suggestions and comment on their practicability.

a) Issue more debentures

b) Sell their investments

c) Halve the period that the receivables are allowed to pay (all sales on credit)

d) Issue more ordinary shares

To Magic Works Directors

From Reporting Accountant

Date 27 March 2017

The Magic Works board of directors requested suggestions and recommendations for raising the required £50m for a new Magic Institute. The directors have provided the company income statement which has been analysed using vertical analysis, (Appendix A). The companies comprehensive statement of financial position has also been provided and can be found in Appendix B. A detailed financial ratio analysis using both the income and comprehensive statement information has been completed, (Appendix C) with these analyses reviewed throughout this report. The directors have specifically requested we explore four separate possible methods of funding the new Magical Institute including debentures, selling investments, halving the receivables period and finally issuing of new company shares.

Management have asked us to look at issuing more debentures as a method of raising additional finance, and as per Fisher (1993) the definition of a debenture “includes debenture stock, bonds, and any other securities of a company, whether constituting a charge on the assets of the company or not.” The debentures currently used by Magic Works are the secured variety and account for 41% of the total company assets, (Appendix B). With £58M in non-current assets available to secure future debentures this would be a feasible method to raise the required additional amount, however if the full £50M is raised in this fashion it will result in reducing the operating profit to zero, (Appendix A). This will result in a net loss of £3000 for the company after taxation and if the board continued to support a £1000M dividend there would be a need to reduce retained earnings by £4000M per year going forward. Obtaining the full investment amount would also reduce the company’s current investment coverage ratio from 2:1, (Appendix C) whereas a “prudent value for a company is 5 times” (Walsh, 2003: 126). The combination of operating profit falling to zero, the reduction in retained earnings, if dividends are maintained at the present level, as well as the interest coverage ratio dropping to 1 would all be negative indicators to both current investors as well as future investors which could result in loss of confidence and share price. As we have not been informed what the return on investment will be for this venture, we would want the return on investment for this to increase revenue enough to offset the negative impacts listed above before positively endorsing securing the entire £50M investment in this manner. Revenue would need to increase by £60M (Appendix D) to maintain the current level of dividends and retained profits assuming all costs and taxations rise at the same percentage level as they are with the current revenue level.

The second option management requested to be explored would be to sell their investments to raise the required £50M investment amount. As shown in Appendix B the total investments currently held only total £30M so this will not cover the full amount needed. Management also needs to take into consideration the likely negative impact the shareholders will have if management decide to sell, what is a cost value £45M investment for a market value of £30M resulting in a loss of £15M. Without knowing if these investments are expected to increase in value, back towards or cost value or continue to decrease in value we are not certain if this is a sound financial decision. In addition, we do not know the full investment return on the new magic institute and therefore are unable to confirm if selling the investments at a loss is justified at this time. If management does proceed to fund part of the investment in this manner, the legal team should be consulted prior to any sale to ensure that the current debentures are not secured using these investment instruments.

The third option that the directors have requested be explored involve the halving the receivables period on all sales to raise the required £50M investment. Currently, as per ratio analysis in Appendix C, the receivable period is only 15.21 days. Wilson and Summers, (2002) indicate that credit terms greatly depend on the nature of the business, demand for their products as well as the size of the business. The UK Government on their invoicing and payments page, (Gov.UK, 2017), also indicate that unless agreed otherwise, 30 days is the standard. If we compare the ratio analysis of 15.21 days, (Appendix C), with the receivables of £5000, (Appendix B) it can be shown that halving the receivables period will only result in £2.5M in additional funding, leaving an additional £47.5M of funding to obtain and even if management were to reduce the receivables days to zero it would only result in a total of £5M of the required amount. The directors would also need to consider the extra workload to their employees as a result of halving the receivable period, as well as the repercussions from their customers for the demands for payment sooner than normal. Changing the receivable period is a short-term investment option and impacts on liquidity rather than long term investments.

The last financing option management requested to be reviewed involves issuing more ordinary shares to raise the requested capital, and as issuing shares is cheaper than using debentures, this would appear to be a better option, however there are some concerns. Without knowing the current market value of the share’s, we are unable to forecast how many shares would need to be issued to raise the full £50M required, how many shares this would leave outstanding and what impact this would have on the current dividend level and company profit. The number of shares required to be issued, if excessive, might also change the ownership structure of the company up to and including the directors. Management would also need to decide if they will conduct a public offering or a rights issue. We would suggest, as mentioned for other options above, that management publish the expected rate of return on investment for the magical institute. This would not only help investors make an informed decision, reducing their possible risk, it would also allow us to accurately analysis what the share increase would mean to the company and investors. Currently each shareholder receives a 3% dividend on their investment as shown in Appendix A. If we assume that the number of outstanding shares doubles, and the dividend level remains at its current 3% return, this would have the effect of eliminating the company’s profit.

In conclusion without knowing the expected rate of return on this investment, as well as the of market value of the company’s ordinary shares, any of our conclusions cannot be fully supported by analysis. Of the four options discussed above, only issuing debentures or ordinary shares might allow management to raise the full amount, however both options are likely to reduce the company’s operation profit to zero if all other factors remain the same and could result in a drop in retained earning if the company maintains the current dividend level. Neither selling the investments or halving the receivables will, by themselves raise the full amount required and legal would have to ensure selling the investments is even possible while halving the receivables period induces more stress to employees and risk to adverse customer reaction then it’s worth. Management, after carefully reviewing the return on investment for this project could proceed with some combination of the 4 options above to try and reduce the downsides for each. Besides the options outlined here, the value of the current land and plants held by the company combined with the new land and plants acquired as part of the investment mean that management could use debt financing as a preferable option. Low interest rates, below the company’s current rate of return of 4.1% (Appendix A) should be possible based on the current financial statement. Other possible financial options could be to use leasing or asset financing based on the existing equipment. If the Magical Institute is to be an educational centre, then government grants might be possible to obtain to help defray part of the investment cost, (Nesta, 2017), or even from the National Lottery as an education project, (National Lottery Good Causes, 2017). Investment crowdfunding is a possible alternative enticing local investment groups based around either the location of the magic institute or the investors interest in magic or education. Venture capitalists would also be possible under the crowdfunding option, however in return for their investment management would likely have to give up some level of control of the company, (Bonini et al., 2011), so any option involving this method would have to be carefully considered.

MARKERS COMMENTS: good

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