IB BM HL 3.2.2 External sources of finance

[Maximum number: 10]

Speedy Delivery (SD)

Speedy Delivery (SD) is a private limited company that delivers freshly cooked meals by bicycle. SD only delivers. Restaurants subcontract SD to deliver meals to customers who place orders online and expect quick and efficient delivery. SD has been operating profitably for two years. Currently, it has the highest market share in the city.
SD is now facing two issues:
- It operates at 98 % capacity utilization. Recently, some restaurant owners complained to SD that meals arrived late and cold to customers.
- The market for home delivered, freshly cooked meals is growing quickly and some new delivery companies have just entered the market.
The CEO wants to address the delivery quality issues and the threat of competitors, two of whom recently merged. He is considering an internal growth strategy involving investing in new electric scooters and employing more staff to deliver a greater number of meals more efficiently. SD must raise a large sum of finance. Major shareholders are in disagreement regarding the internal growth strategy.
The financial manager has provided some financial information.

Table 1: Current information

Table 2: Predicted return on the investment

Discuss two appropriate sources of finance for SD to purchase the scooters.

Some of the possible sources of finance:
Issuing more shares - as a private limited company, SD can definitely issue more shares. Currently, SD is highly geared =6 5 % so the option of shares might be an appropriate one, especially if the banks will not offer finance. Issuing shares will not require any payback of the loans and will not subject SD to vulnerability of interest rate fluctuations. GPM (20\%)/NPM (9 \%)are healthy in this industry, so dividends are likely to be paid. The payback is relatively short and the ARR is quite high / reasonable. If the current shareholders buy extra shares, ownership will not be diluted;
if other friends and family buy the shares, the current shareholders' control might be diluted and they may raise objections. However, the current shareholders still control who buys the shares. Control will be not lost.

Going public (IPO) - an expensive and very time consuming source of finance that may not be judged as suitable for SD as a quick reaction to the competitors is needed. However, SD can raise a significant amount of finance needed to purchase the scooters which is much needed as stated in the stimulus. Ownership may be diluted with a risk of losing control. However, a very low current ratio of 0.9 indicates liquidity problems which might deter investors.

Long term bank loans - If agreed, the money can be given quickly / quicker than issuing shares, this is a very significant advantage for SD given the urgent need for action. However, the banks will be worried about SD being highly geared with its current obligation to pay interest as well as to pay back the loan. Moreover, given the low current ratio, it is likely that the bank's financial manager will refuse the loan due to liquidity problems. Also,SD does not manage its short term liquidly- see debtors and creditors hence the bank may be worried of insolvency.

Leasing the scooters - could provide a good solution for SD. The scooters can be leased quickly and maintained by the leased company. This fits the managers' objectives of a quick response. SD will pay a relatively small amount every month, which mitigates the problem of raising a large sum pf money. However, while, if bought, the scooters will become SD fixed assets after 3.2 years (payback), if leased, they will never be SD's. Still, one may judge this issue as less significant as the need for a quick reaction is vital

Venture capitalists/business angel - As SD is highly geared, coupled with the likelihood that the banks refuse a loan, the use of the above might seem highly suitable especially if there is potential to make a quick /significant profit as seen given the GPM 20\% and NPM 9 \%. However, venture capitalists/business angels might be reluctant to join SD due to the merger between competitors and some discord with shareholders re: the methods of growth.
However, a very low current ratio of 0.9 indicates liquidity problems which might deter investors.

Accept different arguments for the above option if fully justified.
Using retained profit - SD is profitable. GPM is 20 % and NPM is 4 %. While we do not know the industry norm, one may judge this option as highly suitable as SD will not be subject to fluctuating interest rates and repayments. It is also likely that being Ltd, the shareholders will agree to have less dividends to pursue the strategic option of internal finance.
However, some shareholders might object to this option. Despite the percentage given of the profit margin, it might not be sufficient to generate the large sum of finance required and SD might have to opt for external source of finance.

Sell fixed assets - The main assets are bicycles. Selling these assets can generate some finance. However, it might be judged as a limited source /method to raise finance, as the bikes will not generate the cash needed, if any. Another possibility is to sell some fixed assets like the office.

Accept different arguments for the above option if fully justified.
Please note:
- Long-term or medium-term sources of finance only should be considered.
- Do not accept some short-term sources of finance such as an overdraft, short term loan or creditors.
- Accept debtors or debt factoring if the candidate comments on their unsuitability given the liquidity problem.
- Accept 'Ioan'
- If the candidate wrote 'short term loan' instead of just 'loan' but the arguments for /against are relevant /applicable give some credit.
- It is expected that the candidates suggest the suitability or otherwise of two different sources of finance. Within the above categories, candidates can suggest any source of finance, including some, which might not be highly appropriate, as long as they evaluate the appropriateness of their chosen sources. Candidates are expected to use the financial information provided as part of their evaluation. Not using any quantitative information reduces the quality of application and makes the response rather generic, therefore award up to 5 marks.
- Candidates should not divert into a solution to some cash-flow problem given the debtor and creditors ratios
- It is not expected that the candidate incorporate all of the above arguments.
- Accept any other relevant issue.
- Accept any other relevant discussion.
- A conclusion with judgment is expected.

A balanced response is one that covers at least one issue/argument for and at least one argument against each option.

Marks should be allocated according to the markbands on page 5 with further guidance below.

For one relevant issue that is one-sided, award up to [3]. For more than one relevant issue that is one-sided, award up to a maximum of [4].

Award a maximum of [6] if the answer is of a standard that shows balanced analysis and understanding throughout the response with reference to the stimulus material but there is no judgment/conclusion.

Candidates cannot reach the [7-8] markband if they give judgment/conclusions that are not based on analysis/explanation already given in their answer.

IB Business Management HL 3.2.2 External Sources of Finance Questions

Exam points

IB Business Management HL 3.2.2 External Sources of Finance Questions question 1