IB Business Management HL 3.2 Sources of Finance Questions

Evaluate finance sources by comparing control, cost, risk, flexibility and repayment obligations in IB Business Management HL cases.

Exam points

Define and identify the key concepts and tools in 3.2 Sources of finance.
Apply 3.2 Sources of finance to business calculations, case evidence or management decisions where relevant.
Analyse and evaluate 3.2 Sources of finance using case context, stakeholder impacts and business trade-offs.

Covered syllabus points

3.2.1—Internal sources of finance 3.2.2—External sources of finance 3.2.3—Short-term and long-term finance

[Maximum number: 6]

Copper Health (CH)

Copper Health (CH) was the market leader in the production of anti-venom* vaccines to treat poisonous snake bites. CH's mission - influenced heavily by corporate social responsibility (CSR) - is to put customers first and profits second in the treatment of snake bites.
Despite 100000 deaths worldwide each year from snake bites and 400000 serious injuries, CH recently announced that it will no longer produce anti-venom vaccines. Several large Mexican, Brazilian and Indian pharmaceutical companies have entered the market selling anti-venom vaccines at a much lower price than CH.
A spokesperson for CH said: "We will remain a private limited company where corporate social responsibility (CSR) remains an important driving force for our mission. Our medical research is only financed from retained profit. When the lower-priced competition arrived, our sales and profits of anti-venom vaccines decreased significantly. Treating snakebites no longer makes financial sense. Instead, the technology used to produce anti-venom vaccines will be used to research and develop (R&D) other life-saving vaccines".
A non-governmental organization (NGO) has demanded action. "CH is the largest manufacturer of anti-venom vaccines in the world. Although CH's competitors are increasing their production of anti-venom vaccines they will not be able to produce enough to satisfy demand for the next two years. There will be a major shortage. This will result in many life-threatening injuries and deaths."
The non-governmental organization (NGO) has urged CH to seek new sources of finance to continue the production of the anti-venom vaccine.
* anti-venom: a medication made from antibodies that is used to treat venomous bites and stings

(a)

Define the term retained profit.

[ 2 ]

(b)

Explain two possible external sources of finance CH could use to continue production of anti-venom vaccines.

[ 4 ]

The question is sufficiently broad to allow candidates to explain a range of possible sources of finance, but any candidate who looks at internal organic sources, such as increasing sales/profits, must be not given credit.

Possible external sources include:
- As CH is a private limited company, the decision could be taken to raise funds through an initial public offering. CH could be "floated or listed" on the appropriate local share market to raise funds targeting ethical investors.
- Angel investors who have strong ethical/CSR intent could provide funds.
- The NGO has demanded action. Given the number of deaths and injuries from snakebites, the NGO could be approached to provide new finance or governments in those countries predominantly affected. There could be the possibility of a private public partnership.
- Bank loan. If candidates uses this source of finance, it is expected that the candidate either comments on the fact that is likely to come from banks with ethical objectives or from banks which accept the risk associated with CH's mission statement or that the bank is likely to give a loan for a cause such as saving lives.

It is expected that the candidates incorporate the ethical investors/ ethical support issues given the current mission statement of 'people before profit 'as application.

Candidates do not have to use the exact words as above but to show understanding that whoever provides the finance should believe in/ support CH's mission/able to justify given the finance that might be risky due to CH's mission and the possible impact on the population.

Accept any other relevant possible source. (grant, subsidies)
Donation is not really an applicable source of finance for what has to be done. CH is not a charity
Mark as 2 + 2.
- For an identification or a description of one possible source of external finance with or without application [1].
- For explanation of one source with no application [1].
- For explanation of one source and application [2].

Application must refer to the possible sources of finance for production of anti

venom vaccines.

[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.

[Maximum number: 9]

In June 2010, Michel was asked to help finance the start-up of a new non-profit music school called “Inclusive Music” (IM). IM’s aim was to support young musicians from low income families. At first, Michel was very enthusiastic and prepared a business plan. Unfortunately, he realized that Rox could not afford to finance IM fully. External sources of finance other than contributions from Rox would be needed for IM to grow. Until then IM would only have a limited budget for marketing and market research.

IM’s finances were deteriorating, and Louis could not attract external sources of finance. Michel took action and organized a concert by Rox to promote IM. He also examined IM’s accounts and discovered a significant liquidity problem. Without consulting anyone, he dismissed Louis. In the music media, Michel received much criticism for dismissing Louis. Journalists argued that the two main problems were, IM’s vague mission statement and poor marketing. However, Michel aimed to ensure that IM became sustainable in the long term.

Rox and Inclusive Music (IM)
Rox was a music band managed by Michel Mbappe. The band enjoyed considerable commercial success thanks to Michel's autocratic leadership style. He personally made all decisions. Rox had given generously to local schools and other non-profit organizations. The band received many awards for their acts of corporate social responsibility. Their last CD "Action Not Words" had brought them considerable fame.
In June 2010, Michel was asked to help finance the start-up of a new non-profit music school called "Inclusive Music" (IM). IM's aim was to support young musicians from low income families. At first, Michel was very enthusiastic and prepared a business plan. Unfortunately, he realized that Rox could not afford to finance IM fully. External sources of finance other than contributions from Rox would be needed for IM to grow. Until then IM would only have a limited budget for marketing and market research.
In June 2011, IM opened with the mission statement "Action not words". To support its mission, it offered free lessons and allowed students to borrow musical instruments. Michel asked a popular former singer, Louis Marsaud, to be the school's director. Louis adopted a laissez-faire leadership style, hoping it would allow creativity among students. Initial student attendance was lower than expected and quickly worsened. Within three months, many instruments had gone missing and many students were no longer attending music lessons.
IM's finances were deteriorating, and Louis could not attract external sources of finance. Michel took action and organized a concert by Rox to promote IM. He also examined IM's accounts and discovered a significant liquidity problem. Without consulting anyone, he dismissed Louis. In the music media, Michel received much criticism for dismissing Louis. Journalists argued that the two main problems were, IM's vague mission statement and poor marketing. However, Michel aimed to ensure that IM became sustainable in the long term.

Discuss two possible medium- to long-term external sources of finance that IM could use to help solve its financial problems.

Possible medium- to long-term external sources of finance include:
- Seek new funding/finance from philanthropic investors/business angels. However, new business angels may demand greater scrutiny, or ask for control in the organization. This could have an impact on IM's mission statement.
- Bank loan secured against future royalties from Rox. However, a bank may impose a high interest rate if it thinks that the risk is high.
- Rox to invest further in IM to demonstrate their commitment to CSR. However, will Rox be willing to bail out IM? It is already invested in the organization and is holding a concert. There is an indication in the stimulus material that the group has insufficient funds.
- Share capital (probably private and restricted to businesses/musicians in the music industry) sufficient funds could be raised. However, financial controls demanded by the new investors may inhibit some forms of creativity. Michel will have to justify this strategy to the shareholders and seek approval;
moreover, issuing shares may be expensive. New investors may demand a quick return for their involvement and this adds additional pressure on IM at a time of falling revenue.
- Government grants/subsidies. On the positive side, this money does not have to be paid back. However, is the government likely to offer a subsidy for such a luxurious product?

However, as the business is quite a new venture it may be difficult to source external finance. Michel will have to present IM as a viable business venture which may be difficult given its questionable success ("low attendance", "student missing lessons"). It already says in the stimulus that he has been unable to attract external sources of finance. This is a difficult decision for Michel given his leadership style. He would have to give up some form of control of the organization.

It is expected that the candidates provide substantiated conclusions which incorporate the significance of the arguments presented which are prioritized.

Accept any judgment, provided it is well substantiated/supported and relevant to IM.

Accept any other substantiated discussion with a conclusion.

If the candidate does not discuss two possible sources of external finance then they can only achieve up to a maximum of [3 to 4 marks].

If the response is a one-sided relevant approach with no discussion, award a maximum of [4 marks].

Award a maximum of [ 5 marks] 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 [5 to 7] markband if they give judgment/ conclusions that are not based on analysis already given in their answer.

Marks should be allocated according to the markbands on page 4.

All question bank results loaded

Covered syllabus points

Question 1

Question (a)

Question (b)

Question 2

Question 3