Evaluate final accounts and financial statements to interpret profitability, financial position and decisions in IB Business Management HL cases.
Recruiting a new CEO
A company can spend a large amount of money to recruit a well-known and successful Chief Executive Officer (CEO) from outside the organization. However, recently published research suggests that recruiting externally is not only costly, but it is also risky, disruptive and demotivating.
Two long-term studies of 36 large public limited American companies found the following:
- The companies that promoted CEOs internally performed better than those that recruited externally.
- "Outsider" CEOs (recruited externally) have a significantly higher failure rate than "insider" CEOs (recruited internally). 40 % of "outsider" CEOs stayed for two years or less.
- The average financial reward package for "outsider" CEOs, including salary, bonuses and profit-related incentives, was 65 % higher than for those appointed internally.
- "Outsider" CEOs feel empowered to impose rapid change and to assert their authority on the company, even before they really understand the organizational culture. The arrival of an "outsider" CEO is often quickly followed by the departure of senior managers.
- "Outsider" CEOs are very good at rapid cost-cutting and eliminating unprofitable products/ activities, a skill that is very valuable when a competitive advantage needs to be gained or restored in a competitive environment.
Apple, Dell , Microsoft , Intel , McDonalds and Nike are successful American companies that appointed CEOs internally between 1998 and 2007.
A comparison of average performance indicators between 1998 and 2007 is shown below:
Some critics of the two American studies argue that companies promoting CEOs internally usually have a strong corporate culture and are already efficient and profitable. These critics also argue that the performance indicators in the table do not measure the exact contribution of individual CEOs.
(C) The Times 04 2013]
Explain the importance of earnings per share to a shareholder.
Call it Magic (CIM)
Call it Magic (CIM) is an online jewellery store that sells silver earrings. It has completed its first year of trading, during which it sold 1000 pairs of earrings. CIM's selling prices are low compared to those of other jewellery stores. The average unit cost per pair of earrings is $5, and overhead costs are already at a minimum level.
Table 1: Selected financial information for CIM for the year ended 31 December 2022
Using relevant information provided above and in Table 1:
calculate CIM's cost of goods sold, X, in 2022 (show all your working);
calculating Y and Z, construct a profit and loss account for CIM , for 2022;
Chips to Go (C2G) produce potato chips for the British market. C2G’s Chief Executive Officer (CEO) is Charles Chip who is a dynamic entrepreneur famous for taking risks with chip flavours such as “banana and sour cream” and “chocolate fudge” and promoting them with humour especially appealing to British culture. C2G has created a number of successful snack products under the C2G family brand. Charles uses intuitive rather than scientific decision-making. He rarely consults with senior managers or considers financial data. C2G’s value as a company in terms of goodwill, brand value and other intangible assets is tied very closely to the personality and lifestyle of Charles. He is the company’s most valuable intangible asset and is very popular among the younger generation. He is constantly in the news trying to travel around the world in a canoe, or taking risks by parachuting off high buildings to gain free publicity and word-of-mouth promotion. Current and potential investors have contacted the finance department as to what may happen to the value of these intangible assets if Charles were to have a serious accident.
Chips to Go (C2G)
Chips to Go (C2G) produce potato chips for the British market. C2G's Chief Executive Officer (CEO) is Charles Chip who is a dynamic entrepreneur famous for taking risks with chip flavours such as "banana and sour cream" and "chocolate fudge" and promoting them with humour especially appealing to British culture. C2G has created a number of successful snack products under the C2G family brand. Charles uses intuitive rather than scientific decision-making. He rarely consults with senior managers or considers financial data.
C2G's value as a company in terms of goodwill, brand value and other intangible assets is tied very closely to the personality and lifestyle of Charles. He is the company's most valuable intangible asset and is very popular among the younger generation. He is constantly in the news trying to travel around the world in a canoe, or taking risks by parachuting off high buildings to gain free publicity and word-of-mouth promotion. Current and potential investors have contacted the finance department as to what may happen to the value of these intangible assets if Charles were to have a serious accident.
C2G is looking for ways to increase market share in an increasingly competitive domestic snack market. One long-time aim for Charles has been the creation of a potato chip with all the taste of regular chips but without any fat. The marketing department of C2G is very excited with this idea but the Production Manager has indicated to Charles that it cannot be produced. Charles has been told and was furious.
A second strategic option could be to launch the potato chips into a new international market. One of Charles's closest advisers has argued that C2G would need to be careful with its product and promotion, as overseas customers may not share British tastes in potato chips, or British humour in promotion. He urges Charles to take time to carry out extensive market research of the new international market.
Explain two reasons why it may be difficult to value C2G's intangible assets.
At 54 years old, Kos was nervous about the risks of increasing the scale of operation of his business. He enjoyed the job security at the officers’ dining hall. His salary and the profits from selling produce to the UWP Mission were sufficient to provide for himself and his family. However, Kos realized that he was entirely dependent on the UWP Mission for his income. What would happen if the UWP Mission withdrew from Loyka when he was 60 or 62, when it would be more difficult for him to start over again?
He knew that he could increase the scale of his business operations with the UWP Mission without any additional marketing. This would also allow for significant economies of scale, but the logistics would be more complex. He would have to drive and collect produce using dangerous remote unpaved roads outside the protection of the UWP Mission. These remote communities might perceive Kos as collaborating with the UWP troops. He would also have to dedicate all his time to his business and would no longer be able to work in the officers' dining hall. Although that job did not pay particularly well, it was in a safe environment and provided a regular source of income.
To collect larger quantities of produce in remote areas, Kos would need to purchase a large lorry (truck). He discussed potential sources of finance with his bank. The bank manager indicated as a condition for the granting of a loan that the bank would require the lorry as collateral. Secondly, the poor quality of the roads meant that the lorry would lose value quickly.
Kos prepared a business plan and compiled information comparing his current income to his forecast income if he increased his scale of operation (Appendix 5). The income comparison showed that the expansion of his business would be very profitable - as long as the UWP Mission remained in Loyka. However, even after a number of conversations with Colonel Donovan, Kos was still unsure how long the UWP Mission would remain in Loyka.
Consequently Kos drew up three possible options for his produce distribution business:
- Option 1: No change. Keep the same scale of operation and stay working at the UWP Mission.
- Option 2: Increase the scale of operation of his business. Sell more produce to the UWP Mission and to the university or hospital. Kos would need to leave his job at the officers' dining hall and lose his regular source of income.
- Option 3: Maximize the scale of operation. Supply produce not only to the UWP Mission and to the university or hospital, but also to retailers in Beral. In Beral there is no city-wide wholesaler for the produce that Kos distributes. Becoming a wholesaler would require setting up and managing supply chains, employing staff, increasing working capital and adopting a new business structure.
As part of his evaluation of Option 3, Kos Palouk consulted Sami Taibi, who owned and operated a medium-sized grocery store. Sami said that Beral had no reliable produce suppliers and there was a business opportunity if someone could make reliability their unique selling point (USP). However, the deterioration of the situation outside of the UWP-protected area was making reliable purchase and distribution of produce difficult (Item 1).
To ensure reliability, Kos would require a loan of \$ 42000 to:
- Purchase two lorries (2 at \$ 15000=\$ 30000 ). Because of the poor quality of the roads, the lorries would require frequent maintenance. One lorry could still deliver produce while the other was being maintained.
- Increase working capital (\$12000) for higher stock levels.
Unfortunately, the bank will loan Kos a maximum of \$ 30000, as they do not wish to loan funds for working capital as well as for the purchase of the lorries (Item 2).
Kos had an idea. He proposed to Sami that they merge his grocery store with Kos' wholesale produce business. The combined operation would be organized as a private limited company and Kos proposed a 50-50 share ownership. It would also have the following advantages:
- It would have two revenue streams: wholesale (from Kos' operations) and retail (from Sami's grocery store).
- The grocery store would acquire produce at wholesale prices.
- The combined operation would always guarantee supply to the grocery store before other customers.
However Sami was reluctant to give up 50 % ownership of his grocery store for an unproven operation. Sami made a different proposal: Kos would merge his wholesale operation into Sami's grocery store in exchange for 25 % of the shares of the new private limited company. The merger would also result in a new contract and management structure (Items 3 and 4).
Additional Information
Item 1: Extract from Beral Courier, a local newspaper
Rumours of increased violence outside the UWP-protected area were recently confirmed by the office of the local governor. Attacks against vehicles on roads near Bosca, Boussena, Saura and Gana have been confirmed by local police. One driver, who was returning from Saura, was seriously injured.
In another instance, there was severe damage to a road, causing vehicles to take a different route, which doubled the travel time. The local governor announced an increase in police patrols in the area.
The impact of the increased violence has had an immediate impact on local Beral shops, which reported shortages of produce.
| Loan amount: | $30 000 |
|---|---|
| Interest rate: | 8% (fixed) |
| Repayment schedule: | 7 years, payments monthly |
| Monthly payment amount: | $475 (principal and interest) |
| Collateral: | all assets of business, including the two lorries, and Kos’ personal residence |
Item 2: Bank loan offer to Kos
| Kos’ ownership: | 25% |
|---|---|
| Sami’s ownership: | 75% |
| Kos’ monthly salary: | $650 |
Item 3: Sami’s proposal for a new contract — 3.1: At start of new (merged) business
If there are dividends, Kos would receive 25 % of the dividends.
The new private limited company would take out the $30 000 bank loan. Sami’s grocery store would provide the additional $12 000.
3.2: Potential change in ownership structure
Sami has set Kos a target of annual sales of $96 000 ($8000 per month on average) for the wholesale operation for 2 consecutive years (this figure would not include “sales” to Sami’s grocery store).
- If the wholesale operation did not reach the annual sales target for 2 consecutive years within 7 years (the duration of the loan), Kos would remain a 25 % owner with his original salary of $650 per month (no change in ownership structure).
- If the wholesale operation meets the two-year performance target, Kos would receive an additional 24 % ownership in the private limited company. His salary would be adjusted so that it was always equal to 96 % of Sami’s salary. He would also be entitled to 49 % of any dividends.
Item 4: Management structure if Sami’s proposal is implemented
New (merged) business — General manager: Sami
Grocery store — Profit centre manager: Sami
Wholesale operation — Profit centre manager: Kos
Calculate:
the annual depreciation expense of one $ 15000 lorry with a useful life of 7 years and a residual value of $ 1000 using the straight line method.
the depreciation expense in the second year of one lorry using the reducing balance method, with a depreciation rate of 32 % (show all your working).
Easy E Booking (EEB) is a small, well-known, reputable and financially stable online hotel reservation service. EEB employees are highly motivated and take great pride in their work. EEB has received recognition for their high quality customer service. Due to an increase in global demand, greater competition and changes in technology, the finance director, Maia, has decided to upgrade EEB’s computers and/or software. Maia has two options: Option A: purchase only a new software called “Book-Fast” from a local software designer. Option B: purchase new computers with installed software called “Global Reach” from a manufacturer abroad.
The estimated return/total revenue in $ per year is shown below:
| Year | Discount factor at 4% |
|---|---|
| 1 | 0.9615 |
| 2 | 0.9246 |
| 3 | 0.8890 |
| 4 | 0.8548 |
Discount factors (reference only)
Easy E Booking (EEB)
Easy E Booking ( EEB ) is a small, well-known, reputable and financially stable online hotel reservation service. EEB employees are highly motivated and take great pride in their work. EEB has received recognition for their high quality customer service. Due to an increase in global demand, greater competition and changes in technology, the finance director, Maia, has decided to upgrade EEB's computers and/or software.
Maia has two options: manufacturer abroad.
[C International Baccalaureate Organization, 2013]
The estimated return/total revenue in $ per year is shown below:
The average rate of return (ARR) of Option A is 46.25 %.
Maia is considering using a straight line method of depreciation.
EEB employees favour Option A, even though some of their competitors using "Book-Fast" have reported problems with the software, including security issues. However, Maia has chosen Option B, which will provide more up-to-date, sophisticated and secure reservation system software. It will also give EEB a competitive advantage and an ability to handle a large global volume of hotel reservations.
Describe one strength and one weakness of EEB using a straight line method of depreciation.