IB Business Management SL 3.2 Sources of Finance Question Bank

DA has a long-standing social commitment: employees live in Ville d'Ablet with subsidized rent and access to a hospital, school and leisure facilities. The proposed employment package would replace annual salary with low basic wages and profit-related bonuses, charge market rent and fees for facilities, and offer compensation payments to employees who leave. This could reduce employment costs but may damage morale, trust and DA's social values. DA has recently made losses, while its two strategic options have different risks. Option A would move DA from high-end niche markets to the mass market using the DuLow brand and outsourced mass production by SE. Option B would invest €500 million in cellular manufacturing and modular click-and-fix products. The option must be assessed against the cash inflows, finance, product life cycle, brand loyalty, innovation, production costs, environmental concerns and possible future demand.

DA's board must make two major decisions.

Decision 1: DA needs to reduce employment costs. A new system of pay and benefits is under consideration. This includes:
- changing from an annual salary to low basic wages with profit-related bonuses
- reducing social benefits for employees, such as paying market rents for the housing in Ville d'Ablet and having to pay for the use of the leisure facilities
- offering generous compensation payments to employees who are prepared to leave the business.

Decision 2: The three options from DA directors must be considered.
Immediately prior to the board meeting, Mia withdrew her proposal (Option C).
There is now additional information available on the remaining options.

Louise plans to target the mass market and proposes using the brand name DuLow for the redesigned products. She is planning for DA to outsource production to Star Electrics (SE). SE uses mass production together with some customization of products. SE keeps costs low by importing cheap raw materials and paying low wages.

Ben, the human resource management director, is concerned about the impact this change would have on DA's employees.

Salah's plan requires new production lines, one for each product. Salah proposes using cellular manufacturing. The investment cost is estimated to be € 500 million. Salah estimates the following net cash inflows (excluding the initial investment cost).

Louise thinks the option is expensive. Dodi, the finance director, thinks that the investment is too large and he believes that some shareholders are also concerned about the size of future dividends. Salah believes that shareholders will be pleased about the revenues that this investment will generate. Mia is worried that the products would be expensive to produce and that demand might fall in five to seven years.

Define the term retained profit.

Pablo's Peanuts (PP)
Pablo recently emigrated from Argentina to Miami, Florida, which has a large Hispanic* population. However, he could not find caramelized peanuts - known as garrapiñada -at any of the Latin American markets in Miami. These tasty sweet snacks, sold by street vendors, are very popular in Latin American countries. Pablo began testing different recipes to make the snack himself. Once convinced he had the perfect product, he conducted primary market research in several Hispanic neighbourhoods. He was overwhelmed by the positive response.
As a result, Pablo set up Pablo's Peanuts ( P P ) as a private limited company. He then purchased a food truck (a large vehicle equipped to cook and sell food). From Tuesday to Sunday, he drove to different Latin American markets in the Miami area to cook and sell his product. PP soon became profitable, but meeting demand was difficult.
Pablo wants PP to grow. To do this, he needs a second food truck and an employee. The second truck would require an investment of $\$ 100000$. Pablo's break-even analysis shows that the expected increased output would more than double PP's profits if the cost of fuel for the food trucks remains constant.
Pablo is considering two options to finance the second truck:
- Option 1: A local Miami bank, clearly impressed by the break-even analysis data, is willing to lend Pablo $\$ 100000$ with a 10 % interest rate.
- Option 2: A business angel, Ana Perez, with a strong portfolio of Latin American food products, has approached Pablo. She is offering $\$ 100000$ for 35 % of shares in PP.

* Hispanic: relating to Spain or to Spanish-speaking countries, especially those of Central and South America