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T4 Test of Professional Competence – Part B Case Study Examination

T4 – Part B Case Study Examination
Wednesday 28 August 2013

Instructions to candidates

You are allowed three hours to answer this question paper.

You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, make
annotations on the question paper. However, you will not be allowed, under
any circumstances, to begin using your computer to produce your answer or
to use your calculator during the reading time.

This booklet contains the examination question and both the pre-seen and
unseen elements of the case material.

Answer the question on page 17, which is detachable for ease of reference.
The Case Study Assessment Criteria, which your script will be marked
against, is included on page 17.

Maths Tables and Formulae are provided on pages 25 to 28.

Your computer will contain two blank files – a Word and an Excel file.
Please ensure that you check that the file names for these two documents
correspond with your candidate number.

Contents of this booklet: Page

Pre-seen material – N Multi-channel retailer case 2-9
Glossary 10
Pre-seen Appendices 11-16
Question Requirement 17
Case Study Assessment Criteria 17
Unseen Material 19-24
113813

Maths Tables and Formulae 25-28

© The Chartered Institute of Management Accountants 2013

 N – Multi-channel retailer case

N Company History

N Company (N) is a multi-channel retailer selling a wide range of goods through its online and bricks
and mortar channels. It became a household name during the 1950’s as a department store, so called
because it was, and is, organised to sell a wide range of goods such as designer fashion, clothing,
perfumes, furnishings, hardware, white goods, electronic products, computers, TVs etc. which are
generally organised into departments within the store.

During its prime as a department store N had outlets in every large town and city of Country Z and
was considered the leading retailer, being one of the first to develop a returns policy and to provide
very good employment conditions for its front line staff.

Its strategy was one of differentiation through quality both in terms of the products it offered for sale
and in the kind of service it offered to customers. Its target market was middle income customers who
were prepared to pay a premium price for quality products and excellent service.

N’s success in its home country Z, which is located in Europe (but outside the euro zone; the currency
being the Z$), encouraged its management to extend its operations to markets abroad and it has
established operations in countries across the world. During the late 1990’s N became noted as one
of the most profitable retailers in Country Z.
st
As N moved into the 21 Century it became clear that its once market dominance was over. A
number of changes in the retailing environment occurred, most notably the growth of online retailing,
(to which N responded much too slowly) and more dynamic competitors have quickly eroded N’s
market share.

The outcome of these changes was that N’s revenues and profits fell significantly. In 2004, N’s
Directors bought out the Company. The Directors leading the buyout had to rely on support from the
venture capitalist company 4J, and a number of other institutional investors which together took the
majority of shares (80%) in the re-financed Company.

After a series of management changes and cost-cutting measures such as store closures and the
sale and lease-back of stores, N’s trading position was stabilised but with revenues and profits
considerably below where they had been at their peak. During the years from 2005 to 2012, N
attempted to keep pace with its competitors by introducing an online channel and bringing in new
designers but it always seemed to be behind its major competitors.

Overview of N

N currently operates from a head office of about 2000 staff located in the north of Country Z. This is
its main administration and distribution centre, which distributes to 6 regional distribution centres and
then to the stores. It also has a small city office in the capital city of Country Z, which has been
maintained as part of the Company’s corporate image, dealing mainly with investor relations. An
organisation chart is shown at Appendix 1.

Management information is provided by a variety of information systems. Sales information is

provided by the bar-coding till systems which are directly connected to the head office and has for
some time been the mainstay of management information. The daily sales have always formed an
important part of the analysis of company performance.

Stock is controlled and issued through a separate system, with cost of goods being allocated to stores
by category as and when delivered from the distribution centre. This is then held as store stock within
the relevant department, until matched with sales by the till system. Payroll is operated by the HR
function which also makes available relevant labour cost information for inclusion in the management
and financial reports.

September 2013 2 T4 Part B Case Study

The compilation of the Store Performance Report (SPR) is achieved by consolidating the information
from these systems. The SPR shows the sales per store and sales by product category within the
store less the relevant direct costs, giving an indication of gross profit by category per store. After
adding an apportionment for overhead costs, based on the floor area occupied by the departments,
the overall performance of the departments and stores is measured. These reports are made
available to store managers, forming an integral part of the management control process and are
consolidated at product and regional level to enable both the individual store and the overall
performance of the business to be assessed on a monthly basis.

N sells a wide variety of goods which are split into various product groupings. It has a total of 160
stores with a customer facing sales area of 1,114,800 square metres. A detailed analysis of the sales
categories and the margins associated with them together with an analysis of current and forecast
company performance can be found in the Finance Director’s report to the Board (Appendix 2).

The majority of goods sold, 80%, are ‘own bought’, but like many department stores, N also welcomes
concessionaires into its stores because they are another attraction that increases footfall.
Concessionaires operate like shops within shops. These specialist retailers offer attractive goods
such as high quality jewellery, expensive exclusive clothing and other desirable goods not stocked by
the department store itself. They are usually granted the concession to sell within the store paying a
fixed rental per square metre of space occupied or a percentage commission on the value of business
generated.

On the retirement of the existing Chief Executive Officer (CEO) in late 2012 the Board, under the
direction of 4J, agreed that it should seek out a chief executive who could take decisive steps to put N
back amongst the leading competitors in the retailing industry. The Chairman of N welcomed Ms.
Bilder as CEO. She came with a reputation as someone well known for her record in turning
companies around.

Ms. Bilder found on her appointment that N faced a series of formidable challenges. Some of these
challenges came from the changing retail environment, others derived from problems and
weaknesses within N itself.

The developing industry context

Like other department stores which originated in the early twentieth century, N located its main stores
in the central shopping areas of major towns and cities. This was advantageous at the time when
railway lines, tram and bus routes converged on the city or town centre but became a disadvantage
with the growth of car ownership, the increasing congestion in cities and the need for convenient car
parking space.

The subsequent growth of out-of-town shopping centres with ease of access for cars and spacious
car parking has led to the relative decline of many high street stores located in town centres as
shoppers have preferred the convenience of shopping in the out-of-town stores. In order to compete
therefore, N is faced with the problem of store relocation and the financial problems of coping with this
change.

The growth of competition from other retail formats is one of the biggest challenges facing department
stores like N. Once thriving and profitable, many are now struggling to compete with supermarkets
and specialty shops. At the lower end of the market, the main threat is from supermarkets and
hypermarkets while at the higher end of the market, specialty stores are significant competitors for N.
New entrants from abroad, including companies from the USA as well as from Country Z’s European
neighbours provide an increasing international challenge.

One of the problems for department stores like N concerns the strategies that each company might
adopt to fend off this twin group of rivals, one of which erodes its customer base with the offer of low
prices, while the other out-competes them by offering fashionable specialty products.

It is important to note in this context that the room for manoeuvre for large retailers like N is limited by
the competition policy of Country Z which seeks to prevent takeovers that might reduce competition
between retailers in the same industry sector.

September 2013 3 T4 Part B Case Study

Faced with the saturation of their home market and the expansion restriction imposed on buying the
market share of a competitor, large retailers like N have sought to expand their operations by moving
into overseas markets. In some cases such moves have been successful but in others less so.

The key to successful overseas expansion seems to be in how to take advantage of the economies of
scale that a multinational organisation enjoys while at the same time adapting to a different retail
environment and customising the offer to consumers of a different cultural background.

Department stores are also challenged by shifting demographic structures especially in their own
domestic markets. Senior age consumers with large disposable incomes are not only increasing their
savings rates but are also shifting their spending towards goods and services not traditionally offered
by department stores, such as health and well-being, home-improvement and entertainment products
outside the home.

As this post Second World War generation of the customer population grows older, it is not being
replaced by younger customers because this younger segment have developed different buying
habits. Analysts claim there is a growing psychological disconnect among young shoppers who
consider department stores to be old-fashioned and outdated. Today's younger generation shop at a
mix of stores ranging from online, to discount, to niche specialty shops; all of which appear able to
react faster to the latest trends and fashions in shopping.

The challenge for N and other department stores is to maintain their appeal to older affluent
customers while improving their attractiveness to the younger generation of shoppers.
One of the most important changes in retailing in the last two decades has been the emergence of
online retailing. Its impact, until quite recently, has been limited and some retailers have chosen to
ignore it assuming that their existing strategy of providing the right products and good service in-store
would allow them to continue much as they have always done.

Recent changes

During the festive season between the end of 2012 and the start of 2013 however, two developments
occurred that signalled significant change in the retailing industry. One of these was the collapse of a
number of bricks and mortar-only retail chains that specialised in the sale of particular categories of
goods such as music, cameras and electrical goods. These retailers were unable to compete with
Web-only retailers that did not have the expense of staffing, running and maintaining bricks and
mortar stores.

The other development was a sudden increase in the rate of growth of online shopping. This was of
particular relevance to N because although it registered an increase in online sales of 10 per cent
over that enjoyed in the same period in 2011/2012, some of N’s department store competitors
experienced increases in excess of 40 per cent with online sales making up to a quarter of their total
sales. Even taking into account this exceptional seasonal effect on sales, such a rate of increase in
growth was unexpected. The conjunction of these two developments provided a stark warning to
bricks and mortar retailers which had not developed an online channel or had such a channel but
which lacked the latest refinements.

These developments also led some retail analysts to forecast major changes in the retail landscape.
In particular, the increased rate of growth of online retailing, has led to the claim that the purpose of
the conventional retail store will need to be rethought, perhaps with some of the stores acting
primarily as showrooms for online buyers. One implication of this, it is argued, will be the need for
conventional retailers to reassess their store portfolios, both in terms of the number of stores and in
the location of their stores. Predictions to date suggest a decline in the number of store outlets and a
concentration of stores where footfall is greatest.

Mobile devices

One impetus for the recent growth in online shopping has been the increasing availability of affordable
mobile devices such as the smartphone and the tablet that provide access to the internet. The
improvement in the functionality and power of these devices has led to an upsurge in their purchase
and use.

September 2013 4 T4 Part B Case Study

Aside from the many benefits of these devices for personal communication, social media,
photography, direction finding and other benefits, these mobile devices are now increasingly used by
shoppers whilst at home or in-store for a variety of shopping tasks. These include activities such as:
browsing for goods other than the ones on showroom display, receiving promotional offers and other
marketing material, viewing product reviews from other customers, searching online for lower prices
elsewhere and using mobile devices made available by store personnel to pay for goods.

These benefits for customers, it is predicted, will lead to an even greater increase in the use of mobile
devices whilst shopping and will require significant investment by retailers if they are to maintain their
competitiveness. In particular retailers will need to ensure that wireless connectivity is available
throughout their stores as a lack of the ability to use their mobiles in-store has been shown to lead to
frustration for consumers and a loss of some sales. Such retailers will also need to make sure that
their web pages are configured in such a way that they are as easily available to the mobile phone-
user as they are for the conventional computer-user. Retailers will also have to ensure that their
delivery of online purchases is as good, if not better, than that of competitors.

In this context it is also worth noting that the increase in mobile shopping is a global phenomenon not
confined to the mature economies but is fast growing in emerging economies as the preferred way of
online shopping. For multinational retailers the development of mobile devices that have wireless
connection to the internet has enabled them to develop online channels in their overseas businesses
more quickly and at lower cost than previously. With wireless technology, retailers no longer have the
expense of cabling for internet connection but can install private Wi Fi (wireless) systems that allow
wireless connectivity relatively quickly. Indeed the evidence is that major retailers are now investing
large sums on bringing themselves up to date with best mobile technology practices in the industry
both at home and abroad.

Challenge for retailers

There is however a particular challenge for retailers to ensure that their online channel, mobile
channel and bricks and mortar channels are well integrated with each other so that customers who
want to use a mix of channels can do so in a seamless manner. So whether customers order goods
by their mobile, online from their computer or in person at the store, he or she can have goods
delivered or collect them in-store at his or her convenience.

Other associated problems of adopting an online channel include questions of customer security and
protecting the integrity of the customer’s personal information during the online transaction process.
Another problem for retailers is how to ensure continuation of service if a technical problem occurs in
the retailer’s computer systems.

Finally it is important to note that the on-going economic recession in Country Z and the associated
squeeze on family budgets is a major problem for retailers like N. The eurozone problems inevitably
have a depressing impact on Country Z’s economy and this together with the fierce competition N is
experiencing in its home market is another reason for it to consider the expansion of its international
business.

Review of N’s operational activities.

Soon after her appointment as CEO, Ms. Bilder gathered the executive team of N together in order to
conduct a review of N’s current activities.

Ms. Bilder introduced the review with a description of her previous record in helping the turnaround of
several companies, one of which had been a large retail organisation, before proceeding with an
outline of what she perceived to be the existing position of N while listing some of its key problems
and the challenges it faces.

Drawing on her experience of turning companies around, Ms. Bilder felt that one of the weaknesses,
common to all these companies, had been their inadequate management of risk. Few of them had
had contingency plans in place and when the economic downturn came along they were completely
unprepared for it. She added that she did not intend N to be unprepared for future risks.

September 2013 5 T4 Part B Case Study

Her own view, based largely on the financial statements and Finance Director’s report (Appendix 2)
was that although the decline in the Company’s performance had slowed down, and that N remained
profitable, the current performance was a long way below that of the 1990’s when profitability
outperformed that being presently achieved.

She went on to acknowledge the profound changes that had taken place in the retail industry since
the 1990s, many of which had made competition in the industry fiercer than ever. She ended on the
optimistic note that N had a great past as one of the founding giants of retailing in Country Z and was
capable of seizing leadership in the industry once more.

She then invited the directors comprising the executive team to provide an update on how their
particular area of responsibility was performing. Ms. Bilder made it clear that she was interested in
how N stood in relation to its competition and in particular the strengths and weaknesses of the
Company as compared with its key competitors.

Updating from senior executives

Sales and Marketing

The Sales & Marketing Director opened the presentations with an apology for some mistakes, most
notably certain sales which had fallen short of expectations in the recent past. Ms. Bilder quickly set
the tone for the meeting by stating that she was looking for analysis not excuses.

He quickly recovered and gave a polished PowerPoint presentation of how his team had performed in
the recent past together with its main successes and occasional failures. In particular he emphasised
N’s success with own brand products, adding that this was partly due to recessionary times as
consumers struggled to meet the rising cost of living, particularly for transport and winter heating.

N already had a fairly high proportion of own brands (60%) and he felt that this was a good time to
increase the number of N’s own brands since there was a higher margin on these than on the sale of
branded goods.

He also noted that some of N’s competitors who were selling white and electrical goods had managed
to persuade manufacturers to produce own brand goods for them and wondered if N should do the
same.

The Sales and Marketing Director emphasised the importance of maintaining and possibly increasing
the marketing budget in order to maintain the Company image and the constant requirement to
remain ahead of the competition, particularly in relation to clothing sales which accounted for 45% of
total sales in the year to 31 March 2013.

Also of major concern is the rapid increase in the industry of online business, and the fact that the
Company is not well equipped to take advantage of this ever increasing trend. Many of the store
managers are reporting customers browsing and inspecting goods in the stores, but not buying. A
rapid and effective expansion of this aspect of the business is urgently required, in terms of
improvements in the online order processing systems and improvements in the online customer
interface. Marketing campaigns will be needed to improve customer awareness of the enhanced
multi-channel experience.

IT and Logistics

The IT and Logistics Director was the next to speak. His was a dazzling performance illustrated with a
range of charts and diagrams. Much of what he had to say went over the heads of his audience but
the following important points emerged from his presentation.

First he explained some of the problems that had arisen from the way in which N managed its multi-
channels. Customer surveys clearly indicated that the present structure of N in which the online
channel, the mobile channel and the bricks and mortar channel all operated independently did not
provide the desired customer experience.

September 2013 6 T4 Part B Case Study

Customers ordering online were unable to pick up products from many of the bricks and mortar
outlets or return unwanted goods to them. Also the system allowing customers to use their smart-
phones to order products while on the move was not yet up and running and younger consumers in
particular found this irritating.

By contrast, several of N’s major competitors had seamlessly integrated the management of their
channels so that customers could order online and collect in-store, (click and collect). They could
order using their internet based devices, tablets and smartphones at their convenience and arrange
for delivery direct to their home or collect from a store of their choice.

The competitors’ integrated multichannel structure and technology also allowed any returns to be
collected by courier or to be returned to a store. One of the advantages of customers being allowed to
pick up and make returns to stores was that customers were often attracted to purchase other
products while visiting the store.

Other problems noted during the IT and Logistics Director’s presentation included those relating to the
back office logistical problems involved in ensuring smooth and reliable delivery of products from
manufacturer and supplier to N’s central and regional warehouses and then to their stores on time
and in the required quantity. A number of stock-outs during the periods running up to seasonal
national celebrations had proved financially damaging and embarrassing for N and highlighted the
urgent need for modernisation of the product ordering and communication system.

Although the introduction of N’s online channel had gone smoothly and online sales achieved 3.2% of
total revenue in the year to 31 March 2013, competitors’ online sales were increasing far more rapidly
with comparable figures of typically 8-10% of their total revenue and with plans to double this in the
medium term.

Human Resources

The HR Director believed that the excellent customer service which had formed one of the
cornerstones of N’s competitive strategy had continued to be a differentiating factor but competitors
were catching up fast. She also believed that it was as essential to train local managers and corporate
staff working in overseas subsidiaries as comprehensively as staff in the home country if N’s
corporate brand was to be successful in its international businesses.

Estates Management

The Estates Management Director was pleased to report that the modernisation programme for
existing stores was going well and he expected that the timetable as set out two years ago would be
met for all refurbishment completions. On the matter of store closures he expressed regret that a
number of stores in the smaller towns of Country Z had been closed because sales had been falling
year-on-year. A study of the demographics suggested there was no realistic possibility of such stores
returning to profit.

He was happy to report however, that two out-of-town flagship stores had recently opened on time
and early indications suggested that shoppers found them to be very attractive. Sales were going very
well and this was an encouraging development especially as another similar flagship store was due to
open in City T in the west of Country Z in the coming months.

Prompted as to what other formats N might adopt other than flagship stores and the existing smaller
department stores in major towns, the Estates Management Director suggested that N might consider
opening convenience stores of the type already offered by some of its competitors. Some of the
present department stores, in the smaller towns for example, might be downsized to become
convenience stores stocking food and other everyday requirements while others might be opened on
the auto-routes that cross Country Z.

His final point however, was the most important. He had been in discussion with the IT and Logistics
Director and they had agreed that N’s coverage of the country was limited if the trend for the ‘Click
and Collect’ multi-channel activity continued to grow. Compared with competitors, they felt N had too

September 2013 7 T4 Part B Case Study

few stores on the perimeter of big towns and cities where parking facilities were more readily available
and where out-of-town retail parks already attracted an increasing volume of shoppers each week.

International Operations

The International Operations Director began with an overview of N’s performance in overseas
markets. This presented a mixed performance: N’s priority markets of Asia and the Middle East are
performing well. In North America and Europe trading conditions were more challenging and
performance was less positive. He noted with regret the closure of some stores in Europe.

He then went on to remind his colleagues that N had recently introduced a new structure for the
management of its global operations in which the business had been divided into four regions;
Europe, Asia, North America and the Middle East. A general manager had been appointed to lead
each region together with a head of business development to drive growth. He felt that this new
structure would enable greater focus on emerging markets, and whilst there were considerable up-
front costs associated with these developments he felt that this would be well worth the investment in
the longer term.

Looking to the future he confirmed that N was seeking to expand its international business especially
in emerging markets as these showed the greatest potential for future growth. Its principal mode of
entry would be by a series of franchises with suitable partners but he noted that in some cases, N
would look at the acquisition of existing retail stores and even build new stores. He added that an
investigation into the best strategy for competing in particular foreign markets would be necessary as
a means of assessing advantages and possible risks.

Procurement

The Procurement Director began by making clear that the updating of N’s procurement policies,
procedures and technology while making progress had still some way to go and that in some respects
was less effective and efficient than that of its main competitors.

With regard to commodity prices, the price of cotton was a major concern as this had more than
doubled in recent years as a result of poor harvests and rising demand from the Chinese domestic
market. This had also resulted in increases in wool and polyester prices.

He also noted that procurement policy in N had swung back and forth between that of fostering good
and long standing relationships with a few large suppliers and the alternative of shifting between large
numbers of different suppliers according to what N considered was the best offer at a particular point
in time.

The Procurement Director agreed with his colleague in IT and Logistics that N’s information and
communications systems needed urgent attention if merchandise was to be shipped to distribution
centres and stores as efficiently as its leading competitors.

Merchandising

The recently appointed Merchandising Director began by thanking her colleagues for the warm
welcome she had received from members of the executive team on taking up her appointment. Her
brief on appointment had been to review all of the merchandising activities but with a particular focus
on women’s clothing. She was in the early stages of her review but had already come to a number of
conclusions. She welcomed the exciting new look of the modernised stores and felt that the
atmospherics ideally suited the kind of clientele N was seeking to attract.

She also felt that N was targeting the right market segment and felt that it had most of the skills and
competences to meet the fashion aspirations of the women in the age range 25-45 which N targets.
She was disappointed however, with the existing product assortment and pointed out that the racks of
unsold garments in the recent seasonal collection demonstrated clearly that N was not meeting the
expectations of even its most loyal customers. On inspection, she had found huge gaps in the range
of clothing offered. In particular there were no petite sizes, no larger sizes and the clothing offered did
not look fashionable.

September 2013 8 T4 Part B Case Study

She was also surprised by the differences in average lead time between N and its leading competitors
in delivery of garments from manufacturer to distribution centre and then on to stores. It took N’s
suppliers 20 weeks to manufacture and deliver fashion items to stores as compared with a lead time
of 12 weeks for N’s main competitor. She had already been given the go ahead to make drastic
changes including a training programme for all of N’s buyers and faster overnight deliveries of fashion
garments from distribution centres to stores to speed up delivery. In addition, she also proposed to
the Procurement Director that a switch be made to new suppliers.

Finance

The Finance Director gave the last presentation summing up the observations of all her colleagues,
explaining how these were reflected in the financial performance of the company.

Talking through her report (shown in Appendix 2) which had been circulated to the board, the
essential points were that while N remained profitable, it was not keeping up with competitors in terms
of sales growth, particularly in the more recent on-line order and collect business. Cost pressures
continued in all areas but particularly in distribution as a result of increased fuel and road usage
charges and in the administration of the business as warehouse distribution management became
increasingly expensive. She went on to emphasise that with the sales figures as described it was
essential that the forecast costs be kept to plan.

Also with regard to the financing of the business, the original buyout agreement envisaged that the
venture capitalists and all other shareholders would forgo dividends for a period in order that profits
were reinvested in the business. This period had now come to an end with the payment of a dividend
of Z$ 50.0 million in the current year. Similar dividend pay-outs are expected in future years.

She also pointed out that the revolving bank finance agreement of Z$ 600.0 million will require
renegotiation in 2016. Care will need to be taken with cash forecasting and investment decisions.

September 2013 9 T4 Part B Case Study

Glossary for N Case

Atmospherics/ambience - store factors such as display, design, fixtures, flooring, smell, sound,
lighting, temperature, wall coverings, which can be controlled by a retailer to influence the consumer's
buying mood.

Bricks and mortar - businesses that have a physical (rather than virtual or online) presence - in other
words, stores (built of physical material such as bricks and mortar).

Concession - the right granted to a retail business to sell goods within another establishment. The
owner of the concession - the concessionaire - pays either a fixed sum or a percentage of revenue for
the rights to do so.

Flagship store - a large store in a prominent location, (often a major city) that holds or sells the
highest volume of merchandise in the chain.

Footfall - the number of people visiting a shop or a chain of shops in a period of time.

Mobile channel – refers to the use of mobile devices such as smartphones, tablets and the like to
investigate availability of goods, to compare prices, view promotions, order and pay for goods and
arrange delivery whenever and wherever the customer happens to be, at home or on the move.

Own-bought goods – goods purchased by the company for resale, maybe branded or own label.

Own-label goods – goods manufactured by the original manufacturer but sold under the N company
label.

Retail format - refers to the retail mix in terms of range of products and services, pricing policy,
promotion, operating style or store design and visual merchandising.

Returns policy - a policy which allows the customer to return a product if not satisfied with it within a
certain period of time, subject to the policy of the retailer.

Revolving credit facility – a credit facility which has an agreed upper limit available for an agreed time
period and which will fluctuate with the cash requirements of the company. An arrangement fee is
usually charged and incorporated in the balance due.

Specialty store - refers to a retail store that offers specific and specialised types of item. These stores
focus on selling a particular brand, or a particular type of item, for example, one that sells only
smartphones. Sometimes it includes chain retail-stores that sell a specific brand of clothing.

Web-only retailers - use the Internet as their primary means of retailing as contrasted with bricks and
mortar retailers which use the Internet to promote goods or services but also have the traditional
physical stores available to customers.

September 2013 10 T4 Part B Case Study

Appendix 1

Organisation Chart of N as at 31 March 2013

Chairman

Chief
Executive
Officer

Sales & Estates Finance HR IT & Logistics Merchandising International Procurement

Marketing Management Director Director Director Director Operations Director
Director Director Director
Finance staff HR staff based Staff based in
based in main IT staff based in Merchandising Staff based in administration
in main
Regional sales Store based administration administration staff based in City office & centre & City
administration
teams maintenance centre and City centre administration Internationally office
centre and City
teams office office centre

Store
managers &
staff

September 2013 11 T4 Part B Case Study

 Appendix 2

Finance Director’s report to the Board for the year ended 31 March 2013.

The business has faced another challenging year. Revenue has increased by Z$ 49.5 million or
2.5% on the year, to Z$ 2,029.9 million (2012: Z$ 1,980.4) which takes into account the new
stores opened but it is not keeping pace with competitors which are achieving increased
revenues of almost 4.0%. N has sales per square metre (sq. m.) of customer-facing floor area of
Z$ 1,820.86, (total floor area 1,114,800 sq. m.) which is considerably less than our major
competitors, which are achieving over Z$ 1,900 per sq. m. Cost of sales including purchases,
employee and other operating costs are 86.7% of sales resulting in a gross profit for the year of
Z$ 270.0 million, 13.3% of sales value (2012: Z$ 263.4 million, also 13.3% of sales value).
Extracts from the current year, and forecast are attached.

Distribution costs of Z$ 64.9 million increased by 13% over the year (2012: Z$ 57.4 million) as a
result of increased fuel and transport operating costs. Administrative expenses increased by
2.5% to
Z$ 40.6 million for the year (2012: Z$ 39.6 million). This has resulted in a lower operating profit
in 2013 of Z$ 164.5 million (8.1% of sales as compared to 8.4% in 2012.)

Finance costs of Z$ 15.0 million have reduced slightly (2012: Z$ 16.0 million) as the business
has reduced the loan finance position net of cash from Z$ 665.5 million to Z$ 592.9 million. After
some lengthy discussions with 4J and other institutional shareholders it was agreed that a
dividend be paid of Z$ 0.50 per share totalling Z$ 50.0 million.

The revolving credit facility with the bank of Z$ 600 million, excluding the arrangement fee, will
require renegotiation in 2016. Accurate cash monitoring and planning and backing from
shareholders will be vital to a successful outcome.

The enclosed forecast for 2014-2016 is based on current performance and cost relationships
continuing into the immediate future with distribution costs increasing by 10% year-on-year and
finance costs remaining static.

Because of this and sluggish sales growth, the forecast indicates that N will experience declining
profitability over the 3 year period. It is essential that there is further investment in areas such as
on-line sales channels, with customers able to easily pick up or return goods. Also an
improvement in margins through increasing own branding and a thorough administrative review
are required to improve on the forecast position.

While the operational cash position remains manageable, the funding of investments required to
develop the business will require careful planning and consideration.

September 2013 12 T4 Part B Case Study

Extract from Published Statement of Profit or Loss for N for the year ended 31 March

2013 2012
Z$ million Z$ million
Revenue 2,029.9 1,980.4

Cost of sales 1,759.9 1,717.0

Gross profit 270.0 263.4

Distribution costs 64.9 57.4

Administrative expenses 40.6 39.6

Profit from operations 164.5 166.4

Finance costs 15.0 16.0

Profit before tax 149.5 150.4

Tax 41.9 42.1

Profit for the year 107.6 108.3

September 2013 13 T4 Part B Case Study

Statement of Financial Position of N as at:

31 March 2013 31 March 2012

Note Z$ million Z$ million
Assets
Non-current assets
Property, plant and equipment 1 941.2 935.5

Current assets
Inventories 2 461.7 455.2
Trade and other receivables 101.3 90.5
Cash and cash equivalents 147.2 61.7
710.2 607.4
Total assets 1,651.4 1,542.9
Equity and liabilities
Ordinary share capital issued 100.0 100.0
Share premium 250.0 250.0
Retained earnings 232.6 175.0

Total equity 582.6 525.0

Non-current liabilities
Loans and borrowings 3 530.1 605.6

Total non-current liabilities 530.1 605.6

Current liabilities
Loans and borrowings 210.0 121.6
Trade and other payables 286.8 248.6
Tax payable 4 41.9 42.1
Total current liabilities 538.7 412.3
Total equity and liabilities 1,651.4 1,542.9

Note:
1. Assets are at net values after charging depreciation.
2. Consists of items held for resale.
3. Represents the outstanding balance of the revolving credit facility, including the arrangement
fee.
4. The tax rate is 28%.

Note: Paid in share capital represents 100,000,000 shares of Z$ 1.00 each at 31 March 2013

Statement of Changes in Equity Share Share Retained Total

For the year ended 31 March 2013 capital premium earnings
Z$ million Z$ million Z$ million Z$ million

Balance at 31 March 2012 100.0 250.0 175.0 525.0

Profit for the year - - 107.6 107.6
Dividends paid - - (50.0) (50.0)
Balance at 31 March 2013 100.0 250.0 232.6 582.6

September 2013 14 T4 Part B Case Study

 Statement of Cash Flows for N for year ended 31 March 2013

Z$ million Z$ million
Cash flows from operating activities

Profit before tax 149.5

Adjustments
Depreciation 88.0
Finance costs 15.0 103.0

Movements in working capital

(Increase)/decrease in inventories (6.5)
(Increase)/decrease in trade receivables (10.8)
Increase/(decrease) in trade payables 38.2 20.9

Cash generated from operations 273.4

Finance costs (net paid) (15.0)
Tax paid (42.1) (57.1)

Net cash from operating activities 216.3

Cash flows from investing activities

Purchase of non-current assets (93.7) (93.7)

Cash flows from financing activities

Dividend paid (50.0)
Increase in loans and borrowings 12.9 (37.1)

(Decrease)/increase in cash and cash equivalents 85.5

Cash and cash equivalents at the beginning of the year 61.7

Cash and cash equivalents at the end of the year 147.2

N: Product Sales and Profitability Analysis for the year ended 31 March 2013

Sales Cost of Inventory Gross Margin

% Sales Z$ million Z$ million Z$ million

Womenswear 22.5 456.7 174.3 282.4
Menswear 14.0 284.2 88.1 196.1
Childrenswear 8.5 172.5 66.3 106.2
Health & Beauty 24.0 487.3 299.1 188.2
Accessories 10.5 213.1 85.2 127.9
Home (Household) 20.5 416.1 312.1 104.0
Total 100.0 2029.9 1025.1 1004.8

September 2013 15 T4 Part B Case Study

 The following costs have been included in arriving at cost of sales:

2012/ 2013 2011/2012

Z$ million Z$ million

Cost of inventory 1025.1 1010.0

Employee costs 308.0 305.6
Staff development and training 25.0 25.0
Depreciation 88.0 85.0
Maintenance 35.2 34.0
Rental charges 90.2 86.8
Energy costs 38.4 35.6
Advertising and promotion 150.0 135.0
1759.9 1717.0

Forecast Statement of Profit or Loss for N for 2014-2016

Year to 31 March 2014 2015 2016

Z$ million Z$ million Z$ million

Revenue 2,080.6 2,132.6 2,185.9

Cost of sales 1,803.9 1,849.0 1,895.2
Gross Profit 276.7 283.6 290.7

Distribution costs 71.4 78.5 86.4

Administrative expenses 41.6 42.6 43.7

Profit from operations 163.7 162.5 160.6

Finance costs 15.0 15.0 15.0

Profit before tax 148.7 147.5 145.6

Tax 41.6 41.3 40.8

Profit for the year 107.1 106.2 104.8

September 2013 16 T4 Part B Case Study

N – Multi-channel retailer case – Unseen material provided on examination day

Additional (unseen) information relating to the case is given on pages 19 to 24.

Read all of the additional material before you answer the question.

ANSWER THE FOLLOWING QUESTION

You are the Management Accountant of N.

The Finance Director (FD) has asked you to provide advice and recommendations on the issues
facing N.

Question 1 part (a)

Prepare a report that prioritises, analyses and evaluates the issues facing N and makes
appropriate recommendations.
(Total marks for Question 1 part (a) = 90 Marks)

Question 1 part (b)

Prepare an e-mail for the Finance Director explaining the strategic, financial and operational
factors which need to be taken into account in deciding on whether or not to make a bid for P.

Your e-mail should contain no more than 10 short sentences.

(Total marks for Question 1 part (b) = 10 Marks)

Your script will be marked against the T4 Part B Case Study Assessment Criteria shown below.

Assessment Criteria
Criterion Maximum
marks
available
Analysis of issues (25 marks)
Technical 5
Application 15
Diversity 5
Strategic choices (35 marks)
Focus 5
Prioritisation 5
Judgement 20
Ethics 5
Recommendations (40 marks)
Logic 30
Integration 5
Ethics 5
Total 100

September 2013 17 T4 Part B Case Study

 This page is blank

September 2013 18 T4 Part B Case Study

 N – Multi-channel retailer case– unseen material provided on examination day

Read this information before you answer the question

N marketing proposal

At a recent board meeting the Sales and Marketing Director expressed his urgent concerns that
certain segments of the sales portfolio are underperforming and that rival companies, which are
spending more on specific promotions, are potentially eroding N’s market share. He has
requested a Z$ 45.0 million increase in his promotion budget for the current year. He indicated
that sales volumes of womenswear will increase by 15% on average and menswear by 5% on
average for the whole year 2013/14, (based on the same sales and profitability analysis as for
the year ended 31 March 2013), if these further campaigns are run successfully.

The Financial Director (FD) is under pressure to sign off on this, but is concerned that this would
represent an increase of around 30% on the marketing spend for the year and also recalls the
Merchandising Director’s observations about weak trading performance of some of the clothing
lines. The FD has asked you to analyse and recommend whether this marketing campaign
should be pursued.

The product sales and profitability analysis for the year ended 31 March 2013 are shown in
Appendix 4.

Departmental management

The clothing department of one of N’s stores has a very good record of having the highest sales
per square metre of all clothing departments across the group. The Manager of the department,
C, has however, established a reputation as someone who shows little regard for his staff.

On some of the occasions when members of staff have made suggestions for potential
improvements to store layouts he has not received these suggestions well, thinking his
judgement is being questioned. He has responded by issuing implied and sometimes explicit
threats including writing poor appraisals for staff members, deductions of bonuses and in some
cases he has even suggested the possibility that the staff members’ jobs might be at risk.

A number of staff members have taken their complaints to the Store Manager but he has
brushed their complaints aside and suggested that they are exaggerating the situation and
should get back to work and ‘cease their childish complaints’. These issues have come to the
attention of the HR department.

Expansion by acquisition

The 4J representatives at the Operations Review meeting held earlier in the year expressed
their concern at the weak performance of N, particularly in relation to the approach adopted to
online and multi-channel business, which is lagging behind rivals. These activities are seen as
an increasingly important element of the sales mix. Part of the problem for N is that many of its
stores are within inner cities and do not have their own parking facilities. They are not easily
accessible to customers who wish to collect larger electrical and home (household) products
after placing their order.

A solution to this may be the purchase of a supermarket chain, P, which operates throughout
Country Z. It has always been family-owned and the family now wants to sell the company. Most
of the premises P occupies are on out-of-town sites with good parking facilities, and it is
considered that this may be an opportunity for N to expand and diversify its business.

September 2013 19 T4 Part B Case Study

A summary of the results for P over the last three years is as follows:

P summarised results
Year ended 31 March 31 March 31 March
2013 2012 2011
Z$ million Z$ million Z$ million

Revenue 2530 2349 2158

Profit from operations 130 137 133

Net asset value 980 930 850

P’s owners are willing to sell on the basis of a 10% premium on its net asset value at 31 March
2013.

It is estimated that the acquisition will enable online sales revenue for N to increase by 10% over
and above the total forecast revenue for 2013/14, generating extra revenue of Z$ 208.1 million
in 2014/15 and a gross margin on this of 50%. The amount of the extra revenue is forecast to
increase by 5.0% year-on-year after 2014/15 and to continue to produce a gross margin of 50%.

The operating profit of P, Z$ 130 million, for the year ended 31 March 2013 is also expected to
increase by 2.5% to Z$ 133.3 million for the current year 2013/2014, and to continue increasing
by 2.5% year-on-year in the future. If successful the acquisition is planned to take place on 1
April 2014.

The current owners are only interested in a cash buyout. 4J is prepared to provide all the
funding and operate the business as a wholly-owned subsidiary of N on the following basis:

x funds will be provided at a pre-tax cost of capital of 6% on 1 April 2014

x an expectation of recovering its investment within 5 years on a discounted payback

basis.

The FD has asked you to prepare a report detailing whether the 4J requirement will be achieved
and whether there are any other aspects of this potential investment you consider relevant in
reaching a decision.

Improvements in N’s value chain

During the review of N’s operational activities, a number of weaknesses were identified by the
senior management team. These weaknesses were apparent in a number of areas.

In particular, N appears to have back-office logistical problems because delivery of supplies

from its regional distribution centres is unreliable and has resulted in a number of costly stock-
outs.

Product assortment is also an area of major weakness as evidenced by the slow moving sales
of women’s fashion clothing.

In comparison with competitors, it is also evident that N has been slow in developing high
margin own brands especially in its electrical and white goods product categories.

Given the recent record growth of online sales by N’s key competitors, perhaps the greatest
concern is N’s relatively poor sales performance in its online channel. This appears to stem from
problems with N’s outdated multi-channel structure. The fact that some customers have been
unable to return goods bought online to their local store is just one indication of the need for an
integrated multi-channel organisational structure.

September 2013 20 T4 Part B Case Study

Other areas identified as problematic during the operational review include lack of investment in
customer-facing services necessary to maintain N’s competitive edge and the need for a
consistent and effective policy in its procurement function.

Ms. Bilder, conscious of the weaknesses identified, has issued an instruction indicating to the
directors that she requires N to achieve the following in 2013/14 from the 1 October 2013:

x a 1% improvement above the overall forecast sales volume for the year, coupled with
x a 1% improvement above the overall forecast selling prices for the year, and
x a 1% reduction below the overall forecast cost of sales and overheads for the year.

The FD has asked you to report on the operating profit improvement that will result in the current
financial year if this is achieved from 1 October 2013. You are also asked to identify the
weaknesses in N’s value chain and the activities which need to be improved and explain how an
analysis of N’s value chain can assist in achieving the improvement in order to meet Ms. Bilder’s
requirements.

Note: You are not required to draw the value chain diagram in your answer. A copy of Porter’s
Value Chain diagram is available for reference in Appendix 3, and the forecast profit or loss
statement for 2013/14 is shown in Appendix 5.

Store refurbishment

N employed a contractor during the refurbishment of one of its stores. The contractor was
awarded the contract by the Estates Management Director solely on the grounds of being the
lowest bidder. A new Contracts Manager at N was subsequently appointed to his post but was
later found to have limited experience. Largely because of this lack of experience he tended to
leave the contractor to get on with the job with limited inspection of the refurbishment process.

As things turned out, one of the store ceilings that the contractor removed contained harmful
material. This was discovered on a routine check by one of the Government’s Health and Safety
(H&S) Inspectors who became concerned that the dust from the ceiling was being blown into
one of the entrances of N’s store. Hundreds of customers and several dozen employees were
exposed to this dust and the H&S Inspector has reported his findings to the official government
organisation that oversees all health and safety matters in Country Z and to the store manager
with a copy to N’s senior executive team.

International markets

Country G which lies in South East Asia has been described as an ‘emerging economy’ due to
its rapid economic growth and rising levels of affluence.

Given its unique culture and climatic conditions, consumers in Country G have different tastes to
those in the other countries in which N operates. This is especially so in the case of everyday
requirements and clothing. Differences also extend to its business environment, competitive
situation and retail market.

Prior to 2010, Country G’s retail markets were closed to foreign retailers due to strong
protectionist policies. In late 2010 Country G’s government recognised that the retail sector, then
dominated by very small traditional family run stores, was out of step with a modernising
industrial economy and deregulated its distribution sector.

A number of foreign multinational retailers quickly moved into Country G buying up retail assets
that were attractively priced following a devaluation of Country G’s currency. The foreign new
entrants into Country G’s retail market were either large American or European companies, one
of the latter being N.

All these companies, including N, adopted a standardised ‘global’ strategy. They offered the
same product categories using similar store formats in other countries as in their home markets.
These large new entrants also made use of their considerable buying power and established a

September 2013 21 T4 Part B Case Study

network of suppliers in the global sourcing of products. This enabled them to offer standardised
global products at competitive prices to consumers in a wide range of countries including
Country G.

Because this strategy had already worked successfully in other countries around the world, the
foreign new entrants were reasonably confident that the strategy would work in Country G.

To date however, the actual return on investment has been below expectations as the foreign
new-comers, including N have failed to generate the sales expected in Country G. Ms. Bilder is
very concerned about the poor performance of N’s stores in Country G. She has asked the FD
to lead an interdepartmental team to recommend a strategy that would turnaround the
performance of N’s stores in Country G.

The FD has asked you to join the interdepartmental team and to provide her with an explanation
of why the standardised ‘global’ strategy has failed to work in Country G and what you would
recommend in its place.

September 2013 22 T4 Part B Case Study

Appendix 3 Porter’s Value Chain

September 2013 23 T4 Part B Case Study

Appendix 4

N: Product Sales and Profitability Analysis for the year ended 31 March 2013
(as shown in the pre-seen material)

Sales Cost of Inventory Gross Margin

% Sales Z$ million Z$ million Z$ million

Womenswear 22.5 456.7 174.3 282.4
Menswear 14.0 284.2 88.1 196.1
Childrenswear 8.5 172.5 66.3 106.2
Health & Beauty 24.0 487.3 299.1 188.2
Accessories 10.5 213.1 85.2 127.9
Home (Household) 20.5 416.1 312.1 104.0
Total 100.0 2029.9 1025.1 1004.8

Appendix 5

Forecast Statement of Profit or Loss for the year 2013/2014

(as shown in the pre-seen material)

Year to 31 March 2014

Z$ million

Revenue 2,080.6
Cost of sales 1,803.9
Gross Profit 276.7

Distribution costs 71.4

Administration expenses 41.6

Profit from operations 163.7

Finance costs 15.0

Profit before tax 148.7

Tax 41.6

Profit for the year 107.1

End of unseen material

September 2013 24 T4 Part B Case Study

 APPLICABLE MATHS TABLES AND FORMULAE

Present value table

-n
Present value of 1.00 unit of currency, that is (1 + r) where r = interest rate; n = number of periods until
payment or receipt.

Periods Interest rates (r)

(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621
6 0.942 0.888 0.837 0.790 0.746 0.705 0.666 0.630 0.596 0.564
7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513
8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467
9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424
10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386
11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350
12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319
13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290
14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263
15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239
16 0.853 0.728 0.623 0.534 0.458 0.394 0.339 0.292 0.252 0.218
17 0.844 0.714 0.605 0.513 0.436 0.371 0.317 0.270 0.231 0.198
18 0.836 0.700 0.587 0.494 0.416 0.350 0.296 0.250 0.212 0.180
19 0.828 0.686 0.570 0.475 0.396 0.331 0.277 0.232 0.194 0.164
20 0.820 0.673 0.554 0.456 0.377 0.312 0.258 0.215 0.178 0.149

Periods Interest rates (r)

(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402
6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335
7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279
8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233
9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194
10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162
11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135
12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112
13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093
14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078
15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.079 0.065
16 0.188 0.163 0.141 0.123 0.107 0.093 0.081 0.071 0.062 0.054
17 0.170 0.146 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.045
18 0.153 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.038
19 0.138 0.116 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031
20 0.124 0.104 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026

September 2013 25 T4 Part B Case Study

Cumulative present value of 1.00 unit of currency per annum, Receivable or Payable at the end of
each year for n years ª r
1(1 r )  n º
«¬ »¼

Periods Interest rates (r)

(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791
6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355
7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868
8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335
9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759
10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145
11 10.368 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495
12 11.255 10.575 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814
13 12.134 11.348 10.635 9.986 9.394 8.853 8.358 7.904 7.487 7.103
14 13.004 12.106 11.296 10.563 9.899 9.295 8.745 8.244 7.786 7.367
15 13.865 12.849 11.938 11.118 10.380 9.712 9.108 8.559 8.061 7.606
16 14.718 13.578 12.561 11.652 10.838 10.106 9.447 8.851 8.313 7.824
17 15.562 14.292 13.166 12.166 11.274 10.477 9.763 9.122 8.544 8.022
18 16.398 14.992 13.754 12.659 11.690 10.828 10.059 9.372 8.756 8.201
19 17.226 15.679 14.324 13.134 12.085 11.158 10.336 9.604 8.950 8.365
20 18.046 16.351 14.878 13.590 12.462 11.470 10.594 9.818 9.129 8.514

Periods Interest rates (r)

(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991
6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326
7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605
8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837
9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031
10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192
11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327
12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 4.793 4.611 4.439
13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533
14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611
15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675
16 7.379 6.974 6.604 6.265 5.954 5.668 5.405 5.162 4.938 4.730
17 7.549 7.120 6.729 6.373 6.047 5.749 5.475 5.222 4.990 4.775
18 7.702 7.250 6.840 6.467 6.128 5.818 5.534 5.273 5.033 4.812
19 7.839 7.366 6.938 6.550 6.198 5.877 5.584 5.316 5.070 4.843
20 7.963 7.469 7.025 6.623 6.259 5.929 5.628 5.353 5.101 4.870

September 2013 26 T4 Part B Case Study

FORMULAE

Valuation Models
(i) Irredeemable preference share, paying a constant annual dividend, d, in perpetuity,
where P0 is the ex-div value:
d
P0 =
k pref

(ii) Ordinary (Equity) share, paying a constant annual dividend, d, in perpetuity, where P0 is
the ex-div value:
d
P0 =
ke
(iii) Ordinary (Equity) share, paying an annual dividend, d, growing in perpetuity at a constant
rate, g, where P0 is the ex-div value:
d1 d 0 [1  g ]
P0 = or P0 =
ke - g ke  g

(iv) Irredeemable (Undated) debt, paying annual after tax interest, i (1-t), in perpetuity, where
P0 is the ex-interest value:
i [1  t ]
P0 =
k dnet
or, without tax:
i
P0 =
kd
(v) Future value of S, of a sum X, invested for n periods, compounded at r% interest:
n
S = X[1 + r]

(vi) Present value of £1 payable or receivable in n years, discounted at r% per annum:

1
PV =
n
[1  r ]

(vii) Present value of an annuity of £1 per annum, receivable or payable for n years,
commencing in one year, discounted at r% per annum:

1ª 1 º
PV =
«
r ¬
1
n »
[1  r ] ¼
(viii) Present value of £1 per annum, payable or receivable in perpetuity, commencing in one
year, discounted at r% per annum:
1
PV =
r

September 2013 27 T4 Part B Case Study

(ix) Present value of £1 per annum, receivable or payable, commencing in one year, growing
in perpetuity at a constant rate of g% per annum, discounted at r% per annum:
1
PV =
r g

Cost of Capital
(i) Cost of irredeemable preference capital, paying an annual dividend, d, in perpetuity, and
having a current ex-div price P0:
d
kpref =
P0
(ii) Cost of irredeemable debt capital, paying annual net interest, i (1 – t), and having a
current ex-interest price P0:

i [1  t ]
kdnet =
P0
(iii) Cost of ordinary (equity) share capital, paying an annual dividend, d, in perpetuity, and
having a current ex-div price P0:

d
ke =
P0
(iv) Cost of ordinary (equity) share capital, having a current ex-div price, P0, having just paid a
dividend, d0, with the dividend growing in perpetuity by a constant g% per annum:

d1 d 0[1  g ]
ke =  g or ke = g
P0 P0
(v) Cost of ordinary (equity) share capital, using the CAPM:
ke = Rf + [Rm – Rf]ß

(vi) Weighted average cost of capital, k0:

ª VE º ª VD º
k0 = ke
«V  V »  kd
«V  V »
¬ E D¼ ¬ E D¼

September 2013 28 T4 Part B Case Study

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 T4 – Test of Professional
Competence - Part B Case Study
Examination

September 2013

September 2013 32 T4 Part B Case Study