MOCK EXAM 4 ANSWERS FOR SNAKWHEEL

CIMA MAY-AUG 22 SCS CASE STUDY

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While the following solutions have been expertly written and vetted by our content team, it is
important to note that these solutions do not represent the only answers that could have been
given.

There may be equally valid answers that do not feature in the answers below that would have
achieved equal merit.

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 Section 1

From Senior Manager

To Peter Fodya, Chief Finance Officer
Subject RE: Strategic implications and currency risks

Dear Peter,
Please see my notes below which address your questions.
A. Strategic implications
Costs
Switching our data storage and processing to a third-party cloud services provider like Blueframe could lower our costs. Blueframe benefits
from economies of scale as the company likely services multiple clients simultaneously. At least, in theory, Blueframe should be able to pass
those savings to us. The switch to Blueframe would also allow us to reduce the number of IT staff employed in Snakwheel, resulting in further
cost savings. In addition, our current setup makes it costly to increase our data storage and processing capacity. Switching to a cloud services
provider allows us to only pay for the data storage and processing capacity that we want to use.
Board capacity
Snakwheel is a company that is heavily dependent on its IT systems. Invariably, the management and oversight of the company’s information
systems is a time-consuming process. The use of Blueframe’s services will reduce the amount of time that the board must spend reviewing and
overseeing the company’s IT systems. However, the switch to Blueframe would not fully relieve the board of responsibility for the company’s
information systems. The board will have to implement a series of controls to ensure that Blueframe is managing Snakwheel’s information
systems effectively. A robust service level agreement and a series of contingency plans will also need to be drafted and approved by the board.
Control
The switch to Blueframe’s service would result in a loss of control over IT operations. In addition, the switch also results in a high degree of
dependency on Blueframe’s level of service. If Blueframe’s servers have issues, then Snakwheel’s operations will run into issues as a result.
Given our technology-dependent nature, this loss of control may not be palatable to the board. Technical issues associated with Snakwheel’s
apps or tablets may also be slower to resolve as there will need to be a determination as to whether the issue is coming from Blueframe or
Snakwheel. Blueframe may be slower to resolve the issue than we are used to, especially if they operate in a different time zone.

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 Cyber risk
It could be argued that the switch to Blueframe may result in a greater level of exposure to cyber risk. At the moment, our data centre is an
attractive target for a hacker because of the sensitive information it stores. However, Blueframe's data centres are likely to contain data from
multiple companies. These data centres are a more attractive target for a hacker because access to Blueframe’s servers could provide the
hacker with sensitive information from various companies (including Snakwheel). Blueframe likely has robust cybersecurity measures in place;
however, the board’s ability to influence these measures is limited.
Internal competencies
Snakwheel currently employs a large number of IT professionals, including programmers, analysts, IT technicians and IT engineers. By using
the services of Blueframe, Snakwheel will be forced either reallocate these staff to other areas of business, upskill them or make them
redundant (most likely outcome). Snakwheel will effectively lose the competency of managing an in-house data centre due to the switch. If the
board ever wanted in-house data storage and processing in the future, this would likely be very costly as an entire team of new staff would
need to be recruited. Therefore, the switch to Blueframe is a long-term commitment and is not easily reversed.

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 B. Currency risk
Transaction risk
Transaction risk refers to the risk of a foreign currency transaction being recorded at one currency rate but eventually settled at a different
currency rate. Blueframe will charge Snakwheel using Nordland's home currency, the N$. Since Snakwheel's home currency is the W$, any
exchange rate fluctuation between the W$ and N$ (between the transaction date and the settlement date) can result in a foreign exchange loss
or gain. Unlike a one-off capital transaction, our contract with Blueframe will result in recurring payments. This means that each invoice issued
by Blueframe will result in transaction risk.
Economic risk
Economic risk refers to the risk of a change in the present value of a company’s future cash flows due to unexpected changes in exchange
rates in the medium to long term. If the W$ were to weaken against the N$ in the long term, more W$ would be needed to purchase N$. If this
happens, there is a cash flow impact for us as it gets more expensive to pay Blueframe as the W$ weakens against the N$. Macroeconomic
conditions will influence long-term fluctuations. As a result, there is little Snakwheel can do to influence the long-term M$/N$ exchange rate.
Upside economic risk may not result in lower costs as Blueframe may increase prices if the W$ strengthens against the N$.
Invoice in home currency – Mitigation strategy
The most simple mitigation strategy is to insist that Blueframe invoice in W$. Snakwheel is a large, listed organisation and given our size, we
have leverage when negotiating with Blueframe. Blueframe may be willing to concede invoicing in their domestic currency during the
negotiation process, especially if Snakwheel is willing to pay a little more for this contract term. If Blueframe invoices in the W$, transaction and
economic risk are effectively managed. However, there is still a risk that Blueframe will try to increase prices if W$/N$ exchange rate
movements result in their W$ receipts becoming worth less over the medium to long term.
Hedging tools – Mitigation strategy
Using Blueframe’s service will result in a long-term commitment to reoccurring payments denominated in N$s. External hedging tools may be
difficult to use when hedging the transaction risk associated with these payments because the cost of using the hedging tools may be greater
than the benefit they provide. It might be worth exploring whether Blueframe would be willing to invoice over longer periods (for example, every
six months or annually). If Blueframe is willing to do this, the cost of using hedging tools such as currency options, futures and forwards could
become economically worthwhile.

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 Ignore currency risk – Mitigation strategy
One way to approach the currency risks stemming from the use of Blueframe’s services is to ignore economic and transaction risks. It could be
argued that currency gains and losses over time may end up netting each other out and that the effort and cost involved in hedging these
currency risks through financial derivatives may not be worthwhile. There is a strong case for ignoring currency risk if there is a small spread for
the M$/N$ exchange rate, as currency losses and gains may be immaterial when considered over a year. I would not advise this approach if
the spread is large and volatility in the exchange rate is expected in the future.
Kind regards,
Senior manager

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 Section 2
From Senior Manager
To Peter Fodya, Chief Finance Officer
Subject Ethics and dividend policy

Dear Peter,
Please see my notes below which address your questions.
A. Ethics
I will use the principles of the CIMA Code of Ethics to assess the ethical implications of lobbying Westaria’s government.
Professional behaviour
One of the principles of the CIMA Code of Ethics is professional behaviour. This principle of professional ethics requires Snakwheel to comply
with relevant laws and regulations. Each country has its own approach to legislating the act of lobbying. Generally, lobbying is legal in most
countries; however, there tend to be rules around the manner in which the lobbying occurs. I believe that lobbying the Westarian government is
consistent with this principle of professional ethics as long as Snakwheel conducts its lobbying activities within the confines of the rules and
laws of Westaria. However, I recommend that legal counsel is sought to ensure that our lobbying is carried out in a legal manner at all times.
Integrity
Acting with integrity means being straightforward and honest in professional and business relationships. If Snakwheel’s lobbying is to be
consistent with this principle of professional ethics, communications with the government regarding Snakwheel’s reasons for preventing the tax
must be truthful. Snakwheel’s board should be able to make a valid and honest commercial argument as to why the tax will harm the
company’s growth and increase prices for consumers. It would be dishonest for Snakwheel to claim that it wants to prevent the implementation
of the tax in the interest of consumer health, for example. This lobbying is ethical as long as it is done in an honest and straightforward way.
Objectivity – Board
Objectivity means that a person or entity should not compromise professional or business judgment because of bias, conflict of interest or
undue influence of others. It could be argued that Snakwheel’s board is acting objectively. The act of lobbying is quite controversial, and many
people have reservations about the conflict of interest that lobbying creates for the government and elected representatives. Members of the
Snakwheel board may be willing to pursue lobbying as part of their professional duty to increase shareholder wealth, despite their personal
opinions on the implications of lobbying.

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 Objectivity – Government
Lobbying could, in theory, deteriorate the objectivity of Westaria’s government. Snakwheel will put forward a strong case as to why the tax
should not be implemented when lobbying the government. The judgement of elected representatives may be compromised as a result.
However, it could be argued that it is up to the government to make a weighted judgment based on available information. Pressure groups will
lobby for the tax to be introduced, while Snakwheel will lobby for the opposite. The government’s responsibility is to absorb this information and
make an unbiased decision as to what they feel is best for the Westarian public. In this respect, I believe that this lobbying is ethical.
The lobbying effort is likely to be ethical as long as it is performed in a legal, straightforward, and honest way.

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 B. Dividend policy
Financial implications
In 2021, we paid a dividend of W$110m. With the 30% increase, dividends would rise to W$143m. Increasing the dividend payment by 30% in
2022 would reduce equity (reserves). Snakwheel reported W$5.4 billion in retained earnings for 2021, so there will be no problem in making this
increased dividend payment. One disadvantage of increasing the dividend payment is that it will, in theory, increase gearing. However, our gearing (as
measured Debt / Debt + Equity) was 13% in 2021 and is low by industry standards. Increasing dividends by 30% will have an immaterial impact on our
gearing ratios for 2022.
Signalling effect
The act of increasing our dividends by 30% may create an unrealistic expectation in the market. If investors do not read our annual report, there may
be an expectation that Snakwheel will sustain this increased dividend level into the future or that dividends will continue to grow at this increased rate.
When the subsequent dividend is called, and it is lower, investors may be displeased and sell their Snakwheel shares. It may be better to return the
cash to shareholders through a share repurchase instead of a dividend because the perception of the repurchase is that it is a ‘one-off’.’ In contrast,
this dividend increase may be perceived as continuable into the future.

Shareholder perception
The perception of the increased dividend may be that the board has no positive net present value (NPV) projects to invest in. Shareholders may
believe that Snakwheel is paying this dividend because there are no other opportunities to deploy this cash. If shareholders hold this belief, they may
question the board’s competence. If shareholders believe that the board has run out of opportunities to deploy cash, they may sell their shares and
invest in a different organisation. This being said, shareholders are likely to be pleased that Snakwheel’s board is doing something with the cash
rather than letting it sit in the company’s bank account, losing value each year due to increases in inflation.
Clientele effect

The clientele effect states that companies attract a certain type of shareholder based on their dividend policy. At the moment, Snakwheel pays about
35% of its profits in dividends. The increased dividend would increase this payout percentage to 45% (assuming no change in 2022’s profits). The
increased payout ratio may attract a new type of investor (i.e. one who wants a company to pay an increased amount of profits in dividends).
Conversely, increasing the dividend payout ratio may cause some existing shareholders to invest in companies that retain a bit more cash in their
respective businesses.

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 Tax implications
The increased dividend payment will have tax implications for our shareholders. In most countries, dividends and capital gains are taxed differently. If
the dividend payment increases, shareholders will be subject to more tax on their dividends. For shareholders based in jurisdictions where capital
gains are taxed at a lower rate than dividends, they may have preferred a share buyback rather than an increased dividend. However, given that we
currently pay about 35% of our profits in dividends, our shareholders must already have some exposure to dividend taxes. Issues may occur if
dividends are taxed in progressing brackets, and our additional dividend payment pushes a shareholder into a higher tax bracket.
Share price volatility
The increase in the company’s dividend will likely cause some share price volatility. After the increased dividend payment announcement,
Snakwheel’s share price is likely to rise. Even after the dividend is paid, the share price may remain increased if the market believes that such
increases in dividends are sustainable. As noted in your email, we plan on bringing dividends back to normal levels in the future. Some shareholders
will realise that their Snakwheel shares are overvalued and will sell them, causing the share price to depress. This issue can be avoided if an
explanation for the increased dividend is provided and communicated to shareholders.

Kind regards,
Senior manager

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 Section 3
From Senior Manager
To Peter Fodya, Chief Finance Officer
Subject RE: Disclosures and board accountability

Dear Peter,
Please see my notes below which address your questions.
A. Risk report
Reliance
Snakwheel now fully relies on Blueframe for its data processing and storage needs. One of the risks associated with this is that the success of
Snakwheel’s operations depends heavily on Blueframe. Our risk report already states that orders cannot be processed if any part of the system
fails. This risk is now heightened because a third party is managing the main component of our information system. If Blueframe’s servers have
technical issues or are hacked into, there is little that Snakwheel can do other than wait for Blueframe to respond to queries. I recommend we
disclose in our risk report that Snakwheel’s operations are dependent on the performance and integrity of Blueframe’s servers.
Legal issues
Blueframe is based in the country of Nordland. There is a risk that differences in data protection legislation between Nordland and Westaria
may result in Blueframe using Snakwheel’s data for purposes that are deemed illegal in Westaria but legal in Nordland. Snakwheel could be
held in contempt of data protection legislation if Blueframe does not handle our data per Westaria’s data protection legislation. This risk needs
to be disclosed in our annual risk report. To mitigate this risk, we should seek legal advice to explore the differences between data protection
law in Nordland and Westaria. A robust service level agreement (SLA) can be used to manage any differences in data protection laws.
Technical issues
As a result of switching to Blueframe, Snakwheel will become exposed to technical issues that occur as a result of using a cloud services
provider based in a different country. For example, if Nordland has connectivity issues either due to technical problems or natural disasters,
Snakwheel’s operations will be affected as a result. The risk of technical issues occurring as a result of using a cloud services provider in a
different country should be disclosed in the risk report. Based on your attachment, these technical issues appear to be unlikely; however, they
are still important to monitor and could arise due to unforeseen circumstances such as a natural disaster.

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 Cessation
The cessation of our contract with Blueframe creates a series of risks. If Blueframe goes into liquidation, it may be difficult for Snakwheel to
reclaim its data from the company. Given that Blueframe operates in a different legal jurisdiction, it may take some time for Snakwheel to legally
reclaim this data if Blueframe is unwilling to provide it before the liquidation begins. In addition, the switch to Blueframe makes it more
challenging to switch to another provider in the future. Transferring our data from Blueframe to another provider could be costly and time-
consuming. We may pay an early termination penalty depending on the terms of our contract with Blueframe. I recommend we disclose the
risks around ceasing our contract with Blueframe in our risk report.

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 B. Board accountability
Role of the board
The role of Snakwheel’s board is to promote the long-term sustainable success of the company and generate value for shareholders. The
board of Snakwheel is ultimately accountable for all of the company’s decisions and the results of those decisions. The board may not be
directly responsible for everything that happens in the business, but they are ultimately accountable. In this instance, just because a third-party
organisation holds the data does not mean that the board can absolve itself of the responsibility for this data’s security. The board is ultimately
responsible for everything the business does, and the security of the company’s data held by Blueframe is no exception.
Delegation
It could be argued that the board is not accountable for the security of the data held by Blueframe because it has given that accountability to a
mid-level or senior-level manager. This is a fairly weak argument because the board would not be expected to directly manage the security of
the data itself. Instead, the board would be expected to provide oversight over the security of the data and delegate the responsibility of
monitoring the data’s security to a competent and experienced individual. Delegation cannot be used to shift the board’s accountability for the
security of the data held by Blueframe since the person to whom the work is being delegated is ultimately accountable to the board.
Signal
If Snakwheel’s board were to deny accountability for the security of the data held by Blueframe, this would be considered poor corporate
governance. If staff within Snakwheel observe the board denying accountability for the security of the data, then this might encourage other
layers of the organisation to take less accountability for areas under their remit. The board sets the tone for what is right and wrong in the
organisation, so other business areas may adopt the same approach the board has taken in this case. If employees in Snakwheel observe this
lack of accountability, there is a serious concern that Snakwheel’s control environment will be weakened.
Power
Blueframe is responsible for ensuring that all of its data held, not just Snakwheel’s, should be secure and safe from cyber-attacks. However,
Snakwheel’s board holds the ultimate power to terminate the agreement with Blueframe. As a result, the board should be held ultimately
responsible for the security of the data held by Blueframe and any other issues relating to the relationship because they can terminate the
agreement at any stage. If the board feel that the level of security being provided is insufficient, then they can terminate the agreement and
decide to bring data processing and storage in-house or switch to a more secure provider.

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 Controls
It could be argued that the board does not have accountability for the security of the data held by Blueframe because controls implemented to
manage the relationship with Blueframe will be monitored and implemented by staff operating at a lower level in the organisation. This is
another fairly weak argument. The board’s role is to oversee whether controls are being adhered to and put forward actions if those controls are
not being followed. Despite not being involved in the day-to-date monitoring of the controls, the board is responsible for the security of the data
as it has a duty to oversee these controls and request the implementation of new controls when it sees fit.
Severity
If the board fails to take accountability for the security of the data held by Blueframe, the issue of data security may become less important as a
result. If the board is held accountable for this issue, effective measures and controls will likely be put in place to monitor the security of the
data held by Blueframe. If the accountability for this issue is shifted elsewhere, the issue of data security may not be taken as being a critical
issue, thus leaving Snakwheel more exposed to data security risks as a result. Snakwheel’s shareholders will want to see this level of
accountability and may replace board members if accountability is shifted elsewhere.
Kind regards,
Senior manager

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