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IB Business and Management IA (SL)

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IB Business and Management IA (SL)

Business and Management (SL) IA
Commentary on:

‘Has the purchase of a larger toughening furnace by XXX Glass been a sound financial decision?’

Candidate Name: ------------

Candidate Number: -------------

Word Count: 1477

I confirm that this work is my own work and is the final version. I have acknowledged each use of the words or ideas of another person, whether written or oral.

Signed:

_____________________________

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Name

IB Business and Management IA (SL)

Contents Page
Contents Introduction Section 1 – SWOT Analysis Section 2 – Costs and Savings for Purchase Section 3 – Payback Period Section 4 – Accounting Rate of Return Conclusion Bibliography Supporting Documents 1 – Capital Expenditure Proposal 2 – Consolidated Profit and Loss Summary 3 – The Australian 4 – Survey and Results 5 – ABC Radio Page 3 4-5 6-7 8-9 10-11 12-13 14-15 16 17 18 19-20 21-23

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IB Business and Management IA (SL)

Introduction
XXX Glass is a wholly owned subsidiary of YYY Ltd, an Australian manufacturing company with highly diversified interests in sugar and building products. XXX was formed in 2007 when YYY purchased ZZZ Glass and PPP Glass, which were subsequently rebranded and merged with the new strap line „New World Glass‟1. XXX has operations in Australia and New Zealand, and seeks to continue ZZZ and PPP‟s success in Australasia2. XXX first entered the Townville market over 40 years ago and since that time has been the market leader in the region. The branch has recently acquired a new toughening furnace – a product which accounts for 64.4% of the branch‟s gross profit, so efficient production of toughened glass is crucial to their ongoing success3. I have chosen to write this commentary on the purchase of the new toughening furnace for the Townsville branch in Queensland. XXX purchased the larger Landglass furnace to better meet demand4. Using the supporting documents, I will analyse whether this was a financially sound decision for XXX.

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YYY Building Products Ltd. XXX: New World Glass. XXX Glass Website. (2008) (Online) http://www.XXXglass.com/default.aspx (10/11/2009) 2 XXX Glass. http://www.YYY.com.au/facts/Pages/default3278.aspx 3 Capital Expenditure Proposal – See Supporting Document 1 4 The Australian Financial Review. “YYY is looking good on reflection,” 63

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IB Business and Management IA (SL)

I have based my commentary on the following supporting documents:
1. Capital Expenditure Proposal for Townsville 2. Consolidated Profit and Loss Summary for XXX Glass 3. The Australian – “YYY plans dignified debut for twin daughter companies” 4. Survey on furnace purchase with ---------, Regional Manager for North Queensland 5. ABC Radio – “Worst Yet to Come for Queensland Builders”

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IB Business and Management IA (SL)

Section 1 – SWOT Analysis
Based on the information found in the supporting documents, as well as some additional sources, I compiled a SWOT Analysis5 of XXX‟s Townsville branch. Table 1.0 – Table to show SWOT analysis for XXX’s Townsville branch since the purchase of the toughening furnace Strengths
 Well-established customer base and brand recognition in the region and strong market share   Able to toughen Low-E glass to compete in this market More reliable service for customers due to fewer breakdowns than old furnace   Larger production capacity to manage larger orders Reduced operating costs, due to fewer staff and no overtime necessary, and lower transport costs   

Weaknesses
 Higher prices than some new local and international competitors The new furnace is running well beneath capacity, increasing operating costs Unexpected delays and breakdowns of new furnace caused XXX to fall behind local competitors Furnace is not being paid off due to lower-than-predicted sales

Opportunities
   Market for toughened glass in northern Queensland is expanding North Queensland population has increased New mining opportunities in region are a major stimulant to the regions‟ economy as more workers are drawn to the area

Threats
 Sustained downturn in sales volume due to global economic crisis and slowing commercial sector  Local competitors offering lower prices and discounts to win new customers.  Imported glass is significantly cheaper than locally made product, leading to loss of market share

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Paul Hoang, 98

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IB Business and Management IA (SL)

Until late 2008, XXX had the only toughening furnace north of Brisbane. Almost all major customers dealt with them to allow quick access this much needed product. With the growing market in Northern Queensland, XXX saw the need to purchase a larger toughening furnace in order to meet current and future demand. Rival businesses, including UUU Glass Pty Ltd, purchased a furnace in October 2008, bringing increased competition to the local market and increasing the need for them to have a reliable furnace6. Plans for the installation of the furnace forecasted that it would be up and running in October 2008, the same time as UUU Glass, which should have placed them well ahead of their competition7. The ability to process larger orders, toughen Low-E glass and greater reliability of the furnace would have been a huge advantage. However, there were problems with the delivery and assembly of the furnace, mainly engineering faults at the assembly stage, caused delays. This resulted in a reduced capacity of 40% for the furnace8. XXX has not yet met the projected figures for its output of toughened glass9. While UUU Glass also suffered some setbacks with their furnace, they were fully functional before XXX. Since then, a number of other firms in the area have also installed toughening furnaces. Rival firms have purchased furnaces that also produce Low-E glass. With the installation delays, XXX was one of the last businesses to enter this market, causing them to lose the opportunity to establish themselves as the market leader in the area.

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Capital Expenditure Proposal. See Supporting Document 1 Capital Expenditure Proposal. See Supporting Document 1 8 Survey. See Supporting Document 4 9 Consolidated Profit and Loss Summary. See Supporting Document 2.

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IB Business and Management IA (SL)

Section 2 – Costs and Savings for Purchase
The old, Tamglass furnace presented many issues due to frequent breakdowns and was too small to meet demand10. When the furnace would break down, it cost the branch and unaffordable $7200 per day. Chart 2.1 - Summary of annual operational savings made by investing in new furnace.11

Operators Overtime Transport Casing

Table 2.0 – Table to show annual operational costs and savings for XXX’s Townsville branch with the purchase of the new furnace, as represented in Chart 2.1
Operators Overtime Transport Casing Increase in Electricity Total Savings
$86,000 $80,000 $70,000 $36,000

($15,000) $257,000

The greatest savings that would result from the purchase of the larger toughening furnace were the operators‟ salaries and overtime payments. Since the new furnace is larger and more efficient than the previous furnace, almost three times the amount of glass could be made in the same amount of time. This means that the operational staff are no longer required to work overtime in order to meet demand. The
10 11

Capital Expenditure Proposal. See Supporting Document 1 Capital Expenditure Proposal. See Supporting Document 1

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IB Business and Management IA (SL)

Landglass furnace is also easier to manage, meaning that fewer staff are required, resulting in more savings in staffing. Transport costs were reduced because the toughened glass previously sent to Townsville first had to be cut to size in Brisbane to accommodate for the capacity constraints of the Tamglass furnace. This meant greater packaging and cutting costs in Brisbane and Townsville. With the Landglass furnace, large sheets of glass can be sent straight from the production lines directly to Townsville. The only increased cost would be the electricity consumption of the furnace due to its larger size. However, it would only be running for 7 hours each day, compared to 14 hours each day12. Although electricity usage would increase, the toughened glass that the new furnace produces would be made in significantly less time.

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Capital Expenditure Proposal. See Supporting Document 1

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IB Business and Management IA (SL)

Section 3 – Payback Period for the Toughening Furnace
Figure 3.0 – Calculation of the payback period13 of the toughening furnace based on projected sales volumes14 Initial Investment = $771000 Operating Profit* Year Operating Profit ($ ,000) 1 461 2 530 3 530

$771000 - $461000 $310000 outstanding after Year 1 Monthly Cashflow in Year 2: $530000 = $44166.70/ month 12 months Payback Period for Year 2 $310000 $44166.70 = 7.02 months ≈ 8 months

Therefore, the payback period for the furnace and power upgrade is 1 year and 8 months
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Based on these assumptions, the new furnace has a very attractive payback period of only 1 year and 8 months. As the furnace would be paid for from borrowed money, a faster payback meant that less interest would accrue, saving money in the longterm. Most bank loans, as a long-term external source of finance, are generally expected to run over a longer period, particularly for capital equipment.

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Paul Hoang, 350 Capital Expenditure Proposal. See Supporting Document 1

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IB Business and Management IA (SL)

Taking into account the installation problems and lowered demand, the investment has been unprofitable at this stage16. Much of the expected savings have not been realised at this point as sales volumes and pricing pressure from competitors have negatively impacted operational costs and gross profit. Table 3.1 – Table to compare sales volumes and prices for January 2009 and January 2010, and the percentage decrease from 2009 to 201017
Description Toughened Glass Volume m2 Toughened Glass Price per m2 Jan-09 39 71.38 Jan-10 25.7 61.3 % Decrease 34.10 14.10

While the furnace was purchased with the purpose of meeting higher future demand, the reduced present demand due to the slowing of the commercial sector has rendered the furnace unprofitable18. XXX also had to lower their prices to compete. Additionally, higher operational costs have reduced the profit margin on toughened glass19. This means that the payback period for the furnace will be longer than originally projected, which will cost XXX in loan interest and lost profits.

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Consolidated Profit and Loss Summary. See Supporting Document 2 Consolidated Profit and Loss Summary. See Supporting Document 2 18 The Australian. “YYY offer a sweeter deal for investors,” 19 19 ABC Radio. See Supporting Document 5

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IB Business and Management IA (SL)

Section 4 – Accounting Rate of Return for Landglass Furnace
Figure 4.0 – Calculations for the accounting rate of return20 of the toughening furnace based on projected sales volumes21
Project Profit: $5231000 – $771000 = $4460000 Accounting Rate of Return: total profit during project / number of years of project x 100 initial amount invested ($) $4460000 / 10 years = $446000 per year $446000/ $771000 x 100= 57.8%

These projected figures, as seen in Section 3, have not been realised. While the rate of return will be reduced, this does not necessarily mean that the furnace was a completely unsound decision. As with any capital expenditure, the investment into the furnace was for the long-term benefit of the business. Once the commercial sector recovers, the costs of production for the branch will be reduced, increasing the profit margin and allowing them to pay off the remaining debt on the furnace, and placing them in an excellent position to meet future demand. It is important to remember that most of the threats to XXX that caused the furnace to be unprofitable occurred after the final planning had been completed. All the projected figures, despite taking reduced demand of 10% into consideration, did not allow for the downturn caused by the GFC and, more particularly, the slowdown in mining activity over this time22. Many of the weaknesses XXX currently faces are

20 21

Paul Hoang, 352 Consolidated Profit and Loss Summary. See Supporting Document 2 22 Capital Expenditure Proposal. See Supporting Document 1

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IB Business and Management IA (SL)

also directly related to these threats. In fact, if the financial crisis had not happened, most, if not all, of the weaknesses and threats would not be present, creating an ideal market for maximum return on the furnace23.

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The Australian. “YYY sets glacial pace in demerger,” 28

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IB Business and Management IA (SL)

Conclusion
In conclusion, the purchase of the new toughening furnace was a sound financial decision for the long-term profitability and competitive advantage of the business. However, the expenses brought about by the purchase will cause the Townsville branch to be unprofitable in the short term. By the time the global financial crisis began to affect the Australian building industry, the furnace was already purchased and XXX was awaiting its installation. The resulting downturn in Queensland added to the pressure to reduce prices on toughened glass, as customers were turning to the cheapest suppliers they could24. At the same time, the overall demand was lower, causing production volumes for the furnace to be reduced25. With competition from local and international competitors for price, XXX lost many large and long standing customers26. XXX‟s sales in Townsville decreased more sharply than the rest of the North Queensland Market, which indicates that they lost market share to new entrants. All these factors caused the profit margin to be very low for the branch, hindering their ability to repay their debt on the bank loan and decreasing return. Despite these problems, the new toughening furnace represents a valuable asset for XXX. With the old one unable to meet high demand and costing XXX profit due to frequent breakdowns, the Landglass furnace enables the business to provide for higher demand more efficiently and reliably. Should market conditions improve, then XXX will have a more capable furnace to service their customers and better meet
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ABC Radio. See Supporting Document 5 Consolidated Profit and Loss. See Supporting Document 2 26 The Australian. “YYY plans dignified debut for twin daughter companies,” 20. See Supporting Document 3

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IB Business and Management IA (SL)

demand, which they could not have done with the Tamglass furnace, placing them in a much stronger position. The furnace, despite many temporary setbacks, will prove an advantage for XXX in the long term. Once it is operating at full capacity, the costs will be reduced to the point that XXX will be able to offer lower prices, and regain the market share that it lost. The sale of toughened glass accounts for the majority of the profit made by the branch, so having this reliable and efficient equipment will ensure that this important part of the Townsville branch‟s profile is secure. The unfortunate timing of the purchase led to significant setbacks27; however, based on my findings from the supporting documents, I think that this investment remains a sound financial decision for XXX, and will prove essential for the long-term profitability of the Townsville branch.

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The Australian. “YYY plans dignified debut for twin daughter companies,” 20. See Supporting Document 3

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IB Business and Management IA (SL)

Bibliography
Supporting Documents
1. Capital Expenditure Proposal: Landglass ----- Furnace Project. 14 March 2008 2. Consolidated Profit and Loss Summary: Townsville January 2009/2010 3. ----, -----. “YYY plans dignified debut for twin daughter companies.” The Australian 27 Oct. 2009: 20 4. Survey of --- ----, Regional Manager for North Queensland. (Produced by author March 2010) 5. --------------. “Worst Yet to Come for Queensland Builders”. ABC Radio. (2010) (Online) http://www.abc.net.au/news/stories/2009/11/18/2746084.htm (17/02/2010)

1. YYY Building Products Ltd. XXX: New World Glass. XXX Glass Website. (20--) (Online) http://www.XXXglass.com/default.aspx (10/11/2009)

2. YYY Limited. XXX Glass. YYY Company Website (20--) (Online) http://www.YYY.com.au/facts/Pages/default3278.aspx (--/--/20--)

3. Hoang, Paul. Business and Management: For Use with the International Baccalaureate Diploma Programme. Melton: IBID Press, 2007 4. ----, ---. “YYY offers a sweeter deal for investors.” The Australian -- Oct. 20--: -5. ---, ---. “YYY is looking good on reflection.” The Australian Financial Review -March 20--: --

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I would also like to acknowledge the verbal and written input of my Business and Management teacher, --- ---, in this commentary.

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IB Business and Management IA (SL)

Appendices: Supporting Documents
Appendix 1 – Capital Expenditure Proposal
Capital Expenditure Proposal: -------- Furnace Project. 14 March 2008

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IB Business and Management IA (SL)

Appendix 2 – Consolidated Profit and Loss Summary
Consolidated Profit and Loss Summary: Townsville January 20--/20---

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IB Business and Management IA (SL)

Appendix 3 – The Australian “YYY plans dignified debut for twin daughter companies”
----- ----. “YYY plans dignified debut for twin daughter companies.” The Australian -- --. 20--: --

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IB Business and Management IA (SL)

Appendix 4 – Survey and Results
Survey of --- ---, Regional Manager for North Queensland. (Produced by author March 2010)

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IB Business and Management IA (SL)

Appendix 5 – ABC Radio
Butler, Nicole, Peter Ryan and Tony Eastley. “Worst Yet to Come for Queensland Builders”. ABC Radio. (2010) (Online) http://www.abc.net.au/news/stories/2009/11/18/2746084.htm (17/02/2010)

Worst yet to come for Queensland builders
By Nicole Butler, Peter Ryan and Tony Eastley for AM

Posted Wed Nov 18, 2009 11:00am AEDT

Queensland developers, particularly on the Gold Coast, are struggling to get project finance (ABC TV News) The Australian economy may be improving, but experts say the worst is yet to come for Queensland developers who have been particularly hard hit by the financial crisis. Former Queensland Premier Joh Bjelke-Petersen used to count the number of cranes on Brisbane's skyline to measure the health of the state's economy. Apply the late Sir Joh's test today and the results are dismal. Around a dozen cranes hung over the heart of Australia's third largest city before the financial crisis - now there is around six. And the situation is much the same in the construction sector Queensland-wide. "The commercial sector is about 40 per cent down on year to date turnover, we've had over 20,000 redundancies out of the commercial sector and the latest report to September 2009 showed that we had $3.3 billion of projects that had been deferred and another $500 million worth of projects which had been abandoned," said John Crittall from the Master Builders Association.

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"So yes, the downturn has hit us the hardest of all states by far." Mr Crittall says within Queensland, the Gold Coast is the worst affected area. He says the glitzy tourist zone has become a construction dead zone. "There's about four or five major projects at the coast and we would be used to 20," he observed. "We've already seen significant price reductions where people are going in and cutting each others' throats to try to win work to survive, and I think 2010 will be no different." Theo Meredith is a director of TDM Constructions, a medium-sized building company that has shared the good times on the Gold Coast. "We're battling. I mean we're sort of holding our own at the moment, as far as our workforce goes we've had the 80, and we've gone down to a 27 I think we had at one stage, and we're slowly starting to creep back up to about 40," he said. Mr Meredith says Government stimulus-related work is making up the bulk of the construction business going around in his part of Queensland. "The problem with the school work though is it's not full time employment for the blokes it's probably a week's worth of work and then you've got to find the next school or the next government project. It's certainly not the development, unit development side that we had to fall back on - that's sort of pretty much dried up really." The lack of new projects is also having a huge impact on Gold Coast workers. Long-time construction worker Jimmy Tribe says the slowdown has left a lot of people out of work. "There's not enough, not much, everything's so slow in getting going," he said. "I personally know a hundred steel fixers out of work."

Widespread impact
Mark Stockwell is the managing director of the Queensland-based development company Stockwell. The former Olympic swimmer says no one in the private industry has escaped the impact of the economic downturn. "We're more of moderate-sized player and I think all sectors are feeling it, even the bigger developers and the bigger landowners are struggling - and I heard a fact the other day that coming into the GFC in Queensland there were 47 entities that would lend money now there's about three, possible four and they're the major banks," he said. The man known as the godfather of Queensland construction, Kevin Seymour, says the worst is yet to come.

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"We're in the process at the present time of finishing off what's been in the pipeline for 18 months, but there's not private construction work starting," he commented. "I'd say that unless something dramatically happens in the next say six months, we'll all be looking for work." Steve Greenwood from the property council fears what will happen to the building industry when the Government projects end. "The cranes you're still seeing on the skyline, but most of those projects will finish off, but then those cranes will disappear and they probably won't come back for a number of years."

Financing problems
The key to the future for the construction sector is the willingness of banks to lend money to developers. Those that do get credit are having to pay a greater interest margin and need to jump much greater hurdles to prove their ability to repay the debt. Martin North, a banking analyst and the managing consulting director at Fujitsu, says the days of cheap and easy credit are history, especially for small players. "If you go back 10 or 15 years, what happened over that period of time is that everybody got into easy credit, the banks were actually happy to lend, they could get funding from securitisation and other funding mechanisms which meant there was inexhaustible supply [of money to lend]," he said. "That has all changed now. It's quite a lot tougher to get capital, there's significantly higher risk ratios being applied across the world and therefore, you know, the world has changed, I don't think we're ever going to see easy credit again to be honest." That is something concerning the Reserve Bank, which sees the lack of new apartment developments as one of the major factors contributing to a shortage of housing that is pushing dwelling prices higher.

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