Question
Fort Industries (FI)
Fort Industries $(F I)$ manufactures aircraft. Jacques Fort founded the business in 1957 as a private limited company. He owned 100 \% of the shares and managed the company strictly, making most of the decisions himself. FI grew through both internal and external growth. Later, it began to manufacture aircraft parts for other manufacturers.
Jacques led his workforce by using Taylor’s motivation theory. He regularly set clear objectives and monitored his employees carefully. Employees had to meet international quality and safety standards. Although Jacques was controlling, employees had job security and believed that he had their best interests at heart.
FI became a public limited company in 1988 and grew. Jacques found this transition difficult. He liked privacy and rarely spoke to the media. This had to change. Employees also began to ask for less supervision, wider spans of control and greater control over quality standards. Jacques retired in 2000 and his son, Henri, took over as CEO. Henri consults widely with his executive team and line managers on all decisions.
Recently, FI has been struggling with liquidity. Henri implemented strict cost controls and analysed the following ratios (see Table 5).
Table 5: Liquidity ratios for $F I$ for 2019 and 2020 and industry averages for 2020
Often, $F I$ has to delay payment to creditors. Employees are concerned that by saving money, safety standards at $F I$ have been reduced.
Henri is considering two options to solve the liquidity problem:
- Option 1: A long-term loan.
- Option 2: Issuing and selling additional shares in FI.
a. State two types of external growth.[2]
b. Explain one advantage and one disadvantage for FI of motivating its employees using Taylor’s motivation theory.$[4]$
c. Explain two reasons why Jacques may have found the transition difficult when FI became a public limited company.$[4]$
d. Recommend whether Henri should choose Option 1 or Option 2.[10]
▶️Answer/Explanation
Ans:
a. Types of external growth include:
- Mergers
- Acquisitions
- Strategic alliances
- Joint ventures
- Franchising
Award [1] for each type of external growth up to [2]. Maximum award: [2].
b.Taylor’s motivation theory will clearly have advantages for FI.
Advantages:
- Setting ‘specific targets’ enhances production levels for FI
- Having ‘close monitoring’ enables better control for FI
- Due to the ‘close monitoring’ quality standards can be maintained and errors reduced
- Limited consultation enables quicker decisions by management
- Careful planning of tasks allow optimal use of resources for FI.
Disadvantages:
- The need to ‘monitor closely’ requires more management/supervisory time
- Reducing all tasks to fixed routines reduces flexibility
- Using Taylor does not allow team working which might otherwise give efficiency benefits
- Does not encourage creativity and new ideas for production methods
- There is clearly potential stress under this motivational regime. Pressure to perform and meet international quality and safety standards. This could be demotivating for some workers and it could increase staff turnover at FI.
Award [1] for a theoretical response with an additional mark for application to FI.
Do not reward candidates who argue the advantages/disadvantages from the point of view of the worker and NOT the company.
Mark as a [2+2].
When FI became a public company, Jacques’s situation changed. As a largely autocratic leader, he had not ever had to explain his decisions to anyone. He was in control. Now that he is the head of a public limited company with many shareholders, he had to explain his decisions to a board of directors that he had not personally selected.
As head of a privately held company, Jacques could use company resources as he saw fit. If he made a poor decision and it hurt the finances of the company, he was only hurting himself. Now, as head of a publicly traded company, he has a fiduciary responsibility with the resources of the company. All resources should be used judiciously with the aim of improving the return to shareholders.
As a public limited company, FI was subject to greater media scrutiny, which meant that any issue or problem was potentially subject to public viewing through the press. Jacques had always valued privacy. He largely controlled what information got to the press. Now as head of a publicly traded company, FI had to adopt an aggressive public relations strategy as a way to minimize informational risk and maximize shareholder value.
Accept any other valid and relevant reason Jacques may have found the transition difficult.
Mark as [2 +2].
Award [1] for identification of a reason he may have found the transition difficult and an additional [1] for explanation and application.
Refer to Paper 2 markbands for 2016 forward, available under the “Your tests” tab > supplemental materials.
The advantages of long-term debt are that FI gets money now and the repayment is over many years. Ownership is not affected by long-term debt, and, for a company as old and established as FI, financing from banks or other financial institutions would probably not be that hard to obtain.
The disadvantages of long-term debt are that interests costs will rise, which increases outflows and liquidity will decrease. Additionally, the bank may put some restrictions on FI in the loan agreement which might limit future liquidity solutions in the future.
The alternative method, issuing and selling additional shares of stock, has the advantage that it would raise equity, which has no interest payments. Thus, FI could raise money and invest it in current assets such that it could start taking trade and other discounts. Liquidity through increased cash inflow would improve.
The main disadvantage is that the ownership of FI would be diluted. The Fort family would own a lesser percentage of the company than they currently do. Further, with greater equity, return on capital employed ratios would probably initially go down. Stakeholders will be concerned by this perceived fall in profitability.
Any other strategies probably would not be appropriate or enough to fix the problems. Tinkering around with the composition of current assets is unlikely to make much of a difference. Presumably, FI turns its inventory as fast it can. Making debtors pay more quickly is not very likely to occur, as they will resist. This move could give FI’s competitors a competitive advantage if competitors do not alter payment terms.
“Balanced” means that the candidate has provided at least one argument for and one arguments against for each option.
Marks should be allocated according to the paper 2 markbands for May 2016 forward.
Candidates may contrast one option with another for a balance as long as at least two arguments are given for each option.
Award a maximum of [6] if the answer is of a standard that shows balanced analysis and understanding throughout the response with reference to the stimulus material but there is no judgment/conclusion.
Award a maximum of [6] if the answer makes no reference to the quantitative data in the question.
Candidates cannot reach the [7–8] markband if they give judgment/conclusions that are not based on analysis/explanation already given in their response.
Question
Copper Health ( $\mathrm{CH})$
Copper Health $(\mathrm{CH})$ was the market leader in the production of anti-venom vaccines to treat poisonous snake bites. $\mathrm{CH}$ ‘s mission – influenced heavily by corporate social responsibility (CSR) – is to put customers first and profits second in the treatment of snake bites.
Despite 100000 deaths worldwide each year from snake bites and 400000 serious injuries, $\mathrm{CH}$ recently announced that it will no longer produce antivenom vaccines. Several large Mexican, Brazilian and Indian pharmaceutical companies have entered the market selling anti-venom vaccines at a much lower price than $\mathrm{CH}$.
A spokesperson for $\mathrm{CH}$ said: “We will remain a private limited company where corporate social responsibility (CSR) remains an important driving force for our mission. Our medical research is only financed from retained profit. When the lower-priced competition arrived, our sales and profits of antivenom vaccines decreased significantly. Treating snakebites no longer makes financial sense. Instead, the technology used to produce anti-venom vaccines will be used to research and develop (R\&D) other life-saving vaccines”.
A non-governmental organization (NGO) has demanded action. ” $\mathrm{CH}$ is the largest manufacturer of anti-venom vaccines in the world. Although $\mathrm{CH}$ ‘s competitors are increasing their production of anti-venom vaccines they will not be able to produce enough to satisfy demand for the next two years. There will be a major shortage. This will result in many life-threatening injuries and deaths.”
The non-governmental organization (NGO) has urged $\mathrm{CH}$ to seek new sources of finance to continue the production of the anti-venom vaccine.
* anti-venom: a medication made from antibodies that is used to treat venomous bites and stings
a. Define the term retained profit.[2]
b. Explain one advantage and one disadvantage for $\mathrm{CH}$ of having a mission statement.$[4]$
c. Explain two possible external sources of finance $\mathrm{CH}$ could use to continue production of anti-venom vaccines.$[4]$
d. Discuss $\mathrm{CH}$ ‘s decision to stop producing anti-venom vaccines.[10]
▶️Answer/Explanation
Ans:
a.Retained profit is profit that is not given to shareholders in the form of dividends but is held back as part of shareholder equity to provide a source of funds for possible future activities.
Accept any other relevant definition.
N.B. no application required. Do not credit examples.
Award [1] for a basic definition that conveys partial knowledge and understanding.
Award [2] for a full definition that conveys knowledge and understanding similar to the answer above. A candidate must demonstrate an understanding that retained profit is part of shareholder equity and that it can be used as a source of funds for possible future business activities
b.Advantages for CH of having a mission statement include:
Provides an example of where a business currently sits in the eyes of its stakeholders, such as customers, employees and managers. CH produces vital anti-venom vaccines, but its mission statement demands that CH carry out its operations in a socially responsible manner. Mission statements can have an influential role in setting organizational objectives.
CH’s mission statement may act as a motivating force for employees and could lead to low staff turnover and/or benefits for the recruitment of new employees.
Disadvantages include:
Some mission statements may be written as vague statements of intent. It can be difficult to ascertain exactly what the business stands for in terms of setting sustainable business objectives. This may discourage some investors. CH is stating that profitability is secondary after CSR. Yet this profitability is being used to finance future growth and research. Investors may not commit funds given this perceived confusion from the mission statement.
Accept any other relevant advantage/disadvantage.
Mark as 2 + 2.
For an identification or a description of one advantage/disadvantage with or without application [1].
For explanation of one advantage/disadvantage with no application [1].
For explanation of one advantage/disadvantage and application [2].
Application must refer to the issues around CH having a mission statement.
c. The question is sufficiently broad to allow candidates to explain a range of possible sources of finance, but any candidate who looks at internal organic sources, such as increasing sales/profits, must be not given credit.
Possible external sources include:
As CH is a private limited company, the decision could be taken to raise funds through an initial public offering. CH could be “floated or listed” on the appropriate local share market to raise funds.
Angel investors who have strong ethical/CSR intent could provide funds.
The NGO has demanded action. Given the number of deaths and injuries from snakebites, the NGO could be approached to provide new finance or governments in those countries predominantly affected. There could be the possibility of a private public partnership.
Accept any other relevant possible source.
Mark as 2 + 2.
For an identification or a description of one possible source of external finance with or without application [1].
For explanation of one source with no application [1].
For explanation of one source and application [2].
Application must refer to the possible sources of finance for production of anti-venom vaccines of anti-venom
Refer to Paper 2 markbands for 2016 forward, available under the “Your tests” tab > supplemental materials.
Answers at the top level will look at the ethical arguments of retaining the production of anti-venom vaccines versus the final implications for doing so.
CH’s mission statement alludes to “putting customers first and profits second”. The decision to stop producing the anti-venom vaccines will be viewed as hypocritical by stakeholders and will lead to a loss of its market leader status. There could be a consumer backlash/boycott, and this will hamper marketing attempts for any new life-saving vaccines. The drop in revenue could be considerable and as a result there may be no profits to finance research and development. The comments from the NGO are unhelpful and will bring increased scrutiny and further unwelcome publicity. Stopping production may damage the economic sustainability of CH to the point where they may cease to exist.
However, the increased competition and wave of price reductions cannot be ignored. We must assume that this new competition has a product that competes with CH on price because, as the market leader, we would assume CH has a certain degree of brand loyalty. Clearly, consumers see the competition from Brazil, Mexico and India as a substitute, and unit sales of CH’s vaccine have fallen significantly. If CH does not stop production and cut its losses now, it may not have time or finance to develop new life-saving vaccines, through which it may be able to recreate its market leader status.
The profit motive is the reward for entrepreneurial initiative and risk. CH is quite within its rights to stop production of a loss-making vaccine and switch to a market that may be underdeveloped, albeit one with considerably more risk. Ironically, if the decision to stop production is made quickly, CH may be the beneficiary of some panic buying, boosting short-term revenues before the anti-venom vaccine is withdrawn from the shelves.
Given the ethical and moral issues in this case, CH may be wise to wait and carry out some further market research on the competition. It is indicated that for two years, the new competition will be unable to fill the gap left by CH if it decides to leave this market. CH is still the market leader. Possibly CH could emphasize its product quality over the competition and see if this acts as a spur.
A conclusion with judgment is expected.
A balanced response is one that covers at least two arguments for and at least two arguments against.
Marks should be allocated according to the paper 2 markbands for May 2016 forward with further guidance below.
For one relevant issue that is one-sided, award up to [3]. For more than one relevant issue that is one-sided, award up to a maximum of [4].
Award a maximum of [6] if the answer is of a standard that shows balanced analysis and understanding throughout the response with reference to the stimulus material but there is no judgment/conclusion.
Candidates cannot reach the [7–8] markband if they give judgment/conclusions that are not based on analysis/explanation already given in their answer.
Candidates cannot reach the top marks if there is no relevant reference/ application to the stimulus.vaccines.
