1. 1
Consultancy Report
The Bankruptcy of the Japan Airline Ltd and subsequent
reorganization
Consultancy Management
Peter Meehan
Date: 03/06/2016
Student No:2159403
Name:Bilal Ahmed
MBA-Full Time
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Table Of Contents
Introduction...........................................................................................................3
Project Aims: .................................................................................................................. 3
Japan Airline Ltd Background ...............................................................................4
External Factors: ............................................................................................................. 5
Problem Definition.................................................................................................6
Figure 4.1: The Five Why’s and Fishbone Diagram....................................................... 7
5WHYs Worksheet – Japan Airline................................................................................ 7
Literature Review:.................................................................................................8
Impact of Leverage: ........................................................................................................ 8
Phases of Organizational Distress:.................................................................................. 9
Turnaround Management:............................................................................................. 10
Organizational Restructuring........................................................................................ 10
Structure Implication on other elements....................................................................... 11
Human Resource Management:.................................................................................... 12
Leadership Styles.......................................................................................................... 12
Behavioral Leadership: ................................................................................................. 13
Portfolio Restructuring.................................................................................................. 13
Financial Restructuring................................................................................................. 13
Change Management .................................................................................................... 13
Transformational Change: ............................................................................................ 14
Managing Change:........................................................................................................ 14
Potential shortlisted models ................................................................................15
Research Methodologies: ...................................................................................15
Secondary research ....................................................................................................... 15
Primary Research:......................................................................................................... 15
Findings/Results: ................................................................................................16
Questionnaire................................................................................................................ 16
Recommendation................................................................................................19
Conclusion..........................................................................................................21
References .........................................................................................................22
3. 3
Introduction
The consultancy report is compiled at the request of Japan airline
ltd(JAL).Japans state-backed institution such as development bank and
enterprise turnaround initiative corporation(ETIC) sponsoring the research and
compiling of this documents,. project comprise financial and non-financial
benefits in terms of employees morale and optimum credit rating along with
sustainable competitive edge, however these benefits are difficult to quantify but
underpin the master objective of turn the fate of persistent loss making
organization. the report include findings, recommendation and conclusion based
on academic research,journals,business magezines,articles ,peer reviews,
working papers and extensive primary and secondary research has been
undertaken which is exclusively focus to diagnose the root cause of problem and
to eliminate them. other research platform such as print, electronic and social
media ,internet ,government and economic publication also has been exploited.
The report is part of organizational strategy to create value and enhance the
potential of revenue in overall organization framework. This framework is to
develop business reconstruction strategies together with the optimum position of
creditors, employees and other stakeholders as a result of reorganization.
(Rachael Thompson) “Define that stakeholder management is critical to the
success of every project in every organization I have ever worked with. by
engaging the right people in the right way in your project, you can make the big
difference to its success. And to your career” One way to satisfy stake holder
concerns and promote transparency is to involve project affected stakeholders in
monitoring the implementation of mitigation.participational monitoring tend to
strengthen relationship between the project and its stakeholders.
Project Aims:
The aim of this project is to add value in to client in order to revive and sustain its
profitability. As the organization undergoing transformation in fast pace
environment, it is necessary to examine the word add value” it is clear that what
end up being valuable for client and its system is not always obvious or what’s
expected. the variety of way consultant can add value is useful in meeting the
wide range of needs emerging in the client world, for consultant when defining
value added it is necessary to determine which dimension to include and whose
perspectives to use.(David w Jamison).as the reorganization being supervised
by government institution and has involved renown financial institututions
,objectives was predefine and is obvious to cut cost without affecting the earning
capacity of airline in three year time as a condition of financial aid. Objective help
to determine the aims given below;
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Ascertain the root cause of problem by carrying out profound research
using formalized tools such as 5 why, cause and effect and 5 what’s
analysis in consultation with client. Which help to breakdown the problem
in smaller pieces and pave the way for further primary and secondary
research and help to design the recommendations.
Provide recommendations based on diagnosis to JAL on potential solution
and measures required to increase revenue/cut cost and to remain
competitive in airline industry, propose new business
processes/procedures, Assisting in implementation of potential solutions.
Recommendation will consider corporate strategy,competitve analysis,
operation management and human resource.
Facilitate JAL management in gaining knowledge of methods and to
understand relevant models and the applicability of models in distress
situation is required to avoid such problems in future
To achieve desired aim, it is necessary to conduct research in order to collect
and analyze meaningful data. Research consist of external and internal
research, internal research and will encompass both primary and secondary
research. Internal research mainly take the from of interview with key
stakeholders and the questionnares.hand written notes will also be utilized as
part of primary research. This will combined with brain storming session and
meetings. A literature review will be conducted to analyze the research
papers, journals and academic books to identify best fit framework and the
contemporary models in particular issue and the ease of their applicability.
Japan Airline Ltd Background
JAL is second largest airline of Japan. its headquarter based in Tokyo Establish
with the capital of 2bn in year 1951.initially its operation was restricted to
domestic routes ,later it obtain a license as a sole international scheduler Japan
airline in Japan and operating successfully in 35 countries worldwide. During its
life cycle it was listed in Japan stock exchange under first and second section but
it was fully privatize in 1987. In 2009 it has negative profit, which raise concern
about its profitability in fututre,JAL profitability has decline from 30096 in 2005 to
(63194) in 2009.see Figure below for JAL Comparative income statement
(jal.com/30.march 2009)
5. 5
Source (JAL.com )
External Factors:
The global financial crisis which was born due to the failure of the major financial
institutions caused the drastic impacts on the world economy. And as the aviation
is the important part it also got affected heavily by the crisis. Due to which this
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aviation sector which is one the fastest growing industry has to face negative
growth rate. Also the aviation sector has to face huge losses. Some aviation
companies was able to bare such huge losses but there is a big number of those
aviation companies who do have capacity to bare such huge losses so they go
bankrupt after the global financial crisis(ukessays.com)
Japan Airline as announce by its CEO is working on Premium strategy medium
term revival plan by implementing a variety of measure such as cost cutting
measures, no –holds barred to routes restructuring, fuel efficient aircrafts, the
current fall in profitability is mainly by economic crisis, volatility in share price and
sharp decline in demand for air service.(See figure highlighting)
Problem Definition
Albert Einstein said” If I were given the one hour to save the planet, I would
spend 59 minutes defining the problem and one minute resolving it” Problem
definition in the area of strategic decision in more often governed by internal
decision.(James.p.neelankavil) define that most common mistakes in problem
definition by the client is that they define problem too broadly or too narrowly.
This situation is describe by (Bjorn Anderson)”that client often familiar with the
symptom of rather than cause ,and these symptoms help the Firm to detect the
recurrence of problem. These symptometer uses as a yardstick to monitor
whether problem has eliminated or still recurs.” mistakes can be overcome by
systematic approach by approaching problem definition in two stages. in the first
stage problem is define in broadest term, and the various components of the
problem are identified. in the second phase the components of the problem are
prioritized from the most critical to the least critical.” James.p.neelankavil
To counter this potential issue the consultant has utilized a formalized structure
approach within an informal interview process. This would allow identifying the
diverse and complex components of problem and help to drill down the problem
further.” Beneath every problem lie a cause, thus when trying to solve the
problem consider this approach. Identify the cause or causes of the problem, find
way to eliminate that causes and prevent them from recurring.”(Bjorn Anderson
and tom Fagerhaug :2006)
This approach will utilize number of structured tools To determine the root cause
with JAL consultant will utilize cause and effect diagrammed known as the
ishikawa fishbone diagrammed(clary and wandersee,2010) and Five why
develop by sakichi toyoda(shoe maker et al 2013).(see figure for the graphic
illustration of the five why’s and fishbone diagramme).
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Figure 4.1: The Five Why’s and Fishbone Diagram
Source (Skool, 2013) (Clary and Wandersee, 2010)
The five why is very useful tool to identify the actual root cause beneath the
problem ,as the root cause is the evil at the bottom that sets in motion the entire
cause and effect chain causing the problem(Anderson Bjorn:2006).(see figure for
five why root cause analysis).however root cause analysis has some inherent
limitation, most obvious one is the assumption underlying in the model in that
each presenting symptom has only one sufficient cause. which is not always the
case, another downside the model does not distinguish between casual factors
and root cause. open minded approach with no pre conceived ideas to the end
result is ideal for mutual benefit.(Stewart Anderson)
5WHYs Worksheet – Japan Airline
Define the Problem: (Declining Revenue and Negative Net current assets) in
2008-09
Why is it happening? (Identify each as a concern, influence or control.)
1. Incurring too much fixed cost in relation too revenue Why is
that?
2. Inefficient management of resources by
Financial,operating and human resource dept.
Why is
that?
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3.No visionary and vibrant leadership,organizational
structure is rigid and mechanistic
Why is
that?
4.Influence of senior govt officials in
important decisions.
Why is
that?
Caution: If your last
answer is
something you cannot
control
go back up to previous answer.
By Applying Root cause analysis together with other research methods such as
interviews and questionnaires, it is possible to find out the problem. This
consultancy management tool is very effective and simple non-statistical tool
which widely used to determine the major cause and the origin of problem.
Encompass the findings with research it can quickly build on potential
recommendation.
Literature Review:
A business failure can be cause by both internal and external factors, According
to(dominic elliot et al) that the crisis incidents or bossiness interruptions are
systematic in nature, comprising of both social and technical elements.”
companies generally tend to focus on profitability due to its reflection on financial
statement as a performance indicator, however JAL liquidity is very essential
element to pay day to day expenses and other obligation, since bankruptcy mean
that a firm fail to honor all its promised payment to other firms.(Bailey
:2003)”Argue that smart entrepreneur is one who balance the desire to grow
against the desire not to go bankrupt “
Impact of Leverage:
Borrowing to finance investment is frequently cited as a contributor to financial
crisis. when a financial institution invest its own money at the worst it can lose its
own money but it borrow in order to invest more, it can potentially earn more but
5. Common practice in japan,known as”Amakudari” Why is
that?
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can also lose more than all it has. therefore leverage magnifies the potential
return from investment, but also create a risk of bankruptcy. it may spread
financial troubles from one firm to another (suresh goel 2009).Airline industry
use leasing as a main source of finance to buy aircraft hence cost structure
highly consist of fixed cost in terms of leasing interest etc which make it more
vulnerable to fluctuations in demand.
Phases of Organizational Distress:
James shine describe phases of organizational distress; if the organizational
cannot fix it problem in one phase it eventually go in to another phase with less
time to repair the damage.
Blind Phase: company typically begin in blinded phase, revenue may have
stagnated or even fallen off slightly. Management perceives fall in revenue
is seasonal or cyclical variation. Organization and the related parties
denied realities for long time allowing JAL to collapse.
Inaction phase: Organization is likely to remain profitable, but its problem
has grown to the point which they cannot be denied.thier inertial
resistance to change inspiring irrational hope that thing will turnaround on
their own.
Faulty Action: at this point management is spurred to action but due to
inaccurate information or incompetent leaders, these proposed remedies
only make the situation worse.
Crisis: Sustain faulty action drive the Firm in to crisis phase, at this point
company has probably tripped covenants with its lenders and its bleeding
cash. supplier insist on cash in demand and auditor raise genuine concern
about the ability of the firm to continue as a going concern, companies
often retain an investment bank to consider strategic option or even direct
their outside council to draft document for the bankruptcy filing.
These phases present a value framework, because study has shown that earlier
Organization recognize itself in one of these phase and launches a turnaround
efforts, the greater the likelihood of its succes,as companies slide down the
organization distress curve, they find themselves in a rapidly tightening noose.
There are three approaches to help client;
Expert model
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The doctor patient model
Process consultation model.
Edgar shein develop third process consultation model define that the consultant
immediately involve with the client as a partner. the consultant and client
collaboratively diagnose the problem, design and implement intervention and
evaluate the success of intervention.” (shien 1999)
Turnaround Management:
(David Vance) suggested that corporate restructuring should be conducted in two
phases.
To get company to profitability.
To get company to superior performance"
Leadership is an important management skills .it can be define as inter-personal
influence directed toward the achievement of goals.(peter senge:1990)Define
that leader in a learning organization are strategic visionaries these leaders are
able to get other peoples to understand complexity clarify vision and improved
shared mental models”. Timely action by management, leader define that what
the firms is and what it will become, it give direction to every part of the firm form
corporate finance to the loading dock.( john brown) in an interview to HBR in
1997 define “ A business has to have a clear purpose, if the purpose is not
crystal clear people will not understand what kind of knowledge is critical and
what they have to learn in order to improve performance” in absence of such
purpose and clear goal organizational efficiency will be reduce(Henry mintzberz)
“define managers as a craftsman and strategy is their clay, like the potter they sit
between a past of corporate capabilities and future of market
opprotunities”leadership and the management the development of human
resource affect all aspect of business strategy.
Organizational Restructuring
Contingency theory is the management study of (burn and stalker:2015).they
identified that an organic structure is better suited to an entity that need to be
responsive to change in its products, environment and markets, on the other
hand a mechanistic structure is suited to entity in stable environment. Where
change is gradual. structure highly depend on internal and external
circumstances and network of relation ships (johnson,scholes and whittington)
argue that” poor performance might be the result of inappropriate configuration
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for the situation or inconsistency between structure process and relationship”
it is more difficult with mechanistic structure to adapt in the fast changing
environment. it is characterized by bureaucratic type of structure formalize roles
and responsibilities,standardisation of work and centralize decision making,
emphasize on managers authority rather then the expertise of employees. on the
other hand matrix structure is capable to adapt to environmental disruption(davis
and lawrrence 1977) define a matrix structure that any organization that employ
a multiple command system that include not only a multiple command structure
but also related support mechanism and an organizational culture”
Companies which are surrounded by billions of task mostly rely on matrix .A
mechanic structure is fixed unbending structure. See figure below the chart of
JAL structure
Structure Implication on other elements
(Mckinsey 7S) was published in 1981, it is the model for successful
implementation of change. According to the framework there are seven factors
which contribute to the effectiveness of organization (the 7s).these consist of
three hard factors and four soft factors. a change in one factor has a knock on
effect on effect on other S factors. Model is used to asses the changes in other
elements as a result in amendment in one or more factors.
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Soft Factors: Hard Factors:
Strategy
Structure
Systems
Staff
skills
style
Shared Values
Human Resource Management:
According to nakia maledo”in mechanistic structure employees are dissatisfied
with their work due to the pressure of formalization. lack of participation and
involvement by employees in decision making reduce the level of engagement.
According to (Robinson et al .2004) “an engage employee can be differentiated
from unengaged employee by the following traits. He Willing to go extra miles,
believe in and identifies with an organization, want to work to make things better,
understand the business context and bigger piture,respect and help colleagues”.
most of the emergent strategies originated from employees ,the resource based
view of strategy has become highly influential,entitis should make full use of
employees (johnson,scholes and whittington)suggested” if employer can only see
strategies in deliberate plnannig,they not only risk that such strategies can go
unrealised,but they also waste the learning that can emerge from
employees”empoylee voice can be enhance through various mechanism such as
representative consultation, upward problem solving. Suggestion schemes and
project teams.
Leadership Styles
In mechanistic structure communication flow vertical up and down in the from of
instructions and orders employees have no power to participate in matters
(Kondalkar;2009)Baurucracy is highly rigid and has a tendency to promote
politics and power blocks. it decrease the efficiency of firm in highly changing and
volatile environment.(Macleod and clarke:2009) emphasized that leader which
ensure a strong transparent and explicit organizational culture which gives
employees a line of sight between their jobs and the vision and aims of the
organization.
13. 13
Behavioral Leadership:
(Huczynski and buchanan:2007) define that organizational behavior us the study
of structure ,functioning and performance of organization, and the behavior of
groups and individual within them. This theory of leadership is based on style
rather than traits or quality of leader, in most situations it is the style of leader that
matters. mechanistic structure emphasize to autocratic leadership which retain
most of the power in its hand, on the other hand participative leader try to
encourage participation by subordinates in major decisions. As a result employee
will be more motivated and will perform better in their work. Motivated individuals
are much more likely to work harder to achieve clear work objectives.
(Burns:1977) made a distinction between transactional and transformational
leader” transactional leader approach their follower with an eye to trading and
transformational leader seek to appeal the better nature of their followers,
change them for the better.
Portfolio Restructuring
Portfolio restructuring is the acquisition or disposal of assets in form of
divestment, demergers, spin off or management buyout. this include the sale of
underperforming assets. portfolio restructuring can be seen as a part of strategy
to increase the performance of the organization.(Bowman and Singh 1993)define
that it encompasses the broad range of transactions such as selling business
lines, changing the capital structure through the infusion of debt or altering the
internal organization of the firm.
Financial Restructuring
Financial reconstruction scheme is the scheme whereby Firm organise its capital
structure, including leverage buyouts, leverage capitalisation and equity for debt
swaps. a reconstruction scheme might be agree when organization is in danger
of being put in to liquidation, owing debts that it cannot repay or organization may
be willing to undergo some financial restructuring to better position itself for future
success. The empirical evidence shows that market response positively to
financial restructuring.
Change Management
Change happens continually in organization ,strategic development inevitability
result in some change, planned change is deliberate and intended change, As
JAL incorporation struggling to move out from current situation to a new
situation.JAL change is one off event but rather it is continually developing
process which has wider effect on every aspect of organization from human
14. 14
resource, to organizational structure,.
Transformational Change:
A major reorganization or restructuring required a through and deep seated
change of the firm system and its procedures. This kind of change has big impact
on entity and on people working on it. in Japan Airline company change is
necessary because the current organization and system is no longer appropriate
and change is needed. This encompass reorganization of structure (structural
change), downsize in work force and rationalisation of operation to increase
effectiveness(Elizabeth Ross kanter:2004) suggested that there are cultural
reasons why the organization might be more change adept than others.
According to (kanter) ,change adept organization have three key attributes; the
imagination to innovate, professionalism to perform, openness to collaborate.
Managing Change:
(Moss Kanter:2000) suggested that manager in change adept entity should have
the following skills they are environmentally awrare,are prepared to challenge the
prevailing organizational wisdom, have ability o communicate the vision,builduing
coalition, learning to preserve, making everyone a hero. The successful strategy
will not realise unless it is embed in business.
As part of meeting with senior managers it was determined that strategy would
be more successful if integrated in to business process and facilitated by
consultant. Consulting is more than giving advice as suggested by hierarchy of
purposes of consultant (Arthur n turner SEP 1982 HBR)
providing information to client
solving a client problem
making a diagnosis which may necessitate redefinition of problem
making recommendation based on diagnosis
assisting with implementation of recommended solutions
Facilitating client learning teaching client how to resolve similar problem in
future, permanently improving organizational performance.
Having determined the problem definition JAL utilise some core models,
Figure;
15. 15
Potential shortlisted models
item Priority Consultant Client
1 High Kurt lewin Leadership model
2 Low Deming total quality management
3 High Force Field Analysis strategy implementation
4 High The Gemini 4S strategy implementation
5 High The 7S Approach Transformational change
6 Medium Balogun and hope Hailey change management
7 High The cultural Web change management
8 High Psychological contract Employees model
Research Methodologies:
The research area has been broken down in to two part, primary and secondary
reseach.it was argued by (Leech,2004) that mix research method paradigm can
also help to bridge the schism between qualitative and quantitative research.
(Onwuebuzie and leech:2004)
Secondary research
Focus toward to glean crude date and collect information about industry as a
whole, competitors and their performance via financial statement, clientele and
government regulation in industry, service standards, employee’s laws. This will
entail the trend analysis in particular industry, financial health of similar size
competitos, general economic indicators/trends such as inflation,interest,money
supply etc.and to analyze the fuel oil prices .and academics literature to with the
aim designed financial strategy encompassing the areas of
Finance,marketing,governance and human resource.Academic research will be
used to recommend business models such as lewin force field model and the
Gemini 4rs model to apply change successfully in JAL.
Primary Research:
incorporate the qualitative and quantitative reseach,JAL middle management
and senior management will be interviewed to get in depth information probably
commercially sensitive ,the scope of qualitative research will extend to
encompass government officials who were involved in decision making in JAL
board, informal conservational interviews will be exploit to identify potential data.
16. 16
the drill down and 5 so what strategy will be the formal part of primary research.
Primary research uses quantitative method to gauge the level of employees
motivation for example: how far are you satisfied with management incentive
provided by organization and to asses the influence .at an external level to the
organization customer satisfaction survey would be conducted and
complementors,lenders dependence on JAL airline will be measure. Primary
research will be organization wide, include employees through probability method
and key government officials.
Findings/Results:
Questionnaire
to measure the motivation level of employees and to asses the likelihood
resistance level as a result of change.There were total 100 participants in this
project which conducted throughout the organization in almost every department
to gauge the level of engagement with work and to identify the likely resistance
due to the change being imposed. Answer given by participants by completing
the questionnare.The pie chart below represent the answer given by participants.
Chart 1: Employees in many organization willingly accept change?
Agree
Neutral
Disagree
Chart 2:Employees Here are willing to take new task as needed?
17. 17
Agree
Neutral
Disagree
Chart 3:Employees in many organizations take initiatives to help other
employees when they needed?
Agree
Neutral
Disagree
Chart 4: Employees proactively identify future challenges and
opportunities.
Agree
Neutral
Disagree
Chart 5:In my organization employees adapt quickly to difficult situations?
18. 18
Agree
Neutral
Disagree
Chart 6:I am determined to give my best efforts at work each day?
Agree
Neutral
Disagree
Chart 7:I am inspired to meet my goals at work?
Agree
Neutral
Disagree
These responses show a low level of engagement with work, and strict
19. 19
resistance to change. following set of recommendation being proposed to
successfully implement turn around strategies.
Recommendation:
By having determined the problem definition with in JAL,Following
recommendation has been proposed to the management of JAL group which
closely meet the aims of report.
It is highly recommended that JAL change its organizational structure
towards organic structure is more flexible and embed with quick decision
making, lead by transformational leader will increase the flow of
information in both directions, increase the level of employees
participation and discretion help them to focus on task rather than
underlying formalize standard operating procedures of doing task .it will
help to increase employees productivity and creativity , decentralization
and proper delegation of authority will enhance the potential of middle
mangers they will feel more motivated and responsible by enhancing the
number of subordinates in their command(Flat structure) and through
delegation of authority. in nut shell business have the ability to cope with
unpredictable and dynamic environment.JAL can utilize matrix structure at
this stage Increase employees participation in decision making, implement
learning and development programmes,increase employees motivation
through formal techniques such as job enrichment, and incentive planning.
In the research phase it was found that there is unrest in employees, as
part of restructuring plan we have to cut 13000 jobs, which possibility
result in protest and negative publicity and we also going to cut pension of
retired employees as a part plan. the effect on employees must be
recognized, this aspect of change is very important and may make change
unsuccesfull.effective communication with everyone affected with change
will reinforce the change process, this should be two way communication
management should listen as well explain why change is necessary for
everyone. Employees should given training and education which underpin
change process. Implementation of structured rewards and performance
appraisal system for all employees. also there is a need to revise key
performance indicators(KPI) and critical success factors(CSR) .
It is found that during meeting with operational executive that JAL is
running many unprofitable routes which engage lot of resources in terms
of employees ,Assets and management time. management immediately
need to divest unprofitable routes and unfeasible markets. careful
20. 20
consideration for portfolio restructuring is required in order to release
funds for other strategic areas this will help Firm to fulfill lenders
obligation, a shut down in facilities lead to downsize in work force, it will
help to focus on major profitable routes and efficient control over activities,
increase operational effectiveness and will realize value for business. as a
part of portfolio restructuring acquisition of new fuel efficient aircraft should
be acquire rather than Boeing 737,boieng 777x is most efficient in terms of
cost and size. It would help to tackle fuel cost which is the key component
of operating cost.
It has been found that adherence to best practice is being neglected which
assure a transparent and smooth running business. It can be evident by
transport ministry recent order to JAL management to review airline safety
procedures, as it was found neglected safety rules and took off aircraft in
Tokyo without permission from aircontrollers.adherence to formalized
rules and voluntary code of conduct help to avoid most of the mishaps and
troubles. Implement of corporate governance practices will help to
overcome many problems in the area of control and supervision. strict
adherence to the requirement of governance codes will lead to establish
independent non-executive committees consist of external CEO’S to
oversee executives of the company, these committees will comprise of
remuneration committee which supervise the remuneration of employees
and take key decisions in this area, audit committee to ensure objective
and independent audit has been carried out possibly through liaison with
internal/external audit teams and nomination committees who rigorously
oversee the mechanism of hiring and selection of key employees.
During the interview session with Government officials it was reveal that
,they plan to substantially support JAL restructuring through bailout
21. 21
package. two state-owned institution are working on behalf of Japan
government . JAL total Liabilities amount to 25$ billion, Enterprise
turnover initiative corporation(ETIC) agreed to inject 17.7$ billion and state
owned development bank contribute to this package by 2.2$ billions.
Remaining 5.5$ b can be settle with can utilize debt/equity swap model, in
which all creditors and lender would have share in restructure firm. if they
agree to give-up their debt. As debt is increasing at alarming rate, D/E
ratio is 4.6% which consider high in airline industry. Debt for equity swap
would counter this risky level and offer a better position to lenders after
financial reconstruction without harming relationship.
Achieving strategic objectives required successful implementation.JAL
rigid and complex nature of culture need to be change by transformational
approach, existing rituals and way of doing thing would be highly affected
and existing employees probably resist the cahnge,which required careful
monitoring at all stage.
It is believed that Japan Airline will implement above mentioned
recommendation, they can make their operation successful.
Conclusion:
It is concluded that JAL group bankruptcy was highly contributed by internal
issues, despite being privatized in 1987, it seems wholly state controlled
entity involvement of government officials and conflict of interest which highly
contribute to its failure. as it is clear that current business environment is very
volatile which demand flamboyant leader who can translating vision in to
realistic business strategies consider peoples skills-leading employees and
help them to achieve objective which in turn enhance the potential and
effectiveness of otrganization.mechanistic structure inherent with limited
communication and limited range of perspectives in decision making affect
the operational efficiency most, inefficient use of assets, less motivated work
force together with leadership gap,absense or proper formulation of policy
statements, procedural guide and governance code of conduct ,all have
contributed to deterioration in performance of JAL.
22. 22
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analysis[Online].Avaialalbehttps://books.google.ie/books?id=N7bCQty-yH0C&printsec.
Accessed[20 May 2016]
VG .kondalkar.2009 .organization Effectiveness and change management[Online].Available:
https://books.google.ie/books?id=xOmwrhQSN1oC&pg=PT82&dq. Accessed[30 May 2016]
Louise Wicham.2012.Delivering an effective project.4th
Ed.[online]Available
https://books.google.ie/books?id=vbObpwAACAAJ&dq=how+to+effectively+done+consultan
Accessed[25 May 2016]
http://www.japantimes.co.jp
https://hbr.org
http://centreforaviation.com
https://leaderswedeserve.wordpress.com
24. 1
MASTER OF BUSINESS ADMINISTRATION- MBA
Financial Management
LECTURER–Paul Doherty
INDIVIDUAL ASSIGNMENT
Bilal Ahmed - Nº 2159403
Full time Student
Dublin- 27/05/2016
25. 2
Contents
1.Report ..................................................................................................................................................3
1.1 The Performance of Artic plc. ..........................................................................................................3
Operating cost...............................................................................................................................4
1.2 Profitability:..................................................................................................................................5
1.3 Liquidity:......................................................................................................................................6
1.4 Efficiency:....................................................................................................................................7
1.4 Financing Ratios......................................................................................................................11
1.5 Investment Ratios:...................................................................................................................12
1.6 Assumptions:............................................................................................................................14
1.7 Recommendation: ...................................................................................................................14
2 Investment appraisal: .....................................................................................................................17
2.1)Net Present Value:..................................................................................................................18
Outcome ......................................................................................................................................19
Calculation...................................................................................................................................19
2.2 Payback:....................................................................................................................................20
Outcome ......................................................................................................................................21
2.3 Internal Rate of Return: ..........................................................................................................22
Outcome: .....................................................................................................................................23
Comparison of Npv and IRR: ...........................................................................................................25
2.4 Accounting Rate Of Return:...................................................................................................25
2.5 Recommendation: ...................................................................................................................27
3.Capital rationing ..............................................................................................................................29
3.1 Hard Capital Rationing:...........................................................................................................30
3.2 Soft Capital Rationing: ............................................................................................................30
3.3 DIVISIBLE PROJECTS: .........................................................................................................30
3.4 Profitability Index: ....................................................................................................................30
4.Non divisible Project:......................................................................................................................31
4.1 Recommendation: ...................................................................................................................32
5.Theoretical And practical difficulties................................................................................................32
References..........................................................................................................................................33
26. 3
1.Report
To; Artic Plc. finance management
From: Financial Accountant
Date:27/05/2016
Subject: Performance of Artic Plc.
As Requested I have analysed the performance of artic plc. based on given ratios.
Compare to previous year, against industry norms and similar size competitor ratio,
this would probably give insight in to the issues and highlight the areas which need
further investigation. The ratios I have calculated are in appendix to this report.
1.1 The Performance of Artic plc.
The shareholders and other fund providers of company. would probably be worry
about artic plc financial performance. Despite the revenue growth artic plc. inefficient
management of working capital and immense rise in gearing usurp economic
advantage earn as a result of growth in revenue.
Growth of income:
The artic plc. has grown in terms of turnover, which has increase by 25.4% during
four year peiod,but it appear that growth in turnover is achieve by giving generous
credit terms to customers. .this could be witness by debtor collection period which
has increased by 46% in four years .which is quite higher than industry norm.in the
absence of more information, such as competitor sales figures and changes in its
capital expenditure of competitor, which would potentially increase our ability to
asses changes in whole industry, it appear that whole industry is not growing at the
same pace as artic plc. has grown, it has capture the market share from
competitors, although gross profit increased by 47.3%as compare to turn over which
is enhance by 25.4% lead to net increase in gross profit by 5%,from 30% in 2012 to
35% in 2015 ,3% higher than industry norm, which also support our view that sales
price and sales units both are likely cause of increase turnover, as gross profit is the
27. 4
difference of revenue less cost of sales ,so misalignment between these two ratios
either due to higher sales price/volume or lower cost of sales. Apparently direct
overhead in COGS has decline by27% during this period, it might be due to
economic of scale ,these benefits probably realise in the form of bulk purchase
discount, lower fixed cost as a result of higher production level etc. But wages has
increased dramatically which is non-proportional to total sales level, wages
increased by 86%,this is perplexing ,labour gain learning advantage in production
over time increased efficiency as a result labour cost should decrease. Magnificent
increase in labour cost indicate that labour are in short supply and/or role of trade
unions are stronger in our industry. Despite rising turnover and gross profit artic plc.
net margin is very low from beginning ,it was 2% in 2012 which has now decrease to
1.52% ,while industry norm is 4.1% and similar size competitor in industry are
making 5.3%on a total sales. There are likely to be a various reasons behind this
deterioration.
2012 2013 2014 2015 change change
Wages 1690500 2148460 2874300 3151200 86.40% 9.60%
Overhead 5071500 5055200 3527550 3676400 -27% 4.20%
Operating cost
Artic plc. Has incurred unusual operating cost which has eroded this incremental
sale advantages ,this higher sales lead to operating expense increase by 51.9%
which is much higher to support revenue, result in lower operating profit. Incremental
expense borne by artic plc. to increase sales(25.4%-51.87%=-26.47%) increase in
operating expense compare to increase in sales, and PBIT as a % of sales, from
3.3% in 2012 to 2.9% in 2015.this 0.4% deterioration is solely attributed to higher
operating cost which is increased by 51.8%. And gross profit enhance by
2270,000(47.3%).the net difference of 4.6% higher operating cost compare to gross
profit appear to contribute by depreciation charges and indirect overhead increased
as a result of higher sales. “Higher depreciation” as a result of purchase/Revalue of
noncurrent assets and indirect overhead which possibly arise as a relevant cost
which has to be borne to support given level of sales due to higher activity level,
increasing activity level required a fund to inject for support higher production level, it
is inevitable in growing business, it seems that artic plc. is funding this investment
28. 5
via debt capital. Gearing has increased significantly, which possibly lead to
commensurate increase in “finance cost”(interest),that could be a possible reason of
deterioration in net profit. but this could be temporary and improve in later years if
had occurred due to the choice of accounting policies adopted it will improve
accounting profit, we do not know which depreciation method is being used, if artic
plc. is using straight line method depreciation remain the same throughout assets
life, but if it is using reducing balance method than operating cost will definitely
reduce in subsequent periods which contribute to improve operating margin.
As gearing has almost double during the period, it seems that new fixed assets
which also increase at a same rate finance by debt capita.in absence of information
we might assume increase in assets is due to “acquisition” rather than revaluation.
Which lead to higher interest cost and higher depreciation. Which cause accounting
profit deterioration, these two elements on statement of financial position(Fixed
Assets Debt) are major contributor to finance cost(interest)and depreciation expense
on income statement. Although deteriorating net profit cannot completely ascribe to
gearing, because in year 2012 artic plc. gearing was very low on 35%, while industry
norm is 49%,which is quite common in manufacturing industries,50% threshold is
seen as usual. Despite it lower gearing ,NP was “2%” in 2012 ,which support the
view that major contributor in terms of deteriorating NP is “depreciation” and
“overdraft”. Overdraft often used to bridge the gap shortage of cash by overdraft
which is expensive than other short term source of finances which usually used to
finance fluctuating level of cash shortfalls, cause by higher investment in working
capital.
1.2 Profitability:
ROCE
is a measure to calculate total income which is attributable to long term finance
providers, this is linked with efficiency of business resources(Assets) and net profit
on sales. Any changes in this measure can directly relate to these two
determinants,roce has decline from 3.3% to 2.4%,this is 0.9% decline in four year
this is mainly due to lower net profit for the reasons discuss above and partly due to
return on assets which also has slightly fallen as a result of significant increase in
new assets, fixed assets productivity decrease by 60% which contribute to 1.25%
29. 6
decline in return on total asset(net margin*ROCE).in 2015 return on asset together
with net profit gives us 2.4%ROCE. (1.58*1.52=2.40) it has slightly better from
previous year by 0.1% but overall decline. The second element of ROCE net profit
was below the industry average, its support our view that artic plc. is in growing
stage ,its revenue is increasing but at the expense of incremental expense, which
can be reduce by proper planning and management. On the contrary;
ROE
which measure the return on shareholder funds, is amazingly been improved
,although it is below the industry average and similar size competitor. Whose ROE
is7.8%in 2015,our organization stand at at 4.3% which show the 1.20% improvement
throughout 4 years period.it is not strange ,artic plc. gearing increased enormously
during this period ,and no new share capital has been issued during this period as
ROE is(Net profit/average no of shares),so the non-conformity is probably caused
by t lowest proportion of share, that lead to higher ROE despite deterioration in other
profitability ratios.
1.3 Liquidity:
Liquidity is the ability of artic plc. to meet its short term cash obligations when they
fall due. Having access to sufficient cash to meet all the payments obligations when
they fall due. Having sufficient liquidity is the key to survival in business. it is some
times suggested that ideal current ratio is 2:1,but it is depended on type of industry.in
our industry which manufacture electronic components, inventory often held for
longer period than other industries,if inventory is held for very short period ,current
ratio might be more useful because it is quickly convertible in to cash. But for
manufacturing companies inventories are slow moving ,the quick ratio is better guide
to judge liquidity. In manufacturing business like artic plc. it would be appropriate to
calculate the inventory turnover period as a sum of three different elements;
Raw Material and purchase components are held in inventory before they
issue to production(Raw material Turnover Period)
The Production Cycle(work in progress)
finished goods are held in inventory before sale
too much high ratio is not good, neither it is a symbol of high liquidity nor an
indication of excess cash, but it show the level of excessive investment in working
30. 7
capital. Artic plc. current ratio is very high at 3.1:1 ,although it has decreased during
the four year period by 11%but it is still consider to be high,2:1 is typical in
manufacturing industries, in our industry ,acceptable norm is little over the typical
ratio, it is 2.1:1 which must be adjusted according to industry characteristics and a
reflection of particular industry features it is also the safest across different industries
.similar size competitor also slightly higher from industry norm ,but it is in modest
range. We are wasting resources ,which are tied in working capital and can not be
utilise elsewhere. ideal quick ratio is 1:1quick ratio but it also depend on industry
type. Quick ratio together with inventory turnover period give indication on some
issues regarding inventory, artic policy inventory days have risen slightly this does
not give any immediate cause for concern it might be due to increase production
level and the fact that artic plc. is avoiding unnecessary stock out and potential
delays. quick ratio is falling in artic plc. in 2015 but is in in line with industry norm at
1.7,it is a 29% reduction from 2012,this is continuously decreasing more than
current ratio which is plausible and in line with industry average.
1.4 Efficiency:
Customers: business entities that sell to other business normally sales on credit.
Often standard credit term applied for most business transactions are 30 to 60 days.
Offering credit lead to higher sales volume, which result in higher profit. But this
incurred the cost in trade receivable normally calculated as average trade
receivables*cost of capital in the period, higher bed debt , administration cost and
monitoring cost of debtors. These are increasing at tremendous rate,35 days has
increased during period under consideration which is 46% higher than base year,
and also higher 43 higher from industry norm and 60 days higher from competitor,
which can probably be caused by poor credit control system, or to support sales and
offer kind credit terms. As sales figure also increase in line with collection, it
strengthen our view that Artic plc. generating extra sales in constant industry through
higher credit terms strategy. Debtor collection period has increased from a level of
76 days to 111 days in 2015.by allowing longer credit to customers sales has
increased significantly, this strategy has given artic plc. the chance to capture market
share from competitors , as it can be evident in competitor share price, market price
per share is the multiple of (net profit*P/E Ratio), our share price
is(307000*10.77=3306390)divided by total number of shares give us a value of
31. 8
“14.12” per share double than the competitor 7.25share price in 2015,this could be
an indicator of static market in terms of growth. Despite this increasing turnover we
are not able to materialise it in terms of net profit. This situation is further terrible due
to the fact that we are paying too early to our creditors;
Creditors
artic seem to be new business ,unable to negotiate longer terms to its supplier. And
in fact paying 2 days earlier from similar size competitor in industy,and from industry
norm in comparison to allow credit to customers. account payable is short term
finance source ,which save interest. Probably further increase in payable period
could incurred cost, such as higher prices charge by supplier ,the decision can be
taken by analyse all cost which can save as a result of longer credit and try to curtail
receivable period at least 90 days. As a result of this mismatch;
operating cycle
has inclined to 152 days more than double the industry 68 days norm and three
times higher than competitor 52 days. Most of the money tied up in account
receivable and inventory,these unfunded days need to be fund by other sources of
finance which is probably being obtained by bank overdraft, short term finance
source. which could be major contributor in overall finance cost and partly debt level
in artic plc. Further information will be needed to measure the implication of overdraft
i.e. whether artic plc. including its in total debt and whether it is pursuing aggressive
working capital management policy or conservative policy, which further guide us
about the proportion of short/long term debt and strengthen our analysis. Besides it
is obvious that investment in working capital;
working capital:
is getting high. Which is the measure of efficiency in working capital management. Its
comprise of investment in current assets to support day to day operation. The
amount of working capital should be proportional to sales revenue, because there
should be a certain amount of working capital require to support a given quantity of
sales, it is essential to hold inventory and to offer credit to customers, investment in
current assets in unavoiadable,however this investment does not provide any
financial return but it incurred cost which has to be meet by long term or short term
source of finance.it is the measure of how much sales has been earned in every 1$
32. 9
invested in working capital. Declining ratio suggest that investment is getting higher
in working capital to support given level of sales. Artic plc working capital Turnover
has been falling which is in accordance with other ratios, reflecting the inefficient use
of resources ,it has decrease by 16.60%,from 2.7(2012)to 2.25(2015)which means
that 45c less sales has been generated in 2015 on 1$ invested in working capital.
Artic plc appear to facing difficulties to generate sufficient cash through operation, in
absence of complete data, we cannot calculate the absolute level of cash flow artic is
generating but it is appear from figures that cash position is deficient. Cash flow
position of entity can be estimate using its investment in working capital. Increase in
current asset reduce cash on the contrary increase in current liability (account
payable)increase cash.it is obvious that artic plc. has invested too much cash in
inventory and account recievable,resultantly it is fulfilling its short term cash
requirement through lending from bank. Which lead to higher gearing. Below is the
specimen of cash flow to better understand liquidity position of Artic plc.;
Extract from statement of cash flow
Profit before interest and tax
Depreciation
Increase inventory
Increasein receivables
Reduction in trade payables
Operating cash flow before interest and tax
xxx
xxx
(xxx)
(xxx)
(xxx)
xxxx
Overtrading:
Overtrading is a state of affairs when organization are shortage of actual
need(Professor basu,2004) Overtrading refer to a situation when business try to
support to much volume of trade with too little long term capital , typical symptoms of
overtrading can be reflect in higher sales ,acquisition of non current assets, less
efficient working capital management. Growth in assets is finance by long term
equity and debt as it can be evident by turnover to capital employed ratio which is
33. 10
(20200000/11401345=1.77) in 2015 suggesting that every 1$ invested in form of
long term capital generate 1.77 sale in 2015.A rapid increase in turnover artic plc.
has experience a 25.5% increase in its turnover. Current Assets increased by 59%
while non current asset increase upto 98% form 2012 level, even greater than the
rate of sales. Even in overtrading business operates as a profit, it could run in to
serious trouble because of cash shortage. there must be optimum composition of
Debt/Equity, artic plc is appear to finance high growth through debt which is cheaper
source of finance then equity but at optimum level, after reaching certain point debt
transform in to expensive in terms of increasing risk of insolvency, high gearing,
higher finance cost. Artic plc debt proportion is too high and it has eroded profitability
and increase risk.it seems that organization is going through the same stage which
can be witness by these figures. Company has liquidity problems but still manage to
pay creditors on time,it seem to finance by overdraft. Remedial action to avoid
overtrading problem is to increase long term capital(Share Capital) or reduce the
volume of business. The aim should be to achieve balance between long term
capital to sales.
Working Capital Management:
Working Capital is the aggregate difference between two balance sheet aggregated
account,current assets and current liabilities.(James sagnar, 2011: P 1)Two
approaches are used in maturity matching the aggressive approach and the
conservative approach.
Conservative working capital:
policy aim to keep adequate working capital for the organisation needs. Inventories
are held at a level to ensure customer will be supplied and stock outs will not occur.
Generous terms are given to customer which attract more customers and supplier
are paid on time. Use long term finance to fixed assets,permenant working capital
and part of fluctuating working capital.as in the case of artic plc which can be evident
by significant increase in gearing.
Aggressive working capital:
policy as oppose to conservative management policy will seek to keep working
capital to a minmum,low finished goods inventory, low account recievable,tight credit
control. “Use a mixture of long term/short term finance for non-current t and short
34. 11
term finance to all Permanent and temporary working capital requirement.”(S.Rao,
2013,p 8)
1.4 Financing Ratios
Gearing: “The uk term Gearing and the us term leverage mean the same thing.
Financial gearing measure the extent to which company is financed by debt
capital”.(Accaglobal.com) Although debt is cheaper than equity finance, due to the
fact that interest cost is an allowable tax expense, this make debt finance most
cheaper and attractive source of finance.it simply means what interest artic plc pay
monthly is does not pay tax on that amount. But above the certain level it turnout to
be costly and start to eradicate benefits obtain through cheaper finance. We are not
sure about the absolute amount of value of preference share in total debt, but it is
certain that total debt include preference share are more likely to be shown as long
term liability in balance sheet. Artic plc total capital consist of 71%Debt the most
significant element and appear to be the root cause of most problems in company,
artic plc estimate gearing using debt/ total capital employed ,”according to this
measure gearing is said to be higher when it goes beyond 50%”(Accaglobal.com)it
is threshold which is also confirm by our industry norm(49%) and our competitor
gearing slightly higher than norm(52%) ,artic plc gearing has increased during period
of four year at tremendous amount 35% in 2012 to 71% in 2015.this is too risky to
bear too much debt, it is an mandatory obligation to make annual interest payment
on debt as long as debt remain outstanding. That highly geared companies more
likely to liquidate and seen as too risky to potential investor, artic plc should avoid
high gearing above the level that it can comfortably afford. Fund provider ask for
higher return for invest in highly geared artic plc in the form of Risk premium above
the risk free investment. With high financial gearing a % change in PBIT result in a
greater % change in EPS.major reason of immense gearing is seem to be due to
Turnover is growing at faster rate which has to be funded by somehow, artic plc
seem to funded all growth in current and non-current asset through long term
finance.as most of the companies which pursuing conservative working capital policy
does. Rising gearing lead to corresponding increase in Finance cost, which can be
seen in deteriorating; Interest Cover which measure the ability of entity to pay
interest out of earned income, as a general guide interest cover ratio of less than 3
is consider too risky and in our industry it is the norm to have income before interest
35. 12
five time higher than interest. A small change in PBIT can have a higher impact on
profit after tax if financial gearing is too high. And is of importance for debt provider
and shareholders, this is also depressing and quiet below form industry norm, it has
significantly decline from 3 to 2.1,which is too risky any little variation can lead to
bankruptcy .interest expense has increased by 58% during four year period. From
177965 in 2012 to 281361 in 2015.it seems that artic plc using overdraft facility
persistently from a long time, because interest charge on overdraft only when
amount is drawn, deteriorating interest cover support this view that amount has been
drawn and increasing to maintain liquidity.it also mean that profit available for
dividend is very small, which make it difficult to raise capital in share market on
acceptable rates, shareholders probably ask for higher return to invest in a artic plc
which is highly geared. There is a risk of default, which give lender right to take
action against the borrower to recover loan.
Gearing Risk:
High gearing is risky for equity investors, risk can be define as volatility in earning
per share. This means that relatively small change in actual sales, above or below
the expected level, will result in a much greater change in Earning per share.
Investor appetite
an investor looking for fair and predictable return usually avoid high geared
companies. Investor will ask for risk premium(higher than average return).it has an
impact on cost of equity capital.
1.5 Investment Ratios:
Earning Per Share:
EPS is not too low in recent year our EPS is 1.31 while similar size competitor , is
1.75,EPS allocate the net profit to average number of shares during the particular
year. Improvement in EPS by 63.75% is mainly due to the fact that all of growth is
being finance by debt capital ,debt holder except interest due on this excess debt all
residual benefits belong to shareholders. Our market value of equity has reduced
significantly by 36% in absolute terms it was 5176880 in 2012 now stood at
(10.77*307000=3306390) while the proportion of debt capital has increased from
2787551 to 8094955,whichsuggest that market value of equity has decline for the
reason discuss about corresponding increase in gearing ,we had 407500 shares in
36. 13
2012 which has been reduced to 234351.this measure if look in isolation by ignoring
other variables look plausible but reducing share capital indicate that EPS
improvement is temporary. Below industry norm and competitor EPS has been
increased by 1 cent during the period.in 2013 it increased by 14c and in 2014 further
by 4c but in current year get back to 2012 level. Main determinants of this measure
is net profit and number of shares in market.in high gear companies EPS changes
rise/fall by a much larger percentage amount in response to profit before interest
and tax. Because interest paid PBIT is very high which left little over to distribute for
shareholders. Increase in gearing would be a problem if profit after tax also increase
with this. Reduction in market confidence can be seen in lower P/E rartio;which is the
major evaluating tool for investor. Exhibit the market confidence on artic plc share
and very sensitive to new project and future financial health of a artic plc;
P/E Ratio:
it is the multiple of earning per share to its market price, its reflect the market
appraisal of share future prospect. High P/E ratio is metaphor for high growth
companies’ declining P/E ratio can cause various problems ,it become easy target
for takeover bid P/E is main determinant to calculate share price any variance in P/E
ratio can alter the share price quickly.in artic plc it has decline 67.5% during the
period despite its high turnover. From 15.88 in 2012 to 10.77 in 2015.competitor P/E
ratio is 12 in recent year indicating that whole industry is suffering difficulties.(P/E
ratio*Net profit=total equity)
Dividend policy:
Investors prefer current income rather than future income. Company dividend entail
this fact in to its dividend policy, it also used to disseminate different messages in
market, by paying high dividend investor decode this as future growth, while sudden
decline in dividend could transmit a perception of difficulties. Artic plc. dividend policy
appear to maintain stable dividend between a range of 30c per share to 45c per
share, it can be seen that except in 2013 and 2014 its dividend per share is quite
similar.it might be due to avoid negative signals in share market to avoid further
deterioration in P/E ratio. Constant dividend policy lead to fluctuating pay-out ratio .
Dividend Cover Ratio
37. 14
it is inverse of dividend pay-out ratio and help investors to judge level of profitability
the variation in pay-out can be attribute to constant dividend policy.
Dividend Yield
very high in first year ,more higher than industry and competitor yield, but has
deteriorating persistently.5.3% in 2012 to 2.1% in 2015.
1.6 Assumptions:
It has been assumed that;
Overdraft is part of total debt and reflected in gearing ratio.
Increased in noncurrent asset is due to acquisition rather than revaluation.
Artic plc is growing much faster than the industry.
Artic plc is facing difficulty to raise share capital in market.
Artic plc is using straight line depreciation method.
Pursuing conservative working capital management policy.
Summary:
although artic plc has manage to survive and increased it turnover in constant growth
market ,but unable to materialise all the benefits of this strategy. Showing all signs of
overtrading.it has finance its growth mainly through debt, which result in sub
optimum capital structure and high interest cost. less efficient working capital
management usurp the benefits achieve through higher growth in turnover. Increase
in debtor collection increase the unfunded days which result in to borrow money
probably through overdraft or loan capital. Moreover we are paying high wages as
compare to other elements of coast of sales, this area require further investigation
and data relate to pay rates, grade of labours, industry rates and influence of trade
unions in industry and supply of labour in industry.it been assumed throughout the
case that artic plc pursuing conservative working capital management approach, so
these unfunded days are supposed to be fund with Debt capital.further more it
appear that artic plc is facing difficulty to raise share capital due to excessive level of
gearing, which exacerbate the deterioration in form of higher debt.
1.7 Recommendation:
Artic plc should pay immediate attention to following areas;
38. 15
Wages
Increase in production level come along with economy of scale/scope advantages,
which can be observe in lower purchase cost due to bulk buying, lower overheads as
a result of exploiting full capacity of fixed assets, and in a form of lower labour cost
mainly due to learning curve, which is not seem to be realise in our artic plc. This
should be investigated and remedial action should be taken.
Short Term Finance
Artic plc should use short term source of finance to manage day to day operation,
most prominent short term sources are bank over draft,short terms loans and
account payable. Most cheaper source is trade payable, as mention above it contain
no cost artic should try to negotiate favourable credit terms, it might involve some
cost in terms of late penalty/surcharge etc,these cost element should be examine as
compare to cost incurred as a result to fulfil immediate cash needs through other
sources such as Overdraft.
Debtor Collection
Amend credit terms for customers and bring it down to 90 days at least without
harming relationship and sales. Communicate customers that still your credit days
are much higher than industry level and to bring it down would be better for mutual
relation.
Capital Structure
optimum balance between debt/equity in capital structure is a matter of urgency, artic
plc need to enhance the proportion of equity capital, there is a possibility that
shareholders demand higher return as gearing is to high, company should approach
to risk taking/optimistic investor, who might be incline to invest on the expectancy of
higher return in the form of capital gain rather than yearly dividend as there is a need
to stop paying dividend.
Dividend Policy
Board of directors should stop paying dividend completely, as it is not mandatory
obligation to pay dividend, so we can use this fund for expansion rather than borrow
it from lenders.
40. 17
EPS 0.8 0.94 1.23 1.31 63.75% 6.50%
P/E 15.88 14.78 11.02 10.77 -67.50% -2.26%
Dividend Yield 5.30% 3.20% 1.90% 2.10% -3.20% 0.20%
Dividend cover 2 2.9 3.7 3.1 55% -16.20%
Dividend pay-out 50% 34.50% 27% 32.26% -17.74% 5.26%
share price 12.7 13.9 13.54 14.12 11.18% 4.20%
Dividend/Share 40c 32.4c 33.24c 42c 5% 26%
no of shares 407500 377660 250407 234351 42.50%
2 Investment appraisal:
is the evaluation of proposed project involving capital expenditures, We have wide
range of choices and models available to evaluate proposed capital project, the most
superior one is indeed NPV which is highly align with the objective of financial
management to maximise share holder wealth. But we will evaluate these project
with combination of different models as each technique has different significance and
scope to judge variety of implications.
Methods:
Net present Value
Internal Rate of Return
Accounting Rate of Return
Payback
We will use NPV with payback method and Accounting rate of return in order to
enhance our dimension and view the investment with diverse range of dimension to
better guide our decision making. The basic purpose of this evaluation is to make
sure whether the capital expenditure in project is worthwhile in term of maximising
shareholder wealth.
This project involves the purchase of assets. Which is being finance by bank loan.
There are two different ways of using Discounted cash flow in decision making: Net
present value and internal rate of return;
41. 18
2.1)Net Present Value:
measure the absolute change in share holder wealth as a result of new project. This
model is widely acceptable and mostly undertaken by financial managers to
evaluate investment that will provide adequate investment return over time.it has
certain advantages and drawbacks;
Advantages:
It is technically superior to any other method, if two projects are mutually
exclusive, IRR and NPV would give conflicting rankings, as which project to
select. Where there is a conflict,NPV is always superior.
It is based on cash flow not accounting profit, accounting profit is subject to
different accounting treatments, such as depreciation policy, accruals
/prepayments, while cash flow enhance the wealth of shareholders.
This technique look for the cash flow of whole period, other models such as
payback ignore the whole cash flow of project.
The main advantage to use NPV takes account of time value of money, every
cash flow represent in “today value “every economy carry certain amount of
inflation ,which depreciate the value of money over time, secondly to invest in
certain project ,take away the opportunity to earn interest in risk free
government bonds etc. Finally there is a risk in future return, every one want
money now rather than few years later, by incorporating these factors through
the discount rate,NPV measure the realistic increase in the wealth.
It is absolute measure unlike ROCE ,which is relative and measure the return
on initial investment, it means that NPV represent that by undertaking a
project what will be the overall change in shareholder wealth.
When discount rate is expected to differ during the project, it can be easily
incorporated in NPV calculation but not in IRR.
Disadvantages:
The time value of money and present value concepts are not easily
understood.
There might be uncertainty about accurate cost of capital, which is subject to
variation due to changes in capital structure and risk profile of artic plc.
42. 19
Assumption
Net cash inflow generated from the project will be reinvested at the cost of
capital.
The cost of capital Represented by is return required by investors or
organization.
All cash flow are assume to be occur at the end of year.
(Advance Financial Management,2014:p 12)ACCA P4
Outcome:
Project D NPV 29.294
project E NPV 11.85
based on Npv of both projects, project D is preferable and seem to increase
shareholder wealth Project is feasible to undertake but if there are other non-
financial consideration which management realise as worth considering must need
to be take in to account before proceed.
Calculation:
Project D TIME
Cash
Flow
Discount
Factor
Present
Value
Initial capital Expenditure 0 -145 1 -145
Cash flow 1 78 0.909 70.902
2 72 0.826 59.472
3 42 0.753 31.626
4 8 0.683 5.464
Resale Value 4 10 0.683 6.83
NPV 29.294
Project E TIME
Cash
Flow
Discount
Factor
Present
Value
Initial capital 0 -115 1 -115
43. 20
Expenditure
1 38 0.909 34.542
2 36 0.826 29.736
3 45 0.753 33.885
4 32 0.683 21.856
Resale Value 4 10 0.683 6.83
NPV 11.849
2.2 Payback:
“Payback is usually used as a first screening device before calculating NPV and
IRR”.companies with capital rationing mostly used this model to asses project .it is
the length of time before the cash invested in project will be returned.it ignores the
time value of money. (cimaglobal.com) As artic plc is highly geared ,it can be
assumed that cost of capital(cost to obtain finance)must be high.
Advantages:
It is simple and easy to calculate, can be understood by non financial
managers.
It measure cash flow rather than accounting profit. Investment is about
investing cash o earn cash, in this regard it is better than ARR.
It is often use with DCF,particularly for the companies which have liquidity
problems. Investment which pass the payback test can then be used to
evaluated using NPV or IRR.
Disadvantages:
The most prominent one that it ignore all cash flow after the payback
period.ost of investment entail higher cash return in later periods, Payback
ignore them.
It ignore the timing of cash flow, and suppose that all cash flow occur at the
end of year. Distribute evenly throughout the year.
Assumption:
44. 21
All cash flow occur evenly throughout the year for example cash flow of the
whole year equally divided between months.
(Financial Management march,2013:p 160)
Note: In addition to cash flow payback, we also estimated discounted payback to add the
value in decision, which takes in to account time value of money,
Outcome
Project Payback Discounted payback
D 1 year and 11 months 2 year and 6 months
E 2 year and 11 months 3 year and 7 months
Calculations:
Project D TIME
Cash
Flow
Cumulative
Cash
Initial capital Expenditure 0 -145 -145
1 78 -67
2 72 5
3 42 47
4 8 55
Resale Value 4 10 65
Payback period is 1.11yr
Discounted Payback 2.6yr
Project E TIME
Cash
Flow
Cumulative
Cash
Initial capital Expenditure 0 -115 -115
1 38 -77
2 36 -41
3 45 4
4 32 36
Resale Value 4 10 46
45. 22
Payback Period 2.11yr
Discounted Payback 3.7yr
Calculation: negative cumulative cash of year 3 ×12=10.90
Cash flow of year 4
2.3 Internal Rate of Return:
With this approach the expected return on investment over the life of project is
calculated, and compare with minimum required investment return. The project
should be undertaken if expected return are in excess of required return.
Advantages:
Its take in to account time value of money, it is the most important feature for
the project which last for long time.
it takes in to account whole cash flow of the project unlike payback which
ignore the cash flow after recoup of initial investment
.IRR is more easily understood by non-financial managers, it gives relative
difference in percentage terms, for example it represent the percentage return
of project which can be compare to artic plc cost of capital.
Weakness :
IRR ignore the relative size of investment. Therefore it ignores the absolute
increase in shareholder wealth, which will be result as a project.
Major weakness of IRR is ,where cash flow pattern is non conventional,ie
when project cash flow changes from positive to negative during the project
life. Project will give multiple IRR ,which decision maker must be aware to
avoid wrong decision.
Limitations:
When we are dealing with independent projects,IRR come with same
decision as NPV it merely indicate whether or not project has positive
NPV,however it can not be used to distinguish between ” mutually exclusive”
46. 23
projects.IRR does not tell us about the magnitude of NPV ,Hence it can not
decide which is superior project. rate actual r is the cost is the actual return
expected from investment.
(Advance Financial Managenemt,2014;178) ACCA,P4
Outcome:
Project D 22%
Project E 15%
Interpretation:
Project D IRR which indicate that cost of capital has to increase by 12 % to
make this project loss making or breakeven.it is very safer rate provide a
broad margin of 12% for cost of capital to increase or project return to
decrease.
Project E : IRR and 5% increase in cost of capital can make project non-
viable and will not lead to maximisation of shareholder wealth.as it is crystal
clear that newer debt will lead to increase cost of capital, eventually project
may turn in to loss making.
Calculation:
Project D
Using 10% discount rate
Project D TIME
Cash
Flow
Discount
Factor
Present
Value
Initial capital Expenditure 0 -145 1 -145
Cash flow 1 78 0.909 70.902
2 72 0.826 59.472
3 42 0.753 31.626
4 8 0.683 5.464
Resale Value 4 10 0.683 6.83
NPV A 29.294
47. 24
Using 25%
IRR TIME
Cash
Flow
Discount
Factor
Present
Value
Initial capital Expenditure 0 -145 1 -145
Cash flow 1 78 0.8 62.4
2 72 0.64 46.08
3 42 0.512 21.504
4 8 0.409 3.272
Resale Value 4 10 0.409 4.09
NPV B -7.654
Internal Rate Of Return 22%
MIRR 15%
10+29.294/29.294+7.654(2510)=21.87%
Calculation: 10+ 29.294 (25-10)
29,294-(-7.654)
Project E
Using 10% discount rate
IRR TIME
Cash
Flow
Discount
Factor
Present
Value
Initial capital Expenditure 0 -115 1 -115
1 38 0.909 34.542
2 36 0.826 29.736
3 45 0.753 33.885
4 32 0.683 21.856
Resale Value 4 10 0.683 6.83
NPV A 11.849
Using 25% discount rate
IRR TIME
Cash
Flow
Discount
Factor
Present
Value
48. 25
Initial capital Expenditure 0 -115 1 -115
Cash flow 1 38 0.8 30.4
2 36 0.64 23.04
3 45 0.512 23.04
4 32 0.409 13.088
Resale Value 4 10 0.409 4.09
NPV B -21.342
Internal Rate Of Return 15%
MIRR 12.75%
10+11.849/11.849-(-21.342)(25-
10)=15.32%
Calculation: 10+ 11.849 (25-10)
11.849-(-21.342)
Comparison of Npv and IRR:
The rule of making investment under NPV is that where project is mutually
exclusive invest in one which has higher NPV,when project are independent invest
in all projects which have positive NPV.The reason for this they are generating
sufficient cash flow to give an acceptable return to providers of debt and equity
finance.
“IRR rule states that, where investment has cash outflow followed by cash inflow, it
should be accepted if it IRR higher than cost of capital, this is because such
investment has positive NPV”
(Advance financial management,2014;p 178).ACCA P4
2.4 Accounting Rate Of Return:.
ARR measure the accounting profit of the particular project, it is similar to
ROCE,although ROCE measure the return of whole business it measure only the
project return in term of accounting profit, accounting profit usually the profit, which
49. 26
takes account of accounting conventions and practices which has impact on profit
of the business in income statement but not on real cash flow.it is useful for
companies who have targeted ARR,either imposed by share holders or
management.it provide the basis for decision on target ARR.
Advantages:
It uses simple concept such as accounting profit and ROCE which are
understandable to non financial managers.
It has higher visibility to stakeholders ,who usually based their decision on
financial statements published annually.
It is simple to calculate and in accordance with accounting conventions and
practices..
Drawbacks:
It ignore the time value of money, a profit in first year and in later year under
ARR would be equally valuable, it is wrong in modern financial environment.
It base on accounting profit not on cash flow, cash flow is major determinant
to evaluate investment, moreover it is based on average profit and
investment, which can be manipulate by depreciation methods.
It is relative measure and not guide about absolute return. For example it
measure the return of project investment on the size of investmement,in
mutually exclusive project it would give wrong indication of profitability based
on the same fact above unless used in conjunction with NPV.
(accaglobal.com)
Outcome:
Project D 21%
Project E 18.4%
Calculation:
Project D:
Total investment:145m
Scrap Value:10m
50. 27
Total Depreciation: 145-10=135m
Average Investment: 145+10/2=77.5
Total Inflow less depreciation: 78+72+42+8=200-135=65
Average Annual Profit: 65/4=16.25
Accounting Rate of Return: 16.25/77.5=20/9% or 21%
Project E:
Total investment:
Scrap Value:
Total Depreciation:
Average Investment:
Total Inflow less depreciation
Average Annual Profit:
Accounting Rate of Return
115m
10m
115-10=105m
115+10/2=62.5
38+36+45+32=150-105=46
46/4=11.5
11.5/62.5=18.4%
2.5 Recommendation:
Evaluation analysis begins with payback method as initial screening device, due to
the fact that Artic plc. has liquidity problems and above average gearing, it
investment must not be tied for longer time. Payback give higher value to project D
in terms of recoup of initial outlay.it would take 23 month to recover investment
cash flow from project D and take approximately 2.6 year to recover discounted
cash flow as compare to project E which would take 2.6 year for cash flow. . The
NPV of both project is positive.so both project are financially acceptable,NPV
method states that all projects which have positive NPV should be invest in.it will
51. 28
maximise total return, project D has higher NPV as compare to project E by 17.4m
it means project D is more superior than project E . As we have said that both
project are independent to each other, alternatively not mutually exclusive and we
can pursue both alongside, so the result obtained from IRR and NPV is similar.
Both measure has favour project D in terms of higher NPV. Because of the fact that
NPV is absolute measure and does not take in to account the relative size of
investment, We have also calculated the ARR which take in to account the relative
size of investment and gives us 2.6% higher value in favour of project D.all
methods are in favour of project D. which is accompanied by higher investment
In my opinion and based of the information provided, i would prefer project D over
project E.it is technically superior and offering higher return. Project D is better in
every aspect ,it gives higher return, early recoup of investment and overall
maximisation of shareholder value. Without taking other factor in to consideration
such as Risk, uncertainty etc,project D should be undertaken. But as it was
indicated that lender will use financial information of previous four year to grant loan
to artic plc by analysing the financial performance it seems that bank will refuse to
advance loan to our artic plc.by borrowing 145m for this project our total gearing
would increase to 183094055 from 2015 level of 8094955,and gearing ratio will be
98.2%. from 71% if share capital remain constant.it would have a major impact on
interest cost, as our interest cover in only 2.1 ,further borrowing will bring our artic
plc closer to bankruptcy. Company must pave the way to raise capital through
capital market(share holders).or alternatively uses internally generated funds. The
relative proportion of share capital and debt is depicted in below graph. And in 2016
as a result of new loan from bank.
52. 29
Limitation
Above assessment is completely financial and and contain financial implication as a
result of given projects there are many factors which can aid decision making make
project unacceptable besides its financial viability
Other Factors;
In addition to financial evaluation, other factors such as risk associate with each
project need to be analyse.it might be appropriate to use risk and sensitivity analysis
before undertaken project.
The certainty of cash flow in each year,
Stability of cost of capital, as it is appear from information provided that gearing is so
high, there must be an impact of cost of capital. Adjusted present value method is
recommended which estimate the change in cost of capital as a result of project.
3.Capital rationing
Companies do not have inexhaustible resources therefore it is likely that only limited
fund would be available for capital investment in projects. Capital rationing occur
when due to limited fund artic plc cannot invest in all project that have positive
0
5000000
10000000
15000000
20000000
25000000
2012 2013 2014 2015 2016
Gearing
Share
Debt
53. 30
NPV.capital in a short supply so there has to be made a decision which investment
project to invest in the project.
There are two types of capital rationing
3.1 Hard Capital Rationing:
This occurs when shortage of capital imposed by external factors, such as refusal by
bank to advance any more money or inability to raise more fund through capital
market.
3.2 Soft Capital Rationing:
This occur when rationing imposed by internal factors such as management decision
to limit capital budget for the year.
Artic plc:appear to be hard capital rationing, as it was specified by bank that
thorough analysis of artic plc performance would also be consider as a part to take
decision for advance a loan. Moreover artic plc has not issued any share during the
four year period which also suggests that due to high gearing level shareholders
demand for share premium in the form of dividend growth and/or capital
appreciation.
3.3 Divisible projects:
Project are fully divisible mean that part of the investment can be made in project
lead to partial return(proportional to amount invested).this decision is taken based on
profitability index.it incorporate the total NPV plus initial investment ,it is calculate the
return on per 1$ invested.
3.4 Profitability Index:
Project D offer higher return on invested capital, the decision rule under profitability
index is to go ahead with project D first ,Optimum investment plan is to invest
completely in project D and use remaining amount to invest fraction of project Invest
in project D will lead to 29.294 from project D and part of the NPV from project
E,3.090,Which is the 26.08% of total NPV based on the fact that 30% investment in
project lead to 30% return.
profitability index
54. 31
Project D Million Project E
Initial investment 145 115
Present Value of cash
flow
29.294 11.849
Total Value 174.294 126.849
Profit Per 1 invested 1.202028 1.103034783
Rank 1 2
Result Million NPV
Available Fund 175
Project D -145 29.294
Project E -30 3.09
Net Maximisation of
value
0 32.384
4.Non divisible Project:
If project were not divisible, the optimum policy is to invest completely in project D
and invest remaining fund in bank @8%. Current interbank offer rate is 8% We can
invest 30m residual fund ,which will give us a total value in four year time 10.8 million
,in today money term by discounting to company cost of capital is 9.82m(30-
40.81/1.10).
Yr1 Yr2 Yr3 Yr4
30m@8% 32.4 34.99 37.79 40.8
Net
Value 10.8
Total return as a result of this policy would be;
Npv From Project D 29.24
NPV from invested capital 9.82
55. 32
Total value 39.06
4.1 Recommendation:
It would be advisable to invest completely in project D,and remaining fund could be
use for two purpose, either it can be return to bank to avoid excess debt,or it can be
invested in bank which will maximise value by 9.82,which is6.73m higher than
project E (9.82-3.09)
5.Theoretical And practical difficulties
As we discuss earlier that our artic plc. is in financial difficulty and any further
increase in debt could lead to serious trouble.comapny should not consider to use
debt capital for proposed projects at first place. When bank and other lenders will
read our performance analysis report they probably does not allow further
capital.(Hard Capital Ration).artic plc. should invest in project through shareholders
funds.
In order to avoid bad decision making, company should gather as much detail as
possible from the project, the information we currently possess is very basic and limit
our ability to forsee.it should further include;
accurate estimate of inflows
timing of cash flow
inflation rate (erode quality of cash flow)
tax benefits (as a result of capital expenditure)
Risk assessment(Sensitivity analysis, simulation)
Working capital requirement(minimum investment required for operation)
New project would entail 175 m loan from bank. Company financial gearing is too
high and it is difficult to obtain it under normal commercial rates, certainly bank would
demand for higher return. Overall gearing will increase to 98.2%.on the other hand if
it uses this fund by share capital it would potentially help to reduce gearing level and
lead to utilise the emerging benefits of debt capital.
56. 33
If you have any question about the content of this report please feel free to ask me.
Financial accountant Date:
Bilal Ahmed 27/may/2016
57. 34
References
illustrativefinancialstatement,2011,unitedkingdom,kpmg ltd
Financial Management. 2010. 4th ed. London. BPP learning media
Financial management. 2013. 6th
ed. UK. Emilewolf publishing
Advance financial management. 2015. 1st
ed. Uk. Wokingham. Kaplan publishing ltd
Advance financial management. 2015. 8th
ed. BPP house eldin palace London. BPP learning media
Advance financial management. 2015. 9t
hed. BPP house eldin palace London. BPP learning media
S.RAO VALLABHANENI,.2013 internal audit knowledge management[ONLINE].Avaialble :
https://books.google.ie/books?id=vSQiyrlbDIMC&pg=RA15-
PT401&dq=aggressive+and+conservative+approach+of+working+capital Accessed[2o may 2016]
James Sagner. 2011. Essential of working capital management[ONLINE].
Available:https://books.google.ie/books?id=Ek3dzA1LIYsC&printsec=frontcover&dq=working+capital
+management Accessed[20 may 2016]
www.Opentution.com/Acca
www.cimaglobal.com
www.accaglobal.com
www.freeaccastudymaterial.com
60. 1
MASTER OF BUSINESS ADMINISTRATION- MBA
Strategic Management
LECTURER–Trish Ganly
INDIVIDUAL ASSIGNMENT
Lecturer:Trish Ganlay
Bilal Ahmed - Nº 2159403
Full time Student
Dublin- 27/05/2016
61. 2
Contents
Executive Summary:............................................................................................................................4
Introduction: ..........................................................................................................................................4
Samsung at a glance.......................................................................................................................7
Large Conglomerate........................................................................................................................7
Core Value ........................................................................................................................................7
Corporate Structure: ........................................................................................................................8
History in china:................................................................................................................................8
Samsung Competitive Advantage And Strategic Direction: ..........................................................9
External Environment: ..........................................................................................................................10
Political Factors: .............................................................................................................................11
Economic Factors: .........................................................................................................................12
Social and cultural environment:..................................................................................................14
Technological Factors: ..................................................................................................................15
Environmental:................................................................................................................................16
SWOT Analysis: .................................................................................................................................16
Resource Audit:..............................................................................................................................16
Value Chain.....................................................................................................................................17
RESEARCH AND DEVELOPMENT: ..........................................................................................17
Management Competency:...........................................................................................................18
Employees:......................................................................................................................................18
Intangible Resources:....................................................................................................................18
Weakness:.......................................................................................................................................19
Strategic choices:...............................................................................................................................20
BCG Matrix......................................................................................................................................20
Head-on Attack...............................................................................................................................21
Collaboration...................................................................................................................................22
Lock-in Strategy..............................................................................................................................22
Structural Changes ........................................................................................................................22
Vertical Integration:........................................................................................................................22
McKinsey 7S Framework ..............................................................................................................23
Conclusion...........................................................................................................................................24
