Question

This Activity is fairly straightforward as you will assess your understanding of which sources of finance are appropriate and why. You will need to make judgments and support those judgements. In each case, assume the business has carried out the necessary market research and has planned the move appropriately.

Sanrio 1: A medium-sized engineering firm with an annual turnover of £2.5 million has decided to install a new piece of machinery to help improve its productivity. The equipment needs to be housed in a new building to be constructed on the site. The forecast cost of the building is £150,000 and the equipment £400,000. Sanrio 2 An individual has been made redundant after 20 years with a major organisation and has received a lump sum redundancy payment of £70,000. The individual is planning to set up a bookmakers and has identified a suitable premises valued at £180,000 near to a major town shopping precinct.

Sanrio 2 An individual has been made redundant after 20 years with a major organisation and has received a lump sum redundancy payment of £70,000. The individual is planning to set up a bookmakers and has identified a suitable premises valued at £180,000 near to a major town center shopping precinct.

Sanrio 3: A large plc is planning on moving a major part of its production facility to Cornwall. It has identified a site near a former chalk pit that is now not used. The estimated cost of the facility is £4.5 million. Sanrio 4: A rugby club is anticipating turning fully professional after the team secured promotion to the Zurich premiership. To take its place in the league, the league committee have insisted that it also improves facilities

Sanrio 4: A rugby club is anticipating turning fully professional after the team secured promotion to the Zurich premiership. To take its place in the league, the league committee have insisted that it also improves facilities at the ground. It has been estimated that the cost of these two measures will be £550,000.

Sanrio 5: A major UK plc is planning the takeover of a competing business. The move has been investigated by the Competition Commission and permission has been granted. The current share price of the rival firm is 260p and the firm has made an offer of 340p per share. The current market capitalisation of the target firm is £4.5 billion.

Sanrio 6: A small newsagent in a rural village firm has decided to purchase a new freezer cabinet and oven/roasting unit to provide hot meals for village workers and for students at the secondary school which serves the surrounding area which is located half a mile from the village firm. The cost of the units is £3,500.

Sanrio 7: A large charity organisation has followed a consultancy programme on streamlining its records. The consultants have suggested investing into a software package that will provide a sophisticated database programme that will do all the things that the charity will require for the next 10 years. The cost of the software package is £65,000.

Sanrio 8: Following the construction of a new housing estate on the outskirts of a major city, a group of 10 ambitious young professionals has decided to try to exploit the type of resident moving into the area by setting up a gym and health firm on earmarked land within the development. The building has been bought by the group for £800,000 but needs to be furnished and fitted out for the purpose intended. The cost of the restaurant and gym facilities is estimated at £95,000 but the other major cost is the swimming pool, spa and sauna area. This could be utilised on a separate project to the fitness firm as the local council want to secure use for local school children and elderly residents - this being part of the purchase arrangements associated with the new housing development.

Answer 1

Sanrio 1)  A medium-sized engineering firm with an annual turnover of £2.5 million has decided to install a new piece of machinery to help improve its productivity. The equipment needs to be housed in a new building to be constructed on the site. The forecast cost of the building is £150,000 and the equipment £400,000.

Solution: We can assume that the firm earns 10% of its turnover as its Net Income. With this assumption the firm makes £250,000 as Net Profit. The firm can have a mixed capital to source the project. It can raise a part of the capital in the form of Equity and the rest through debt from the bank. My suggestion would be to fund 20% of the project (150,000 of building and 400,000 of equipment) = 110,000 from equity and 440,000 from bank loan debt. Assuming 10 year debt wih 5% interest rate please find the payment schedule of the loan.

Year	Loan Amount	EMI Payment		Balance Principal
		Interest	EMI for the year
1	440000	22000	56982	405018
2	405018	20251	56982	368287
3	368287	18414	56982	329719
4	329719	16486	56982	289223
5	289223	14461	56982	246702
6	246702	12335	56982	202055
7	202055	10103	56982	155176
8	155176	7759	56982	105953
9	105953	5298	56982	54269
10	54269	2713	56982	0

This would be the best source of funds for the firm as the EMIs wont be a burden for the firm and after 10 years the asset would become debt free. If we calculate the per month the EMI for the month would be as low as 5000 pounds for the month. The productivity of the firm as mentioned will also increase, so over the period of time the loan would not be a burden for the firm. Plus the interest payment will give the firm a tax shield over its net income.

2) Sanrio 2 An individual has been made redundant after 20 years with a major organisation and has received a lump sum redundancy payment of £70,000. The individual is planning to set up a bookmakers and has identified a suitable premises valued at £180,000 near to a major town center shopping precinct.

Solution: A person wins or looses, a bookmaker will always make money through commissions and earn a big portion of the money through the looses of the people partcipating in the bets. The best case for the person is to invest a part of the project lets say 20% through his own funds (36,000) and the rest through Band debts (144,000). The reason why i am not advising for a huge down payment to be made from his own funds is because he would need some funds to service his loan for the initial period till his business picks up, to do marketing for his business, to buy betting equipments, interiors etc. So 52,000 pounds of money will help him do that.

I would suggest to take a loan for the period of 5 years as usually bookmakers make 10% commission of every bet placed minus the payments made to the winner. A 5 year loan with 5% interest would be 2,771 EMI per month.

Sanrio 3: A large plc is planning on moving a major part of its production facility to Cornwall. It has identified a site near a former chalk pit that is now not used. The estimated cost of the facility is £4.5 million.

Solution for a Large PLC, investing in such a huge asset would help the balance sheet of the firm to become stronger. As its a PLC the information for the company would be available and raising funds for them would not be a problem. I would suggest a mix bag for them too, i.e. A mixture of debt and capital in the ratio of 50% each.

Debt schedule at 5% interest is as follows:

Year	Loan Amount	EMI Payment		Balance Principal
		Interest	EMI for the year
1	2250000	112500	291386	2071114
2	2071114	103556	291386	1883284
3	1883284	94164	291386	1686062
4	1686062	84303	291386	1478979
5	1478979	73949	291386	1261542
6	1261542	63077	291386	1033233
7	1033233	51662	291386	793509
8	793509	39675	291386	541798
9	541798	27090	291386	277502
10	277502	13875	291386	0

The reason for the mixture of debt and capital is because of the following reasons:

An entire debt finance would pressure the PLC to pay huge sums of money as interest and the earnings would take a hit. Keeping a balance of both will please the shareholders, bankers, the managing board and the creditors. After a period of 10 years when the loan is paid off, the entire asset becomes debt free giving them full value to the firm. If we would have invested full project with the equity then a huge part of the Retained earnings would have got blocked in the project leaving little room for taking up small and new projects. Taking no debt would have not given any Tax Shield to the firm. I believe that this owuld be the best possible option for the PLC.   

Sanrio 4: A rugby club is anticipating turning fully professional after the team secured promotion to the Zurich premiership. To take its place in the league, the league committee have insisted that it also improves facilities at the ground. It has been estimated that the cost of these two measures will be £550,000.

Solution: As the rugby team has been promoted to Zurich Premiership and would be playing at a top level, we could expect the team to draw good and huge sponsors for the team. The team can go for the 2 possible solutions:

a) A revolvong round of credit: The reason for this investment is to make all the expenditure upfront and them pay off the money when they bring in new sponsors to the team. This will not burden the club with huge interest as they will only be charged with whatever moeny they use to develop the facilities.

b) Debt & Equity: As they have got promoted they would find it a lot easy to raise funds from banks and Financial Institutes which they can pay them throuh monthly installments and not be pressurized to pay huge amount upfront. Some portion of the funds can also be brought in by the owners, which they will indirectly benefit from sponsors, increased ticket sales to fans and marketing of new merchandise.