Cocoa-Mocha-Chai (CMC) Co is a large listed company based in Switzerland and uses Swiss Francs as its currency. It imports tea, coffee and cocoa from countries around the world, and sells its blended products to supermarkets and large retailers worldwide. The company has production facilities located in two European ports where raw materials are brought for processing, and from where finished products are shipped out. All raw material purchases are paid for in US dollars (US$), while all sales are invoiced in Swiss Francs (CHF).

A four-year CHF60,000,000 loan taken out to part-fund the setting up of four branches (see proposal two below). Interest will be payable on the loan at a fixed annual rate of 2•2% or a floating annual rate based on the yield curve rate plus 0•40%. The loan’s principal amount will be repayable in full at the end of the fourth year.

Proposal two
This proposal suggested setting up four new branches in four different countries. Each branch would have its own production facilities and sales teams.

As a consequence of this, one of the two European-based production facilities will be closed. Initial cost-benefit analysis indicated that this would reduce costs related to production, distribution and logistics, as these branches would be closer to the sources of raw materials and also to the customers.

The operations and sales directors supported the proposal, as in addition to above, this would enable sales and marketing teams in the branches to respond to any changes in nearby markets more quickly. The branches would be controlled and staffed by the local population in those countries.

However, some members of the BoD expressed concern that such a move would create agency issues between CMC Co’s central management and the management controlling the branches. They suggested mitigation strategies would need to be established to minimise these issues.

Response from the non-executive directors
When the proposals were put to the non-executive directors, they indicated that they were broadly supportive of the second proposal if the financial benefits outweigh the costs of setting up and running the four branches.

However, they felt that they could not support the first proposal, as this would reduce shareholder value because the costs related to undertaking the proposal are likely to outweigh the benefits.

Required:

(d) Prepare a memorandum for the Board of Directors (BoD) of CMC Co which: 
(ii) Discusses the agency issues related to proposal two and how these can be mitigated. (9 marks)

Professional marks will be awarded in part (d) for the presentation, structure, logical flow and clarity of the memorandum.  (4 marks) (50 marks)