ACCA AFM Syllabus A. Role Of The Senior Financial Adviser - Purpose of Financial Management - Past Papers ^{1 / 2}

Limni Co is a large company manufacturing hand-held electronic devices such as mobile phones and tablet computers. The company has been growing rapidly over the last few years, but it also has high research and development expenditure. It is involved in a number of projects worldwide, developing new and innovative products and systems in a rapidly changing industry.

Due to the nature of the industry, this significant growth in earnings has never been stable, but has depended largely on the success of the new innovations and competitor actions. However, in the last two years it seems that the rapid period of growth is slowing, with fewer products coming to market compared to previous years.

Limni Co has never paid dividends and has financed projects through internally generated funds and with occasional rights issues of new share capital. It currently has insignificant levels of debt. The retained cash reserves have recently grown because of a drop in the level of investment in new projects.

The company has an active treasury division which invests spare funds in traded equities, bonds and other financial instruments; and releases the funds when required for new projects. The division also manages cash flow risk using money and derivative markets. The treasury division is currently considering investing in three companies with the following profit after tax (PAT) and dividend history:

All of the three companies’ share capital has remained largely unchanged since 2009.

Recently, Limni Co’s Board of Directors (BoD) came under pressure from the company’s larger shareholders to start returning some of the funds, currently retained by the company, back to the shareholders.

The BoD thinks that the shareholders have a strong case to ask for repayments. However, it is unsure whether to pay a special, one-off large dividend from its dividend capacity and retained funds, followed by small annual dividend payments; or to undertake a periodic share buyback scheme over the next few years.

Limni Co is due to prepare its statement of profit or loss shortly and estimates that the annual sales revenue will be $600 million, on which its profit before tax is expected to be 23% of sales revenue. It charges depreciation of 25% on a straight-line basis on its non-current assets of $220 million.

It estimates that $67 million investment in current and non-current assets was spent during the year. It is due to receive $15 million in dividends from its subsidiary companies, on which annual tax of 20% on average has been paid. Limni Co itself pays annual tax at 26%, and the tax authorities where Limni Co is based charge tax on dividend remittances made by overseas subsidiary companies, but give full credit on tax already paid on those remittances.

In order to fund the new policy of returning funds to shareholders, Limni Co’s BoD wants to increase the current estimated dividend capacity by 10%, by asking the overseas subsidiary companies for higher repatriations.

Required:

Discuss Limni Co’s current dividend, financing and risk management policies, and suggest how the decision to return retained funds back to the shareholders will affect these policies. (8 marks)

Mezza Co is a large food manufacturing and wholesale company. It imports fruit and vegetables from countries in South America, Africa and Asia, and packages them in steel cans, plastic tubs and as frozen foods, for sale to supermarkets around Europe.

Its suppliers range from individual farmers to Government run cooperatives, and farms run by its own subsidiary companies. In the past, Mezza Co has been very successful in its activities, and has an excellent corporate image with its customers, suppliers and employees.

Indeed Mezza Co prides itself on how it has supported local farming communities around the world and has consistently highlighted these activities in its annual reports.

However, in spite of buoyant stock markets over the last couple of years, Mezza Co’s share price has remained static. It is thought that this is because there is little scope for future growth in its products.

As a result the company’s directors are considering diversifying into new areas. One possibility is to commercialise a product developed by a recently acquired subsidiary company. The subsidiary company is engaged in researching solutions to carbon emissions and global warming, and has developed a high carbon absorbing variety of plant that can be grown in warm, shallow sea water.

The plant would then be harvested into carbon-neutral bio-fuel. This fuel, if widely used, is expected to lower carbon production levels.

Currently there is a lot of interest among the world’s governments in finding solutions to climate change. Mezza Co’s directors feel that this venture could enhance its reputation and result in a rise in its share price. They believe that the company’s expertise would be ideally suited to commercialising the product.

On a personal level, they feel that the venture’s success would enhance their generous remuneration package which includes share options. It is hoped that the resulting increase in the share price would enable the options to be exercised in the future.

Mezza Co has identified the coast of Maienar, a small country in Asia, as an ideal location, as it has a large area of warm, shallow waters. Mezza Co has been operating in Maienar for many years and as a result, has a well developed infrastructure to enable it to plant, monitor and harvest the crop.

Mezza Co’s directors have strong ties with senior government officials in Maienar and the country’s politicians are keen to develop new industries, especially ones with a long-term future.

The area identified by Mezza Co is a rich fishing ground for local fishermen, who have been fishing there for many generations. However, the fishermen are poor and have little political influence. The general perception is that the fishermen contribute little to Maienar’s economic development.

The coastal area, although naturally beautiful, has not been well developed for tourism. It is thought that the high carbon absorbing plant, if grown on a commercial scale, may have a negative impact on fish stocks and other wildlife in the area. The resulting decline in fish stocks may make it impossible for the fishermen to continue with their traditional way of life.

Required:

Discuss the key issues that the directors of Mezza Co should consider when making the decision about whether or not to commercialise the new product, and suggest how these issues may be mitigated or resolved. (17 marks)