Fruit Confectionery Limited (FCL) is a small-medium sized enterprise based in Scotland. The company manufactures and sells confectionery made from fruit to a range of wholesalers and retailers in the UK. The company has only been in existence for three years but already has made its first revenue from sales to mainland Europe but suffered an exchange rate loss due to a decrease in the value of the â¬.
The rapid expansion concerns the Board of Directors as financial systems have grown on an ad hoc basis to date. One of the major concerns the Board has is its management of working capital, in particular the credit control function. Despite its best credit control efforts, including analysing customers into slow, medium and fast payers and chasing them accordingly, FCL still incurred some significant bad debts in its first three years.
FCL offers its customers a 1% discount for settlement in 30 days but less than a third of the customers take advantage of this. Revenue for the year just ended was £4,065,694 with variable cost of sales of £3,862,410.
The following working capital financial information is available for the year just ended:
 |
£ |
Inventory |
210,000 |
Trade receivables |
490,000 |
Trade payables |
185,000 |
Analysis of the outstanding trade receivables at the end of the year just ended and forecast bad debts incidence (based on historical actuals) as a percentage of the balance shows the following:
 |
 |
 |
 |
 |
Forecast |
 |
 |
Receivables Balance |
Average time to pay |
Current discount |
bad debts |
Category |
 |
 |
 |
 |
|
 |
 |
£ |
days |
% |
% |
Fast |
145,000 |
30 |
1. 0 |
0.0% |
|
Medium |
175,000 |
45 |
0.0 |
4.0% |
|
Slow |
95,000 |
60 |
0.0 |
10.0% |
|
European |
75,000 |
90 |
0.0 |
12.0% |
|
 |
 |
490,000 |
 |
 |
 |
It has been proposed that the discount for early payment be increased from 1% to 2% for settlement within 25 days. Other plans to improve working capital management have led the Board of directors to forecast the following:
Other information:
Hazel Tree Hotels (HTH) is a Scottish company that operates tourist hotels throughout the UK and Europe. The Board of Directors has decided that strategically the company requires to diversify into running bus tours in order to build greater value for its shareholders. As this is an entirely new venture for HTH, it was decided by the Board to evaluate it over a four-year period initially.
The previous CFO left the company recently and the financial controller was asked to undertake a financial investment appraisal of the proposed âBeech Tree Buses (BBB)â project. The Board has been given the following net present value (NPV) estimate and recommendation by the financial controller:
 |
 |
 |
Yr0 |
Yr1 |
Yr2 |
Yr3 |
Yr4 |
Trading: |
 |
 |
£'m |
£'m |
£'m |
£'m |
£'m |
Revenue |
- |
3.50 |
4.60 |
6.70 |
4.00 |
||
Direct costs |
- |
(2.10) |
(2.50) |
(3.20) |
(2.40) |
||
Fixed costs |
- |
- |
- |
- |
- |
||
Interest |
 |
- |
(0.16) |
(0.16) |
(0.16) |
(0.16) |
|
Taxable profit |
- |
1.24 |
1.94 |
3.34 |
1.44 |
||
Corporate tax payable |
 |
(0.25) |
(0.39) |
(0.67) |
(0.29) |
||
Profit after tax |
- |
0.99 |
1.55 |
2.67 |
1.15 |
||
Capital: |
 |
 |
 |
 |
 |
 |
 |
Investment |
(6.00) |
 |
 |
 |
0.50 |
||
Net cash flow |
(6.00) |
0.99 |
1.55 |
2.67 |
1.65 |
||
WACC @ 6% |
 |
1.000 |
0.943 |
0.890 |
0.840 |
0.792 |
|
Present values |
(6.00) |
0.94 |
1.38 |
2.24 |
1.31 |
||
NPV |
(0.13) |
 |
 |
 |
 |
 |
Net present value is negative £0.13 million, and therefore the recommendation is that the âBBBâ project should be rejected.
A new CFO has since joined the company and has indicated that there may be a problem with the above analysis. She is concerned that there are a few errors in the calculations and indeed that the wrong approach has been taken. She believes that an adjusted present value (APV) approach should have been taken, as the âBeech Tree Buses (BBB)â project is quite different from operating tourist hotels.
Jimmy Jalopy (âJJâ) is a quoted company that operates in the bus tour business. JJ is financed by 22 million shares trading at £2.50 each and £10 million debt trading at £89 per £100. JJâs equity beta is estimated at 1·70. The current yield on government treasury bills is 1% and it is estimated that the average return on the market is 7%. JJ pays corporate taxation at a rate of 18%.
The new CFO has found the working notes and assumptions used by the financial controller to compile his NPV assessment: