May 2009 Examinations TOPCIMA Question Paper 2 Examiner’s Answers 29 The answers published here have been written by the Examiner and should provide a helpful guide for both tutors and students. Published separately on the CIMA website (www.cimaglobal.com/students ) from August is a Post Examination Guide for the paper which provides much valuable and complementary material including indicative mark information. © The Chartered Institute of Management Accountants. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recorded or otherwise, without the written permission of the publisher.
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May 2009 Examinations TOPCIMA Question Paper 2 Examiner’s Answers 29 The answers published here have been written by the Examiner and should provide a helpful guide for both tutors and students. Published separately on the CIMA website (www.cimaglobal.com/students) from August is a Post Examination Guide for the paper which provides much valuable and complementary material including indicative mark information. © The Chartered Institute of Management Accountants. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recorded or otherwise, without the written permission of the publisher.
P10 – Test of Professional Competence in Management Accounting
Thursday 21 May 2009
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins during which you should read the question paper and, if you wish, make annotations on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or to use your calculator during the reading time.
This booklet contains the examination question and both the pre-seen and unseen elements of the case material.
Answer the question on page 17, which is detachable for ease of reference. The TOPCIMA assessment criteria, which your script will be marked against, is also included on page 17.
Maths Tables and Formulae are provided on pages 24 to 27.
Write your full examination number, paper number and the examination subject title in the spaces provided on the front of the examination answer book.
Also write your contact ID and name in the space provided in the right hand margin and seal to close.
Contents of this booklet:
Page
Pre-seen material – Dizz Mobile Phone Case 2
Pre-Seen Appendices 1 – 5
11 - 15
Question Requirement and
Assessment Criteria
17
Unseen Material 19 - 22
Maths Tables and Formulae
24 - 27
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© The Chartered Institute of Management Accountants 2009
Dizz mobile phone case
Market overview Since mobile telephony was introduced in Europe in 1985, the market has grown at a far higher pace than was originally expected. Furthermore, mobile phones have reached all levels of the market place, with market saturation levels being achieved at a much earlier date than industry commentators had forecast. This has resulted in many European mobile phone network operators seeking new markets around the world where growth can still be achieved. Many European mobile phone network operators have become global companies with investments in mobile networks in many countries across several continents. A mobile phone network operator is defined as a company which has been issued with an operating licence by the respective government to operate a mobile phone network, at particular frequencies in the atmosphere owned by each country. The mobile phone network operator pays a licence fee to the respective government. The mobile phone network operator which has been granted a licence is responsible for the construction and operation of a mobile phone network. The network comprises thousands of transmitters (sometimes known as base stations) which transmit the signal from the mobile phone to the telephone network. A mobile phone network operator is also responsible for invoicing its customers for contracted revenues according to their usage of the network services. Within each country the mobile phone market is monitored by Regulatory Authorities appointed by each Government. These Regulatory Authorities have powers to influence pricing and encourage fair competition. The European market for mobile phones has changed dramatically over the last decade due to competitive pressures, which the Regulatory Authorities have encouraged. A customer is defined as the user of a single mobile phone handset. Customers have a choice in many European countries as to which mobile phone network operator to select. Their choice is determined by price, the range of the services provided and the perceived quality of the various mobile phone network operators. However, the deciding factor on customer loyalty and new connections is often based on the most suitable price package available to suit customers’ requirements. The choice of mobile phone handset is also a deciding factor. There is a high level of ‘churn’ in this industry. The ‘churn rate’ is defined as the number of customers who disconnect from a mobile phone network operator in a given period, divided by the average number of customers in that same period. In some European countries there are more mobile phone customers than there are people and this is called a ‘saturated’ market. There is now generally little difference between mobile phone network operators in terms of the quality of the signal and network coverage. Therefore mobile phone network operators face greater challenges in attempting to differentiate their services. The largest growth potential for new mobile phone customers is in the emerging markets, mainly in Asia. In India, for example, with a population of over 1,100 million, the number of mobile phone customers is currently only 15% of the population. Many of the large international mobile phone network operators are therefore targeting these emerging markets as a way to generate additional growth and ultimately to increase shareholder wealth. Dizz Dizz is an international mobile phone network operator, which is listed on a European stock exchange. It has operations in 17 countries across Europe, Africa and Asia. Dizz does not have any operations in the USA or the Australasian markets. Dizz was established in the mid 1980’s when mobile telephony was first launched in Europe, and was then a subsidiary of a landline telephony company. Dizz became a listed company during the 1990’s. It has since established or acquired a shareholding in a number of other mobile phone network operators. Dizz currently owns 100% of the shareholdings in mobile phone network operators in 3 European countries and also owns majority shareholdings in other European, Asian and African
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countries. Dizz has 214 million customers, in total, across all of its subsidiary and fully owned companies. It attained group revenues of over €52,000 million in the financial year ended 30 June 2008. The Income Statement, Balance Sheet and Statement of Changes in Equity for Dizz for the last 2 financial years are shown in Appendix 1 on page 11. Dizz’s Statement of Cash Flows is shown in Appendix 2 on page 12. All of the financial and statistical data in respect of Dizz’s network operations represents the entire network and all of its customers. The minority interests are accounted for in the Income Statement and Balance Sheet in Appendix 1. In 7 European countries, as well as in all of the African and Asian countries in which it operates, Dizz holds a majority shareholding in the mobile phone operating company, as it is not allowed by the respective governments to hold a 100% shareholding. The fees for the licences which have been issued to Dizz for the 17 countries in which it operates are included in the Non-current assets in Dizz’s Balance Sheet, shown in Appendix 1. The licence fee cost is amortised over the period for which Dizz, and the consortium companies, have been granted the operating licences. None of the licences for the 17 countries in which Dizz operates are due to expire before June 2014. A summary of the Dizz group’s shareholdings and customer numbers, analysed by country, is shown below: Region Dizz
shareholding Customer numbers
(end June 2008) (Million)
Europe - 3 countries
100%
69
Europe - 7 other countries
Majority
34
Europe - Total of 10 countries
103
Africa - 3 countries
Majority
35
Asia – 4 countries
Majority
76
Overall - total 17 countries
214
Dizz’s Organisation structure The main Dizz Board is shown in Appendix 3 on page 13. Dizz has 12,600 employees in the companies in which it holds a 100% shareholding. In the other mobile phone networks around the world in which it has a majority shareholding, a further 6,500 are employed. Additionally, Dizz outsources a number of functions to a range of specialised outsourcing companies. The group is split into 3 divisions, geographically, with a Chief Executive Officer (CEO) managing each division. The 3 divisions are:
• Europe • Africa • Asia
The CEO of each of the 3 divisions has a seat on the main Dizz Board and is also responsible for all operations for the Dizz subsidiary companies in his geographical area. Within each division the CEO has a senior management team which is responsible for each of the mobile networks. The Dizz group’s annual and 5-year plans are prepared within each division, to encourage ownership and accountability. However, they have to be approved by the main Dizz Board. The main Dizz Board will also cascade down group objectives for growth, cost reduction,
corporate social responsibility (CSR) and quality standards. Therefore, although the 5-year plans are produced by the management team within each division, these plans need to meet the overall objectives set by the Dizz Board. The Dizz Board has always been a strong believer in the importance of developing the company’s own management team. The Dizz management trainee scheme, which was first implemented in 1990, has been regularly enhanced to develop an experienced well trained pool of managers. Dizz wants to invest in its people, as the Group CEO is confident that in this way employees will have the power to influence the success of the company in this highly competitive environment. Only by investing in its employees’ welfare and continuous education can Dizz try to release each individual’s true potential to increase value for the group. The Dizz Board believes that by investing in training and development, both vocational and personal (such as development of language skills not directly related to the employee’s job responsibility), Dizz is improving the wider skill base of its employees. The Group CEO and HR Director both believe that trained employees will be highly motivated and will stay with Dizz for longer. Furthermore, the belief at a senior level is that these trained employees will not become complacent. Therefore they will provide Dizz’s customers with high quality customer service. This should ultimately deliver growth in shareholder wealth. The HR Director is continuing to work with his teams to create an environment within all areas of the group, across all countries, where staff can excel and be rewarded for their contribution. The Executive Directors and senior management teams across all 3 divisions receive performance related pay, based on added value principles. This is extremely difficult to measure. The group rewards senior employees using a range of performance measures. These measures include revenues, share price and customer numbers, as well as quality indicators, such as customer satisfaction, churn, and the introduction of new products and services. The Executive Directors all have share options which can be exercised at €24.00 per share. Analysis of revenues and profits and customer growth by geographical area Dizz has a variety of tariffs, both for individual users and for business users. Some of Dizz’s business users have fewer than 10 mobile phone handsets, whereas other large corporate clients have hundreds of mobile phone handsets. Each mobile phone handset represents a customer for Dizz. All of the revenue data given in this pre-seen material is based on the average revenue per user (ARPU). ARPU is used widely in this industry to measure the average revenue generated by a customer. ARPU is defined as the average revenue per mobile phone handset in a specified time period and includes all usage fees but excludes one-off revenues such as those from handset sales or connection fees. The specific time period for the ARPU statistics included in this case material is for each financial year. The ARPU figures in this case comprise the total revenue generated by the mix of “pay as you go” mobile phones and contracted monthly payment mobile phones, including corporate contracts for business users. Therefore it is not necessary to understand the complex range of pricing plans that are available in this industry as these have been summarised in the ARPU figures. An analysis of network revenues and operating profit for the last financial year ended 30 June 2008 is shown below. This table excludes €2,810 million which relates to non network revenues. Please refer to Appendix 4 on page 14 for analysis of revenue by division. Network revenues
€ million Operating profit
€ million Europe 35,530 9,400Africa 6,100 2,200Asia 7,660 2,300 Total 49,290 13,900
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An analysis of the forecast growth in customers is shown in the graph below and also in the extracts from Dizz’s 5-year plan in Appendix 4 on page 14. This shows that Dizz is planning to increase its total number of customers from 214 million in June 2008 to 474 million by June 2014. This graph represents the organic growth of customer numbers for the mobile phone networks in the 17 countries in which Dizz currently operates. Therefore it excludes customer growth due to any further possible acquisitions of mobile phone networks which Dizz may, or may not, undertake during the 5-year plan period. The Dizz Board has recently thoroughly reviewed the agreed 5-year plan and its underlying assumptions in the light of the current economic climate. The Board has agreed that the 5-year plan is realistic and achievable. (Extracts from the 5-year plan are shown in Appendix 4 on page 14.)
Dizz - Growth in customer numbers
050
100150200250300350400450500
2006 2007 2008 2009 2010 2011 2012 2013 2014
Year
Num
ber o
f cus
tom
ers
EuropeAfricaAsiaTotal customers
In the European mobile phone network operating marketplace it is becoming difficult for Dizz to maintain its brand image and create differentiation. Dizz tries to maintain its brand image through the selection and procurement of exclusive mobile phone handsets, as well as through marketing campaigns and sponsorship. Dizz has successfully differentiated itself through an exclusive European procurement contract for the new generation of mobile phone handsets. This new handset allows the user to access the Internet in an easier and faster way. This new mobile phone handset was launched in January 2008. In the second half of the financial year ended June 2008, the average revenue per user (ARPU) increased slightly in Europe as a result. Quality of service Dizz’s quality of service in most European countries is among the best. Dizz’s mobile phone networks offer coverage to over 99.5% of the population in the European countries in which it operates. Mobile phone networks operate by the transmission of mobile phone calls, messages and data by the handset sending a signal to a Dizz operated transmitter. Dizz has experienced few operational problems with transmitters, despite some being quite old. As part of its cost reduction programme in Europe, Dizz is currently re-equipping its transmitters with the latest technology using a standard design, which generates cost savings in repairs and maintenance and lower carbon emissions. This re-equipping of its transmitters is also helping Dizz to meet its quality of service targets and will ensure minimal disruption to customers, when particular transmitters fail, usually due to bad weather. May 2009 5 P10
Dizz has a range of quality of service targets, including overall customer satisfaction (using market surveys), accuracy of billing, on time delivery of mobile phone handsets to new customers, quality of its network connections and “drop-off” rate (where a call is cut off due to a network fault). The CEO for each of the 3 divisions is responsible for the mobile phone networks in the countries in their area. Each division has a Service Quality Manager, whose responsibility is to maintain Dizz’s mobile network service at the agreed quality targets and to take action where quality is below target. Each division also has a Customer Service Manager whose responsibilities include the accurate registration of new customers and accurate billing to all of its customers. Both the Customer Service Managers and the Service Quality Managers within each of the 3 divisions work closely together to find innovative ways to enhance the service quality, improve customer satisfaction, retain customers and lower Dizz’s churn rate. Customer Service In Europe, the industry is very competitive. Customers can select almost identical mobile phone handsets, mobile phone networks and price packages. Therefore the differentiating factor is the quality of the overall customer experience. The European Customer Service Manager has established call centres in each of the countries in which Dizz operates. This has enabled Dizz to remain close to its customers and avoid creating any barriers to communication. Communication difficulties often occur when call centres are located outside the country where the customer is situated. The Group CEO has stated that each time a customer contacts the company this is an opportunity to gain his or her loyalty. Many customers only contact Dizz when they have a problem. It is the role of the customer services team to turn that problem into an opportunity and to ensure that the customer is satisfied. The Group CEO insists that in this competitive industry, if Dizz is unable to satisfy the needs of its customers, the customer will move to a competitor. New customers can register for Dizz’s network service in a variety of ways. These include using Dizz’s web site on the Internet, over the phone to Dizz’s sales offices or by going to Dizz’s retail shops. Dizz’s Customer Service Managers consider the contact with any customer an important feature of their experience of Dizz in terms of forming each customer’s impression of the company. This applies whether that contact is face to face or by phone. By employing trained, highly motivated employees Dizz can continuously meet high standards of customer service. Whilst competition in the African and Asian markets is not yet as strong as in Europe, it is increasing. In Africa, there are a small number of customer call centres which provide a good basic level of customer service. However, Dizz’s African Division Customer Service Manager is planning changes within the next year. In Asia, each country has its own dedicated customer service team. New technologies Dizz has expanded its business away from its core strengths of mobile telephony to meet the challenges of new technology. It has continued to be innovative to deliver solutions to meet its customers’ communication needs. The competitive pressure has helped to rapidly drive forward a range of technological and pricing changes. This enables Dizz to meet, or exceed, its customers’ expectations. Dizz has a range of new technologies available to its customers including Internet services and data transmission. During the financial year ended June 2008, it completed the upgrade of all of its transmitters across Europe to make its networks fully compatible to 3G standards in order to meet its licence requirements. 3G is defined as the third generation technology which uses new data transmission standards. Dizz’s market research teams continue to look at emerging technologies and new services in order to deliver improved telephony packages for its customers.
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Pricing Dizz operates in a very competitive market place that has seen prices fall significantly in real terms over the last decade. It needs to continually review its pricing and service packages to ensure that it offers a price which attracts new customers as well as retaining existing ones. Dizz offers value for money for its customers in most markets, by amending tariffs to reflect the volume of usage on its network. In several European countries, Dizz has reduced the cost of mobile phone calls made outside the home country in which the mobile phone is registered, by over 20% over the last 2 years. This has been a significant selling point for European business users who use their mobile phones extensively outside of their home country. With fierce competition and an increasingly tough regulatory environment in many of the European countries, the Dizz Board is under pressure to increase revenues and cut costs in order to maintain profitability. The price pressure exerted by the competitive environment is causing mobile phone network operators to look closely at ways in which they can increase the average revenue per user (ARPU). Like other mobile phone network operators, Dizz’s customer base is a mix of individuals and corporate business customers. An individual is a single user of a mobile phone handset. A corporate business customer could have hundreds of users of mobile phone handsets, each of which Dizz regards as a single user, generating a different ARPU. One of the many ways in which Dizz has successfully increased its ARPU is through the higher revenue generated by its corporate business customers accessing and sending data over the Dizz mobile phone networks. As a result of the improved ability to carry data over its 3G network in Europe, Dizz has seen its revenue rise. Dizz’s business customers, who access the Internet or transmit data, generate a high ARPU. Therefore Dizz is keen to facilitate the ways in which its customers can receive and send data and access the Internet. A summary of the ARPU by division (based on the average number of customers – see Appendix 4 for further details) is shown below: ARPU
Actual for the year ended 30 June 2008
ARPU Planned for the year ended 30 June 2014
€ per year € per year Europe
359
430
Africa
185
211
Asia
111
134
Overall average ARPU
245
250
It should be noted that the planned overall average ARPU changes to €250 per year by 2014 due to the predicted change in the mix of customers in the 3 geographical areas. The planned growth in the ARPU in Africa is based on higher levels of data transmission revenues as well as increased use of mobile phones. This additional revenue is offset by planned reductions in prices for voice usage due to forecast competitive pressures. Investment in a mobile phone network in Asia In August 2007, Dizz acquired a 75% shareholding in a mobile phone network in Yee (a fictitious Asian country). This country currently has a low density of mobile phone customers and is a target growth market for Dizz. The network in which Dizz acquired a majority shareholding had 28 million customers at the end of July 2007. The total acquisition cost for Dizz’s 75% shareholding in this mobile network was €17,000 million. This network is forecast to increase customer numbers by over 20% per year. The average ARPU in Yee is lower than Europe and
Africa at only €115 per year at present. It is however, slightly higher than the average ARPU achieved to date in other Asian countries. Including Yee, Dizz’s ARPU for Asia increased to an average of €111 for the financial year ended 30 June 2008. Additionally, the forecast growth in new customers in Yee is expected to generate large profits for Dizz over the next few years. This investment was financed using cash reserves, cash generated from operations and a new 10 year loan of €12,000 million, repayable in 2018. Possible future acquisitions in mobile phone networks The Dizz Board has not ruled out further large acquisitions in order to secure majority shareholdings in growing networks in the emerging markets. However, any further large acquisition may require a share exchange or a rights issue to finance the acquisition. The current approved 5-year plan does not include any acquisitions. Instead it is based only on the forecast growth of the customer base in the mobile phone networks in which Dizz currently has shareholdings. Mobile phone handsets Dizz supplies a mobile phone handset as part of its contract with its customers. These mobile phone handsets are procured from 10 leading international mobile phone handset manufacturers. Depending on the style and cost of the mobile phone handset and the type of contract with the customer, Dizz may generate additional revenues from its customers for the supply of the mobile phone handset. The cost of the mobile phone handset is recognised as an operating cost in the Income Statement, against which the customer’s monthly payment and call revenues are matched. Due to competition, Dizz is generally unable to charge its customers for supplying a standard model mobile phone handset. However, for some new high technology mobile phone handset models, Dizz is able to charge some of its customers an additional fee, to offset the procurement costs. The revenue generated from charges for mobile phone handsets is included in “Other revenue” and is not included in ARPU statistics. Dizz’s Procurement Director is responsible for sourcing sufficient numbers of mobile phone handsets to supply its customer base in each of the countries in which Dizz operates. Dizz has very close links with all of the large global mobile phone handset manufacturers, with an efficient supply chain. Dizz’s IT systems fully integrate with all of the handset manufacturers’ order systems, to provide updated tracking and delivery data for all mobile phone handsets that Dizz has ordered. Dizz has procurement contracts for exclusive designs of certain mobile phone handsets with 3 of the 10 mobile phone handset manufacturers. These handset models are only available to Dizz’s customers. Dizz’s IT systems Dizz’s integrated IT system, called CAS, handles all aspects of customer connections, accounts and billing. The CAS is also used to transfer call and billing data to other mobile phone network operators and landline phone operators, both in the same country and internationally. The CAS system is operational in all of the countries in which Dizz operates a network and it has proved reliable and accurate. With the huge volumes of calls and messages being transmitted daily through all of the networks in which Dizz operates, it is necessary to have very sophisticated IT systems to track and identify all aspects of customer usage. When Dizz acquires a shareholding in a mobile phone company in a new country (as it did in Asia in August 2007) it replaces the acquired companies’ existing IT systems with its CAS system. This helps to ensure compatibility of data across the Dizz group. Dizz has recently completed its enhanced and fully automated IT system for ordering and tracking all handset purchases from manufacturer, right through to delivery to the end customers. This system is operating well and has enabled Dizz to save administrative costs. The employees who previously tracked deliveries and followed up on queries have now been
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relocated into customer services or other roles within Dizz, thereby retaining their skills and knowledge of the company. The Dizz network system, which daily handles huge volumes of data, is totally dependent on the capabilities and integrity of the IT systems in place to enable the business to operate effectively. Dizz’s IT Director has submitted proposals to the main Dizz Board for further IT investment. The requirement is for both hardware and software to provide the necessary IT infrastructure to support the planned growth in customer numbers over the next few years. Across the 17 countries in which Dizz operates, this IT capital expenditure proposal is for €1,500 million spread over the next 3 years. This is included in the overall capital expenditure levels shown in the 5-year plan in Appendix 4 on page 14. Network security The Global Operations Director is responsible for ensuring that adequate systems are in place to prevent any of the Dizz networks from failing. In conjunction with the IT Director, the Global Operations Director has to maintain the integrity of the network systems to ensure that the system is operating legally and that no data is being lost or duplicated. It is also vital that data used for billing customers is accurate. The Global Operations Director is also responsible for ensuring that the technology meets the requirements of the mobile network licences granted by each country’s government. It is a recognised fact that all telephone operators, both landline and mobile phone networks, lose some revenues due to fraud. There is an ongoing problem with mobile phone “hackers” (defined as individuals who find a way of breaking into the secure coded mobile phone network so that they are able to make telephone calls without the call being tracked) who cause mobile phone network operators to lose revenues. The exact volume of fraudulent calls cannot be established, but the Dizz Global Operations Director is working with other global telecoms companies to further develop fraud prevention technology and to strengthen the controls and improved access codes required to prevent fraudulent calls. Landline telephony Some mobile phone network operators have diversified into providing a landline telephone service. The landline telephone business is also highly competitive. Dizz considers that the mobile phone market is growing globally, and it considers that mobile telephony is the future cash cow. Dizz has made the strategic decision to concentrate its resources on building up its mobile phone customer base and to provide its customers with the technology to interface with landline telephones. Therefore it has made a firm strategic decision not to enter the market for landline telephony. Marketing and sponsorship Like all leading brands, brand image and customer perception is achieved through the use of effective marketing. Each of the Dizz divisions is responsible for its own sales and marketing campaigns. However, the Global Marketing Director is responsible for strategic alliances with other global branded companies and Internet access alliances. Dizz uses a range of other media to ensure that the Dizz brand continually attracts positive media attention. Depending on the country and the maturity of the market, different marketing campaigns are undertaken. For example in Asia, most of Dizz’s marketing campaigns are directed at attracting new customers, by demonstrating the benefits of mobile telephony. Dizz has been running a range of television, radio and billboard advertising campaigns to promote the availability of the Dizz network in the 4 Asian countries in which it operates. These advertising campaigns are proving effective in getting the message across to potential new customers and have helped to achieve high growth in new connections in Asia. In Europe, where the market is almost saturated, Dizz’s marketing campaigns are aimed at increasing the usage of mobile phones, and thus increasing the ARPU. Dizz’s European advertising campaigns promote awareness for its existing and prospective customers on issues
such as reduced call charges at certain times and encouraging customers to stay in closer contact with family members and friends by phone. A recent campaign resulted in higher call usage of 3%, thereby increasing the ARPU. Further advertising campaigns are planned across all European countries. Dizz’s Global Marketing Director is keen to align the Dizz brand with Internet search engines through the use of joint marketing so that Dizz becomes associated with these global Internet brands. Dizz has over 110 different sponsorship contracts, across the 17 countries in which it operates. These sponsorship contracts include a range of sporting activities, including football and sailing. Dizz is actively involved in community projects in every country in which it operates. The Group CEO has stated that “it is important that Dizz plays a role in the communities in which we operate as more people begin to understand the impact that global companies can have on their environment”. The Group CEO believes that playing an active role in the community of each country will create a positive brand image for Dizz. Dizz currently also supports community initiatives such as recycling projects, some charity organisations and also media events including a series of television programmes. Dizz sets a precedent to other mobile network operators in the way it recycles ‘used’ mobile phone handsets and reduces paper consumption through the use of email and paperless bills. An extract from Dizz’s Corporate Social Responsibility (CSR) report is shown in Appendix 5 on page 15. Dizz’s aims Dizz has established three core aims:
1. To increase profits in the European markets by revenue stimulation and cost reduction programmes
2. To continue to be innovative and to develop new products and services to meet the
changing communication needs of its customers
3. To continue to develop, and to invest, in communications in emerging markets in Africa and Asia in order to generate high growth in revenues and profits.
Shareholder wealth As part of the Board’s commitment to deliver growth in shareholder wealth, Dizz has paid 50% of the profit attributable to the owners of the parent (after minority interests) in dividends. Dizz plans to continue with this dividend payout ratio. Dizz’s share price has continued to grow because of strong market confidence in the company’s ability to grow its customer base and continue to deliver its strategic plans. Dizz’s earnings per share (EPS) for the year ended 30 June 2008 was €0.511 per share, an increase of 18.8% on the previous year. An extract from Dizz’s 5-year plan is shown in Appendix 4 on page 14. The Chairman is confident that Dizz is working towards achieving the group’s long term strategic aims to generate further growth in earnings, despite the competitive environment, the current economic climate and pressure from the Regulatory Authorities. The Chairman considers that if the Dizz group is able to achieve its strategic aims, then shareholder wealth will increase as a result of increasing dividends and a higher share price. The Dizz share price was €11.25 at the end of June 2008. The company’s P/E ratio was 22. The latest share price, at 31 December 2008, is €12.04.
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Appendix 1
Extracts from Dizz’s accounts: Income Statement, Balance Sheet and Statement of Changes in Equity
Income Statement Year ended
30 June 2008 Year ended
30 June 2007 € million € million Revenue 52,100 43,517 Operating costs 38,200 32,117 Operating profit 13,900
11,400
Finance costs 3,322 2,568 Tax expense (effective tax rate is 30%) 3,173 2,650 Profit for the period
7,405
6,182
Less: Minority interest 1,575 1,277 Profit attributable to owners of the parent
5,830
4,905
Balance Sheet As at 30 June 2008 As at 30 June 2007 € million € million € million € million Non-current assets (net) 208,000 182,900 (including goodwill and licence fees) Current assets 7,100 8,600 Total assets 215,100 191,500 Equity and liabilities
Equity Share capital 5,700 5,700 Share premium 91,200 91,200 Retained earnings 15,715 12,800 Total equity attributable to owners of the parent 112,615 109,700 Minority Interests 44,900 37,000 Total equity 157,515 146,700 Non-current liabilities
50,000
38,000
Current liabilities 7,585 6,800 Total equity and liabilities 215,100 191,500
Note: Paid in share capital represents 11,400 million shares of €0.50 each at 30 June 2008
Statement of Changes in Equity Share Capital
Share premium
Retained earnings
Total equity attributable to owners of the parent
€ million
€ million
€ million
€ million
Balance at 30 June 2007 5,700 91,200 12,800 109,700 Profit attributable to owners of the parent - - 5,830 5,830 Dividends paid - - (2,915) (2,915) Balance at 30 June 2008
5,700
91,200
15,715
112,615
Appendix 2
Statement of cash flows
Year ended 30 June 2008
€ million
€ million
Cash flows from operating activities:
Operating profit 13,900 Less: Finance costs (3,322) Profit before taxation 10,578 Adjustments: Depreciation 7,785 Finance cost 3,322 11,107 21,685 (Increase) / decrease in inventories and trade Receivables
1,800
Increase / (decrease) in trade payables excluding tax
262
2,062 Cash generated from operations 23,747 Finance costs paid (3,322) Tax paid (2,650) (5,972) Net cash from operating activities
17,775
Cash flows from investing activities:
Net purchase of non-current assets (32,885) Less increase in Minority Interests 7,900 Dividends paid to Minority Interests (1,575) Net cash used in investing activities
(26,560)
Cash flows from financing activities:
Proceeds from new loan 12,000 Equity dividends paid (2,915) Net cash from financing activities
9,085
Net increase in cash and cash equivalents
300
Cash and cash equivalents at 30 June 2007 700 Cash and cash equivalents at 30 June 2008 1,000
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Appendix 3 Dizz’s Organisation Chart
Chairman (Non – Executive)
Group Chief Executive Officer
(Group CEO)
CEO Europe
10 x Non-Executive Directors
Group Finance Director
Human Resources
Director
Global Operations
Director
IT Director
Global Technology
and Development
Director
Global Procurement
Director
Global MarketingDirector
CEO Africa
CEO Asia
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Appendix 4 Extracts from 5-year plan
Financial data (All data for financial years ended 30 June)
Actual
Latest Full Year Forecast
Plan Note: All figures shown in the financial data below
are based on 2009 prices 2008 2009 2010 2011 2012 2013 2014
€ million
€ million € million
€ million
€ million
€ million
€ million
Network revenue: Europe 35,530 40,101 45,219 50,524 55,934 61,645 67,938Africa 6,100 7,039 8,041 9,186 10,494 11,988 13,696Asia 7,660 9,861 12,583 15,727 19,438 24,025 29,695Total Network revenue
49,290 57,001
65,843
75,437
85,866
97,658 111,329
Other revenue* 2,810 3,420 3,950 4,526 5,152 5,860 6,680 Total revenue
52,100 60,421
69,793
79,963
91,018
103,518 118,009
Operating costs
38,200 44,510
51,337
58,372
65,905
74,310 84,013
Operating profit
13,900 15,911
18,456
21,591
25,113
29,208 33,996
Profit for the period 7,405 8,725 10,459 12,654 15,025 17,797 21,148
Minority interests 1,575 1,866 2,256 2,765 3,328 3,998 4,823Profit attributable to the owners of the parent
5,830 6,859 8,203 9,889
11,697
13,799 16,325
Capital expenditure
24,985 13,100
14,300
15,000
16,900
19,600 24,500
Total loans - end year
50,000 50,000
52,000
52,000
56,000
56,000 56,000
*Note: Other revenue includes connection fees and sale of mobile phone handsets and this is not included in the ARPU figures below Business statistics (All data for financial years ended 30 June)
Actual
Latest Full Year Forecast
Plan
2008 2009 2010 2011 2012 2013 2014 Customers: (as at end June each year)
million
million
million
million
million
million
million
Europe 103 113 123 133 143 153 163 Africa 35 39 44 49 55 62 69 Asia 76 96 117 140 168 202 242Total customers 214 248 284 322 366 417 474Customers: (Average for year)
million
million
million
million
million
million
million
Europe 99 108 118 128 138 148 158 Africa 33 37 42 47 52 58 65 Asia 69 86 106 129 154 185 222Total customers 201 231 266 304 344 391 445 ARPU per year
€
€
€
€
€
€
€
Europe 359 371 383 395 405 417 430 Africa 185 190 191 195 202 207 211 Asia 111 115 119 122 126 130 134 Overall ARPU
245 247
248
248
250
250 250
P10 14 May 2009
May 2009 15 P10
Appendix 5
Extracts from Dizz’s Corporate Social Responsibility (CSR) report
Dizz’s 5 Corporate Social Responsibility goals are:
1. Putting our customers and their needs first to ensure maximum customer satisfaction Goals On-going Activities in 2008 Examples of Outcomes of Activities in 2008
Social responsibility Working to ensure Child Protection and increasing awareness of Internet safety and prevention of child exploitation
Key member in development of the International Child Protection Task Force
Worked with national advertising agencies to produce formal advertising guidelines
Openness and communication
Discussion forums with local authorities and residents for all network roll outs and transmitter locations
Responded to 93% of siting enquiries within 10 days. Held 325 meetings with local authorities and resident groups regarding planning and site locations
2. Innovation Initiatives to remain competitive
Corporate Initiatives Creating bespoke services for corporate customers to help reduce costs
Worked with several hospitals in Europe to develop technologies to improve communication with patients via text reminders for medication
Mobility Services Developing technology to assist more flexible working for corporate clients
Developed and implemented technology to allow home workers to access company databases securely for 3 large corporate clients
3. To be a responsible business with regard to both the environment and society in general
Waste Management and Re-cycling
Waste management programmes to reduce network and office wastage
Re-cycled 65% of office waste, 10% more than the previous year
Collected and re-cycled 180,000 mobile handsets, 20,000 below target but 5,000 more than 2007
Energy Usage Identify opportunities to reduce energy consumption and CO2 emissions at transmitters and in offices
Installed energy efficient air cooling systems at 800 transmitters, reducing energy consumption by 11% from 2007.
Achieved stated target to reduce CO2 emissions by 12% in 2008 by installation of energy saving, low CO2 emission transmitters.
Employee secondment
Secondment of employees to charitable organisations to assist in set-up and administration
15,000 employee days seconded to charitable and community activities in 2008, 3% higher than 2007
4. To be a responsible business with regard to our employees
Training and Development
Offering structured training and career pathsleading to improved staff retention
Spent €390 per employee on training, with over 70,000 person days spent on training.
Health and Safety Make Health and Safety an integral part of staff management and training
Accident rate per 1000 employees has fallen by 2%, but is still above the target rate.
5. To adhere to strong business principles in relation to our internal and external business relationships
Procurement and Supplier management
Corporate Responsibility is one of 5 criteria used to select suppliers
78% of procurement staff received Corporate Responsibility training – 5% below target
Quality Management Quality is an integral part of our business operations. We use a range of internationally accredited quality standards to measure and improve performance
ISO14001 has been maintained
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P10 16 May 2009
[This page is detachable, for ease of reference]
Dizz – Unseen material provided on examination day Additional (unseen) information relating to the case is given on pages 19 to 22. Read all of the additional material before you answer the question ANSWER THIS QUESTION You are the consultant appointed by the Dizz Board. Prepare a report that prioritises, analyses and evaluates the issues facing Dizz and makes appropriate recommendations. Your script will be marked against the TOPCIMA assessment criteria given below:
Criterion Maximum marks available
Analysis of issues (25 marks) Technical 5 Application 15 Diversity 5 Strategic choices (40 marks) Focus 5 Prioritisation 10 Judgement 20 Ethics 5 Recommendations (35 marks) Logic 20 Integration 10 Ethics 5 Total
100
May 2009 17 P10
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P10 18 May 2009
May 2009 19 P10
May 2009 Dizz - unseen material provided on examination day Read this information before you answer the question
Appointment of a consultant At the Dizz Board meeting held in mid May 2009, it was agreed that a consultant would be appointed to advise the Board on the issues facing Dizz. Proposal to invest in network infrastructure in DAL network in Asia Dizz holds a 60% shareholding in a mobile phone network, DAL, in a country in Asia. This shareholding is currently valued in Dizz’s Balance Sheet at €1,000 million. During 2008 there was a short period of civil unrest, which resulted in damage to roads, bridges, electricity transmission and also mobile phone transmitters in some parts of the country. Both of the 2 licenced mobile networks in this country are affected. A new democratically elected Government is now in place and the civil unrest has been significantly reduced. The DAL network had to partially suspend some of its service during the period of civil unrest but the service has been fully restored to some cities. However DAL’s national network service is not available due to extensive damage. DAL’s 12 million customers are dissatisfied with the lack of national coverage of the network. Dizz’s CEO for Asia has submitted a request to the Dizz Board for a further investment in DAL of €1,500 million, which is Dizz’s 60% share of the total investment required. The existing 40% minority shareholder in DAL, LL, has indicated that it is prepared to invest €1,000 million, its share, into the DAL network. This investment, of €2,500 million in total, is required to re-equip the DAL network to make it fully operational countrywide, and for it to meet the requirements of the Regulatory Authority of this country. The replacement equipment, using the latest technology, will be capable of supporting much higher customer numbers. It is forecast that with customer growth and efficiency savings from the new investment, Dizz’s 60% share of cash inflows would be €255 million post-tax in Year 1. It is forecast that the cash inflows will grow by 12% each year (at current prices). The evaluation of the investment proposal is based on a risk adjusted post-tax cost of capital of 15%. The CEO for Asia considers that as technology is changing rapidly, cash inflows for a 10 year period only should be used to evaluate the investment. If the Dizz Board decides not to invest further, then the DAL network would not meet the requirements of the Regulatory Authority, and would have its licence to operate suspended within the next year. Therefore if Dizz decides not to invest in the infrastructure of the DAL network, Dizz would be forced to sell its existing 60% shareholding. LL is the only company that appears to be interested in acquiring Dizz’s 60% shareholding. LL has stated that the maximum that it would pay for Dizz’s 60% shareholding is €500 million. Proposal to increase Dizz’s shareholding in POP network Dizz currently has a 51% shareholding in a mobile phone network, POP, in another Asian country, ZED. The Regulatory Authority in ZED has recently announced that non-ZED based companies will be allowed to increase their shareholdings in ZED-based telecom companies up to a maximum of 90%, effective from September 2009. The other shareholder in POP, which is a ZED-based company, has many interests and is understood to be keen to sell some of its shareholdings, to release cash to enable it to further diversify. The Financial Controller of the Asian division of Dizz has prepared some forecast figures to help to assess whether Dizz should acquire a larger shareholding in POP. Growth to date has been over 20% each year and is forecast to continue at 20% each year for the next 10 years. If Dizz chose to increase its shareholding in POP, from the current 51% shareholding to the maximum
90% allowed, it would cost Dizz €1,500 million. The NPV for this proposal is €1,046 million. This is based on an investment of €1,500 million and forecast post-tax cash inflows of €240 million for Year 1, increasing by 20% per year from customer growth. These figures exclude the cash inflows that would be achieved from Dizz’s existing 51% shareholding in POP. At present there are only 2 mobile phone networks in ZED. However, the Government of ZED is currently considering issuing 2 additional mobile phone network licences. The forecast NPV of Dizz acquiring an increased shareholding in POP, shown above, is €1,046 million and this is based on growth in customer numbers of 20% per year. However, if the Government of ZED were to issue additional mobile phone network licences, this would impact on POP’s customer base. Following sensitivity analysis, it is forecast that the investment to acquire an extra 39% shareholding in POP (up to the allowed 90%) would breakeven at a customer growth rate of 6.25% per year. Forecast reduction in profits and marketing proposals The Dizz Board has approved the 5-year plan shown in Appendix 4 of the pre-seen material and has communicated some of the key figures to market analysts and also to its own shareholders. With less than 2 months until the end of the current financial year, the planned profit figure (after minority interests) of €6,859 million is forecast to be achieved. The planned profit figure (after minority interests) for the year to June 2010 is €8,203 million. There are a few changes in the underlying data which will have an effect on the planned profits for the financial year ended June 2010. These are as follows:
• Europe – a decrease of 2 million in the average number of customers, from the planned level of 118 million to 116 million and a decrease in the average revenue per user (ARPU) of €4 per year, from €383 to €379 per year.
• Asia – an increase in the average number of customers of 1 million, from the planned
level of 106 million to 107 million. The ARPU for Asia is forecast to be unchanged at €119 per year.
There are no changes forecast in respect of Africa. Overall operating margins are forecast to remain the same as originally planned for the year to June 2010 at 26.4% of revenues. Tax is forecast to remain at 30% and minority interests are forecast to remain as planned for the year to June 2010 at 21.6% of the profit for the period. As a result of the forecast reduction in profits the Group CEO is considering 2 proposals: 1. To procure “designer” mobile phone handsets, designed and manufactured exclusively for
Dizz. “Designer” mobile phone handsets are defined as handsets designed by, and carrying the logo of, leading global fashion designers or sports companies. It is forecast that “designer” mobile phone handsets could appeal to over 25 million of Dizz’s customers worldwide, and also attract new customers, who would be willing to pay a premium price for these exclusive handsets. These customers are likely to be high revenue generating customers. Due to the high costs of development and the licencing costs payable to the global brands, the range of “designer” mobile phone handsets will be manufactured exclusively for Dizz in batches of 10 million handsets. If Dizz were to procure only 10 million handsets, the unit cost would be 60% higher than the cost of procuring 20 million handsets. If Dizz were to procure 30 million or more handsets then the unit costs would be even lower.
P10 20 May 2009
May 2009 21 P10
2. To launch a large scale advertising campaign in Europe only, using various media, aimed at stimulating call revenue. The proposed advertising campaign in Europe is forecast to generate the following post-tax NPV’s (after minority interest).
Probability Europe Incremental post-tax NPV’s
(after minority interest) € million
50% 200 30% 30 20% (70)
Carbon emission targets Dizz has met its target to reduce its carbon emissions by 12% in 2008 in accordance with its CSR report (shown in Appendix 5 to the pre-seen material). Dizz has since stated that it will continue to reduce its carbon emissions by 12% each year and this ongoing target reduction has been included in all of its marketing literature and in its submissions to the governments of the countries in which it operates. New energy-saving, low carbon emission transmitters are being installed as part of Dizz’s global capital expenditure programme. However, Dizz’s Global Operations Director now considers that the carbon emission target reductions are unrealistic and overstated. It is forecast that Dizz will not meet its stated target of a 12% reduction in carbon emissions in the year ending June 2010 unless it increases its capital expenditure in the low carbon emission transmitters by €100 million in the next financial year. The existing transmitters are being replaced to reduce power costs and carbon emissions. The CEO questions the effectiveness of this investment and its impact on shareholder value. He suggests that the target for Dizz’s reduction in carbon emissions should be lowered and that this new, lower target is published. Therefore the forecast capital expenditure on these transmitters would be reduced accordingly. Business relationship with a maintenance company Dizz has reduced its number of suppliers in all areas and it currently has only 10 companies worldwide to which it outsources its maintenance work. MAIN is one of Dizz’s outsourced maintenance companies. MAIN is responsible for all maintenance work for Dizz’s mobile phone networks in 4 European countries. Furthermore, under a separate contract some of MAIN’s engineers also undertake the installation of new transmitters. MAIN has worked closely with Dizz for over 15 years. Over the last 2 years, Dizz’s Procurement Director has introduced numerous changes to the annual contract and service level agreements with MAIN. The contract and service level agreements are intended to reduce the cost to Dizz and ensure that the specification of the work to be undertaken is explicit, so that no “short cuts” can be made. The standard of the maintenance performed by MAIN is very good, although it has failed to meet some of the new targets in its service level agreement during the current year. Negotiations are currently taking place for the forthcoming financial year starting in July 2009. Dizz has included further price reductions in the new contract. MAIN has stated that these lower prices will have an impact on its margins, making some areas of the contract loss making. MAIN is also concerned about the level of maintenance that it can provide at the proposed reduced prices. MAIN has stated that it is considering cancelling its contract with Dizz. There is a 3 month contractual notice period.
Children’s charity Dizz has been involved with a leading global children’s charity for 2 years. All of Dizz’s marketing material, customer invoices and corporate stationery include the logo for this charity. Furthermore, all the publicity material from the charity carries Dizz’s logo. Dizz’s Global Marketing Director is confident that this is helping Dizz to maintain and increase its market share. Dizz contributes to the charity in a variety of ways. It currently seconds 10 employees for 6 month assignments (5 person years) to help improve the charity’s administration and has assisted with IT and direct mail campaigns, which ask the public for donations. The charity has recently requested Dizz to increase the number of employees seconded to 30 person years each year. The charity also requested that Dizz’s mailing lists are provided free of charge. The charity wishes to request donations from Dizz’s customers.
[End of Unseen Material]
P10 22 May 2009
May 2009 23 P10
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APPLICABLE MATHS TABLES AND FORMULAE Present value table Present value of 1.00 unit of currency, that is (1 + r)-n where r = interest rate; n = number of periods until payment or receipt.
Interest rates (r) Periods (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826 3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751 4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683 5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621 6 0.942 0.888 0.837 0.790 0.746 0705 0.666 0.630 0.596 0.564 7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513 8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467 9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424 10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386 11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350 12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319 13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290 14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263 15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239 16 0.853 0.728 0.623 0.534 0.458 0.394 0.339 0.292 0.252 0.218 17 0.844 0.714 0.605 0.513 0.436 0.371 0.317 0.270 0.231 0.198 18 0.836 0.700 0.587 0.494 0.416 0.350 0.296 0.250 0.212 0.180 19 0.828 0.686 0.570 0.475 0.396 0.331 0.277 0.232 0.194 0.164 20 0.820 0.673 0.554 0.456 0.377 0.312 0.258 0.215 0.178 0.149
Interest rates (r) Periods (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694 3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579 4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482 5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402 6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335 7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279 8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233 9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194 10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162 11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135 12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112 13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093 14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078 15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.079 0.065 16 0.188 0.163 0.141 0.123 0.107 0.093 0.081 0.071 0.062 0.054 17 0.170 0.146 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.045 18 0.153 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.038 19 0.138 0.116 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031 20 0.124 0.104 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026
P10 24 May 2009
Cumulative present value of 1.00 unit of currency per annum, Receivable or Payable at the end of
each year for n years ⎥⎦⎤
⎢⎣⎡ −+−
rr n)(11
Interest rates (r) Periods
(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736 3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487 4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170 5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791 6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355 7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868 8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335 9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759 10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145 11 10.368 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495 12 11.255 10.575 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814 13 12.134 11.348 10.635 9.986 9.394 8.853 8.358 7.904 7.487 7.103 14 13.004 12.106 11.296 10.563 9.899 9.295 8.745 8.244 7.786 7.367 15 13.865 12.849 11.938 11.118 10.380 9.712 9.108 8.559 8.061 7.606 16 14.718 13.578 12.561 11.652 10.838 10.106 9.447 8.851 8.313 7.824 17 15.562 14.292 13.166 12.166 11.274 10.477 9.763 9.122 8.544 8.022 18 16.398 14.992 13.754 12.659 11.690 10.828 10.059 9.372 8.756 8.201 19 17.226 15.679 14.324 13.134 12.085 11.158 10.336 9.604 8.950 8.365 20 18.046 16.351 14.878 13.590 12.462 11.470 10.594 9.818 9.129 8.514
Interest rates (r) Periods
(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528 3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106 4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589 5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991 6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326 7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605 8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837 9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031 10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192 11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327 12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 7.793 4.611 4.439 13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533 14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611 15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675 16 7.379 6.974 6.604 6.265 5.954 5.668 5.405 5.162 4.938 4.730 17 7.549 7.120 6.729 6.373 6.047 5.749 5.475 5.222 4.990 4.775 18 7.702 7.250 6.840 6.467 6.128 5.818 5.534 5.273 5.033 4.812 19 7.839 7.366 6.938 6.550 6.198 5.877 5.584 5.316 5.070 4.843 20 7.963 7.469 7.025 6.623 6.259 5.929 5.628 5.353 5.101 4.870
May 2009 25 P10
FORMULAE
Valuation Models (i) Irredeemable preference share, paying a constant annual dividend, d, in perpetuity,
where P0 is the ex-div value:
P0 = prefk
d
(ii) Ordinary (Equity) share, paying a constant annual dividend, d, in perpetuity, where P0 is the ex-div value:
P0 = ek
d
(iii) Ordinary (Equity) share, paying an annual dividend, d, growing in perpetuity at a constant rate, g, where P0 is the ex-div value:
P0 = gk
d
-e
1 or P0 =
gk
g
−
+
e
0 ][1d
(iv) Irredeemable (Undated) debt, paying annual after tax interest, i (1-t), in perpetuity, where P0 is the ex-interest value:
P0 = net
][1
dk
ti −
or, without tax:
P0 = dk
i
(v) Future value of S, of a sum X, invested for n periods, compounded at r% interest:
S = X[1 + r]n
(vi) Present value of £1 payable or receivable in n years, discounted at r% per annum:
PV = n
r ][1
1
+
(vii) Present value of an annuity of £1 per annum, receivable or payable for n years, commencing in one year, discounted at r% per annum:
PV = ⎥⎦
⎤⎢⎣
⎡+
−n
rr ][1
11
1
(viii) Present value of £1 per annum, payable or receivable in perpetuity, commencing in one year, discounted at r% per annum:
PV = r
1
P10 26 May 2009
(ix) Present value of £1 per annum, receivable or payable, commencing in one year, growing in perpetuity at a constant rate of g% per annum, discounted at r% per annum:
PV = gr −
1
Cost of Capital (i) Cost of irredeemable preference capital, paying an annual dividend, d, in perpetuity, and
having a current ex-div price P0:
kpref =
0P
d
(ii) Cost of irredeemable debt capital, paying annual net interest, i (1 – t), and having a current ex-interest price P0:
kdnet = 0
][1
P
ti −
(iii) Cost of ordinary (equity) share capital, paying an annual dividend, d, in perpetuity, and having a current ex-div price P0:
ke =
0P
d
(iv) Cost of ordinary (equity) share capital, having a current ex-div price, P0, having just paid a dividend, d0, with the dividend growing in perpetuity by a constant g% per annum:
ke = gP
d+
0
1 or ke = g
P
gd+
+
0
]1[0
(v) Cost of ordinary (equity) share capital, using the CAPM:
ke = Rf + [Rm – Rf]ß
(vi) Weighted average cost of capital, k0:
k0 = ke ⎥⎦
⎤⎢⎣
⎡⎥⎦
⎤⎢⎣
⎡+
++ DE
Dd
D
E
VV
Vk
V
V
EV
May 2009 27 P10
P10 – Test of Professional Competence in Management
Accounting
May 2009
Thursday Afternoon session
P10 28 May 2009
TOPCIMA – Dizz Case – May 2009
REPORT To: Dizz Main Board From: Consultant Date: 21 May 2009
Review of Dizz Contents 1.0 Introduction 2.0 Terms of reference 3.0 Prioritisation of the issues facing Dizz 4.0 Analysis of the issues facing Dizz and Dizz’s strategic choices 5.0 Ethical issues and recommendations on ethical issues 6.0 Recommendations 7.0 Conclusions Appendices Appendix 1 SWOT analysis for Dizz Appendix 2 PEST analysis Appendix 3 Financial and Ratio analysis Appendix 4 Forecast effect of changes to profit (after minority interests) for year
ending June 2010 Appendix 5 Expected NPV of proposed advertising campaign Appendix 6 NPV analysis of proposed further investment in DAL or divestment 1.0 Introduction Dizz is an international listed company, which has operations in 17 countries throughout Europe, Asia and Africa. It had 214 million customers and in the financial year ended June 2008 had group revenues of over €52,000 million. Dizz operates in competitive markets and is also under pressure from the regulatory authorities in each of the countries in which it operates. Dizz is operating in the same competitive countries as other leading mobile phone operators such as Vodafone and Telefonica, which both operate globally. Both of these companies started mobile phone operations in their home countries and have grown both by expansion into new markets and by acquisition. 2.0 Terms of reference I am a consultant appointed by the Dizz Board to prioritise and analyse the issues facing Dizz and to discuss the strategic choices available and to make appropriate recommendations. This report will discuss a range of strategic choices and make recommendations in order to help the company to achieve its agreed 5 year plan.
29
3.0 Prioritisation of the issues facing Dizz 3.1 Top priority – Forecast reduction in profits and marketing proposals This issue is a top priority as it has an impact on financial data released to market analysts and shareholders concerning the level of profits for the forthcoming financial year ending June 2010. This could have an impact on market confidence in Dizz and also affect its share price. Customer numbers have changed from the approved 5-year plan and ARPU has decreased in Europe, offset by a small increase in customer numbers in Asia. Overall this will have an adverse effect on profits and management action needs to be taken to address these changes. There are 2 marketing proposals to be assessed which are whether to procure designer mobile phone handsets and whether to launch a large scale advertising campaign. 3.2 Second priority – Business relationship with maintenance company, MAIN Dizz procures a maintenance service from MAIN for all maintenance work for its mobile networks in 4 European countries. This maintenance work is vital to the smooth operation of the Dizz mobile network and this is why this has been ranked as second priority. Dizz is putting MAIN under severe price pressure and is in danger of losing this trusted and long serving maintenance company which has a good track record. It is also unethical to treat a key supplier so badly, which could put the jobs of MAIN’s employees at risk if the contract were not to be renewed. Dizz must find a way to resolve the pricing differences and to be fair to this key supplier. If MAIN were to cancel the maintenance contract, Dizz would only have 3 months to find another (or several) companies to undertake this work. 3.3 Third priority – Proposal to invest in network infrastructure in DAL network in Asia Following the period of civil unrest, parts of the DAL mobile network have been damaged or destroyed. The regulatory authority in this country insists that the DAL network must be made fully operational nationwide. This issue is ranked as the third priority as Dizz needs to choose whether to invest further in the DAL network infrastructure. Dizz also has the opportunity to divest its 60% shareholding in DAL and it has been offered €500 million against the current book value for this mobile phone network of €1,000 million, resulting in a large write off. The possible divestment also raises the issue of opportunity costs. There is no option of doing neither, as there are mobile network licence requirements to consider. 3.4 Fourth priority – Proposal to increase Dizz’s shareholding in POP network This alternative investment proposal is ranked as fourth priority. Dizz currently has a 51% shareholding in the profitable and growing POP mobile phone network in ZED (a different Asian country to that in which DAL operates). Following a change by the regulatory authorities in ZED, Dizz is now allowed to increase its shareholding to 90%, and the other shareholder in the POP network is keen to sell, so that it can diversify. This could cost Dizz €1,500 million. The growth rate looks very good at 20% per year, but further mobile phone network licences may be issued, which would make competition greater. 3.5 Fifth priority – Carbon emission targets Dizz has a carbon emission reduction plan with carbon reduction targets published in its CSR report. This business policy has also generated some favourable publicity.
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Dizz is currently behind plan for the installation of lower emission transmitters and it is forecast that without an increase in capital expenditure of €100 million during the financial year ending June 2010, the planned reduction of 12% in emissions will not be met. This issue has business and ethical dimensions and a decision needs to be made whether the target should be met and steps put in place to achieve it, or whether Dizz should allow the target reduction to be missed. 3.6 Sixth priority - Children’s charity Dizz is able to generate favourable publicity for this global children’s charity. The charity has requested additional support from Dizz in the form of additional secondments of Dizz’s employees and also free access to Dizz’s mailing lists. This issue has business and ethical dimensions and Dizz needs to decide whether it should meet the requests from the charity. A SWOT analysis summarising the strengths, weaknesses, opportunities and threats is shown in Appendix 1. A PEST analysis is shown in Appendix 2. 4.0 Analysis of the issues facing Dizz and Dizz’s strategic choices 4.1 Overview Dizz is a successful and profitable listed company with operations in 17 countries spanning 3 continents. Dizz increased its earnings per share (EPS) in the financial year ended June 2008 by 18.8% to €0.511, which was helped by the acquisition of a majority shareholding in a mobile network in Asia in August 2007. The forecast profit after minority interests for 2009 is €6,859 million, which equates to an EPS of €0.602, an increase of 17.8%. The high level of growth in profits is mainly due to high growth in the number of customers, which is forecast to grow to 248 million at the end of June 2009, an increase since the end of last financial year of over 15%. Dizz faces a number of challenges, mainly from growing competition and the pressure to maintain growth in its profits to satisfy shareholders and market analysts. The reason for the latest forecast for the next financial year, ending June 2010, being placed as the top priority is due to the repercussions if profit targets are not achieved. It is necessary to take management action to try to ensure that the profit targets in the approved 5 year plan are met. 4.2 Forecast reduction in profits and marketing proposals As can be seen from Appendix 4, the forecast effect of the changes to customer numbers in Europe and Asia and the slight reduction in the ARPU in Europe, results in reduced revenues of over €1,100 million. After operating costs, tax and minority interests these changes result in a fall in profits (after minority interests) of €161 million, which represents a reduction from planned profits of 2%. The planned profit after minority interests for the year ending June 2010 was €8,203 million and with these changes, will fall to €8,042 million. This will result in a lower
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level of growth in profits to only 17.2% (€8,042 million for 2010 compared to €6,859 million for 2009). There are 2 marketing proposals to try to boost revenues and profits and these are discussed below: 1. The proposal to procure a range of “designer” mobile phone handsets in order to
gain an element of exclusivity. These exclusive mobile phone handsets could help Dizz to attract new customers globally and also to retain existing customers.
The possible outcomes that Dizz faces in respect of “designer” handsets are as follows:
• If Dizz procured “designer” handsets, it may attract new customers who would
be willing to pay a premium price for the handsets. This would cover the increased procurement costs.
• Perhaps the “designer” handsets will attract new customers, but the
customers will not pay a premium price for the handsets and Dizz could make a loss on the procurement costs for these handsets
• There is a risk that the “designer” handsets procured by Dizz will not be
attractive to its customers and Dizz could be left with inventories that are worthless. Furthermore, Dizz may even need to give them away to prevent them becoming technologically obsolete as the pace of technological change is very fast in this industry. For example a top of the range mobile phone handset that does not have a feature now regarded as “standard”, such as an inbuilt camera, would be difficult to supply to demanding European customers. However, Dizz may be able to sell these phones in its other markets in Africa and Asia where customers may not be as insistent on receiving the latest phones.
• Dizz’s competitors could follow and also procure other “designer” handsets,
which could make Dizz’s handsets appear less exclusive, which could lead to less demand and a loss on the cost of handsets procured by Dizz
• Dizz could decline this proposal to procure “designer” handsets.
It is likely that the proposal to purchase “designer” handsets will happen and it is only a question of who procures the handsets, at what cost to the network operator and how much customers are willing to pay for these exclusive handsets.
Dizz needs to ensure that it does not lose out on attracting new customers, especially high revenue generating customers who these handsets are aimed at, but also that it does not procure large quantities and could be left with an inventory write off.
2. The proposal to launch an advertising campaign aimed at stimulating call
revenue. • This is a realistic proposal as additional call revenue results in higher bottom
line profits. The expected NPV for this proposal is shown in Appendix 5. This
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shows an expected forecast incremental post-tax NPV (after minority interests) of €95 million.
• Whilst there is a 20% risk of a negative NPV, there is an 80% overall
probability of increasing cash flows. The largest probability of 50% is for an increase in post-tax cash flows of €200 million. If this were to happen, then this proposal alone will help to fill the gap in profits caused by the forecast reduction in profits after minority interest of €161 million shown in Appendix 4.
4.3 Business relationship with maintenance company Dizz procures a maintenance service from MAIN for all maintenance work for its mobile networks in 4 European countries. Dizz is putting MAIN under severe price pressure and is in danger of losing this trusted and long serving maintenance company, which has a good track record. The ethical issues of treating its maintenance company so badly is discussed in section 5.0 below in Ethics. Like many large companies which wield power over their suppliers, as per Porter’s Five Forces model, Dizz appears to be trying to force prices down and make MAIN meet ever increasingly tight Service Level Agreements across the 4 European countries in which it operates. However, Dizz may have proposed price cuts and service level terms for MAIN too far for the contract that is currently being negotiated for the forthcoming financial year. MAIN has stated that some aspects of the contracted work results in losses for it, which is clearly unacceptable to MAIN. Either MAIN needs to become more efficient to cut its costs (which is in opposition to the need to provide better standards of service for Dizz) or it could cancel some or all of its service for Dizz. If Dizz were to lose such a key supplier, it would be under pressure to replace MAIN’s services in 4 countries within 3 months. Is it feasible that Dizz could locate, negotiate and appoint a different company or several companies to take on this level of work across 4 countries in the 3 month contractual notice period? It is a high risk strategy to chance losing MAIN, as it could be left with no maintenance service or one of a lesser standard. Dizz would be better off negotiating ways in which costs could be cut that are acceptable to both companies. Dizz is dependent on MAIN, and MAIN probably has high levels of employees who are solely employed for Dizz’s network maintenance work. If the contract were to be terminated, then MAIN would perhaps have to make a number of its employees redundant and would incur the cost of redundancies. This is not in anyone’s favour – especially the maintenance employees. Dizz needs to find a way to negotiate and resolve the pricing differences with MAIN so as to keep it satisfied and motivated, and one which meets the demands of Dizz’s cost control.
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4.4 Proposal to invest in network infrastructure in DAL network in Asia Following the period of civil unrest, parts of the DAL mobile network have been damaged or destroyed. The regulatory authority in this country insists that the DAL network must be made fully operational nationwide. This proposal requires an investment of €1,500 million. Alternatively, Dizz could divest its 60% shareholding in DAL and it has been offered €500 million against the current book value for this mobile phone network of €1,000 million, resulting in a large write off. There is the opportunity cost relating to alternative future cash inflows, as a choice to invest results in the opportunity cost of the sales proceeds of €500 million. Therefore, Dizz’s strategic choices in respect of its investment in the DAL network is limited to only 2 alternatives:
• Invest further at a cost of €1,500 million and forego the opportunity cost of the sales proceeds of €500 million for the divestment
• Divest its share and account for the write-off of €500 million. Note: this write
off may be treated as a usual operating cost and does not need to be treated as an “extra-ordinary” loss.
It should also be noted that the write off of €500 million is a book loss only to be accounted for by Dizz. As the assets have been damaged during the recent civil unrest, it is recognised that the Balance Sheet value should be written down to reflect their realisable value, in accordance with the usual prudence concept. The only cash flow implication of Dizz divesting its share in DAL is the cash in-flow of €500 million. The investment proposal in Appendix 6 shows that if Dizz were to invest further, the NPV over a 10 year period is positive at €474 million. However, the investment assumes growth at a constant rate of 12% and a risk-adjusted discount rate of 15%. The proposal only breaks even, using discounted cash flows in year 8, which is a long period of time in such a volatile environment. There are no guarantees that there will not be any further outbreaks of civil unrest in this country. Furthermore, there is an opportunity cost of not receiving the cash flows of €500 million from the sale of Dizz’s shares in the DAL network to LL. This makes the net overall NPV negative at €(26) million, as shown in Appendix 6. The investment is needed to install new technology following the recent civil unrest which has left part of the DAL network non-operational. This has led to some customers being very dis-satisfied. In order to retain customer loyalty to the DAL network, DAL should agree to refunds for its customers (or zero bills) until the network is operational in each main region of the country. It is unrealistic to bill customers for a service that DAL is not providing. If the revenue is billed, then the accounts of DAL could be over-stated as it is unlikely that customers will pay for a service they are not receiving. It is a high risk strategy to invest a further €1,500 million so soon after civil unrest. What happens if the new government is unable to maintain political stability? If the new transmitters were to be damaged or destroyed by new periods of civil unrest, it would be unlikely that the replacement cost would be covered by Dizz’s insurers, as insurance usually does not cover war and civil unrest.
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If Dizz chose not to invest in the network infrastructure of the DAL network, then the Regulatory Authority could withdraw the licence. The licence would only be continued if Dizz were to sell its shareholdings to another company that was prepared to invest in the network infrastructure. This could be either the minority company LL or another buyer, if one could be found. This is unlikely. Therefore, if Dizz chose not to invest further, which carries high risks, then it would be forced to sell its 60% shareholding at €500 million. It must be stated that €500 million is still a material payment for Dizz’s shareholdings in this network. Clearly LL attaches some value to the future earnings from DAL, and it is prepared to invest its share of the further investment, which shows commitment on its part. However, the €500 million results in a book loss, which would be accounted for in Dizz’s accounts. €500 million loss represents 6% of the planned post-tax profits after minority interests of €8,203 million and is therefore quite material. Investors and market analysts could view this divestment adversely and this could have a detrimental effect on Dizz’s share price. In summary, Dizz has 2 choices which are:
Invest further
€ million
Divest
€ million NPV of future cash flows
474
500
Opportunity cost of not receiving funds from divestment
(500)
-
Net overall NPV
(26)
500
The above table shows that there is a negative NPV when the opportunity cost is included which indicates that further investment is not financially attractive. There may be other reasons to stay in this market, such as economies of scale on such items of equipment such as transmitters or mobile phone handsets, which could increase Dizz’s costs in other markets. However, Dizz should be cautious and prudent. In the light of the financial crisis in the banking sector, due to high risk loans that subsequently caused huge losses, Dizz should be careful that it does not decide to stay in this market for the wrong reasons. The Dizz board is accountable to its shareholders. Whilst shareholders are looking for high growth, they would not accept high growth which does not generate positive cash flows. 4.5 Proposal to increase Dizz’s shareholding in POP network This proposal is in respect of Dizz’s opportunity to increase its shareholdings from 51% to 90% in the POP network in a different Asian country. This proposal could also help to offset any adverse publicity from the DAL problem. This proposal is for Dizz to increase its shareholding (currently 51%) in the profitable and growing POP mobile phone network in ZED to 90%. This is now allowed due to a recent change by the Regulatory Authority in ZED. The other shareholder in POP appears keen to sell and if it is a local company, the question is why it is keen to sell? Does it have some information concerning the Government issuing further mobile phone network licences? If 2 further mobile phone network licences are issued then this would have a detrimental effect on future cash
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flows as there would be more intense competition and growth would be substantially lower. The forecast NPV given in the case material arising from the extra 39% shareholding in POP is forecast to be €1,046 million based on cash flows of €240 million for Year 1 and growth at 20% per year. However, if growth were to be materially lower, if additional mobile networks are licenced, then this investment does not look as favourable. The growth required for this investment to breakeven is stated in the case material at 6.25%. However, if 2 further mobile phone network licences are issued, it is possible that these new networks would attract existing customers away from the POP network and also reduce its forecast growth significantly. It is possible that the POP network could experience negative growth in customer numbers. Therefore a breakeven customer growth rate of 6.25% is still rather ambitious. Therefore there is a high risk of a negative NPV if the ZED government does proceed with issuing 2 further licences. The UK Government in the 1980’s initially issued just 2 mobile phone licences, which were to O2 and Vodafone. Competition between these 2 network operators had failed to drive down the cost for customers, which remained at around £25 per month plus the cost of calls. Therefore the UK government issued 2 further licences in the 1990’s to 2 other mobile phone network operators, Orange and T-mobile (trading as “3”). This has helped to stimulate competition and has driven down prices to mobile phone users. It is highly likely that the ZED government could issue 2 further mobile phone licences in ZED which could have a significant effect on 2 aspects of the POP network, in which Dizz has a 51% share:
• It could drive down revenues, adversely affecting profits • It could cut down POP’s share of the market and future market growth, which
would also have an adverse effect on future profits. In the light of these comments it would be a very high risk strategy to increase Dizz’s shareholdings in the mobile network POP just before further licences may be issued. It is possible that Dizz could continue with its current 51% share in the POP network until the ZED government were to make a decision and an announcement as to whether it intends, or not, to issue any further licences. With the possibility of further licences being granted, Dizz’s share of future cash flows is risky. It would make no commercial sense to increase this risk at this time when the situation regarding future additional mobile phone network licences is still unknown for certain. 4.6 Carbon emission targets
Dizz has a carbon emission reduction plan with carbon reduction targets published in its CSR report. This business policy has also generated some favourable publicity. Dizz is currently behind plan for the installation of lower emission transmitters.
It is forecast that without an increase in capital expenditure of €100 million during the financial year ending June 2010, the planned reduction of 12% in emissions will not be met. Dizz has 3 choices:
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• It can bring forward the planned installation of lower carbon emission transmitters and spend a further €100 million in the current financial year. Dizz would need to procure the required volume of new transmitters and allocate adequate manpower to install these.
• Dizz could miss the target and make it clear that the target has not been achieved
• Dizz could speed up the installation so that the target is almost achieved. It would be bad business to miss the stated target reduction in carbon emissions. It would also be bad business to publish a lower target as this is simply “moving the goal posts” and the CEO should not be confusing shareholder value with agreed CSR targets. Any decision not to increase capital expenditure would result in Dizz not achieving its stated CSR aims and this compromises the integrity of Dizz’s CSR statement. 4.7 Children’s charity Dizz is able to generate favourable publicity for this global children’s charity. The charity has requested additional support from Dizz in the form of additional secondments of Dizz’s employees and also free access to Dizz’s mailing lists. As Dizz is making high levels of profit and these requests have a small cost to Dizz, it would make good business sense to agree to the requests or at least to negotiate a higher level of seconded employees than at present. In respect of the request for mailing lists to be provided free of charge, Dizz could easily provide these at no cost. Dizz would need to ensure that it had its customers’ permission to release this data to a third party, but it is usual for customers to agree for information to be shared with Dizz and authorised partners. The children’s charity is clearly a company which is close to Dizz.
5.0 Ethical issues and recommendations on ethical issues 5.1 Range of ethical issues facing Dizz There is a range of ethical issues in this case, including the following:
• Carbon emission targets • The way in which Dizz is treating MAIN, the maintenance company • The request for more help from the children’s charity
5.2 Carbon emission targets 5.2.1 Why this is an ethical issue Dizz is operating unethically if it reduces the carbon emission target in order to save capital expenditure. Dizz has published a target reduction in carbon emissions of 12% reduction and it should endeavour to meet this target. The suggestion by the CEO and whether the investment will deliver shareholder value contradicts the published target reduction in emissions. The suggestion of “moving the goal posts” is a very unethical suggestion. The CEO is proposing to put profits above emissions reductions, which is unethical. 5.2.2 Recommendations for this ethical issue
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It is recommended that published targets for reductions in carbon emissions should be met and the necessary capital expenditure should be invested to achieve the company’s targets. Dizz has received good publicity for its reduction in carbon emissions and it is not good business practice to put shareholder wealth before reduced emissions. It is therefore recommended that Dizz should invest the required €100 million in the next financial year, ending June 2010, to ensure that the published 12% reduction in emissions is achieved.
5.3 The way in which Dizz is treating MAIN, the maintenance company 5.3.1 Why this is an ethical issue Dizz’s maintenance company, MAIN, is being treated unethically by Dizz as Dizz is trying to enforce new price reductions and increased demands for tighter service level agreements, into the new contract with MAIN, making some aspects of the maintenance contract unprofitable. It is unethical for a large company like Dizz to treat its suppliers with such disrespect and to squeeze MAIN’s margins so much that the 2 companies are in such a hostile situation and that MAIN is considering cancelling its contract with Dizz. There are many examples in the real world of suppliers exerting pressure on its suppliers, including Tesco and the reduced prices paid to farmers for milk. There is a further ethical issue, as it is likely if the contract were to be cancelled that MAIN would make many of its employees redundant. If MAIN were to choose to terminate the contract, then it would make many of its employees redundant due entirely to the power wielded by Dizz. 5.3.2 Recommendations for this ethical issue It is recommended that Dizz’s senior management should arrange a series of meetings with MAIN in order to agree service levels and contract prices that are mutually acceptable. MAIN will need to satisfy Dizz that its costs and the underlying manning levels are fair for the level of service required by Dizz and Dizz needs to satisfy itself that MAIN is operating efficiently and not making unreasonable levels of profits from different parts of the maintenance contract in different European countries. It is recommended that both companies use a mediator if necessary to come to an agreement as the loss of MAIN, which has in the past provided a good service, could leave Dizz very exposed, as the quality of its service levels are an important differentiator in this competitive market. It is not in either company’s interests for MAIN to cancel the maintenance contract as MAIN would lose a major customer and Dizz would lose a key supplier. The situation must not be allowed to escalate any further. An agreement for 2009/10 on contract prices must be negotiated with perhaps targets for cost reductions agreed in advance for future years.
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5.4 Children’s charity 5.4.1 Why this is an ethical issue Whilst Dizz has no responsibility to increase the level of secondments to the children’s charity, it would demonstrate that Dizz held a high ethical stance in respect of what level of support it was prepared to make towards this charity. This would be good business ethics. As Dizz’s involvement in this charity generates good publicity and Dizz is highly profitable, with profits in the current financial year forecast to exceed €6,800 million, the small amount of extra cost to help such a good cause would demonstrate that Dizz is operating ethically. Additionally, Dizz is not obliged to provide a mailing list free of charge to the children’s charity, but again, this would be at no cost to Dizz and would generate good publicity and again demonstrate Dizz’s high level of business ethics. It is unethical also for Dizz to charge the charity for access to its customer details when providing this data has no direct additional cost to Dizz. 5.4.2 Recommendations for this ethical issue It is recommended that Dizz increases the number of staff seconded to this children’s charity. At present Dizz seconds the equivalent of 5 person years to the charity each year. The request for a 6 fold increase to 30 person years seems to be a very large increase. Perhaps Dizz can agree to an increase each year of the number of seconded Dizz employees. It is recommended that Dizz doubles its commitment to 10 person years for the next financial year, to June 2010. Furthermore it is recommended that Dizz increases its number of seconded employees by 5 person years each year for the next 4 years so that the requested 30 person years is reached in 5 years time, in the financial year ending June 2014. It is also recommended that Dizz does provide a mailing list free of charge for the charity to use to ask for donations. When Dizz’s customers sign an agreement for their mobile phones they would have been asked whether they agreed, or not, to Dizz sharing this data with other companies, which is normal business practice. Therefore the mailing list of customers who agreed to have their details shared with other companies is easily available on Dizz’s database of customers. As there is an established link between this charity and Dizz, it is recommended that this mailing list, which does not additionally cost Dizz anything, is provided free of charge. Furthermore, the updated mailing list, with new Dizz customers’ details, should be provided to the children’s charity at regular intervals of perhaps twice each year for the next 3 years. 6.0 Recommendations 6.1 Forecast reduction in profits and marketing proposals The forecast effect of the changes in customer numbers and ARPU levels results in a profit reduction for the year to June 2010 of €161 million after minority interests. It is clear that shareholders and market analysts would react badly to a 2% fall in profits and this could lead to a fall in Dizz’s share price. It is recommended that an updated forecast is prepared for release to the market, which shows the effect of the adverse movement offset by the effect of the proposed advertising campaign, which it is recommended should be accepted.
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Therefore the overall effect is for profits for the year to June 2010 to fall slightly to €8,137 million, which represents the revised profit of €8,042 million plus the expected post tax effect of the advertising campaign at €95 million. (Note: this assumes cash flows have the same effect of profitability). This helps to close the gap in forecast profits. It is recommended that Dizz should procure a range of “designer” mobile phone handsets in order to gain competitive advantage. It is recommended that Dizz should procure 20 million handsets to minimise unit costs. However it is recommended that Dizz should ensure that these are actively promoted to attract new customers so that inventories of these expensive handsets are not held, so as to minimise the risk of inventory write offs. As the “shelf life” for the technology and these designs are short in this competitive industry, they should be sold to customers as soon as possible to reduce possible inventory write downs or write offs. It is recommended that the advertising campaign in Europe to stimulate call revenue should proceed as the expected NPV is €95 million. This could help to close the gap in the forecast profit shortfall of €161 million. 6.2 Business relationship with maintenance company It is poor business practice to force price cuts on the outsourcing company to such an extent that it is considering terminating the contract. If Dizz were to lose the services of MAIN there is no guarantee that it could procure the maintenance services from other maintenance companies either at the same or lower cost and also to the same standard required. Furthermore, the case material states that the standard of maintenance performed by MAIN is very good. Therefore it is recommended that Dizz and MAIN re-negotiate a revised contract that is fair to both companies and allows both companies to be satisfied on several areas, such as standard of service, speed of maintenance, cost and efficiency and areas required for future productivity improvements. It is necessary for both companies to understand the cost profiles and to work together to increase efficiency and to drive down costs. 6.3 Proposal to invest in network infrastructure in DAL network in Asia It is recommended that the further investment in DAL is too risky and should not proceed. The overall NPV is negative at €(26) million after taking into account the opportunity costs of divesting its shareholding. Therefore it is recommended that Dizz divests its 60% shareholding. Dizz should try to sell its 60% shareholding in DAL for a higher price than the €500 million indicated that would be offered by LL. The sale to LL at €500 million would create a book loss of €500 million (as the assets are valued at €1,000 million). However, it could be argued that the assets in Dizz’s Balance Sheet should be written down to the current realisable value, following the damage to these assets during the civil unrest. Therefore this loss in value would need to be accounted for in the current year’s Income Statement anyway, whether Dizz were to re-invest or to sell its share.
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The important issue here is about future cash flows, and the certainty of €500 million now to sell, is greater than the NPV of investing and achieving only net cash inflows, with a lot of risk, of only €474 in 10 years time. 6.4 Proposal to increase Dizz’s shareholding in POP network in Asia It is recommended that the proposal to increase Dizz’s shareholding in POP is rejected. The high NPV of €1,046 million assumes growth will continue at 20%. If the government in ZED were to issue 2 further mobile licences then the increased competition could seriously affect new customer growth and could even lead to a decline in Dizz’s customer base. The proposal shows cash flows of €240 million growing at 20%. However, there is a high risk of lower growth. Growth of 6.25% would be required for this proposal to breakeven. At a lower growth level, or a fall in customers, Dizz would not cover the cost of the investment in a higher shareholding. Therefore this proposal should be rejected and at this point Dizz should remain a 51% shareholder in POP. 6.5 Carbon emission targets It is recommended that Dizz should procure the new low carbon emission transmitters and allocate sufficient manpower to ensure that the target reduction of 12% in emissions is met during the financial year ending June 2010.
6.6 Children’s charity It is recommended that Dizz should increase its secondments of employee to this charity to 10 person years in the year ending June 2010, rising by 5 person years each year so that by June 2014, there are 30 person years seconded. It should also provide mailing lists free of charge to support the charity’s fundraising work. 7.0 Conclusions Dizz is a highly profitable, cash generating business, which is reasonably well protected from the problems associated with the current economic climate. However, this is a risky business, particularly in overseas markets. The recommendation to not invest further in the 2 Asian countries is a risk averse attitude which should protect shareholder wealth in the long term. However, it should be recognised that the sale of Dizz’s share in DAL, to LL, would result in a book loss and reduce the current year’s profits. However, the €500 million cash receipt from the sale could be used to invest elsewhere in Asia to generate growth. Dizz needs to manage its relationship with its key suppliers in order to maintain its ability to differentiate itself in this very competitive market place. Dizz’s profit levels are forecast to be lower than planned and management action to boost revenues is necessary in order to generate the returns expected by shareholders and market analysts. New innovative ways to grow the business are required in order that the Dizz share price can continue to rise and to generate increased shareholder value.
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Appendix 1
SWOT analysis for Dizz
Strengths • Listed company with a market presence
in 17 countries • High growth market in emerging countries • Strong management team and
management training scheme • Performance related pay for Executive
Directors and senior managers • Significant growth in revenues and profits
of around 40% in last 2 years • Approved 5 year plan with good growth
prospects • Service quality good • Investment in Yee is expected to
generate large profits in future years • Range of handset models with new
models being introduced each year (innovative)
• Strong asset backed balance sheet • High market profile with many
sponsorship contracts • Experienced employees • CAS system • Satisfied shareholders with a 50%
dividend policy and high growth in EPS
Weaknesses • Forecast reduction in profits for the next
financial year • Cannot pass the cost of mobile phone
handsets onto customers due to competitive market, except for some new high technology handset models
• Problems with DAL network following civil unrest requiring substantial new investment
• Dependent on its handset manufacturers for mobile phone handsets
• Behind schedule in meeting its announced carbon emission targets
• Dizz could lose the goodwill from an important outsourced company, MAIN, due to tough new contracts and price cuts being imposed on it
Opportunities • New technologies • Marketing proposal to stimulate call
revenue • Marketing proposal to procure “designer”
handsets • Proposal to invest further in DAL network
in Asia • Proposal to increase shareholding from
51% to 90% in POP network in Asia • Growth in emerging markets, particularly
Asia • Growth in ARPU (during the 5 year plan
period) in African and Asian markets where competition is not as strong as in Europe
• Concentrate the focus on corporate business customers who generate a higher ARPU than average customers
• Proposal to be further involved with the global children’s charity
Threats • Highly regulated • Operating in a highly competitive market
place • Difficult to maintain brand image and
differentiation in the marketplace • Quality of customer service is a critical
success factor, especially in Europe • Further civil unrest in DAL country • Risk of regulatory pressure to invest or
close the DAL network • Loss of DAL future cashflows if DAL is
divested • Slowdown in customer growth especially
in Europe • Loss of MAIN, the outsourced European
maintenance company due to tough contract negotiations
• Risk of not meeting published targets of reductions in carbon emissions
42
Appendix 2
PEST analysis
Political/Legal
• Highly regulated industry • Government and regulatory control high • Possible loss of DAL mobile phone network licence if further investment in
network infrastructure is not made by Dizz or LL • New licences could be issued in ZED to stimulate competition which could
adversely affect Dizz’s profits and customer growth in the POP network Economic
• Price competition • Economic slowdown could lead to a fall in ARPU • European market reaching saturation point • Increased regulatory control to reduce prices • Recession could lead to a fall in demand and slower growth or even negative
growth Social
• Increased trend for customers to switch network provider to get the best deal and best phone
• Changing customer taste and expectations from handsets and mobile network provider
• Customers want increased value for money • Dizz considering procuring “designer” mobile phone handsets to attract and
retain customers Technological
• Changing technologies • Pressure to reduce carbon emissions • Pressure to cut operating costs through the effective use of new technologies • Handset manufacturers under pressure to develop new, better, smaller
handsets at lower unit costs.
43
Appendix 3
Financial and Ratio analysis
All data for the financial year ended 30 June each year
Actual 2008
Forecast 2009
Increase since 2008
Plan 2014
Increase in 5
years from 2009
€ million € million % € million %Network revenue: Europe 35,530 40,101 12.9% 67,938 69.4%Africa 6,100 7,039 15.4% 13,696 94.6%Asia 7,660 9,861 28.7% 29,695 201.1% Total network revenue 49,290 57,001 15.6%
111,329 95.3%
Total revenue 52,100 60,421 16.0% 118,009 95.3% Profit attributable to the owners of the parent
5,830 6,859 17.7% 16325 138.0%
Key statistics: Average number of customers (million)
201 231 14.9%
445 92.6%
ARPU overall € 245 247 0.8%
250 1.2%
Number of shares million 11,400 11,400 -
11,400 -
EPS € 0.511 0.602 17.8%
1.432 137.9%
Loan finance € million 50,000 50,000 - 56,000 12.0%
Book value of equity € million 112,615 116,045 3% 146,002 25.8% Gearing 30.7% 30.1% (2.0%) 27.7% (8.0%) Market capitalisation € million (at P/E 22)
128,260 150,898 17.7%
359,150 138.0%
44
Appendix 4
Forecast effect of changes to profit (after minority interests) for year ending June 2010
ARPU
€ €
million 1. Decrease in Europe of 2 million to 116 million customers
383 -766
2. Decrease of €4 ARPU per year in Europe for 116 million customers
379 -464
Sub total – total effect in Europe -1,230
3. Increase in Asia of 1 million customers to 107 Million
119
+119
Overall effect on revenues for the year to June 2010 -1,111 Operating profit at 26.4% -293 Finance costs – no change
-
Tax at 30%
+88
Overall effect on Profit for the period for the year to June 2010
-205
Minority interests at 21.6%
+44
Profit change after minority interests for the year to June 2010
-161
€ million
Planned profit after minority interests for the year to June 2010 8,203 Profit reduction (as shown above) -161 Revised profit after minority interests for the year to June 2010 8,042
Note: the revised profit after these adjustments could be presented in a variety of ways in order to earn the full marks available. The above format is just the suggested format for the changes.
45
Appendix 5
Expected NPV of proposed advertising campaign
Probabilities Europe Incremental
post-tax NPV
€ million
Expected NPV
€ million
50% 200 100
30% 30 9
20% -70 -14 Expected NPV
95
46
Appendix 6
NPV analysis of proposed further investment in DAL or divestment
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
Year 9
Year 10
€
million €
million €
million €
million €
million €
million €
million €
million €
million €
million €
million
Investment -1,500
Post-tax cash inflows 255 255 286 320 358 401 449 503 563 631
Growth at 12% 0 31 34 38 43 48 54 60 68 76
Total post-tax cash in flows
255 286 320 358 401 449 503 563 631 707
Risk adjusted cost of capital 15%
1.000 0.870 0.756 0.658 0.572 0.497 0.432 0.376 0.327 0.284 0.247
Discounted cash flows
-1,500 222 216 211 205 199 194 189 184 179 175
Cumulative discounted cash flows
-1,500 -1,278 -1,062 -851 -646 -447 -253 -64 120 299 474
NPV for investment 474 Opportunity cost of not divesting Dizz’s shareholding in DAL (i.e. loss of sale)
-500
Net overall NPV
-26
47
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