Task II (20 marks)　　You are a college student. Recently, a n

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(ii) Discussion of financial performance
It is clear that 2006 has been a difficult year for Merton plc. There are very few areas of interest to shareholders where
anything positive can be found to say.
Profitability
Return on capital employed has declined from 14·4% in 2005, which compared favourably with the sector average of
12%, to 10·2% in 2006. Since asset turnover has improved from 1·5 to 1·6 in the same period, the cause of the decline
is falling profitability. Gross profit margin has fallen each year from 27·5% in 2004 to 25% in 2006, equal to the sector
average, despite an overall increase in turnover during the period of 10% per year. Merton plc has been unable to keep
cost of sales increases (14% in 2006 and 10% in 2005) below the increases in turnover. Net profit margin has declined
over the same period from 9·7% to 6·2%, compared to the sector average of 8%, because of substantial increases in
operating expenses (15·4% in 2006 and 10·6% in 2005). There is a pressing need here for Merton plc to bring cost
of sales and operating costs under control in order to improve profitability.
Gearing and financial risk
Gearing as measured by debt/equity has fallen from 67% (2005) to 63% (2006) because of an increase in
shareholders’ funds through retained profits. Over the same period the overdraft has increased from ￡1m to ￡8m and
cash balances have fallen from ￡16m to ￡1m. This is a net movement of ￡22m. If the overdraft is included, gearing
has increased to 77% rather than falling to 63%.
None of these gearing levels compare favourably with the average gearing for the sector of 50%. If we consider the large
increase in the overdraft, financial risk has clearly increased during the period. This is also evidenced by the decline in
interest cover from 4·1 (2005) to 2·8 (2006) as operating profit has fallen and interest paid has increased. In each year
interest cover has been below the sector average of eight and the current level of 2·8 is dangerously low.
Share price
As the return required by equity investors increases with increasing financial risk, continued increases in the overdraft
will exert downward pressure on the company’s share price and further reductions may be expected.
Investor ratios
Earnings per share, dividend per share and dividend cover have all declined from 2005 to 2006. The cut in the dividend
per share from 8·5 pence per share to 7·5 pence per share is especially worrying. Although in its announcement the
company claimed that dividend growth and share price growth was expected, it could have chosen to maintain the
dividend, if it felt that the current poor performance was only temporary. By cutting the dividend it could be signalling
that it expects the poor performance to continue. Shareholders have no guarantee as to the level of future dividends.
This view could be shared by the market, which might explain why the price-earnings ratio has fallen from 14 times to
12 times.
Financing strategy
Merton plc has experienced an increase in fixed assets over the last period of ￡10m and an increase in stocks and
debtors of ￡21m. These increases have been financed by a decline in cash (￡15m), an increase in the overdraft (￡7m)
and an increase in trade credit (￡6m). The company is following an aggressive strategy of financing long-term
investment from short-term sources. This is very risky, since if the overdraft needed to be repaid, the company would
have great difficulty in raising the funds required.
A further financing issue relates to redemption of the existing debentures. The 10% debentures are due to be redeemed
in two years’ time and Merton plc will need to find ￡13m in order to do this. It does not appear that this sum can be
raised internally. While it is possible that refinancing with debt paying a lower rate of interest may be possible, the low
level of interest cover may cause concern to potential providers of debt finance, resulting in a higher rate of interest. The
Finance Director of Merton plc needs to consider the redemption problem now, as thought is currently being given to
raising a substantial amount of new equity finance. This financing choice may not be available again in the near future,
forcing the company to look to debt finance as a way of effecting redemption.
Overtrading
The evidence produced by the financial analysis above is that Merton plc is showing some symptoms of overtrading
(undercapitalisation). The board are suggesting a rights issue as a way of financing an expansion of business, but it is
possible that a rights issue will be needed to deal with the overtrading problem. This is a further financing issue requiring
consideration in addition to the redemption of debentures mentioned earlier.
Conclusion
Ordinary shareholders need to be aware of the following issues.
1. Profitability has fallen over the last year due to poor cost control
2. A substantial increase in the overdraft over the last year has caused gearing to increase

3. It is possible that the share price will continue to fall
4. The dividend cut may warn of continuing poor performance in the future
5. A total of ￡13m of debentures need redeeming in two year’s time
6. A large amount of new finance is needed for working capital and debenture redemption
Appendix: Analysis of key ratios and financial information

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(ii) AUTHORITY is the scope and amount of discretion given to a person to make decisions by virtue of the position held within the organisation. The authority and power structure of an organisation defines the part each member of the organisation is expected to perform. and the relationship between the organisation’s members so that its efforts are effective. The source of authority may be top down (as in formal organisations) or bottom up (as in social organizations and politics). In the scenario, authority is from the top and should be delegated downwards.

参考答案：A

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You will be aware of the importance of accurate resource valuation to Worldwide Minerals (WM). Unfortunately, I have to
inform. you that the reserve of mallerite, one of our key minerals in a new area of exploration, was found to have been
overestimated after the purchase of a mine. It has been suggested that this information may have an effect on shareholder
value and so I thought it appropriate to write to inform. you of how the board intends to respond to the situation.
In particular, I would like to address two issues. It has been suggested that the overestimation arose because of issues with
the internal control systems at WM. I would firstly like to reassure you of the importance that your board places on sound
internal control systems and then I would like to highlight improvements to internal controls that we shall be implementing
to ensure that the problem should not recur.
(i) Importance of internal control
Internal control systems are essential in all public companies and Worldwide Minerals (WM) is no exception. If anything,
WM’s strategic position makes internal control even more important, operating as it does in many international situations
and dealing with minerals that must be guaranteed in terms of volume, grade and quality. Accordingly, your board
recognises that internal control underpins investor confidence. Investors have traditionally trusted WM’s management
because they have assumed it capable of managing its internal operations. This has, specifically, meant becoming aware
of and controlling known risks. Risks would not be known about and managed without adequate internal control
systems. Internal control, furthermore, helps to manage quality throughout the organisation and it provides
management with information on internal operations and compliance. These features are important in ensuring quality
at all stages in the WM value chain from the extraction of minerals to the delivery of product to our customers. Linked
to this is the importance of internal control in helping to expose and improve underperforming internal operations.
Finally, internal control systems are essential in providing information for internal and external reporting upon which, in
turn, investor confidence rests.
(ii) Proposals to improve internal systems at WM
As you may be aware, mineral estimation and measurement can be problematic, particularly in some regions. Indeed,
there are several factors that can lead to under or overestimation of reserves valuations as a result of geological survey
techniques and regional cultural/social factors. In the case of mallerite, however, the issues that have been brought to
the board’s attention are matters of internal control and it is to these that I would now like to turn.
In first instance, it is clear from the fact that the overestimate was made that we will need to audit geological reports at
an appropriate (and probably lower) level in the organisation in future.
Once a claim has been made about a given mineral resource level, especially one upon which investor returns might
depend, appropriate systems will be instituted to ask for and obtain evidence that such reserves have been correctly and
accurately quantified.
We will recognise that single and verbal source reports of reserve quantities may not necessarily be accurate. This was
one of the apparent causes of the overestimation of mallerite. A system of auditing actual reserves rather than relying
on verbal evidence will rectify this.
The purchase of any going concern business, such as the mallerite mine, is subject to due diligence. WM will be
examining its procedures in this area to ensure that they are fit for purpose in the way that they may not have been in
respect of the purchase of the mallerite mine. I will be taking all appropriate steps to ensure that all of these internal
control issues can be addressed in future.
Thank you for your continued support of Worldwide Minerals and I hope the foregoing goes some way to reassure you
that the company places the highest value on its investors and their loyalty.
Yours faithfully,
Tim Blake
Chairman

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(b) Controlling variable costs
The first step in the process of controlling costs is to measure actual costs. The second step is to calculate variances that show
the difference between actual costs and budgeted or standard costs. These variances then need to be reported to those
managers who have responsibility for them. These managers can then decide whether action needs to be taken to bring actual
costs back into line with budgeted or standard costs. The operating statement therefore has a role to play in reporting
information to management in a way that assists in the decision-making process.
The operating statement quantifies the effect of the volume difference between budgeted and actual sales so that the actual
cost of the actual output can be compared with the standard (or budgeted) cost of the actual output. The statement clearly
differentiates between adverse and favourable variances so that managers can identify areas where there is a significant
difference between actual results and planned performance. This supports management by exception, since managers can
focus their efforts on these significant areas in order to obtain the most impact in terms of getting actual operations back in
line with planned activity.
In control terms, variable costs can be affected in the short term and so an operating statement for the last month showing
variable cost variances will highlight those areas where management action may be effective. In the short term, for example,
managers may be able to improve labour efficiency through training, or through reducing or eliminating staff actions which
do not assist the production process. In this way the adverse direct labour efficiency variance of ￡252, which is 7·3% of the
standard direct labour cost of the actual output, could be reduced.
Controlling fixed production overhead costs
In the short term, it is unlikely that fixed production overhead costs can be controlled. An operating statement from last month
showing fixed production overhead variances may not therefore assist in controlling fixed costs. Managers will not be able to
take any action to correct the adverse fixed production overhead expenditure variance, for example, which may in fact simply
show the need for improvement in the area of budget planning. Investigation of the component parts of fixed production
overhead will show, however, whether any of these are controllable. In general, this is not the case2.
Absorption costing gives rise to a fixed production overhead volume variance, which shows the effect of actual production
being different from planned production. Since fixed production overheads are a sunk cost, the volume variance shows little
more than that the standard hours for actual production were different from budgeted standard hours3. Similarly, the fixed
production overhead efficiency variance offers little more in information terms than the direct labour efficiency variance. While
fixed production overhead variances assist in reconciling budgeted profit with actual profit, therefore, their reporting in an
operating statement is unlikely to assist in controlling fixed costs.

 

 

 

 

 

 

 

 

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(ii) ‘No frills’ low-cost budget airlines are usually associated with the following characteristics. Each of these characteristics
is considered in the context of Oceania National Airlines (ONA).
– Operational economies of scale
Increased flight frequency brings operational economies and is attractive to both business and leisure travellers. In
the international sector where ONA is currently experiencing competition from established ‘no frills’ low-cost budget
airlines ONA has, on average, one flight per day to each city. It would have to greatly extend its flight network, flight
frequency and the size of its aircraft fleet if it planned to become a ‘no frills’ carrier in this sector. This fleet
expansion appears counter to the culture of an organisation that has expanded very gradually since its formation.
Table 1 shows only three aircraft added to the fleet in the period 2004–2006. It is likely that the fleet size would
have to double for ONA to become a serious ‘no frills’ operator in the international sector. In the regional sector, the
flight density, an average of three flights per day, is more characteristic of a ‘no frills’ airline. However, ONA would
have to address the relatively low utilisation of its aircraft (see Tables 1 and 2) and the cost of maintenance
associated with a relatively old fleet of aircraft.
– Reduced costs through direct sales
On-line booking is primarily aimed at eliminating commission sales (usually made through travel agents). ‘No frills’
low-cost budget airlines typically achieve over 80% of their sales on-line. The comparative figure for ONA (see
Table 2) is 40% for regional sales and 60% for international sales, compared with an average of 84% for their
competitors. Clearly a major change in selling channels would have to take place for ONA to become a ‘no frills’
low-cost budget airline. It is difficult to know whether this is possible. The low percentage of regional on-line sales
seems to suggest that the citizens of Oceania may be more comfortable buying through third parties such as travel
agents.
– Reduced customer service
‘No frills’ low-cost budget airlines usually do not offer customer services such as free meals, free drinks and the
allocation of passengers to specific seats. ONA prides itself on its in-flight customer service and this was one of the
major factors that led to its accolade as Regional Airline of the Year. To move to a ‘no frills’ strategy, ONA would
have to abandon a long held tradition of excellent customer service. This would require a major cultural change
within the organisation. It would also probably lead to disbanding the award winning (Golden Bowl) catering
department and the redundancies of catering staff could prove difficult to implement in a heavily unionised
organisation.
Johnson, Scholes and Whittington have suggested that if an organisation is to ‘achieve competitive advantage through
a low price strategy then it has two basic choices. The first is to try and identify a market segment which is unattractive
(or inaccessible) to competitors and in this way avoid competitive pressures to erode price.’ It is not possible for ONA to
pursue this policy in the international sector because of significant competition from established continental ‘no frills’
low-cost budget airlines. It may be a candidate strategy for the regional sector, but the emergence of small ‘no frills’ lowcost
budget airlines in these countries threaten this. Many of these airlines enter the market with very low overheads
and use the ‘no frills’ approach as a strategy to gain market share before progressing to alternative strategies.
Secondly, a ‘no frills’ strategy depends for its success on margin. Johnson, Scholes and Whittington suggest that ‘in the
long run, a low price strategy cannot be pursued without a low-cost base’. Evidence from the scenario suggests that ONA
does not have a low cost base. It continues to maintain overheads (such as a catering department) that its competitors
have either disbanded or outsourced. More fundamentally (from Table 2), its flight crew enjoy above average wages and
the whole company is heavily unionised. The scenario acknowledges that the company pays above industry salaries and
offers excellent benefits such as a generous non-contributory pension. Aircraft utilisation and aircraft age also suggest a
relatively high cost base. The aircraft are older than their competitors and presumably incur greater maintenance costs.
ONA’s utilisation of its aircraft is also lower than its competitors. It seems highly unlikely that ONA can achieve the
changes required in culture, cost base and operations required for it to become a ‘no frills’ low-cost budget airline. Other
factors serve to reinforce this. For example:
– Many ‘no frills’ low-cost budget airlines fly into airports that offer cheaper taking off and landing fees. Many of these
airports are relatively remote from the cities they serve. This may be acceptable to leisure travellers, but not to
business travellers – ONA’s primary market in the regional sector.
– Most ‘no frills’ low-cost budget airlines have a standardised fleet leading to commonality and familiarity in
maintenance. Although ONA has a relatively small fleet it is split between three aircraft types. This is due to
historical reasons. The Boeing 737s and Airbus A320s appear to be very similar aircraft. However, the Boeings
were inherited from OceaniaAir and the Airbuses from Transport Oceania.
In conclusion, the CEO’s decision to reject a ‘no frills’ strategy for ONA appears to be justifiable. It would require major
changes in structure, cost and culture that would be difficult to justify given ONA’s current position. Revolution is the
term used by Baligan and Hope to describe a major rapid strategic change. It is associated with a sudden transformation
required to react to extreme pressures on the organisation. Such an approach is often required when the company is
facing a crisis and needs to quickly change direction. There is no evidence to support the need for a radical
transformation. This is why the CEO brands the change to a ‘no frills’ low-cost budget airline as ‘unnecessary’. The
financial situation (Table 3) is still relatively healthy and there is no evidence of corporate predators. It can be argued
that a more incremental approach to change would be beneficial, building on the strengths of the organisation and the
competencies of its employees. Moving ONA to a ‘no frills’ model would require seismic changes in cost and culture. If
ONA really wanted to move into this sector then they would be better advised to start afresh with a separate brand andairline and to concentrate on the regional sector where it has a head start over many of its competitors.

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(ii) On the other hand, the job description is based on information gathered from a job analysis and defines the position and role
that has to be fulfilled. It is a statement of the component tasks, duties, objectives and standards. It describes the purpose
and relationships of the specific job together with the physical, social and economic factors which affect it. Fundamentally, it
describes the job to be done.

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(ii) The ROI of Beetown is currently 13·96%. In order to obtain an ROI of 20%, operating profit would need to increase to
(20% x $3,160,000) = $632,000, based on the current level of net assets. Three alternative ways in which a target
ROI of 20% could be achieved for the Beetown centre are as follows:
(1) Attempts could be made to increase revenue by attracting more clients while keeping invested capital and operating
profit per $ of revenue constant. Revenue would have to increase to $2,361,644, assuming that the current level
of profitability is maintained and fixed costs remain unchanged. The current rate of contribution to revenue is
$2,100,000 – $567,000 = $1,533,000/$2,100,000 = 73%. Operating profit needs to increase by $191,000
in order to achieve an ROI of 20%. Therefore, revenue needs to increase by $191,000/0·73 = $261,644 =
12·46%.
(2) Attempts could be made to decrease the level of operating costs by, for example, increasing the efficiency of
maintenance operations. This would have the effect of increasing operating profit per $ of revenue. This would
require that revenue and invested capital were kept constant. Total operating costs would need to fall by $191,000
in order to obtain an ROI of 20%. This represents a percentage decrease of 191,000/1,659,000 = 11·5%. If fixed
costs were truly fixed, then variable costs would need to fall to a level of $376,000, which represents a decrease
of 33·7%.
(3) Attempts could be made to decrease the net asset base of HFG by, for example, reducing debtor balances and/or
increasing creditor balances, while keeping turnover and operating profit per $ of revenue constant. Net assets
would need to fall to a level of ($441,000/0·2) = $2,205,000, which represents a percentage decrease
amounting to $3,160,000 – $2,205,000 = 955,000/3,160,000 = 30·2%.