Solution to ICAN May 2015 Case Study- Part1/2 RE-UPLODED

To: The Finance Director, Ice Age Manufacturing Limited
A (draft) Report on the Value Chain and Financial Position of Ice Age Manufacturing Limited
Prepared by: Dawodu & Dawodu (Chartered Accountants)
Date: 24th May, 2015
Disclaimer
The report has been produced for the sole use of Ice Age Manufacturing Limited (IAML). No liability is accepted except to the Directors of Ice Age Manufacturing Limited.
1.      Value Chain of  Ice Age Manufacturing Limited
a.      Wider context
IAML is an un-listed company. Therefore, it is not subject to pressure from the stock market to increase its profits. There is also a lower amount of pressure on it to pay dividend from its earnings.
b.      Inbound logistics
i.                    Suppliers

IAML suppliers are on very good terms with it and are willing to continue their trading relationship. This makes it less likely that IAML will experience a shortage of raw materials. These good relationships may be a possible reason for the absolute increase of IAML’s gross profits from N2.739m in 2013 to N3.27m in 2014.


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ICAN CASE STUDY- Use of Information (with Audio lecture)

ICAN CASE STUDY- Use of Information
This is an area where it is extremely easy to either gain or lose marks. The use of information marking boxes requires you to use information in the various exhibits in the question paper to justify your figure or point.
Requirements 1 and 2 always have their individual use of information boxes. So, this is an opportunity to score ten marks because each box is worth 5 marks.
Exhibit 1 is usually the letter in which you are told what to do.  No mark has been awarded in past for using information in this letter.
The other exhibits provide information that will help you to answer the question. The financial statements are part of these exhibits. It is these exhibits that you must use.


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Let’s have a look at past Use of Information boxes
MAY 2015
NOVEMBER 2015
•  Uses (Ice Age Manufacturing Limited’s
(IAML’s) financial statements
-  Profit or loss statement
-  Statement of financial position
•  Uses  notes  on  IAML’S  financial
statements (Exhibit 4)
•  Uses information in email from IAML
(exhibit 2)
•  Identifies wider context for IAML’s
business
-  A  non-listed  company  (market
expectations)
• Uses MNC’s Financial Statements:
- Income statement
- Statement of financial position
• Uses other relevant information
(Exhibit 4)
• Uses information in Chairman’s
statement
• Uses information in letter from MNC
(Exhibit 2)
• Identifies wider context for MNC‟s
business - A non-listed company
(market expectations)



i.                    NOV 2014
This exam deviated from the trend due to the nature of the requirements.
Section 1 was purely a calculation requirement. So, marks were awarded for following the right steps in calculating the required figure and using the correct numbers to calculate the figure.
 Despite this, there were 2 marks available for using FS information and using information another exhibit. This shows that some boxes can not be predicted with 100% accuracy. The most important thing is to do what the question says.
In section 2, there were available marks for using information in the financial statements and analysing the wider context of the company. You will score the other points if you do what the question says. So, the question is king.
No matter what ICAN sets, there is always a mark for using information in the financial statements for the two sections. That’s a guaranteed 2 marks.
ii.                  How to use information
The information should be used in your explanations. This means in most cases, there is no “correct” explanation. Most marks for explanation are flexible.
Example
In your appendix, you calculated NP margin to be 10%, GP margin to be 5%, ROCE to be 3%.
After transferring these figures to your report, you have to explain them (I will explain this more in another post). Here’s a sample:
Net profit margin
Net profit margin was 10%. This was probably due to the increase in Company XYZ’s profit(you have used information in the profit or loss).
GP margin
Gross profit margin was 5%. This is probably due to the fact that Company XYZ’s workers went on strike(this information must be in another exhibit for you to score another mark).
Before you solve requirement 1 or 2, jot down the list of exhibits somewhere(excluding exhibit 1). Tick this list as you use information in these exhibits.
iii.                Notes
For the purpose of this exam, they are not part of the financial statements. So, just assume the notes are a different exhibit. This is because there might be a separate mark for using information in it.
iv.                Financial statements
This is divided into SOP/L and SOFP. If you use information in the SOP/L, you score 1/2. The same applies to information in the SOFP that you use.
One thing I want you to note is that in a ratio-analysis section, you automatically use information in the financial statements. This is because some ratios use SOFP and SOP/L figures. For example, ROCE picks PBIT from SOP/L and Capital Employed from SOFP.
v.                  Wider context
This section of the report doesn’t have to be long. What you do here is to look at the company from a strategic point of view.
The companies in MAY and NOVEMBER 2015 were private companies, so, a mark was awarded for stating that they under less pressure to pay dividend/make high profits, e.t.c.
The wider context for the company should be explained in requirement 1.
The wider context for the company’s business environment should be described in requirement 2. You will explain how the company’s competitors, industry, customers, e.t.c. will be affected by anything the company wants to do. 
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ICAN Case Study- Models(with audio lecture)

ICAN Case Study- Models
1.      Elements
If you correctly identify the elements of the model they asked you to use, you automatically get 5 marks. For example, if SWOT analysis is required and you talk about Strengths, Weaknesses, Opportunities and Threats in your report, that’s an easy 5 marks. Here are past marking boxes:
November 2014
May 2015
November 2015
Performs PESTEL analysis
• Political factors
• Economic factors
• Socio-cultural factors
• Technological factors
• Ethical factors
• Legal factors
• Identifies the inbound logistics issues
•  Identifies the operational issues
•  Identifies the outbound logistics issues
•  Identifies the marketing and sales issues
•  Identifies the service (after sales) issues
• Identifies the financial perspectives
issues
• Identifies the customer perspectives
issues
•  Identifies the learning and growth
perspectives issues
• Identifies the internal processes perspectives issues
• Identifies the ratios relevant to MNC’s industry that need to be computed

In November 2014, PESTEL was required, so writing about the elements of PESTEL was worth 5 marks.
The required model in May 2015 was the Value chain model. Just writing about the elements of the value chain diagram was worth 5 marks.
In May 2015, the required model was the balanced scorecard. Correctly identifying and writing about its elements was worth 5 marks.
Note, what you write should be relevant to the case.
Remember
You only need to score four points to get your full 5 marks. So, if you only remember the Political, Economic, Legal and Technological components of PESTEL, you will still get your full mark for writing something about them (that is relevant to the case ooooooo)
Conflict
In some situations, a point can be includes in two or more elements of a model. For example, tax is a political factor and a legal factor.
In this case, there’s no need to repeat your point. You can either choose to put tax under political or legal factors.
Conclusion
If you learn all the relevant models, you are guaranteed 5 marks.
2.      Limitations
There’s always a mark for identifying the limitations of the required model. So, learn them as well. For example, a limitation of balanced score card is that you may sweat before preparing it.
3.      Alternative model
Also, there’s always a mark for suggesting another model that you can use instead of the model they asked you to use. For example, Value chain can be used instead of SWOT.
4.      Diagram
You can score another mark by drawing the model’s diagram in your appendix.
5.      Models that could be tested
i.                    SWOT
ii.                  PESTEL
iii.                Strategic planning model
iv.                Three levels of strategy,i.e Corporate Strategy, business strategy and functional strategy
v.                  Strategic lenses
vi.                Mendelow’s Stakeholders’ mapping
vii.              Types of culture- Charles Handy
viii.            Strategic cultures- Miles and Snow
ix.                The cultural web
x.                  Key drivers of change in the business environment
xi.                5 forces
xii.              Porter’s diamond
xiii.            Nine Ms model e.g men, money, e.t.c.
xiv.            Value chain
xv.              Value network
xvi.            Product life cycle
xvii.          Ansoff’s matrix
xviii.        Porter’s generic strategy
xix.            Strategic clock
xx.              BCG
xxi.            Strategic rationale- Johnson and Scholes
xxii.          Ashridge Portfolio
xxiii.        Marketing mix
xxiv.        Business process re-engineering
xxv.          Harmon’s process strategy matrix
xxvi.        Mintzberg’s structural confihurations
xxvii.      Force field analysis- Lewin
6.      How do I learn all these models?
A good way to learn them is by looking at them over and over again. Some people can sing all Wizkid’s songs from A to Z simply because they have listened to his songs many times.
I think you should use ACCA’s P3 materials. You can also jot small notes on the models that you can easily go through over and over again.
7.      Additional cheap marks.
In May 2015 and November 2015, ICAN dashed more cheap marks for the required model
November 2015
May 2015
• Recognises the Balanced Scorecard Model
• Considers the four perspectives of the model
• Considers the usefulness of the model
•  Applies the model using information
from the case
•  Recognises the Value Chain Model
•  Considers the primary activities of the model.
•  Considers the support activities of the model
•  Applies the model using information
from  the  case  to  determine  the company’s strengths and weaknesses

i.                    Recognising model
A very very simple mark was available for just using the model when writing the report.
ii.                  Full model
I said that you can get 5 marks in the previous marking box without knowing the full model. In this second box, ICAN awarded marks to students that explained all the elements of the required model in their report.
In November 2015, an additional mark was awarded for explaining the four perspectives of the balanced score card.
The value model is divided into primary and secondary activities. In May 2015, 1 mark was available for explaining the primary and secondary activities.
iii.                Applying the model to the case
The question will tell you what to use to model for. If you do what question says you should do, you will automatically get this mark.
iv.                Usefulness of the model
In November 2015, 1 mark was available for stating the advantage of using the Balanced scorecard. This is the only time that a mark has been awarded for doing this. Despite that, try to state the advantage(s) of the required model in your report.
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8

Full solution to ICAN CASE STUDY-NOV 2015

Report
To: The Finance Director, Magic Network Communications Limited
A (draft) Report on The Strategic Performance and the Call Centre of Magic Network Communications Limited
Prepared by: Phoenix-Adele Global Partners
Date: 19 November, 2015
Disclaimer
The report has been produced for the sole use of Magic Network Communications Limited . No liability is accepted except to the Directors of Magic Network Communications Limited.
1.      Strategic Performance of Magic Network Communications Limited
i.                    Wider context
MNC is an un-listed company. Therefore, it is not subject to pressure from the stock market to increase its profits. There is also a lower amount of pressure on it to pay dividend from it earnings.
This will change when it obtains a stock market listing.
ii.                  Financial Perspective
a.       Net profit margin (Appendix (number/letter/roman numeral-whatever you use to number your appendix)) e.g Appendix 1
MNC’s net profit margins were 5.5% and 8.1% in 2015 and 2014 respectively. This represents a fall. (sometimes, there may be different marks for stating the ratio and stating whether or not it increased or decreased)
This fall is probably due to the fall in MNC’s service rating form 7.9 in 2014 to 5.7 in 2015.(justify every figure)
b.      Current Ratio
MNC’s current ratios were 0.5:1 and 0.8:1 in 2015 and 2014 respectively. Its current ratio fell. This implies that MNC’s liquidity was poorer in 2015.
The fall was probably due to the sharp rise in MNC’s current liabilities from N73.41bn in 2014 to N105.67bn in 2015.
c.       Gearing
MNC’s gearing was 32.2% and 0% in 2015 and 2014 respectively.  The gearing rose.
A possible reason for this is that MNC took on some debt to finance its investment projects.
d.      Operational Cashflows
MNC’s operational cashflows were N134.34bn and N55.35bn in 2015 and 2014. This represents an increase.


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Foreign exchange risk management(Part 3)- Hedging with options

Foreign exchange risk management(Part 3)- Hedging with options
1.      Foreign exchange option
This is an instrument that gives you the choice as to whether to buy/sell a foreign currency at a future date. An instrument is a sheet of paper that evidences something. If you buy options from someone, the documentary evidence is an “instrument”.
2.      Choice
It is not compulsory to exercise your option. You will only do so if it is favourable to you unlike a forward contract.
 For example, Liverpool has an option to buy Jordon Ibe back from Bournemouth. They will only exercise this option if Ibe’s market value rises higher than the option’s exercise price. That’s one of the reasons Madrid bought Morata back.
3.      Premium
A premium must be paid if options are used. This premium can be very expensive. That’s what discourages companies from using options to hedge.
 The premium is the maximum loss that can be suffered due to hedging using options.
4.      Types of Options
a.      Call option
A call option gives you the right to buy a foreign currency at a fixed exchange rate and at a future date.
b.      Put option
This gives you the right to sell a foreign currency at an agreed exchange rate and at a future date.
Call=buy, Put=sell
5.      Exercise/strike rate
The is the exchange rate at which you can choose to sell/buy a foreign currency at a future date. It is the rate stated on the option’s instrument.
6.      In-the-money option
An option is in-the-money if you will gain from exercising it.
7.      Out-of-the money option
An option is out-of-the-money if you will lose due to exercising it. It will not make sense to exercise this option.
8.      At-the-money option
Exercising this option will neither lead to a gain or loss.
9.      Gain/loss
This can be measured at any day. It is not only at the exercise date that you can measure whether an option is in/out/at the money.
Example
You bought a call option on Monday to buy a Dollar on Thursday for N350
The spot rates were N300, N350 and N400 on Tuesday, Wednesday and Thursday respectively.
On Tuesday, the option was out-of-the money because you could buy a dollar at a cheaper price in the FOREX market.
On Wednesday, the option was at-the-money because the strike rate was equal to the spot rate. So, no gain, no loss.
The option was in-the-money on Thursday because the you could gain by exercising it. If you exercised it, you will have bought a dollar at cheaper price than you could have bought it in the FOREX market. So, your gross gain will be N50.
 To get your net gain, you have to deduct the option premium you paid.
10.  Exchange-Traded Option
This is an option that you can buy in the market. The market for options is known as the options- exchange just like the market for futures is the futures exchange.
11.  Over-the-Counter Option
This is an option that you buy from the bank. The calculation for this one is more straight-forward.
12.  Relative merits of exchange traded-options
i.                    They can easily be sold in the market if not required
ii.                  No time is wasted negotiating with a bank
13.  Relative merits of Over-the-counter options
i.                    They can be used for exact-hedging
ii.                  Can be used to hedge larger amounts and and hedge for longer periods of time
14.  Hedging
If you buy a dollar, you give out naira. That means that you are selling Naira. The currency you receive is what you are buying and the one you give out is what you are selling.
15.  Question- Over-the-Counter Option
You have an Over-the-Counter put option to sell $1000 at N200/$1. The option premium is N5,000. Determine the amount of Naira you will actually receive  if the spot rate on the exercise date is N250/$1?
You have to option to sell the dollars at the rate of N200/$1. The means that for every dollar you sell, you will receive N200.
The price at which you can sell the dollars in the market is N250/$1. You can make more money by selling the option in the market, so, the option shouldn’t be exercised.
When you eventually sell the $1000 in the market, you will makeN250,000. This is your gross receipt
When hedge with options, you must always deduct the option’s premium determine your net payment or receipt. Your net receipt will be N245,000(N250k-5k). this is what you will go home with.
Premium reduces your receipt because it’s a bad thing and a gain is a good thing. The premium will be added to your gross payment because they are both negative figures.
16.  Question- exchange-traded option
A European company owes a US supplier $1,000,000 payable in August. The spot rate is $1-$1.1=E1
The details for $/E E50,000 options (cents per E ) are as follows.
Premium cost per contract
                            Calls                                    Puts
Strike price        June    July   August  June  July  August
1                        6.34     6.37    6.54     0.07   0.19   0.50
1.05                   3.86    4.22    4.59     0.08   0.53   1.03
1.1                     1.58    2.50     2.97      0.18   1.25   1.89
Show how traded currency options can be used to hedge the risk at a strike price of $1.05/E1. Calculate the Euro cost of the transaction if the spot rate in July is $1.3-$1.4 to 1 euro

First of all, the company will have to pay Dollars in May because it is owing $1m. To pay dollars, it has to buy dollars and sell Euros. The question said we should determine the Euro cost, so, we have to think in terms of Euros. So, it will be selling Euros. Since, it will sell Euros, a put option should be bought.
         The option price of $1.05 means that the company has the choice to sell 1 euro for $1.05.
In the market, the company can sell 1 euro for $1.3. This is because the bank will buy at the cheaper rate.

Therefore, the option is out of the money and should not be exercised. Euros should be sold in the market.

The gross amount of euros that will be needed to pay the loan is $1m/$1.3=E0.769m. Now, let’s calculate the option’s premium.

The formula for calculating the option’s premium is=
Contract size*Number of Contract s*Premium cost/contract

We will use the table to calculate the option.
The first thing is to determine the number of options to be bought.
The formula is Transaction amount/Option value
The option value is E50k and the transaction amount amount is $1m. These two figures must be in the same currency. The option value is a fixed amount, so, the transaction amount has to be translated to Euros. The strike rate of the option was bought will be used because the $1m will be paid on the exercise date of the option.
$1m/$1.05= E0.952m.
So, number of contracts= E0.952m/E0.05m= 19.04 contracts. The number of contracts should be approximated to a whole number. This is because, you can either buy 0/1/2.... contracts. You can not buy half. So, the number of put options to be bought is 19.

The date of the put option should be the payment date. So, 19 August put options will be bought. This makes every non-August figure in the table irrelevant.
Next, we use the exercise price to determine the premium. The exercise price is $1.05/E1. Go back to the table and the pick the premium.
The premium is 1.03 cents/Euro. It is cents and not Dollars, go back and read the sentence before the table.
We have to convert this to dollars. 100 cents are equal to 1 dollar. So, 1.03 cents are equal to $0.0103. This is the premium cost/ dollar. We now have everything we need.
Total premium= $0.0103*19 contracts*E50,000=$9,785.
The currency of the premium is the currency of the premium/contract. In this case, it was dollars.
The question asked for the Euro cost of the transaction, so, this premium has to be converted to Euro. Premium is paid when the option is bought. So, the spot rate on that date will be used.
The premium is quoted in dollars. So, you have to buy dollars to pay it. Therefore, you have to sell Euros to the bank to buy dollars.
The bank will buy your euros at the cheaper rate, so, the exchange rate for the premium is $1.
The convert the premium to Euros= $9,785/$1= E9,785.
The net cost in euros will be the gross cost+premium= E769,000+E9,785= E778,785.
17.  If the option is exercised
In the above example, the option was not exercised because it was out-of the money. Assuming the option is exercised:
 the gross payment= Number of options*option value=19*E50,000=E950,000. The premium will be deducted as usual.

The gain/loss incurred due to not using usual the exact number of contracts required also has to be added/deducted. The gain or loss= transaction value-gross payment. These two figures must be in the same currency.
The transaction value is $1m.

The gross payment is E950,000. This payment will actually be made on the exercise date of the option, so, the exercise rate will be used to translate it to dollars.
=E950k*1.05=$997.5k.
The gain earned due to hedging using the options is $1m-$0.9975m=$0.0025m
So,net cost= E950k-25k+9.785k= E934.785k.
The premium remains the same. The gross payment is standardized and you have to determine any net gain/loss

18.  Conclusion
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