Case Study-QA321

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Financial Management Case Study
 

Group Work Protocol
 
The following group work protocol is required to satisfy the by-laws on assessment tasks of the Faculty of Business at UTS.
 
Group work and group assignments are an important part of business education. The purpose of group work goes beyond the requirements of the group project itself. Group work is also intended to develop awareness of the dynamics of teamwork and your role in a team environment. In undertaking group work it is expected that each team member will communicate with other team members in a professional and courteous manner. Resolving any conflict or difficulties that arise within the team is also part of the group dynamics that may emerge during the project. It is expected that each team member will take responsibility for managing and reducing any conflict that may arise. After group membership is decided, you must clearly communicate any dissatisfaction with a group member for non-contribution (or other reasons) directly to them before any decision to eject the group member is taken by the other members. If the team members are unable to resolve tensions or conflicts then this MUST be discussed with the lecturer as soon as it becomes obvious that a resolution within the team cannot be agreed.
 
In the learning environment of group work we are seeking to ensure that you develop and demonstrate both academic skills and important group work skills such as:
 
• Commitment to working with others (eg, undertaking a fair share of the work, sharing ideas, doing the tasks allocated, attending meetings)

• Collaboration and inclusiveness (eg encouraging and supporting others, respecting others; recognising the skills and valuing the contribution of others, helping resolve conflicts)

• Contribution to establishing and working towards a common outcome (eg establishing and supporting team goals, plans, rules, roles, decisions)

 

Case Study

 
Western Distributors
 

Earlier this year Grace Best, the Managing Director of Western Distributors, was making one of her regular inspections of one of the company’s three warehouses and its diversified inventory. On this trip her daughter Kathy was with Grace. Kathy had just completed her MBA at UTS, with a High Distinction in Financial Management. Grace was complaining to Kathy that “this is a complete mess, something must be done or we will go out of business. The family has put the decision off for too long”. The decision Grace was referring to is a decision to consolidate the warehouses.
 

Western Distributors is a family-owned company, started soon after Grace’s father migrated to Australia from Dublin in the late 1930s. Its had a long-established reputation that enabled it to move from just a small distributor in western Sydney to a large operation in 2017, with annual sales over $42 million. The company now has three divisions all involved in distribution of imported goods. The main division distributes clothing from the original warehouse in Parramatta, which also doubles as the head office. The second division distributes a variety of household items such as carpets and curtains through a rented warehouse in Liverpool. The third division distributes small electrical goods from South East Asia and is located in Blacktown.
 

Grace told Kathy that the company employs around 200 people, over three-quarters of them are employed in the warehouse distribution network and the remainder are administrative and head office staff. Western Distributors owns its Parramatta warehouse, which is an old building. Other buildings in the area have been demolished to make way for modern, medium density housing. Western Distributors occupies the entire building. Grace told Kathy that she thinks the building has some good points but lately it has been getting harder to avoid conflicts with the residents living in the area and the maintenance costs are high. In addition the building needs to be updated with air-conditioning and needs to satisfy new OHS fire regulations.
 

Grace’s Dilemma
 
As mentioned, currently Western Distributors has three separate locations, these are the Parramatta head office, Liverpool and Blacktown warehouses. In preliminary planning for the consolidation Grace has purchased a non-refundable option to buy land for a distribution centre in western Sydney. Presently none of Western Distributors’ locations are suitable for dispatch and receipt of large quantities of stock because they are unable to use modern materials handling equipment and they cannot get large containers into the premises. Delivering stock from the warehouses to the client locations is time-consuming because it can require up to three separate stops collecting goods before delivery. Sometimes urgent deliveries are sent by taxi as the trucks are all busy taking half full loads from one location to another. Also, the turnaround time is too long.
 

The multiple locations of warehouse space and holding an average level of inventory valued at $4.2 million require a large amount of handling. The supervision of warehouse and distribution activities has become more and more difficult. Grace told Kathy that operating expenses have become a major issue because they are growing at a faster rate than sales. Grace estimates that they will be able to have a once off immediate reduction in the holdings of inventory of $800,000 if the consolidation goes ahead. This would save Western Distributors $68,000 a year in interest using the current bank loan rate of 8.5%pa.
 

Another issue is that the three locations are causing major problems with deliveries. For example a customer may receive stock from both the Parramatta and Liverpool locations. This can involve two deliveries with trucks usually half full. Charging the customer for two deliveries results in customer frustration and lost sales.
 

Grace told Kathy that even experienced staff have difficulties understanding the broad range of products that Western Distributors hold. Staff are unable to tell a customer if a certain item is stocked. Grace feels that if they could see the broad range of stock, staff performance would improve considerably.
 

Grace’s discussion with Kathy revealed that having three separate warehouses is the most serious obstacle to the good management and future progress of the family company. Grace thinks that the consolidation of operations into a single new location close to good transport links is a desirable long-run goal for the company. Grace has made some preliminary investigations into alternative arrangements, expected benefits, construction costs, building sites and has some ideas on sources of finance, and has asked Kathy to help her conduct a proper financial analysis using the practical skills she developed studying at UTS.
 

Grace’s Findings
 
Grace has asked the bookkeeper of Western Distributors, Barney Grumble, to submit a preliminary report on the expected savings from the firm consolidating its operations. This includes savings in inventory, reduced lost sales and rental costs. The bookkeepers’ report partly presented in Table One shows the savings to be significant. Barney advises Grace that Meriton’s offer to buy the Parramatta property will allow Western Distributors to reduce its current interest-only bank loan of $25 million by $10 million. Grace and Barney have estimated that the increased sales with the move would be $720,000 in the first year and $1,400,000 a year thereafter.
 

Cost associated with consolidating
 
Grace has engaged the consultant and architect Montgomery Burns to examine the existing operations and come up with a recommendation for a suitable new warehouse and location. Grace also asked Montgomery to look into the efficiency of use of the current space. Montgomery’s findings show that Western Distributors is only 65% efficient in the use of its current space. This confirms Grace’s thoughts that the current Parramatta building is totally unsuitable for renovation due to the undesirable characteristics of the current layout. The recommended design is for a total floor area of 180,000 square meters of which 170,000 meters would be used for warehouse and the balance would be office space.
 

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The plan to consolidate all warehouse locations into one location means that Western Distributors would eliminate double delivery costs currently borne by Western Distributors. Grace’s discussions with the Chamber of Commerce informed her that the best location for the warehouse would be at the junction of the F7 and M4 motorways. Grace is so confident this is the ideal location that she has already purchased a non refundable option to buy land suitable for their needs. In addition, being on the motorway junction will make it easy to transport goods. The estimated building, fit out cost, comprising fixtures and fittings for such an area is around $3.65 million depending on the building. However the architect has qualified this estimate by saying, depending on the site, it may be $1 million more or less than this figure. Mr Burns advises that in line with industry standards, the warehouse would have to embark on a refurbishment cycle replacing the outdated fixtures and fittings at the end of year 10. The cost of the refurbishment in 2017 dollars is $1.35 million. Mr Burns has already been paid $613,000 for their work to date.
 

Grace’s non-refundable option over the block of land has excited her immeasurably. She has reached agreement on the terms of purchase. The best part about all this for Grace is that there would be no rental contracts and annual rental increases. Grace thought the purchase figure sounded quite reasonable and the $20,000 spent on the non-refundable options contract was well worth the risk of not going ahead. The major costs associated with the new building are listed in Table Two. Barney the bookkeeper has informed Grace that the consultants and architect’s cost should be spread over the 20-year life of the project. This includes the $613,000 already paid and the $560,000 for the final design of the warehouse.
 

Kathy has suggested that part of the reason for consolidating was to better manage stock. This will require the upgrade of their computerised inventory control system and IT software estimated to cost $850,000. Kathy and Grace discussed the relocation issues and Grace estimates that their current computer and inventory control system is fully written off and is now worthless. In addition both Barney and Kathy agreed the computer inventory software system will have to be upgraded/replaced every five years to keep Western Distributors up to date. The upgrade/replacement cost will be a constant $850,000 and there will be no sale value for the old software. Also the fixtures and fittings in the current space have to be left behind if they vacate the premises. The fixtures and fittings are all obsolete and are in serious need of modernising anyway. Kathy reviewed Western Distributors’ asset register and discovered that the current book value is zero.
 

Additional Information
 
1. The bookkeeper has advised that the costs and benefits have not taken into account inflation which is estimated at 3% pa for the next 20 years.
2. All dollar figures are in constant 2017 dollars.
 
3. Western Distributors is a profitable company paying tax at the company tax rate of 30%. Grace believes it is going to remain so for many years to come.
4. Consistent with management accounting procedures, Western Distributors depreciates all assets over 20 years straight line to zero.
 
5. If they consolidate, a delivery vehicle will become surplus to requirements and will be sold. This vehicle has been fully depreciated to zero for tax purposes, however it has a book value of $5,300 using Western Distributors management’s depreciation method. The vehicle can be sold today for $5,300.
6. For taxation purposes all fixtures and fittings can be depreciated over 20 years straight line. Computer software can be depreciated straight-line over five years. Buildings can be depreciated over 40 years straight line.
 
7. All outdated fixtures and fittings and computers have no scrap value.
8. Building renovations at Parramatta in 2011 that cost $2.6 million were claimed as a tax expense when paid in 2011. However Barney has advised this expense has been amortised over a ten year period starting in 2012 in accordance with Western Distributors’ management reporting procedures. If the consolidation goes ahead then Barney would have to bring to account the remaining balance in the management accounts.
 
9. Western Distributors’ previous investment decisions have used a real required rate of return of 15%pa. and a 20-year period of analysis. The bank loan rate is 8.5%pa.
10. Consultants and architect fees can be claimed as a tax deduction when paid.
 
11. The Parramatta land was bought prior to the 1986 introduction of capital gains tax and can be sold tax-free. This ruling has been confirmed by Western Distributors tax accountant in discussion with the tax office.
12. Rental increases at the current warehouses are only in line with inflation.
 
13. Land prices are not expected to change in real terms over the life of the project. Buildings can be sold for the original construction cost in 20 years time. Fixtures and fittings have no value after ten years.
 

Your task
 
Kathy has asked you to help prepare a report for Grace that includes an executive summary, a page of major assumptions used in preparing workings and recommendation. Kathy has also asked you to include a spreadsheet which should itemise all the cash flows for the project. Kathy is also concerned about how Grace sees her work and the recommendations about the project. Kathy wants to impress Grace and has asked you to include in your report other information and workings on other factors that Grace should consider.
 

QUESTIONS
 
1. Identify the incremental cash flows for this project (ie produce a table of the incremental cashflows for capital budgeting analysis).
Use the supplied Excel spreadsheet for this task. Failure to do so will cost you marks

2. Write a brief executive summary to Kathy with your recommendation. Include a summary of your workings supporting your recommendation.
Make sure you look at the guide to writing assignments on how to do an executive summary. The executive summary must not be more than one page in length

3. The bookkeeper used the Accounting Rate of Return as an indicator of the merit of the move to the new facility. Is this decision criterion the one that should be used? Give reasons why you would use this criterion and one why you would not.

4. What others factors should Western Distributors consider?
 

Table One
 
Extract of Bookkeepers’ Report
 

1. Labour Savings
 
a. Elimination of duplications – saving 52 hours per week.
b. Elimination of delivery vehicle drivers – savings 70 hours per week
c. Reduced transportation time – savings 39 hours per week
Total hours saved per week 161. Average salary of $720 for a 38-hour week plus on costs of superannuation, workers compensation and payroll tax of 24%.

 
Total Labour savings = 161* (720/38) * 124% * 52 = $200,796
 
2. Elimination of One Delivery Truck.
 
Current running cost of the truck is $2.67 per kilometre and is driven approximately 26,700 km a year

Total truck savings 26,700 * 2.67 = $71,289
 

3. Rent on Space Currently Leased
 
Current annual total rental on all rented space is $2,335,000

 

4. Cost of Space Currently Owned
 
The head office building over its sixty plus year life has had a number of renovations. The original cost of the building has been fully written off for taxation purposes. However Barney has reminded Grace that the last building renovation in 2011 costing $2,600,000 is being amortised over ten years. This building was bought well before capital gains tax was introduced. Current annual operating costs of the building are $1,752,000. At the bank loan rate of 8.5% pa, the opportunity cost of the funds tied up in this land and building (using a current market value of $6,700,000) is $569,500.
 
The head office is located on land that was bought back in 1939 when Grace’s daddy first arrived in Australia. He paid £780 for the land. Grace has calculated the purchase price in today’s dollars at the bank loan rate of 8.5% pa equates to $313,370. Recently Meriton Apartments has offered to buy the building and land for a total of $6,700,000.

Annual running operating costs $1,752,000
Opportunity cost of land and Buildings 6,700,000 *8.5% = $569,500

Total Savings $569,500 + $1,752,000= $2,321,500

 

Table Two
 
Costs associated with consolidating
 
Purchase land $789,000
Construction of warehouse 2,300,000
Fixtures and fittings 1,350,000
Pre paid non refundable option contract 20,000
Computer software -inventory management system 850,000
 

Annual operating costs 5,678,000
 

 
Product code: Case Study-QA321
 
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