Assessment Brief
Case Study Background - Mycroft plc
Mycroft plc is a manufacturer of computer hardware and accessories (Information Technology or IT from now on).
It was established in the UK in 1975 and has become a well-established supplier to IT retailers particularly in Western Europe and North America (but has begun to make progress in selling to the African, Asian, Middle Eastern and South American markets).
This growth into a multi-national company (based from the UK) was supported by becoming a publicly listed company (plc) in 1995, listed on the London Stock Exchange.
The present Chairman of the company is Mary Morstan, who has been with Mycroft since 1988 and is the daughter of the company's founder, John Watson, who died in 2004, after which Mary became Chairman.
Mycroft's product range
The three core products for Mycroft have followed the general evolution in IT.
The company still manufactures desktop computers, although the demand for this product has been in general decline. It has a customer base which tends to be businesses, who need the higher processing power and the larger hard drive space.
For customers buying computers for personal use, the laptop has generally replaced the desktop computer in the last 10 years as the main device for IT purposes. There is a wide range of laptop manufacturers in the market but it is the product which presently makes the highest contribution to Mycroft's revenue.
The last core product is the tablet representing the shift to more mobile IT devices. This is a growth area in both the personal and business IT market and is expected to become Mycroft's main product by 2019.
Mycroft also sells a number of accessories to complement the above products including keyboards, mice, printers, laptop cases and tablet covers.
Mycroft has also been focusing on the development and launch into the market of two types of new products, which are based on making use of the increasing trends in the use of mobile IT. These are:
A hybrid (combination) of two core products, the tablet and laptop, which allows the consumer to enjoy the advantages of both products. Sales of the hybrid have been good and presently have not impacted on the sales of either laptops or tablets in their separate form.
Mycroft has also been focused on wearable technology which includes products like smart watches, and digital eyewear. These products have been popular with consumers who like to possess the latest IT products, but have also developed specific groups of consumers. For instance, the smart watches are popular with consumers who enjoy running and the digital eyewear is frequently used by surgeons in the medical sector.
Mycroft's expansion
Mycroft plc is in a two-phase expansion strategy
- Phase one - which commenced at the start of 2016 is based around supplying a new range of products to the market. (Noted above)
- Phase two - In 2018 Mycroft is seeking to take this wider range of products to make further progress in the African, Asian, Middle Eastern and South American Markets.
- The company is considering the possible options for this overseas expansion. One option would be for the company to develop production capability either in or close to these new markets. Alternatively the company could either take over a local company (through a merger or acquisition), or act in conjunction with a local company through a joint venture or alliance. All these options will be extremely expensive, and they therefore need to secure external finance. They have approached your bank (Hudson Bank) to support them.
Your role
You are Michael Lestrade, a financial analyst working for the Hudson Bank in their Loans department.
Mycroft's Chief Financial Officer (CFO), Molly Hooper, has approached your bank about giving them financial support (in the form of a loan) for phase two of the expansion strategy set out above.
The CFO has had some discussions with Irene Adler, the Head of Hudson's Loan department (set out in Exhibit 4) and presently the Bank is considering whether to initially approve the application. This is where the bank will decide in principle whether or not to lend the money. The next stage, where the amount of financing required by Mycroft is agreed with the Bank, is not relevant to this assignment.
You have been asked to analyse the financial performance and position of Mycroft and produce a report for the Head of the Loans department Irene Adler, which sets out your findings and makes a recommendation as to whether Mycroft's application for long-term borrowing should be given initial approval. This will form your UFS assignment.
You have also been asked to produce a separate report for the Head of Loans department which will focus on the operations of the company, including its management and corporate governance, its strategic plans, and the possible methods that could be adopted for overseas expansion. You will make a recommendation as to whether the company is well-run and how the loan (if approved) might best be used in the overseas expansion. This will form your Commercial Awareness assignment.
Questions
You are Michael Lestrade, a financial analyst within Hudson's Loans department and you have been asked to analyse the financial performance and position of Mycroft and produce a report for Irene Adler, the Head of the Loans department, which sets out your findings (based on the questions below) and makes a recommendation as to whether Mycroft's application for long-term borrowing should be given initial approval.
The report will help support the overall recommendation and should be structured as set out in the question requirements below.
1. Key features of Mycroft's Financial Statements
The table below is relevant to question 1a
|
Description 1
|
The audit fees from the external auditor were £3million for their audit of the 2017 financial statements.
|
|
Description 2
|
Mycroft purchased 100 3D printers for £15 million which will produce the plastic moulds for desktops, laptops and tablets sold across the next five years.
|
|
Description 3
|
Mycroft received a statement from a microchip supplier indicating that they owed the company £34 million as at 31 December 2017.
|
a. For Mycroft Plc, consider the THREE descriptions above and FOR EACH OF THEM state whether it would be shown as a transaction in the Statement of Profit or Loss (SPL) or a balance in the Statement of Financial Position (SOFP) (3 marks), and under what heading(s)
b. All three of the primary financial statements are linked together, with transactions or balances from one statement feeding into one or both of the other two. Using figures in Exhibits 1 and 2, give ONE specific example FOR EACH of how:
i. Mycroft's Statement of Profit or Loss and other Comprehensive income (SPLOCI) feeds into the Statement of Financial Position (SOFP);
ii. Mycroft's SOFP feeds into the Statement of Cash flows (SOCF); and
iii. Mycroft's SPLOCI feeds into the SOCF.
Please note that you should have a different example for each of these, and that the figure itself from the first statement might not be separately identifiable in the second statement as it might be part of a larger balance.
c. "If Mycroft consider the £300 million receivable from Great Computers to be a bad debt, the receivable will be reduced to zero, effectively no longer recognised as an asset."
Using the criteria from the CONCEPTUAL FRAMEWORK for recognising an asset, explain why the £300 million receivable due from Great Computers Ltd fails these criteria and is therefore not recognised as an asset. It will help in this question if you state the definition of an asset and the recognition criteria from the FRAMEWORK.
2. Interpretation of the Statement of Profit or Loss and other Comprehensive Income
Use the case study information to analyse and comment on the following FIVE movements in Mycroft's Statement of Profit or Loss (financial performance) in Exhibit 1 during the year 2017 compared to 2016, as required below:
- Revenue
- Gross Profit
- Other Operating Income
- Administration Expenses
- Operating Profit
Ignore the revised statements in Exhibit 5 in answering this question.
Use the additional financial information in Exhibit 2 and the relevant ratios shown in Exhibit 3 to enhance the quality of your analysis.
Taking each item in turn:
i. For revenue, other operating income and administration expenses calculate the percentage movement (trend) between 2017 and 2016. For gross profit and operating profit, compare the movement in the margin for each, as shown in Exhibit 3.
ii. Comment upon whether the movement is a positive or negative indicator of financial performance; and
iii. Use the narrative in the case study to identify and explain at least ONE reason why each movement analysed in part 3a(i) has happened.
3. Interpretation of the Statement of Financial Position
a. Use the case study information to analyse and comment on THREE movements in Mycroft's Statement of Financial Position in Exhibit 1 during the year 2017 compared to 2016. You may use the ratios in Exhibit 3 to enhance your answer.
Ignore the revised statements in Exhibit 5 in answering this question.
Taking each item in turn, for each item you select:
i. Use an appropriate financial technique (Ratio or trend analysis) to quantify the movement between 2017 compared to 2016;
ii. Comment upon whether the movement could have a positive or negative impact on the bank's decision to initially approve Mycroft's request for finance to support their expansion; and
iii. Use the case study to identify and explain at least ONE reason why each movement analysed in part 3a(i) has happened.
b. "Mycroft was unable to pay a dividend to shareholders. Instead of this payment, Mycroft made a 1 for 2 shares bonus issue". Explain the following:
i. In which TWO accounts has the Bonus issue been reflected in Mycroft's financial statements in 2017? (You may need to refer to note 2 in Exhibit 2 to help you with this question)
ii. What are the shareholders receiving instead of a dividend?
iii. Describe ONE key difference between a bonus issue and a rights issue.
c. Using the revised financial statements set out in Exhibit 5:
i. Explain how the solvency ratios (gearing and interest cover ratios) help us assess a company's financial solvency;
ii. Calculate revised liquidity and gearing ratios using the new figures in Exhibit 5; and
iii. Compare your calculation in 3c(ii) with the present liquidity and solvency ratios (Exhibit 3) and discuss whether the revised information is likely to have an impact on the bank's decision to provide financial support to Mycroft.
4. Interpretation of the Statement of Cash Flows
Consider this quote from the meeting notes in Exhibit 4:
"In previous years Mycroft has been known to be a cash-rich business (generating lots of positive cash flow from their trade) and a regular payer of dividends to shareholders. However in 2017 the company experienced a shortage of cash, which meant that it was unable to pay a dividend to shareholders."
i. Identify THREE entries in the Statement of Cash flows which indicate Mycroft is no longer cash-rich, and is experiencing an outflow of cash.
ii. Using the ratios in Exhibit 3, calculate Mycroft's Operating Cash Cycle (OCC) for 2016 and 2017
iii. Briefly explain why the OVERALL movement in the OCC calculated in 4a(ii) contributes to Mycroft's cash shortage; and
iv. Use the case study to identify and explain at least TWO reasons why the OCC movement (identified in part 4a(ii)) has occurred.
5. Professional report format
Marks are allocated for setting out your answer in the format of a professional business report.