Distinguishing Business Terms

Distinguishing Business TermsPart A

Explain each of the following terms: Investment decision, financing decision and distribution decision. Your answer must distinguish between these terms, explain the linkages between them.

Answer:

Investment decision

Investment decision in the context of corporate finance refers to an agreed course of action by the corporate entity, embodying current outlays in return for a stream of economic benefits in future years. However, it is pertinent to note that corporate entities always intend to realize inflow of economic benefits in exchange of outflow of economic resources. Hence, the investment decision is regarded as the key business activity because of the anticipated risks associated with the expenditure that might unable to be recouped over the period. There are two types of investment decisions that are distinguished solely on the basis of time; that is the short-term and long-term investment decisions also known as “capital investment”. Short-term decisions are those that involve a relatively short time horizon, say one year, from the commitment of funds to the receipt of benefits. CITATION Arn05 t l 1033 (Arnold) On the other hand, capital investment decisions are those decisions where a significant time period elapses between the outlay and recoupment of the investment. CITATION Dav10 l 1033 (Hillier)Business entities’ investment decisions include investments in plant and machinery, research and development for innovation, advertising and warehouse facilities. CITATION Jon11 l 1033 (Jonathan Berk)In making capital investment decisions, the entities use certain appraisal techniques which indicate whether it will be a lucrative investment or not; commonly include, the pay-back period, net present value using discounted cash flows, accounting rate of return as well as internal rate of return.

Financing decision

Financing decision is the planned action of the corporate entity for raising the funding as and when required to be ventured in the business. Since businesses always run on the availability of adequate funds in the form of cash such as to support the investments, and for managing operational requirements. CITATION Ric10 l 1033 (Richard A Brealey)Therefore, corporate entities use financing decision as a tool to figure out why, when and how the provision of economic resource in the form of cash is required and for what purpose. It is quite often, the strategic planners of the organization such as the Board of Directors that devise strategies before execution of a project that addresses these questions such why, when and how they are going to finance it. CITATION Ste11 l 1033 (Stephen Lumby)The word ‘why’ deciphers the reason for financing, whereas “when” means the timeline required for financing and “how” means the source from which the finance would be availed. The need for further financing does not arise if the entity has sufficient funds in its equity and the required funding can be met through its own equity. In contrast, if the entity does not possess adequate funds it would go for acquiring finance and for this purpose it will evaluate the amount require for finance and also as to for how long it needs financing depending upon the execution of the project and the source of finance. The source of finance is either through its own internally generated funds in the form of equity, borrowing from a financial institution such as a bank or selling of equity. CITATION Arn05 t l 1033 (Arnold)Distribution decision

Distribution decision refers to the implementation of a planned and viable mechanism adopted by the business entity intended to make accessibility of the products or service to the target market base. CITATION Arn05 t l 1033 (Arnold) In making such an important decision, the strategic planners such as the Board of Directors consider both the financial and non-financial factors. The financial factors include the amount of funds for investment and the source used for financing it (which is the linking factor between the above two decisions). However, the non-financial factors include preparation of a marketing plan intended to communicate the objectives, target market, behavioral segmentation variables and related promotional activities etc. CITATION Jon11 l 1033 (Jonathan Berk)In order to make the distribution decision, the Board should evaluate whether the decision made is both effective and efficient in terms of its functioning. The effectiveness relates to the provision of the product or a service in an accurate and good condition through a reliable ordering and delivery system. It should also facilitate for safe storage and by charging an optimum price beneficial to the customer and the entity alike in order to remain competitive in the market. In contrast, the efficiency relates to savings of cost and time in distribution of the product or service. The decision once implemented needs consistent evaluation by putting adequate efforts for improvement in the process and identification of loopholes for remedial action. CITATION Dav10 l 1033 (Hillier)Part B

Obtain the recent published accounts of a UK limited company (plc or Ltd). Using the information contained in these accounts (together with any other sources that you think may be useful – such as press reports); explain the key investment, financing and distribution decisions that have been made by the company during the year and comment on them. How do these relate to the theory in Part A? In answering this part of the requirement, it may be useful to include consideration of the following issues within the current economic climate:

What investments were made, and why?

Answer:

During the financial year 2012 ending 30 December 2012, Dominos Pizza Group PLC hereinafter referred to as “The group” carried out following key investments;

In order to boost revenue, the group has opened 69 new stores during the 53 week period ending 30 December 2012 (2011: 62) with 58 stores in the United Kingdom and 12 stores in Switzerland resulting in a total of 805 stores in four countries at the end of the year. CITATION Ann121 l 1033 (Annual Report and Accounts 2012)The group has key relationship with Domino’s Pizzas International Franchising Inc., the master of franchisor of Domino’s Pizza across the globe. During the year, the group has entered into third master franchise agreement on 24 September 2012 which relates to Switzerland acquiring 12 Swiss stores’ trade and assets of Domino’s Pizza Switzerland. The total acquisition cost was £ 4.6m. CITATION Ann121 l 1033 (Annual Report and Accounts 2012)

On 29 July 2012, the Group acquired 100% of the issued share capital of two companies, DA Hall Trading Limited and DAHT Limited. The consideration of £ 4.68m was satisfied by cash. CITATION Ann121 l 1033 (Annual Report and Accounts 2012)Investment in new commissary capacity amounting to £ 1.9m, which will now produce more pizza dough than its predecessor did and still has significant spare capacity to meet increased demand in the future. CITATION Ann121 l 1033 (Annual Report and Accounts 2012)Distribution decision by an investment in marketing activities amounting to £14.79m in TV ads, sponsorships, outdoor leafleting and also in newer tools like email, android and iPad apps, associate sites, search engine optimization, digital display and many others. CITATION Ann121 l 1033 (Annual Report and Accounts 2012)Significant cash outflows arising from investing in purchasing property, plant and equipment and investment in IT systems amounting to £4.4m. This investment primarily includes roll-out of a brand new company intranet which will provide the group’s employees with the latest news and corporate information, promoting staff engagement and increasing transparency. CITATION Ann121 l 1033 (Annual Report and Accounts 2012)Payment made to Commerzbank amounting to £ 2.2m under the arrangements of the acquisition of Domino’s Leasing Limited as well as £4.7m investment in UK joint ventures during the year. CITATION Ann121 l 1033 (Annual Report and Accounts 2012)Were there any significant disposals?

Answer:

Disposal of a subsidiary:

On 21 December 2012, the Group disposed 100% of its interest in DP Milton Keynes Limited for cash consideration of £840,000 less transaction costs of £12,000. The net assets at the date of disposal were £41,000. The gain of £507,000 has been recognized on this disposal following recognition of the loss in reserves and an accrual of £55,000 for final settlement obligations. CITATION Ann121 l 1033 (Annual Report and Accounts 2012)Who comments on these investments/disposals in the report – Chairman/CEO/CFO and why? Was finance obtained from internal or external sources (or both)? Was finance from short term or long term sources?

Answer:

The group has a 12 member Board of Directors together as an Executive Committee that comments on the aforementioned investments/disposals in their report. The Board comprises of;

S# Name Designation

1 Lance Batchelor Chief Executive Officer (Chairman)

2 Lee Ginberg Chief Financial Officer

3 Adam Batty Company Secretary & General Counsel

4 Ian Douglas Procurement Director

5 Simron Wallis Sales and Marketing Director

6 Kerri Saunders Operations Director

7 Jane Franks HR Director

8 Micheal Botha Commercial Director

9 Andrew Emmerson Business Development Director

10 Colin Rees IT Director

11 Patricia Thomsa International Development Director

12 Kory Spiroff Germany Managing Director

The Executive Committee is responsible for the day to day management of the Group’s operations within the limits contained in the Board’s delegation of authority and for delivering the Group’s strategy. During the year 2012, the Board has approved decisions pertaining to the acquisition of the Domino’s Switzerland business, further financing for franchisees, redesign for the five year strategic plan for Germany, approval of 2013 budget and operational plan, entry into two joint ventures with Franchisees in the United Kingdom and two in Germany. CITATION Ann121 l 1033 (Annual Report and Accounts 2012)The Group is availing finance from both internal and external sources as well as from short and long term sources as shown in the following table;

What were the sources of any external finance?

Answer:

Fully paid share capital

During the period, 2,386,957 (2011: 312,349) ordinary shares of 1.5625p each with a nominal value of £37,296 (2011: £4,880) were issued between 64.53p (2011: 17.19p) and 482.4p (2011: 341.00p). The total cash consideration received was of £2,594,000 (2011: £593,000) to satisfy the share options that were exercised. CITATION Ann121 l 1033 (Annual Report and Accounts 2012)Bank revolving facility – Long Term Borrowing

The Group has restructured the existing long-term borrowing revolving credit arrangement obtained from the bank amounting to £25m to £30m dated 1 August 2012. This long-term facility was fully availed as on 30 December 2012 and has a five year term. It carries mark-up at 1.35% (2011: 0.5%) per annum above London Inter Bank Offering Rate (LIBOR) in addition to a 0.5% utilization fee. All the costs incurred in relation to re-structuring of the existing finance are being included in the carrying amount of the facility and are amortized over the term of the facility; at 30 December 2012, amortization of £35,000 has been recognized. CITATION Ann121 l 1033 (Annual Report and Accounts 2012)Bank overdraft facility – Short Term Borrowing

The group has also acquired an overdraft facility from the Barclays Bank dated 5 October 5, 2012 with a maximum limit of £5,000,000 which will be used of managing short term working capital requirements. The interest is charged at 1.25% per annum above LIBOR. At 30 December 2012m there was £nil drawdown on the facility. CITATION Ann121 l 1033 (Annual Report and Accounts 2012)Is there any governance discussion of the risk relating to the investments/disposals and the impact on financing?

Answer:

Yes, the corporate governance section in the report duly discusses the associated risks with the investments and disposal and the impact on financing. Since the risk is an inherent part of doing business, therefore the Board is fully committed to identifying, evaluating and monitoring significant risks facing the business. Accordingly, the Board is updated regularly with regard to the financial structure of the group which is evidenced through strong track record of financial performance combined with effective and robust business model and seen as a strong covenant by the banks and investors. Relationships are carefully nurtured by the Board of Directors, senior management and franchise facing employees in all departments and for this purpose regular one-to-one business reviews meetings are held with each franchisee at least annually. Further, in collaboration with Domino’s Pizza master franchisors the risks relevant to commissary production issues and interruptions in supply chain are mitigated through efficient resource management. Moreover, as the group continue to invest heavily in IT systems and innovation for business efficiency and better customer experience, the implementation of disaster recovery plan and centralized electronic point of sales system serve the purpose. CITATION Ann121 l 1033 (Annual Report and Accounts 2012)Was there evidence of any finance being repaid to investors? How do this year’s dividends compare to previous years?

Answer:

Yes, the evidence of finance being repaid to investors is clearly disclosed in the group’s cash flow statement such as in case of external financing from bank repayment of long term borrowing and overdraft facility along with interest costs. However, in case of equity financing the finance being repaid is termed as dividend through profits as follows;

The equity dividends paid during the year 2012 were amounting to £ 21,746m whereas in the year 2011, total paid dividends were £18,025m which indicates the increase amounting to £ 3,721m, which is 21% more than the prior year. Further, dividend per share for the period was up 17.9% to 14.50 pence (2011: 12.30 pence). CITATION Ann121 l 1033 (Annual Report and Accounts 2012)Part C

How were the investment, financing and distribution decisions (from Part b) linked? Can you find evidence in the report and accounts of any comment on the intended strategic impact of these decisions?

Answer:

The investment, financing and distribution decisions are directly inter-linked among each other. It is obvious that in order to carry out an investment decision, there is a need for setting financing decision beforehand. Accordingly; the financing decision takes precedence because unless or until the funds are available for venturing in the business, an investment activity would not be carried out. The group has financed all of its investments through external as well as the internal source of financing. The equity and bank loan are external source of financing whereas the cash held in the bank in the form of highly liquid short-term investments. Such investments yield high interest rates on a daily basis and the working capital are internal source of financing. Both the equity and the long-term bank credit are for long-term investment projects, however the internally generated funds are for short-term investment project because of the relative materiality of the amounts. The investment decision once made needs the distribution decision that is how to get it across the target market. The group has opened and acquired new stores, enhance commissary activities but it then requires the ways to deliver the pizzas to the people accurately and expeditiously with least cost. For this purpose, the group has spent high on innovative IT systems in order to have efficiency in the business processes; information processing is centralized for adequate control purposes and decision making.

The evidence of the intended strategic impact of these decisions is found on the group’s report. The group ensures that it remains a strong credit rating and healthy capital ratios in order to support its business and maximize shareholder value. It always manages its capital structure and makes adjustments to it in the light of changes in economic conditions. To maintain or adjust the capital structure, the Group may adjust the dividend payment to shareholders, return capital to shareholders or issue new shares

References

1. Glen Arnold (2005) Corporate Financial Management, 3rd edition, United Kingdom: Financial Times/ Prentice Hall.

2. David Hillier (2010) Corporate Finance: European Edition, Kindle edition, Europe: McGraw-Hill Higher Education.

3. Jonathan Berk, Peter DeMarzo (2011) Corporate Finance, 2nd edition, England: Pearson Education.

4. Richard A Brealey, Stewart C Myers, Franklin Allen (2010) Principles of Corporate Finance – Global Edition , 10th edition, United Kingdom: McGraw-Hill Higher Education.

5. Stephen Lumby, Chris Jones (2011) Corporate Finance Theory & Practice, 8th edition, United Kingdom: Cengage Learning EMEA.

6. Dominos Pizza Group PLC (2012) Annual Report and Accounts 2012, United Kingdom: Forest Stewardship Council.