MODULE TITLE: Global Business Economics and FinanceMODULE NUMBER: SOE1144NAME OF MODULE LEADER:

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Global Business and Finance

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To: The Board of Directors and Management of Scylace on the evaluation of two alternative proposals for building a new superstore and a proposal to make a bid for Helibed plc.

Contents

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Executive Summary PAGEREF _Toc17384119 \h 4Introduction PAGEREF _Toc17384120 \h 4Methodology PAGEREF _Toc17384121 \h 5Evaluation PAGEREF _Toc17384122 \h 6Conclusion PAGEREF _Toc17384123 \h 9Recommendations PAGEREF _Toc17384124 \h 9References PAGEREF _Toc17384125 \h 11

Executive SummaryScylace PLC seeks to expand its market reach by opening more stores. However, the company's management is faced with a challenging task of selecting two out of three competing options. The options include building two new stores in location A and location B and acquiring an established business. All three options are viable and to select two of the most viable out of the three options, then all the options will have to been evaluated. While many variables can be evaluated, they all need to contribute to more profit or reduce the cost of operation. This paper has found that the proposed superstore at location A and the acquisition of Helibeb will be the most viable options. As such, the paper recommends that the two options be implemented. By implementation, this paper means that a superstore should be constructed at the proposed location A and the acquisition of Helibeb should be executed. The reason for selecting the first location over the second location is that the first location, though more expensive to build than the superstore at the second location, it will make the company more profitable. The rate of return of the superstore at the first location will also be higher than the rate of return of the superstore at the second location. The second recommendation to acquire Helibeb instead of building a new superstore at the second location is based on the current financial state of the Helibeb. An analysis of Helibeb's financial data shows that the company's financial health has been improving by reducing the amount of debt it owes to other entities and by increasing the net profit margin of all sales.

IntroductionIn a bid to increase its market share in the area in which it is operating Scylace PLC wants to increase the number of outlets it has. It wants to do so by increasing the number of stores that it operates. It has two ways of doing so. The first one is building two new stores in the area of interest while the second way is building one store and then making an acquisition of another store called Helibeb. Helibeb is a store that is in the same industry as Scylace PLC. The method to use will depend on a lot of factors such as the cost of developing the new retail stores, the cost of developing the second retail store compared to the cost of acquiring the store that is already owned by Helibeb. The projected sales that each of the two retail stores will make annually is also a matter to be considered.

During expansion, business managers consider buying an already established business to be more beneficial than building one from scratch (Green, 2017). Some of the benefits of buying an established business include a working infrastructure, an existing customer base, inventory, distribution network, and supply chain. However, buying a business is costly hence making the final decision must ensure that the benefits outweigh the disadvantages.

MethodologyThe process of issuing bonds is a complex and tedious one as it involves several steps. In this case, the process starts with determining the most profitable options for Scylace to invest in and expand. In the previous section, it was discussed that the best option for the company is to build one store and buy another already established store so as to minimize risks (Green, 2017). In this view, the first step involves determining and comparing the profitability of store at location A with the store at location B. The formula for determining the annual profit is given as; Annual Sales Revenue - Annual Cost of Sales - Annual Staff Costs - Depreciation - Other Annual Costs= Annual profits (Annand & Dauderis, 2014). Using the data given for both locations, the annual profit for option A is 1million while that for option B is 0.66million. This means that option A will earn more for Scylase than option B. in order to compare the two options effectively, the average rate of return is used. The average rate of return (ARR) refers to the percentage rate of return projected on an investment in comparison to the initial cost. ARR is obtained using this formula; Annual Profit / Average Investment= ARR. Applying the data provided for both options, option A has an ARR of4 while option B has an ARR of 1.03. Based on this data, it is clear that option A is more profitable than option B hence Scylace should build a new store in location A. The difference in the cost of construction for the two locations becomes clear when the residual costs of the buildings are put into the account (Investopedia, 2013). In this case, the average investment is calculated using this formula; (Cost of New Superstore + Residual Value) / 2

As it has already been established, Scylace PLC will build one store at location A and then acquire Helibeb. Before the acquisition, it is vital to examine the solvency and profitability of Helibeb. The rate of return on shareholder's equity for Helibeb increased between 2017 and 2018. The rate of return on shareholder's equity is obtained using the following formula;

Net Profit After Tax 2

(Opening Shareholders' Equity + Closing Shareholders' Equity)

The decision to issue bonds as a form of financing is further reinforced by the fact that bonds are a form of debt which will have to be repaid in the future. On the other hand, equity is available in the form of shares and is not paid back but earns interest. For this reason, financing through equity is more expensive than debt. In the case of Scylase, they are better off taking the 50-year bond at a rate of 6.05 percent to finance the acquisitions of Helibeb (Galo, 2015). The 50-year bond is cheaper than the 20-year bond because of the difference in interest. It also has a higher redemption yield of 5.05 percent compared to the 3.33 percent for the 20-year bond.

In a nutshell, the decision to acquire Helibeb and build a new store at location A was arrived informed by the results obtained from the formulas applied. The application of these formulas had several advantages and a few disadvantages. One of the advantages is that they help to make data-based decisions which tend to be highly effective. Also, the use of formulas helped compare the profitability of the different options. The primary objective of a business is to make money and remain profitable in the long run. As such, the use of the formulas helped determine the best financing method that would raise the required capital and maintain the operational costs at minimum levels. However, the formulas can be misleading when the wrong data is used leading to incorrect results hence bad decisions.

EvaluationFrom the data provided about Scylace plc, it is clear that the company cannot afford to build the two superstores or to build one and acquire the other from another company. However, opting to build the two stores would expose the company to significant risks since this will be a new market will no customer base and little knowledge about the market itself. Although building the stores would allow Scylace PLC to tailor the operations into its own liking, there would be too many uncertainties involved. Such uncertainties include unfamiliarity with the customers, huge time lags for business to start making money, and the overall likelihood of success (Green, 2017). Given these factors, it is important for Scylace PLC to minimize risk exposure by building one store and buying the other from Helibeb (Trainer, 2017).

Although the aforementioned factors are important in making the final decision, the management must be guided by the company's financials as they reveal areas where the company is most exposed as well as those where there is little risk. In this view, the first consideration relates to the availability of cash flow or the ability of Scylace PLC to meet operational costs. According to the data provided, the net worth of Scylace PLC assets is PS312 million, including PS14 million in cash, with total liabilities of PS98 million. The available data also shows that the total cost of building a new store at location A will amount to PS51.4 million. This includes the cost of the new Superstore (40million), the annual cost of sales (9.1million), annual staff costs (1.2million), and other annual costs (1.1 million). In the same way, the total cost for a new superstore in location will amount to PS33.9 million. However, the available cash flow for Scylace is PS14 million and assets worth less than three hundred million. It is unclear how much of the assets can be easily liquefied or turned into cash hence the decision will be based on the cash at hand. Based on this premise, it is clear that Scylace cannot afford to open the two new locations. Looking at the idea of acquiring an existing store, Helibeb plc, it is clear that Scylace plc does not have sufficient funds to make it happen. That is because Helibeb's shareholder's equity was PS113million in 2017 and PS124million in 2018. With a cash flow of only PS14million, it would be impossible for Scylace to acquire Helibeb. To finance the expansion project, Scylace can raise money using two ways. One way is to create more shares and then sell them and the second way is by issuing bonds set to mature after a certain period. While both methods can finance the expansion project, this report recommends Scylace to issue bonds for several reasons. One of the reasons is that interest accrued on bonds is deducted from the company's income tax while the dividends earned on shares are not deducted from the company's income tax returns (Isbitts, 2018). Another advantage of issuing bonds is that they do not dilute the investor's or stakeholders' ownership of the company because they are a form of debt.

Residual value for any of the superstores is the cost that the buildings and the assets associated with the superstores will be worth after they are no longer useful as superstores. This means that a superstore that costs 40 million pounds to build has a residual value of 10 million pounds after it is no longer useful as a superstore (Annand & Dauderis, 2014). To put it simply, after Scylace PLC no longer has any profitable use for the first superstore building, it will still be worth one-quarter of its construction cost. By the end of fifty years, the building will only have depreciated some part of its value. If the depreciation is taken on a straight line, then the annual depreciation is the quotient of the cost of the building less than the residual cost. The value is about 0.6 million pounds annually. This represents a rate of depreci...