Case 2) Wholesale Trading Limited Background Wholesale Trading Limited is a wholesale private company that operates as an importer and distributor Based in Nicosia, Cyprus. The company imports mainly children toys and souvenirs. The Company's turnover for the year just ended (2018) was 4.8m down by 1.2m compared with its 2017 turnover of 6m. The drop in the company's turnover was discussed at the Board's special meeting last week. The main conclusion was that the 20% drop in the company's turnover between 2017 and 2018 was due to the poor response of the market. However it is estimated that the 4.8m turnover of 2018 will remain unchanged for 2019, thus the annual sales level is expected to stabilize The board has examined the preliminary results of 2018 in comparison to those of 2017 which clearly show substantial drop in the Earnings Per Share (EPS) of the Company. The EPS in 2018 have been half of those achieved in 2017 and of course the main shareholder, the Michael's family, which controls 80% of the share capital does not feel happy. It has always seen Wholesale Trading Limited as a milk cow for its other business activities drawing the full amount of EPS achieved every year as dividend (the company has in issue im ordinary shares of 1.00 each). Finances The audited Income Statements for Wholesale Trading Limited for 2017 and the un-audited of the last year (2018) show the following: Wholesale Trading Limited Income statement 2018 2017 Em Cm 4.80 6.00 4.50 3.60 1.20 1.50 0.15 Turnover Cost of Sales Gross Profit Selling and Distribution Expenses Administration Expenses Finance Expenses Total Operating costs Net Operating Profit (profit before tax) EPS (see note at the end of the case) 0.15 0.40 0.40 0.15 0.25 0.70 0.80 0.40 36c 0.80 72c Based on the results of 2018, the directors have discussed the possibility of increasing the profitability of the business by looking at its operating cycle, its administrations expenses and its selling and distribution expenses. A close examination on the efficiency of operating the Company's working capital has revealed that its stock turnover period was 3 months, its debt collection period was 2 months and its credit period taken 1 month. The New Working Capital Operation and Costs Reduction Proposal The new working capital operation proposal involves a change in the operating policy of the Company's working capital such that, the Stock turnover period to be reduced from 3 to 2 months, the debt collection period from 2 to 1 months and an extension of the credit period taken from 1 to 2 months. Since the company has an available working capital to finance its operations of 100,000, and the rest of its cash requirement is financed by an overdraft facility at an annual cost (interest on overdraft) of 15%, it is estimated that on the basis of the 2018 turnover, the 2019 EPS will be restored to its 2017 level. This will be achieved by assuming that the terms of trade will remain unchanged (ie the gross margin will not change) and that there will be a reduction in the administration expenses of 0.175m and in the selling and distribution expenses of 0.075m. The drastic expenditure cuts will be achieved by making redundant a number of employees, by applying a 20% salary reduction to the remaining staff and by applying tide measures on the general expenses and the selling and distribution expenses of the Company. Note: Corporation tax is 10%. This is applied to the net operating profit since all company expenses (including finance expenses) are considered for the calculation of the net operating profit. Thus EPS are calculated on Net Operating Profit after the deduction of 10% corporation tax. End of Case 2 Prepared by Marios Christou, University of Nicosia, December 2018 Question for Case 2) You have been asked by the board of directors of Wholesale Trading Limited to independently advise them on the viability of the proposal, clearly showing how the working capital structure of the company will change, to reflect the proposed reduction on the cost of the overdraft borrowing, which is used to finance the existing working capital requirement of the business. in your answer, given the proposed Working Capital and Cost Reduction Model, you should include the projected Income Statement of Wholesale Trading Limited for 2019. On the basis of the proposed plan, show how the EPS of Michal's family will return back to the 2017 levels at the end of 2019, indicating that if the EPS are issued as dividend in full the dividend income of Michael's family for 2019 is expected to be 576,000