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Case Study Nelson Plc ( NLP ) is a Canadian company with a solid national reputation for innovative business systems. It has four divisions: manufacturing,
Case Study Nelson Plc NLP is a Canadian company with a solid national reputation for innovative business systems. It has four divisions: manufacturing, Software Development, Business Systems Development and SalesDistribution All the divisions are based in Canada, with a Head Office based in Montreal. Two years ago, NLP decided to start selling its services internationally using a team of salespeople to visit different countries. The initiative has not been particularly successful, and the company is considering the proposal that it should radically restructure its operations along the following lines: Relocate some of the manufacturing divisions to lowcost countries such as China Relocate parts of the software development division in India Considerably reduce the size of the salesdistribution division in Canada and replace it with regional offices in as many different countries as possible NLP is considering a name change to the International NL Systems. The plan would be to restructure by combining wholly or partly owned overseas subsidiaries, branches, franchises and joint ventures. The process will require a considerable amount of new finance, but the intention would be to spread the change over several years. The NLPs board of directors members have not agreed on this proposal, although they mostly appreciate the need to restructure. However, some committee members have significant doubts about certain aspects of the proposal. These include: The costs involved in setting up overseas subsidiaries There are additional risks involved in operating overseas, primarily in less developed countries. This board faction generally emphasises franchising its overseas operations because it will require less new capital. The company has recently been approached by a consortium of businesses from Hong Kong, where NLP has enjoyed the most success, with a proposition for a franchise arrangement. The terms of the agreement are that NLP would: contribute HK$ million for the purchase of fixed assets provide technical support in the setting up and running of the franchise NLP estimates that this will cost the company C$ per year for the life of the arrangement sell the franchise outright to the consortium after three years for a oneoff payment of HK$ million receive half of the net cash flows for the three years of the agreement agree to pass over any existing arrangements with customers in Hong Kong to the franchise and not seek any future customers on its account. Page of Net cash flows from the franchise are estimated at HK$ million in the first year of operation, increasing at yearly for each of the next two years. NLP forecasts that there will be a net loss of contribution of C$ million per annum from its existing Hong Kong customers for the first year of the franchise and that this could be expected to double year on year for the next two years the franchise. One of NLPs directors is concerned that the franchise may be too sensitive to changes in some of the forecast variables of the proposal. In particular, he is concerned that the forecast of HK$ million may be too low to purchase the fixed assets required. He also feels that the NLPs cost of capital may increase due to the company taking on the franchise. The spot exchange rate is HK$ to the C$ However, this is expected to change over the project's life, as inflation in Canada is currently only whilst it is in Hong Kong. NLPs weighted average cost of capital is estimated at and the company has a debtto equity ratio of one to one based on market values. The company wishes to maintain its current debttoequity ratio and intends to fund the franchise arrangement using a combination of debt and equity. The company thinks it will raise additional debt at the same interest rate as its current debt. However, it fears the cost of equity may rise to from due to a lack of franchising experience. Assume that all the cash flows above have already been adjusted for the expected effects of inflation. Ignore taxation. You are in charge of the finance function in Canada and have been asked to produce a report which covers: the Hong Kong Franchise the additional burdens that will face your department if the company decides on the option to set up subsidiaries abroad an evaluation of the financing of the overseas acquisitions the benefits that can accrue from the multinational status Page of Required: Produce a report which covers the following: a Evaluate the franchise arrangement using the companys revised weighted average cost of capital. Briefly discuss any reservations you may have regarding the figures you have produced. Note: If you cannot calculate NLPs revised weighted average cost of capital, you may use its current rate although fewer marks will be awarded. You are also expected to use at least NPV for evaluating the project Your report should address the concerns what will be the revised weighted average cost of capital
Case Study
Nelson Plc NLP is a Canadian company with a solid national reputation for innovative
business systems. It has four divisions: manufacturing, Software Development, Business
Systems Development and SalesDistribution All the divisions are based in Canada, with a
Head Office based in Montreal. Two years ago, NLP decided to start selling its services
internationally using a team of salespeople to visit different countries.
The initiative has not been particularly successful, and the company is considering the
proposal that it should radically restructure its operations along the following lines:
Relocate some of the manufacturing divisions to lowcost countries such as China
Relocate parts of the software development division in India
Considerably reduce the size of the salesdistribution division in Canada and replace
it with regional offices in as many different countries as possible
NLP is considering a name change to the International NL Systems. The plan would be to
restructure by combining wholly or partly owned overseas subsidiaries, branches, franchises
and joint ventures. The process will require a considerable amount of new finance, but the
intention would be to spread the change over several years.
The NLPs board of directors members have not agreed on this proposal, although they mostly
appreciate the need to restructure. However, some committee members have significant
doubts about certain aspects of the proposal. These include:
The costs involved in setting up overseas subsidiaries
There are additional risks involved in operating overseas, primarily in less
developed countries.
This board faction generally emphasises franchising its overseas operations because it will
require less new capital.
The company has recently been approached by a consortium of businesses from Hong Kong,
where NLP has enjoyed the most success, with a proposition for a franchise arrangement. The
terms of the agreement are that NLP would:
contribute HK$ million for the purchase of fixed assets
provide technical support in the setting up and running of the franchise NLP estimates
that this will cost the company C$ per year for the life of the arrangement
sell the franchise outright to the consortium after three years for a oneoff payment
of HK$ million
receive half of the net cash flows for the three years of the agreement
agree to pass over any existing arrangements with customers in Hong Kong to the
franchise and not seek any future customers on its account.
Page of
Net cash flows from the franchise are estimated at HK$ million in the first year of operation,
increasing at yearly for each of the next two years. NLP forecasts that there will be a net
loss of contribution of C$ million per annum from its existing Hong Kong customers for the
first year of the franchise and that this could be expected to double year on year for the next
two years the franchise.
One of NLPs directors is concerned that the franchise may be too sensitive to changes in
some of the forecast variables of the proposal. In particular, he is concerned that the forecast
of HK$ million may be too low to purchase the fixed assets required. He also feels that the
NLPs cost of capital may increase due to the company taking on the franchise.
The spot exchange rate is HK$ to the C$ However, this is expected to change over the
project's life, as inflation in Canada is currently only whilst it is in Hong Kong.
NLPs weighted average cost of capital is estimated at and the company has a debtto
equity ratio of one to one based on market values. The company wishes to maintain its
current debttoequity ratio and intends to fund the franchise arrangement using a
combination of debt and equity. The company thinks it will raise additional debt at the same
interest rate as its current debt. However, it fears the cost of equity may rise to from
due to a lack of franchising experience.
Assume that all the cash flows above have already been adjusted for the expected effects of
inflation.
Ignore taxation.
You are in charge of the finance function in Canada and have been asked to produce a report
which covers:
the Hong Kong Franchise
the additional burdens that will face your department if the company decides on
the option to set up subsidiaries abroad
an evaluation of the financing of the overseas acquisitions
the benefits that can accrue from the multinational status
Page of
Required:
Produce a report which covers the following:
a Evaluate the franchise arrangement using the companys revised weighted average
cost of capital. Briefly discuss any reservations you may have regarding the figures
you have produced.
Note: If you cannot calculate NLPs revised weighted average cost of capital,
you may use its current rate although fewer marks will be awarded. You are also
expected to use at least NPV for evaluating the project
Your report should address the concerns
what will be the revised weighted average cost of capital
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