Question Notes

1. Aim of free trade

 Free trade exists where there is no restriction on imports from other countries or exports to
other countries.
 EU is a free trade area for trade between its member countries.
 Mostly, there are many barriers to trade because government wants to protect their home
countries from foreign competition.
 So, free trade area aims to remove barriers to trade and allow freedom of movement of
production resources such as capital and labor within the EU.
 In addition to this, EU also has a common legal structure across all member countries and tries
to limit any discrimination against compaines operating in these countries.

2. Benefits operating within EU

 Protection from non-EU companies because companies outside EU may find it difficult to enter
EU markets due to barriers to trade.
 Common legal structure ensure that the standards of food quality and packaging apply equally
across all the member countries and so this reduce compliance costs.
 Having access to capital and labour within the EU may make it easier to set up the branches
inside the EU.
 The company can access to any grants which is available to companies based within EU.

3.
(i) Legal Risks to operate outside EU or invest in project which will operate outside EU

 Trade barriers such as import quotas in the countries concerned and this will make the company
difficult to operate.
 The countries may have different regulations on food preparation, quality and packaging
 Different countries may have different regulations regarding product liability from poorly
prepared or stored food which can cause harm to customers.
 The legal regulations may more lax in countries outside EU but complying only the minimum
standards can impact the company image negatively.

(ii) Mitigation strategies

 The company need to understand sufficient research into the countries’ current laws and
regulations to ensure the company complies all the standards required.
 It is also necessary to ensure that the company is up-to-date with all the potential changes in
the law.
 It is better to ensure that the company complies with best practice even if it is not the law yet.
 Strict contracts need to be set up between the company and its agents it use to transport and
sell the food and it is also necessary to follow up regular checks to ensure the standards are
maintained.
Kit Page 162 – Assumptions

Factors to determine the long term finance policy

 Can use various principles to determine the long term financial mix.
1. Follow consistent long term policies or
2. Changes as circumstances change.
 Present – using mixture of debt and equity.
 First issue - Need to find whether the directors are aiming for the optimal level of gearing or
there is level they do not wish to exceed.
 If want to maintain gearing at the optimal level, determine by the risk and advantages.
 Risk – not being able to maintain the required level of payment such as interest, dividend and
capital to the finance providers
 Advantages – lower cost of debt, tax relief on finance costs, not legally required to pay dividend.
 Second issue – find whether the directors has preference about what source of finance should
be used in what order.
 Eg – Pecking Order theory – 1. Retained Earning, 2. Debt, 3. Equity
  In this theory – composition of shareholders unchanged, RE and long term debt are low risk
 Other source of finance may also have benefits which attracts the directors or drawbacks which
deter them.
 Matching source of finance with specific investment – greater flexibility, avoid interest burden
 But to adopt this approach, the board need assurance that the investment will be able to meet
finance cost and repayment.

Communication with the stakeholders

- The directors are likely to communicate with the major shareholders and external investors on a
regular basis more than once a year.
- They will have to know the importance to communicate what their plans are to other important
stakeholders.
- They also need to assure that their communication keeps both sets of stakeholders happy if they
have different priorities.
- Investors of the company are likely to know how future strategies of the company are different
from the ones the company has been pursued recently.
- They also want to know about the attitudes to the risk management and risk management
policies.
- In addition to this, they are also interested in the changes in finance policy particularly if
dividend policies are likely to differ.
- Employees and suppliers are important as the company will have plan for operational
efficiencies.
- Employees may be interested about changes in working conditions.
- Attempts to import tougher conditions on employees without communication will lead to
employee departures and other disruptions.
- Suppliers are concerned about dealing with the smaller company and so may seek to impose
shorter credit periods and credit limits if they do not have sufficient information.

Advantages of demerger

- If the managers of the division believes that they can run the division better without the
interventions of the senior management of the company, the business may be able to achieve
operational efficiencies and increase in value.
- The demerger may allow the company’s management team to focus on the remaining division
and no need to spend time dealing with the demerger division’s team.
- The new company is not linked to the financial commitment of the remaining division in terms
of finance costs and loan repayment and so its management can determine the best financial
structure suitable for the company.

Disadvantages of demerger
 - There will be legal costs associated with the demerger such as costs for listing the new company,
setting up new company and etc.
- So, neither the existing company and new company can focus on the external opportunities and
challenges for some time impacting the results.
- The new company may suffer adverse effects for being the smaller entities and so economies of
scale may lose and this will make the company difficult to raise new finance.
- In overall, both companies may fall their distributable profits.

Advantages and disadvantage of direct investment compared to licensing (kit page 273)
Page 123
Page 159
Benefits of using 100% of PAT for the dividend

 Ensure that the company has sufficient funds to pay the required level of dividend and fulfill
own investment requirement which means the shareholders will be happy.
 It means that the company will have less retained funds available for the company but the
investment opportunities may be more profitable.

Problems of using 100% of PAT for the dividend

 Taking all of the post tax earnings as the dividend

 A limited fall in the earnings will make the company not being able to pay the promised dividend
level.
 A fall could easily happen due to the competitive environment.
 As the company has used 100% of PAT for dividend, there is no money left for the retained
earnings to invest.
 As a consequence, the company cannot be able to sustain the earnings level and dividend.
 The bonus for the company is also linked with after-tax profits and this policy will also make the
directors not to be able to receive the bonus.
 The directors might leave the company and join the competitors.

Agency Problems

 An agency situation arises between the board and the management and the proposals are likely
to involve agency costs.
 The principal, the board, are normally likely to oversee the company’s management to make
sure they are performing for the best interests of the shareholders.
 Increased supervision will increase agency costs as well as time.
 The policy limits the discretion of the management by restricting the amount of retained funds
available.
 The management may also feel that the new policy threatens their remuneration and bonus as
the limited funds available for investment will adversely affect the company’s ability to maintain
its profit level.
 Due to these factors, the managers might seek to join competitors and this can disrupt the
operations of the company.

Resolving agency problems

 Weakening the link between the results and remuneration might motivate the managers of the
company to work harder even if it is for themselves.
 For example, the company can use performance-related pay, share options and bonus for their
related performance in order to resolve these agency problems.
  However, on the other hand, these methods have drawbacks as well.
 These methods may lessen their incentives to produce the company’s results needed to
maintain the required level of dividend.

Difference between sell-off and management buy-in