TASK
Read the Case Study below and evaluate the Korean Composites Co investment project on behalf of Zircon Cars plc. Advise Zircon Cars plc on whether they should undertake the project and identify the maximum price Zircon should pay to acquire the Korean Composites Co. Also, advise the firm on the potential impact of foreign exchange on the project and evaluate the alternatives for financing the purchase.
Your answer should be presented in the form of a report of 2500 words total (excluding the reference list).
Zircon Cars plc (B)
Zircon Cars plc is a manufacturer of luxury high performance sports cars based in the UK. The firms assembly plant is located 10 miles to the West of Reading in Berkshire.
The firm produces only one model, the ZC500 F1, which has a list price of £340,000. The cars are assembled by hand in the same way as a Formula 1 Grand Prix car, with a single lead engineer overseeing the build from the start of assembly to delivering the car personally to the customer. After delivery, the customer has direct access to the lead engineer by phone, SMS, and e-mail, throughout the life of the vehicle. Thus each car produced is ‘owned’ by a Zircon engineer who oversees routine maintenance and any unscheduled servicing which may be required.
This is the standard of service and excellence offered to Zircon customers.
Production
The ZC500 F1 is designed and assembled at a purpose built factory in Berkshire UK. Zircon have searched the world for the very best components thus most of the components are imported. The engines come from Japan whilst the carbon fibre composite body shells are manufactured in South Korea. Other components such as interior fittings, windows, wheels electronic control systems and the drive train are sourced from various European manufacturers including the UK. A breakdown of the cost base is given in Table 1
Component Proportion of Production Cost (%)
Source Country
Currency
Engine
25.0
Japan
Yen
Composite Body shell
15.0
South Korea
Won
Other parts (eg Drive train)
20.0
Europe
Euro
Other parts (eg electronic controls)
15.0
UK
Sterling
Assembly cost
25.0
UK
Sterling
Sales
Most of the ZC500 F1 cars are exported. There is a small but stable market in both Europe and the UK but the USA has been the main market for a number of years. A recent development is the growing importance of China which now accounts for 30% of output. A full breakdown of sales is given in Table 2. UK and European sales are handled directly by head office in Berkshire. Zircon operates in the USA , China and the Middle East through a wholly owned sales subsidiary in each location. The sales offices have showrooms which are
located in Los Angeles, Beijing and Dubai.
Country
Proportion of
Zircon Sales (%)
Currency
United Kingdom
5
Sterling
USA
35
US Dollar
Middle East
20
UAE Dirham
China
30
Renminbi
Europe
10
Euro
Table 2: ZC500 F1 Market Structure
The ZC500 F1 has a number of competitors and the main ones are shown in Table 3 below.
Model
List Price
Lamborghini Aventador
£350k
Noble M600
$300k
Ferrari 458
€250k
Porshe 918
£540k
Table 3: ZC500 F1 Competitors
When compared to the direct competitors listed in Table 3 the ZC500 F1 currently has a market share of 21.5% in the UK and in all of the countries to which the vehicle is exported. In the USA there is additional competition from US domestic manufacturers of super-cars who produce such models as the Seleem Raptor (list price $400k) and the March 7 Falcon (list price $200k).
Finance
Zircon Cars plc has a net profit margin of 20% and manufacturing cost is 70% of total cost. An abbreviated balance sheet is shown below.
Zircon Cars plc
Balance Sheet at 30th September 2014
£000 £000
Fixed Assets: 182,125
Current assets 66,615
Less: Current liabilities 58,120
8,495
190,620
Financed by:
Creditors due after more than one year:
7% Debentures 2019 30,000
Shareholders funds
Authorised Issued
Ordinary shares of £1 100,000 95,000
8% Preference shares of £2 18,000
Share premium 25,000
Profit & loss 22,620
190,620
Typically, Zircon pay out 45% of their profits as dividends and their return on equity has been 17.5% on average over the last four years. Millennium ordinary shares are presently trading at £1.55 and their preference shares at £1.70 (both ex dividend) whilst the debentures are trading at £104.22 per £100 nominal. The prevailing rate of corporation tax in the UK is 21%. Millennium have been able to increase their dividend per ordinary share from 10p in 2010 to 13.5p in 2014.
Developments
In order to reduce costs, the management of Zircon are considering an opportunity to purchase Korean Composites Co, the South Korean company which makes the composite body shells for the ZC500 F1. The owners of the business, have indicated that they are willing to sell but it will be a major investment for Zircon as the purchase price is expected
to be in the region of £35(m). There is an offset because if the acquisition goes ahead Zircon will get a 2.5% discount on the cost of body shells. Due to the pace of technology change Zircon have a seven year time horizon for this investment and the Finance Director has provided the details of Korean Composites Co given below.
Korean Composites Co
Korean Composites Co manufactures carbon fibre body shells for the automotive industry and has confirmed orders for 1000 units in 2016 at a price of W48.14(m) each. Demand is
expected to grow thereafter at 5% per annum (pa) and selling price by 3% pa. One third of output is sold to Zircon and this is expected to continue into the future as Zircon increases sales of the ZC500 F1.
Due to the nature of composite manufacturing Korean Composites fixed costs tend to be rather high and will be 32% of sales revenue in 2016. Fixed costs are not expected to change before 2023. Variable costs are 48% of sales revenue and of this 40% relates to labour cost with the remaining 60% being other variable cost. Labour costs are expected to increase at
8% whilst other variable costs are expected to increase at 5%pa
Korean Composites Co has depreciation of W4,300(m) pa and has fixed interest charges of
W510(m)pa. The interest charge relates to debt issued to support working capital.
Corporation tax in South Korea is 24.2% and the current exchange rate is W1694.62/£. Assume corporation tax is payable at the end of the accounting year in question (you may also assume for the purpose of this case that accounting profit and taxable profit are identical.)
Submission requirements:
You should use Arial font size 12 and 1.5 line spacing. Exceeding the word count by 10% or more or deviations from the formatting instructions will attract a penalty of up to 5%.
Guidance for the preparation of your report.
The purpose of this assignment is simply to give you the opportunity to demonstrate that you have acquired the knowledge and skills identified in the Module Handbook and that you can apply them in a typical business situation.
You should approach the task as a business manager dealing with a ‘real’ business and
should:
a) Adopt a coherent approach to dealing with the set task with a clearly stated business purpose.
b) Identify an appropriate theoretical dimension and consider the implications for practice.
c) Adopt appropriate analytical methods and a critical perspective. d) Refer to empirical work where appropriate.
You may wish to include charts, diagrams and/or calculations in the report but these should only be used where they demonstrate a point you are trying to make.
