The Master Bean: Ethics or Bust?

The Master Bean imports raw coffee beans from South-East Asia and roasts them ready to
supply to cafés in Australia. Tom Cain, who founded The Master Bean, built the business from a
passion into one that now employs 35 staff and has become one of the largest Australian
importers of coffee beans. Tom’s business objectives have changed from survival, to increasing
The Master Bean’s market share but with a strong ethical focus.

Unfortunately, for the past four years, profit margins have fallen and The Master Bean has
struggled to break even. A key element of the value of Tom’s business is the goodwill that he
has with his suppliers. He pays above market prices as part of his commitment to ethical trade
agreements such as Fair Trade. However, with rising costs and no growth in revenue, he may
need to make redundancies.

Recent political changes have also impacted on The Master Bean. Tom has been told that the
government of his major South-East Asian supplier has decided to join a regional economic
trading bloc. As Australia is outside the trading bloc, Tom’s importing costs will rise
significantly.
The Master Bean has two strategic options.
1. Tom could import his coffee beans from a country which is not a member of the trading
bloc. This will be a cheaper alternative and jobs at The Master Bean will be saved.
However, the government of this new supplier has been found guilty of human rights
abuses. Transport costs will rise, but early financial forecasts show that The Master Bean
will return to profitability.
2. The Master Bean could merge vertically with his major South-East Asian supplier. This
will retain the long established relationship, goodwill and ethical stance. However, Tom
will have to relocate parts of The Master Bean to that country in order to avoid higher
importing costs. A number of his staff have expressed concern and have said that they do
not want to move to that country.

1. For The Master Bean, explain the meaning and value of goodwill.
[6 marks]

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Altair Incorporated

Altair Incorporated has been operating in the pharmaceutical industry for over 50 years. Over
the past 5 years, it has been conducting research to try and develop a vaccine to minimize the
effects of malaria. No cure currently exists.

Stakeholder anticipation has been considerable. Recent media reports suggest that Altair
Incorporated is very close to manufacturing a prototype, called Zyra. Furthermore, the media
speculation has revealed that Altair Incorporated is considering locating a new production
facility in either one of two countries located in sub-Saharan Africa where malaria is most
prevalent. If successfully patented, Zyra will guarantee Altair Incorporated substantial profits.
Two potential countries have been identified as potential sites and have been code named Alpha
and Bravo. The construction of each facility and product launch is expected to take one year, the
patent will last for 5 years.

The cost of building the facilities in 2009 is as follows:

$m
Alpha 240
Bravo 180

The estimated net cash inflow ($m) from Zyra is as follows:

2010 2011 2012 2013 2014

80 80 70 60 50

Alpha is a prosperous nation with a stable government, reliable infrastructure and a strong
economy. Labour costs are higher than in Bravo and the unemployment rate is 4 %. A
competitor is already located there and this may give the potential for external economies of
scale.

Bravo is in the middle of reconstruction after a civil war. Much of the country’s infrastructure
needs to be rebuilt. Some financial assistance may be provided by the World Bank to Altair
Incorporated. The incidence of malaria in Bravo is much higher than in Alpha.

Because of the high research and development costs, shareholders want Zyra to be brought to
market quickly. Altair Incorporated also wants to set a fixed price for Zyra globally. However,
some international pressure groups have been critical of pharmaceutical companies that have
refused to conduct price discrimination. They have argued that it is unethical to charge high
prices to customers who are at the greatest risk of malaria infection, but who can least afford
them.

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2. Define the term patent.
[2 marks]

Passionate Pizza

Passionate Pizza is a chain of over 30 franchised takeaway pizza outlets in New Zealand and
has a market share of 15 % of all pizzas sold. It mainly targets the 18-30 year old single male
market segment. Passionate Pizza’s market share has been growing despite charging higher
prices than its competitors.

Controversial use of below-the-line promotion has driven Passionate Pizza’s success and
growing brand value. The company does not use above-the-line promotion and has relied upon
positive word of mouth to generate sales growth. It has won a number of awards for its point-of-
sale material but the government’s advertising regulator has received a number of complaints
about Passionate Pizza’s most recent customer newsletter.

Table 1: An extract from the profit and loss account for the year ended 31 December 2008:

Item $m
Sales 10
Cost of goods sold 4
Gross profit 6
Advertising expenditure 2
Other indirect costs 2
Net profit 2

Cost of goods sold will increase or decrease by the same percentage as an increase or decrease
in the number of pizzas sold. Independent market research commissioned by Passionate Pizza
shows the following:
• Price per pizza: $10
• Price elasticity of demand for Passionate Pizza’s pizzas: 0.5
• Advertising (above-the-line) elasticity of demand for Passionate Pizza: 1.0
• Cross-elasticity of demand for Passionate Pizza with respect to the market leader: 0.05.

Concerns about the increasing levels of obesity among young males have led Passionate Pizza
to consider a more ethical marketing approach. There is also a threat that the economy may
move into recession.

The directors are unsure of the next step. In order to increase market share, they may have to try
and appeal to a new market segment. They are discussing a two-stage strategy to extend the
brand:

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 1. reduce prices by 10 %
2. launch a new television advertising campaign costing $0.5 million.

3. (i) Prepare a forecast profit and loss account, using the same format as Table 1, for
Passionate Pizza for the year ended 31 December 2009, assuming that they implement
the two-stage strategy at the start of the year. (Show all your working)
[8 marks]

(ii) Comment on your results from part (i) using your forecasts and other information from
the stimulus material.
[3 marks]

Neat Organization

Neat Organization is a leading provider of resort-based budget holidays in Spain for price
conscious consumers. Its business strategy is based on offering low-cost holidays. Competition
in this market segment is becoming increasingly intense. Information on the external
environment is included below:

Predicted macro-economic trends

Economic
Year Interest rates
growth rates
2009 –2% 0.3%
2010 1% 1%
2011 2% 2%
2012 2% 2.5%
2013 3% 3%

As part of its growth strategy, Neat Organization intends to purchase a number of coaches to
transport holidaymakers from the airport to the resort as the cost of transport has increased
rapidly in recent years. After 7 years (the predicted useful life of the coaches), the management
hopes that they will have enough residual value that can then be used towards purchasing a new
fleet. The projected net cash inflows from this investment are shown below:

Year Projected net cash inflows ($)

1 100 000
2 150 000
3 250 000
4 300 000
5 250 000
6 200 000

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 7 200 000
Total inflows 1 450 000

The initial cost of the coaches is $1 000 000.

Excerpt from the profit and loss account for Neat Organization
for the year ended 31 December 2008
$m
Sales revenue 20
Cost of goods sold 8
Gross profit 12
Advertising expenses 4
Other indirect expenses 4
Expenses 8
Net profit before interest and tax 4

Excerpt from Neat Organization’s balance sheet as at 31 December 2008

$ $
Fixed assets 30 000 000
Current assets
Stock 2 000 000
Debtors 500 000
Cash 700 000
Total assets 3 200 000
Current liabilities
Creditors 1 500 000
Short-term borrowing 500 000
Total 2 000 000
Net assets 31 200 000
Share capital 20 000 000
Loan capital 4 000 000
Retained profit 7 200 000
Capital employed 31 200 000

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4. Define the term fixed asset.
[2 marks]

5. Calculate the depreciation at 20 % using the reducing balance method for the first 7 years of the
coaches (Show all your working).
[3 marks]

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 Gemel Ltd

George Melly started a new business in January 2008. He set the firm up as a private limited
company, Gemel Ltd. George took a majority 80 % shareholding in the business and appointed
himself as Chief Executive Officer. His accountant, Peter Mears, joined George buying the
remaining shares. To finance the launch, George estimated a figure of $300 000. He produced a
business plan and forecast financial information as part of the process of obtaining most of the
required finance (see table below). George presented this financial information to Peter Mears.

Peter examined the figures and pointed out that George had omitted a provision for depreciation
of the firm’s fixed assets, which were valued at $200 000 on start-up. He suggested that George
worked on the basis of a four-year life for the assets and estimated a scrap value of $40 000.

Forecast financial information for Gemel Ltd for the years 2008 and 2009

2008 ($000) 2009 ($000)

Turnover 485 870
Cost of sales 245 450
Expenses 91 138
Non-operating income 11 13
Interest 20 55
Tax 35 60
Dividends 60 75

6. Using straight-line depreciation, calculate the annual provision for depreciation that George had
omitted. (Show all your working)
[2 marks]

7. Using the financial information provided for 2008 and 2009, prepare profit and loss accounts
for the two years, adjusting the figures in the table above to include the provision for
depreciation and re-calculating the tax payment to equal 25 % of net profit before tax.
[8 marks]

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 The Battle for the Best

A growing number of companies are complaining that they are finding it harder to recruit
people. An international survey for the Corporate Executive Board in 2006 found that 62 % of
senior human resource managers are worried about company-wide talent shortage. Managers
face a dilemma. How do you recruit and retain employees when there is a shortage of skilled
labour? How do you reward and motivate people who can easily move elsewhere?

It is argued that intangible assets account for half of the market value of America’s public
companies. The world supply of workers is contracting. By 2025, the number of people aged 15
to 64 is projected to fall by 7 % in Germany and 14 % in Japan. In addition, the retirement of
the “baby boom” generation will lead to the loss of many experienced workers. Demographic
and social change means that companies will find it harder to find suitable replacements
domestically. They will have to develop their employees’ talent through training and be
prepared to consider changes in work patterns and practices.

Companies will also have to deal with the collapse of loyalty as workers are more willing to
move to the highest bidders. Even China and India are suffering from acute skills shortages at
the higher skill end of the market. Workers are starting to demand higher rewards for their
talents.

[Source: adapted from The World in 2007: The Economist]

8. Define the term intangible assets.

[2 marks]

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 Due to the loss that was made in 2006, Organix has commissioned a report from Seagers, a firm
of accountants. However, due to a breakdown in communication over the deadline for the
report, it has been delayed for several months. Max is trying to establish further the cause of the
loss and so has collected together appropriate financial documents to prepare some draft
accounts. However, the documentation is incomplete and only includes the figures below.

Figures (for year ending 31 December 2006) $000

Total sales revenue 975
Gross profit 230
Expenses 265
Net profit before tax and interest –35
Interest 35
Tax 0
Net profit after tax and interest –70
Figures (as at 31 December 2006)
Fixed assets 800
Cash 29
Stock 71
Debtors 50
Current liabilities 64
Net assets 886
Loan capital 745
Retained profit 141
Capital employed 886

9. Define the term gross profit.

[2 marks]

10. Using the figures above, prepare the balance sheet (as at 31 December 2006) and the profit and
loss account (for the year ended 31 December 2006) for Organix.
[6 marks]

11. Discuss two reasons for Organix suffering a loss in 2006 (lines 137-139).
[8 marks]

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The quest for customer satisfaction

What does Mercedes-Benz have in common with H.J.Heinz and Coca-Cola? The obvious
response is a strong brand, but what creates this strength? The three companies are among the
top ten US organizations for customer satisfaction and that is an important indicator of market
strength and financial success.

Keeping existing customers costs much less than acquiring new ones. The existing customer
base is thus a significant intangible asset. However, firms need to understand the customers they
want to retain. Susan Fournier, a researcher from the University of Harvard, says that “a
relationship is not just getting a newsletter, responding to a questionnaire or holding a frequent-
buyer card. It has to do with product quality, consistency and brand image”.

Research by the US retailer, Sears, identified a clear correlation between employee attitudes,
customer attitudes and financial results. As employee motivation improved, so did sales. The
research showed that introducing programmes of Total Quality Management can increase
employee loyalty, when the process includes genuine participation, job enrichment, collective
decision-making, self-managed teams and an appropriate reward system.

The six most important questions of the Sears employee survey concentrated on individual
employee’s attitudes to their job:

1. How does the amount of work you are expected to do influence your attitude to your job?
2. How do your physical working conditions influence your attitude to your job?
3. How does the way you are treated by those who lead you influence your attitude to your job?
4. Do you like the kind of work you do?
5. Does your work give you a sense of accomplishment?
6. Are you proud to say you work for the company?

[Adapted from http://www.thinkingmanagers.com. Reproduced with permission.]

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 Tesco goes green

In a recent report to shareholders, the chief executive of Tesco, the biggest supermarket chain in
the UK reported it had increased sales by 13.2 % and pre-tax profit by 16.7 % in the last 12
months. He also noted that cost increases were likely in the coming year with little opportunity
to raise prices due to strong competition.

The chief executive responded to critics of its significant internal expansion by announcing
plans to invest in environmental projects. Critics argue that these investments are due to a 60 %
rise in energy costs last year, and that they are not purely motivated by environmental concerns.

To counter these critisisms, the chief executive announced plans to:

• install more wind turbines on stores and distribution depots
• use solar power to generate electricity in the stores
• double the amount of recycling facilities at the stores
• convert the entire fleet of 2000 lorries to more environmentally friendly fuels.

Pressure groups say that Tesco is still a long way from being a truly environmentally and
socially responsible company because of:
• its rapid growth (it has built many supermarkets in the UK and around the world)
• its sourcing of products from overseas
• the threat it poses to small independent retailers.

[Source: adapted from “Tesco’s growth slips as cautious consumers catch up with giant”, Sara Butler, “Stores to go
green with cuts of energy usage”, The Times, 26 April 2006 and “Lorries in fuel switch as Tesco takes the green
road”, Jenny Davey, The Sunday Times, 17 December 2006]

12. Tesco has “increased sales by 13.2 % and pre-tax profit by 16.7 %”.
Comment on how it is possible for profits to increase at a faster rate than sales.
[4 marks]

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 Following the request from the board of directors, the finance manager, Colin Buckley, prepared
more outline budgets for 2007 and also produced a detailed variance analysis of recent budgets.
These were discussed at the last board meeting. Some of the variances showed worrying trends,
particularly related to sales levels and wage and administration costs, where significant negative
variances were identified.

Following personal criticism of his role as finance manager, Colin Buckley resigned from
Gladrags Ltd. In response, the board of directors appointed external business consultants,
Hansons, to develop a business plan for the year 2007 to 2008.

Included in the plan were the following financial objectives and targets:
• improving gross profit margin by examining supplier costs
• taking emergency measures to address cash flow issues
• improve profitability performance to match industry averages of 30 % gross profit margin
and 12 % net profit margin
• increasing investment in new production and communication technologies.

13. Discuss whether the objectives and targets set by Hansons are achievable. Use ratio analysis and
other financial and non-financial information provided in the case study to support your answer.
[8 marks]

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