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Level 2 – Corporate Strategy, Ethics & Governance
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Category: Level 2 - Corporate Strategy, Ethics & Governance

Corporate governanceLevel 2 - Corporate Strategy, Ethics & GovernancePrevious Syllabus

Nov 2015 Q3 b.

Corporate governance is now a very popular and important area in strategic management. However, corporate governance is poor in a number organisation. Explain FIVE(5) symptoms of poor corporate governance                                             [10marks]

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1. Domination by a single individual
A feature of many corporate governance scandals has been boards dominated by a single senior executive with other board members merely act as a rubber stamp. Sometimes the single individual may bypass the board to action his own interests. This can result in management and directors awarding themselves remuneration and company perks that do not align with company performance or shareholder interests. This is an inherent problem in agency theory.
Even if an organisation is not dominated by a single individual, there may be other weaknesses. The organization may be run by a small group centered round the Chief Executive and Chief Financial Officer and appointments may be made by personal recommendation rather than a formal, objective process.
2. Lack of involvement of board
Boards that meet irregularly or fail to consider systematically the organization’s activities and risks are clearly weak. Sometimes the failure to carry out proper oversight is due to lack of information being provided.
3. Lack of adequate control function
Another potential weakness is a lack of adequate technical knowledge in key roles, for example in the audit committee or in senior compliance positions. A rapid turnover of staff involved in accounting or control may suggest inadequate resources, and will make control more difficult because of lack of continuity.
4. Lack of supervision
Employees who are not properly supervised can create large losses for the organization through their own incompetence, negligence or fraudulent activity. The behaviour of Nick Leeson, the employee who caused the collapses of Barings bank was not challenged because he appeared to be successful, whereas he was using unauthorized accounts to cover up his large trading losses. Leeson was able to do this because he was in charge of dealing and settlement, a systems weakness of lack of segregation of key roles that featured in other financial frauds.
5. Lack of independent scrutiny
External auditors may not carry out the necessary questioning of senior management because of fears of losing the audit, and internal audit do not ask awkward questions because the Chief Financial Officer determines their employment prospects. Often corporate collapses are followed by criticisms of external auditors, such as the Barlow Clowes affair were poorly planned and focused audit work failed to identify illegal use of client monies.
6. Lack of contact with shareholders
Often, board members grow up with the company and lose touch with the interests and views of shareholders. One possible symptom of this is the payment of remuneration packages that do not appear to be warranted by results.
7. Emphasis on short-term profitability
Emphasis on success or getting results can lead to the concealment of problems or errors, or manipulation of accounts to achieve desired results.
8. Misleading accounts and information
Misleading figures are often symptomatic of other problems (or are designed to conceal other problems) but clearly poor quality accounting information is a major problem if markets are trying to make a fair assessment of the company’s value. Giving out misleading information was a major issue in the Enron scandal as discussed previously.

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Audit CommitteeCorporate governanceLevel 2 - Corporate Strategy, Ethics & GovernancePrevious Syllabus

Nov 2015 Q3 a.

The role of Audit Committee in corporate governance cannot be overemphasized.
i) What should be the composition of an Audit Committee?                                                                                               [4marks]

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1) The audit committee should comprise at least three directors, the majority of whom should be non-executive.
2) The membership of the audit committees should ideally comprise directors with adequate knowledge of finance, accounts and the basic element of the laws under which the corporate body operates or is subject to.
3) The chairman of the committee should be a non-executive director.
4) The managing director/chief executive officer , the finance director, the head of internal audit and a representative of the external auditors should ordinarily be invited to attend meetings

ii) Explain FOUR (4) functions of an Audit Committee.                                                                                                    [6marks]

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1) Recommend the appointment of the external auditors of the corporate body;
2) Liaise with the external auditors for the purposes of maintaining and ensuring audit quality, effectiveness, risk assessment, interaction with internal auditors and dealing with situations governing the resignation of the external auditors and dealing with situations governing the resignation of the external auditors;
3) Review with the auditors their report on the financial statements of the corporate body;
4) Review the adequacy of systems and internal controls and of the degree of compliance with material policies, laws and the code of ethics and business practices of the corporate body;
5) Provide a direct channel of communication between the board and the external and internal auditors of the corporate body, accountants and compliance officers (if any) of the corporate body;
6) To report to the board on all issues of significant extraordinary financial transactions;
7) To assist the board in developing policies that would enhance the controls and operating systems of the corporate body.

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Green concernsLevel 2 - Corporate Strategy, Ethics & GovernancePrevious Syllabus

Nov 2015 Q2 b.

Business activities, in general, were formerly regarded as problem for the environmental movement, but the two are now increasingly complementary. There has been an increase in the use of green approach to market products.
Explain in FOUR (4) ways how physical environmental conditions are important for strategic planning.                      [10marks]

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Physical environmental conditions are important for strategic planning.
i. Resource inputs. Managing physical resources successfully (e.g. oil companies, mining companies) is a good source of profits.
ii. Logistics. The physical environment presents logistical problems or opportunities to organisations. Proximity to road and rail links can be a reason for sitting a warehouse in a particular area.
iii. Government. The physical environment is under the control of other organisations.
1. Local authority town planning departments can influence where a building and necessary infrastructure can be sited.
2. Governments can set regulation about some of the organization’s environmental interactions.
iv. Disasters. In some countries, the physical environment can pose a major ‘threat’ to organisations.

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Business ethicsLevel 2 - Corporate Strategy, Ethics & GovernancePrevious Syllabus

Nov 2015 Q2 a.

Managers have a duty to aim for profit. At the same time, modern ethical standards impose a duty to guard, preserve and enhance the value of an enterprise for the good of all touched by it, including the general public.
Explain FOUR (4) ethical problems managers face in dealing with stakeholders.                                                           [10marks]

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In the area of products and production, managers have responsibility to ensure that the public (consumers) and their own employees are protected from danger. Attempts to increase profitability by cutting costs may lead to dangerous working conditions or to inadequate safety standards in products. In the United States, product liability litigation is so common that this legal treat may be a more effective deterrent than general ethical standards.
Another ethical problem concerns payment by companies to government officials who have power to help or hinder the payers’ operations. Some of the issues which exist in this area are:
i. Extortion. Foreign officials have been known to threaten companies with the complete closure of their local operations unless suitable payments are made.
ii. Bribery. This refers to payments for services to which a company is not legally entitled. There are some fine distinctions to be drawn; for example, some managers regard political contributions as bribery.
iii. Grease money. Multinational companies are sometimes unable to obtain services to which they are legally entitled because of deliberate stalling by local officials. Cash payments to the right people may then be enough to oil the machinery of bureaucracy.
iv. Gifts. In some cultures (such as Japan) gifts are regarded as an essential part of civilized negotiation, even in circumstances where to Western eyes they might appear ethically dubious. Managers operating in such a culture may feel at liberty to adopt the local customs.
v. Discrimination against an employee or any group of employees based on gender, religion, beliefs, etc.
vi. Environmental pollution and degradation
vii. Failure to provide the right working environment and conditions of service for employees (e.g. unfair labour practices on the part of management-which can result in legal actions and avoidable cost for the company).

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Level 2 - Corporate Strategy, Ethics & GovernancePESTEL FrameworkPrevious Syllabus

Nov 2015 Q1 a.

CASE STUDY: GRACE TELECOM LIMITED
Introduction
Grace Telecom Ltd. is a well-established company which is providing telecommunications services both nationally and internationally. Its business has been concerned with telephone calls, the provision of telephone lines and equipment, and private telecommunication networks. Grace Telecom Ltd. has supplemented these services recently by offering mobile phone, which is an expanding market worldwide
The company maintains a diverse customer base, including residential users, multi-national companies, government agencies and public sector organisations. The company handles approximately 100,000 million calls each working day, and employs nearly 140 personnel.
Strategic development
The Chairman of Grace Telecom Ltd stated within its latest Annual Report that there were three main areas in which the company aimed to develop in order to remain a world leader in the telecommunications market. He believes that the three main growth areas reflect the evolving nature of the telecommunications market and will provide the scope for development.
The areas in which development is planned are:

  • expansion of the telecommunications business in the national and overseas markets, both by the company acting on its own and through partnership arrangements with other suppliers
  • diversification into television and multi-media services, providing the hardware to permit telephone shopping from home and broadcasting services
  • extension of the joint ventures and strategic alliances which have already been established with companies in West Africa.
    The Chairman explained that the company is intent on becoming a world leader in communications. This will be achieved through maintaining its focus on long-term development by improving its services to customers, developing high quality up-to-date products and being innovative, flexible and market-driven. His aim is to deliver a world-class service at competitive cost.
    Financial information
    The following comparative statistics show extracts from the company’s financial performance in its national telecommunications market over the last two years:

The company estimates its cost of capital to be approximately 18%.
The Chairman expressed satisfaction with the increase in turnover and stated that cost efficiencies were now being generated following the completion of a staff reduction programme. This would assist the company in achieving a target return on capital employed (ROCE) of 20% in this market over the next three years.
Business opportunities
The Chief Executive of Grace Telecom Ltd. has stated that the major opportunities for the company lie in the following areas:

  • encouraging greater use of the telephone
  • provision of advanced services, and research and development into new technology, including the internet and systems integration.

the increasing freedom from government control of worldwide telecommunication services.
An extensive television and poster advertising campaign has been used by the company. This was in order to penetrate further the residential market segment by encouraging greater use of the telephone with various charging incentives being offered to residential customers.
To further the objective of increasing long-term shareholder value, the company is actively considering an investment of GHS200 million in each of the next three years in new technology and quality improvements in its national market. Because of its specialist technical nature, the investment is not expected to have any residual value at the end of the three-year period.
Following the investment, the directors of Grace Telecom Ltd. believe that its rate of profit before interest and tax to turnover in its national telecommunications market will remain constant. This rate will be at the same level as last year for each of the three years of the investment.
Markets and competition
The company is currently experiencing an erosion of its market share and faces increasingly strong competition in the mobile phone market. While Grace Telecom Ltd. is the leader in its national market, with an 85% share of the telecommunications business, it has experienced a reduced demand for the supply of residential lines in the last five years as competition has increased.
The market for the supply of equipment in the national telecommunications market is perceived to be static. The investment of GHS200 million in each of the next three years is estimated to increase Grace Telecom Ltd.’s share of this market to a level of 95%. The full improvement of 10% is expected to be received by Grace Telecom Ltd. next year, and its market share will then remain at this level for the full three-year period. It is anticipated that unless further investment is made after the three-year period, Grace Telecom Ltd.’s market share will revert to its current level as a consequence of the expected competitive response.
Industry regulation
The government has established an industry regulatory organisation to promote competition and deter anti-competitive behaviour.
As a result of the activities of the regulator and aggressive pricing strategies, it is anticipated that charges to customers will remain constant for the full three-year period of the new investment.
All cash flows can be assumed to occur at the end of the year to which they relate. The cash flows and discount rate are in real terms.
Future outlook
The business still remains under family control, but the board is considering an expansion programme for which and that the family would need to raise GH¢200 million in equity or debt finance. One of the possible risks of expansion lies in the fact that the market for fixed telephone lines is falling. New income is being generated by expanding the product range to include mobile money transfer. The key to profit growth for Grace Telecom is the ability to generate sales growth, but the company recognizes that it faces stiff competition from large telecom companies in respect of the prices charged.
In planning its future, Grace Telecom is advised to look carefully at a number of external factors which may affect the business including government economic policy. In recent months the following information has been published in respect of key economic data.
i) Bank base rate has been reduced from 22% to 20%, and the forecast is for a further 0.5% reduction within six months.
ii) The annual rate of inflation is now 12%, down from 14% in the previous quarter, and 16% 12 months ago. No further falls in the rate are expected over the medium term.
iii) Personal and corporate tax rates are expected to remain unchanged for at least twelve months.
Required:
Explain the nature of the political, economic, social, and technological forces which will influence Grace Telecom Ltd. in developing its business and increasing its market share.                                                                               [8 marks]

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  • Political factors
    Grace Telecom Ltd. currently dominates its national telecommunications market with an 85% shares of the market. The company will be under political pressure from the national government to reduce its dominance by opening up the national telecom market to competition and reducing prices for telecom products charged to consumers.
    The government has appointed an industry regulator to be directly involved in the control of the telecom industry and no doubt Grace Telecom Ltd will be under close scrutiny. Political forces will be a major factor affecting the operations and plan of Grace Telecom Ltd.
    Also a very important consideration is the political conditions comprising of the stability and the policies of the government of the day in the international markets where Grace Telecom Ltd has operations.

Economic factors
There are three main economic elements that Grace Telecom Ltd. needs to consider. These are;
– Shareholder wealth – Grace Telecom Ltd.’s shareholders are a major stakeholder group who will have economic objectives of profit maximization and rising share value. This is crucial especially as the company plans of obtaining public funds from the stock exchange.
– The contribution of the telecommunications industry to the national economy – The telecommunications industry plays a major role in contributing towards economic growth and prosperity. Grace Telecom Ltd. has a responsibility to develop new technology and to provide a reliable, value for money service to its users.
– The economies of foreign countries – the economic conditions in each foreign country that Grace Telecom Ltd. operates in should be considered e.g. foreign currency exchange rates and national economic boom and slump cycles.
– National Economic Indicators– Considering the propose investment in technology for Grace Telecom Ltd. and considering the favorable national economic indicators within the external environment, the company can capitalize on the reducing interest rate to acquire cheaper debt capital towards its anticipated expansion programmes. The operational expansion could be supported by increasing demand within the economy due to falling inflation- however, this would largely depend on the elasticity of the products and services supplied Grace Telecom.

  • Social factors
    Telecommunication products are social products used by people for many reasons. The company should ensure that it understands the social needs of its customers and provide a reliable service. The company should also portray itself as socially responsible company with a set of social objectives and keep close contact with consumers e.g. by producing a range of services for elderly citizens who are more dependent on telephones for obtaining help when needed. Another dimension of the social environment, which includes the culture of the different markets where Grace Telecom operates, is issues of branding. Grace Telecom could pursue a strategy of inculcating the values and culture each of their local markets into their products and services
  • Technical factors
    The telecommunications industry is a high-tech industry that is currently very dynamic. Grace Telecom Ltd. is the market leader in the industry and must be innovative to maintain its competitive advantage. The company must invest in research and development to ensure it has a constant supply of new products in the years ahead to replace those going into the decline stage of their product life cycle. Grace Telecom may also have to think of integrating after sales support services as a core activity in its value chain for very technical products especially as they are contemplating on investing in high technology.

 

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2.3 Audit & AssuranceAnsoff’s Product/ Market Growth MatrixLevel 2

Nov 2015 Q1 b.

CASE STUDY: GRACE TELECOM LIMITED
Introduction
Grace Telecom Ltd. is a well-established company which is providing telecommunications services both nationally and internationally. Its business has been concerned with telephone calls, the provision of telephone lines and equipment, and private telecommunication networks. Grace Telecom Ltd. has supplemented these services recently by offering mobile phone, which is an expanding market worldwide
The company maintains a diverse customer base, including residential users, multi-national companies, government agencies and public sector organisations. The company handles approximately 100,000 million calls each working day, and employs nearly 140 personnel.
Strategic development
The Chairman of Grace Telecom Ltd stated within its latest Annual Report that there were three main areas in which the company aimed to develop in order to remain a world leader in the telecommunications market. He believes that the three main growth areas reflect the evolving nature of the telecommunications market and will provide the scope for development.
The areas in which development is planned are:

  • expansion of the telecommunications business in the national and overseas markets, both by the company acting on its own and through partnership arrangements with other suppliers
  • diversification into television and multi-media services, providing the hardware to permit telephone shopping from home and broadcasting services
  • extension of the joint ventures and strategic alliances which have already been established with companies in West Africa.
    The Chairman explained that the company is intent on becoming a world leader in communications. This will be achieved through maintaining its focus on long-term development by improving its services to customers, developing high quality up-to-date products and being innovative, flexible and market-driven. His aim is to deliver a world-class service at competitive cost.
    Financial information
    The following comparative statistics show extracts from the company’s financial performance in its national telecommunications market over the last two years:

The company estimates its cost of capital to be approximately 18%.
The Chairman expressed satisfaction with the increase in turnover and stated that cost efficiencies were now being generated following the completion of a staff reduction programme. This would assist the company in achieving a target return on capital employed (ROCE) of 20% in this market over the next three years.
Business opportunities
The Chief Executive of Grace Telecom Ltd. has stated that the major opportunities for the company lie in the following areas:

  • encouraging greater use of the telephone
  • provision of advanced services, and research and development into new technology, including the internet and systems integration.

the increasing freedom from government control of worldwide telecommunication services.
An extensive television and poster advertising campaign has been used by the company. This was in order to penetrate further the residential market segment by encouraging greater use of the telephone with various charging incentives being offered to residential customers.
To further the objective of increasing long-term shareholder value, the company is actively considering an investment of GHS200 million in each of the next three years in new technology and quality improvements in its national market. Because of its specialist technical nature, the investment is not expected to have any residual value at the end of the three-year period.
Following the investment, the directors of Grace Telecom Ltd. believe that its rate of profit before interest and tax to turnover in its national telecommunications market will remain constant. This rate will be at the same level as last year for each of the three years of the investment.
Markets and competition
The company is currently experiencing an erosion of its market share and faces increasingly strong competition in the mobile phone market. While Grace Telecom Ltd. is the leader in its national market, with an 85% share of the telecommunications business, it has experienced a reduced demand for the supply of residential lines in the last five years as competition has increased.
The market for the supply of equipment in the national telecommunications market is perceived to be static. The investment of GHS200 million in each of the next three years is estimated to increase Grace Telecom Ltd.’s share of this market to a level of 95%. The full improvement of 10% is expected to be received by Grace Telecom Ltd. next year, and its market share will then remain at this level for the full three-year period. It is anticipated that unless further investment is made after the three-year period, Grace Telecom Ltd.’s market share will revert to its current level as a consequence of the expected competitive response.
Industry regulation
The government has established an industry regulatory organisation to promote competition and deter anti-competitive behaviour.
As a result of the activities of the regulator and aggressive pricing strategies, it is anticipated that charges to customers will remain constant for the full three-year period of the new investment.
All cash flows can be assumed to occur at the end of the year to which they relate. The cash flows and discount rate are in real terms.
Future outlook
The business still remains under family control, but the board is considering an expansion programme for which and that the family would need to raise GH¢200 million in equity or debt finance. One of the possible risks of expansion lies in the fact that the market for fixed telephone lines is falling. New income is being generated by expanding the product range to include mobile money transfer. The key to profit growth for Grace Telecom is the ability to generate sales growth, but the company recognizes that it faces stiff competition from large telecom companies in respect of the prices charged.
In planning its future, Grace Telecom is advised to look carefully at a number of external factors which may affect the business including government economic policy. In recent months the following information has been published in respect of key economic data.
i) Bank base rate has been reduced from 22% to 20%, and the forecast is for a further 0.5% reduction within six months.
ii) The annual rate of inflation is now 12%, down from 14% in the previous quarter, and 16% 12 months ago. No further falls in the rate are expected over the medium term.
iii) Personal and corporate tax rates are expected to remain unchanged for at least twelve months.
Required:

Apply Ansoff’s Product/Market Growth matrix to assess the extent of the potential market development opportunities available to Grace Telecom Ltd.                                                                                                                                   [12 marks]

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1. Market penetration strategies – Grace Telecom Ltd. currently has 85% of its national market. There is little scope for obtaining any growth by increasing its market share. Most households and businesses will have a conventional telephone line so some of the company’s products will be at the maturity stage of their life cycle offering little prospect of growth. Some market growth might be achieved by getting existing customers to use the telephone more. A market penetration strategy only offers limited growth prospects.
2. Product development strategy – This strategy involves introducing new products into existing markets. Grace Telecom Ltd. has already achieved a good track record for new product development and with continued investment in research and development should maintain its momentum. There is a lot of market opportunity in the industry for this strategy e.g. further development in mobile phone and internet technology.
3. Market development strategy – Grace Telecom Ltd. has pursued a successful strategy of expanding into foreign markets with existing products. It currently has operations in North America, Europe, India and the Far East. In Grace Telecom Ltd.’s latest annual report, the Chairman refers to developing countries such as those in Africa where the company currently has operations.
4. Diversification strategy – This involves introducing new products to new markets and is a high-risk strategy. Grace Telecom Ltd. is a large profitable company with a prospector (innovative) culture. The company should evaluate carefully the risk of any diversification strategy and if opportunities exits they should be considered e.g. digital television technology.
The company should pursue all four strategies with the main emphasis on product development and market development, as these exploit the company’s main strengths of expertise in research and development, and growth in foreign markets.
Note: Some students may draw the Ansoff’s Matrix. If this is correctly done without any subsequent explanation and relating it to the case, half of the total mark may be awarded (i.e. 1.5 each)

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GSE listing requirementLevel 2 - Corporate Strategy, Ethics & GovernancePrevious Syllabus

Nov 2015 Q1 e.

CASE STUDY: GRACE TELECOM LIMITED
Introduction
Grace Telecom Ltd. is a well-established company which is providing telecommunications services both nationally and internationally. Its business has been concerned with telephone calls, the provision of telephone lines and equipment, and private telecommunication networks. Grace Telecom Ltd. has supplemented these services recently by offering mobile phone, which is an expanding market worldwide
The company maintains a diverse customer base, including residential users, multi-national companies, government agencies and public sector organisations. The company handles approximately 100,000 million calls each working day, and employs nearly 140 personnel.
Strategic development
The Chairman of Grace Telecom Ltd stated within its latest Annual Report that there were three main areas in which the company aimed to develop in order to remain a world leader in the telecommunications market. He believes that the three main growth areas reflect the evolving nature of the telecommunications market and will provide the scope for development.
The areas in which development is planned are:

  • expansion of the telecommunications business in the national and overseas markets, both by the company acting on its own and through partnership arrangements with other suppliers
  • diversification into television and multi-media services, providing the hardware to permit telephone shopping from home and broadcasting services
  • extension of the joint ventures and strategic alliances which have already been established with companies in West Africa.
    The Chairman explained that the company is intent on becoming a world leader in communications. This will be achieved through maintaining its focus on long-term development by improving its services to customers, developing high quality up-to-date products and being innovative, flexible and market-driven. His aim is to deliver a world-class service at competitive cost.
    Financial information
    The following comparative statistics show extracts from the company’s financial performance in its national telecommunications market over the last two years:

The company estimates its cost of capital to be approximately 18%.
The Chairman expressed satisfaction with the increase in turnover and stated that cost efficiencies were now being generated following the completion of a staff reduction programme. This would assist the company in achieving a target return on capital employed (ROCE) of 20% in this market over the next three years.
Business opportunities
The Chief Executive of Grace Telecom Ltd. has stated that the major opportunities for the company lie in the following areas:

  • encouraging greater use of the telephone
  • provision of advanced services, and research and development into new technology, including the internet and systems integration.

the increasing freedom from government control of worldwide telecommunication services.
An extensive television and poster advertising campaign has been used by the company. This was in order to penetrate further the residential market segment by encouraging greater use of the telephone with various charging incentives being offered to residential customers.
To further the objective of increasing long-term shareholder value, the company is actively considering an investment of GHS200 million in each of the next three years in new technology and quality improvements in its national market. Because of its specialist technical nature, the investment is not expected to have any residual value at the end of the three-year period.
Following the investment, the directors of Grace Telecom Ltd. believe that its rate of profit before interest and tax to turnover in its national telecommunications market will remain constant. This rate will be at the same level as last year for each of the three years of the investment.
Markets and competition
The company is currently experiencing an erosion of its market share and faces increasingly strong competition in the mobile phone market. While Grace Telecom Ltd. is the leader in its national market, with an 85% share of the telecommunications business, it has experienced a reduced demand for the supply of residential lines in the last five years as competition has increased.
The market for the supply of equipment in the national telecommunications market is perceived to be static. The investment of GHS200 million in each of the next three years is estimated to increase Grace Telecom Ltd.’s share of this market to a level of 95%. The full improvement of 10% is expected to be received by Grace Telecom Ltd. next year, and its market share will then remain at this level for the full three-year period. It is anticipated that unless further investment is made after the three-year period, Grace Telecom Ltd.’s market share will revert to its current level as a consequence of the expected competitive response.
Industry regulation
The government has established an industry regulatory organisation to promote competition and deter anti-competitive behaviour.
As a result of the activities of the regulator and aggressive pricing strategies, it is anticipated that charges to customers will remain constant for the full three-year period of the new investment.
All cash flows can be assumed to occur at the end of the year to which they relate. The cash flows and discount rate are in real terms.
Future outlook
The business still remains under family control, but the board is considering an expansion programme for which and that the family would need to raise GH¢200 million in equity or debt finance. One of the possible risks of expansion lies in the fact that the market for fixed telephone lines is falling. New income is being generated by expanding the product range to include mobile money transfer. The key to profit growth for Grace Telecom is the ability to generate sales growth, but the company recognizes that it faces stiff competition from large telecom companies in respect of the prices charged.
In planning its future, Grace Telecom is advised to look carefully at a number of external factors which may affect the business including government economic policy. In recent months the following information has been published in respect of key economic data.
i) Bank base rate has been reduced from 22% to 20%, and the forecast is for a further 0.5% reduction within six months.
ii) The annual rate of inflation is now 12%, down from 14% in the previous quarter, and 16% 12 months ago. No further falls in the rate are expected over the medium term.
iii) Personal and corporate tax rates are expected to remain unchanged for at least twelve months.
Required:

Outline FOUR (4) methods whereby Grace Telecom Ltd can obtain quotation for its share on the Ghana Stock Exchange.                                                                                                                                                                   [4 marks]

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i. An offer for sale, which is an offer to the public by an issuing house or broker of securities already in issue or for which they have agreed to subscribe.
ii. An Offer for Subscription
iii. A Right issue, which is an issue of shares at a special price by a company to its existing shareholders in proportion to their holding of old shares.
iv. A Bonus/Capitalization issue, which is an issue of additional shares to shareholders instead of paying dividend, in proportion to shares already held.
v. A placing, which is the term used to describe the sale of or obtaining subscription for securities privately by an issuing house or broker through the market and to or by their own clients.
vi. An introduction, which describes an application where no marketing arrangements are required because the securities to be listed are already of such an amount and so widely, held that their adequate marketability when listed can be assumed.

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Level 2 - Corporate Strategy, Ethics & GovernancePrevious SyllabusStrategic Analysis

Nov 2015 Q1 d.

CASE STUDY: GRACE TELECOM LIMITED
Introduction
Grace Telecom Ltd. is a well-established company which is providing telecommunications services both nationally and internationally. Its business has been concerned with telephone calls, the provision of telephone lines and equipment, and private telecommunication networks. Grace Telecom Ltd. has supplemented these services recently by offering mobile phone, which is an expanding market worldwide
The company maintains a diverse customer base, including residential users, multi-national companies, government agencies and public sector organisations. The company handles approximately 100,000 million calls each working day, and employs nearly 140 personnel.
Strategic development
The Chairman of Grace Telecom Ltd stated within its latest Annual Report that there were three main areas in which the company aimed to develop in order to remain a world leader in the telecommunications market. He believes that the three main growth areas reflect the evolving nature of the telecommunications market and will provide the scope for development.
The areas in which development is planned are:

  • expansion of the telecommunications business in the national and overseas markets, both by the company acting on its own and through partnership arrangements with other suppliers
  • diversification into television and multi-media services, providing the hardware to permit telephone shopping from home and broadcasting services
  • extension of the joint ventures and strategic alliances which have already been established with companies in West Africa.
    The Chairman explained that the company is intent on becoming a world leader in communications. This will be achieved through maintaining its focus on long-term development by improving its services to customers, developing high quality up-to-date products and being innovative, flexible and market-driven. His aim is to deliver a world-class service at competitive cost.
    Financial information
    The following comparative statistics show extracts from the company’s financial performance in its national telecommunications market over the last two years:

The company estimates its cost of capital to be approximately 18%.
The Chairman expressed satisfaction with the increase in turnover and stated that cost efficiencies were now being generated following the completion of a staff reduction programme. This would assist the company in achieving a target return on capital employed (ROCE) of 20% in this market over the next three years.
Business opportunities
The Chief Executive of Grace Telecom Ltd. has stated that the major opportunities for the company lie in the following areas:

  • encouraging greater use of the telephone
  • provision of advanced services, and research and development into new technology, including the internet and systems integration.

the increasing freedom from government control of worldwide telecommunication services.
An extensive television and poster advertising campaign has been used by the company. This was in order to penetrate further the residential market segment by encouraging greater use of the telephone with various charging incentives being offered to residential customers.
To further the objective of increasing long-term shareholder value, the company is actively considering an investment of GHS200 million in each of the next three years in new technology and quality improvements in its national market. Because of its specialist technical nature, the investment is not expected to have any residual value at the end of the three-year period.
Following the investment, the directors of Grace Telecom Ltd. believe that its rate of profit before interest and tax to turnover in its national telecommunications market will remain constant. This rate will be at the same level as last year for each of the three years of the investment.
Markets and competition
The company is currently experiencing an erosion of its market share and faces increasingly strong competition in the mobile phone market. While Grace Telecom Ltd. is the leader in its national market, with an 85% share of the telecommunications business, it has experienced a reduced demand for the supply of residential lines in the last five years as competition has increased.
The market for the supply of equipment in the national telecommunications market is perceived to be static. The investment of GHS200 million in each of the next three years is estimated to increase Grace Telecom Ltd.’s share of this market to a level of 95%. The full improvement of 10% is expected to be received by Grace Telecom Ltd. next year, and its market share will then remain at this level for the full three-year period. It is anticipated that unless further investment is made after the three-year period, Grace Telecom Ltd.’s market share will revert to its current level as a consequence of the expected competitive response.
Industry regulation
The government has established an industry regulatory organisation to promote competition and deter anti-competitive behaviour.
As a result of the activities of the regulator and aggressive pricing strategies, it is anticipated that charges to customers will remain constant for the full three-year period of the new investment.
All cash flows can be assumed to occur at the end of the year to which they relate. The cash flows and discount rate are in real terms.
Future outlook
The business still remains under family control, but the board is considering an expansion programme for which and that the family would need to raise GH¢200 million in equity or debt finance. One of the possible risks of expansion lies in the fact that the market for fixed telephone lines is falling. New income is being generated by expanding the product range to include mobile money transfer. The key to profit growth for Grace Telecom is the ability to generate sales growth, but the company recognizes that it faces stiff competition from large telecom companies in respect of the prices charged.
In planning its future, Grace Telecom is advised to look carefully at a number of external factors which may affect the business including government economic policy. In recent months the following information has been published in respect of key economic data.
i) Bank base rate has been reduced from 22% to 20%, and the forecast is for a further 0.5% reduction within six months.
ii) The annual rate of inflation is now 12%, down from 14% in the previous quarter, and 16% 12 months ago. No further falls in the rate are expected over the medium term.
iii) Personal and corporate tax rates are expected to remain unchanged for at least twelve months.
Required:

Explain whether Grace Telecom should continue with its expansion plans. Clearly justify your argument for or against the expansion.                                                                                                                                                                [10 marks]

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i) Need to increase sales
Due to the low level of gross margins, Grace Telecom Ltd needs to increase the level of sales in order to trade profitably. In view of the low level of recent seals growth, in spite of the addition of new products, it seems that the only way to increase sales significantly is by the opening of new outlets.
ii) Bulk order discounts
Expansion of the business will increase the level of purchase and could lead to an improvement in the level of buying power with suppliers, and the ability to take advantage of bulk order discounts. This would in turn have a positive impact on gross margins and profitability.
iii) Wider geographical spread
A wider geographical spread will make the business less vulnerable to local even, such as an increase in the level of unemployment or the opening of a new superstore.
iv) Economic of scale
Expansion could lead to some economies of scale, for instance in the wider deployment of regional management.
Arguments against expansion
i) Nature of products
Expansion will not change the fundamental weakness of the business, which is that most of the business is in low value products with strong price competition. There is limited potential to grow, and other factors, the greater convenience of being able to buy practically all products required at a single large store, are working against the business.
ii) Risk of political pressure
Grace Telecom Ltd. risk coming under greater political pressure if it tries to expand further to obtain large share of the marker (already 85% is very significant and could lead to monopolistic behaviours by the company). Such political pressures could lead to greater political regulation and costs that may hinder the operations of the company.
iii) Competitive pressures
Strong price competition due to low inflation and the position of the supermarket sector is likely to continue for the foreseeable future.
Conclusion
In conclusion, Grace Telecom Ltd should think very carefully before committing to the expansion, since this is unlikely to do much to increase margins and profitability. The company could perhaps consider an alternative strategy of selling different higher added value products, and changing the whole style of the operation. For example, it could consider expanding into areas which present greater opportunities for competing based on cost/price.

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Finance perspective : OthersLevel 2 - Corporate Strategy, Ethics & GovernancePrevious Syllabus

Nov 2015 Q1 c.

CASE STUDY: GRACE TELECOM LIMITED
Introduction
Grace Telecom Ltd. is a well-established company which is providing telecommunications services both nationally and internationally. Its business has been concerned with telephone calls, the provision of telephone lines and equipment, and private telecommunication networks. Grace Telecom Ltd. has supplemented these services recently by offering mobile phone, which is an expanding market worldwide
The company maintains a diverse customer base, including residential users, multi-national companies, government agencies and public sector organisations. The company handles approximately 100,000 million calls each working day, and employs nearly 140 personnel.
Strategic development
The Chairman of Grace Telecom Ltd stated within its latest Annual Report that there were three main areas in which the company aimed to develop in order to remain a world leader in the telecommunications market. He believes that the three main growth areas reflect the evolving nature of the telecommunications market and will provide the scope for development.
The areas in which development is planned are:

  • expansion of the telecommunications business in the national and overseas markets, both by the company acting on its own and through partnership arrangements with other suppliers
  • diversification into television and multi-media services, providing the hardware to permit telephone shopping from home and broadcasting services
  • extension of the joint ventures and strategic alliances which have already been established with companies in West Africa.
    The Chairman explained that the company is intent on becoming a world leader in communications. This will be achieved through maintaining its focus on long-term development by improving its services to customers, developing high quality up-to-date products and being innovative, flexible and market-driven. His aim is to deliver a world-class service at competitive cost.
    Financial information
    The following comparative statistics show extracts from the company’s financial performance in its national telecommunications market over the last two years:

The company estimates its cost of capital to be approximately 18%.
The Chairman expressed satisfaction with the increase in turnover and stated that cost efficiencies were now being generated following the completion of a staff reduction programme. This would assist the company in achieving a target return on capital employed (ROCE) of 20% in this market over the next three years.
Business opportunities
The Chief Executive of Grace Telecom Ltd. has stated that the major opportunities for the company lie in the following areas:

  • encouraging greater use of the telephone
  • provision of advanced services, and research and development into new technology, including the internet and systems integration.

the increasing freedom from government control of worldwide telecommunication services.
An extensive television and poster advertising campaign has been used by the company. This was in order to penetrate further the residential market segment by encouraging greater use of the telephone with various charging incentives being offered to residential customers.
To further the objective of increasing long-term shareholder value, the company is actively considering an investment of GHS200 million in each of the next three years in new technology and quality improvements in its national market. Because of its specialist technical nature, the investment is not expected to have any residual value at the end of the three-year period.
Following the investment, the directors of Grace Telecom Ltd. believe that its rate of profit before interest and tax to turnover in its national telecommunications market will remain constant. This rate will be at the same level as last year for each of the three years of the investment.
Markets and competition
The company is currently experiencing an erosion of its market share and faces increasingly strong competition in the mobile phone market. While Grace Telecom Ltd. is the leader in its national market, with an 85% share of the telecommunications business, it has experienced a reduced demand for the supply of residential lines in the last five years as competition has increased.
The market for the supply of equipment in the national telecommunications market is perceived to be static. The investment of GHS200 million in each of the next three years is estimated to increase Grace Telecom Ltd.’s share of this market to a level of 95%. The full improvement of 10% is expected to be received by Grace Telecom Ltd. next year, and its market share will then remain at this level for the full three-year period. It is anticipated that unless further investment is made after the three-year period, Grace Telecom Ltd.’s market share will revert to its current level as a consequence of the expected competitive response.
Industry regulation
The government has established an industry regulatory organisation to promote competition and deter anti-competitive behaviour.
As a result of the activities of the regulator and aggressive pricing strategies, it is anticipated that charges to customers will remain constant for the full three-year period of the new investment.
All cash flows can be assumed to occur at the end of the year to which they relate. The cash flows and discount rate are in real terms.
Future outlook
The business still remains under family control, but the board is considering an expansion programme for which and that the family would need to raise GH¢200 million in equity or debt finance. One of the possible risks of expansion lies in the fact that the market for fixed telephone lines is falling. New income is being generated by expanding the product range to include mobile money transfer. The key to profit growth for Grace Telecom is the ability to generate sales growth, but the company recognizes that it faces stiff competition from large telecom companies in respect of the prices charged.
In planning its future, Grace Telecom is advised to look carefully at a number of external factors which may affect the business including government economic policy. In recent months the following information has been published in respect of key economic data.
i) Bank base rate has been reduced from 22% to 20%, and the forecast is for a further 0.5% reduction within six months.
ii) The annual rate of inflation is now 12%, down from 14% in the previous quarter, and 16% 12 months ago. No further falls in the rate are expected over the medium term.
iii) Personal and corporate tax rates are expected to remain unchanged for at least twelve months.
Required:

Explain the relevance of each of the items of economic data listed in the case to Grace Telecom Ltd.                      [6 marks]

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i) Reduction in bank base rate
1) Change in costs of borrowing
This may occur directly through the change in the cost of borrowing and therefore the cost of capital. A fall in interest rates will make borrowing cheaper, and therefore reduce the cost of raising the finance for the proposed expansion. This is likely to apply to any means of financing the company, since corporate borrowing rates are generally set at a certain premium above base rate. If Grace Telecom Ltd. applies DCF techniques in evaluating the expansion, the reduction in the cost of capital will lead to an increase in the level of the NPV for the proposals.
2) Level of demand
Level of demand within the economy could be indirectly affected through the effect of interest rates. Keynesian theory contends that a fall in the level of interest rates will increase the demand for money, and hence the overall level of demand within the economy. Monetarists, on the other hand, believe that the level of consumer demand is unaffected by changes in interest rates. Grace Telecom Ltd is trading in low value basic products for which the level of demand is relatively inelastic. Even if a fall in interest rates affects overall demand in the way that Keynesians predict, this is unlikely to have any significant effect on the level of demand for Grace Telecom Ltd.’s products.
3) Economic confidence
The reduction in the interest rate will increase general economic confidence and encourage expansion. Again though it is likely that the level of confidence will not have much impact on the type of product the company is dealing in.
4) Summary
To summarize, the reduction in the bank’s base rate is likely to reduce the cost of the expansion plans, but will probably have little effect on the level of sales.
ii) Effect of present and forecast rates of inflation
1) Interest rates
Interest rates are unlikely to rise if inflation remains so low
2) Costs of purchases
The cost of the products that Grace Telecom purchase should remain stable. Wage rates may be less affect, there may be pressures other than inflation rates that cause wage increases.
3) Price increases
In conditions of low inflation, it is hard to make any price increase without losing business. Grace Telecom, as already noted is offering low value products and services and thus are unlikely to increase prices up to a certain extent, thereby reducing its ability to compete favourably based on price.
Low inflation is therefore likely to present more of a threat than an opportunity to Grace Publishing
iii) Effects of stable tax rates
1) Consumer demand
Changes in personal tax rates can affect consumer demand, but as was discussed above, demand for Grace Telecom products and services are inelastic, and therefore the stability or otherwise of tax rates is unlikely to have much effect on sales.
2) Tax relief
When planning the expansion, it is easier to plan with confidence since the levels for tax relief available to both the company and individual equity investors are known.
Stable personal and corporate tax rates will therefore help in developing the expansion plans.

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