Core Activity A - Evaluate opportunities to add value

Question 1

What tools can be used to analyse the industry ecosystem?

Answer 1

Porters five forces

PESTEL

Industry lifecycle analysis

Question 2

How does FLATTHALL define value ?

Answer 2

‘Strategic’

Focus on student needs - providing safe and attractive purpose built accommodation creating a relaxed environment.

Question 3

Describe the components of the business ecosystem relevant to flathall

Answer 3

Society

Markets

Tech

Risk & Opportunity

Question 4

How does FLATHALL create value ?

Answer 4

‘Operational’

Pro active in identifying appropriate sites. Good quality building materials in high demand locations. Considerable expertise in acquisition and construction.

Question 5

How does FLATTHALL deliver value ?

Answer 5

‘Operational’

Through relationships with institutions underpinning commercial success. And relationships with students who recommend FLATTHALL or often return themselves.

Question 6

How does FLATHALL capture value?

Answer 6

‘Strategic’

Residual value is captured through charging realistic rents. Rents are only maintainable if the quality of the accommodation does not deteriorate. Asset management is key here in relation to upgrades, refurbishment and renovations.
Cost model is key, economies of scale, hedging strategies
Dividend policy - payout 37%, cover 2.7

Question 7

Who are FLATTHALL’s key stakeholders?

Answer 7

Students
Institutions
Other institution partners .. gig venues / gyms / shops etc
Government
Shareholders
Employees
Construction partners
Construction supply chain
Other suppliers

Question 8

Describe porters 5 forces

Answer 8

Competitive rivalry
Bargaining power of customers
Bargaining power of suppliers
Threat of substitutes
Threat of new entrants

Question 9

Describe the digital ecosystem that Flatthall operates in ?

Answer 9

Political - Unknown
Economic - Unknown
Society
Tech
Environmental
Legal

Question 10

Describe the CGMA business model framework

Answer 10

Define, Create, Deliver, Capture

Networks
- Society
- Markets

Enablers
- Technology
- Risk and opportunity

Question 11

What approaches could be taken in a VUCA ecosystem environment?

Answer 11

Volatile, uncertain, complex, ambiguity
(Fast decision making required)
Innovate
Withstand
Pivot/ move

Question 12

What are real options and how could Flathall use them when assessing a capital investment decision?

Answer 12

Option to follow on - Are there opportunities for new projects arising from this investment?

Option to abandon - This would provide Flathall with the opportunity to withdraw from a failed project, ie a break clause in lease agreement. Or a short term rental agreement

Option to delay - This would bring Flathall more flexibility which would in turn reduce uncertainty associated with forecasting that will help to determine if the project is a success.

NPV’s can be compared before considering the real option, to after, to understand if the consideration of a real option, leads to a financial benefit.

Question 13

What strategies could flathall use to build a disruptive business model?

Answer 13

Build
Buy
Partner
Invest
Incubate

Question 14

What are the steps involved in making investment decisions? ie capital allocation

Answer 14

Initiation phase - Identify objective, seek out opportunities, understand the ‘states of nature’ (controllable and non controllable factors)

Decision phase - List possible outcomes (scenario planning), Investment appraisal & significant financial analysis, Rank and select the investment project based on risk appetite PI index etc.

Implementation phase - Obtain authorisation ie CFO, Capex committee, Review capital Investment via post implementation audit to ensure it on track to deliver the expected returns.

Question 15

How might Flathall decide which investment project to take when all funds are not available?

Answer 15

Capital rationing techniques such as Hard or soft (ie restricting itself//soft..not enough money..hard)

Using the profitability index can be useful to rank projects in terms of efficiency. Best use of return per 1 dollar invested

Question 16

What non financial factors may Flathall consider when making a capital investment decision?

Answer 16

Internal constraints
Ms model (management information, machinery, manpower, methods, materials, money)

External constraints
PESTEL

Question 17

What investment appraisal techniques could Flathall use when making an investment decision?

Answer 17

Payback
ARR

IRR
MIRR
NPV

Annuity/ Perpetuity

Question 18

What is ARR?

Answer 18

Earnings before interest and tax / Capital investment

Advantages
- Simple and well understood

Disadvantages
- Uses profits instead of cash flows
- Doesn’t incorporate the TVM

Question 19

How might Flathall approach the investment appraisal of 2 projects with limited capital ?

Answer 19

Via capital rationing using NPV and profitability index rating the efficiency of the capital.

Question 20

How might Flathall go about formulating an investment appraisal decision?

Answer 20

3 phases

Initiation
Identify objectives (positive npv/ non financial?)
Identify states of nature (variables/ risk) sensitivity analysis etc
Scenario planning
Seek out investment opportunities

Decision
Review returns
Review risks
Prompt more detailed investment appraisal
Review again
Select investment and rational

Implementation
Review again
Obtain authorisation from capex committee
Agree budget
Proceed with decision

Question 21

What is payback?

Answer 21

Number of years expected to recover funds

Invested amount / expected relevant cash flows

Advantages
- Simple screening technique
- Simple to understand and communicate
- Uses cash flows

Disadvantages
- Non DCF but can be adjusted to discounted payback
- Does not evaluate post payback period
- No benchmark

Question 22

What is discounting ?

Answer 22

Discounting is the mathematical inverse of compounding.

Question 23

Describe NPV?

Answer 23

NPV formula calculates the direct increase or decrease in shareholder wealth as a result of undertaking the project. It uses relevant cash flows and incorporates the time value of money by discounting each cash flow to its PV using an appropriate discount rate, usually the cost of capital in similar risk level investments.

Question 24

Describe the advantages and disadvantages of using NPV?

Answer 24

Advantages
- Uses relevant cash flows
- Incorporates risk using cost of capital
- TVM is incorporated
- Clear decision criteria (ie positive NPV)
- NPV in absolute terms

Disadvantages
- Complex for non financial
- Discount rate difficult to determine and can be arbitrary

Question 25

Describe MIRR?

Answer 25

The IRR of the project is the rate of return that sets the NPV equal to zero. If the IRR of the project is greater than the discount rate the project should be accepted. It’s not completely useful when comparing projects however as it doesn’t indicate absolute return.

MIRR is superior to IRR as it assumes surplus funds are invested @ the cost of capital which is more realistic.

Question 26

What are the advantages and disadvantages of MIRR?

Answer 26

Advantages
- Presented as a percentage
- Incorporates TMV
- Provides a measure of approximate returns
- Can use excel =MIRR and change reinvestment rate

Rule
Projects with a MIRR > cost of finance should be undertaken

Disadvantages
- Discount rate can be arbitrary if complex project.
- Detailed financial analysis required.

Question 27

How might Flathall simplify investment appraisal for fully occupied properties?

Answer 27

We could incorporate annuities and perpetuities. This simplifies the NPV for constant amounts or constant amounts that rise by a fixed amount, such as inflation.

An annuity may be more appropriate for Flathall as the buildings are made up of several components with varyings asset lifecycles. ie plumbing system, structure, electrical system etc F&F.

We would need to analyse the asset life and calculate the harmonic mean to give us the Annuity period before further capital investment is required. Ie complete rewire etc.

Question 28

What is the formula for Profitability Index?

Answer 28

NPV of Project / PV of capital Investment

PI can be ranked with the highest PI representing a more efficient use of capital. ie greater NPV per dollar invested.

Question 29

How might Flathall analyse replacement cost cycles with different expected asset lives ?

Answer 29

By using EAC analysis - Equivalent annual cost analysis.

EAC = PV of costs / annuity factor

AF = discount rate and asset life

Question 30

What examples are there of information systems at different levels?

Answer 30

Operational - Transactional / efficiency orientated. Includes, Inventory management, accounting systems, CRM etc

Management - allows the summary of the detailed operational data to aid decision making

Strategic - Allows the preparation of information specifically related to the strategy & aids strategic decision making and comprises of internal and external information.

Question 31

What factors are important when considering Information systems?

Answer 31

Accuracy
Timeliness
Relevance
Completeness
Consistency

Question 32

What relevant Digital data sources exist for Flathall ?

Answer 32

• IT systems
• Research commissioned by institutions on student trends and numbers
• Own commissioned research on trends
• Research commissioned by competitors
• Social media trends
• Internet searches
• Purchasing data (student shops)
• GPS data
• Streamed media (communal rooms etc)
• Fast food data
• Key pass data

Question 33

What are the 4 V’s in relation to big data?

Answer 33

Volume - Scale of data
Velocity - Speed in which its processed
Variety - Number of data sources
Veracity - Accuracy

High volumes and variety may lead to inaccuracies

Question 34

What variables may impact Flathalls pricing strategy?

Answer 34

• Current position in the market (market leader)
• Product stage in Lifecycle (new rooms etc)
• Level of competition
• Sensitivity of the market

(Flathalls room price is driven by the market and what it can afford)

Target costing usefull

Question 35

What are the different types of market based pricing strategies and how could these be used by Flathall?

Answer 35

Market Skimming
- Not really relevant to Flathall unless drastic changes are made to the design of rooms. May still only fall into premium pricing.

Loss leader
- This could be the branding merch etc or even a gym/ cinema

Premium pricing
- Could be useful for postgrads who want more luxury or higher end areas or International students ?

Market penetration
- Already has market share but PBSA is only a very small part of the total market. Could be used to attract students from HMO’s and living with parents.

Product bundling
- Bundling all security, utilities, amenities such as gym etc into one price.

Question 36

What are the varying types of cost based pricing strategies?

Answer 36

Cost plus - not useful to Flathall as pricing is very market driven.

Target Costing - super useful to help improve cost efficiencies without compromising on quality.

Question 37

What Ecosystem trends could prove disruptive to Flathall?

Answer 37

P
- Changes in student funding
E
- High inflation and impact on costs
- Increased cost of finance (IR)
S
- Room/ time share
- LGBTQ facilities
- Increased popularity of apprenticeships
T
- Advances in online learning
E
- Student travel habits/ cycle storage etc
L
- Changes in tenant protection law

Question 38

Describe the WACC?

Answer 38

The WACC is the average cost of a company’s finance, taking the cost of each type of finance (ordinary shares, bank borrowing, preference shares, bonds) and weighting them according to the proportion of the overall finance pool they represent. Hence, the company can see the overall cost of the finance it uses. Key in deterring economic profitability and high level decision making.

Question 39

How does the calculation of cost differ between debt and equity?

Answer 39

Debt is tax deductible. It is therefore sensible to incorporate this into the cost of capital by using the post tax figure.

Equity holders also want a risk premium

Question 40

What are the key limitations to WACC?

Answer 40

Cost of equity part is not perfect.

DDM assumes constant dividend

Cost of equity can be arbitrary and vary depending on investor experience and availability of similar risk level opportunities

CAPM uses beta and isn’t often used in real life. Stock volatility is not an accurate measure of real business risk.

Not useful if the project carries different risk profile

Doesn’t include short term finance or new finance for project being assessed.

MCC more appropriate

Question 41

Describe the DDM?

Answer 41

Predicts the price of equity by discounting the sum of future expected dividends.

Arbitrary discount rate and assumes dividends grow at constant growth rate. Also only useful for companies issuing a dividend.

Question 42

Describe CAPM?

Answer 42

Attempts to determine expected return or used to estimate cost of equity

Expected return =

Risk free rate
Beta
Expected return of market

Question 43

Describe risk premium?

Answer 43

The difference between the expected return of the investment less the risk free rate

Question 44

What components make up the WACC?

Answer 44

Market value of debt (bonds)
Book value of debt (bank loans)
Market value of equity (Ordinary share price)
Book value of equity (preference shares)

Question 45

Define a digital ecosystem?

Answer 45

A digital ecosystem is a group of interdependent organisations, people, and devices that share digital platforms for mutual benefit. Digital ecosystems enable businesses to interact with customers, partners, markets, and competitors.

The internet ….
Websites
Forums
Social media
Digital news
Research portals accessed digitally

Question 46

What’s the formula for post tax cost of debt ?

Answer 46

After tax cost of debt = pre tax cost of debt x (1 - tax rate)

Question 47

What is meant by states of nature of in decision making ?

Answer 47

States of nature refer to all future events that could occur

Question 48

Describe the relevance of WACC?

Answer 48

Relevant when understanding the weighted average cost of the company’s existing finance.
Comprised of, the cost of debt & the cost of equity (dividend discount model).

Used as the discount rate during investment appraisal with the objective achieving a positive NPV. Or if translating the NPV analysis into MIRR, a healthy spread between the discount rate (WACC) and the (MIRR). Smaller or weaker spread indicates higher risk. This can be further analysed with the the use of sensitivity analysis, SD & coefficient of variation.

WACC becomes less relevant during the analysis of a new project whereby further external finance is raised. A more accurate measure here would be the MCC as this includes the cost of the new finance, once successfully raised the MCC becomes the new WACC for investment appraisal.

The analysis directly translates the objectives of the firms shareholders, that is, to create wealth for shareholders.

NPV can be confusing to non Finance stakeholders, the translation into MIRR, the same language as the comparable discount rate, can help to simplify the discussions around wealth creation and economic spread.

Question 49

Why is the capital asset pricing model not used?

Answer 49

Because stock market volatility ‘beta’ is not a reliable measure of risk.

We should focus on business risks (!)

Buffet example

Question 50

What’s buffets cost of capital theory ?

Answer 50

The cost of equity models are ridiculous

Cost of capital should simply be the opportunity cost, ie what other options are available to the investor that carry similar risks?

Also, if external finance is available .. how much does that cost and what’s the finance markets view on the risk? Easier with property and mortgages etc due to the sucured PPE

Question 51

What is the formula for enterprise vale?

Answer 51

Market cap + debt - cash

Question 52

How do you calculate factors in relation to the TVM?

Answer 52

= 1/ (1+i)^n

Question 53

How might you choose to rank stakeholders?

Answer 53

Using mendalow’s steak holder matrix

Rank stakeholders based on interest and power.

Key players
keep satisfied
keep informed
low priority

Question 55

What does the PI tell is ?

Answer 55

For every one dollar invested the project will return a NPV of the PI index (example .37)

Question 56

Define IRR

Answer 56

The rate of return at which the projects NPV would be equal to 0.

This doesn’t take into consideration any external discount rate and simply suggest the NPV is equal to 0 if the IRR was the discount rate.