Hungry Box is a private limited company primarily
owned by Mr. Hanger and his family. The company specializes in delivering
freshly cooked meals and has partnered with approximately 25 restaurants in
Mumbai. Delivery personnel work in shifts, with the first delivery commencing
at 5 AM and the last pick-up at 11 PM.
Despite its popularity for quick delivery, Hungry Box
is not achieving the expected profit, and its return on investment (ROI) falls
short of the company's goals. As the market becomes increasingly competitive,
any additional investment may not yield the desired returns.
To address these challenges and adapt to changes in
the market, the management of Hungry Box is considering aggressive investment
strategies. Their expansion plan includes the following options:
Option 1: Acquire Hot Meals, another food delivery
service, to enhance market penetration and improve current delivery services.
Option 2: Expand operations to include the delivery of
home essentials such as groceries, vegetables, fruits, and fresh flowers.
Option 3: Purchase additional delivery scooters and
hire more staff to reach a broader customer base.
However, except for Option 2, the other options
require substantial investment. Although Hungry Box is profitable, it lacks
sufficient retained earnings to support these initiatives.
a) Outline two features of retained profit. [2 marks]
b) Explain one advantage and one disadvantage of an
internal source of finance. [4 marks]
c) With reference to HB’s proposed growth options,
distinguish between internal growth and external growth [ 4 marks]
d) With reference to Option 1 in the stimulus, discuss
two external sources of finance and recommend the best source. [10 marks]
Suggested answers
a) Outline two features of retained profit [2 marks]
Two features of
retained profit are:
·
Internal
source of finance:
Retained profit is generated from the company's own earnings, making it an
internal source of finance, hence it is quick and safe.
·
No
interest or repayment obligation: Since retained profit is the company's own money, using it does not
incur interest or require repayment, unlike loans or other external financing
options.
b) Explain one advantage and one disadvantage of an
internal source of finance. [4 marks]
Advantage of an internal
source of finance:
Internal
sources, like retained profit, allow Hungry Box to fund expansion without
taking on debt or issuing more shares. This means the company won't incur interest payments or
dilute ownership, enabling the business to maintain control and improve
profitability in the long term.
However, Hungry
Box has limited retained earnings, and relying solely on internal finance may
restrict its ability to pursue aggressive investment strategies (like acquiring
Hot Meals) since these options require substantial funds. This could hinder its
growth opportunities in a highly competitive market.
c) With reference to HB’s proposed growth options, distinguish between internal growth and external growth [ 4 marks]
Internal growth (organic growth) refers to expanding
the business using its own resources, typically by increasing sales, developing
new products, or expanding operations. In the case of Hungry Box, Option 2
(expanding to deliver home essentials) and Option 3 (purchasing additional
scooters and hiring more staff) represent internal growth. These options rely
on improving and scaling up current operations to achieve growth without
merging with or acquiring other companies.
External growth (inorganic growth) involves expanding
by merging with or acquiring other businesses. Option 1 (acquiring Hot Meals)
is an example of external growth for Hungry Box, as it involves the acquisition
of another company to enhance market penetration and service capabilities. This
method usually leads to faster growth but requires significant investment and
carries higher risks compared to internal growth.
d) With reference to Option 1 in the stimulus, discuss two external sources of finance and recommend the best source. [10 marks]
Hungry Box's profit and return on investment (ROI) are
below expectations, while the market is becoming increasingly competitive. The
management is at a crossroads, considering various growth options and suitable
sources of finance. This response
evaluates the pros and cons of Option 1 and recommends the best source of
finance for the company's expansion.
External source 1: Bank loan- advantages of a Bank loan for Hungry Box:
Immediate capital access: A bank loan provides Hungry Box with quick access to
a substantial amount of capital needed for the acquisition of Hot Meals,
allowing the company to expand its market presence and improve services without
delay.
Ownership retention: By opting for a bank loan, Hungry Box can retain
full ownership and control of the business, as it does not require issuing
shares or diluting the family’s stake in the company.
However, Debt obligation: Taking out a bank loan creates a fixed
financial obligation, requiring regular interest payments and principal
repayments, which could strain the company’s cash flow, especially if revenues
do not increase as projected.
Credit risk: If Hungry Box fails to meet repayment terms, it
risks damaging its credit rating, which could affect future borrowing
capabilities and lead to potential legal consequences or bankruptcy.
External source 2: Going Public - advantages for Hungry Box are:
Access to capital: By going public, Hungry Box can raise significant
capital through the sale of shares, providing the necessary funds to acquire
Hot Meals and support further expansion initiatives without incurring debt.
Increased visibility and credibility: Becoming a publicly traded company can enhance Hungry
Box's profile in the market, attracting more customers, partners, and investors
due to increased visibility and perceived credibility.
However, Going Public for Hungry Box involves the following challenges:
Loss of control: Going public means sharing ownership with
shareholders, which can dilute the control that Mr. Hanger and his family have
over the company’s decisions and direction, potentially leading to conflicts
with investors.
Regulatory and compliance costs: The process of becoming publicly listed involves
substantial legal, accounting, and regulatory compliance costs, as well as
ongoing expenses to maintain public reporting standards, which can be
financially burdensome for the company
To evaluate the above two sources, a bank loan provides
immediate funds without diluting ownership, but it increases the company's debt
burden, which could be risky for a business with an already low ROI. On
the other hand, going public offers more significant capital, but the loss of
control and regulatory costs make it less appealing for a family-owned private
limited company like Hungry Box. Based on the entire discussion and evaluation,
a bank loan is the best option
for Hungry Box. It provides the necessary funds for the acquisition without
losing control of the business, though careful planning will be required to
manage the increased debt.
However, additional information in the case study would have
strengthened the bank loan recommendation. Key details such as financial
statements, market analysis, current interest rates and loan terms, projected
revenue growth from acquiring Hot Meals, and insights into the management
team's integration capabilities would provide a clearer picture of Hungry Box's
financial health and growth potential. This information would help evaluate the
loan's feasibility and associated risks, leading to a more informed decision.
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