Sources of finance Case study 10

 

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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