Question

Lean Conductors Ltd is a mid-sized Public limited company engaged in the manufacture and sale of electrical cables. As a public limited company the organization was performing reasonably well, earning steady profits and declaring a stable dividend of 12-15%.

The CEO was feeling the urge to expand the business and taste the growth of business operations and profits. He started addressing various options and shortlisted 2 options namely manufacture of LED bulbs and solar panels.

He called the Gen Mgr. - Finance for a discussion in this regard to probe the matter further. He also went on to share his dream of making the company a larger one and his belief in people like the GM who needs to stay and grow with the organization.

The GM felt excited at this prospect and started making a project report. He decided in his own mind the solar panel project with a larger profit margin looked to be a better one than LED bulbs which was dealer intensive and lesser in terms of unit margin.

Feeling the need to expand rapidly on the investment of the company and make it bigger and become a CFO in the bargain, he chose the solar panel project which was more capital intensive. An assumption about a capital structure and cost congruent to the existing structure was assumed and the projected financials were prepared.

The board of directors representing the majority of shareholders believing in the recommendations of the report adopted it for implementation. The project faced various hurdles in its implementation such delay in signing collaboration agreements, inflated cost due to poor supply of money in the market, downturn of the economy and so on. The project cost started spiraling up and to fund the expansion the funds of the existing business line were inducted into the new project since no further borrowing could be made. The company slipped into the red and reached a stage of bankruptcy without the new project even taking off.   

Questions:

1. Trace the conflict between the management and the shareholders in this case study.
2. Is the act of the GM Finance an error or sin?
3. Where do you think the CEO went wrong?
4. What according to you is the approach the CEO should have taken?

Answer 1

Answer-

*PART (A) Conflict of Interest

There is complete conflict of interest between management and shareholders.The Board of directors representing the shareholder's. So it is their duty to increase the value for shareholders rather than thinking about own self. In this case there are no of instances where there is a conflict of interest.

(1) First the General Manager of the company has selected the project without due diligence.To become the CFO of the company in bargain, he selected the project which is more capital intensive and does not increase the shareholders wealth.

(2)The board of directors also put the project into action without doing due diligence on their part.They completely relied on the recommendations on the GM rather than checking on their own.

(B) The act of General Manager is completely a Sin because :

(1) Firstly he thinks in his own mind that solar panel project is having high profit margins rather than checking the actual market scenario.

(2) And on the urge to become CFO of the company he selected the project which is high capital intensive without taking care of adding value to the company.

PART (C) The CEO only thinks of expanding & diversifying business. He did not took decision on the basis of due diligence. He only looks the current profits of the company and putting those profits into some project rather than checking which project will provide better returns in future.

He also taste the business operation i.e. want to use the resources of current business operation into new business operation without checking the relevancy of the business.

He also urge to start new project in economy downturn which will prove bane for their company .

Part (D) Following are the points which needs to kept in mind to select the appropriate project:

(1) Before selecting the project, a due diligence is required whether a particular project is adding value to the company and shareholders or not.

(2) CEO can take NPV( Net present value) to select a particular project. In this approach a series of future cash flows is predicted and discounted at rate to find the present value. If the present value of inflow is greater than present value of outflow, then is always adding value to company .

(3) Before implementing the project we should take top down approach. In this approach we should consider first economy, then industry and in last company. In the following case study, an economy is in downturn. So still if the project is viable it will not be able to run in long term as long as economy remains sluggish.