©tutor2u AQA AS Business Studies Case Study Toolkit June 2003 AQA AS Business Studies Case Study...

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AQA AS Business Studies Case Study Toolkit June 2003

AQA AS Business StudiesCase Study Toolkit

Analysis of Data in the Case Study

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Contents

• Macro-economic forecasts

• How to interpret the data

• Exchange rates

• Interest rates

• Business cycle

• Inflation

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Macro-economic forecasts

• Black Looks is affected by many macroeconomic factors:– Changes in demand for all goods and services (business cycle), – Changes in the general level of prices (inflation), – Prices of goods from abroad and prices of selling goods abroad (exchange

rates)– The number of people out of work (unemployment)– Cost of borrowing money on consumers and businesses alike (interest

rates)

• Forecasts are estimates of future values– In Tables 1 and 2 the forecasts are made for the next two years and have

three different estimated values for each time period. – Sam, the cinema owner, has collected estimates from 20 different City

economists – these are people whose job is to provide information to their financial clients on the state of the economy.

– NOTE: the wide range of estimates tells us that the business of forecasting is difficult and often inaccurate.

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How to interpret the data

• When looking at data it is important to do the following:– Outline the trend (e.g. up, down, the same)

– Explain the implications to the business of this trend (application and analysis)

– Question the usefulness of the data to the business (show judgement)

• REMEMBER TO BE CLEAR WHAT EACH SET OF FIGURES REPRESENTS– For example $s per £: the price of pounds in terms of dollars

• DON’T IN YOUR ANSWERS– Repeat each number in the series – just use the trends

– Forget to use the right units e.g. talk about Euros and dollars and percentages

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Exchange Rates (1)

• Black Looks buys some product in foreign currency– To buy products in the US you need to use dollars, in France and Spain

Euros and in Japan Yen. The same is true of foreigners trying to buy UK products, they need £’s.

– Therefore pounds need to be exchanged for Euros, Dollars and Yen and vice versa.

– The rate at which they are changed is known as the exchange rate. The value of the pound is expressed in terms of the amount of currency £1 can buy. E.g.£1:$1.56.

• Exchange rates between currencies change every day. – 27th March £1:$1.56 28th March £1:$1.58

– This means that one pound buys more dollars – the pound is “stronger”, or has “appreciated” against the dollar.

– If say on 29th March £1:$1.54 then the reverse is true. One pound buys less dollars, it is “weaker” and “depreciated”

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Exchange Rates (2)

• Effect of exchange rate on Black Looks imports– Black Looks imports Luster and Sleek from the US)

– Increase in value of pound (e.g. from £1:$1.5 to £1:$1.6) means imports are cheaper

– Good for Black Looks who are importers – raw material and finished good prices are lower

– Not so good for those UK companies competing against foreign products (Black Looks would lose some of its own label business)

• Effect of exchange rate on Black Look exports– Black Looks exports own label goods to Europe – selling via their shops in

Paris and Berlin…)

– Increase in value of pound means exports are more expensive

– Bad for Black Looks trying to sell abroad – may have to cut prices or take lower profit margins to compete

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Interest Rates (1)

• Interest rates– The cost of borrowing money or the return on saving money– Banks charge interest on loans and mortgages – there is a payment,

normally every month, part of which pays off the loan, part of which pays for the interest

– Consumers also pay interest on overdrafts and credit cards– Individuals and businesses can get interest on money they have with a

bank, e.g. deposit accounts

• UK interest rates are based on the “base rate” which is set by the Bank of England – A change in the base rate will mean all interest rates will probably move in

line with the change– Interest on savings will be less than the base rate, depending on the

account you hold– Interest payable on loans will be higher, it will also reflect the risk involved –

the higher the risk, the greater the interest rate is above the base rate

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Interest rates (2)

• Implications of change in interest rates for Black Looks• An increase in interest rates has the following affects:

– Bank overdraft becomes more expensive

– Interest on loans from Sam, Seyi and Corrine maybe more expensive (depends on what the interest arrangement is)

– Black Looks less likely to borrow money – more expensive!

– Consumers tend to spend less because of higher personal repayments on loans and less likely to borrow money

– Consumers spend less on high priced items (not really applicable to Black Looks’ products though)

– Exchange rate will rise, meaning cheaper imports, more expensive exports.

• The opposite is true of a decrease in interest rates• THINK DEMAND FROM CONSUMERS and INVESTMENT

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Business Cycle (1)

• Business cycle shows fluctuations in demand for goods and services in an economy over time.

• BOOM – high GDP growth

• SLUMP/DOWNTURN – less GDP growth

• RECESSION – negative GDP growth

• RECOVERY – GDP grows, making up for lost GDP during recession Time

GDP

BOOMSLUMP

RECOVERY

RECESSION

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Business Cycle (2)

• Business implications for Black Looks• Boom

– High demand, chance to increase prices, higher profits and may need to invest to meet increased demand

• Slump/Downturn– Falling demand, may find increase in stocks, so might need to reduce prices

• Recession– Low or no demand for products, as consumers become unemployed and

businesses go bust – falling profits or losses

• Recovery– Uncertainty whether increasing demand will be sustained, so may not take

on new workers yet or invest in new machinery/technology

• THINK production issues, pricing strategy and type of product – Black Looks produces cosmetics which are more INCOME ELASTIC than more necessary products.

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Inflation (1)

• Inflation means an increase in the general level of prices of goods and services

• Some prices will have gone up, some down, some may have stayed the same. Inflation measures the average of a typical households basket of goods (Retail Price Index – RPI)

• Inflation goes up because:– Demand is high for products in the economy which means firms can put

their prices up – high demand comes from increase in consumers incomes or lower interest rates

– Higher costs to businesses (e.g. higher wages)

– Expectations – if consumers expect prices to rise in the future, they will buy now, increasing demand and therefore increasing prices

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Inflation (2)

• Business implications for Black Looks• Increasing inflation means:

– Uncertainty over prices in the future, making investment decision more difficult to make

– Workers will demand higher wages to maintain their standard of living

– Suppliers may demand higher prices to cover their own increasing costs

– Bank of England may put up interest rates to prevent further inflation – see implications of higher interest rates

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Exchange Rate of the US $ per £

1.4

1.5

1.6

1.7

1.8

1.9

Max Ave Min

Current

Dec-03

Jun-04

Dec-04

o Average estimated trend is up by 4% after 6 months, 5% over 18 months

o Maximum estimated trend is up by 15% after 6 months, 17% over 18 months

o Minimum estimated trend is down by 8% after 6 months, and the same after 18 months

Summary

The pound looks like it will go up in value against the dollar in the next two years by approximately 5%, though there is a risk it might fall as much.

APPLICATION AND ANALYSIS

• Cheaper imports of Palmer’s, Luster and Sleek from US

• More price competition for own label products

• Could reduce price of US imports in own shops

• Could keep prices the same and increase profit margin

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US $ per £

1.4

1.5

1.6

1.7

1.8

1.9

Max Ave Min

Current

Dec-03

Jun-04

Dec-04

EVALUATION

• Depends on price elasticity of demand for US products – big brands so probably inelastic PED, so cutting price will lower revenue. Therefore better to enjoy higher profit margin.

• There is a risk because though the average forecast suggests an increase, there are some forecasts that say it will go down.

• The size of the changes will make a difference to costs.

The pound is forecast to appreciate or strengthen against the dollar

Profit margin is the profit as a percentage of the sales revenue

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Consumer spending

0%

1%

2%

3%

4%

5%

6%

7%

Max Ave Min

Dec-03Jun-04Dec-04

o Average estimated trend is up to 3.5% a year after 18 months,

o Maximum estimated trend is up to just over 6% a year in 18 months time

o Minimum estimated trend is up to less than 2% a year in 18 months time

APPLICATION, ANALYSIS AND EVALUATION• Consumer spending forecasts will help Black

Looks (and their suppliers as well) plan their production for the next 18 months

• Consumer spending makes up over two thirds of all spending in the economy – any increase will lead to an increase in GDP

• The increases predicted here would mean that a recession is not so likely, especially as the most pessimistic level is still positive.

• For Black Looks, an increase in consumer spending might mean an increase in the market size, allowing them to compete with CC plc for new customers (Boston Matrix)

Consumer spending increasing by about 3.5% a year

Consumer spending is households spending on all goods and services – if it is increasing then more more will be spent on income elastic products like DVDs and cosmetics.

3.5% is a low figure compared to the ‘consumer boom’ of the last few years and could be seen as a slow down in the economy as consumer tighten their belts and spend their extra income on their homes

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Euros per £

1

1.1

1.2

1.3

1.4

1.5

1.6

Max Ave Min

CurrentDec-03Jun-04Dec-04Column 5

o Average estimated trend is up by 1% after 6 months, down 7% over 18 months

o Maximum estimated trend is up by 9% after 6 months, 14% over 18 months

o Minimum estimated trend is down by 14% after 6 months, and the 23% after 18 monthsThe pound will weaken by 7% against the Euro. The

difference between the upper and lower estimates is large, indicating less certainty over £:Euro forecasts in the next 18

months than £:$

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Euros per £

1

1.1

1.2

1.3

1.4

1.5

1.6

Max Ave Min

CurrentDec-03Jun-04Dec-04Column 5

APPLICATION AND ANALYSIS• A falling pound is good news for exporters of

goods to the Euro-zone and especially Black Looks with it’s new shops across some of Europe's major cities.

• A one pound good in the UK now costs less to buy in Europe i.e. £1: 1.4 Euros changes to £1: 1.3 Euros in 18 months time.

• Therefore there should be an increase in demand for Black Looks products, without having to change the price.

The pound is forecast to depreciate or weaken against

the Euro

EVALUATION• Given the possibility of a recession and

fiercer competition in the UK for CC plc this seems a good opportunity to expand further into Europe

• Depends on European demand – at present it seems that most European countries are suffering from a recession

• High risk of going up, more risky than change in dollar pound estimates.

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UK Interest rates

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

5.00%

5.50%

6.00%

Max Ave Min

CurrentDec-03Jun-04Dec-04

o Average estimated trend is for interest rates to fall by 0.5% over 18 months

o Maximum estimated trend is for interest rates to go up by nearly 2% over 18 months

o Minimum estimated trend is for interest rates to go down by 2½% over 18 months

The average forecast suggest that interest rates will fall slightly over the next 18

months.

APPLICATION AND ANALYSISFalling interest rates means:1. Cost of borrowing money falls so Black

Looks could expand more cheaply if they wanted to borrow money

2. Repayments on loans and overdrafts are cheaper, so Black Looks would not face such high overheads, meaning higher net profits

3. Consumers are more likely have more money (for the same reasons as above) so may increase spending on more income elastic products such as cosmetics.

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Inflation (%RPI)

0

0.5

1

1.5

2

2.5

3

Max Ave Min


• All the trends are DOWN• Average trend is that inflation will

fall to nearly 1%• Maximum trend is for inflation to

fall to and remain around 2.2%• Minimum trend is for inflation to

fall to less than 0.5%

The retail price index, which measures average increases in prices across the

whole economy, is set to fall by whatever forecast is taken.

Advanced comment: it seems very unlikely that inflation will go below 1% since this is well below the governments target rate (even taking into account mortgage interest payments – RPIX). However the conclusions will remain the same.

APPLICATION, ANALYSIS AND EVALUATION• Low and falling inflation means that workers

will not be making claims for much higher wages, nor will suppliers be putting pressure on Black Looks by increasing their costs

• Lower predicted inflation means that it is easier for Black Looks to map out is cash flow because it is more certain over the future value of its forecasted revenues

• This low inflation will probably not have much adverse effect on the way that Black Looks operates,. If anything it continues to make life easier, because price levels in the future are more certain.

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Unemployment

2

3

4

5

6

7

Max Ave Min


o Average estimated trend is up to just over 4% over 18 months, a steady rise 1% of the total working population

o Maximum estimated trend is up to over 6% after 18 months, a big increase of over 3% of the working population (possibly another 900,000 people unemployed)

o Minimum estimated trend is set to stay the same.

Unemployment seems set to rise by perhaps 300,000 in the next 18 months

An increase in unemployment in certain areas is part of structural unemployment

Cyclical unemployment is due to a general fall in demand in the whole economy.

It is probable that the predicted rises have an element of both.

APPLICATION, ANALYSIS AND EVALUATION• Increasing unemployment means that there may be less

demand for goods, because consumers incomes are falling• Workers will lose some of their bargaining power because

there will be a larger pool of labour available to hire from• Black Looks will be affected in the UK if the unemployment

is concentrated in the city areas that their shops are based in.

• Unemployment is known as a ‘lagged’ indicator of the business cycle. It tends to grow after a fall in demand in the economy because businesses take time to reduce the size of their workforce.

• However the increase may be proof of a possible recession – even the minimum level is not falling

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Business investment

-5-4-3-2-1012345678

Max Ave Min

Dec-03Jun-04Dec-04

o Average estimated trend is for company investment to rise between 1% and just over 2% over the next 18 months

o Maximum estimated trend is for company investment to go up at a rate of 4 to nearly 7% over the next 18 months

o Minimum estimated trend is for company investment to go down by 3-4% over 18 months

Company investment is set to rise over the next 18 months.

Company investment can be seen as part of the business cycle. Companies will buy more capital stock (e.g. machines and new technology) if they think that future demand will increase.

The figures suggest that on average forecasters think that firms think that GDP will rise over the next 18 months

Application, analysis and evaluation• Increasing investment spending suggests increasing

demand is coming, not a recession as some newspapers suggest

• Increasing investment spending also suggests that more workers will be employed, therefore increasing wages and increasing demand for goods in the economy, increasing demand for Black Looks products

• However the low level of investment spending might mean that the UK government may encourage firms to invest more by giving them grants. This may provide Black Looks with opportunities for more funds for expansion purposes.

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Economic forecast thoughts (1)

• Government policy choices– Low inflation, increasing unemployment and low company investment might mean that

the government may want to BOOST GDP– They could do this by increasing government spending, reducing taxes and reducing

interest rates. – Black Looks needs to be prepared to have spare capacity to meet the possible

increased demand for it’s products.

• The key data can be regarded as the changes in exchange rates, the changes in consumer spending and changes in interest rates

– Exchanges rates directly affect Black Looks’ prices and costs– Consumer spending patterns help them decide on production plans (a regional

breakdown of consumer spending and Europe wide figure would be useful)– If they are considering borrowing money for expansion, then interest rates give

them an indication of the cost of this borrowing.

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Economic forecast thoughts (2)

Economic and financial information from The Economist who poll forecasters – this should be the most up to date forecast data.

Indicator Economists

Prediction

2004

Comment

UK GDP +2.7% No recession, but sustainable growth

UK Inflation +2.5% Higher than case study predicts, but no cause for alarm

Euro GDP +2.2% Good opportunities in Europe, with major economies coming out of the slowdown next year.

All forecasts come with a health warning – Sam should be ‘prudent’ with his interpretation of the direction of each forecast – i.e. expect the worst.

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Figure 1: Cash flow Forecast

First store First store opening in opening in BrixtonBrixton

Using nearly Using nearly all start up all start up capitalcapital

Planned Planned opening in opening in second storesecond store

Probably need overdraft or short Probably need overdraft or short term loan to cover approximately term loan to cover approximately £40,000 over cash reserves£40,000 over cash reserves

Forecast positive Forecast positive cash flow, a year cash flow, a year after openingafter opening

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Figure 2: profit and people

A healthy profit margin after only one year of trading – 14% on sales and predicted to stay the same for the next 18 months – will it change with the arrival of CC plc?

Ambitious store opening programme – how will it be financed (think of the falling interest rates) and will there be enough demand (new locations away from CC plc)?Much bigger workforce forecast – will the Brixton office need to be expanded?

Diseconomies of scale may creep in

First store First store opening in Brixtonopening in Brixton

On budget for On budget for store openingsstore openings

UK stores and UK stores and Euro stores?Euro stores?

No CC plc!No CC plc!

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Figure 2: profit and people

all figures in£'000 Actual Actual Actual Budget Budget BudgetSe01-Fe02 Ma02-Au02 Se02-Fe03 Ma03-Au03 Se03-Fe04 Ma04-Au04

Stores 1 2 4 7 12 18Sales turnover 285 450 1,130 1,620 2,850 3,880 Profit 40.1 61.8 132 211 450.2 525Profit margin 14% 14% 12% 13% 16% 14%Annual sales 735 2,750 6,730Annual profit 101.9 343 975.2Annual profit margin 14% 12% 14%per storeSales turnover 285 225 283 231 238 216Profit 40 31 33 30 38 29

Have they taken into Have they taken into account increased account increased overheads because of size overheads because of size of business?of business?

Lowest profit Lowest profit marginmargin

Not as profitable Not as profitable as the first storeas the first store

Seasonal?Seasonal?

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Appendix A: Capital Structure

SHARES

Each share bought for £200.

Lily and Seyi have 52% of the shares and therefore have control of the company.

Seyi would need Sam to outvote Lily.

Note the low level of investment from Lily, she may have even had to borrow money to buy the shares

LOANS

So that the ‘ownership’ can remain with the founders, the other investors have loaned the money

Black Looks will probably be paying fixed interest on these loans. Since it is a new business, the interest payments from ‘friends’ is likely to be less than the repayments on a loan from a bank.

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