Gertrude Fromm is a transportation sector analyst at Tucana Investments. She is conducting an analysis of Omikroon, N.V., a publicly traded European transportation company that manufactures and sells scooters and commercial trucks. Omikroon’s petrol scooter division is the market leader in its sector and has two competitors. Omikroon’s petrol scooters have a strong brand-name and a well-established distribution network. Given the strong branding established by the market leaders, the cost of entering the industry is high. But Fromm anticipates that inexpensive imported small petrol-fueled motorcycles may become substitutes for Omikroon’s petrol scooters. Fromm uses return on invested capital as the metric to assess Omikroon’s performance. Omikroon has just introduced the first electric scooter to the market at year-end 2014. The company’s expectations are as follows: Competing electric scooters will reach the market in 2016. Electric scooters will not be a substitute for petrol scooters.
The important research costs in 2015 and 2016 will lead to more efficient electric scooters. Fromm decides to use a five-year forecast horizon for Omikroon after considering the following factors: Factor 1 The annual portfolio turnover at Tucana investments is 30%. Factor 2 The electronic scooter industry is expected to grow rapidly over the next 10 years. Factor 3 Omikroon has announced it would acquire a light truck manufacturer that will be fully integrated to its truck division by 2016 and will add 2% to its total revenues. Fromm uses the base case forecast for 2015 shown in Exhibit 5 to perform the following sensitivity analysis: The price of an imported specialty metal used for engine parts increases by 20%. This metal constitutes 4% of Omikroon’s cost of sales. Omikroon will not be able to pass on the higher metal expense to its customers. EXHIBIT 5 Omikroon’s Selected Financial Forecasts for 2015 Base Case (€ millions) Petrol Scooter Division Commercial Truck Division Electric Scooter Division Total Sales 99.05 45.71 7.62 152.38 Cost of sales 105.38 Gross profit 47.00 Operating profit 9.20 Omikroon will initially outsource its electric scooter parts. But manufacturing these parts in-house beginning in 2016 will imply changes to an existing factory. This factory cost € 7 million three years ago and had an estimated useful life of 10 years. Fromm is evaluating two scenarios: Scenario 1 Sell the existing factory for € 5 million. Build a new factory costing € 30 million with a useful life of 10 years. Scenario 2 Refit the existing factory for € 27 million.
1. Using Porter’s five forces analysis, which of the following competitive factors is likely to have the greatest impact on Omikroon’s petrol scooter pricing power?
A. Rivalry
B. Threat of substitutes
2. Threat of new entrants The metric used by Fromm to assess Omikroon’s performance takes into account:
A. degree of financial leverage.
B. operating liabilities relative to operating assets.
C. competitiveness relative to companies in other tax regimes.
3. Based on Omikroon’s expectations, the gross profit margin of Omikroon’s electric scooter division in 2016 is most likely to be affected by:
A. competition.
B. research costs.
C. cannibalization by petrol scooters.
4. Which factor best justifies the five-year forecast horizon for Omikroon selected by Fromm?
A. Factor 1
B. Factor 2
C. Factor 3
5. Fromm’s sensitivity analysis will result in a decrease in the 2015 base case gross profit margin closest to:
A. 0.55 percentage points.
B. 0.80 percentage points.
C. 3.32 percentage points.
6. Fromm’s estimate of growth capital expenditure included inOmikroon’s property, plant, and equipment under Scenario 2 should be:
A. lower than under Scenario 1.
B. the same as under Scenario 1.
C. higher than under Scenario 1.