CACC2504: Strategy and Business Performance Assessment

Part A

Task 1

Four ethical issues are provided below, but only two were required.

1. Ryan met with Andrew and told him confidential information about Oceanic Telecom’s (OT) strategic choices. This disclosure has breached the fundamental principle of confidentiality. The Code of Ethics requires Ryan, as a Chartered Accountant, to respect the confidentiality of information acquired in his role. Ryan should act in the best interest of OT by not disclosing confidential information that could disadvantage OT’s shareholders or provide an unfair advantage to Summit Bridge, Andrew or other shareholders of SouthNet.
   Recommendation:
   Ryan needs to disclose to OT’s board of directors that he has discussed confidential information with Andrew. As an ASX-listed company, OT must immediately disclose any information that is market-sensitive to the ASX (‘market- sensitive’ means a reasonable person would expect the information to have a material effect on the price or value of OT's securities).

2. Ryan owns SouthNet shares, and this creates a self-interest threat to the fundamental principle of objectivity. A Chartered Accountant must exercise professional or business judgement without being compromised by bias that may arise from having a personal interest in the acquisition target.
   Recommendation:
   Ryan should be asked to divest his shares in SouthNet. OR OT should appoint an appropriate reviewer who has no personal interest in the acquisition to assess whether the key judgements and conclusions in Ryan’s work are appropriate.

3. Ryan and Andrew are close friends, which creates a familiarity threat for Ryan. As a Chartered Accountant, Ryan must uphold the fundamental principle of objectivity. Andrew is pushing for a quick transaction with very few conditions attached, and he recommends skipping a proper due diligence investigation of SouthNet to secure the purchase. Ryan appears susceptible to Andrew’s pressure by recommending the acquisition to the leadership team as ‘the only and best option’. It appears Ryan’s objectivity is being compromised due to his close relationship with Andrew.
   Recommendation:
   To minimise this threat, OT should appoint an impartial advisor to act on its behalf in the potential acquisition.

4. Ryan has suggested not completing due diligence of the valuation when advocating for the acquisition. He must exercise care and diligence in his role as CFO to ensure that OT’s decisions are well-informed and prudent, and to minimise risks to OT and its shareholders. As a Chartered Accountant, Ryan must maintain professional competence and due care, which also includes applying his knowledge and skills diligently.
   Recommendation:
   Mia should organise a proper and independent due diligence process and discuss the due diligence outcome with the leadership team and board of directors before any offer is made.

Task 2

Six non-financial issues provided below, but only four were required.

1. SouthNet places a strong emphasis on customer satisfaction, which is confirmed by a consistent customer satisfaction rating of greater than 4 on a 5-point scale. The issue is whether OT can maintain these excellent customer satisfaction levels following the acquisition.
   Justification:
   This issue is significant as customer satisfaction rates are a leading indicator of future revenue growth. If OT fails to keep customer satisfaction levels high, customers would likely leave and forecast revenue growth would not be achieved. This would affect the valuation of SouthNet.

2. SouthNet has a low customer churn rate of 8% compared with the industry average of 21%. A prudent rate of 10% has been used in the forecast, but OT must consider the consequences if it cannot maintain churn at a significantly lower rate than the industry following acquisition.
   Justification:
   This is significant as low churn is a leading indicator of future revenue growth. It is stated that rural broadband is likely to face increased competition. This increase will give customers the opportunity to seek alternative providers and may lead to churn for SouthNet moving closer to the industry average. A failure to keep customers would result in lower revenue than expected and affect the valuation of SouthNet.

3. SouthNet believes an 8.0% new subscriber growth rate is achievable despite current growth sitting at 7.2%. An issue to consider is whether the new subscription growth rate, well above the industry rate of 4.5%, can be achieved and maintained over all 5 years in an industry experiencing growing competition.
   Justification:
   This is significant as subscriber growth is a driver of future revenue growth. Failure to attract new customers would result in OT not achieving its strategic objectives.

4. The SouthNet network has availability of more than 99.6%. The issue is whether a 99.6% uptime is still feasible with an increasing network size in future years.
   Justification:
   Maintaining the uptime threshold is a leading indicator of network maintenance expenses and future capex. Going forward, a more modest capex-to-revenue ratio of 0.05 is expected (instead of 0.06). As such, it forms an important part of OT’s due diligence investigation.

5. SouthNet only covers NZ rural market, and not Australia.
   Justification:
   This is significant to the pending decision as it does not achieve the strategic choice to expand into underserviced rural regions of Australia.

6. SouthNet staff have shown exceptional loyalty to the company, with a reported annual turnover rate of 7% compared with the industry average of 18%.
   Justification:
   Staff loyalty is favourable if long-time service means that key staff are motivated to stay with SouthNet and it retains valuable experience and expertise.

Task 3

Five key errors provided below, but only four were required.

1. The assumptions state that the customer churn rate is 10% p.a. for all forecast years, but an 8% churn rate is included in the model.
   Explanation:
   This significantly overstates revenue in Y1–Y5 and impacts the free cash flows negatively in all years. The error has cumulatively led to an overall enterprise value that is significantly higher than it should be.

2. The assumptions state that the capex-to-revenue ratio is 0.05 for the whole forecast period, but a ratio of 0.06 is included in the model.
   Explanation:
   Lower capex will result in higher free cash flows during the whole forecast period and have the cumulative effect of significantly increasing the enterprise value. The error overstated the capex, and a lower capex would increase the calculated enterprise value.

3. The salary and benefit increase in the model’s forecast free cash flow section is calculated at 0.07% over inflation, when the assumptions state it should be calculated at 0.7% over the inflation rate.
   Explanation:
   The increase for Y1 should be 3.9% (inflation 3.2% plus increase above inflation of 0.7%) and for subsequent years, 3.3% (inflation 2.6% and 0.7% increase). Therefore, salary and benefit expenses are understated, and the failure to correctly reflect these expenses has resulted in free cash flows being overstated for each of the forecast years. Overall, this has resulted in an overstated enterprise value.

4. In the current valuation model, the forecast gross margin calculation for Y1–Y5 does not include gross profit on other operating income.
   Explanation:
   The total gross profit is understated, meaning EBITDA (used to calculate free cash flows) is also understated. This profit understatement is reflected in an understated enterprise value.

5. The terminal value calculation does not use mid-year discounting that takes constant cash flows into account.
   Explanation:
   This is important because this will lead to a lower terminal value and therefore a lower EV as the terminal value makes up a large proportion of the EV.

Task 4

Candidates must make a clear recommendation to either proceed or not proceed. Either is acceptable so long as the justification provides sufficient support and is clearly linked to factors identified in tasks 2 and 3.

• Factors that support a recommendation to proceed include at least one factor from the following:
– Inaccuracy in the valuation model that results in an understatement of the enterprise value.
– List non-financial factors from requirement 2 that are favourable and point to an enterprise value to the upside.

• Factors that support a recommendation not to proceed include the following:
– Inaccuracies in the valuation model means that it would be too risky to place reliance on the valuation.
– Lack of a due diligence investigation, hence not able to rely on the valuation, and adverse non-financial factors not being identified.

Part B

Suggested solution

Task 1

The following table summarises the revised valuations:

Scenario – Original valuation ($) – Revised valuation ($) – Movement ($)

1. The inflation rate does not decrease as quickly as initially predicted. — 40,647,221 — 40,975,266 — 328,045

2. The takeover generates synergies in number of staff. — 40,647,221 — 50,293,908 — 9,646,687

3. Competition from Starlink Satellite Internet poses a risk to the growth of the customer base. — 40,647,221 — 32,561,170 — (8,086,051)

4. Regulatory issues result in a more costly rollout of the 5G network and the future planned development of the 6G network. — 40,647,221 — 36,527,669 — (4,119,552)

Explanation of impact of each scenario:

1. An increase in inflation rates across all forecast years increases the enterprise value. This is due to two key factors (one is sufficient):
   – It is assumed that all the following are linked to the inflation rate: Average revenue per user telecommunications services (which is how revenue from telecommunications is derived); Staff salaries and benefits per FTE; Marketing and advertising expenses per new subscriber (user); Administrative expenses per FTE; Network maintenance expenses per subscriber (user); and Other operating expenses per FTE.
   – The change in inflation rate in Year 5 also has an impact on the terminal value as the inflation rate in Y5 is assumed to be the Y5 growth rate used in calculating the future cash flows into perpetuity. A higher inflation rate (in theory) would increase the terminal value for SouthNet due to the increase in FCF in Y5.

2. The takeover is expected to generate synergies in staff numbers. This reduction in staff is determined by a higher revenue per FTE ratio after the acquisition. This, in turn, decreases staff salaries and benefits, which has an upward effect on future FCFs and the EV.

3. Competition from Starlink Satellite Internet could pose a risk to the growth of the customer base. In this scenario, a new subscriber growth rate of 6% p.a. and a customer churn rate of 12% p.a. will affect the number of subscribers adversely. Consequentially, there will be a reduction of revenue with lower FCFs and TV, resulting in a decrease in the EV.

4. Regulatory issues are likely to result in a more costly rollout of the 5G and 6G network. The revised capex-to- revenue ratio of 0.065 and higher network maintenance expenses per subscriber (user) of (inflation rate + 0.3%) for all forecast years both have a negative effect on FCFs and therefore lead to a reduction in EV.

Task 2

Factors that could affect SouthNet’s achieving its revised revenue include the following:

1. Failure to achieve the expected growth rate. SouthNet is currently achieving a new subscriber growth rate of 7.2%, which the model lowers to 6?sed on rising competition from Starlink. (restatement of facts)
   Explanation:
   This rate is still well above the industry average of 4.5% so may not be realistic in an environment with Starlink increasing its presence and growing competition from larger telecom players in urban regions. Competition will put pressure on market share. If the new subscriber growth rate is not achieved, expected revenue from both telecommunications services and equipment sales will be lower than expected.

2. Failure to achieve the expected churn rate. The revised churn rate is expected to be 12% for all years despite Starlink expanding its presence in the market, and it will remain unchanged over all 5 years. (restatement of facts)
   Explanation:
   This rate is very low compared with the industry average of 21%, and an increase in urban competition is likely to see existing customers switching providers. The growing competition from larger telecom players in urban regions may see new competitors open in future years, so a constant churn rate for all 5 years may be optimistic. If the churn rate increases more than expected, revenue will decrease.

Part C

Suggested solution

Task 1

To calculate the maximum available bank loan, we must first consider the bank covenants that OT has in place. OT’s current gearing ratio is 1.17 (rounded), but the bank will allow an increase to 1.2. Based on OT’s current balance sheet, there is limited headroom (additional borrowing capacity) of $8,306,792. Therefore, OT could extend its borrowing facility to the value of $8,306,792.

OT has a surplus in its existing cash reserves of $32,614,541 − $10,000,000 = $22,614,541. Hence, the total available is $30,921,333. As the asking price for 100% of the shares in SouthNet is $40,000,000, the available headroom leaves a significant shortfall in funding to the value of $9,078,667.

The calculation for this shortfall is presented in the following table:

Funding Calculation — $
Net assets — 315,215,948
Total liabilities — 369,952,346
Current gearing ratio — 1.17
Gearing ratio allowed — 1.2
Minimum operating cash — 10,000,000
Total liabilities supported at 1.2 — 378,259,138
Capacity to borrow — 8,306,792
Funding availability
Cash — 22,614,541
Debt — 8,306,792
Total head room — 30,921,333
Purchase price — 40,000,000
Shortfall — 9,078,667

Since the acquisition cannot be fully funded using excess cash and additional debt, OT will need to consider other sources of finance.

Task 2

Four funding options are provided below, but only two were required.

• Combination of debt and equity from existing shareholders (rights issue)
OT could raise the funds by using cash and debt from its existing lender and issuing new shares to existing shareholders (maybe at a discount). The shortfall of $9,078,667 could be funded by existing shareholders via a rights issue. They could be offered the new shares at a price lower than the current market value. This discount would make the new shares more attractive and valuable, offsetting the dilution effect. At the latest AGM, existing shareholders expressed their willingness to provide additional funding to support expansion where necessary, so this is a viable option for OT. While debt is typically cheaper than equity (due to the tax deductibility of interest payments), this option would mean debt is maxed out. It would limit OT’s financial flexibility and put a high level of risk on operations to support the high level of debt. OT would also be less likely to withstand operational pressures and may need to rely on shareholder injections in the future.

• Funding from existing shareholders (rights issue)
At the latest AGM, shareholders indicated a desire to support expansion financially. It would therefore be appropriate for OT to seek the additional funding via a share issue to existing shareholders. By purchasing the additional shares, shareholders would maintain their proportional ownership in OT. This option has the advantage that OT does not take on any additional debt or the cost associated with such loans.

• Funding via seasoned equity offering (SEO)
OT could issue additional shares to the general public to raise the $40 million in capital it requires. This would help it avoid the financial strain of interest payments and debt repayment. However, OT would need to be mindful that, if new shares are issued and offered to the public, this would dilute the ownership percentage of existing shareholders and may affect the stock price if perceived negatively by the market.

• Issue preference shares
Does not breach the bank's debt covenant. Existing shareholders would not experience a dilution of ownership or control. Note: 'Convertible preference shares' is not acceptable as these could be regarded as debt and could then impact upon the bank covenant.

Recommendation:
OT's strong asset base, the board’s indication that it does not wish to take on more debt, and the existing shareholders’ willingness to provide funding for expansion all indicate that an SEO would be the best option to fund the $40 million acquisition of SouthNet.

Summary of Assessment Requirements

The assessment required students to analyse the potential acquisition of SouthNet by Oceanic Telecom (OT) through multiple tasks across ethical, non-financial, financial-modelling and funding considerations. Students were required to:

Part A

1. Task 1: Identify and explain key ethical issues in the scenario and recommend actions.

2. Task 2: Identify non-financial issues impacting the acquisition decision and justify their significance.

3. Task 3: Detect errors in the financial valuation model and explain their impact.

4. Task 4: Make a justified recommendation on whether OT should proceed with the acquisition, linking it to earlier findings.

Part B

• Recalculate valuations under four revised scenarios.

• Explain how each scenario impacts the enterprise value and cash flows.

• Identify factors affecting SouthNet’s ability to achieve revised revenue figures.

Part C

• Calculate OT’s funding capacity using gearing covenants, cash reserves and purchase price.

• Identify feasible funding options and evaluate their implications.

• Make a recommendation on the appropriate funding strategy.

Overall, the assessment required integrating ethical reasoning, financial analysis, valuation modelling, strategic thinking, and corporate funding evaluations.

How the Academic Mentor Guided the Student 

The mentor approached the assessment by breaking it into structured, manageable sections and guiding the student in a logical sequence:

1. Understanding the Scenario and Requirements

The mentor first helped the student interpret the case study—identifying key characters, relationships, and corporate context. Together, they mapped the assessment tasks to the details in the scenario so the student could clearly see:

• Where ethical breaches occurred

• What non-financial indicators mattered

• How financial model errors affected valuation

• How funding constraints shaped the acquisition decision

This step ensured the student knew what the assessor was looking for in each part.

2. Tackling Part A: Ethics, Non-Financial Issues & Model Errors

Task 1 – Ethical Issues

The mentor guided the student to read the scenario line-by-line and highlight actions conflicting with the Code of Ethics. Each issue was matched with relevant ethical principles such as confidentiality, objectivity, due care, and professional behaviour. The student was then guided to summarise each issue and propose a recommendation.

Task 2 – Non-Financial Issues

Next, the mentor helped the student categorise business risks (customer satisfaction, churn, growth rate feasibility, network uptime, market coverage and staff loyalty).
The student learned to connect each issue to revenue potential and valuation impact.

Task 3 – Financial Model Errors

The mentor helped the student compare the given assumptions with the numbers used in the model. This enabled the student to spot mistakes and understand how each error overstated or understated cash flows and enterprise value.

Task 4 – Recommendation

The student was coached to base their final recommendation on evidence from Tasks 2 and 3 rather than personal opinion.
The mentor emphasised linking all insights into a coherent argument.

3. Tackling Part B: Revised Valuations and Scenario Impacts

Revised Valuation Table

The mentor explained how scenario-based valuation works and how changes in inflation, competition, synergies or regulatory costs affect key valuation drivers.

Scenario Explanations

The mentor helped the student interpret why enterprise value increased or decreased under each scenario by connecting:

• Inflation → cash flows → terminal value

• Synergies → reduced costs → higher cash flows

• Competition → reduced subscribers → lower cash flows

• Regulatory issues → higher costs → lower cash flows

Revenue Impact Factors

Guidance was provided to help the student justify the realism of churn and growth assumptions, especially under increasing competition.

4. Tackling Part C: Funding Analysis

Funding Capacity Calculation

The mentor walked the student through gearing ratio calculations, borrowing constraints and cash reserve adjustments.
The student learned how shortfall figures were derived and why bank covenants matter.

Evaluating Funding Options

The mentor helped the student analyse each funding option rights issue, seasoned equity offering, preference shares, and debt-equity mix, discussing:

• Dilution impact

• Debt capacity

• Shareholder sentiment

• Cost of capital considerations

Funding Recommendation

The student was coached to select the most appropriate funding option and justify it based on evidence from OT’s financial position and strategic considerations.

Final Outcome and Learning Objectives Achieved

By the end of the guided process, the student:

• Understood and articulated the ethical issues in a corporate acquisition scenario
• Identified key non-financial business factors influencing valuation
• Detected and explained critical errors in a valuation model
• Interpreted how scenario changes adjust enterprise value
• Performed funding capacity calculations using gearing ratios and cash reserves
• Evaluated multiple funding strategies and justified the best option
• Delivered a coherent, evidence-based acquisition recommendation

The major learning objectives achieved were:

• Application of professional ethics in accounting

• Ability to integrate financial and non-financial analysis

• Understanding valuation drivers and model sensitivity

• Conducting scenario-based financial analysis

• Assessing corporate funding and capital structure options

• Presenting recommendations supported by data and reasoning

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