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IBEX 1_2_3 by jizhen1947

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									TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                                   1


MEMORANDUM



PRIVATE & CONFIDENTIAL

From:        A N Accountant

Subject:     Reports on capital expenditure proposals

To:          Jonathan Clamber



I have prepared the three reports requested by you in relation to the current capital expenditure proposals. If
you have any comments or queries on the content of any of the reports please do not hesitate to contact me.


Regards



A N Accountant
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                    2



                                                 PRIVATE AND CONFIDENTIAL




                   REPORT TO THE FINANCE DIRECTOR OF IBEX PLC

               ON THE PROPOSED ACQUISITION OF CHEAP HOTEL LTD




                                                 PREPARED BY: A N Accountant

                                                        DATE: 10 February Yr 21
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                         3




CONTENTS

SECTION                                                  PAGE


1.       Introduction                                    4

2.       Executive Summary                               4

3.       Commentary on trading projections               4-7

4.       Tax consequences of proposed acquisition        7-9

5.       Commentary on proposed purchase price           9

6.       Cash flow consequences                          10

7.       Other matters consequent to acquisition         11

8.       Conclusion                                      12


         Appendices 1 -3 (Tax consequences of proposed
                             acquisition)                13 - 15

         Appendix 4 (Purchase price of Cheap Hotel)      16

         Appendix 5 (Cash flow forecast)                 17
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                                     4




1. Introduction
This report considers all matters relevant to the proposed acquisition of Cheap Hotel Ltd, which has only
one asset, Bristol Valley Hotel. It is intended that the report will be made available to the board of Ibex plc
to assist the acquisition negotiations.

The information used in the preparation of the report has primarily been provided by the directors of Cheap
Hotel and has not been the subject of any independent verification by us. It is important that we carry out a
full diligence of the figures provided by Cheap Hotel in order to satisfy ourselves as to the accuracy of the
information. There may be changes therefore to the conclusions reached in the report should any major
discrepancies or errors come to light following the due diligence.

The tax advice is based on legislation at today‟s date. If any actions take place in the future it will be
necessary to confirm the tax position at that time.


2. Executive Summary
The board of Ibex plc is currently considering the purchase of Cheap Hotel. There are a number of matters
that should be highlighted to the board and addressed prior to the acquisition. There are also a number of
matters that will be relevant to the purchase negotiations.

   The financial projections provided by Cheap Hotel indicate that this is a very attractive investment. It will
   however be necessary to perform a full due diligence on these figures and to examine fully, using our
   knowledge of the industry, the assumptions behind these figures.

   There are a number of potential tax consequences depending on whether Ibex purchases the shares or the
   assets of Cheap Hotel. It is probable that Hawke will seek to sell shares whilst Ibex would be better
   advised to buy the assets only.

   By purchasing the assets only the seller will become liable to a chargeable gain leading to tax payable of
   £512k. The board must be aware that Hawke may seek recompense by virtue of a higher sales price.

   If assets are purchased it is likely that VAT would be chargeable on the sale of the hotel, with the resultant
   adverse effect on cash flow until the VAT could be reclaimed, unless it was considered to be a transfer of
   a going concern.

   Purchasing the shares of Cheap Hotel Ltd may result in a corporation tax bill of £1.51m due to the de-
   grouping of Cheap Hotel Ltd from its parent company. It may be possible for Cheap Hotel and Hawke
   leisure Ltd to elect to re-allocate the de-grouping charge back into Hawke leisure Ltd, otherwise we
   should negotiate a lower price. The purchase of shares would also expose Ibex to the historic liabilities of
   Cheap Hotel Ltd.

   On the basis of the valuation methods used, the proposed purchase price of £6m is favourable to Ibex.
   The capital required for the purchase is available from Ibex‟s current overdraft facility. We would also
   remain well within our existing covenant obligations.

   Consideration requires to be given by the board to a variety of matters consequent to the acquisition.
   These include such points as retention of key management, staff morale, integration of systems, due
   diligence and warranties.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                                    5




3. Commentary on trading projections of Cheap Hotel Limited
The projections used in assessing the proposed acquisition target have been prepared by the directors of
Cheap Hotel Ltd and have not been the subject of any independent verification. It is however possible to
extract and highlight for consideration by the board a number of underlying assumptions inherent in the
project figures.


3.1 Room sales
The revenue projections for all sources of income of the hotel are heavily dependant on the projected room
revenue making a detailed analysis of this essential.

3.1.1 Occupancy rates
The projections are based on a constant annual occupancy of 75%. This would appear, on the face of it, and
from my knowledge of the industry to be very high and quite optimistic. It is not uncommon for hotels to
have average occupancy rates of closer to 40-50%. It will therefore be necessary to consider the past
performance of the hotel in terms of occupancy rates achieved. As all the other projections derive from the
occupancy rate assumed, any decrease in this rate would impact the projections considerably.

As an example of this, should the occupancy rate achieved be only 60%, there would be a consequent fall in
net profit in year one of around £279,000. A rate of 50% would impact profit adversely around £464,000.

3.1.2 Room rates
The room rate assumed in the 10 year projections for year 1 is £34.50. The likelihood of attaining this will
require to be considered taking into account the current internal state of decoration, the hotels popularity and
its location. Further, the projections assume that a 3% rise in room rate charged will be achievable in each
future year. In times of low inflation and increased competitiveness, again the likelihood of this being
achieved must be considered.

3.2 Other income forecasts
The forecast provided by Cheap Hotel includes projected income streams from food and liquor sales, leisure
club and other income. As noted above these projections are solely derived from the projected room sales
and therefore will vary in direct proportion to any change in the assumptions underlying room sales income.

3.2.1 Food and liquor sales
The forecast income for food and liquor is derived from projected room revenue. The projections assume
that liquor sales will be around 76% of room sales and that food sales will be 165% of room sales. The
board members of Ibex will be aware of the industry norms for these sources of income and, using this
knowledge, should make an assessment of the reasonableness of those used by Cheap Hotel. For example
food sales may not be directly linked to room sales and other factors such as non-resident bar meals may
affect such assumptions.

There is also, due to the derivation from room sales, a projected increase in both types of income of a steady
3% in each year of the projections. It should be noted that it is possible that a greater increase than this may
be achievable and hence the projections may be conservative in terms of forecast net profit levels.

3.2.2 Leisure club and other income
The projections assume that the leisure club will generate income amounting to 7% of room sales and that
the hotel will also make other income of 18% of room sales. Again the board of Ibex must use its knowledge
to assess these percentages.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                                        6




3.3 Analysis of gross profit
The overall gross profit before wages and overheads is predicted to be in the region of 78%. This can be
compared with what is currently being achieved by other hotels operated by Ibex, to assess whether it is
realistic. The overall percentage can be analysed in more detail to enable a more accurate evaluation of the
gross profit to be undertaken.

3.3.1 Food and liquor gross profit
The gross profit level from food sales is predicted to be 70%. This must be reviewed and compared to the
industry norm by Ibex. It must also be assessed in view of the type of restaurant that the Bristol Valley has
and the level of profit margin likely to be achieved. Local perception of the quality and popularity of the
restaurant must also be investigated and considered.

The gross profit from liquor sales is also anticipated to be 70%. This should be relatively straightforward to
assess, as it is likely to be standard across the industry. The only factor that will vary depending on
establishment will be the absolute level of sales and hence gross profit achieved, as considered above.

3.3.2 Leisure club and other income gross profit
The leisure club is expected to produce a gross profit of 100% of sales, which is reasonable in view of the
circumstances. The most important projection is therefore the projected sales level achieved, as noted above.

The other income, which will include gaming machines, telephones and other hotel services, is projected to
produce a gross profit of 65% during the lifetime of the forecast. This again will be easily compared with
industry averages for this type of income to assess for reasonableness.

3.4 Other costs

3.4.1 Staff costs and overheads
The projected figures for staff costs and overheads are as direct percentages of total sales, with wages
projected as 27% of total sales and overheads as 15%. As any increase in these percentages would have
direct impact on net profit, Ibex must also consider whether these accurately reflect the likely level of cost.

3.4.2 Fixed costs and depreciation
Fixed costs are projected at 3% of total sales for the duration of the projected period. The figure used in the
forecast for depreciation remains constant throughout the projected period and it should be borne in mind
that any capital expansion or improvement work carried out in the hotel would result in a higher depreciation
charge and reduce the ultimate profitability of the project.

3.5 General comments

3.5.1 Time span of projections
It is very important that the Board is aware of the potential unreliability of the projections. It is very difficult
to forecast accurately and it is obviously not possible to foresee every change that may occur and have an
impact on the underlying assumptions. This becomes more of an issue the further into the future the
projections are being made. Thus to predict 10 years into the future may be nothing more than a guesswork
exercise and it is important that only limited reliance is placed on these projections.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                                       7




4. Tax consequences of proposed acquisition
Cheap Hotel‟s tax advisers have prepared the financial information used to assess the tax position. The tax
legislation affecting the transfer of companies contains a number of potential pitfalls. It is therefore vital that
all the tax consequences affecting both parties to the deal are identified and quantified in order that
negotiations can be structured so as to achieve the most tax-efficient buy out. This will generally centre upon
whether the purchase should be of the shares of the company or the assets and this is considered in detail
below.

4.1 Purchase of shares
A purchase of the shares in Cheap Hotel Ltd would mean that Ibex would acquire a new group company, as
it would become a 100% owned subsidiary. One of the primary tax consequences of this is that Ibex would
inherit the entire tax history of the target company as well as all assets and liabilities existing at the date of
takeover. The most important tax consequences of a purchase of the share capital are identified below.

4.1.1 Chargeable gains
Cheap Hotel is at present wholly owned by Hawke Leisure Ltd and as such is part of a chargeable gains tax
group. It has had transferred to it within the past six years an asset on a no gain/no loss basis. As a result,
should Ibex purchase the share capital, Cheap Hotel would cease to be a member of the group and, as the
departing company, would become liable to tax on the chargeable gain on the hotel. The computation of this
charge to tax is laid out in Appendix 1 and would result in tax payable of £1.57m. This would clearly become
an effective liability of Ibex as the new owners of Cheap Hotel and hence in effect increase the proposed
purchase price by £1.51m. If we plan to purchase the shares of Cheap Hotel Ltd and Mr Singh has not taken
this into account when proposing a price of £6m, this should be drawn to his attention in case he wishes to
reduce the offer to take this liability into account. Alternatively, Cheap and Hawke could re-allocate the de-
grouping charge back into Hawke. This in turn may affect the sales price sought by Hawke.

If Ibex were to acquire the shares in Cheap Hotel and hold these for at least 12 months, any subsequent sale
would qualify for the „substantial shareholding exemption‟ and no gain would arise.

4.1.2 Capital allowances
By purchasing outright the shares in Cheap Hotel, the unused capital allowances would be available to Ibex.
From the information provided by Currie & Lewinski CA on the tax status of Cheap Hotel, the written down
value of the capital allowances pool is currently £200,000 giving rise to capital allowances of 20% on a
reducing balance over the next few years.

Ibex would also become entitled to the remaining unused industrial buildings allowance („IBA‟). IBAs are in
the process of being phased out and the maximum allowances are shown at Appendix 2.

4.1.3 Existing tax liabilities
It is imperative that warranties be sought from Cheap Hotel in respect of any unpaid corporation tax from
prior years, as Ibex would inherit any such liabilities. These warranties would require to be very specific and
may need to be drafted by a solicitor. They should include corporation tax, VAT, PAYE and NIC on
transactions prior to the change of ownership.

4.1.4 Corporation tax thresholds
By purchasing the shares of Cheap Hotel, it would become an associate for corporation tax purposes. This
would have the effect of lowering the thresholds for corporation tax and could result in a higher overall tax
charge for the group.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                                      8




4.2 Purchase of assets of Cheap Hotel
The second alternative is to purchase only Bristol Valley Hotel. The effect of this is to give Ibex the right to
choose assets are wanted and to purchase them free of any hidden liabilities. It is important to consider the
tax implications in the decision as to which route to choose.

4.2.1 Chargeable gains
If Ibex were to acquire the assets only, the base cost of the hotel (ie the cost for any future gain calculation)
would be uplifted from the original cost of £2.3m to the current valuation of £6m.

4.2.2 Capital allowances
A purchase of the hotel only would result in this becoming an asset of Ibex and as a result capital allowances
would be available, both for the building and the fixtures and fittings. Ibex would be entitled to industrial
buildings allowance based on the residue after sale until these allowances are phased out in Yr 22. The
calculation of this is laid out in Appendix 3.

Ibex would also be entitled to capital allowances based on the price paid for those capital items contained
within the Hotel. This may be more or less than the current Tax Written Down Value (TWDV) depending
on the price negotiated.

If purchasing the hotel it will be very important to ensure that the purchase price is allocated between the
structure of the building, any plant/machinery, and any integral fixtures, ensuring that the correct allowances
are claimed. Plant machinery and integral fixtures receive higher allowances than the building and it is
important to identify these. A surveyor may be required to ensure an accurate valuation.

4.2.3 Conclusion
In view of the foregoing, from our point of view, it would not be desirable to purchase the share capital of
Cheap Hotel as this would result in a substantial charge to corporation tax on chargeable gains due to the
degrouping charge, falling to be paid by Ibex as the new owners of Cheap Hotel. During negotiations
therefore Ibex should be pressing to purchase the Bristol Valley Hotel only and not the share capital of
Cheap Hotel. The effect of this on the seller is considered below.

4.3 Impact on Hawke Leisure
Due to the fact that we are still in the negotiation stage, it will be of importance to subsequent negotiations to
be aware of the effect of the alternative acquisition methods on Hawke Leisure, the parent company of
Cheap Hotel.

4.3.1 Chargeable gains
If Hawke sells the share capital of Cheap Hotel there will be no chargeable gain as the substantial
shareholding exemption would apply.

However, if the assets are sold, a chargeable gain will arise in Cheap Hotel Ltd, which will now be a shell
company. The gains would result in a charge to tax of approximately £512k as shown in Appendix 1, and
this would have to be borne by Hawke Leisure. It could however be mitigated by Hawke deferring the gains
using rollover relief on the reinvestment of proceeds into other appropriate qualifying purchases (eg land and
buildings). This should be possible if Hawke has a programme of capital expansion.

4.3.2 Balancing charges
There may be balancing charges for Cheap Hotels Ltd if plant and machinery are sold for a price in excess of
the tax written down value of £200,000.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                                     9




4.4 VAT consequences
It is of extreme importance that the VAT consequences of the acquisition are considered in order to ensure
that any potential liability and adverse cash flow consequences are minimised. There are two alternatives
available in relation to the purchase of the assets of Cheap Hotel.

   The sale of assets is a taxable supply for VAT purposes since Hawke has “opted to tax” and it would be
   necessary for Hawke Leisure to charge VAT to Ibex on the sale of 20%. This VAT could be reclaimed by
   Ibex in the next VAT quarter although there would clearly be an adverse cash flow impact from this until
   the reclaim was submitted to HMRC. This is likely to be the approach that would have to be followed.

   An alternative would be to treat the sale of the hotel as a “transfer of a going concern” and as a
   consequence it would be outwith the scope of VAT. The effect of this is that no VAT would be payable
   by Ibex and would clearly be the more desirable manner of acquisition from our point of view. It will be
   necessary to convince HMRC that the transaction is in fact a transfer of a going concern which seems
   likely in this case. HMRC would require evidence that the assets sold are capable of separate operation.

   Ibex will need to decide whether it also wishes to elect to waive exemption from VAT in relation to the
   hotel. The “election to waive exemption” or “opt to tax” provision allows supplies of certain property,
   which would otherwise be exempt, to be standard rated. The purpose of this option is to allow the
   recovery of input VAT that would otherwise be lost under the partial exemption rules.

   The sale of shares would be an exempt supply and no VAT would be payable by Ibex.

4.5 Stamp taxes (stamp duty and stamp duty land tax)
If Ibex acquired the shares of Cheap Hotel, stamp duty would be payable by Ibex at a rate of ½% of the
consideration ie ½% x £6,000,000 = £30,000. However, should the hotel be acquired directly, stamp duty
land tax would be payable by Ibex at a rate of 4% of the VAT-inclusive consideration. If it was not deemed
to be a going concern, this would amount to 4% x £7,200,000 (6000,000 x 120%) = £288,000 (because VAT
would apply to the sales price). The difference in tax arising is significant and may impact on negotiations for
the final purchase price.

5. Commentary on proposed purchase price
The board of Ibex is considering a purchase price of £6m for Cheap Hotel. There are two valuation
methods that can be used to analyse and comment upon the proposed price and these are considered below.
The detailed calculations of the basis can be found in Appendix 4.

5.1 Return on investment
One of the primary factors influencing the decision as to whether to proceed with the purchase is the future
cash flow that it is intended to generate. In view of this fact the most appropriate manner of assessing the
price is to calculate the return on investment that the hotel will provide to Ibex.

The return, which would be made on the basis of the financial projections provided, would be 27.6%
(average cash flow over ten years as a percentage of purchase price). This is a significant rate of return and it
is unlikely that such a high level could be obtained from any similar low to medium risk investment, such as
securities, money market deposits or internal capital expansion. It should however be noted that this rate of
return is based upon an industry approach using an exit cash multiplier of 10 applied to the final year cash
flow, (ie year ten of the projections). I am aware that Ibex feel this to be a reasonable multiplier within the
hotel industry but it does again highlight the need to examine the projections in detail in order to evaluate the
reliability of the final year forecast as well as deciding whether or not a multiplier of 10 is suitable in this
instance. It should be noted that the calculation of returns is done before the effects of tax payment are
accounted for.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                                   10




5.2 Assets basis
The net assets of Cheap Hotel as at 31 December, which is the most recent available, amounted to £3.64m.
This compares with a proposed purchase price of £6m. However, it should be noted that the building,
which is the only asset of Cheap Hotel, is included in the latest accounts at a value that is considerably below
its current market value. On the basis of the information provided the market value 3 years ago was in
excess of £9m and despite a downturn in property values the hotel is likely to be worth at least £6m as a
going concern. This basis would therefore indicate that the proposed price is a fair one.

5.3 Earning basis
The earnings basis is most accurate when applied to the first few years of financial projections, which as
noted above are likely to be most accurate. Therefore, on the basis of the first three years forecast earnings
and assuming a PE ratio of 6 as representative of the industry norm a value can be placed on the company of
around £7m.

6. Cash flow consequences
The following points should be noted in relation to the effect of the acquisition on the cash flow position of
Ibex.

   Ibex has recently recovered from financial difficulties and is now intending to embark on a period of
   aggressive expansion. The requisite funding facility has been successfully negotiated with our bankers and
   is therefore important that the impact of any proposed capital projects on cash flow is carefully
   considered.

   The impact of the proposed acquisition on Ibex cash flow and the effect of the revised interest payments
   due to the higher overdraft level is set out in Appendix 5. From this it can be seen that by incorporating
   the cash flows of Cheap Hotel contained within the projections and the purchase of Cheap Hotel at a
   price of £6m, Ibex remains well within its banking covenants and overdraft limit.

   It should be noted that the effect of any positive or adverse working capital movement within Cheap
   Hotel post acquisition has not been incorporated in the projections due to the limited information
   available.

   It is essential that the cash flow situation be kept under close management review in order to ensure that
   our covenants continue to be met on a monthly basis. It should also be noted that the projections have
   been prepared on the assumption that the cash flows of Cheap Hotel accrue evenly throughout the year.
   As there is likely to be some seasonality in the business, the effect of this must also be closely monitored.

   The computations have so far excluded the effects of taxation, as these will depend to a large extent on
   the legal structure of the proposed acquisition. Revisions will be necessary once this decision is made.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                                    11




7. Other matters consequent to acquisition
In view of the fact that Ibex is planning to make a substantial capital outlay in order to acquire Bristol Valley
Hotel it is vital that the board is aware of the whole spectrum of issues that require to be considered and
addressed in order to ensure the success of the integration.

7.1 Retention of key management
In order to ensure that the Bristol Valley Hotel continues to be a profitable and successful venture it will be
necessary to identify and retain those key senior personnel who have contributed to the past growth of the
hotel. This should also serve to provide some continuity within the hotel and assurance to the existing
employees. This could be achieved by a number of methods, for example

   Improved and attractive remuneration packages
   Regular meetings to keep managers informed of developments
   Appointing a key senior manager to the board of Ibex.

7.2 Integration of systems
The success of the acquisition will be heavily dependant on the speed and efficiency with which the existing
systems of the Bristol Valley Hotel can be integrated with those of Ibex. This will involve the harmonisation
and standardisation of the accounting and other management information systems. It may therefore be
necessary to implement new systems if the existing ones are not compatible with those of Ibex.

It may also be necessary to consider the transmission of data between the hotel and our head office.

7.3 Due diligence
In view of the fact that financial projections will form an extremely important element in the decision as to
whether to proceed with the acquisition it will be necessary to instruct our accountants to perform a due
diligence exercise in order to verify the accuracy of the figures provided as at the intended purchase date.
This will have to be arranged in advance in order to ensure that there is no delay in the issuing of the report
that will be required before the purchase price is paid to Hawke.

7.4 Staff morale
In order to assist with a smooth integration of the new hotel, it is of importance to ensure that morale among
the existing staff is retained. Keeping staff informed of developments and providing assurance as to jobs can
achieve this. It may of course be necessary to streamline operations and make redundancies and this should
be communicated to the staff as soon and as fully as possible. If redundancies are likely the correct
procedures must be followed.

7.5 Structural report
As in any purchase of property it is essential that we instruct a surveyor to carry out a full structural survey
into the fabric of the building. This will serve to highlight any existing or potential structural defects, which
we could then bring to the sellers attention to obtain a reduction in the purchase price.

7.6 Warranties
It is important that we obtain from Hawke Leisure certain undertakings in respect of the Bristol Valley Hotel
and its employees‟ rights in order to ensure that we do not become responsible for any existing liabilities or
contingencies. This would cover such matters as tax and VAT, pension rights, employees‟ contracts and legal
claims.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                                  12




8. Conclusion
The proposed acquisition of Cheap Hotel by Ibex raises a number of matters that must be considered by the
board. The primary points for consideration will be the appointment of accountants to carry out a due
diligence on the figures provided by Cheap Hotel and a review of the tax figures provided.

The purchase price proposed is a fair price and every attempt should be made during final negotiations to
ensure that the final price does not significantly exceed £6m. It is also essential that Ibex purchase only the
assets of Cheap Hotel as opposed to share capital in order to avoid a significant charge to capital gains tax.

There are also a number of incidental matters noted in this report, which merit consideration by the board
prior to the purchase.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                      13


                                                                                        APPENDIX 1


Ibex plc

Tax consequences of proposed acquisition


CHARGEABLE GAIN
Sale of company - Assessed on Cheap Hotel Ltd by leaving chargeable gains group (unless the de-
grouping charge is re-allocated back to Hawke)


                                                                                   £
Market value at the date of intra group transfer (May Yr 16)               9,000,000

Less: cost                                                                (2,000,000)
      enhancement costs                                                     (300,000)

Less: indexation at 0.567 x £2m                                           (1,134,000)
                    0.481 x £300,000                                        (144,300)
Chargeable gain                                                            5,421,700

Tax @ 28%                                                                  1,518,076

Indexation factors

Date of disposal: May – Yr 16 (ie 5 years ago)
Date of acquisition: May – 21 years ago

Cost              (197.7 – 126.2)/126.2 = 0.567 (using May 1990 and May 2006)
Enhancement       (197.7 – 133.5)/133.5 = 0.481 (using May 1991 and May 2006)


Sale of Assets - Assessed on Cheap Hotel Ltd

Market value (sale proceeds)                                               6,000,000

Less: cost                                                                (2,000,000)
      enhancement costs                                                     (300,000)

Less: indexation at 0.826 x £2m                                           (1,652,000)
                    0.727 x £300,000                                        (218,100)

Chargeable gain                                                            1,829,900

Tax @ 28%                                                                   512,372


Indexation factors

Date of disposal: July – Yr 21
Date of acquisition: May – 21 years ago

Cost              (230.5 – 126.2)/126.2 = 0826 (using May 1990 and July 2011)
Enhancement       (230.5 – 133.5)/133.5 = 0.727(using May 1991 and July 2011)
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                          14



                                                                                       APPENDIX 2

Ibex plc

Industrial buildings allowance – purchase of shares.


                                                                 Original
                                                                 Building         Extension
                                                                    £000              £000

Original qualifying cost                                               960               180

Year to 31 Dec Yr 20
(3/12 x 2%) + (9/12 x 1%) = 1.25%                                       12.0               2.25

Year to 31 Dec Yr 21
(3/12 x 1%) + (9/12 x 0%) = 0.25%                                        2.4               0.45

Year to 31 Dec Yr 22
No IBAs would be available in Yr 22 and beyond


Note – We are only entitled to IBA‟s from year ended 31 December Yr 21 onwards. Hawke Leisure Ltd are
entitled to the IBA‟s for year ended 31 December Yr 20
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                          15


APPENDIX 3


Ibex plc

Tax consequences of proposed acquisition


Industrial buildings allowance - purchase of Bristol Valley Hotel



                                                              Original
                                                              building         Extension
                                                               £000              £000

Residue at sale                                                 226.4               57.1

Tax Life remaining (years)                                           4               5

IBAs per annum (before phasing out)                                 56.6            11.42

Year to 31 Dec Yr 20
(3/12 x 50%) + (9/12 x 25%) = 31.25%                                17.7             3.57

Year to 31 Dec Yr 21
(3/12 x 25%) + (9/12 x 0%) = 6.25%                                   3.5             0.71

No IBAs would be available in Yr 22 and beyond



Note – We are only entitled to IBA‟s from year ended 31 December Yr 21 onwards. Hawke Leisure Ltd are
entitled to the IBA‟s for year ended 31 December Yr 20
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                             16


APPENDIX 4


Ibex plc

Purchase price of Cheap Hotel


EARNINGS BASIS                                                                      £000

Average forecast earnings (3 years forecasts)                                       1,187

PE Ratio, say 6 giving valuation of                                                 7,122

Notes
1.    PE ratio estimated on the basis of PE for comparable quoted company (leisure, entertainment and
      hotels) at 15, less 30% for lack of marketability and 30% for lack of transferability.

2.    The earnings valuation has been calculated using profit before tax when strictly speaking the profit
      attributable to shareholders (ie after tax) should be used for this valuation method.

ASSETS BASIS

Net assets per accounts                                                             3,640
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 1)                                                                 17



                                                                                            APPENDIX 5


Ibex plc

Cash flow forecast incorporating Cheap Hotel Limited


                         Note    June     July      Aug      Sep      Oct      Nov      Dec      Total
                                 £000     £000      £000     £000     £000     £000     £000      £000

Profit before interest
 and tax                   1       280      380      506      626      402      388       536      3,118
Depreciation               4        40       50       50       50       50       50        50        340
Asset Disposals                                      400                                             400
Working capital
 movement                  1       117      708     (655)     (169)     (53)    154       700       802

Net cash inflow (outflow)          437    1,138      301      507      399      592     1,286      4,660

Purchase of Cheap Hotel                   (6,000)                                                (6,000)
Interest payable        2          (92)      (91)   (133)     (131)    (128)    (126)    (122)     (824)

Opening debt                    (11,315) (10,970) (15,924) (15,755) (15,380) (15,109) (14,643)

Closing debt                    (10,970) (15,924) (15,755) (15,380) (15,109) (14,643) (13,479)

Net outflow for month to December                                                                  2,164

COVENANTS

                      Note June            July     Aug      Sep      Oct      Nov      Dec
Profit before interest/interest 3              4      4         5        3       3        4

Cash inflow                        437    1,138      301      507      399      592     1,286

Notes

1. It is assumed that the forecast profit for Bristol Valley Hotel, in the 10 year projections, for year 1
   (£1,148k) accrues evenly at £96k per month. I have not attempted to adjust the working capital
   movement in consequence of the acquisition.

2. Interest charge for the month is based on applying interest to the closing overdraft at the end of the
   previous month at the prevailing rate of 10%.

3. Bank facilities available total £18m so peak requirement leaves £2m of headroom.

4. Depreciation for BVH is estimated at £10k per month (£120k for first year per BVH forecasts).
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 2)                                   1




                                                 PRIVATE AND CONFIDENTIAL




                   REPORT TO THE FINANCE DIRECTOR OF IBEX PLC

           REVIEW OF PROPOSED CAPITAL EXPENDITURE PROGRAMME




                                                  PREPARED BY: A N Accountant

                                                         DATE: 10 February Yr 21
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 2)                             2




CONTENTS


SECTION                                                         PAGE

1.              Introduction                                     3

2.              Executive Summary                                3

3.              Review of proposals                              3

4.              Commentary on selection of projects              6

5.              Conclusion                                       6


                Appendix 1 (Assessment of capital expenditure
                             proposals)                          7

                Appendix 2 (Cash flow forecast)                  8
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 2)                                                                     3




1. Introduction
This report examines the current capital expenditure proposals before the board. It considers which
projects should be undertaken whilst remaining within the current financial constraints of Ibex.

The report is based on the capital expenditure proposals put forward by the branch managers for much
needed improvements to a number of Ibex properties.

It is intended that the report be made available and be used as a basis for decision making by the
management board of Ibex. It is not intended for any external use.

2. Executive Summary

    The current moratorium on capital expenditure is to end and new projects are to commence from 1
    September this year.

    The projects have been ranked according to the return per pound of investment and profitability. It has
    then been assumed, in the absence of further information, that those projects showing the highest
    profitability are the most desirable projects and those that should be undertaken first.

    The timing of the projects requires to be phased in line with projected overdraft levels during the
    months of September to December.

    The effect of the capital expenditure programme will be to increase the level of overdraft and as a result
    also the interest payable. The revised cash flow projections do not indicate that any banking covenants
    would be breached as a result of the capital expenditure proposals.

    Ibex should consider factors other than profitability in assessing the desirability of proposals in future, as
    this should not be used in isolation as the sole criterion for project selection.

3. Review of capital expenditure proposals
The individual branch managers have formulated proposals for capital improvements to a number of Ibex
properties. These have been ranked in terms of return on capital invested in order to assess the relative
desirability of each project as per Appendix 1. It is now necessary to consider which projects should be
undertaken and the respective timing.

The proposals require to be assessed within the financial constraints in place regarding the bank overdraft
limit and covenants. More specifically, the board wishes to maintain a margin of £500,000 below the
maximum overdraft limit, which has been observed in determining the pattern of capital expenditure.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 2)                                                                  4




3.1 September projects
The capital expenditure programme is due to commence on 1 September, after the purchase of Cheap Hotel
has gone ahead. The level of overdraft will determine the amount of free cash available for the proposals at
the beginning of the month.

                                                                    £000

             Bank overdraft at 1 September                        (15,755)
             Spending limit                                       (17,500)
             Cash available                                         1,745

Therefore the highest-ranking projects, which can be undertaken with the free cash available, are as follows:

                                                                    £000

             Wilmslow Diner                                           174
             Cambridge Restaurant                                     500
             Oxford Hotel                                             950

                                                                    1,624

These three projects could commence as soon as practicable after 1 September. The unused cash of
£121,000 will be carried forward to be used in relation to projects commencing in October.

As a result of the above capital expenditure the closing overdraft at the end of September would become
£17,004k (£15,380k + £1,624k)

3.2 October projects
As with the September projects the proposals which can be undertaken in October will be determined by the
amount of available cash based on the overdraft limit. The amount of free cash, assuming the projects to be
undertaken commence on the first of the month, is as follows:

                                                                    £000

             Bank overdraft at 1 October                          (17,004)
             Spending limit                                       (17,500)
             Cash available                                           496

Therefore the highest-ranking projects, which can be undertaken with the free cash available, are as follows:

                                                                    £000

             Jedburgh Lodges                                          200
             Aberdeen Club                                            100

                                                                      300

The next highest-ranking project is the Bath Hotel, which requires a capital outlay of £258k. As there is only
available remaining cash of £196k there is clearly a shortfall as regards commencing the Bath Hotel at the
beginning of October. There are two options available to Ibex in relation to this, which are as follows:
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 2)                                                                 5



(i)     Delay work on the Bath Hotel until the end of October, by which time the overdraft will be lower
        and the requisite amount of cash would be available; or

(ii)    Commence work on one of the lower ranking projects. This would have to be the Edinburgh
        Disco, as the two projects that rank next in order, St Andrew’s Links and Glasgow Bistro, require
        capital in excess of that which is available.

Assuming that the Bath Hotel project is undertaken late in October, the overdraft level at the end of October
would be £17,304m.

3.3 November projects
As with the two earlier months of the capital expenditure programme the proposals which can be undertaken
in November will be determined by the amount of available cash based on the overdraft limit. The amount
of free cash available at the beginning of November, is as follows:

                                                                    £000

             Bank overdraft at 1 October                         (17,304)
             Spending limit                                      (17,500)
             Cash available                                          196

The next highest-ranking projects are St Andrew’s Links and Glasgow Bistro requiring capital outlays of
£500k and £700k respectively. A review of the cash flow forecast set out in Appendix 5 to the report on the
acquisition of Cheap Hotel illustrated that although only £196,k is available at the beginning of November
the realisation of profit and working capital movements will release some £592k by the end of November.

Therefore it is recommended that work be delayed until the latter part of November and at this point to
commence the following projects:

                                                                    £000

             St Andrew’s Links                                       500
             Edinburgh Disco                                         150

                                                                     650

This will cause the overdraft to increase to £17.5k by the end of November. This is £7k above the board
recommended maximum but remains well within the actual lending limit imposed by the bank. It is unlikely
that the board would object to this proposal given the small amount involved.

3.4 Cash flow implications
The effect of the projects on the overdraft levels has been noted and discussed above. A revised cash flow
forecast incorporating the effect of the capital expenditure has been prepared and set out per Appendix 2. It
should be noted that there is an increase in interest payable as a result of the higher overdraft levels.

It is also of note that even with the effect of the capital expenditure programme on the forecast Ibex remains
well within its banking covenants, which will serve to highlight to the bank that we are indeed capable of
controlled and successful expansion of our existing business and activity levels.

3.5 Projects carried forward
It is clear from the above and due to the financial constraints imposed upon us as well as the fact that all
projects require to be commenced by 1 December, that some projects will require to be carried forward into
the next financial year.

It will require to be made clear to the relevant branch managers that these projects will require to be
resubmitted at the beginning of Yr 22 and will again be considered on their individual merits and be ranked
alongside any new proposals put forward at that time.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 2)                                                                     6




4. Commentary on selection of proposals
The proposals, which have been laid before the board in Yr 21, have been assessed in this report on the basis
of ranking determined by level of financial return on the investment. This has been necessary as this is the
only information available relating to the proposals at the time of preparation of the report. It is however of
extreme importance that the board is aware of the other factors which may play as important a role in the
selection of capital projects which it has not been possible to examine in this report. The matters, which
ought to form part of the selection decision, are:

    The extent to which the proposals are consistent with the overall strategy of Ibex in relation to its market
    position and perception. Each proposal should be considered on its merits and consideration should be
    given to selling any properties which no longer fit with the company image we wish to project.

    The time span over which the benefits from the capital expenditure will be seen.

    The tax implications of a particular project, such as the level of capital allowances that would be available.

    The impact of the project under consideration on other projects currently being undertaken. This
    would cover such matters as the availability of cash for the projects and the proximity of the proposed
    project to other similar Ibex owner properties. It would be necessary to ensure that by incurring capital
    expenditure we are not detracting from other cash generating activities.

5. Conclusion
Ibex is restricted in the capital expenditure proposals that can be undertaken during the latter part of Yr 21
by its current overdraft facility. The proposals have been ranked in this report on the basis of profitability
and an indication has been given as to how the projects should be phased in line with cash availability.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 2)                                             7


                                                                               APPENDIX 1

Ibex plc

Assessment of capital expenditure proposals

Branch                       Capital         PV of future   Return per £    Ranking
                             Expenditure     cash flows     of investment

Oxford Hotel                   950,000        1,272,050         1.339           3
Cambridge Restaurant           500,000          750,050         1.500           2
Glasgow Bistro                 700,000          863,015         1.233           8
St Andrew’s Links              500,000          627,770         1.256           7
Bath Hotel                     258,000          326,500         1.266           6
Edinburgh Disco                150,000          184,800         1.232           9
Newcastle Bar                  250,000          308,000         1.232           9
Inverness Hotel                250,000          304,200         1.217          11
Jedburgh Lodges                200,000          263,000         1.315           4
Glasgow Travelodge             240,000          290,400         1.210          12
Thames Hotel                   125,000          151,000         1.208          13
Wilmslow Diner                 174,000          305,000         1.753           1
Birmingham Lodge               111,000          130,000         1.171          14
Aberdeen Club                  100,000          127,000         1.270           5
Northampton Lodge              600,000          700,000         1.167          15

                             5,180,000        6,602,785
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 2)                                                               8



                                                                                            APPENDIX 2

Ibex plc

Revised cash flow forecast incorporating capital expenditure

                                  June    July      Aug     Sep      Oct       Nov       Dec       Total
                                  £000    £000      £000    £000     £000      £000      £000       £000

Profit before
interest and tax                   280      380      506     626       402       388       536       3,118
Depreciation                        40       50       50      50        50        50        50         340
Asset Disposals                                      400                                               400
Working capital movement           117      708     (655)    (169)      (53)     154       700         802

Net cash inflow (outflow)          437    1,138      301     507       399       592     1,286       4,660

Purchase of Cheap Hotel                   (6,000)                                                   (6,000)
Interest payable                   (92)      (91)   (133)    (131)    (142)     (144)     (146)       (879)

Opening debt                  (11,315) (10,970) (15,924) (15,755) (17,004) (17,304) (17,507)
Capital expenditure                                       ( 1,624)   (558)    (650)                 (2,832)

Closing debt                  (10,970) (15,924) (15,755) (17,004) (17,304) (17,507) (16,367)


COVENANTS AFTER CAPITAL EXPENDITURE

Profit before interest/interest      3         4       4        5         3        3         4

Cash inflow                        437    1,138      301     507       399       592     1,286

NOTE: Interest charge for the month is based on applying interest to the closing overdraft at the end of the
previous month at the prevailing rate of 10%.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 3)                                  1




                                                 PRIVATE AND CONFIDENTIAL




                   REPORT TO THE FINANCE DIRECTOR OF IBEX PLC

             PROPOSED SYSTEM OF CAPITAL EXPENDITURE CONTROL




                                              PREPARED BY: A N ACCOUNTANT
                                                        DATE: 10 February Yr 21
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 3)          2




CONTENTS

SECTION                                      PAGE

1.       Introduction                        3

2.       Executive Summary                   3

3.       Initial assessment of proposals     3

4.       Approval procedures                 4

5.       Ongoing review of projects          4

6.       Capital Budgeting                   5

7.       Post completion audit               5

8.       Conclusion                          5
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 3)                                                                   3




1. Introduction
This report outlines a suitable and effective system of capital expenditure control in view of the
unsatisfactory manner in which capital expenditure proposals are currently formulated and approved.

The report covers the entire scope of capital expenditure from the submission and initial assessment of each
proposal to final post completion audit.

It is intended that the report be made available and be used as a basis for the implementation of the new
system of capital expenditure by the management board of Ibex. It is not intended for any external use.

2. Executive Summary
   The current system for capital expenditure control within Ibex is unsatisfactory and a new system requires
   to be put in place with immediate effect.

   The new system will require to ensure that projects are thoroughly researched and defined prior to further
   approval being given by senior management. The proposals must also meet defined financial and
   strategic considerations.

   There must be defined delegated authority limits put in place as to who can approve individual projects.
   In tandem with this Ibex must set up a capital expenditure approval committee of senior management to
   review in detail all significant projects.

   It is also important that the projects are regularly reviewed during their life in order to avoid or mitigate
   overspends. This facility should be incorporated into the accounting system.

   Ibex should also set up procedures relating to capital budgeting and post completion audits of certain key
   projects.

3. Initial assessment of proposals
It is vital in a system of capital expenditure control that the procedures relating to the initial stages of the
formulation of the proposals are clearly defined. This will ensure that only those proposals, which are
sufficiently meritorious and meet Ibex’s defined criteria, are put forward for further consideration. The
specific control, that should be in place are as follows:

   There should be proforma request forms for capital expenditure that are completed by the originator,
   who must be at least a department head. The form will contain full details of the nature of the proposal,
   the estimated costs to complete, timescale involved and an indication of the level of return that may be
   expected.

   The responsibility for researching all aspects of a proposal will rest with the originator and standard forms
   should be devised to act as an aide memoire in this respect. This will include environmental impact,
   benefits expected and how the project fits in with Ibex’s corporate strategy.

   The request should then be passed to the relevant director for authorisation. The director must consider
   the proposal on its merits and evaluate whether it meets with the defined criteria for accepting proposals.

   It will also be necessary in every case for the finance department to review the proposal to ensure that the
   financial return expected is both correctly calculated and meets or exceeds the level of the return by Ibex.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 3)                                                                    4




   Following on from this it is clear that Ibex must lay defined criteria that must to be met at the initial
   stages of evaluation. The most important of these at the initial stage will be the level of return on
   investment in that if a project is not expected to produce a minimum level of return it is unlikely to
   proceed further.

4. Approval procedures
As any capital expenditure plans are likely to involve the outlay of substantial amounts of cash, it is necessary
that limits and procedures be put in place to ensure that proposals are appropriately authorised. The
suggested specific controls, which should be in place, are as follows:

   Ibex should consider the setting up of a committee made up of middle and senior management that is
   responsible for considering all significant proposals. The types of issues, which the management
   committee will consider, are whether the proposal fits in with the company’s overall strategy and the
   potential environmental impact and public reaction. The committee will also carry out a sensitivity
   analysis on the projects so as to define the level of risk inherent in the projects.

   There must be financial limits in place to determine the extent of an individual’s authority and it will be
   necessary to put in place delegated authority limits. As an example the board may wish to consider the
   following:

   -    Branch managers/department heads up to £2,500

   -    Area directors up to £5,000

   -    Departmental directors up to £10,000

   -    Board over £10,000

   It would be necessary for all projects to meet the above authorisation criteria and for all managers to be
   made aware of these limits.

   All projects must also be submitted to the finance department to ensure that the return expected has been
   correctly calculated and have been calculated in consistent manner.

   All projects should require to be set up individually within the accounting system and there should be
   programmed procedures in place to ensure that the correct authorisation procedures have been followed.
   For example the limits of an individual’s authority is programmed and this cannot be overwritten when
   trying to set up a project on the system.

5. Ongoing review of projects
   The finance department should be responsible for preparing cash flow forecasts showing the effect on the
   cash flow position both during the expenditure period and the subsequent payback period.

   It will also be necessary to set up a procedure for monitoring the costs incurred on each project as it
   progresses and compare this to the initial estimates contained in the proposal. This can be done by the
   use of detailed coding in the accounting system to enable all costs relating to each project to be easily
   extracted at each month end and compared against budget.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 3)                                                                    5




   The accountant in conjunction with the individual department managers and directors should then be
   responsible for presenting these comparisons to the board on a monthly basis together with the
   explanations for variances. This procedure should also allow any over spends to be identified and dealt
   with at an early stage. The system should also have incorporated to it a method of flagging projects that
   are within, for example, 10% of their approval limit.

This should also serve as a useful record over time of the type of projects which are generally successful and
those which are not and do not meet forecast targets.

6. Capital budgeting
   The senior accountant will be responsible for preparing a capital expenditure budget each year for the
   group as a whole. In order to make this as effective as possible the senior accountant should collate from
   all the departments details of the nature of proposals and whether they have yet been approved.

   This should then be discussed with the capital expenditure approval committee and the projects ranked in
   order of merit. From this the accountant will be able to prepare a capital expenditure budget analysing
   the projected spend on a monthly basis. The effect of the proposals on the monthly cash flow position
   will also require to be forecast, using both capital expenditure outflows and anticipated future inflows.

   The budget should then be approved by the Chief Executive and distributed to each of the departments.

7. Post completion audit
In order to assess the general level of accuracy being attained in relation to proposals it will be beneficial to
carry out post completion audits, particularly on the larger projects. The main aspects to be considered in
such an audit will be as follows:

   A comparison of the actual cash outflows and inflows with the budgeted cash flows. This should be
   supplemented by further enquiry into exactly why any variances occurred and whether these could be
   avoided in future.

   An examination as to the actual time taken to complete the project and how this compared with the
   estimated time necessary for completion. This is important, as delays in completing projects are costly.
   Such analysis may serve to highlight contractors which continually under perform and which should not
   therefore be used in future.

   The conclusions of all post completion audits should be collated and summarised by the finance
   department. These should then be used to identify trends and to avoid consistently poor performing
   types of project being undertaken.

8. Conclusion
It is clear that the current system in place within Ibex to deal with capital expenditure is unsatisfactory. It
does not allow for a well-formulated corporate planning process and instead allows projects which have not
been thoroughly researched and which do not meet with the overall strategy of Ibex.

It is vital, particularly within a forward looking, expanding company such as Ibex that there is a defined
system of capital expenditure control in place which is known to all managers and is strictly adhered to. This
will ensure that in future our capital expenditure proposals are effectively and appropriately researched,
approved, reviewed and incorporated into our overall financial projections.
TPE 2011 - SOLUTION TO IBEX PLC (REPORT 3)   6

								
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