Unit 3.2 Sources of finance suggested answers

1. Identify one form of capital investment suggested from the case. [1]

Answer: Upgrading the factories to manufacture new systems using batch production.

(Explanation: Capital investment refers to spending on fixed assets such as factories, land, or equipment to enhance production capacity.)

2. Explain two advantages that are possible with “access e-keys”. [4]

Answer:

1. Cost Savings – Access e-keys eliminate the need for companies to replace lost physical cards and require only software updates, reducing long-term costs. (2 marks: explanation of cost savings and how software updates reduce expenditure.)

2. Environmental Sustainability – Unlike traditional plastic access cards, digital e-keys reduce plastic waste and support ecological sustainability, which aligns with modern business values. (2 marks: explanation of sustainability benefits and how it aligns with corporate responsibility.)

(Examiner Tip: Answers should clearly explain how each advantage benefits businesses, ensuring full marks.)

3. List three internal sources of finance and three external sources of finance mentioned in the case. [6]

Answer:

✅ Internal sources of finance:

1. Retained profit
2. Sale of assets
3. Personal savings

✅ External sources of finance:

1. Bank loan
2. Leasing
3. Venture capital

(1 mark per correct source, ensuring 3 internal + 3 external.)

4. Explain two sources of finance that would be inappropriate to use to finance the upgrade of the existing factories. [4]

Answer:

1. Trade Credit – Trade credit is a short-term source of finance typically used for purchasing raw materials or inventory rather than large capital investments like factory upgrades. (2 marks: clear explanation of why trade credit is unsuitable for long-term investment.)

2. Debt Factoring – This involves selling accounts receivable (outstanding invoices) at a discount to improve cash flow. Since DAC needs long-term funding for factory renovation, this would not be a suitable option. (2 marks: clear explanation of why debt factoring is unsuitable for long-term investment.)

(Examiner Tip: Answers should explain why the sources are inappropriate rather than just listing them.)

5. Explain why DAC paid out high levels of dividends to shareholders. [2]

Answer:
DAC paid high dividends because:

1. The company was highly profitable with strong market share, and shareholders expected regular returns on their investment. (1 mark: explanation of profitability and meeting shareholder expectations.)

2. Instead of reinvesting in new product development, DAC prioritized keeping investors satisfied, which ultimately led to a lack of diversification in its product portfolio. (1 mark: explanation of lack of reinvestment and consequences.)

(Examiner Tip: The answer should link dividends to business decisions.)

6. Explain why borrowing (gearing) could be a problem for DAC. [2]

Answer:

1. Increased financial risk – If DAC takes on too much debt, the company may struggle to meet repayment obligations, especially if revenue declines due to competition from access e-keys. (1 mark: financial risk explanation.)

2. Lack of diversification – Since DAC relies on one outdated product, banks may see them as a risky investmentif they borrow too much. (1 mark: explanation of limited product portfolio increasing risk.)

(Examiner Tip: Students should demonstrate an understanding of financial risk in borrowing.)

7. Explain one reason why DAC are likely to be given a loan from a bank and one reason why they may not be given a loan. [4]

Answer:
✅ Reason DAC may be given a loan:
DAC owns two factories, land, and machinery worth $2.5 million, which can be used as collateral to secure the loan. (2 marks: explanation of collateral and how it increases the likelihood of bank approval.)

🚫 Reason DAC may not be given a loan:
The company has failed to innovate and relies on an outdated product, making it high risk if competitors replace its market. Banks may fear DAC will struggle to repay the loan. (2 marks: explanation of product decline and risk perception.)

(Examiner Tip: One strong reason for approval and one strong reason for rejection ensure full marks.)

8. Discuss two appropriate sources of finance for the renovation of DAC’s factories. [10]

Answer:

✅ 1. Bank Loan (5 marks – justified explanation, pros and cons.)

• Advantages:

  • DAC has a good relationship with its bank and owns valuable fixed assets that can be used as collateral, making approval likely.
  • Bank loans allow for structured repayment terms over several years, helping DAC fund the renovation without immediate financial strain.

• Disadvantages:

  • If the new product fails, DAC may struggle to repay the loan, increasing financial risk (gearing).
  • Interest rates could be high depending on DAC’s risk profile.

✅ 2. Venture Capital (5 marks – justified explanation, pros and cons.)

• Advantages:

  • Venture capitalists provide long-term funding without requiring immediate repayment, which reduces financial strain on DAC.
  • They may also offer strategic advice and business connections, helping DAC innovate.

• Disadvantages:

  • Venture capitalists demand equity (ownership) in return, which means the Kleiner family loses full control over DAC.
  • Investors expect high returns, which can add pressure on DAC to grow quickly.

Final Evaluation (for full marks)

The best source depends on DAC’s willingness to take financial risk. If they want to retain full control, a bank loanis preferable. However, if they require business expertise and funding without immediate repayment, venture capital may be a better choice.

(Examiner Tip: A well-balanced answer includes both advantages and disadvantages and ends with an evaluation.)