Seagram Greater China

8 Pages   |   1,827 Words

Seagram Greater China: Office Relocation in Hong Kong
Case Analysis

Seagram Greater China office relocation in Hong Kong is a unique example where it requires applying Principals of Managerial Finance. According to Gitman, Lawrence (2003), “Managerial finance is the branch of finance that concerns itself with the managerial significance of finance techniques. It is focused on assessment rather than technique”. Ian Swanson, Vice President, Finance Seagram Greater China is in a dilemma to make the right decision for the well being and survival of the company in the long run. Current situation of Seagram Greater China demand for better integration of the Head offices in Hong Kong, which is essential for the smooth run of Operational Management as the business expands.

In this Case Seagram has three alternatives at hand where the Finance Managers need to carefully evaluate the likely financial impact on the group. In order to make the optimal decision it is vital that managers undertaking a systematic approach which essentially an interdependent approach borrows from both management accounting and corporate finance.  Major elements of such a systematic approach would include Financial Statement Analysis, Time value of money, Risk and Return, Capital Budgeting (NPV) and Cash flow analysis which will be evaluating alternatives on both quantitatively and qualitatively. These elements will provide different perspectives of each alternative thus useful for better understanding of the optimal decision.
 

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The ultimate choice should be in line with the overall objective of Seagram Group’s Strategic Goals. The main reason behind the integration of Head Offices is a result of rapid business growth in the industry which has prompted calls to merge the Hong Kong Offices into one location thus with improved quality and space. This unable the smooth Strategic coordination of Sales Division and Finance & Accounting divisions allowing establishment of finance shared service centre in order to support all the Greater China Markets.
Improved quality and Space for main functions of Seagram Greater China are the most important outcome of this Strategic decision. This enables the better coordination between the key functional areas of the distillery in order to better perform among its peer companies. Split office locations would cause poor functionality among the key performance areas creating barriers for long term growth in every aspect of the company. Therefore it is essential that the end result of the analysis facilitating the overall aim of the Seagram Greater China situation at hand.
As it is discussed in the case, the Overall objective for conducting such analysis is to amplify the performance levels in key areas of Business including Sales, Finance & Accounting divisions. In order to better achieve this outcome, the management looking to enhance the quality of the space in Head Offices merging all offices into one location. When choosing the ideal location for the shared divisions there are number of factors that need to be considered other than the condition of the location itself.
Exiting the Kowloon Centre would leave Seagram two options in hand, either purchasing a new office location or renting the premises for the period in consideration. Prevailing conditions in Commercial Real Estate Markets in Hong Kong is another important factor influencing the most favourable decision. At this moment the market experiencing a hold back which has lead to dramatic price drops in both Sale prices and Rental Prices. Then again the Commercial property prices remains at a Premium and with limited supply causing higher Sale Prices and Rental Prices. Therefore the cost of each alternative decision becomes a dominant issue when analysing the existing dilemma. 
If the decision is to purchase the property this would be contradictory to the Seagram’s General Policy on Fixed Assets. The firm’s objective was to not “be a landlord” and hold property that required a capital investment but to focus instead on the core competencies of the business. Existing Kowloon Centre and purchasing an ideal office premises is largely influenced by the above said Policy, if chosen one should provide reasonable arguments in order to get the approval from the Head Office.
Another important influential factor is the Staff preference of the location. Current polling of the staff indicated that majority of them reside in close proximity to Tsim Sha Thui, Kowloon. It is important that management take this prominent factor into consideration as they intend to enhance overall performance in business in its all aspects. 
Combined Cost of the two towers in Kowloon Centre Space        
                 
3rd Floor - Owned by the company            
                 
Company required to pay monthly management fees = $ 78,672        
                 
Annual Fees = $ 78,682 x 12 = $944,064            
                 
8th Floor - Rental Property            
                 
Monthly Fees = HK$78,520            
                 
Annual Fees = $78,520 x 12 = HK$ 942, 240            
                 
                 
Effective Combined Cost for two floors= HK$ 1,886,304          
                 
                 
                 
Post Strategy - Effective Miramar Tower Cost            
                 
               
                 
Current Leasing Price - $35 sq ft            
Management Fees - $ 5 sq ft            
Rates - 5.5% of the rental rate            
Property Space - 18,500 sq fts            
                 
 
Monthly Fees = (18,500x $35x 1.055) + (18,500x $5) = $ 775,612.50        
Annual Fees= $775,612x 12 = $9,307,344            
                 
Refurbishment Cost =  $          10,452,500.00            
(See calculations in Exh 2)            
                 
Effective Cost to Move to Miramar Towers = $19,759,844          
                 
Net Increase In the effective cost to move to Miramar Tower Space = HK$ 19,759,844 - 1,886,304 = $17, 873,540
Depreciation expenses for the purpose of Tax calculations different in Hong Kong when compared to US and other countries as they classified the assets into three different Capital Asset Pools. Having the lowest Company Tax rate in the region for 16.5% flat rate Hong Kong provides more tax benefits for Business Sector proving a healthy tax environment. This enable the high growth in Business sector creating a highly competitive environment for the rivals in other regions.

Hong Kong Tax Laws provide generous depreciation allowances for Plant and Machinery, where 60% initial written down in the year of purchase followed by 10%-30% annual allowance at the fiscal year end. The total depreciation allowance for the first year can thus be as high as 72% (i.e. 60% plus 30% of the remaining 40%). Providing a Scale on deductions for different asset classes in Plant and Machinery encourage and support wider range of capital investment in Research and Development sector. Never the less proving a scope in allowable deductions for different asset classes would increase expenditure relating to capital expenditure as businesses seek to gain advantage of this opportunity. This leads to improved performance in commercial sector encouraging more investments leading to high economic growth. To name a few IT, Health & Science, Merchandising and Engineering are most favoured under this tax environment and will make more capital investments in its research and development areas.
Sale of 3/F space in Kowloon Centre is expected to be disposition due to its deteriorating property conditions and would need two to three million dollars on renovations. Therefore if the Group decides to exit the Kowloon Centre Space, according to the Finance department’s calculations the premises can generate an estimated profit of USD 4.6 million, in HK$ 35,068,864. This amount is a cash inflow in both Purchasing and Renting Cash flow analysis and would be included in both Cash Flow Analysis and NPV Analysis. It would not have any impact if the decision is to remain in the current building. However the full amount may not be realised since the Property Disposal Authorization was made in the month of May and the Sale decision would be made in the month of June. Although the Managers hope to realize 70-80% of the anticipated Sale Price if Seagram elect to exit Kowloon Centre Space.
The theory behind Seagram’s Value Added is to realize the implicit cost of holding working capital and it is a method which charges managers and businesses for holding working capital. Usually SVA Charge appear in Income Statement as a deduction from net income. Therefore if the decision is to remain in the existing building Seagram Value Added Charge will not have any impact from the Selling price as the company would not have an impact though Selling Price for its Capital Holdings.

If the company decided to exit the premises in Kowloon Centre, the only two options left in the hands of the Managers would be to relocate to Miramar Tower Space where they find it ideal in terms of rental price and associated costs. Furthermore the company also received a better deal at an asking price of $90 million as well as the agency offering a significant discount led the managers to investigate the option further. Hence the company gathered information related to the two available options now it is necessary to identify the project worthiness through NPV analysis.
Based on the NPV calculations shown in Excel Spreadsheets there is a significant difference in Net Present Value projections for the period of 10 years.
If the company decided to Lease the space in Miramar Tower, the project worthiness would be as follows:
NPV Before SVA  $  19,422,845.00
NPV After SVA  $  18,852,953.00
 
If the decision is to Purchase the Property In Miramar Tower the project worthiness would be the following:
NPV Before SVA  $100,217,148.00
NPV After SVA  $  90,828,858.55
 
Comparing the two figures it is highly favourable for Seagram to Purchase property at the prevailing Market conditions in Commercial Real Estate market. This results in gaining a project worthiness of $100,217,148 before Seagram Value added charge. After realizing the implied cost of holding capital which is the SVA Charge, the project worthiness is still at its highest for an amount of $90,828,858. The cost of holding the property for 10 years would be 1/10th of the overall project worthiness over the years.

In contrast to this option is the decision to Lease the premises in Miramar Tower Space, the figures from NPV calculations shows a 1/5th of project worthiness when compared to the purchase decision with an amount of $19,422,845 before realizing the Seagram’s Value Added charge. Cost of holding the Capital expenditure such as leasehold improvements, Machinery and Furniture 1/10th as it illustrates from the two figures.
Purchase decision is contradictory to the company policy thus the projections and analysis can provide well presented arguments and judgements in favour of the purchase decision. As a result considering all the available information at hand and evaluation the results on a long term scale the decision for Seagram is highly favourable to purchase the Miramar Tower Space which is also the most preferred location for its staff.

 As it is discussed above, the implied cost of holding the Capital Assets calculated through Seagram’s Value Added charge, where the charge is equal to Seagram’s Hurdle Rate (10%) x amount of working capital invested in a particular department or area. As Working capital depreciates the cost of holding the Capital Assets also drop in significant amounts. Therefore cost of Holding Capital is only 1/10th of the overall project worthiness in present value. Refer calculations in Spread Sheet under NPV calculations & Capital Asset Pooling.

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