New Strategy and Market Capitalisation | AQA Q2.1, Paper 2 2019

Here are two suggested answers to the 9-mark question exploring the impact of a strategic decision on the market capitalisation of a business.

ANSWER 1

WR’s market capitalisation will be impacted by changes in its share price and this may rise if investors believe that the returns on investment in electric bicycle are likely to be strong as these should improve WR’s profits once the initial investment in entering the market has been recovered. Although investors will be wary of the short-term costs as WR enters the market, many should be attracted by the longer-term positive impact of WR success in what could be a significant opportunity, since WR already operates in the cities it is likely to target. By diversifying into electric bicycles, investors may also believe that WR’s future profits are more likely to be achieved, which in turn, may attract investors to buy WR shares for the first time, thereby also increasing the share price and market capitalisation.

EXAMINER COMMENTARY

This response shows an excellent understanding of market capitalisation but more importantly, the possible impact of the strategic decision to move into electric bicycle rentals on the market capitalisation of the company. Subsequently, the answer is fully focused on the demands of the question.

ANSWER 2

Market capitalisation might fall if investors believe that the costs of entering the electric bicycle market will mean a significant fall in profits and consequently in the dividends paid to WR shareholders, since the dividend is one factor that affects demand for a share. Although WR already operates in most of the cities in which it wants to offer electric bicycle rental, the costs of setting up the service and entering the market in each city are likely to be significant. Many large cities already have existing competitors in the electric bicycle market so WR may incur substantial losses in a city before it even reaches a break-even point. This may consequently restrict the cash and profits available to pay dividends to shareholders, so some shareholders may decide to sell their shares and invest in alternative companies, thereby reducing the share price and therefore market capitalisation.

EXAMINER COMMENTARY

A well developed response that examines the impact of the new strategic direction on the market capitalisation of the firm. The response shows a depth of understanding and this is applied effectively to the context.