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Solution to Case 1: Pace Leisurewear Ltd (1)
(Note: There is no single ‘correct’ solution to this case study. Various approaches could have been adopted. The plan of action proposed should flow logically from the initial analysis of the problems faced by the company.) When analysing the problems faced by the company, the following points may have been raised: · The lack of financial expertise within the boardroom and the apparent lack of financial controls operating within the business (e.g. the fact that the business had breached the overdraft limit on several occasions). The lack of proper business planning. The growth in the company appears to be uncontrolled and unpredicted. There is no evidence that the company has tried to ensure that there is capital available to finance the growth of the business. The company appears to react to the developments in the business as they arise rather than to anticipate problems before they arise. The relatively high dividends being paid despite the liquidity problems of the business.
Table of ratios The following ratios provide a useful insight to the financial health of the business: Year before last Return on capital employed (net assets) Net profit before interest and tax ´ 100% Share capital + Reserves + Longterm loans 2,100 ´ 100% 10,474 4, 618 ´ 100% 15,600 Return on equity (shareholders’ funds) Net profit after longterm interest and tax ´ 100% Share capital and reserves 20.0%
1248 , ´ 100% 6,874 2, 926 ´ 100% 9,000 Gross profit margin Gross profit ´ 100% Sales 6,510 ´ 100% 14,006 10, 792 ´ 100% 22,410 Net profit margin Net profit before interest and tax ´ 100% Sales 2, 100 ´ 100% 14,006 4, 618 ´ 100% 22,410 Stockholding period Stock held ´ 365 days Cost of sales 2, 418 ´ 365 7,496 5, 820 ´ 365 11618 , * based on year end stock levels Debtor collection period (Day’s debtors)
006 8. 418 2.Trade debtors ´ 365 days Credit sales 1614 .78 : 1 1. 820 8. 482 9.2.844 Debt to equity ratio 0.08 times 42 days 61 days 0. 356 .356 22. ´ 365 14.12 : 1 0.5. 844 Quick assets (liquid or acid test) ratio Current assets.006 3.76 : 1 1. 470 + 9. 600 + 4. excluding stock Creditors falling due within one year 4.482 9. 356 2.974 Current ratio Current assets Current liabilities 4. 974 8. 410 14.40 : 1 3 .410 Sales to capital employed ratio Sales Total assets employed 14. 974 .92 times 1. 744 ´ 365 22.
Once again. accompanied by an increase in the net profit margin. 600 ´ 100 15. this ratio will be affected by the need to increase stocks in anticipation of higher sales levels in the future. 600 ´ 100 10. The gross profit ratio increased significantly.Longterm liabilities ´ 100% Share capital + Reserves + Longterm loans 3. an effective use of gearing. Stock is now turning over rather slowly compared with last year. However.474 7.304 (912) (600) (1. Sales last year increased by 37. however. Net profits after tax have increased by 134.600 Comments on the financial results The following points are significant from the results to hand: · Pace Leisurewear has experienced a major expansion of activities.5% compared to the previous year. the level of gearing is now very high. The liquidity position has weakened considerably from what was probably a healthy position to one that looks distinctly unhealthy. but a ROCE in excess of the interest rate had caused an even greater increase in ROE. There has been an increase in the ROCE ratio.4% 42. However.512) 4 . this ratio will be affected by any increase in sales towards the end of the year. The debtors’ collection period has increased significantly over the period.5% over the same period.3% · · · · · Cash flow statement for the year ended 31 December last year £000 Net cash inflows from operating activities (see Note 1 below) Returns from investment and servicing of finance Interest paid Dividends paid Net cash outflow from returns on investment and servicing of finance Taxation £000 3. It is quite clear why the continuing support of the bank is important. 34.
250) (4.298) 3.670) (7.298) (4.298) Cash at bank and in hand Bank overdrafts 5 .670) (8.000) 3. as follows: Analysis of balances of cash and cash equivalents as shown in the balance sheet start £000 56) –) (17) end £000 8) (4.298) To see how this relates to the cash of the company at the beginning and end of the year. another reconciliation can be shown.Corporation tax paid Tax paid Investing activities Payments to acquire tangible fixed assets (See note) Net cash outflow from investing activities Net cash outflow before financing Financing Bank loan Net cash inflow from financing Net decrease in cash and cash equivalents (420) (420) (8.000) (4.242) Change in year £000 (48) (4.242) Balance at 1 January last year Net cash outflow Balance at 31 December last year To explain where the opening and closing balances came from.250) (4. it is useful to show a reconciliation as follows: Analysis of cash and cash equivalents during the year ended 31 December last year £000 56) (4.
However.666 3.: Fixed assets.130 134 £000 4.552 8. The cash flow statement shown above reveals that the company invested nearly £8. the following points may be made: · The company should ensure that someone with financial expertise is brought on to the board of directors to take a firm control of the financing and investing activities of the business. at book value.800 14.744 – 1. adjusted by the depreciation charge.670 17. at the start of the year Add: additions (balancing figure) Less: depreciation Fixed assets. They may be prepared to take on such risks in exchange for potential high returns.600 8. it is necessary to ensure that the level of operations is more closely aligned to the 8. there are certain investors (e.Note: Calculation of net cash inflow from operating activities £000 Net operating profit (from the profit and loss account) Add: Depreciation Add: Increase in trade creditors (2.7m in fixed assets during last year but only raised £4m in loans to fund the business.612 – 1. there may be disadvantages in this approach.820 – 2. the additions must be the difference between the start and end of the year fixed asset values. The company may find it difficult to find potential investors.304 Since there were no disposals. e.418 1.800 7. at book value.470 · · 6 .398 154 3. at the end of the year Plan of action In producing a plan of action.418) Increase in trade debtors (3.402 2.270 2. venture capitalists) who may still find the company attractive. It may be possible to approach customers and suppliers to see whether they would be prepared to make small investments in the business.614) Increase in other debtors (402 – 268) 5.g. The result was inevitably a deterioration in the cash position of the business. Customers and suppliers may wish to use their shares to influence future policy of the business in a way which undermines its autonomy. Although the company is highly profitable.618 2. In the absence of a large injection of funds from outside the business. Nevertheless.970 Less: Increase in stocks (5. However. the Keeble brothers are not keen on having another large shareholder in the company which could prevent this option from being feasible.g. the level of gearing is high and the company is facing a liquidity crisis.214) Increase in other creditors (402 – 248) 1.
If customers and suppliers become concerned with the liquidity of Pace Leisurewear. or at least reduce the rate of growth in order to ensure that orders can be fulfilled. providing the business is prepared to hold back its growth in the short term. the following internal funds can be generated: Reduction in stock level £ Current investment in stocks Revised investment in stocks 11. This means that the company must take a more controlled approach to expanding the business. The company must also find ways of generating finance from within the firm in order to ensure that the bank’s demands are met and the liquidity of the business is improved. 7 . it could precipitate the collapse of the business.410 × 42/365 5820 3756 £ 2064 3744 2579 1165 3229 The above figures suggest that the reduction in the overdraft as required by the bank is possible. In the short term. Although this policy may involve losing sales.618 × 118/365 Reduction in debtors levels Current investment in debtors Revised investment in stocks 22. · By holding sales at last year’s level and reducing stock levels and day’s debtors to the levels of the previous year. the alternative may be that the business collapses through lack of liquidity. The following steps should be considered: — cancel the proposed dividend for the year — sell off any underutilised assets — reduce stock levels — reduce the debtors’ collection period — lease rather than buy fixed assets in the future.· finance available. it may be necessary to reduce the level of activity.
208/304.610) × 365 *Using year end figures and cost of sales rather than credit purchases Sales to capital employed* (322.363) * Using year end figures 100 days 6.917/52.1 times 7.557*)/(38.3% 13.0% 57.2% 53.640) (304.725) × 365 113 days (38.640) × 100] 84.453/138.962/138.557)/304.268/140.6% [(36.917) × 365 (11.642/322.818) × 100 Efficiency Stock turnover period* (28.8% 12.275) × 365 (22.144/322.399/140.818) × 100 Gross profit margin (184.818/38.9% 75 days 58 days 13 days 14 days Average settlement period for creditors* (42.818) × 365 * Using year end figures 95.917) × 100 (164.Solution to Case 2: Carpetright plc The following ratios can be used in assessing the performance and position of the business: 2001 Profitability Return on owners equity (ROE) (31.610) × 365 * Using year end figures Average settlement period for debtors* (11.9 times 8 .613/35.452)/322.2% Return on capital employed (ROCE)* [(44.715/47.917) × 100 (36.783/304.6% 71.609) × 100 (25.552*) /(52.363) × 100] * Interest payable ignored (assumed to be all short term interest payments) Net profit margin (44.578) × 100 2000 66.
474) (42.8% £47.8% £304. Note the percentage change in the profit after tax and net assets figures over the period.4% 70.818 £25.363) × 100 Investment Dividend payout ratio (20. the increase in turnover during the period was more modest.239) Acid test ratio [(55.031/52. The ratios reveal that Carpetright plc is an extremely profitable business.6% 7.453)/93.Liquidity Current ratio (55.428/31. Carpetright plc has grown significantly over the year.) There has been an increase in both the gross profit margin and net profit margin of the business over the period.3:1 0. However.268)/75.613) × 100 Earnings per share* * per accounts 0. the increase in net assets has been proportionately greater. The gross profit margin has increased rather more than the net 9 .609 33.613 £35.6:1 0.578 In some respects. (Although sales have increased.474] [(42.817 – 28.3p The following information concerning changes in the size of the company is also revealing: Turnover % increase Net profit after tax % increase Net assets % increase £322. This decline results from a decrease in the sales to capital employed ratio as the net profit margin has increased over the period.640) × 100 (2.927/25. The ROE and ROCE of the business are very high – although there has been some decline in both over the period under review.9% £31.3% 64.917 5.715) × 100 (17.616 – 22.3:1 9.785/38.6:1 0.715 23.0p 33.817/93.239] Gearing Gearing ratio (5.616/75.0% 42.
trade creditors were more than financing the stocks and debtors of the business. external funding may be unnecessary. of course consider reducing the level of dividends in order to conserve cash. the business received cash from customers 88 days (i. which seems fairly long. However. problem. The carpet manufacturer may feel this issue is worth further investigation. A carpet manufacturer may feel it has much to gain from association with such a successful and growing business. the business is very profitable and has little gearing and so there should be few problems in raising funds to improve the liquidity of the business if it was felt that this was a serious. Carpetright is likely to be demanding on its suppliers. 10 . However.) The average settlement period for debtors has remained much the same over the period (the very low settlement period suggests a high proportion of cash sales). In any event. The liquidity of the business is low but has been stable over the period under review. there has been an increase in the average settlement period for creditors and the stockholding period. An examination of the cash flow statement reveals that although there has been a large outlay on the acquisition of fixed assets. Thus. 13. An investor should have reason to be satisfied with the performance of the business over the period. The business could. These three ratios reveal that during the year. (Note that the distribution costs increased by much more than the increase in turnover. or long term. This may be due to the sale of higher price/higher margin items but it may also may be due to squeezing the suppliers’ margins. There was a slight decrease in the period during the most recent year and given the liquidity problem referred to earlier. dividends and tax during the year.0 + 75) after receiving the goods and paid the creditors 113 days after receiving the invoice for the goods. the expansion of the business combined with high dividend payouts has placed a strain on the liquidity of the business and it may be necessary for the business to consider additional funding in the future if this rate of expansion is to continue.profit margin. However. However. It is interesting to note that Carpetright improved its gross profit margin during the period.e. suppliers are unlikely to be paid much quicker in the future. However. if the business continues to generate strong operating cash flows. At present the dividend payout ratio is very high even though there was a decrease compared to the previous year. this ratio may well reflect tight financial management by the business. This case study is reproduced with permission of Carpetright plc. The improvement in profits over the period has led to a significant improvement in earnings per share and the dividend payout ratio is high. This would mean higher levels of gearing or requiring further funds from equity investors. The acidtest ratio in the most recent year seems very low indeed and might provide cause for concern. The business is growing and is maintaining very high levels of ROE and ROCE. the operating cash flows were able to cover these. which suggests that the increased profitability from buying and selling carpets has been partly consumed by increased operating expenses. The average settlement period for creditors is nearly four months.
100 264.500 100) 3.125) 1.500 168.700 34.000 1.600 178.500 40.200 84.500) 900) 48.500 121.750 2.700 Mar £ 37.125) 20.100 123.500 261.750 3.200 102.000) 27.700 (85.300 113.500 27.250 20.800 112.150 20.000 600 26.500 81.800 232.600 1.500 11 .600 1.600 24.600 82.200 270.250 750 20.500 235.500 164.500 100 3.Solution to Case 3: Gadabout Travel Ltd Cash budget for next year Jan £ Cash Receipts Bookings: WS B 220.750) Surplus/(deficit) for the month Cumulative balance 92.000 Apr £ 12.850) 48.500) 72.000 100 3.200 190.500 447.300 481.000 600 36.000 1.300 100 3.500 88.000 900 20.600 583.800 May £ June £ 121.850) 632.600) 100 3.900 21.500 2.600 546.000 100 3.500 1.200 333.000) 56.600 497.800 20.700 54.000 Payments Airlines: T+LC* EC* Hotels: T+LC* EC* Salaries Electricity Rates Repairs Travel Feb £ 233.500 1.600 38.
150 100 3.Cash budget for next year (continued) July £ Cash Receipts Bookings: WS B Aug £ Sept £ 22.700 10.200 92.000 1.450) 68.000 21.800 78. 12 .250 3.500 170.600 20.050 13.500 2.600 1.000 20.500 281.950 Surplus/(deficit) for the month Cumulative balance (259.400 Dec £ 126.600 34. ** EC is the early cancellations (50 per cent of the total cancellations).450 (66.200 37.150 100 500 21.600 21. 60 per cent of which must be paid.375 20.000 111.500 35.650 Nov £ 113.250 20.000 20.500 1.600 100 500 21.800 141.350 (218.600 63.600 21.750 2.400 126.000 2.375 3.000 Payments Airlines: T+LC* EC** Hotels T+LC* EC** Salaries Electricity Rates Repairs Travel 93.700 139.600 100 3.550) (134.600 1. all of which must be paid in full.500 100 3.050) * T+LC is the holidays taken plus the late cancellations.500 240.600 21.950 20.750) 328.000 100 500 23.650 113.400 116.200 104.500 Oct £ 34.000) (55.
080 + 90) × £150 90 × £90 Beach (3.400 752.450 21.600 325.150 13 .400 327.000 2.500 217.000 8.130 + 140) × £100 140 × £60 Salaries Electricity Rates Repairs Travel Depreciation Budgeted net profit for the year £ £ 711.611.000 11.200 6.080 + 90) × £100 90 × £60 Beach (3.130 + 280) × £270 Hotel charges: Winter sports (2.Budgeted Profit and Loss Account for the year ending 31 December next year £ Sales: Holidays sold (net of agents’ commission) Winter sports (2.700 1.000 1.200 33.100 408.000 5.632.080 + 180) × £315 Beach (3.400 1.800 247.750 10.900 920.500 8.130 + 140) × £125 140 × £75 Airline charges: Winter sports (2.850 557.
600) 500 141.400) Current assets Prepaid rates Cash Current liabilities Accrued electricity Trade creditors (940 winter sports × (£350 – 10%)) £ 210.300 + 21. Since the price is fixed. Also.950 142.600) 255. These need to be carefully managed to gain the maximum benefit from interest receipts. steps could be taken to reschedule some of the payments so as to avoid these cash deficits. During that period. During September and October there are overdrafts scheduled. During much of the year there are major cash surpluses. Steps need to be taken to deal with this.450) · Accounting policy with reference to realisation of profit The generally accepted accounting treatment of revenues is to recognise them when the period in which the work to earn them has substantially been completed.150) 100. There is relatively high sensitivity to changes in demand.450 1.450) Share capital and reserves (79.150) Comments on the results The following five points are worth noting: · · · · A 20–25 per cent return on equity may or may not be considered adequate for the level of risk involved. the revenue is capable of objective measurement.100 297. An overdraft could be negotiated in advance. The profit/contribution margin is relatively small. leaving only the payment to them outstanding. the bookings with the airlines and hotels will be placed. cash is received at the time of the customer making the booking. without placing the funds at serious risk.500 296. they are capable of objective measurement and it seems probable that the cash will be received.Budgeted Outline Balance Sheet as at 31 December next year £ Fixed assets Freehold land and building Equipment and furniture (57.600 (155. Perhaps better. Thus it could be contended that the work to earn the revenue has been substantially completed.000) 45. 14 . 100. It could be argued that this position is established in the period in which the booking is made. selling price and costs.000 – 11.
The process could go wrong in the meantime. a major factor in the decision must be the usefulness of the information provided. This is probably the view that would be taken in practice. If it is felt that one approach gives the more valuable information. 15 . leading to extra work and to extra cost. Ultimately. This is particularly the case here because there are quite good arguments. based on accounting conventions. It could be argued that a prudent view should be adopted so that profit is not recognised until the holiday is actually taken. it is not until the customer actually takes the holiday that the work is fully completed. then this is the approach that would probably be taken.On the other hand. for adopting either policy.
It is common for new management to be ultra prudent initially. The overdraft has reduced to £2. compared with net profits last year of 20. The cash position is aided by the nonadoption of the proposed £800. for whom Pace started making "own brand" items which would be lower price than the Pace branded items otherwise sold. Noticeable is the large Loss.9 million being written off stock and debtors.536 million. prudence was used to determine the level of writeoffs. which generates substantial amounts of cash. It is reasonable to accept writeoffs on such high levels of stock in a fashion industry with rapid obsolescence. mainly due to a total of £1.000 dividend payments. although it can be seen that the gross profit has dropped to 42.Solution to Case 4: Pace Leisurewear (2) The Quarter to 31st March This period sees the start of the turn around in the fortunes of Pace Leisurewear. knowing that any excessive provisions may be relaxed at a later date to make their own performances appear more impressive. Operating profits (before writeoffs) remain healthy. There is now a net loss of 22.6% Interest expense has increased due to the high level of overdraft expense. but not excessive. which would have been unwise in the circumstances. The management and shareholders of Pace would wish to be confident that adequate. which demonstrates the fundamental strength of the business. and debtor writeoffs are not unexpected given the nature of the industry.3%.9% (previously 48. in particular as such a payment would merely confirm a view of financial incompetence in the eyes of the bank. due largely to the impact of the recently accepted order from Arena.2%). 16 .
It is likely that such a replacement would cost the company less than the £300. Significantly both a profit and a positive cash balance are expected by the end of this quarter a reflection on the essential strength of the business and core management team. whether lower margin contracts such as that from Arena should be accepted or not. It would still be essential to employ someone in Peter's role. when it was 34. Jill Dempsey will be pressing for the removal of Peter Drake on the grounds of incompetence.The Quarter to 30th June Many of the figures are unchanged from the previous quarter. It remains to be seen if it is realistic to dispose of any of the fixed assets. which has dropped by 5% from last year. notably the gross margin. The debt to equity ratio remains above the level of two years ago. and a direct replacement would be required for Peter when he comes to leave. Peter Drake might be able to leave soon. and the management may consider whether dividends should be paid as soon as possible. The management will need to consider cost reductions and / or improvements in the sales prices achieved: for example.000 a year that Peter would charge. or whether a sale and leaseback is possible for any buildings. Cost of sales and Operating expenses (except for the additional salary expense of Peter Drake.8% by June. not least because Jill appears to be running out of allies. The challenge for the company to the future will be to increase the profitability ratios.000). but more as a result of having successfully turned the company around and prevented its liquidation than any failure on his part. but it is likely that such an attack would be rejected by the Board. 17 . notably Turnover.4%. It is now expected to be 42. or whether it would be more prudent to use any surplus cash to reduce the level of the bank loan before paying dividends. the company will not yet be in a position where it can pay dividends to its shareholders. However. which is at an annual rate of £300.
9% 20.600 2.300 Net profit margin 4.618 3.700 * 100% 6.6% 183 days 58 days 58 days 61 days 53 days 46 days 1.820 * 365 11.12 : 1 1.404) * 100% 6.140 *91 6.6% (22.744 * 365 22.300 Current Ratio 9.410 (1.Table of ratios Last year Quarter Quarter to March to June Gross profit margin 10.410 3.280 * 91 3.640 * 91 6.720 * 91 3.9% 42.23 : 1 18 .3%) 6.300 3.974 8.618 * 100% 22.410 2.300 Stockholding period 5.792 * 100% 22.2% 42.790 6.844 7.600 (based on period end stock levels * number of days in period) Average settlement period for debtors 3.300 418 *100% 6.340 48.
280 3.64 : 1 1.71 : 1 0.820 8.606 2.974 5.720 6.854 Acid test ratio 9.40 : 1 0.340 6.844 7.606 3.12 : 1 19 .770 3.854 1.6.
Solution to Case 5: Landlord: investment appraisal There is no solution for this case study as it is too open ended. 20 .
it is not a clearcut decision as the NPV is reasonably close to zero.510 122.752) (32.688 81.000 416.816 0. Management should be aware of the likelihood of not achieving the forecast results.000 Conversion of barn in "Top Field" 25.000 Cost of winching equipment for the toboggans 35.900 Yr 7 378.688 Total visitors per annum (at present) Visitors (if 5% compound growth) Extra visitors 21 .957 Net Present Value £ Yr 5 (240.000) Extra contribution [W2] 89.461 198.000 0.710.772) Total Cash Flow (240.935 0.283) (126.080) (123.648 224.089 7% factor 1.231) 0.775 184.000 Cost of 60 plastic toboggans 60.000 18.615) (130.000 459.745 38.000) (45.582 59.461 1. The sensitivity analyses are worth looking at in this regard. However.039 283.940 Extra running costs [W3] (120.000 437.079) Tax rebate/(payable) [W4] 15. Workings [W1] Capital investment The following capital expenditure would be incurred in Autumn Yr 5 and is therefore eligible for Capital Allowances (see Working 5) from trading year Yr 5: £ Landscaping of "Top Field" 30.512.249) £48.763 Present Values (240.000 Aluminium track 90.582 149.) The project generates are positive Net Present Value (NPV) and should therefore be considered favourably by the Blue Hills' management.000 [W2] Extra contribution Firstly consider the extra visitors: Yr 6 378.873 0.305) 79.341) 69.826 (6.713 (32.000 396.000 Total assets 240.000) £ Yr 6 £ Yr 7 £ Yr 8 £ Yr 9 £ Yr 10 (45. to three decimal places.582 Yr 9 Yr 69 378.231) (45. of the discounting factor.745 Yr 8 378.Solution to Case 6: Blue Hills Country Park Limited Net Present Value calculation Capital investment [W1] Opportunity cost (barn) (30.000) (42.900 18.015 386. This is due to the rounding.159 170.036 (Note: you may spot some slight differences with your PV calculations.000 1.
000 (33.e.75 So the total extra contribution per annum can now be calculated by multiplying the extra visitors by the contribution per visitor: Extra visitors Extra contribution (@£4.000 123.672 83.937 (0) Expenditure/WDV b/f Writing Down Allowance (at 25%) Scrap value Written Down Value (WDV) c/f Balancing Allowance 22 .750) 101.75/head) Yr 6 18.283) (126.750) (25.080 40.25) 3.000) Maintenance/electricity/insurance plus: Patent fee (inflationproof) Total 33.000 120.000 Yr 7 £ 135.75 plus: Profit made from extra visitors to the shop (£2 £1) 1.461 Yr 69 198.000) (45.644 90.231 Yr 5 £ Extra contribution Extra running costs Capital Allowances [W5] Tax (rebate)/payable @ 25% The cash flow for these tax figures will occur at the end of the following year.You can now calculate the additional contribution that these extra visitors will generate each year.280 46.940 £943.000 130.000) (18.039 283.619 86.775 £184. i.924 (15.039 £283.079 40.000) (33.000) 180. 4% inflation) New staff (4 x £8.313) 75.937 Yr 9 £ 75.615 40.615 Yr 9 £ 37.745 Yr 8 59.250 Yr 8 £ 101.250 (25.015 386.313) (75.000 (45.000 Yr 6 £ 180.752 32.000 (60. Yr 6's in Yr 7 and so on.826) 6.775 184. Contribution per visitor is shown here: £ Entrance fee 4.937) (60.080) (123. [W5] Capital Allowances Yr 5 £ 240.000) (75.996 50.940 (120.00 less: Variable cost per visitor (0.000 126.079 [W4] Tax calculations Yr 6 Yr 7 Yr 8 Yr 9 £ £ £ £ 89.305) 27.080 Yr 7 £ 34.800 80.615) (130.087 180.000) 135.769 [W3] Extra running costs Yr 6 £ Extra costs (inc.283 Yr 8 £ 35.772 45.688 £89.006 131.283 40.435 52.079) (60.00 Total contribution per visitor 4.900 Yr 7 38.582 Yr 9 81.611 48.937 75. Yr 5's in Yr 6.015 £386.
036 3% visitor growth 195. 23 .989 Clearly the alteration to the visitor growth rate has had a dramatic effect on the NPV of the project and it is therefore very sensitive to changes in customer demand. with a positive NPV.Sensitivity Analysis The Net Present Values (see the spreadsheet for the workings) for the three other situations suggested are shown below: NPV (£) Original forecast 48. The changes to cost inflation and cost of capital have had far less effect and in both cases the project.948 10% money cost of capital 21.049 7% cost inflation 31. is still worthwhile.
0% £0.6T 45 70 1.4% 10.8 1.6% 5.7% 7.6% 3.5 1.260 100 11.7% 63.0% 8.9T 48 70 4.45 100.485 100 1.3% £0.900 109 800 63 12.6% 27.7% 4.1 1.600 103 960 76 12.3 2.700 152 17.460 100 4.870 100 2004 16.5% 6.726 107 30.40 24 .175 136 4.0% 4.945 100 10.650 111 12.3% £0.0% 25.0 2.63 83.5 2.3T 33 61 1.6% 1.48 89.030 101 2005 18.8% 8.0% £0.725 105 896 71 12.Solution to Case 7: Homeland plc (a) Trends 2002 Sales (£000s) Trend Cost of sales (£000s) Trend Gross profit (£000s) Trend Net profit (£000s) Trend Capital employed (£000s) Trend Ratios Profitability GP margin NP margin (after tax) ROSF Efficiency Sales/Capital employed Average receivables (days) Inventories turnover (days) Liquidity Current ratio Acid test Gearing Gearing ratio Investment Dividend payout Earnings per share 2003 14.726 107 22.050 115 4.1 3.800 170 4.4% 21.2 4.900 126 14.4T 39 65 1.
the pursuit of market share appears to have been achieved at the expense of profitability and liquidity. This has led to an increase in the sales to capital employed ratio and raises the question as to whether the business is overtrading.Key points · Since 2002. · The increase in capital employed is small in relation to the increase in sales. sales revenue has increased by 52% but cost of sales has increased by 70%. Despite the declining liquidity and increasing bank overdraft. Overall. It appears that the freehold land is unsecured and may be used as security for a loan if required. · There has been a significant increase in the average trade receivables period (poor controls or a liberalisation of credit to achieve greater sales?) · There has also been an increase in the inventory turnover period (poor controls or expectations of greater future sales?) · · The liquidity ratios show a sharp decline that must be addressed. Unless there is some attempt to reverse this decline in profitability and liquidity.000 ( /2 of £674. · Both overall net profit and the net profit margin have declined each year over the threeyear period. 1 · In addition to the overdraft repayment of £337. Both are now significantly lower than when Jack Bennett was at the helm. the business may soon be in serious trouble. The business has not invested sufficiently in the additional resources required to sustain the growth that it 25 . the dividend payout ratio remained high and swallowed up the whole of the profit in 2005.000). · The effect has been a relatively small increase in overall gross profit and a significant decline in the gross profit margin. · Gearing levels remain low and the business has considerable debt capacity.000 in 2006. the business must repay a loan of £600.
Furthermore.80 (that is 22 x £0. The real question is whether Daniel Bennett. including ROSF. it is not clear from the case study whether the listed business mentioned is really similar to Homeland plc. The worrying trends that have emerged may be reversed. the amount to be raised is not very substantial (£800. if appropriate action is taken. 26 . it is not clear whether he has identified the correct sum that is required or the most appropriate form of finance. has experienced significant decline. the new shares appear to have good asset backing.126m. particularly if the freehold land has a higher market value than the figure shown in the financial statements · Using a P/E ratio of 22 times. the purpose for which the finance is being raised is questionable. the shares of listed businesses enjoy a significant premium over those of unlisted ones because of their marketability.wishes to achieve. therefore. Unless there are plans to address this problem. Priority should be given to helping to restore the viability of the business. (b) Key points · Vulturus Ltd would be investing in a business where profitability. The ability of the business to meet the challenges of the new competitive environment has been weakened rather than strengthened as a result of the ‘dash for growth’. However. Although he is correct in seeking additional resources. the shares of Homeland plc would be valued at £8. · At a figure of £8 a share. the business appears to offer little for an equity investor. Furthermore.40) at the end of 2005. · Homeland plc has 2m shares in issue and its total equity at the end of 2005 is £12. Even if the additional funds are forthcoming.000) and will only cover the annual dividend payment. It will not be enough to underwrite the ambitious growth plans of Daniel Bennett. Nevertheless. who does not seem to be aware of the problems. that the shares are ‘cheap’. which amounts to around £6 a share. the business is not in very serious difficulties at the end of 2005. There is no evidence from this comparison. will take such action.
· · Improve profit margins by raising prices. particularly if equity investors are unconvinced by the future direction of the business. Investigate other approaches to increasing the scale of operations (such as a merger or takeover). · Consider debt as an alternative to equity. 27 . even if this is at the expense of lost sales. including the following: · Reverse the trend in liquidity by restricting dividend payments and tightening credit and inventory policies.(c) Advice Various approaches to Homeland plc’s problems may be feasible.
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