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Using Accounting for Decision Making

Assignment 3:

Ratio Analysis and Capital Budgeting

Belinda Donaldson – S0281394

ACCT11059

Belinda DonaldsonS0281394

A small note to markers.

Since beginning this course my company British Polythene Industries has been bought by another company and they have abolished the original website which contained investors information. The information provided on the new website is very limited and therefore I am unable to refer to their website for any insight. I find that I am heavily relying on the information provided in their annual reports. I am unable to provide links directly to their annual reports and have instead copied the

information directly from the reports.

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Step 1:

Blogging It

My Blog

Below are my blogs from this Assignment.

Ratios

https://beldonald.wordpress.com/2017/01/23/i-got-it-i-got-it-i-dont-got-it/

I have completed my ratio’s with the guide of Maria on the lecture, I am planning to do a re-check against her figures on her spreadsheet but for now I am ready to blog.

Please see my ratios on my spreadsheet below:

belinda-donaldson_company-spreadsheet_s

Ratios of Interest for Me

Financial Structure Ratios Market Ratios Net Borrowing Cost Profit Margin

The biggest contributor to the good and the bad of the ratios all seems to come back to a poorly manager Defined Benefit Pension Scheme.

If I was going to invest in a company it would not be BPI if I held a share based on the dividend payouts (16 pence at a max) it would take me over a thousand years to even break even! Not a good investment.

The biggest challenge that I found with BPI ratios is that the company has now been sold to RPC Group who proceeded to shut down the website that I originally obtained all my annual reports. There are also websites which have now listed the company as defunct and no longer provide information on the company.

Weighted Average Cost of Capital I adopted the 10%. I was able to find reference to the weighted cost of capital with RPC Group but they did not clarify as to the actual figure which was no help at all.

I am still struggling through the drivers on the economic profit. I am having to watch this portion of Maria’s lectures again.

If anyone has any commonality with my company please drop me a post. It would be interesting to see what insights people have achieved from their figures that are common to BPI.

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Economic Profit

https://beldonald.wordpress.com/2017/01/27/drivers-which-am-i/

I have now had a chance to work on identifying my drivers of economic profit. The trend line for BPI's ROE is closest matching to that of the Economic profit. With that I also identified the the Debt/Equity opposite results for the trend lines being that when the company is making a loss the Debt/Equity Ratio is at it's highest. The level of debt and the lack of Equity for BPI appear to be a severe driver of the Economic Profit.

The RNOA and NOA also contribute to the Economic Profit in the same way. Also following the same trend lines as that of the Economic Profit. Both are at their lowest in 2014 when BPI showed a loss and at their highest in 2015 when BPI made it's highest profit of the 4 years.

The Profit Margin appears to have had the least effect on the Economic Profit. Though following the same trend, highest in 2015 and lowest in 2014 the difference from year to year is more stable than the other drivers.

The restated ATO also provides an exact opposite trend to that of the Economic Profit. Does this mean that BPI are overworking their assets?

Discussions with other Students

Here I have included my discussions with other students on the results from my firm.

Boden


I can tell Ausenco and BPI’s figures for the ratios are going to be vastly different straight away, but I thought I would still make a comparison on the trends.

NPM: Nothing to see here; BPI’s NPM rose steadily and Ausenco’s slumped to negatives over the years. It was interesting to find that both companies’ NPM grew by about 0.7% in 2014.

ROA: BPI headed north slowly while Ausenco went south, except in 2014 where it recovered a little temporarily.

Days of inventory do not apply to Ausenco so I have left it out.

Total Asset Turnover: Both companies, while at different levels of total asset turnover, experienced a slide in the ratio. It is interesting that BPI should become more profitable in the NPM and ROA while becoming less efficient. Perhaps this is what Maria was mentioning when a company has too high of a turnover… do you think this is the case?

Current Ratio: 2013 and 2014 brought about ratios which were only 0.09 and 0.02 apart, so levels of current assets to current liabilities were similar in these years. The trend between 2012 and 2014 is

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https://beldonald.wordpress.com/2017/01/27/drivers-which-am-i/


similar between companies as they both experience a diminish in 2013 and return to favourable levels in 2014; although BPI ended off in a better position.

Debt/Equity and Equity Ratio: Such high levels of debt! Ausenco only had at most 79% of debt to equity so both the levels and the trends don’t match in any manner. Looking further below, BPI also has much higher net borrowing costs than Ausenco!

EPS and DPS: In line with the increasing profitability BPI’s EPS and DPS rose slowly. Ausenco, also behaved in line with the profitability and plummeted downwards.

Price earnings: I actually do not think that this is correct. The markets would simply not be willing to trade the shares at this price for these low levels of profitability. It makes it difficult to locate the exact problem here since the annual reports are no longer available (maybe upload them to your blog if you can), but I think the problem lies in the market price per share. I looked at the website you listed in the notes, because it seems like you have listed the number of ordinary shares as ‘000, you would need to list the market price per share as 6.925, 6.8, and 3.975. Please indicate in your assessment whether certain numbers are in hundreds or millions so the marker can see you intentions. Let me know what you think.

ROE: BPI’s ROE is all over the place… I cannot see a similarity here.

RNOA: The RNOA is very much more adverse than the ROA, unlike Ausenco’s which followed a similar trend to the ROA and was not too much larger. Yours actually would be useful for decision-making while mine is not (at least, it doesn’t contribute anything new).

NBC: Ausenco seemed to hit a low point in 2015 with the NBC while BPI encountered this in 2013 and faced an increase in the year after. This is odd as the cost of borrowing around the world appears to be becoming less expensive.

PM: Ausenco’s PM is so similar to the NPM it was hardly worth the calculation. However, it seems that BPI’s holds very little in common with the NPM in terms of scale of affect; the trend would be similar but with higher peaks and troughs.

ATO: BPI seems to have a lot of changes in the restated ratios which makes them more important than Ausenco’s. BPI’s ATO doesn’t follow the same behaviour as the Total Asset Turnover. Ausenco’s values are larger than the Total Asset Turnover however the shape of the graph is the same.

I’ll leave my thoughts on the economic profit for your complete analysis.

My response

I find the ATO interesting as the restated ATO shows a far better efficiency that that of the original ATO. Were they overworking their assets or weren’t they? It’s an interesting item try and establish the drivers.

Thanks for responding even though our companies similarities are small. It’s great to get another persons perspective on the ratios.Unfortunately the low earnings per share and the dividend per share that I have calculated is very

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close to what was given in the annual reports. For 2013 the annual report showed that BPI had an earnings per share of 43.23p the dividends were 14.5p. You are correct I will need to explain this in my assignment.

The PM I feel better reflects the actual standpoint of the company whereas the NPM shows a positive in 2014 this was not the case overall. The negative in the PM better reflects the standpoint.

Have you posted your ratios as yet?

My Note to Suz

https://suzdrovandi.wordpress.com/2017/01/21/a-work-in-progress/comment-page-1/#comment-

24

I had a quick look at your spreadsheet and it’s similarities to mine. Your company has a poor equity ratio and debt/equity ratio as well. I found this to be the item that jumped out at me the most for my company. In 2014 the equity ratio dropped to 15.5% with a Debt/Equity Ratio at 543.7%. Were you able to find reasons behind the ratios? BPI’s poor ratios all seem to be linked to a poorly managed Defined Benefit Pension Scheme. The debt hitting 99.1million pounds at the end of 2014.

Suz Response

What I’ve managed to find is that Daimler has quite large overdrafts (i.e. loan type accounts – are you familiar with them?? ) and from what I can gather haven’t exercised their rights to use these as such but do not want to relinquish them at the same time. Hence they go on their balance sheet as a liability… I know at work nearly all clients (mostly farmers) have an overdraft account with quite a large borrowing capacity (just in case – you know – for the ‘rainy day’ scenario) but are a long way from reaching their limit.

Belinda Husdon


I just had a look through your ratios. It seems I have more differences then similarities though. While your EPS and dividends is very similar to mine (my dividends are slightly higher payout though). It is your market price that is a major difference! I noticed that it costs about 700 pounds each! No wonder it would not be wise to invest in your company. My market price shares are only about 9 pounds each so it only takes about 9 years at the moment to get that back. However, my company is expected to continue to grow with expected increases in dividends and earnings per share.

I also noticed that your debt/equity ratio is very large. Mine was fairly consistent over the four years however, has increased in the last year as my company is borrowing more.

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https://suzdrovandi.wordpress.com/2017/01/21/a-work-in-progress/comment-page-1/#comment-24

https://suzdrovandi.wordpress.com/2017/01/21/a-work-in-progress/comment-page-1/#comment-24


I noticed that your days of inventory seems quite lower compared to mine. Mine is currently at 674 days for 2015. However, I believe this would only be able to be compared to similar companies. As mine is construction company and yours a plastics company.

Sorry I don’t have much similarities to discuss but it is interesting to see the vast differences in companies ratios.

My response

I think I will struggle to find anyone with the same debt/equity ratio as BPI. Only relying on 15.5% of equity seems a phenomenally low amount of equity to rely on for a well established company. It’s no wonder they were bought out in 2016. It’s interesting to see the vast differences between companies. BPI actually produces construction materials. Your company may have purchased from mine! I had to obtain my share prices from third party website but once I calculated the EPS and DPS is closely matched what was in the annual reports. I did doubt myself when searching for the share prices though.

My economic profit seemed to be more inline with the actual standpoint of BPI rather than the Net Profit Margin which did not show the loss that was made in 2014.

I noticed that your asset turnover for your company is less than 1 though they are increasing their efficiency. Is this something to do with the fact that they are a construction company and days of inventory is quite high?

Profit and Ratios

Introduction

This step is the most interesting to me and the step I wish most to understand. To understand the figures that I am producing for more than just their face value. My discussions below are not in the order that we visited in the lectures but in the order of which jumped out at me first. As part of my investigations into each ratio I have also included a short of my understanding of the ratio, what, based on my understanding, would be considered a good ratio or a bad ratio and also my assessment of British Polythene Industries (BPI) ratios as per my spreadsheet.

Financial Structure Ratios

Debt/Equity Ratio

Debt/Equity Ratio = Total Liabilities/Total Equity

2015 2014 2013 2012232.2% 543.7% 266.0% 297.6%

Table 1: Debt/Equity Ratio from calculations in spreadsheet

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The debt/equity ratio is the amount per dollar (or in BPI's case pound) of owners equity compared to how much debt the company currently has. The calculation shows the percentage of liabilities of the owners equity. If the calculation results are shown as a decimal it shows how many times more the liabilities are more than the equity. A good debt equity ratio would be anything less than 100% and would mean that the company is holding less long-term debt than owner's equity. A 200% figure would reveal that the company is 2 to 1 funded my external sources.

In the instance of BPI the company is severely afflicted by debt. From Table 1 we can see the debt is so large that it hits over £200 for every pound the owners are contributing in all 4 years. In 2014 it hits £500 for every pound the owners’ equity covers. £500! This requires further investigation. From looking at the figures I can see that Retirement and Employee Benefit Obligations peaked in 2014 at £99.1million pounds. From the note I can see that this refers to the defined benefit pension scheme. There has been a fall in the yields of corporate bonds so therefore the company is not making as much from the corporate bonds that they expected in fact they are losing more and more money on those bonds.

Figure 1: Table from BPI Annual Report Defined Benefit Pension Scheme Increase

In the Financial Review within the annual report BPI proposed to change operations in 2015 to reduce the debt 'As part of this agreement, to increase the security of pensions for Scheme members, the Company has agreed a one off payment of £11 million to the Scheme in June 2015 and this will further reduce the deficit.' In 2015 we can see that BPI have made an attempt to reduce the deficit. I'm not sure how successful they were in 2016 the company was purchased by RPC Group. They also changed the rate of inflation for pension payments which is predicted to reduce inflation on the deficit.

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Equity Ratio

Equity Ratio = Total equity/total assets

2015 2014 2013 201230.1% 15.5% 27.3% 25.2%

Table 2: Equity Ratio from calculations in spreadsheet

The equity ratio is the percentage of the company that is funded by equity. This figure shows how self sufficient the company is. The higher the percentage the more self-sufficient the company is. The lower the percentage the more reliant the company is on external sources.

BPI's figures show that their equity portion was quite low. For a company established in 1910 this is not a good place to be. In 2015 BPI's retained earnings increased. There is no explanation within the annual report as to why the significant increase in retained earnings. It may be simply to start recovering from the loss in 2014 that the company suffered.

Market Ratios

As part of calculating the market ratios I had to source the price per share at close of the year. BPI's annual reports finished at 31 December. Unfortunately as BPI was bought out by RPC Group their investor relations section of their website was removed. I was able to source the number of orinary shares from the Note 8 in each of the annual reports. The annual reports did not provide details of the current market share price. The annual report referred to the London Stock Exchange which BPI was no longer on the system as they were no longer trading. I used google search to find historical data which I found at London South East, 2017. Please see table 3 and figures 2-5.

2015 2014 2013 2012Number of Ordinary Shares 27.422 27.639 27.756 27.742

Market Price Per Share £692.50 £680.00 £680.00 £397.50

Earnings per Share (EPS) £0.64 £0.59 £0.47 £0.43

Dividends per Share (DPS) £0.16 £0.14 £0.13 £0.12

Price Earnings Ratio 1,085.13 1,146.01 1,451.85 934.53Table 3: Figures and calculations for market ratios

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http://www.lse.co.uk/ShareChart.asp?sharechart=BPI&share=


Figure 2: 2015 market price per share as provided by London South East


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Earnings Per Share

Earnings per Share (EPS) = Net profit after tax/no’s of issued ordinary shares

This item is pretty self explanatory as it calculates how much is being earned by each share the company has. The lower the figure it is the worse it is. BPI have a pretty poor earnings per share (refer Table 3), at a maximum each share is earning 66pence. I believe that this is linked to the low equity the company holds to the high level of liabilities the company holds. There are many references to the earnings per share throughout the annual reports but no explanation is readily available as to the poor state of the shares. Please see Table 3 for details of BPI.

Dividends Per Share

Dividends Per Share = Ordinary dividends/(Weighted Average) number of ordinary shared issued

The dividends per share is what the company actually pays out to its shareholders. This is not a set amount, it is dependent on the dividend policies set-out by the company. A higher return is not always a good thing it is really dependant on the details within the report. If a company borrows money so that it can pay dividends this is a sure sign that something is up. Please see Table 3 for details of BPI.

I found this excerpt from BPI’s 2012 annual report quite interesting considering they paid out only 12p per share.

“Dividend cover is important to many of our shareholders as a measure of our ability to maintain the payment of a dividend.”

If I was a shareholder of this company I would not be overly impressed with a maximum return on shares of 4 years being 16 pence. Which leads us into the next heading.

Price Earnings Per Ratio

Price-Earnings Ratio = Market price per ordinary share/Earning per ordinary share

From Maria’s lecture it is basically how many years you would need to hold the shares to break even with the price they were bought for. Anything beyond this would be a profit. Now if you had shares with BPI based on their earnings per share it would take you an average of 1,155 years before you would start making a profit. I think it is pretty obvious that anyone with shares in BPI is currently kicking themselves. Please see Table 3 for details of BPI.

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Liquidity

Current Ratio

Current Ratio = Current Assets/Current Liabilities

2015 2014 2013 20121.66 1.49 1.30 1.36

Table 4: Current Ratio from spreadsheet calculations

The current ratio is the how many times that the current liabilities could be paid off if all the current assets were converted to cash. Anything higher than 1 to 1 would show good liquidity for the company.

BPI's current ratio increased over the years as per Table 4. Looking into their financials I can see that their bank overdraft was abolished over the 4 years which is a good thing and that a short term loan that they had was paid within the 12 months. One thing of note with the inventories that I found interesting was that Inventories had increased in 2015. Though I am not sure that this is a positive. As you will see from my discussion of days of inventory turnover jumped in 2015. Although Inventories is an asset, you have to be able to sell it to create cash. I think that this figure can be a little misleading and would require being read with the other ratios to gain a clearer picture.

Efficiency

Days of Inventory

Days Inventory = Average(Inventory)/(Average) daily COS (total costs of sales/365)

2015 2014 2013 201274.98 65.84 65.51 65.18

Table 5: Current Ratio from spreadsheet calculations

Days in inventory is the number of days that from the moment the item is made to when it is sold. For this equation we take an average of all inventories and then calculate an average. This is another equation that I think can go either way depending on the industry you are trading in. For instance car sales would have a longer turnover than a bottle of soft drink. These can be benchmarked against the industry.

The biggest challenge I see with BPI inventory turnover is that they have a wide range of products, some with low days of inventory (garbage bags) and some with a high days of inventory (greenhouse film). A particular item in the 2012 annual report caught my eye which explains that some items are produced in winter for sale in spring please see Figure 6.

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Figure 6: 2012 commentary from BPI annual report on inventory

Their management policy was obviously working, I think in an effort to boost earnings BPI increased production though it did not have the desired effect.

Total Asset Turnover Ratio

Asset Turnover = Sales/(Average) Total Assets

2015 2014 2013 20121.88 1.99 2.03 2.08

Table 6: Total Asset Turnover Ratio from spreadsheet

The total asset turnover caculates how efficiently the company is using it's assets. The return on assets calculates how many dollars of sales is made from each dollar of assets. A lower figure indicates that the assets are worth more than the sales being made. 2 to 1 seems to be a good figure. Anything higher could indicate that assets are overworked and may not be sustainable.

BPI's figures seem to be reasonable and though reducing over the years, the figures are still at a good level. The tightening of the sale dollar per dollar of asset seems to be linked to the turnover's of the business.

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Profitability Ratios

Net Profit Margin

Net Profit Margin = Profit after income tax (NPAT)/Sales

2015 2014 2013 20123.7% 3.3% 2.6% 2.5%

Table 7: Net profit margin from spreadsheet

The net profit magin is the percentage of sales that is being made into profit. The higher the net profit percentage the more that the company is turning into profit.

For BPI they having a steadily increases profit margin. It is a shame that their other comprehensive income for 2014 turns it into a loss for the year which I will discuss later with the profit margin from restated figures. BPI were slowly scraping a higher net profit margin up to the sale of the company to RPC group in 2016. From figures 7-9 we can see that BPI have worked at reducing their costs rather than increasing turnover. The decrease is costs is a combination of cost of goods sold, distribution costs and selling and administration costs. Though the reduction is small it is contributing to the increase in the Net Profit Margin.

Figure 7: 2013 Turnover and Profit from Operations Note 2

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I compared the Net Profit Margin with the company that purchased them 2016 RPC Group (a major competitor and also the purchaser of BPI in 2016). We can see that from Table 7 there is not a great difference with the net profit margin. It appears that BPI was on par with its competitors. Please see Figure 10 (Trading Economics, 2017) for the net profit margin ratio's utilised.

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Figure 10: RPC Group Quarterly Net Profit Margin Ratio

Return on Assets

Return on Assets = NPAT/(Average) total assets

2015 2014 2013 20127.0% 6.5% 5.2% 5.1%

Table 8: Return on assets from spreadsheet

The return on assets is the profitability of the assets. Like with the asset turnover a higher percentage though good may not be sustainable if too high. An overworked asset may break down causing longer term issues.

BPI's return on assets steadily increased over time. As with the above I believe that the increase is more in relation to the reduction in costs rather than the utilisation of the assets.

This tells us the profitability of the assets in the business. The average is this year's assets plus last year's assets. The return from assets.

Ratios Based on Reformulated Financial Statements

Return on Equity

Return on Equity (ROE) = Comprehensive income/(average) ordinary equity

2015 2014 2013 201254.99% -58.10% 22.58% 12.26%

Table 9: Return on Equity from Spreadsheet

The Return on Equity is the profit made on each dollar of equity that the company. It shows shareholders how well their investment in the company is being utilised.

With BPI we can see that there was a loss in 2014 so for the me it looks as though the company lost half the money that the shareholders invested in the company. Though they did recover in excess of that amount in 2015.

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Before the other comprehensive income is entered into the calculations the company is still making a profit. The 2014 loss seems to be linked to the Defined Retirement Benefit Scheme and the increase in 2015 seems to be mainly due to the restructuring of that same scheme.

Return on Net Operating Assets

Return on NOA (RNOA) = OI (after tax)/NOA

2015 2014 2013 201241.7% -30.23% 18.76% 13.58%

Table 11: Return on Equity from Spreadsheet

The difference between the RNOA and ROA is that the RNOA takes into account the effect that our operating liabilities impact on the assets. We use a Net Assets figure rather than a Total Assets figure. The RNOA for BPI suffers the same fate of that of the ROE. This Defined Retirement Benefit Scheme (which is considered an operating liability) is a money drainer. I will discuss this as a driver in my discussions on economic profit.

Net Borrowing Cost

Net borrowing cost = Net finance costs after tax/Net financial obligations

2015 2014 2013 201211.54% 12.97% 10.43% 16.73%

Table 12: Net borrowing cost ratios from spreadsheet

The net borrowing cost is the determined is the cost percentage per year for borrowing liabilities. Effectively the interest rate that the company has been stung for the year. Other Loans and Borrowings are the item linked with the elevation and reduction in this percentage. The annual report does not list what these loans are for, I am unable to establish the cause behind inconsistent percentages. Though I personally would not be happy with this interest rate, on my home loan over the last 4 years we reached a maximum 5.5%.

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Profit Margin

Profit Margin = OI/Sales

2015 2014 2013 20129.63% -3.88% 3.68% 2.33%

Table 13: Profit margin from spreadsheet

The restated profit margin I believe shows a clearer picture as to what is actually happening within the business. We can see that the loss for the year is shown in the restated figures whereas with the Net profit margin still shows a profit.

To calculate the restated profit margin we added in a few items from the other comprehensive income section with relation to the Defined Benefit Pension Scheme. With the restructuring of the defined benefit scheme the scheme provided a great gain for 2015 unlike the loss from 2014. The effect of this scheme becomes more prominent for the restated Profit Margin.

Asset Turnover

Asset Turnover = Sales/NOA

2015 2014 2013 20124.33 7.8 5.1 5.83

Table 14: Asset Turnover figures from spreadsheet

The restated ATO is much higher than the original ATO. This appears to be linked to the removal of the other loans and borrowing costs from the calculations this makes the severe cost of the retirement benefit obligations more prominent. Revealing the assets are having to work a lot harder to cover these costs.

Economic Profit

Understanding

Economic profit includes the opportunity cost of what else we could have been doing with our money. Economic Profit is calculated by dividing the (Return of Net Operating Assets less Opportunity Costs (WACC)) by the sales. The opportunity cost is the “What if” which is what has been lost by choosing this particular method of utilising what equity we have.

I adopted the 10% WACC as instructed by the assignment if we were unable to locate an actual figure. BPI did not identify a Weighted Cost of Capital. I also checked the RPC Group annual reports and they did not identify a WACC either.

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Drivers

2015 2014 2013 2012

-£30.00 -£20.00 -£10.00

£- £10.00 £20.00 £30.00 £40.00

Economic profit

Economic profit

Main Drivers

2015 2014 2013 2012

-80.00%-60.00%-40.00%-20.00%

0.00%20.00%40.00%60.00%80.00%

Identifying Drivers

Return on Equity (ROE) Return on Net Operating Assets (RNOA)Profit Margin (PM)

%

2015 2014 2013 20120

20

40

60

80

100

120

Net Operating Assets (NOA)

Net Operating Assets (NOA)

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The above graph shows three of the main drivers of economic profit. We can see that the basic trends are the same though the severity of the trends is apparent. The ROE appears to be the largest driver of the economic profit whilst the profit margin effects the economic profit the least. Whilst the RNOA and the NOA are also identified as drivers of the economic profit also following the same trend as economic profit. With all four we can see the loss in 2014 reflected in the trends and the spike into 2015.

Restated ATO

2015 2014 2013 20120.001.002.003.004.005.006.007.008.009.00

Asset Turnover (ATO)

Asset Turnover (ATO)

BPI are using our assets more efficiently than the original ATO. This is not being reflected in economic profit as it is showing that the year that BPI were most efficient with their assets is the year that they made the biggest lost. We can see from the graph this provides an opposite graph to that of the Economic profit. As per Maria’s lecture this is caused by creating a larger base to spread profit over. It is possible that in 2014 BPI overworked their assets in an attempt to recoup some costs.

Debt/Equity Ratio

2015 2014 2013 20120.00%

100.00%200.00%300.00%400.00%500.00%600.00%

Debt/Equity Ratio

Debt/Equity Ratio

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The debt/equity ratio for the company is significantly high. This is reflected in the economic profit. We can see that the year that the company made a loss the Debt/Equity Ratio was at its highest and also mirrored in that at the lowest point of Debt/Equity Ratio the profits were at their highest.

InsightsWhen I started this subject I was not completely sold on the idea of blogging. My understanding of blogging was that you had to be interesting to other people. I barely interest myself some days let alone others.

In completing Step 1 of this assignment I can see how it benefits the learning experience. Discussions with other students were of real interest for me. Reading other peoples work gave me 'uh huh' and 'ahhh yes' moments as fellow students see the learning material from different perspectives sometimes relating it to my own perspective. Having other students question the figures I had calculated gave me the drive to find answers for them.

My favourite part of this course has been using excel as a medium for learning about accounting. Restating the financial statements and then producing the ratios really provided me with a full picture on BPI. Excel is one of my favourite programs to work with.

It was only when the ratios were completed I could understand where the main issues were. Breaking down the original financial statements into operating and financing provided a different set of figures to calculate with. The split created a way to pinpoint the drivers behind the companies loss in 2014. I had a well-established company and was under the illusion that being a well established company meant that their practices were at their premium, only to find when I calculated the Debt/Equity Ratio, Equity Ratio and Market Ratios that the company was in trouble.

Step 2:

Scenario

British Polythene Industries is interested in expanding its operations into the Australian market. They are looking to purchase an existing factory in Sydney and/or a factory in Perth. As the is the initial break into the Australian market hopes are that in 10 years they will be able to move operations to bigger factories as production increases, selling the old factories vacant to other manufacturers. The investment would be made at 1 January 2018.

Cash flows would comprise of bulk sales to wholesalers less wages, raw material, production costs and other operational costs. These estimated future cash flows are expected to be received on 31 December each year.

For this exercise BPI will adopt a required payback period of 7 years, a minimum NPV of £10.0 million and a IRR of a minimum of equal to the WACC of 10%.

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The original cost, the estimated life, residual value and estimate future cash flows of each investment opportunity are set out in the table below. All amounts are expressed in British Pound GBP. Assuming a rate of return/WACC of 10%.

Estimated Cost and Future Cash Flows

Perth Factory Sydney FactoryOriginal Cost £50.0 million £75.0 million

Estimated Useful Life 10 years 10 yearsResidual Value £2.0 million £3.0 million

Estimated Future Cash Flows31 December 2018 (time period = 1 year) -£3.5 million -£5 million31 December 2019 (time period = 2) £5.0 million £5.0 million31 December 2020 (time period = 3) £10.0 million £10.0 million31 December 2021 (time period = 4) £15.0 million £15.0 million31 December 2022 (time period = 5) £15.0 million £15.0 million31 December 2023 (time period = 6) £20.0 million £20.0 million31 December 2024 (time period = 7) £25.0 million £20.0 million31 December 2025 (time period = 8) £30.0 million £25.0 million31 December 2026 (time period = 9) £30.0 million £20.0 million31 December 2027 (time period = 10 years) £15.0 million £15.0 million

Recommendation

Please see my spreadsheet calculations details.

Results

Option 1: Perth

NPV : £32.85

IRR: : 19%

Payback Period : 6.4 Years

Option 2: Sydney

NPV : £2.48

IRR : 11%

Payback Period : 7.6 Years

My recommendation for BPI would be to proceed with the Perth installation. The results show that, given the prediction for future cash flows, investing in a factory in Perth would provide a suitable investment for the 10 year period. Whilst the Sydney installation only achieves the IRR only slightly higher than the cost of capital whilst the NPV and Payback Period are outside of the requirements set-out. It is possible that with expansion into Perth that once BPI cement their stand-point in the Australian market they may be able to achieve a reputation that will assist in increasing predicted future cash flows for a Sydney venture. It would be my recommendation to revisit the Sydney venture at the end of the 10 years in Perth.

23Assignment 3


Step 3

Feedback Received

24Assignment 3


Feedback Given

References

London South East, n.d., British Polythene Industries PLC Share Charts, viewed 18 January, 2017,


Trading Economics, January 2017, RPC Group Net Profit Margin, viewed 20 December, 2017,

http://www.tradingeconomics.com/rpc:ln:net-profit-margin

25Assignment 3

http://www.tradingeconomics.com/rpc:ln:net-profit-margin


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