ACCT11059 Accounting, Learning & Online Communication ASS#2

Kane Cleaver, 12063072, Brisbane

Assignment Two – Step Seven to Ten

Step 7:

Contribution Margins

Hill & Smith Holdings (H&S) is split into three sections, Road, Utilities and Galvanizing Services. For step 7 I am going to focus on products in just the Utilities section of Hill & Smith Holdings. Whilst this section offers the lowest underlying operating profit percentage of 7.7% (FY2018) for the company, I believe it was the easiest to identify products in to work out the Contribution Margin.

H&S manufacture and then proceed to sell the items, so the variable cost in this example is the total estimated cost for each item. Estimation have been made when picking items selling price, I made the guess that the variable cost for an item is around 80% except for Pipes which is 90%, which I will discuss below. The percentages on the bottom are rounded up percentage of what the Contribution Margin is to the Selling Price.

Item Plastic drainage pipes

Industrial flooring Security fencing

Selling Price $35 $20 $100

Variable Cost $33 $16 $75

Contribution Margin(Selling Price – Variable Cost)

$2 $4 $25

Percentage of Contribution (Rounded up)

6% 20% 25%

From the above graph we can see that the item that contributes the most is the security fencing, whilst the plastic draining is the least. Why would the firm not decide to just sell the fencing as it contributes the most? Reason is they are all different products; each item is used together where flooring can stop mess or make it easier to work on and fencing helps stop people getting in or going into the wrong areas of a job site.

When making a guess for the contribution margin of each of these products the reason I made Plastic draining pipes the smallest contribution is because it is the highest demand in the 2018 annual report. Which I assumed that because this product is the highest demand selling it cheap will move a lot of product thus increase the Contribution Margin due to the volume of this item being sold. Another reason for them to offer the pipe at a cheaper price could be of competition, whilst this is the fast-growing item in this particular sector, they want to gain the biggest market they can.

Constraints mention above one of the constraints H&S may face is competition for piping. Making the piping affordable and being able to produce more can help H&S sell this product. Another constraint that could change the above variable costing is the cost of steel and or

1 | P a g e

ACCT11059 Accounting, Learning & Online Communication ASS#2

plastic required to manufacture these items. As H&S does the manufacturing of the items as well the cost per unit could change depending on the price of the steel/plastic or whatever material is needed to produce these items. So the fencing could be making the best CM at the moment but if price of metals happened to go up this could change the CM from the product.

These constraints can be relevant when deciding how many pipes to produce, if a company is selling piping cheaper H&S may over produce piping which would cause excess inventory and if they were already making only 6% on these pipes they may have to sell at a completive rate and receive a loss for the item to move the inventory, With the pricing of material this is relevant to H&S as they will need to decide how much they are going to price their items for as the cost of manufacturing these products may change throughout the year and end up costing more to manufacture than they are selling for, or could change and end up contributing more to the business than originally intended.

Step 8:

Ratios

After filling out my ratios I believe I have gained a better understanding of where the money is going in the firm.

With the net profit margin, although 2016 was a bigger year from 2015-2018 we can see an upward trend of 4.1% which is good. Also, the same for return on assets. With 2016 being the exception the growth direction of the company I believe is good if they are able to maintain this they will continue to grow into the future.

Looking at the inventory and how many days it takes to sell off is interesting. We can see in 2015 it took 70 days to sell everything where in 2018 its taken 86. But if we look at the total value of inventory in 2015 it was 57m and in 2018 was 97m and its taken only 16 more days to move around 40m more in inventory which to me shows growth that the company is expanding and moving more products.

I didn’t quiet understand this ratio, when I originally did it, it was a negative number but Maria changed hers in the video apart from the last one, so I changed this so it was a positive number, I’m assuming that my company has more assets than liabilities so it’s a 2 to 1 ratio, but because my number was originally negative it could mean that it was a 2 to 1 ratio but had more liabilities than assets, which isn’t a good thing. But from my understanding I have the below:

With the current assets we can see the H&S currently hold double the amount of Assets over Liabilities, which has been similar each year from 2015-2018 which means they aren’t taking on ridiculous amounts of liabilities to grow the business. Which is good to know if you were

2 | P a g e

ACCT11059 Accounting, Learning & Online Communication ASS#2

to invest, you know they have the assets to cover the liabilities if anything was to go in the wrong direction.

With this I believe what is saying is that we have slightly more debt than equity. Which has been pretty consistent across the years apart from 2017 which is almost on par. Which is interesting as 2016 is actually the worst, but in most other ratios this year appears to be ahead of the rest, whilst making more profit and quicker to sell the inventory.

Regarding the Market ratios, we can see each year H&S has successfully grown its earnings per share from 0.38 to 0.70 per share on issue and at the same time the company has also been able to grow its dividend by 12, from 0.18 to 0.3 in the same time frame. In regard to the price earnings ratio, if we used the example a student gave Maria in the lecture, based on the 2018 figures it would take 1571 years to gain back your original investment purely from dividends. But we can see from 2015 the stock price was 753 and closed at 1104 in 2018 which is an increase of almost 70% which is great growth, but not so great dividends. We can see that the company has grown its share base by just over 600,000 within the 4 years also, which isn’t bad considering options and bonus for staff etc.

Restated Ratio

With the restated ratio we have divided by financial and operating. The return on operating assets when we take out financial is 3-6% lower when we compare it to the return on assets.

If no debts needed to be paid we can see that the profit margin every year with the financials is 1% better with our restated figures.

Economic Profit

When calculating economic profit, I used the below %

The reason I used these as in each annual report they have a pre-tax weighted aver cost of capital currently which is the percentage I used from each year.

3 | P a g e

ACCT11059 Accounting, Learning & Online Communication ASS#2

The below screenshot is of the 2018 annual report in the ROIC section in the second line I used the current % they had on brackets, I got this figure from each annual report and believe it to be more accurate than the 10% as this is the figure they were aiming for.

By looking at the figures from 2015 to 2018, the same as above apart from 2016 which appeared to be a good year the figure is growing. My understanding of why the business is continuing to grow is because of the acquisitions the company has been making over the past few years, just last year alone they completed 3 acquisitions. They are slowly acquiring more companies overseas and within the UK which in return is generating profit and increasing manufacturing abilities for H&S whilst not taking on too much debt or liabilities when acquiring these companies.

I believe that because my company is constantly growing whilst I have a good understanding I haven’t gone into depth as much as I would have to see why it would be losing money. I have found they all sectors are increase profit or up year on year by 20% in most cases which leads to the profit the company has been making, quickly looking over 2016 I can’t see anything that stands out to make it a great year apart from exchange differences so this may have something to do with acquiring a company overseas and having a better exchange rate that year bringing cash back to the UK. By breaking it into bits though I am able to see the bigger picture and that the company is sustaining growth each year which is what you want to see. Most of my figures not by huge amounts but are increasing each year.

Step 9

Developing Capital Investment Decision

Below I have listed two opportunities for H&S to invest in long term. Both will have a 10-year cash flow period. One option involves building a factory so they are able to produce more piping for the utility’s division, the other involves purchasing an established company that will be able to produce piping. The established company will cost more but is able to produce more piping hence more profit for H&S but building a factory will be cheaper and will be able to produce half the amount purchasing a company will be able to. Building a factory will cost money in the first few years but will be profit within 3, and the established factory will be able to produce a profit straight away.

Building Factory Established

4 | P a g e

ACCT11059 Accounting, Learning & Online Communication ASS#2

Company with Factory

Original Cost 50 250Estimated Life 10 10Residual Value 10 50Estimated Future Cash Flow31st of December 2018 -4 1031st of December 2019 -1 1031st of December 2020 10 1031st of December 2021 10 1531st of December 2022 12 1531st of December 2023 12 1531st of December 2024 12 2031st of December 2025 15 2531st of December 2026 15 2531st of December 2027 15 25

After putting the above table into excel and working out the NPV, IRR and Payback period we can see clearly that building a factory is the best option for H&S based on these numbers, if there were other factors like workers and how much business the established company brings with it or an extended time period because it could produce more these numbers may differ but as it stands for this example the best option is the factory. The payback period for the factor is just shy of 7 years which is better than not being able to pay off the company. The IRR is above the discount rate which is good and our net present value is a positive.

5 | P a g e