Write a memo to the managing director of the worst

Question

Question 1:

The following financial data (a,b,c)is forthree retail businesses, which are listed on the London Stock Exchange.

a) Tesco PLC

Tesco PLC
Annual Ratios
[GBP Millions]
	22-Feb-2014	23-Feb-2013	25-Feb-2012	26-Feb-2011	27-Feb-2010
Financial Strength
Current Ratio	0.61	0.66	0.64	0.65	0.71
Quick/Acid Test Ratio	0.42	0.43	0.43	0.45	0.51
Working Capital	-8,314.0	-6,520.0	-6,896.0	-6,123.0	-4,623.0
Long Term Debt/Equity	0.63	0.60	0.56	0.59	0.80
Total Debt/Equity	0.76	0.65	0.66	0.67	0.91
Long Term Debt/Total Capital	0.36	0.37	0.34	0.35	0.42
Total Debt/Total Capital	0.43	0.39	0.40	0.40	0.48
Interest Coverage	24.82	32.63	-	217.61	72.02
Payout Ratio	62.15%	77.40%	37.51%	42.00%	44.49%
Effective Tax Rate	15.36%	25.72%	21.64%	23.73%	26.45%
Total Capital	25,928.0	27,477.0	29,524.0	27,610.0	27,869.0
Efficiency
Asset Turnover	1.27	1.26	1.30	1.30	1.24
Inventory Turnover	16.27	16.14	17.31	18.78	19.38
Days In Inventory	22.43	22.61	21.08	19.43	18.84
Receivables Turnover	11.87	12.76	13.90	14.61	15.95
Days Receivables Outstanding	30.75	28.61	26.26	24.98	22.89
Revenue/Employee	124,513	125,097	122,993	123,795	120,548
Operating Income/Employee	5,154	4,700	8,047	8,021	7,323
EBITDA/Employee	8,177	7,766	10,855	10,929	10,254
Profitability
Gross Margin	6.31%	6.55%	8.44%	8.48%	8.10%
Operating Margin	4.14%	3.76%	6.54%	6.48%	6.07%
EBITDA Margin	6.57%	6.21%	8.83%	8.83%	8.51%
EBIT Margin	4.14%	3.76%	6.54%	6.48%	6.07%
Pretax Margin	3.55%	3.24%	6.32%	6.02%	5.58%
Net Profit Margin	3.01%	2.42%	4.94%	4.57%	4.09%
COGS/Revenue	93.69%	93.45%	91.56%	91.52%	91.90%
SG&A Expense/Revenue	2.61%	2.34%	2.52%	2.71%	2.68%
Management Effectiveness
Return on Assets	3.81%	3.03%	6.46%	5.96%	5.10%
Return on Equity	12.22%	8.90%	18.40%	17.74%	16.96%
Valuation
Free Cash Flow/Share	0.00	-0.02	0.09	0.09	0.22
Operating Cash Flow/Share	0.36	0.35	0.55	0.53	0.59
Current Market Multiples
Market Cap/Earnings (TTM)	17.55
Market Cap/Equity (MRQ)	1.12
Market Cap/Revenue (TTM)	0.24
Market Cap/EBIT (TTM)	6.02
Market Cap/EBITDA (TTM)	3.75
Enterprise Value/Earnings (TTM)	28.04
Enterprise Value/Equity (MRQ)	1.79
Enterprise Value/Revenue (TTM)	0.39
Enterprise Value/EBIT (TTM)	9.62
Enterprise Value/EBITDA (TTM)	5.99

b) Morrisons PLC

WM Morrison Supermarkets PLC
Annual Ratios
[GBP Millions]
	02-Feb-2014	03-Feb-2013	29-Jan-2012	30-Jan-2011	31-Jan-2010
Financial Strength
Current Ratio	0.50	0.58	0.57	0.55	0.51
Quick/Acid Test Ratio	0.16	0.20	0.21	0.21	0.19
Working Capital	-1,443.0	-992.0	-981.0	-948.0	-1,060.0
Long Term Debt/Equity	0.53	0.46	0.29	0.19	0.21
Total Debt/Equity	0.65	0.47	0.31	0.19	0.25
Long Term Debt/Total Capital	0.32	0.31	0.22	0.16	0.17
Total Debt/Total Capital	0.39	0.32	0.24	0.16	0.20
Payout Ratio	-127.08%	44.28%	40.10%	40.10%	35.96%
Effective Tax Rate	-	26.39%	27.14%	27.69%	30.30%
Total Capital	7,725.0	7,662.0	7,094.0	6,472.0	6,169.0
Efficiency
Asset Turnover	1.66	1.78	1.86	1.84	1.81
Inventory Turnover	20.34	21.96	23.54	25.24	26.79
Days In Inventory	17.95	16.62	15.50	14.46	13.62
Receivables Turnover	87.31	81.97	78.15	88.84	77.05
Days Receivables Outstanding	4.18	4.45	4.67	4.11	4.74
Revenue/Employee	337,953	322,481	308,961	282,722	276,646
Operating Income/Employee	-1,816	16,893	17,020	15,509	16,283
EBITDA/Employee	5,620	23,373	22,827	20,982	21,776
Profitability
Gross Margin	6.07%	6.66%	6.89%	6.97%	6.89%
Operating Margin	-0.54%	5.24%	5.51%	5.49%	5.89%
EBITDA Margin	1.66%	7.25%	7.39%	7.42%	7.87%
EBIT Margin	-0.54%	5.24%	5.51%	5.49%	5.89%
Pretax Margin	-1.00%	4.85%	5.36%	5.30%	5.57%
Net Profit Margin	-1.35%	3.57%	3.91%	3.84%	3.88%
COGS/Revenue	93.93%	93.34%	93.11%	93.03%	93.11%
SG&A Expense/Revenue	2.01%	1.85%	1.86%	1.96%	2.04%
Management Effectiveness
Return on Assets	-2.24%	6.35%	7.26%	7.06%	7.04%
Return on Equity	-4.80%	12.18%	12.76%	12.19%	12.63%
Valuation
Free Cash Flow/Share	-0.13	0.05	0.05	0.12	-0.06
Operating Cash Flow/Share	0.31	0.47	0.37	0.34	0.28
Current Market Multiples
Market Cap/Earnings (TTM)	-12.70
Market Cap/Equity (MRQ)	0.88
Market Cap/Revenue (TTM)	0.24
Market Cap/EBIT (TTM)	6.64
Market Cap/EBITDA (TTM)	4.09
Enterprise Value/Earnings (TTM)	-20.63
Enterprise Value/Equity (MRQ)	1.43
Enterprise Value/Revenue (TTM)	0.39
Enterprise Value/EBIT (TTM)	10.78
Enterprise Value/EBITDA (TTM)	6.64

c) Sainsbury PLC

J Sainsbury plc
Annual Ratios
[GBP Millions]
	15-Mar-2014	16-Mar-2013	17-Mar-2012	19-Mar-2011	20-Mar-2010
Financial Strength
Current Ratio	0.64	0.61	0.65	0.59	0.66
Quick/Acid Test Ratio	0.48	0.25	0.33	0.27	0.36
Working Capital	-2,403.0	-1,214.0	-1,104.0	-1,221.0	-940.0
Long Term Debt/Equity	0.37	0.45	0.46	0.43	0.47
Total Debt/Equity	0.46	0.48	0.48	0.44	0.49
Long Term Debt/Total Capital	0.26	0.30	0.31	0.30	0.32
Total Debt/Total Capital	0.32	0.32	0.33	0.31	0.33
Payout Ratio	45.83%	52.19%	50.36%	43.86%	44.22%
Effective Tax Rate	20.27%	22.02%	25.16%	22.61%	20.19%
Total Capital	8,787.0	8,619.0	8,488.0	7,837.0	7,396.0
Efficiency
Asset Turnover	1.64	1.86	1.88	1.90	1.91
Inventory Turnover	22.65	22.88	24.09	26.34	27.15
Days In Inventory	16.11	15.95	15.15	13.86	13.44
Receivables Turnover	25.04	85.67	78.64	93.17	129.22
Days Receivables Outstanding	14.58	4.26	4.64	3.92	2.82
Revenue/Employee	484,798	474,603	456,844	438,711	422,072
Operating Income/Employee	20,425	17,963	17,910	17,692	15,011
EBITDA/Employee	31,579	28,493	28,135	27,713	25,137
Profitability
Gross Margin	5.79%	5.48%	5.43%	5.50%	5.42%
Operating Margin	4.21%	3.78%	3.92%	4.03%	3.56%
EBITDA Margin	6.51%	6.00%	6.16%	6.32%	5.96%
EBIT Margin	4.21%	3.78%	3.92%	4.03%	3.56%
Pretax Margin	3.75%	3.31%	3.58%	3.92%	3.67%
Net Profit Margin	2.99%	2.58%	2.68%	3.03%	2.93%
COGS/Revenue	94.21%	94.52%	94.57%	94.50%	94.58%
SG&A Expense/Revenue	1.82%	1.98%	1.88%	1.98%	2.00%
Management Effectiveness
Return on Assets	4.90%	4.81%	5.04%	5.75%	5.60%
Return on Equity	12.09%	10.42%	10.73%	12.32%	12.52%
Valuation
Free Cash Flow/Share	0.01	-0.06	-0.10	-0.16	-0.02
Operating Cash Flow/Share	0.49	0.52	0.56	0.46	0.54
Current Market Multiples
Market Cap/Earnings (TTM)	185.15
Market Cap/Equity (MRQ)	0.83
Market Cap/Revenue (TTM)	0.19
Market Cap/EBIT (TTM)	5.26
Market Cap/EBITDA (TTM)	3.15
Enterprise Value/Earnings (TTM)	248.56
Enterprise Value/Equity (MRQ)	1.12
Enterprise Value/Revenue (TTM)	0.26
Enterprise Value/EBIT (TTM)	7.06
Enterprise Value/EBITDA (TTM)	4.23

You are required to:

(a) Select and justify at least 10 financial ratios and calculate 2 non-financial ratios to analyse the performance and financial position of the three companies. You are expected to use charts to compare performance of the three companies. You will need to look at the audited financial statement and carry out further research to explain the performance of the company over the five years.For clarity, you are expected to rank the companies based on the individual benchmarks and overall.

(b) Write a memo to the managing director of the worst performing company with recommendations of how the financial performance of the business can be improved.

(c) Outline the limitations of relying on financial ratios to interpret firm performance?

Question 2:

Sound Equipment Ltd was formed five years ago to manufacture parts for hi-fiequipment. Most of its customers were individuals wanting to assemble their ownsystems. Recently, however, the company has embarked on a policy of expansion andhas been approached by JBZ plc, a multinational manufacturer of consumer electronics.JBZ has offered Sound Equipment Ltd a contract to build an amplifier for its latestconsumer product. If accepted, the contract will increase Sound Equipment's turnoverby 20%.

JBZ's offer is a fixed price contract over three years, although it is possible for SoundEquipment to apply for subsequent contracts. The contract will involve SoundEquipment purchasing a specialist machine for £150 000. Although the machine has a 10-year life, it would be written off over the three years of the initial contract as it can only beused in the manufacture of the amplifier for JBZ.

The production director of Sound Equipment has already prepared a financial appraisal ofthe proposal. This is reproduced below. With a capital cost of £150 000 and total profits of£60 300, the production director has calculated the return on capital employed as 40.2%. Asthis is greater than Sound Equipment's cost of capital of 18%, theproduction director is recommending that the board accepts the contract.

                                         Year 1        Year 2        Year 3        Total

                                                    (£)              (£)              (£)

Turnover                         180 000      180 000      180 000      540 000

Materials                         60 000        60 000        60 000        180 000

Labour                             40 000        40 000        40 000        120 000

Depreciation                    50 000        50 000        50 000        150 000

Pre-tax profit                   30 000        30 000        30 000        90 000

Corporation tax at 33%      9 900         9 900          9 900          29 700

After-tax profit                20 100        20 100        20 100        60 300

You are employed as the assistant accountant to Sound Equipment Ltd and report toJohn Green, the financial director, who asks you to carry out a full financial appraisal of theproposed contract. He feels that the production director's presentation isinappropriate. He provides you with the following additional information:

i) Sound Equipment pays corporation tax at the rate of 33%;

ii) Themachine will qualify for a 25% writing-down allowance on the reducing balance;

iii) Themachine will have no further use other than in manufacturing the amplifier forJBZ;

iv) Onending the contract with JBZ, any outstanding capital allowances can be claimedas a balancing allowance;

v) The company's cost of capital is 18%;

vi) The cost of materials and labour is forecast to increase by 5% per annum for years 2and 3.

John Green reminds you that Sound Equipment operates a just-in-time stock policy and thatproduction will be delivered immediately to JBZ, who will, under the terms of the contract,immediately pay for the deliveries. He also reminds you that suppliers are paid immediatelyon receipt of goods and that employees are also paid immediately.

Notes:

For the purpose of this task, you may assume the following:

(a) the machine would be purchased at the beginning of the accounting year;

(b) there is a one-year delay in paying corporation tax;

(c) all cash flows other than the purchase of the machine occur at the end of each year;

(d) Sound Equipment has no other assets on which to claim capital allowances.

REQUIRED:

Write a report with recommendations to the financial director. Your report should include:

a) Use the net present value technique to identify whether or not the initial three-year contract is worthwhile.

b) Explain your approach to taxation in your appraisal.

c) Discuss two other investment appraisal methods that could be used to evaluate this project.

d) What others factorswould need to be considered before making a final decision.