valuation assignment · web viewacct11059 – using accounting for decision making. assignment 3....

ACCT11059 – Using Accounting for Decision Making

By Tracey Thompson (nee Mahony)Student No: S0181988Due Date: Monday 13th February 2017Course Coordinator: John McGrath

Assignment 3Ratio Analysis & Capital Budgeting

ACCT11059 Assignment 3 – Ratio Analysis & Capital Budgeting Tracey Thompson s0181988

Table of Contents

STEP ONE: RATIO ANALYSIS AND CALCULATIONS 3

PROFITABILITY RATIOS 3NET PROFIT MARGIN 3RETURN ON ASSETS 3EFFICIENCY (OR ASSET MANAGEMENT) RATIOS 4DAYS OF INVENTORY 4TOTAL ASSET TURNOVER RATIO 4LIQUIDITY RATIOS 5CURRENT RATIO 5FINANCIAL STRUCTURE RATIOS 6DEBT/EQUITY RATIO 6EQUITY RATIO 6MARKET RATIOS 7EARNINGS PER SHARE (EPS) 7DIVIDENDS PER SHARE (DPS) 7PRICE EARNINGS RATIO 7RATIOS BASED ON REFORMULATED FINANCIAL STATEMENTS 8RETURN ON EQUITY (ROE) 8RETURN ON NET OPERATING ASSETS (RNOA) 8NET BORROWING COST (NBC) 9PROFIT MARGIN (PM) 9ASSET TURNOVER (ATO) 9ECONOMIC PROFIT 10DISCUSSION WITH OTHER STUDENTS REGARDING RATIOS 12

STEP TWO: DEVELOP A CAPITAL INVESTMENT DECISION FOR THE NEW WAVE GROUP 13

STEP THREE – PROVIDING FEEDBACK TO OTHER STUDENTS 15


Step One: Ratio Analysis and CalculationsProfitability Ratios

Net Profit Margin 2015 2014 2013 2012Profitability Ratios

Net Profit Margin

Net profit after tax/sales

2.9% 4.1% 4.6% 0.1%

The net profit margin ratio (presented as a percentage) indicates the profit being made on sales. That is, how much profit is generated per each dollar of sales. So for 2015, the New Wave Group saw 2.9 cents of net profit made per $1 of sales which I initially thought was quite low. However I later learnt that between 0% - 10% is considered ‘average’, so this is within normal range. Looking at the trend over the years, the company saw an increase in net profits in 2013 compared to 2012, however this margin decreased in both 2014 and 2015. I investigated further into the 2015 Annual Report to see if I could find a reasoning for this decrease, and the company has stated it is due to changes in the mix of products, customers and regions. All three of these factors could have contributed in the drop of sales which in turn reduced the net profit margin.

Return on Assets 2015 2014 2013 2012Profitability Ratios

Return on Assets

Net profit after tax/total assets

2.7% 3.4% 4.4% 0.1%

The return on assets ratio indicates how efficient a firm has been in order to produce a profit from their assets. This ratio had the same trend as the net profit margin above, with the company seeing an increase in the return on assets in 2013 compared to 2012, however this margin decreased in both 2014 and 2015. This may indicate that the change in the mix of products that the company implemented isn’t performing as favourably as previous years hence the decrease in the return on assets. I think a 2.7% return on assets for 2015 could be considered low to average for a company. I have made this assumption by comparing other investment options on the current market at the moment, For example, there are 12 month term deposits being offered with a 3% return on your cash (asset).


Efficiency (or Asset Management) Ratios

Days of Inventory 2015 2014 2013 2012Efficiency (or Asset Management) Ratios

Days of Inventory

Inventory/av.daily cost of goods sold

327.74 340.01 242.96 248.60

The days of inventory ratio indicates the average amount of days it takes from when the company buys the inventory, to when it is sold. The lower the figure for the days of inventory ratio would indicate the firm is performing well with sales and turnover of inventory. The above figures for the New Wave Group do seem alarming, as 328 days as an average to sell inventory is quite high. Although this ratio is high, the trend does seem to be consistent, seeing a reduction in days in 2013, increase in 2014 and then a reduction again in 2015 with the figure staying around the same with no major increase. The New Wave Group may need to put a further focus on their inventory management system to see what they can do to improve this, whether it be to hold less stock for example.

Total Asset Turnover Ratio 2015 2014 2013 2012Efficiency (or Asset Management) Ratios

Total Asset Turnover Ratio

Sales/total assets

0.91 0.82 0.96 0.96

The total asset turnover ratio indicates how many times the value of our assets we are generating in sales. The higher the figure for this ratio, the more efficient the company is with managing their assets.So for 2015, the New Wave Group generated 0.91 of sales, for every $1 of assets. These ratio figures seem to be a little low, ideally the company would be performing better if this was at least a 1:1 ratio, but they are not too far off this. Looking at the trend with this ratio, the figure remained the same for both 2012 and 2013, saw a decrease in 2014, and then an increase in 2015.


Liquidity Ratios

Current Ratio 2015 2014 2013 2012Liquidity Ratios

Current Ratio

Current assets/current liabilities 3.59 4.89 4.37 4.19

The current ratio indicates the firm’s ability to turn their assets into cash in order to repay their financial debts. To gauge this ability, the current ratio considered the current assets and current liabilities. The New Wave Group has quite high figures for current ratio, which indicates they have a good amount of assets in comparison with their current debts. This measure is said to be good if it is at least 1:1, so the figures for New Wave Group are great. The company saw in increase in 2013, and again in 2014, and then a slight decrease in 2015. Even though there was a slight decrease in 2015, the ratio is 3.59 which is more than satisfactory.


Financial Structure Ratios

Debt/Equity Ratio 2015 2014 2013 2012Financial Structure Ratios

Debt/Equity Ratio Debt/equity

117.96%

117.73%

100.76%

126.82%

Debt/Equity Ratio Debt/equity 1.18 1.18 1.01 1.27

The debt/equity ratio is an indicator of risk, and shows what percentage of the company financing comes from the bank (creditors) and investors (shareholders). The lower debt to equity ratio would indicate that the firm is more financially stable compared to those firms with a high debt to equity ratio, which is considered more risky to creditors and investors. The New Wave Group has a 118% debt to equity ratio for 2015, which indicates more creditor financing (bank loans) is used rather than investor financing (shareholders). Initially I thought this was a really concerning figure since every year has been over 100% (or 1), however after further investigation I discovered that each industry has a different debt to equity ratio benchmarks, and some firms tend to use more debt to finance compared to others. The highest equity to debt ratio was 127% in 2012 which is still within the acceptable debt to equity benchmark. The New Wave Group could definitely work on improving this figure as some creditors and investors may consider large leveraged amounts of debt unfavourable incase the firm is unable to make payments to the bank.It should be noted that the ratio has dropped since 2012, and has not changed much since 2014.

Equity Ratio 2015 2014 2013 2012Financial Structure Ratios

Equity Ratio Equity/total assets 45.9% 45.9% 49.8% 44.1%

The equity ratio indicates how much of the firm is funded by its equity owners (shareholders). The higher the figures, the lower the risk of operation of the firm as this means the more of the firm that the shareholders own. In turn, the lower the figures, the higher the risk of operation as the less it is owned by the shareholders. The New Wave Group has an average reading of 45.9% at the end of 2015, which is slightly concerning seeing as the company has been operating since 1990. It means that just under half of the company is owned by its equity investors, and probably should be higher for a long running company. It’s important to note that the equity ratio has seemed to be sustainable from 2012 to 2015, and stayed between 44% to 50%. Ideally, the company should be aiming to have this figure higher than 50% so the company is owned majority by the shareholders.


Market Ratios

Earnings per Share (EPS) 201

5201

4201

3201

2Market Ratios

Earnings per Share (EPS)

Net profit after tax/nos of issued ordinary shares

$2.19

$2.67

$2.82

$0.09

The earnings per share (EPS) ratio indicates the amount which can be earned per unit of a firm’s stock. The New Wave Group’s earnings per share for 2015 is $2.19, which means the firm can earn $2.19 on each unit of share being sold. This is a great figure, and should be noted that it has risen from $0.09 which was the figure in 2012. The trend saw an increase in 2013, with a decrease in both 2014 and 2015. These figure also almost match the firms annul reports, the difference is just due to the way we have calculated the EPS.

Dividends per Share (DPS) 201

5201

4201

3201

2Market Ratios

Dividends per Share (DPS)

Dividends/number of issued ordinary shares

$1.00

$1.00

$1.00

$1.00

The dividends per share (DPS) ratio indicates the amount that needs to be taken out of the earnings per share to be repaid in dividends to the equity investors. This ratio is important as the main goal of the firm is to return value to the shareholders.The New Wave Group has a DPS of $1.00 that has remained the same from 2012 to 2015. This means that for every share that is sold by the firm, $1 needs to be returned in dividends per unit of shares purchased by the shareholder. This figure appears favourable for the New Wave Group, and that fact the DPS has remained constant is a good indicator.

Price Earnings Ratio 201

5201

4201

32012

Market Ratios

Price Earnings Ratio

Market price per share/earnings per share

15.75

14.36

11.67

285.96

The price earnings ratio indicates the number of years it will take for the firm to earn back the investment in the share. To interpret this figure, the lower the number of years to earn back the price of the market shares is said to be better as this displays the firms efficiency to generate profits. As you can see with the above figures, the price earnings ratio for the New Wave Group has dropped quite significantly from 286 days in 2012, down to 15.75 years in 2015. This big improvement should be considered favourable as it

ACCT11059 Assignment 3 – Ratio Analysis & Capital Budgeting Tracey Thompson s0181988demonstrates that the New Wave Group is able to reduce the number of years taken to gain a return on the sales of its shares. Although price earnings ratio did see a little increase from 2013 to 2015, it remains quite stable. The 2015 price earnings ratio of 15.75 years also falls within the generalised benchmark of 15 – 25 years for firms, so is considered quite normal. Ratios Based on Reformulated Financial Statements

Return on Equity (ROE) 201

5 2014 2013 2012

Ratios Based on Reformulated Financial Statements Return on Equity (ROE) 6.89

%15.64

%10.04

%-3.59%

The return on equity (ROE) ratio indicates the rate of return on profits generated on shareholders equity, in other words what comprehensive income has the firm generated for the shareholders. The higher the ratio, the better the company is as this displays the ability of high return on equity for shareholders.The ROE for the New Wave Group varies quite a bit from year to year. 2012 saw a negative ROE figure, which increased substantially in 2013 and 2014, and then decreased in 2015. In comparison with other students firms, a 6.89% ROE for 2015 seems average and nothing to be concerned about. This means that for every $1 invested, shareholders will receive a 6.89% return on their investment. This return would be better than the current term deposits being offered by banks at the moment, although shareholders may want to invest in other companies that have a higher ROE.

Return on Net Operating Assets (RNOA) 2015 2014 2013 2012 Ratios Based on Reformulated Financial Statements Return on Net Operating Assets (RNOA)

5.15% 9.56% 7.48% -0.78%

The return on net operating assets (RNOA) ratio is the same as the return on assets ratio listed above in the profitability ratio section, except RNOA uses the figures from the restated financial statement after isolating the operating income after tax (OI) and the net operating assets (NOA). The RNOA is normally a slightly better figure compared to the return on assets ratio as all of the financing assets have been taken out of the equation, focusing on the operating totals only therefore the common denominator is smaller in the calculation resulting in a higher percentage. This ratio indicates how efficient the firm has been in order to produce a profit from their net operating assets.

The RNOA trend remains the same as the return on assets ratio as expected, seeing an increase in 2013 and 2014, than quite a substantial decrease in 2015. Overall even though there has been a decrease in the last financial year, the RNOA seems to be performing satisfactory as it has seen quite an increase since 2012, and 5.15% return is not a bad profit on assets, more so average.

ACCT11059 Assignment 3 – Ratio Analysis & Capital Budgeting Tracey Thompson s0181988Net Borrowing Cost (NBC)

2015 2014 2013 2012 Ratios Based on Reformulated Financial Statements Net Borrowing Cost (NBC) 2.93% 1.75% 3.36% 2.75%

The net borrowing cost (NBC) ratio indicates the average interest rate the firm is paying on its financing. The higher the ratio, the greater the interest expense is being incurred by the firm.The NBC for the New Wave Group is low, which is a good indication regarding the average interest expense of the company. The NBC did see an increase in 2013, following by a decrease in 2014 and then another increase in 2015. Overall though, the ratio has remained quite low which indicates the company is efficient with their debt management policies.

Profit Margin (PM) 2015 2014 2013 2012 Ratios Based on Reformulated Financial Statements Profit Margin (PM) 4.66% 9.57% 6.30% -0.64%

As already mentioned above, the profit margin indicates the profit the firm is making on sales. I didn’t expect much to change for the profit margin generated by the restated figures, as the only thing that has changed is the financial costs have been taken out of the calculation, focusing only on the operating income after tax (OI). The profit margin for 2015 is 4.66 cents profit is made for every $1 of sales, which is similar to the 2015 net profit margin recorded above of 2.9 cents. The profit margin figures still remain within what is to be considered as a ‘normal’ range (between 0% to 10%), so the firm has an average profit margin. The trend also remained the same as the net profit margin, which saw an increase in 2013 and 2014, and then a decrease in 2015, the figures for the profit margin were just a little higher due to the isolation of the operating income.

Asset Turnover (ATO) 201

5 201

4 201

32012

Ratios Based on Reformulated Financial Statements Asset Turnover (ATO) 1.11 1.00 1.19 1.22

Compared to the total asset turnover ratio discussed above, there is actually an increase with the asset turnover (ATO) which indicates the New Wave Group is becoming more efficient with managing their assets. I did expect the ATO figure to be higher than the total asset turnover as we have isolated the operating assets, so therefore the common denominator is smaller in the calculation due to taking out the financing items. The trend is very similar to the total asset turnover, seeing a decrease in 2013 and again in 2014, and then an increase in 2015. These figures are satisfactory as they are meeting the expectation of reaching the 1:1 ratio for asset turnover.

ACCT11059 Assignment 3 – Ratio Analysis & Capital Budgeting Tracey Thompson s0181988Economic Profit

The economic profit is a measure of performance, which calculates the amount left over after the cost of capital has been taken out of the accounting profit. This is a great indicator as to where the firm is heading, and in turn assists investors making the decision as to whether the firm is worth investing in. The economic profit formula is: (RNOA - cost of capital) x net operating assets (NOA).The below table displays all of the key data which was used to calculate the economic profit for the New Wave Group, along with a couple of other ratios that I found were the main components to impact the economic profit of the firm.

Return on Net

Operating Assets(RNOA)

Cost of Capital

Net operating

Assets(NOA)

Profit Margin(PM)

Return on

Equity (ROE)

Economic Profit

20155.15%

11.20%$4,492.3 4.66%

6.89%-$271.89

20149.56%

11.20%$4,276.6 9.57%

15.64%-$70.12

20137.48%

11.50%$3,407.3 6.30%

10.04%-$38,928.72

2012 -0.78% 11.50% $3,517.5 -0.64% -3.59% -$40,478.58

The cost of capital indicated above was sourced straight from the New Wave Groups annual reports. You will note there is a change in 2014 onwards from 11.50% to 11.20%. I was quite happy using these figures, as they are close to the recommended average of 10% that Martin suggested for those companies who do not list a cost of capital.


2012 2013 2014 2015

($45,000.00)

($40,000.00)

($35,000.00)

($30,000.00)

($25,000.00)

($20,000.00)

($15,000.00)

($10,000.00)

($5,000.00)

$0.00

Economic Profit(in SEK m)

Economic Profit

Graph One: Economic Profit for the New Wave GroupAs you can see with the above Graph One, the economic profit for the New Wave Group, although is in the negative, is trending upward which looks promising for the firm. Most companies have a negative economic profit as they are unable to cover the cost of capital, so these figures are considered within normal range. Now let’s look further into the components that have an impact to the economic profit in the below graph:

2012 2013 2014 2015-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

Economic Profit Drivers

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

Graph Two: Economic Profit Drivers

It is quite interesting to look into the components that impact on the economic profit for the firm as per the above Graph Two. Looking to the firm’s profit margin (PM), it saw the exact same trend at the economic profit. An increase in both 2013 and 2014, then a slight decrease in 2015. When the economic profit was at its highest point in 2014, the profit margin was also at the highest point. The return on net operating assets (RNOA) followed the exact same trend, with an increase in both 2013 and 2014, then a slight decrease in 2015. When the RNOA was at its highest point in 2014, so was the economic profits.

ACCT11059 Assignment 3 – Ratio Analysis & Capital Budgeting Tracey Thompson s0181988There is no surprise that the return on equity (ROE) saw that exact same trend, and the years where the ROE was improving, so was the economic profits.

When comparing economic drivers, it was also noted that when the profit margin, return on net operating assets and return on equity was that their lowest figures so was the economic profit for the firm. It is apparent that these three measures are vital when it comes to the outcome of economic profit.

Please note that I found the Asset Turnover ratio (ATO) was not really linked when looking at this firms economic profit, it was more so the profit margin, return on net operating assets and return on equity that were the main drivers in this instance.

Overall, after analysing the financial statements for the New Wave Group, I feel like I have such a better understanding of the components that investors should look at to determine the financial health of this firm. The New Wave group seems to be performing well, with no real areas of concern at this stage.


Discussion with other students regarding ratiosI created a forum post to determine if any other students had a debt/equity ratio higher than 100%, as I initially thought I had my calculations wrong. I’m glad I did post something, as there were other students firms which had similar results. This helped me understand the debt/equity ratio better and reassured me about my calculations. Here is the link to my blog post where I have created discussions with other students on my analysis and compare ratios.

https://traceythompsonblog.wordpress.com/2017/01/29/ratio-analysis-for-the-new-wave-group-let-us-discuss-and-compare/

https://moodle.cqu.edu.au/mod/forum/discuss.php?d=190113


Step Two: Develop a Capital Investment Decision for the New Wave Group

The CEO of the New Wave Group is considering investing in another company to join their brand in the Sports and Leisure section. He is considering two companies: Rockwear (a popular active wear range), or alternatively Kate Hill (a popular handbag and wallet range).

Each investment opportunity will be assessed below in in order to determine which the best venture is. The original cost, the estimated life, residual value and estimate future cash flows of each investment opportunity are set out in the table below.

Note: A rate of return/discount rate/WACC of 10% will be assumed in these cases.

The investment would be made on 1 January 2017. The estimated future cash flows are expected to be received on 31 December of each year.

Proposed Investment One

Rockwear

Proposed Investment Two

Kate HillOriginal cost $50 million $60 millionEstimated life 1 6 years 7 yearsResidual value 2 $57 million $75 millionEstimated future cash flows2017 (time period = 1 year)

-$1.5 million $-2.0 million

2018 (time period = 2 years)

$2 million $-0.5 million


$10 million $10 million









1 Estimated life is how long the New Wave Group expects to invest in the new company

2 Residual value is the expected cash flow when each investment option reaches the end of its estimated life


Summary of ResultsProposed Investment

OneRockwear

Proposed Investment Two

Kate HillNet Present Value (NPV) $33.29m (SEK) $15.50m (SEK)Internal Rate of Return (IRR)

22.3% 14.7%

Payback Period 4.52 years 5.24 years

Net Present Value The net present value (NPV) is used to determine the profitability of an investment, by calculating the difference between the present value of cash inflows and the present value of cash outflows. A positive NPV indicates the investment profits exceeds the anticipated costs. Both of the above two investment options has a positive NPV, however it is clear that option one with Rockwear generates greater profits ($33.29m) compared to option two with Kate Hill ($15.50m).

Internal Rate of Return The internal rate of return (IRR) is also another measure of profitability, and is an extremely important benchmark used to determine the desirability of an investment. The investment with the highest IRR is considered to be the best and should be undertaken first. In this scenario, the first investment option with Rockwear also generates the highest IRR of 22.3%, compared to the second option with Kate Hill that offers a 14.7% IRR.

Payback PeriodThe payback period should also be considered when making investment decisions, as this analyses the length of time required for the investment to recover its initial outlay costs. Longer payback periods are not typically desirable for investments, so the shorter payback period would be more favourable for the firm. It should also be noted that the payback period does not consider the time value of money, so should not be used as a standalone factor in decision making, but more so compliment the NPV and the IRR in the investment decision.Both of the above investment options above have quite short investment payback periods, with investment option one with Rockwear resulting in 4.52 years, followed shortly behind by investment option two with Kate Hill of 5.24 years.

Investment Recommendation It is evident in the above scenario that investment option one with Rockwear is the more favourable option for the firm. While neither investment has negative results, the profitability generated by option one outweighs investment option two so should be undertaken first. Investment option one generated the higher Net Present Value, the higher IRR, and also had the shortest payback period which is the most beneficial outcome for the firm. Therefore I would

ACCT11059 Assignment 3 – Ratio Analysis & Capital Budgeting Tracey Thompson s0181988recommend for the CEO of the New Wave Group to invest in option one, and have Rockwear join their branding.


Step Three – Providing Feedback to Other Students

Still to complete the providing/receiving feedback section

1. Peer feedback given to

My CommentsStep 1Calculation of ratios Ratios – commentary (blog) Calculate economic profit Commentary – drivers of economic profit (blog) Step 2Develop capital investment decision for your firm Calculation of payback period, NPV & IRR Recommendation & discussion

Step 3Individual feedback with other students

Overall ASS#3





Overall ASS#3

valuation assignment · web viewacct11059 – using accounting for decision making. assignment 3....

Documents