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Task 1


Task 1

1. Prepare a performance report for the two companies for consideration by the directors of Chelsea Plc indicating which of the two companies you consider to be a
better acquisition, the directors require an analysis of these ratios and explanation

2. Indicate what other information is needed before a final decision can be made

Task 2

1) Calculate the annual cash flows for each of the five years.

2) Using the investment appraisal methods calculate the ARR, Payback, NPV and IRR

3) Advise the client on whether this project should be accepted or rejected based on methods used above.

Task 3

1. You are required to prepare a cash budget for the four months August to November 2014. The opening cash balance at 1 August 2014 is £15,400.

2. Budgeting is one of the areas that the management are keen to improve on, could you provide an explanation of why budgeting is beneficial to a business and what
can be done to enhance the budgeting process?

1. Chelsea Plc is considering two companies Kensington (K) and Wimbledon (W) as the target companies which we are required to compare and advice which one is the better target for acquisition. There is certain profitability, activity and liquidity ratios are given for both the companies as well as the industry standards, we need to analyze all such ratios and conclude the decision. Let us discuss and analyze each ratio’s one by one (Bodie, et al, 2011).

Return on Capital Employed is computed by dividing the net operating profit with the employed capital. It denotes the profit earned for each £ of capital employed in the company. The more the profits for the company the better it is so the higher the ROCE ratio the better it is for the company. Here the industry average given for this ratio is 20 whereas the W (28) has higher of this ratio from both industry as well as of K’s (22) (Burns and Morris, 2014). Therefore both the company is better off but W is more profitable. (Return On Capital Employed)

Return on equity is a profitability ratio from the investor’s point of view since it is the ratio of the net income earned from the shareholders fund. It reflects the efficiency of the company to use the shareholder’s money and earn profit from it. In this ratio also W has higher ratio then both K and Industry thus it is in better position (Cao, 2011). Acquiring W will help Chelsea gain more confidence from investors since they will have sense of security that there fund is utilized in creating shareholders wealth and not destroying it. (Return on equity ratio)

Gross profit and Net Profit ratios are the ratios computed by dividing the respective profits by the sales. This ratio reflects the percentage of profit earned on certain level of sales. Here in the given case study gross and net profit ratio of K is better than industry’s average but of W is worst which denotes that profitability of W is lower when compared to that of K. It may be due to mismanagement or unnecessary expenditures which can be corrected by Chelsea after acquisition. Therefore we can say that analyzing the profitability ratios Wimbledon is better target firm. (Gross Profit Ratio) (Net Profit Ratio)

Task 2

Total Asset Turnover ratio indicates Net sales divided by average total assets. The higher ratio is preferable since it indicates that company is efficiently using its assets to generate sales. Here also W is better off from K as well as from the industry standards. Non-current asset ratio is similar only difference being here only the fixed assets is considered and not the total assets. This denotes how efficiently the company is utilizing its fixed asset in generating income for the financers. W has a ratio of 12 whereas Industry and K has 5.1 and 2.3 respectively (Cherneva, 2012). Thus in both the above ratios W is surpassing all other comparisons. (Asset turnover ratio) (Fixed Asset Turnover Ratio)

Receivables collection period are the credit period allowed to debtors. The time period it takes to realize the sales amount in cash is known as receivable collection period. This period is preferred to be lower since the faster the collection is made the sooner the cash can be rolled back into the operating cycle. Here as per the given data W has the lowest collection period and thus it is preferable. (Accounts receivable Collection Period)

Inventory holding period is the period which is required to sell the product to the consumers kept in stock. Like receivable collection period lower inventory holding period will shorten the days to complete one operating cycle and thus will allow Company grab more opportunities (Clift, 2011). Here also the holding period of W is lowest and thus it is in better position. (Average age of Inventory)

In all the liquidity ratios such as current ratio, acid test ratio and debt equity ratio which is considered lower the better W is in better position thus we conclude that in almost all the ratios W is a better acquisition target. (Current Ratio)

These ratios help us to analyze how the various areas are being covered under the ratios and how the decisions can be based on that ratios. Such as debt equity ratios helps us to measure the amount that the company uses as debt for financing the capital and the debt burden also for the company. The various other ratios shows how the company is liquid enough t pay off the debts and the liquidity structure of the company.

The ROCE and ROE is one of the valuable measurements to measure the company’s profitability ratio. By calculating the ROCE for both the companies W and K, it has been observed that the ROCE of W Company is 28 and the ROCE of K Company is 22 (Zhang et al., 2011). This shows that the profitability ratio of W Company is more than the K Company. So, acquiring W will be better for Chelsea to earn more profit from the market. The ROE of W Company is much better than K Company, so it would be better to acquire W by Chelsea Plc. So the Chelsea Plc Company should acquire the W Company to earn huge amounts of profit from market. If the company had more profitability ratio then the observation reflects that the company has more equity value as compared with the debt value of the company. It has been also found that the average borrowing rate is much less for the W Company (Glantz, 2014). So, the management of Chelsea Plc Company should merge with the W Company.

Task 3

2. Final Decision cannot make only based on some ratios. Certain other aspects should be considering before deciding. These are as following in nature:

Numbers of shares that are issues by the company to generate the funds for the operational activities of the company are mainly base on the final decision making strategies of the organization.

Acquisition of a new or popular product in the company is also primary factors that are required to be considering during the final decision taken by the organization. The acquisition activities of the company are mainly base on the decision-making criteria of the particular organization.

Researches of several articles by independent analysts are also required and essential for the decision-making strategies of the organization are mainly base on the certain activities of the company is support the organization to take beneficial decision about the company.

There are several debt amount which is taken by the company which is required to be settle after acquisition activity of company which is mainly based on the capabilities of the organization to fulfilled their organizational obligations which is based on the financial capabilities of the organization.

The legal obligations that are mainly base on the several activities of the company as per the pending legal obligations of the company. Moreover, those are required to sort out the company rules and policies measured by the company. There are certain value addition activities which are required for the decision making activities of the organization which is based on the maintaining the goodwill of the company.

The decision-making activities of the company that is mainly based on the expenditures and the employees retrenchment activities that are mainly base on the certain activities of the organization as per the compatibility of the product line of the organization.

The products price affordability of the company is base on the different purpose of the company decision-making activities of the organization. The decision-making strategies of the organization are mainly base on the several strategies follow by the organization.

The decision-making strategies of the company are mainly base on the several essential activities of the organization for choosing the proper mode of payment of the organization. this is the one of the most famous decision-making aspects of the organization in compare to the others aspects of the organization.

The objectives behind the research on the work culture of the company are mainly base on the organizational decision and which is base on the certain activities of the company. The company is mainly depends upon the certain activities of the cultural factors of the company.

The earnings after merger should evaluate to decide acquisition of the company is mainly support the company to take essential decisions about the organization about their financial and operational activities of the company (Gowthorpe, 2011).

1. As per the research of the Riverside Motorcycle Components Ltd. Company can provide some standard service which has been recently developed by them. For the service provision it requires special machinery which costs £100,000 with a residual value of £20,000 after 5 years. The company’s cost of capital is 12% which can set as the benchmark to achieve this target at least to check the projects viability in some of the appraisal methods. We have been asked to prepare the annual cash flows each year given the data of estimated sales in units each year (Guiso and Rustichini, 2011). These cash flows are calculated by multiplying the contribution per unit amount with the units per year given. The following table shows the computation of annual cash flows each year:

Annual Cash Flows

Particulars

Details

Years

1

2

3

4

5

Units Sold

           5,000

         10,000

         15,000

         15,000

         5,000

 Amount (in £)

Annual Cash Inflow

 SP @ £12per unit

         60,000

       120,000

       180,000

       180,000

       60,000

Annual Cash Outflow

 VC @ £8 per unit

         40,000

         80,000

       120,000

       120,000

       40,000

Net Cash Flows

         20,000

         40,000

         60,000

         60,000

       20,000

 2. The company requires us to compute the investment appraisal methods using different methods such as accounting rate of return, payback period, internal rate of return and net present value method. In the accounting rate of return method average accounting profit of all the years involved in the project is computed and then it is divided by the amount of initial investment resulting in a return percentage (Sagner, 2014). It is also called simple rate of return because it is easy to compute and also simple ratio. ARR is used in investment appraisal it helps in deciding whether the project is viable to adopt or not. The following steps show the computation of the ARR. Since this is rate of return therefore higher the return more viable is the project in this method. (Jan, 2013)

Accounting Rate of Return (ARR)

Step 1: Computing Annual Depreciation

Initial Investment

100000

Salvage Value

20000

No of years

5

Annual Depreciation

16000

Step 2: Computing Average Accounting Profit

Years

Cash Flows

Depreciation

Accounting Profit

1

                   20,000

         16,000

           4,000

2

                   40,000

         16,000

         24,000

3

                   60,000

         16,000

         44,000

4

                   60,000

         16,000

         44,000

5

                   20,000

         16,000

           4,000

Total Accounting Profit

       120,000

Salvage Value

         20,000

Average Accounting Profit

         28,000

Step 3: Computing Accounting Rate of Return

Average Accounting Profit (in £)

28000

Initial Investment (in £)

100000

ARR (in %)

28

Particulars

Years

0

1

2

3

4

5

Initial Investment

               (100,000)

-

-

-

-

-

Cash Flows

-

         20,000

         40,000

         60,000

         60,000

       20,000

Cumulative Cash Flows

               (100,000)

        (80,000)

       (40,000)

         20,000

         80,000

     100,000

Fraction Calculations

 -

n/m

n/m

0.66666667

0.33333333

4

Payback Period

(in yrs)

                     2.667

Payback period is the method which determines the time period in which the initial investment can be recovered resulting profits in further years. Here in the mentioned question the company has an initial investment of £100,000 which will be recovered in the next 5 years since the project lifetime is such. The payback period can be computed in many alternate ways but here we have calculated by using the excel formulae (Ramsden, 2011). After dividing the absolute value of the last cumulative negative cash flows with the cash flow of the first positive cumulative cash flows, we have added it to the number of years before the first positive cumulative cash flows (Harris, 2013). The following table shows the payback period computation with the help of excel formulae in the excel sheet. The worksheet has been attached. (Ajay, 2013)

There are many investment appraisal methods but Net present value method is very prevalent and commonly used. It includes the effect of time value of money thus making the method more effective and appropriate for decision making. In the project the present values are computed by discounting the cash flows each year. The sum of these present values is subtracted with the initial investment to compute the net present value (Peterson, et al, 2012). If the NPV is positive then the project is viable and if it is negative it is not viable. Sometimes the salvage value is also given that gets realized at the end year of the project, in that case we add up the present value of the salvage value with the cash flows of that year and compute the NPV accordingly (Holton, 2012). The following table shows the computation of the NPV of the given problem with help of excel formulae. (NPV & IRR, 2013)

Particulars

Discounting Rate

12%

Years

0

1

2

3

4

5

Initial Investment

               (100,000)

-

-

-

-

-

Cash Flows

-

         20,000

         40,000

         60,000

         60,000

       20,000

Salvage Value

-

 -

 -

 -

 -

       20,000

Present Values

               (100,000)

         17,857

         31,888

         42,707

         38,131

       22,697

NPV

                   53,280

 Since the NPV is positive in the above calculation thus the project is viable for the company.

Internal Rate of Return is the method which compares the inflows and the outflows making it equal. The discounting rate at which the inflow gets equal to outflow is the IRR. The project with the greater IRR should be selected since it is better to have higher IRR. The project is considered viable if the IRR is greater than the hurdle rate. The below table shows the IRR computation using the Excel formulae: (Formulae for calculating IRR in excel)

Particulars

Years

0

1

2

3

4

5

Cash Flows

               (100,000)

         20,000

         40,000

         60,000

         60,000

       20,000

Internal Rate of Return (IRR)

27%

 Since the above IRR is greater than the company’s hurdle rate of 12% we consider the project is viable. In the absence of further information we assume the company’s cost o capital to be its hurdle rate for the IRR computation. (Formulae for computing NPV in Excel)

From the above calculation, it has been observed that the company has invested 100,000 Pound in purchasing a new machine for their manufacturing process. In the first year, the management of the Riverside Motorcycle Components Ltd has a cash inflow around 17,857 Pounds in the first year. In the second year, the management of the firm has received a cash inflow of 31,888 Pounds from the machine installed for the production purpose. In the third year, the company has received around 42,707 Pounds and has a cash inflow of 38,131 Pounds and 22,697 Pounds in the fourth and fifth year respectively. It has been observed from the calculation that the total cash inflow from the machine is 153,280 Pounds in the last five years. The total net present value of the cash inflow is 53,280 Pounds (Media, 2012). As the net present value of the cash flow is positive, the management of the Riverside Motorcycle Components Ltd should invest in the machine to earn more profit. If we compare the NPV, IRR and ARR, it has been observed that the NPV is positive; IRR is more than the hurdle rate of the project (IMA., 2012). The ARR value is 28 % which is very healthy foer the investors to get back the money from the investment. It can be stated that the management of the company can invest in the machine.

3. Since as per the above calculations we get that all the methods give a positive indication towards the project thus the project is completely viable. In the ARR the rate of return earned is quite high i.e. 28%. Similarly in payback period method the years computed is 2.67 years for a five year project which is almost half the total time period which is a positive sign. The company will be able to recover its investment soon and invest in some other new project reaping only profits from this project in further years. The NPV and IRR are also giving good appraisal since the NPV is positive with the good margin and the IRR is greater than the double of the hurdle rate. Thus considering all of the above methods we advise the client to accept the project.

1.  The bookkeeper of the Pedrosa Plc has fallen sick and the new staff is inexperienced. Therefore the directors of the company wishes if we can help them in anyways. It requires preparing a cash budget for the period of four months from the period Aug to Nov ’14. Some information is provided to us by whom we will have to prepare the budget. There are sales and purchase value for the six months period is given. 40% of the total sales constitute cash sales which are realized immediately whereas 60% of the sales are credit sales with a one month credit period given to the debtors (Kimmel, et al, 2011). Similarly the suppliers also provide 1 month credit period which means this month’s purchase will be paid in the next month. The depreciation charge of £2,500 per month is non cash expenditure and thus will not be included in the cash budget. The following tables show the cash budget for four months and the appendix attached.

Cash Budget

For the period Aug '14 to Nov '14

Particulars

Details

August

September

October

November

(in £)

(in £)

(in £)

(in £)

Opening Cash balance

given for Aug

15,400

      37,240

    43,390

      48,930

Inflows

Cash Sales

Appendix 1

    27,060

      24,160

    23,400

      22,200

Collection from debtors

Appendix 1

    39,180

      40,590

    36,240

      35,100

Rent Income

Given

      9,000

        9,000

      9,000

        9,000

Total Inflows (A)

    90,640

    110,990

  112,030

    115,230

Outflows

Payment to Suppliers

Appendix 2

    35,400

      33,600

    32,600

      34,750

Wages

Appendix 3

    18,000

      18,000

    18,000

      19,080

Dividend

Given

-

16000

-

-

Payment for Machinery

Appendix 4

 -

 -

    12,500

        6,250

Total Outflows (B)

    53,400

      67,600

    63,100

      60,080

Closing Balance (A-B)

    37,240

      43,390

    48,930

      55,150

Appendix 1

Sales

Months

 Particulars

 Details

 July

 Aug

 Sept

 Oct

 Nov

 Dec

 Sales Volume

 given

    65,300

      67,650

    60,400

      58,500

    55,500

    64,600

 Cash sales

 40% of sales above

    26,120

      27,060

    24,160

      23,400

    22,200

    25,840

 Credit Sales

 60% of Sales

    39,180

      40,590

    36,240

      35,100

    33,300

    38,760

 Collection From Debtors

 1 month credit period

 -

      39,180

    40,590

      36,240

    35,100

    33,300

Appendix 2

Purchases

Months

 Particulars

 Details

 July

 Aug

 Sept

 Oct

 Nov

 Dec

 Purchase Amount

 given

    35,400

      33,600

    32,600

      34,750

    35,650

    35,600

 Payment to suppliers

 1 month credit period

 -

      35,400

    33,600

      32,600

    34,750

    35,650

Appendix 3

Wages

Months

 Particulars

 Details

 July

 Aug

 Sept

 Oct

 Nov

 Dec

 Wages

 6% inc. from nov onwards

    18,000

      18,000

    18,000

      18,000

    19,080

    19,080

Appendix 4

Machinery

Months

 Particulars

 Details

 July

 Aug

 Sept

 Oct

 Nov

 Dec

 Installments Payment

 25% in Oct, rest in 6 months (Cost= 50,000)

 -

 -

 -

      12,500

      6,250

      6,250



2. Budgeting is the process of managing and approximating the expenditure and the income. It is a plan prepared for future to keep a balance between the income and expense. Budgeting is also very vital in fulfilling the financial needs of the company as they have the plan at hand ready to work on different situations accordingly. Preparation of budgets such as cash budget, purchase budget, sales budget etc helps in proper evaluation of the company’s performance. Any deviation from the budget will alert the management to take necessary actions and work accordingly. (What is Budgeting?) (Nordmeyer)

There can be various ways to enhance the budgeting process. Not achieving it alerts the management and makes them pay more heed to such process. Corporate Performance Management (CPM) and Performance Based Budgeting (PBB) are the ways to enhance the budgeting process (Marney and Tarbert, 2011). The cost benefit analysis is significant in this budgeting process. Thus we conclude that for every organization preparing a budget is crucial part in its management process. (Performance Based Budgetting, 2015)

Accounts receivable Collection Period. (n.d.). Retrieved 2015, from Accounting Tools: https://www.accountingtools.com/receivables-collection-period

Ajay. (2013, April 4). Calculating Payback period in Excel. Retrieved June 6, 2015, from Techtites: https://techtites.com/calculating-payback-period-in-excel/

Asset turnover ratio. (n.d.). Retrieved 2015, from my accounting course: https://www.myaccountingcourse.com/financial-ratios/asset-turnover-ratio

Average age of Inventory. (n.d.). Retrieved 2015, from Investopedia: https://www.investopedia.com/terms/a/average-age-of-inventory.asp

Current Ratio. (n.d.). Retrieved 2015, from My accounting course: https://www.myaccountingcourse.com/financial-ratios/current-ratio

Debt-Equity Ratio. (n.d.). Retrieved 2015, from My accounting courses: https://www.myaccountingcourse.com/financial-ratios/debt-to-equity-ratio

Fixed Asset Turnover Ratio. (n.d.). Retrieved 2015, from Investopedia: https://www.investopedia.com/terms/f/fixed-asset-turnover.asp

Formulae for calculating IRR in excel. (n.d.). Retrieved 2015, from Investopedia: https://www.investopedia.com/ask/answers/022615/what-formula-calculating-internal-rate-return-irr-excel.asp

Formulae for computing NPV in Excel. (n.d.). Retrieved 2015, from Investopedia: https://www.investopedia.com/ask/answers/021115/what-formula-calculating-net-present-value-npv-excel.asp

Gross Profit Ratio. (n.d.). Retrieved 2015, from Accounting Tools: https://go.microsoft.com/fwlink/?LinkId=129791

How to analyze acquisition? (n.d.). Retrieved 2015, from WikiHow: https://www.wikihow.com/Analyze-an-Acquisition

Jan, I. (2013). ARR. Retrieved 2015, from Accounting Explained: https://accountingexplained.com/managerial/capital-budgeting/arr

Net Profit Ratio. (n.d.). Retrieved 2015, from Accounting Tools: https://www.accountingtools.com/net-profit-ratio

Nordmeyer, B. (n.d.). Why is Cash Budgeting important for the organization? Retrieved 2015, from azcentral: https://yourbusiness.azcentral.com/cash-budgeting-important-organization-24074.html

NPV & IRR. (2013). Retrieved 2015, from Investopedia: https://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/npv-net-present-value-irr-internal-rate-of-return.asp

Performance Based Budgetting. (2015, april 24). Retrieved june 2015, from wikipedia: https://en.wikipedia.org/wiki/Performance-based_budgeting

Return On Capital Employed. (n.d.). Retrieved 2015, from My accounting courses: https://www.myaccountingcourse.com/financial-ratios/return-on-capital-employed

Return on equity ratio. (n.d.). Retrieved 2015, from my accounting course: https://www.myaccountingcourse.com/financial-ratios/return-on-equity

What is Budgeting? (n.d.). Retrieved 2015, from My money coach: https://www.mymoneycoach.ca/budgeting/what-is-a-budget-planning-forecasting

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