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Part A

1. Prepare a report for the Board of Zurich Plc. that evaluates the performance of the company in relation to profitability, liquidity, gearing, asset utilisation, and investor potential. Your report must be supported by the calculation of relevant ratios in the five evaluation areas mentioned above (35%).

2. The directors of Zurich Plc want to use the information provided in your report for decision making and believe ratios provide perfect information for this purpose. Therefore, critically evaluate the limitations of ratio analysis for decision-making purposes as an additional section within the report.

Part B - Johnson Ltd

Required:

1. Calculate using the following investment appraisal techniques, and providerecommendations as to the economic feasibility of acquiring the machine:

a. The Payback Period.
b. The Discounted Payback Period.
c. The Accounting Rate of Return.
d. The Net Present Value.
e. The Internal Rate of Return (to two decimal places)

2. Critically evaluate the key benefits and limitations of each of the differing investment appraisal techniques, supporting the response with relevant academic research as to whether each of the differing techniques is applied in practice within a real-life business context.

3. You are also required to critical evaluate the possible sources of finance to fund this investment.
 

Zurich Plc Financial Analysis

The report explains about various financial analysis concepts. Financial analysis is a process which is done by the companies and its stakeholders to identify and evaluate various financial concept of an organization such as evaluation on financial statements, evaluation on the various investment proposals etc. in the given report, performance of Zurich plc has been evaluated on the basis of ratio analysis. And the investment opportunity of Johnson limited has been evaluated on the basis of various capital budgeting techniques and the recommendation has been given to the company that the company should invest into the project or not.

The performance of position of Zurich Plc has been evaluated through identifying the financial performance and strength of the company. For evaluating the financial performance and the position of Zurich plc, ratio analysis study has been conducted. The financial statement of Zurich plc of 2015 and 2016 has been evaluated and it has been analyzed that how much changes have taken place into the financial performance of the company from last year and how is the current position of the company. Various ratios have been calculated to identify the position of the company. Following is the calculations and analysis: 

Ratio analysis is a quantitative analysis which contains and evaluates information related to the financial statement of an organization. It is used to analyze the company’s operating and financial knowledge such as profitability level, solvency level, efficiency level and liquidity level (Shapiro, 2005). Following is the study of ratio analysis on Zurich plc:

Profitability ratios are a part of ratio analysis which expresses about the total ability of an organization to generate and enhance the revenue in context with the various expenses such as selling expenses, operating expenses; cost of goods sold etc. following is the calculations of profitability ratio:

  1. Gross profit margin – Gross profit/revenue x 100
  2. Return on shareholder’s equity – Retained earnings/shareholder’s equity x100
  3. Net profit margin – Retained earnings/revenue x 100
  4. Return on assets – Retained earnings/total assets x 100
  5. Return on capital employed – Retained earnings/capital employed x 100

(Horngren et al, 2005)

Profitability ratio analysis

                                   (amount in £ '000)

Profitability Ratios

2016

2015

Return on shareholder fund

0.048956

0.028693

ROCE

0.094829

0.071527

Gross profit ratio

0.390169

0.358616

Gross Profit

7382

5825

net profit ratio

0.051419

0.035103

Profitability ratio of Zurich plc depicts about the profit generation capability of the company. The calculations express that the position of the company has been better from last year in context with the profitability ratio. The gross profit level and gross profit ratio of the company expresses that the profitability level of the company has been enhanced. Net profit ratio of the company has also been enhanced from last year and due to which the profit generation capability of the company has been better. Lastly, the ROCE and return on shareholder fund has been calculated and it has been found that the investment opportunity in the company is quite better.

Profitability Ratio Analysis

Profitability ratio of an organization could be affected due to many internal and external issues. Earnings and investments are the main sources due to which the profitability ratio of the organization could be affected. Numerous ways are there to impact on the profitability position of an organization and thus it is difficult to evaluate the exact profitability position of the company. This study evaluates the profitability position of an organization for short period only. Future prediction could not be done on the basis of profitability ratio (Kurov and Stan, 2016). Various non controllable factors affect he position. It extremely implicate over the capital structure and position of the company. So, on the basis of profitability ratios, exact financial performance of the company could not be evaluated.

Liquidity ratios are a part of ratio analysis which expresses about the total ability of an organization to pay the short term debt obligation. Following is the calculations of liquidity ratio:

  1. Current ratio – Current Assets/Current Liabilities
  2. Quick ratio – (Current Assets-Inventory)/Current liabilities

(Kiran & Singh, 2014)

Liquidity ratio

                                  (amount in £ '000)

2016

2015

Current ratio

 £   1.38

 £   2.91

Quick ratio

 £   1.06

 £   2.36

Liquidity ratio of Zurich plc depicts about the capability of the company to pay all the short term debts on the basis of short term assets. The calculations express that the position of the company has been better from last year in context with the liquidity ratio. The current ratio of the company expresses that the liquidity level of the company has been lower though the cost has been reduced as well as maximum utilization of minimum resources is done. On the other hand, quick ratio of the company expresses that the company is utilizing the resources at their best. The risk level and the cost level of the company is minimum

Liquidity ratio of an organization could be affected due to many internal and external issues. This study evaluates the liquidity position of an organization is good for short period only. Future prediction could not be done on the basis of liquidity ratio. Numerous non controllable factors, sudden debt and assets make an impact on the liquidity position. It extremely implicate over the working capital and the resources of the company (Jaumotte, Lall and Papageorgiou, 2013). So, on the basis of liquidity ratios, exact financial performance of the company could not be evaluated. 

Gearing ratios are a part of ratio analysis which expresses about the total ability of an organization to manage its risk, return and cost. Following is the calculations of gearing ratio: 

  1. Debt to equity ratio – total debt/total equity
  2. Times interest earned – EBIT/interest
  3. Equity ratio – Equity/total assets
  4. Debt ratio – Total debt/ total assets

(Bandy, 2013)

Gearing ratio analysis

2016

2015

                                   (amount in £ '000)

Gearing ratio/debt equity

1.13521

17.85

Debt Ratio

0.36678

0.03662

Interest cover/ time interest earned

5.3886

6.34904

The gearing ratio of the company expresses about the debt and cost level of the company. On the basis of calculations, it has been evaluated that the company is managing the optimal capital structure. The level of debt has been reduced by the company to manage the risk and cost of the company.  

Liquidity Ratio Analysis

Gearing ratio is based on many assumptions as well as the information manipulates the financial analyst and the financial manager of the company to make a decision. The risk and return calculated through these methods are quite traditional approach and it do not take the concern of all the related factors (Airaudo, Nisticò and Zanna, 2015). So, on the basis of gearing ratios, exact financial performance of the company could not be evaluated.

Asset utilization ratios are a part of ratio analysis which expresses about the total assets of an organization and the capabilities of the company to manage the assets. Following is the calculations of assets utilization:

  1. Asset turnover ratio – Sales/average assets
  2. Accounts receivables turnover ratio – Sales/average inventory
  3. Inventory turnover ratio – Sales/average inventory (Deegan, 2013)

Asset Utilization ratio

2016

2015

                                   (amount in £ '000)

Debtors Turnover

3.81452

3.83995

Total Assets Turnover

0.59256

0.07722

The calculation of asset utilization of the company expresses that the financial performance and the asset utilization strategies of the company is quite similar from last year and it is quite competitive.

The main limitation of this ratio is its dependability. It evaluates both the tangible and non tangible assets of an organization. And due to it, the expected values of the company get affected and it manipulates the financial analyst. So, on the basis of assets management ratios, exact financial performance of the company could not be evaluated

Investment ratios are a part of ratio analysis which expresses about the total financial position and capital structure position of a company. It evaluates the investment level of an organization. Following is the calculations of assets utilization:

  1. Earnings per share – (Net income – dividend to preferred shareholders)/# of shares outstanding.
  2. Dividend yield – dividend per share/ stock price per share
  3. Price earnings ratio – Stock price per share/EPS (Brigham and Ehrhardt, 2013)

Investment ratio analysis

2016

2015

                                   (amount in £ '000)

EPS

0.07839

0.04594

dividend payout

0.51396

0.87693

net profit ratio

0.05142

0.0351

Investment ratios of the company express that the current position of the company is quite better in the market.

Investment ratio takes the concern of irrelevant information and thus it becomes difficult for the organization and the financial analyst to reach over a better conclusion about the investment level of the company. So, on the basis of investment ratios, exact financial performance of the company could not be evaluated

Capital investment appraisal techniques are primarily planned by the companies to evaluate the best investment opportunity for the business. The capital investment program of the company evaluates the long term as well as short term program. Capital investment techniques are used to measure the total investment, profit, and payback period etc of an investment plan. Following is the calculations of investment option of Johnsons limited:

Calculation of payback period:

Payback period is a part of capital investment appraisal technique, it evaluates about the total time period which would be taken by the investment option to pay the total invested amount. Following is the calculations of payback period of the company:

Calculation of Payback period

Years

Cash inflow

Cash outflow

Cash flow

CF

initial investment

-20,00,000

0

-20,00,000

1

1220000

350000

870000

-1130000

2

1220000

350000

870000

-260000

3

1220000

350000

870000

610000

4

1220000

350000

870000

1480000

5

1220000

350000

870000

2350000

6

1220000

350000

870000

3220000

Pay Back Period= Initial investment/ cash inflow per period (Gali, 2015)

2.2988506

Gearing Ratio Analysis

The payback period calculations express that the total invested amount would be get back by the organization in 2.29 years which expresses about a good position of the investment. 

Discounted payback period is a part of capital investment appraisal technique, it evaluates about the total time period which would be taken by the investment option to pay the total invested amount after considering the net present value of the inflows and outflows. Following is the calculations of discounted payback period of the company:

Calculation of Discounted Payback period

Years

Cash Inflow

Factors

P.V. of cash inflows

CF

0

-2000000

-2000000

1

870000

0.909090909

790909.0909

-1209091

2

870000

0.826446281

719008.2645

-490083

3

870000

0.751314801

653643.8768

163561.2

4

870000

0.683013455

594221.7062

757782.9

5

870000

0.620921323

540201.5511

1297984

6

870000

0.56447393

491092.3191

1789077

Pay Back Period = Initial Investment/ Annual Cash flow

2.74977

(Du and Girma, 2009)

The discounted payback period calculations express that the total invested amount would be get back by the organization in 2.75 years which expresses about a good position of the investment.

The accounting rate of return is a part of capital investment appraisal technique, it evaluates about the total return of the investment option which would be get back by the company. Following is the calculations of accounting rate of return of the company:

Calculation of ARR

Years

Cash Outflow

Cash Inflow

depreciation

Net cash inflow

0

20,00,000

1

350000

1220000

250000

970000

2

350000

1220000

250000

970000

3

350000

1220000

250000

970000

4

350000

1220000

250000

970000

5

350000

1220000

250000

970000

6

350000

1720000

250000

1470000

6

500000

683333.3333

1053333

ARR

AVERAGE ACCOUNTING PROFIT/ AVERAGE INVESTMENT

1.54146

(Borio, 2014)

The accounting rate of return expresses that the total accounting rate of the project would be 1.54% which expresses about a good position of the investment.

Net present value is also a part of capital investment appraisal technique, it evaluates about the total return of the investment option which would be get back by the company. Following is the calculations of net present value of the company:

Calculation of Net Present Value

Years

Cash Outflow

Cash Inflow

Factors (1+(1+interest rate))^years

P.V. ofCash Inflow (cash inflow * factors)

P.V. of Cash Outflow (Cash outflow * factors)

0

   20,00,000

1.000

                -   

   20,00,000

1

     3,50,000

   12,20,000

0.909

   11,09,091

     3,18,182

2

     3,50,000

   12,20,000

0.826

   10,08,264

     2,89,256

3

     3,50,000

   12,20,000

0.751

     9,16,604

     2,62,960

4

     3,50,000

   12,20,000

0.683

     8,33,276

     2,39,055

5

     3,50,000

   12,20,000

0.621

     7,57,524

     2,17,322

6

     3,50,000

   12,20,000

0.564

     6,88,658

     1,97,566

6

     5,00,000

0.564

     2,82,237

   55,95,655

   35,24,341

NPV= Total Cash Inflow-Total cash outflow

   20,71,314

The net present value of return express that the total profit of the project would be $ 35,24,341 which expresses about a good position of the investment

The initial rate of return is a part of capital investment appraisal technique, it evaluates about the total return in which the initial rate of return of the company becomes zero.

Calculation Of IRR

Years

Cash Outflow

Cash Inflow

Factors

P.V. ofCash Inflow

P.V. of Cash Outflow

0

20,00,000

1

0

2000000

1

350000

1220000

0.90909

1109091

318182

2

350000

1220000

0.82645

1008264

289256

3

350000

1220000

0.75131

916604

262960

4

350000

1220000

0.68301

833276

239055

5

350000

1220000

0.62092

757524

217322

6

350000

1220000

0.56447

688658

197566

6

500000

0.56447

282237

5595655

3524341

Calculation Of IRR

Years

Cash Outflow

Cash Inflow

Factors

P.V. ofCash Inflow

P.V. of Cash Outflow

0

#######

1

0

2000000

1

350000

1220000

0.89286

1089286

312500

2

350000

1220000

0.79719

972577

279018

3

350000

1220000

0.71178

868372

249123

4

350000

1220000

0.63552

775332

222431

5

350000

1220000

0.56743

692261

198599

6

350000

1220000

0.50663

618090

177321

6

500000

0.50663

253316

5269232

3438993

CF1

 + 

CF2

 + 

CF3

 + ...

 − Initial Investment = 0

( 1 + r )1

( 1 + r )2

( 1 + r )3

Internal rate of return = 10.13%

It explains that the internal rate of return of the project is 10.13%. If the cost of company is lower than this % then the project should be accepted by the company.

Payback period is one of the capital budgeting techniques that are evaluated to analyze the investment opportunity of the company. While calculating the payback period, net cash inflow and outflow is taken into the context to evaluate the total time period that is required by an organization to pull back the outflow of a speculation in terms of profit.

Key Benefits:

This technique is one of the popular techniques of capital budgeting as the calculations of this process is quite simple as well as it expresses about the total time period. It makes it easier for the company and the management to make a better analysis. This technique also evaluates the investment opportunity for small businesses. 

Asset Utilization Ratio Analysis

Payback period process does not take the concern of time value of money as well as it is not useful technique for the long term project. The complexity level of the process is quite higher as well as the process is not much reliable (Fernandes, Lynch and Netemeyer, 2014).

Thus it has been evaluated that this payback period process doesn’t assist the companies to take decision about the long term project. It assists the management of the company to make better conclusion about the new investments.

Discounted payback period is one of the capital budgeting techniques that are evaluated to analyze the investment opportunity of the company. While calculating the payback period, net cash inflow and net cash outflow is taken into the context to evaluate the total time period that is required by an organization to pull back the outflow of a speculation in terms of profit (Gitman and Zutter, 2012).

This technique is one of the popular techniques of capital budgeting as the calculations of this process is quite simple as well as it expresses about the total time period. It makes it easier for the company and the management to make a better analysis. This technique also evaluates the investment opportunity for small businesses. It also takes the concern of the time value of money.

Discounted Payback period process does not take the concern of investments after the payback period. The complexity level of the process is quite higher as well as the process is not much reliable.

Thus it has been evaluated that this discounted payback period process doesn’t assist the companies to take decision about the long term project. It assists the management of the company to make better conclusion about the new investments.

Accounting rate of return is one of the capital budgeting techniques that are evaluated to analyze the investment opportunity of the company. While calculating the accounting rate of return, net cash inflow and net cash outflow is taken into the context to evaluate the total return which would be got by the company.

This technique is one of the popular techniques of capital budgeting as the calculations of this process is quite simple as well as it expresses about the total accounting return of the project. It makes it easier for the company and the management to make a better analysis. This technique also evaluates the total return of the project of small company as well as large company.

Investment Ratio Analysis

Accounting rate of return process does not take the concern of time value of money as well as it is not useful technique for the long term project. It does not express the perfect result (Gambacorta and Signoretti, 2014).

Thus it has been evaluated that this accounting rate of return process doesn’t assist the companies to take decision about the long term project. It manipulates the management of the company to make better conclusion about the new investments.

Net present value expressed about the total return of the company which would be got back by the company after investing into a particular project.

This technique is one of the popular techniques of capital budgeting. The calculation express about the total profit. It makes it easier for the company and the management to make a better analysis. It also takes the concern of the time value of money.

Net present value process does not express a reliable result. It is based on many assumptions. The complexity level of the process is quite higher as well as the process is not much reliable (Horngren et al, 2005)

Thus it has been evaluated that this net present value process doesn’t assist the companies to take decision about the long term project.

The Internal Rate of Return:

Internal rate of return expresses about the total return % of a particular project.

This technique is one of the popular techniques of capital budgeting. It makes it easier for the company and the management to make a better analysis. It also takes the concern of the time value of money.

Calculations of this process is quite difficult as well as it is quite manipulative. The complexity level of the process is quite higher as well as the process is not much reliable (Kaplan and Atkinson, 2015).

Thus it has been evaluated that this internal rate of return process doesn’t assist the companies to make better conclusion about the new investments. 

Internal and external sources of the company:

If the Jonson limited invests into the company than it is required for the company to raise the funds from various sources (Grinblatt and Titman, 2016). The funds could be generated through internal as well as external ways. The given case explains that the  £2,000,000 would be required for the company for 6 years. It explains that the long term investment os required for this project. Following ways could be used to generate the funds:

Johnson Limited Investment Opportunity Evaluation

Company could issue new shares in the market to raise the funds and manage the performance of the company.

Company could also issue new debentures in the market for a limited period of time to raise the funds and manage the performance of the company (Bierman and Smidt, 2012).

Loan could also be taken by the company to raise the funds for a particular investment project of the company.

These sources could assist the company to manage and enhance the level of the company as well as the funds of the company. 

References: 

Airaudo, M., Nisticò, S. and Zanna, L.F., 2015. Learning, monetary policy, and asset prices. Journal of Money, Credit and Banking, 47(7), pp.1273-1307.

Bandy, G. 2013. Financial management and accounting in the public sector. Oxon: Routledge.

Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of investment projects. Routledge.

Borio, C., 2014. The financial cycle and macroeconomics: What have we learnt?. Journal of Banking & Finance, 45, pp.182-198.

Brigham, E.F. and Ehrhardt, M.C., 2013. Financial management: Theory & practice. Cengage Learning.

Deegan, C., 2013. Financial accounting theory. McGraw-Hill Education Australia.

Du, J. and Girma, S., 2009. Source of finance, growth and firm size: evidence from China (No. 2009.03). Research paper/UNU-WIDER.

Fernandes, D., Lynch Jr, J.G. and Netemeyer, R.G., 2014. Financial literacy, financial education, and downstream financial behaviors. Management Science, 60(8), pp.1861-1883.

Galí, J., 2015. Monetary policy, inflation, and the business cycle: an introduction to the new Keynesian framework and its applications. Princeton University Press.

Gambacorta, L. and Signoretti, F.M., 2014. Should monetary policy lean against the wind?: An analysis based on a DSGE model with banking. Journal of Economic Dynamics and Control, 43, pp.146-174.

Gitman, L.J. and Zutter, C.J., 2012. Principles of managerial finance. Prentice Hall.

Grinblatt, M. and Titman, S., 2016. Financial markets & corporate strategy. Prentice Hall.

Horngren, C.T., Sundem, G.L., Stratton, W.O., Burgstahler, D. and Schatzberg, J., 2005. Introduction to management accounting. Upper Saddle River, New Jersey: Prentice Hall.

Jaumotte, F., Lall, S. and Papageorgiou, C., 2013. Rising income inequality: technology, or trade and financial globalization?. IMF Economic Review, 61(2), pp.271-309.

Kaplan, R.S. and Atkinson, A.A., 2015. Advanced management accounting. PHI Learning.

Kiran, R. S., & Singh, V. K. 2014. How to make the financial analysis an easy task – A comparative analysis between the traditional and the modern approach? International Journal of Engineering Research and Applications, 4(8), 61-66.

Kurov, A. and Stan, R., 2016. Monetary Policy Uncertainty and the Market Reaction to Macroeconomic News: Evidence from the Taper Tantrum.

Romney, M.B., Steinbart, P.J., Zhang, R. and Xu, G., 2006. Accounting information systems. Pearson Education.

Shapiro, A.C., 2005. Capital budgeting and investment analysis. Prentice Hall.

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