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Strategic And Financial Decision Making: Ace Printers PLC Add in library

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Questions:

1. Determine which of the proposed pricing strategies would be most attractive to Ace Printers plc, using the following methods of capital investment appraisal:

i) Net Present Value

ii) Internal rate of Return

iii) Accounting rate of return, based on average investment

In addition, clearly explain the rationale for your answers and explain upon which methodology you would place most reliance when considering a capital investment project.
                        
You are not required to take account of taxation.
                                            
2. Beverly Margerison is interested in the capital investment appraisal calculations and mentions that when she was a student she can remember using the Capital Asset Pricing Module in order to calculate a suitable cost of capital for use in determining an appropriate discount factor. She also remembers that the cost of capital for a corporation relies upon the size of the company’s beta factor.

With this in mind she says to you, “I am rather confused by beta as it seems to be rather random. If I look at the beta for two well-known UK registered organisations such as Severn Trent plc and Taylor Wimpey plc, they are 0.77 and 1.23 respectively (Digitallook.com, accessed 29/01/15). How can it be possible that two such companies can have such different betas?

You are required to provide a response discussing explicitly why the betas of the two companies (Severn Trent and Taylor Wimpey) may have such different beta factors and considering the implications of this difference.

3. Provide a critical review of the comments made by Tom Sparkes, the HR Manager, and consider why the source of capital is an extremely important decision for a company and how it may impact upon its investment decisions? You should consider both theoretical and practical    factors.    

4. As Ace Printers plc is expanding quite rapidly it is considering growth strategies into the nearest large market of France. Peter Komakech favours acquiring a French competitor, whereas Beverly Margersion says, “it would be far more sensible to grow organically and carefully.”

You are required to prepare a brief report for the management team providing a critical analysis of the above suggested strategies for growth.
 
 

Answers:

Introduction

The current study will be focusing on studying the business process of Ace Printers Plc and strategies will be assessed that will help the company in generating expected return and market exposure. Further in the study, rationale of the study will be discussed for selection of any particular strategy. On the other hand, the reason behind the difference in betas of two companies, Severn Trent Plc and Taylor Wimpey Plc will be illustrated along with implications so that better result can be gained. A critical review will be made on the suggestion made by the HR manager of the company on source of capital. Moreover, importance of source of capital and its impact on investment decision will be described in brief manner. Lastly, strategies will be studied in relation to expand business in France.

Task 1

 

Strategy 1

Strategy 2

 

 

 

Sales Price

12

11.5

Sales volume

80000

95000

Total Sales

960000

1092500

Increase in Sales Volume

3840

120175

Actual Sales Volume

963840

1212675

Variable Cost

 

 

at 4.50 unit

360000

360000

at 0.10 unit

60384

85267.5

Fixed Cost

165000

165000

Cash Flow

378456

602407.5

 
I. Calculation of Net Present Value

Year

Strategy 1

Strategy 2

Cost of Capital (8.5%)

Present Value of Cash Flow (Strategy 1)

Present Value of Cash Flow (Strategy 2)

1

378456

602408

0.921

348557.976

554818

2

417551

653484

0.849

354500.799

554808

3

459563

708100

0.783

359837.829

554442

4

504385

766181

0.721

363661.585

552417

5

552140

827881

0.665

367173.1

550541

Total Present Value

 

 

 

1793731.289

2767025

Initial Investment

 

 

 

2250000

2250000

Net Present Value

 

 

 

-456268.711

517025


II. Calculation of Internal Rate of Return

Year 1

Strategy 1 (Cash Flow)

Strategy 2 (Cash Flow)

Cost of Capital (18%)

Present Value of Cash Flow (Strategy 1)

Present Value of Cash Flow (Strategy 2)

1

378456

602408

0.8475

320725.42

510515

2

417551

653484

0.7561

315728.54

494128

3

459563

708100

0.6086

279704.23

430972

4

504385

766181

0.5158

260156.17

395188

5

552140

827881

0.4371

241345.48

361874

 Total Present Value

 

 

 

1417659.9

2192677


iii. Accounting Rate of Return

Annual Depreciation

2250000/5

450000

 

Year

Strategy 1

Strategy 2

Annual Depreciation

 Accounting income (strategy 1)

Accounting Income (strategy 2)

1

378456

602408

450000

-71544

152408

2

417551

653484

450000

-32449

203484

3

459563

708100

450000

9563

258100

4

504385

766181

450000

54385

316181

5

552140

827881

450000

102140

377881

Average Accounting Income

 

 

 

12419

261611

Initial Cost

2250000

 

 

 

 

Accounting Rate of Return

Average Accounting Income / Initial Cost

 

 

0.0055196

0.11627

 ARR

 

 

 

0.55%

11.62%


From the above calculations, it is pretty clear that Strategy 2 will be beneficial for the Ace Printers Plc. It can be seen that net present value of Strategy 2 shows a positive and higher value of £51705 in comparison to Strategy 1 which has negative net present value. Moreover, adopting strategy 2 the cash flow of the company will be effectively management would ensure better value and return to the company (Crum, 2013). On the other hand, Ace Printers would be able to add value to the shareholders or investors. Through Strategy 2, the company can be generated enough capital that would help in the growth and expansion of the business. Strategy 1 should be ignored as it accounts negative npv and if company follows this strategy then can be under high debt pressure which would make difficult for them to survive or even may need to shut down the process (Kalyebara and Islam, 2013).

 

Apart from that, the Internal Rate of Return also points that Strategy 2 can be selected. It is known that in a mutually exclusive assignment, the assignment having greater IRR value has to be considered. Therefore, it can be clearly seen that strategy shows higher value in comparison to strategy 1. Therefore, Ace Printers Plc should go for strategy 2. On the other hand, it is also clear from accounting rate of return that strategy 2 ensures higher return up to 11.62% in comparison to strategy 1 which does not even touch 1% rate of return. Thus, strategy 2 will provide higher productivity and Ace Printers would be successful in increasing the market share and better profit (Ortiz-Melina and Phillips, 2010). Moreover, the company would be able to gain higher investors and could be able to increase their earning per share.

2. Severn Trent Plc is a water industry which is based in UK and trade on London Stock Exchange whereas Taylor Wimpey Plc falls under house building industry and it also trade on London Stock Exchange. According to Barndorff-Nielsen and Stelzer (2011), beta is used in order to measure the volatility of the security of the company in relation to the market as an entire scenario. The beta value of Severn Trent is 0.77 and on the other side Taylor Wimpey has a beta value of 1.23. Severn Trent has low beta. The reason is that the security of the company is less volatile in contrast to the market. Apart from that the company accounts low beta as the Severn Trent is taking less risk and playing it safe. As a result of that the return earned by the company is good and return rate is also effective. The stock or security of the company also fluctuates less and due to that their security is in stable mode and ensures better value to the shareholders (Bauwens, Hafner and Pierret, 2012). Therefore, it can be mentioned that security of Severn Trent Plc is largely correlated with the market. Furthermore, it can be pointed that price of the stock of the company does not frequently up and down and as a result, the company acknowledges low beta value. On the contrary, it is known that if any company has a beta lower than 1 then the security is not moving along with the market (Cont and Kokholm, 2011). For instance, if the market ensures10% returns then Severn Trent Plc would gain around 7% from their stock. The investors that does not want invest in riskier portfolios prefers this kind of security that has low beta (Hansen, Lunde and Voev, 2014). Therefore, it helps Severn Trent Plc to engage investors that are risk averse. On the other hand, the low beta ensures a low risk and helps the investor to determine the expected rate of return. Moreover, the Severn Trent Plc uses beta to analyze the market return. The security of the company is moving in a stable way due to that company is able to generate a turnover of 1831.6 million in FY2013 which resulted in an increase of net profit by 32%. In addition it can also be mentioned that company witnessed a total shareholder return of 72% in 2013. Thus, it can be mentioned that an industry with low beta is able to generate higher return as the security are less unstable. It can be understood that in order to run the business in secure manner, the beta value has to be controlled and should not let it increase to higher number otherwise it would generate uncertain risk that may be difficult for the company to control (Jaye, 2013).

 

On the other hand, it can be seen that beta value of Taylor Wimpey Plc is high which reflects that price of the security of the company is more volatile and there is high fluctuation its price.  As a result of that, the company is facing problem in engaging potential investors. Moreover, it can be difficult for the investors to predict the actual value of the price of security in future. Therefore, the security of Taylor Wimpey is 1.23 times is volatile in comparison to the overall market. Due to that, the growth in profit of the company is slow. The company only registered a growth in profit by 18% in comparison to overall market (Kaeck and Alexander, 2013). Apart from that, Kanas (2012) discussed that stocks with higher beta possess higher risk and such kind of stocks may not be preferred by the investors that are risk averse. On the contrary, the investors that are risk inverse would be willing to invest in such kind of stocks. The reason is that such kind of stock has a potential to declare higher returns. Therefore, the stock with beta value more than one would be selected by the investors that are not risk averse. For example, if the market provides a return of 20% on investment then the company can expect that they can get a return of 24.6% which quite better for any industry.  On the other hand, if the market ensures an expected return of 10% with a risk free rate of 2% the return would be 11.84% (=2% + 1.23(10%-2%) with the beta of 1.23 which may not be possible for the company that seeks for low beta (Koutmos, 2011). Apart from that, it can be mentioned that Taylor Wimpey Plc invest in more risky stocks and assets and due to that the company has higher beta value than Severn Trent Plc. Overall it can be mentioned that both lower and higher beta value is productive for the industries if the nature market is studied with highest concentration.

3. The suggestion of HR manager, Tom Sparkes to borrow the capital would be advantageous for the company. The company can borrow capital either as a medium term loan or short term loan. In medium-term loan, the company would be paying the interest over the period of ten years (Wang, 2013). On the other contrary, Ace Printer Plc has to assess their riskiness and credit payment capability. Moreover, borrowing capital would not allow taking ownership position in the company. The company can gain benefit in terms of tax as the interest on the bank loan for business is tax-deductible. Therefore, the company would be able to finance their operation quite effectively or can buy required materials and equipments for increasing the production of printer cartridges. On the contrary, in order to borrow the capital, the company may need to present their track record and may have to prove that they can clear the loan amount in due time (Serafimov and Berk Skok, 2013). If the company fails in repaying the borrowed amount then bank or lending institution may seize the property of the company and can file a case. As a result, it can affect the business of Ace Printers Plc largely. Apart from that, the thought of bank overdraft by manager holds both negative and positive side. Through overdraft, the company would be able to generate more capital over their bank account balance (Rehman, 2010). Moreover, the company may not be liable to deposit any documents for it. Therefore, Ace Printers can have to good cash flow for their business. On the other hand, the company may have to also face consequences of overdraft in the form of fees and interest as interest on overdraft is often at higher rates in comparison to loans. Furthermore, the company may need to deposit their business assets as a security in order to avail the advantage of overdraft (Radosław Kurach, 2013).

 

As per Ortiz-Melina and Phillips (2010) in order to run the business, an appropriate source of capital has to be acknowledged in order to finance different activities of the business or company. There are different source of capital such as long term and short term which is largely used by many industries to finance their operation or either for expanding their business. Using the source of capital, Ace Printers Plc would be able to stock printer cartridges so that whenever there is a demand from the computer industries then a prompt service can be delivered. On the other hand, the capital sources would be effective in enhancing the supply chain (Mathew, 2011). The company would be able to warehouse required materials and product could be delivered to customers with no damage. As a result, it can create a good impression of the company among the clients. Moreover, company would be able to build strong relationship with can be in a position to higher revenue and sales. The source of capital is important as company would be able to generate required capital in order to become more liquid and make investment necessary projects or assets that would ensure better return (Maringer and Ramtohul, 2011). There are number of ways to source capital such as bank lending, right issue, loan stock, retained earnings, finance lease and others. This helps in overcoming the shortage of capital and meeting the requirement of capital so that business process can be improved and expanded so that the company can strongly trade on stock exchange and provide better value to the shareholders (Li, 2013).

On the other hand, source of capital can have significant impact on the investment decision as well. The company can plan their capital source that which source would be useful and could meet up the expectation of capital. For instance, if the company prefers bank to borrow funds then the company would have also consider the interest payment and if the company is not able to generate enough return from the business then it can lead to burden on the company (Kaeck and Alexander, 2013). As a result, the investment of the company may fall and would affect the business prospect. Therefore, the company has to take all account of their strength and weakness in order to meet the required capital expectation. On the contrary, the source of capital can have positive impact too on the investment decision. For example, if the company wants to invest in the production of printer cartridges in bulk number then selecting appropriate source of capital can help in meeting this objective (Mathew, 2011). As a result of that, the company would be able to meet the increasing demand of the computer industry or other clients. Therefore, it would help the company in gaining advantage from their investment decision. Apart from that, financing the activities can help in gaining competitive edge and also Ace Printers Plc could be able to penetrate into other market with their product and service.

4. The strategies of growing carefully and sensibly would be valuable for the business prospects of Ace Printers. It is known that a business success when they have patience to and make progress step by step. As a result, company is able to register better market growth and better revenue from the market in which the business is operating. In the given case, Ace Printer Plc would be able to penetrate into the market of France. It is understood that computer industry in France uses printer cartridges for carrying different activities. Therefore, moving the business into France would help the industry in generating large customer base and building strong relationship with number of clients from whom the Ace Printers Plc gain build strong channel for supplying the printer cartridges at expected level (Vickman, Larsson and Olsson, 2012). Apart from that, moving sensibly would help in understanding the actual requirements of the clients and better understanding of the market. As the company is growing at better pace then the company should not be in hurry to apply any strategies without proper research. However, going organically and sensibly would help in creating impressions among the customers and clients in France (Tagarev, Georgiev and Ivanova, 2012). As a result, it would help in enhancing the brand value of the company and would be able to give tough competition to the competitors that are present in France market. On the contrary, as the company is medium-sized industry and wants to operate in large market then the company may need to focus on their business and enhancing the production capacity so that production of printer cartridges can be met at expected level. Therefore, the demand of the market and customers can be achieved in successful manner (Shimokawa et al., 2012). On the other hand, the Ace Printers Plc would be able to understand the actual requirements of the computer industry or clients in France so that cartridges can be produced according to their demand and expectation.

 

Apart from that, the strategies of engaging with French competitor would be effective as well. By acquiring French competitor, the company may not need to investment in acquiring any property for starting the business. Therefore, the company would be able to save additional cost. On the other hand, the company would not have to hire other employees as they would gain quality employees of the competitor that can help in providing details about the actual preference and taste of the customers (RadosÅ‚aw Kurach, 2013). Therefore, as a result, the company would be able to produce the product as per clients’ expectation. Moreover, it will save the cost of training and development of workers and company can use that capital for improving the infrastructure of the company and business process. Apart from that, the company would not have to invest capital in buying equipments or machine for the manufacture of printer cartridges. The company can make use of the fixed assets of the competitor (Tagarev, Georgiev and Ivanova, 2012). However, the company can invest certain capital for up gradation of the system so that quality product can be accumulated and as a result, the company would be able to engage the clients and providing higher customer satisfaction. Therefore, it would help in generating high sales and strongly operate in the market. Furthermore, the company could gain exposure very soon by acquiring French competitor which will be effective for the growth and development of Ace Printers. On the other hand, the company should be careful in selecting the competitor otherwise it could be a problem for the company in running their business and gaining expected clients (Wang, 2012).

Conclusion

From whole study, it can be concluded that Net Present Value is effective along with IRR and ARR in order to accept any project or strategy that can ensure better value to the company. It has been found that strategy 2 is important for the Ace Printers Plc to gain higher benefit. Apart from that source of capital is useful for financing the activities and buying the profitable assets. On the other hand, beta helped in understanding the reason behind difference in beta between two industries. The movement of security price is the reason behind the beta difference. Further, the strategy of acquiring French competitor and going organically and carefully is both beneficial for Ace Printers Plc to make their mark in France.

 

References

Barndorff-Nielsen, O. and Stelzer, R. (2011). The Multivariate Supou Stochastic Volatility Model. Mathematical Finance, 23(2), pp.275-296.

Bauwens, L., Hafner, C. and Pierret, D. (2012). Multivariate volatility modeling of electricity futures. Journal of Applied Econometrics, 28(5), pp.743-761.

Belanová, K. (2012). "What If" Analyses in Investment Decision Making. FAI, 3(3), pp.5-16.

Cont, R. and Kokholm, T. (2011). A Consistent Pricing Model For Index Options And Volatility Derivatives. Mathematical Finance, 23(2), pp.248-274.

Cooper, R. and Schott, I. (2013). Capital reallocation and aggregate productivity. Cambridge, Mass.: National Bureau of Economic Research.

Crum, R. (2013). Capital budgeting under conditions of uncertainty. [S.l.]: Springer.

Hansen, P., Lunde, A. and Voev, V. (2014). Realized Beta Garch: A Multivariate Garch Model With Realized Measures Of Volatility. Journal of Applied Econometrics, 29(5), pp.774-799.

IMA., (2012). Wiley CMA Learning System Exam Review 2013, Financial Planning, Performance and Control, + Test Bank. Hoboken: Wiley.

Jaye, N. (2013). The Volatility of Volatility. CFA Institute Magazine, 24(5), pp.36-39.

Kaeck, A. and Alexander, C. (2013). Stochastic Volatility Jump-Diffusions for European Equity Index Dynamics. European Financial Management, 19(3), pp.470-496.

Kalyebara, B. and Islam, S. (2013). Corporate governance, capital markets, and capital budgeting. New York: Springer.

Kanas, A. (2012). Implied Volatility And The Risk-Return Relation: A Note. Int. J. Fin. Econ., 18(2), pp.159-164.

Koutmos, D. (2011). Time-varying beta risk, volatility persistence and the asymmetric impact of news: evidence from industry portfolios. Global Business and Economics Review, 13(1), p.42.

Li, C. (2013). Bessel Processes, Stochastic Volatility, And Timer OPTIONS.Mathematical Finance, p.n/a-n/a.

Maringer, D. and Ramtohul, T. (2011). Regime-switching recurrent reinforcement learning for investment decision making. Comput Manag Sci, 9(1), pp.89-107.

Mathew, J. (2011). Engineering asset management and infrastructure sustainability. London: Springer.

Ortiz-Melina, H. and Phillips, G. (2010). Asset liquidity and the cost of capital. Cambridge, Mass.: National Bureau of Economic Research.

Pavkov, I. and Jocic, D. (2012). Using decision trees for investment project evaluating. Skola biznisa, (4), pp.65-69.

RadosÅ‚aw Kurach, R. (2013). Does Beta Explain Global Equity Market Volatility – Some Empirical Evidence. Contemporary Economics, 7(2), p.55.

Rehman, A. (2010). Gulf capital & Islamic finance. New York: McGraw-Hill.

Serafimov, D. and Berk Skok, A. (2013). Capital budgeting decision-making in Telecom sector using real option analysis. Ljubljana: [D. Serafimov].

Shimokawa, T., Kinoshita, K., Miyagawa, K. and Misawa, T. (2012). A brain information-aided intelligent investment system. Decision Support Systems, 54(1), pp.336-344.

Tagarev, T., Georgiev, V. and Ivanova, P. (2012). Analytical Support to Critical Infrastructure Protection Policy and Investment Decision-Making. Information & Security: An International Journal, 28, pp.13-20.

Vickman, S., Larsson, A. and Olsson, L. (2012). Prerequisites for decision aid in socially responsible investment appraisals. International Journal of Engineering Management and Economics, 3(4), p.359.

Wang, Y. (2012). Capacity Investment Under Responsive Pricing: Implications of Market Entry Choice*. Decision Sciences, 43(1), pp.107-140.

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