Financial Analysis and Investment Decisions

Notes to the financial statements

¨ During the year ended 31 December 2018, Lisbon Limited disposed of several items of plant and equipment with a net book value of £10,000,000 cash. The loss on disposal of £2,000,000 has been deducted to achieve the operating profit figure.

¨ New property, plant and equipment was bought during the year.

¨ Depreciation charged on property, plant and equipment during the year amounted to £15,000,000.

¨ During the year to 31 December 2018, Lisbon Limited issued shares for cash and paid a cash dividend of £12,000,000.

¨ Tax of £9,500,000 was paid in cash during the year.

¨ During 2018, part of the bank loan was repaid.

Required:

a) Prepare the statement of cash flows for Lisbon Limited for the year ended 31 December 2018 using the indirect method.

b) Explain 3 key areas a user of the financial statements would look for when analysing the Lisbon Limited’s cash flow statement.

Question 2

Greece is public entity which has grown in recent years by acquiring established businesses. The following financial statements for two potential target entities are shown below for the year ended 31 December 2018. They operate in the same industry sector and Greece believes their shareholders would be receptive to a takeover. A suggestive price for 100% purchase of the entities is £12 million each.

Required:

a) Using the information above, calculate the following ratios for both companies for the year ended 31 December 2018:

Gross profit percentage

Operating profit percentage

Profit after tax percentage

Non-current asset turnover

Earnings per share

Dividends per share

Your calculations should be made to two decimal places where necessary.

b) Using the above information and the ratios calculated in part (a), assess the relative performance of Crete and Kos for the year ended 31 December 2018 in order to assist the directors of Greece to make a purchase decision.

c) Explain the limitations of your evaluation in part (b) above and identify further information that would have improved your analysis.

The company directors are considering the following changes to increase capacity:

i) Reducing the selling price to £45 would increase demand to 85% of capacity without any increase in fixed costs.

ii) Reducing the selling price of £50 by 20% would enable the company to use 100% of its production facility but would require a fixed annual increase in administration expenses of £4,000.

Required:

a) Calculate the break-even point and the margin of safety based on the figures given in the budget for the coming year.

b) Present calculations to support the directors in evaluating the two alternative proposals and make a recommendation on which option (if either) should be adopted.

Required

a) For the new equipment project calculate:

¨ Payback

¨ The accounting rate of return

¨ The net present value (

b) Using the information on cash inflows and the results of your investment appraisal calculations in part a), advise whether the investment in the new equipment should go ahead, providing reasons for your recommendation.

c) Explain the advantages and disadvantages of using net present value when making capital investment decisions.

Required:

a) Calculate the following ratios for 2019 and 2018 for Paris Limited:

Current ratio

Quick ratio

Inventory days

Receivable days

Payables days

Cash conversion cycle

Debt ratio

Gearing ratio

Your ratio calculations should be made to two decimal places where necessary.

Evaluate the liquidity, working capital management and long-term solvency of Paris Limited.