Investment Appraisal and Financial Analysis for SLF Ltd

SLF Ltd is a garden landscaping and fencing company based in South Wales, in the UK. The company was founded 7 years ago by the original owner of the company, Philip Jones (Phil). Phil has worked in the gardening and maintenance sector for over 14 years, and he has a wealth of knowledge, experience, and contacts. The company has expanded organically since it was founded and now employs around 25 people, the success of the company is based upon delivering a very high quality of service and growing the business via word of mouth and customer recommendations.

SLF is a limited company (Ltd), and the directors are Phil, and his daughter, Megan. Megan recently became a director of the company and has a degree in business and marketing, she is very keen to grow the company beyond its current geographical region. She has plans to expand into the Southwest of England and has gathered some figures in terms of costs and potential incremental revenues that could be generated from the planned expansion.

Phil is also keen to explore the options of expanding the business, but is more sceptical than Megan, as he is far more risk averse and doesn’t necessarily fully understand the numbers that Megan has produced. Although Megan has a business education background, she does not have full understanding of financial evaluation techniques, such as investment appraisal.

To enable the expansion of the business the company would need to invest in new capital equipment and new premises. The investment would include the purchase of new vehicles and vans, digging machinery and tree felling equipment. They would also have to rent a new storage and warehousing yard in the Bristol area, this would be required to effectively supply and service new customers in the Southwest of England region.

Investment in working capital would be required to ensure enough inventory of fencing materials are held. This is needed due to recent supply issues surrounding timber materials, which has led to some customer complaints.

The investment would be funded via borrowing from the bank, and to secure the investment the bank is requesting a full financial analysis, including Net Present Value and Internal Rate of Return calculations.

Although SLF Ltd does employ a bookkeeper and accounts assistant, they do not have the necessary skills to undertake the full financial analysis that the bank requires. Therefore, Megan has approached a local accounting and business advisory company to assist in the production of the financial information required by the bank.

The company that Megan has approached and now appointed, One Accountancy Ltd, is a small to medium sized firm of accountants based in Chepstow. The owner of One Accountancy, Virat Rahul, is keen to attract new clients that require business advisory services, as these types of services are higher margin than the more traditional accounts preparation services that the company has traditionally delivered to clients.

The Accounting and Business Advisory Company

Virat has recently employed several graduate accountants and he is supporting their ACCA studying and training courses. These are the members of the team at One Accountancy that will be providing the business advisory services for SLF Ltd, their work will be overseen by Virat himself.

You are the team that Virat has assembled to work as business advisors who will be providing the advisory services to SLF Ltd. As the planned expansion is dependent upon financing from the bank, you will need you to compile a financial information package, which will include investment appraisal analysis, for SLF Ltd, to include the information outlined in the specific requirements below.

Specific Requirements

1. Using the financial data given below you are required to prepare appropriate investment appraisal analysis to assess the viability of the investment. (40% of mark)
2. You are also required to write a business report to the directors of SLF Ltd, informed by the information you have calculated in requirement 1 above. This report must address:
3. Whether or not the investment should be undertaken.
4. The advantages and disadvantages of the investment appraisal methods you have used to assess the project.

As Phil and Megan do not fully understand the investment appraisal techniques that will be used, they have requested that you provided information regarding the wider benefits and issues that might be associated with the use of the IA techniques. Therefore, contained within the business report, a balanced argument must be presented as to why investment appraisal techniques are important (or otherwise) in financial decision making, how widely used are the specific techniques, and how effectively they are used in financial decision making. To be able to present this argument effectively there must be evidence of engagement with relevant academic literature which must be clearly referenced within the report. (60% of mark)

10% of the business report marks will be awarded for presentation.

The team at One Accountancy has agreed a number of KPIs (Key Performance Indicators) in terms of the financial appraisal of investments it undertakes. These are shown after the financial data below.

SLF Ltd is intending to invest in new capital equipment and premises to undertake the planned expansion into the Southwest of England. Having undertaken some market research, Megan has provided the following financial information to the team at One Accountancy.

The cost of the new equipment will be £350,000 and is expected to last for four years. The residual value of the equipment at the end of the investment period will be £50,000 (in money terms). These initial capital costs are for vans, vehicles, digging machinery and tree felling equipment. The additional storage and warehousing space (i.e., the premises) will be rented and the rental costs are included in the fixed costs below.

Megan has worked with Phil regarding the potential business opportunity, and they have predicted the following increased sales volumes. These volumes represent the increased number of jobs that they will be able to complete, given the expansion. Incremental volumes in completed jobs over the next 4 years are as follows:

Year	1	2	3	4
Additional volumes (No. of jobs)	360	385	405	410

Based on their current selling prices and after undertaking market research, the average price for a job has been ascertained as £1,450.00 per job and the average variable cost of completing each job has been estimated at £950.00 per job. Annual incremental fixed production overheads are expected to be £40,000 per annum, as a result of the decision to undertake the expansion. The prices, variable costs and fixed costs are in real terms.

Prices, variable costs and fixed costs are expected to increase due to inflation as follows: -

Average price per job                                                                                     2.00% per annum

Average variable cost per job                                                                         3.00% per annum

Fixed costs and overheads                                                                              5.00% per annum

The business advisory team at One Accountancy ascertained the following information for the cost of capital:

Real cost of capital                           5.00%

General Inflation                              1.90%

As part of their discussions, Megan and Phil have budgeted for the following increased marketing budget (in money terms): -

Year	1	2	3	4
Expenditure	£15,000	£17,000	£18,000	£18,500

 

Additional transportation costs associated with the project are as follows:-

Year	1	2	3	4
% of sales revenue	1%	1.2%	1.4%	1.4%

 

The working capital requirements associated with the project are (in money terms): -

Year	1	2	3	4
Expenditure	£15,000	£18,000	£22,000	£24,000

Other market research costs already incurred on the project have amounted to £17,000.

SLF Ltd pays corporation tax at the rate of 18% and there is a one-year delay on paying tax. Capital allowances can be claimed at 25% on a reducing balance basis.

As part of discussions with Megan and Phil, the team at One Accountancy have advised upon and agreed the following KPIs:

Payback Period                                                Less than 3 years

Target Accounting Rate of Return (ARR)              22%

NPV                                                                 Must meet general decision rules

IRR                                                                   Must meet general decision rules