WM322 Industrial Financial Decision Making & Risk Analysis April 2020 Coursework

1)

ABC Ltd is a large wholesaler of electrical goods formed four years ago by the amalgamation of two smaller companies. Extracts from its annual accounts are shown below.

Early in year 4, one of ABC's most important suppliers insisted that all future deliveries should be paid for on or before delivery. As a result of this, ABC decided not to use this supplier and to source its goods elsewhere.

Management were aware that sales were significantly down in year 4 and had taken the prudent step of drastically reducing ABC’s overheads. Staffing levels had been reduced at each of the depots and in every department at head office, including marketing and accounting.

Due to cost cutting, ABC’s 'quarterly' catalogue, from which most of its sales originate, had been revised only once during the year.

The accounts section lost one-third of their staff and could not keep up with the demand for information. They usually produced management accounts on a quarterly basis but the last set produced was for the first quarter and these were not completed until the middle of month 5.

The chief accountant made a positive decision to concentrate on cash management in order to keep the business afloat.

Early in the year, the chief accountant realised that the company was going to breach its overdraft limit of £110,000. He approached ABC's bank who agreed to increase this to £120,000. But just before the end of the year, he had no choice but to ask the bank for a further increase of £25,000. Very reluctantly, the bank agreed to this, but only on a temporary basis for three months.

As soon as the accounts for year 4 were approved by the auditors, the management team held a meeting to discuss the results. They were aware that, due mainly to a downturn in the house-building market, year 3 had been disappointing compared to year 2.

 It had been assumed that its results would be worse than those of the previous year but when the pre-tax loss of £40,000 was announced, the directors were shocked.

It seemed to them that the drastic cost-cutting exercise of last year had been in vain. They could not see any other overheads that could be reduced without directly harming the business – all the fat had been dispensed with. In fact, they knew that there were certain areas which were in desperate need of more money being spent on them rather than less. They realised that immediate remedial action was necessary, but they did not know what to do or where to start.

Task:

Analyse the company's performance and advise management on the action it should take to restore this to the levels achieved in previous years.

(Assume that the stock at the start of year 1 was valued at £50,000.)

Extracts from profit and loss account (all figures in £000)

2)

Recently a director of a client company said the following to you.

“Over the weekend I was reading an article on finance in a Sunday newspaper. It said that as shareholder wealth maximisation is the generally accepted corporate objective, net present value is the most logical approach to investment appraisal. It then went on to say that the “capital asset pricing model” is the best way to find the appropriate discount rate to use. This is apparently because you can use the average rate of return from other businesses; also it ignores the specific risk of the investment concerned.

This all seems nonsense to me. These days corporate management needs to be concerned with more than just the shareholders. What about all of the other groups who contribute to the business? They can’t be ignored. Even if shareholders’ wealth were the key issue, I don’t see how NPV fits in. Surely internal rate of return is more to the point because it favours investments that get the best returns and cover financing costs. Those investments will make the shareholders richer. As for CAPM, it seems to defy all logic. It can’t be correct to ignore the returns that the investing business seeks and just concentrate on other businesses. Risks must be taken into account. In our business we compare weighted average cost of capital with the IRR and this seems more logical than using CAPM.

The article also said that, in theory, it doesn’t make any difference to the shareholders whether new finance is raised from a share issue or a loan stock issue as they both cost the same. We raise all of our new finance from retained earnings, which doesn’t cost anything, but loan finance has a cost.”

Draft a reply to the director, bearing in mind that he is clearly not very well informed on finance.

25 Marks

 

3)

Johns Limited is considering investing in some new plant. The plant would cost £1,000,000 to implement, it would last 5 years, and it would then be sold for £50,000. The relevant profit and loss accounts for each year during the life of the project are as follows:

Additional information:

•        All sales are made and all purchases are obtained on credit terms.

•        Outstanding trade debtors and trade creditors at the end of each year are expected to be as follows:

Year

Trade debtors

Trade creditors

 

£000

£000

20X1

200

250

20X2

240

270

20X3

300

330

20X4

320

300

20X5

400

150

•        Expenses would all be paid in cash during each year in question.

•        Taxation would be paid on 1 January following each year end.

•        Half the plant would be paid for in cash on 1 April 20X0, and the remaining half (also in cash) on January 20X1. The resale value of £50,000 will be received in cash on 31 March 20X6.

Required:

•        Calculate the annual net cash flow arising from the purchase of this new plant.

•        If the cost of capital is 8%, evaluate the proposed investment using the following techniques:

•        Payback,

•        Return on Investment,

•        Net Present Value,

•        Discounted Net Present Value,

•        Internal Rate of Return.

•        Given the results of the above, how would you advise the company and why?

 

25 Marks

 

 

 

 

 

4)

Using the extracts from the Annual Reports of BP plc;

Evaluate the company’s performance selecting the tools you believe appropriate from this or any other module.

Compare and contrast the results discussing the current day situation.

Advise an investor whether to invest in this company giving detail as to your recommendation.

25 Marks

 

General Instruction:  The total report should not be more than 3000 words (with a maximum of 10% deviation) plus calculations.