assignment two steps 7-10€¦ · web viewassignment two steps 7-10. s0229696 – sharnie...

Assignment TWO Steps 7-10

S0229696 – Sharnie Lightbourne

ACCT11059 Accounting, Learning

and Online Communication

Table of ContentsSTEP 7....................................................................................................................................................3

Contribution Margin..........................................................................................................................3

Resource constraints.........................................................................................................................4

Market constraints............................................................................................................................4

STEP 8....................................................................................................................................................5

Number of issued ordinary shares.....................................................................................................5

Market price per share......................................................................................................................5

WACC.................................................................................................................................................5

Profitability Ratios............................................................................................................................5

Net Profit Margin...........................................................................................................................5

Return on Assets............................................................................................................................5

Efficiency (or Asset Management) Ratios.........................................................................................5

Days of Inventory...........................................................................................................................5

Total Asset Turnover Ratio............................................................................................................5

Liquidity Ratios.................................................................................................................................6

Current Ratio.................................................................................................................................6

Financial Structure Ratios.................................................................................................................6

Debt/Equity Ratio..........................................................................................................................6

Equity Ratio...................................................................................................................................6

Market Ratios....................................................................................................................................6

Earnings per Share (EPS)................................................................................................................6

Dividends per Share (DPS).............................................................................................................6

Price Earnings Ratio.......................................................................................................................6

Ratios Based on Reformulated Financial Statements......................................................................7

Return on Equity (ROE)..................................................................................................................7

Return on Net Operating Assets (RNOA).......................................................................................7

Net Borrowing Cost (NBC).............................................................................................................7

Profit Margin (PM).........................................................................................................................7

Asset Turnover (ATO).....................................................................................................................7

Economic Profit.............................................................................................................................7

STEP 9....................................................................................................................................................8

STEP 10 – Feedback.............................................................................................................................10

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This report contains Steps 7 to 10 of ACCT19059’s Assignment Two

Link to my blog – Sharnie’s Blog

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For this step I have selected three products from the brand Cerruti 1881, one of the businesses of Trinity Group. The three products I have chosen are:

Sunglasses€

Blazer€

Belt€

Selling Price 153 650 125

Variable Cost 137.70 585 112.50

Contribution Margin 15.30 65 12.50

The Contribution Margin measures the contribution to profit by each individual product/service or group of product/services, it compares how profitable each product/service is. The Contribution Margin is measured as the selling price less variable cost. Variable costs are the prices that vary with the quantity or products or services produced. The two products of Cerruti 1881 that I have selected above – Sunglasses and Belt have similar contribution margins because the selling price is close in value and the variable cost to produce the items, I have also estimated to be similar (90% variable cost). If there was a decrease in the market price of leather, for example, the variable cost of the belt would decrease, and thus an increase in the contribution margin. The Blazer however, has a noticeably higher contribution margin, this is because the selling price is higher and the variable cost (also estimated at 90%) is also higher.

Cerruti 1881 might produce a range of products with different contribution margins instead of producing the product with the highest contribution margin to cater for the demands of customers.

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STEP 7

If they are only selling the product with the highest contribution margin and then experience a constraint (resource or market or both) they could lose profits – demand drops equal profit drops. If they sell multiple products with different contribution margins, and they have a fall in sales of the product with the highest contribution market then they can make up for these losses with sales of other products. Also, when a customer is shopping for clothing, they often want a variety of choices or will be looking for more than one product (if they buy a pair of pants, they may also want a shirt and tie to match), by catering for the customers wants, a company can gain more sales instead of the customer going elsewhere.

When a company is choosing which products/services they should sell, they choose what is called a product mix. This is the relative amount of each product manufactured or service provided by a company. Product mix decisions can have a significant impact on the company’s profitability. Managers should choose a product mix that maximizes total profits, that is choosing the product mix that maximizes total contribution margin. If company faces a market constraint or resource constraint, that is limited resources or limited demand for each product, this affects the quantity of each product that can be produced, and consequently the total contribution margin that can be earned.

Resource constraints are limitations on resources necessary to produce a product or service, such as: staff, equipment, materials, etc. Although Cerruti 1881 may not have any current resource constraints that limit how much of a product they can sell, an example of a resource constraint that they could possibly face could be if the price of materials used to produce the product increases it could be harder to acquire the material, for example the virgin wool used to produce the blazer, or leather used to produce the belt.

Market constraints are limiting factors in the market such as, competitors, regulations, customers, and demands. Examples of regulations that Cerruti 1881 could face could include: regulations of the retail market in the countries it sells its products in (Honk Kong, Taiwan, Japan, South Korea, Singapore), demand for the products that the brand sells.

These constraints are relevant when deciding which (and how much) of the three products or services of Cerruti 1881 should produce and sell because if there is a resource constraint such as a scarce resource, the company must decide the best way to allocate the scarce resource to production operations to maximise company profit. This is done by considering the contribution margin per unit of the scarce resource; the product with the highest contribution margin then would be selected. When there is a market or demand constraint, this indicates the maximum sales that can be achieved. Both constraints need to be considered when selecting a product mix in order to achieve the best alternative.

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Number of issued ordinary shares The number of issued ordinary shares I found were listed in the notes to the financials in the annual reports, these do not seem to have changed over the years.

Market price per share The market price per share was a little harder to find, I could not find these in the annual reports so I had to use the Hong Kong stock exchange historical data to obtain these.

WACCFor this I used the 10% as advised by Maria.

Profitability Ratios

Net Profit MarginThis is the amount of net profit per sales made. In 2013 and 2014 these are positive as sales were up and they outweighed the amount of expenses. In 2015 sales dropped significantly, creating a negative net profit margin. Again in 2016, it is negative and significantly lower again as sales continue to fall and they incur restructuring costs.

Return on AssetsThis represents the overall productivity of the company. It shows how profitable the company is in relation to its total assets. For Trinity Limited, it appears that over the years the return on assets is decreasing which means they have put more into capital than they are receiving back in profit.

Efficiency (or Asset Management) Ratios Days of InventoryThis ratio had me confused after following the example of Wesfarmers. Trinity Limited appeared to have inventory in the balance sheet, but no inventory expenses in income statement. After looking at the Notes to the Financial Statements, I found (in Note 24) that the inventory expenses (including raw materials, work-in progress and finished goods) were all included in cost of sales. I am a little unsure whether I have calculated this ratio correctly or not, because my figures are relatively high compared to those of the Wesfarmers example and those of other students’ companies.

Total Asset Turnover RatioThis measures how much is made in sales per dollar of assets. For Trinity Limited these started at 0.44 in 2013, increasing in 2014, decreasing in 2015, and again decreasing in 2016. Therefore in 2013, for every $1 worth of assets, the company earns 44 cents in revenue and by 2016, for every $1 worth of assets, the company earns 35 cents in revenue.

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STEP 8

Liquidity Ratios

Current RatioThis ratio is used to indicate a company’s ability to pay back its liabilities with its assets. Trinity Limited’s current ratio follows the same pattern as its total asset turnover ratio; in 2013 it starts at 1.18 increasing in 2014 then decreasing in 2015 and again decreasing in 2016 to 1.15. This appears to be attributable to an increase in debt and a decrease in

Financial Structure Ratios

Debt/Equity RatioThis ratio indicates the relative portion of shareholders equity and debt used to finance a company’s assets. For Trinity Limited, in 2013 this started at 78 cents was put in from other sources for every dollar the shareholders put in. This decreased in 2014 to 51 cents for every dollar put in by shareholders, this is considered good as it shows the company has less reliance on others to put money into it. By 2016 though, it sits at 87 cents for every dollar put in by shareholder, this is high.

Equity RatioThis measures the amount of assets that are financed by owner’s investments. This started off in 2013 at 56% and increased in 2014 and 2015, but has dropped in 2016 to 53% which is good. This is still concerning as it is still very high, and still needs to decrease more before the ratio starts to look good.

Market Ratios

Earnings per Share (EPS)This is net profit divided by number of issued ordinary shares. This ratio does not look good. Firstly, in 2015 and 2016 it is a negative, which is due to the net profit of the company actually being a loss in both years. The number of ordinary shares issued has not changed over the 4 years according to the annual reports so the change in the ratio is due to the change in net profit over the years.

Dividends per Share (DPS)This is the amount of dividend that the shareholders receive on a per-share basis. By looking at this ratio, we can see that it declines rapidly from $20.30 in 2016 to $10.83 in 2014 and $4.30 in 2015 to eventually zero dividends paid in 2016. This is because in 2013 the company was profitable, and although declining the how profitable it was each year, it was still making a profit in 2014 but by 2015 it was no longer making profit, instead it was running at a loss, hence why in 2016 no dividend was paid because there were no profits to share with its shareholders.

Price Earnings RatioThis ratio is the price an investor is willing to pay for a share in the company relative to its earnings. This ratio, to my understanding, tells me that the shares of the company are not worth a whole lot. This ratio is decreasing from 2013 at 0.14 to 2016 at 0.023.

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Ratios Based on Reformulated Financial Statements

Return on Equity (ROE)This measures how much profit is being generated per dollar of shareholder equity. This ratio is positive in 2013 and 2014, although still not excellent, and decreases to become negative in 2015 and 2016 due to the company running an overall loss in both years.

Return on Net Operating Assets (RNOA)This calculates the return on the company’s assets that are generating revenue. It’s a good indicator of how well a company uses operating assets to create profit. Comparing the RNOA with the ROA, the difference is that the RNOA only accounts for the operating assets and does not include the financing assets. Looking at both these ratios, there is not a lot different, they both decline over the 4 years to become negative. As I mentioned above, this is due to the company making a loss for the 2015 and 2016 years.

Net Borrowing Cost (NBC)This is the average interest rate the firm is paying on its financing. The first thing I looked at when looking at this ratio was the net operating assets, this looks good because the total operating assets have increased from $4,598,836,000 to $4,920,561,000 in 2016 and the liabilities have decreased from $1,248,398,000 to $1,057,574,000. This is a good thing because it means less borrowing equals less interest to pay on borrowings. The other factor effecting this ratio is the operating income after tax which over the years is not looking good as it decreases to become negative in 2015 and 2016.

Profit Margin (PM)This measures the amount of net income earned with each dollar of sales generated. Comparing the PM to NPM, in 2013 the PM is just higher than the NPM but then in 2014-2016, the NPM is higher than the PM. The overall gist of the decline in the ratio from 2013 to 2016 is mainly due to the dramatic decrease in revenue over the years.

Asset Turnover (ATO)This measures the value of a company’s sales or revenues generated relative to the value of its assets. Comparing the ATO to the TATO, the following the same pattern of decreasing from 2014 – 2016. However, the ATO in 2013 – 2014 decreases from 0.80 to 0.76, while the TATO increases from 0.44 to 0.51. After looking in to this, I found that this is because TATO accounts for total assets but ATO only accounts for operating assets. So, although in 2013 – 2014 operating assets increased thus decreasing the Asset Turnover Ratio, the financial assets also increased so when taking that into account in the Total Asset Ratio Turnover it increases it.

Economic ProfitEconomic profit is the difference between the revenue received from the sale of an output and the opportunity cost of the inputs used. That is revenues earned less opportunity costs. I have used the recommended 10% cost of capital here. The Economic Profit for Trinity Limited is looking quite bad. Firstly, it is a negative as it is operating at a loss, quite a significant loss. Their operating assets do not seem to be performing and producing profit. Overall, the company does not seem to be running very well and there are a lot of areas that management need to address.

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CAPITAL INVESTMENT DECISION FOR TRINITY LTD

I have developed the following capital investment decision for Trinity Limited.

Trinity Ltd is a Hong Kong based company principally engaged in the retailing and wholesale of premium menswear and licensing of brands. The company operates in Chinese Mainland, Hon Kong and Macau, Taiwan, and Europe. Trinity Ltd is considering expansion into Australia. In order to do this, they are considering two investments: Engaging in solely retailing men’s apparel in Australia or engaging in retailing and wholesales of men’s apparel.

Ideally, Trinity Ltd would have no plans for closing these stores in the future as it is anticipated that they would remain open for as long as they are profitable and solvent. However, since market demand for premium menswear depends on the wealth of Australian consumers these projects be given a length of 10 years.

If there was a possibility of either one of these investment projects to close down after the 10 years, the retail stores in Australia could be sold for $3million.

The investment would be made on 1 January 2018. The estimated future cash flows are expected to be received on 31 December of each year.

The original cost, the estimated life, residual value and estimate future cash flows of each investment opportunity are set out in the table below. All amounts are expressed in Hong Kong Dollars HK.

Assuming a rate of return/discount rate/WACC of 10%.

Retail Retail & Wholesale

Original Cost -$70 million -$130 millionEstimated Useful Life 10 years 10 yearsResidual Value $3 million $3 millionEstimated Future Cash Flows31 December 2018 (time period = 1 year) $5 million $15 million31 December 2019 (time period = 2) $10 million $15 million31 December 2020 (time period = 3) $10 million $20 million31 December 2021 (time period = 4) $10 million $20 million31 December 2022 (time period = 5) $15 million $20 million31 December 2023 (time period = 6) $15 million $25 million31 December 2024 (time period = 7) $20 million $25 million31 December 2025 (time period = 8) $20 million $30 million31 December 2026 (time period = 9) $15 million $25 million31 December 2027 (time period = 10 years) $10 million $20 million

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STEP 9

Before making such large capital investments, it is important to undertake an analysis of the investments, their benefits and their possible risks. To help determine the most beneficial capital investment option for Trinity Limited, using the above information I undertook analyses three analyses: Net Present Value (NPV), Internal Rate of Return (IRR), and Payback Period.

The results from the analysis are as follows:

Option 1:Retail

Option2: Retail & Wholesale

NPV $4.74 -$3.61

IRR 11.3% 9.4%

Payback Period 6.25 years 6.6 years

The Net present value (NPV) analysis evaluates investment opportunities in terms of dollars of added value. The NPV analysis involves discounting all expected future net cash flow by a discount rate (based on how much capital you use in an investment costs you). A positive NPV indicates an investment would add value to a company, it would return more to than the company than the capital it used. A negative NPV would indicate it would destroy value, it would return less to a company than the cost of the capital it uses. The larger the positive NPV, the more value it would add to the company. The larger the negative NPV, the more value it would destroy for the company. For Trinity Ltd it is evident that Option 1 would be the most beneficial option as it has a positive NPV of $4.74, which means the investment would add value to the company, whereas Option 2 would have the opposite effect, it would destroy it.

The Internal Rate of Return (IRR) of a potential investment opportunity is the rate of return where the net present value of the expected cash flow of the investment equals zero. The IRR expresses an evaluation of investment opportunities as a percentage return on the amount invested, this is makes it easy to understand. For Trinity Limited, the best option in this analysis is Option 1 because the IRR for Option 1 is 11.3% which is higher than the required rate of return of 10%. Whereas, Option 2’s IRR is 9.4% which is lower than required rate of return.

The Payback Period of an investment is how long it is expected to take before an investment returns the cost of the initial investment. The payback period is an important analysis because once an investment has returned the original cost of the initial investment, the company can no longer lose money on the investment. For Trinity Limited, in both options, the payback periods are both 6 years however Option 1 is slightly lower with just 6.25 years. This would make Option 1 the better investment option in this case, because the shorter the payback period, the shorter time in which the company could make loss on its investment.

Overall, after analyzing the results of the analyses taken in the table above, it is obvious that Option 1 is the better capital investment option for Trinity Limited.

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The following pages, I have provided feedback on the assessment number two steps 7-9 drafts of other students in the unit. Providing & receiving feedback is a great way for students to give their opinions on ways we can make our assignments better, noting anything that may have been left out, or any mistakes that have been made. It helps us to improve our assessment pieces and gives a chance to look at the way other students have responded to the task which could spark ways we can improve our own.

I hope that my feedback can help these students some positive reinforcement of their work so far and can assist them in making their assignments even better and help them pick up anything they have missed.

The three students I have provided feedback for include:

Keira Esler

Rachel Cauchi

Eliza Jones

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STEP 10 – Feedback

PEER FEEDBACK SHEET: ASS#2 (Steps 7-10)

Feedback From: Sharnie Lightbourne

Feedback To: Keira Esler .

My Comments

Step 7

Identify three products or services of your firm

Estimate selling price, variable cost & CM

Commentary – contribution margins

Constraints – identify & commentary

You have identified clearly 3 products of your firm, estimating the selling price and variable price by digging deeper into what variable costs are and estimating them based on your own thoughts as opposed to just using the 90%. Your comments on contribution margins and constraints are easily identifiable, making it easy to read and understand.

Step 8 I couldn’t find much fault with your calculation of ratios,your spreadsheet is neat and all the cells are linked backto the financial statements and restated financial statements. Your commentary for your ratios is also verygood. You have dug deep into the meaning behind eachfigure and I can see that you have a good understandingof your company’s financial position. Your calculation of economic profit looks good, the commentary also looks great including why you chose to use a different WACC percentage.

Calculation of ratios

Ratios – commentary (blog)

Calculate economic profit

Commentary – drivers of economic profit (blog)

Step 9 You have developed some excellent capital investment options for your company, using realistic cost and cash flow figures.Your calculations for payback period, NPB and IRR seem to be working correctly with the formulas in the spreadsheet.Your discussion of these results and recommendations for your company’s best investment option are brief, but do reflect the results that you have come up with.

Develop capital investment decision for your firm

Calculation of payback period, NPV & IRR

Recommendation & discussion

Step 10

Feedback step not completed yet.Individual feedback with other students

Overall ASS#3 Your draft for assessment 2 steps 7-10 is looking great! It is easy to read and easy to follow. You have answered each step in detail and presented it nicely. Good job!

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Feedback To: Rachel Cauchi .

My Comments

Step 7





Step 7 looks great! You have clearly identified your company’s three products and I like how you have included a description explaining what exactly each product is. You have done well estimating the selling price and variable costs of each product, given that you could not find that actual prices of each of them. Your commentary on contribution margins and constraints is excellent! You have answered each part of the assessment requirements clearly and very thoughtfully.

Step 8 Wow, I am very impressed with your spreadsheet and calculation of ratios! Each cell seems to be populated with the correct formulas and measurements. I can see how you have taken steps to make sure your calculations are adding up to exactly what they should be, indicating that you have checked your numbers after calculating them. Your discussion of ratios and the comparisons between them is really detailed and indicates you have a good understanding of your company’s ratios and the reasons behindthe numbers. Same goes for your economic profit calculation and commentary.





Step 9 You have developed well thought out capital investment optionsfor your company and your calculations and discussions of the analyses you performed are clear and very well done.

Your recommendations reflect the results of the analyses, good job!




Step 10 This step is not yet completed, but so far it is good to see that you are giving positive feedback to other students and taking the time to really read through their work to make any helpful suggestions.Individual feedback with other students

Overall ASS#3 You should be very proud of your final assessment for this course, you have done an excellent job in covering all the requirements of the assessment and have presented it in way that is easy to read.Congratulations on completing it, I hope you receive excellent marks!

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Feedback To: Eliza Jones .

My Comments

Step 7





You have made a great start to Step 7 with an introduction of your company and the products/services they offer. I like how you chose to use prices of a similar product/service of another company because you could not find the price of your own. That makes it a realistic estimate. Your commentary and explains of contribution margins and calculations are great, easy to understand. You have listed some really good constraints for your company, good job!

Step 8 Your calculations of ratios look really good. The figures seem to be populating from your financial statements and restated financial statements well with the formulas.Your commentary on your ratios could be a little more detailed with the profit margin and liquidity ratios of your company, dig into the reasoning behind those numbers.The calculation and commentary of economic profit however is great, well done!





Step 9 It looks like you have put a lot of time and effort into this step and come up with some excellent capital investment options for your company, using realistic figures. This step is very well done!Calculations of NPV, IRR and payback period in your spreadsheet with the formulas look to be working correctly. Your discussion of these analyses and results are excellent, with recommendations that reflect these.




Step 10

Step 10 not yet completed.Individual feedback with other students

Overall ASS#3 Overall, I think you still have a little bit to add to it, but so far it looks like you have made great progress and put in a great effort. Good luck, I hope you do well!

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