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Assignment 2Step 7-9

ACCT11059 Accounting, Learning, and Online Communication

Kellie Broszat

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Assignment 2

Step 7

Contribution Margin

My company Frontier IP deal mostly in intellectual property, and commercialising of new

technologies arising from their research. As Frontier IP itself is mostly service based in

nature, I have chosen products that have been produced by several of their spin off companies

(of which Frontier itself still owns a percentage).

Product One:

Alusid’s SilicaStone is a new material made from fused recycled glass and ceramics,

designed as an adaptable alternative to natural stone. SilicaStone has the feel of natural stone

and being resin free is heat and fire resistant and UV stable. Made from 96% to 100% locally

sourced recycled materials has a wide range of applications, including kitchen work surfaces

and building cladding. In addition to being available in standard configuration, it can be

custom blended or shaped to specification.

[Type text] [Type text] ACCT11059 Assignment 2Kellie Broszat

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As I was unable to find the actual price of SilicaStone, I have used £260 per square meter as

an approximation based on the price per square meter for engineered stone benchtops in

Australia which I found on the website below, I then converted this amount into pounds

https://www.homeimprovementpages.com.au/article/how_much_does_a_stone_benchtop_cost

I have also assumed that the variable cost of this product is around 75% of the selling price,

Variable costs = £260 x 75%

= £195 per square foot

Contribution Margin = Selling Price – Variable Costs

= 260 – 195

= £65 per square foot

Constraints:

Building a house is probably the most expensive exercise that most people will ever

attempt with their own money, so they may be hesitant in choosing a new type of

material as they unsure as to whether or not future buyers will see the value in it.

There are already quite a few different products available; it will be difficult to stand

out in the crowd, so to speak.

People who are environmentally conscious will be interested in this product, but will

people who are not.

As this is a product is at the higher end of the price range, there will be other products

available which are much cheaper.

Colours and designs need to be updated to keep up with the latest trends.

I think that the contribution margin for this product is acceptable. I also believe that all of the

constraints listed above are relevant in deciding how much product to produce and sell.

There would have to be enough standard stock on hand to fill orders quickly as customers

don’t like to wait too long for their purchases. However as colours and designs change each

year with the latest trends, caution would have to be taken not to make so much product that

it does not sell before new colours are required.


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https://www.homeimprovementpages.com.au/article/how_much_does_a_stone_benchtop_cost

Product Two:

PoreXpert was formed to accelerate the commercialisation activity of Plymouth University’s

Environmental and Fluid Modelling Group which develops software for modelling porous

systems. In close partnership with Thermo Scientific, Porometer nv and MicrotracBEL Inc,

the company provides software, for sale or through consultancy, which generates a three-

dimensional simulation of the voids within a sample, based on porometry, porosimetry or,

less directly, electron or optical microscopy. The resulting structure can then be used to

simulate properties that include depth filtration efficiency and absolute permeability. The

software also has a ‘targeted modification’ feature which allows the user to make alterations

to the structure virtually, so they can optimise the properties of a given material in a cost

effective manner or simulate future effects such as weathering.

PoreXpert Professional

Annual lease - £7200

I have approximated variable cost for this product to be around 50%, as it is available over

the internet, there are no ‘middle men’, transportation costs or fees associated with storage of

stock etc.

Variable Costs = 7200 x 50%

= 3600


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= 7200 – 3600

= £3600 per year

Constraints:

This is a very specific program, which although it has a number of different

applications is still only going to be desirable to a very specific consumer base.

There are a number of different programs available online so engaging with possible

consumers may present problems.

This type of software must be updated regularly to keep up with the latest technology.

I think that the contribution margin for this product is quite acceptable. I also believe that

because there are quite a few similar products available on the net, it is necessary to make

sure that the product integrates the latest technology to keep ahead of their competitors.

Product Three:

Cambridge Sensor Innovation develops sensor technology for use in industrial processes

where the composition of the processing atmosphere is important, specifically ovens and

kilns. Its suite of products comprises an ultra-low range differential Pressure Sensor, a

Humidity Sensor, and an Intelligent Control System. The benefits of the technology include

reduction in greenhouse gases and optimisation of the quality and consistency of oven-

manufactured goods. The company is initially focused on multinational companies in the

food and speciality chemicals markets, but the technology can be applied within any industry

which uses ovens and kilns.


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As I was unable to find any information regarding the price of this product, I have estimated a

selling price of £500 as this is an industrial grade device for use in specific conditions. I have

also assumed a variable cost of 80% as this device uses new technology, so the cost of

production will be high.

Variable Costs = £500 x 80%

= £400


= 500-400

= £100

Constraints:

This is a brand new product, so they are going to have to ‘break into’ a well-

established market.

While there are many applications for this device, as it is only currently targeted at a

specific group of clients, it has a narrow consumer market.

The device will last a long time therefore the replacement rate will be low. The

company will have to constantly find new consumers.


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It may be difficult to establish this product in the market place, even though utilises a new

technology to recreate something a little bit unique. It still performs a similar function to

traditional gauges that have been on the market for decades. The firm has decided to target a

specific consumer market in these initial stages, with the thought of making the name for

their product in one area before expanding into other markets and I think that this is probably

a good idea. By doing this the firm is hoping to minimalize overcapitalising on an untested

product, and gauge market reaction before expanding.

Step 8

Commentary on Ratios

Net profit margin which is expressed as a percentage shows how much out of every dollar of

sales the firm keeps as profit. My firm Frontier IP has gone from making a loss of 314.5% in

2013 to a profit of 55.7% in 2016. I believe that the firm has taken some big strides in

profitability in just a few short years and if they can maintain the percentages achieved in

2015 and 216 that they will be financial healthy.

My firm Frontier IP has a low return on assets ratio, as it is mainly a service based company

and does not maintain a lot of assets. This being said they have still managed to increase their

return on assets percentages from -13% in 2013 to 14.5% in 2016. Being a service based

company, also means that my firm did not have any inventory listed in the annual report, as

such I was unable to calculate a Days of Inventory ratio, and the Total Asset Turnover ratios

are also quite low ranging from 6.32% to 2.88%.

The Current ratios, which measures a company’s capacity to pay short-term and long-term

obligations for my company, have strengthened from 32.99% in 2013 to 70.08% in 2016,

which means that each year the company has increased its ability to meet is financial

obligations.

My firm also maintains very low debt/equity ratios from 3.1-1.4% which means that while

they using very little shareholders’ equity to finance their assets, they may also not be taking

advantage of the increased profits that financial leverage may bring.


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Equity ratios of between 97-98.6% means that my company is mostly owned by its

shareholders, again these high rates are also a result of Frontier IP being a service bases

company with a only a small amount of assets.

Frontier IP also maintains a custom of paying out substantially more in dividends that it

earns, after only earning between £0.04 and £2.78 per share the company then payed

dividends to its shareholders of between £4.00 and £33 per share. They may have done this to

attract investors who like the steady income associated with dividends.

My company had a price earnings ratio of 337.78 in 2014, which could be attributed to the

fact they had an increase in total revenue of £608000 due to the booking of an unrealised

profit adjusted from the holding value on one portfolio company. This may have boosted

Shareholders optimism concerning the firm’s growth prospects. Then this ratio fell

substantially in 2015 and 2016 when growth may not have kept up with shareholders’

expectation.

The Return on Equity ratio which measures how much profit each dollar of common

stockholders’ equity generates for the company has slowly increased over the four years,

from -13.38% in 2013 which is really quite bad, to 14.75% in 2016 which is a level that

financial analysis’s would consider attractive.

Economic Profit

The Return on Net Operating Assets ratio, which indicates how profitable a company, is

relative to its total assets. It illustrates how well management is employing the company’s

total assets to make a profit. My company Frontier IP went from having relatively poor

Return on Net Operating Assets ratios in 2013 and 2014 to relatively good returns in 2015

and 2016.

My company Frontier IP also has low Net Borrowing Cost ratios, which investors will like as

it means less of the profits of the company are going to be creamed off to pay interest on

debts and more profit for equity shareholders. As the company is also not burdened with high

borrowing costs, there is less risk associated for shareholders as well.


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Frontier IP had a particularly bad Profit Margin in 2013, due in part to the investment in three

new spin off companies for which they were still securing funding at the end of the reporting

period. In 2014 the company regained significantly to return to a Profit Margin of 2.16%,

although a margin of this amount is not huge it is still a huge turnaround from the year

before. Frontier IP then went on to produce quiet attractive profit margins of 40.62% in 2015

and 55.67% in 2016.

Again as Frontier IP is fundamentally a service based company, it has maintained low assets

turnover ratios of between 0.05 and 0.32, as the company largely does not use its assets to

generate sales.

Economic profit or loss is the difference between the revenue received from sales and the

opportunity cost of the inputs used. In 2013 and 2014 my company had negative economic

profits which means that the projects invested in, in that year failed to make enough profit to

cover the cost of doing business. Frontier IP generated high economic profits, in 2015 and

2016 which means that the projects for the last two years made large profits for the company.

However, it is important to note that calculation of economic profit depends heavily on

invested capital, and it is therefore most applicable to asset-intensive companies that are

generally stable, no service based companies with a lot of intangible assets.

Step 9

I have developed the following capital investment decision for Frontier IP. Frontier is

considering whether to invest in two new software packages. One package, Celerum, is

planning and scheduling software targeted at the offshore oil and gas industry. The other,

Porexpert, provides software for the modelling of porous systems, which generates a three-

dimensional simulation of voids within a sample.

As computer software has a short commercial lifespan, I have decided that these projects be

given a length of six years. The cash flows for the Celerum would predominately be

generated from online sales, less operational costs such as licencing fees, staff wages and

advertising. The cash flows for the Porexpert package would be similar where cash flows


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would be generated mostly from online sales, less operational costs such as licencing fees,

continual development fees and staff wages,

Celerum Porexpert

Origional Cost 3.0 3.5

Estimated Life 6 6

Residual Value 0.25 0.5

Estimated Cash Flows

2018 -1 0.5

2019 1 1

2020 2 3

2021 5 5

2022 3 4

2023 2.5 2.5

Porexpert is the better option between these two mutually exclusive projects, with more

promising results in all areas. Porexpert generated a NPV or Net present value of £7.34

compared with Celerum’s result of £5.25. Net present value is the difference between market

value (where all expected future net cash flows are discounted at a certain rate to account for

inflation) and cost. It is the preferred decision criterion when making decisions, however it

does have some limitations. Determining the correct discount rate can be difficult sometimes

and involves using a lot of ‘guess work’, also forecasting future cash flow from investments

can be subjective.

Payback period is the amount of time that it will take to recover the initial cost of a project; it

is easy to understand and is biased toward liquidity. Some disadvantages associated with

using the payback period method are that it ignores the time value of money, requires an

arbitrary cutoff point and it also ignores cash flow beyond the cut-off date. With a payback

period of two years and eight months Porexpert outshines Celerum’s payback period of three

years and two and a half months.

As these two projects are mutually exclusive, the internal rate of return calculation cannot be

used to rank these two projects, but with Porexpert’s rate of return of 48.76% and Celerum’s


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37.37%, both projects appear to be quite promising. The internal rate of return is calculated

using expected future cash flow rather than accounting profits. It is the most important

alternative to NPV and is widely used in business today. As the NPV’s for these two projects

predict a similar result there is no conflict between NPV and IRR in this case, however if

there was I would use the NPV results and not the IRR on which to base my decision.

With a cumulative cash flow of £12.5 for Porexpert compared with £9.75 for Celerum, and

taking into account all the other results returned for these two options, I have determined that

Porexpert is the clear choice of project to accept.


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