Financial analysis

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2021/22 SEMESTER [2] MODULE TITLE: Financial Analysis (FINA) TITLE OF ASSESSMENT: Assessment 2 (Resit): Coursework LEVEL: H7 COURSE(S): MBA (Full Time), MBA (Executive) DEADLINE DATE FOR SUBMISSION BY STUDENT: Monday 25th July 2022 by 3:00 pm (UK) MARKS: 60% SUBMISSION LOCATION: Online (via Mybeckett) EXAMINER(S): Lillian Lee, Dr Peter Djabang and Dr Anup Chowdhury __________________________________________________________________________ Notes for candidates: This is an individual assessment that students should hand in via MyBeckett as an MS word document via Turnitin (till 15:00 pm UK time) on 25th July 2022 (Monday).

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Your report will be assessed as a whole in the following areas:

Coverage of theoretical underpinnings involved

Demonstration of a critical understanding of the theoretical aspects involved

Practical application of the theoretical aspects of the case study

Application of mathematical knowledge

Evidence of additional and relevant research

Coherence and quality of the report

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Introduction

Put yourself in the following situation as a member of the Financial Services Team of XYZ plc,

which is a UK conglomerate. It owns companies across different industries, such as – car

manufacturing, consumer goods, leisure etc.

You have been requested to provide meaningful financial analysis and information for decision

making concerning financing, performance, capital investment, constrain in production,

budgeting, and sensitivity analysis. Accordingly, you are required to write a report (3,000 words in

total) providing information about these areas.

You must submit the report online via the Turnitin link by 15:00 pm (UK time) on 25th July

2022 (Monday). Please use the Harvard referencing where relevant, do not use lecture slides or

any Pedia (such as Wikipedia or Investopedia) as reference. You should report your calculations and

supplementary information in Appendix. Don’t forget to mention your assumptions and the

limitations of your analysis.

Financial analysis related to Investment Strategy:

Because of the climate change target of the UK (the road to net-zero target), the company’s newly

appointed investment manager Ms Madison came up with a new investment strategy – closing five

of the company’s existing brand and focusing more on the company’s most popular electronic

vehicle brand in the UK. According to her assessment, this closing decision will generate around

£100 million free cash flow, which the company could reinvest to expand its popular brand – ‘eXi

Drive’. Madison suggests that the market survey indicates this is one of the most popular brands

in England, and demand is increasing. The year-to-year sales of the ‘eXi Drive’ brand have gone

up by 25% (5,000 units in 2021 compared to 2020), which was higher than all of those five brands

together.

Moreover, she has indicated that the expansion decision will reduce the overall cost while

improving quality. This cost-quality dynamic will help the company face competition and achieve

a larger market share. However, this expansion will cost £150 million for the company, which

require rigorous strategic assessment, including financial viability. Now, she has approached you

to evaluate this possible restructuring decision, whether it is a financially viable strategy or not. She

also has suggested that this expansion project will run for the next five years, and after that, the

company will enter into a new strategic cycle.

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You have collected the following information from her to do the financial analysis for meaningful

decisions.

The expansion is expected to increase the sales of ‘eXi Drive’ by the following units.

8,000 units in 2022 8,000 units in 2023 10,000 units in 2024 11,000 units in 2025 12,000 units in 2026

In 2021 the market price of this brand was £45,000, but the company wants to reduce it by £5,000

in 2022 and then will increase/decrease with the pace of the economy and purchasing power of

the consumers. KPMG has projected that the Bank of England’s bank rate will remain 0.50 per

cent for the next couple of years, which will allow the post-Brexit-and-Covid expansion of the

economy. In line with this economic assessment, your company has decided not to increase the

price for the next three years (i.e., till 2024), but from the fourth year, a contingency plan is in place

to increase the unit price by £2,000.

The production cost is £20,000 per unit, which will increase in the line of inflation and other

materials cost over the project’s life at a rate of 10% each year starting from year two. The

production involves fixed overhead expenditure of £20 million in 2022 and 2023, £15 million in

2024 and £10 million in 2025 and 2026. The project requires a working capital investment of

£850,000 at the beginning, 50 per cent of which the company will recover at the end of project

life. The cost of promotion and R&D will be £5 million, respectively, over the five years. Assume

that there is no other cost involved in this investment. The company is currently following the

straight-line depreciation method, and historically 10% of the cost price of such investment is

recovered in the final year.

Financing choices: (the Board of Directors have agreed)

The Board of Directors disapproved reinvesting the £100 million free cash flow from closing the

existing five brands. Instead, they want to keep this fund reserve for future uncertainty. For this

expansion project recommended by Ms Madison, the Board has recommended raising capital from

alternatives financing from external sources.

The company has three choices for financing this expansion: issuing new equity, issuing a bond,

or issuing preference shares.

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The equity of XYZ plc is currently trading in London Stock Exchange (LSE) with a face value of

£10. The market price of each share is as follows:

Date Closing Price

04.11.20 £34.50

03.12.20 £36.20

06.01.21 £33.55

03.02.21 £35.10

To date £ 34.80

In the last fiscal year, the company had declared a £1.2 per share dividend (DPS). The company’s

investment banker KPMG always charges an issuing (i.e. flotation) cost of 20% on the face value

to issue new common stock in the market. Historically, the company’s earnings per share are as

follows:

Year EPS (Earning Per Share

2017 22p

2018 26p

2019 17p

2020 22p

2021 25p

The company has also assessed the possibility of issuing a bond in the market. Currently, bonds

of similar companies are selling at £110, slightly over the face value (i.e. £100) with a coupon rate

of 10% and maturity of 5 years. The company’s third financing option is to issue preferred stock

in the LSE. The industry average preferred dividend and the current market price of preference

shares of similar companies are £10 and £108, respectively.

You have also collected additional data on the UK financial market and the company. Currently,

the yield of the 3-month UK Gilt is 3.0%, the FTSE 100 index has an average yearly return of

10%, and the average corporate tax rate in the UK is 30%. In addition, the beta of XYZ plc is 1.5,

which is slightly higher than the market beta of 1.

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The company wants to maintain its existing capital structure policy of 50% debt, 10% preferred

equity and 40% common equity for this new investment.

Ms Madison has requested you to make a report based on the following queries so that she can

present it at the next board meeting.

1. What will be the cost for each source of financing? Consider both DDM (i.e. Dividend

Discount Model) and CAPM (i.e. Capital Asset Pricing Model) method for common

equity. Please provide your comments on the assumptions of each approach and their

merits and limitations.

2. Determine the optimum cost of capital using the Weighted Average Cost of Capital

(WACC) approach for target capital structure. (Hints: Ms Madison would prefer to use CAPM

over DDM).

3. Evaluate the total value addition (i.e. total NPV) and breakeven rate (i.e. IRR) of this

possible restructuring decision. (Hints: Use the WACC as your discount rate to evaluate the

investment projects)

4. Assume that the product lifecycle of five years is viewed as a safe bet, but the scale of

demand for the product is highly uncertain, mainly due to possible BREXIT and COVID-

19. Analyse the sensitivity of the projected NPV to the unit sales and the cost of capital.

5. Explain how the BREXIT could affect the UK automobile manufacturing sector and the

possible strategic changes required in this industry to cope with the risk?

(Total 30 marks)

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[Following profit statement is just for your reference to calculate the net cash benefit

given by your investment manager Ms Madison]

Income Statement

2017 2018 2019 2020 2021

£m £m £m £m £m

Sales 1,622 1,800 2,730 2,654 2,703

Cost of Sales (908) (1,056) (1,855) (1,897) (1,754)

Gross Profit (Loss) 714 744 875 757 949

Overheads

Fixed Overheads 120 156 165 154 146

Stock Upkeep Cost 0 1 0 17 31

Promotion 50 60 149 149 409

Research and Development 0 194 20 27 16

Market Research 15 15 15 15 15

Depreciation 68 80 78 72 65

(253) (506) (427) (433) (682)

Operating Profit (Loss) 461 238 448 323 267

Investment Disposal Income 0 8 11 0 0

Interest on Current Account 0 7 8 8 10

Interest on Loans (34) (45) (33) (11) (12)

(34) (30) (14) (3) (2)

Pre-Tax Profit (Loss) 427 208 434 320 265

Tax (85) (27) (126) (137) (78)

Post Tax Profit (Loss) 342 181 308 183 187

Cost of Dividends (20) (40) (36) (40) (28)

Year Retained Profit (Loss) 322 141 272 143 159

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Financial Analysis for internal management:

The management accounting team of XYZ plc also came up with some questions and requested

you to explain/answer them for the upcoming board meeting:

1. A chain of XYZ plc, BHealthy Ltd is a wholesale manufacturer of healthy foodstuffs.

Because of a series of machine-related accidents at one of its factories, working practices

have been revised and altered. It has resulted in a reduction in the number of labour hours

available next period to 60,000. Four ready-made meals are produced in this factory and

estimated data for the next accounting period are as follows:

Product S1 S2 S3 S4

Maximum Demand (units) 8,000 6,500 4,800 3,200

Selling and costing information (per unit)

£ £ £ £

Selling price 80 110 145 170

Direct materials 12 30 35 40

Direct labours (Labour rate = £5/hr) 16 20 15 20

Variable overhead 8 10 14 16

Selling overhead 4 4 4 4

The team wants to know about the limiting factor and requested you to help calculate the maximum profit which can be achieved in the period?

They also asked to provide TWO alternatives BHealthy Ltd has to overcome the limiting factor?

(10 marks)

2. Another chain, Phase3 Sports Club, is opening an exquisite new gym with a luxury spa

within the city centre of Leeds as part of its growth strategy, but it needs to attract new

members to make sure it survives. Over the last few years, demand for sports facilities has

been rising as more and more consumers become health conscious, resulting in a

significant increase in the number of sports clubs within the city of Leeds. Phase3 club has

to come up with the right pricing strategy to attract and retain customers to achieve their

financial objectives.

The budgeted fixed costs (for the rental of the building and sports equipment) for the first

month are £7,500, and they are expected to be 27.27% of the total overheads at breakeven.

The managers estimate that each member will use about £200 in resources over a year. In

addition, each club member will be charged a £275 annual membership fee.

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The management accounting team has the following questions for you:

a. How many members will the club need to have to break even?

b. Calculate the margin of safety percentage if Phase3 attracts 200 or 300 members in the first month.

c. If Phase3 wishes to make a profit of £2,400, how many members should it target?

d. The managers decide that a £275 fee is too high. What would happen if they reduced the membership fee to £245? Make the adjustment and recalculate the contribution, breakeven point, and margin of safety percentages at output levels stated in b) and advise management of the feasibility of a price reduction.

e. Explain the limitations of Cost Volume Profit (CVP) analysis. (15marks)

3. Budget planning is an essential process for an organisation, with many advantages.

However, there can be negative aspects to the budgeting process. The management

accounting team of XYZ plc wants you to discuss and provide examples of both of these

aspects of budgeting.

(5 marks)

Thank you and best of luck.

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ASSESSMENT CRITERIA

Report format used, introduction clear and concise with appropriate business language.

Marks will be awarded for good supporting evidence of either academic sources or examples.

Marks will be awarded for clear conclusions drawn from the preceding analyses.

More specific illustrative assessment criteria are set out below:

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Assessment

Criteria 70%+ 60%+ 50%+ 40%+ <40%

Financial

analysis related

to Investment

Strategy

(indicative

weighting 50%)

(Total marks

30)

Correctly identify

all the costs of

capital and WACC.

Excellent

description of

merits and demerits

of each method.

Excellent analysis

of the investment

appraisal. Excellent

and well-supported

recommendations.

Insightful

understanding and

evaluation of the

NPV and IRR

techniques,

including their

limitations.

Excellent

evaluation of

sensitivity analysis.

Correctly identify

some of the costs

of capital and

WACC. A very

good description of

merits and demerits

of each method.

Very good analysis

of the investment

appraisal. Very

good and

supported

recommendations.

Very good

understanding and

evaluation of the

NPV and IRR

techniques,

including their

limitations. Very

good assessment of

sensitivity analysis.

Reasonably identify

the cost of capital

and WACC. A

reasonable

description of the

merits and demerits

of each method.

Reasonable analysis

of the investment

appraisal.

Reasonably

supported

recommendations.

Reasonable

understanding and

evaluation of the

NPV and IRR

techniques,

including their

limitations.

Reasonable

evaluation of

Limited analysis on

the cost of capital

and WACC.

Limited description

of merits and

demerits of each

method. Limited

analysis of the

investment

appraisal. Limited

supported

recommendations.

Limited

understanding and

evaluation of the

NPV and IRR

techniques,

including their

limitations. Limited

evaluation of

sensitivity analysis.

Limited discussion

Little or no analysis

on the cost of

capital and WACC.

Little or no

description of

merits and demerits

of each method.

Little or no analysis

of the investment

appraisal. Little or

no supported

recommendations.

Little or no

understanding and

evaluation of the

NPV and IRR

techniques,

including their

limitations. Little or

no evaluation of

sensitivity analysis.

Little or no

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Excellent

discussion on the

impact of BREXIT

on the UK market.

Very good

discussion on the

impact of BREXIT

on the UK market.

sensitivity analysis.

Reasonable

discussion on the

impact of BREXIT

on the UK market.

on the impact of

BREXIT on the

UK market.

discussion on the

impact of BREXIT

on the UK market.

Financial

analysis for

internal

management

(Indicative

weighting 50%)

(Total marks

30)

Thorough and

excellent

knowledge,

explanation, and

evaluation of the

limiting factors,

Excellent

identification of

alternatives to

overcome the

limiting factor.

Excellent

evaluation of

breakeven, the

margin of safety,

target profit. An

insightful

discussion of

limitations of CVP.

Excellent

Very good

knowledge,

explanation, and

evaluation of the

limiting factors,

very good

identification of

alternatives to

overcome the

limiting factor. Very

good evaluation of

breakeven, the

margin of safety,

target profit. Very

good discussion of

limitations of CVP.

Very good

underpinning from

Reasonable

knowledge,

explanation, and

evaluation of the

limiting factors,

reasonable

identification of

alternatives to

overcome the

limiting factor.

Reasonable

evaluation of

breakeven, the

margin of safety,

target profit.

Reasonable

discussion of

limitations of CVP.

Reasonable

underpinning from

Limited knowledge,

explanation, and

evaluation of the

limiting factors,

limited

identification of

alternatives to

overcome the

limiting factor.

Limited evaluation

of breakeven, the

margin of safety,

target profit.

Limited discussion

of limitations of

CVP. Limited

underpinning from

budgeting and its

examples.

Little knowledge,

explanation, and

evaluation of the

limiting factors,

little or no

identification of

alternatives to

overcome the

limiting factor.

Little or no

evaluation of

breakeven, the

margin of safety,

target profit. Little

or no discussion of

limitations of CVP.

Little or no

underpinning from

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underpinning from

budgeting and its

examples.

budgeting and its

examples.

budgeting and its

examples.

budgeting and its

examples.

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Feedback:

Date generic feedback will be available:

Within four weeks of the assessment period, subject to the date set for the release of results

Date provisional marks will be available

Within four weeks of the assessment period, subject to the date set for the release of results

How provisional marks will be returned to you:

Posted on the module on MyBeckett.

Date individual feedback will available

Following the Examination Committee and the return of all scripts from the External Examiner

How individual feedback will be returned to you:

By collection of assessments as directed by your Admin Team