Introduction
Put yourself in the following situation as a Financial Services Team of Analytic Electronics member.
You have been requested to provide meaningful financial analysis and information for decision- making concerning financing, performance, capital investment, constrain in production, budgeting and variance analysis. Accordingly, you are required to write a report (3,000 words) providing information about these areas.
You must submit the report online via the Turnitin link by 14:00 (UK time) on 9th May 2023 (Tuesday). 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. Do not forget to mention your assumptions and the limitations of your analysis.
Financial analysis related to Investment Strategy:
Analytic Electronics has grown from a company with a £10 million turnover to a £201 million turnover and £18m profit in the last ten years. The existing owners have put all their financial resources into the firm to enable it to grow. The directors wish to take advantage of a fascinating market opportunity after Brexit and COVID-19 but would need to find £50 million of new equity capital as the balance sheet is already over-geared (i.e. has high debt). The options are discussed relatively uniformly, including flotation on the Main Market of the London Stock Exchange (LSE), flotation on the Alternative Investment Market (AIM), and private equity (PE). Write a report to enlighten the board on the merits and disadvantages of these three possibilities. (10 Marks)
Ms Nichola, the Investment Manager, has requested some analysis concerning a proposed 5- year investment. The company plans to open a showroom in Leeds and has narrowed its selection down to two locations: (1) Thorpe park and (2) Beeston. You have to evaluate these options based on the following information. Analytic will lease the showroom initially for five years, and the total initial investment cost is estimated to be £20 million each.
Option one: Thorpe Park
It is expected that the Thorpe Park showroom will increase the overall sales revenue of the company by 11% per annum from 2023, and the variable cost will be forty percent of sales revenue. The fixed overhead cost for the initial three years will be £3,500,000, £2,000,000 and £1,500,000, and zero afterwards. The promotion cost will be £500,000 in the first two years and £200,000 for the next three years. All other operating expenses will be 10% of the total contribution margin. The company will need a working capital investment of £5 million in year two, 80% of which will recover at the end of the project’s life. The company follows a straight- line depreciation method and expects to sell the assets at 10% of historical cost in year 5.
Option two: Beeston
On the other hand, if the showroom is opened at Beeston, then it will require fixed overhead costs for four years £2,500,000 in year one, £2,800,000 in year three, £2,100,000 in year four and £2,100,000 in year five. All other operating costs will be 10% per year of the contribution margin. The working capital investment will be £5,500,000 in year three, and 75% will recover in the last year. The sales revenue will increase by 12% per annum, and variable cost will be 47%. The company will follow a similar depreciation and promotional cost strategy as the Thorpe Park showroom.
Financing the investment
The company has several choices for financing this expansion – issuing new equity or bond or using existing retained earnings. The shares of Analytic are traded in the Alternative Investment Markets (AIM) for £3.5. However, the face value is £1.0, and last year’s dividend was £0.35. HSBC will charge a flotation cost of 9% to issue the new common share in the market. There is a projection that the dividend will grow 5% yearly in the coming years. In addition, the firm can issue an additional long-term bond at an interest rate (before tax) of 8% (i.e., Coupon rate). Similar bonds are selling at £105 in the market, slightly over the face value (£100), with five years of maturity. The market risk premium is 6%, the 3-month UK gilt rate is 4.5% (risk-free rate), and the average Beta of the Electronic goods industry is 1.53.
The company is also planning to issue preferred stocks. The industry average preferred dividend and current market price are £10 and £96, respectively. The company wants to maintain a capital structure of approximately 40% debt, 10% preferred equity and 50% ordinary shares. The current corporate tax rate is 35%.
Required
Determine the Weighted Average Cost of Capital (WACC) for the target capital structure.
Evaluate the showrooms and comment on which one should be selected (Hints: use NPV and IRR). Ms Nichola prefers to use CAPM (i.e., Capital Asset Pricing Model) over DDM (i.e., Dividend Discount Model).
Advise accordingly with appropriate assumptions and rationales for the future. (5+10+5 = 20 Marks)
[Following profit statement is provided for your reference to calculate the net cash benefit by your investment manager Ms Nichola]
PROFIT STATEMENTS
(£ million)
Years
2018
2019
2020
2021
2022
£
£
£
£
£
Sales revenue
176.200
190.000
199.110
201.240
201.545
Cost of Sales
28.629
31.294
32.111
32.919
32.382
Gross profit
147.571
158.706
166.999
168.321
169.163
Fixed and semi-variable costs
Fixed overhead
34.283
40.872
42.478
44.014
45.523
Promotion
5.000
6.000
7.000
8.000
9.000
Research and Development
6.000
6.500
7.000
7.500
8.000
Depreciation
31.500
49.400
51.350
53.300
55.250
New model launch
20.000
0.000
0.000
0.000
Professional charges
8.000
8.000
8.000
8.000
8.000
Stock upkeep
0.000
0.362
0.376
0.472
0.504
Total fixed and semi variable
104.783
111.134
116.203
121.286
126.277
Operating profit
42.788
47.572
50.795
47.036
42.887
Interest on loans
15.000
25.000
30.000
30.000
15.000
Profit before tax
27.788
22.572
20.795
17.036
27.887
Tax
9.726
7.900
7.278
5.962
9.760
Profit after tax
18.062
14.672
13.517
11.073
18.126
Dividends
10.000
10.000
10.000
10.000
10.000
Retained earnings
8.062
4.672
3.517
1.073
8.126
Financial Analysis for internal management:
The management accounting team of Analytic Electronics has also come up with some questions and requests you to explain/answer them for the upcoming board meeting:
1 What is the point of distinguishing absorption and marginal costing? Why do they report different profits? Explain with an example. (5 Marks)
The management of A&E, a subsidiary of Analytic, is concerned about its inability to obtain enough trained labour to enable it to meet its current budgeted projection:
Service
A
B
C
Total
Sales revenue
45
35
39
119
Variable costs
Materials
8
6
7
21
Labour
11
8
14
33
Expenses
5
4
4
13
Allocated fixed cost
6
15
12
33
Total cost
30
33
37
100
Profit
17
4
4
25
The available labour cost to spend is £24,000. All the labours are paid at the same hourly rate across the services. You are requested to prepare a plan to produce a higher profit, ensuring that at least 50 per cent of the budgeted sales revenues can be achieved for each service. The fixed cost is £30,000.
Prepare the statement, with explanations, showing the highest profit could be achieved from the limited amount of skilled labour available within the constraint stated. (10 Marks)
What steps could the business take to improve profitability considering the labour shortage? (5 Marks)
A&E makes Product G, the standard costs of which are:
Sales Revenue
£45
Direct labour (1 hour per unit)
(13)
Direct materials (1 kg per unit)
(12)
Fixed overheads
(5)
Standard profit
10
The budgeted output for February 2023 was 1,000 units; however, the actual production was 1,100 units sold for £48,400. There were no inventories at the start or end of February.
The actual production costs were:
Direct labour (1,075 hours)
£14,513
Direct Materials (1,170 kg)
13,455
Fixed overheads
5,700
Calculate the variance for March from the available information and use them to reconcile the budgeted and actual profit figures.
How will a flexible budget help this company identify the budget variance? (2 Marks)
Thank you, and best of luck.
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