ACC3015 Accounting and Finance for Managers

You are required to:

(a) Selection and justification of at least 10 financial ratios and calculate 2 non-financial ratios to analyse the performance and financial position of the three companies. You are expected to use charts to compare performance of the three companies using the latest three years financial and non-financial data. You will need to look at the audited financial statements and carry out further research to explain the performance of the company over the three years. Overall ranking of the company’s position is required .

(b) Identify (based on the ranking in (a)) which is the best performing company and discuss reasons if this company would be a positive investment opportunity.

(c) Identify (based on the ranking in (a)) which is the most poorly performing company and discuss recommendations of how the financial performance of the business can be improved.

You are required to prepare a memo on the topic of ‘Investment Appraisal’, addressing the following areas:

(a) Identify and explain the key stages in the capital investment decision-making process, and the role of investment appraisal in this process.

(b) Identify and explain the main methods of investment appraisal used in practice (including DCF), use numerical examples to help illustrate the key aspects.

Section A

Question 1

a) Select and justify 10 financial ratios and 2 non-financial ratios in analyzing the financial performance of the three companies.

GlaxoSmithKline Plc
Particulars	Formula	2015	2016	2017
Profitability
Sales		23923	27889	30186
GP		15070	18599	19844
Gross Profit Ratio	GP/Sales*100	63%	67%	66%
Operating profit		2628	6026	6061
Operating profit ratio	Operating Profit/Sales*100	11%	22%	20%
Net profit		8422	912	1532
Net profit Ratio	Net profit/sales*100	35%	3%	5%
Total assets		53446	59081	56381
Return on assets		0.158	0.015	0.027
Stockholder’s equity		5114	1124	-68
Return on Equity	Net profit/Stockholder's equity	0.16	0.02	0.03
Liquidity ratios
Current assets		16587	16711	15907
Current liabilit ies		13417	19001	26569
Current ratio	Current assets/current liability	1.24	0.88	0.60
Inventory		4716	5102	5557
Quick ratio	(current assets-inventory)/current liabilities	0.88	0.61	0.39
Gearing ratios
Long term debt		15277	14620	14221
Equity capital		5114	1124	-68
Gearing ratio	Long term debt/equity capital	2.99	13.01	-209.13
Investing Ratios
Sales		23923	27889	30186
Total assets		53446	59081	56381
Asset turnover ratio	Sales/total assets	0.45	0.47	0.54
Share performance ratios
Net income		8422	912	1532
No. of outstanding shares		1340	1342	1343
Earnings per share	Net income/no. of outstanding shares	6.29	0.68	1.14

Source: GSK, 2017

	2015	2016	2017
GP	63%	67%	66%
Operating Profit	11%	22%	20%
NP	35%	3%	5%

Higher gross profit is due to lower cost of goods sold and higher sales earned by the firm in all the three years due to good marketing of the company’s products. Operating expenses of this enterprise are higher which decreases the operating profit and so as for the net profit. 

	2015	2016	2017
Return on assets	0.158	0.015	0.027
Return on equity	0.16	0.02	0.03

In 2015, return on equity is higher than the return on assets which further decreased till 2017 due to decreasing earnings of an entity.

	2015	2016	2017
Current ratio	1.24	0.88	0.6
Quick Ratio	0.88	0.61	0.39

The position of both the ratios are not good as this ratio shows neck to neck position but its performance is declining at the same time due to higher current liabilities (Ratio analysis, 2017).

	2015	2016	2017
Gearing Ratio	2.99	13.01	-209.31

A negative and decreasing result of the gearing ratio is due to the higher burden of the long-term debt on an entity in comparison with the available equity held by an entity.

	2015	2016	2017
Asset turnover	0.45	0.47	0.54

Investing ratios of an entity is ascertained by determining the asset turnover of the company for all the three years in determining the actual position of the firm is increasing. 

	2015	2016	2017
Earnings per share	60.29	0.68	1.14

The poor performance of GlaxoSmithKline is due to decreased net income of an entity which is clearly visible with the help of this bar chart. This needs to be improved by increasing the sources of income. 

ASTRAZENECA PLC
Particulars	Formula	2015	2016	2017
Profitability
Sales		24708	23002	22465
GP		20062	18876	18147
Gross Profit Ratio	GP/Sales*100	81%	82%	81%
Operating profit		2614	3572	2157
Operating profit ratio	Operating Profit/Sales*100	11%	16%	10%
Net profit		2825	3499	2868
Net profit Ratio	Net profit/sales*100	11%	15%	13%
Total assets		60124	62526	63354
Return on assets	Net profit/total assets	0.047	0.056	0.045
Stockholder’s equity		18490	14854	14960
Return on Equity	Net profit/Stockholder's equity	0.05	0.06	0.05
Liquidity ratios
Current assets		16007	13262	13150
Current liabilities		14869	15256	16383
Current ratio	Current assets/current liability	1.08	0.87	0.80
Inventory		2143	2334	3035
Quick ratio	(current assets-inventory)/current liabilities	0.93	0.72	0.62
Gearing ratios
Long term debt		14137	14495	15560
Equity capital		18490	14854	14960
Gearing ratio	Long term debt/equity capital	0.76	0.98	1.04
Investing Ratios
Sales		24708	23002	22465
Total assets		60124	62526	63354
Asset turnover ratio	Sales/total assets	0.41	0.37	0.35
Share performance ratios
Net income		2825	3499	2868
No. of outstanding shares		316	316	317
Earnings per share	Net income/no. of outstanding shares	8.94	11.07	9.05

Source: AstraZeneca, 2017

	2015	2016	2017
GP	81%	82%	81%
Operating Profit	11%	16%	10%
NP	11%	15%	13%

Except for gross profit, operating profit and the net profit of the company is showing stable and decreased return which is not fruitful for the company as the market competition is severe. Gross profit is higher due to the controlled cost of goods sold of an entity. 

	2015	2016	2017
Return on assets	0.047	0.056	0.045
Return on equity	0.05	0.06	0.05

Increasing returns shows the efforts applied by an entity in accomplishing all its goals and the objectives by considering all the pros and cons of the company to respect the shorter deadlines given by the client.

	2015	2016	2017
Current ratio	1.08	0.87	0.8
Quick Ratio	0.93	0.72	0.63

Both the current ratio and the quick ratio of the company is decreasing slightly from one period to another due to the imposition of current and the quick liabilities of an entity. The burdens of liabilities need to decrease by keeping track of all these in advance (Working capital, 2017). 

	2015	2016	2017
Gearing Ratio	0.76	0.98	1.04

Gearing ratio of AstraZeneca is depicting its uniqueness by showing a positive plus increasing return from one period to another reflects the hard work of the company in front of its external users. 

	2015	2016	2017
Asset turnover	0.41	0.37	0.35

The investing ratio trend is like a staircase which is reducing from top to the bottom position depicts the deficiency of the firm in achieving its returns within a stipulated deadline. This is due to higher assets and lower net income of an entity.

	2015	2016	2017
Earnings per share	8.94	11.07	9.05

The highest earning share of AstraZeneca is marked in the year 2016 due to higher net income of the company as compared to other years such as 2015 and 2017 where returns are in stable position. 

SHIRE PLC
Particulars	Formula	2015	2016	2017
Profitability
Sales		6417	3865	4865
GP		5448	-3817	-4701
Gross Profit Ratio	GP/Sales*100	85%	-99%	-97%
Operating profit		1543	-9445	-11763
Operating profit ratio	Operating Profit/Sales*100	24%	-244%	-242%
Net profit		1338	604	4254
Net profit Ratio	Net profit/sales*100	21%	16%	87%
Total assets		16610	67035	67757
Return on assets	Net profit/total assets	0.081	0.009	0.063
Stockholder’s equity		9829	28948	36176
Return on Equity	Net profit/Stockholder's equity	0.08	0.01	0.06
Liquidity ratios
Current assets		2256	7540	7608
Current liabilities		3706	7743	7882
Current ratio	Current assets/current liability	0.61	0.97	0.97
Inventory		635	3562	3292
Quick ratio	(current assets-inventory)/current liabilities	0.44	0.51	0.55
Gearing ratios
Long term debt		70	19553	16411
Equity capital		9829	28948	36176
Gearing ratio	Long term debt/equity capital	0.01	0.68	0.45
Investing Ratios
Sales		6417	3865	4865
Total assets		16610	67035	67757
Asset turnover ratio	Sales/total assets	0.39	0.06	0.07
Share performance ratios
Net income		1338	604	4254
No. of outstanding shares		59	59	81
Earnings per share	Net income/no. of outstanding shares	22.68	10.24	52.52

Source: Shire, 2017

	2015	2016	2017
GP	85%	-99%	-97%
Operating Profit	24%	-244%	-241%
NP	21%	16%	87%

Profitability position of Shire plc is not good as the gross profit of an entity is showing negative results after the year 2015 that depicts the burden of costs of goods sold on an entity (Lee, Lin and Shin, 2018). Operating results is increases as shire plc has control over its operating expenses. Net profit of the firm is excessively negative due to the immense pressure of the taxation of the country. 

	2015	2016	2017
Return on assets	0.081	0.009	0.063
Return on equity	0.08	0.01	0.07

Return on equity and assets shows the involvement of internal business components in creating higher returns in the external market. This shows the importance of an entity’s skills in creating a special place for an enterprise among its existing market rivals. In the year 2015, both returns on equity and assets show stabilizing position which decreases in 2016 and again increases in 2017 which in total shows fluctuating trend. 

	2015	2016	2017
Current ratio	0.61	0.97	0.97
Quick Ratio	0.41	0.51	0.55

Liquidity is essential for a business in taking lead in a competition as a business runs on a credit which requires working capital to pay off daily expenses. The current ratio is increasing year by year from 2015 to 2017 as the current assets are higher in comparison to the current liabilities. On another hand, quick ratio is also increasing but lesser as against to the current ratio. This shows the influence of the inventory in the current assets as quick ratio shows the absence of inventory in a current asset group.

	2015	2016	2017
Gearing Ratio	0.01	0.68	0.45

Gearing ratio compares the long-term debt with the available equity held by an entity to meet the interest payable on the debentures and bank loan in the form of debt taken by an entity (Rodrigues and Rodrigues, 2018). It shows the calibre of a firm in paying off its debt on time. In the first year, Shire plc is not able to meet its debt but in the next year the firm outperforms and clear its entire previous debt burden but in the year 2017 the performance of the firm slightly decreases due to a higher dividend paid to the shareholders. 

	2015	2016	2017
Asset turnover	0.39	0.06	0.07

Asset turnover shows the utilization of assets of an entity in generating the final outcomes of an enterprise. The bar chart shows the decreasing returns from 2015 to 2017 in a descending order. Higher returns booked in the initial year of 2015 which further decreases in the year 2016 and then in 2017 due to a lower amount of assets held by Shire plc. 

	2015	2016	2017
Earnings per share	22.68	10.24	52.52

Earning per share is a medium used to reflect the fluctuating market trend of stock market earrings of an entity by showcasing its external market position on attracting its external as well as the internal clients (Mo, and et. al., 2018). The above figures show the increasing position of earnings from 2015 to 2017 due to higher net profits.

Non financial ratio

	GlaxoSmithKline
Particulars	2015	2016	2017
Net profit	8422	912	1532
Number of employees	43021	42479	40934
Profit per Employee	20%	2%	4%
Total assets	53446	59081	56381
Assets per employee	1.24	1.39	1.38

	2015	2016	2017
Profit per Employee	20%	2%	4%

	2015	2016	2017
Asset per employee	1.24	1.39	1.38

	AstraZeneca
Particulars	2015	2016	2017
Net profit	2825	3499	2868
Number of employees	59700	66481	298272
Profit per Employee	5%	5%	1%
Total assets	60124	62526	63354
Assets per employee	1.01	0.94	0.21

Source: GSK number of employees, 2017

	2015	2016	2017
Profit per Employee	5%	5%	1%

	2015	2016	2017
Asset per employee	1.01	0.94	0.21

	Shire
Particulars	2015	2016	2017
Net profit	1338	604	4254
Number of employees	22000	10268	718926
Profit per Employee	6%	6%	1%
Total assets	16610	67035	67757
Assets per employee	0.76	6.53	0.09

	2015	2016	2017
Profit per Employee	6%	6%	1%

	2015	2016	2017
Asset per employee	0.76	6.53	0.09

b) Identify the best performing company and state the reasons if the company would be consider as a positive investment opportunity.

On the basis of the results of the ratio analysis, it has observed that AstraZeneca is a best-performing company as compared to GlaxoSmithKline and Shire plc as all these three companies are of pharmaceutical companies. AstraZeneca is considered as positive investment opportunities in the future due to various reasons are given below:

• Higher earnings per share of the company open up the path for increasing the stock returns on the London stock exchange to avail the market volatility.
• Increasing net income is utilized in investing in different sources of investments

c) Identify worst performing company and discuss the recommendations of how the financial performance of the firm can be improved

Shire Plc is proved as a worst performing company whose results in the form of financial ratios are decreasing from one period to another. Following are the reasons which prove that this company is considered as a negative investment opportunity for an individual or an entity is given as below:

• Decreased profitability of the company will not attract an investor towards this firm as this entity will not able to pay off the interest of investors due to its low profit.
• Higher debt burden reflects the gearing performance of the firm

Question 2

a) Identify and explain the key stages in the capital investment decision-making process and the role of investment appraisal in the process.

Before considering any project, an entity uses capital appraisal techniques to select the most desirable project which generates higher profit in the future. The capital budgeting technique plays a significant role for an entity in prioritizing among the different projects that produce higher returns as compared to all other projects evaluated by an entity. For the growth of the business, the investment plays a significant role as the owner of a business emphasizes on expanding its existing business by utilizing its own efforts to get the lead in its business (Giustinelli and Manski, 2018). There are various techniques of the capital appraisal or economic appraisal techniques whose aim is to increase the profitability of a project by considering the existing skills of a project to beat its competitors existing in a similar market. Various methods of the capital appraisal help to achieve all the desired aims and the objectives within a stipulated time period with a motive to improve its image in front of it's internal as well as the external users. It includes payback period, net present value, accounting rate of return, internal rate of return. All these approaches belong to different concepts in determining the future profitability in advance in alerting the clients before stepping ahead in the investment market (Bridge and Dodds, 2018). A risk of the whole investment market is conveyed to the clients with the help of all these methods. An individual or group of individuals is required to follow a procedure of capital investment decision which is given below:

Identification of a project

The first and the foremost step in the capital investment decision is to search for all the projects available in the market that generates higher returns for an entity or an individual on selection. Different projects are there which fulfils the needs of a person such as a project for newly equipped machines and replacing decision by eliminating old machines held in a business, exclusive and the inclusive investment decisions. Before taking the investment decisions, an individual seeks various criteria’s in selecting the best suitable project which meets all the criteria’s in order to be called as the most desirable and suitable project (Lefley and Sarkis, 2018). Various criteria’s uses by an individual include budget or cost of a project, the rate of return used to discount the present cash flows in determining the future profitability of a concern project. An initial cost of the project is used as an integral factor in ascertaining the future profitability by comparing this with the present value of the cash flows which is discounted at a specific rate of return. An individually initially observes the initial capital and the cash flows generated from a project in the overall years of a project to consider the same in comparison with all other projects available in the market for selection.

Defining of a project

In this stage, the project is defined in detail to guide an investor whether to select or reject the project by creating different selection measures to tests the entire performance of a project. The aim of an individual is to select the most suitable project which meets all the criteria’s develops by an entity for the betterment of an entity. Detailed defining of a project includes the financial as well as non-financial components of a project to help a user in considering the same for the future purpose as their aim is to positively influence all its users whether directly or indirectly associated with its business (Berechman, 2018). Employees are the internal users of an entity who represents the company in front of the external parties, which is essential to be satisfied with the services offers by an enterprise as this satisfaction will further reflect in attracting the clients towards the firm. The owner of the business will involve all the employees and other internal users of its firm in this decision and consider their opinions whether to select or reject the project will help in maintaining the image of the firm among its users. This decision of an entity owner helps in stealing the attention of external investors and the shareholders to take the active interest in the proceedings of a business.

Analysing the project

This is the third stage of the capital appraisal process, under which an entity will evaluate the shortlisted projects by an entity by discussing its advantages and the disadvantages to consider the best suitable projects for the betterment of an enterprise. In the analysis stage, all the measures created by an entity in the above two steps are clubbed together in testing the overall performance of a project as this project is feasible enough in generating the higher returns or not. Alternatives are identified in context to the shortlisted project for backup as if these projects are rejected then all the alternatives will uses by an entity for generating better results for the company (Asmussen, Kristensen and Wæhrens, 2018). The motive of an enterprise is to attract all the parties towards the business in building a strong base of customers by delivering quality oriented services to all its users. In this segment, an entity will analyze all the risks involved in this project by prioritizing among all the risks by knowing its severity as the identified risks are categorized into three levels. These three levels of the risks include low, medium and high as these criteria’s depicts the likelihood of occurring the risks in this project along with its effect on an entity. The risk is a un-favorable component which needs to be identified by an individual in the present stage top avoid future problems easily as this may lead to the deterioration of the established image of the business concern in front of all the internal as well as the external users of an enterprise.

Monitoring

After identifying the positive and the negative outcomes from all the evaluated projects by an entity, shortlisted on the basis of crafted measures by an enterprise. Measures are crafted by an entity to test the overall performance of a business in the form of investment made by an entity in various bonds, lands, machinery and many more as according to the existing nature of an entity. Investing abilities of an entity are checked throughout this procedure which helps an individual or a group of individuals in moving the head in grabbing lots of market opportunities (Zhao and Yang, 2018). Monitoring is one of the important functions of management in which shortlisted and the evaluated projects are taken care to select the most desirable projects which meets the needs and higher expectations of a market. The negative or positive traits of a project are tested through the pilot testing survey in which the actual reality of all these projects is identified to take the best suitable investment decisions by an entity within a stipulated time period.

Post audit

Last stage of the capital investment decision process is considered as the most crucial stage which helps in deciding the final selection or rejection of a project by an enterprise. The result of the monitoring stage includes the positive or negative reactions of the general public in pursuance of the evaluated projects to help an entity in selecting the best suitable projects by an enterprise. Time plays a significant role in considering the best suitable project out of the available projects in the market (Shahab, Ye, Riaz and Ntim, 2018). A project which posses lesser risks, costs and which generates returns in the lesser time period is considered by an individual Nowadays, time acts an integral source of competition in a market as delivering quality oriented services before the stipulated deadline helps an entity in beating all its existing competitors. This actor will create a benchmark for its potential rivals in a market to increase its productivity to create a competitive spirit like an entity in the overall market.

b) Identify and explain the main methods of investment appraisal used in practice with the help of numerical examples.

Different methods of the capital appraisal or economic appraisal methods includes net present value method, internal rate of return, payback period, average accounting rate of return methods which is based on the different concepts used to evaluated all the available project in order to prioritize the project to consider the best suitable projects out of the total project held for use by an individual (Marx and Turner,2018). Variability of the methods helps an entity in selecting the suitable projects easily by seeking all the components in the shortlisted projects. There are different kinds of capital investment decisions methods which are given as below:

Payback period- This method is a traditional approach of the capital investment decision or economic appraisal method in which time factor of a future generated returns are considered as a comparison factor among all the available projects held for selection in a market. In this approach, a project is selected or rejected on the basis of returns generated in the lower time period among the projects which are compared with each other (Yang, 2018). A project which generates the overall costs of the project through its cash flows in a specific period will consider as the generation of future returns in that particular period. A disadvantage of this method is that it disregards all the cash flows after achievement of the goal as returns generated after recovering the initial capital of the project is not considered in selecting the project.

Year	Project X	Cumulative cash flows
Initial investment	400000	-400000
1	$ 120,000.00	$ (280,000.00)
2	$ 150,000.00	$ (130,000.00)
3	$ 180,000.00	$ 50,000.00
4	$ 185,000.00	$ 235,000.00
5	$ 190,000.00	$ 425,000.00
6	$ 220,000.00	$ 645,000.00
Payback period	2.77

Year	Project Y	Cumulative cash flows
Initial investment	400000	-450000
1	$ 100,000.00	$ (350,000.00)
2	$ 160,000.00	$ (190,000.00)
3	$ 185,000.00	$ (5,000.00)
4	$ 195,000.00	$ 190,000.00
5	$ 220,000.00	$ 410,000.00
6	$ 260,000.00	$ 670,000.00
Payback period	$ 3.03

Net present value- Net present value method is based on the concept of the time value of money which is a concept which helps in ascertaining the future in advance in the present period. Discounting rate of return is used to determine the present value of the cash flows of an enterprise. This approach aims to identify the profitability of a project in the present period by applying the concept of time value of money which helps a user in guiding how much money to invest by an investor in the present time (Zheng, He,Wang and Jia, 2018). Initial cost of the project is compared with the present value of the cash flows of the project to know the amount of net present value of a project. Positive and higher net present value of a project is consider by an entity in selecting or rejecting a particular project out of all other projects held available for use.

Year	Project X	Discounted Factor @12%	DCF	Project Y	Discounted Factor @12%	DCF
Initial investment	400000			450000
1	$ 120,000.00	0.893	$107,160.00	$ 100,000.00	0.893	89300
2	$ 150,000.00	0.797	$119,550.00	$ 160,000.00	0.797	127520
3	$ 180,000.00	0.712	$128,160.00	$ 185,000.00	0.712	131720
4	$ 185,000.00	0.567	$104,895.00	$ 195,000.00	0.567	110565
5	$ 190,000.00	0.507	$ 96,330.00	$ 220,000.00	0.507	111540
6	$ 220,000.00	0.452	$ 99,440.00	$ 260,000.00	0.452	117520
Present value			$655,535.00			$ 688,165.00
Less: Initial investment			400000			450000
NPV			$255,535.00			$ 238,165.00

Internal rate of return- This concept is similar like a break even concept in which an entity identifies a specific rate of return at which the overall costs of the project gets zero. This shows the shutdown point of the business as just achieving the costs o the project us not aim of an entity as they intends to accomplish the profitable goals along with the recovery of the initial capital applied on a project. The returns of a project surpasses the initial capital applied in the project will results to higher returns for an enterprise will increases the image of the firm in front of its external and the internal users who gets satisfied when they get their salary, return and investor’s interest on time to keep satisfied with the services and quality oriented products offers by an entity to all its users on within a short span of time (Lefley, 2018). A projected is selected when the internal rate of return is higher than the rate of return used by an entity as this will results into higher profits otherwise will only meet the overall capital applied by an entity in the initial project in the form of capital of strengthening the overall project.

Year	Project X	Project Y
Initial investment	-400000	-450000
1	$ 120,000.00	$ 100,000.00
2	$ 150,000.00	$ 160,000.00
3	$ 180,000.00	$ 185,000.00
4	$ 185,000.00	$ 195,000.00
5	$ 190,000.00	$ 220,000.00
6	$ 220,000.00	$ 260,000.00
IRR	33%	29%

Average accounting rate of return- This approach is only emphasizes on the generation of a profit from a project without considering any other features of a project. Average profit produces by a project is counted in assessing the productivity of a project. The rate of return of this method should be higher as compared to the exiting rate of return of a project (Piel, Humpert and Breitner, 2018). The higher rate of return of a project reflects the higher generating of profits which is clearly indicates the decreasing costs involved in a project is a favourable condition for an entity. Disadvantage of this approach is that this considers only profit of a project rather than considering all other feature of project in selecting the most desirable project which generates fruitful results for an enterprise within a stipulated time or not.

Year	Project X	Project Y
Initial investment	400000	450000
1	$ 120,000.00	$ 100,000.00
2	$ 150,000.00	$ 160,000.00
3	$ 180,000.00	$ 185,000.00
4	$ 185,000.00	$ 195,000.00
5	$ 190,000.00	$ 220,000.00
6	$ 220,000.00	$ 260,000.00
Average profit	$ 174,166.67	$ 186,666.67
ARR	44%	41%

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