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ASSIGNMENT STAGE 2Rochelle BurneySTEP 7: CONTRIBUTION MARGINS AND CONSTRAINTSHargreaves Services PLC provides a wide variety of services, I have identified three of the services they offer below and will use these in completing this step.Port Service Logistics – Transportation of deliveries from site to port harbour and vice versaLogistics waste disposal services, this service includes assessing the different types of waste, report on best disposal option, pickup, transportation and disposal of construction site waste.Logistics transportation of industrial chemicalsI selected these three services as I really am not familiar with the costs and sales prices for any of the services Hargreaves Services PLC provide. I do have some understanding of Logistic services, and would like to have my estimates of these to be as realistic as possible. So I selected the services I had the best understanding of. Another reason for my selection was as my firms services vary dramatically, I selected all services in the same area, being that all the services I selected use the same trucks and/or machinery and so the sales and costs estimated would be comparable. Despite much research I could not find any prices for these types of services in the UK, and so I had to estimate my best guess. To keep these services comparable I have based these estimates on one common ground, as there are different size trucks and different services being offered I have tailored these estimated prices per weight as I have no idea how these prices are usually calculated. I have used some logistic services myself for landscape supply deliveries which are calculated based on the weight of the delivery and whenever I take a load of rubbish to the tip the cost is calculated by the weight of my load, so I have made the decision that I will quote these services based on the weight. In this instance we will use the Less Than Truckload (LTL) cost per pound (KPI), with a truck capacity of 4500lbs.Port service logistics – ?0.80 LTL KPI = ?3,600Waste disposal services - ?1.90 LTL KPI = ?8,550Transportation of industrial chemicals - ?1.80 LTL KPI = ?8,100Once again I could not find any variable cost information for my firm, quiet frustrating. However as I know from reading the study guide variable costs are all those costs that change according to the level of activity and usually are the direct costs associated with the services the firm provides. For my firm this would be items such as fuel costs, maintenance costs on vehicles, waste disposal costs and so on. I have estimated my best guess as to the percentage of the selling price which would be allocated to these variable costs. Port service logistics – 35%Waste disposal services – 42%Transportation of industrial chemicals – 40%Based on these percentages of variable costs I can calculate the actual figures for each of the services I have selected.Port service logistics – ?0.80 LTL KPI = ?3,600 x 35% = ?1,260 in variable costsWaste disposal services - ?1.90 LTL KPI = ?8,550 x 42% = ?3,591 in variable costsTransportation of industrial chemicals - ?1.80 LTL KPI = ?8,100 x 40% = ?3,240 in variable costsContribution Margin (Sales – Costs):Port service logistics – ?3,600 - ?1,260 = ?2,340Waste disposal services - ?8,550 - ?3,591 = ?4,959Transportation of industrial chemicals - ?8,100 - ?3,240 = ?4,860From these figures I can see the total amount from each of the services my firm offers that then contributes to the fixed cost and profits for the firm. Below I have calculated the actual contribution margin ratio for each of the services I have selected Contribution Margin Ratio (Contribution margin / sales revenue)Port service logistics – ?2,340 / ?3,600 = 65%Waste disposal services - ?4,959 / ?8,550 = 58%Transportation of industrial chemicals - ?4,860 / ?8,100 = 60%Based on these figures I can see that the service that offers the higher contribution ratio is the port service logistics. That means 65% of each dollar can contribute towards the firms fixed costs and profits. The reason these services might differ in the contribution margins is because of what the services might actually entail. For example the port services are simply transportation, meaning less costs involved. The waste disposal services has a higher variable costs due to the processes involved in analysing and disposing of the waste materials on top of the transportation costs and so on. So this contribution margin varies depending on the services. Variable costs are also not the only costs associated with the services a firm offers, while a service might offer a higher contribution margin, if the fixed costs associated with this same service are higher, than the service might not be as profitable. A firm would also choose to deliver a range of products or services rather than simply focusing on the service with the higher contribution margin to also target a wider range of markets. Constraints are a lot easier to identify in production industries, for that reason I struggled with this one. The only real constraints I could think of that may hinder my firm’s services they offer are listed belowCouncil approvals for land developments Lack of available spots with regards to port logistic services in particular for client with time restraintsThe numbers and locations of available machinery (trucks for transportation services or machinery used in earthworks or mining services)Availability, location and price of land for developmentMoney/Budget (there would be a budget as to how much a firm could spend on any development)One good example of constraints would be for my firm to decide on which property developments to take on and the types of things they would need to take into consideration would be Price, location, land conditions (if it was rocky landscape would mean excess costs might be involved in the earthworks), environmental concerns and so on. There would be limits as to how many of these types of projects my firm could take on at one time, and so these constraints would all play their part in making a decision on which development project my firm might pursue over the alternative. STEP 8: RATIO ANALYSIS AND COMMENTARY The first thing I looked at with this step was collating the ordinary share information for my company, this process was relatively straight forward. I found my companies annual financial statements very helpful here. Finding the number of ordinary shares issued as at 31st of May for all my years straight away. So I had my information for this, now I just had to translate the figure to reflect my dollar amount which was in thousands, while the number of ordinary shares issued was just the standard figure. This was extremely easy, moving the decimal place forward three spaces to create the number of ordinary shares issued in thousands. I also found the cost of capital or discount rate figures in my firm’s financial statements was revealed to be 9% for all years except the 2014 year. This was very odd, the 2014 year had a discount rate of 12%. Once again this seemed very high to me, however I presume since this information is stated in my firms financial statements then it must be correct. Furthermore the 9% for all other years sounds correct to me, not wanting to waste any more time on this as it seems to be not particularly important to my outcome since we were instructed to use 10% if we did not have the information, in the interest of moving forward I entered these figures for the WACC and proceeded.I found tracking down the share price a little more confusing and I am still not quite sure my figures are correct. Despite finding the same figures on a number of sites include Hargreaves Services PLC’s website, they actually have a chart depicting all previous share prices which I found to be in line with the stock exchange websites I viewed. However the share prices seem to be extremely high to me, which made me wonder if this was because these shares are predominantly purchased by larger entities or perhaps by the related companies of Hargreaves rather than the general public. Not knowing a great deal about shares I assumed the figure was correct and proceeded. The other question I had was what does 10p mean in the description of the shares, does this mean a 10 pack (fairly sure I will get laughed outta class revealing this thought, it’s not like I am purchasing a pack of pens or a 10 pack of soft drinks). This thought seemed ridicules to even me, intrigued I turned to Google and found that this “Hargreaves Services PLC (HSP) Ordinary 10p Shares” was simply just the way the shares were described and has no meaning relevant to my needs. Still feeling hesitant about this share price, I went back through the share prices and it clicked to me that these share prices were in ‘pence’ which is why the figure seemed so high, I then converted the figure to British pound. This looked much better. Feeling pumped after completing that section with relatively few dramas, I was excited to continue on to the next section, linking and calculating my ratios.Once again calculating the Net Profit Margin was very easy, the video was so helpful in completing these steps. I did struggle however in trying to decide which ‘sales figure’ I am supposed to be using in this calculation. As in my financials there was the revenue amount of ?342,868,000, however of this revenue amount ?309,832,000 was the cost of sales. Now originally I had thought obviously you want the total sales amount which is a firm’s revenue, however after entering this figure into my ratio spread sheet my profit margin was only 2.1% in the 2017 year. Meaning for every dollar of my firms sales, there was a profit of 2.1 cents. This is a massive firm, I find it very hard to believe that this firm only has a profit margin of 2.1%. I then looked further at the 2016, 2015, and 2014 years. In 2016 there was a profit margin of -3%, the 2015 year there was a profit margin of 2% and in the 2014 year there was a profit margin of 4.9%. Now 4.9% sounds like it might be a more reasonable figure, however still seems so low to me. This made me question if this ‘sales’ figure is indeed the one I am supposed to be using, however of all I understand about profit margins, they are calculated on the total sales amount, that is revenue. This company has gone through some changes in the last few years as I know from my previous investigations, selling one of its entities as well as selling a lot of its legacy assets. I will assume for now that the dramatic changes in my firms profit margins are simply reflecting these changes and press forward hoping to uncover more of the puzzle as I progress. Next step was to look at my firms ‘return on assets’, here we are again, the 2014 year there was a reasonable figure showing there was an 11% return on the firm’s assets for that year. This figure dropped dramatically over the following three years and was actually -3.6% in the 2016 year. This is very odd…. Profits picked up slightly in the 2017 year to 2.5% (in comparison to the 2016 year) however this is not good enough for a firm this size, especially when you consider the other investment options and the returns they could offer with no risks involved. Term deposit for example, would offer a higher return with no risks involved. Something has happened in the last few years for this firm, judging from these figures this firm is not as profitable as it certainly should be and looking at the 2014 year it’s not nearly as profitable as it has been in the past. Looking at my financials and it appears that the firm took a massive loss of ?10,455,000 in the 2016 year. That is a massive amount. Looking at the gross profit figures and it is clear to see the profits have been progressively declining since 2014. Looking further at the financial statements and I can see that the 2016 year had a massive loss in impairment of non-current assets. Impairment of non-current assets basically means the firm took a loss on its assets, basically the market price of the firm’s assets were a lot lower than the value the firm had them listed at. Having the prior knowledge of the firm’s goals to sell off its legacy assets, I assume these are the assets that have depreciated. The firm also appears to have a lot larger cost of sales and admin expenses over the 2015 and 2016 years which also appears to have contributed to these drops.The next step for me was calculating how long it takes for my firm to sell its inventory (Days of inventory). This was very easy in my particular case as my firm had listed both the inventory and the cost of sales in a neat tidy sum in the financial statements. My cost of sales was a negative figure so I had to negate this negative in my equation. I particularly liked completing these steps, I love working with excel and really enjoyed the equation used to calculate this figure for the year (365 days). My firm seems to have had a good turnover period for most years being just over a month, except for (surprise, surprise) the 2016 year, this seems to have been a real problem year for my firm and the issues they faced have so far effected all of their figures for this year. However the turn over time of inventory for my firm seems to be reasonable to me, offering services in mining, logistics, earthworks and so on. The types of inventory they would hold (majority of them) would have a very long shelf life and so it would not seem unreasonable for them to take almost 2 months to turn over this inventory, which was the case in 2016 year. Furthermore the amount of time it takes for this firm to turnover its inventory is fairly standard across all years (excluding the 2016 year), which leads me to think since the trend over the years is consistent then the timeframe should be appropriate for this industry. After spending a bit of time looking for information on industry benchmarks online for the United Kingdom, to see if this was in fact a reasonable amount of time, I found nothing that would point me in the right direction. I decided to make the call that since the inventory rollover period for my firm is very reasonable even for some food industries I will presume this is ok for my industry also and continue on. Moving onto the Total Asset Turnover, this is the figure that my firm has generated times its sales value. For my firm this figure was very strong in the 2014 and 2015 years sitting at around 2.5, however this then fell dramatically to 1.22 for both the 2016 and 2017 years. The reason for this is very obvious, with the total asset figures for these years dropping slightly and the sales figures dropping massively for these two years. In saying that however I wonder if this initial figures of 2.5 or thereabouts, for the earlier years were perhaps too high and thus unsustainable. Was it just the case were my firm was overworking their assets? Still a 1.22 return on assets for the last two years is a reasonable figure. After watching the video I noted that a firm should at least have a 1 to 1 for its liquidity ratio, that is a firm’s short term liquidity or current assets vs. current liability. I was surprised to see my firm was ahead of this benchmark, particularly for the 2016 year. My firm had double its current asset value to its current liabilities in all years except the 2015 year. In 2014 the Liquidity ratio was 2.22, 2015 was 1.69, 2016 was 2.05 and 2017 was 1.94. All seem to be very solid figures for this firm. This is surprising to me, as my firm has assets of high value to offer the services it does, I assumed they would have a large amount of liabilities for this reason, and I had assumed this would show up in the short term liquidity ratios. Looking at the financial ratios for my firm and it has me concerned, how is it possible to have over 100% debt/equity ratio. Surely this is not good. This debt equity ratio basically means for each dollar contributed by a shareholder this percentage represents the amount contributed by the banks. Hargreaves services has a debt/equity ratio of 104.3% for the 2017 year, so for each dollar put in by the shareholders the bank has put in $1.04. That is massive…. Looking at the financials and it is easy to see that my firm has far more total liabilities then it does total equity. It looks as though my firm decreased their debt by 56.6% in 2015, however they have obviously taken on more debt in the following year as the 2016 year had increased by 13.5%, and decreased in the 2017 year meaning the debt decreased also. In the 2014 year my firm’s debt/equity ratio was sitting rather high at 156.4%, I also noted it did not have any property assets listed in its financials however it has for all other years. This debt/equity ratio is such a high figure for this year, I wonder if the company has taken out the debt to purchase the property that is listed on the 2015, 2016 and 2017 years, however with the time lag in contracts and so on, this purchase of property was not listed in the financials until the following year. I also noted with the big jump in the difference in debt between the 2014 and 2015, my firm had a much lower ‘assets held for sale’ and ‘inventory’ figures in this 2015 year which they could have used the proceedings from to decrease the value of their debt. Their ‘Property, plant and equipment’ figure also dropped in the 2015 year. Perhaps they could have sold some of these legacy assets and used the proceedings to decrease their debt also. In general their debt to equity ratio has decreased since the 2014 year, which tells me firstly, that the trend is heading in the right direction and secondly, that the debt they do have is able to be maintained at least for now. Looking further at the Equity ratio, or the amount of assets that is funded by the shareholders over the years and it appears to be the opposite trend to the debt/equity ratio. This is what you want to see, all figures look ok to me and make sense after reviewing the debt/equity ratio above. Out of interest I also calculated the debt ratio for my firm, as discussed above my firm has taken on further debt in the 2016 year. However I did find it interesting to see the debt to assets ratio in this format, it made it very easy to see where my firm was sitting financially with the bank contributing 50% and higher from 2014 through to 2017. This was my expectation from this firm, with the services it offers, I had always thought this firm will have a large amount of debt powering its services with all the expensive machinery required for the mining and earthworks services in particular, not to mention the cost of the trucks to ‘motor’ the logistics services. I found this process absolutely fascinating and made so much sense when looking through my financials, the number of items I linked back when analysing my ratios and in doing so really created a sense of where items belong and the effect they have on the financials. Analysing my firms market ratios was not as consistent, my firms ‘earning per share’ that is the profit per share, seem to jump all over the place with the 2017 year being ?0.22, the 2016 year was -?0.31, 2015 year ?0.41 and the 2014 year ?1.28. Which of course was reflecting my firms varying total income across the years. The dividends per share, or what was actually paid per share was very low which at first had me a little confused however after watching the ratio video I believe my figures are probably fairly average. However I did note this figure was higher for the 2014, 2015 and 2016 years and after looking at my financial statements I can see that my firm paid out a lot more in dividends for these years then they did in the 2017 year. The dividend amounts paid was never higher than the dividend profits per share for the corresponding year, however I did think it funny that my firm paid out a larger amount per share in the 2015 year than it did in the 2014 year despite the 2014 year making over double the profits in comparison to the 2015 year. Learning about the price earnings ratio and I have to say I really did not understand what this figure actually told us about the firm until it was explained my Maria the way one of her students had explained it to her, that being this number tells us the amount of time it will take for a shareholder who has invested in the share to see their money returned. This was such a brilliant way to explain this concept and one I could really relate to. That being said, this figure is also very inconsistent for my firm. In 2014 it would only take 5.95 years for a shareholder to see their money returned, in 2015 it would be 9.31 years, in 2016 it would take 5.75 years. However if a shareholder invested in my firm in the 2017 year it would be 15.54 years before they could expect the same returned. Now to look at our restated financial statements, and I am interested to see just what effect separating the operating and financial activities has on my firm when looking at these ratios. The first one I looked at in the list was the Return on equity, seeming a little more consistent then the last few ratios I analysed, at least in the decline. In 2014 there was a return of 28.14%, which then dropped right down to 9.11% the following year and continued to drop to be 5.19% in the 2017 year. These figures were at least consistent over the years, and also seemed to me to be a reasonable return for investors.It was interesting to look at the return on net operating assets (that is the return on assets after I separated and removed the financial activities from the picture). Looking back at my Return on assets figure above in comparison and it was interesting to note how different they were, with my return on net operating assets being almost double the original ROA. The trend appears to be the same however the return was much high when looking at just the operating assets, these figures were very positive for my firm. Looking at the cost of my firms debt or ‘Net borrowing cost’ at first I could not make sense of the figures I was looking at. For a start the figures were extremely high, when considering these figures are basically an interest rate they seem far too high. In the 2015 year the cost of debt was 71.58%. Which seemed completely out of place to me as that was the year Hargreaves actually had the least amount of debt as can be seen in the debt ratio above. It seemed backwards to me as the 2014 year which was the year that had the most amount of debt was one of the lower cost of debt figures being just 5.21%. The only possible reason I could think of was that perhaps the higher debt meant a lower interest rate, however I would think as the firm continued to grow and expand (property investments and so forth) the interest rates would decrease gradually. This was not the case with Hargreaves, and I wonder if this had something to do with the decrease in the firm’s assets in this 2015 year? They had a wide variance in these Net borrowing costs, seeming particularly odd for the 2017 and 2016 years where the debt amount was very similar, however the 2017 year had a net borrowing cost of 13.71% in comparison to the 2016 year which only had 3.71%. Which blows my thought of the assets affecting the interest rate as the firm had a property portfolio in the 2017 year twice the value of the 2016 year and yet also had a higher net borrowing cost. Perhaps this was simply the case of dealing with different banks or different loan structures. Seems very odd to have such a variance across all years.Now to look at Profit margin, first thing I notice is the trend looks about right. After the drop between the 2014 and 2015 year, the figures continue on and are very close in comparison with a slight decline. However as of the 2017 year Hargreaves services for every dollar of sales it makes 2.51 cents of operating income. Now this seems very low…. Furthermore when comparing this profit margin to the net profit margin above, I can see that the figures are very similar with the highest variance being only 0.7 in the 2015 year. So by separating out our operating activities from our financial activities there is little difference in our profit margin, which means most of the income comes from the operating activities for this firm. Looking at the asset turnover and I can see the trend is much the same as the above, starting at 4.02 in the 2014 year, a slight increase to 4.29 in 2015, then decreasing to 2.04 in 2016 and rising slightly to 2.35 in 2017. The asset turnover is telling me how efficient my firm is in utilising its assets to generate sales, and from these figures I would say my firm is not overall efficient, at least not compared to previous years, however in the last two years my firm increased its asset turnover slightly and to look at these 2016 and 2017 figures alone I would say this is a reasonable turnover for my firm. In comparison to the Total asset turnover ratio above, the asset turnover amount is nearly double, this means that my asset turnover has improved massively in separating my operating and financial activities. STEP 8: ECONOMIC PROFIT As stated above I have used 9% for my firm’s cost of capital (weighted-average cost of capital - WACC) for all years except the 2014 year which I used 12%. The reason I have used these figures is because they were stated in my firm’s financial statements. So to calculate my firm’s economic profit for each year, I of course used the equation Return on net operating assets (RNOA) less the cost of capital amount times net operating assets (NOA). The first thing I noticed when calculating my firm’s economic profit is that 2016 and 2017 years were both negative figures this is because my firm’s return on net operating assets (RNOA) amount was less than my firm’s weighted average cost of capital (WACC) amount, meaning my firms RNOA for those two years did not cover my firm’s cost of capital. For all other years my firm had a greater return than the cost of capital, which is good. In the 2014 and 2015 year my firm’s economic profit changed substantially. In 2014 my firm’s economic profit was more than four times that of the 2015 year despite the fact that the weighted-average cost of capital for the 2014 year was higher at 12%. My firm’s RNOA was also substantially higher in the 2014 year than all other years which was partially to do with the much higher operating income after tax amount recorded in the financial statements for the 2014 year. However the much higher net operating asset amount recorded for this year which was at least 50,000,000 higher than all other years also played a big part in deciding this figure as we know RNOA = Operating income after tax (OI) / net operating assets (NOA). And of course Economic profit = (RNOA – WACC) * NOA. Majority of the differences (compared to all other years) that can be seen for this 2014 year is in the Inventory and the Property Plant and Equipment values recorded in the restated financial statements as discussed earlier. While the total operating liabilities was also much higher for the 2014 year it was ultimately these operating asset figures that have my firms economic profit for the 2014 year so much higher than all other years. While this higher figure would normally mean a good thing for my firm, as we can see with all other years it has not continued on this trend, therefore this figure would seem to be unsustainable. It is very hard to make further judgement on the economic profit for my firm as none of the figures follow a trend, with the 2014 and 2015 years having such a variance and in the most recent two years of my firms operations they had a negative economic profit as discussed above. After reviewing a number of my fellow students economic profit figures for their firms I cannot say I found many similarities. For a start the other firm’s that I did look at had much smaller operations than my own firm, therefore the variances they recorded for the economic profit amounts seem to be much smaller than my own. After some discussion with these students I found that having this negative economic profit figure was quiet common, and further to that, majority of students have not had the WACC amounts recorded in their firm’s financial statements and instead used the 10% as in instructed which I found interesting that not a lot of the firms disclosed this information in their financial statements. In conclusion I found it very helpful breaking my firm’s financial statements into bits. I have learnt so much from my financial statements. Looking at these equations, analysing the outcomes and investigating into the differences has really helped me to understand the varying changes one figure can have on how a firm’s overall financial position appears. I found this process really insightful and interesting. STEP 9: CAPITAL INVESTMENT DECISION FOR HARGREAVES SERVICES PLC Hargreaves Services PLC is considering whether to invest in further property for small residential developments which will include new homes, and a shopping complex. There are two different locations for these proposed developments the first is the Monkton Estate in Barnsley, United Kingdom and the second it the Blindwells Estate in East Lothian, United Kingdom. The timeframe for these developments differ, with the Monkton Estate development estimated at 9 years and the Blindwells Estate development being estimated at 10 years, each will be sold after this time. Please see completed table for the capital investment decision for my firm in my companies excel spreadsheet. Based on these calculations I would advise that Option 2 - Blindwells Estate be the recommended option for my firm. Let’s start with the Payback Period, as you can see Option 1 would have a payback period of 10 years, which means the firm would not expect to see the initial investment costs returned in the estimated time frame of development being 9 years. However Option 2 has a payback period of just 6.22 years, well within the estimated timeframe. Once more this means that after this time the firm should not expect to make a loss on this option. For this reason option two has nearly half the risk factor for the firm. Now we will look at the internal rate of return (IRR) for both options. Option 1 potentially offers 2.1% return on my firm’s investment, whereas Option 2 offers 12.6% return on my firm’s investment. That really doesn’t require any further explanation. There is a massive difference in that return amount and it is clear which offers the better opportunity. Finally we will look at the Net present Value (NPV) for both options. Net present value tells us how much ‘value add’ there is for a firm after the cost of capital (10% in this case). Once again this is easy to see Option 2 is the way to go, offering an NPV of ?257,134,000 in comparison to Option 1 which offers an NPV of ?109,890,000. In conclusion Option 2 not only offers a better return on my firm’s initial investment, it also offers a lower risk level being the investment potentially could be returned in under 7 years and offers 100% profit after this time. STEP 10: FEEDBACK ................
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