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ASSIGNMENT 3 RATIO ANALYSIS AND CAPITAL BUDGETINGUSING ACCOUNTING FOR DECISION MAKING, 2016COUSE CORDINATOR: MARTIN TURNERSTUDENT: PRASHANT SHARMAPROFITABILITY RATIOSProfitability ratios measures an organisation’s capacity to produce profit with respect to deals, equity and assets. These ratios evaluates the capacity of an organisation to create income, benefits and money stream with respect to some metric, frequently the measure of cash contributed. They highlight how successfully the profitability of a company is being managed. Some examples of profitability ratios are return on investment, return on sale, and return on equity. Different profitability ratios give different helpful bits of financial health and performance of an organisation.PROFIT MARGIN The profit margin ratio, additionally known as return on sales ratio or gross profit ratio, is a productivity ratio that measures the amount of net wage earned with every dollar of offers created by looking at the net wage and net sale of an organization. At the end of the day, the profit margin ratio indicates what rate of sales are left over after all costs are paid by the business. It is used by the creditors and investors to find out how capably a company can convert sales into net income.The formula for profit margin is = Net profit after tax/ Sales Year2014201320122011Profit margin-9.6%1.6%-22.6%0.3 %By finding out the profit margin of EVZ limited company, it can be seen that the company is doing good year by year at achieving more profit for every dollar of sale. We cannot recognise it by just looking at the ratios. The beginning year 2014 and 2012 are negative margin and need more investigation. RETURN ON ASSETSReturn on assets (ROA) is financial ratio that demonstrates the rate of benefit that an organization procures in connection to its general assets (all out resources). Return on assets is a key profitability ratio which measures the amount of benefit made by an organization for each dollar of its advantages. It demonstrates the organization's capacity to create benefits before influence, as opposed to by utilizing influence. Not at all like other profitability ratio, for example, return on equity (ROE), ROA estimations incorporate the greater part of an organization's assets – including those which emerge from liabilities to lenders and those which emerge from commitments by speculators. In this way, ROA gives a thought concerning how effectively administration use organization resources for create benefit, however is more often than not of less enthusiasm to shareholders than some other monetary proportions, for example, ROE.Formula for Return on investment is: Net profit after tax/ total assetsYear2014201320122011Return on assets-13.5%1.8%-29.6%0.3%As noticing the Return on investment by four years, we can see that the company is not doing to initiate profit. The company should utilise their assets efficiently so that they can generate profit. The ratios do not clear the point that how company is using its assets.EFFICIENCY RATIOIt is a type of ratio that is used to inspect that how efficiently a company uses its assets and liabilities within the company. Some examples of ratios are accounts receivable turnover, sales to inventory and stock turnover ratio. It calculates the repayment of liabilities, usage of inventory and machinery and quantity of equity.DAYS OF INVENTORYIt is a part of Efficiency ratio that calculates the average number of days a company keeps its inventory in the stock before selling it.Days of inventory= Inventory/ average daily cost of goods soldYear 2014201320122011Days of inventory13.6513.8013.6910.26By looking at the figures of days of inventory we can see that the company is not doing efficient work as the company has to keep the stock for a long time to sale the goods and that’s not good for the company.TOTAL ASSETS TURNOVER RATIOThis is a financial ratio that estimates the coherence of company’s utilising its assets for producing sales revenue or sales income to the company. Companies which have low profit margin seems to have high assets turnover and on other hand, the companies which have high profit margin have low assets turnover.Year 2014201320122011Total assets turnover1.401.161.311.30From the figures we can see that the EVZ limited has become more efficient from the year 2011 to 2014. It was fluctuated in between in the year 2013 but has an average efficient work.LIQUIDITY RATIOSThese are the financial obligations that are used to find either a company is able to pay off its short term debts or not. If the value of the ratio is higher than there would be higher margin of safety and if the ratio is lower than the margin of safety would also be low.CURRENT RATIOThe current ratio is a liquidity ratio that processes the capability of a company to pay off short term and long term debts. To measure the capability, current ratio considers total assets of a company comparative to company’s total liabilities. Current ratio= Current assets/current liabilities Year2014201320122011Current ratio1.030.821.351.20The current ratio of the company is going down by year by year and that is not good for the company as it would not be enough capable to pay off its short term and long term debts.FINANCIAL STRUCTURE RATIOSIt is the combination of long term debts and liabilities which a company uses to finance its activities. It directly marks the risk and values of the business. The main decision of the financial manager is that how much money should be borrowed and the best fusion of debt and capital to gain. One more decision is taken by the financial manager that he has to find the least expensive sources to be used by the business.DEBT/EQUITY RATIODebt ratio is the total ratio of long term and short term debt divided by its total Equity. If the debt ratio is high it means that company has high rate of debt related to its assets. It means that interest payment takes an important place in company’s cash flow. When the debt ratio is low that time interest payment do not take such a large share in the cash flow. Low rate of debt illustrates that the company can use the leverages to develop the business of the company. Debt ratio= Debt/ Equity Year2014201320122011Debt ratio1.470.981.010.62By considering the figures of Debt ratio we can see that the company has increased ratio year by year. So it signifies that the company has high rate of debt on its assets.EQUITY RATIO The equity ratio is the percentage of equity that is applied to finance the assets of a company. It does not include any debt financing used by the company to raise fund. Equity ratio= Equity/ Total assetsYear 2014201320122011Equity ratio40.4%50.5%49.7%61.6%As we can see that the equity ratio is being decreased year by year, which is good for company if the equity share would have been high it means that the company has more creditors (loans).MARKET RATIOSEARNINGS PER SHAREEarnings per share is the part of a company’s profit allotted to each outstanding share of common stock (kind of security that symbolizes ownership in a corporation). It is a kind of indicator which shows that company is doing profit. While calculating earnings per share, it is more accurate to use weighted average number of shares unpaid over the recording term. Because the number of shares unpaid can be changed anytime. Though, Statistics sources sometimes signifies the calculation by using the number of shares outstanding at the end of period.Formula for calculating Earnings per share= (net income – dividends on preferred stock) / average outstanding common sharesYear2014201320122011EPS-0.030.43-0.070.00The table above can show you that the earnings have reduced every year and came in minus in year 2014. By this the company is losing money and there would be less chances of generating profit for the company. DIVIDENDS PER SHAREIt is the total of declared dividends for each ordinary share issued. It is the total dividends funded out over a whole year divided by number of outstanding ordinary share issued.Dividends per share= Dividends/ number of issued ordinary shares Year2014201320122011DPS0.000.000.000.00As you can see in the table that all the dividends per share in each and every year is zero because the company has not paid any dividend in all these years.PRICE EARNINGS RATIOPrice earnings ratio is a ratio that calculates the current market price of a stock related to its earnings by comparing the market price of each share by earning per share. Moreover, the market price ratio shows the thing that market is ready to pay for a stock based on its recent earnings. It indicates the dollar amount an investor can expect to invest in an organisation keeping in mind the end goal to get one dollar of that company’s earnings. Investors usually use this ratio to estimate that what should be the fair market price of a stock by forecasting future earnings per share. Price earnings ratio helps investors to analyse what amount should be paid by them for a stock based on its present earnings.Formula for price earnings ratio= Market price per share/ earning per share Year2014201320122011Price earnings ratio -0.340.02-0.1510.00Price earnings ratio decreases means that the company is doing well and in these figures show that the PE ratio is falling since 2012 and comes to minus in year 2014. So, it is good for the company as it is performing better year by year.RATIOS BASED ON REFORMULATED FINANCIAL STATEMENTS RETURN ON EQUITYReturn on equity is a ratio that calculates the capability of a company to make profit by the investment done by the shareholders in the company. In other words, income that is returned as a proportion of shareholders equity. It means that if a shareholder invests 1 dollar so 1 dollar will be returned as net income for the company. Mostly it is calculated for common shareholders. ROE is a profitable ratio according to investors. The money generated is based on how much investors have invested in the company.Formula for Return on equity= Comprehensive income/ Shareholder’s equityYear2014201320122011Return on equity-29.61%7.58%-56.56%1.68%By looking at the figures that the figures are going in negative and negative return indicates that the company has financial loss for an exact period of time. Business faces financial loss in the initial time of the company setup. Mostly, new established business does not get profit until it’s been few years passed.RETURN ON NET OPERATING ASSETS It only concentrates only on those types of assets which help to gain profit. In short it is a measure of financial performance. The return on net operating assets is a measurement of financial performance of an organisation that considers profit of an organisation with respect to fixed assets and net working capital. It helps the company to calculate the proportion of profit the company is getting from the assets. By this ratio we can be cleared with the point that how hard company is working to get profit by its assets. In many company assets are the only option to generate profit. As much higher Return on net operating asset is that much profitable it is for the company. Higher RNOA signifies that the company is working effectively and efficiently to generate profit. Increased RNOA indicates that the company is improving financial performance of the company.Formula for Net operating Asset= Operating income after tax/ Net operating assetsYear2014201320122011RNOA-19.49%5.44%-39.50%4.02%In the table you can see that the figures are fluctuating in different years but mostly it is going in minus and by this it is clear that the company is generating less operating income as compared to the profit being expected by investing assets in the BORROWING COSTNet operating cost means the interest paid by the organisation for borrowed capital that is used to purchase assets. It involves the total responsibility of paying the debt including interest payments and other financial fees. Mostly the borrowing cost of business goes up when current market interest rates are increasing at the time GDP borrowing cost= Net financial expenses after tax/ Net financial obligationsYear2014201320122011Net borrowing cost-11.39%-12.56%-10.06%4.00%It can be seen in the table that figure from 2011 to 2012 the debt has been changed and has gone negative year by year. The company has paid financial expense only in year 2011 as all the rest years are in minus.PROFIT MARGIN Profit margin indicates the overall health of the business. It shows weather the average cost added to the cost margin on products and services will be enough to recover direct expenses and generate profit. Creditors use this ratio to find how efficiently a company can change sales into net income. It can help you to provide perception of alternative aspects of company’s financial position. Low profit margin indicates that the company is not earning much profit. Low profit margin experiences decrease in sales. Companies should use profit margin to compare companies within the same sector. Formula for profit margin = Operating income after tax/sales Year2014201320122011Profit margin-8.55%3.30%-21.47%0.80%Figures in the table indicates that the company is not Earing much profit. It can be seen that company is getting hard to keep its cost low because of management problem. This indicates that the cost need to be controlled.ASSET TURNOVERIt is the ratio of the cost of sales and revenues made related to the cost of its assets. It also shows how the company is using its assets to gain revenue. Higher turnover indicates that the company is utilising its assets very effectively. On the other hand, lower turnover shows that the company is not utilising assets effectively and problems with extra use of production capacity, and sufficient collection methods. Usually turnover ratio depends on the standard of company. Companies should be compared to other companies to know that how well the company is using its assets. Assets turnover gives an idea to the investors that how well the company is managed.Formula for Asset Turnover= Sales/Net operating assetsYear2014201320122011Asset turnover228.02%165.02%183.99%504.12%The figures are decreasing year by year which shows that company is not growing capably.ECONOMIC PROFITEconomic profit is the performance that compares operating profit to total cost of capital. It is significant as it shows how beneficial company plans are. It includes opportunity cost related to production and is lower than accounting profit. It tells how much and from where company generates money. It forces managers to think about assets and expenses in their decisions. Economic profit can be time consuming. It is only applied to a specific period of time not for forecasted period of time. The calculation of Economic profit heavily depends on the capital invested.Economic profit= (RNOA - cost of capital) x net operating assets (NOA)year2014201320122011Economic profit-8332529.26-1580861.04-16832509.16-944283.26eCONOMIC PROFIT VS aCCOUNTING PROFITComparision2014201320122011Economic profit-8332529.26-1580861.04-16832509.16-944283.26total profit(6,211,495)889,768(14,149,900)207,400Year2014201320122011RNOA-19.49%5.44%-39.50%4.02%COST OF CAPITAL10%10%10%10%NOA28,257,749.634,664,793.434,002,885.615,802,709.6PM-9.6%1.6%-22.6%0.3 %ATO228.02%165.02%183.99%504.12%THE BIG DIFFEREnces we can see are in year 2012 and 2013 and noa is also.The reason of negative economic profit is because of RNOA as cost of capital is 10% here and if RNOA is less than cost of capital then it means economic profit will be negative. However, the company has negative value means it is in high debt and not earning profit from a long time. COMPARISON EVZ TO GEODYNAMICS LIMITEDAfter looking at the economic profit of Geodynamics limited I looked again because both of us had negative economic profit for all the four years. In year 1 economic profit of Geodynamics is better as compared to EVZ limited because there was margin of 919654.56. However, in year 2 EVZ had economic profit of 16832509.16 and Geodynamics Ltd had 106815.5 followed by year 3 where Geodynamics had economic profit of 16319.5 whereas, EVZ had 1580861.04. In the last year Geodynamics has improved a little bit as it came to 14737.3 but EVZ is in more loss. Overall if we compare the economic profit we can see that Geodynamics is better than EVZ limited.DISCUSSION WITH OTHERS ABOUT ECONOMIC PROFIT 2CAPITAL INVESTMENT DECISION FOR EVZ LIMITEDA planning technique that organizations and government offices use to evaluate the potential gainfulness of a long term investment. Capital investment decision evaluates long term investment, which may incorporate fixed assets like hardware, machinery or land. The objective of this procedure is to pinpoint the alternative that is well on the way to be the most beneficial for the business. Organizations may utilize methods, for example, discounted cash flow analysis, risk return analysis, risk neutral valuation.Power sectorThe power sector designs and installs constant load power stations, back-up power generation equipment and sustainable energy solutions. In addition, the segment services, maintains and hires all types of generators and associated equipment. This sector invests 22m for business and has residual value of 5m with 6 years estimated life.Water sectorThe water sector designs syfonic roof drainage systems for large and/or complex roof structures, supplies and installs fibreglass panel tanks and prefabricated hydraulic systems. It invests 25m in project of with the residual value of4m and 6 years estimated life.CALCULATIONSsectorPOWER SECTORWATER SECTORNPV$37.58$53.07IRR46.6%59%PAYBACK PERIOD2.53 YEARS2.46 YEARSNET PRESENT VALUE (NPV)NPV of POWER SECTOR is 37.58 with the investment of 22m and WATER SECTOR NPV is 53.07 with the investment of 25m. WATER SECTOR gives much higher NPV and by chance NPV is higher than the investment.INTERNAL RATE OF RETURN (IRR)IRR of WATER SECTOR is 59% with the higher value as compared to the IRR of POWER SCTOR with 46.6%. In this case WATER SECTOR has higher value.PAYBACK PERIODBoth the sectors have near about same payback period with little bit difference. Power sector’s payback period is 2.53 years and water sector’s payback period is 2.46years. Here we can see that power sector will have to send more time to cover the investment amount whereas, water sector will take less time.DECISIONAccording to the values of NPV and IRR of both the sectors I would choose water sector as it has higher NPV and higher IRR values as compared to power sector and this sector will take less time to payback the investment. STRENGHT and WEAKNESS OF ANALYSISSTRENGTHNPVIt gives importance to time value of money and maximises the firm’s value .While calculating NPV, both after and before cash flow over the life length of the project are considered. Profit and loss of the project are on high priority.IRRIt is very simple to understand after IRR is calculated. There is no base for selecting any particular rate in IRR. Here we do not need to calculate cost of capital because without calculating it we can check profitability capability of any project.WEAKNESSNPVNPV is hard to use and difficult to calculate approximate discount rate. The decision by NPV may not be exact because of the amount of investment of mutually exclusive projects are not equal.IRRIt’s not good for comparing two companies are there are exclusive investment. While calculating IRR we think that if we invest money in IRR, after receiving profit we can easily reinvest our investment profit on same IRR. It seems to be unrealistic assumption. In some situations students do not understand why we are calculating different rates in it and it becomes more difficult after getting the two experimental rate real value of IRR because of nor equal values of cash PARISON TABLE FROM EXCELPOWER (all figures are in millions)????????????????????????????????????NPV CALCULATION?????????????????????????YEAR?0123456CASH FLOW?(22)8615221323?NPV$37.58???????????????????????????????????????????IRR CALCULATION???????YEAR?0123456CASH FLOW?(22)8615221323?IRR46.6%??????????????????????????????????PAYBACK PERIOD????????????????YEAR?0123456CASH FLOW?-228615221323CUMULATIVE CASH FLOW??81429516487PAYBACK PERIOD?2.53 YEARS?? 0.53 ????WATER (all figures are in millions)????????????????????????????NPV CALCULATION????????????????????YEAR?0123456?CASH FLOW?-25121326142422????????????NPV$53.07??????????????????????????IRR CALCULATION????????????????????YEAR?0123456?CASH FLOW?-25121326142422????????????IRR59%????????????????????????????????????PAYBACK PERIOD????????????????????YEAR?0123456?CASH FLOW?-25121326142422?CUMULATIVE CASH FLOW??1225516589111???????????PAYBACK PERIOD?2.46 YEARS?? 0.46 ??????????????Power sectorWater sectorOriginal cost 22 m25 mEstimated life6 years6 yearsResidual value5 m4 mEstimated future cash flows??20168 m12 m20176 m13 m201815 m26 m201922 m14 m202013 m24 m202118 m18 mPayback period2.53 years2.46 yearsNPV37.5853.07IRR46.6%59%DISCUSSION WITH OTHER STUDENTS From: Prashant Sharma Feedback To: Katrin Clichon My CommentsStep 1 Your overview of Ratios is wonderful. You gave all the required information as much needed. Your calculation work seems good. I checked all the formulas of your excel sheet and all seems right. Your information shows your depth knowledge about your company. You explained everything very specifically.If we talk about commentary, I think you have the whole idea of the assignment. You have explained what you actually went through which I think is enough to have. One more think I like about your assignment is bar charts you have shown, really attractive.In calculation of economic profit you have done very good work. It was all complete but in commentary I would have liked to see the reasons by which your company was in profit for all four years. The way you have compared your company’s economic profit with others was great, I had this question that do we need to compare our company’s economic profit with others and I got the answer from you.Thanksss.Calculation of ratiosRatios – commentary (blog)Calculate economic profitCommentary – drivers of economic profit (blog)Step 2 Calculations were complete but I was expecting more about this means some discussion like how did you find all this, what is the strength and weakness.Develop capital investment decision for your firmCalculation of payback period, NPV & IRRRecommendation & discussionStep 3Individual feedback with othersI have not seen anything here so not seen anything means no comments.Overall ass # 3Overall you have done excellent job. These are some points which I have mentioned in there, might be helpful for you.Good luck for final marks.Feedback From: Prashant Sharma Feedback To: Renee .My CommentsStep 1Your calculation is complete and is allied correctly in your spreadsheet.I loved your commentary part you have gone into detail of every part of ratio. You did same as I expected for this part as you have shown the value for all the years and gave the reason behind the values means how you got all those values in each and every year.Calculation for economic profit is complete. There is nothing I can see you are left over with. You have explained each and every thing in economic profit with the support of discussion and recommendation. Everything seems perfect like you showed calculation of economic profit in the table for all the years then you told the factors behind economic profit’s result.Moreover, you explained economic profit for each and every year with the reasons. I do not think you need to give more information than this for economic profit. It’s enough.Calculation of ratiosRatios – commentary (blog)Calculate economic profitCommentary – drivers of economic profit (blog)Step 2In this step there was a brief scenario discussion and calculations were complete. But in the calculation there is just one point which I am confused with that how you got this much big amount of NPV??I am trying to find what have you left but could not find this part seems totally perfect with your explanations of each point. Develop capital investment decision for your firmCalculation of payback period, NPV & IRRRecommendation & discussionSTEP 3Individual feedback with othersI have not seen anything here so no comments.Overall Ass # 3When I started reading your assignment I thought you have not done much as it was looking with very less matter but when I started reading it then saw that you did not even leave a single point. Hope you score very good marks.Feedback from: Prashant SharmaFeedback to: Jiajia FanMy CommentsStep 1I can see that you have done calculation very perfectly in excel sheet for all the ratios.I was expecting more in commentary for ratios. As what these ratios mean etc., a little bit more information about these ratios. More brief discussion about these ratios.I think you have calculated it correctly and did excellent job in explaining economic profit, The role of economic profit. But what I am thinking is that you are missing somethings in commentary part as you just told the reason that why the profit is fluctuating every year. I think you need to explain for each and every year in brief and need to compare it with other’s companies. I also did economic profit commentary as you have done but when I was looking at the assignments of other students then I saw that most of the students have briefly explained each and every year and compared it with other.Hope it will help you and me both. Calculation of ratiosRatios – commentary (blog)Calculate economic profitCommentary – drivers of economic profit (blog)Step 2Perfect discussion and example provided.Calculation seems complete with supporting discussion and recommendations.Develop capital investment decision for your firmCalculation of payback period, NPV & IRRRecommendation & discussionSTEP 3Individual feedback with othersI have not seen the discussion that I am involved in so no comments.OVERALL ASS# 3Overall the assignment was very good and I have got some points which would be helpful for my assignment as well. Hope you score very good marks for it.Best of luck… Feedback from: Prashant SharmaFeddback to: Bikiran SimkhataMy CommentsStep 1 Calculation of ratiosRatios – commentary (blog)Calculate economic profitCommentary – drivers of economic profit (blog)Step 2Develop capital investment decision for your firmCalculation of payback period, NPV & IRRRecommendation & discussionSTEP 3Individual feedback with othersOVERALL ASS# 3Feedback From: Feedback To: .My CommentsStep 1Calculation of ratiosRatios – commentary (blog)Calculate economic profitCommentary – drivers of economic profit (blog)Step 2Develop capital investment decision for your firmCalculation of payback period, NPV & IRRRecommendation & discussionOverall ASS#3Step 3Individual feedback with other studentsOverall ASS#3Step 3Individual feedback with other students ................
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