Discuss the limitations of relying on financial ratios to interpret firm performance.

Assignment Brief

Assignment title:
AS1
Weighting:
60%
Deadline:
10th April 2016
Feedback and Grades due:
28th May 2016
Resit Date 8th July 2016

Purpose of the Assessment

The purpose of this assignment is to test communication skills together with the ability to analyse, to interpret and to report. This assignment will also encourage research and investigation.

Assessment Task

The case study consists of two sections- Section A consists of 70 marks and Section B consist of 30 marks. Students are expected to read the case study thoroughly and to answer all the required questions in a structured and organised manner with reference to published work. This is an individual assignment and it is worth 60% of the total module mark.

Academic Honesty: Plagiarism will not be tolerated and could lead to your failure, so please make sure you cite and reference correctly.

Submission deadline: Your answers should be submitted through Turnitin on NILE no later than 10th April 2016, at 11:59 PM (UK time). Please keep in mind that late submissions will not be allowed. If you have any mitigating circumstances that hinder your ability to submit on due date, please inform your module leader before the submission date. To learn more about the University’s mitigating circumstances policy please see the link below:
http://tundra.northampton.ac.uk/results/searchresult.asp?Title=mitigating+circumstances&Description=&Author=&Department=&Date+Created=&Until+Date+Created=&Document+Type=&Perspectives=&submit=Search

Feedback: There will be a written feedback four weeks after the deadline for submission. You will be informed through NILE when the feedback is ready.
Question 1

The following financial data is for clothing retailer companies that are listed on the London Stock Exchange.
You are the assistant to the Chief Financial Officer (CFO) of Asol Ltd, a large fashion retailer. The CFO of Asol is considering purchasing shares in either of these companies and has asked for your help in making the decision.

⦁ Next Plc
Next plc
Annual Ratios
[GBP Thousands]
24-Jan-2015 25-Jan-2014 26-Jan-2013 28-Jan-2012 29-Jan-2011
Financial Strength
Current Ratio 1.82 1.76 1.48 1.54 1.28
Quick/Acid Test Ratio 1.16 1.18 0.97 0.91 0.72
Working Capital 729,400 633,600 391,800 397,500 234,400
Long Term Debt/Equity 2.60 2.80 1.98 2.93 2.03
Total Debt/Equity 2.61 2.81 2.31 2.96 2.57
Long Term Debt/Total Capital 0.72 0.73 0.60 0.74 0.57
Total Debt/Total Capital 0.72 0.74 0.70 0.75 0.72
Pay-out Ratio 35.04% 35.23% 32.80% 34.90% 35.84%
Effective Tax Rate 20.12% 20.43% 23.69% 25.07% 27.66%
Total Capital 1,163,100 1,090,000 945,900 882,900 829,400

Efficiency
Asset Turnover 1.81 1.85 1.89 1.89 1.89
Inventory Turnover 6.62 6.97 6.91 6.47 6.89
Days In Inventory 55.13 52.37 52.83 56.38 52.99
Receivables Turnover 5.45 5.56 5.72 5.97 6.14
Days Receivables Outstanding 67.00 65.65 63.78 61.14 59.49
Revenue/Employee 135,729 130,916 125,360 119,962 114,727
Operating Income/Employee 27,985 25,301 24,561 21,192 19,719
EBITDA/Employee 31,864 29,411 28,702 25,365 23,869

Profitability
Gross Margin 33.59% 33.16% 31.48% 30.38% 29.27%
Operating Margin 20.62% 19.33% 19.59% 17.67% 17.19%
EBITDA Margin 23.48% 22.47% 22.90% 21.14% 20.81%
EBIT Margin 20.62% 19.33% 19.59% 17.67% 17.19%
Pre-tax Margin 19.87% 18.59% 18.79% 16.84% 16.48%
Net Profit Margin 15.87% 14.79% 14.34% 12.62% 11.93%
COGS/Revenue 66.41% 66.84% 68.52% 69.62% 70.73%
SG&A Expense/Revenue 13.53% 13.74% 13.26% 12.99% 12.20%

Management Effectiveness
Return on Assets 28.68% 27.40% 27.14% 23.81% 22.55%
Return on Equity 208.75% 193.43% 200.12% 190.90% 214.98%

Valuation
Free Cash Flow/Share 4.14 3.29 3.58 2.37 1.83
Operating Cash Flow/Share 4.86 3.97 4.09 3.12 2.49

Current Market Multiples
Market Cap/Earnings (TTM) 17.38
Market Cap/Equity (MRQ) 34.52
Market Cap/Revenue (TTM) 2.78
Market Cap/EBIT (TTM) 13.85
Market Cap/EBITDA (TTM) 12.13
Enterprise Value/Earnings (TTM) 18.26
Enterprise Value/Equity (MRQ) 36.27
Enterprise Value/Revenue (TTM) 2.92
Enterprise Value/EBIT (TTM) 14.56
Enterprise Value/EBITDA (TTM) 12.74

⦁ H & M Hennes & Mauritz
H & M Hennes & Mauritz AB
Annual Ratios
[GBP Thousands]
30-Nov-2014 30-Nov-2013 30-Nov-2012 30-Nov-2011 30-Nov-2010
Financial Strength
Current Ratio 2.11 2.25 2.66 2.71 2.96
Quick/Acid Test Ratio 1.07 1.22 1.49 1.69 2.06
Working Capital 1,915,437 2,033,634 2,169,570 2,372,168 2,472,996
Long Term Debt/Equity 0.00 0.00 0.00 0.00 0.00
Total Debt/Equity 0.00 0.00 0.00 0.00 0.00
Long Term Debt/Total Capital 0.00 0.00 0.00 0.00 0.00
Total Debt/Total Capital 0.00 0.00 0.00 0.00 0.00
Payout Ratio 80.78% 91.99% 93.22% 49.69% 42.08%
Effective Tax Rate 22.86% 23.86% 24.31% 24.45% 25.30%
Total Capital 4,401,116 4,222,746 4,095,389 4,158,106 4,033,125

Efficiency
Asset Turnover 2.14 2.04 2.01 1.84 1.91
Inventory Turnover 3.46 3.29 3.37 3.47 3.70
Days In Inventory 105.63 110.84 108.29 105.32 98.60
Receivables Turnover 33.12 33.16 32.42 29.64 32.92
Days Receivables Outstanding 11.02 11.01 11.26 12.32 11.09
Revenue/Employee 138,467 147,942 156,151 159,858 166,639
Operating Income/Employee 23,395 25,420 28,120 29,616 37,878
EBITDA/Employee 28,008 30,243 33,149 34,357 42,580

Profitability
Gross Margin 58.81% 59.13% 59.50% 60.13% 62.93%
Operating Margin 16.90% 17.18% 18.01% 18.53% 22.73%
EBITDA Margin 20.23% 20.44% 21.23% 21.49% 25.55%
EBIT Margin 16.90% 17.18% 18.01% 18.53% 22.73%
Pretax Margin 17.10% 17.46% 18.45% 19.04% 23.05%
Net Profit Margin 13.19% 13.30% 13.96% 14.38% 17.22%
COGS/Revenue 41.19% 40.87% 40.50% 39.87% 37.07%
SG&A Expense/Revenue 38.96% 39.06% 38.76% 38.97% 37.69%

Management Effectiveness
Return on Assets 28.28% 27.16% 28.03% 26.51% 32.91%
Return on Equity 41.27% 38.38% 38.36% 35.84% 44.07%

Valuation
Free Cash Flow/Share 0.76 0.89 0.68 0.70 0.93
Operating Cash Flow/Share 1.25 1.34 1.07 0.99 1.20

Current Market Multiples
Market Cap/Earnings (TTM) 23.13
Market Cap/Equity (MRQ) 8.51
Market Cap/Revenue (TTM) 3.04
Market Cap/EBIT (TTM) 18.06
Market Cap/EBITDA (TTM) 15.04
Enterprise Value/Earnings (TTM) 22.17
Enterprise Value/Equity (MRQ) 8.16
Enterprise Value/Revenue (TTM) 2.91
Enterprise Value/EBIT (TTM) 17.31
Enterprise Value/EBITDA (TTM) 14.41

You are required to:

Prepare a report for presentation to the CFO, which analyses the financial information for these two companies and recommends which company would be a more viable option to invest in. The report must include:

⦁ Selection and justification of at least 10 financial ratios and calculate 2 non-financial ratios to analyse the performance and financial position and investment potential of the two companies. (20 Marks)

⦁ The use of charts to compare performance of the two companies. You will need to look at the audited financial statement and carry out further research to explain the performance of the company over the five years. (20 Marks)

⦁ Provide recommendations of how the financial performance of the poorly performing business can be improved. (20 marks)

⦁ Discuss the limitations of relying on financial ratios to interpret firm performance (10 Marks).

You are expected to research for more information on the companies and cite the material correctly. You can use the Global Business Browser database to access analysts’ and SWOT reports.
Question 2: Capital Investment Appraisal

The following information relates to Hilltop Limited a medium sized manufacturing company.

Hilltop Limited has the opportunity to become involved in one of two potential & mutually exclusive (but not both) projects. Each project will involve the purchase of machines.
The following data relate to the two projects:

Net Profit Project A Project B
Machine 1 Machine 2
£000’s £000,s
2016 40 10
2017 40 20
2018 40 30
2019 30 60
2020 30 70
2021 20 55
200 245

Additional Information:
⦁ The initial cash investment for Machine 1 or Machine 2 will be £120,000. The purchase would take place on 1st January 2016. It is assumed that all other cash flows would be received on 31 December
⦁ Machine 1 would be disposed of for cash on 31 December 2018, the cash proceeds amounting to £21,000. Another machine (Machine X) would then be purchases for £50,000 in cash on that day. It would have a life of 5 years, and it would then be disposed of at the nil residual value.
⦁ Machine 2 would have a life of six years with no residual value
⦁ The company uses a straight line method of depreciation
⦁ The companys cost of capital is 20%

Required
⦁ Using appropriate investment appraisal techniques advise senior management whether they should opt for project A or project B (20 Marks)
⦁ Discuss the limitations of using investment appraisal techniques to aid long term decision making (10 Marks)

(Total 30 marks)

ADDITIONAL GUIDANCE
⦁ All calculations must be detailed and presented clearly.
⦁ Use of published work (citing references) within text is expected.
⦁ A full list of references should be presented at the end of the case study.
⦁ Please avoid the use of ‘I, We, Us’ in your case study. You are expected to write in third person.
⦁ Include the assignment front sheet and marking scheme which is attached to the assignment brief.
⦁ Your answer should not repeat the question as it will be included in your word count.
⦁ Formatting:
⦁ Font Type: Arial.
⦁ Font size 11/12.
⦁ Line spacing 1.5 to 2.
⦁ All pages must be numbered
⦁ All graphs, charts and tables should have a number and a title.
⦁ All text must be aligned to the left.
⦁ Good use of English, referencing, presentation will earn marks.
⦁ Submit online and on time, late submissions will not be accepted.
⦁ For extensions or deferral of assessment, please refer to the University policy on mitigating circumstances.

Accounting and Finance Penalties
⦁ Word Count*: All assessments have a word count with a tolerance of 10% only. Submissions that exceed the word count will be penalised as follows-one grade point* for every 150 words or part thereof.
⦁ Missing References – penalty is three grade points minimum (see module guide for further details).
⦁ Front sheet missing-penalty one grade point.
⦁ Word count missing or inaccurate-penalty one grade point.
** Front sheet, contents page, references and any appendices do not count in the word count.
Accounting & Finance Front Sheet
ACC3015DL
NB. This sheet must be attached to any submission of Accounting & Finance field module coursework ONLINE.
No assignment will be accepted without it.
Student IDs _________________________________________
Student Name
Title of Coursework ACC3015 Case Study
Marking Tutor
Hand in Date 10 April 2016

Checklist before submission

1. Have you read, understood and acted in accordance with the referencing guidelines set out in the appropriate Accounting & Finance Module Guide.
2. Where you have quoted directly from or where you have paraphrased the work of others, have you acknowledged and appropriately referenced the source of your quotation in the body of the text?
3. Have you placed all direct quotations in inverted commas?
4. Have you listed and correctly cited all your sources in your bibliography?
Declaration by the candidate named above
1. I confirm that this is my own work (or, in the case of a group assignment, the work of my group) and that, although I may have consulted others in the course of assembling material for the work, the finished article has been completed without help or participation of any other person (other than, in group assignments, other members of the same group).
2. The work contains no material drawn from unattributed sources.

Student Signature ________________________

Date Signed ________________________

Question 1 MARKING GUIDE (70%)

Student Name:

Student ID Number:

Marking Criteria-Please note word limit of 2,500 words (excluding bibliography and any appendices) Marks
FINANCIAL RATIOS
Justification and analysis of the ratios to be used to determine success/failure of the companies. Ratios should cover all the main ratio groups and also incorporate market data. To determine the financial strength of the company in areas such as profitability, liquidity, investor ratios, gearing, and share price performance-other financial information of use. Use tables and charts to summarise data and show trends. Rank best and worst for each ratio analysed. Justify the chosen ranking method and discuss results. 30
Marks for FINANCIAL RATIOS 30
NON-FINANCIAL RATIOS
Justification and presentation of the non-financial ratios to be used to determine success/failure of the company offer. Undertake these calculations and tabulate data. Ratios should be important to the retail sector. Rank best and worst for each ratio analysed. Justify the chosen ranking method. 10

Marks for NON-FINANCIAL RATIOS 10
Memo to MD of WORST performing Company
Present summary ranking for each ratio group and explain reasons for poor financial and no-financial performance. Outline and explain strategic recommendations to improve the firm performance in the medium term (3-5 years). 20
Marks for MEMO 20
LIMITATIONS OF FINANCIAL RATIOS
10
Marks for Discussion 10
Total Marks
70

Question 2 MARKING GUIDE 30%

Marking Criteria
2 a
Calculation of net cash flows /5
Payback /5
Project NPV /5
Project ARR /5
2b
Limitations of investment appraisal techniques /10
TOTAL /30

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