Analysis of Perry Rose Case - Essay Example

? Perry Rose Case Study Introduction Corporate, individual and financial specialist analyst conducts various computations to determine whether a particular project should be determined. This study provide a case of Perry Rose Ltd that is utilize to determine whether the company was making sound decisions as well as giving recommendations based on the computations. The incremental cash flows, pay back periods and project present values will be computed to determine the anticipated cash flow to be received by undertaking the project. This will help to evaluate the performance of the company as well as determine measures that may be adopted to improve performance of the company. Additionally, a Memo will be prepared to the board advising them on whether to accept or reject the project. The study will put forth factors that a bank should consider prior advancing loans. Additionally, calculations will be utilized in order to determine whether the bank should grant the required increase in the overdraft for Gainsborough Fashions Ltd. In above connection, the Year0 Year1 Year2 Year3 Year4 year5 Year6 ?000 ?000 ?000 ?000 ?000 ?000 ?000 Equipments (500) - - - - - (100) Sales Revenue 0 450 470 470 470 470 470 (-)Less Cost Materials 0 0 126 132 132 132 132 Labour 0 0 90 94 94 94 94 Overheads 0 0 300 300 300 300 300 Add back Depreciation 0 0 120 120 120 120 120 Working Capital (180) - - - - - - Incremental cash flows 320 450 74 64 64 64 (36) (b) Calculate: (i) The project’s payback period. Time Net Cash Flows Cumulative Cash flows (?000) (?000) Immediately cost of equipment (500) (500) 1 Years Time: Operating profits Before Depreciations 450 50(-500+450) 2 Years Time: Operating profits Before Depreciations 74 24(-50+74) 3 Years Time: Operating profits Before Depreciations 64 4 Years Time: Operating profits Before Depreciations 64 5 Years Time: Operating profits Before Depreciations 64 6 Years Time: Operating profits Before Depreciations -36 Payback period=1years+?24?12=years and 4months ?74 =1 Years and 4months The cash flows were adjusted by taking into considerations the expenses that were incurred during the six years periods. Whereby, some expenses such as material, labour and overheads were deducted. Additionally depreciation was added back in order to obtain incremental cash flows for the six years periods. ii) The project’s net present value as at 31 December Year 0. Years Incremental cash flow Discount factor (12%) Present Value 0 (?500) 1 (?500) 1 ?450 0.893 ?401.85 2 ?74 0.797 ?58.98 3 ?64 0.712 ? 45.57 4 ?64 0.636 ? 40.70 5 ?64 0.567 ?36.29 6 (?36) 0.507 (?18.25) Net Present Value=?101.64 (c) Write a memo to the board advising on the acceptance or rejection of the project. (7 marks) Perry Rose Plc Finance Public Limited Company Bromsgrove 6th April 2013. To: The Board of Perry Rose Plc. From: Assistant Accountant of Perry Rose Plc Subject: Acceptance or Rejection of the Project The computation above indicates that the amount invested would be recovered within a very short time. This is based on the pay back period which shows that the amount invested will be recovered within a period of 1year and 4 months. Additionally, the above computations indicate that the Board of Perry Rose Plc should undertake the project because it has a positive net present value of ?101.64. Whereby, a positive net present value indicates that better returns will be derived by investing in this project (Hansen, Mowen and Guan, 2009). Therefore, I would recommend the company to undertake the project because the benefits outweigh the cost. Yours Sincerely Finance and Accounting Department 2. (a) Identify and discuss the major factors that a bank would take into account before deciding whether to grant an increase in the overdraft of a business. An overdraft involves amount of money given by bank account to the business and it should be repaid upon bank request. An overdraft provides current account holders with an opportunity to withdraw more funds than what it is already available in their account (Coyle, 2002). The bank may set a limit on the amount of overdraft that each business can make. Some of the factors taken into consideration include; Capacity, character, capital, collateral and condition (Lieber, 2010). The Capacity to pay an overdraft together with the interest attached. Whereby, a bank conducts a comprehensive assessment to determine whether the business is in good capacity to make payment. The Character of the business should be taken into account, this may determining whether the business has been repaying other loans faithfully without any defaults (Martin and Lieber, 2010). The bank should scrutinize whether the bank has adequate capital that can act as an assurance that the amount of overdraft rendered will be repaid (Stricter regulation needed on bank overdraft fees, 2013). In above connection, the banks should take into consideration whether the business has enough collateral for the loan. Normally, collateral may act as a security for the amount of funds rendered (Mangla, 2008). In above connection, the bank should take into consideration other factors such; as facility, profit margin, aims of borrowing, amount borrowed as well as insurance (Overdraft Rip-Off, 2006). Facility involves ensuring the amount of overdraft given should not exceed the bank credit limit (Merriden, 1999). On the other hand, profit margin involves taking into consideration whether the business has a higher or a lower profit margin (Fitzpatrick and Sidel, 2010). Whereby, if a business has a lower profit margin it is an indication that the company is incurring more variable expenses (Harrison, 1983). Therefore, the ability to repay overdraft and interest attached has been compromised by other loans commitments. This means that a bank may not offer an overdraft to such a business (Karas, 2011). The bank also takes into consideration the amount of overdraft required by the business as well as how the loans advanced will be utilized (Zywicki, 2012).Additionally, some banks may take into consideration whether the business has taken an insurance cover commonly known as payment insurance cover that act as an assurance that the amount of overdraft advanced will be paid (Kim, 2009). (b)State whether, in your opinion, the bank should grant the required increase in the overdraft for Gainsborough Fashions Ltd. You should provide reasoned arguments and supporting calculations where necessary. (i).Return on Capital Employed (ROCE) = EBIT = 38,000 (Total Assets- Current Liabilities) (275,000-194,000) Return on Capital Employed (ROCE) =0.4691?100=46.91% (ii)Operating Profit Margin=Net Income before Interest and tax = 38,000 = 15.14% Sales 740,000 Liquidity ratios (iii)Working Capital=Current Assets- Current Liabilities Working Capital=201,000-194,000 =7 (iv).Current ratio= Current Assets Current liabilities Current ratio for Gainsborough Fashions Ltd =?201,000 =1.036 ?194,000 (v) Quick Ratio/ Acid Test ratio= Cash + Marketable Securities + Accounts Receivable Current Liabilities Quick Ratio/ Acid Test ratio= 3000 =0.155 194,000 Gearing Ratio= long term debts = ?40, 0000= 2 Share holders Equity ?20,000 Return on Investment ratio=Net Profit before Tax = ?33,000 = 1.65 Shareholders Equity ?20,000 The higher the current ratio indicates that the business has stronger ability to repay the obligation of its creditors. Therefore, above current ratio indicates that Gainsborough Fashions Ltd has moderate strength to repay its current liabilities. Additionally, the acid test ratio of Gainsborough Fashions Ltd is 0.155; this indicates that the company has ability to meets its short term obligations. On the other hand, the profit margin of Gainsborough Fashions Ltd indicates the company is able to cover all its variable overheads by operating at a lower profit margin of 15.14% (Vasigh, Fleming and Mackay, 2010).Additionally the return on capital employed was 46.91% while the rate of borrowing was 12%. This indicates that capital employed was bringing better returns to equity shareholders. The gearing ratio for this company was found to be 2; this means that there was a leverage risk of 2. Connectively the return on investment was found to be 1.65.This indicates that a return of 1.65 was received by equity shareholders. 3. (a) Using the data from Sparkrite Ltd, the following ratios may be used to measure inventories and trade receivables; i. Receivable Turn over = Net Credit Sales Average Account Receivable Return on Capital Employed Receivable Turn over for this year=?1,800= 4.8 ?375 Receivable Turn over for this year=?1,920=4 ?480 ii. Inventory Turn over ratio = Cost of goods sold Average Inventory Inventory Turn over ratio in this year=?1,080 =5.4 ?200 Inventory Turn over ratio last year=?1,125=4.5 ?250 iii. Account receivable turnover = total credit sales Average accounts receivable balance Account receivable turnover this year =?1,800 =4.8 ?375 Account receivable turnover last year =?1,920= 4.5 (?375+?480?2) iv. Accounts Receivable Collection Period= Average accounts receivable Annual sales ? 365 days Accounts Receivable Collection Period for this year=?375 =76days (?1800?365) Accounts Receivable Collection Period for last year=?427.5 =81 days (?1,920 ?365) v. Days of sales in Inventory= Average Inventory? Number of Days in the Period Cost of Goods Sold Days of Inventory for this year =?375 ?76days= 26 days ?1,080 Days of Inventory for the last year=?427.5?81= 31days ?1,125 b. Discuss the ways in which the management of Sparkrite Ltd could exercise control over inventories levels and Trade receivables levels. The management of Sparkrite Ltd could have control inventories levels by first taking into consideration the time when inventories should be ordered as well as determining the amount of inventories to be ordered (Bowhill, 2008). Inventory, management involves three stages namely, control of purchases, control of store and issues control (Carey, Knowles and Towers-Clark, 2011). The inventory control may be summarized in the diagram below; Inbound logistics operations outbound logistics Source: Oppermann, 2009. Therefore, stock control may involve determining the minimum point when stocks may be re-ordered (Oppermann, 2009). This point is normally called re-order point or level. Some of the methods of stock control include; just in time, economic order quantity, re-order lead time and control of batch. The just in time method aims at ensuring that stocks are delivered to the buyers and sellers promptly (Weil and Noi, 2001). Additionally, Just in time method aims to reduce cost be eliminating cost associated with late delivery such as losing customers and sales(Horner and Mott, 2013).On the contrary, economic order quantity is a standard method for controlling inventory by ensures that a balance between holding a lot of stocks or a few stocks is maintained (Info Entrepreneurs, 2013). Additionally, re-order lead time inventory control method take into consideration the period in which an order was placed and the time in which that order would be received (Puttick, Van esch and Kana, 2007). Batch control is an inventory control method that involves managing the right number of batch covering already existing batch till the next batch is received. In above connection, other methods of managing inventory may involve techniques such as; First in First out (FIFO) whereby, those inventories that were received first should be released first (Dunham, 1949). This method may help to reduce the quantity of perishable goods that may appear in the stores. Other methods such as LIFO and actual stock count may be applied in controlling inventories (Take control of your accounts receivable, 2006. Connectively, stock control systems such as re-order system, stock cards and stock book may be used at ensuring efficient and effective inventory control (Info Entrepreneurs, 2013). Sparkrite management could control trade receivables levels by creating invoices for the customers (How to Create a Smart Credit Policy, 2009). The invoices must be authenticated prior any shipments are made. The terms of the agreement should be reviewed as well as establishing credit memos which must be approved by the manager. The billing software should be secured using a password in order to prevent an authorised access from tempering with the entries made. Additionally, payments from the incoming customers should be allotted to different individuals. Whereby, invoices journals should be reviewed by the internal audit team (Horner and Mott, 2013). Conclusion Therefore, based on the computations above it can be scrutinized that the company had a positive net present value and a shorter pay back period. This is an indication that the initial outlay would be recovered within a short period. Additionally, the study has put forth factors that a bank should take into consideration prior making a decision whether to increase the amount of overdraft rendered to the business. In above connection, data from Sparkrite Ltd has been utilized to compute ratios used to measure inventories and trade receivables. Conclusively, ways in which Sparkrite Ltd could exercise control over inventories levels and Trade receivables levels have also been put forth. Reference List Baker, H. K., and Powell, G. E. (2005). Understanding Financial Management a Practical Guide. Oxford, Blackwell Pub. http://public.eblib.com/EBLPublic/PublicView.do?ptiID=243549. Bowhill, B. (2008). Business planning and control: integrating accounting, strategy, and people. Chichester, England, Wiley. Carey, M., Knowles, C., and Towers-Clark, J. (2011). Accounting: a smart approach. Oxford, Oxford University Press. Coyle, B. (2002). Bank finance. Canterbury, Financial World. Dunham, A 1949, 'Inventory and Accounts Receivable Financing', Harvard Law Review, 62, 4, pp. 588-615, Academic Search Premier, EBSCOhost, viewed 6 April 2013. 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