Financial Performance of Titanic Plc - Essay Example

Question Report on Financial Performance of Titanic plc Directors of Titanic plc Asst. Accountant 20 November Analysis of financial performance of Titanic plc Introduction I have been assigned to draft a report on the financial performance of Titanic plc for the past three years i.e. 2012, 2011, and 2010. The financial performance has been analyzed by using four types of ratios, which are profitability, liquidity, solvency, and stock market ratios. The calculations in this regard are shown in the appendices attached at the end of this report. Profitability Analysis Titanic plc showed a disappointing image of its profitability in past three years as its profitability has been dropped from ROCE of 30.8% to merely 3.1% in 2012 as compared to 2010. The main reason behind the reduction in ROCE is the decrease in asset turnover as well as the net profit margin. During the past three years, asset turnover has declined from 1.71 times to 1.34, which shows that the assets remain stagnant even in stabilizing the sales level. Similarly, net profit margin also showed sluggish performance i.e. experienced a steeper drop from 18% to 2.3% in the same period. The core element causing such a fall in the net profits of Titanic plc is the heavy fixed cost in the form other operating costs. If Titanic plc could manage this cost in a better way, then there is likelihood that its profitability can be enhanced. If gross profit margin and net profit taken into consideration, it can be noted both of these ratios have shown declining trends especially net profit margin which even could not attain 1% of the sales. Due to lower gross profits and consistent other operating costs, net profits have experienced such a steeper drop in its percentage. Return on assets and return on equity also showed the disappointing results mainly because of extremely low net profit in the year 2012 such that both of them could not even reach 1% of total assets and total equity. Efficiency Analysis Cash operating cycle mainly depicts the time involved in making payments in respect of purchasing inventory and receiving the receipts on account of credit sales. As far as the cash operating cycle of Titanic plc is concerned, the figures are quite dispersed due to which any conclusive evidence cannot be drawn from the results of cash operating cycle. If the overall liquidity position of Titanic plc is taken into consideration, it can be noted that there are two main alarming situations for the company, which are highlighted as under: Firstly, the inventory holding period for Titanic plc has been increased from 76 days to 122 days in 2012 as compared to previous year. The main reason is the diminishing level of sales, which increases the inventory level. Since the company operates in the pub industry, therefore, there is likelihood that the inventory in form of beer stored in barrels can be deteriorated because once the barrel is opened, it perishes very quickly. Titanic plc should write off such inventory however, this would cause a further drop in the profitability level of the company. Secondly, there is a considerable drop from 169 to 78 days in respect of accounts payable payment period, which shows that Titanic plc is quickly paying off its suppliers, which is affecting its liquidity position. Titanic plc needs to increase the time in making payments to its suppliers as this would make the cash available to be utilized rather in a better way. Liquidity Analysis Liquidity position of Titanic plc has remained better than expected such that its current ratio has increased to double which shows that the form has now £2 current assets to pay off £1current liability which is a better sign. Likewise, quick ratio has also performed well for Titanic plc given the inventory cost are ignored from current assets, it increased from 0.61 to 1.12 which shows that the firm has more liquid current assets to pay off its current liabilities. Gearing Analysis The gearing position of Titanic plc has not experienced much changing in the past two years, as the debt position of the company has remained stable after paying off the debt of £5 million in the year 2010. Interest cover or times interest earned ratio for Titanic plc shows a dangerous position as it has been reduced from10.9 times to 1.25 times in the current year as compared to the previous year. This shows that in 2011 the company had 10.9 times more profits to cover its interest expense but now company has the profits of hardly 1.25 times in order to pay off its interest expense. However, the company has enough cash resources available, which can be used to pay off its interest expense in few years but the important thing is that the company is running short of its net income in a considerable manner, which is not a good sign in any case. The amazing consideration in the whole case is that the company is having around £9.8 million in the form of hard cash. The company should use this cash either to redeem some component of its debt or invest in opportunities that are more profitable. However, Titanic plc can afford to have such lower level of times interest earned as the company has significant cash reserves as well as the interest payments are small in magnitude thus showing that the solvency position of Titanic plc is satisfactory. Stock Market Ratio Analysis P/E multiple of Titanic plc has experienced a sharp increase up to 227 times which is in fact caused by the lower level of EPS. Low level of earnings has apparently boosted the P/E multiple however the other stock market related information are quite disappointing. Price per share of Titanic plc has also experienced significant fall of around 50% i.e. its current share price is £2.27, which was around £4.55 two years ago. Since the company has not also paid any dividends, therefore the wealth of the shareholders of Titanic plc has been reduced in two years time. It would have been a better option if industry averages of the whole pub industry were given as the whole industry is facing serious difficulties. However, the industry information is not available in the given scenario. In the times when the existing profitability is on a declining trend and no improvement chances are approaching, it appears as if the future price per share of the company would experience a further decline. Conclusion and Recommendations There are significant considerations and concerns in respect of Titanic plc’s existing position, which are highlighted below: Low level of profits which are mainly caused by the external factors facing by the overall pub industry Low level of confidence especially in the stakes of Titanic plc and in general affecting the pub industry Increased cash pileups which is making Titanic plc an attractive takeover opportunity especially for the rival firms Disgusting working capital management causing serious liquidity concerns to Titanic plc Titanic plc is required to address the above-mentioned concerns in a quick time if it wants to avoid future bankruptcy. Following are some of the recommendations in this regard: Titanic plc should increase the product range so that it can attract new customers. Higher level of cash can aid the company in adopting this strategy, which can ultimately increase the profitability of the company and ensuring the going concern for the company in the near future. There is a need to develop a new working capital management policy, as the existing policy has remained unsuccessful in improving the liquidity position of the company. Another important consideration can be a positive message to the shareholders of the company, which can ease out the image of the company in the market. APPENDIX PROFITABILITY RATIOS 2012 2011 2010 Return on Assets (ROA) = Net Profit ÷ Total Assets (in percentage) 0.2 ÷ 43.3 = 0.46% 5.5 ÷ 52.5 = 10.47% 6.5 ÷ 54.7 = 11.88% Return on Equity (ROE) = Net Profit ÷ Total Shareholders’ Equity (in percentage) 0.2 ÷ 22.5 = 0.88% 5.5 ÷ 22.3 = 24.66% 6.5 ÷ 19.8 = 32.8% Return on capital employed (ROCE) = (operating profit ÷average capital employed) (in percentage) 1.0 ÷ (22.5+10.0) = 3.1 8.7 ÷ (22.3+10.0) = 26.9 10.7 ÷ (19.8 + 15.0) = 30.8 Gross Profit Margin = Gross Profit ÷ Revenue (in percentage) 17.2 ÷ 43.6 = 39.44% 26.3 ÷ 61.7 = 42.62% 27.6 ÷ 59.5 = 46.38% Net Profit Margin = Net Profit ÷ Revenue (in percentage) 0.2 ÷ 43.6 = 0.45% 5.5 ÷ 61.7 = 8.91% 6.5 ÷ 59.5 = 10.92% Operating profit margin = (operating profit ÷ Revenue) (in percentage) 1.0 ÷ 43.6 = 2.3 8.7 ÷ 61.7 = 14.1 10.7 ÷ 59.5 = 18.0 Asset turnover = net sales ÷ capital employed (in times) 43.6 ÷ (22.5+10.0) = 1.34 61.7 ÷ (22.3+10.0) = 1.91 59.5 ÷ (19.8+15.0) = 1.71   EFFICIENCY RATIOS 2012 2011 2010 Inventory Turnover = (Cost of Goods sold ÷ Inventory) (26.4 ÷ 8.8) = 3 (35.4 ÷ 7.4) = 4.78 (31.9 ÷ 7.8) = 4.08 Days inventory in hand = (inventory ÷ cost of goods sold) x 365 (in days) (8.8 ÷ 26.4) x 365 = 122 (7.4 ÷ 35.4) x 365 = 76 (7.8 ÷ 31.9) x 365 = 89 Debtors collection period = (accounts receivables ÷ sales) x 365 (in days) (2.4 ÷ 43.6) x 365 = 20 (1.7 ÷ 61.7) x 365 = 10 (1.6 ÷ 59.5) x365 = 10 Creditors payment period = (accounts payables ÷ cost of goods sold) x 365 (in days) (7.8 ÷ 26.4) x 365 = 108 (16.4 ÷ 35.4) x 365 = 169 (8.6 ÷ 31.9) x 365 = 98 Cash conversion cycle (in days) 34 -83 1   LIQUIDITY RATIOS 2012 2011 2010 Current ratio = Current assets ÷ Current liabilities (in times) 21 ÷ 10.8 = 1.94 20.8 ÷ 20.2 = 1.02 20 ÷ 19.9 = 1.005 Quick/Acid Test ratio = (Current assets – Inventories) ÷ Current liabilities (in times) (21 – 8.8) ÷ 10.8 = 1.12 (20.8 – 7.4) ÷ 20.2 = 0.66 (20 – 7.8) ÷ 19.9 = 0.61 GEARING RATIOS 2012 2011 2010 Debt ÷ (debt + equity) (using book values in percentage) 10 ÷ (10+22.5) = 31 10 ÷ (10+22.3)= 31 15 ÷ (15+19.8) = 43 Debt ÷ (debt + equity) (using market values in percentage) 10 ÷ (10+45.4) = 18 10 ÷ (10+68.2) = 13 15 ÷ (15+91) = 14 Interest cover or Times interest earned (in times) 1.0 ÷ 0.8 = 1.25 8.7 ÷ 0.8 = 10.88 10.7 ÷ 1.2 = 8.92   Market value of equity = Number of shares outstanding x Price per share 2010: (10 million ÷ 0.50) x 4.55 = £91 million 2012: (10 million ÷ 0.50) x 2.27 = £45.4 million 2011: It is assumed that the price share is the average price per share for the year 2010 and 2012 i.e. £3.41 and the total equity is assumed to be the average equity for the year 2010 and 2012 i.e. £68.2 million. STOCK MARKET RATIOS 2012 2011 2010 Earnings per share = profit after tax ÷ number of shares outstanding (in £) 0.2 ÷ 20 = 0.01 5.5 ÷ 20 = 0.28 6.5 ÷ 20 = 0.33 P/E multiple = price per share ÷ EPS (in times) 2.27 ÷ 0.01 = 227 3.41 ÷ 0.28 = 12.2 4.55 ÷ 0.33 = 13.8 Question 2 a) Summary Investment Appraisal Technique Proposal Alpha Proposal Beta Proposal Gamma Proposal Omega     Payback 1.67 years 3.08 years 2.33 years 2.89 years ARR 13.33% 42.00% 35.00% 30.00% NPV £21.19 £49.23 £35.78 £68.11 b) Recommendation From the summary table, it can be noted that the Proposal Alpha has generated the lowest payback period with lowest ARR and NPV. Since, only payback is favourable in case of Proposal Alpha, which only describes the time-period in which the initial investment is recovered, therefore, this proposal should be avoided. Proposal Beta takes the highest amount of time in respect of payback but provides the best accounting rate of return. Since ARR are based upon the net profits rather than cash flows, therefore, its results cannot be relied upon. As far as Proposal Gamma is concerned, it has shown the neutral performance in all three respects. However, its NPV is quite low due to which this proposal may not likely to generate handsome cash flows. Proposal Omega has not performed quite well in respect of its payback period and ARR. Since both these techniques have their own deficiencies, and their results are not considered as reliable, therefore the decision to accept a proposal should be made based on NPV. Since Proposal Omega has generated the highest NPV, therefore, this project should be considered for acceptance the other quantitative and qualitative factors such as taxation, inflation, legal and regulatory issues etc. APPENDIX Project Alpha Years 0 1 2 3 4 5 Cash Flows -120 80 60 40 20 -40 RV 0 Cumulative Cash Flows -120 -40 20 60 80 40   1 0.67   Cost of Capital (10%) 1.000 0.909 0.826 0.751 0.683 0.621 Discounted Cash Flows -120.00 72.73 49.59 30.05 13.66 -24.84     Payback 1.67 years   ARR 13.33%   NPV £21.19           Total Profits (80+60+40+20-40-120) 40 Average Annual Profits (40 ÷ 5) 8 Average value of fixed assets (120 ÷ 2) 60 Accounting rate of return 13.33% Project Beta Years 0 1 2 3 4 5 Cash Flows -95 10 40 40 60 50 RV 5 Cumulative Cash Flows -95 -85 -45 -5 55 105   3 0.083   Cost of Capital (10%) 1.000 0.909 0.826 0.751 0.683 0.621 Discounted Cash Flows -95.00 9.09 33.06 30.05 40.98 31.05     Payback 3.083 years   ARR 42.00%   NPV £49.23           Total Profits (10+40+40+60+50-5-90) 105 Average Annual Profits (105 ÷ 5) 21 Average value of fixed assets (95+5) ÷ 2 50 Accounting rate of return 42.00% Project Gamma Years 0 1 2 3 4 5 Cash Flows -80 30 40 30 30 20 RV 0 Cumulative Cash Flows -80 -50 -10 20 50 70   2.00 0.333   Cost of Capital (10%) 1.000 0.909 0.826 0.751 0.683 0.621 Discounted Cash Flows -80.00 27.27 33.06 22.54 20.49 12.42     Payback 2.33 years   ARR 35.00%   NPV £ 35.78           Total Profits (30+40+30+30+20-80) 70 Average Annual Profits (70 ÷ 5) 14 Average value of fixed assets (80 ÷ 2) 40 Accounting rate of return 35.00% Project Omega Years 0 1 2 3 4 5 Cash Flows -160 30 50 90 80 60 RV 40 Cumulative Cash Flows -160 -130 -80 10 90 150   2.00 0.89   Cost of Capital (10%) 1.000 0.909 0.826 0.751 0.683 0.621 Discounted Cash Flows -160.00 27.27 41.32 67.62 54.64 37.26     Payback 2.89 years   ARR 30.00%   NPV £ 68.11           Total Profits (30+50+90+80+60-40-120) 150 Average Annual Profits (150 ÷ 5) 30 Average value of fixed assets (160 + 40) ÷ 2 100 Accounting rate of return 30.00% Question 3 a-i) Terms of rights issue Working: 25% discount: Total no. of shares to be issued: £250 million ÷ £4.5 = 55.6 million shares Therefore, 55.6 million ÷140 million = 0.40 shares to 1 share held or 2 for 5 Amount of rights issue = £4.5 x 55.6 million shares = £250.2 million 45% discount: Total no. of shares to be issued: £250 million ÷ £3.6 = 69.4 million shares Therefore, 69.4 million ÷140 million = 0.5 shares to 1 share held or 1 for 2 Amount of rights issue = £3.6 x 69.4 million shares = £249.8 million Discount Price of Rights Issue Share Issue required terms Amount raised Total number of shares 25% (£6 x 75%) = £4.5 2 shares for every 5 shares held £250.2 million (140 + 55.6) = 195.6 million shares 40% (£6 x 60%) =£3.6 1 share for every 2 shares held £249.8 million (140+ 69.4) = 209.4 million shares a-ii) Theoretical Ex-right Price Calculation Discount Theoretical ex-right price Number of shares Value of shares Value per share 25% 2 shares for £4.5 x 20 ÷ 15 5 shares for £6.0 Total Theoretical ex-right price = £6.0 2 5 7 12 30 42 £6.0 40% 1 shares for £3.6 x 20 ÷ 15 2 shares for £6.0 Total Theoretical ex-right price = £5.6 1 2 3 4.8 12 16.8 £5.6 b) Merits and demerits of Directors The arguments of the lady director has some sort of validity in her concerns regarding the negative impact of rights issue at a discount of 40%. If the rights issue is made on 40% discount, then this might result in the fall of the share price below £6.0 i.e. £5.6. Conversely, if the rights issue is made on 25% discount, then this would result in the same share price even after the rights issue. On the other hand, the argument of marketing director does not have any theoretical validity that the 40% discount rights issue would be taken up by the higher number of existing shareholders. Since the wealth of shareholders remains the same before and after the rights issue, therefore, there would be no impact of percentage of discount on the wealth of the shareholders. Factors affecting the share price The public announcement of the rights issue may cause the share prices before and after the rights issue. There are certain factors, which cause such fluctuations in share prices such as: Efficiency of capital markets The degree and extent to which the rights issue and other projections accepted by the market participants The confidence of existing shareholders in the financial projections of the company REFERENCES Baker, H. Kent . and Martin, Gerald S., 2011.Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice. New York: John Wiley & Sons. Berk, Jonathan B. and DeMarzo. Peter M., 2010. Corporate finance. 2nd ed. New York: Prentice Hall. Bierman, Harold., 2003. The capital structure decision. New York: Springer. Brigham, Eugene F. and Ehrhardt, Michael C., 2008. Financial management: theory and practice. 12th ed. New York: Cengage Learning. Jaffe, Jeffrey. and Ross, Randolph Westerfield., 2004. Corporate Finance. New Delhi: Tata McGraw-Hill Education. Khan, M. Y., 2004. Financial Management: Text, Problems And Cases. 2nd ed. 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