Financial Ratio Analysis for David Jones and Myer - Case Study Example

Name] [Course] [Lecturer] [Unit Code] [Date of Submission] Financial Management Question 1: Financial Ratio Analysis Financial ratios form the toolbox used to perform financial analysis of companies. Ratios are easy to understand and interpret to potential investors considering that the final statements of accounts are not easy to interpret. This report is focused on the financial analysis of two main retail companies operating in Australia. The companies are David Jones and Myer for two reporting periods, 2011 and 2012 (Steven, 2012). a Ratio Calculation I. 2012 Ratio Formula David Jones Myer Current ratio 323,249/306,298 = 1.06 times 441,472/502,869 = 0.88 times Quick ratio (323,249-279,099)/306,298 = 0.14 times (441,472-385,702)/502,869 = 0.11 times Inventory turnover 1,167,987/279,099 = 4.15 times 1,464,574/385,702 = 3.80 times Average collection 365/113.97 = 3.20 days 365/152.15 = 2.40 days Total asset turnover 1,867,817/1,240,897 = 1.51 times 2,612,700/1,918,193 = 1.36 times Debt/equity - 421,193/877,680 = 0.48 times Times interest earned 154,760/10,938 = 14.15 times 234,632/34,263 = 6.85 times Gross profit margin 699,830/1,867,817 = 0.3747*100 = 37.47% 1,288,421/2,612,700 = 0.4931*100 = 49.31% Net profit margin 101,103/1,867,817 = 0.0541*100 = 5.41% 141,067/2,612,700 = 0.0540*100 = 5.40% Return on Assets 101,103/1,240,897 = 0.0815*100 = 8.15% 141,067/1,918,193 = 0.0735*100 = 7.35% Return on equity 101,103/547,028 = 0.1848*100 = 18.48% 141,067/519,776 = 0.2714*100 = 27.14% Price/earnings 2.44/0.194 = 12.59 1.62/0.239 = 6.78 II. 2011 Ratio Formula David Jones Myer Current ratio 327,101/266,133 = 1.23 times 442,920/584,360 = 0.76 times Quick ratio (327,101-288,850)/266,133 = 0.14 times (442,920 – 381,161)/584,360 = 0.11 times Inventory turnover 1,194,474/288,850 = 4.14 times 1,551,112/381,161 = 4.07 times Average collection 365/99.90 = 3.65 days 365/109.36 = 3.34 days Total asset turnover 1,961,744/1,214,550 = 1.62 times 2,666,083/1,974,132 = 1.35 times Debt/equity - 419,951/861,330 = 0.49 times Times interest earned 247,111/7,789 = 31.73 times 260,138/38,747 = 6.71 times Gross profit margin 767,270/1,961,744 = 0.3911*100 = 39.11% 1,271,630/2,666,803 = 0.4768*100 = 47.68% Net profit margin 168,139/1,961,744 = 0.0857*100 = 8.57% 159,665/2,666,803 = 0.0599*100 = 5.99% Return on Assets 168,139/1,214,550 = 0.1384*100 = 13.84% 159,665/1,974,132 = 0.0809*100 = 8.09% Return on equity 168,139/525,105 = 0.3202*100 = 32.02% 159,665/519,479 = 0.3074*100 = 30.74% Price/earnings 3.05/0.33 = 9.24 2.64/0.274 = 9.64 b Year-on-Year Trend Analysis (2012 vs. 2011) Ratios David Jones Myer Year Year Time series Year Year Time series 2011 2012 2011 - 2012 2011 2012 2011 - 2012 Liquidity ratios Current ratio 1.23 1.06 Went down by 0.17 points 0.88 0.76 Declined by 0.12 points Quick ratio 0.14 0.14 No change 0.11 0.11 No change Activity ratios Inventory turnover 4.15 4.14 Declined by 0.01 points 3.80 4.07 Went up by 0.27 points Average collection 3.20 3.65 Went up by 0.45 days 2.40 3.34 Went up by 0.94 days Total asset turnover 1.51 1.62 Went up by 0.11 points 1.36 1.35 Declined by 0.01 points Debt ratios Debt/equity - - No borrowings reported 0.48 0.49 Went up by 0.01 points Times interest earned 14.15 31.73 Went up by 17.58 points 6.85 6.71 Declined by 0.14 points Profitability ratios Gross profit margin 37.47 39.11 Went up by 1.64 points 49.31 47.68 Declined by 1.63 points Net profit margin 5.41 8.57 Went up by 3.16 points 5.40 5.99 Went up by 0.59 points Return on assets 8.15 13.84 Went up by 5.69 points 7.35 8.09 Went up by 0.74 points Return on equity 18.48 32.02 Went up by 13.54 points 27.14 30.74 Went up by 3.60 points Market ratios Price/earnings 12.59 9.24 Declined by 3.35 points 6.78 9.64 Went up by 2.86 points c 2012 Financial Ratios Comparison Liquidity ratios Ratio David Jones 2012 Myer 2012 Interpretation Current ratio 1.06 0.76 David Jones performed better Quick ratio 0.14 0.11 David Jones performed better Activity ratios Ratio David Jones 2012 Myer 2012 Interpretation Inventory turnover 4.14 4.07 David Jones performed better Average collection 3.65 3.34 Myer performed better Total asset turnover 1.62 1.35 David Jones performed better Debt ratios Ratio David Jones 2012 Myer 2012 Interpretation Debt/equity - 0.49 David Jones had no borrowings Times interest earned 31.73 6.71 David Jones performed better Profitability ratios Ratio David Jones 2012 Myer 2012 Interpretation Gross profit margin 39.11 47.68 Myer performed better Net profit margin 8.57 5.99 David Jones performed better Return on assets 13.84 8.09 David Jones performed better Return on equity 32.02 30.74 David Jones performed better Market ratios Ratio David Jones 2012 Myer 2012 Interpretation Price/earnings 9.24 9.64 Myer performed better Question 2: Risk and Return a) Calculate the expected return over the four year period for each of the three alternatives I. Alternative 1: 100% of asset F Formula used: = 0.175 II. Alternative 2: 50% of asset F and 50% of asset G Formula used: 0.175 = 0.155 = 0.165 III. Alternative 3: 50% of asset F and 50% of asset H Formula used: 0.175 = 0.155 = 0.165 b) Calculate the standard deviation of the returns over the four year period for each of the three alternatives I. Alternative 1: 100% of asset F Variance F = (0.16 – 0.175)2 + (0.17 – 0.175)2 + (0.18 – 0.175)2 + (0.19 – 0.175)2 = 0.000225 + 0.000025 + 0.000025 + 0.000225 = 0.005 Standard deviation = = 0.07 II. Alternative 2: 50% of asset F and 50% of asset G Variance FG = [(0.16 – 0.165)2 + (0.17 – 0.165)2 + (0.18 – 0.165)2 + (0.19 – 0.165)2]*0.5 + [(0.17 – 0.165)2 + (0.16 – 0.165)2 + (0.15 – 0.165)2 + (0.14 – 0.165)2]*0.5 = [0.000025 + 0.000025 + 0.000225 + 0.000625]*0.5 + [0.000025+ 0.000025 + 0.000225 + 0.000625]*0.5 = 0.0009 Standard deviation = = 0.03 III. Alternative 3: 50% of asset F and 50% of asset H Variance FH = [(0.16 – 0.165)2 + (0.17 – 0.165)2 + (0.18 – 0.165)2 + (0.19 – 0.165)2]*0.5 + [(0.14 – 0.165)2 + (0.15 – 0.165)2 + (0.16 – 0.165)2 + (0.17 – 0.165)2]*0.5 = [0.000025 + 0.000025 + 0.000225 + 0.000625]*0.5 + [0.000625+ 0.000225 + 0.000025 + 0.000025]*0.5 = 0.0009 Standard deviation = = 0.03 c) Use your findings in parts a) and b) to calculate the coefficient of variation for each of the three alternatives. Formula used: Coefficient of variation = standard deviation / expected return I. Alternative 1: 100% of asset F Coefficient of variation = 0.07/0.175 = 0.40 II. Alternative 2: 50% of asset F and 50% of asset G Coefficient of variation = 0.03/0.165 = 0.18 III. Alternative 3: 50% of asset F and 50% of asset H Coefficient of variation = 0.03/0.165 = 0.18 d) Based on your findings above, which of the three investment alternatives would you recommend? Why? The coefficient of variation indicates the risk per unit of return, and it offers a very significant base for evaluation at the time the expected returns on two alternatives are not equal. The smaller the coefficient of variation, the lower risk factor, therefore alternatives II and III are preferable than alternative I. Alternative I has a higher coefficient of variation than alternatives II and III whose coefficient of variation is identical. Question 3: Capital Budgeting and Cash Flow Principles a) Calculate the initial investment associated with each alternative I. Alternative 1 Item Value ($) Selling price 20,000 Book value (0) Book profit 20,000 Tax on profit (6000) Net cash flow from sale 14,000 Item Value ($) Machine renewal cost (90,000) Net cash flow from sale 14,000 Initial cash flow (76,000) II. Alternative 2 Item Value ($) Selling price 20,000 Book value (0) Book profit 20,000 Tax on profit (6000) Net cash flow from sale 14,000 Item Value ($) Machine renewal cost (100,000) Installation costs (10,000) Net cash flow from sale 14,000 Initial cash flow (96,000) b) Calculate the incremental operating cash inflows associated with each alternative I. Alternative 1 Yearly depreciation = 90,000/5 = 18000 Year 1 Year 2 Year 3 Year 4 Year 5 Revenue 1,000,000 1,175,000 1,300,000 1,425,000 1,550,000 Expenses before depreciation 801,500 884,200 918,100 943,100 986,100 Depreciation 18,000 18,000 18,000 18,000 18,000 Net profit before tax 180500 272,800 363,900 463,900 545,900 Tax 54,150 81,840 109,170 139,170 163,770 Net profit after tax 126,350 190,960 254,730 324,730 382,130 Operating cash flow 144,350 208,960 272,730 342,730 400,130 II. Alternative 2 Yearly depreciation = 100,000/5 = 20,000 Year 1 Year 2 Year 3 Year 4 Year 5 Revenue 1,000,000 1,175,000 1,300,000 1,425,000 1,550,000 Expenses before depreciation 764,500 839,800 914,900 989,900 998,900 Depreciation 20,000 20,000 20,000 20,000 20,000 Net profit before tax 215,500 315,200 365,100 415,100 460,100 Tax 64,650 94,560 109,530 124,530 138,030 Net profit after tax 150,850 220,640 255,570 290,570 322,070 Operating cash flow 170,850 240,640 275,570 310,570 342,070 c) Calculate the terminal cash flow at the end of five years associated with each alternative I. Alternative 1 Item Value ($) Selling price 8,000 Book value (0) Book profit 8,000 Tax on profit (2,400) Net cash flow from sale 5,600 Change in networking capital 15,000 Terminal cash flow 20,600 II. Alternative 2 Item Value ($) Selling price 25,000 Book value (0) Book profit 25,000 Tax on profit (7,500) Net cash flow from sale 17,500 Change in networking capital 22,000 Terminal cash flow 39,500 d) Use your findings in questions a), b) and c) to depict on a time line the relevant cash flows associated with each alternative I. Alternative 1 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Initial cash flow (76,000) Operating cash flow 144,350 208,960 272,730 342,730 400,130 Terminal cash flow 20,600 Total (76,000) 144,350 208,960 272,730 342,730 420,730 II. Alternative 2 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Initial cash flow (96,000) Operating cash flow 170,850 240,640 275,570 310,570 342,070 Terminal cash flow 39,500 Total (96,000) 170,850 240,640 275,570 310,570 381,570 e) Based solely on your comparison of their relevant cash flows, which alternative appears to be better? Why? I. Alternative I End of year Cash flow ($) Number of year discounted PVIF @12% PV ($) 1 144,350 1 0.89 128,471.5 2 208,960 2 0.80 167,168 3 272,730 3 0.71 193,638.3 4 342,730 4 0.64 219,347.2 5 420,730 5 0.57 239,816.1 Total 948,441 NPV = PV + C0 = 948,441 – 76,000 = $ 872,441 II. Alternative II End of year Cash flow Number of year discounted PVIF @12% PV 1 170,850 1 0.89 152,056.5 2 240,640 2 0.80 192,512 3 275,570 3 0.71 195,654.7 4 310,570 4 0.64 198,764.8 5 381,570 5 0.57 217,494.9 Total 956,482.9 NPV = PV + C0 = 956,482.9 – 96,000 = $ 860,482.9 Alternative I has a net present value of $ 872,441 whereas Alternative II has a net present value of $ 860,482.9. Alternative I is better. References Martin, S.F and Fernando, A., Financial Statement Analysis: A Practitioner’s Guide, 2002, John Wiley & Sons Steven, M.B., Business Ratios and Formulas: A Comprehensive Guide, 2012, 3rd edn, Wiley Steven, M.B., Financial Analysis: A Controller’s Guide, 2006, 2nd edn, Wiley Read More