An Analysis of Javelins Current Position Utilizing Financial Ratios - Essay Example

An Analysis of Javelin’s Current Position Utilizing Financial Ratios

The financial ratios are essential methods for the improvement of the firm’s performance along with its financial position. Javelin Railways Co is opting to obtain a five years franchise from the UK government to operate in the high-speed commuter rail service from 2017 to 2021. Business organizations venture into projects with an aim of improving their productivity and profitability. The main aim of the franchise formation, in this case, is to increase the profitability of the company. For the company to venture into franchise project, they have to acquire new trains before starting the operation in 2017. The operation is expected to start in 2017 where the company will be expected to pay the initial annual license fee of 3 million dollars to the UK government. The license fee will be paid on an annual basis and the amount will increase at a rate of 2% per year at a compound interest. The company has already invested 450,000 sterling pounds in the feasibility study that supports the traffic data that constitutes the foundation of the two proposals which are still under consideration.

Despite the growth in the international franchising, it is important that there must be mutual understanding between the parties involved in the franchise. Lack of mutual understanding results to conflict in the franchise and may affect the performance of the entire business venture. The development of the mutual relationship determines the viability of the franchise formation. In this case, it is assumed that the companies involve the franchise contract are in good agreement. Therefore, the analysis concerning the viability of the franchise formation will be based on the external factors. The most important tool in the analysis is the cost-effectiveness of the project (Crundwell 2008, p.40).

In the transport industry, the amount of profit generated is directly proportional to the number of passengers transported. Measuring the profitability of a business can be measured in terms of the ratio of the profit margin to the revenue generated. The contract will last for about five years and the company must ensure that it regains the cost used in the venture before the termination of the contract to avoid incurring the loss.

The purchase of a franchise may offer various advantages; however, proper management of the new venture is required to increase the profitability of the investment. Conducting an in-depth research is very important in the investigation of the value of the franchise. One should choose a franchise on the industry they are familiar with; they must have analyzed the performance of the industry over the past. In this case, the company is likely to benefit from venture because of the good historical performance in the U.K transport industry. However, before investing in a given sector, it is important to analyze the cost involved in the venture and the value of the return on capital.

WACC impact over investment decisions

In this context, high ratio of gross profit margin specifies feasible profit for the company as long as it sustains its overhead costs. Weighted Average Cost of Capital (WACC) is an essential aspect of financial statement that provides a clear conception concerning the rate of return over the required investment needed for the company. To assess the company’s present internal scenario, WACC is essential and the analysis will be based on two investment proposals. Based on the company’s financial ratios including liquidity ratio and the profitability ratio, the company is in a good position to invest in the franchise.

The company’s liquidity ratio = current assets/current liability

=

Financial leverage ratio = total debts/total equity

Total debts = 36.46 million dollars

Total equity =91

The financial leverage ratio =

This shows that the company has been aggressive in financing its growth with debts. The debt to equity ratio of greater than 2 indicates that the company is at high risk of the investors. The value of dividend payout ratio = dividend/net income. On this case, the value for 2015 will be 95/3204 =.029. From the calculations, it is evident that the company retains a lot of its earning which can be used in the investment.

First case

In case the company purchases train from the Schneller Zug, the total price that will be incurred is 115.63 million Euros. The trains will be supplied by the end of December 2016; this shows that the company will deliver the products in time. The initial sales revenue obtained from the selling of the tickets will be 40 million sterling pounds. And the ticket price inflation is estimated at 3% per year. The operating cost involved in the Schneller Zug is 35% of the revenue while the operating overheads are 0.2 million sterling pounds per year. The feasibility study indicated that 5 million dollars working capital are required before the franchise becomes in operation. The trains will become obsolete in 2020; therefore, there will be no terminal value.

The amount of money required in the financing the franchise is equivalent to the amount of money required to start a new business. Before forming a franchise, it is important to consider all the hidden costs and analyze the feasibility of the business deal (Libava 2012, p.39). The other factors that affect the franchise include competition in the local market and the government policy. The government policies on taxation are some of the hidden costs that may not be evident during the franchise formation. It is important to analyze such factors keenly and ensure that they do not affect the performance of the business operation. In this case, the research is based on the analysis whether the Javelin Railway Co plc is prepared to meet the startup cost and the operational cost involved in the franchise. The revenue generated must be able to meet the cost of daily expenditures (Crundwell 2008, p.45).

The second case

The Kyuko Densha is a Japanese firm that supplies Kyuko Densha trains at a unit cost of Y17, 574.84 million. The train has double-deck carriages and can carry more passengers compared to the German train. The Kyuko Densha has a larger carriage capacity compared to the Schneller Zug; therefore, the initial revenue generation from the sale of tickets is expected to be high. The initial income generation is estimated at 53.20 million sterling pounds. The inflation is expected to be at 3% per year. The variable operating cost is estimated at 41% of the sales revenue and the operating overheads are estimated at o.380 million sterling pounds per annum. The feasibility study indicated that working capital of 6.2 million dollars is required before the franchise becomes in operation. The amount should be provided within the year 2016. The trains will become obsolete in 2020; therefore, there will be no terminal value.

calculations for the German train

$ '000'

current assets

57.62

operating cost

20.167

fixed asset

131.07

starting capital

5

license fee

3

liquidity ratio =57.62/

/28.167

2.04

return on asset value = 57.62/

159.237

0.36

calculation for the Japanese train

fixed asset 160.79

current assets

76.59

operation cost

31.4019

starting capital

6.2

license fee

3

liquidity ratio =76.59/37.6019 =2.03

/40.6019=

1.885

return on assets = 76.59/160.79=0.476

/201.009

0.38

A simple estimation of the return on capital of the two cases can be done by dividing the revenue generated with the total cost to assess the profitability of the two cases. It is evident that inflation will be constant in both cases. Also, both the train offers will become obsolete in 2020 meaning that there will be no terminal value. The total cost required in the initial operation in case one will be 156.237 million dollars while the revenue to be generated will be 57.62 million. The return on the initial investment will be 57.62/156.237= 0.368 which is equivalent to 36.8%.

The cost required to start the business operation in case two is 198.3919 million dollars while the revenue that will be generated is 76.59 million. The return on investment at the beginning of the business operation = 76.59/198.3919 =0.38 which are equivalent to 38%.

Theoretical perspective of the case

The fisher theory of capital investment provides guidance in the analysis of the Franchise project case. The theory is also reinforced by Keynes who introduced the concept of marginal efficiency of investment. The marginal efficiency is the rate of interest on an investment. Fisher posits that an investment at any time period yields an output only in the next period. For instance, in case the world has only two times, the t1 and t2, the investment in t1 will yield output during the t2. This shows that during an investment, one ought to consider the time it will take for the investment to realize gains and the amount of input required in the investment.

Based on the ROCE value, the company employs its capital effectively and has generated shareholder value; therefore, they can venture into the franchise. The neoclassical macro model theory provides the inter-relationship between the demand and supply in an economy. In case the demand is high, the manufacturers must increase the supply of the products in the market so as to offset the deficit. When the suppliers increase the volume of commodities supplied in the market, the revenue generated also increased. In this case, the company must consider the availability of the market and then provide enough services to meet the supply (Crundwell 2008, p.21). The trains are fast moving and this shows that they will improve the efficiency and time management. In addition, the double-decker trains offer an advantage over the other train because it will be able to carry many people at a time and also make many trips in a day. The real economy is governed by real demand and supply that companies must consider before investing. The main challenge, in this case, is determining the best offer from the two proposals, the offer that will result in high profitability. In addition, the company must consider whether the whole project will be beneficial by analyzing the cost expenditure and the expected returns. The expected returns may vary from time to time because of the uncertainties in the business operation (Libava 2012, p.39).

Sensitivity Analysis

Javelin Railway Co plc is a large and integrated transport operator that is listed on the London Stock Exchange. From the balance sheet, it is evident that operating profit of the company as at 3oth April 2015 was 312.41 million dollars (217 million sterling pounds). The turnover value is 4612.8 million dollars (3,204 million sterling pounds). The inventory turnover ratio is a key figure that analyzes the efficiency of a company in the handling of goods as it purchases the raw materials and sells the finished goods. From the balance sheet, it was also evident that the net asset value was 95 million sterling pounds. The company has a 5.75% loan note 2020 and 4.36% loan note 2025. The total value of the loans is 735 million sterling pounds.

Based on the above analysis, the company is in a good position to meet the total expenses required in the franchise formation. The company can either use the capital reserves of borrow some amount from the lending institutions. The franchise is expected to generate a lot of income that will help boost the profit margin of the company (Crundwell 2008, p.40). It will also a strategy of expanding the scope of operation of the company since the company can use the chance maximize on its operation in the UK. The total equity value was 95 million sterling pounds. In as much as the company has some loan liabilities, the financial report indicates that the 5.75% loan note is trading at a value of 103.15 sterling pounds while the 4.36% loan note is trading at a value of 101.20 sterling pounds. The investment in the franchise project will be advantageous to the company considering the fact that the company is in a position to meet the initial capital required in the starting of the business. Also, the UK government bonds have been increasing with time.

Considering the two train offers, it is evident that the term sin the Kyuko Denshe deal s better compared to the German manufacturer’s deal. The return in investment is a metric tool that helps in the assessment of the financial consequences of an investment (Behr 2004, p.79). The metric measurement mainly focuses on comparing the magnitude of investment and the investment gains. In the assessment of the viability of an investment, it is important to consider the starting capital required and the gains associated with the investment. From the analysis above, it is evident that the Kyoko Denshe case involves high starting capital that may be discouraging. On the other hand, the cost required to initiate the business operation using the Schneller Zug (fast trains) is lower compared to the Kyuko Densha fast train. Both the trains are fast speed trains and they will make various trips that guarantee the company an increased revenue earning. The cost of buying the Schneller Zug train is a bit lower compared to the price required to purchase the Kyuko Densha. However, analyzing the two proposals based on the returns on investment concept, the second proposal will be appropriate because of the high returns in investment value.

Available Methods for Financing the Acquisition and Consideration of Appropriate Method

The return on investment mainly compares the magnitude of the investment costs and the direct investment gains. The returns on investment are a measure of profitability in an investment. The steps required to calculate an accurate value of the returns on investment is complicated and therefore, the whole step is not employed in this case. The calculations above mainly compares the revenue acquired at the beginning of the investment with the total capital used to initiate the investment operation (Behr 2004, p.49). The value of return on investment in both cases is less than 100% because of the high capital investment in the business but with time, the company will be able to regain the cost involved in the starting of the business. As time progresses, the value of return on investment will increase because the cost of operational expenses will reduce. The total cost at the beginning of the business is usually high and it may scare people from investing in a given business enterprise.

The company will improve profitability be devising measures of reducing the expenses and increasing the revenue generation. It is advisable that Javelin Railway Company invests in the franchise because of the lucrative nature it presents. Purchase of the Japanese train, Kyuko Densha will increase the profitability of the investment since the train has a high capacity to carry many people compared to the German train. The train has a number of double-deck carriages and can accommodate more passengers at a time compared to the German train. The more the capacity of the train, the more income generated from the carriage services. The corporation tax is charged at a rate of 19% percent on the profits of the UK firms.

Franchise involves a scenario where the franchisor grants the franchisee the opportunity to engage in development business concept. A franchise system is a complex contract since the parties involved must agree on how their cooperation will result in increased profitability. The agency theory motivates the franchise formation since it states the expected relationship between the franchisor and the franchisee. Incentives and insurance are some of the most significant incentives in the franchise formation (Behr 2004, p.45).

Conclusion

Finally, the decision-making process, in this case, involves analysis of the return on investment on the project proposed. The investment metrics measures the efficiency of an investment and it involves the measure of the company’s earn using the base asset. Before venturing in a project, it is important to analyze the return investment which gives an overview of the benefits to be accrued in the investment. The capital employed component in the ROCE can be calculated using the current assets and the current liabilities. The franchise deal will be advantageous to the Javelin Railway Co plc because the anticipated benefits surpass the cost of investment. The profitability can be increased depending on the choice of the train to use in the project. In this case, it is advisable to use the Kyuko Densha train because it will generate a lot of income compared to the German train. By the end of the franchise contract, the company will have gained profit to offset the cost involved in the investment.