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BU5001

Managing

Resources

Portfolio Part

Three Assignment

Kingston ID: K1411991

Word Count: 4956 words

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Table of Content

1. Ratio analysis and interpretation of big 3 UK supermarkets

1.1.Introduction………………………………………………………………3

1.2.Gearing Ratio……………………………………………………………3

1.2.1. Interest Coverage Ratio………………...…………………..4

1.3. Profitability Ratio…………………………………..………………...5

1.3.1. Gross Profit Margin………………………..…………….…..5

1.3.2. Return on Capital employed……………….……….……...6

1.4. Efficiency Ratio……………………………………….……..……….6

1.4.1. Fixed asset turnover………………………………………….6

1.4.2. Trade Debtor Collection Period……….…………………….7

2. Short- term decision making and CVP analysis

2.1. Breakeven sales and units…………………………………………..9

2.2. Tickets sold to earn $30,000.………………………………………..9 2.3. Result if 8,000 tickets are sold.…………………………….………10 2.4. Margin of safety for 10,000 tickets.………………………………..10

2.5. Ticket sales increase by 25%………………………………………10 2.6. CVP Graph.…………………………………………………………..11

2.7. The assumptions and limitations of CVP.…………………………12

3. Investment appraisal and decision-making

3.1. ARR method.………………………………………………………...13

3.2. If ROCE to be at 25% ………………………………………………15 3.3. Payback period method.……………………………………………16 3.4. Considering acceptable Payback Period to 3 years…………….18

3.5. Net Present Value method…………………………………………19 3.6. Which of the 3 projects are worth considering……………….....20

3.7. IRR method..…………………………………………………………20 3.8. If the rate of return is at 15%………………………………………21 3.9. Overall conclusion.………………………………………………….22

3.10. Advantages and disadvantages.…………………………………..23

4. Referencing………………………………………………………….…25

5. Appendix…………………………………………………………….….27

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1. Ratio analysis and interpretation of big 3 UK supermarkets.

1.1. Introduction

“Ratio is a technique that helps management and external uses…by

examining relationship with certain data” (Collis and Hussey, 2007). It

useful when comparing companies together, as the ratios will gave the

companies specific financial information, which based on it the

company, will improve their performance depending on those ratios.

This report going to evaluate the three big UK supermarkets Tesco,

Sainsbury and M&S, using three ratio analysing technique (Gearing

Ratio, Profitability Ratio and Efficiency Ratio), using last 5 years

financial information downloaded from Bloomberg. The reason behind

choosing those specific three ratios is because profitability ratio is to

maximize the wealth and profit of the business and we need to

compare which of the three companies has increased their profit over

the last 5 years. Efficiency ratio is useful only when comparing with

other companies (Dyson, 2010). This also shows how company is

turning their effectively business into cash. Lastly, gearing ratio is

chosen because, it describes the debt and equity used to finance a

business (Davies and Crawford, 2011).

Tesco was found by Jack Cohen in 1919. Tesco operating in 12

different countries, and employ over 530,000 people (Tesco plc, 2016).

The second largest supermarket is Sainsbury’s was founded in 1869.

Sainsbury’s operates over 1,200 supermarkets and convenience stores

and employs around 161,000 people (J-sainsbury.co.uk, 2016). Last

large supermarket will be considered in this report is M&S. M&S was

found in 1884, it has 852 stores in UK, which serves 33 million

customers (Corporate.marksandspencer.com, 2016).

1.2. Gearing Ratio

The gearing ratio measures how much a company's borrowed

funds to its equity. (Davies and Crawford, 2011). It shows the

financial risk that the business can get. A high gearing ratio leads to

a high debt, and a low gearing ratio leads to a low debt. Gearing

ratio can be measured by the formula below.

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Gearing Ratio= 𝐿𝑜𝑛𝑔 𝑇𝑒𝑟𝑚 𝐿𝑜𝑎𝑛𝑠+𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑆ℎ𝑎𝑟𝑒𝑠

𝑆ℎ𝑎𝑟𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙+𝑅𝑒𝑠𝑒𝑟𝑣𝑒𝑠 +𝐿𝑜𝑛𝑔 𝑇𝑒𝑟𝑚 𝐿𝑜𝑎𝑛𝑠 +𝑚𝑖𝑛𝑜𝑟𝑖𝑡𝑦 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡

From the above graph, it shows that M&S and Tesco gearing ratio in

2010 was really high as it was 0.51 and 0.45 compared to Sainsbury’s

it was 0.32. However, it decreased over the following four years, so in

2014 it reached 0.37 and 0.38. This is may be because the investor

has lower the amount of money going into the business. Sainsbury’s

increased over the years until 2013 the gearing was 0.34 this is

because they are depending on finance coming from their owners more

than external financing. But in 2014 it decreased to 0.27. Sainsbury’s

compared to the other two is in the same financial position, but is less

risky in terms of capital structure the other two. As if Gearing is low

then the company is borrowing less money, which means the

borrowing of the company, has reduced.

1.2.1. Interest Coverage Ratio

Interest coverage ratio, it calculates how easily can a company

pay the outstanding debt they have borrowed (Investopedia,

2004). It can be calculated by the below formula.

Interest Coverage Ratio=𝑃𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥𝑎𝑡𝑖𝑜𝑛

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑝𝑎𝑦𝑎𝑏𝑙𝑒

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This above graph illustrate, that Tesco in 2012 has the highest interest

coverage ratio, as it was 9.20. Sainsbury’s has increased on the amount paid

from 4.57 in 2010, to 7.09 2014. On the other hand M&S seems to increase

and decrease of its ratio over the 5 years, this is a good indicate for M&S as

they generating enough profit after the tax to efficiently be out of its

outstanding debt. So it performs better than the other two companies.

1.3. Profitability Ratio

1.3.1. Gross Profit Margin

Gross profit ratio measures how much the profit of business was earned in

relation to the sale that was made (Dyson, 2010). Gross profit is what remains

from the sales after a company pays off the price of good sold

(InvestorWords.com, 2016). The company can calculate the gross profit by

the below formula.

Gross Profit Margin = 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟ℎ𝑖𝑛∗100

𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒

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The graph shows that M&S had the highest gross profit for 5 years compared

to the other two companies. Tesco preform a bit better than Sainsbury’s as its

gross profit in 2014 was 6.31, however Sainsbury’s was 3.391. So

Sainsbury’s is the least in generating good gross profit. However M&S has the

best gross profit. This means that they have more cash to invest on new

products and services to meet their company needs and wants. The

differences between gross and net is that gross is the full money and the net

is the money after taxation.

1.3.2. Return on Capital employed

This is a measurement of return that the company will take from its capital. The result ratio it represents the capacity, which the capital is being used to

generate the revenue (InvestorWords.com, 2016). The company can calculate the return on capital employed by the below formula.

ROCE=𝑃𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥𝑎𝑡𝑖𝑜𝑛∗100

𝑆ℎ𝑎𝑟𝑒 𝑐𝑎𝑝𝑖𝑡𝑎𝑙+𝑟𝑒𝑠𝑒𝑟𝑣𝑒𝑠 +𝑙𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑙𝑜𝑎𝑛𝑠+𝑚𝑖𝑛𝑜𝑟𝑖𝑡𝑦 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡

The graph shows that M&S is the safest company for inventors to invest their

money at, as the return on capital employed is really high compared to the

other two companies. Sainsbury’s can be the second safest investor to invest

on as the figures increasing since 2010. However Tesco is the least save to

invest on as the figures is not stable since 2010 so more risk going to be on

Tesco. The difference between the net and grass profit are some expenses

that the business has, so if the graph has changed significantly from gross to

net that indicates the company has some additional expenses which are not

important so they can take it off from their expenses.

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1.4. Efficiency Ratio

1.4.1. Fixed asset turnover

Fixed asset is very important area in efficiency ratio as it examines the point

of view of efficiency. Fixed asset enables the business to function more

effectively, as high level of fixed assets will bring more sales and profit to the

company. This area is useful only when comparing with previous years or with

other companies, therefore it is really useful to be used in this report, to draw

a clear understanding of the three fixed asset supermarket (Dyson, 2010).

The formula below shows how to calculate the fixed asset turnover.

Fixed Asset Turnover= 𝑆𝑎𝑙𝑒𝑠

𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 𝑎𝑡 𝑁𝐵𝑉

The graph above shows that Sainsbury’s in 2014,fixed asset turnover was

5.514 that has increased a lot since 2010 it was 2.169. M&S has not changed

at all since 2010. But Tesco has increased slightly between those 5 years.

This makes Sainsbury’s less risky to invest on as the turnover is increasing.

This means that Sainsbury’s is generating more revenue from every $ of

assets that has, which makes it more efficient in generating profit than the

other companies.

1.4.2. Trade Debtor Collection Period

Getting fixed assets is very good, but no need for the business to buy them if

the customer will not pay for them. Customers may be encouraged more by

buying lower selling price. If the debtor is paying back the money as quickly

as possible, then the business may have flow cash problems. Therefore the

business needs to watch trade debtor position very carefully. The business

can check how well it has been by doing the trade debtor collection period

ratio (Dyson, 2010). Which can be calculated by this formula.

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Trade Debtor Collection Period= 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒

𝑆𝑎𝑙𝑒𝑠 𝑥 365

This graph shows that M&S debtor collection period is decreasing as in 2010

it was 4.489 and in 2014 reached 2.92. Which shows that they are collecting

their money form customers more frequently, which increases the collection

period. However, Tesco and Sainsbury’s are preforming bad, as the period is

increasing not decreasing. Which M&S is the only company that preforms well

out of the other two.

Ratio analysis has some limitations, which needed to be considered such as;

comparison with other firms will lack the meaning if the other firms are

different so the result will be not accurate. Also one set of data for one year

would not allow the investigation to go through as it need more than one year

to have the proper calculations and the profit out of ratios. Furthermore, when

analyzing the ratio a huge care must consider seeing if the profit earned in a

good manner and does not have other illegal accounts that the money came

from. Lastly, ratios uses historical data and does assume any future data

which it will be no use for a company if want to plane for the next couple of

years (Horner, 2015).

The best preforming company from my opinion depending on the above

information is M&S as in most of the ratios above preforms better than the

other two companies which indicated that they are gaining profit and not

having any difficulties, unlike the other two companies, which the information

above show that they are a bit struggling. I would recommend that the other

two companies to work hard to find what is their weakness in those ratios and

try to fixe them up as soon as possible. Those companies should have some

additional expenses, so they can manage their inputs with outputs and in time

of difficulties they can use it.

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2. Short- term decision making and CVP analysis

2.1. The number of tickets that must be sold to breakeven (both in terms of sales and units)? Explain your results.

Total Revenue = selling price x unit sold

25 x 10000 = 250,000

Fixed cost= $125,000

Sales per unit = $25

Variable cost per unit = $10

Contribution margin per unit= sales – variable cost

25 – 10 = 15 per unit

This mean that 15 unit could be generating, is to cover up the fixed

sales unit.

Contribution margin total = 250,000 – 100,000 = 150,000 - FC

(125,000) = profit

150,000 – 125,000 = 25,000 is the total contribution.

This means that the 25,000 amount of contribution which it is the sales per

unit, is the total cover up for the business. Manager at this time does not

consider the end of the financial of the year, as there is no tax at this time.

Break Even Point unit = FC / UCM

BEP = 125000/15= 8,333.33 need to sell for the business to

break even.

CMR = CM / Sales CMR = 150,000 / 250,000 = 0.6 = 60.00%

Any sales beyond this point are a loss, any sales after this point is a

profit, so this would consider as the break-even point.

BEP sales = total fixed cost / contribution margin ratio

BEP sales= 125,000 / 0.6 = 208333.33 break point for sales

2.2. How many tickets must be sold to earn $30,000 profit?

Unite sold to attain target profit= fixed expenses + target profit / unite

contribution margin. USTATP= 125,000 + 30,000 / 15 = 10,333,33 tickets must be sold to

meet the $30,00 target.

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2.3. What profit/loss would result if 8,000 tickets are sold?

Revenue = 25*8000 = 200,000 - Variable cost = 10*8000 = 80,000 - Fixed cost 125,000

- Profit/loss = -5000

There is a $5000 loss if the business will sell 8,000 tickets; therefore the business needs to sell more tickets to make a profit or event reach it Break-even point

2.4. Estimate the margin of safety for a sale of 10,000 tickets (both in sales and % age terms). Explain your result.

Margin of safety (Sales) = Revenue – BEP MOS Sales = 250,000 –208333.33 = 41666.67

This means that when this number is reach then the company is above

their breakeven point.

MOS (%)= 41666.67 / 250,000 = 16.67 %

This to check the percentages of the MOS and to make sure that the

business is not falling beyond their target percentage.

2.5. Suppose if the management expectations of ticket sales increase by 25%, with fixed cost and selling price per ticket

remaining constant, what would be the % age increase in profit.

Old

Tickets: 10,000

Revenue: 250,000 25* 10,000

Variable cost: 100,000 10* 10,000

Contribution: 150,000 250,000- 100,000

FC: 125,000

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Profit 25,000 150,000 – 125,000

New

Tickets: 12,500

Revenue: 312,500 25* 12,500

Variable cost: 125,000 10* 12,500

Contribution; 187,500 312,500 – 125,000

FC: 125,000

Profit: 62,500 187,500 – 125,000

Percentage change in profit= old profit – new profit / old profit

PCP= (62,500 – 25,000)/ 25,000 = 15.0% is the age increase in profit if

the tickets sells increase by 15% which means the company will get more profit from the percentage increasing.

2.6. Draw a CVP Graph for the given scenario based on volume range of 0 tickets to 14,000 tickets sold? Label the graphs and

clearly indicate the BEP (units/sales), profit/loss region and the cost lines.

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The profit earned at a certain level can be measured by the distance between

the total cost and the revenue at any level of the output. The low levels of the output, the total is lower than the revenue, the gap between the two would

measure the loss at the output level. If we look to the break even point we can see the total revenue is higher than the total cost, by measuring the distance between the two, the profit earned by the company could be found. Break-

even point is where the company has not lost profit neither gained any. Anything before the breakeven point is a loss and anything after it is a profit

for the company (Horner, 2015). Break-even point is where sales line meets the total cost line. Moreover the loss is taking place until break-even point then profit will take place. Margin of safety is the distance between the break-

even point and the maximum sales, which takes place. It called margin of safety because it gives the management an idea of how much is remaining to

make a profit not just to break even (Black and Al-kilani, 2013).

2.7. Using appropriate literature, explain the results in light of the assumptions and limitations of CVP analysis.

In every graph there is limitations, which would be a drawback to the

business such as, the output which in the CVP graph is the only affecting cost factors, there is no external factors which included into it, for example; inflation, efficiency and political factors. In reality the costs

cannot be split easily, but in this graph the total cost is divided into fixed and variable cost, which is unreasonable to do if it does not

happen easily in reality. Moreover, the fixed costs do not remain at the same level all the time beyond certain rangers, and the behavior between the cost and revenue in liner, which is a rare thing to happen

between those two. Furthermore, the PVC graph does not have uncertainty in the prediction of costs and sales revenue. Usually

businesses produce more than one product and sale mix this is not constant but it changes due to the demand of the products, so the graph does not gave a single product. (Davies and Crawford, 2011).

Lastly, the time value money is ignored, this means that this graph does not realize the change in money over the next few years, then this

graph in 3 years time it wont be accurate to use so the business have to do another one. Those limitations are very real which every business which use this graph knows about, those limitation it wont change

overnight so needs time to be developed to be changed. Nerveless, the principles of the CVP analyses continue to be true, and some of the

above limitations can be overcome, by considering alternative pricing options, that use marginal and full absorption costing approaches (Davies and Crawford, 2011). Those limitations will affect the answer

for the above CVP analysis, but it is still usable at this moment, if the business will use this graph after 3 years time it will not be affective at

all. Therefore the business should update this graph nearly every year, so they have accurate information.

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3. Investment appraisal and decision-making

3.1. Rank the 3 projects using ARR method

Accounting rate of return is a method to judge the project by its

profitability. Profit earned each year is referred to as a percentage in

the project. Because this method is using profit rather than cash flow

then any cash flow needs amendment so we can work out the profit of

the project (Horner, 2015).

Alpha

Depreciation-Straight line Method

The investment will lose value, if not applying the straight-line method

(Horner, 2015).

5,000 – 1,000

DEP = = 1,000

4

PBD – DEP

Year 1 1,000 – 1,000 = 0

Year 2 1,000 – 1,000 = 0

Year 3 3,000 – 1,000 = 2,000

Year 4 3,000 – 1,000 = 2,000

2,000 + 2,000 = 4,000

4,000 / 4 = 1,000

Average annual capital employed

Depending on the straight-line method the ACE needs to be done.

Here we want to show the average value investment rather than the

net value, which it will be not useful to this calculation (Horner, 2015).

5,000 + 1,000

ACE = = 3,000

2

Accounting Rate of Return

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1,000 * 100

ARR= = 33.33 %

3,000

Beta

Depreciation-Straight line Method

8,000 – 2,000

DEP = = 1,500

4

PBD – DEP

Year 1 3,000 – 1,500 = 1,500

Year 2 3,000 – 1,500 = 1,500

Year 3 3,000 – 1,500 = 1,500

Year 4 3,000 – 1,500 = 1,500

1,500 + 1,500 + 1,500 + 1,500 = 6,000

6,000 / 4 = 1,500

Average annual capital employed

8,000 + 2,000

ACE = = 5,000

2

Accounting Rate of Return

1,500 * 100

Alpha PBD DEP

year 1 1,000 1,000 0

yaer 2 1,000 1,000 0

year3 3,000 1,000 2,000

year 4 3,000 1,000 2,000

tottal 4,000

1,000

ARR 1,000 * 100

3,000 33.33%

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ARR= = 30 %

5,000

Delta

Depreciation-Straight line Method

10,000 – 3,000

DEP = = 1,750

4

PBD – DEP

Year 1 5,000 – 1,750 = 3,250

Year 2 5,000 – 1,750 = 3,250

Year 3 1,000 – 1,750 = -750

Year 4 1,000 – 1,750 = -750

3,250 + 3,250 + - 750 + - 750 = 5,000

5,000 / 4 = 1,250

Average annual capital employed

10,000 + 3,000

ACE = = 6,500

2

Accounting Rate of Return

1,250 * 100

ARR= = 19.23 %

6,500

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ARR is more useful because it takes into account the size of the return of the

investment, which aiming to increase the profit of the company (Horner,

2015). It is easy to understand, and not difficult to compute, also it draws and

attention to overall profit (Dyson, 2007). However, the drawback of this

method is that it treated all years equally does not consider the changes that

could happen over the years. This could be a low risk if planning for a short

period of time, which will be great method to use (Horner, 2015).

Rank 1: Delta

Rank 2: Beta

Rank 3: Alpha

3.2. Considering the company’s historical ROCE to be at 25%.

Which of the three projects are worth considering for

investment?

Alpha and Beta will increase the share value of the company, as they

are greater than 25% so it is feasible; however the Delta is not feasible

as it has lower percentages than the ROEC. Therefore the company

should choose Alpha and Delta to secure a profit and worth

considering for investment.

Rank 1: Alpha

Rank 2: Beta

3.3. Rank projects using Payback period method

Payback means the time taken for the nest flow to match original cash

flow out of the investment. It will be measured in years and it a good

method because it have a shortest payback period possible to meet

(Horner, 2015). This method is useful if a company wants to avoid

having large amount of capital tied up in project for period of time. By

counting how much they can recover the cost they have invested into

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this project. As any other methods there are limitations to this method

as well, such as the profitability of the project will be ignored, also the

cash flow after payback period will be ignored as well (Horner, 2015).

Ignoring a profit will be an issue as it could lead to serious problems to

the project. Finally this method does not take time value of money,

which means that no considerations of the changing of the value of

money in the years coming, which is a huge draw back for this method.

Year 0 is the current year, which start with negative number all the

times.

Alpha

CF – CCF

-5,000 – 1,000 = - 4,000

-4,000 – 1,000 = - 3,000

- 3,000 - 3,000 = 0

0 – 3,000 = 3,000

Payback period point is at year

Beta

CF – CCF

-8,000 – 3,000 = - 5,000

-5,000 – 3,000 = - 2,000

- 2,000- 3,000 = 1,000

1,000 – 3,000 = 4,000

Alpha CF CCF

year 0 5,000 -5,000

year 1 1,000 -4,000

year 2 1,000 -3,000

year 3 3,000 0

year 4 3,000 3,000

PP at year 3

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To find the exact months the following formula should be done

Amount needed to reach payback *12

Amount received in year

- 2000

Number of month after last cash flow = * 12 = 8 months

3,000

Payback period point is at 2 years and 8 months.

Delta

CF – CCF

-10,000 – 10,000 = - 5,000

-5,000 – 5,000 = 0

0 - 1,000 = 1,000

1,000 – 1,000 = 2,000

Payback period point is at 2 years

3.4. Considering company maximum acceptable Payback Period to

be 3 years. Which of the 3 projects are worth considering for

investment?

All three of the project can be considerable as feasible, they all meeting

the payback period. However, Delta is quickest payback period than

the other two projects as it pays back the company after 2 years. If

choosing from the three project Delta comes first, second would be

Beta and Alpha will be consider last as it payback at 3 years exactly.

Rank 1: Delta

Rank 2: Beta

Rank 3: Alpha

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3.5. Rank projects using Net Present Value method. Consider

discount rate of 5%

NPV is a method used to examine the technique in order to express all

future cash flow in the same terms; it takes into account the value of

money (Gowthorpe, 2011). Choosing an appropriate discount rate

would be depending on the cost of the capital as well as the riskiness

of the investment (Horner, 2015).

DF 5%

Alpha

PP for Alpha is at 3 years and 2months, it is less than max acceptable,

which is 4 years hence feasible investment option.

Beta

PP for Beta at 2 years and 11 months, it is less than max acceptable

PP of 4 years hence feasible investment option.

Delta

PP for Delta is at 2 years and 9 month; it is less than max acceptable

of 4 years hence feasible investment option.

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3.6. Which of the 3 projects are worth considering for investment?

All of the three projects are feasible and are worth of investment, but Delta

would be the best option as the PP is in 2 years and 9 months, which is

the quickest to pay back. Secondly would be Beta as the pay back period

would be 2 years and 11 months and lastly Alpha would be considered as

its payback period in 3 years and 2 months.

Rank 1- Delta

Rank 2- Beta

Rank 3- Alpha

3.7. Rank projects using IRR method

IRR is the discount rate, which applies to cash flow and produces an

NPV of zero. If the IRR greater than the business cost then the project

is acceptable. The higher the IRR the better the project is (Gowthorpe,

2011).

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3.8. If the company’s required rate of return is at 15%. Which of the

3 projects are worth considering for investment?

IRR Alpha 8.28%

Hurdle rate for the company is 15% IRR (Alpha) is > hurdle rate so the project is feasible

IRR Beta -5.42%

Hurdle rate for the company is 15%

IRR (Beta) is > hurdle rate so the project is feasible

IRR 13.97%

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Delta

Hurdle rate for the company is 15%

IRR (Delta) is > hurdle rate so the project is not feasible

Rank 1 Alpha

Rank 2 Beta

Alpha and Beta would be suitable for the business as they both have a

percentage more than 15%, which they are feasible to use for the business.

However, Delta is not a good project to consider, as it is less than 15%, which

will give a loss to the business.

3.9. Having evaluated the projects using alternative investment

appraisal technique, provide an overall conclusion of the most

appropriate method/methods you would consider for

appraising the three projects and Why?

Capital budgeting is designed to achieve more profit and reduce the

costs in private and public sectors. It has a broader perspective and

tries to explain and describe the process by “which projects become

identified, developed, justified and finally approved” (Capital

Budgeting Process: Theoretical Aspects, 2011).

Of all the methods evaluated in this report, the net present Value

method (NPV) the business should consider the best to use when

making investment appraisal decision. Based on the project Delta

would be the best option as the PP is in 2 years and 9 months,

which is the quickest to pay back project. The NPV method it

provide the investor with valuable tools, which will help on deciding

which project to use, it is also a financial measurement tools that

gave the time value money in a business, this techniques very

important to have moreover, the majority of the others methods

does not has this specific feature, that why the business should

consider the NPV when investing. Due to the above this technique

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is very popular for investment decision (An investigation into the

impact of investment appraisal techniques on the profitability of

small manufacturing firms in the Nelson Mandela Bay Metropolitan

Area, South Africa, 2010). Asma Arshad said that “NPV is the most

preferable and mostly used method to analyse the projects”, which

is very true to say (Net Present Value is better than Internal Rate of

Return, 2012). However, investors intend to find NPV does not

measure the amount relative to the amount invested. But many

investors prefer to use the NPV regardless this small limitation that

it has (Net Present Value is better than Internal Rate of Return,

2012).

Modigliani and Miller (1958) argued that managers should only

focus on the NPV and leave all the unnecessary calculations and

methods, which would increase the value of the firm. Similarly,

Hastie (1998) has recommended using the NPV, as a “utilization of

sophisticated techniques”, which it improves decision-making and

increase the value of the business. Those are the same reasons as

Modigliani and Miller (An investigation into the impact of investment

appraisal techniques on the profitability of small manufacturing firms

in the Nelson Mandela Bay Metropolitan Area, South Africa, 2010).

NPV it required a discount rate to value expected cash flow. This

may decrease the value of the project investing on and may cause

the management to give up investment opportunities. Therefore, the

manager does not have access to a flexibility they need to make a

investment decisions regarding this (An investigation into the impact

of investment appraisal techniques on the profitability of small

manufacturing firms in the Nelson Mandela Bay Metropolitan Area,

South Africa, 2010).

3.10. Provide a critical analysis of the appraisal methods used to

evaluate projects and Justify your recommendation in light of

the advantages and disadvantages of each of the method used

to evaluate long-term investment projects?

Accounting Rate of Return (ARR) has many advantages and

disadvantages. The advantages are the calculations is very

straightforward, is widely used measurements, it is also easy to

compare to ROCE for a business and non-financial managers can

easily understand it. On the other hand the disadvantages are it

does not account the time value money, it calculates depending on

the profits instead of the cash flow and it fails to take into account

the size of competing project (Gowthorpe, 2011). Another method

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used is payback period the advantages are; its calculation is very

straightforward, it can be useful when rapid recovery of funding is a

priority and non-financial managers can do its measurements.

However, its disadvantages are; Payback period does not take an

account of the time value of money, it provide very little useful

information, also all the cash flows beyond the payback period is

ignored (Gowthorpe, 2011).

Moreover, the net present Value method (NPV) advantages are; it

counts the time value of the money, it takes all the future cash flow

into account and it is very useful when ranking different projects. On

the other side its disadvantages are; it can be difficult to explain it to

non-financial managers also it is difficult to approach the discounted

rate (Gowthorpe, 2011). Lastly the Internal Rate of Return method

(IRR) it has only one advantage, which it builds the time value of

money into its calculations. However, it has a lot of disadvantages

such as, it can be difficult to explain to non financial managers,

because it expressed in percentage terms then the value is ignored,

it also difficult to approached a target discount rate, and finally it is

not always possible to calculate it (Gowthorpe, 2011).

The best method that the company should use in this case is the

NPV method because, it have very little weaknesses such as; it can

be difficult to explain it to non-financial managers also it is difficult to

approach the discounted rate. Its strengths are way more than it

weakness some strengths are; it counts the time value of the

money, it takes all the future cash flow into account and it is very

useful when ranking different projects. Furthermore, because most

of the companies now uses computers when doing any calculations

and the fact that the NPV available on computers, it is much easier

to be used and calculate with no time (Gowthorpe, 2011). The

positions that are good for the company are Positions Alpha and

Delta as both of them has first ranking for most of the above

discussed decisions, which means the company could use them to

be successful and generate more profit to the company.

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Referencing

Books

Black, G. and Al-kilani, M. (n.d.). Accounting and finance for business. Collis, j. and Hussey, r. (2007). Business accounting an introduction to financial and management accounting. Palgrave Macmillan.

Davies, T. and Crawford, I. (2011). Business accounting and finance. Harlow: Financial Times Prentice Hall.

Davies, T. and Crawford, I. (2011). Business accounting and finance. Harlow, England: Pearson/Financial Times Prentice Hall. Dyson, J. (2007). Accounting for Non-Accounting Students. 7th ed. Financial

Times Pitman Publishing imprint. Dyson, J. (2010). Accounting for non-accounting students. 8th ed. Financial Times.

Gowthorpe, C. (2011). Business Accounting and Finance. 3rd ed. Brendan George.

Horner, D. (2015). Accounting for non Accountants. 10th ed.

Website

Corporate.marksandspencer.com, (2016). About Us. [online] Available at:

http://corporate.marksandspencer.com/aboutus# [Accessed 2 Mar. 2016]. Investopedia, (2004). Interest Coverage Ratio Definition | Investopedia. [online] Available at:

http://www.investopedia.com/terms/i/interestcoverageratio.asp [Accessed 3 Mar. 2016].

InvestorWords.com, (2016). What is Gross Profit Margin? definition and meaning. [online] Available at: http://www.investorwords.com/2250/gross_profit_margin.html [Accessed 2

Mar. 2016]. J-sainsbury.co.uk, (2016). J Sainsbury plc / About us. [online] Available at:

http://www.j-sainsbury.co.uk/about-us/ [Accessed 2 Mar. 2016]. Tesco plc, (2016). Tesco plc. [online] Available at: http://www.tescoplc.com/index.asp?pageid=11 [Accessed 2 Mar. 2016].

Zenwealth.com, (2016). Ratio Analysis. [online] Available at: http://www.zenwealth.com/businessfinanceonline/RA/RatioAnalysis.html

[Accessed 2 Mar. 2016].

Journals

An investigation into the impact of investment appraisal techniques on the

profitability of small manufacturing firms in the Nelson Mandela Bay

Metropolitan Area, South Africa. (2010). African Journal of Business

Management, [online] 4(7), pp.1274-1280. Available at:

http://www.academicjournals.org/article/article1380730553_Olawale%20et%2

0al%202%20(1).pdf [Accessed 20 Apr. 2016].

CAPITAL BUDGETING PROCESS: THEORETICAL ASPECTS. (2011). ECONOMICS AND MANAGEMENT, [online] pp.1130-1134. Available at:

K1411991

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http://internet.ktu.lt/lt/mokslas/zurnalai/ekovad/16/1822-6515-2011-1130.pdf

[Accessed 20 Apr. 2016]. Net Present Value is better than Internal Rate of Return. (2012).

INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS, [online] 4, ( 8), pp.211-215. Available at: http://journal-archieves26.webs.com/211-219.pdf [Accessed 20 Apr. 2016].

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Appendix

1. Gearing Ratio

Tesco

2010 11744+0

5200+9396+ 11744 +85 =0.445

2011

9689+0

5298 +11237 +9689+88 =0.368

2012 9911

5366+12409+9911 +26=0.358

2013 10068 +0

5423+11220+10068+18 =0.377

2014

9303+0

5485+9230+9303 +7 =0.387

M&S

2010

2278+0

2845.6+(−677) +2278+17 .3

=0.510

2011

1924.1+0

2854+1924+(−180.5)+3.9

=0.418

2012

1948 .1

695.7+2094.5+1948.1+(−11.4)

=0.412

2013

1727 .3+0

718 .6+1819 .9+1727 .3+(−19) =

0.407

2014

1655.1+0

763 .6+1943 .7+1655.+(−0.6)

=0.379

SAINSBURY’S

2010

2357 +0

1565+3401 +2357+0 =0.321

2011

2339+0

1583+3841 +2339+0 =0.301

2012

2617 +0

1599 +4030+1948.1+0 =0.345

2013

2617+0

1616+4221 +1727.3+1 =0.346

2014

2250 +0

1636+4367 +2250+2 =0.272

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2. Interest Coverage

TESCO

2010 3080

579 =5.319

2011 3485

483 =7.215

2012 3785

411 =9.201

2013 2672

429 =6.229

2014 2909

447 =6.508

MARKS AND SPENCERS

2010 841

162 .2=5.185

2011 819

98.6 =8.306

2012 810 .1

136 .8 =5.922

2013 778 .6

201 .6 =3.862

2014 741 .9

121 .3 =6.116

SAINSBURYS

2010 677

148 =4.574

2011 738

116 =6.362

2012 782

138 =5.667

2013 868

128 =6.781

2014 915

129 =7.093

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3. Efficiency Ratio

3.1. Fixed asset turnover

TESCO

2010 56910

24203 =2.351

2011 60455

24398 =2.478

2012

563916

25710 =2.487

2013 63406

24870 =2.549

2014 63557

24490 =2.595

M&S

2010 9536 .6

4722 =2.019

2011 9746.3

4602.2 =2.091

2012 9934 .3

4789.9 =2.074

2013 11026 .8

5033 .7 =1.992

2014 10309.7

5139.9 =2.005

SAINSBURYS

2010 19964

8203 =2.169

2011 21102

8784 =2.402

2012 22294

9329 =2.39

2013 23303

9804 =2.377

2014 23949

4343 =5.514

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3.2. Trade debt collector period

TESCO

2010 30.70

52,303 𝑥 365 = 0.214

2011 28.67

55,330 𝑥 365 = 0.189

2012 33.63

58,519 𝑥 365 = 0.209

2013 48.13

59,252 𝑥 365 = 0.296

2014 56.25

59,547 𝑥 365 = 0.344

M&S

2010 110 .89

5,918.1 𝑥 365 = 6.839

2011 104 .29

6,015 .6 𝑥 365 = 6.327

2012 93.32

6,179.1 𝑥 365 = 5.512

2013 89 .97

6,230 .3 𝑥 365 = 5.270

2014 87.70

6,439.0 𝑥 365 = 4.971

SAINSBURYS

2010 332 .73

18,882 𝑥 365 = 6.431

2011 257 .34

19,942 𝑥 365 = 4.710

2012 219 .65

21,083∗ 365 = 3.802

2013 195 .82

22,026 𝑥 365 = 3.244

2014 189 .32

22,562 𝑥 365 = 3.062

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4. Profitability Ratio

4.1. Gross Profit Margin

TESCO

2010

4607 ∗100

56910=8.095

2011

5125 ∗100

60455=8.477

2012 5397 ∗100

63916=8.440

2013

4154 ∗100

63406=6.550

2014 4010∗100

63557=6.310

M&S

2010

3618 .5∗100

9536.6= 37.943

2011 3724.7∗100

9746 .3=38.241

2012

3755 .2∗100

9934 .3= 37.8

2013

3796.5∗100

10026.8=37.864

2014 3870.7∗100

10309.7=37.544

SAINSBURYS

2010 1082∗100

19964=5.42

2011 1160∗100

21102=5.497

2012 1211∗100

22294=5.432

2013 1277∗100

23303=5.48

2014 1387∗100

23949=3.391

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4.2. Return on Capital employed

TESCO

2010 3080 ∗100

5200+9396+11744+85= 11.656

2011 3485 ∗100

5298 +11237 +9689+88= 13.245

2012 3785 ∗100

5366+12409+9911 +26= 13.656

2013 2672∗100

5423+11220+10068+18= 9.997

2014 2909∗100

5485+9230+9303 +7=12.108

5. CVP Graph

SAINSBURYS

2010 677∗100

1565+3401 +0+2357= 9.225

2011 738∗100

1583+3841 +2339+0= 9.507

2012 782 ∗100

1599 +4030+2617 +0= 9.483

2013 868∗100

1616+4221 +2617+1= 10.267

2014

915∗100

1636+4367 +2250+2= 13.708

MARKS & SPENCERS

2010 841∗100

2845.6+2278 +17.3= 14.45

2011

819∗100

2854+180.5+1924.1+3.9= 16.504

2012

810.1∗100

695.7+2094.5+1948.1+11.4= 17.056

2013 778 .6∗100

718 .6+1819 .9+1727 .3+19= 18.171

2014

741 .9∗100

763 .6+1943 .7+1655+0.6= 17.004

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6. Accounting Rate of Return (ARR)

6.1. Alpha

6.2. Beta

6.3. Delta

Alpha PBD DEP

year 1 1,000 1,000 0

yaer 2 1,000 1,000 0

year3 3,000 1,000 2,000

year 4 3,000 1,000 2,000

tottal 4,000

1,000

ARR 1,000 * 100

3,000 33.33%

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7. Payback period Method

7.1. Alpha

7.2. Beta

7.3. Delta

Alpha CF CCF

year 0 5,000 -5,000

year 1 1,000 -4,000

year 2 1,000 -3,000

year 3 3,000 0

year 4 3,000 3,000

PP at year 3

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8. Discounted Payback period

8.1. Alpha

8.2. Beta

8.3. Delta

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9. IRR Method

9.1. Alpha

9.2. Beta

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9.3. Delta