Long Term Decision Making Techniques

The assignment provides a detailed analysis of the limitations of using investment appraisal techniques in long-term decision making. It also includes a report on the payback period and NPV of two projects, Alpha and Beta, which are compared to determine which project is recommended for investment based on their respective cash flows and discount rates.

Assessment Brief 2
Managerial Finance

Contents
INTRODUCTION.......................................................................................................................................4
5.1 Task.......................................................................................................................................................4
Portfolio 1................................................................................................................................................4
5.1.1 Task 1:............................................................................................................................................4
a) Calculation of 10 financial ratios as given below for two years (2017 - 2018):.......................................4
b) Analysis of the performance of two selected companies and analysis of their financial position and
investment potential.................................................................................................................................5
c) Recommendations of how the financial performance of the poorly performing business can be
improved..................................................................................................................................................9
d) Discuss the limitations of relying on financial ratios to interpret companies performance..................9
Portfolio 2:.............................................................................................................................................10
5.1.2 Task 2: Capital Investment Appraisal...........................................................................................10
a) Using appropriate investment appraisal techniques, advise senior management on whether they
should opt for Alpha project or Beta project......................................................................................10
Payback period (PBP)........................................................................................................................10
Net Present value method (NPV).......................................................................................................11
b) Discuss the limitations of using investment appraisal techniques to help in long term decision
making...............................................................................................................................................12
CONCLUSION.........................................................................................................................................12
REFERENCES..........................................................................................................................................14

INTRODUCTION
Managerial finance refers to a branch of finance that is associated with the managerial
importance of techniques used in finance. It also highlights the most optimum way in which
money can be utilized in order to enhance futuristic opportunities related to money making. Also,
this helps in significantly reducing the consequences of financial losses and unfavourable
situations (Combs, Samy and Cengiz, 2017). This report includes the financial analysis of Marks
and Spencer and Next Plc. Also, this explores the various recommending by adopting which the
financial performance of poorly performing entities can be improved in an effective manner.
Furthermore, the limitations of relying upon financial ratios for analyzing a company’s
performance have been discussed. Also, capital appraisal techniques have been highlighted along
with their limitations in long term decision making.
5.1 Task
Portfolio 1
5.1.1 Task 1:
The analysis of the financial statements of Marks and spencer and Next plc. has yielded the
followings:
a) Calculation of 10 financial ratios as given below for two years (2017 -
2018):
M&S NEXT PLC
Formulae 2017 2018 2017 2018
Current ratios CA/CL 0.728 0.722 2.290 1.964
Quick ratios QA/CL 0.407 0.294 1.668 1.429
Net Profit Margin Net profit /net revenue 1.09% 0.27%
15.67
% 14.44%
Gross Profit margin Gross Profit/ net revenue 24.29% 23.22%
34.19
% 33.10%
Gearing ratios Total long-term debts/Equity 0.881 0.938 2.290 2.412
P/E ratio MPS/EPS 9.814 10.172 11.335 8.681

Earnings per share PAT/n 30.4 27.8 441.3 416.7
Return on capital employed Operating Profits/CE 4.27% 2.73%
49.27
% 46.15%
Average inventories turnover
period 365/Inventory Turnover 27.23 27.53 60.74 66.27
Dividend payout ratio DPS/EPS 58.22% 63.67%
23.79
% 12.72%
b) Analysis of the performance of two selected companies and analysis of their financial
position and investment potential.
From the above estimations it is apparent that MARKS AND SPENCER GROUP PLC has a
poor liquidity position as compared to Next Plc. In 2017 Next Plc has a current ratio of 2.29 and
the same has declined slightly in 2018 to 1.97. However, the same for MARKS AND SPENCER
GROUP PLC is .728 in 2017 and .722 in 2018. This means the MARKS AND SPENCER
GROUP PLC does have enough current assets to provide cover for the current liabilities in both
the years and that’s a cause of concern for the company’s management. It would not be able to
meet payment obligation unless it makes short term borrowing arrangements and the same would
increase its interest expenses. Next plc however has the current liabilities well covered and is
successfully maintaining an ideal current ratio.
The same is shown as follows:

2017 2018 2017 2018
M&S NEXT PLC
0
0.5
1
1.5
2
2.5
0.72774493243243
3 0.72174151150054
8
2.29048275862069
1.96491036292086
Current Ratio
From the above estimations it is also pretty evident that MARKS AND SPENCER GROUP PLC
has a poor quick ratio as compared to Next Plc. In 2017 Next Plc has a current ratio of 1.67 and
the same has declined slightly in 2018 to 1.43. However, the same for MARKS AND SPENCER
GROUP PLC is .40 in 2017 and .294 in 2018. This means the MARKS AND SPENCER
GROUP PLC does have enough quick assets to provide cover for the current liabilities in both
the years and that’s a cause of concern for the company’s management. It would not be able to
meet payment obligation unless it makes short term borrowing arrangements and the same would
increase its interest expenses. Next plc however has the current liabilities well covered and is
successfully maintaining an ideal current ratio. Thus, it can be concluded that Next plc is
maintaining a good liquidity position than Marks and Spencer’s.
The Profitability ratios are an indication of the way business operations are carried out with
efficiency and costs are minimized or not. The gross margin of the Marks and spencer group plc
is 24.29% in 2017 and 23.22% in 2018. However, the gross profit for the Next plc is higher in
both the years at 34.2% and 33.1%. this means the costs of goods sold for Next plc is lesser than
that of marks and spencer’s in both the years. The gross and net profit margin is shown below for
both the company:

2017 2018 2017 2018
M&S NEXT PLC
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
24.29% 23.22%
34.19% 33.10%
1.09% 0.27%
15.67% 14.44%
Gross and Net Margin %
Gross Profit % Net Profit %
The Net margin of the Marks and spencer group plc is estimated to be 1.09% in 2017 and .27%
in 2018. However, the net profit for the Next plc is higher in both the years at 15.67% and
14.44%. this means the next plc’s operating costs for both the years remain lower than Next plc.
However it can be observed that Marks and spencer suffers from lower gross margin and if it is
able to increase the gross profit by reducing direct costs of procurements and production to the
level of Next plc then it would have an easily comparable net profit margin like Next plc. Art
present the growth of Mark and spencer’s revenue is either lower or negative and the same is
weighing down the company. It needs to increase its revenue significantly to increase net profits
by more efficiently utilizing the current level of fixed operating costs.
Return on capital employed (ROCE) is one of the few practical ratios and the same can be
applied across different segments of the economy by making comparison of the operating profit
to that of the various forms of capital employed. It shows how well the capital employed is used
to generate operating profit. Capital employed is the summation of the shareholders equity and
outside long-term liabilities. A higher ratio implies better utilization of capital and vice versa.
Marks and spencer have been able to generate a ROCE of 4.27% and 2.73% in 2017 and 2018
but the same for Next plc is 49.27% and 46.15%. this shows that the Next plc has managed to
generate higher profits for the capital being used. ROCE of the frim is shown as below:

2017 2018 2017 2018
M&S NEXT PLC
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
4.27% 2.73%
49.27% 46.15%
ROCE
It is imperative for companies to reduce their dependence on outside funds for smooth operation of their
business and reduce debts by utilizing the retained earnings unless there is enough opportunities to
expand the operations through new debts. At present the gearing ratio (debt to Equity) of the Marks and
spencer’s plc is .881 and .938 respectively in the period between 2017 and 2018. This means Marks and
spencer’s have been less dependent upon external interest-bearing funds for expanding heir business. On
the other hand, the Next plc has a much higher debt to equity ratio of 2.29 in 2017 and 2.412 in 2018.
This means the gearing ratio of Next plc is much higher and interest cost of the company is weighing
down the operating profits. Hence it is certain that Marks and spencer has been maintaining a better
capital structure and is also primed to take new loans for expanding into new areas. Next plc has a higher
financial risk and it needs to lower the gearing in the near term (Combs, Samy and Cengiz, 2017).
The EPS for the last years of the two firms are quite different. While Next plc has a higher EPS
than marks and spencer’s the same has also helped the company to have a much higher Price
earning ratio. However, despite lower EPS in both the years (2017 and 2018) Marks and
spencer’shas beenemphasizing ona much higher dividend payout ratio to maintain a constant
market price for its stocks. Investors in the market are however more bullish about the prospects
of Next plc as seen form very high EPS and comparable Price earnings ratio to that of marks
andspencer. Overall the next plc is able to generate a higher return for the shareholders of the
firm in the last two years (Combs, Samy and Cengiz, 2017).

The averageAverage inventories turnover period shows the no of days that would be needed by a
company to convert the inventory into sales. This means a lower Average inventories turnover
period would mean higher sales for the company and vice-versa. The marks and
spencer’scompany has been able to convert the inventory into sales in 27.5 days approx. in both
the years. On the other hand, the Next plc takes more days to convert the inventory into sales. It
takes 61 days for conversion of stocks into sales in 2017 and 66 days for the conversion in 2018.
The same is shown as follows:
2017 2018 2017 2018
M&S NEXT PLC
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
27.23 27.53
60.74
66.27
Average Invetory turnover period
This means Marks and spencer has been able to convert the inventory quicker than Next plc. However,
under the circumstances it needs to do even better and reduce the same to less than 22-23 days which
would increase the sales further and help increasing the net profits (Asongu, 2015).
c) Recommendations of how the financial performance of the poorly performing business
can be improved.
Marks and spencer is suffering from a lower and negligible profit margin in both last
fiscal years. There is an urgent need for the management of the firms to address the issue and
increase growth of revenue and reduce costs. Marks and spencer suffers from lower gross margin
and if it is able to increase the gross profit by reducing direct costs of procurements and
production to the level of Next plc then it would have an easily comparable net profit margin like
Next plc. At present the growth of Mark and spencer’s revenue is either lower or negative and

the same is weighing down the company. It needs to increase its revenue significantly to increase
net profits by more efficiently utilizing the current level of fixed operating costs.
Marks and spencer is a bigger firm than that of Next plc and is thus more used to see
fluctuations in profits due to uneven business environment. It can correct the lower profitability
issue through the following measures:
a) It needs to address the gross margin through long term supply agreements with
experienced and reliable suppliers and keep costs down and constant in the long term.
b) It also needs to pare the fixed costs which are underutilized and save huge operating
costs. Selling and general administration costs needs to be lowered (Vesty, Brooks and
Oliver, 2015).
c) More objective selling and advertising campaigns can be prepared to increase sales
growth which has remained stagnant in the last three years. Higher sales growth would
mean higher contributions and bigger net margins.
d) Discuss the limitations of relying on financial ratios to interpret companies
performance.
While ratio analysis is a good tool for performance evaluation oflisted firms the same suffers
from several limitations which must be considered during ratio analysis:
a) The ratios which are calculated for evaluating performance is related to the last fiscal
years and it is not highly probable that the same performance would be separated by the
company in the future as well. Using historical data might backfire.
b) The rates of inflation are different in different years and which affects the costs incurred.
Thus, comparison across periods suffer from lack of knowledge about inflationary
conditions.
c) Different companies which are being analyzed during a period might be using different
accounting policies regarding depreciationetc. and which might make it impossible for
the accounting figures to be compared and judge correctly. Results under different
accountingpolicies would be highly subjective and would lead to difference of opinion
(Penman, 2015)

d) It would also be impractical for business operations to be compared if the two businesses
are in different segments of the industry. Like one company is in retail business and while
the other is a producing concern.
Portfolio 2:
5.1.2 Task 2: Capital Investment Appraisal
Required:
a) Using appropriate investment appraisal techniques, advise senior management on whether
they should opt for Alpha project or Beta project.
The following investing appraisal techniques are being used to evaluate the projects Alpha and
Beta.
Payback period (PBP)
Paybackperiod of machine 1 and Machine 2 is estimated as shown below:
Machine 1
0 1 2 3 4 5 6
Initial cash
flow -125,000
Net Profit 60,000 60,000 60,000 50,000 50,000 40,000
Salvage
value 0
Net cash
flows -125,000 60,000 60,000 60,000 50,000 50,000 40,000
Cumulative
CF -125,000 -65,000 -5,000 55,000 105,000 155,000 195,000
Payback period (Machine 1) = 2 years + (5,000/60,000) = 2+ .0833 = 2.0833 years
Machine2
0 1 2 3 4 5 6
Initial cash flow -125,000
Net Profit 20,000 30,000 40,000 70,000 80,000 65,000
Salvage value 10,000
Net cash flows -125,000 20,000 30,000 40,000 70,000 80,000 75,000
Cumulative CF -125,000 -105,000 -75,000 -35,000 35,000 115,000 190,000
Payback period (Machine 2) = 3 years + (35,000/70,000) = 2+ .5 = 2.5 years
Net Present value method (NPV)
Machine 1
0 1 2 3 4 5 6
Initial cash
flow -125,000

Net Profit 60,000 60,000 60,000 50,000 50,000 40,000
Salvage value 0
Net cash
flows -125,000 60,000 60,000 60,000 50,000 50,000 40,000
PVF @ 20% 1.000 0.833 0.694 0.579 0.482 0.402 0.335
PV -125000.00 50000.00 41666.67 34722.22 24112.65 20093.88 13395.92
NPV 58,991.34
NPV of the Machine 1 is £58,991.34 approx.
Machine 2
0 1 2 3 4 5 6
Initial cash
flow -125,000
20,000 30,000 40,000 70,000 80,000 65,000
Salvage value 10000
Net cash flows -125,000 20,000 30,000 40,000 70,000 80,000 75,000
PVF @ 20% 1.000 0.833 0.694 0.579 0.482 0.402 0.335
PV -125,000 16,666.67 20,833.33 23,148.15 33,757.72 32,150.21 25,117.35
NPV 26,673.42
NPV of the Machine 2 is £26,673.42 approx.
Note:
As there is no corporate tax the estimation of depreciation won’t have any effect on the
estimation of the cash flows and this is why the same is ignored.
Recommendations:
a) as per the payback period estimation of both Alpha and Beta projects, the Project1 or
Alpha has a lower payback period of 2.0833 years and hence the same is recommended to
be invested. This is because while Alpha project would be able to recover the initial cash
investments in 2.0833 years the Beta Project or Beta Machine would take slightly higher
time frame of 2.5 years to recover the initial cash outflows. Thus Alpha (machine 1 is
recommended for investment) (Bender & Ward, 2012).
b) The NPV of the projects are estimated as £58,991.34 and £26,673.42 respectively. As
the Alpha project has a higher NPV of £58,991.34 the same is recommended for

investing. This also means if Alpha project is accepted the same would be able to
increase the value of the firm by £58,991.34 where as Beta would be able to increase
value by only £26,673.42 (Laitinen, 2018)
b) Discuss the limitations of using investment appraisal techniques to help in long term decision
making.
a) One of the foremost limitations of the capital budgeting techniques is that of estimating
the cash flows correctly. This is often turned out to be the decisive factor as actual cash
flows are found to be either higher or lower than budgeted values (Gitman, Juchau and
Flanagan, 2015)
b) The other limitation is that of estimating the discount rates correctly and incorporating
the risk element in the project. If discount rate is higher then good projects would be
rejected and if the same is lower then bad projects would be accepted.
c) In non-discounted techniques the methods often ignore the cash flows occurring after the
payback period is reached and it also ignore the discounting and time value of the cash
flows.
CONCLUSION
From the above report, it has been concluded that managerial finance is an essential
element related to every organization. Also, it has been analysed that financial analysis of
companies is significant to gain knowledge about their growth and development over a period of
time. It has also been assessed that by engaging in long term supply agreements and introducing
effective marketing campaigns, poorly performing companies can improve their performance.
Furthermore, it has been ascertained that financial ratios is not an effective tool for analyzing the
financial performance of a company.

REFERENCES
Books and Journals
Asongu, S. A., 2015. Finance and growth: new evidence from meta-analysis. Managerial
Finance. 41(6). pp.615-639.
Combs, A., Samy, M. and Cengiz, H., 2017. An Analysis of how Financial Ratios of Companies
in Turkey Are Affected by National Standards, and IFRS. International Business
Research.
Gitman, L. J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Pearson
Higher Education AU.
Laitinen, E. K., 2018. Financial Reporting: Long-Term Change of Financial Ratios. American
Journal of Industrial and Business Management. 8(09). p.1893.
Penman, S. H., 2015. Financial Ratios and Equity Valuation. Wiley Encyclopedia of
Management, pp.1-7.
Vesty, G., Brooks, A. and Oliver, J., 2015. Contemporary capital investment appraisal from a
management accounting and integrated thinking perspective: case study evidence.
Gotze, U., Northcott, D. and Schuster, P., 2016. INVESTMENT APPRAISAL.
SPRINGER-VERLAG BERLIN AN.