Financial Analysis of Tech Gadgets, Valuation of Drone2000 Ltd, and Project Analysis of Burglar Catcher

This report contains a financial analysis of Tech Gadgets, shows the impact of omitted transactions, provide an overview of valuation methods used for determining the value of Drone2000 Ltd and make a project analysis of Burglar Catcher which is to be undertaken by Tech Gadgets.

RUNNING HEAD: FINANCE
finance

Finance 1
Contents
Introduction................................................................................................................................2
Requirement 1............................................................................................................................2
Part b.......................................................................................................................................2
Part c.......................................................................................................................................4
Requirement 2............................................................................................................................4
Requirement 3............................................................................................................................6
Part a.......................................................................................................................................6
Part b.......................................................................................................................................6
Part c.......................................................................................................................................7
Requirement 4............................................................................................................................8
Part a...........................................................................................................................................8
Part b.......................................................................................................................................8
Part c.......................................................................................................................................9
Conclusion..................................................................................................................................9

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Introduction
This report contains a financial analysis of Tech Gadgets, shows the impact of omitted
transactions, provide an overview of valuation methods used for determining the value of
Drone2000 Ltd and make a project analysis of Burglar Catcher which is to be undertaken by
Tech Gadgets.
Requirement 1
Part b
 Current ratio: This ratio measures the Tech Gadgets’ ability to pay its short term
liabilities with use of its current assets. The ideal ratio is 2:1 (Saleem and Rehman,
2011). It is observed that CR of Tech Gadgets was highest in 2015 reported at 12.40.
In 2017, the same ratio was reported at 6.74 more than the sector average of 5.23.
This means company is capable of utilizing its current assets more efficiently in
paying off its liabilities.
 Quick Ratio: It is also used for measuring the liquidity position of a firm. The
company uses its quick assets such as cash and marketable securities for paying off its
current obligations (Parrino, Kidwell and Bates, 2011). The QR of Tech Gadgets was
5.92 in 2017 and 8.77 in 2014. The highest was at 10.61 in 2015. However, the ratio
is still more than the sector average of 4.88. This implies that the company has stable
liquidity position in the industry in which it operates.
 Gross profit margin: This ratio measure the gross profit earned by the company in
terms of sales percentage (Bragg, 2012). It shows the portion of sales which is earned
as a gross profit by the firm. Tech’s GPR has increased over the period of four years.
In 2014, it was 60% and the same reported at 68% in 2017. The industry average was
57%, less than the company’s ratio. This implies that Tech is able to maintain its

Finance 3
profitability position in the market and has shown a continuous increase in its profit
figure.
 Operating profit margin: It indicates the amount of revenue left after paying all the
cost of goods sold and the operating expenses. The figure is expressed in terms of
percentage and is used for measuring the profitability of the company. In 2016,
Tech’s OPR was 41% which reduces to 37% in 2017. Also the operating profit
margin of the company remains lower than the sector average of 45% throughout the
four years.
 Return on Capital Employed: This ratio evaluated the profitability of an organization
on the basis of the capital employed or invested in the business. Fluctuations are been
noticed in Tech Gadgets’ ROCE. In 2014, the ratio was 23% which rises to 27% in
2016. Later in 2017, it reduces to 24%, becoming lower than the industry average of
26.80%. This reduction is due to the decreased EBIT of the company and it implies
that company is not able to make more profits from its capital employed as compare
to its competitors within the industry.
 Net Asset Turnover: It is one of the efficiency ratio which determines the potential of
a company to generate sales from its assets. A high ATR is considered to be more
desirable as it makes a firm more efficient (Jenter and Lewellen, 2015). The ATR of
Tech Gadgets continuously decreases over the period of four years. This is due to the
continuous increase in the net assets of the company. Also the sector average is 0.97
which is more than the company ratio of 0.65 in 2017.
 Average inventory turnover ratio: It shows the number of times a firm has converted
its inventory into cash. Generally, companies having high ITR are considered to more
efficient in managing their inventory and other assets (Vogel, 2014). Tech’s ratio has
been increased over the years and in 2017 it was 1.94 times. However, it was less than

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the industry ratio of 2.33 times. This implies that, Tech Gadgets is not much more
efficient in generating revenue from its assets as compare to the industry in which it
operates.
 Trade receivables period: It shows the time taken by a company to collect its account
receivables. Tech Gadget’s receivable period was 43 days in 2017 which is less than
the sector average of 53 days. This means the company is collecting its debtors
effectively and efficiently.
Part c
Limitations of ratio analysis:
 The analysis is done on the basis of historical data, which may be unreliable for
interpreting future trends.
 The comparison of different companies’ ratios is not possible because of the different
accounting policies used by various firms.
 The ratios are calculated in general terms, thus ignoring the changing business
conditions.
 Sometimes, it is difficult to interpret the ratios like current ratio or day sales
outstanding.
Requirement 2
The impact of ten transactions that are been missed out on the drafted financial statement is
as follows:
1. The treatment for credit sales amounted to £432,000 will impact the value of
accounts receivables as well as the amount of total revenue. In the balance sheet,
debtors will be increased by this amount as well as the total revenue will also rise

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in income statement. Also the cost associated worth £385,000 will increase the
COGS in income statement. The inventory will reduced.
2. Cash sales of £23,667 will result in increase in cash balance on the asset side of
the balance sheet and also in the revenue reported in P&L statement. COGS will
increase by £19,900, inventory reduces and the overall impact will be on the net
profit.
3. The journal entry for prepaid rent is as follows:
Prepaid rent A/c Dr. £135,000
To Cash/bank A/c £135,000
This will reduce the cash balance and include an additional item on the asset side
of the balance sheet as prepaid expenses.
4. A Van purchased worth £11,560 will impact both the sides of a balance sheet.
Company’s total asset will increase by £11,560 and the liabilities will also rise by
same amount under head creditors.
5. The Amortisation expense of £2,355 will appear in the income statement as a
written off expense. The same will appear on balance sheet on contra side as
accumulated amortisation account.
6. For the inventory bought in cash, the entry will be:
Inventory A/c Dr. £3,880
To Cash A/c £3,880
This will impact the balance sheet as the cash balance will reduce and inventory
will increase.
When inventory bought on credit:
Inventory A/c Dr. £102,223
To Accounts Payable A/c £102,223

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This will increase the amount of inventory on the asset side as well as increase the
balance of creditors on the liability side.
7. Wages amounted £314,102 paid in cash will reduce its balance from the balance
sheet and add an expense to the income statement. The unpaid wages of £77,900
will be entered as a liability on balance sheet with the term wages payable or
accrued wages. The same figure will be added to wages expense in income
statement.
8. An unpaid invoice of £35,778 will require an accounts payable entry. It will
increase the amount of creditors in the balance sheet on the liability side. As well
as expenses will also increase by the same figure.
9. The amount paid for short term loans will also include the interest amount. As a
result of which, an interest expense will be debited and shown in the income
statement. Along with this the balance of loan payable account as well as cash
account will reduced by the paid amount.
10. Research cost of £5,200 is charged as an expense in the income statement and is
amortised over the future periods.
Requirement 3
Part a
The tech Gadgets must acquire the company as its priced reasonably, has low debts and clear
financial statements. It can be seen that, Drone2000 Ltd has minimum liabilities and debt
load is also very low. So, Tech Gadgets can adopt the option of acquiring the company.
Part b
 Asset based approach

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According to this method, the business is valued as per the amount of its net assets. However,
there are three ways of evaluating the net assets of a company. They are named as book
value, net asset value and replacement values. The book value method basically includes that
value of total assets which is been reported on the balance sheet of the company. Net
realisable value is total assets less current liabilities. It basically represent the amount left for
shareholders, if the assets are been sold and liabilities are been paid. However, if the business
is sold in a higher value then the stakeholders will be getting more than the net realisable
amount. The third way is replacement value which determine the cost that would be incurred
if the business were being started now (Pinto, Henry, Robinson and Stowe, 2015).
For the valuation of Drone2000 Ltd, book value approach is been used. On the basis of
which, the net assets of the company are valued at £11,300.00. This will be the value of the
company at time of its acquisition.
 Dividend Valuation Method
It is also known as dividend discount model which is used for the valuation of stock price of a
company. The calculation is done on the basis of predicted dividends and discounting rate
(Kumar, 2015). According to DVM method, the value of Drones2000 Ltd. is £15,901.78.
However, this value is less than the amount obtained by using asset based method.
 Price-earnings ratio
This ratio measures the current share price of the company against its earnings per share. It
basically shows the amount an investor is willing to pay per dollar of earnings (Tracy, 2012).
The suitable P/E for Drone2000 is 12 which implies that the company will be paying $12 for
every $1 of current earnings.

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Among the methods used, the most appropriate one is Dividend valuation method as the
dividends shows the actual cash flows going to the shareholders. It indicates the true value of
the firm and calculation of the present values determine the future value of company’s share.
So, it is expected that Drone2000 Ltd. should worth £15,901.78.
Part c
Limitations of CAPM
 The risk free rate used is the yield on short term government bonds and it may vary
due to the volatility in the yield. Change in this rate will also change the expected rate
of return.
 Accurate determination of beta is not possible. Beta is the only measure of risk
associated with the investment which has to be accurate.
 The market return may turned negative in long term, leaving a great impact on the
expected return.
 The CAPM assumption that investors can borrow and lend at risk free rate is not
possible in reality. As a result of which the required return calculated by the model
may differ from the minimum required line of return (Levy, 2011).
These limitations may affect the value calculated for the Drone2000 Ltd.
Requirement 4
Part a
The NPV of the project is negative that is -£33,625.75. This implies that Tech Gadgets should
not invest in this project as it will not be able to recoup its initial investment within its useful
life. Also it will not generate profits over the 6 years. So, it is better to reject the proposal.

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Part b
 Market research cost are not included in the calculation of discounted cash flows that
are used for the project valuation. Cost incurred on Market research is treated as sunk
cost because this expense has already been incurred and will not be recovered if the
project is rejected. So, it will not be included in cash flows.
 Interest payment on loan are subtracted from the cash flows that are associated with
the debt financing. After such reduction, residual cash flows are obtained which are
then discounted at the required rate of return.
 Depreciation is a non-cash expense and is an ongoing carrying amount of a fixed
asset. It is basically designed to reduce the cost of the asset over its useful life. While
calculating the cash flows, depreciation is usually deducted from the expenses,
thereby showing that there is no effect on the cash flows.
 Fixed cost is the cost which remains same at all level of output. It does not change
with the change in the level of output. In order to reach to the level of after tax cash
flow, fixed cost is been deducted from the contribution amount to derive the net
profit.
 Lost Contribution will be taken as for decision making purpose and is not included in
the cash flow calculation.
Part c
Internal rate of return is also an appraisal technique used for evaluating the business
proposals. It estimates the profitability of an investment and is known as that discounting rate
where the value of NPV is zero. However, the rate cannot be calculated analytically and
requires trial and error method. Generally a high IRR means the project is more desirable
(Baker and English, 2011).

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Comparing between the NPV and IRR, most suitable and preferred method is NPV as it takes
into account the multiple discount rates and each cash flow can be discounted separately. It
also represents the value of currency which is lost or added by undertaking a project
(Bierman and Smidt, 2012).
Conclusion
The above report concludes that Tech Gadgets has good financial performance and is also
able to acquire another company named as Drone2000 Ltd. Also the omitted transactions will
impact the drafted financial statements of a company to a great extent. However, the
company must not invest in Burglar Catcher as the project is not viable and also has negative
NPV.

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References
Baker, H. K., and English, P. (2011). Capital budgeting valuation: Financial analysis for
today's investment projects (Vol. 13). New Jersey: John Wiley and Sons.
Bierman Jr, H., and Smidt, S. (2012). The capital budgeting decision: economic analysis of
investment projects. 9th ed. New York: Routledge.
Bragg, S. M. (2012). Business ratios and formulas: a comprehensive guide (Vol. 577). 3rd ed.
New Jersey: John Wiley and Sons.
Jenter, D., and Lewellen, K. (2015). CEO preferences and acquisitions. The Journal of
Finance, 70(6), 2813-2852.
Kumar, R., (2015). Valuation: Theories and concepts. United States: Academic Press.
Levy, H. (2011). The capital asset pricing model in the 21st century: Analytical, empirical,
and behavioral perspectives. USA: Cambridge University Press.
Parrino, R., Kidwell, D. S., and Bates, T. (2011). Fundamentals of corporate finance. 2nd ed.
USA: John Wiley and Sons.
Pinto, J.E., Henry, E., Robinson, T.R. and Stowe, J.D., (2015). Equity asset valuation. New
Jersey: John Wiley and Sons.
Saleem, Q., and Rehman, R. U. (2011). Impacts of liquidity ratios on
profitability. Interdisciplinary Journal of Research in Business, 1(7), 95-98.
Tracy, A. (2012). Ratio analysis fundamentals: how 17 financial ratios can allow you to
analyse any business on the planet. RatioAnalysis. net.
Vogel, H.L., 2014. Entertainment industry economics: A guide for financial analysis. 9th ed.
USA: Cambridge University Press

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