Investment Analysis & Capital Structure of Adairs (ADH) Report

This report provides an analysis of Adairs' (ADH) capital structure and payout policies, evaluating the effectiveness of its capital management and dividend strategies. It examines the factors influencing capital structure decisions, such as cost of capital, company size, and government policies. The report also assesses a potential investment in machinery for Hotel International using various capital appraisal techniques, including Net Present Value (NPV), Internal Rate of Return (IRR), Accounting Rate of Return (ARR), Payback Period, and Profitability Index, to determine the viability and potential benefits of the investment. The analysis concludes with a recommendation to invest in the plant and equipment based on the positive results from all investment criteria.

FINANCE FOR MANAGERS
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Table of Contents
TASK 1............................................................................................................................................3
Describing Adairs (ADH) capital structure and pay- out policies...............................................3
Explaining capital structure using factors to be considered while setting...................................6
TASK 2............................................................................................................................................6
Preparing memo...........................................................................................................................6
REFERENCES................................................................................................................................0
APPENDIX......................................................................................................................................1
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TASK 1
Describing Adairs (ADH) capital structure and pay- out policies
The capital structure is being defined as the combination of both equity and debt which
company is using in order to manage finance of the company. The capital structure of Adairs for
the year 2020 was not effective. The reason pertaining to the fact is that for the acquisition of
Mocka limited the company had to make upfront cash payment of A$42.5 million which was
funded through debt. Along with this by analysing the company capital management it was
evaluated that total of debt for 2020 was $34755 whereas equity was 140571 (Adairs. 2021).
Also, the company is using the gearing ratio in order to monitor the capital and aims at keeping
the gearing ratio below 50 %. With the evaluation of gearing ratio, it was calculated that it is 20
% this means that company is having less of debt in comparison to equity.
Information Explanation Debt level
Profitability With the analysis of financial
ratios, it is clear that the
profitability of company is
increasing. This is particularly
evident in all the profitability
ratio that is gross margin,
operating margin and net
margin.
High
Assets in balance sheet With the acquisition of Mocka
the asset of Adairs has
increased as goodwill was
$48.409 million and the
intangible asset was valued at
$33.114 million. Thus, this
implies that capital structure
of company involves good
amount of
High
Business interruption With respect to current
pandemic, there was a
Low
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shutdown of all stores in
Australia and other parts.
Thus, this resulted in loss for
the company
Dividend pay- out policy
Figure 1Adairs dividend
(Source: Adairs Ltd ADH, 2021)
The pay- out policy is defined as the way in which company provides a return to the
equity investors. This is done in form of either dividend or share repurchases. Having a good
dividend policy is very helpful for the company as it will assist business in outlining the amount
of dividend and paying it to shareholder to keep them satisfied and happy. In case of Adairs, the
company has declared a final dividend of 11.0 cents per share. This represent the pay- out ratio
of 72 % of the net profit after tax. This dividend will attract more of the people to invest within
the company’s equity as they are getting the good dividend (Gyimah and Gyapong, 2021). Thus,
the current pay- out policy of ADH is good and it will attract more of the investors.
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Figure 2: Dividend per share paid by company
Dividend compared to earning
Figure 3: Comparison of dividend per share and Earning per share
2020 2019
Pay-out ratio 72 % 81.31%
Dividend yield 8.00 % 5 %
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Level - With this it is clear that the pay- out ratio of Adairs is 72 % whereas the yield of dividend
is 8.00 %.
Form- the form of dividend payment is regular on basis of cash only.
Stability- there is no stability as dividend yield has increased in comparison to last year (Adairs,
2019).
Explaining capital structure using factors to be considered while setting
Before deciding the capital structure, there are many factors which Adairs need to be
consider for the decision relating to capital structure. The major factor which company need to
analyse is the cost of capital. This is the important factor as in case cost of capital will be high of
one source then this will not be selected. The reason pertaining to the fact is that in case the cost
of raising the capital is high then that source of capital will not be selected whether be it equity
or debt. In addition to this, another major factor to be analysed at time of deciding the capital
structure is that size of the company. the reason pertaining to the fact is that when the size of
company is small then it is not necessary for the company that they issue equity. On the other
side, in case the company is of large scale then it is very essential for the business to have a
balance between the debt and equity to have a good capital structure.
Along with this analysing the government policies also need to be considered at time of
decision relating to the capital structure. The reason pertaining to the fact is that many a times
government of the country also provides some benefits on taking debt from them.
TASK 2
Preparing memo
To: The Board of directors,
Hotel International
Date: 13th October, 2021
Sub: Recommending on whether it is worth investing in machinery.
The present memo is to acknowledge Hotel International to provide information that
whether the machinery is worth investment or not. This is particularly because it will involve
application of various techniques to analyse whether the investment is viable or not.
Context
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Hotel International is a company which has two chain of three and four- star hotel in
Australian city. But due to the current pandemic the company is facing drastic fall in demand.
Hence, for recovering from this loss company is planning to have “COVID normal” which
involves undertaking equipment’s and process for ensuring safety.
Discussion
Table 1: Expected cash flow
Attached in appendix
With the help of the above cash flow analysis it is clear that net cash flow is increasing which
implied that project will provide more return. This further reflects that in case of any uncertainty,
company is in position to meet the requirement as they are having enough cash flow. Hence, any
uncertainty will be managed by the company.
Calculating five investment decisions
For deciding to implement the new technology with respect to current COVID 19 is very
important for Hotels International Ltd. The reason underlying this fact is the due to current
pandemic the sales of hotel has reduced (Lee, 2020). Also, as per the new “COVID normal” the
hotel is deciding to bring some changes which requires investment. Hence, for this the
investment decision will be taken with help of five different investment decision.
Table 2- Result of NPV analysis
Attached in appendix
From the above table it can be evaluated that net present value derived from taking the
discounting factor into consideration is 34001395. The discounted cash flow derived is
46501395 which is higher than initial investment capital. NPV method helps in assessing the
future cash flow so that profitability can be assessed (Keown and et.al., 2020). From the derived
result it can be interpreted that company will be benefited by taking this decision.
Table 3- Result of IRR
Attached in appendix
This method of capital appraisal technique is concerned with determining annualized
rate of return for investment. With help of above diagram it can be stated that particular
investment has 92% of IRR. It can be interpreted that this will provide higher internal rate of
return which is positive to take into consideration.
Table 4- Result of ARR
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Attached in appendix
Accounting rate of return is higher or greater than required rate of return then project is
acceptable. From the evaluation it can be interpreted that company will receive 200% which is
greater so accepting the particular project will be beneficial for the organization (Pettenuzzo,
Sabbatucci and Timmermann, 2021). From the perspective of this particular technique of capital
technique it can be analysed that entity should go with this option.
Table 5- Result of Payback period method
Attached in appendix
Payback period provides assistance in assessing that how effectively an organization can
recover its invested capital in terms of years. The above illustrated table reflects that
organization will receive its invested capital 12500000 in 1 years and 8 months which is
positive sign. This is particularly because of the reason that the company will get its return in
only 1.8 years and after that company will start earning profits.
Table 6- Result of Profitability index
Attached in appendix
From the profitability index it can be interpreted that firm will receive positive outcome
from the investment appraisal technique. Thus it helps of the property ability index it can be
stated that the investment attractiveness is very good. this is particularly because after the
profitability index 12 million. Hence, this outlines the fact that investment within the option is
worth and it will provide a good outcome to the company as well.
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With the above analysis it is concluded that investment within the plant and equipment
will be beneficial. The reason underlying this fact is that all the investment criteria provides
positive and good result. Hence, this implies that when the company will invest in the plant and
equipment then this will increase the working in good and effective manner.
Sincerely
Financial analyst
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REFERENCES
Books and journals
Gyimah, D. and Gyapong, E., 2021. Managerial entrenchment and payout policy: A catering
effect. International Review of Financial Analysis. 73. p.101600.
Keown, A. J. and et.al., 2020. Financial management. Prentice Hall.
Lee, T. A., 2020. Financial accounting theory. In The Routledge companion to accounting
history (pp. 159-184). Routledge.
Pettenuzzo, D., Sabbatucci, R. and Timmermann, A., 2021. How to outlast a pandemic:
Corporate payout policy and capital structure decisions during Covid-19. Swedish
House of Finance Research Paper.
Online
Adairs. 2021. [Online]. Available through: < https://www.adairs.com.au/>
Adairs Ltd ADH. 2021. [Online]. Available through: <
https://www.morningstar.com/stocks/xasx/adh/performance >
Adairs. 2019. [Online]. Available through: <
https://investors.adairs.com.au/FormBuilder/_Resource/_module/51fbMLwe2UG-
5KJ3qHCF4w/file/Adairs-2019-Annual-Report.pdf>
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APPENDIX
Table 1: Expected cash flow
Particulars 1 2 3 4 5
Cash inflows
Sales revenue 15000000 15300000 15606000 15918120 16236482
working capital 16650000 16983000 17322660 17669113 18022495
Total cash inflows 31650000 32283000 32928660 33587233 34258978
Cash outflows
variable operating cost 4500000 4590000 4681800 4775436 4870944.7
marketing and training cost 6000000
Maintenance and Administration
cost 5000000 5150000 5356000 5570240 5793050
Depreciation 2400000 2400000 2400000 2400000 2400000
Total cash outflows 17900000 12140000 12437800 12745676 13063994
Cash deficit / surplus or closing
cash balance 13750000 20143000 20490860 20841557 21194984
tax 4125000 6042900 6147258 6252467 6358495.1
Net cash flow 9625000 14100100 14343602 14589090 14836488
Table 2- Result of NPV analysis
Computation of NPV
Year Cash inflows
PV factor
@ 13%
Discounted
cash inflows
1 9625000 0.885 8517699
2 14100100 0.783 11042447
3 14343602 0.693 9940836
4 14589090 0.613 8947762
5 14836488 0.543 8052652
Total discounted cash inflow 46501395
Initial investment 12500000
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NPV (Total discounted cash inflows -
initial investment) 34001395
Table 3- Result of IRR
Computation of IRR
Year Cash inflows
0 -12500000
1 9625000
2 14100100
3 14343602
4 14589090
5 14836488
Internal rate of return (IRR) 92%
Table 4- Result of ARR
Computation of Average rate of return
Year Cash inflows
1 9625000
2 14100100
3 14343602
4 14589090
5 14836488
Average profit or cash inflow 13498856
Average initial investment 6750000
average initial investment [(initial investment + scrap value) / 2]
ARR 200%
Table 5- Result of Payback period method
Computation of Payback period
Year Cash inflows Cumulative cash inflows
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1 9625000 9625000
2 14100100 23725100
3 14343602 38068702
4 14589090 52657792
5 14836488 67494281
Initial investment 12500000
Payback period 1
0.8
Payback period 1 year and 8 months
Table 6- Result of Profitability index
Profitability index
formula
1+(NPV / initial
investment)
PI 3.7201116
NPV 34001395
Initial investment 12500000
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