Financial Analysis and Information

This paper presents a financial statement analysis, and the primary goal of the assessment is to develop analytical, critical thinking and communication skills using which we can provide a review on the findings. The assessment provides an understanding of dynamics, which reflect the ability of financial position of an organisation. Various financial methods and techniques are used in this assessment like Dividend discount model (DDM), Capital Asset Pricing Model (CAPM) ; Weighted Average Cost of Capital (WACC); Net Present Value (NPV), Internal Rate of Return (IRR) etc.

FINANCIAL ANALYSIS
(FINA)
Assessment 2 - Resit
Course - Graduate MBA
Word Count - 3154

Overview
This paper presents a financial statement analysis, and the primary goal of the
assessment is to develop analytical, critical thinking and communication
skills using which we can provide a review on the findings, I have reviewed
and analysed few key aspects of XYZ plc financial disclosures, this
document evaluates organisational financial disclosures and other items,
which influences the company’s financial ability. This assessment provides
an understanding of dynamics, which reflect the ability of financial position
of an organisation. Various financial methods and techniques are used in
this assessment like Dividend discount model (DDM), Capital Asset Pricing
Model (CAPM) ; Weighted Average Cost of Capital (WACC); Net Present
Value (NPV), Internal Rate of Return (IRR) etc.,

CONTENTS
Overview
A. Financial analysis related to investment strategy
1. Source of financing
1.i.Dividend Discount Model (DDM) 3
1.ii.Capital Asset Pricing Model (CAPM) 3
1.iii.Merits & Demerits 4
2. Optimum Cost of Capital 5
3. Evaluate the restructuring decision
3.i.Net Present Value (NPV) 5
3.ii.Internal Rate of Return (IRR) 5
4. Analysing the sensitivity of projected NPV
5. Impact of BREXIT 6
B. Financial analysis for internal management
1. XYZ PLC 6
2. Phase 3 Sports Club 8
3. Budget Planning 12

A(1) What will be the cost for each source of financing? Consider both DDM
(i.e. Dividend Discount Model) and CAPM (i.e. Capital Asset Pricing
Model) method for common equity. Please provide your comments on
the assumptions of each approach and their merits and limitations.
 Dividend Discount Model (DDM)
“The Dividend Discount Model is a valuation formula used to find the fair value
of a dividend stock.”
The Dividend Discount Model states that the value of the stock is the sum of
discounted values of future dividends. The discount rate applied is the
investors required rate of return.
Information Value
Expected Growth Rate 5.0%
Current Annual Dividend £ 1.20
Risk-Free Rate 1.3%
Estimated Market Return 10%
Beta 1.5
Future Forward Dividend
(Current Annual Dividend*(1 + Expected Growth
Rate)
£ 1.26
Discount Rate
(Beta * Estimated Market Return + Risk-Free
Rate)
16.3%
Dividend Discount Model
(Future Forward Dividend / (Discount Rate -
Expected Growth Rate))
£11.15
The fundamental analysis use above model or some of their variations for estimating
the fundamentals price-earnings multiple of security. Towards this end, they devote
considerable efforts in assessing the impact of various kinds of information on a company's
future profitability and the expected return of the stakeholders. If the prevailing price or the
P/E multiple of a security is higher than the estimated fundamental value, they recommend a
selling stance with respect to that security. Since once the information become common
knowledge, the price of the security may be expected to fall. On the other hand, if the
security is under-priced in the market the prevailing price of the security being lower than
the estimated fundamental value, they recommend buying the security, counting upon a
price arise.
 Capital Asset Pricing Model (CAPM)
The Capital Asset Pricing Model (CAPM) describes the relationship between
systematic risk and expected return for assets, particularly stocks. CAPM is
widely used throughout finance for pricing risky securities and generating
expected returns for assets given the risk of those assets and cost of capital.
Rf + Beta (Rm – Rf)
= 3% + 1.5 (10 – 3)

CAPM = 13.50%
From the above calculation it states that there is high risk of return from the assets.
Capital assets pricing model is helpful for the organization to measure the risk
related to the pricing of the product.
Merits & Demerits of DDM Model
Merits Demerits
 It helps to calculate the price
of shares in an efficient manner. It
shows to differentiate the price of
stocks and shares of different
companies and helps finalize the
suitable price for a particular stock. It
gives a profitable deal to lock the price
for a share to be brought in market by
the firm. It gives huge revenues to the
company if executed with proper
analysis and calculations. It is a better
model to evaluate the cost of equity
than other models since it considers
the systematic risk.
 It does not show accountability
of loyalty of the product, dealership of
intangible assets, etc. The prospects of
the dividend valuation technique could
not be evaluated in terms of revenues
and on long term basis. It gives benefit
to those companies which are already
stable in the financial terms.

Merits & Demerits of CAPM Model
Merits Demerits
 It is a better model to calculate
the cost of equity than other models
since it considers the systematic risk.
 The discounting rate
provided by CAPM is far better than
other means.
 It assists in eliminating
unsystematic risk since it assumes
that the investor holds a diversified
portfolio.
 CAPM model has too many
assumptions which may not be
practical to apply in all situations.
 The variables used in CAPM
must calculated with utmost care and
accuracy else it my give unrealistic
rate of return.
 One of the major assumptions
of CAPM is that funds can be lent and
borrowed at risk free rate and the
same may not be valid in the current
economic situations.
 Also, it ignores unsystematic
risk and assumes that it can be
diversified away which does not make it
a comprehensive
method.

A(2) Determine the optimum cost of capital using the Weighted Average Cost of
Capital (WACC) approach for target capital structure. (Hints: Ms Madison would
prefer to use CAPM over DDM).
The weighted average cost of capital (WACC) is the implied interest rate of all forms
of the company’s debt and equity financing which is weighted according to the proportionate
dollar-value of each.
Cost of equity- The cost of equity refers to two separate concepts, depending on the party
involved. If you are the investor, the cost of equity is the rate of return required on an investment
in equity. If you are the company, the cost of equity determines the required rate of return on a
particular project or investment.
 Cost of Equity = DPS (MPS – FC)
= 1.2/34.80 – 10 * 20%
=1.2 / 32.8
= 3.44%
Cost of debt-The cost of debt is the effective rate that a company pays on its debt, such as bonds
and loans. Debt is one part of a company's capital structure, with the other being equity.
Calculating the cost of debt involves finding the average interest paid on all of a company's debts.
 Cost of Debt = 1/kd (1-t)
= 10% * 100/100
=10%
Cost of preference-The cost of preference capital is a function of the- dividend expected by
investors. Preference capital is never issued with an intention not to pay dividends. Although it is
not legally binding upon the firm to pay dividends on preference capital, yet it is generally paid
when the fim1 makes sufficient profits.
 Cost of Preference = DPS / MPS
= 10/108
=9.26
Calculation of WACC
Source of capital Cost of capital % of total capital Total
Equity share capital 3.44% 0.34% 0.02%
Preference share
capital 9.26% 0.33% 0.03%
Long term debts 10.00% 0.33% 0.03%
Total WACC 0.08%
The above calculation shows that the total WACC is 0.08% which is sum of various
sources of capital that includes Equity share capital, preference share capital and
long term debts.

A(3) Evaluate the total value addition (i.e. total NPV) and breakeven rate (i.e. IRR) of
this possible restructuring decision. (Hints: Use the WACC as your discount rate to
evaluate the investment projects.
Funds from operations (FFO) refers to the figure used by real estate
investment trusts (REITs) to define the cash flow from their operations. Real
estate companies use FFO as a measurement of operating performance.
 NPV: It is used to calculate the present day overall value of a future move of
payments. If the NPV of a project or investment is advantageous, it
approach that the discounted gift fee of all future cash flows associated
with that task or investment may be suitable, and therefore attractive.
Period Cash flow
0 -150,000,000
1 32000000
2 32000000
3 400000000
4 462000000
5 504000000
Required return 10%
NPV $758,690,612.40
 IRR : It is a metric used in financial evaluation to estimate the profitability of
capacity investments. IRR is a reduction price that makes the net present
fee (NPV) of all coins flows identical to 0 in a discounted cash float analysis.
Period 01-Jan-22 01-Jan-23 01-Jan-24 01-Jan-25
Cash Flows -150000000 32000000 32000000 400000000
Internal Rate of Return (IRR) 0.515
A (4) Assume that the product lifecycle of five years is viewed as a safe bet, but the
scale of demand for the product is highly uncertain, mainly due to possible BREXIT
and COVID19. Analyse the sensitivity of the projected NPV to the unit sales and the
cost of capital.
The internal rate of return is 0.515 during year 2022. The NPV of the year
2022 is $758,690,612. The total weighted average cost of capital is 0.07%. This
impacted the economy in a bad manner as all the prices of the consuming product
rises to its peak and all the financial market in the world crashed down to its bottom.
It impacted the price of the currencies in the world also as all the currencies also
crashed down. The positive NPV shows that the predicted earnings generated by a
project or investments is in excess of anticipated costs. It is being observed and
investment with a positive NPV is profitable for the organization. WACC assists the
analysts to determine the value of the investments.

A (5) Explain how the BREXIT could affect the UK automobile manufacturing sector
and the possible strategic changes required in this industry to cope with the risk?
Automobile industry is one of the major contributors in UKs revenue and it has
Automobile industry is one of the major contributors in UKs revenue and it has
impacted heavily along with the other industries due to Brexit. As UK exports 80% of
automobiles manufactured in UK are exported and half of its exports are made to
European union (EU). All industries are wait on the way the Brexit will get through,
whether it is done being a liberal, or governments could come up with certain new
guidelines, which are not in favor of the industries. Governments could come up with
the new proposals on the new tax policies, which may not be beneficial for the
automobile brands, as this will impact their revenues and profits. This will not only be
restricted to the new cars, Spare parts and its components will also have the impact.
New tax policies, which will be into the picture as the foreign exchange currency value
will make the cost of the new vehicles and their spare parts to be premium due to the
regular changes in the foreign exchanges between UK (£) & Euro (€). There is a
possibility that governments may not make any changes to the existing ways of the
functionality in terms of tax policies etc., which may not influence the automobile
industry.
industry.
B (1)
Selling & Costing Information S1 S2 S3 S4
1 Selling Price 80 110 145 170
2 Direct Materials 12 30 35 40
3 Direct labours (Labour rate = 5/hr) 16 20 15 20
4 Variable overhead 8 10 14 16
5 Selling overhead 4 4 4 4
6 Total Expenses (2+3+4+5) 40 64 68 80
7 Contribution Per Unit (1 – 6) 40 46 77 90
8 Direct Labour Hours Per Unit (3 / 5) 3.2 4 3 4
9 Contribution/Hour(As Labour Hours
is Limiting factor) (7 / 8) 12.5 11.5 25.67 22.5
10 Product Ranking (based on 9) III IV I II

Total Labour hours available next period = 60,000 hours
Information S1 S2 S3 S4
1 Maximum Demand (Units) 8000 6500 4800 3200
2 Product Ranking (above table) III IV I II
3 Direct Labour Hours Per Unit
(above table) 3.2 4 3 4
4 Utilisation hours (1 * 3) 25600 7200 14400 12,800
Manually adjusted for Product S2 as the Total hours are 60,000 and after calculating
for Products based on the ranking (Row 2 of the above table) S3 (14400) + S4
(12800) + S1 (25600) = 52,800. Remaining is manually adjusted for Product S2 as
7200 (60,000 – 52800)
Maximum demand (Units) for Product S2 is manually calculated as the Production
hours are calculated as below. [Products are listed based on their ranking, excluding
S2)
S3 S4 S1
1 Maximum Demand (Units) 4800 3200 8000
2 Direct Labour Hours Per Unit 3 4 3.2
2 Production (Hours) 14,400 12,800 25,600
Total Production hours for S3 + S4 + S1 = 52,800
Total Labour hours = 60,000
Remaining hours = 60,000 – 52,800 = 7200 hours
7200 / 4 (Direct Labour Hours Per Unit for Product S2) = 1800
S2(Max demand 6500 but can be produced only 1800 as labour is limiting factor.) Total Profit
calculation
Information S1 S2 S3 S4
1 Maximum Demand (Units) 8000 1800 4800 3200
2 Contribution Per Head (table 1) 40 46 77 90
3 Profit (1 * 2) 320,000 82,800 369,600 288,000

Total profits earned by 4 Products together (S1 + S2 + S3 + S4) = £1,060,400.
Following are two alternatives which will help BHealthy Ltd to overcome the limiting
factors
1. By increasing the efficiency of labour by giving them proper training.
2. By making the products more machine oriented than labour oriented.
B (2)
a. How many members will the club need to have to break even?
The break-even point is the point at which there is no loss or gain for your
business. At the break-even point, total cost and total revenue are equal.
Breakeven formula -
Break-Even Quantity = Fixed Costs / (Sales Price per Unit – Variable Cost Per
Unit
Information Value
Fixed Cost £7500 £90,000 (£7500*12)
Variable Cost per Unit £200 per year
Annual Membership £275 per year
Using the above breakeven formula,
= 90,000 / (275 – 200)
= 90,000 / 75
= 1200
So, Phase 3 Sports club requires 1200 Members to Break even.
b. Calculate the margin of safety percentage if Phase3 attracts 200 or
300 members in the first month.
As we have calculated Breakeven above, anything below the breakeven will results in
loss for a business
Phase 3 Sports club requires 1200 Members to Breakeven, below is the margin of
safety percentage, as the club attracts 200 members in the first month.
 Attracting 200 members in the first month.
Margin of Safety Percentage = [current sales – breakeven point / current sales] * 100
Margin of Safety Percentage = (200*275)-330000/(200*275)*100
= 55000-330000/55000*100

= -275000/55000*100
= -5*100
= -500%
By attracting 200 members in the first month, Phase 3 Sports club’s margin of safety
percentage is in Negative – 500%
 Attracting 300 members in the first month.
Margin of Safety Percentage = (300*275)-330000/(300*275)*100
= 82500-330000/82500*100
= -247500/82500*100
= -3*100
Margin of Safety Percentage = -300%
By attracting 300 members in the first month, Phase 3 Sports club’s margin of safety
percentage is in Negative – 300%
c. If Phase3 wishes to make a profit of £2,400, how many members should it
target?
If Phase3 Sports Club wishes to make a profit of £2,400, how many members should
it target?
After the break-even point profit from a single membership is 75. i.e. Sale per unit
275 - variable cost per Unit 200 (275 - 200= 75)
So to gain 2400 profit, we need 2400/75 = 32 members over break-even.
If Phase3 Sports Club wishes to make a profit of £2,400, it should target 1232
Members.
d. The managers decide that a £275 fee is too high. What would happen if they
reduced the membership fee to £245? Make the adjustment and recalculate
the contribution, breakeven point, and margin of safety percentages at output
levels stated in b) and advise management of the feasibility of a price
reduction.
As the management decides to reduce the membership fees to £245, then the revised
breakeven will be as following.
Break-Even Quantity = Fixed Costs / (Sales Price per Unit – Variable Cost Per Unit)
= 90000/(245-200)
=90000/45
= 2000

So, Phase 3 Sports club requires 2000 Members to Breakeven with the revised
membership fees.
With the revised Breakeven of 2000 members, if Phase 3 sports club decides to attract
200 members in the first month, then the margin of safety percentage is calculated as
below.
Margin of Safety Percentage = [current sales – breakeven point / current sales] * 100
= (200*245) - 490000/(200*245)*100
= 49000 - 490000/49000*100
= - 441000/49000*100
= -9*100
= - 900%
By attracting 200 members in the first month, Phase 3 Sports club’s margin of safety
percentage is in Negative – 900% with the revised membership fees.
With the revised Breakeven of 2000 members, if Phase 3 sports club decides to attract
300 members in the first month, then the margin of safety percentage is calculated as
below.
Margin of Safety Percentage = (300*245)-330000/(300*245)*100
= 73500-490000/73500*100
= - 416500/73500*100
= - 5.667*100
= - 566.7%
By attracting 300 members in the first month, Phase 3 Sports club’s margin of safety
percentage is in Negative – 566.7% with the revised membership fees.
e. Explain the limitations of Cost Volume Profit (CVP) analysis.
Cost-volume-profit (CVP) analysis, commonly referred as CVP, it is a planning
process of management which uses to predict the future volume of activity, costs
incurred, sales made, and profits received. In other words, it is a mathematical
equation that computes how changes in costs and sales will affect incomes in future
periods. CVP analysis classifies all costs as either fixed or variable.

Following are few limitations.
l Many issues are occurred while performing of a multi-product analysis under
the auspices of the CVP. To begin, it is important to identify the facilities that
are shared by unrelated products. The analysis will be satisfactory if fixed costs
and facility usages can be linked to items. A non-linear relationship between
the units of measurement poses a second issue. With different goods,
contribution margins, and production numbers, the costs can vary widely.
l CVP analysis that inventory amounts do not vary over the time under
consideration. That is, the opening and closing inventory units are the same.
This also implies that the number of units generated during the period is the
same as the number of units sold. CVP analysis gets more difficult as inventory
levels fluctuate.
l If prices, unit costs, sales mix, operating efficiency, or other important
elements changes, the entire CVP analysis and linkages must also be
changed. Due to these assumptions, cost data is meaningless.
l To use CVP analysis, it is assumed that expenses can be accurately split into
fixed and variable. This sort of categorization can be tough to implement in the
real world.
l CVP is an estimate at best because of the many assumptions it depends on.
CVP analysis lacks precision and accuracy because of the guesses and
approximations required to collect the relevant data.
l It is assumed that total revenues and total costs are linear in CVP analysis,
hence straight lines are used to illustrate these figures. There are some
situations where this assumption may not be accurate. It is possible that the
variable expenses per unit may be reduced if more units are sold by a
commercial enterprise.
l Cost Value Profit Analysis has problems in identifying fixed and variable costs.
l In Cost Value Profit Analysis, fixed costs are not always fixed.
l In Cost Value Profit Analysis, the proportional relation between variable
cost and volume of output is not always effective.
l In Cost Value Profit Analysis, Unit selling prices are not always constant.
l Cost Value Profit Analysis is not suitable for a multi-level firm.
l In Cost Value Profit Analysis Ignoring the influence of other factors on cost and
profit.
l The presence of inventory is not considered in Cost Value Profit Analysis.
l Cost Value Profit Analysis is not effective in the long run.
l Cost Value Profit Analysis emphasis more on sales.

B (3)
Budget planning is a process of planning of various estimates for the budget. This will
be a detailed plan about the income of the organisation along with the cost estimate
of the organisation and it will help to accurately manage the expenditure at various
futuristic time periods. Budget planning focuses at identifying the sources of the
income and it will be considering all the current in the future expenses and it will be
helping in meeting the financial goals.
Advantages of Budget Planning
Budgeting helps executives to transfer authority while yet keeping management over
the business. It immediately identifies organisational defects, inefficiencies, and
aberrations that may be corrected to get the desired result (Asogwa and Etim, 2017).
l Planning orientation. The process of creating a budget takes management
away from its short-term, day-to-day management of the business and forces it
to think for longer-term. This is the chief goal of budgeting, even if
management fails in meeting its goals as outlined in the budget - it is thinking
about the company's competitive and financial position and how to improve it.
l Profitability review. It is easy to lose sight of where a company is making
most of its money, during the scramble of day-to-day management. A properly
structured budget points out what aspects of the business produce money and
which ones use it, which forces management to consider whether it should
drop some parts of the business or expand in others.
l Assumptions review. The budgeting process forces management to think
about why the company is in business, as well as its key assumptions about its
business environment. A periodic re-evaluation of these issues may result in
altered assumptions, which may in turn alter the way in which managements
decides to operate the business.
l Performance evaluations. Working with employees to set up their goals for a
budgeting period, and possibly also tie bonuses or other incentives to how they
perform. You can then create budget against actual reports to give employees
feedback regarding how they are progressing toward their goals. This approach
is most common with financial goals, though operational goals (such as
reducing the product rework rate) can also be added to the budget for
performance appraisal purposes. This system of evaluation is called
responsibility accounting.
l Cash allocation. There is only a limited amount of cash available to invest in
fixed assets and working capital, and the budgeting process forces
management to decide which assets are worth investing in.
l Funding planning. A properly structured budget should derive the amount of
cash that will be spun off or which will be needed to support operations. This
information is used by the treasurer to plan for the company's funding needs.
Negative aspects of Budget planning
l Time Consuming. Budget planning is a time-consuming process where there
will be requirement to investment large teams.

l Creative Limitation. There is a high possibility that restricting a
certain budget to complete a task, will reduce the growth of an
organisation.
l Excess Spending. This is a flip side in counter with the above aspect as the
organisation might end up spend up more than, what is required to complete a
task.