Financial Decision Making

This report presents about the financial decision making with respect to acquisition of Roast Ltd which is a UK based coffee house chain to be acquired by Starbucks. It highlights the current coffee house industry, key competitors, challenges and opportunities. It analyzes the financial performance and position of Roast Ltd and evaluates investment appraisal techniques.

Financial Decision
Making

EXECUTIVE SUMMARY
This report presents about the financial decision making with respect to acquisition of
Roast Ltd which is a UK based coffee house chain to be acquired by Starbucks. This report
highlights about the current coffee house industry along with the key competitors prevailing in
the business environment along with the challenges and opportunities available. The profit or
loss statement analyzeddepicts about the currentfinancial performance of Roast Ltd which is
good. The financial position of Roast Ltd is analyzed which states that the current financial
position is not good and also by cashflow analysis it is determined that the cash flow from
operating activity is negative which might be the reason for not distributing dividend to the
shareholders. Along with that the different investment appraisal techniques are evaluated based
on which decision is taken the Starbucks should acquire Roast Ltd as the overall business
performance is good and further investment plans are also feasible.

TABLE OF CONTENTS
Task..................................................................................................................................................4
Part 1: Review of industry...............................................................................................................4
Part 2: Analyzing performance of business.....................................................................................4
2.1 Assessing profit and Loss statement......................................................................................4
2.2 Analyzing statement of balance sheet....................................................................................5
2.3 Determining cash position by making use of cash flow statement........................................6
Part 3: Investment appraisal.............................................................................................................8
3.1.a Forecast of management.....................................................................................................8
3.1.b. Capital budgeting Techniques...........................................................................................8
3.2 Funding sources...................................................................................................................11
REFERENCES..............................................................................................................................14
APPENDIX....................................................................................................................................16

Task
Part 1: Review of industry
 Coffee is the popular drink among the residents of UK.
 The instant coffee has a turnover of £810 million in the year 2017 which is equal to 54%
of £1.5 billion total turnover generated by all coffee products.
 The total estimated revenue in the year 2017 was £7.2 billion which represents an
average growth of 7% during the period 2012-17.
 The coffee industry has approximately 7.5% of workforce with respect to thewhole food
and beverage industry.
 The industry is affected by the impact of Brexit along with the value of pounds.
Manufacturers have seen an increase in the price (Ferreira, 2017).
 The majorcompetitorsin the industry are - Costa Ltd., Caffe Nero Group Holdings Ltd
along with Starbucks.
 Costa Ltd is the market leader and is having the highest number of outlets which is 2121
in UK followed by Starbuck with 898 and Caffe Nero with 650 stores.
 The major challenges faced the coffee industry is the increasing cost of landand
labourcost and the impact of Brexit.
 The opportunities available in the industry is the emergence of sustainability and plant-
based menus (Luty, 2019).
 These leading coffee chains have already introduced the vegan menu and along with
meeting the requirement of oat milk.
Part 2: Analyzing business performance
2.1 Assessing P&L statement
It has been interpreted from the statement that over the year revenue of Roast Ltd is
increasing that is from Pound 2022 in the year 2017 to Pound 2534 in 2018. This reflects that the
sales of an entity have been increasing that in turn seen as the positive sign and better
performance of the firm. With an increase in the sales, COGS also increases from pound 1505 in
2017 to 1990 in 2018. This means that the variable cost of Roast Ltd has increased from one
accounting period to another in associated with the cost of sales. Therefore, the company should
focus on ensuring or keeping control on its cost so that it could earn higher profits on its sale. In

order to reduce the cost regarding the sales, an organization should increase its revenue with a
greater value with incurring less or minimal variable cost incurred in producing the product
within the premises of business.
The gross profit also seen as increasing from one period to another which is stated as the
profits generated by the firm after paying off its cost attached with the sales. Though the amount
of gross profit is increasing but the ratio over the year is seen as declining because the cost of
goods sold increased with a greater value against a small value of increase in the sales. This
shows that for improving the operational performance, company must ensure adequate control
over its expenses. Similarly, with increase in operating income, the operating expenses are also
depicted as rising from one accounting period to another. This leads to increase in the operating
profit ratio or margin which in turn indicates that Roast Ltd is earning adequate amount of
income for paying itsoperating expense.
Moreover, the net profit ratio of an enterprise is also increasing that clearly means that
the company is performing well with earning higher return and profits. This also depicts that the
firm is generating higher profits after paying off all its cost, expenses and the tax obligation.
Overall the profitability performance of Roast Ltd is evaluated and found as better with passage
of one accounting year to another in an overall market.
2.2 Analyzing statement of balance sheet
The balance sheet provides an insight about the how the company is operating and helps
in grabbing deep insight into the business functioning. There are three important things to be
taken care of while analyzing the balance sheet, which are, liquidity, capital and financial
structure and the working capital of the business. As per theinformation provided in the
Statement of financial position of Roaster Ltd. it can be seen that there aremany changes in the
company’s total assets and total liabilities and to get a clear picture, financial ratios are used.
Liquidity ratio: It will help in analyzinghow company can convert its current assets into cash in
order to pay offits short-term liabilitieswithout raising any additional capital (Lessambo, 2018).
The main liquidity ratios that are essential for the business are stated below.
Current ratio, shows the relationship between current asset with current liabilities (Williams and
Dobelman, 2017). The current ratio of Roast Ltd has reduced from 2.51 times in 2017 to 1.45

times in 2018 which indicates that Roast Ltd has either increased the used of short-term debt or
reduced investment in current assets as the ideal ratio of 2:1. This indicates that the Roast Ltd.
needs to effectively manage its current ratio otherwise it may not be in the position to meet
itscurrent business requirements.
Quick ratio, it is similar to current ratio but it is conservative as it takes into consideration
only that assets which can be easily convertible into cash (Yasa and Wirawati, 2016). It
includes cash, marketable securities and account receivable but excludes inventory because it
cannot be easily converted to cash. Higher the ratio better it is for the company. The quick
ratio of Roast Ltd has reduced from 1.64 in 2017 to 0.48 in 2018 which is not a good
indicator. This means that company will struggle in paying off its short-term debts.
Net working capital, it is derived by deducting current liabilities from current assets,
which measures the company’s liquidity and ability to meet its short terms needs and funding
the operation of the business (Afrifa, 2016). It is ideal to have positive working capital, when
there is more current assets in comparison to current liabilities. The net working capital of
Roast Ltd. has reduced to £139 in 2018 from £209 in 2017. This indicates that the short-term
liquidity position of the business is under concern.
Leverage ratio: This ratio shows the proportion of debt accompany has its capital structure.
It shows how the business operation is financed using debt and equity.
Debt-to-equity ratio, it is derivedby dividing total debt of the company against the total
shareholder’s equity (Indrawan, Suyanto and Mulyadi, 2017). It measures the degree to
which Roast Ltd is financing its business operation and shows the ability of shareholder’s
equity to cover all the debts during times of downfall. The higher ratio indicates higher risk
to shareholders. The debt-to-equity ratio of Roast Ltd has increased from 0.31 to 0.68 in
2018. But is less than one which is preferable.
Apart from the ratios stated above, the other key aspects to be considered is that Roast
Ltd. has not distributed dividend which may be because of its expansion plan for which it
wants to retain the amount for reinvestment for expanding business which has caused an
increase in retained earnings. The debtor collection of the Roast Ltd. has increase from 17
days to 21 days which is because of the reason that in the year 2018, the major customer of

the companysuffered some financial issuesfor which the payment period increased to 90 days
instead of 30 days.
2.3 Determining cash position by making use of cash flow statement
The cash flow statement analysis assists the company in analyzing the cash flows of the
business during the period. The cash flow comes from three types of activities, which are,
operating, investing and financing activities.
Cash flow from Operations
The operating profit of Roast Ltd is £127 which is higher in comparison to £51 in 2017.
Roast Ltd has the cash flow from business operation negative which means the company has
made more expenditure. The increase in operating profit is because of income received from
other sources (Das, 2018). Also, the expansion plan in Romania is successful which has resulted
in increase in revenue. But the increase in inventory and trade receivable of £179 and £55
respectively and decrease in trade payable by £97 indicates cash outflow which has affected its
working capital management.
Cash Flow from Investment Activities
In this, the Roast Ltd has made investment by purchasing fixed asset of £358 which is
mainly for its Romania expansion plan. This has led to huge amount of cash outflow.
Cashflows from financing activities
In the year 2018, Roast Ltd has taken debtof £175 which has represented as thecash
inflow of the business.
Based on the aboveanalysis, it can be said that the cash flow position of the business is
not that good. Irrespective to the other activities the most important is the cash flow from the
operating activity which is negative.
Operating cash cycle of Roast Ltd
This cycle indicates the amount of timethe company takes for selling its inventory, collect
the amount from receivables and make payment to its account payables (Jalal and Khaksari,

2019). It is favorable to have the shorter cycle which means which means that liquidity position
of the company is strong. It is also called cash conversion cycle.
CCC = Days of Sales Outstanding (DSO)+ Days of Inventory Outstanding (DIO)- Days of
Payables Outstanding (DPO)
Operating cash cycle (2017) = 17+29-33 = 12 days
Operating cash cycle (2018) = 21+55-43 = 33 days
Operating cash cycle shows that the Roast Ltdis not effectively managing its working
capital assets (Chang, 2018). This indicates that there might be difficulty in growing business
because of less liquidity and may increase the need for borrowing for business operation.
Dividend policy of Roast Ltd for the year 2018
In the year 2018, the company uses residual dividend policy which is mostly used by the
company. In this, the company pays out from the profits after meeting all the expenditure
(Hauser and Thornton Jr, 2017). The amount paid to the shareholders is not fixed and sometimes
not even paid as it is retained for future business opportunities. The company should have paid
dividend in 2018 instead of 2017 because in 2017 the expansion was done in Romania but in
2018 the actual sales were made and at this point company should have paiddividend to its
shareholders.
Part 3: Investment appraisal
3.1.a Forecast of management
The manager of Roast Limited has forecasted that in the coming 5 years of period the
revenue of company in respect to its new product lines would be increasing. Similarly the
variable cost is also reflected to be rise along with the revenue. The resulted contribution will
also increase that in turn indicates that the cash inflows would be increasing with passage of one
to another. This clearly shows that company would be earning higher amount of the profits in the
future y making investment in creating a new product lines in the Romania.

3.1.b. Capital budgeting Tools
Payback period- It can be defined as the time period it takes to cover cost of an initial
investment. It is the duration that an investment takes for reaching its BEP. Payback period can
be calculated by dividing cost of investment by annual cash flow. The shorter the payback
period, better is the investment (Alkaraan, 2017). Therefore, it is recommended to keep the
payback period short in order to reduce the cost of interest and to increase the profit.
Advantages Disadvantages
The major advantage of payback period is that it is
simple to use and also very easy to understand. In
order to calculate payback period only the initial
cost of project and annual cash flows are required
which makes it suitable to use for businesses of all
scale.
The major problem with payback period is that it
does not consider the number of years required to
recover the sum invested.
The payback period is reveals crucial information
related to liquidity. It helps the managers in
identifying projects with lower risk and a shorter
payback period (Jibril and Jagun, 2018). It helps
businesses to recover the initial cost fast which can
be later invested into other ideas.
The payback period also ignores the profitability of
an investment as it does not account for what
happens once the money is repaid. As a result,
many organizations prefer to use Net Present Value
as a tool for making decisions related to
investment.
The payback period is most suitable for industries
and businesses that are uncertain and operate in
dynamic industry. It highlights the projects with
shorter repayment period so that the chances of loss
get minimized.
Unlike capital budgeting, it also ignores the time
value of money which means that it ignores to
assess the future value of present money.
Interpretation- long duration of the payback period, longer is the time taken by the
proposal in covering initial cost of investment. However, shorter period reflects that the proposal
will recover the initial cost within short time frame. The analysis shows that the payback period
resulted as 4 years which is counted as longer payback period. This means that the project will be
taking 4 years to recover an initial outlay so it would not be recommended as better option for
Roast Ltd.

ARR- It is also called as average return rate, is a financial ratio used in the process of
capital budgeting (Hicks, 2017). ARR can be computed by dividing the annual net profit by the
initial cost of the asset or investment. Further, the resulted value must be multiplied by 100 so
that the value can come in percentage form.
benefits Limitation
The ARR takes into account the net earnings
concept that includes earnings after tax and
depreciation. It is very essential factor for
promoting the investment proposal.
Just like payback period, this method too ignores
the time factor. Thus, it fails to provide alternative
use of time value of funds.
It helps in easy comparisons of new project with
previous projects or that of competitive nature
(Sinha and Datta, 2020). This further helps in
comparing the profitability and in making
corrective actions to make the project feasible.
It does not consider the cash inflows that are
actually more crucial than accounting profits thus
affecting the entire future profitability of project.
It helps in measuring and monitoring the current
performance of the company and provides great
satisfaction to the owners by providing the them the
information about return on investment.
This method also ignores the life period of various
investments.
Interpretation-It has been represented that higher the ARR, greater return will be
generated by Roast Ltd through the expansion in new types of product range. From the analysis
it has been represented that Roast Ltd will gain higher profits from this proposal as accounting
rate of return resulted as higher equating to 18%.
Net present value- It is considered to be the difference between present value of cash
inflows and cash outflows. Net present value is also used to calculate capital budgeting and
investment planning to analyze the profitability of an investment (Warren and Seal, 2018).
Positive NPV showcases that the expected earnings are more than the projected cost which
means that project is profitable whereas negative NPV means that the project is running in loss
and is not feasible to continue.
Advantages Disadvantages

The major benefit of NPV is that takes into account
the concept of time value of money which means
that the money invested today is worth more than
the money invested tomorrow because of its
earning capacity.
NPV considers inflation which means that the
profitability of an investment in the currency is not
worth the same as today because of inflation.
However, the money today can be invested and
make it future value higher than the money
received in future at some point of time.
It also helps the management in decision making by
evaluating the projects of same size and by
calculating whether the current investment is
profitable or in loss.
NPV only takes cash flows of a project into
account which means that it fails to consider other
cost that have an impact on the true value of
investment.
NPV uses organization’s capital cost as the
discount rate which means that it is the minimum
rate shareholders need to invest in the company.
An increase in NPV does not guarantee more
investment (Elmassri, Harris and Carter, 2016). For
instance, if there are two investments available for
decision then the Net present value will be higher
for that project as it will provide large numbers.
Thus, it defeats the purpose of accounting and in
order to identify the profitability it is important to
calculate it in investment form.
Interpretation- Positive value of NPV means that value of revenue is higher than costs
and this result to profitability. However, when Net present value is negative, it states that the
proposal will generate losses. As per the evaluation, Net present value for the proposal accounted
as 110 which means that an investment is feasible, viable and desirable for Roast Ltd.
3.2 Funding sources
Equity financing- It is a method of raising capital for the company by selling company
shares to the investors and general public. The people receive ownership interests in the
company in return for the money invested (Ababneh, Shrafat and Zeglat, 2017). There are
various sources from where a business can raise equity finance like angel investors, venture
capitalists, initial public offer (IPO) or to entrepreneur’s friends and family. Equity financing is
concerned with the sale of common equity but also includes other instruments like preferred
stock, instrumental stocks, common shares and warrants.

Advantages Disadvantages
The major advantage of equity financing is that it
reduces the burden of repayment of loan. Thus, a
business does not have to pay monthly loan
interests which are beneficial especially when the
business is in its initial phase.
The major disadvantage of equity financing is that
the entrepreneurs have to share the profits with
investors.
Equity financing can also help a business grow by
getting knowledge and skills from experienced
investors and individuals.
Equity financing also leads to loss of control and
authority from the founders of the business which
causes difference in opinions and further leads to
conflicts in the organization.
Equity financing reduces the cash out flow which
can be used by a business to increase its operational
activities and become more profitable in the long
run.
The owner has to give opportunity to investors as
well so that they can share their opinion and
implement it in the business thus it loses the
authenticity and original purpose of company
because it can be possible that the purpose of
forming the company by the owner might be
different from the investors.
Debt financing- Debt financing is concerned with raising capital for the company from
external sources like banks, institutional investors, creditors, friends and family. It is the duty of
the company to repay principle amount and interest on debt on timely basis (Hsiao and Kelly,
2018). It is imperative for the company to raise both debt and equity finance adequately in order
to reduce the burden and to ensure the free flow of business.
Advantages Disadvantages
Debt financing is cheaper than equity financing
because the interest paid on debt is deductible from
earnings before interest and tax which means that a
business needs to pay less income tax as compared
to equity financing.
It is imperative for every company to pay interest
on debt monthly even if they are suffering from
loss. In case a business fails to repay the loan
amount then it can face legal trouble.
In debt financing there is no external control in the
working of the company from other parties which
means that a business can operate freely without
In most cases a business needs to have collateral
asset which they have to keep as security to the
bank as a secondary form of loan repayment. A

any intervention. business cannot procure loan without a collateral
property.
Monthly payment of interest also helps a business
in building its credit worthiness which is really
helpful in securing loans from bank and financial
institutions in the near future.
It also affects the future growth prospects of a
business because it leads huge cash outflow
monthly thus it restrains organization from earning

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Online
Luty, J., 2019. Leading coffee shop chains United Kingdom (UK) 2016, ranked by store number.
[Online]. Available Through:< https://www.statista.com/statistics/297863/leading-
coffee-shop-chains-in-the-united-kingdom-uk-store-number/ >.

APPENDIX
Calculating operating cash cycle
Days of Sales Outstanding (DSO)
Particulars Formula 2017 2018
Trade receivables 93 148
Sales 2022 2534
Debtors collection
period Trade receivables / Sales *365 17 days 21 days
Days of Inventory Outstanding (DIO)
Particulars Formula 2017 2018
Closing inventory 120 299
Cost of goods sold 1505 1990
Inventoryoutstandingrati
o
Closing inventory/Cost of
goods sold *365
29
days
55
days
Days of Payables Outstanding (DPO)
Particulars Formula 2017 2018
Trade payables 138 235
Purchase 1505 1990
Creditors payment
period
Trade payables / purchase
*365 33 days 43 days