Calculation of Ratios for Financial Analysis

The report includes the calculation of financial ratios such as return on capital employed, return on shareholders’ investment, gross margin, operating profit margin, acid-test ratio, asset turnover ratio, inventory days, and days payables outstanding. The ratios are calculated based on the income statement and balance sheet of the company for the years 2015 and 2016. Other information such as dividend paid, number of equity shares, and market price is also provided.

Answer 1:
Initial Investment £ 340,000.00
Inflow per year £ 100,000.00
Outflow per year £ 25,000.00
Part A: Payback period
Years Cash Flows Cumulative CF
0 -£ 340,000.00 -£ 340,000.00
1 £ 75,000.00 -£ 265,000.00
2 £ 75,000.00 -£ 190,000.00
3 £ 75,000.00 -£ 115,000.00
4 £ 75,000.00 -£ 40,000.00
5 £ 75,000.00 £ 35,000.00
6 £ 75,000.00 £ 110,000.00
Payback Period 5.53
5 years + 6 months
(Brigham and Michael, 2013)
Part B: Weighted Average Cost of Capital (WACC)
Return on Equity 7%
Interest Rate 6%
Tax No taxes
Risk Premium 1.50%
Weight of Equity 50.00%
Weight of Debt 50.00%
Formula of WACC: Weight of Equity * Cost of Equity + Weight of Debt * Cost of Debt
Assumption It is assumed that return on equity includes risk premium and there
is no impact of risk premium on debt capital
Calculation of WACC
Capital Weights Cost of Capital Weighted Cost
of Capital
Equity 0.5 7% 3.50%
Debt 0.5 6% 3.00%
WACC 6.50%
(Damodaran, 2011)
Part C: Net Present Value

Discount rate (WACC) 6.50%
Formula of NPV: Present value of cash inflows – present value of cash outflows
Calculation of Net present value of the project
Years Cash Flows PVF @ 6.5% PV @ 6.5%
0 -£ 340,000.00 1.000 -£ 340,000.000
1 £ 75,000.00 0.939 £ 70,422.535
2 £ 75,000.00 0.882 £ 66,124.446
3 £ 75,000.00 0.828 £ 62,088.682
4 £ 75,000.00 0.777 £ 58,299.232
5 £ 75,000.00 0.730 £ 54,741.063
6 £ 75,000.00 0.685 £ 51,400.059
NPV £ 23,076.017
Part D: Accounting Rate of Return (ARR) of the project
Year Project
Cash Flows
0 -£ 340,000.00
1 £ 75,000.00
2 £ 75,000.00
3 £ 75,000.00
4 £ 75,000.00
5 £ 75,000.00
6 £ 75,000.00
Initial Investment £ 340,000.00
Salvage Value Assumed to be zero
Average investment £ 170,000.00
Annual Depreciation
(Initial Investment − Scrap Value) ÷
Useful Life in Years
£ 56,666.67
Average Accounting Income
Yea
r Cash inflows Depreciation Net Cash inflows
1 £ 75,000.00 £ 56,666.67 £ 18,333.33
2 £ 75,000.00 £ 56,666.67 £ 18,333.33
3 £ 75,000.00 £ 56,666.67 £ 18,333.33

4 £ 75,000.00 £ 56,666.67 £ 18,333.33
5 £ 75,000.00 £ 56,666.67 £ 18,333.33
6 £ 75,000.00 £ 56,666.67 £ 18,333.33
Total £ 110,000.00
Average Accounting Income £18,333.33
Accounting Rate of Return (A) = Average accounting income /Average Investment
10.78%
Part E: Recommendation as per managing director requirements
Capital Budgeting
method
Managing
director
Criteria
Result Accept the
project or
reject
Discussion
Payback period 4 years 4 years 6
months
Reject On the basis of
managing director
requirement it is
recommended to the
company not to select
the project as it has
very high payback
period as compared to
limit set by the
managing director.
Managing director has
set the limit of 4 year as
the payback period but
project has payback
period of 4 years and 6
months.
Net Present value Positive NPV £23,076.017 Accept It is highly
recommended to accept
the project as it very
good NPV and also
satisfies the managing
director criteria
Accounting rate of
return
5 % 10.78% Accept As Project has
accounting rate of
return of 10.78% it is
highly advised to
accept the project as it
far greater than the
limit of 5% set by the
managing director.

Overall Recommendation: It is highly advised to select the project due to high NPV and High
accounting rate of return (Davies and Crawford, 2011).

Answer 2:
Part A:
The two types of business structures that the owner of Xstore can consider along with
their advantages and disadvantages are explained below:
Private Limited Company
It is regarded as a separate identity legally that will provide the benefits of both a sole
proprietorship and corporation to the owner of the store. It will enable the owner to possess
complete control over the ownership structure of the company and the shareholders cannot claim
any possession over its property.
Advantages
 The development of a private limited company structure will enable the owners to
develop a separate legal entity of their business
 It retains the complete control of the owners and thus does not result in causing the
transferring the ownership of the company to the shareholders
 It enables the company to gain access to funds by issuing the debentures and also
acquiring funds from the shareholders
 It will also provide the owners who are previously running the business as sole trader
to gain tax advantages as the corporation tax is paid on the profits gained and the
owners are not liable to pay personal income tax rates (Krantz, 2016)
Disadvantages
 The major drawback of the method used is that establishing a private limited
company results in incurring higher cost for the sole traders. This is because the
company needs to meet the regulations imposed by the government in order to gain
legal existence as a private limited entity
 The decision-making control is lost by the owners as any major decisions need to be
taken by involving the major shareholders of an entity
 It leads to increase the legal formalities of owners as the company is required to make
fillings regarding taxes, annual returns and conducting meetings
Partnership Firm
It is another form of business formation where two more people agree to share the profit
of the business. In partnership firm ownership can be kept with one partner acting for all or can
be shared with all partners. Partnership is formed through oral or written agreement between the
partners and it give rise to lawful business that has existence in eyes of law. In partnership
business, liability of business is shared by the partner in the agreed ratio and if there is no ratio
defined that in capital investment ratio. In partnership firm no partner can transfer their share in
partnership firm without the consent of all partners.
Advantages:

 It is very easy to form the partnership firm as it is only the contractual agreement
between the partners
 Through use of partnership firm there can be more capital investment as there are
more persons to make investment
 More persons means more talent, high level of skills and judgment power within the
business
 Risk of doing business get distributed in defined ratio
 Partnership firm allow to business in more flexible manner
Disadvantages
 Partnership increase the liability of the partners as in this type of business there is
unlimited liability of partners
 More partners mean more distribution of profit. It means profit earned by the business
get distributed among more person instead of one (Moles and Kidwekk, 2011)
Part B:
Working capital can be regarded as a part of the overall capital employed by a company
and can be stated as the difference between the current assets and liabilities of a company. It can
be stated as the daily cash that is required by a company to conduct the regular operational
activities. The management of working capital is highly necessary for business entity to ensure
that it possess sufficient liquidity base for smooth carrying of daily business operations. Thus, it
can be said that working capital management is highly essential for a business entity as it a
potential measure that reflects its efficiency, liquidity ad overall financial health. The inadequate
management of the working capital can deter the future financial growth of a business as it can
lead to increase in the financial risk of insolvency, liquidation or potential bankruptcy. The
development of strategies that ensures maintaining an adequate amount of liquidity for meeting
the financial obligation as they become due will help in promoting the goodwill of the company
among the investors. It would untimely result in maximizing the returns generated by the
company and thus ensuring its continued growth and development (Tian, 2011).
The bushiness can adopt the use of aggressive working capital policy in which minima
investment is made on current assets. A firm may tend to adopt the use of such a policy if it
possess lower level of current assets in proportion to the total assets or is having a higher
proportion of short-term debt. The use of such policy can eventually results in gaining higher
profitability by a firm by taking higher amount of risk (Afza and Nazir, 2009).

Answer 3:
Part (i): Calculation of Ratios
Information provided
Income Statement
Particulars 2016 £m 2015 £m
Revenue £ 2,017.00 £ 1,957.00
Cost of sales £ 1,856.00 £ 1,804.00
Gross profit £ 161.00 £ 153.00
Administrative expense £ 86.00 £ 84.00
Operating profit £ 75.00 £ 69.00
Finance cost £ 6.00 £ 8.00
Profit before taxation £ 69.00 £ 61.00
Taxation £ 20.00 £ 17.00
Retained profit £ 49.00 £ 44.00
Balance Sheet
Particulars 2016 £m 2015 £m
Assets
Non Current Assets
Property, plant & equipment £ 188.00 £ 162.00
Intangible assets £ 122.00
£
73.00
Other assets £ 56.00
£
42.00
£ 366.00 £ 277.00
Current assets
Inventories £ 248.00 £ 214.00
Trade & other receivables £ 80.00
£
72.00
Cash and short-term deposits 32 54
£ 360.00 £ 340.00
Total assets £ 726.00 £ 617.00
Liabilities
Non-current liabilities

Retirement benefit and other liabilities £ 39.00
£
21.00
Interest bearing loans £ 12.00
£
5.00
Other liabilities £ 3.00 £ -
£ 54.00
£
26.00
Current liabilities
Trade & other payables £ 442.00 £ 416.00
Income tax payable £ 21.00
£
17.00
Interest-bearing loans £ 84.00
£
53.00
Provisions £ 4.00
£
5.00
£ 551.00 £ 491.00
Total liabilities £ 605.00 £ 517.00
Equity
Share capital £ 347.00 £ 347.00
Reserves £ 13.00
£
12.00
Retained earnings -£ 239.00 -£ 259.00
Total equity £ 121.00 £ 100.00
Total Liabilities and Equity £ 726.00 £ 617.00
Other Information
Dividend paid in year 2016 £ 29,000,000.00
Dividend paid in year 2015 £ 27,000,000.00
Number of Equity Shares 423600000
Market Price April 2016 £ 0.79
Market Price April 2015 £ 1.50
Information Calculated 2016 2015
Earnings per share
£
0.12
£
0.10
Quick assets
£
112.00
£
126.00

Purchases (Assumed to same as Cost
of goods sold)
£
1,856.00
£
1,804.00
Dividend Per Share
£
0.07
£
0.06
Ratios Formula 2016 2015
Return on Capital
Employed
EBIT/(Equity + non-current
liabilities) 42.86% 54.76%
Return on shareholders’
investment (ROI) Net Profit after tax / Total Assets 6.75% 7.13%
Gross margin Gross profit /Net revenue 7.98% 7.82%
Operating profit margin EBIT /Net revenue 3.72% 3.53%
Acid-test ratio Quick Assets/Current liabilities 0.20 0.26
Asset turnover ratio Revenue/Total Assets 2.78 3.17
Inventory days (Inventory*365)/Cost of Sales 48.77 43.30
Days payables
outstanding 365*Account payable/Purchases 86.92 84.17
Days receivables
outstanding 365*Account Receivable/Revenue 14.48 13.43
Dividend yield
Dividend per Share / Market Value
per Share 8.67% 4.25%
Dividend payout ratio Dividend per share/earnings per share 59.18% 61.36%
Price/Earnings ratio
Market Price per share/Earnings per
share 6.83 14.44
(Peterson and Fabozzi, 2012)
Part (ii): Financial health of the company from management and shareholder’s point of
view
A: Management of the company: Management is mainly concerned liquidity, efficiency, and
market value of the company during the period. Liquidity has been measured through application
of acid test ratio as it is best method to measure the liquidity position of the company. The acid
test ratio of Media Tech Plc was 0.26 times in year 2015 and 0.20 times in year 2016 that clearly
shows that company liquidity performance has decreased in year 2016. It means management has
fewer resources to pay the short term liabilities as and when it arises. Efficiency refers to the
ability of the management to handle day to day activities like collection of account receivable,
payment of account payable and inventory utilization. Day’s receivable outstanding has been
increased to 14.48 days in year 2016 to 13.48 days in year 2015 that shows management takes
one day extra to collect the account receivable in year 2016 as compare to 2015. Day’s payable
outstanding has been increased to 86.92 days in year 2016 from 84.17 days in year 2015 that
reflects improved efficiency of management to hold payment of suppliers. Inventory days
outstanding has also been increased in year 2016 that shows company takes more time convert

inventory into sales. There was significant decline in P/E ratio in year 2016 that reflects poor
market strategy of management that had led to decrease in market price from 1.50 pounds in year
2015 to 0.79 pounds in year 2016. Return on capital employed is also consider important from
the management perspective as it shows percentage of return earned on total capital employed by
the management in business. There was decline in return on capital employed ratio that reflects
poor management performance during year 2016 (Ross, Jaffe and Kakani, 2008).
Shareholders: Shareholders are the true owner’s of the company and they have interest in
profitability performance and market return of their investment in company. It has been seen
from the return on shareholder’s investment ratio that return has been reduced from 7.13 % I
year 2015 to 6.75 % in year 2016. It has been seen from the gross margin ratio and operating
margin ratio that profitability performance has been improved in year 2016. There was 20%
increase in earnings per share and 7% increase dividend per share that shows profitability has
been increased in year 2016 as compared to year 2015. Due to decrease in market value per share
dividend yield was increased but on the other hand dividend payout ratio was decreased. So
overall it can be said that profitability performance of the company has increased in year 2016
but market performance has declined (Davies and Crawford, 2011).

Answer 4:
Part A:
Budgetary control is regarded as the management control in which the income and
expenses realized are compared with the planned income and spending for assessing whether the
financial goals are achieved or not. The differences in the results achieved are used for making
important decision regarding improving internal control over the operations of a company. The
budgetary control can be regarded as the technique for assisting the managers to have a control
over the organizational activities. The process of development of budgets is undertaken by a
business entity for providing assistance to the managers to plan, monitor and control the financial
performance. This is because the identification of the deviations in the actual and budgeted
performance assists the management to develop plans regarding the future growth that involves
establishing goals for achieving the determined targets. The business managers develop strategic
decisions for gaining control over the organizational activities to overcome the discrepancies
identified so that they does not restrict in achieving the determined objectives. The process of
budget development helps in resource allocation and enables the managers to take remedial
action for overcoming the variances identified. The development of clear targets and goals to be
achieved by the business managers also helps in providing a clear direction to the employees and
thus leads to improvement in their performances (Arnold, 2013).
Thus, it can be stated that the process of budgeting enables the management to promote
coordination between financial and non-financial goals for ultimately developing the strategies
that leads in promoting organizational growth. The development of plan for acquiring the
resources for achieving company long-term goals can be developed effectively with the use of
budgets developed. The plans developed should be monitored regularly for identifying the
differences in order to take effective control actions for overcoming the variances. In the context
of the above discussion held, it can be rested that budgets are an effective toll to be used by
business managers for planning, monitoring and controlling the business performance.
Part B:
It is highly important for developing and preparing the accounting information as per the
standard accounting concepts for improving the reliability and validity of the financial outcomes
disclosed by businesses for the end-users. The main objective behind the preparation of financial
or management accounts by a company is to fairly depict the real economic worth to its
stakeholders. The true and fair financial information can be disclosed by an entity with the use of
accounting concepts. In this context, the four fundamental accounting concepts can be discussed
as follows:
Going Concern

It can be stated as fundamental principle of accounting which assumes that the company
will continue to operate its operations in the future financial period also. The company will
continue to use its existing asset base for meeting the financial obligations in the future period
also.
Consistency
The accounting concept of consistency means that a business entity need to follow the
same principles of accounting for developing and presentation of financial information from one
accounting period to another. This requires for making comparison of the financial information
effectively over the consecutive financial years.
Prudence
This accounting concepts states that business managers need to adopt the use of a
cautious view for anticipating the future problems and costs of the business. The accounting
concept states that a business need to recognize revenue only when t is actually realized by
liabilities should be reported as soon as they are occurred (Weston and Brigham, 2015).
Matching
Matching principle is also regarded as one of the basic accounting concept that should be
adopted by the accountants during development of financial statements. The accounting principle
requires businesses to direct a company for reporting the expenses incurred on its income
statement in the same period as compared to the revenue realized. Thus, the accounting concept
requires that a business entity should report the revenues and the associated expenses in the same
accounting period for avoiding the occurrence of any issue related to misinterpretation of the
financial information.

References
Afza, T., and Nazir, M. S. 2009. Impact of Aggressive Working Capital Management Policy on
Firms’ Profitability. The IUP Journal of Applied Finance, 15(8), pp.19-30.
Arnold, G., 2013. Corporate financial management. Pearson Higher Ed.
Brigham, F., and Michael C. 2013. Financial management: Theory & practice. Cengage
Learning.
Damodaran, A, 2011. Applied corporate finance. John Wiley & sons.
Davies, T. and Crawford, I., 2011. Business accounting and finance. Pearson.
Krantz, M. 2016. Fundamental Analysis for Dummies. John Wiley & Sons.
Moles, P. and Kidwekk, D. 2011. Corporate finance. John Wiley &sons.
Peterson, P,P and Fabozzi,F,J,. 2012. Capital budgeting: theory and practice. John Wiley & sons.
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