ACCT11059 - Prada Group: Financial Analysis and Investment

This report provides a comprehensive financial analysis of Prada Group, a leading luxury fashion house. It identifies three key products: leather handbags, travel accessories, and perfumes, and estimates their selling prices, variable costs, and contribution margins. The report discusses the differences in contribution margins and their importance for managerial decision-making. It also examines the reasons for product diversification beyond the highest contribution margin item and the resource constraints affecting Prada Group. Furthermore, the analysis includes ratio analysis using restated financial statements to evaluate the company's financial condition and calculates economic profit over several years. Finally, the report assesses two capital investment options for machinery, applying investment appraisal techniques such as NPV, IRR, and payback period, and provides recommendations based on the analysis, concluding that selecting the second machine would increase overall sales and profit margin. Desklib provides similar solved assignments and past papers for students.

Running head: ACCOUNTING, LEARNING AND ONLINE COMMUNICATION
Accounting, Learning and Online Communication
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Table of Contents
Step 7: Variable costs and contribution margins.............................................................................2
7.1 Identification of three products of Prada Group:...................................................................2
7.2 Estimation of selling prices, variable costs and contribution margins for the identified
products:.......................................................................................................................................2
7.3 Difference in contribution margins for the three identified products and importance of such
difference:....................................................................................................................................4
7.4 Reasons for not producing the product only with the highest contribution margin:..............5
7.5 Resource constraints for Prada Group and relevancy of these constraints on the identified
products for decision-making:.....................................................................................................5
Step 8: Ratio analysis and economic profit:....................................................................................6
8.1 Ratio analysis:........................................................................................................................6
8.2 Economic profit:....................................................................................................................7
Step 9: Capital investment decision.................................................................................................8
9.1 Options available to Prada Group:.........................................................................................8
9.2 Application of investment appraisal techniques on the available options:............................8
9.3 Recommendations:.................................................................................................................9
References:....................................................................................................................................11

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Step 7: Variable costs and contribution margins
7.1 Identification of three products of Prada Group:
Prada Group is a leading luxury fashion house in Italy founded in 1913 and it operates in
the global market as well by taking into account all the social and cultural factors
(Pradagroup.com, 2018). The three products of the organisation that have been considered here
include leather handbags, travel accessories and perfumes. The first two products constitute of a
significant portion of the business earnings of Prada Group. The contribution of perfumes is not
enough; however, this product has been selected to find out the way the unessential product aids
the profitability of the organisation.
7.2 Estimation of selling prices, variable costs and contribution margins for the identified
products:
After conducting adequate research, it has been identified that the average price for each
handbag in the Italian leather market is €50. In addition, as Prada Group is involved in selling
quality products, the average price charged for travel accessories is €500. Finally, the average
cost of each perfume for Prada Group is obtained as €45. As obtained from the annual report of
2017 of Prada Group, the variable cost identified is selling, general and administrative expense.
The total selling, general and administrative expense is provided as €661,437,000, out of
which it is assumed that 60% of the expenses are spent on these products only. Hence, the total
selling, general and administrative expense on these products is €396,862,200 (€661,437,000 x
60%). Out of this cost, 60% of the cost is variable and the remaining 40% is fixed. Hence, the
total variable cost for the three identified products is €238,117,200. A certain percentage of the

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total selling price of each item is allocated to the variable cost of that particular unit, which is
depicted as follows:
 Leather handbags - 40%
 Travel accessories - 50%
 Perfumes - 10%
Based on the above information, the following table is prepared for arriving at the total
contribution margin ratio:
In addition, another table is prepared to determine the contribution margin and
contribution margin ratio for each of the three products, which is represented as follows:

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7.3 Difference in contribution margins for the three identified products and importance of
such difference:
In accordance with the above two tables, it could be stated that with the help of
contribution margin, the managers could ascertain the contribution of a product for covering
fixed costs (Chenhall & Moers, 2015). The main difference between the contribution margins of
the three products is due to the variation in the selling price and sales volume of each of the three
products along with the variation in variable cost. In case of leather handbags and travel
accessories, the sales volume is higher; however, the selling price for each travel accessories is
higher in contrast to the leather handbags. This has lead to the difference in profit generated from
each item.
On the other hand, the contribution margin for perfumes is much lower, since the volume
of sales is lower in the market and the selling price is the lowest in contrast to the other two
products. In addition, it does not need extensive services that need to be undertaken. Thus, it is
inherent to identify the difference in the contribution margins of the three products. In addition,
such difference would help the managers of the Prada Group to identify the most profitable
segment and accordingly, investment could be made to enhance those areas of business activities
and operations (Kamal, 2015).

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7.4 Reasons for not producing the product only with the highest contribution margin:
There are certain reasons that Prada Group would not produce only travel accessories,
since it has the highest contribution margin and such reasons are described as follows:
 If the competitors come up with identical products at cheaper prices, the customers might
switch over to them. As a result, the contribution margin for Prada Group would be
minimised.
 Secondly, if the cost of raw materials for producing travel accessories rise, there would
be increase in variable cost of the product as well. As a result, the contribution margin of
that product would decline.
 Finally, diversification of product base would help in generating additional customers for
Prada Group, since they could obtain various products from a single place. Not all the
customers are prone to purchase travel accessories only; thus, the other products are
included in order to maintain the profitability level of the organisation.
7.5 Resource constraints for Prada Group and relevancy of these constraints on the
identified products for decision-making:
The possible constraints that could affect the decision-making process of Prada Group
comprise of the following:
 Skilled staffs are the most significant resource constraint that Prada Group might face in
order to carry out its business operations effectively. This is because there are various
departments within the organisation, which include customer-handling department,
storage department and many others (Otley, 2016). Hence, it needs to recruit skilled and

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competent staffs for carrying out complex tasks, which could have impact on future
services.
 Another significant resource constraint is the availability of raw materials required to
produce the final products. The suppliers might raise the prices of materials, which
would increase its product cost in the operating market.
Step 8: Ratio analysis and economic profit:
8.1 Ratio analysis:
The following ratios are conducted with the help of the restated financial statements for
evaluating the financial condition of Prada Group:

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According to the above table, it could be found out that the profit margin of Prada Group
has fallen over the years due to the increase in operating cost and raw material price, while there
is fall of product demand in the market. This is further supported by the inventory turnover ratio
(in days), since the organisation is taking 215 days in 2016 to complete one inventory cycle. This
is quite a longer time span and hence, it needs to minimise its inventory level in order to avoid
inventory loss or theft. However, the current ratio of the organisation is well above the ideal
standard of 2 in 2016, which denotes that Prada Group has adequate amount of idle working
capital.
On the other hand, despite the fall in earnings ratio and price earnings ratio below 1, the
organisation is paying increased dividend per share to its shareholders, which denotes that it
intends to maximise the wealth of the shareholders. The similar trend is observed in case of
ratios based on restated financial statements, which implies that Prada Group is not enjoying
healthy and competitive position in the apparel industry of Italy.
8.2 Economic profit:
Economic profit or loss is the difference between the revenue obtained from selling an
output and opportunity cost of the inputs used. Thus, the opportunity costs are subtracted from
revenues earned at the time of calculating economic profit. The economic profit for Prada Group
for the years 2016, 2015, 2014 and 2013 is depicted as follows:

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In case of Prada Group, the economic profit for Prada Group has fallen over the years,
which denotes that the organisation is struggling to maintain competitive advantage in the
operating market.
Step 9: Capital investment decision
9.1 Options available to Prada Group:
It is assumed that Prada Group is planning to install machinery for increasing its
production level. Two machines are available to the organisation in the form of alternatives, in
which various assumptions are made. The first machine would help in raising the overall sales
volume of the organisation, while the second machine would focus on increasing the overall
product quality. These assumptions are depicted as follows:
Assumptions:
Particulars Units
Initial investment
for machine 1 € (2,000,000)
Initial investment
for machine 2 € (2,700,000)
Discount rate 10%
9.2 Application of investment appraisal techniques on the available options:
The following investment appraisal techniques are used for both the projects, which are
depicted briefly as follows:

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9.3 Recommendations:
Based on the above tables, it could be stated that the NPV for machine 1 is obtained as
€1,039,862.33, while the same for machine 2 is €1,861,949. This measure is used in capital
budgeting to analyse the profit level of a projected investment (Taleb, Gibson & Hovey, 2015).
The higher the NPV, the better is the profitability of the specified investment. In this case, the
NPV is greater for the second machine, which signifies that Prada Group should choose the
second machine for maximising its profitability and productivity.
IRR is used in capital budgeting for similar purpose like NPV and if it is higher than the
discount rate, it is considered as a feasible investment (Uyar & Kuzey, 2016). In case of machine
1, the IRR is obtained as 17.9%, while in case of machine 2, the IRR is 21.8%. Thus, in terms of

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IRR, machine 2 needs to be selected. On the other hand, payback period denotes the duration
within which the capital investment could be recovered. In this case, the payback period for the
first machine is 5.93 years, while the same for the second machine is 4.48 years. Hence, by
evaluating the techniques of investment appraisal, it could be inferred that Prada Group needs to
select the second machine for increasing its overall sales and profit margin.

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References:
Chenhall, R. H., & Moers, F. (2015). The role of innovation in the evolution of management
accounting and its integration into management control. Accounting, Organizations and
Society, 47, 1-13.
Kamal, S. (2015). Historical Evolution of Management Accounting. The Cost and
Management, 43(4), 12-19.
Otley, D. (2016). The contingency theory of management accounting and control: 1980–
2014. Management accounting research, 31, 45-62.
Pradagroup.com. (2018). Retrieved 6 February 2018, from
https://www.pradagroup.com/content/dam/pradagroup/documents/Financial-Report---
presentation/2_FULL-YEAR-2016-results----12-Apr-2017/e-Annual%20Report
%202016.pdf
Taleb, M. A., Gibson, B., & Hovey, M. (2015). Fifty years of Sustainability Accounting: does
accounting for income in business sustainability really exist?. International Journal of
Accounting and Financial Reporting, 5(1), 36-47.
Uyar, A., & Kuzey, C. (2016). Does management accounting mediate the relationship between
cost system design and performance?. Advances in Accounting, 35, 170-176.