Operating Margin Fixed Assets And Intreset Expense

Published Date: 02 Nov 2017

Introduction:

Authur and Lucy have started their business in 1985 with the name of Bellingham PLC. The business was established to to design the studio and showrooms in high reputed area. After some time the company has registered itself as a publicly quoted company. In the start showrooms were started in Beaconsfield and Kensington, the demands for their kitchens are very high and the partnerships for the Bellingham had been expanded very rapidly. The company had registered itself as a limited company in 1990 and it faced very rapid growth until 1999. Additionally, the directors feel that company company has reached its growth limits and now it needs the expansion on a large scale. For this large scale development, directors are not able to raise the sufficient funds so that company management decided to go for international diversification and expansion. For this act company should take into account the most significant action and decided to acquire the acquisition of subsidiary which is working in the United States of America. For this proposal company should forecast the project so that finance director should evaluate the American Creations proposal on the behalf of Bellingham PLC. Under following are the detailed discussion of this proposal along with the calculations of the proposed models and their calculations.

1) An analysis of Bellingham's current position using relevant financial ratios. You should show the calculation of the ratios and provide interpretation of the results.

Ratio Analysis:

Financial ratios are the very simple tool to judge the performance and capabilities of the company. The ratio analysis Involves methods of calculating and interpreting financial ratios to analyze and monitor the firm’s performance (Rushinek and Rushinek, 1995).

Current ratio:

The current ratio of the company shows the downturn in the last three years 1.42, 1.23 and 1.56 in year 2012, 2011 and 2012 respectively. These figures give the idea about the company's operating efficiency. The benchmark for this ratio is 1 but in this case the company ratio is greater than the one it shows the company have safe liquidity but on the other hand it shows the long inventory turnover and indicates the company is not using their assets efficiently.

Quick ratio:

Quick ratio of this company shows the higher trend in the last year but in the year 2011 and 2010 it shows low figures. This ratio indicates the how assets can be quickly converted into cash. Furthermore, the speed is a more conservative measure because the list will be deducted from current assets and the resulting number is divided by the current liabilities. The nature of the business as a whole determines the value of this ratio. The companies who list high speed ratio being low and vice versa.

In this case of Bellingham PLC the quick ratio is high at 2012, this figure shows that every 1 pound company has 2.5 pounds of liquid assets to cover the its immediate obligations. This same trend follows in the later years 2010 & 2011, however in these two years the ratio is very low that's means company have less assets to cover its obligations.

Debt to equity ratio:

Debt to equity ratio is calculated by dividing total debt by total shareholder equity. It measures the proportion of debt and shareholders' equity used to finance a company's assets.

The company debt to equity ratio shows that company has less amount to pay its creditors. In 2011 and 2010 this ratio is increase that's means company have many obligations to pay its creditors. Recent year company has increased its operations and paid its debts on time.

Accounts Receivable turnover:

Accounts receivable are used to determine the effectiveness of an organization by expanding its credit as well as regaining its debts. By sustaining accounts receivables organizations company can extend their interest free loans to their clients and extend their operations. In last years company makes the receivables collection system very effective through its efficient performance. In 2010 the receivables days was almost 10 days and in 2012 days are 5.5 that's means company recover its cash very rapidly and it has opportunities to invest cash in other business to generate more profit.

Inventory turn over:

Inventory turnover refers to the days inventory held by the company in its warehouses. In this ratio company have maintained its invention over by almost 2 months. The companies deal in furniture business and it takes time to sell a single unit so that company require this much time to hold the inventory. Moreover company should take measures which keep the inventory day's low so that companies' sales will increase by this action.

Return on Equity

Return on equity is calculated by dividing sales by shareholders' equity. It measures the ability of managers to generate an adequate return on the investments made by the owners of the company. The figures show that return on equity is lower than the previous two years that's mean company making 1.08 pounds against 1£ investment.

Return on Assets:

Return on assets is calculated by dividing sales by total assets of the company. It measures the company's ability to generate earnings / profits on the assets used for the business, is money made per pound of assets. The return on assets of the company is approximately kept constant because the amount making profits on assets is almost same over last three years.

Operating Margin, Fixed Assets & Intreset Expense:

The operating margin ratio shows the amount of making profits on the investment. The ratio shows that the amount of making profits is going because in last three, the company has to increase its efficiency and performance to intensify its profits. The fixed assets ratio indicates the making of profits over fixed assets, the figures show that the company increases its capability for making profits over fixed assets. The interest expense ratio shows the company's ability to pay the interest over the loans. The ratio indicates the company paying the interest on their long term liabilities.

2) Calculation of Bellingham's cost of capital, using alternative methods and arriving at the most appropriate figure.

Cost of Capital:

The weighted average cost of capital (WACC) is an important factor which provides the rate of return on the required investment needed for the project. It is based on the proportion of equity, debt, the market value of the company and beta which shows the risk factor. It is very important for assessing company's health (Ward, 1999).

The calculated cost of capital of Bellingham's is 7% which is based on the 35 percent of equity and 65% of debt and the beta require for this cost of capital is 1.65.

3) Calculation and discussion of alternative valuations of acquiring the share in American Creations and how these would impact on the investment appraisal.

The alternative valuations of acquiring the shares in American Creation should be done in three ways. The first method which is discussed in the report is the evaluation of Net Present Value. The second method which can be used is the share evaluations of the Harvey Wilkinson Designs plc and the third method is the evaluation of shares of Cucci Lifestyle plc. In the case the directors of Bellingham plc indicates that the firm nominal capital share is $2.5 million and the value of the company is five times the year 2010 profit.

4) A sensitivity analysis of the proposal and interpretation of the results.

400 - 500 required for this solution

5) An investment appraisal of the American Creations proposal assuming the valuation Suggested in the case, using a variety of methods and evaluation of the results.

Evaluation of Net Present Value:

Net present value is a very valuable source to provide the decision about the investment. Net present value is the difference of all the future cash flow which are produced by the project and the amount of the cash investment for the required project (Hwa, 2008).

In the case of Bellingham PLC the net present value for the acquiring of American creations is $4047. 2 Million. The the present value of the projected cash flows for the next five years gives the $11547 million and then invest required for the this question is $7500 million. The difference between cash inflows and outflows shows that the company has the additional value of $4047. 2 million, which gives the company additional advantage in terms of revenue and growth.

Additionally, this acquisition project spread over five years time period, so one of the most important benefits for the positive net present value is that it gives the Bellingham plc more income which they are earning from the discount rate that indicates, the company should go with acquisition projects. Furthermore, the company should provide the foreign currency exchange rate so that Bellingham plc also evaluate the any international currency risk associated with the investment. Moreover, the past currency exchange rates provides the idea about the fluctuations in the foreign currency. Under following there is graph which shows the PV value of cash flows.

Figure Graphical representation PV of Cash Flows

6) Calculation and discussion of alternative valuations of acquiring the share in American Creations and how these would impact on the investment appraisal.

The alternative valuations of acquiring the shares in American Creation should be done in three ways. The first method which is discussed in the report is the evaluation of Net Present Value. The second method which can be used is the share evaluations of the Harvey Wilkinson Designs plc and the third method is the evaluation of shares of Cucci Lifestyle plc. In the case the directors of Bellingham plc indicates that the firm nominal capital share is $2.5 million and the value of the company is five times the year 2010 profit.

We can take these two companies for the alternative evalution

1st Method

Evaluation of American Creations

The comparative price earnings multiplier is 5 for American Creation plc

Profit for year 2010 is 1500

1500*5 = 7500 Million

2nd alternative

Evaluation of Harvey Wilkinson Designs plc:

The comparative price earnings multiplier is 10 for Harvey Wilkinson Designs plc

Profit for year 2010 is 1500

1500*10 = 15000 Million

NPV = -3452.834

3rd evaluation:

Evaluation of Cucci Lifestyle plc:

The comparative price earnings multiplier is 8 for Cucci Lifestyle plc

Profit for year 2010 is 1500

1500*8 = 12000 Million

NPV = -452.8339

The net present value of the 2nd and 3rd evaluation methods is in the negative, which indicates that the projected investment did not give return on investment and it will give less. In the case of Bellingham plus the company should go for the first option because it provides enough return to provide the stability of the company.

A discussion of the various available methods of financing the acquisition and consideration of which is the most appropriate.

To complete the process of acquisition Bellingham should raise the capital to finance this acquisition. However, question is very important for the Bellingham PLC because its threats competitive advantage, open new opportunities for the business and enhances the product line. To complete this process company need the adequate amount of capital which can be debt, equity and acquirer's stocks or any combination of these. Under following is the discussion of the various sources of finance (Gordon, 1963).

Debt financing:

Debt is the most cheap and easy way to finance the acquisition and it can be done in various forms. The amount of debt is directly based on the projected cash flows of the both companies and it has a very significant effect on acquirer and target company. The bank will provide the lowest priced debt which is called senior debt. There are so many other suppliers available in the market who provide the senior debt in different ways of structured loans (Watson and Head, 2010).

In the similar way the debt is very cheaper than the equity, the amortization and interest requirements are very convenient which gives the company financial flexibility. The companies looking for the rapid future growth they always require the adequate amount of capital, so they will go for debt financing.

Equity Financing:

Equity is the very high-priced type of capital because it is more risk than debts and the company have no claim over the assets while using the equity as a financing option. The whole process of acquisition is a very unstable process, it carries unbalanced cash flows and very turbulent market Constance, so sometimes it requires a very big amount of equity. Furthermore, equity requires to give some proportion of ownership of the organization, this will require the authorization from the board of directors (Redman, Tanner and Manakyan, 2002).

Stock Swaps:

Stock swap is another method for financing for acquisition, in this method the company exchange its few assets with acquiring company assets. For the stock swap both companies will be evaluated equally and swap ratio will be determined. However, to complete the process the both company's equity and share prices will be evaluated. There is a collection of methods to evaluate the stock swap (Graham, 2004).

Discounted cash flow valuation analysis

Equivalent transaction valuation analysis

Value of publicly traded shares analysis

Most appropriate Method of financing:

According to the debt to equity ratio in ratio analysis and the calculation of cost of capital the company must go for stock swap option for acquisition of USA subsidiary. In the cost of capital the debt proportion is 65% which indicates that the company aggressively taking debts for its rapid growth. Moreover, if a company takes more debt as borrowings it can reduce the future earnings of the Bellingham PLC so that according to my recommendation company should offer the stock swap option to raise the capital to finance its acquisition.

Note: For all calculations please refer to Excel Spread Sheet file