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Provisional Uncapped
Q1 quant. 12 12 All ratios correct Mark Marks will be capped
if this was a late
Some incorrect statements-2; some submission or resit
assessment and may be
descriptive elements rather than moderated up or down by
the examination board.
analytical -2; efficiency -1; gearing -
1; WCM required further analysis -
qual. 28 17 2; Incorrect evaluation on financial 85 %
market -2; do not use phrases like
“a tough cookie” this is colloquial
and not academic or professional
-1.
All contributions correct; missing
suggestions to evaluate whether
Marginal the discontinuing product is
Q2 15 13
Costing dependant or independent -1;
lacking discussion on improving
sales-1

Well done; no mention of risk, used

Project
Q3 15 14 colloquial/unprofessional term
Appraisal
“cuts it close” -1

Scarce
resource Well done; change company policy
Q4 planning 30 29 to avoid losing money by making
and uninformed decisions -1
budgeting

1
ID Number: 19145025
 TOTAL 100 86

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2
ID Number: 19145025
 Proper report header/ format used. This is an easy mark. NB - please
ensure you use a proper header as this shows your ability to follow
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scheme for mark(s) available for the format.
1.1
To: The Directors of Alphabet Holdings Plc
From: Maitham Rajvani – Financial Analyst at Alphabet Holdings Plc
Date: 11th January 2020
Subject: Financial Analysis of 2 Acquisition Targets: ABC Ltd &XYZ Ltd
Introduction
This report demonstrates the financial analysis of both companies that could be potential
investments for Alphabet Holdings Plc. Along with a critical evaluation, I have also explained my
recommendation on which company to acquire and why.

Profitability
The average shareholder’s expectation as per Standard and Poor’s 500 is approximately 10%
(S&P Global, 2020), therefore both companies can satisfy investors from a profitability
perspective.
Excellent writing style with benchmarking (to Standard Poor 500) shows the student's evidence-based writing skill. Would have been more
effective if the student had captured the industry/ competitor comparisons as well - much closer to the case.
With a yearly profit of 21%, XYZ is likely to produce the highest return for shareholders. Due to
recruiting less staff, XYZ also has a GPM of 62.7% compared to ABC’s 36.5% who recruit more
to care for young children.
Incorrect grammar, yellow. A very good attempt linking profitability to practical staffing issues. Understand nature of business to understand costs
affecting gross profit and those affecting net operating profit - advised to fully understand the business and business nature to inform
However, ABC’s nature of business results in them having less than half the asset base
compared to XYZ who store and repair vehicles, giving them a higher ROA and ROCE.
Overall, XYZ is more profitable and their operations seem to be more in line with Alphabet’s
current investments. Captured practical issues that affect profitability

Liquidity
This is an organisation’s ability to pay for its current obligations (Kontus and Mihanovic 2019)
and a current ratio of above 1 is deemed to be enough (Durrah. Et.al 2016).
Theory, requiring context but well referenced.
ABC is within this range, however, XYZ has almost three times more. On the contrary, a ratio of
4.2 demonstrates inefficiency of current assets being in the bank and receiving 0.1% return
(Mosquera, 2020) rather than investing in current assets to receive 41.3% return.
Very good attempt but requires consideration of implications and industry in context. Also important to capture alignment to acquiring company
policy and/or future efforts required.
Ultimately, XYZ holds more than three times the amount of cash, compared to ABC resulting in
XYZ being the more appropriate company to invest in, especially from a “cash is king”
perspective.

Management Efficiency
This ratio assists in analysing the utilization of current assets and management of liabilities for
an organisation, from an internal perspective (Borad, 2019) Theory

ABC is running a safe operation since their client is the government who pay them obediently
within 19 days. On the contrary, ABC takes 97 days to clear their payables, giving them a cash
cycle of -78 days. This gives them a very good cash cycle where they receive almost five times
the amount of money, before having to pay it out once. Excellent context consideration i.e
nature of clients - government
XYZ’s nature of business means their clients are individuals who are away for long periods of
time with the Heavy Goods Vehicles (HGV), resulting in their trade receivables being cleared
after 83 days. Unlike ABC, XYZ clear their payables after 119 days, giving them a cash cycle of
-37 days.

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ID Number: 19145025
ABC has a better cash cycle, however XYZ is deemed to be more ethical, would be more
valued and promises to be able to result in long-term relationships with their suppliers.

Gearing
The optimum gearing ratio is advised to be between 25-50% (Siyanbola, 2019).

XYZ has a ratio of 50%, keeping it within range while ABC has 0 since they have no debt. No
debt may sound great, but it can be argued to be a missed opportunity. Banks grant loans with
7% interest (Barclays, 2020) and this can easily be financed by ABC who can in return, earn
18% net profit or if they invested in capital employed or assets, earn 64%. Another alternative
would be to invest in cost of sales, earning 36.5% gross profit.

ABC could also use that cash to invest into buying a hotel, which would be easily affordable
considering they would have a mortgage of about 3-4%, saving them the lease costs currently
being paid.

XYZ’s 50% gearing may be slightly concerning at first, however their interest cover ratio
demonstrates their operating profit being almost ten times more than what they pay as interest
charges, classifying their gearing as ideal.
Captured theory, referenced
(See Appendix 1 for all Ratio Calculations)

Conclusion
ABC and XYZ are both profitable and sustainable businesses to invest in.

ABC is a safe option and has the better cash cycle considering their nature of business,
however XYZ is more profitable and has the better liquidity making them the better target, while
ABC is a good tenant.

Recommendation
XYZ’s line of business provides more synergy and greater potential for long-term success as
well as better monetary benefits for Alphabet Holdings.

Having said that, several practices will have to be improved upon, in order to make this
business more profitable. Hiring debt collectors to follow up on pending payments and investing
in assets by using the cash in the bank would be my initial suggestions, which should see XYZ
turning over much greater revenue and resulting in greater profit margins with less trade
receivables.

The directors of Alphabet Holdings should consider entering a contractual agreement with ABC,
leasing the loss-making hotel to them, resulting in creation of external income and cancelling
out any losses.

Also consider inadequacy of information - only one year's financials given, unable to
do trend analysis which is beneficial. Also consider other limitations of ratio analysis
e.g reliance on historical data, changes in dynamics, manipulation risks.

Also consider strategic fit and synergies.

Also borrow from PESTEL model in analysis considering practical issues as
applicable e.g Brexit, Russo-Ukranian war, oil prices, inflation, interest rates etc
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ID Number: 19145025
Appendix

Ratios Abbreviations Formula Unit ABC Care XYZ Vehicle

Services Services
Ltd Ltd
Profitability
Return on ROCE PBIT/Capital % 64% 41%
Capital Employed
Employed
Return On ROA PBIT/Total Assets % 64% 41.3%
Assets
Assets AT Revenue/Total x 3.7 1.4
Turnover Assets
Gross Profit GPM Gross Profit/Revenue % 36.5% 62.7%
Margin
Net Profit NPM PBIT/Revenue % 18% 29.3%
Margin
Efficiency
Receivables R Trade Days 19 Days 83 Days
Collection Receivables/Sales
Period (R) *365
Payables P Trade Payables/Cost Days 97 Days 119 Days
Payment Period of Sales * 365
(P)
Cash Cycle R-P Days -78 Days -37 Days
Liquidity
Current Ratio Current x:1 1.6:1 4.2:1
Assets/Current
Liabilities
Financial Risk
Gearing Fixed Interest % 0.0% 50%
Capital/Capital
Employed
Interest Cover PBIT/Interest x 0.0 9.6
Ratio Charges

Well presented table.

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ID Number: 19145025
1.2 Working Capital Management (WCM)
According to Ganesan (2007), WCM can be described as cash used by an organisation to
maintain an efficient balance between its current assets and current liabilities. Working capital
ratio is calculated as:

(Leiwy and Perks, 2013)

Below are the Working Capital Ratio’s for ABC and XYZ:

ABC Ltd
Current Assets £83,406
Current Liabilities £51,806
Working Capital Ratio 1.6

XYZ Ltd
Current Assets £130,287 Also required to consider efficiency
Current Liabilities £30,736 ratios in relation to industry dynamics
Working Capital Ratio 4.2

A ratio of 1.5-2.0 is optimal, keeping the company on solid financial footing (Biedron, 2019).
Therefore, with a ratio of 1.6, ABC is within range of an optimal working capital.

However, XYZ is out of range with a ratio of 4.2. A higher ratio is preferable to a lower one, but
a ratio of 4.2 shows available capital as underutilized and inefficient. This means assets exist in
excess that have not been re-invested to generate additional income but have rather
accumulated in the bank account, generating zero return, considering the base rate on fixed
deposits are approximately 0.1% (Bank of England, 2020). As a result, this will lead to a poor
ROA and a missed opportunity for additional income.

Conclusively, ABC is considered to have a stronger Working Capital since it is more within ideal
range rather than XYZ.

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ID Number: 19145025
1.3 Sources of Finance
The first step is to estimate the amount of capital required in order to acquire XYZ.

As per the Price Earnings Ratio Database, the Price-Earnings Ratios (PER) is 6.4 (PERDa,
2020). Therefore, if we multiply it by the operating profit of XYZ, it gives a total of £472,000,
rounding it off to £500,000. Hence, Alphabet Holdings Plc requires about £500,000 to buy XYZ.

Some of the sources of finance available to Alphabet Holdings Plc are:

Advantages Disadvantages Accept/Reject
Long Term Bank Loan Tax in this case is It is a risky source Reject to avoid
(Wenta, 2018) cheap because since the lender risk.
interest is deductible. requires security and in
case of non-payment,
Generally, it is reserves the right to
cheaper than equity. seize the assets of the
company.
Shares – Right Issue Share prices in this The company can be Reject to find
(BBC, 2020) case are lowered, viewed as going into cheaper and more
making it very financial difficulty. credible options.
attractive to
shareholders and is a
very quick source of
finance.
Preference Shares In case of a low Dividends are fixed and Reject to avoid
(Korchak, 2019) performance and no therefore must be paid risk and creating a
profits, paying first before paying tense atmosphere
dividends is not an ordinary shareholders, between all the
obligation. resulting in an element different types of
of risk. It is also bound shareholders.
Can provide long-term to create tension and
capital with no fixed conflict amongst the
date of repayment. different types of
shareholders.
Stock exchange Good recognition to be Expensive. Reject to keep
market. on the market. Can result in hostile security of the
(Scott, 2016) Limited liability for takeover company.
shareholders
Mixture of shares and Easy to convince Shares sold to them Accept as it has
cash with directorship. directors with cash, won’t generate minimum risk and
(Glautier and shares and revenue. is cheaper than all
Underdown, 2001) directorship. other options
Cheap as well. ABC
keeps ownership of
both companies.
Alphabet Holdings should offer £50,000 each to both XYZ directors and 22.5% shares, in order
to acquire their company. It could be enough to convince them however, in case they still prove
to be a tough cookie, they should be given a seat at the table to be a director of the Holding
company. This source of finance is cost-free to Alphabet Holdings as the £100,000 will be from
XYZ’s bank reserve. Although both directors will receive a combined 49% of shares, Alphabet
Holdings will remain owners and will have acquired XYZ successfully. This source of finance is
highly recommended as it proves to be a win-win for both the Holding company as well as XYZ.
Well laid out but could also consider need for information regarding
holding company gearing 7ratio etc
ID Number: 19145025
2 (i) Marginal costing is an essential method that should be used to make short-term decisions
with regards to profitability, since they are unlikely to change during small durations. It splits the
costs into two; variable and fixed (Leiwy and Perks, 2013).

Once the costs are split, we can now calculate the contribution a single product makes by
subtracting the variable cost from the sales revenue, while fixed costs remain uniform for all the
products.
Below we have the marginal costing calculations for each of the products:

DEF PRODUCTS LTD

AXOR BOZON CARBON TOTAL
£m £m £m £m
Sales Revenue 7,920 5,280 3,780 16,980
Variable Costs
Materials (2520) (1680) (1680) (5880)
Labour (2520) (2520) (2520) (7560)
Contribution 2880 1080 (420) 3540

Fixed Costs (3780)

Net Operating Income (240)

ii) From the findings in part (i), BOZON has the second highest contribution after AXOR,
therefore ceasing the production of BOZON would result in a greater loss. Below is the marginal
costing, reflecting the impact on the net operating income if BOZON’s production is ceased:
AXOR CARBON TOTAL
£m £m £m
Sales Revenue 7,920 3,780 11,700
Variable Costs
Materials (2520) (1680) (4200)
Labour (2520) (2520) (5040)
Contribution 2880 (420) 2460

Fixed Costs (3780)

Net Operating Income (1320)

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ID Number: 19145025
iii) CARBON results in a negative contribution, therefore ceasing its production would result
positively on the Net Operating income, if AXOR and BOZON are both being produced. The
table below shows the impact:
AXOR BOZON TOTAL
£m £m £m
Sales Revenue 7,920 5,280 13,200
Variable Costs
Materials (2520) (1680) (4200)
Labour (2520) (2520) (5040)
Contribution 2880 1080 3960

Fixed Costs (3780)

Net Operating Income 180.00

iv) The directors have been misled into thinking that fixed costs would be deducted if they were
to cease the production of a specific product.

Marginal costing has proved, regardless of the number of products that are to be produced,
fixed costs remain to be £3780, which is why marginal costing is very effective in evaluating
product value.

v) Ceasing the production of both BOZON and CARBON will not increase profitability, but rather
result in a greater loss from £240m to £900m. Below is the calculation:

AXOR TOTAL
£m £m
Sales Revenue 7,920 7,920
Variable Costs
Materials (2520) (2520)
Labour (2520) (2520)
Contribution 2880 2880

Fixed Costs (3780)

Net Operating Income (900)

Use proper academic language

My suggestion is to cease the production of CARBON; however, the organisation must continue
producing AXOR and BOZON, resulting in a Net Operating Income of £180m.

I’d also suggest increasing the production of AXOR since it has the highest contribution, and it
should result in profit maximisation, if fixed costs will continue to remain uniform.

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ID Number: 19145025
3) i) Calculating the Net Present Value (NPV)
Year 0 Year 1 Year 2 Year 3 Total
£ £ £ £ £
Capital Investment
Land (100,000) (100,000)
Building Costs (158,000) (158,000)
Fittings and Equipment (36,600) (36,600)
(294,600)
Sales Revenue 600,600 612,612 624,864 1,838,076
Operational Costs
Cost of Axor Products Sold (165,900) (169,218) (172,602) (507,720)
Cost of Bozon Products Sold (118,860) (121,237) (123,662) (363,759)
Staff Costs (24,780) (25,276) (25,781) (75,837)
Light and Heat (35,196) (35,900) (36,618) (107,714)
Other Overheads (134,904) (137,602) (140,354) (412,860)

Total Cash inflow/outflow (294,600) 120,960 123,379 125,847 370,186

Cost of Capital is 12%

Present Value Factor at 12% 1.000 0.893 0.797 0.712

Calculating the Net Present Value:

Year 0 Year 1 Year 2 Year 3 Total
£ £ £ £ £
Capital Investment (294,600) (294,600)
Sales Income 600,600 612,612 624,864 1,838,076
Operating Costs
Cost of Axor Products Sold (165,900) (169,218) (172,602) (507,720)
Cost of Bozon Products Sold (118,860) (121,237) (123,662) (363,759)
Staff Costs (24,780) (25,276) (25,781) (75,837)
Light and Heat (35,196) (35,900) (36,618) (107,714)
Other Overheads (134,904) (137,602) (140,354) (412,860)
Net Cash Flow (294,600) 120,960 123,379 125,847 75,586
PV Factor 1.000 0.893 0.797 0.712
Discounted Cash Flow (294,600) 108,017 98,333 89,603
Net Present Value 1,353

ii) Payback Period (PBP):

Year 0 Year 1 Year 2 Year 3
£ £ £ £
Net Cash Flows (294,600) 120,960 123,379 125,847
Cumulative (294,600) (173,640) (50,261) 75,586

The Payback period is 2 years and [(50,261/125847) * 12] = 2 Years and 4.8 Months.

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ID Number: 19145025
 Discounted Payback Period (DPBP):
Year 0 Year 1 Year 2 Year 3
£ £ £ £
Discounted Cash Flows (294,600) 108,017 98,333 89,603
Cumulative (294,600) (186,583) (88,250) 1,353

The discounted payback period is 2 years and [(88,250/89,603) * 12] = 2 Years and 11.8
Months.
Well presented
iii) Internal Rate of Return (IRR)

The company’s criteria were set at a 5% cushion for possible increase in inflation rates after the
current cost of capital which is set at 12%, giving an accumulated total of 17%. Therefore, for
this project to be accepted, the IRR must be higher than 17% at least.

In this scenario, the Internal Rate of Return is: 12.26%

iv) Recommendations

Summary of findings:
METHOD RESULT CRITERIA Decision
Net Present Value £1,332 Must be Positive Accept
Payback Period 2 Years and 4.8 Must be less than 3 Accept
months years
Discounted Payback 2 Years and 11.8 Must be less than 3 Accept
Period months years
Internal Rate of Return 12.26% Must be 17% or more Reject

I would not recommend that this project should be undertaken because the discounted payback
period cuts it close to just within the range of under 3 years, however when we look at the
Internal Rate of Return, it is nowhere close to the criteria set by the company. Therefore, this
project will not be able to cope with any future inflations possible and hence, I don’t recommend
going forward with this specific project.
Do not use contractions like don't didn't etc in
writeups
Well evaluated. Critical analysis needs to consider issues regarding value of NPV (how close
is it to zero), payback and discounted payback periods' closeness to threshold.

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ID Number: 19145025
 More context required but well attempted.
v) Limitations of project appraisal techniques

Appraisal Technique Advantages Disadvantages

Net Present Value Considers the time value for This is a cash-based
money and thus is a very forecasting technique and
easy appraisal technique therefore isn’t a universal
where a positive result is appraisal technique that can
accepted and a negative one be used in all projects
is rejected (Hopkinson, (Hopkinson, 2016).
2016).
Payback Period It is simple, easy to calculate PBP does not consider time
and focuses on cash flows value for money and is
which is very useful, completely based on net cash
especially where cash is a flows which is inaccurate,
scarce resource (Leiwy and considering businesses
Perks, 2013). operate in a dynamic
environment (Leiwy and
Perks, 2013).
Discounted Payback Period Considers time value for DPBP is unable to give a
money and calculates the clear result on what value the
actual risk involved in a project would give the firm
project (Jones, 2006). (Jones, 2006).
Internal Rate of Return Unlike NPV, this appraisal Companies often assume a
technique is universal and will figure for the internal rate of
remain constant even if NPV return which can also be
values are doubled. This described as a form of
appraisal technique is very blanket discount rate, which
useful for large projects that one can argue to be
may be accepted when inaccurate to some extent
calculating the NPV but (Atril and McLaney, 2017).
would be very marginal when
calculating its IRR. (Atril and
McLaney, 2017).

My recommendation to Alphabet Holdings Plc is to always use the above four appraisal
techniques when deciding to invest into a project. The above four techniques have proven to be
accurate indicators of how long an investment can take to be paid back thus a project should
only be accepted when all four appraisal techniques give results that meet the conditions set by
the company.

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ID Number: 19145025
4.1
4.1.1 Fixed and Variable Overheads using High/Low Method
Silver Gold Platinum Total
£ Units £ Units £ Units
High 66,000 9,000 45,750 4,500 163,200 7,000
Low 60,000 8,000 42,000 4,000 120,000 5,000
Difference 6,000 1,000 3,750 500 43,200 2,000

Variable Overhead
Per Unit 6 7.50 21.60

Total Variable
Overhead 54,000 33,750 151,200

Fixed Overhead 12,000 12,000 12,000 36,000

4.1.2 Marginal Cost Card

Silver Gold Platinum
Sales (£) 180,000 150,000 500,000
Units 8,000 4,000 5,000
Selling Price (£) 23 38 100
Variable Costs
Raw Materials (£) 60,000 66,000 144,000
Direct Labour (£) 24,000 20,000 130,000
Variable Costs Per Unit (£) 16.50 29 76.40

Contribution Per Unit (£) 6 8.50 23.60

4.1.3 Contribution of unit per scarce resource

Silver Gold Platinum
Contribution Per Unit (£) 6 8.50 23.60
Amount required to produce (Kg) 2 5 6

Contribution Per Scarce Unit (£) 3 1.70 3.93

RANKING:
1st: Platinum
2nd: Silver
3rd: Gold

Well presented, methodical

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ID Number: 19145025
4.2 Budget Production Schedule considering the Gold contract is honoured:

Total Available Material: 90,000 Kgs Silver Gold Platinum Total

Units required 8500 5000 8000
Heat resistant per unit (kg) 2 5 6
Total amount required (kg) 17000 25000 48000 90000

Marginal Cost Income Statement as per the above budget schedule:

Silver Gold Platinum Total (£)
Sales Revenue (£) 191,250 187,500 800,000
Sales (Units) 8500 5000 8000
Variable Costs
Raw Materials (£) 63,750 82,500 230,400
Labour (£) 25,500 25,000 208,000
Overheads (£) 51,000 37,500 172,800
Total Variable Costs (£) 140,250 145,000 611,200

Contribution per product (£) 51,000 42,500 188,800 282,300

Fixed Costs (£) 36,000
Total Profit (£) 246,300

4.3 Budget Production Schedule considering the Gold contract is not honoured:
Silver Gold Platinum Total
Units required 10000 4400 8000
Heat resistant per unit (kg) 2 5 6
Total amount required (kg) 20000 22000 48000 90000

Marginal Cost Income Statement as per the above budget schedule:

Silver Gold Platinum Total (£)
Sales Revenue (£) 225,000 165,000 800,000
Sales (Units) 10000 4400 8000
Variable Costs
Raw Materials (£) 75,000 72,600 230,400
Labour (£) 30,000 22,000 208,000
Overheads (£) 60,000 33,000 172,800
Total Variable Costs (£) 165,000 127,600 611,200

Contribution per product (£) 60,000 37,400 188,800 286,200

Fixed Costs (£) 36000
Total Profit (£) 250,200
Penalty for not honouring Gold contract (£) 10,000
Total Profit (£) 240,200
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ID Number: 19145025
4.4 Suggestion to the Directors of Continental Engineering Ltd

As per the marginal income statements, profit is maximised when the contract for producing
Gold percolators is not honoured. However, the clause in the contract agreement results in a
penalty of £10,000, restricting profit maximisation and results in a lower profit than if the contract
is honoured.

Therefore, I advise the company to honour the contract and prioritise the production of Gold
percolators before moving onto the production of Platinum and Silver respectively.

In this scenario, Continental Engineering Ltd has lost out on approximately £4000 profit due to
the sales director accepting an order for Gold percolators without consulting the financial team
of advisors.

I suggest all the sales directors should be shown these marginal income statements and should
be strictly advised to consult the finance team before committing to any orders, enabling the
organisation to maximise profits.

Well attempted with the need to consider more practical implications e.g risk of
losing disappointed customers and the knock-on effect.

15
ID Number: 19145025
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