ASSIGNMENT 3 DRAFT

ACCT11059 USING ACCOUNTING FOR DECISION MAKING

ASSIGNMENT 3

NAME: Ian Eisenhuth            STUDENT ID: s0274317

STEP 1:                   Ratio Analysis and Economic Profit

- See attached excel spreadsheet in Assignment 3 submission section on CQU Moodle site.

Commentary: The net profit margin is how much of every dollar the company keeps in earnings and return on assets is how efficient the company is at using their assets to generate income. Salmat’s net profit margin and return on assets profitability ratios remained fairly constant for 2011 and 2012 with their net profit margin 4.2% and 3.7% respectively and their return on assets was 5.2% and 4.4% respectively. They then experienced 2 years of massive swings where their net profit margin was 8.6% in 2013 and only 0.2% in 2014 and their return on assets was 9.2% in 2013 and 0.2% in 2014. This dramatic drop would have been due to a number of factors. The primary factor a result of a change in their business model and them restructuring the business in June 2013. The income statement shows that Salmat's revenue almost halves from 2012 to 2013 from some $823 million to $467 million and their profit before tax went from $40-50 million in 2011 and 2012 to $11 million in 2013. The profit from discontinued operations artificially boosted the profit for the year and hence the higher profit margin in 2013. 2014 appears to be a terrible year and this is due to the fact that the business experienced issues with implementing the new strategy and as a consequence the net profit margin is only 0.2% for 2014 the business put in place experienced issues when it came to implementing it. The sales for 2014 like 2013 are approximately half of the sales experienced in 2011 and 2012 and the all the costs except for finance costs for each year are similar. Considering a net profit margin of 10% is seen as good it is quite evident that Salmat has not performed very well in this aspect over the 4-year period. The same can be said for the return on assets as generally a value greater than 5% is viewed as good and Salmat performed below this.

The efficiency ratio is the amount of sales generated per dollar of assets and generally speaking the higher the number the better. Overall Salmat’s total asset turnover ratio remained fairly constant over the 4 years but it did deteriorate marginally in 2013 and 2014. This would have been due to the fact that the total assets were reduced as sales decreased. The sales decreased roughly inline with the total assets and this would have been a result of the company selling their BPO division in 2013.

Prior to the restructure of the business (ie in 2011 and 2012) the debt equity ratio and equity ratio were both constant at approximately 100% and 40% respectively. This is fairly high leverage for a business and represents refinancing risks as debt matures. Following the sale of the BPO division into 2013 the debt to equity is reduced to 38.5% in 2013 and 30.9% in 2014 and the equity ratio improved to 58.8% in 2013 and 52.5% in 2014. This represents an improved balance sheet position with less risks should debt markets deteriorate. Even though 2014 in particular was a terrible year from an earnings point of view at least there is less risk from a debt refinancing point of view because what sends a company broke is not being able to repay debt becoming due over the coming 12 month period, so the less debt expiring in the next 12 months the better.

The earnings per share (EPS) were not published or available for 2011. The EPS was 19.2 cents for 2012, 20.4 cents for 2013 and 2 cents for 2014. Clearly 2 cents per share for 2014 is a disastrous number, which reflects the considerably reduced income as the business transformation struck difficulties.

Salmat experienced negative economic profit for the years 2011, 2012 and 2014. This would have been due to the fact that the business cost of capital I used being 10% (as per recommended by Martin) is more than RNOA for each one of these years. 2013 they had a positive economic profit but again this was a result of the RNOA being artificially inflated and because the NOA has been decreased from the sale of the BPO division but there was still profit from BPO division being booked as profit from discontinued operations. It can be seen that the business has never really met its cost of capital total thresholds, although admittedly it got close in 2011 and 2012. 2014 was clearly a disaster on this metric as well as on all other metrics given the slow implementation of the new business strategy.

Overall these ratios tell me that Salmat as a company really has not performed that well at all, particularly in 2014 and even though the ratios make it look like 2013 was a good year it was just due the fact that everything was artificially inflated due to the sale of their BPO division that year for $375 million.

STEP 2:  Capital Investments decisions: Payback period, NPV and IRR

- See attached excel spreadsheet in Assignment 3 submission section on CQU Moodle site.

Commentary:  The 2 capital investment decisions I decided to work with are:

Option A: Voice recognition taxi booking service for Sydney (similar to the one already set up in New Zealand). It has initial investment/cost of $50 million with a forecast profit of $5 million per annum not growing to be sold in 10 years on the basis of a price earnings ratio of 10 times.

Option B: Voice recognition taxi booking service for Melbourne. It has an initial investment/cost of $50million with a forecast initial profit of $1 million which is lower than Sydney’s but which grows over time. Again it is sold after 10 years at a price earnings ratio of 10 times.

Judging from the payback period, the NPV and the IRR calculations the better business decision for Salmat and the one I would recommend for them to invest in would be the option B: the voice recognition taxi booking service for Melbourne. Even though the payback period for each option is fairly similar (option B = 9.5 years and option A = 10 years) option B is clearly superior when it comes to the NPV and IRR. The NPV for option B is $64 million (approx.), which is greater than the initial $50 million investment whereas option A NPV is only $48 million (approx.) which is less than the initial $50 million investment. Along with this the IRR for option B is 13.15%, which is greater than the 10% cost of capital (which I have used as the discount rate) whereas option A IRR is only 9.44%, which is lower than the 10% cost of capital. As you can see option B is clearly the better option for Salmat to invest in.

STEP 3:       Student Feedback

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