UNIVERSITY OF SYDNEY BUSINESS SCHOOL
FMBA5006 FINANCIAL MANAGEMENT
INDIVIDUAL ASSIGNMENT
PART A (70 marks)
You have been approached by the strategy team in your company. They are considering the acquisition of one of two companies, each of which are deemed to be a good strategic fit for the company. You have been asked to review the financial performance of each company over the last six years (let’s call them ‘Target A’ and ‘Target B’) and provide a narrative on their performance that could be presented to the Board of Directors. The strategy team acknowledge that while the future trajectory of these companies matters more than their past performance, your commentary will help them understand the journey these companies have traversed and if it would be appropriate to keep the current leadership/management team of these companies in place post-acquisition.
Required
Drawing on whatever analytical tools and measures you deem appropriate, provide a narrative on each company in terms of its financial performance over the measurement period. As a guide, you should consider the following:
The overall financial performance of the company over the period.
The actions management appear to have taken in certain periods and the extent to which these actions appear to have been successful.
Any other factors you deem relevant.
Based on your analysis, provide a recommendation for the strategy team on which company you feel has performed the strongest over the period, noting the different business models that the financials may appear to reflect.
Note the strategy team do not want you to know the name of the companies to conduct this exercise, nor do you need to identify them. The aim is to demonstrate your ability to analyse and interpret the financial reports of a company and ‘tell their story’ in a meaningful way.
The financial reports for Target A and Target B are presented below. To assist you, the data has been put into an Excel file and uploaded to Canvas.
Word Guide: For this assessment, your report for the strategy team should not exceed 3,000 words (excluding tables and appendices). The strategy team is hoping they can include your commentary and analysis directly in the Board papers.
PART B (15 marks)
Presented below is the latest income statement and balance sheet for Verbose, a rapidly growing start-up business.
The founder is required to provide a forecast income statement and balance sheet for each of the next 3 years and has asked for your assistance. Details are as follows:
In line with the rapid growth that Verbose has been experiencing, revenue is expected to double each year over the next 3 years
Expenses are forecast to be equal to 70% of revenues
The tax rate on profits is 30% each year
Receivables are equal to 25% of revenue each year
Inventories are equal to 20% of revenue each year
Plant, property, and equipment (PPE) is steady $100,000 each year
There is no depreciation on PPE over the next 3 years
There are no payables or borrowings over the next 3 years.
Share capital remains at $169,000 per year.
Required
Construct the income statement and balance sheet for Verbose for each of the next 3 years. Based on these forecasts, what will be the cash at bank balance at the end of year 3? Based on your calculations, when meeting the founder, what advice would you give with respect to the business/operating model of Verbose?
Suppose at the meeting the founder reveals that a major equity investor expects a dividend of $40,000 at the end of 3 years, and Verbose will need to increase its PPE by $80,000 at the end of year 3 to support revenue growth beyond that year. The founder also believes Verbose needs a minimum cash at bank balance of $9,000 to support contingencies. What is the minimum amount of debt that Verbose will need to raise at the end of year 3 given this information?
Word Guide: Short answers are required here and not included in the 3,000-word limit for this assignment.
PART C (15 marks)
Synapsing Limited is contemplating an investment in equipment which will enable it to increase production in its neurotransmitter range. The equipment, which has a 5-year life for depreciation purposes, is currently available at a price of $1 million. Preliminary financial analysis has been undertaken and the details are as follows:
Revenue at the end of the first year is estimated to be $1,080,000 and this is expected to increase by 5% per year.
Cost of sales will be to 63% of revenues each year.
Fixed cash expenses are estimated to be $110,000 per year.
Synapsing has spent $50,000 on researching this investment over the last 12 months.
Maintenance costs on the equipment will be $28,000 at the end of the first year and are expected to increase by 10% per year as the equipment ages.
Depreciation is based on the purchase price of the equipment. The equipment is expected to have a cash scrap/salvage value of $100,000 at the end of 5 years and depreciation should be calculated on a straight-line basis to a book value of $100,000 at the end of year 5.
Tax on profits is calculated at a rate of 30% and tax is paid at the end of each year.
Working capital of $200,000 is required to support production and needs to be raised at the beginning of the investment. This is fully recoverable at the end of the 5-year period.
There are no plans to invest in new equipment at the end of 5 years, and as such, the analysis should be conducted over a 5-year investment horizon.
The hurdle rate (cost of capital) for investments of this type is 10%.
Income and expense items should be recognised at the end of the year in which they occur.
Inflation is low and for the purposes of this analysis should be considered to be zero.
Required
What is the net present value (NPV) and internal rate of return (IRR) for the proposed investment? Should it proceed?
What minimum annual growth rate in revenue is required for this investment (1 decimal place please)?
Returning to the original data, you have heard that the vendor of the equipment may be willing to negotiate on price. What is the maximum price at which you can negotiate for the purchase given the information provided in the dot points above?
Returning to the original data, suppose you can make an additional investment of $100,000 in a new technology that will enable the same level of production but with a lower cost of sales and less working capital. The technology can be amortised straight-line over 5 years. You estimate that the cost of sales will fall to 60% of revenue is this investment is undertaken. How much will working capital need to fall to in order for the investment to be worthwhile?
Word Guide: Short answers are required here and not included in the 3,000-word limit for this assignment.
PART D (Optional question – zero marks)
A company plans to launch a new product line and has two options to choose from – Product A or Product B. Each product will require $25m in development costs up-front. The cash flow profiles of the products differ significantly: Product A is expected to have a steady stream of cash each year. Product B is expected to disrupt the market and grab large cash flows early, but these will taper off as the product itself is expected to be disrupted with emerging technology.
The company uses a ten-year investment horizon for its new products. The annual cash flows for each product, expressed in $m, are as follows:
The cost of financing product development is 10% and consequently this represents the hurdle rate for each investment.
The CEO is a big fan of the internal rate of return (IRR) technique for evaluating investments because of a belief it is easier to convey to the Board. Which product would be selected if IRR is used as the investment evaluation tool?
Peter Craig, a recent MBA graduate and advisor to the CEO, strongly recommends using the net present value (NPV) technique. Which product would be selected if NPV is used as the investment evaluation tool?
Despite Peter’s strong influencing skills, the CEO remains adamant that the Board want to compare returns on each product relative to the hurdle rate of 10% that the firm uses. How might Peter meet the CEO’s request, while ensuring the best product is selected for development?