Coventry University London M004LON Sample Work

ProEssay
专业代写 WeChat：pro1essay

1. Introduction
Madison plc, a UK based firm, plans to expand its presence in Europe through the
acquisition. Both Puteaux digital France and Melia Portfolio Research Spain are its target
firms but Madison can acquire one of them. Thus, Madison has to assess these two firms
through ratio analysis and sources of funding, and then makes the final decision. Another
challenge faced by Madison is that the company needs to invest in a new software product
since the current one is outdated. Two options are available for Madison: Madison Super
and Madison Platform. This report uses the net present value (NPV) approach to
determine whether Madison Super and Madison should be undertaken. The rest of the
report is structured as follows: section 2 critically discusses the sources of funding;
section 3 explains the significance of working capital management; section 4 analyzes
the two software proposals through NPV method; section 5 uses break-even analysis to
determine which software should be produced; section 6 discusses the factors that may
affect the investment decisions; section 7 performs the ratio analysis to select the target
company; section 8 summarizes the main findings of the report.
2. Sources of Funding
Madison has been operating in the UK for the past 10 years and plans to expand
its presence in Europe. Either its acquisition plan or software production needs funds. On
the one hand, Madison can use internal financing (e.g. retained earnings) to support the
acquisition and investment projects. The most significant advantage of internal financing
is that the company can control its operation without the interference from the external
and that the company does not need to carry on the burden of interests (Goergen and
Renneboog, 2001).However, the use of internal funds reduces the capability of firms to
face the emergent need of cash flows and worsens the financial health of firms. More
importantly, even the most profitable firms cannot only rely on their retained earnings to
finance their growth or investment projects (Blazenko and Pavlov, 2009). Madison will not
be an exception.
On the other hand, as a publicly traded firm, two most common sources of external
funding are available for Madison: debt financing and equity financing. According to Hui
(2003), debt financing refers to the obligations to the lenders plus the fixed payments.
Within the category, there are three options of debt financing: bank loan, corporate bond,

ProEssay 专业代写 WeChat：pro1essay

and leasing (either operating or financial). There are some advantages associated with
debt financing. First of all, companies remain the control of their business and facilitate
the effectiveness of the resources utilization. This is because companies have to
effectively use their resources to ensure their ability to pay back the interests and the debt
to the lenders. In addition, the interest payments are tax deductible. The employment of
debt allows firms to explain their repayment schedule (Brigham and Ehrhardt, 2013). The
disadvantages of debt financing consist of two aspects: the requirement of credit rating
and the need of collateral. Furthermore, companies need to notice that the carry-on of
extensive debt is considered as a signal of high risk business. For Madison, if it
determined to use debt financing, it would ensure that the benefits of debt financing
surpass the costs.
With the regard to equity financing, it refers to the selling of shares (both common
stocks and preferred stocks) to investors (Zhengfei and Kangtao, 2004). The first
advantage of equity financing is that companies do not need the repayment of principle
and interests. In other words, it enhances the value of firms. Moreover, equity financing
leads to the introduction of expertise into the management or the board of directors of
firms. In addition, companies can benefit from the knowledge and network of equity
contributors (Gompers and Lerner, 2010). However, the use of equity financing leads to
the sharing of the profits between shareholders and companies. The control of companies
is diluted due to the issuing of new shares. In addition, the conflicts of shareholders with
different interests may interrupt the operation of companies (Wu, Chua and Chrisman,
2007). It is necessary for Madison to evaluate the capital need for its acquisition plan. If
the capital need is high, the company may use of a mix of debt financing and equity
financing.
3. Work Capital Management
Working capital refers to the difference between current assets and current
liabilities (Gill, Biger and Mathur, 2010). The importance of effective working capital
management is reflected by its role in the cash conversion cycle of firms. In other words,
working capital management addresses the liquidity elements of current assets and
liabilities of firms (Brigham and Ehrhardt, 2013). The effective working capital
management can reduce the capital tied in the current assets of firms and hence improve


the cash flow position of firms. If companies want their working capital management to be
effective, they have to concentrate on the control of trading receivables and the collection
period as well as the management of inventory levels. In doing so, firms can improve their
cash flow positions.
4. Results of Two Investment Proposals
NPV method has been the most common way for companies to determine whether
they should undertake or reject an investment proposals. It is on the basis of discounted
cash flow techniques and the difference between the present value of cash inflows and
cash outflows (Awomenwe and Ogundele, 2008). The summative outputs for the two
proposals are presented in Table 1 and Table 2 and the detailed calculation process is
illustrated in the Appendix. It is clear that the NPV of Madison Super is 3,691,430 and
that of Madison Platform is 3,288,041. On the basis of the rule of thumb, an investment
project with a positive NPV should be accepted. On the contrary, an investment project
with a negative NPV should be rejected (Drury, 2004). The two options for Madison are
mutually exclusive. Thus, the company should accept the project with higher NPV. It is
evident that the NPV of Madison Super project is higher than that of Madison Platform. In
addition, Madison has £5.5 million of funds available for the new investment. Thus, based
on the evaluation of NPV and the capital constraints, the company should accept Madison
Super software project.
Table 1 NPV for Madison Super
Year (In Thousands) 0 1 2 3 4 5
New Software Cost 5500
Sales Revenue 5665 6695 7931 9012.5 10094
Less:
Component A 696.8 832 988 1144 1404
Component B 1112.8 1560 1872 2184 1872
Overheads 283.25 334.75 396.55 451.14 504.7
Cost of Senior Technology
Officer 1 294 299.6448 305.398 311.2616 317.2378
Officer 2 170 171.496 173.0052 174.5276 176.0635
Taxable Cash Flow 3108.15 3497.109 4196.047 4747.571 5819.999
Less: Tax Liabilities 1025.69 1154.046 1384.695 1566.698
Add: Tax Benefit 453.75 340.3125 255.2344 191.4258
Less: Working Capital
(Incremental) 400 166.5 154.5 154.5 154.5


After-tax cash flows 2941.65 1863.17 2547.188 2953.141 4061.875

Discount rate at 14% 1 0.877193 0.769468 0.674972 0.59208 0.519369
Present Value -5900 2580.395 1433.649 1719.28 1748.497 2109.61
NPV 3691.43
Table 2 NPV for Madison Platform

Year 0 1 2 3 4 5
Sales Revenue 6386 7790.92 9271.03 10846.93 12366.18
Less:
Component A 354.64 550.16 842.4 1095.12 1498.64
Component B 1372.8 1950 2340 2831.92 3062.8
Overheads 191.58 233.81 278.1 325.48 370.8
Officer 1 294 299.6448 305.398 311.2616 317.2378
Officer 2 170 171.496 173.0052 174.5276 176.0635
Add: Tax Benefit 701.25 525.9375 394.4531 295.8398
Less: Working Capital
(Incremental) 500 172.59 157.59 157.59 157.59
Discount rate at 13% 1 0.884956 0.783147 0.69305 0.613319 0.54276
Present Value -9000 3389.726 1884.24 2172.908 2328.756 2512.411
NPV 3288.041
The NPV is considered as the best technique to assess the investment projects
(Bhandari, 2009). Under the NPV method, the risk, time value of money and cash flows
are justified in order to maximize the shareholders’ wealth. More specifically, if companies
accept an investment project with positive NPV, the shareholders’ wealth would increase
accordingly. There are other methods to assess investment projects: payback period and
internal rate of return (IRR). According to Ehrhardt and Brigham (2013), payback period
is the number of years that companies need to cover its initial investment. The shorter
payback period is more attractive. However, the drawbacks of payback period technique
include the ignoring of time value of money, cash flows after payback period and inability
to relate shareholders’ wealth with payback period. With the regard to the IRR, an
investment project with higher IRR is more acceptable for companies. The assumption


behind the IRR is that the cash flows of firms can be reinvested at the IRR (Awomenwe
and Ogundele, 2008). In other words, the unrealistic return is realized by firms. But this
report also calculate the IRR of two investment projects. The output is presented in Table
3. In Table 3, the IRR of Madison Super is 19% while that of Madison Platform is 12%. It
is clear that, on the basis of the IRR, the company should accept Madison Super project
since the IRR of Madison Super is higher than that of the benchmark (10%).
Table 3 The IRR of Madison Super and Madison Platform
Madison Super Madison Platform
IRR 19% 12%
5. Break-even Analysis
Break- even analysis can also be used as a tool to help the decision making of
firms. Breakeven is a point in which the revenue of products are equal to the costs of
production (Alhabeeb, 2012). In the case of Madison, break even analysis can help the
firm to determine which one of these two new software to be produced. Since the fixed
costs of two products are the same, the influential factors are selling price and variable
costs of these two software. If the production is equal to zero, the variable cost is equal
to zero. But variable costs increase as the production level increases. This report uses a
simple example to illustrate how Madison can use breakeven analysis to determine which
software should be produced.
Table 4 Projected Breakeven Analysis
Selling Price per unit 750
Variable Cost per unit 250
Fixed Cost 100000
Quantity for Break -Even Point 200
Figure 1 Breakeven Analysis

Revenue
Breakeven Point
Number of unit sold


More specifically, Madison can use the breakeven point to determine which
software should be produced. The software with lower breakeven point should be
selected. This is because the decline in the breakeven point leads to the increase in the
contribution margin. Accordingly, producing software with higher contribution margin,
Madison can quickly cover its fixed costs or take less sales to cover its fixed costs,
compared to the software with lower contribution margin. Especially for Madison, the fixed
costs are same to the two software. Therefore, the case company should choose the
software with lower breakeven point.
6. Other Factors Affecting Investment Decision Making
Although this report uses the NPV method to make the investment decision, there
are other factors that can influence the decision making process as well. The existing
literature documents the factors that have the impact on investment decision making. On
the one hand, the investment decision of firms is exposed to the influence of the external
environmental, including the economic risks, political and social conditions as well as the
regulatory frameworks (Enoma and Mustapha 2010). If companies believe that the
current economy is expected to face a downside pressure, they would be more cautious
and conservative in investing. In addition, the study of Karim and Azman-Saini (2013)
highlights the influence of macroeconomic prospects and fiscal policy on the investment
decisions. The decline in gross domestic product growth and the increase in interest rate
could impede the investment decisions of firms. In addition, the informational
transparency and market trustworthiness or uncertainty are the important factors that
affect the investment decisions (Kahraman 2011).
Moreover, within the company, some internal factors may also influence their
investment decision as well. For instance, Kahraman (2011) suggest that the liquidity
position and the serving of debt of firms can affect their investment decisions. This is
because, if firms are ineffective and inefficient in the collection of their receivables, they
are less likely to take new investment projects into consideration due to its insufficient
capital available. In addition, the behaviors of government could significantly affect the
investment decisions of firms as well. Beyond the fiscal policy, the tax policy has also
played an important role in the investment decision of firms, since the corporate tax rate
directly influence the return of investment projects (Overesch and Wamser 2010).


Furthermore, Qureshi and Hunjra (2012) document that the corporate governance of firms
can affect their investment decisions since firms with the risk adverse corporate
governance are likely to reduce the investment in new projects.
7. Ratio Analysis of Two Target Firms
The case company plans to expand its presence in Europe through the acquisition.
Both Puteaux digital France and Melia Portfolio Research Spain are its target firms but
Madison can only acquire one of them. In order to assess which one is a better decision
for the case company, this report employs ratio analysis to evaluate their overall
performance during the period from 2011 to 2013. The output of ratio analysis is
presented in Table 5. First of all, this report examines two profitability ratios (operating
profit margin and net income margin) of these two target firms, respectively. It is clear in
Table 5 that the operating profit margin of Puteaux France is much higher than that of
Melia Spain which is negative. In addition, there is an upward trend in the operating profit
margin of Puteaux France. The similar result is identified through the interpretation of net
profit margin. The upward trend of net profit margin is also found in Puteaux France.
However, the net profit margin of Melia Spain is negative, suggesting that Melia Spain
experienced the losses in the period of 2011-2013.
Table 5 Ratio Analysis of Madison plc
Puteaux France Melia Spain
Ratio 2011 2012 2013 2011 2012 2013
Profitability Ratio
Operating Profit
Margin 25.45% 29.31% 29.65% -9.00% -9.00% -9.00%
Net Profit Margin 17.63% 20.32% 20.79% -8.93% -8.94% -8.93%
Liquidity Ratio
Current Ratio 1.78 2.99 4.92 0.58 0.48 1.69
With the regard to liquidity ratio, this report focuses on the current ratio, which
measures the capability of firms to cover its short-term obligations through the liquidation
of their current assets. According to the rule of thumb, the current ratio of Puteaux France
in three years is much higher than 1, implying that the company has a very strong liquidity
position. On the contrary, Melia Spain had the current ratio that was lower than 1 in 2011
and 2012 although its current ratio increased to 1.69 in 2013. Compared to Puteaux


France, Melia Spain has a much worse liquidity position, which indicates that the
company may have difficulties to meet the requirement of its short-term obligations.
Based on the analysis of profitability and liquidity, Puteaux France is a better choice for
Madison to acquire for its expansion plan. But it is better to know the reasons of Melia
Spain’s negative operating profit. If its negative operating profit is attributable to the
macroeconomic conditions, the further analysis is required. In addition, the corporate
culture is another factor that should be considered by Madison as well. If corporate culture
between Puteaux France and Madison is totally different, the acquisition may not be
executed.
8. Conclusion
This report mainly assessed two investment proposals of software and the two
potential target firms for the expansion plan of Madison. This report found that the NPV
of Madison Super project is higher than that of Madison Platform. In addition, Madison
has £5.5 million of funds available for the new investment. Thus, based on the evaluation
of NPV and the capital constraints, the company should accept Madison Super software
project. With the regard to its target firms of acquisition, Puteaux France has higher
profitability and stronger liquidity position than those of Melia Spain. Based on the
analysis of profitability and liquidity, Puteaux France is a better choice for Madison to
acquire for its expansion plan.


Reference
Alhabeeb, M.J., 2012. Break-Even Analysis. Mathematical Finance, pp.247-273.
Blazenko, G.W. and Pavlov, A.D., 2009. Investment timing for dynamic business
expansion. Financial Management, 38(4), pp.837-860.
Brigham, E. and Ehrhardt, M., 2013. Financial management: Theory & practice. Cengage
Learning.
Drury, C. (2004), Management and cost accounting, 6th Edition), London: Thompson
Learning
Enoma, A. and Isedu, M., 2010. Monetary Policies and Efficacy of Monetary Supply in
Nigeria. Available at SSRN 1604165.
Gill, A., Biger, N. and Mathur, N., 2010. The relationship between working capital
management and profitability: Evidence from the United States. Business and
Economics Journal, 10(1), pp.1-9.
Goergen, M. and Renneboog, L., 2001. Investment policy, internal financing and
ownership concentration in the UK. Journal of Corporate Finance, 7(3), pp.257-
284.
Gompers, P. and Lerner, J., 2010. Equity financing. In Handbook of entrepreneurship
research (pp. 183-214). Springer New York.
Hui, W., 2003. Debt Financing, Corporate Governance and Market Valuation of Listed
Companies. Economic Research Journal, 8, pp.28-36.
Kahraman, C. (2011). Investment decision making under fuzziness. Journal of Enterprise
Information Management, 24(2), pp.126–129
Karim, Z.A. and Azman-Saini, W.N.W., 2013. Firm-level investment and monetary policy
in Malaysia: do the interest rate and broad credit channels matter?. Journal of the
Asia Pacific Economy, 18(3), pp.396-412.
Overesch, M. and Wamser, G., 2010. Corporate tax planning and thin-capitalization rules:
evidence from a quasi-experiment. Applied Economics,42(5), pp.563-573.
Qureshi, S.A. and Hunjra, A.I., 2012. Factors affecting investment decision making of
equity fund managers. Wulfenia Journal, 19(10), pp.280-291.
Wu, Z., Chua, J.H. and Chrisman, J.J., 2007. Effects of family ownership and
management on small business equity financing. Journal of Business


Venturing, 22(6), pp.875-895.

Zhengfei, L. and Kangtao, Y., 2004. The Puzzle of Equity Financing Preference in China's
Listed Companies. Economic Research Journal, 4, pp.50-59.


Appendix
NPV Method for Madison Super
Year 0 1 2 3 4 5
Sales Revenue 5665 6695 7931 9012.5 10094
Less:
Component A 696.8 832 988 1144 1404
Component B 1112.8 1560 1872 2184 1872
Overheads 283.25 334.75 396.55 451.14 504.7
Officer 1 294 299.6448 305.398 311.2616 317.2378
Officer 2 170 171.496 173.0052 174.5276 176.0635
Add: Tax Benefit 453.75 340.3125 255.2344 191.4258
Less: Working Capital (Incremental) 400 166.5 154.5 154.5 154.5
Discount rate at 14% 1 0.877193 0.769468 0.674972 0.59208 0.519369
Present Value -5900 2580.395 1433.649 1719.28 1748.497 2109.61
NPV 3691.43
Worksheet 1 0 1 2 3 4 5
Revenue initial 5500 6500 7700 8750 9800
Revenue (3%growth） 5665 6695 7931 9012.5 10094
Worksheet 2 0 1 2 3 4 5
Component A 670 800 950 1100 1350
Component B 1070 1500 1800 2100 1800
Component A(Inflation) 696.8 832 988 1144 1404
Component B(Inflation) 1112.8 1560 1872 2184 1872
Worksheet 3 0 1 2 3 4 5
Overheads 275 325 385 438 490
Overheads(3% growth) 283.25 334.75 396.55 451.14 504.7
Worksheet 4 0 1 2 3 4
Initial 400 550 700 850 1000
Total Working Capital 400 566.5 721 875.5 1030
Incremental working Capital 400 166.5 154.5 154.5 154.5
Worksheet 5 0 1 2 3 4 5
Officer 1 294000 299644.8 305398 311261.6 317237.8
Officer 2 170000 171496 173005.2 174527.6 176063.5
in thousands
Officer 1 294 299.6448 305.398 311.2616 317.2378
Officer 2 170 171.496 173.0052 174.5276 176.0635
Worksheet 6 0 1 2 3 4 5
Capital Allowance 1375 1031.25 773.4375 580.0781 1740.234 Tax Rate 33%
Tax Benefits 453.75 340.3125 255.2344 191.4258 574.2773


Madison Platform
Year 0 1 2 3 4 5
Sales Revenue 6386 7790.92 9271.03 10846.93 12366.18
Less:
Component A 354.64 550.16 842.4 1095.12 1498.64
Component B 1372.8 1950 2340 2831.92 3062.8
Overheads 191.58 233.81 278.1 325.48 370.8
Officer 1 294 299.6448 305.398 311.2616 317.2378
Officer 2 170 171.496 173.0052 174.5276 176.0635
Add: Tax Benefit 701.25 525.9375 394.4531 295.8398
Less: Working Capital (Incremental) 500 172.59 157.59 157.59 157.59
Discount rate at 13% 1 0.884956 0.783147 0.69305 0.613319 0.54276
Present Value -9000 3389.726 1884.24 2172.908 2328.756 2512.411
NPV 3288.041
Worksheet 1 0 1 2 3 4 5
Revenue initial 6200 7564 9001 10531 12006
Revenue (3%growth） 6386 7790.92 9271.03 10846.93 12366.18
Worksheet 2 0 1 2 3 4 5
Component A 341 529 810 1053 1441
Component B 1320 1875 2250 2723 2945
Component A(Inflation) 354.64 550.16 842.4 1095.12 1498.64
Component B(Inflation) 1372.8 1950 2340 2831.92 3062.8
Worksheet 3 0 1 2 3 4 5
Overheads 186 227 270 316 360
Overheads(3% growth) 191.58 233.81 278.1 325.48 370.8
Worksheet 4 0 1 2 3 4
Initial 500 653 806 959 1112
Total Working Capital 500 672.59 830.18 987.77 1145.36
Incremental working Capital 500 172.59 157.59 157.59 157.59
Worksheet 5 0 1 2 3 4 5
Officer 1 294000 299644.8 305398 311261.6 317237.8
Officer 2 170000 171496 173005.2 174527.6 176063.5
in thousands
Officer 1 294 299.6448 305.398 311.2616 317.2378
Officer 2 170 171.496 173.0052 174.5276 176.0635
Worksheet 6 0 1 2 3 4 5
Capital Allowance 2125 1593.75 1195.313 896.4844 2689.453 Tax Rate 33%
Tax Benefits 701.25 525.9375 394.4531 295.8398 887.5195

Coventry University London M004LON Sample Work

Încărcat de

Informații document

Drepturi de autor

Formate disponibile

Partajați acest document

Partajați sau inserați document

Opțiuni de partajare

Vi se pare util acest document?

Este necorespunzător acest conținut?

Drepturi de autor:

Formate disponibile

Coventry University London M004LON Sample Work

Încărcat de

Drepturi de autor:

Formate disponibile

ProEssay

After-tax cash flows 2941.65 1863.17 2547.188 2953.141 4061.875

Table 2 NPV for Madison Platform

Figure 1 Breakeven Analysis

Number of unit sold

Venturing, 22(6), pp.875-895.

S-ar putea să vă placă și