Accounting ratio analysis and capital budgeting

Step 1: Ratio Analysis

1. This assessment task involves you calculating a range of ratios for your firm and using these ratios to assess the business performance of your firm.

2. Go to the ‘Ratios’ tab in your firm’s spreadsheet. In this worksheet is a list of ratios. Please calculate these ratios for your firm.

Calculate these ratios for the last four (4) years for your firm. Do this by linking back to the numbers in your firm’s financial statements (in your ‘Financial Statements’ worksheet) or to the numbers in your firm’s restated financial statements (in your ‘Restated Financial Statements’ worksheet). If you are unsure about how to link cells between worksheets in Excel, see this short video about how to link cells between worksheets (control + click on this link):

Linking Data from Different Excel Sheets and Workbooks

You can also discuss with others in the course about how to do this – everyone will be facing the same issue.

Once you have calculated these ratios for your firm sit back and have a look at them. What do these ratios actually tell you (or not tell you) about your firm? How do you make sense of them?

Discuss your ratios with other students in the course. How do your company’s ratios differ to the ratios of companies of other students in the course? What do your firm’s ratios tell you about how well your firm is performing?

3. Calculate economic profit for your firm for the past four (4) years. Use 10% as your firm’s cost of capital when calculating your firm’s economic profit (unless you have reasons to use a different number; if so, clearly state those reasons).

4. The key drivers of your firm’s past economic profit are RNOA, cost of capital and NOA. The two key accounting drivers of RNOA are PM and ATO. (See Study Guide Chap 4, Section 4.4).

Comment on what is driving or causing your firm’s economic profit over the past four years to be at the levels it is. If your firm’s economic profit is negative (or positive), what is causing it to be negative (or positive)? If it is a large number, what is causing it to be so large? If it is a small number, what is causing it to be so small? If it changed a lot over the past three or four years, why did it? If it stayed much the same over the past three or four years, why was this?

5. Discuss your thoughts on what is driving your firm’s economic profit with other students. What similarities or differences are there between the economic profit of your different firms? Why is this? What is causing these similarities or differences? What insights have you gained by ‘breaking into bits’ your firm’s financial statements? What insights have you not gained?

6. Include in your assignment your firm’s spreadsheet, including your firm’s ratios and economic profit that you have calculated, as well as a Word file setting out your commentary on your firm’s ratios and what is driving your firm’s economic profit.

Please allow about 540 – 600 minutes to complete Step 1.

Step 2: Capital Budgeting

Develop a capital investment decision for your firm. This decision should involve a choice between two options and involve you discounting cash flows for between 5 and 10 years.

Please use a required cost of capital of 10% (Hint: This is the discount rate to use).

Calculate the payback period, net present value (NPV) and internal rate of return (IRR) for each of the two options for your firm that you developed and advise your company which option it should invest capital in.

Please go to the ‘NPV & IRR’ worksheet and calculate the NPV and IRR for each of the two capital investment options for your firm in this worksheet, using the NPV and IRR functions in Excel. See this short video for guidance about how to calculate NPV and IRR using Excel (control + click on this link):

Calculating IRR (Internal Rate of Return) and NPV (Net Present Value) using Excel

Briefly discuss your thought processes in coming to your recommendation. Also briefly discuss the strengths and weaknesses of your analysis.

For example, I have developed a capital investment decision for Ryman Healthcare. This is shown in the Appendix to this assignment. This is by way of example only. Please do not use this example in your answer to Step 2. You need to develop your own capital investment decision for your firm.

1. Estimated life is how long Ryman Healthcare expects to own the new retirement village units before selling the retirement village they are part of.

2. Expected cash flow when sell each retirement village to another retirement village operator at the end of the ’Estimated life’.

3. Comprise estimated future cash flows from selling occupancy rights to the retirement village units each year, and fees from management rights and other services.

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