Objective of this report is to carry out the investment analysis for Aztec Caterings. Investment appraisal carried out reveals that the net present value is greater than one showing that the present value of the expected cash flow is greater than the actual fund invested in the project making the paper to recommend that the company should pursue the project.
Aztec's Capital Investment
Company Overview
Aztec Caterings is in catering line of business. The company provides the catering service for business, hospitals, recruitment home, schools and colleges. Aztec operates entirely in the UK midlands and south of the UK and its competitors are the Compass Group and larges multinational UK companies. Two directors formed Aztec Catering 40-year ago and after they left the company, they still own 70% of the company shares, and the venture capita owns 30% of the company shares. Outcome of the board meeting held in 2012 made the directors set a future direction for the company focusing on the following three corporate objectives:
To maintain a profit margin of 24%
To maintain current strong financial position for the company
"To satisfy the shareholder by maintaining a dividend payout ratio of 50%"
Objective of this report is to carry out the investment analysis for Aztec Caterings. The paper also carries out the appraisal and suitability of the company chosen financial objective and the company financial records.
Appraisal of the Company Chosen Objectives
Profit margin is a profitability ratio that measures every dollars earned from sales. Typically, a profit margin is a useful financial tool used to compare a company with the industry. It is also a useful tool to compare a company with the competitors and the higher the profit margin, the more profitable a company and the more a company has a better control over its costs. Overview of the Aztec's profit margin reveals that the company records 24% ratio in profit margin in 2012. The company profit margin ratio reveals that the company records a net income of $0.24 from every dollar made from sales. With reference to the company objective, Aztec intends to maintain its 24% profit margin and overview of the company projected financial records reveals that Aztec intends to increase the sales by £120 Million in 2013, $150 Million in 2014, and £190 on 2015. To maintain 24% ratio in profit margin, Aztec will need to increase its net income as the company increase its sales. As being revealed in Table 1, the company will need to record £29 Million in the net income in 2013, £36 Million in 2013, and £46 Million in 2015. The increase in the net income and decline the cost of sales will assist the company to maintain 24% profit margin.
Table 1: Financial Record of Aztec Caterings (£Million)
2015
2014
2013
TOTAL REVENUES
NET INCOME
46
36
29
Net Margin
24.2%
24%
24.2%
Comparative analysis of Aztec financial record with Compass Group financial record reveals that Aztec has potential to maintain 24% profit margin. Compass Group primary objective is "to provide the best possible service to our customers." Based on the company financial record, Compass Group has been able to provide high quality service to customer. Since 2008, Compass has recorded the increase in sales because of the increase in the customer participation. Typically, the Compass has been able to increase its total revenue from £14.5 Billion to £15.8 Billion between 2010 and 2011. More impressively, the company has been able to reduce its cost of goods sold from 91.60% to 91.51% making the company to achieve a bottom line growth from £675.0 Million to £728.0 Million in 2010 and 2011 respectively. As being revealed in Table 2, the Compass net income increased from £443 Million in 2008 to £728 Million in 2011. Moreover, the company net profit margin increased from 3.9% in 2008 to 4.5% in 2011. Thus, Aztec could also maintain its sound financial record because Aztec and Compass Group are operating within the same industry.
Table 2: Financial Record of Compass Group (£Million)
2011
2010
2009
2008
TOTAL REVENUES
15,833.0
14,468.0
13,444.0
11,440.0
NET INCOME
Net Profit Margin
4.5%
4.6%
4.3%
3.9%
GROSS PROFIT
1,344.0
1,216.0
1,096.0
2,426.0
ROE
17.44%
17.75%
16.97%
14.35%
ROCE
79.85%
Net Assets
2,208
2,545
3,073
3,503
Source: (Businessweek, 2012, Morningstar, 2012)
Aztec second objective is to maintain its current strong financial position. Aztec is operating in the UK hospitality and leisure industry, and the industry has enjoyed a robust slow growth in the last few years. However, pressure on the household budget has made the growth rate within the industry to slump down from 3% to 2.8% at the second quarter of 2012. Since the onset of the financial crisis, the industry has experienced volatility in the growth rate coupled with the adverse impact of severe weather condition. However, the slow growth that the sector has experienced in the last few years has been due to the 7% increase of North American visitors coupled with the 2% increase in European visitor.
Slow growth rate in restaurants and pubs sector will specifically affect Aztec's to maintain its current financial position. In the UK, consumer spending continues to decline annually and the real growth rate of restaurant and pub slowed by 1.7% in the second quarter of 2012 making the growth rate in the restaurant and pub sector to remain challenging. To maintain current strong financial position, Aztec will need to use different strategies based on the current challenges facing the UK Hospitality and Leisure industry in the last few years. Although, the industry experienced a drastic decline in the growth rate between 2008 and 2009, however, since 2010, the industry has enjoyed a gradual slow growth. (Barclays, 2012). Thus, Aztec will need to use brand differentiation strategy to outwit the competitors in the market to maintain the current strong financial position.
To maintain shareholders' value by maintaining dividends payout ratio of 50%, the company will need to maintain its current strong financial position. Ernst & Young (2012) argues that the growth rate of the UK pubs and restaurants sector depends largely on the performances of the UK economy as a whole. Based on the data presented by Ernst & Young (2012), the UK pubs and restaurants sector experienced a considerable improvement between 2010 and 2011. The data in Table 1 reveal that the consumer spending increases with the growth in the UK GDP. The GDP and domestic demand forecast between 2013 and 2014 reveals that the consumer spending will greatly improve between 2013 and 2014.
Table 1: Forecast of the UK GDP Domestic Demand Consumer Spending
Year
GDP
Domestic Demand
Consumer Spending
2008
-1.1
-1.4
-1.5
2009
-4.4
-4.4
-3.5
2010
2.1
1.6
1.2
2011
0.7
-0.9
-1.2
2012
0.4
0.3
0.8
2013
1.5
1.0
1.1
2014
2.6
2.0
2.1
Source: (Ernst & Young, 2012)
Based on the data projected for the GDP and consumer spending in 2013 and 2014, Aztec Caterings will be able to satisfy shareholders' by providing a dividend payout ratio of 50%. Comparatively, Compass has been able to enjoy the growth rate in the last 4 years based on the fact that the company increases yearly return on equity ratio. Thus, Compass has been able to achieve its primary objective by providing best possible service to customer. Since Aztec Caterings is trying to follow the footstep of Compass, the company will be able to achieve its corporate objectives.
Effective financial plan is critical to assist a company to achieve its laid down objectives. The paper presents Aztec's financial plan needed to assist the company to achieve its corporate objectives.
Task 2: Three-Year Financial Plan
Financial plans are the series of steps that organizations use to achieve their financial objectives. The plan allocates the future income and various expenses of Aztec Caterings within the next three years. More importantly, the plan will also allocate savings of the company assets projected to produce future income. Overview of the Aztec Caterings' 2012 financial statements reveals that the company non-current assets is equal to the company current liabilities making the company to record zero non-current assets. While the company non- current assets are £60 million, the company current liabilities are also £60 Million. Although, the company current assets is £100 Million, however, the company depends more on bank loans than raising share capital from the public. The company debt / capital employed ratio is 40% revealing that the company long-term debt is very close to the shareholder funds. Clarke, (2002) argues that if the debt / capital employed ratio is above 50%, the company debts is more than shareholders' fund. By relying on bank loan, the issue could serve as a setback for Aztec, which could make the company to face challenges in meeting its financial objectives.
The paper assesses the company liquidity position to enhance greater understanding on the extent the company could meet its current liabilities. Overview of the company current ratio reveals that the Aztec may have problem in the future to meet its current liabilities.
The Current Ratio is stated as Current Assets/Current Liabilities
Aztec Current Ratio= 100/60
Aztec Current Ratio 1.66
The current ratio of Aztec Caterings is 1.6:1. Clarke, (2002) argues that current ratio of 2:1 is recommended for most businesses because the current ratio indicates the availability of the company liquidity to meet its current liabilities. Based on the rate Aztec intends to raise the bank loan, the company current ratio will decline in the future making the company to face challenges in meeting its current liabilities.
Thus, the paper provides the following recommendations on the strategies that the company will use to prepare its 3-year financial plan to achieve its corporate objectives.
First, Aztec needs to rely more on the share capital as source of fund than raising fund from the bank loan. Loan capital is the fund borrowed from the bank while the share capital represents the funds raised by selling shares to the public. Typically, share capital should be clearly a preferred option of raising fund because the company only liable to pay dividends for such funds which is only between 2 and 3% of the market value of the equity per annum. On the other hand, loan capital is a borrowed fund that has a fixed interest which a company should pay no matter its financial conditions.
Aztec would enjoy several advantages from raising fund from the share capital. First, the company will be able to raise cheap fund from the public making the company to pay only dividend to shareholders which is just a little percentage from the company net profits. Moreover, the risk of losing capital is spread on large number of people and not just founders of the company. More importantly, shareholders are likely to regards their shares as long-term investment thereby stick to company in a good or bad time. The only shortcoming of share capital as source of fund is that the larger percentages of shares should not be in possession of external investors because possession of larger percentages of shares will make external investors to have great influence on the company. (Danielson, and Scott 2006)
By relying on loan capital, Aztec Catering may increase its overall leverage which may make the company to face the risk of long-term debt financing consequent leading to the risk of bankruptcy.
Thus, the paper provides the 3-year financial plan to assist the company to meet its corporate objectives. The projected profit and loss table reveals that the Aztec will record net profits of £37 Million in 2013, £47 Million 2014 and £81 Million 2015. Based on the data presented in the company-projected balance sheet, the company total assets will be £522 Million in 2013, £555 Million in 2014, and £620 Million in 2015. The total assets include the current assets, non-current assets, equipment, building and land. The financial plan will assist the company to achieve the following corporate objectives:
To maintain a profit margin of 24%
To maintain current strong financial position of the company
"To satisfy the shareholder by maintaining a dividend payout ratio of 50%"
Aztec Projected Profit and Loss (£000)
31/12/2013
31/12/2014
31/12/2015
Revenue
Gross revenue
£120 000
£150 000
£190 000
Cost of goods sold
10 000
10 200
10 608
Gross margin
£110 000
£139 800
£179 392
Other revenue [source]
£0
£0
£10 000
Interest income
$1 000
£0
£0
Total revenue
£111 000
£139 800
£189 392
Operating expenses
Sales and marketing
£10 000
£10 200
£10 608
Payroll and payroll taxes
15 000
£15 300
£15 912
Depreciation
8 000
8 100
8 500
Insurance
8 500
£8 670
£9 017
Maintenance, repair, & overhaul
1 500
15 300
15 600
Utilities
2 500
£2 550
£2 652
Property taxes
3 000
£3 060
£3 182
Administrative fees
2 000
£2 040
£2 122
Other
4 000
£4 080
£4 243
Total operating expenses
£54 500
£69 300
£71 836
Operating income
£56 500
£70 500
£117 556
Interest expense on long-term debt
3 590
2 866
2 106
Operating income before other items
£52 910
£67 634
£115 450
Loss or gain on sale of assets
0
0
1 000
Other unusual income expenses
0
0
0
Earnings before taxes
£52 910
£67 634
£116 450
Taxes on income
30%
15 873
20 290
34 935
Net income (loss)
£37 037
£47 344
£81 515
Dividend
£18,518.5
£23,672
£40,757.5
Retained profit
£18,518.5
£23,672
£40, 757.5
Aztec Caterings Projected Balance Sheet (£000)
Assets
Initial balance
Year 1
Year 2
Year 3
Cash & short-term investments
£30 000
£100 559
£141 801
£214 855
Accounts receivable
3 000
3 000
3 000
3 000
Total inventory
27 000
27 000
27 000
27 000
Prepaid expenses
0
0
0
0
Deferred income tax
0
0
0
0
Other current assets
Total current assets
£160 000
£230 559
£271 801
£344 855
Buildings
£100 000
£100 000
£100 000
£100 000
Land
Capital improvements
0
0
0
0
Equipment
Less: (Accumulated depreciation expenses)
0
8 000
16 100
24 600
Net property/equipment £300 000
£292 000
£283 900
£275 400
Goodwill
$0
$0
$0
$0
Deferred income tax
0
0
0
0
Long-term investments
0
0
0
0
Deposits
0
0
0
0
Other long-term assets
0
0
0
0
Total assets
£460 000
£522 559
£555 701
£620 255
Liabilities
Initial balance
Year 1
Year 2
Year 3
Accounts payable
£2 000
£2 000
£3 000
£3 000
Accrued expenses
0
0
0
0
Notes payable/short-term debt
0
0
0
0
Capital leases
0
0
0
0
Other current liabilities
60 000
60 000
60 000
60 000
Total current liabilities
£0
£62 000
£63 000
£63 000
Long-term debt derived from the loan payment calculator
£40 000
£65 522
£50 320
£34 358
Other long-term debt
Total debt
£102 000
£127 522
£113 320
£97 358
Other liabilities
0
0
0
0
Total liabilities
£102 000
£127 522
£113 320
£97 358
Equity
Initial balance
2013
2014
2015
Owner's equity (common)
£10 000
£10 000
£10 000
£10 000
Paid-in capital
0
0
0
Preferred equity
0
0
0
0
Retained earnings
0
37 037
84 381
Total equity
£10 000
£47 037
£94 381
£175 897
Total liabilities & equity
£112 000
£174 559
£207 701
£273 255
Task 3:
Aztec is proposing a significant investment using the working capital and non-current assets to finance the project and the investment lifecycle will be within the next three years. The paper applies shareholder value analysis (SVA) to estimate whether the investment will increase the shareholder value. The shareholder value suggests a decisive measure that a company employs to enrich shareholders. Within financial environment, the idea of shareholder value shows that shareholders' money should be invested wisely to generate higher rate of returns for shareholders. Based on the decision of Aztec Catering to invest its non- current assets and its working capital in the next three years, the paper uses discounted cash flow (DCF) and net present value (NPV) to determine whether the investment will increase shareholders value. The main advantage of using NPV technique is its strong correlation with shareholder value. Since the major objective of a company is to maximise shareholder wealth. Thus, NPV is a powerful tool to evaluate a project. (Afonso, 2009).
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