Capital Budgeting of Bathurst Site
Figure 1: (Image Showing Capital Budgeting Techniques for Bathurst Site)
Source: (Created by Author)
Figure 2: (Image Showing Capital Budgeting Techniques for Wodonga Site)
Source: (Created by Author)
The above images show that for the purpose of selection of best possible site for the business. NPV analysis, profitability index and payback period are calculated. When compared with the results of capital budgeting for both the sites, it is clear that the best option which is available to Saturn pet care is Wodonga site. As per the computation, Wodonga site has an NPV of $ 95,94,827 which is much more than the NPV of Bathurst site whose NPV is shown to be $ 58,44,567. This signifies that the cash flow which can be generated by Wodonga site is much more than cash inflows which can be generated by Bathurst site as per the calculations. In case of analysis of the profitability index, Wodonga site has a better index of 1.349 in comparison to Bathurst site which has an index of 1.177. This shows that the site of Wodonga is more profitable than Bathurst site and thus making Wodonga site a clear option (Zeitun & Tian, 2014). In case of payback period, Wodonga site take lesser time to recover the initial investment made by the company in comparison to Bathurst site and thereby makes the Wodonga site the best option for Saturn pet care for incorporating production of the new product.
Product Cannibalization refers to a strategy which is followed by companies when they are introducing a new product in the market. The strategy requires the business to reduce the volume of sales of an existing product of the business so that a new product can be introduced in the market. In the case of Saturn pet care, there is a possibility that the business would apply such a strategy in order to launch the new product in the market.
As per Nathan who is a director of Saturn pet care has the opinion that the increase in sales which has been estimated by the marketing department from year to year basis is incorrect and thus the capital budgeting analysis might get affected and show incorrect results. The concerns of Nathan is correct and the same can be rectified if the management follows NPV analysis wherein the management can increase certain cash outflows so as to nullify the effect of over estimated sales increase from year to year basis.
As per the view of Nathan, the factory shed which was already there should be included in the initial investment while conducting NPV analysis so as to produce a more accurate result. The view of Nathan is wrong as NPV analysis only considers the actual cost of any investment which is undertaken for the project. If original cost of the existing factory shed is included than it produce an wrong result.
Introduction
This part of the assignment deals with ARB ltd which is engaged in manufacturing business of road motor accessories. The capital structure of ARB ltd is to be analysed and a comparison is to be made with the capital structure of similar company engaged in a similar business. The assignment will also make recommendation as to how the capital structure of the company can be improved.
The above table shows that the existing capital structure of the company is only made up of equity capital and there is no presence of debt capital in the capital mix of the business (Yang & Zhang, 2013). This shows that the company is solely dependent on the equity-based capital and does not rely on any leverage. The company’s capital structure which is shown in the above figure is $ 2,72,341.
The above figure shows the changes which has happened in the cost of capital of the company. The Weighted Average Cost of Capital (WACC) which is shown in the above figure comes to 18.05% which has reduced from previous year. This is a favourable sign as the reduction of cost of capital of the business signifies that the level of risks which is faced by the business is also reduced (Frank & Shen, 2016). The cost of equity is calculated following general method and the same is shown to be 18.05%. As there is no debt capital in the capital mix of the company therefore the cost of equity which is calculated is considered to overall cost of capital of the business.
Capital Asset Pricing Model (CAPM) is considered to be one of the most effective methods of computing cost of equity of a business. CAPM is known to produce the most accurate results when it comes to calculation of cost of equity (Barberis et al., 2015). The cost of equity for the business under CAPM is shown to be 7.906% which is very much different from cost of capital computed under general method (Hann, Ogneva & Ozbas, 2013). The cost of capital computed shows favourable results as the market return is more than the cost of the cost of equity which signifies that the business meets the expectations of the shareholders of the company (Barth, Konchitchki & Landsman, 2013).
In order to make comparison with ARB ltd, a company is selected which is Modine Ltd. Modine ltd is a company which is engaged in manufacturing activities of products which are similar to ARB ltd and also belongs to the same industry as ARB ltd. The capital structure of Modine ltd comprises of equity share capital of $ 421.20 million and also employs debt capital in the capital mix of the business which amounts to $ 510.90, thus making the total capital employed to $ 932 million. The capital structure of Modine Ltd shows that the it has more amount of debt capital in comparison to equity capital. This shows that the business relies on debt capital more than equity capital. Whereas, the capital structure of ARB ltd is made up of only equity share capital and there is no presence of debt capital in the capital structure of the company. Thus, it can be said that the capital structure of the Modine ltd is much better in comparison with ARB ltd as it has the advantage of debt capital. In addition to this, the company using the debt capital is also able to take advantage of tax reductions.
As per the above table, the ratios which are computed shows computation of different ratios such as profitability ratio, solvency ratio and efficiency ratio (Zainudin & Hashim, 2016). The net profit margin of the company shows that it has decreased slightly from previous year as the ratio is shown to be 0.128 in 2017 which was 0.133 in 2016. The return on equity and return on assets have also decreased which signifies that the profit which is available to the shareholders and the return which is on an asset has reduced from previous year. The solvency ratio shows that current ratio has increased from the previous year which is a positive sign which displays that the business has appropriate liquidity. The inventory turnover ratio shows that it has increased from previous year’s estimate which is a favorable sign for the business. The debtor turnover ratio shows that the estimate has reduced from previous year’s figure.
The changes in capital structure of the company is shown in the above table. The company at present is using only equity capital in the capital mix and the same has improved or increased from previous year (Arrow, 2017). The changes in the capital structure shows that there has been a 9.11% change in the capitals structure of the company.
The above figure shows that the NOPAT which is generated by the company. NOPAT refers to the profit which is available to the shareholders of the company. The NOPAT for the year 2017 is shown to be $ 49152 which has slightly increased from previous year. The analysis shows that the company is not able to generate wealth growth for the shareholders of the company (Jones & Felps, 2013).
The recommendations which can be suggested to the management of ARB ltd are given below:
Conclusion
Thus, from the above discussion it is clear that ARB ltd needs to improve the capital structure of the business and also make improvements in the cost of capital of the business. In addition to this, the company needs to formulate strategies which will result in wealth maximization for the shareholders of the company.
References
Arrow, K. J. (2017). Optimal capital policy with irreversible investment. In Value, capital and growth (pp. 1-20). Routledge.
Barberis, N., Greenwood, R., Jin, L., & Shleifer, A. (2015). X-CAPM: An extrapolative capital asset pricing model. Journal of financial economics, 115(1), 1-24.
Barth, M. E., Konchitchki, Y., & Landsman, W. R. (2013). Cost of capital and earnings transparency. Journal of Accounting and Economics, 55(2-3), 206-224.
Frank, M. Z., & Shen, T. (2016). Investment and the weighted average cost of capital. Journal of Financial Economics, 119(2), 300-315.
Hann, R. N., Ogneva, M., & Ozbas, O. (2013). Corporate diversification and the cost of capital. The journal of finance, 68(5), 1961-1999.
Jones, T. M., & Felps, W. (2013). Shareholder wealth maximization and social welfare: A utilitarian critique. Business Ethics Quarterly, 23(2), 207-238.
Robb, A. M., & Robinson, D. T. (2014). The capital structure decisions of new firms. The Review of Financial Studies, 27(1), 153-179.
Yang, Z., & Zhang, H. (2013). Optimal capital structure with an equity-for-guarantee swap. Economics Letters, 118(2), 355-359.
Zainudin, E. F., & Hashim, H. A. (2016). Detecting fraudulent financial reporting using financial ratio. Journal of Financial Reporting and Accounting, 14(2), 266-278.
Zeitun, R., & Tian, G. (2014). Capital structure and corporate performance: evidence from Jordan.
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