Executive Summary
The assignment is based on two separate tasks which focuses on two different companies which are Saturn Pet care ltd which is engaged in manufacturing of pet products and ARB Ltd which is engaged in manufacturing activities of road motors accessories. In the first task capital budgeting technique will be applied so as to select from two different production site which are Bathurst site and Wodonga site. In the second task the capital structure of ARB ltd is to be analysed and also compared with a similar company belonging to same industry.
Part A
Capital Budgeting of Bathurst Site
Figure 1: (Capital Budgeting of Bathurst Site option)
Source: (Created by Author)
Capital Budgeting of Wodonga Site
Figure 2: (Capital Budgeting of Wodonga Site option)
Source: (Created by Author)
As per the computation which are shown in the above figure for both the site which involves NPV analysis, analysis of profitability index and payback period (Sanchez et al., 2013). The results of the analysis quite clearly show that the clear option for the business is Wodonga site which has better NPV, profitability index and payback period as compared to Bathurst site. The NPV analysis for Wodonga site reveal that the NPV computed comes to $ 95,94,827 which is more than NPV of Bathurst site which is computed to be $ 58,44,567. The Profitability index shows that the Wodonga site has an index of 1.349 which is much more than Bathurst Profitability index which is shown to be 1.177 which signifies that Wodonga site is much more profitable than Bathurst site. The payback period analysis shows that the Wodonga site has the lower payback period which signifies that Saturn pet care will be able to recover the initial investment which the company spend on the production project. Thus, it is clear that Wodonga site is the clear option.
Product Cannibalization
This can be described as a technique which is used by businesses to promote or introduce new products in the market by reducing the sales volume of another product (Lin & Okudan, 2013). In the case of Saturn pet care, it is expected the management will be applying this technique in order to promote the new product of the business in the market.
Rectifying the Excessive Sales Recorded
The sales which is recorded and estimated by the marketing department of Saturn pet care as per one of the directors of the business has been incorrectly estimated and the accurate one might be a bit lower than what has been anticipated. Such an error in estimation can impact the decision-making process of the business and therefore needs to be rectified. The management can apply NPV method and increase the cost figures of the business so as to neutralize the erro in estimation.
Inclusion of Original Cost of Old Factory Shed
It is also the opinion of the director that the existing factory site which is vacant which is going to be used in the production process also must be included in the costs of initial investment made by the business. This is an incorrect estimation as NPV analysis only recognizes current investments which are undertaken for the project. Th initial investment must not include the such costs in the initial investment of the business.
Part B
Introduction
This part will be analyzing the capital structure which is used by the business for the purpose of financing its operations. The later paragraph will also be containing an analysis which will compare the capital structure of ARB ltd and another company belonging to same industry. There will also be recommendations as to how the business can further develop.
Capital Structure and Cost of Capital
The capital structure of the company shows that it is made up of equity capital which shows the reliance of the company over the internal control of the business (Graham, Leary & Roberts, 2015). The company does not use any portion of debt capital in the capital structure of the company. The image which is related to the present capital structure is depicted below:
Weighted Average Cost of Capital below
The weighted average cost of capital which is shown in the table below shows that the cost of equity is 18.05%. As the company has no debt capital in the capital mix of the company therefore the cost of equity which is calculated becomes the weighted average cost of capital. The overall cost of capital has reduced from previous year and such a change is favorable from the point of view of the management.
Cost of Capital Under CAPM
As per CAPM method, the risks which is calculated following the value of by Beta (B), risk free rate of return and market rate of return for the purpose. This method is considered to be one of the most popular methods of analyzing a viability or the worth of a project (Baker & Wurgler, 2015). The cost of capital which is computed following CAPM approach comes to about 7.906% which is a favorable result as the market rate of return is 8.54% which means the needs of the shareholders are meet.
Comparison between ARB ltd and Modine ltd
For the purpose of conducting a comparative study, Modine ltd is selected which belongs to the same industry as ARB ltd. The first observation which is made judging by the capital structure of Modine ltd is that the company has a favorable capital structure and has employed both equity and debt capital which are $ 421.20 million and 519.90 million respectively. ARB ltd only has employed equity capital in the capital mix of the business.
Financial Ratios of ARB Ltd
The current ratio which is covered in the liquidity ratio of the business shows that the ratio has increased from previous year which suggest that the liquidity situations of the company has improved. The debt equity ratio shows a slight increase in the ratio from the previous year’s estimate (Fitó, Moya & Orgaz, 2013). The net profit margin of the company has reduced which may be due to some issues which the company might be facing with the operational activities of the business. The efficiency ratio of the business also shows favorable results especially inventory turnover ratio.
Changes in capital structure
The capital structure of the company has changed over the year as depicted in the image which is shown below after the explanation. In 2015 the company did use debt capital in the capital mix and since then the company has been following the equity capital only option.
Wealth Maximization
The company is committed toward the goal of the business which is to maximize the profits of the business. The NOPAT of the company has increased from the previous year however there has not been a significant growth in the NOPAT (Nakhaei, Nik Intan & Melati, 2013). This can be attributed to the various other factors which affects the NOPAT of the business.
Recommendations
The recommendations which can be provided are given below in detail:
Conclusion
The conclusion which can be drawn from the above analysis is that the business of ARB Ltd needs to add debt capital or borrowings in the capital mix of the business. The company also needs to improve the wealth maximization principle of the business and also ensures that the risks are kept at minimum which can be done by getting a favorable capital mix.
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