ACCT11059 Accounting, Learning and online communication€¦ · Web view2018-02-12 · Author:...

Maree SmithStudent No: 12074320

ACCT11059 Accounting, Learning and online communication

Assignment 2, Steps 7 - 10

ACT11059 Accounting Learning & Online CommunicationTerm 3

Maree SmithStudent No. 12074320

Step 7 – Identify 3 products or services and estimate their selling price and variable cost. Comment on contribution margins and constraints.

From my understanding of the Study Guide coming into this step, a Contribution Margin (CM) is the portion of sales revenue that is available to cover the fixed costs of a firm. It is represented by the equation CM = Sales Revenue (S) – Variable Costs (VC).

Variable costs are those that are directly related to the sale of a product, and by their very nature, vary with number of sales made.

Fixed costs are those that remain constant regardless of the number of sales a firm makes and include rates, rent, electricity, some labour, and maintenance. Because the firm cannot directly identify these as being specifically related to the production or provision of a good or service, they must be covered in the contribution margin of its sales.

Grand Baoxin Auto Group is an investment holding company that does not manufacture any goods. It earns income from its ownership of subsidiary companies. To date I have considered this to be a blessing for the purpose of this unit… until now.

The companies it owns essentially sell ready made vehicles, which are imported, distributed then sold to the Public. They also offer additional services being after sales service and repairs to vehicles and also spare parts sales through the operation of 4S Stores.

Grand Baoxin pride themselves as the leading dealership of BMW in China. They also specialise in luxury and ultra-luxury cars as their main business, such that I have chosen to use 2 different vehicle types for this exercise and a scheduled service on a vehicle (being the vehicle I chose as my first item). I have chosen to review the vehicles for the purpose of this exercise as the simplest option, and also because I had been able to track down some actual sales figures (RRP) from the car manufacturers websites. This is also the major component of Grand Baoxins revenue, with new vehicle sales accounting for approx. 89% of the firms revenue for 2016. While these are not necessarily the final selling price of a vehicle, given the many options available for new car purchases (upgrades including tyres, wheels, and other add-ons for example), these figures are for the base models. Without access to more detailed information of my company, I have chosen to adopt these for this exercise.

I also chose the service as from my research, these generally seem to have a greater profit margin than vehicle sales, and it is something that I can identify with (from my own vehicle in Australia) to make some educated guesses on the costs. After-sales services accounted for approx. 11% of the firms revenue for 2016.

Finance leasing services, being the third revenue identified accounted for 0.02% of the total revenue.

Other aspects of the firm such as detailing and repairs I was unable to find any information on potential costs, so would be based purely on guesses, particularly having no other insider knowledge of the automobile industry. As such, I have not chosen these as one of my products/services for this exercise.

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As such, the three Products I have chosen are:

1. BMW X1 sDrive18iA – Model designed specifically for China 2. Maserati Levanti 3. BMW X1 25,000km/12 month Basic Service

Selling Price (Yuan/RMB)

1. RRP RMB 290,990.00 (Starting Price)2. RRP RMB 1,060,000.00 (Starting Price)3. RMB 5,105.00 (Based on an estimated cost comparison of AUD $1,000)

From my initial investigations, it seems that profit margins for new car sales in Australia and the US are relatively small for lower end cars – generally less than 5%. This increases to at least about 10% - 20% (or more) for higher end cars. I have considered these figures in my calculations for the variable costs and contribution margins.

The variable costs for the new car sales would be relatively few (purchase from manufacturer, import and delivery costs, commissions and some labour) although seem to account for a large portion of the costs, i.e. these products would have a much smaller contribution margin.

The variable costs for the scheduled 25,000km/12 month service of the BMW however, would most likely be greater in number, although these would account for a much smaller portion of the actual cost, resulting in a larger contribution margin. The variable costs for the service would include labour and spare parts (rubbers, belts, filters, oils and fluids etc) that would be used in undertaking the service.

The selling price, variable costs and contribution margins for each product I have chosen are included below:

BMW X1(RMB)

Maserati Levanti(RMB)

BMW X1 25,000km/12 month service

(RMB)

Selling Price 290,990 1,060,000 5,105

Variable Costs 276,440 848,000 1,787

Variable Costs as % 95% 80% 35%

Contribution Margin 14,550 212,000 3,318

Contribution Margin as % 5% 20% 65%

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From the above table, it can easily be seen that each of these products/services has a positive contribution to the firm. The lower end car (being classed as a luxury car) provides the least contribution margin to the firm. The Maserati (being an ultra-luxury, higher end car) provides a greater contribution margin for the firm, although still at (what I would consider to be) a more satisfactory percentage, although still would not be sufficient to cover the fixed costs of the firm, unless these cars were sold in great numbers. Given that the sales of new cars accounts for such a large amount of the firms revenue, this may very well be the case.

Despite this, the 12 month service provides the greatest contribution margin, and it would be easy for the managers of the firm to identify exactly what the variable costs are. However, the provision of this service is also likely to be highly dependent on the firm maintaining its new car sales, and accreditation with the manufacturers, such that the product/service that provides the greatest profit margin would also be dependent on the product that provides the least.

Resource constraints that this firm would face would be mostly directly related to the supply of vehicles and specific parts from the manufacturers. Any shortage in raw materials (eg steel) experienced by car manufacturers and resulting shortages of their product would be then experienced by the company. They in turn may need to be more selective in their purchase of vehicles from manufacturers, and potentially explore options for supply of alternative models or manufacturers if there are raw material shortages experienced by car manufacturers.

Manufacturers who fail to keep up with technological changes and demands of purchasers would also reflect negatively in its sales. For example, the firm has experienced a reduction in sales of certain BMW models as they were considered “out dated” by the public, when compared to other manufacturers. As discussed above, the firms vehicle service would also therefore be directly affected by a reduction in new car sales. Conversely, if sales of a particular vehicle increased, revenue from its scheduled servicing (and potentially faults services and repairs) would similarly increase. However, the increases in the service department would not be felt until perhaps 12 months later, according to the scheduled servicing. There would be a time lag in the ripple effects of its motor vehicle sales through the other arms of the company.

However, managers would be able to therefore more accurately be able to predict future patterns in this aspect of the firms operations, based on their past sales figures.

Market constraints of the firm are also fairly broad, although I found fairly easy to identify. In China particularly, they would include the Governments incentives for domestic car manufacturers and therefore increased costs for imported cars. Their restrictions on issuing of new car number plates (the number plate lottery as discussed in my Assignment 1) would also likely affect sales.

These constraints in particular will likely mean that the public is more likely to “shop around” if they are lucky enough to be able to purchase a new car. The company will need to constantly ensure their suppliers are keeping up with market demands and advancements in the automobile industry.

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Step 8 – Calculating Ratio & Ratio Analysis.

I found the actual calculation of the majority of the ratios fairly straight forward. However, the description of the ratios was a great help and the only difficulty I had a couple of times was which spreadsheet to use.

Taylor Burgiss (https://moodle.cqu.edu.au/mod/forum/discuss.php?d=269943) initially posted her draft ratio calculations on the Moodle Forum, and I found this also a really helpful check on the calculations I had done. I also replied to her thread with my calculated (draft) ratios and outlined one of the main difficulties I had in my calculations. This was the calculation of the Market Ratios. Initially, I didn’t understand what to enter for the “Number of Issued Ordinary Shares”. This figure was the same over the 4 years for my firm, so I was unsure whether it meant that the same number of shares was issued each, or if no additional shares were issued in subsequent years. I decided that the figure went in as the same amount for each year, which then indicated that no additional shares were issued.

I then had difficulty in interpreting the price per share. In the annual report, it states that the shares were issued at a rate of HK$0.01. Firstly, this would need to be converted to RMB to be consistent with the figures in the financial reports. Secondly, this was also consistent over the 4 years. However, the share price reported on the Hong Kong Stock Exchange, obviously isn’t consistent. So I wasn’t sure what figure to use here. I did play with a few different figures, and in my searches I did manage to find some stock prices as at 31st December each year. So I decided, after also having a look at some of the other student ratios that I should use the actual share prices, convert them to RMB and they should be my figures.

Ratio Analysis

The first question from the assignment material after I had done the ratios was “ What do these Ratios tell you (or not tell you) about your firm? How do you make sense of them?”

My initial response – I have no idea!!!

I did not understand how to read these ratios or what they were trying to tell me about my firm. The equation behind the ratios themselves, I understood. But the difficulty I had was in determining if the figures were good, bad or indifferent.

The first thing I noticed about my figures was that they were all what I thought to be relatively low, with the exception of the Debt/Equity Ratio, which looked disturbingly high. Particularly when I looked at the example of Wesfarmers provided.

I found this figure particularly odd. Firstly because its telling me that the firm owes more than three times its equity – surely this isn’t a good thing. I know if I went to the bank and asked to borrow 3 times what my house is worth, they would laugh me straight out the door. They wouldn’t even lend a 100% equivalent. So the concept of being so much in debt I did find a little uncomfortable.

Secondly, this stuck me as strange because according to the annual reports and to the figures themselves, the firm is actually in less debt than it has been in previous years. Yet the ratio is the highest it has been during the 4 year period. So I guess this (in conjunction with the figures themselves) is telling me that although they’ve apparently paid back a lot of debt, they’ve also either lost a lot of equity or perhaps obtained more (new) debt in that same period. I also noted that this ratio was fairly consistent for the 2013 – 2015 financial reports.

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https://moodle.cqu.edu.au/mod/forum/discuss.php?d=269943



As an investor, I would be rather concerned about this.

The rest of the numbers didn’t stand out to me at all. Besides the fact that they were generally low numbers, they didn’t really mean anything, and I didn’t know how to interpret them.

So I hit google – hard. I searched everything from definitions of these basic terms, to “analysing accounting ratios”.

I also started having a look at other student’s ratios, and what they had determined their figures to mean – which helped me a lot!

To start with, Taylor’s spreadsheet and ratios looked more similar to mine than what mine did to Wesfarmers. Her numbers were lower like mine and her firm’s debt/equity ratio was also quite large.

I then decided that I very obviously needed to gain a better understanding of what each of these ratios are trying to tell me. This is what I found and what it shows for Grand Baoxin Auto Group:

1. Profitability Ratios

Net Profit Margin (NPM)This is the percentage of revenue left after expenses are deducted. So obviously the higher this figure, the better. However there are always going to be expenses so there would be an approximate figure that is considered “good” for various industries.

From my initial research, it seems that approximately 25% would be considered a good net profit margin. Using this as a guide, it would seem that Grand Baoxin is far from good, being less than 5% for each of the 4 years analysed.

It seems that 2015 was the worst year with a net profit margin of only 0.94%. It would be considered positive however, that 2016 was up on this figure, to 1.63%.

This means essentially that the firm isn’t achieving good sales prices for the cost of providing their goods.

This would generally be reflective of the overall downturn in the Chinese Economy over the 2014/2015 years, which recorded the lowest growth rate in the economy since 1990, as reported in the management and chairman’s discussions.

The company has therefore had an excess in inventory that has had to be cleared, and significant changes in the structure of the firm over the 2016 year.

Moving forward, this will hopefully turn into additional profit, after likely being the main source of an increase in costs while it was implemented.

Return on Assets (ROA)This shows the profit (as a percentage) a company earns in relation to its assets – how much income its assets are generating. Again, this percentage should ideally be as high as possible.

In 2013 this ratio (percentage) was at its highest for the 4 years analysed at 5.7%, with again 2015 being the lowest at 1.2%.

Essentially, this would indicate that Grand Baoxin isn’t necessarily making good use of its assets, and should look to use its assets more efficiently.

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2. Efficiency Ratios

Days of InventoryThe days of inventory shows how long a company holds its inventory before selling it or the time it takes to sell it.

Obviously the lower this figure the better. The faster stock is sold and turned into profit, the better. In this instance, a good ratio would vary significantly between industries.

For Grand Baoxin, their current ratio for 2016 is the highest of the 4 years, being 42.71 days. The firm has become less efficient at turning its inventory into profit over this 4 year period.

I haven’t been able to find anywhere that might indicate that this is a satisfactory turnover of stock, although I would think a more efficient ratio would be more attractive for both management and investors.

Total Asset TurnoverThe total asset turnover ratio measures how efficiently the assets generate revenue. It identifies how many dollars of revenue are generated per dollar of assets.

A higher asset turnover ratio in this case again would obviously be better, and indicate the assets are operating efficiently. The acceptable ratios for a firm appear to vary significantly for each industry, and it appears that substantial industry and company knowledge is required to determine a satisfactory figure, but for now, given that my firm is producing greater revenue than the value of its assets, I will consider that this is acceptable, although likely to be room for improvement.

Interestingly, in 2016, Grand Baoxin’s asset turnover ratio was 1.18, the lowest for the 4 years assessed. For every 1 RMB of asset, the firm is raising 1.18 RMB of profit. While it would seem positive that the company is at least making a profit when the macro economy is facing such difficult times, this ratio only reflects gross figures, and so does not show the full story of how well the assets are performing, when outside factors (costs, comprehensive income and finance) are considered.

3. Liquidity Ratios

Current RatioThe current ratio identifies whether a firm has sufficient resources to meet its short term obligations. The acceptable ratio appears to be dependent on perspective – the end users of the information. For example, a lender would prefer a higher ratio, as this indicates the firm is better placed to repay debts, and therefore less risk. However, as an investor, a higher ratio may indicate that it is not efficiently using its assets or its financing facilities.

In the case of Grand Baoxin, the ratios are fairly consistent throughout the 4 years, ranging from 1.00 (in 2015) to 1.45 (in 2016).

From my research, I would think this ratio is considered low, although may be acceptable for this type of industry.

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4. Financial Structure Ratios

Debt/Equity RatioThe debt/equity ratio as discussed above (based on my initial understanding) shows the percentage of the company’s financing that comes from lenders vs investors. As I mentioned, this ratio for Grand Baoxin seems to be very high. In 2016 the ratio was 332.2% - the highest for the 4 years. Essentially, creditor financing (lending) accounts for more than 3 times the amount of investors, which, from a lending point of view, makes the firm risky. The 3 years 2013 – 2015 this ratio was much steadier, ranging from 278.3% in 2015 to 284.1% in 2014.

Looking at the figures from the financial statements, it can be easily identified that this increase in ratios is due to increase in liabilities, as the equity has been the more constant figure over the 4 years.

Equity RatioThe equity ratio shows what percentage of the assets are funded by equity. From the Wesfarmers example, the balance of this figure is then what percentage is funded by debt. From my understanding (and a bit of logic) it seems that it would be more favourable to have a higher equity ratio than a debt ratio. This is also reflected in the Wesfarmers example, which is closer to 50%. My understanding from my research in this step is that it is good for a firm to have some level of finance, an equity ratio of 100% would be undesirable (and most likely unattainable). However, Grand Baoxin’s equity ratio was 23.1% for 2016, down from the range of 26.0% – 26.4% for the 3 years prior. So it seems that the firm is relying heavily on creditors to fund its operations.

5. Market Ratios

These I struggled with the most, although the lack of information about payment of dividends over the last few years from the annual reports is starting to become a little clearer.

I understand that these ratios are likely to be of the most interest to equity investors/shareholders as they identify the return on their investments past and future. The aspect of these ratios I found most difficult stemmed mostly from understanding the shares of my company (Grand Baoxin).

Once I started providing my feedback to others, and also reviewing their formulas, plus re-watching the tutorial videos, I think I have finally got this aspect of the spreadsheet correct.

Earnings per ShareThe earnings per share ratio is the amount of profit allocated to each share. It indicates the potential maximum return for investors from their purchase of shares. In the case of Grand Baoxin Auto Group in 2016 for every share purchased at RMB 0.01 each, a return of RMB 0.16 was earned from profits of the company. Again, the EPS has followed the patterns of the other figures for the 4 years, where the highest was experienced in 2013 at 0.40, decreasing in 2014 to 0.28 and again in 2015 to its lowest at 0.09. However, this amount is not always paid back to the shareholders (see below).

Dividends per ShareThis ratio shows how much of the profits are actually paid back to investors. When I initially posted these on my blog, my figures were incorrect and I had a couple of errors in my formulas.

When I was providing feedback to others I compared my spreadsheet to theirs and realised my errors. When I redid the formulas and changed the market price per share back to that reported in the annual reports (rather than on stock market process), the ratios seemed more accurate to me.

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They showed that no dividends were paid to investors in 2016, meaning that all earnings were invested back into the company.

Dividends were paid in the 3 years previous, although the payment ratio seems to be a little more selective. The earnings per share for 2013 – 2015 was on a steady decrease. The Dividends however peaked in 2014 at 0.12 and again decreased to below the 2013 level for 2015, paying just 0.04.

Obviously as an investor, the higher the dividends the better, and the earnings and dividends recorded are not ideal.

Price Earnings Ratio (PE)

From my research and understanding, the price earnings ratio shows essentially whether the shares are a good deal (cheap) or expensive. It shows potential investors whether the company is a good investment or not, based on past and anticipated future earnings, and how long it would take to pay back their investment.

In order to get this figure, I initially had to make an additional check calculation, as the market price per share was indicated in Hong Kong Dollars, and the remainder of the figures in RMB. I was unable to locate the share prices in my firm’s annual reports so I took to google and found the share prices as at 31 December for each of the years.

The only price I could locate was under the notes (Note 38) to financial reports where it confirms the number of ordinary and paid ordinary shares of 2,557,311,429 of HK$0.01 each. This figure was also consistent in each financial report for the 4 years, which didn’t really seem to be correct. So I decided to adopt the market share prices I had found, as these would be the actual figures shareholders would invest in the company at.

Once I had worked out these figures, it generated the figures for each of the years. Essentially, there was more bad news for the shareholders/new investors.

Based on the share prices, it would take anywhere from 12.79 years (2014) to 40.23 years (2015) to payback their investment. This is essentially the payback period for the investors which I don’t think would be acceptable.

These figures would tell me (or a prospective investor) that the company is not a very good investment.

6. Ratios Based on Reformulated Financial Statements

Return on Equity (ROE)This ratio shows how much profit is being generated per unit of shareholder equity. For Grand Baoxin, for 3 of the 4 years analysed this figure was positive. However, in 2015 this was negative. This figure has seen a large decline for Grand Baoxin over the past 4 years from 21.84% in 2013 to -0.09% in 2015. It has returned to positive territory in 2016 where it currently sits at 1.73%. This means that for every RMB 1 invested by shareholders, RMB 0.173 is being generated as profit.

As an investor, I would think this is a particularly low figure and one that I would hope could be improved.

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Return on Net Operating Assets (RNOA)The RNOA is the amount of operating income being earned for each unit of net operating assets. It indicates how well a company uses its operating assets to create profit. Again, the larger this figure is, the better the company is position in the efficiency of its assets. For Grand Baoxin in 2016, this figure was considered fairly low at 3.76%, although this is a slight improvement on the 2015 figure of 3.02%. In a similar pattern to other figures however, 2015 was the lowest for the 4 years, down from the better figures of 10.76% and 15.29% for the years 2014 and 2013 respectively.

RNOA vs ROAAfter calculating the RNOA, I then compared this figure to the ROA determined above.The difference in these ratios is that RNOA considers only the operating figures, and does not consider the financial figures.

It is clear from the table below that the RNOA fell more rapidly than the ROA to its lowest in 2015, although has increase at a more comparable and consistent rate.

2013 2014 2015 201602468

1012141618

RNOA vs ROA

Net Borrowing Cost (NBC)The Net Borrowing Cost is essentially the cost or interest rate of borrowing money. This figure I could relate to the most, comparing to my own mortgage. Obviously then, the lower this figure the better. It can be seen that over the past 4 years, Grand Baoxin has greatly improved their costs of finance, from its highest in 2013 at 8.48% constantly decreasing to 5.3% in 2016.

I know how much this would affect my own mortgage so I can only imagine how much this would (positively) affect the expenses of Grand Baoxin in their finance.

The annual reports also mention that the company has been considered to pose less risk to creditors and has a good credit rating with financial institutions. Perhaps this is part of the reason, when they have been able to get their financing costs down – and also why they have been able to borrow more, shown by the increase in the Debt/Equity Ratio.

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Profit Margin (PM)The profit margin measures the amount of revenue the company keeps in earnings. For example, a profit margin of 50% means that for every unit (RMB) of revenue earned, the company keeps RMB 0.50. For Grand Baoxin, in 2016 this was 1.70%, meaning that for every 1 RMB, the company kept 0.017 RMB.

From my research and in thinking about this logically, obviously the higher this percentage the better. However, I would think that the larger the company, the better it is able to cope with such smaller PMs. However, this still does not seem like a very good margin and something that the company would be likely aiming to improve.

In the 3 years prior, again the figure hit a low point in 2015 at 1.43%, which fell consecutively from 3.75% in 2014 and 4.71% in 2013.

PM vs NPM

The PM compares then to the NPM, the difference being that PM does not consider the financial income. These two ratios when compared side-by-side show an interesting pattern. While they have generally shown the same trends, the differences haven’t been consistent, and are now at a point where they are essentially equal.

2013 2014 2015 20160

0.51

1.52

2.53

3.54

4.55

PM vs NPM

Asset Turnover (ATO)Asset Turnover measures the company’s ability to generate sales from its assets. It shows how efficient the company’s assets are.

This figure (not percentage) shows the value of each unit of currency invested in the company’s operating assets.

This figure has followed the trends of others in the analysis where there has been a decrease since from 3.25 in 2013 to a low of 2.12 in 2015 and growing again in 2016 to 2.21.

This shows that for 2016, for every single RMB invested (its assets) Grand Baoxin will generate RMB 2.21 in sales.

It’s positive that the figures still show the firm as achieving a profit from its assets, although I believe these figures could improve significantly. I believe that Grand Baoxin is not using its operating assets as efficiently as it could.

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ATO vs TATO

ATO can be compared to TATO, with the difference being that the TATO includes both the operating and financial assets of the firm.

When the two are compared together, it is evident that the firm is achieving a better profit from its operating assets than it is from its operating and financial assets combined.

This could be as a result of the firm purchasing China Grand Automotive and expanding their operations which also increased their inventory stocks.

2013 2014 2015 20160

0.5

1

1.5

2

2.5

3

3.5

ATO vs TATO

Economic Profit

Economic Profit (or loss) is the difference between the revenue received from its sales and the opportunity cost of the inputs used.

This figure surprised me the most in undertaking these calculations. When I first starting reading up on my company, and reviewing the annual reports and various material and figures, I had thought that my company was essentially in a good position and would be a good company to invest in. I guess the “marketing material” at the start of the annual reports was successful in convincing me of the firms success.

However, the Economic Profit for Grand Baoxin was actually negative for the 2015/2016 years, being an economic loss, and in a fairly big way I believe. The first loss in 2015 of (671,504.6) was a huge turnaround from the 2013 year where the company actually did record an economic profit of RMB582,896.9.

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2013 2014 2015 2016

-800000

-600000

-400000

-200000

0

200000

400000

600000

800000

Economic Profit

In analysing these figures, and the reasons behind them, I found it easier to work forward this time, from the 2013 year when the company was in its best position, through to 2016 where it has had an economic loss, although appears to be improving from the low of 2015. From this I could determine where the company was making good decisions, and then what decisions they have made that have potentially caused the economic losses seen over the last 2 years.

The year 2013 seems to be, across all figures, the most positive for the firm. The firm seems to have been in a good position at this time, despite there still being room for some improvements. The ratios that follow the same pattern as the economic profit most closely are the ROA and the RNOA. These are likely to have affected the economic profits the most from within the firm, which may indicate the efficiency of the firm’s assets may be what is letting it down the most.

From an industry perspective, there were other external influences at play that have contributed significantly to the downturn seen in the above figures.

The Chinese macro economy was facing a recession. As mentioned previously, growth rates were the lowest they had been since 1990 and this would result in the firm experiencing losses regardless of their structure, inventories, turnover rates or sales.

In hind sight, the firm to a certain extent maybe had to “whether the storm” and do the best it could to turn around figures as quickly as possible. This resulted in a management re-structure, purchase of additional selective subsidiary companies.

Regardless of these, the firm is still facing some pretty heavy losses. So what does this mean? When all the figures I had analysed so far were coming out positive (albeit very low) I figured the firm would surely then have to still be making an economic profit, right? Well, for 2 of the 4 years, yes.

So here’s my best shot at an analysis, as the build up to “the big one” hadn’t really shed much light on my understanding.

Economic profit is based on the RNOA, the Weighted Average Cost of Capital (WACC) and the NOA. It measures the opportunity costs of capital in the investment decisions made by management. When these opportunity costs are positive, the firm has made positive choices for the company. When the economic profit is negative (or a loss) the opportunity cost is greater, reflecting poor choices of management.

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The greater the WACC, the worse it is for the economic profit (or loss). In determining which figure to use, the WACC Expert from Moodle suggested 9%, while the Assignment suggests 10% without anything firm to justify otherwise. I have adopted 10% in this instance as the assignment suggests.

From playing with the figures, it seems to me that the main drivers for economic profit for Grand Baoxin are its Operating Income. This is the figure that it needs to increase, its operating income after tax, or the OI part of the RNOA. If Grand Baoxin can (obviously) increase its revenue, but at least reduce its costs of services or even more specifically the administration and selling & distribution expenses, this seems to make a huge impact on the Economic Profit.

The company (any company) needs to maintain a RNOA above 10% (or the WACC) in order to be making an economic profit. Obviously the WACC is also a key driver in economic profit (or losses).

On review of the annual reports, I can see that Grand Baoxin has taken steps to do exactly this. The administration expenses may or may not be able to be significantly reduced, although they have undertaken a major restructure of the company. Essentially now, each store is responsible for its own new car and spare parts ordering and inventory. This will hopefully reduce (possibly significantly) its selling and distribution expenses with a reduction in warehouse costs while a central department holds and distributes new cars and parts. Instead, they will go straight to the stores.

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Step 9 – Capital Investment Decision.

Given the challenges faced by Grand Baoxin over the past 3 years with a downturn in the Chinese Economy, falling sales from “outdated” car models, increasing pressures on the population to purchase used vehicles and incentives for domestically manufactured vehicles, the company is considering 2 options for its expansion.

The first option is the opening of a 4S Store in an outer district as a retailer of Land Rover vehicles. The firm has chosen this brand as it offers a greater range of vehicle price ranges to cater for a population base generally on slightly lower than those in the major cities, but still also luxury vehicles generally in high demand. Some models of these vehicles are also manufactured in China, such that there will be less costs than importing all models of vehicles.

The second option is the adoption and implementation of a new computer software program for the used car aspect of the company. The new software will benefit both the employees with information to be more streamlined and easily accessible, and will also provide a better online shopping experience for customers, also providing a more interactive experience with sales staff and offering links to financing, after sales service and beautification/enhancement options currently only provided to new car purchases.

Given the increasing demand for used car sales, this aspect of the industry is anticipated to provide great growth for the company into the future, particularly with the government relaxing the taxes and fees applicable to these transactions, combined with the increased pressure and taxes on imported vehicles.

It is anticipated initially that the 4S Stores life expectancy would be indefinitely while the firm is making a profit, although this is highly dependent on market demands. Although if advancements in technology for vehicles is not adequately incorporated into the Land Rover brand, or if the Chinese Governments approach to new car sales (with purchasing permits tightening in large city areas) were to be applied to other outer areas, the 4S Store may not be financially viable indefinitely.

However, the computer software would have a more defined shelf life generally of about 5 years. In this instance, given that this package will include options for inclusion of the other business services offered by the company it is anticipated that the software could have a shelf life of 10 years.

Each of these options has been given a length of 10 years.

At the end of its life, the software will be redundant. No costs could be recouped from the initial outlay at the end of its life. On the other hand, the 4S Store bricks and mortar could be onsold.

Cash flows from the 4S Store would be easily identified and include new car sales, car services, after sales services, finance etc., less operational costs such as vehicle purchases and delivery, wages, inventory and land rental.

Cash flows from the computer software would be the used car sales, finance and also to vehicle beautification as part of the purchase packages and options available through the software, less operational costs such as labour in the monitoring of the websites and costs associated with administration in addition to the initial outlay for design of the product.

The investment would be made on 1 January 2019. The estimated future cash flows are expected to be received on 31 December of each year.

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The original cost, the estimated life, residual value and estimated future cash flows of each investment opportunity are set out in the table below. All amounts are expressed in Chinese Renminbi (RMB).

Assuming a rate of return/discount rate/WACC of 10%.

From these figures, I have been able to calculate the Payback Period, Net Present Value (NPV) and Internal Rate of Return (IRR) for both options, summarised as follows:

New 4S Store Used Car SoftwarePayback Period 5.1 years 4.2 yearsNPV 20.18 million 37.24 millionIRR 17.4% 26.5%

Analysis & Recommendation:

Option 1 – New 4S Store

The option of the new 4S Store with anticipated future cash flows indicates a payback period of 5.1 years. This indicates that the 6th, 7th, 8th, 9th and 10th years will provide a positive return on the investment and profit for the company.

The net present value of this investment is RMB20.18 million, which suggests the new 4S Store will generate that much revenue above the cost of the initial investment.

The IRR is above the required return of 10%, suggesting that this option would be a good investment for the company.

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New 4S Store

Used Car Software

Original Cost ¥40 million ¥30 millionEstimated Useful Life 10 Years 10 YearsResidual Value ¥5 million 0Estimated Future Cash Flows31 December 2019 (time period = 1 year) -¥7 million -¥3 million31 December 2020 (time period = 2) ¥5 million ¥5 million31 December 2021 (time period = 3) ¥10 million ¥10 million31 December 2022 (time period = 4) ¥15 million ¥15 million31 December 2023 (time period = 5) ¥15 million ¥15 million31 December 2024 (time period = 6) ¥17 million ¥20 million31 December 2025 (time period = 7) ¥17 million ¥20 million31 December 2026 (time period = 8) ¥15 million ¥15 million31 December 2027 (time period = 9) ¥10 million ¥15 million31 December 2028 (time period = 10) ¥10 million ¥10 million



Option 2 – Used Car Software

The second option of purchasing the software package for the used car sales indicates a payback period of 4.2 years based on the anticipated future cash flows. This indicates that years 5 - 10 will provide a positive return on the investment and profit for the company.

The net present value of this investment is RMB37.24 million, which suggests the software package will generate that much revenue above the cost of the initial investment.

The IRR at 26.5% is well above the required return of 10%, suggesting that this option also would be a good investment for the company.

Decision

In comparing the two options side-by-side, either could be considered positive for Grand Baoxin. However, the opportunity cost of opening the new 4S Store would be greater. The returns would not be as good as they would be for the software package, and the payback period is slightly longer.

Given the economic losses experienced by the firm during 2015 & 2016, the company needs to be realising greater profits on its assets as quickly as possible.

As these options are mutually exclusive, given the above results, I would recommend that the company invest in the new software package for its used car business.

The new 4S Store, still presenting a positive investment opportunity, may be investigated in the future.

Strengths and Weaknesses

I believe the strengths of my capital investment analysis and decision are:

The options are realistic – in that they are relevant to the business, and I would think that opening new stores (or at least acquiring companies with other stores) and implementation of appropriate software packages would both be considered by the managers of the firm as part of the ongoing business operations.

All figures lead to same conclusion – the figures all confirm that the software package is the best option in terms of the profitability for the company.

The weaknesses at this stage are unfortunately greater than the strengths in this hypothetical situation, which I guess is to be expected. Those I have identified are:

The figures are purely speculative. I have had to guess how much it might cost to open a new 4S store and for the purchase (or contract for the creation) of the new software package.

The company may consider the existing software package already sufficient and viable. It is difficult to gauge a good understanding of how the existing websites and any existing packages operate, as this website is in Chinese and doesn’t translate overly well.

I have adopted the suggested WACC as I didn’t find conclusive figures to substitute. Any adjustments to the WACC would amend these results, although they would be relative to each other and in theory (as long as they are the same) would provide the same outcome.

Step 10 – Feedback

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I initially posted my draft for feedback on my blog and also in the feedback forum on moodle on 5 th February:

Link to Blog post:

https://wordpress.com/post/mareesmithblog.wordpress.com/83

Link to Moodle post:


In total, I have received feedback from 2 other students:

Rachel Cauchi Eliza Jones

I was particularly nervous about getting feedback from other students given my own reservations of my work and understanding.

Feedback From: Rachel Cauchi

Feedback To: Maree Smith .

My Comments

Step 7

Identify three products or services of your firm

Estimate selling price, variable cost & CM

Commentary – contribution margins

Constraints – identify & commentary

I like how you have clearly explained your understanding of variable and fixed costs before diving into step 7. You have certainly done a great amount of research on your company in order to back yourself up for three different products and service you have chosen. I like the three products and service you have chosen however, I think a description or even photo of each where they are first listed may be helpful to the reader and to also make you Contribution Margin’s look more realistic before going into details.I like your take on the possible constraints that Grand Baoxin Auto Group may face as they seem very legitimate which are very clearly explained.

Step 8 I loved reading about you thoughts and experiences whilst completing step 8. I liked how you thoroughly explained in detailed each different ratio with a heading, which it made it much easier for the reader to follow along with. I particularly liked how you created graphs for some of the ratios as it was easy to see the comparison between ratios and throughout the past 4 years.

You mentioned that you were not completely finished with this step however, I think you have done quite a good job overall anyway! And the completed ratios in your spreadsheet look right to me.

Calculation of ratios

Ratios – commentary (blog)

Calculate economic profit

Commentary – drivers of economic profit (blog)

Step 9 I thought your capital investment decision of your firm was quite though out, which again showed your understanding of your firm. I think your discussion is very strong and well supported with your thoughts on each investment opportunities.

Develop capital investment decision for your firm

Calculation of payback period, NPV &

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https://wordpress.com/post/mareesmithblog.wordpress.com/83



IRR

I think the figures you have assumed are realistic, however I don’t believe you mentioned any strengths or weakness in regards to using the calculations of the payback period, net present value (NPV) and internal rate of return (IRR)

Recommendation & discussion

Step 10 You have started to outline what is going to be included in this step of the assignment before actually giving or receiving any feedback, so well done on starting early but yet to be completely completed. Individual feedback with other

students

Overall ASS#3 You have done a really good job on you last piece of assessment for this unit! I can only really recommend expanding on you vocabulary by using ‘bigger’ words (complex but simple) to tidy up your wording. Other than that you have followed through the assessment tasks very closely as majority of the main points of each step was covered, which were clear and easy to understand. Hoping my feedback helps, there was only very few things I could provide some suggestions for. Well done on your work!

Rachel’s was the first feedback I received and it was a relief to get something positive after feeling apprehensive about the work I had done.

She also noted that I hadn’t included the strengths and weaknesses for my payback period calculations which I has forgotten to do so I was grateful for that.

Feedback From: Eliza Jones

Feedback To: Maree Smith .

My Comments

Step 7





I like your three choices. Also, I would love to own a Maserati Levanti! You have done plenty of research into your three chosen products, and given a nice description of each. You have identified the selling price, variable cost, and CM for each option. You have explained in detail your thoughts and understanding in your commentary. You write well and I enjoy reading through your work. I like how you have identified that manufactures constantly need to keep up to date with technological changes to suit the demands of consumers. I am impressed with the detailed and interesting research you have done in this step. Your explanations are detailed and informative.

Step 8 Again, a good read. I too had some confusion with my firms shares, but I went online to stock exchange websites to find their volume of shares and share prices over the last few years. Your commentary

Calculation of ratios Ratios – commentary (blog)

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clearly shows your thought process and shows your engagement and understanding of the material. You have clearly explained in detail each ratio under a separate heading, this is great for the

Calculate economic profit Commentary – drivers of

economic profit (blog)

Step 9 You seem to have a great understanding of your firm and write with an authority on the concepts covered in this step. Your capital investment decision is very detailed showing that you have thoroughly researched each choice. You support your reasons with the figures which you have created in this capital investment decision scenario, and figures all look very realistic. I am trying to look for faults in your work so I can offer constructive criticism, but so far I cannot fault your work. You seemed to have covered all the marking criteria, except that you could offer some more information on the strengths and weakness of your analysis.


Calculation of payback period, NPV & IRR


Step 10 You are active on online forum discussions.

Individual feedback with other students

Overall ASS#3 Well done for finishing the last assessment so well. Your work is logical, detailed and well presented. It shows you have done plenty of research on your firm and that you have a good understanding of the concepts covered in this unit.

Eliza feedback was also reassuring, was very thorough in her commentary on my assignment and also noted the strengths and weaknesses I had forgotten to include.

I am very grateful for the time taken in checking my draft assessment and found the feedback very useful.

I then went on to try to provide feedback to other students. I actually found this rather difficult to provide constructive feedback as I wasn’t entirely comfortable with my knowledge on the ratios to start with. I heavily relied on the Feedback Sheet for guidance, and went on to (hopefully) provide some advice to 3 students:

Lillian McCracken Amanda O’Day Louize Smit-Dreyer

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Feedback From: Maree Smith

Feedback To: Lillian McCracken .

My Comments

Step 7





I think you’ve done a really great job with your Step 7. You’ve researched the products and their uses well, and identified the prices and costs thoroughly, as well as identifying the constraints and threats to the company.

Your explanations are easy to follow and you have a well thought out conclusion :)

Step 8 Again, I think you’ve done a great job with the ratios and the explanations and findings – particularly given everything you are going through!

NPM – the only very minor thing I noticed in your explanation is that you had a typo for the NPM of 2016, written as 2019.

TATO – again a minor typo in your 4th line, 5th word should be assets, rather than ratios. Again only minor, and I know exactly what you were referring to :)

Market Ratios – explanations still to be completed. I have only noted this so you don’t overlook it before submitting your assignment. I noticed that you have completed the ratios in your spreadsheet which appear correct, and also match back to your Income Statements.

RNOA – Your company’s RNOA for 2016 is very impressive! I initially thought this was an error!

NBC – Explanation to be included although figures appear correct.

ATO – Explanation to be included although figures appear correct.

The Wesfarmers Example Spreadsheet also includes suggestions to compare the RNOA & ROA; PM & NPM and ATO & TATO. If you’re up to it, it may help provide additional insights or understanding, or at least food for thought.

Maybe also include a little more in depth explanation of the drivers of your firms economic profit and what activities it has done specifically to achieve these numbers.





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Step 9 Your investment decision provides a good example and your rationalisation and recommendation are well analysed.

Your spreadsheet looks complete.




Step 10 To be included.


Overall ASS#3 Overall I think you’ve done a great job of your assignment, especially considering your own personal challenges!

My understanding of all these things I limited so I apologise if my feedback is a bit broad. Hopefully it is of some help.

Hope you’re feeling better soon!

Good luck with completing your assignment :)


Feedback To: Amanda O’Day .

My Comments

Step 7





You have certainly had to do a great amount of research for your company and you’ve definitely done a great job of interpreting the information you’ve gathered. You seem to have a great understanding of your company and have identified the products/services, contribution margins and constraints really well.

Step 8 As you mentioned you are still working on expanding the ratio analysis, although the commentary you have included seems to be on the right track.

The prompts you have also listed for yourself seem to cover the things that are remaining, and the completed ratios in your spreadsheet look right to me.





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Step 9 Your capital investment decision for your firm is fantastic! Again, you have got a great grasp on your firm, its costs and analysing the annual reports and figures.

I think the figures you have adopted are very accurate (probably as accurate as you could ever get them as an outsider!). Your explanations are very detailed although still very easy to follow and logical.




Step 10 To be completed


Overall ASS#3 You have done a really fantastic job with such a difficult company. Your understanding of the concepts and industry is admirable and obviously reflects the amount of time you have dedicated to the unit.

I’m sure when you complete the inclusion of your explanations for Step 8 you will have a top rated assignment.

Well done and good luck :)


Feedback To: Louize Smit-Dreyer .

My Comments

Step 7





I like the way you have set up your assignment. It’s easy to follow and the diagram is a good way to show how revenue is broken into costs of a firm. The only (minor) error I found in it was that you noted the CM covers variable costs instead of fixed.

You’ve obviously done a great deal of research into your company, which I’m sure hasn’t been entirely easy to get a grasp of. It’s a different company in the services it provides and you’ve done really well to get a good grasp on it all.

Step 8 Again, I like the way you have set up your assignment – its easy to follow and your explanations are easy to follow and related back to your company which is great. Calculation of ratios

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One thing I did notice was that in your discussion about economic profit you noted a negative economic profit for 2014, although the figure in your spreadsheet are positive. The rest of your calculations appear correct and well analysed.

Your discussion on the drivers of your forms economic profits and losses is well researched and reported.




Step 9 Your investment decision is one of the best I have seen laid out. You’ve thought out your options really well and gone through each of the scenarios and figures really well.

I agree that although both options could contribute positively to the firm, Option A proves to be the most profitable.




Step 10 Not included


Overall ASS#3 I thought your assignment was well structured and your explanations were easy to read and understand.

You’ve done a really great job – well done.

Good luck

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