Financial and Economic Analysis, Summative Assessment 2

Published: 14 Dec, 2024
Category Assignment Subject Finance
University Leeds Beckett University Module Title Financial and Economic Analysis

Summative Assessment 2

Diversifying to survive recessions OLA plc is a software development company in Leeds that has been developing mobile apps and web platforms for over 15 years. Its business has proven to be successful over the years with profits tripling over the last doubling over the last 4 years. At a recent board meeting, members of the board of directors expressed the desire to diversify its operations into unrelated industries in the wake of uncertainties in the global economy and the threat of a recession. The chairperson of the board has proposed that the company can diversify into either the furniture industry or the pharmaceutical sector. They requested the accountant to prepare cash flow projections for the first 8 years and the finance officer to prepare estimates of the costs involved in either project and suggest sources of finance. The cash flow projections by the accountant is in Table 1.

Table 1: Net Cashflow projections

Year 

Clothing Retail

Automotive

1

-15,000 

-55,000

2

-10,000 

-35,200

3

0 

-5,500

4

25,000 

45,350

5

42,500 

98,510

6

56,350

163,850

7

68,750

244,100

8

84,000

327,750

The finance officer has estimated that the company will need an initial investment of £90,000 for the Clothing Retail business and £325,000 for the Automotive business. She also provided information on some ratios for both industries which is shown in table 2.

Table 2: Financial ratios 

 

Clothing Retail industry 

Automotive Industry

2023 

2022 

2021

2023 

2022 

2021

Gearing Ratio

35% 

41% 

56%

55% 

57% 

59%

Current ratio 

1.85 

1.55 

1.15

2.63 

1.90 

1.72

Acid Test ratio

0.99 

0.82 

0.72

1.20 

1.29 

1.01

Gross profit margin 

75%  

72% 

64%

59% 

54% 

44%

Operating Profit margin

6.3% 

7.9% 

7.1%

7.2% 

8.3% 

9.6%

Return on Capital Employed

4.8% 

3.9% 

3.1%

2.6% 

2.8% 

3.1%

The accountant and the finance officer have submitted the estimates and projections to the Board, but the members of the Board are not clear how to interpret or use the information they have been given.

In a meeting with the Board, the finance officer expressed scepticism about the timing of the new project. She thinks because of the political tensions in the MiddleEast and its potential effects on the European and the UK economy, along with the continuing conflict in Ukraine, a recession is imminent.

She also pointed to recent inflation and interest rate patterns citing the Office for National Statistics and the Bank of England websites. She is suggesting that the proposed project should be postponed for at least 2 years.

The Board chairman however disagrees with her and has argued that the uncertainties are the reasons why the business needs to diversify.

Required:

  1. You have been contracted by the Board as an independent consultant to advise them on the above matter. The board has asked you to write a comprehensive report of about 2000 words and submit the report in the next 2 weeks. Your report should provide a recommendation on which project to pursue and must provide reasons to justify every recommendation made.
  2. Your report must include an interpretation and discussion of the industry ratios, NPV calculations and one other investment appraisal technique as well as a discussion of at least 2 alternative sources of finance for the recommended project.
  3. The relevant discount rate for OLA plc is the February 2024 Bank of England Base Rate plus 4.5 percentage points.
  4. You should also respond to the concerns of the finance officer by discussing what is meant by a recession, the causes of a recession and its likely effects on OLA Plc’s current business and the project you have recommended. 
  5. Explain the implication of the trend of inflation and interest rates and how the political tensions in the Middle-East and the conflict in Ukraine could impact the business.
  6. You are free to also discuss the effects of other industry specific factors and macroeconomic variables.
  7. A good report is one that is one that is research based and supported by relevant data. You can include tables and graphs within your report and should include an appendix where you can show additional tables, graphs and other information you did not produce but which will be helpful to OLA plc’s board of directors to make a decision.

 

 

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