The following report related with financial management will be useful for the users in order to understand the basic concepts and techniques related to financial accounting and the deep analysis of the report will assist the users in analysing the financial performance and position of an enterprise under consideration. The various techniques used in managerial accounting consisting of ratio analysis and capital budgeting will be applied in this report. For the same purpose, the company William Hill Plc. and Paddy Power Betfair Plc. will be taken into consideration in order to assess the financial performance and position during the last three years. The ratios will be calculated and the investment recommendation will be given in the report. The techniques of capital budgeting consisting of NPV and payback period will be applied in the report in order to evaluate the investment option under consideration The overall report will be significant in order to understand the concept of financial accounting.
It is a UK based company which has been listed on London Stock Exchange. The company was founded in late 1934 by William Hill when gambling was illegal in Britain. William Hill plc. is engaged in the business of sports betting and gaming services in UK, US, Australia, Spain and other international platforms. The company has been operating a licensed betting office which offers the betting and gaming services to its customers. The company has been also operating the online betting and gaming services which provides pre match and in play betting and gaming. The financial review of the company states that the revenues of the company have increased and there has been correspondence decrease in the financing costs of the company. The major aim of the company is to invest in the business itself and the planning are done in order to invest in the long term objectives of the company (William Hill PLC, 2018).
Paddy Power Betfair was formed and established in 2016 and has been considered as a multi chain and international sports betting company also involved in game operating. The business has four operating divisions and has been listed on London Stock Exchange. It has its market leading presence in the market of Ireland, USA, Australia and UK. The operations of the company are extended towards Europe. The financial review of the company states a satisfactory position over the last few years in which the revenues has increased adequately (Paddy Power Betfair PLC, 2018).
It can be observed that there has been slight decrease in the gross profitability of the company William Hill Plc. in the year 2017. The revenues have increased significantly over the last few years with the correspondence increase in the gross profit acquired by the company. The same has been 75% in the year 2017 whereas the same was 76% in the year 2016 and 2015 (Muritala, 2018).
For the company Paddy power the gross profit ratio has increased by 1% in the year 2016 and the same ratio has been maintained in the year 2017. It can be observed that there has been revolutionary increase in the revenues and profitability of the company in the 2016 and the same was the efforts made towards diversification and expansion. Thus the same has been profitable option for the investors (DeFusco, et. al., 2015).
For William Hill Plc. the net profit ratio was 12% in the year 2015 which decreased to 10% in the year 2016 ad ultimately the operations resulted in loss for the company in the year 2017 when the net profit was -5%. The same has been due to major increase in the operating expenses of the company. The operating expenses amounted to £1336.8 million in the year 2017 whereas the same were £1012.3 in the year 2016 (DeFusco, et. al., 2015). For Paddy power the net profit ratio shows adequate amount of profitability and it can be established that the company has maintained a sound net profit ratio of 12% when compared to industry averages operating in UK. The company experienced a loss in the year 2016 when the operating loss amounted to £5.7 million but the same was improved in the year 2017.
In the present situation Tim Farrow is an investor who is a risk averse person and does not like to take much risk while investing in certain portfolios. The risk averse investor will be referred to as the person who will be willing to earn lower returns with known risks rather than earning higher returns with corresponding high and unknown risks. As per the description of Tim Farrow he is an investor who will be looking forward to avoid the risks while making investments in the shares of William Hill Plc. and Paddy Power Betfair Plc. Therefore the portfolio with minimum risk will be suitable for him in order to achieve his goals (Minnis & Sutherland, 2017).
While analysing the ratio analysis conducted above for both the companies’ relevant conclusions can be drawn:
Profitability risk – It can be seen that both the companies are earning similar rate of return when it comes to gross profitability of the company. The returns are however higher in the case of Paddy power. The net profitability of the companies shows that William Hill Plc. is having losses in the year 2017 whereas the operating performance of Paddy power is adequate. Therefore by recognizing the profitability position it can be concluded that Paddy power will be a good option for investment purposes (William Hill PLC, 2018).
Liquidity risk – The liquidity risk will represent the risk associated with payment of short term liabilities for the company. It can be assessed that current ratio and cash ratio for both the companies are sound but it is higher in the case of Paddy Power plc. The company has enough cash ad current assets in order to serve the current liabilities of the company. Therefore when avoiding the risk of short term liquidity company Paddy power bet fair plc. will be chosen for investment purposes. However the investment can be done in William Hill also as the ratios match the industry averages (Grant, 2016).
Leverage position – The leverage position will represent the solvency position of the company when it employs the capital in the company The debt equity ratio of William Plc. is much higher when compared to Paddy Plc. and therefore the investment will be suggested in the company William Hill Plc. The company has more debts in comparison to Paddy power but the same is necessary in order to achieve the lowest minimum cost of capital. However the debt in Paddy power is very low which will affect the profitability of the company but the risk is very low in terms of solvency.
Investor return risk – The investor risk return has been measured by calculating the return on capital employed ratio. The return ratio for William Hill Plc. is not good in the year 2017 but it has maintained high ratios in the previous years. Whereas the returns for investors in case of Paddy power has been very fluctuating and there has been no fixed pattern in relation to the returns. Therefore when the risk needs to be lower the investment will be made in William Hill Plc.
By assessing and analysing the current situation presented above, it can be seen that the risk associated with solvency is much lower in the case of William Hill Plc. However the profitability will be moderate in that case. The profitability position of Paddy power is much better than William Hill Plc. but the solvency position is at a higher risk. Considering that Tim Farrow is a risk averse investor, he should employ more of his funds in William Hill Plc. as the risk will be low in that case. However the remaining funds can also be invested in the shares of Paddy Power (Minnis & Sutherland, 2017).
The calculations have been made for analysing the proposals recommended for Patel Mintro. The calculation of net present value for project A shows that the cash inflows and outflows during the lifetime of the project will result in net present value amounting to £67655. The net present value for project B will amount to £72440. The basic concept behind the net present value technique is related with the fact that the project with the higher net present value represents the project earning high cash flows in present value terms for the company. Therefore the project with high cash flows will generate sound profitability for the company and thus higher NPV project will be accepted by the company. In the given case the net present value of project B is higher than project A and therefore project B will be selected (Hayward, et. al., 2017).
The calculation of payback period helps in determining the time required for recovering the initial investment made in the project. The initial investment made in project A was £160000 however the same was higher in project B amounting to £220000. The payback period, after considering the cash flows incurred in both the projects have been 3.556 years for project A and 3.667 years for project B (Demerjian & Owens, 2016). This shows that project B will take longer time to recover its initial cost when compared to project A. But there has been very little difference in the number of years for recovering the initial cost. Based on payback period method project A will be selected. By analysing both the methods of NPV and payback period it can be recognized that returns are higher in project B when it comes to cash inflows. Therefore project B will be selected (Demerjian & Owens, 2016).
The calculation of Accounting rate of return will require calculation of average rate of return for both the projects under consideration and the same will be divided by the initial investment made in the project in order to achieve ARR for the company. The accounting rate of return as calculated for project A has amounted to 24% whereas the same has been 22% for project B. The average of return for project A comes out to be £37942.5 after considering the time value of money however the same has been £48740 in case of project B. This shows that the returns are higher in project A and therefore project A will be accepted by the company Patel Mintro. The higher accounting rate of return represents the situation where the operating results will be positive for the company as the project will be earning high cash flows and the outflows are minimum (Zhang, 2017). This will lead to a situation where company will be investing in the projects with higher ARR. Thus in this case depending on the situation of Patel Mintro and the ARR calculated for both the projects, project A will be selected with the ARR of 24%.
Both the techniques, their advantages and disadvantages are discussed in detail as under:
Firstly, we will discuss the advantages and shortcomings of Payback Technique as a method of evaluating capital projects:
Payback method is a method which helps us to calculate the time period which is required to pay back the initial investment being made in the project.
Hence the formula taken to calculate the same is:-
Payback Period = Initial investment / cash flows per year
Simplicity: It is very easy to calculate and makes it simple to make comparison between different projects and the project with the shortest payback period is preferable.
Liquidity: This method helps the user to provide a crude measure of liquidity and also provides the information on the risk of the investment.
Time value of money not considered: This method does not take into account the time value for money and ignores the cash flows beyond the payback period taken into account.
Risk neglected: This technique ignores the risk of future cash flows (Zhang, 2017).
With this technique, there is no concrete decision which indicates whether the investment increases the firm’s value.
NPV is a technique which is used to make the calculations in currency whereas the payback period works on the principle of calculating time period.
The formula for NPV is as under: NPV = (Today’s value of the expected cash flows) – (Today’s value of invested cash)
Under the Net present value method, all the cash flows in the business are examined whether positive or negative. NPV method discounts the future value of cash flows. With the help of this method, a comparison is made between the amount invested today and the future value of cash returns and the cash flows are discounted by a specified rate of return (Hayward, et. al., 2017). It can prove to be a very useful technique to evaluate a project but not suitable for every project as it has it’s pros and cons which are discussed here under:
Time Value of Money: In this technique, the time value of money is considered by taking into account the discounting rate. All the cash flows are discounted by taking some specified rate of return.
It helps us to evaluate whether the investment will increase the firms value and considers all the cash flows unlike the payback period technique.
Risk of future cash flows and cost of capital is also considered in this technique (Andor, et. al., 2015).
It also takes into consideration the cash flows over the life span of the project unlike the payback period where only cash flows during the payback period is taken into effect.
Profitability has been of high importance as this technique and helps in maximizing the firm’s value.
Guesswork Required: The major disadvantage of this technique is that it requires us to make assumptions about the firm’s cost of capital i.e. estimation is required which cannot prove to be accurate always.
Size of the project is not considered: This technique does not take into account the size of the project and it is not ideal for comparing the two projects with two different sizes.
It is expressed in value and not calculated in percentage.
This method is difficult to use as well as calculate (Graham, et. al., 2015).
NPV method cannot provide us or assure us to give correct result if the amount of investment in mutually exclusive projects is not equal.
In an investment appraisal process, along with the financial factors there are some non-financial factors also that play a key role and needs to be considered. Financial factors are quantitative in nature whereas non-financial factors are qualitative in nature and they play a vital role in decision making as per 77 % of the firms as studied by Petty, Scott and Bird (1975). They are briefly discussed as below:
Relationships: For an investment appraisal process, a business should build healthy relationships with its employees, creditors, suppliers and emphasize on improving staff morale, develop its relationships with local community and also improve its business reputation by doing so (Andor, et. al., 2015).
Government Regulation: Before making any investment appraisal, the rules and regulations applicable on the proposed project should be properly evaluated so that there does not arise any kind of problem afterwards. It should not violate the environmental rules or the things which are banned by the government should not be used in the project has to be ensured.
Climatic / Environmental issues: The company should focus on investing in a project which is environmental friendly and does not breaks the health and safety regulations as this is the most important requirement in today’s world and focused upon.
Availability of Man Power: The Company should properly evaluate the availability of the manpower and resources needed in the proposed project as without manpower no work can be initiated and they must have the knowledge of operating the equipment in which the company is planning to invest (Rossi, 2014).
Competitors Action: The competition in the market should be evaluated and worked upon before starting the project. In order to operate efficiently in the market and set market for the product, the action of the competitor has to be considered.
Safety: It has to be ensured that the project does not affect the safety of the employees and public. It has been observed many a times that the organizations ignore the factor that the projects may have hazardous impact on social environmental as well as the people operating them which has to be taken seriously and taken care of.
Technology Availability: If the technology used in the project is inadequate or incorrect then it mat even lead to the failure of the project being proposed which would have resulted in profitable gains if proper technology would have been used in it. Hence the availability of technology must be first checked before introducing the investment appraisal project. As found by Kantel (2002) and Kenny (2003), level of technology used in a project is the most important technical characteristic.
Tax benefits or incentives: A company may also evaluate the tax benefits available for a particular project like setting up certain business plants in Special Economic Zones or export oriented undertakings helps the owners to avail certain benefits like tax exemption and other duty relief and relief from certain restrictions put by the government. It helps in increasing the gains as the taxation costs are reduced (Rossi, 2014).
Location / Site Selection: As discussed above the location may be chosen taking the tax benefits in mind. However, another important factor to be kept in mind while choosing the location is the level of pollution produced by the implanting the project or it may also require the disposal of waste etc. The needs of the project are also kept in mind while finalizing the location.
Maintaining the existing product line or entering the new product line: There are many examples where the investment appraisal is undertaken just to reduce the manufacturing costs, improve production capacity or bring some other changes while on the other side the business may enter into a totally new product line with a view to expand the business (Graham, et. al., 2015).
The above report related with financial management helps in concluding that all the techniques of capital budgeting and ratio analysis will assist the users in analysing the projects under consideration and the investment decision can be made carefully and appropriately. The decision relating with investment in the share of a company can be taken after considering the ratio analysis for the past few years and the recommendation will be made accordingly. In case of Tim Farrow the investment should be made in the shares of William Hill Plc. While implementing the capital budgeting techniques in case of Patel Mintro it can be concluded that there will be different opinions when considering different methods of capital budgeting and therefore the decision shall be made after considering relevant conditions.
Andor, G., Mohanty, S.K. and Toth, T., 2015. Capital budgeting practices: A survey of Central and Eastern European firms. Emerging Markets Review, 23, pp.148-172.
DeFusco, R.A., McLeavey, D.W., Pinto, J.E., Anson, M.J. and Runkle, D.E., 2015. Quantitative investment analysis. John Wiley & Sons.
Demerjian, P.R. and Owens, E.L., 2016. Measuring the probability of financial covenant violation in private debt contracts. Journal of Accounting and Economics, 61(2-3), pp.433-447.
Gitman, L.J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Pearson Higher Education AU.
Graham, J.R., Harvey, C.R. and Puri, M., 2015. Capital allocation and delegation of decision-making authority within firms. Journal of Financial Economics, 115(3), pp.449-470.
Grant, R.M., 2016. Contemporary strategy analysis: Text and cases edition. John Wiley & Sons.
Hayward, M., Caldwell, A., Steen, J., Gow, D. and Liesch, P., 2017. Entrepreneurs’ capital budgeting orientations and innovation outputs: Evidence from Australian biotechnology firms. Long Range Planning, 50(2), pp.121-133.
Kraft, P., 2014. Rating agency adjustments to GAAP financial statements and their effect on ratings and credit spreads. The Accounting Review, 90(2), pp.641-674.
Minnis, M. and Sutherland, A., 2017. Financial statements as monitoring mechanisms: Evidence from small commercial loans. Journal of Accounting Research, 55(1), pp.197-233
Muritala, T.A., 2018. An empirical analysis of capital structure on firms’ performance in Nigeria. IJAME.
Paddy Power Betfair PLC, 2017, Annual Report 2016, [ONLINE], Available at: https://www.paddypowerbetfair.com/investor-relations/annual-reports/2018, [Accessed on: 29.11.2018]
Paddy Power Betfair PLC, 2018, Annual Report 2017, [ONLINE], Available at: https://www.paddypowerbetfair.com/investor-relations/annual-reports/2018, [Accessed on: 29.11.2018]
Rossi, M., 2014. Capital budgeting in Europe: confronting theory with practice. International Journal of Managerial and Financial Accounting, 6(4), pp.341-356.
Rossi, M., 2015. The use of capital budgeting techniques: an outlook from Italy. International Journal of Management Practice, 8(1), pp.43-56.
Weygandt, J.J., Kimmel, P.D. and Kieso, D.E., 2015. Financial & managerial accounting. John Wiley & Sons.
William Hill PLC, 2017, Annual Report 2016, [ONLINE], Available at: https://www.williamhillplc.com/investors/results-centre/2018/, [Accessed on: 29.11.2018]
William Hill PLC, 2018, Annual Report 2017, [ONLINE], Available at: https://www.williamhillplc.com/investors/results-centre/2018/, [Accessed on: 29.11.2018]
Zhang, G., 2017. Fundamental (versus Market) Risk and Capital Budgeting Decisions: Distinguishing between the Investment Hurdle Rate and the Cost of Capital.
Zietlow, J., Hankin, J.A., Seidner, A. and O'Brien, T., 2018. Financial management for nonprofit organizations: Policies and practices. John Wiley & Sons.
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