assignment 2: steps 7-10 · web view2021. 5. 31. · assignment 2: steps 7-10. shanell fisher:...
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Assignment 2: Steps 7-10Step 7
I originally found the task of selecting three products or services provided by Downer Group incredibly intimidating. Most of their products and services have to do with civil construction and are not only difficult to differentiate, but they are also incredibly difficult to estimate prices for due largely to the customisable nature of their products, services and requirements of their clients. Luckily, Downer Group owns several different companies and I managed to find one who’s products and services made sense to me. Epicure is an event management company owned by downer group that hire venues and provide catering for a wide range of events across exclusive locations in Australia’s capital cities. I chose their Taronga Zoo location in New South Wales and focused in on their wedding packages. I found it difficult to find any pricing guide on their website so I made a phone call to Rose Rodrigues at Taronga Centre Reception and she kindly emailed me through the below pricelist:
For the purposes of this assessment, I have chosen the Gold, Platinum and Diamond Wedding Packages Adult options. I did struggle with estimating the variable costs for my options. Things like catering and alcohol would be considered variable costs, but things like security hire would be considered a fixed cost. With this in mind, and considering that venue hire is not included in these package options, I estimate that the variable costs would be around 80%. I then multiplied the selling price by 0.80 to work out the estimated variable cost for each option. Finally, I worked out the contribution margin of each option by subtracting the estimated variable cost from the selling price.
Product
$165.00
$132.00
$33.00
$185.00
$148.00
$37.00
$210.00
$168.00
$42.00
All three package options, while different, are inherently similar in terms of what they both offer the client and the costs they require to be fulfilled by Epicure. It is for this reason that I believe that it is understandable that they have similar contribution margins. My partner often says to me that the luxury goods market is the only market where you can make luxury profit margins. For some reason this sentiment came to mind when I saw that the most expensive option yielded the highest contribution margin.
While the Diamond option produces the largest contribution margin, it would not be wise for Epicure to only provide this option as it would significantly reduce the size of their target market by income demographic and therefore reduce their overall sales. It is better to appeal to a wider income demographic and produce more overall sales than sell only a few units of a higher priced item. For example, Epicure may sell 4 weddings of 250 guests the Gold package in a year, 2 weddings of 250 guests the Platinum package in a year and only 1 wedding of 250 guests the Diamond package in a year, if they were to eliminate the Gold and Diamond packages, theoretically they would miss out on the contribution margin of $51,500.00 for that year and make only $10,500.00 of contribution margin for the year on the single Diamond package they sold.
One constraint that Epicure faces is the limitations on guest numbers based on venue size and licencing regulations. They also have the constraint of a limited number of days within a year in which to hire out their services. I also imagine the seasonal nature of wedding events would further limit this, as well as, the preference to have wedding on weekends. These constraints mean the Epicure’s revenue potential is limited. It is for this reason that I can understand why they have expanded their services over several locations across Australia: to increase their revenue potential.
Further to this, Epicure would face the constraint of seasonal availability for some of their menu items. This would contribute to a fluctuation of variable costs across the seasons that they would have to take into consideration when pricing their options.
Competition provides another constraint for Epicure. There are many alternatives for events in all of the cities that Epicure operates in. It is for this reason that the company markets their Taronga Zoo venue as being a truly unique event location and offer many add-on services that offer a point of difference to their competitors.
Lastly, the COVID-19 pandemic is a huge constraint that would have and would still be impacting Epicure’s sales. Many weddings and events had to be cancelled and those that were able to go ahead had to do so with decreased numbers as to comply with the governments social distancing measures.
The aforementioned constraints would be relevant when deciding the pricing for each of the three options. For example, Epicure would have to ensure that their pricing was able to produce a contribution margin large enough to cover their fixed costs, and as such, they may consider a minimum requirement for guest numbers. They would also have to ensure that their pricing remained competitive with alternative vendors and that they are able to justify that their prices reflect the value they provide to potential clients. Epicure would have to reassess the way they provide their services as a result of government imposed COVID-19 restrictions, and as such, would have had to limit the number of guests that they are able to accommodate for their events and possibly increase their prices to ensure their costs are covered. The impact of COVID-19 could have possibly lead to Epicure removing some options from their events service list entirely, if it was no longer possible for them to provide the services within the constraints of the restrictions.
Step 8
Profitability Ratios
I was very apprehensive when calculating the profitability ratios for Downer EDI. Their net profit margin was very low for years 2017, 2018 and 2019 at just 2.4, 0.5 and 2.1 cents of profit made for every dollar of revenue received respectively. The 2020 year was even worse with -1.4 cents being lost for every dollar of revenue earned. This does make sense as the company made a loss in 2020. From what I can see, this may be a result of the impairment of non-current assets and the depreciation of leased assets as a result of their portfolio restructure when taking full ownership of Spotless Group. The return on assets ratio tells us the percentage of profit made for every dollar of assets held in that year. As Downer made a loss in 2020 it makes sense that this ratio would be negative for that year.
Efficiency ratios
The days of inventory ratio tells us on average how many days it takes the company to sell or use that inventory. I noticed that in the last 3 years, Downer EDI does not hold inventory for long. This makes sense to me as Downer mainly deals with construction projects and I imagine that most inventory stock would be ordered and used as needed for particular projects. It stands to reason that the 50-day benchmark would be the average time it would take from the stock to be ordered by the project managers and used in the construction project. They did manage to lower this time from 2017 to 2018 due to a reduction in their held inventories of $32.9 million from the divestment of freight-rail inventory and the tightening of their inventory management as outlined in the 2018 Director’s Report.
The total asset turnover ratio reflects this streamlining of inventory management from 2017 to 2018, where we can see the higher level of held inventories and subsequent slower turnover rate meant that Downer EDI was only making 96 cents for every dollar of assets they held. The reduction in their held inventories and increased turnover rate saw this ratio increase in the following 3 years, indicating improvement in asset management.
Liquidity Ratios
The current ratio tells us about the company’s ability to pay their debts by comparing their total current assets and total current liabilities. In 2017, Downer held only 96 cents of assets for every dollar of liabilities. This may be attributable to the majority takeover of Spotless Group, which significantly increased Downer EDI’s liabilities as mention in the 2017 Director’s Report.
Financial Structure Ratios
The debt/equity ratio looks at how much of the company is funded by shareholders equity and how much is funded by debt. Downer EDI have increased their debt over the last 4 years. In 2017 they had $1.115 of debt for every dollar of shareholder equity, which gradually increased to $2.309 of debt for every dollar of shareholder equity. I can see that Downer EDI has both decreased shareholder equity and increased debt over the 4 years. In 2020 the company managed to secure $787million of new debt facilities to improve the liquidity of the company as a response to the COVID-19 pandemic as outlined in the 2020 Director’s Report. In 2020, the reduction in equity is attributable to the loss the company made as well as the dividends paid and the impact of the adoption of AASB 16 leases. In 2019, debt increased due to redrawing to fund business activities and equity decreased following the adoption of AASB 15 and dividend payments. In 2018, the reduction in equity is attributable to dividend payments and the acquisition of majority share of Spotless Group. Debt increased in 2018 as a result of a reduced net cash position.
The percentage of assets that have been funded by shareholder equity are shown in the equity ratio. In Downer EDI’s case, it makes sense that the percentage of assets that have been funded by shareholder equity has decreased over the last 4 years as we can see that equity itself has decreased over the last 4 years. Conversely the debt ratio shows the percentage of assets that have been funded by debt and as Downer EDI’s debt has increased over the last 4 years it makes sense that this ratio has also increased. The debt and equity ratio should add up to 100% and I was very happy to see that mine did exactly that.
Market Ratios
The earnings per share ratio shows the profit for the year divided equally across the number of shares on issue. In 2020, Downer EDI’s earnings per share was negative. This makes sense as the company made a loss for the year. The 3 years before, Downer EDI had relatively low earnings per share, with a slight improvement in 2019.
Dividends per share show the amount the company paid out to shareholders per share for the year. Downer EDI have kept their dividend payments fairly consistent over the 4 years despite fluctuations in their earnings per share. I understand that it is best to keep shareholders happy in this regard. This would have significantly impacted their profit for years 2018 and 2020, when the earnings per share were lower than the dividends per share.
The price earnings ratio shows how many years it would take shareholders to make back the money they invested on shares in the company by comparing the earnings per share and the market price of the share. I found this ratio a bit confusing as the 2020 figure was negative. While this makes sense because the earnings per share for 2020 is negative, I am unsure how to interpret this ratio for this year. I understand that if the company continues to run at a loss that shareholders would never make back the money they invested so perhaps this is what the negative indicates. The previous three years are far more straightforward. For 2019, 2018 and 2017, it would take shareholders 14.99, 74.12 and 21.48 years to earn back the money they invested respectively.
Ratios Based on Reformulated Financial Statements
The return on equity ratio shows us the percentage of return on shareholders’ equity based on the total comprehensive income for the year. In 2020, Downer EDI’s shareholders are losing money which makes sense considering the company made a loss in that year. In 2019, however, this ratio is quite good, indicating that the 2020 figures show the impact of the portfolio reshuffle. It would stand to reason that Downer EDI may see the benefits of their acquisition of Spotless Group in years to come, resulting in a positive return for their shareholders.
The return on net operating assets (RNOA) shows the percentage of return that the company is receiving from the use of their operating assets. Unsurprisingly, Downer EDI has a negative RNOA for 2020, although when we compare this figure to the return on assets ratio, we can see that it is significantly less, indicating that the financing activities have a larger impact on the return on assets ratio than the operating activities.
The net borrowing cost ratio shows the average interest rate by comparing the company’s net financial expenses to the net financial obligations. Despite the increased debt over the 4 years, Downer EDI have a reduced interest rate from 2018 to 2020. This decrease is attributable to debt refinancing causing interest rate drops.
The profit margin ratio compares the operating income after tax against the sales for the year to show the percentage of operating income received for every dollar of sales made. In 2020, Downer EDI made a negative profit margin ratio. This again reflects the loss they made that year. However, this figure is significantly lower than the net profit margin ratio, indicating that the company’s financing activities have a greater impact on the net profit margin than the operating activities. This is true for years 2020, 2019 and 2018, however 2017 shows a far closer figure to the net profit margin ratio. This may be a result of their lower debt for that year and lower net borrowing cost ratio.
The asset turnover ratio shows the efficiency of the company’s operating assets by comparing them to the sales made for the year. For Downer EDI, the operating assets are being utilised to return more revenue than can be see when comparing the ratio to the return on assets ratio. This indicates that the operating assets are being used more efficiently than the financial assets.
Economic Profit
The economic profit compares a company’s profit to its cost of capital, taking its opportunity costs into consideration. The opportunity costs are the missed earning potential of the next best investment opportunity when deciding between two options. Put simply: when deciding between two options to invest their capital into, if the company decides on one option, the opportunity cost is the missed earning potential they would have received had they invested in the other option. The economic profit is calculated by first subtracting the weighted average cost of capital (WACC) from the return on net operating assets (RNOA) then multiplying the result by the net operating assets (NOA). Downer EDI’s economic profit figures are negative for 3 of the last 4 years. This made sense for me for 2020 as they did not make a profit for this year, however, I was surprised to learn that the 2018 and 2017 were also negative. As I assessed the components of the equation I realised that the RNOA for the 3 negative years was less than the weighted average cost of capital of 8%, therefore the answer would have to be negative for those years. The company has quite a high number of net operating assets and these figures are relatively consistent over the 4 years, however the impact of the RNOA on the economic profit is significant and I can see how the two ratios are closely linked. For example, in 2019, the RNOA was 9.05%, 1.05% above the WACC, which translates to an economic profit of $60.85, significantly better that the other 3 years. It will be interesting to see if Downer EDI is able to reap the benefits of gaining 100% control of Spotless Group and their portfolio reshuffle in coming years to improve their performance as a company.
It was an interesting 4 years to assess for Downer EDI. There are a lot of changes that happened for the company in terms of portfolio reshuffling as well as the precautions they took as a result of the COVID-19 pandemic. Their majority takeover of Spotless Group began in 2017 and they took complete control of the company in 2020 which has had a significant impact on their figures. I believe Downer EDI will improve and see the benefits of their portfolio diversification. I remember a pearl of wisdom from my economics unit: systematic risk can be diversified away. Therefore, portfolio diversification can only be a good thing. While this will not protect them from unsystematic risks, such as the COVID-19 pandemic, Downer EDI seemed to have acted accordingly in response by increasing the liquidity of the company by securing more debt and negotiating lower interest rates.
My favourite discovery was finding out about how Downer EDI streamlined their inventory management and how that change was reflected in the figures. After completing this journey with my company, I have a new-found appreciation and interest for this process. I really enjoy solving problems and figuring out exactly why things are the way they are and now I have an entirely new way of doing that.
Step 9
Downer EDI has two opportunities to choose from starting in the 2020-21 financial year. The first is to enter a 10-year contract with a company that researches lithium battery technology. Downer EDI would provide funding to the research and in return they would own the patent rights and be able to sell the batteries alongside their renewable technology products and services. After 10 years they would be able to sell the patent.
The second option is to open a fabrication plant in Western Australia where a large construction project is set to begin spanning 10 years. They would be producing the same engineering products and increase their reach across Australia, allowing them to cash in on the construction project in that area. They would be required to purchase the land, build the facility and fit it out with the required machinery. After 10 years, the building, land and assets are unlikely to be sold and will be kept by the company.
Patent research (a)
24 million
10 million
Once I calculated the internal rate of return (IRR), the net present value (NPV) and the payback period (PP), for both options, I recommend that Downer EDI invest in option B: The West Australian Fabrication Plant. The NPV for option B is quite modest at $19.19 million while the NPV for option A is negative. The IRR for option B is 12% which is reasonable while option A is -1.5%. The payback period for option B is 6.45 years while option A is only payed back after the residual value is collected. Option B will make the company money while option A will only make a very small amount after 10 years of making a loss.
Step 10
I found this part of the assignment relatively straightforward. Maria answered any questions I had and I found the concepts and equations quite easy. I did see students on the Facebook page unsure what to put for their future cash flow figures for step 9, this is something that I also struggled with, but when I saw that there were others in the same boat I decided to just try my best at estimating them and I think I did okay in this regard.
I was very happy that I provided feedback to 3 of my peers as it made me realise that I had used the wrong WACC percentage! It’s moments like that that make me understand how valuable this process is to not only help others but reflect on my own work and refine it.
Feedback given to other students:
PEER FEEDBACK SHEET: ASS#2 Step 10
Feedback From: Shanell Fisher
Feedback To: Kelsey Jamieson
Estimate selling price, variable cost & CM
Commentary – contribution margins
Constraints – identify & commentary
Your maths all looks correct to me and I liked that you included the reasoning for each of the variable cost percentages. Your constraints are well thought out and well written. Well done!
Step 8
Your ratios section of your spreadsheet looks great to me! The only thing I was curious about is why you opted to use 8% for your weighted average cost of capital? I can see that you were unable to find this for your company but I was under the impression that Maria says to use 10% in her video.
Your explanations and commentary look great, there are just a few spelling errors: you used ‘an’ instead of ‘and’ in the section about return on assets and a few times you have used ‘then’ instead of ‘than’. But other that those very minor things you have done an exceptional job!
Calculation of ratios
Ratios – commentary (blog)
Calculate economic profit
Step 9
You have done really well for step 9, all of your calculations look great! Well done!
Develop capital investment decision for your firm
Calculation of payback period, NPV & IRR
Recommendation & discussion
Overall ASS#2 Steps 7-9
Great job! You should be proud of what you have achieved, I hope you can relax now that you are all done!
PEER FEEDBACK SHEET: ASS#2 Step 10
Feedback From: Shanell Fisher
Feedback To: Jedidiah Page
Estimate selling price, variable cost & CM
Commentary – contribution margins
Constraints – identify & commentary
Wow! You have done such a great job! The only comment I can make is that maybe you could move the table up to above the commentary so that the reader can look at the figures before you explain them. Other than that, there are just a few grammatical errors. Very minor details, you have done so well!
Step 8
Your calculations look spot on! Well done, the only thing I am curious about is why you chose 8% for your WACC when Maria says to use 10% in her video? I am actually beginning to think that maybe I have missed something and that I should be using 8% as well as you’re the second person that I have come across that has done this.
Your commentary is well written and your explanations are great!
Calculation of ratios
Ratios – commentary (blog)
Calculate economic profit
Step 9
You have definitely gone above and beyond with this assignment! I don’t have one thing to correct you on!
Develop capital investment decision for your firm
Calculation of payback period, NPV & IRR
Recommendation & discussion
Overall ASS#2 Steps 7-9
You have done such a great job with this assignment! Well done! Hopefully you can relax a little now that you have finished.
PEER FEEDBACK SHEET: ASS#2 Step 10
Feedback From: Shanell Fisher
Feedback To: Alicia Anderson
Estimate selling price, variable cost & CM
Commentary – contribution margins
Constraints – identify & commentary
Your company did not provide you with clear products and services which would have made this step way more difficult than most other students. My company was also difficult to pinpoint products and/or services so I do sympathise with you in this respect. Although I did manage to find some eventually. You have done really well to complete this step. Other than a few spelling/grammatical errors (you used ‘there’ instead of ‘their’ in this section) there is very little for me to correct. Well done!
Step 8
You have stated that you have used 8% for your WACC but your table says 10% on your word document. I can see that you have used 8% on your spreadsheet though.
Your ratios all look correct to me. I did find it odd that your company has no dividend payments listed in their financial statements, but I guess you can only go off the figures that you are given. It’s great that you have included an explanation for this in your word document. I can’t see anything wrong at all here.
I thought your theories and explanations about your ratios were great! I also really like the way you write, it feels like we are having a conversation. Well done!
Calculation of ratios
Ratios – commentary (blog)
Calculate economic profit
Step 9
I loved the options you created for your company. It shows that you have a really good understanding of your company and their motives. Great job with this!
Develop capital investment decision for your firm
Calculation of payback period, NPV & IRR
Recommendation & discussion
Overall ASS#2 Steps 7-9
Really well done! You definitely didn’t have an easy company in terms of getting all of the information you needed but you improvised and I think you have done a great job. Hopefully you can relax a little now that you have completed your assignment.
Feedback provided from other students:
None yet provided.
Conclusion
I quite enjoyed these steps of assignment 2. I found the calculations relatively straightforward and the concepts easy to understand. I feel like everything I’ve learned this semester has all settled in and I can now make sense of it easily. There were many times when I felt like a deer in the headlights but I can now see the bigger picture. I really enjoyed the insights I gained from calculating my company’s ratios. I feel like I have a better understanding of what is actually going on at Downer EDI and I have somewhat pack-bonded with the company. I think I would like to invest as I believe they are on their way up in terms of profitability. This has been a very interesting unit. It is unlike any other that I have done before and while I found it to be incredibly demanding at times, I really liked the step-by-step nature of the assignments. I hope that there will be other units that follow this layout as I found it incredibly beneficial and I feel I have performed better as a result.
13
I originally found the task of selecting three products or services provided by Downer Group incredibly intimidating. Most of their products and services have to do with civil construction and are not only difficult to differentiate, but they are also incredibly difficult to estimate prices for due largely to the customisable nature of their products, services and requirements of their clients. Luckily, Downer Group owns several different companies and I managed to find one who’s products and services made sense to me. Epicure is an event management company owned by downer group that hire venues and provide catering for a wide range of events across exclusive locations in Australia’s capital cities. I chose their Taronga Zoo location in New South Wales and focused in on their wedding packages. I found it difficult to find any pricing guide on their website so I made a phone call to Rose Rodrigues at Taronga Centre Reception and she kindly emailed me through the below pricelist:
For the purposes of this assessment, I have chosen the Gold, Platinum and Diamond Wedding Packages Adult options. I did struggle with estimating the variable costs for my options. Things like catering and alcohol would be considered variable costs, but things like security hire would be considered a fixed cost. With this in mind, and considering that venue hire is not included in these package options, I estimate that the variable costs would be around 80%. I then multiplied the selling price by 0.80 to work out the estimated variable cost for each option. Finally, I worked out the contribution margin of each option by subtracting the estimated variable cost from the selling price.
Product
$165.00
$132.00
$33.00
$185.00
$148.00
$37.00
$210.00
$168.00
$42.00
All three package options, while different, are inherently similar in terms of what they both offer the client and the costs they require to be fulfilled by Epicure. It is for this reason that I believe that it is understandable that they have similar contribution margins. My partner often says to me that the luxury goods market is the only market where you can make luxury profit margins. For some reason this sentiment came to mind when I saw that the most expensive option yielded the highest contribution margin.
While the Diamond option produces the largest contribution margin, it would not be wise for Epicure to only provide this option as it would significantly reduce the size of their target market by income demographic and therefore reduce their overall sales. It is better to appeal to a wider income demographic and produce more overall sales than sell only a few units of a higher priced item. For example, Epicure may sell 4 weddings of 250 guests the Gold package in a year, 2 weddings of 250 guests the Platinum package in a year and only 1 wedding of 250 guests the Diamond package in a year, if they were to eliminate the Gold and Diamond packages, theoretically they would miss out on the contribution margin of $51,500.00 for that year and make only $10,500.00 of contribution margin for the year on the single Diamond package they sold.
One constraint that Epicure faces is the limitations on guest numbers based on venue size and licencing regulations. They also have the constraint of a limited number of days within a year in which to hire out their services. I also imagine the seasonal nature of wedding events would further limit this, as well as, the preference to have wedding on weekends. These constraints mean the Epicure’s revenue potential is limited. It is for this reason that I can understand why they have expanded their services over several locations across Australia: to increase their revenue potential.
Further to this, Epicure would face the constraint of seasonal availability for some of their menu items. This would contribute to a fluctuation of variable costs across the seasons that they would have to take into consideration when pricing their options.
Competition provides another constraint for Epicure. There are many alternatives for events in all of the cities that Epicure operates in. It is for this reason that the company markets their Taronga Zoo venue as being a truly unique event location and offer many add-on services that offer a point of difference to their competitors.
Lastly, the COVID-19 pandemic is a huge constraint that would have and would still be impacting Epicure’s sales. Many weddings and events had to be cancelled and those that were able to go ahead had to do so with decreased numbers as to comply with the governments social distancing measures.
The aforementioned constraints would be relevant when deciding the pricing for each of the three options. For example, Epicure would have to ensure that their pricing was able to produce a contribution margin large enough to cover their fixed costs, and as such, they may consider a minimum requirement for guest numbers. They would also have to ensure that their pricing remained competitive with alternative vendors and that they are able to justify that their prices reflect the value they provide to potential clients. Epicure would have to reassess the way they provide their services as a result of government imposed COVID-19 restrictions, and as such, would have had to limit the number of guests that they are able to accommodate for their events and possibly increase their prices to ensure their costs are covered. The impact of COVID-19 could have possibly lead to Epicure removing some options from their events service list entirely, if it was no longer possible for them to provide the services within the constraints of the restrictions.
Step 8
Profitability Ratios
I was very apprehensive when calculating the profitability ratios for Downer EDI. Their net profit margin was very low for years 2017, 2018 and 2019 at just 2.4, 0.5 and 2.1 cents of profit made for every dollar of revenue received respectively. The 2020 year was even worse with -1.4 cents being lost for every dollar of revenue earned. This does make sense as the company made a loss in 2020. From what I can see, this may be a result of the impairment of non-current assets and the depreciation of leased assets as a result of their portfolio restructure when taking full ownership of Spotless Group. The return on assets ratio tells us the percentage of profit made for every dollar of assets held in that year. As Downer made a loss in 2020 it makes sense that this ratio would be negative for that year.
Efficiency ratios
The days of inventory ratio tells us on average how many days it takes the company to sell or use that inventory. I noticed that in the last 3 years, Downer EDI does not hold inventory for long. This makes sense to me as Downer mainly deals with construction projects and I imagine that most inventory stock would be ordered and used as needed for particular projects. It stands to reason that the 50-day benchmark would be the average time it would take from the stock to be ordered by the project managers and used in the construction project. They did manage to lower this time from 2017 to 2018 due to a reduction in their held inventories of $32.9 million from the divestment of freight-rail inventory and the tightening of their inventory management as outlined in the 2018 Director’s Report.
The total asset turnover ratio reflects this streamlining of inventory management from 2017 to 2018, where we can see the higher level of held inventories and subsequent slower turnover rate meant that Downer EDI was only making 96 cents for every dollar of assets they held. The reduction in their held inventories and increased turnover rate saw this ratio increase in the following 3 years, indicating improvement in asset management.
Liquidity Ratios
The current ratio tells us about the company’s ability to pay their debts by comparing their total current assets and total current liabilities. In 2017, Downer held only 96 cents of assets for every dollar of liabilities. This may be attributable to the majority takeover of Spotless Group, which significantly increased Downer EDI’s liabilities as mention in the 2017 Director’s Report.
Financial Structure Ratios
The debt/equity ratio looks at how much of the company is funded by shareholders equity and how much is funded by debt. Downer EDI have increased their debt over the last 4 years. In 2017 they had $1.115 of debt for every dollar of shareholder equity, which gradually increased to $2.309 of debt for every dollar of shareholder equity. I can see that Downer EDI has both decreased shareholder equity and increased debt over the 4 years. In 2020 the company managed to secure $787million of new debt facilities to improve the liquidity of the company as a response to the COVID-19 pandemic as outlined in the 2020 Director’s Report. In 2020, the reduction in equity is attributable to the loss the company made as well as the dividends paid and the impact of the adoption of AASB 16 leases. In 2019, debt increased due to redrawing to fund business activities and equity decreased following the adoption of AASB 15 and dividend payments. In 2018, the reduction in equity is attributable to dividend payments and the acquisition of majority share of Spotless Group. Debt increased in 2018 as a result of a reduced net cash position.
The percentage of assets that have been funded by shareholder equity are shown in the equity ratio. In Downer EDI’s case, it makes sense that the percentage of assets that have been funded by shareholder equity has decreased over the last 4 years as we can see that equity itself has decreased over the last 4 years. Conversely the debt ratio shows the percentage of assets that have been funded by debt and as Downer EDI’s debt has increased over the last 4 years it makes sense that this ratio has also increased. The debt and equity ratio should add up to 100% and I was very happy to see that mine did exactly that.
Market Ratios
The earnings per share ratio shows the profit for the year divided equally across the number of shares on issue. In 2020, Downer EDI’s earnings per share was negative. This makes sense as the company made a loss for the year. The 3 years before, Downer EDI had relatively low earnings per share, with a slight improvement in 2019.
Dividends per share show the amount the company paid out to shareholders per share for the year. Downer EDI have kept their dividend payments fairly consistent over the 4 years despite fluctuations in their earnings per share. I understand that it is best to keep shareholders happy in this regard. This would have significantly impacted their profit for years 2018 and 2020, when the earnings per share were lower than the dividends per share.
The price earnings ratio shows how many years it would take shareholders to make back the money they invested on shares in the company by comparing the earnings per share and the market price of the share. I found this ratio a bit confusing as the 2020 figure was negative. While this makes sense because the earnings per share for 2020 is negative, I am unsure how to interpret this ratio for this year. I understand that if the company continues to run at a loss that shareholders would never make back the money they invested so perhaps this is what the negative indicates. The previous three years are far more straightforward. For 2019, 2018 and 2017, it would take shareholders 14.99, 74.12 and 21.48 years to earn back the money they invested respectively.
Ratios Based on Reformulated Financial Statements
The return on equity ratio shows us the percentage of return on shareholders’ equity based on the total comprehensive income for the year. In 2020, Downer EDI’s shareholders are losing money which makes sense considering the company made a loss in that year. In 2019, however, this ratio is quite good, indicating that the 2020 figures show the impact of the portfolio reshuffle. It would stand to reason that Downer EDI may see the benefits of their acquisition of Spotless Group in years to come, resulting in a positive return for their shareholders.
The return on net operating assets (RNOA) shows the percentage of return that the company is receiving from the use of their operating assets. Unsurprisingly, Downer EDI has a negative RNOA for 2020, although when we compare this figure to the return on assets ratio, we can see that it is significantly less, indicating that the financing activities have a larger impact on the return on assets ratio than the operating activities.
The net borrowing cost ratio shows the average interest rate by comparing the company’s net financial expenses to the net financial obligations. Despite the increased debt over the 4 years, Downer EDI have a reduced interest rate from 2018 to 2020. This decrease is attributable to debt refinancing causing interest rate drops.
The profit margin ratio compares the operating income after tax against the sales for the year to show the percentage of operating income received for every dollar of sales made. In 2020, Downer EDI made a negative profit margin ratio. This again reflects the loss they made that year. However, this figure is significantly lower than the net profit margin ratio, indicating that the company’s financing activities have a greater impact on the net profit margin than the operating activities. This is true for years 2020, 2019 and 2018, however 2017 shows a far closer figure to the net profit margin ratio. This may be a result of their lower debt for that year and lower net borrowing cost ratio.
The asset turnover ratio shows the efficiency of the company’s operating assets by comparing them to the sales made for the year. For Downer EDI, the operating assets are being utilised to return more revenue than can be see when comparing the ratio to the return on assets ratio. This indicates that the operating assets are being used more efficiently than the financial assets.
Economic Profit
The economic profit compares a company’s profit to its cost of capital, taking its opportunity costs into consideration. The opportunity costs are the missed earning potential of the next best investment opportunity when deciding between two options. Put simply: when deciding between two options to invest their capital into, if the company decides on one option, the opportunity cost is the missed earning potential they would have received had they invested in the other option. The economic profit is calculated by first subtracting the weighted average cost of capital (WACC) from the return on net operating assets (RNOA) then multiplying the result by the net operating assets (NOA). Downer EDI’s economic profit figures are negative for 3 of the last 4 years. This made sense for me for 2020 as they did not make a profit for this year, however, I was surprised to learn that the 2018 and 2017 were also negative. As I assessed the components of the equation I realised that the RNOA for the 3 negative years was less than the weighted average cost of capital of 8%, therefore the answer would have to be negative for those years. The company has quite a high number of net operating assets and these figures are relatively consistent over the 4 years, however the impact of the RNOA on the economic profit is significant and I can see how the two ratios are closely linked. For example, in 2019, the RNOA was 9.05%, 1.05% above the WACC, which translates to an economic profit of $60.85, significantly better that the other 3 years. It will be interesting to see if Downer EDI is able to reap the benefits of gaining 100% control of Spotless Group and their portfolio reshuffle in coming years to improve their performance as a company.
It was an interesting 4 years to assess for Downer EDI. There are a lot of changes that happened for the company in terms of portfolio reshuffling as well as the precautions they took as a result of the COVID-19 pandemic. Their majority takeover of Spotless Group began in 2017 and they took complete control of the company in 2020 which has had a significant impact on their figures. I believe Downer EDI will improve and see the benefits of their portfolio diversification. I remember a pearl of wisdom from my economics unit: systematic risk can be diversified away. Therefore, portfolio diversification can only be a good thing. While this will not protect them from unsystematic risks, such as the COVID-19 pandemic, Downer EDI seemed to have acted accordingly in response by increasing the liquidity of the company by securing more debt and negotiating lower interest rates.
My favourite discovery was finding out about how Downer EDI streamlined their inventory management and how that change was reflected in the figures. After completing this journey with my company, I have a new-found appreciation and interest for this process. I really enjoy solving problems and figuring out exactly why things are the way they are and now I have an entirely new way of doing that.
Step 9
Downer EDI has two opportunities to choose from starting in the 2020-21 financial year. The first is to enter a 10-year contract with a company that researches lithium battery technology. Downer EDI would provide funding to the research and in return they would own the patent rights and be able to sell the batteries alongside their renewable technology products and services. After 10 years they would be able to sell the patent.
The second option is to open a fabrication plant in Western Australia where a large construction project is set to begin spanning 10 years. They would be producing the same engineering products and increase their reach across Australia, allowing them to cash in on the construction project in that area. They would be required to purchase the land, build the facility and fit it out with the required machinery. After 10 years, the building, land and assets are unlikely to be sold and will be kept by the company.
Patent research (a)
24 million
10 million
Once I calculated the internal rate of return (IRR), the net present value (NPV) and the payback period (PP), for both options, I recommend that Downer EDI invest in option B: The West Australian Fabrication Plant. The NPV for option B is quite modest at $19.19 million while the NPV for option A is negative. The IRR for option B is 12% which is reasonable while option A is -1.5%. The payback period for option B is 6.45 years while option A is only payed back after the residual value is collected. Option B will make the company money while option A will only make a very small amount after 10 years of making a loss.
Step 10
I found this part of the assignment relatively straightforward. Maria answered any questions I had and I found the concepts and equations quite easy. I did see students on the Facebook page unsure what to put for their future cash flow figures for step 9, this is something that I also struggled with, but when I saw that there were others in the same boat I decided to just try my best at estimating them and I think I did okay in this regard.
I was very happy that I provided feedback to 3 of my peers as it made me realise that I had used the wrong WACC percentage! It’s moments like that that make me understand how valuable this process is to not only help others but reflect on my own work and refine it.
Feedback given to other students:
PEER FEEDBACK SHEET: ASS#2 Step 10
Feedback From: Shanell Fisher
Feedback To: Kelsey Jamieson
Estimate selling price, variable cost & CM
Commentary – contribution margins
Constraints – identify & commentary
Your maths all looks correct to me and I liked that you included the reasoning for each of the variable cost percentages. Your constraints are well thought out and well written. Well done!
Step 8
Your ratios section of your spreadsheet looks great to me! The only thing I was curious about is why you opted to use 8% for your weighted average cost of capital? I can see that you were unable to find this for your company but I was under the impression that Maria says to use 10% in her video.
Your explanations and commentary look great, there are just a few spelling errors: you used ‘an’ instead of ‘and’ in the section about return on assets and a few times you have used ‘then’ instead of ‘than’. But other that those very minor things you have done an exceptional job!
Calculation of ratios
Ratios – commentary (blog)
Calculate economic profit
Step 9
You have done really well for step 9, all of your calculations look great! Well done!
Develop capital investment decision for your firm
Calculation of payback period, NPV & IRR
Recommendation & discussion
Overall ASS#2 Steps 7-9
Great job! You should be proud of what you have achieved, I hope you can relax now that you are all done!
PEER FEEDBACK SHEET: ASS#2 Step 10
Feedback From: Shanell Fisher
Feedback To: Jedidiah Page
Estimate selling price, variable cost & CM
Commentary – contribution margins
Constraints – identify & commentary
Wow! You have done such a great job! The only comment I can make is that maybe you could move the table up to above the commentary so that the reader can look at the figures before you explain them. Other than that, there are just a few grammatical errors. Very minor details, you have done so well!
Step 8
Your calculations look spot on! Well done, the only thing I am curious about is why you chose 8% for your WACC when Maria says to use 10% in her video? I am actually beginning to think that maybe I have missed something and that I should be using 8% as well as you’re the second person that I have come across that has done this.
Your commentary is well written and your explanations are great!
Calculation of ratios
Ratios – commentary (blog)
Calculate economic profit
Step 9
You have definitely gone above and beyond with this assignment! I don’t have one thing to correct you on!
Develop capital investment decision for your firm
Calculation of payback period, NPV & IRR
Recommendation & discussion
Overall ASS#2 Steps 7-9
You have done such a great job with this assignment! Well done! Hopefully you can relax a little now that you have finished.
PEER FEEDBACK SHEET: ASS#2 Step 10
Feedback From: Shanell Fisher
Feedback To: Alicia Anderson
Estimate selling price, variable cost & CM
Commentary – contribution margins
Constraints – identify & commentary
Your company did not provide you with clear products and services which would have made this step way more difficult than most other students. My company was also difficult to pinpoint products and/or services so I do sympathise with you in this respect. Although I did manage to find some eventually. You have done really well to complete this step. Other than a few spelling/grammatical errors (you used ‘there’ instead of ‘their’ in this section) there is very little for me to correct. Well done!
Step 8
You have stated that you have used 8% for your WACC but your table says 10% on your word document. I can see that you have used 8% on your spreadsheet though.
Your ratios all look correct to me. I did find it odd that your company has no dividend payments listed in their financial statements, but I guess you can only go off the figures that you are given. It’s great that you have included an explanation for this in your word document. I can’t see anything wrong at all here.
I thought your theories and explanations about your ratios were great! I also really like the way you write, it feels like we are having a conversation. Well done!
Calculation of ratios
Ratios – commentary (blog)
Calculate economic profit
Step 9
I loved the options you created for your company. It shows that you have a really good understanding of your company and their motives. Great job with this!
Develop capital investment decision for your firm
Calculation of payback period, NPV & IRR
Recommendation & discussion
Overall ASS#2 Steps 7-9
Really well done! You definitely didn’t have an easy company in terms of getting all of the information you needed but you improvised and I think you have done a great job. Hopefully you can relax a little now that you have completed your assignment.
Feedback provided from other students:
None yet provided.
Conclusion
I quite enjoyed these steps of assignment 2. I found the calculations relatively straightforward and the concepts easy to understand. I feel like everything I’ve learned this semester has all settled in and I can now make sense of it easily. There were many times when I felt like a deer in the headlights but I can now see the bigger picture. I really enjoyed the insights I gained from calculating my company’s ratios. I feel like I have a better understanding of what is actually going on at Downer EDI and I have somewhat pack-bonded with the company. I think I would like to invest as I believe they are on their way up in terms of profitability. This has been a very interesting unit. It is unlike any other that I have done before and while I found it to be incredibly demanding at times, I really liked the step-by-step nature of the assignments. I hope that there will be other units that follow this layout as I found it incredibly beneficial and I feel I have performed better as a result.
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