Step 7-10 – Assignment #2Emily Davis

Blog: https://emsaccountaholic.home.blog/

Step 7:My company, DWS Group, provides services not products and therefore I had to take a bit of a guess as to what services my company provides. I decided to choose:

- Business Case Development & Investment Planning Package – Platinum Package

Selling price: $35,000Variable cost: $24,500

- Enterprise Testing – Basic PackageSelling price: $12,000Variable Cost: $8,400

- Digital Architecture & Development – Premium PackageSelling price: $20,000Variable Cost: $14,000

As my company did not outright display what their services were, I had to guess what they were. Also due to DWS Group not listing their products, I could not find a selling price or a variable cost, so I had to guess what these were. I decided to estimate 70% for my variable cost as I don’t believe they would have high-volume services, compared to, for example, a supermarkets products.

Contribution margin: Sales price – Variable cost = Contribution Margin

Business Case Development & Investment Planning - Platinum Package

35,000 – 24,500 = $10,500$10,500 is the amount that every Business Case Development & Investment Planning – Platinum Package contributed to the fixed costs of DWS Group.

Enterprise Testing – Basic Package

12,000 – 8,400 = $3,600$3,600 is the amount that every Enterprise Testing – Basic Package contributed to the fixed costs of DWS Group

Digital Architecture & Development – Premium Package

20,000 – 14,000 = $6,000$6,000 is the amount that every Digital Architecture & Development – Premium Package contributed to the fixed costs of DWS Group.

The contribution margin of every service mentioned above is the amount that contributed to the overall fixed costs of DWS Group. These fixed costs include things such as lease of buildings, depreciation of buildings, insurance, electricity and internet. If I wasn’t to use these services, the contribution margin could have differed greatly. I attempted to show in the services I used the different types of packages that could be purchased. For example, the platinum package is the most expensive, followed by the premium package then the basic package is the cheapest, as it’s only basic. I tried to incorporate these into my answer to demonstrate that different services and different levels of services would have a different selling price and variable price, which would then contribute to a different contribution margin. As shown by my contribution margins above, what I tried to show worked out perfectly. Depending on what service is being provided, will differ the contribution margin. The more expensive package, the platinum had the highest contribution margin, the premium had the next highest contribution margin and the basic package had the lowest. This is what I was attempting to demonstrate by providing different levels of packages.The reason why DWS Group doesn’t just provide the one service, for example, Business Case Development & Investment Planning - Platinum Package, as it has the highest contribution margin is because it is not a high-volume service. This means that if they only provided this service, it is unlikely that they would make

nearly as large of a profit as what they do by providing many services. The combined contribution margin of all their products is much higher than what it would be if they just provided the one product with the highest contribution margin. There are many possible constraints with providing their services. As technology advances, there are so many ways of looking up how to do things; so many online instructions, videos and tutorials, that it is possible that some of DWS Group’s products, for example, Digital Architecture & Development – Premium Package, may not be as wanted by consumers in future years to come, as apps may advance and be able to create the design they want without human interaction, therefore being no need for that specific package. However, I do not see that happing anytime soon, as technology has not advanced that quick. Another constraint could be the increase in fixed costs, meaning that the firm will have to increase their prices to keep up with the high fixed costs, which would mean that less customers would be able to afford the service and it would make the service a low-volume service. For example, the price of electricity could soar due to the current global crisis with climate change and the coal industry, therefore DWS Group would have to increase their prices on their services, meaning that less customers would purchase the service which would make it a low-volume service. However, I also don’t see that happening too near in the future as there are many power alternatives if worst comes to worst. I don’t believe that at the present DWS Group should limit the amount of services they provide as there doesn’t seem to be any crisis’s that will affect them in the near future.

Step 8:Completing the ratios for my company, DWS Group, was a lot easier than I expected. Following Maria’s video was fairly straight forward, however, I was unable to calculate a few ratios due to my companies’ financial statements not providing the required information. I was unable to calculate the ‘Days of Inventory’ ratio as what is required for it is the inventory account. Due to my company providing services, not products, I could not find the inventory account and complete the ratio. I checked the notes section of my report in the “other” section, however there was no inventory to be found. This was a limitation of my data. I got confused with the ‘Total Asset Turnover Ratio’ as I didn’t have sales. After spending quite some time searching for a sales account, I remembered that different companies call their accounts different things, and although I am unsure I linked to the right account, I used the ‘revenue from continuing operations’ as my sales account. I did this because my company provides services, therefore it does not have a specific sales account, but it must have an account that accounts for the money received from them providing a service. None of the other accounts in their financial statements seemed to be a match for sales, so I decided that ‘revenue from continuing operations’ must be it. This is another limitation to my data as I’m uncertain whether it’s the correct account to have used. It therefore makes the data I have collected an uncertain

representation of DWS Group’s financial position, as I’m technically not completely sure I’ve got the right figures, but I’ve attempted to find them to the best of my ability.I also couldn’t find the cost of capital, it wasn’t mentioned in my company’s financial statements therefore I used the generic amount of 10%. This is yet again another limitation of the accuracy of my data as I’ve estimated the cost of capital, instead of using a percent specific to the company. However, because the financial statements did not include it, it is the best I can do based off the information given to me. Each individual ratio told me a lot about my firm and its financial status.Net Profit MarginThe net profit margin helps to measure profit by determining how much net profit is made from every dollar of sales. My assigned company, DWS Group’s net profit margin was 12.6% in 2018. This means that for every dollar of sales made by the company, for the sale of a service, that they made 12.6 cents. This is an increase from the previous years, 2016 and 2015 as DWS Group only earnt 11.6 and 11 cents for every dollar of sales. 2018 and 2017’s net profit margin is the almost same, at 12.6% and 12.7%. Although 2017’s net profit margin was higher by 0.1%, it is not of concern since it’s such a small percentage difference. Return on AssetsThe return on assets is very similar to the net profit margin. Instead calculating the money made from every sale, instead it’s every asset. It focuses on how much net profit is generated from every dollar of assets. DWS Group’s return on assets for the 2018 financial period was 15.6%, which means for every dollar of assets, they make approximately 15 cents. For this ratio, the higher the figure, the better due to companies wanting a higher return on assets, as it means they earn more from their assets. This is not a bad return on assets percentage, however 2018’s percentage has dropped from 2017’s percentage of 16.1% and this due to the decrease of net profit after tax and total assets. DWS Group’s net profit decreased from $17,390 in 2016, to only $15,917 in 2018. This was mostly due to the decrease in revenue from continuing operations, as according to their financial statements, the income statement in particular, there were no large increases in expenses. Their total assets also decreased in 2018. In 2016, it was at its highest in four years at $114,477, however it dropped to $108,156 in 2017 and continued to drop in 2018 to only $102,277. This is concerning and is mostly due to a decrease in current assets from previous years as their total liabilities for the year were also on a decrease from the previous years. For DWS Group to improve their return on assets they must increase their current assets which will improve their total assets, and they must also improve their revenue. Total Asset TurnoverThe total asset turnover is an efficiency ratio that calculates how many months it takes for a business to turnover its assets into sales. In DWS Group’s case, the total asset turnover I have calculated is 1.23, this means that it takes 1.23 months for DWS Group to turnover its assets and make money out of them in sales. Compared to previous year’s total asset turnover ratios, DWS Group has had a decrease. In 2016 the ratio was at 1.27 and 2016 was 1.26. This, however,

is not a big decrease and is nothing to be concerned about. The slight decrease is a result of the sales and total assets figure decreasing from previous years.Current RatioThe current ratio is a test of the liquidity of a company. It determines if the company had to stop work today and pay off all its current liabilities, whether it would have enough current assets to do so. If a company is unable to pay off all of its current liabilities, because it has too high of a figure, then it’s a serious concern as the company is operating whilst being at risk of digging themselves deeper in debt. DWS Group, however, has no issue with liquidity. Their current ratio is 1.49 for 2018, which is a good figure at it’s more than the required amount of 1:1, or 100%. Although this is a good ratio result, the company’s current ratio has decrease dramatically since 2015 at 205% all the way to 2018, at just 149%. This could be a concern that the company should look into. The reason for this decrease is the major decrease of current assets over the past four years, from the highest of $41,263 to 2018’s amount of just $29,310. To improve the current ratio, DWS Group must improve and increase their total current assets. The Debt and the Equity RatiosThe debt ratio is the proportion of the company’s assets that are funded by debt. The equity ratio is the proportion of the company’s assets that are funded by equity. It is always better to have a higher equity ratio than a higher debt ratio as it’s better to own your assets rather than owe them. It was not required to do the debt ratio, however watching Maria do it to her company, Wesfarmers, made me decide to do it to mine as I really like the hands-on approach type of learning. Before doing this ratio I felt confused and as if I wasn’t really absorbing any of the information or steps, however, when it came to this ratio, I felt like I finally understood what I was doing. When I saw DWS Group’s 2018 debt ratio of 29.5% and equity ratio of 70.5% combine together to make 100% I was thrilled. Firstly, because that meant that I was doing my statement correctly, but secondly because I felt like I understood what Maria was talking about and how the ratios were related. Debt/Equity RatioThe debt/equity ratio compares both the debt ratio and the equity ratio together to determine how much of the company is funded by external sources. It’s best to have a low percentage when it comes to the debt/equity ratio as it’s better to own more of your own company, than to owe parts of the company to external sources such as a bank or other financial provider. The 2018 debt/equity ratio for DWS Group was 41.8%, which is a good percentage compared to previous years, 2016 for example, which had a ratio of 75.6%. This demonstrates that 2018’s ratio is nothing to be concerned about. 2018’s percentage of 41.8% is the lowest the debt/equity ratio has been in the past four years for DWS Group, which is a huge achievement. It is the combination of the decrease of total liabilities and the increase of total equity for 2018 that has contributed to the low percentage for the debt/equity ratio. Earnings Per Share

The earnings per share ratio calculates on the basis of the company giving all their profit to shareholders, and how much each shareholder would receive. It is very unlikely that a company will in fact give all of its profit to its shareholders, but this is a handy ratio when investing in the stock market to see what a shareholder could potentially be given in dividends. The 2018 earnings per share was 12 cents. This is a 1 cent drop to previous years, 2017 and 2016, however an increase from 2016 at only 8 cents. Dividends Per ShareUnlike the earnings per share, the dividends per share demonstrates how much the shareholders actually got paid in dividends for the year, not what they could get paid, like in the earnings per share. It is normal that the dividends per year share will be a smaller figure than the earnings per share, as companies usually like to make a profit out of every share they pay out. DWS Group’s dividends per share for 2018 was 10 cents. This is a really good figure in comparison to their earnings per share as the company makes a profit of 2 cents per share and pays out the rest to their shareholders. Price Earnings RatioIn Maria’s video, there were quite a few explanations of the price earnings ratio, but I really liked the explanation from the past student, so I modified it a simpler term that included the name of the ratio, so I wouldn’t forget it. I believe the price earnings ratio can be explained in this way: it is how long the price paid in shares takes to turn into earnings and break even for the shareholder. Re-reading that, I’m not sure if it’s really a simpler term, but I feel like I’ll remember it, since my personal explanation has the words “price” and “earnings” in it. DWS Group’s price earnings ratio for 2018 was 10.34. This means that it would take approximately 10.3 years for the shareholder to get back the money they paid for the shares. The figure has decreased from the previous year, from 11.3 to only 10.3, which is good if you’re looking at the ratio in the same way as me. However, if you were looking at the ratio in the way that another student Maria talked about in her video sees it, that’s technically not as good, as less people have invested their money in the company and it doesn’t look like as many people believe the company is expected to do well in the future. However, a 1 year decrease from 2017 to 2018 is nothing to be concerned about as 2018’s figure has risen from 2016 and 2015 lower figure of 7 and 8 years. Return on EquityReturn on equity is how much return shareholders are getting back from their investments in the business. It is the percentage the shareholders are getting of the whole comprehensive income for the year. DWS Group’s return on equity is 22.06%. This percentage has been on a decrease since 2016 at 25.75%. Although there has been a slight decrease over the past three years, it’s not concerning due to the decrease being such a small amount. The decrease is however related to the decrease in the total comprehensive income. So to improve the return on equity, DWS would need to improve their total comprehensive income. Return on Net Operating Assets

This is essentially the same as return on assets, however this is specifically the operating assets. Return on net operating assets does not include the financial assets, which can drastically change the ratio. This ratio calculates how much profit DWS Group is generating from every dollar of net operating assets. According to my spreadsheet, they are generating 22.03% of return on net operating assets, which gives a much higher figure than return on assets with just 15.6% return. The exclusion of the financial assets has changed my figure drastically and improved it greatly. There has been a 2% decrease from 2017’s return on net operating assets, to 2018’s figure, however this is nothing of concern as it’s such a small percentage. This was caused however, by the decrease in the comprehensive operating income after tax which was caused by the decrease of operating income due to the small figure of revenue from continuing operations. Net Borrowing CostThe net borrowing cost calculates the interest rate that the company was paying off their interest at. I calculated the net borrowing cost to be 21.32% in 2018, which is a huge increase in the ratio from the previous years. In 2017 the rate was only 11.9%, 2016 it was 5.84% and in 2015 it was -4.79%. I can see from the debt ratio that in 2016 the company contained 43% borrowed money, the most they’ve borrowed in the past four years, but their net borrowing cost was only 5.84%, which means although they borrowed a lot, they got it at a good, low interest rate. This is unlike the latest financial year in my data, 2018, where they only borrowed 29.5% and their net borrowing cost is 21.32%, meaning that they borrowed less or are paying off less money at a higher interest rate. Profit MarginThe profit margin calculates how much operating income the business earns from every dollar of sales. This is very similar to the net profit margin, however it does not include financial revenue. The profit margin for 2018 was 13.15% which demonstrates that DWS Group’s profit margin is on a rise as every year for the past four years this ratio has increased. When comparing this ratio to the net profit margin for 2018, there is only a small difference between the two ratios as the net profit margin for 2018 is 12.6%, however the profit margin gives me an accurate figure of only the operating income. There isn’t too much of a difference between the figures in the net profit margin and the profit margin, which is a good thing as it shows that if I was to make judgements on the business off either of their margins, it wouldn’t necessarily affect my opinion of the business by seeing the other margin. Asset TurnoverThe asset turnover is a method to calculate how much we’re earning from every dollar of operating assets as it’s turned into sales. In DWS Group’s situation their asset turnover is 1.68 which means they earn $1.68 for every dollar of operating assets. This is a decrease from the past 3 years as it was at its peak in 2017 at 1.83, however it dropped to 1.68 in 2018, the lowest figure in my data. Compared to the total asset turnover ratio for all the four years, the asset turnover is producing much higher figures. This is because the finance assets have been excluded from the asset turnover and it is strictly a reflection of the net operating assets and the sales.

Economic ProfitThe economic profit is the cost of choosing one pathway and determining how much profit could have been made if the business had chosen another pathway. Economic profit is determined by the return on net operating assets subtracting the cost of capital and multiplying that amount by the net operating assets.Economic Profit = (RNOA – Cost of Capital) x NOAA company adds value to its firm by shareholders investing their money it. The company then uses the investors capital to create a return greater than the cost of capital. The economic profit focuses on how successfully and efficiently the company has been able to add value on the capital and create a higher return than the cost of getting the investors capital. In DWS Group’s case, their return on net operating assets is greater than their cost of capital. This is obvious as their 2018 ratio figure is 9.057 billion. This demonstrates that DWS Group’s net operating assets are $9.057 billion greater than their cost of capital which is great as it proves that they are operating successfully and using their capital efficiently to add value to their business. Their economic profit has, however, decreased from 2017, when it was at its peak at $10.558 billion down to only $9.057 billion in 2018. This could be due to a large number of factors.

One of the reasons for this decrease in the economic profit is the decrease in the return on net operating assets. This is stemmed from the decrease in comprehensive operating income which was a direct result from a decrease in operating income. The decrease in net operating assets influenced the drop in the economic profit due to the decrease in operating assets for the financial period. Another reason for 2018’s economic profit figure being lower than 2017’s figure is that none of my economic profit figures are certain, they are all estimated. I wasn’t able to find the weighted average cost of capital (WACC) in my company financial statements – pretty wack that they didn’t put it in there for the public’s perusal (please get my pun, lol). But the issue with me not being able to find the WACC means that I used a generic percentage of 10% to

2018 2017 2016 20150

2,000,000,000

4,000,000,000

6,000,000,000

8,000,000,000

10,000,000,000

12,000,000,000

Economic Profit

calculate the economic profit. This is a limitation of my data as it effects the accuracy of my data as I’ve estimated the WACC, rather than using a percentage specific to the company. However, because the financial statements did not include it, it is the best I can do based off the information given to me.

Step 9:DWS Group is considering the expansion or the upgrade of their business. They are considering to either expand their offices and open a new one in Perth or to upgrade their computers to the latest iMacs at all their four locations in Sydney, Adelaide, Brisbane and Canberra. If DWS Group were to open the store at Perth, it would not have the latest iMac computers.If DWS Group were to open an office in Perth, they have no expectations of closing as it is anticipated that the office would perform well and bring in enough income to remain solvent. However, since there are many existing technology companies already located in Perth, such as Forrest Grove Technology, there will be ample amount of competition and therefore it is suggested that the project be given a length of 10 years.In addition to this, the iMac computers would only be able to be used for 10 years until they would need to be upgraded. This is due to the rise in new technology being introduced every decade. There are 15,000 computers that DWS Group would need to replace and upgrade and each computer is $2,000 each. The cash flows created by the office in Perth would consist of technology, data and software services to clients. The cash flows created by the upgraded iMac computers would be employees using the computers to create, analyse and interpret data and software being supplied to clients. At the end of 10 years, the computers could be sold to the public once the data has been erased off them. The Perth office could also be sold to a developer to re-develop the land.The investment would be made on 1 January 2019. The estimated future cash flows are expected to be received on 31 December, each year.The original cost, the estimated life, residual value and estimate future cash flows of each investment opportunity are set out in the table below. All amounts are expressed in Australian Dollars (AUD).The rate of return/discount rate/WACC for this table is 10%.

iMac Computers Perth OfficeOriginal Cost $30,000,000 $60,000,000Estimated Useful Life 10 Years 10 YearsResidual Value $1,500,000 $5,000,000Estimated Future Cash Flows31 December 2019 (time period = 1 year)

-$5,000,000 -$15,000,000

31 December 2020 (time period = 2 year)

$2,000,000 -$5,000,000

31 December 2021 (time period = 3 year)

$12,000,000 $10,000,000

31 December 2022 (time period = 4 year)

$15,000,000 $15,000,000

31 December 2023 (time period = 5 year)

$20,000,00 $20,000,000

31 December 2024 (time period = 6 year)

$25,000,000 $30,000,000

31 December 2025 (time period = 7 year)

$15,000,000 $35,000,000

31 December 2026 (time period = 8 year)

$20,000,000 $40,000,000

31 December 2027 (time period = 9 year)

$25,000,000 $45,000,000

31 December 2028 (time period = 10 year)

$7,000,000 $55,000,000

After calculating the Net Present Value (NPV), Internal Rate of Return (IRR) and the Payback Period, it is very obvious which upgrade DWS Group should proceed with. The NPV determines how much value is created from an investment. It is always best to have a higher NPV as this means that the firm will receive more value and more profit for their investment. The NVP is the dominant method of capital investment decision making. Which ever option has the highest NVP is the best option to choose as it will provide more income and value for the firm’s investment over the certain period. The NVP considers all the cash flow pathways in its calculation as it includes the cash flow and the weighted average cost of capital (WACC) in the formula. It also allows the person interpreting the data to be able to rank the options by the highest to lowest NPV. The only limitation to the NVP is the WACC. As I have used a generic WACC, 10%, all my data is based off this generic number, however, if I was to change the WACC, my NVP would change dramatically, therefore possibly increasing or decreasing my NVP. The NPV for the iMacs is $43.81 million and the NPV for the Perth Office is $56.44 million. Judging from the NVP’s the obvious option is the Perth Office, as it will generate an extra $12.64 million by the end of the 10 year period. As the NPV is the dominant option, I must go with the Perth Office, as it will provide DWS Group with more value for their investment.Although I’ve already decided to go with the Perth Office option, it is still important to look at the IRR to see what the rate of return is. The discount rate is the generic amount of 10%. For an investment to be worth while according to the IRR, it must be above the 10% mark. The IRR for the iMac option is 27.3%, compared to the Perth Office option of only 19.9%. This means that within the time period of only 10 years, the IRR for the Perth Office will not be as high as the iMacs. This is most likely due to the iMacs costing less, therefore able to make a profit faster within the 10 years than the Perth Office. Although the IRR favours the iMac option, because the NPV is the dominant method of capital investment decision making, I must go still go with the Perth Office option.

The last method of capital investment decision making is the payback period. This period determines how long it takes to recover the initial cost of the project. It determines the amount of years, months and days to break even on an investment, which is extremely important. In my spreadsheet, the maximum time for a payback period is 10 years, as this is how long I’ve accounted for my options to be used for. The payback period for the iMacs is four years and approximately 110 days, which is also the equivalent of 4 years and 3.6 months and 4.3 years. This is an excellent payback period as it will only take four years for DWS Group to get their money back on their iMac investment, and they have another 6 years to add value to their investment. The payback period for the Perth Office is 6 years, 2 years longer than the iMacs. It will take approximately 6 years and 52 days to break even on their Perth Office investment, which is the equivalent to 6 years and 1.7 months or 6.14 years. The reason why the payback period for the Perth Office is longer than the iMacs is because the Perth Office’s original cost is double the price of the iMacs, therefore meaning it will take longer to make a return on their investment.The reason I have chosen that it would be most economically beneficial for DWS Group to invest in the Perth Office is because it has the highest NPV. This means that the firm will get the most value from this investment regardless of the lower IRR and payback period. Although the IRR and payback period are higher for the iMac, it doesn’t mean that the iMac is the best option. This is because, judging off my spreadsheet the cumulative cash flow for the Perth Office is $185 million, compared to only $107.5 million for the iMacs. This means that at the end of the period DWS Group will have earnt $185 million on their $60 million investment. Once the 10-year period has ended, DWS Group will be left with $60 million on their investment, including the $5 million residual value from selling their office to a developer. This is a huge profit and is the economically best option for the business, therefore DWS Group should go with option 2, the Perth Office to upgrade their business.