USING ACCOUNTING FOR DECISION MAKING

Step 1: Ratio Analysis
1. This assessment task involves you calculating a range of ratios for your firm and using these ratios to assess the business performance of your firm.
2. Go to the ‘Ratios’ tab in your firm’s spreadsheet. In this worksheet is a list of ratios. Please calculate these ratios for your firm.
Calculate these ratios for the last two (2) years for your firm. Do this by linking back to the numbers in your firm’s financial statements (in your ‘Financial Statements’ worksheet) or to the numbers in your firm’s restated financial statements (in your ‘Restated Financial Statements’ worksheet). If you are unsure about how to link cells between worksheets in Excel, see the short video at either of these two URLS about how to link cells between worksheets.

discuss with others in the course about how to do this – everyone will be facing the same issue.
Once you have calculated these ratios for your firm sit back and have a look at them. What do these ratios tell you about your firm? How do you make sense of them?
You have calculated a few financial ratios for your firm. Tell me what sense you can make of them. Discuss with other students in the course your ratios. How do your company’s ratios differ to the ratios of companies of other students in the course? What do your firm’s ratios tell you about how well your firm is performing?
3. Calculate economic profit for your firm for the past two years. Use 10% as your firm’s cost of capital when calculating your firm’s economic profit (unless you have reasons to use a different number; if so, clearly state those reasons).
4. The key drivers of your firm’s past economic profit are RNOA, cost of capital and NOA. The two key accounting drivers of RNOA are PM and ATO. (See Study Guide Chap 4, Section 4.4, pp70-75).
Comment on what is driving your firm’s economic profit over the past two years to be at the levels it is. If your firm’s economic profit is negative (or positive), what is causing it to be negative (or positive)? If it is a large number, what is causing it to be so large? If it is a small number, what is causing it to be so small? If it changed a lot over the past two years, why did it? If it stayed much the same over the past two years, why was this?
5. Discuss your thoughts on what is driving your firm’s economic profit with other students. What similarities or differences are there between the economic profit of your different firms? Why is this? What is causing these similarities or differences? What insights have you gained by ‘breaking into bits’ your firm’s financial statements? What insights have you not gained?
6. Include in your assignment your firm’s spreadsheet, including your firm’s ratios and economic profit that you have calculated, as well as a Word file setting out your commentary on your firm’s ratios and what is driving your firm’s economic profit.
Step 2: Capital Budgeting
The Great Kayaking Company is considering making an investment in new equipment to build kayaks. The investment would be made on 31 December 2013. The company is considering purchasing one of two types of new machines:
Machine A
Machine B
Original cost
\$50,000
\$40,000
Estimated life
9 years
6 years
Residual value
Nil
Nil
Estimated future cash flows
2014
\$15,000
\$10,000
2015
\$15,000
\$10,000
2016
\$20,000
\$10,000
2017
\$5,000
\$10,000
2018
\$6,000
\$15,000
2019
\$7,000
\$20,000
2020
\$8,000

2021
\$8,000

2022
\$8,000

The estimated future cash flows are expected to be received on 31 December of each year.
The Great Kayaking Company has a required cost of capital of 10% (Hint: This is the discount rate to use). It also has a rule of thumb that an investment proposal should not be accepted unless it has a payback period of 4 years or less.
Calculate the payback period, net present value (NPV) and internal rate of return (IRR) for each machine and advise the company which machine it should purchase.
Please go to the ‘NPV & IRR’ worksheet and calculate the NPV and IRR for each of Machine A and Machine B in this worksheet using the NPV and IRR functions in Excel. See this short video for guidance about how to calculate NPV and IRR using Excel:

Briefly discuss your thought processes in coming to your recommendation. Also briefly discuss the strengths and weaknesses of your analysis.