FINANCIAL DECISION MAKING

Case Study 1

Pierrodel SpA (Pierrodel) is a long-established Italian company, selling high quality gearboxes to the automotive industry throughout Europe. Revenue and profit growth have been strong over the past few years, and the board of directors has been investigating various plans for further sustainable growth.

Youu bought shares in the company at ? 7.50 per share a year ago on the recommendation of a business colleague. In conversations with other colleagues you discover that many of them were delighted with their total shareholder returns in other companies over the last year. When looked at together, your colleagues' total shareholder returns averaged out at just over 5.5%.

This is the first set of financial statements that you have seen since buying your shares and the price of the share on 31 May 2021 was ? 7.75. The price today has risen to ? 8.00.

Pierrodel's Draft Statement of Financial Position at 31 May 2021 and its Draft Income Statement for the year ended 31 May 2021 are summarised below:

Statement of Financial Position as at 31 May 2021 Em Em Non-current assets 44.0 Current assets: Inventory 22.0 Accounts receivable 9.0 Cash 5.0 36.0 Total assets 80.0 Equity and liabilities Issued share capital (nominal value per share (0.10) 4.0 Share premium 4.0 Profit and loss reserve 36.0 44.0 Non-current liabilities: 10% bond (redeemable 2023) 8.0 12% 4-year bank loan - portion repayable 2023-2025 3.0 11.0 Current liabilities: Bank overdraft (3% interest) 8.0 12% 4-year bank loan - portion repayable 2022 1.0 Accounts payable 16.0 25.0 Total equity and liabilities 80.0Formula Sheet for Financial Decision Making Financial ratios Current ratio Current assets Gross margin (%) Current liabilities Gross profit - x 100 Quick test (acid ratio) Revenue Current assets - Inventory Operating margin (%) Current liabilities Operating profit - x 100 Working capital turnover Revenue Revenue Return on capital employed (%) Net working capital Operating profit - x 100 Inventory turnover Shareholders equity + Long-term debt " Cost of sales Return on equity (%) Inventory Profit after taxation x 100 Shareholders equity Inventory days Return on total assets (%) Inventory - x 365 Profit after taxation " x 100 Cost of sales Total assets Debtors days Asset turnover Trade receivables - x 365 Revenue Revenue Total assets Of Share price Trade debtors x 365 Revenue Earnings per share Earnings yield Creditors days Earnings per share Trade payables Share price - x 365 Purchases Dividend per share (DPS) or Total dividends for the period Trade creditors x 365 Number of ordinary shares in issue Purchases Dividend cover If 'Purchases' figure not available, use 'Cost of sales'. Profit after taxation Financial gearing (%) Total dividends for the period Long-term debt * 100 Dividend payout (%) Long-term debt + Shareholders equity Total dividends for the period x 100 Interest cover (times) Profit after taxation Operating profit Interest charges DPS x 100 Earnings per share (EPS) EPS Profit after taxation Dividend yield Number of ordinary shares in issue Dividend per share Price / earnings ratio (P/E) Share priceRevenue growth 20% Gross margin 39% Working capital cycle 30 days Financial gearing 25%. PE ratio 29Income Statement for the year ended 31 May 2021 Em Revenue 125.0 Cost of sales 75.0 Gross profit 50.0 Depreciation 5.0 Operating expenses 27.0 Operating profit 18.0 Interest 1.3 Profit before tax 16.7 Tax (at 30%) 5.0 Profit after tax 11.7 Dividends 4.7 Retained earnings 7.0