m Question 1 Cora PLC is a listed and well-established supermarket chain operating through much of the UK. Its summarised financial statements for the last 3 financial years, 2017 to 2019, are below: Cora PLC Income Statement for the year ended 30th April 2017 2018 2019 m m Turnover 8,103 9,519 10,646 Cost of Sales (7,424) (8,682) (9,654) Gross profit 679 837 992 Operating Expenses (152) (212) (572) Operating Profit 527 625 420 Interest received 84 108 185 Interest paid (149) (180) (237) Profit Before Tax 462 553 368 Tax (162) (201) (225) Profit after tax 300 352 143 Dividends (21) (46) (33) Retained profit for the year 279 306 110 2017 m 2018 m 2019 m Statement of Financial Position as at 30th April Non-Current Assets Property Machinery Investments 1,983 1,256 3 3,242 3,225 1,074 3 4,302 4,158 1,170 2 5,330 Current Assets Stock Debtors Securities Cash 33 54 452 320 30 2 38 390 3,632 347 75 306 447 1175 5,477 57 596 5,926 Total Assets Current Liabilities Bank overdraft Trade creditors 495 608 1,103 (713) 2,529 750 678 1,428 (253) 4,049 693 750 1,443 (847) 4,483 Net current assets Total assets less current liabilities Non-Current Liabilities Long-term loan Total net assets Capital and reserves Share capital (1) Retained profit 647 1,881 810 3,239 1112 3,371 1,485 396 1,881 2,536 703 3,239 2,558 813 3,371 Additional information: 1. On 15 April 2019 a fire at one of the company's warehouses destroyed some of the stock, resulting in a damage valued at 300m. The charge for this damage was made against the operating expenses. 2. On 1 May 2019 a new CEO joined Cora PLC. On her first statement to the shareholders, she identified Mercator PLC, another supermarket chain, as the main competitor to her company. The summarised statements for Mercator PLC for the last 3 financial years, 2017 to 2019, are below: Mercator PLC 2017 2018 2019 Income Statement for the year ended 30th April m m m Turnover 10,395 11,720 13,043 Cost of Sales (9,453) (10,575) (11,738) Gross profit 942 1,145 1,305 Operating Expenses (240) (315) (384) Operating Profit 702 830 921 Interest received 119 119 177 Interest paid (144) (173) (156) Profit Before Tax 677 776 942 Tax (210) (245) (278) Profit after tax 467 531 664 Dividends (101) (146) (239) Retained profit for the year 366 385 425 Statement of Financial Position as at 30th April 2017 2018 2019 m m m Non-Current Assets Property 3,183 3,732 4,500 Machinery 924 1,089 1,250 Investments 29 32 47 4,136 4,853 5,797 Current Assets Stock 462 542 543 Debtors 138 170 116 Securities 78 36 333 Cash 209 165 261 887 913 1,253 Total Assets 5,023 5,766 7,050 Current Liabilities Bank overdraft 723 815 962 Trade creditors 722 834 867 1,445 1,649 1,829 Net current assets (558) (736) (576) Total assets less current liabilities 3,578 4,117 5,221 Non-Current Liabilities Long-term loan 1,470 1,608 1,259 Total net assets 2,108 2,509 3,962 Capital and reserves Share capital (1) 1,350 1,366 2,394 Retained profit 758 1,143 1,568 2,108 2,509 3,962 Ratios for Cora PLC (Based on the above Financial Statements) 2017 2018 Return on capital employed (ROCE %) 20.8% 15.4% Gross Margin (GP%) 8.4% 8.8% Operating Margin (OP %) 6.5% 6.6% Asset Turnover (times) 3.2 2.4 Gearing (Debt/Equity) 0.3 0.3 Stock Turnover (days) 15.7 14.6 Receivable (days) 1.4 2.9 Payable days (trade) (days) 29.9 28.5 2019 9.4% 9.3% 3.9% 2.4 0.3 1.2 1.9 28.4 Ratios for Mercator PLC (Based on the above Financial Statements) 2017 2018 2019 Return on capital employed (ROCE %) 19.6% 20.2% 17.6% Gross Margin (GP %) 9.1% 9.8% 10.0% Operating Margin (OP %) 6.8% 7.1% 7.1% Asset Turnover (times) 2.9 2.8 2.5 Gearing (Debt/Equity) 0.7 0.6 0.3 Stock Turnover (days) 17.8 18.7 16.9 Receivable (days) 4.8 5.3 3.2 Payable days (trade) (days) 27.9 28.8 27.0 Required: a) Make the necessary adjustments and recalculate the 2019 ratios for Cora PLC. Explain why these adjustments are necessary to provide a more meaningful interpretation of Cora's underlying performance. (5 marks) b) Prepare a report for the CEO of Cora PLC in which you compare the performance of her company with that of its main competitor, Mercator PLC, using all the information provided above. (16 marks) The borrowing of Cora PLC is subject to financial covenants tested on a yearly basis. The first covenant is a fixed charge covenant, calculated as operating profit over net interest. The second covenant is a leverage covenant, calculated as capital employed over gross profit Calculate and briefly comment on the performance of Cora PLC in relation to these covenants (i.e., covenant slack) from 2017 to 2019, if the minimum threshold for the fixed charge covenant is 7 and for the leverage covenant is 3.5. (5 marks) d) Define the Debt Covenant Hypothesis from Positive Accounting Theory. Describe and explain its predictions on the choices of accounting policies by firm managers and also how managers will respond to proposed new accounting standards. (4 marks) c)