Question 3 (35 Marks) Mike and Vusi, who have both invested in the engineering sector of the JSE, are comparing their respective investments. Mike's investments comprise 1,000 ordinary shares in Gauteng Machinery Ltd, a company that manufactures heavy-duty machinery. Vusi 's investment consists of 1,500 ordinary shares in Kwazulu-Natal Plant & Machinery Ltd, a company specializing in the manufacture of plant and machinery for the sugar - cane industry. Mike believes that he has made the better investment and suggests that they examine the information available to them in order to reach a conclusion. Both companies' financial year ended on 30 June 20x8, on which date the following information appeared in the financial press: Gauteng Kwazulu-Natal Price - earnings ratio 5,33 4,17 Dividend yield 2,50% 1,00% The abridge statement of profit or loss and statement of financial position at 30 June 20x8 for each company were as follows: STATEMENT OF PROFI OR LOSS FOR THE YEAR ENDED 30 JUNE 20x8 Gauteng Kwazulu-Natal N$000 N$000 Sales (all on credit) 28,000 48,000 Cost of sales (14,000) (25.000) Gross profit 14,000 23,000 Operating expenses (1,500) (3,000) Interest paid (1.500) (5.000) Profit before tax 11,000 15,000 Taxation (35%) (3,850) (5,250) Profit for the period 7,150 9,750 Kwazulu-Natal N$000 25,000 36,000 10,000 25,000 STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20x8 Gauteng N$000 ASSETS Non-current assets 29,500 Current assets: 21,950 Inventory 15,950 Accounts receivable 3,000 Short-term deposits 2,250 Cash and bank 750 51,450 EQUITY AND LIABILITIES Equity 27,000 Ordinary share capital (issued for 9,000 C10) Retained earnings 18,000 Non-current liabilities 10,500 Current liabilities: 13,950 Accounts payable 10,500 Short-term loan 1,500 Taxation payable 1,950 Bank overdraft 51,450 1,000 61,000 44,000 15,000 29,000 5,000 12,000 9,000 1,000 2,000 61,000 STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20x8 Gauteng Share Capital Retained Total N$000 earnings N$000 N$000 Balance , 30 June 20x7 9,000 11,850 20.850 Profit for the period 7,150 7.150 Dividends (1,000) Balance, 30 June 20x8 9,000 18,000 Kwazulu-Natal Share Capital Retained Total N$000 earnings NS000 N$000 Balance, 30 June 20x7 15,000 19,750 34,250 Profit for the period 9,750 9,750 Dividends (500) (500) Balance, 30 June 20x8 15,000 29,000 44,000 (1. 27 Additional information: Inventory, 30 June 20x7 Accounts receivable, 30 June 20x7 Total assets Gauteng Kwazulu-Natal N$000 N$000 13,050 12,000 5,000 15,000 41,160 51,850 7 of 10 The comprehensive published financial statements contained the following ratios and information: Gauteng Gauteng N$000 N$000 Current ratio 1,57 3,00 Profit percentage 26,79% 25,00% Debt ratio 0,48 0,28 The directors of Gauteng Machinery Ltd informed their shareholders that, during the next financial year, their company was committed to major expansion in Southeast Asia, as well as to a major and aggressive export drive into central and eastern Africa. In order to implement their foreign investment and export expansion drive, they will issue debentures to the value of N$20 000 000 on the local market. The sugar-cane industry in Kwazulu-Natal is flourishing and during the 20x8/9 financial year, Kwazulu-Natal Plant & Machinery Ltd is planning for locally driven growth and expansion. This will include acquisition of non-current assets costing N$1 000 000. The funds for this capital expenditure will be generated from the company's operating activities. During the course of their discussions, Mike and Vusi made the following comments: Mike: Based on the market measures, I would say that my investment in Gauteng Machinery Ltd is better than yours in KwaZulu-Natal Plant and Machinery Ltd, Vusi. What do you think? Vusi: I don't know, Mike. It might be a bit premature to say that without first calculating other ratios such as the acid test ratio, inventory turnover ratio, accounts receivable turnover ratio, accounts receivable turnover ratio, return on total assets, interest cover and earnings per share. Mike: Perhaps you are right, Vusi. Let's calculate the ratios that you have mentioned and see whether we can evaluate our investments more comprehensively and accurately. YOU ARE REQUIRED TO: 1) Comment on the five financial ratios provided in the question. (10 marks) 2) Calculate and comment on the six ratios mentioned above by Vusi. (17 marks) 3) Identify which of the two companies represents a better investment. Justify your conclusion and indicate what additional information would have been useful in making your evaluation. (8 marks)