PDE4232 Financial

Management in Engineering
Course Work 2

Name Tariq Mirza Ali Khan

Student ID. M00945879
Module Leader Ahsun Khan
Tutor Dr Solomon McQuay
Word Count 2204

MIDDLESEX UNIVERSITY | MSc Engineering Management

Table of Contents
1. Introduction ................................................................................................................... 2

2. Option 1: Modernisation of Manufacturing Infrastructure .......................................... 2

3. Option 2: Emerging with Existing Company. .............................................................. 5

4. Conclusion ..................................................................................................................... 9

5. References ................................................................................................................... 10

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1. Introduction

Homage Engineering plc is a well-known and established company that supplies vital
parts and components to the engineering industry and plays a key role in the growth of
the economy. Since its establishment ten years ago, the company has produced all its
components in the UK and supplied them to different markets domestically as well as
internationally.

The company lost quite a share of the domestic and international market due to tough
competition from China, Romania, and Poland. The impact can be noticed in a sharp
drop in annual turnover and sales of the company. The company had a turnover of £25
million pa at its peak while recent data showed sales of £15 million only with profit less
than £2 million. To increase sales and restore its market share, the directors have
suggested a few solutions that will resolve the problem. After a deep discussion
between the directors of the company, they have reached a crossroads where they
have to choose between two options. One of the options is to modernise the existing
machinery with more efficient and modern machinery which will help to boost production
and improve the quality of the product. On the other hand, option 2 suggests merging
with or taking over one of the large companies in the EU. This move will establish a
foothold for the company in the large EU market and provide a competitive advantage
against other adversaries like China.

Our consultancy will evaluate the financial cost-effectiveness of investing in the

modernization of existing equipment as well as conduct a detailed and comprehensive
analysis of the financial statements of two companies suggested to be merged or taken
over. We will also assess the financial health of each company with ratio analysis of its
financial statement and provide a reasonable recommendation. Finally, we will provide a
conclusion on which option will be most useful for company growth.

2. Option 1: Modernisation of Manufacturing Infrastructure

The modernization of the company’s manufacturing infrastructure and machinery is
estimated to cost around £7.5 million. This investment will boost the production and
efficiency of the plant and increase sales. The company's shareholders agreed on a
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10% p.a rate of return on capital. Additionally, the investment cycle must be done every
8 years, and the expected scrap value of the old machinery is £900,000.

The below table demonstrates the expected cash inflow from the project and the Net
Present Value.
Annual Cash Flow Cumulative Cash
Year
(£'000) flow (£'000)
1 1,000 1,000
2 2,200 3,200
3 2,300 5,500
4 2,500 8,000
5 2,400 10,400
6 1,300 11,700
7 1,100 12,800
8 1,000 13,800
Scrap Value 900 14,700

As mentioned above, the cost of investment in the modernization project is around 7.5
million. According to the cash flow in the table, the expected payback period of the
investment is:
2,000
3𝑦𝑒𝑎𝑟𝑠 + = 3.8 𝑦𝑒𝑎𝑟𝑠
500

On the other hand, taking into account the cost of capital 10% p.a, the following results
are acquired in the below table.

Annual Cash Flow PV Discount Factor

Year Present Value (£'000)
(£'000) 10%

0 -7,500 1.000 -7,500

1 1,000 0.909 909.0
2 2,200 0.826 1,817.2
3 2,300 0.751 1,727.3
4 2,500 0.683 1,707.5
5 2,400 0.621 1,490.4
6 1,300 0.564 733.2
7 1,100 0.513 564.3

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 8 1,000 0.467 467.0
8 900 0.467 420.3
Net Profit Value (NPV) 2,336.2

The above positive Net Present Value (NPV) represents a favorable outcome which
indicates that the investment in the modernization of the company’s manufacturing
infrastructure will generate enough turnover to cover its cost as well as increase the
overall value of the company. Therefore, the estimated cash flows from the investment
exceed the invested amount and generate more value than it costs.

On the other hand, some key non-financial factors must be considered before taking
any further steps in modernization as they will have some impact on the output result.

 Brexit:
The implication of Brexit will have some negative impact on the company, but
some positive points must be highlighted. The British government will impose
post-Brexit control over the border and charge a reasonable amount of money as
tariffs on goods coming from the EU. Those new border rules and regulations will
make the imported items less favorable and give a competitive edge to local
products in the domestic market. Hence, it will help Homage Engineering plc to
further consolidate its shares in the domestic market.

 Skilled Workers and Technicians:

The company must take into consideration that the existing skilled workers are
unfamiliar with the new machinery and must be not left behind during the
transition period. Therefore, the company must invest in its human resources by
providing adequate training to the existing skilled workers and hiring new skilled
workers and technicians familiar with the new machinery.

 Market Changes:
The company must collect regular data from the customers and invest in the
research and development sector to meet the future needs of the market and
have a competitive edge against its competitors.

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 3. Option 2: Emerging with Existing Company.

Emerging or taking over a company in the EU after Brexit will create an opportunity to
have a strong foothold in the EU market as well as provide a competitive edge. This
move will create a sharp increase in sales and revenue and avoid losing the competition
in the EU market. Therefore, the market dynamics and financial performance of the two
companies are thoroughly examined in this report for the years 2021 and 2022 using
the balance sheet provided.

 Balance sheet Trends

Liquidity ratios:

The investor must analyze the liquidity of the company to measure its financial
stability and its ability to fulfill its obligation to pay off its current liabilities without
raising external capital. One of the tools used to measure the capability of the
company to pay off its short-term debts is the liquidity ratio. Companies with high
liquidity ratios are seen to be less hazardous investments because they are more
likely to satisfy short-term obligations and preserve financial stability amid economic
downturns. On the other hand, a low liquidity ratio demonstrates weak financial
status and a high-risk investment for the investors.

The data collected from the balance sheet of the two companies demonstrated the
below trends regarding their Liquidity ratio:

Current Current Cash Current Quick Cash

Company Year Inventory
Assets Liabilities Equivalent Ratio Ratio Ratio

2021 1,950 3,800 640 80 0.51 0.34 0.02

Company
A
2022 1,690 3,120 490 120 0.54 0.38 0.04

2021 17,406 13,372 7,262 2,788 1.30 0.76 0.21

Company
B
2022 18,306 16,472 9,816 1,424 1.11 0.52 0.09

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 From the above ratios, company A had a lower Current ratio and quick ratio
demonstrating weak financial stability and difficulty in fulfilling its current liabilities.
Meanwhile, Company B indicates stronger liquidity with a current ratio of 1.30 and a
quick ratio of 0.76 in 2021. Besides, there was a decline in the current ratio and
quick ratio in 2022 but it still performed better than company A and indicated the
strong ability to cover its current liabilities.

Solvency ratios:

Unlike the Liquidity ratio, A solvency ratio determines the company's ability to cover
its long-term debt. It is a key performance metric that indicates whether the company
has adequate cash flow to fulfill its long-term debts. A higher solvency ratio reveals
the financial health of the company and its stability in the long term.

From the data provided in the balance sheet, below is the solvency ratio of the two
companies.

Share
Total Interest Debt to Interest
Company Year Holder EBIT
Debt Expense Equity Coverage
Equity
2021 1,755.00 2,045.00 655.00 95.00 0.86 6.89
Company A
2022 1,445.00 1,675.00 464.00 69.00 0.86 6.72

2021 13,372.00 7,326.00 3,026.00 570.00 1.83 5.31

Company B
2022 16,472.00 8,994.00 3,206.00 570.00 1.83 5.62

Company A maintained a consistent debt-to-equity ratio of 0.86 in 2021 and 2022,

indicating a relatively stable capital structure. Its interest coverage ratio was 6.89 in
2021 and 6.72 in 2022, demonstrating a healthy ability to cover interest expenses.
On the other hand, Company B exhibited higher leverage with a debt-to-equity ratio
of 1.83 in both years. However, its interest coverage ratios of 5.31 in 2021 and 5.62
in 2022 suggest sufficient earnings to cover interest obligations. In summary, while
Company A has a more conservative capital structure, Company B, despite higher

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leverage, maintains reasonable interest coverage ratios, indicating better solvency in
terms of meeting long-term debt obligations.

Profitability ratios:

The profitability ratio is a financial tool used by investors to measure the company's
ability to generate profit from the balance sheet assets, revenue, and shareholders’
equity. This indicates how well a company utilizes the assets allocated to it.

From the data provided in the balance sheet, below is the solvency ratio of the two
companies.

Operating
Net Profit
Operating Net Profit
Company Year Sales Margin Ratio
Income Income Margin
%
Ratio %
2021 920 370 11,200 8.21% 3.30%
Company A
2022 669 345 9,750 6.86% 3.54%

2021 373 235 31,321 1.19% 0.75%

Company B
2022 676 433 33,861 2.00% 1.28%

The above table indicates that company A outperformed company B with a huge
margin and demonstrated high profit-generating ability as compared to company B.
The operating profit margin ratio indicates that Company A consistently
outperformed Company B with 8.21% in 2021 and 6.86% in 2022, while Company B
has lower margins of 1.19% and 2.00% for the respective years. On the other hand,
Company A had a net profit margin of 3.30% in 2021 and 3.54% in 2022 compared
to Company B's lower margins of 0.75% and 1.28%. Overall, Company A exhibited a
better profitability ratio and stronger financial status than Company B.

Efficiency ratio:

The efficiency ratio is the performance ratio which measures how well a company
utilizes its assets and liabilities internally. An efficiency ratio can calculate the

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 turnover of receivables, the repayment of liabilities, the quantity and usage of equity,
and the general use of inventory and machinery. A key performance metric that
looks at the company's financial performance and the time it takes to convert
inventory to cash. It also indicates how well a company manages its assets to
generate as much profit as possible.

From the data provided in the balance sheet, below is the solvency ratio of the two
companies.

Average Average Average Asset Equity

Average Net
Company Year Accounts Total Shareholders’ Turnover Turnover
Inventory Sales
Receivable Assets Equity Ratio ratio

Company 2021 1,230 640 11,200 3,800 2,077 2.95 5.39

A 2022 1,080 490 9,750 3,120 2,085 3.13 4.68

Company 2021 7,378 7,262 8,340 26,398 6,264 0.32 1.33

B 2022 7,066 9,816 10,020 31,166 6,389 0.32 1.57

The above data shows that Company A outperformed Company B in asset turnover
as well as equity turnover ratio. Company A had performed better in utilizing the
assets and equity allocated to it and generated high sales as compared to Company
B. On the other hand, Company B had demonstrated a weak efficiency ratio which
indicates less efficient utilization of asset and equity.

After the analysis of the balance sheet of both companies, it can be concluded that
Company B indicates better financial stability with healthy liquidity as well as solvency
ratio as compared to Company A. Meanwhile, Company A outperformed Company B by
demonstrating better profitability ratio and efficiency ratio, showcasing its capability to
utilize its resource and good return from investment. Therefore, Company A indicates a
better return on investment and will be the better choice as compared to Company B.

Besides the financial stability and profitability of the company, other factors must be
taken into account before making the decision. The market trends, human resources

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available, customer and supplier relationships, and political changes may create
obstacles to the development and progress of the company.

4. Conclusion

Overall, Company A has low liquidity, while Company B encounters low profitability and
utilization of its resources. Thus, option 1 can be considered more desirable, as it will
provide an opportunity for the company to redirect its focus on its domestic market and
secure its position. Additionally, the suggested modernization plan will improve the quality
and quantity of the product, leading to a sharp increase in sales. Therefore, option 1
proves to be the better choice for long-term sustainability and growth.

Furthermore, the suggested plan of modernization and enhancing the quality of products
can solidify the position of the company and will merge as a strong competitor in
international markets. This will increase the annual turnover of the company and create
a path for the long term growth of the company.

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5. References

Beenstock, M. and Chan, K.-F. (2009). ECONOMIC FORCES IN THE LONDON STOCK
MARKET. Oxford Bulletin of Economics and Statistics, 50(1), pp.27–39.
doi:https://doi.org/10.1111/j.1468-0084.1988.mp50001002.x.

Chelley-Steeley, P.L. (2008). Market quality changes in the London Stock Market. Journal of
Banking & Finance, 32(10), pp.2248–2253. doi:https://doi.org/10.1016/j.jbankfin.2007.12.049.

Fernando J., (2023). Net Present Value (NPV): What It Means and Steps to Calculate It. [online]
Available at: https://www.investopedia.com/terms/n/npv.asp (Accessed: 7 January 2024).

Pareto Labs. (2021). Financial Ratios: How to Calculate and Analyse. [online] Available at:
https://www.paretolabs.com/financial-ratios-how-to-calculate-and-analyze/ (Accessed: 7
January 2024).

Velez-Pareja, I. (2020). Financial Analysis and Control - Financial Ratio Analysis. SSRN
Electronic Journal. doi:https://doi.org/10.2139/ssrn.1638279.

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