Analysis of Business Expansion Option of Saturn Pet Care

The first part of the assessment will be analysing the business expansion option of Saturn Pet care which will be done following capital budgeting techniques. The technique will be using NPV analysis, Payback period and Profitability Index to select the option for the production site of the company. The production site options which are available to the company are Bathurst Site and Wodonga Site.

From the analysis it is clear that the Wodonga site is the best option which the company has for expanding the production of business. The net present value of the Wodonga site as per the computation is shown as $ 95,94,827 which is much more than the results of Bathurst site which is shown as $ 58,44,567. The results of NPV analysis shows that the expected cash inflows from Wodonga Site is more than Bathurst Site. The profitability index of the company also depicts a similar result (Visser & Fiksen, 2013). This signifies that the business of Wodonga Site is much more profitable than Bathurst site. The payback period of the Wodonga Site is much better than the payback period of Bathurst site.  Thus, from the above discussion it is clear that Saturn Pet care should select Wodonga site for the purpose of establishing a production site.

This refers to a strategy which is adopted by businesses in which the sales revenue and volume of a product is lowered so that another product can be introduced and promoted in the market (Hvolby & Steger-Jensen, 2015). In the case study of Saturn pet care, there is a possibility that the technique might be used in order to promote the new product among the customers. The purpose of using Product Cannibalization is to establish a product in the market for the purpose of sales maximization.

Nathan who is one of the directors of the company is of the view that the marketing department of the company has recorded sales a bit than what is accurately correct. The management needs to rectify such an estimation as this will be hamper the planning process if proper target is not set and there is also a chance that targets which is set by the company might be completely unrealistic. The management can follow NPV method in which the cash outflows can be increased in order to balance the overestimated sales (Bianchini et al., 2016).

The director of the company is also of the opinion that for the purpose of NPV analysis the original cost of the vacant factory space should be considered. However, this is not correct as the original cost of the factory shed will not fall under initial investment and any new investment which is undertaken by the company for the purpose of the production.

Product Cannibalization in Saturn Pet Care

This part of the assignment will be focusing on the analysis of the capital structure and its effectiveness of ARB ltd. The capital structure of the company will be compared with another company’s structure so as to establish which business has an effective capital structure. ARB ltd is engaged in the manufacture of road motor vehicle accessories.

The capital structure of ARB ltd clearly shows that the business only uses equity-based capital for financing different activities of the business (Bartoloni, 2013). In other words, the capital structure of the company is made up of only equity capital and there is no presence of debt capital in the capital mix of the business (Ghosh, 2017). The equity capital which is used by ARB ltd is of $ 2,72.341 which is shown in the financial statement of the company.

The beta of the company is shown at 0.89 and the market return of the company is shown at 8.54% which are used for the purpose of computation of Cost of capital under Capital Asset Pricing Model (CAPM). The cost of equity which is calculated as per the general method is computed at 18.05% for the year 2017 which has reduced from the previous year’s estimates which was 19.01%. As the company does not uses any debts the business therefore will be having no cost of debt and also the cost of equity of the business will be regarded as the overall cost of capital of the business.

The cost of equity which is calculated following CAPM method requires risk free rate of return, beta and market rate of return (Lasfer, 2015). The cost of capital which is calculated following CAPM model comes to 7.906%. This shows that the company is meeting the needs of the shareholders expectation as the market return is more than the expected cost of capital as per CAPM method (Evstigneev, Hens & Schenk-Hoppé, 2015).

The company which is selected for the comparison purposes is Modine ltd which is engaged in manufacturing business which belongs to the same industry. The capital structure of Modine ltd comprises of equity capital and debt capital. The equity capital and the debt capital of the business is shown as $ 421.20 million and $ 519.90 million respectively. The capital structure of the company is much better as compared to ARB ltd and shows a general balance which is necessary for capital structure of any business. Moreover, there is other advantages of keeping debt capital in the capital mix as it provides tax advantage to the companies. The comparison between ARB ltd and Modine ltd is displayed below in the table.

Evaluation of Capital Structure of ARB ltd

As per the ratios which are computed for ARB ltd shows various ratios which are related to profitability, solvency and efficiency situation of the company. The net profit margin of the company shows minor changes in the ratio (Heikal et al., 2014). The net profit margin of the company has reduced from the previous year. The return on assets and return on equity has estimates have reduced from previous year’s estimates which can be due to the slight fall in the net profit of the company. The solvency ratio shows that the current ratio of the company has increased from previous year which is a positive sign as it means that the business has a strong liquidity situation (Pierret, 2015). The debt equity ratio for the year 2017 is 0.157 and the same was 0.145 in 2016. The debt equity ratio signifies that the debts of the company have increased and the company is applying more debt capital in the capital mix. The efficiency ratio of the company shows that the inventory turnover ratio of the business has increased from previous year’s figure which is a positive sign for the business (Mowris, 2013). The debtor turnover ratio show that it has decreased from previous year which shows that the debt collection policy of the company can further improve.

The capital structure of the company shows that at present the company is only relying on equity capital which forms 100% of the capital structure of the company. In 2016 as well, the equity share capital is shown at $ 2,49,608 which is the only capital used in the capital structure mix by the management of the company. In 2015 however, the company used some portion of debt capital which is of $ 2000 in the capital mix. Thus from 2015, the company approach towards capital structure has significantly changed. 

The company has not been able to achieve the growth which is desired even though the NOPAT of the company has increased slightly from the previous year’s estimate (Fernandez, 2015). The positive fact is that the cost of capital of the company which signifies risks has decreased from previous year’s estimate. The company needs to attain growth so that they are able to generate more wealth for the shareholders of the business.

The recommendation which can be offered to ARB company are given below:

1. The company needs to add debt capital in the capital structure to attain a desired balance in the capital structure mix(Jõeveer, 2013). This will also help business to take tax advantage which debt capital can provide and the leverage might help the business to further attain growth.
2. The company needs to focus on the wealth maximization principle of the business and ensure that the wealth generation is given key focus which involves improving the NOPAT of the business.
3. The cost of capital can be reduced further if an efficient capital mix balance is attained by the business which the business must pursue to attain.

Conclusion

Thus, from the above discussion on ARB ltd, it can be said that the company needs to improve its capital structure so that it can minimize the risks which the business faces and also take advantage of other benefits which an efficient capital structure provides. Moreover, the company needs to improve the NOPAT of the business which can be done by attaining an appropriate balance in the capital structure of the company. 

Reference

Bartoloni, E. (2013). Capital structure and innovation: causality and determinants. Empirica, 40(1), 111-151.

Bianchini, A., Gambuti, M., Pellegrini, M., & Saccani, C. (2016). Performance analysis and economic assessment of different photovoltaic technologies based on experimental measurements. Renewable Energy, 85, 1-11.

Evstigneev, I. V., Hens, T., & Schenk-Hoppé, K. R. (2015). Capital Asset Pricing Model (CAPM). In Mathematical Financial Economics (pp. 53-59). Springer, Cham.

Fernandez, P. (2015). EVA and cash value added do not measure shareholder value creation.

Ghosh, A. (2017). Capital structure and firm performance. Routledge.

Heikal, M., Khaddafi, M., & Ummah, A. (2014). Influence analysis of return on assets (ROA), return on equity (ROE), net profit margin (NPM), debt to equity ratio (DER), and current ratio (CR), against corporate profit growth in automotive in Indonesia Stock Exchange. International Journal of Academic Research in Business and Social Sciences, 4(12), 101.

Hvolby, H. H., & Steger-Jensen, K. (2015). Managing cannibalization of perishable food products in the retail sector. Procedia Computer Science, 64, 1051-1056.

Jõeveer, K. (2013). Firm, country and macroeconomic determinants of capital structure: Evidence from transition economies. Journal of Comparative Economics, 41(1), 294-308.

Lasfer, M. (2015). Cost of Capital. Wiley Encyclopedia of Management, 1-2.

Mowris, R. J. (2013). U.S. Patent No. 8,583,384. Washington, DC: U.S. Patent and Trademark Office.

Pierret, D. (2015). Systemic risk and the solvency-liquidity nexus of banks.

Visser, A. W., & Fiksen, Ø. (2013). Optimal foraging in marine ecosystem models: selectivity, profitability and switching. Marine Ecology Progress Series, 473, 91-101.