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Methods through which Lego Plc expanding business

Organization Selected : Lego Plc

INTRODUCTION

A business with a view of expansion reflects the long term growth vision of the business. For expansion of the business the two of the major measures are acquisition of an existing business or to invest in capital projects which will lead to the overall expansion of the business. In the present case study of Lego Plc the evaluation related to expansion of business is carried out. The company is thinking of expansion through investing in a capital project and acquisition of a business unit. In the report presented below evaluation of two project is done to select the more profitable project for investment by Lego Plc. Two given business are also evaluated for the acquisition purpose. The Lego Plc is also given recommendation about the project and business unit it shall take into consideration for investment and acquisition respectively, after a det

MAIN BODY

1. Following are the sources of funding for the Lego PLC

1- Equity shares

Equity shares is the best sources of funding for the Lego PLC. Not all the business can use these sources as it is governed by a lot of legislation it is the most satisfactory source of generating effective capital for better capital structure and availability of funds for operations. An important function of the equity share is the sharing of ownership right and therefore shareholders rights are diluted.

Advantage-

  • Helpful in raising long term capital for the company.
  • This funding is committed to the business and its related projects.

Disadvantages-

The owners of Lego Plc will no longer have control over the business.

  • There is a legal and regulatory issues to comply when you raise your fund from equity shares.

2- Debentures

Debentures are another common means of finance which the Lego PLC can used to raise their funds. Debt is considered to be cheaper mode of finance compared to equity. Debentures involves some cost of issuing and they are collated and realized by assets of the company.

Advantages-

  • Different shareholders are there, so there are no voting rights.
  • Ensures a fixed percentage of returns to the debenture holders.

Disadvantages-

  • High cost of raising capital, high stamp duty
  • Change in earning can prove fatal for the company.

3- Loan

Loan is the best and easiest source of funding. It does not include too much cost of the issuing because it is given by some bank or financial institution. The common public is not involved in it. Loan can be financed by the financial institution on the basis of some legal documents of the company. A rigorous analysis of Lego Plc's financials and future plans is done by the bank to judge the debt servicing capacity of the company. These loans are also secured by some assets.

Advantages-

  • Bank loan do not take the ownership position in the business.
  • There are no obligations to the lender once a loan has been paid off.

Disadvantages-

  • Difficult to obtain without a substantial track record.
  • High interest rates sometimes can't get enough funding to meet the business needs.

4- Leasing and hire purchase

Taking hire purchase or lease as an option over paying the full amount to the suppliers of goods can help business delay its cash payment which is equal to having its good financed.

Advantages

  • One can claim for lease payment as business expenses.
  • Relocating from a leased property can be easier than depending on the sale of own premise

Disadvantages

  • Rent money does not contribute to the business assets or capital growth.
  • More expensive that outright purchase over the long term.

Recommendation: Lego Plc is thinking to raise the funds as capital loans for acquisition purpose. The company can do so and raise the funds as debt for the bank or other financial institutions. Lego Plc can also raise funds through the issue of share capital but it is recommended to company to issue debenture to maintain the level of paid up share capital. For the purpose of investment in one of the two projects the company need not to raise any outside finds as the initial investment for the projects are not too high and company is available with some working capital which can be allocated to the project so selected. However, if Logo Plc still wants to raise funds for capital project it can do be taking a lone from the banks.

2. Analysis of investment proposal using NPV and IRR method

Evaluation of projects:

PROJECT 1: LEGO SUPER

Computation of cash flows

particular

rise and inflation

actual rate

inflated rate

0

1

2

3

4

5

initial investment

     

15900

         

working capital

     

900

1100

700

500

400

0

sales revenue

       

2400

6000

7800

4800

3700

total

     

900

3500

6700

8300

5200

3700

Rise

3.00%

   

0

105

201

249

156

111

Total cash infllow

       

3605

6901

8549

5356

3811

actual inflow

     

15900

4705

7601

9049

5756

3811

less

                 

overheads

     

0

220

220

230

200

200

rise

3.00%

     

6.6

6.6

6.9

6

6

actual overheads

     

0

226.6

226.6

236.9

206

206

                   

component A

       

460

600

720

720

900

component B

       

1100

1000

1200

1500

1700

total

       

1560

1600

1920

2220

2600

rise

3.00%

     

0

48

57.6

66.6

78

total value of component

     

0

1560

1648

1977.6

2286.6

2678

                   

salary of senior technology officer 1

     

0

         

working hours

              (25%)

1170

877.5

0

1170

877.5

877.5

877.5

877.5

pay per hour

2.50%

180

184.5

0

184.5

184.5

184.5

184.5

184.5

salary

       

215865

161898.75

161898.75

161898.75

161898.75

                   

actual salary of STO 1

       

215.865

161.89875

161.89875

161.89875

161.89875

                   

salary of senior technology officer 2

                 

working hours

-20

1400

1120

 

1400

1120

1120

1120

1120

pat per hour

2.50%

140

143.5

0

140

143.5

143.5

143.5

143.5

                   

salary 

     

0

196000

160720

160720

160720

160720

actual salary of STO 2         

196

160.72

160.72

160.72

160.72

                   

Depreciation

       

3180

3180

3180

3180

3180

                   

Total expenses

       

5151.865

5150.61875

5480.2188

5789.2188

6180.6188

                   

Profit / loss

       

-446.865

2450.38125

3568.7813

-33.21875

-2369.619

Less: tax

         

490.07625

713.75625

-6.64375

-473.9238

Profit after tax

       

-446.865

1960.305

2855.025

-26.575

-1895.695

add: depreciation

       

3180

3180

3180

3180

3180

cash inflow

       

2733.135

5140.305

6035.025

3153.425

1284.305

Net present Value

Year

cash inflow

PV factor @15%

Discounted cash inflows

1

2733.135

0.869565217

2376.63913

2

5140.305

0.756143667

3886.809074

3

6035.025

0.657516232

3968.126901

4

3153.425

0.571753246

1802.980978

5

1284.305

0.497176735

638.526567

     

12673.08265

   

TDCF

15900

   

NPV

-3226.91735

Internal rate of Return

Year

cash inflow

 

-15900

1

2733.135

2

5140.305

3

6035.025

4

3153.425

5

1284.305

IRR

5%

Evaluation: The initial investment for the project Lego super is 15900 and the available working capital with logo plc is 900, so the initial cash requirement for this project is 15900. The life for project is 5 years so for the fifth year there is no sales revenue from the project. By using the discounting rate of 15%, the present value of future cash inflow is 12673 which is less than the initial cash outflow of the project. The IRR for the project is 5% which means at this discounting rate the project will have equal inflow for the initial outflow for the given life of 5 years of the project. There is a huge gap between the IRR and the given discounting rate of 15%. the project is also giving a negative NPV of 3733. 70, so the project Lego super shall not be considered by Lego Plc.

Evaluation: The project Lego Platform requires an initial investment of 8500 and with the available working capital of 2100 the cash required for the project is 6400. with a 5-year life and a discounting rate of 18% the present value or the future inflows is 7011.55. The present value is more than initial investment of 6400, hence gives a positive NPV of 611.55. IRR for this project is 21.80%. means at this rate the NPV of this project will be zero. The project is profitable as it is giving a positive NPV and an IRR more than discounted rate in the life span of 5 years. Therefore, this project shall be accepted.

3. Use of break even analysis and budgets as management tool

Break even analysis: break even analysis is used to determine the point where the cost and profits of the business are equal. For the purpose of capital budgeting this is significant tool for analysis of various projects as it helps in determination of margin of safety. The first step of a project will be attaining the break even point. The project which have reached the break even sales or revenue shall be selected this shows that in future the project will be profitable.

Budgets: budgets are prepared to forecast the future incomes and expenses for a particular time period and then they are compared with the actual data of earning and spendings of the business at the end of such period. The capital budgets create the blueprint which evaluates capital investment need for the project. The budgets also determine the profitability and long term investment benefits related to different projects.

For a business it is necessary to attain the brake even point to reach a step near the profitability and for a project it essential to determine its gain. The budgets are prepared to forecast the proposed income and expenses a business wants to achieve. On the other hand capital budgets are prepared for project a business wants to invest in.

4. Evaluation of target companies and recommendations

Evaluation of two different companies considered for acquisition:

Puteaux digital, France:

Over past three years from 2016 to 2018 the sales revenue of the business have increased from 10406 to 12516. With this there is an increment in gross, operating, net profit of the business. The sales have reached to 12156 from 10406 and the net profit of the firm has reached to 4114 from 3377. there is a diminution in non-current assets which can effect the liquidity position of the business. The amount due to the creditors have also reduced in past three years by 491. the company has a share capital of 500 with a share premium of 7400 and capital redemption reserve of 10.

Melia portfolio research, Spain:

Sales of the company Melia portfolio research have reached to 23510 in 2018 from 16529 in 2016. the total rise in sales in past three years is 6981. The administrative expenses are more than the revenues for each year, but a cost control can be seen as the is a decrease in amount of loss. There is an increase in the non current assets of the business of 2897 from 2016 to 2018. the current assets of the business Melia have also increased from 5724 in 2016 to 7252 in 2018. there is huge increase in amount of creditors of 7853. The huge increase in amount of creditors of Melia shows that company is falling back of cash and purchases are made on credits. the company has a paid up share capital of 450 with on retained earning and share premium.

Recommendation:

The sales revenue of Melia have shown more growth than the revenue of Puteaux i.e. growth in revenue for Melia was 2110. Though there is increase in sales revenue of Melia it is still operating at loss. The creditors of Melia have also increased in past 3 years which shows that company lacks working capital as there is no major increase in cash and cash equivalents. As compared between both the companies have a paid up share capital but Pauteaxu have share premium and retained earnings as well. Lego Plc will raise the investment funds for acquisition through capital loan from the parent entity. This will enhance the long term borrowing of Lego Plc. With Pauteaxu Lego Plc can enhance the sales revenue and pay back its long term borrowing on time without default. With Melia it a situation of default can arise though with a boost in sales. Hence, it is recommended to the to Lego Plc to acquire Pauteaxu as it is a profitable company and with a promising bright future.

5. Literature review

Investment appraisal analysis and budgets:

According to Dyson and Berry (2014) investment appraisal is a planning process which is used to determine whether the business's long term investment are worth for funding through the capitalisation structure of business or not. The long term investment can be for new machinery or replacement of old one, new plants and products etc. one of the primary goal of a business for capital budgeting investment is to enhance the value of the business for its shareholders. This analysis provide mangement with best decision making information. As per Hayward and et.al., (2017) investment appraisal is a sensitive analysis as it allows changing of the assumptions used in forecast which can change the whole analysis and can sometimes reverse the decisions. The analysis allows the key assumption to change which changes the degree of risk associated with it.

Li and Trutnevyte (2017) stated that, budgets are a future forecast of income that a business shall earn and the expenses that it shall incur for the operating a business. The budgets are useful as it set target for the company related to earning of profit margins and limits or extent of cost that the business shall meet in order to achieve economic advantages. As far as Rossi (2014) is concerned, budgets can sometimes lead the business away from the reality as it can be based on pure assumption or the budgets can be prepared with facts and data which have changed over the period.

Break even analysis:

According to Calabrò (2017) break even analysis is determination of a point where the revenues received are equal to the cost incurred on generating such revenues. This is point where profits of a firm equals losses. To reach break even means first step towards profitability. For break even analysis a business must know its fixed variable and semi variable cost. However, as per P.H. Gutierrez and N.L. Dalsted (Shaban, Al-Zubi and Abdallah, 2017), break even do not analyse the effect on demand at different price levels. The sales prices are considers constant at all level of output, which can sometimes give a wrong interpretation. The sales and production levels are considered same at all levels.

Shaban, O. S., Al-Zubi, Z. and Abdallah, A. A., (2017) stated that break even is useful tool used to study the relationship between fixed and variable cost and return. For a business it is helpful as it predict the effects of changes in sales prices. The effect of cost and efficiency changes on profitability can also be predicted by managers of a business. As far as Sun and et.al., (2018) is concerned, break even analysis can sometimes be misleading to a management of a business as depends on certain assumptions and can carry on calculation with assumptions on market conditions. This analysis has a limited possibility of actual implementation in the business so management of business shall not rely completely on break even analysis.

6. Issues to be considered by the company for the projects

While evaluating two different projects Lego Plc s while

  1. Inflation: both the cash flows and the discounted rates should either be in real terms or nominal terms, i.e. expected or adjusted inflation. The management shall also consider the factors that how it would deal with hyperinflation and inflation after stock prices.
  2. Incremental cash flow: while preparing the budgets incremental cash flow shall always be considered. The sunk cost and opportunity cost must also be considered when a project is not undertaken. These are the cost for taking one project over another.
  3. Leverage effects: cash flows and discounted rate shall match up with investor group being analysed. That is when discounted rate is cost of equity the cash flow shall be of equity investors and when rate is cost of capital cash flows shall be of firm.
  4. Taxation effect : all the investment analysis shall be done in after tax terms. For the projects in which profits can be set off against losses tax shield should be credited in project.

With taking all the above points in consideration the managers of Lego Plc shall evaluate and analyse both the projects. After the evaluation the both projects, Lego Platform shall be selected.

Ratio analysis

Profitability ratio analysis

Particulars

Formula

Puteaux France £'000

Melia Spain £'000

   

2016

2017

2018

2016

2017

2018

Operating profit

 

4,394

5,169

5,414

-397

-107

-146

Net profit

 

3,377

3,917

4,114

-390

-103

-139

Sales revenue

 

10,406

11,812

12,516

16,529

19,849

23,516

Operating profit ratio

Operating profit / sales * 100

42.23%

43.76%

43.26%

-2.40%

-0.54%

-0.62%

Net profit margin

Net profit / sales * 100

32.45%

33.16%

32.87%

-2.36%

-0.52%

-0.59%

Liquidity ratio analysis

Particulars

Formula

Puteaux France £'000

Melia Spain £'000

               

Current assets

 

5,650

7,160

10,520

5,724

6,438

7,252

Current liabilities

 

2184

1490

1693

9834

13490

17687

Current ratio

Current assets / current liabilities

2.59

4.81

6.21

0.58

0.48

0.41

By doing ratio analysis it has assessed that, in 2017, operating profit margin of Puteaux France increased from 42.23% to 43.76% respectively. In the financial year 2018, operating and net profit margin of Puteaux France accounted for 43.26% significantly.

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