BUSINESS VALUATION

Assignment -2

SUBMITTED BY:

GROUP X7

AYUSH MADAN (040)

AKSHAT AGARWAL (015)

ARNAV KULKARNI (071)

ACHAL MITTAL (006)

Question 1: What are the pros and cons of B&B's owners wanting to keep 100% control of
the business?

Ans:

Pros:

Greenwood can retain the business as she had wished earlier, not to dilute the ownership.
By controlling the business 100% she can be completely sure the quality of her products
and in turn maintain the customers trust.
By this she can also take care how the marketing strategy, product design etc. should be.
She can also maintain B&Bs philosophy, vision and mission.
They will have advantage of tax shield effect.

Cons:

Controlling 100% of the business and not inviting any outside investor means shouldering
all the risk herself. If outside investors are there in the business, finances are also taken
care of and risk is also distributed.
It will be an obligation for Greenwood to pay all the debt holders, irrespective of the fact
that the firm is profitable enough to do that or not.
Less interference is a double-edged sword, she might go wrong thinking she is concerned
about the quality of the product and doing best for the organization.
Q2. What specific financial ratios, ratio trends, and other key factors will be taken into
consideration by the lender to assess whether they will fund the loan?

Ans.

Scenario 3

Liquidity ratios 2014 2015 2016 2017

current ratio 1.05 0.20 0.34 0.68
quick ratio 0.37 0.05 0.16 0.46

Cash conversion cycle

Inventory to sale 147 days 146 days 139 days 139 days
Sale to cash 7 days 7 days 7 days 7 days
Purchase to payment 54 days 73 days 70 days 70 days
Cash conversion cycle 100 days 80 days 77 days 77 days

Leverage ratios
Total debt to assets 0.33 0.66 0.60 0.52
Interest Coverage 42.97 6.29 9.95 12.27

Profitability ratios
Gross profit margin 80% 80% 79% 79%
Operating profit margin 13% 9% 14% 16%
Return to assets 47% 9% 19% 22%
Return to equity 84% 32% 56% 53%

Explanation-

We can see a drop in current ratio may be due to balance payment of 110000 in the 2015,
still they are making enough profits. Quick ratio is also decreasing but got stable in the end.
There is an increasing trend in net income from 2015 to 2017.
Cash balance is also increasing from 8901 in 2015 to 407000 in 2017.
Interest coverage ratio is high in 2014, we can see a drop in 2015 as we took a loan and
interest expense increased.
Cash conversion cycle is less is decreasing from 2014 to 2017 indicating a positive sign.
Total debt to assets is increasing significantly from 2014 to 2015 as we took a hefty loan ,
but it has started decreasing as we made annual payments to pay our obligations.
Scenario 4

Liquidity ratios 2014 2015 2016 2017

current ratio 1.05 0.08 0.14 0.25
quick ratio 0.37 -0.06 -0.01 0.10

Cash conversion cycle

Inventory to sale 147 days 146 days 139 days 139 days
Sale to cash 7 days 7 days 7 days 7 days
Purchase to payment 54 days 73 days 70 days 70 days
Cash conversion cycle 100 days 80 days 77 days 77 days

Leverage ratios
Total debt to assets 0.33 0.73 0.70 0.69
Interest Coverage 42.97 3.92 4.85 3.87

Profitability ratios
Gross profit margin 80% 80% 79% 79%
Operating profit margin 13% 3% 5% 2%
Return to assets 47% 1% 3% -1%
Return to equity 84% 4% 13% -3%

Explanation

The liquidity position of the company is deteriorating. Quick ratio is also decreasing
simultaneously.

Return on equity is decreasing and became negative for 2017.

Current ratio and quick ratio are either very less or negative in itself.
They incurred losses amounting 8800 has been incurred in this scenario.
Cash balance has been negative for year 2015 and 2016
Return on assets has also become negative, decreasing continuously.

So, as a lender we would give loan in scenario 3, but we would not avail any credit facility under
scenario 4 ( buy building with no revenue growth)
Q3. What factors (in addition to what the lender is assessing) should Greenwood and Thomas
consider before they take out a loan to buy the building?

Ans.

Quality of Earnings- They should be able to generate enough cash flow through their
operating activities to pay the loan at the time of requirement.

Interest coverage ratio- they should generate enough profit to meet the interest payments
which the firm is obligated to pay.

Compare the cost of loan and cost of equity- Lower the cost of borrowing for the firm,
better it will be, but in this case, it is better if company rents out the building.

Q4. What are the advantages and disadvantages of adding rental space in both the revenue
growth of 15% and No Growth in Unit Demand scenarios?

Ans.
Adding rental space -Growth 15%

Advantage: If they take rent, the firm that way will not add any financial leverage, and hence no
financial distress risk

Net income is increasing from 2,29,000 in 2014 to 3,89,000 in 2017. So, it is a positive sign
and can be seen as a n advantage.
Cash balance is also increasing as there is growth of 15% in the units sold.
Renting will also increase the return on capital than compared to not renting
Annual rent cost is less than annualized total payments i.e., $75000 vs $80000.
In case the operations of the business fail due to change in customer preference or demand
going down, then the building cost will become a sunk cost

Disadvantages:

Return on assets is decreasing as after 20 years you wont the assets.

Adding rental space No growth

Advantage:

Not such advantage as it is a pessimistic scenario.

Disadvantage:

Owners cannot draw dividends for the expected years as the cash balance is not more than
$50000.
PAT is negative for the last year.

Q5. What recommendations would you make to B&B and why?

We would recommend Scenario 1 ( Rent +15% growth in sales) as the most feasible and best
choice among the four scenarios. We should go for renting out the building, as in this case

Cash balance (in all the years) is highest among the other scenarios.
Net income is highest for scenario 1, if rented than purchased.
Cash conversion cycle is almost same as with scenario 3 but still it is slightly better in
case 1
Return on equity is clearly higher if the space is rented.
The accounts payables are almost same for all the scenarios.

Hence from all these dimensions which are crucial for taking a financing decision, it validates
the decision to rent out the space and assume the 15% revenue growth than purchase the building
and add to the capital cost.

Q6. How has financial modeling helped the lender and B&B to make better decision?

Financial modelling gave us a better representation of ratios, risks to be assessed and the
options Bubble and Bee organic have in their hands. It became easy compare all the four
scenarios which were possible for them.
Past performance can be ascertained in comparison to future expected performance using
financial modelling.
We considered the cost of equity, cost of debt and return on capital employed to ascertain
the best cost-effective approach cost. It gave us dependable results which made our
decision making simpler.
Q7. What suggestions do you have for improving the assumptions and financial modeling
for B&B?

Assumption:

The assumptions for considering ending receivables, ending inventory balance, ending
accounts payable are taken as fixed percentage of sales for all the 3 years. Representation
would be accurate if some adjustments would have been done in different years.
All the assumptions for items in income statement were taken as percentage of sales.
Expenses should take as percentage of COGS.
Sales growth has been arbitrarily taken as 15% (fixed) for all the upcoming years, it could
have varied with pessimistic and optimistic scenarios analysis.
Sensitivity testing can be done considering various factors and parameters.