in K million) Statement of Financial Position Larfage Dangote Great Wall Cement
ID: 2818497 • Letter: I
Question
in K million) Statement of Financial Position Larfage Dangote Great Wall Cement PLC Cement Ltd Cement Ltd 100 Non-current assets Current assets 100 250 350 100 400 500 425 200 100 150 50 150 350 250 150 uity Term Loan 10% interest rate Current liabilities 425 500 You are a financial advisor to Mr. Ndhlovu who is considering investing in any one of the following three companies in the same cement industry. He considers them to be equal in all regards except for the differences described below. Mr. Ndhlovu has asked you to help him understand the effects of the different working capital strategies adopted by each company. He has provided you with the following information: In each case, Mr. Ndhlasuespect earnings before interest and tax to be 10% of sales. Under normal trading conditions, he would expect annual sales to be twice the present level of current assets. ou may ignore taxation. Required (a) Advise Mr. Ndhlovu which company will provide the best return on equity (b) Discuss what other matters, including risk, which Mr. Ndhlovu should consider when the working capital strategiesExplanation / Answer
a) Considering only working capital and ignoring all other factors, the best company to invest in would be the one which has the highest Sales to Equity ratio, since it would result in highest EPS.
Sales to Equity ratio = Sales / Equity
Lafarge Cement PLC:
=> (250*2) / 150 = 3.33
Dangote Cement Ltd:
=> (325*2) /200 = 3.25
Great Wall Cement Ltd:
=> (400*2) / 250 = 3.20
Since Lafarge Cement PLC has the highest Sales to Equity ratio, Mr. Ndhlovu should invest in this company.
b) While determining the best investment option among the given three companies, apart from current assets, there are two more factors that must be considered; Current Ratio and Current level of long-term debt.
Current ratio will tell the riskiness of the firm as a healthy ratio is important. A weak current ratio would mean that the company may need to sell-off its long-term assets to pay its current debt and this would have a significant adverse impact on the operations of the company dragging down sales and profits.
Long-term debt is another thing to be considered, since it would impact the Net Profit of the company. A higher level of debt would result in higher interest costs that would drag down Net Profit resulting in lower EPS.
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