- 20 Marks
Question
Chisom Plc experienced rapid growth in recent years through the acquisition and integration of other companies. Chisom Plc is interested in acquiring Oyowood Limited, a retailing company, which is one of several companies owned and managed by the same family.
The summarized financial statements of Oyowood Limited for the year ended December 31, 2022, are as follows:
From the above financial statements, Chisom Plc has calculated for Oyowood Limited the ratios below for the year ended December 31, 2022. It has also obtained the equivalent ratios for the retail sector average, which can be taken to represent Oyowood‟s sector.
Additional Information:
- Oyowood Limited buys all inventories from family companies at a 10% discount below market prices.
- Post-acquisition, Chisom Plc would replace the board of directors with a new board at a remuneration cost of ₦2.5 million per annum.
- Directors’ loan accounts will be refinanced through a 10% interest-bearing commercial loan of the same amount.
- The purchase price for Oyowood Limited is expected to be ₦30 million.
Required:
a. As the financial analyst for Chisom Plc, recalculate the ratios for Oyowood Limited after adjustments based on points (i) to (iv) above. (10 Marks)
b. Draft a memo to the managing director of Chisom Plc commenting on the adjusted performance of Oyowood Limited. (10 Marks)
Answer
Oyo wood’s adjusted ratios:
On the assumption that after the purchase of Oyowood Ltd, the favourable effects of the transactions with other companies owned by the family would not occur, the following adjustments to the statement of profit or loss should be made:
These adjustments would give rise to a revised Statement of Profit or Loss below:
Memo to Managing Director
Subject: Comments on the Performance of Oyowood Limited
Dear Sir,
Following your request to assess the viability of acquiring Oyowood Limited, I have reviewed the company’s financial performance using adjusted accounting ratios. The findings are as follows:
- Profitability: Oyowood’s profitability ratios, particularly before adjustments, suggest high profitability. However, after adjusting for anticipated post-acquisition changes, the company’s ROE, gross profit, and net profit margins fall closer to sector averages, indicating that its strong financials were partially influenced by preferential transactions within the family-owned business network.
- Return on Equity (ROE): Initially high, ROE is impacted by new director remuneration and commercial loan interest. After adjustments, it aligns with the sector average, showing that profit was previously influenced by below-market costs.
- Net Asset Turnover: While above the sector average, the adjusted turnover ratio suggests a less drastic but still efficient use of assets compared to peers, indicating solid revenue generation.
In summary, while Oyowood Limited’s adjusted performance remains commendable, the revised ratios bring profitability closer to industry norms, suggesting a need for cautious negotiation regarding valuation.
Best regards,
[Analyst Name]
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