1Tangier’ssummarisedfinancialstatementsfortheyearsended30Sep
tember2014andthecomparativefiguresareshownbelow.Statement
sofprofitorlossfortheyearended30September:20142013$m
$mRevenue2,7001,820Costofsales(1,890)(1,092)––––––––––
––Grossprofit810728Administrativeexpense(345)(200)Distr
ibutioncosts(230)(130)Financecosts(40)(5)––––––––––––
Profitbeforetaxation195393Incometaxexpense(60)(113)––
––––––––––Profitfortheyear135280––––––––––––Statements
offinancialpositionasat30September:20142013$m$m$m$
mNon-currentassetsProperty,plantandequipment680410Intangi
bleasset:manufacturinglicence300200Investmentatcost–Rar
emetal230nil––––––––––1,210610CurrentassetsInventory200
110Tradereceivables19575Banknil395120305––––––––
––––––––––Totalassets1,605915––––––––––Equityandliab
ilitiesEquitysharesof$1each430250Retainedearnings375
295––––––––––805545Non-currentliabilities5%securedloannot
es10010010%securedloannotes300400nil100––––––––C
urrentliabilitiesBankoverdraft110nilTradepayables21016
0Currenttaxpayable80400110270––––––––––––––––––To
talequityandliabilities1,605915––––––––––Thefollowinga
dditionalinformationhasbeenobtainedinrelationtotheoperat
ionsofTangierfortheyearended30September2014:(i)On1Jan
uary2014,TangierwonatenderforanewcontracttosupplyJets
idewithaircraftengineswhichTangiermanufacturesunderarece
ntlyacquiredlicence.Thebiddingprocesshadbeenverycompetit
iveandTangierhadtoincreaseitsmanufacturingcapacitytoful
filthecontract.(ii)ThecompanyalsodecidedtoinvestinRarem
etalbybuying8%ofitsequitysharestosecuresuppliesofspec
ialisedmaterialsusedinthemanufactureoftheengines.Nodivi
dendswerereceivedfromRaremetalnorhadthevalueofitsshare
sincreased.Onseeingtheresultsforthefirsttime,oneofthe
company’snon-executivedirectorsisdisappointedbythecurrent
year’sperformance.Required:Explainhowthenewcontractandits
relatedcostsmayhaveaffectedTangier’soperatingperformanced
uringtheyearended30September2014,identifyinganyfurtheri
nformationregardingthecontractwhichmaybeusefultoyourans
wer.Note:Youranswershouldbesupportedbyappropriateratios;
however,ratiosandanalysisofworkingcapitalarenotrequired
.Answer1Note:Referencesto‘2014’areinrespectoftheyearen
ded30September2014and‘2013’referstotheyearended30Sept
ember2013.Despiteanincreaseinrevenuesof48·4%(880/1,820x
100)in2013,thecompanyhassufferedadramaticfallinitspro
fitability.Thishasbeencausedbyacombinationofafallinggro
ssprofitmargin(from40%in2013toonly30%in2014)andmarke
dlyhigheroperatingoverheads.Aneight-foldincreaseinfinance
costcausedbytheincreasedborrowingatdoubletheinterestra
teofexistingborrowingand(presumably)someoverdraftinterest
hasledtotheprofitbeforetaxmorethanhalving.Thisisalso
borneoutbythedramaticfallinthecompany’sinterestcover(
from79·6in2013toonly5·9in2014).Thisisallreflectedint
heROCEfallingfromanimpressive61·7%in2013toonly19·5%in
2014(thougheventhisfigureisrespectable).ThefallintheR
OCEisattributabletoadramaticfallinprofitmarginatoperat
inglevel(from21·9%in2013toonly8·7%in2014)whichhasbee
ncompoundedbyareductioninthenon-currentassetturnover,wi
thonly$2·23beinggeneratedfromevery$1investedinnon-curre
ntassetsin2014(from$2·98in2013).Theinformationintheque
stionpointsstronglytothepossibility(evenprobability)that
thenewcontractmayberesponsibleformuchofthedeterioration
inTangier’sperformance.Itislikelythatthenewcontractmay
accountfortheincreasedrevenue;however,thebiddingprocess
was‘competitive’whichimpliesthatTangierhadtocutitsprice
(andthereforeitsprofitmargin)inordertowinthecontract.T
hecostsoffulfillingthecontracthavealsobeenheavy:Investme
ntinproperty,plantandequipmenthasincreasedby$270million
(atcarryingamount),representinganincreaseof66%.Theincrea
seinlicencecoststomanufacturethenewengineshascost$100
millionplusanyamortisation(whichisnotidentifiedintheque
stion).TheinvestmentinRaremetaltosecurematerialssuppliesh
ascost$230million.Therehasbeennobenefitin2014fromthis
investmentintermsofdividendsorcapitalgrowth.Itisimposs
ibletoquantifythebenefitofsecuringmaterialsupplieswhich
wasthemainreasonfortheinvestment,butithascomeatahigh
cost.Itisalsoquestionablehowtheinvestmenthas‘secured’t
heprovisionofmaterialsasan8%equityinvestmentdoesnotnor
mallygiveanymeaningfulinfluenceovertheinvestee.Analterna
tive(lessexpensive)strategymighthavebeentoenterintoalo
ng-termsupplycontractwithRaremetal.Thefinancecostofthene
w$300million10%loannotestopartlyfundtheinvestmentinno
n-currentassetshasalsoreducedreportedprofitandincreasedd
ebt/equity(oneformofgearingmeasure)from18·3%in2013to49
·7%in2014despiteissuing$180millioninnewequityshares.At
thislevel,particularlyinviewofitslargeincreasefrom2013
,itmaygivedebtholders(andothers)causeforconcern.Ifit
couldbedemonstratedthattheoverdraftwasnotabletobeclear
edforsometime,thiswouldbeanargumentforincludingitint
hecalculationofdebt/equity,makingthegearinglevelevenwors
e.Itisalsoapparentfromthemovementintheretainedearnings
thatTangierpaidadividendduringtheyearof$55million(295
,000+135,000–375,000)whichmaybeaquestionablepolicywhen
thecompanyisraisingadditionalfinancethroughborrowings.It
couldbespeculatedthatthe73%increaseofadministrativeexpen
sesmaybeduetoone-offcostsassociatedwiththetenderingpro
cess(consultancyfees,etc)andthe77%higherdistributioncost
scouldbeduetoadditionalfreight/packing/insurancecostofth
eengines,deliverydistancesmayalsobelonger(evenabroad).Al
lofthisseemstoindicatethatthenewcontracthasbeenveryd
etrimentaltoTangier’sperformance,butmoreinformationisneed
edtobecertain.ThecontractwasnotsigneduntilJanuary2014
andthereisnoinformationofwhenproduction/salesstarted,but
clearlytherehasnotbeenafullyear’srevenuefromthecontra
ct.Alsothereisnoinformationonthelengthortotalvalueof
thecontract.Unlessthecontractisforaconsiderabletime,the
increasedinvestmentinoperatingassetsrepresentsaconsiderab
lerisk.Therearenofiguresfortheseparaterevenuesandcosts
ofthecontract,butfrom2014’sdecliningperformanceitdoesn
otseemprofitable,thusevenifthecontractdoessecureworkfo
rseveralyears,itisofdoubtfulbenefitiftheworkisloss-ma
king.Analternativescenariocouldbethattheearlycostsassoc
iatedwiththecontractarepartofa‘learningcurve’andthatfutureproductionwillbemoreefficientandthereforethecontractmaybecomeprofitableasaresult.Relevantratios20142013Grossprofit%(810/2,700x100)30·0%40·0%Profitmarginbeforeinterest%(235/2,700x100)8·7%21·9%ROCE(235/(805+400))19·5%61·7%Non-currentassetturnover(2,700/1210)2·23times2·98timesDebt/equity(400/805)49·7%18·3%Interestcover(235/40)5·9times79·6times1 |
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