Indicators and Measurements of Enterprise Growth

Sources of Funds for Lego Plc and Their Advantages and Disadvantages
The sources of funds can be internal and external.

Internal:

Share capital LEGO Plc. can raise funds through the issue of share capital. The shares can be equity and preference shares. The equity shares are issued to owners of the company (Detzer et al., 2017). Preference shareholders have a fixed percentage of the dividend, irrespective of the earnings of a business.

Advantages

• Helps businesses raise long-term capital
• The funds are committed to the business and are the equity of the owners.

Disadvantages

• The owners will no longer have control over the operational activities of LEGO Plc.
• The legal regulation is very lengthy and cumbersome when raising capital.

Retained earnings

LEGO plc can also use retained earnings, as they have a direct impact on the number of dividends. This is the profit that is invested as retained earnings; otherwise, it would have been distributed as dividends.

Advantages

• A readily available source with business
• No legal or procedural requirements are needed to be fulfilled

Disadvantages

• Funds are related to shareholders, and so businesses shall restrict self-financing.
• No overly generous dividends and salaries to shareholders and directors, respectively.

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External Sources

Debentures

Debentures are a form of loan stock, and this is a debt incurred by LEGO Plc. Contains a provision for payment of interest at a certain rate and repayment of capital.

Advantages

• No participation in the voting in business issues.
• A fixed percentage of return is guaranteed.

Disadvantages

• A cost stamp duty and cost are incurred for raising capital.
• Changes in earnings can become fatal for the business.

Bank borrowing

The borrowings can be short-term as overdrafts, medium-term as loans for 3-10 years, and long-term in the form of loans for over 10 years (Advantages & Disadvantages of Different Sources of Finance, 2018). LEGO plc can borrow funds according to the time duration of projects.

Advantages

• Petty funds can be raised in a short time without many formalities.
• One's loan is repaid with no obligation on business and does not include any possession of ownership.

Disadvantages

• For an overdraft, the interest rate is variable, which can lead to more payment of interest.
• With no substantial record of earlier repayment, it is difficult to obtain loans.

Recommendations

LEGO plc is considering undertaking a capital project and the acquisition of a business unit as well. For the capital project, it can use the retained earnings of the business and it can also borrow a short-term loan for the capital project. For acquisition, LEGO plc can raise funds by issuing equity shares, as it does not involve a fixed payment of dividends. The business can also raise long-term loans (Anzoategui et al., 2016). It is recommended that LEGO Plc use retained earnings for capital projects and issue equity share capital for acquisitions, as loans will require a payment of interest to the bank.

Analysis of Investment Proposal

LEGO Super

The given project has a life of 5 years and an initial investment of 15900 worth a working capital availability of 900. so the initial fund required for investment is $15,000. The discount rate for these projects is 15%. After all the adjustments in working capital, overheads, components, salary of two technology officers, depreciation, capital allowance, and taxation, the total cash flow from the project comes out to be 11112.26, which is less than the initial fund requirement of 15900, hence giving a negative NPV of 4787.74. The IRR for the project is .9%, which is very low compared to the actual rate of discounting.

LEGO Platform

This project also has a life span of 5 years with an initial fund requirement of $8500. The working capital available with the firm for this project is 2100, which reduced the capital requirement for the project to 6400. The discount rate for this project is 18%. With all given adjustments in working capital, overheads, and components, and considering the salary of one technology officer, the total present value of cash flow at the discounted rate is 8777.89, and with the initial investment of 8500, the NVP of this project comes out to be 277.89. The projects give a positive NPV because only one technology officer is appointed to the project, which reduces the expense related to the project. The IRR of the LEGO Platform is 19.73%, which is higher than the discounted rate of cash flow.

Recommendation

The criteria for project selection under the NPV method of capital budgeting are positive NPV. The project LEGO platform is giving a Positive NPV of 277.89 as compared to LEGO Super, which gives a negative NPV of 4787.74. One of the major reasons for this difference is the initial cost of the projects. The difference between the initial cost of LEGO Super and LEGO Platform is $7400, which is a huge gap. Another reason is the availability of the working capital with the firm for the year in which the project needs investment (Freeman, 2016). The gap at the 0-year in the working capital available with the business is 1200. For the project LEGO Super, two technology officers are being appointed, whereas for LEGO Platform, only one officer is appointed The salary difference of one officer has an impact on the expenses related to the project and reduces the expense liability of LEGO Platform. All these factors together lead to giving a positive NPV to the LEGO Platform. Hence, it is recommended that LEGO Plc select the project LEGO Platform, which is a profitable project.

Other Techniques Lego Can Use and Its Limitations:

Another technique used for this evaluation is IRR; this is a technique that estimates the profitability of a potential investment. LEGO Super gives an IRR of .9% and LEGO platform gives an IRR of 19.73%. Based on this technique, also the LEGO platform shall be selected.

Limitations

• It can give conflicting answers for mutually exclusive projects.
• It can contradict the results given by the NPV method.

Management Tools: Break-Even Analysis and Budgets

Break-even analysis: this is an analysis that is carried out for the determination of the point where the revenues and the expenses incurred for generating such gains become equal. LEGO Plc shall determine the point where income and expense are equal, and this is the point where the firm makes its first step toward profitability (McGee, 2015). This analysis is important for project evaluation. The project with a lower break-even point shall be selected as that would yield profits at an earlier time and stage.

Budgets: The future income and expenses are forecasted in budgets for a particular time frame. The budges are compared with actual performances and the degree of deviation is seen for taking corrective and controlling measures. The capital budgets are prepared to make a blueprint for investment in capital projects. These budgets determine the profitability and long-term investment related to the projects.

Evaluation of Target Companies

Pauteaux Digital France-

The sales revenue of the business has increased from 10406 to 12516, which is 2110. With an increment in sales, the gross and net profit of the business have also increased. The increment in administrative cost is not proportionate to sales revenue, which indicates the cost control by Pauteaux Digital. The increment in net profit is 737. The liquidity position of Pauteaux Digital can be affected as there is a fall in non-current assets of the business from 8658 to 6450 (Internal Rate of Return, 2018). The amount due to creditors has reduced from 2184 to 1693, which indicates that the company is going towards a less credit policy. The company owns a share capital of $500 with a share premium and retained earnings of $7400 and $10, respectively.

Melia portfolio Research, Spain

There is a huge increment in the sales revenue of the business of 6981. This will lead the business towards higher profits, but the operational cost of the business is more than its sales revenue, which hasn't been reduced yet. Still, there is a proportioned reduction in the administration cost as compared to sales revenues. The loss amount of the firm has also reduced, but it hasn't reached profitability. The non-current assets have increased by 2897 over the past three years. The current assets have seen a growth from 5724 to 7252 from 2016 to 2018. The amount of creditors of the organization has also increased by 7583, which is not a good sign in a long-term situation. This indicated that purchases are made on credit and the company is facing a situation of lack of cash and liquid funds. With no share premium and retained earnings, the share capital of Melia is 450.

Recommendation:

The sales revenue of Melia has shown more growth in comparison with Pauteaux; the sales revenue of Pauteaux has increased by 2110, while the increase in sales of Melia was 6981. With an increase in sales, Melia is still not able to operate at profits. The creditors in Melia have increased, while for Pauteaux there is a decrease. When compared between both companies, Melia only has a paid-up share capital of 450, while Pauteaux has a share premium of 7400 and retained earnings of 10. It is recommended to LEGO Plc that it acquire Pauteaux, as this company is operating at a profit, which indicates that it has achieved the break-even point. It can also use the retained earnings for investment in capital projects. With the acquisition of Pauteaux, it generates more profits, which will enhance its sales revenue. Therefore, LEGO Plc shall acquire Pauteaux for long-term benefits and profitability.

Literature Review

Investment Appraisal Analysis and Budgets:

As per Detzer et al. (2017), with the investment appraisal planning tool, a business can determine whether the long-term investments of the business are worth funding through the capital structure of the company. The long-term investment of a business is related to the acquisition or replacement of new plant, machinery, or product(s). The objective of a business is to enhance the business value for its stakeholders, which is done through capital budgeting and investment. However, Freeman (2016) says that investment appraisal allows changes in assumptions used in forecasts, which makes it a sensitive analysis. With a change in the assumption, the degree of risk involved also gets changed, which sometimes can be good or may get worse.

Anzoategui et al. (2016) stated that in a business, revenues and expenses are forecast through budgets. The budgets tell the prospective incomes a business must earn and the expected costs and expenses it shall incur to generate such profits. The budgets are prepared to guide the business towards better profitability. The budgets set targets for a business unit that it shall achieve. As far as Chittenden and Derregia (2015) are concerned, erstwhile budgets can present unrealistic figures that cannot be linked with reality. They are sometimes based on pure assumptions. The facts and information used to prepare budgets can also change with changes in the national economy and market conditions.

Break-Even Analysis:

According to de Andrés, de Fuente, and San Martín (2015), the breakeven tool assists a business in determining the point where the cost incurred on business operations is equal to revenues generated by it. This is a point where profit and loss both are Zero. A condition of no profits and no loss for the business. A breakeven analysis for an organization is carried out to exactly determine the income that a firm must earn to meet its essential business expenses. However, McGee (2015) pointed out that breakeven analysis does not evaluate the impact of different price levels on demand. The sales prices of the product are assumed to be constant at all levels of output, which is not a realistic approach.

Andor, G., Mohanty, and Toth (2015) stated that this tool describes the relationship between fixed and variable costs with returns. This helps a business anticipate the impact of sales price changes. The managers can also foresee the effects of cost and efficiency alteration on the profitability of the business. As per Calabrò, F. (2017), breakeven analysis can sometimes lead to mislead the managers. It takes many assumptions to reach the breakeven point; the assumptions are related to the sales quantum and price of the product or service. With all the assumptions, the implication of this analysis in the actual scenario has fewer possibilities, and managers cannot rely on this assumption-based analysis.

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Issues to be Considered by LEGO on the Two Projects

1. Effects of leverages: The discounted rate and cash flows must match up with the group of investors. With the discounted rate as the cost of equity, the cash flow shall be of equity investors, and with the discounted rate as the cost of capital, the cash flows shall be of firms.
2. Effects of taxation: The investment shall be analyzed in after-tax terms. A tax shield must be credited to a project when the losses are set off against the profits of the project.
3. Inflation: Cash flows and discounted rates used shall either be in real terms or nominal terms. In relation to expected or adjusted inflation. A strategy shall also be prepared by the managers of LEGO plc to deal with hyperinflation and after-stock price inflation.
4. Cash flows must be incremental. Incremental cash flows shall be considered as they include direct or indirect consequences on the project. Sunk costs shall not be charged as they are not recoverable. Opportunity cost is considered as it is the cost of resources used in projects that are already owned by LEGO Plc.

The management of LEGO Plc shall consider all the above-mentioned points while considering a project, as this will assist the management in reaching a real and factual analysis of both projects. The project selected after considering all the above points by LEGO Plc is LEGO Platform.

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CONCLUSION

In the above report, LEGO plc advises raising the funds either through the issue of equity share capital or raising a capital loan for the acquisition and using the retained earnings available with it for investment in a capital project. The company must invest in the project LEGO Platform. It is recommended that LEGO Plc acquire Pauteaux with higher returns, stable liquidity, and retained earnings, as this can be beneficial for the business. The managers are also presented with the issues that they shall take into consideration while analyzing the projects and for a better selection decision.

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