PATCO is a synoname Company stands for Port Arthur Timber Company started its life in 1830 as a small timber firm (PATCO, 2010).
PEST analysis
PEST stands for “political, economic, social and technology”; in order to analyze a country or an industry environment involves analysing the vital factors that exist in that country or the industry and may affect any firm operating in that country or the industry sector. Political factors include issues such as government taxation policies, industrial policies, tariffs, rules and regulations among others (IntangAbility.com, 2011).
The economic factors in this case include; interest rate, inflation, per capita income, exchange rate, demand and supply, and economic growth (IntangAbility.com, 2011). Besides this, there are culture factors which include traditions of the people, social status, age group, lifestyle, taste and preference (IntangAbility.com, 2011). Finally, there are technological factors which include skills, production process, use of automated machine, technological advancement, research and development (Businesswire.com, 2007).
Brazil forms three fifth of the South American economy and is a member of the BRIC society (Brazil, Russia, India and China) which is one of the largest emerging marketing organizations in the world. This means that Brazil is growing economically in terms of market capitalization and purchasing power. Therefore, this provides an opportunity for the Port Arthur Company to venture in Brazil and utilize the available business opportunities that exist in the region. The government of Brazil has to develop its infrastructure in order to attract investment, engage in research and development, and make favourable policies which will attract foreign investors (Datamonitor.org. 2009).
If it opts to undertaking business venture in Brazil, Port Arthur Company will face political risks; both domestic and international exchange rate risks that might interfere with its cash flows, interest rate risks and country specific risks. If the Port Arthur management is a risk taker and want to venture into new market especially Brazil which is a world’s producer of timber; meaning it has available raw materials, then the Company should undertake a joint venture in Brazil.
Financial analysis
Constant economic conditions
Based on spreadsheet data of PATCO provided in the excel file and assuming that all factors in the economy are held constant such as labour costs, product prices, exchange rate and government tax policies, then the sales revenue, taxes and overall profit is expected to remain unchanged. This is because the Company uses straight line method of depreciation in its accounting calculations. In the following section let us provide some financial ratios figures that would compromise the financial analysis of part of this task.
Profitability ratio
Profitability ratio measures the management effectiveness as shown by the turnover generated on sales and investment (GoldmanSachs.com, 2011). This means that if a firm can be able to make a profit it will be able to meet its short term obligations and also pay dividends to its owners. The following are some of the profitability ratios;
Net profit margin
= Net profit/Sales * 100
The above figures indicates that the firm has been efficient in controlling its production, operating and financing costs as shown by the constant net profit margin of 6.7% that the Company has been attaining for the five years duration period (Netmba.com, 2002).
Operating profit margin
This is given by;
= Operating profit/Sales * 100
The firm operating profit ratio over the five years is seen to be constant and it appears that it will remain so over the coming years; this indicates the Company efficiency in controlling its operating expenses.
Operating expenses ratio
= Operating expenses/Sales * 100
Operating expenses is given by adding cost of sales to other expenses such as administration, sales and distribution (Microstrategy.com. 2011). PATCO five years operating expenses are quite high as shown by the ratios when compared to sales revenues. Through the use of the available accounting information and financial ratios one would immediately assess that PATCO should undertake joint venture in Brazil in order to reduce the operating costs. But when one consider investment appraisal method such as the net present value (NPV), the answer would be that PATCO should not take risk by investing in Brazil.
This is because the discounted cash flows shows a negative value of CAN $-408393 and a discount rate of 20% which would indicate that the net present value of Port Arthur Timber limited is negative (PATCO.com, 2010). Using the accept-reject rule of appraising a project using net present value; this appraisal method states that a project should be accepted when the NPV is positive and in case of a mutually exclusive project only that with the highest NPV should be accepted (Meir, 2008). Therefore, using the NPV, PATCO should not undertake a joint venture in Brazil.
Sensitivity analysis
Please refer to the spreadsheet for the financial analysis and non-financial analysis below.
Since Port Arthur Timber Company is operating in a dynamic market environment it means that it is exposed to risks such as financial risks and business risks which mean that the economic indexes cannot be constant over the five years.
By performing a sensitivity analysis on the above scenario (when economic variables are kept constant) and then by changing the Company discounting rate from 20% to 10%, the discounted cash flow will change to CAN $ 1,422,365 which indicate a positive NPV figure if the initial investment cost does not exceed the discounted cash flow. This implies that PATCO should accept the joint venture in Brazil.
When indices are applied the figures would be as indicated below; indices are used by the government for wage policies, price policies, taxation and general economic policies (Schmidt, M. 2011).
The discounted cash flow will be negative (CAN $ -895, 364) with a discounting factor of 20% which means that NPV will be negative when initial investment cost (in year 2008) is subtracted from the discounted cash flow.
Under such a case it would mean that the joint venture in Brazil should not be undertaken. On the other hand when using a discounting factor of 10% the NPV will be positive (due to positive discounted cash flow of CAN $781,883 assuming that the initial investment does not exceed this amount) then the joint venture should be undertaken. But there are many factors that might affect the change in NPV, these are; changes in price, changes in taxation, general expenses, wage, depreciation and exchange rate when adjusted by the changes in indices (Investorwords.com, 2008). For instance the prices of a commodity like timber may change due to changes in the level of inflation in the economy.
This will cause the price to be adjusted upwards due to high inflation and downwards if the inflation rate falls. This is where indices come in; indices are constructed in order to change or match purchasing power with the level of inflation (GoldmanSachs.com. 2011).
When the index is 100 for instance it would mean that there is no inflation, but when the index changes to 110 it means that the prices have increased by 10% which is an indication of the level of inflation in that country. The change in the exchange may also be due to other factors such as financial crises in other country which may indirectly affect the country’s exchange rate. Another factor is the cash flow discounting rate, the higher the rate the lower or the negative the NPV is (at a discounting rate of 20% the discounted cash flow is CAN $ -895,364) and the lower the rate the positive or the higher the NPV is. This is because at a discounting rate of 10% the discounted cash flow is CAN $781,883 with assumption that initial investment cost is lower than the discounted cash flow.
Now when using the financial ratios (with changed indices) the following will be the figures
Net profit margin
= Net profit/Sales * 100
The figures indicate that the firm has been efficient in controlling its production in year 2009 because there was an increase in the net profit margin from 6.7% to 8.3, in the year 2010 the same trend was documented. This will mean that this year (2011) and next year (2012) the trend is expected to continue with an increase in the net profit margin. The increase in the ratio may be as a result of increase in sales, increase in inflation, and reduction in labour cost and G & A expenses.
Operating profit margin
= Operating profit / Sales * 100
Based on the above figures the firm ratio over the five years has and will remain constant, this indicate the Company efficiency in controlling its operating expenses even after the price changes due to inflation has occurred the operating expenses did not change and are therefore not expected to change over the next few years.
Operating expenses ratio
= Operating expenses/ Sales * 100
The five years operating expenses of the Company are quite high as shown by the ratios when compared to sales revenue. Since the net profit margin is on the rise while the operating profit margin and operating expense ratio constant, then PATCO should consider undertaking a joint venture in Brazil instead assuming that the Brazilian political, economic, social and technological factors will remain the same as those in home country (Camacho, 2004). The discounting rate for cash flow is the major element in determining the present value of the expected cash flows.
A borrowing firm will consider the borrowing rate and compare it with the discounting rate; the higher the discounting rate the lower the Net present value and the lower the discounting rate the higher the NPV, thus at a lower discounting rate the project will be accepted than when a higher discount rate is used. This means that a 10% discount will be more favourable than 20% discounting rate.
Thus, the minimum borrowing rate or the base rate will depend on the government cost of capital policies and the country’s exposure to risks (Camacho, 2004).
References
Businesswire. 2007. The Retail Sector in Brazil – PEST Analysis Is a Perfect Tool for Managers and Policy Makers. Web.
Datamonitor. 2009. Country Analysis Report – Brazil – In- depth PESTLE Insights. Web.
Camacho, F. 2004. Cost of capital of regulated industries in Brazil, Revista do BNDES. Web.
GoldmanSachs. 2011. BRICs. Web.
IntangAbility. 2011. Non Financial Evaluation. Web.
Investorwords. 2008. Economic indicator. Web.
Marketingteacher. 2000. PEST Analysis. Web.
Meir, L. 2008. Financial ratio analysis. Web.
Microstrategy. 2011. Financial Analysis. Web.
Netmba. 2002. PEST Analysis. Web.
PATCO. 2010. PATCO history. Web.
Schmidt, M. 2011. Discounted cash flow (DCF) / Net Present Value (NPV) / Present value PV / Future Value FV. Web.