Essay: The category of capital budgeting decision

Introduction

Purchase and /or acquisition decisions fall in the category of capital budgeting decision which requires a high start -up capital. Additionally, business acquisitions carry a high risk compared to other decisions due to the significant amount of primary capital outlay required. Therefore, before making a buy decision, a potential investor ought to carry out a thorough analysis of both financial and non-financial performance of the target investment. Additionally, capital projects usually affect any given organization in the long-run either positively or negatively. Negative effect on the firm’s value could lead to closure due to liquidation or insolvency.

Non-financial analysis

One of the non-financial questions that the investor interested in the purchase of the business is the maximum price he is willing to part with to purchase the restaurant. This will involve setting the maximum price he is willing to pay for the investment before the negotiations begin. Setting a maximum offer before negotiation is necessary as this based on a through analysis of worth of the given project and/or investment. Additionally, a given target price will help the buyer to maintain a desirable level of cash out-flow associated with the project. Similarly, maintaining a desirable level of cash out-flows will help the management not to jeopardize existing opportunities strength as well as profitability (Dayananda, 2002).

Similarly, an investor should ask questions relating to effective implementation of the strategic objectives or goals after acquisition. This involves making decisions on weather the business targeted for acquisition will for settle a full-time job or in-house corporate development. A firm’s strategic objective will determine the amount of both capital and human resources needed in the future. For instance, a firm with a long-term objective of venturing into global market will require more investment in both capital and human resources that companies operating in the local and national markets only (Houston & Brigham, 2007), Additionally, the buyer should consider the appropriate mix of private costs and social costs to be incurred after acquisition as well as social and private benefits that will accrue from the investment. Private benefits are those benefits which accrue to the individual firm as a result of investing in a particular project.

Social benefits are those benefits which accrue to the whole community as a result of a firm’s establishment in a certain location. Similarly, private costs which are incurred to finance the operations of the business while social costs are those costs that are incurred by a given business to support the interest of the overall community. Social cost adds to the overall cost of the company and has the effect of reducing the overall profitability of the company in the short-run. However, these costs can increase the long-term profitability of the firm as the management adopts social responsibility. Increased productivity is brought about by the improved corporate image which leads to high turnover in sales and hence the corresponding profitability. Therefore, the investor should consider an optimal mix of social and private costs which does not compromise the firm’s returns both in the short-run and long-term basis. Additionally, the buyer should ask questions regarding existence of red signals/flags on related fraud cases or scandals which could compromise the image of corporation and going concern in the foreseeable future. This is done by evaluation the motivation of the staff to establish of their morale in work. Scrutiny of the workers job satisfaction can be done through interviews of operational staff and the line managers.

Additionally, scrutiny can be done by studying their pay rates and minimum wage set by the company. The investor should also explore on the share ownership schemes and pension schemes if any. Analysis of job satisfaction of employees is crucial as profitability of any given company is directly proportional to the productivity of the human resources. Human resources productivity can be boosted employing factors that enhance job satisfaction to employees. Additionally, the degree of government intervention into the affairs of the restaurant is one indispensible question that any investor ought to explore. Government intervention is determined by the laws and regulations governing trade in a certain nation. In countries where laws governing entry are strict, industry entry might be costly and in the extreme case impossible. Again, a government controlled market brings fewer returns to the investors as inmost instance as commodity prices are set by the government. In contrast, a market not regulated by the government has its prices determined by forces of demand and supply and/or the market mechanism.

Financial analysis

Ratio computation for 2008 and 2007 depict BJ’s Restaurant current ratio sailing higher than that of J. Alexander’s Corporation.Using 2008 fiscal year as the basis of comparison, current ratio of BJ restaurant is higher than that of its competitor by a margin of about 0.79. Current ratio a parameter used to is used to indicate a firm’s liquidity position by indicating its capacity to finance its short-term obligations and /or liabilities upon maturity. Therefore, using this measure of liquidity, BJ’s Restaurant shows a higher capacity of financing these obligations using current assets than Alexander’s Corporation. Moreover, quick ratios estimates show higher figures for BJ’s Restaurant than Alexander Corporation. Quick ratio also a parameter is used to measure the liquidity position of any given firm. Quick ratio points out a company’s capacity to finance its short-term obligations and /or liabilities upon maturity using the current asset which are classified as most liquid. That is, debtors, cash at bank and cash at hand.

Using Acid test ratio as a basis of analysis portrays BJ Corporation as better in terms of liquidity than its competitor (Alexander restaurant). This further implies that BJ Corporation employs a higher level of management of working capital elements than Alexander restaurant. Again, Alexander restaurant liquidity ratios are below the industry averages which are deemed appropriate. For any company to sustain a strong liquidity position and achieve efficient management of working capital, it should cover current liabilities more than two times using current assets financing. Also, for a firm to break-even and attain a competitive edge in the industry, it should have an acid test ratio > 1 (i.e. greater than one). This implies that the firm should have a capacity to finance its short-term obligations and /or liabilities upon maturity using the current asset which are classified as most liquid at least without mixing the financing.

Moreover, Stock-turnover for BJ restaurant is greater than its competitor Alexander restaurant. According to Dayananda (2002), Stock turnover shows the regularity or frequency a company uses to convert inventory to sales revenue. A low rate indicates a higher frequency of converting inventor and thus is preferred. This implies that BJ Corporation Manages inventory less efficiently than Alexander firm. Additionally, using 2008 fiscal period as the basis of comparison, debtor’s turnover in days is greater for BJ than Alexander Corporation. Debtor turnover in days shows the aging schedule of a given company. It shows the time period taken by a given corporation to recover amount that the debtors owe the entity through credit sales. Firms usually invest excess cash at their disposal in short-term financial instruments to earn interest. Length recovery period on the amount owed to the firm by credit customers and/or debtors reduces the cash and cash equivalent at hand for the company. This leads to loses in terms of foregone interest as the cash held in receivables could have formed the excess supply of cash and cash equivalent for investments which are short-term in nature.

Similarly, lengthy period most often than not leads to increased expenses for the company and thus the resultant or corresponding profitability. Such expenses include provisions for doubtful debts which are abnormally high and expenses relating to debts which are irrecoverable. These expenses could be minimized by effectively managing the elements of working capital. Moreover, the receivable turnover shows a favorable ratio for Alexander Corporation than BJ restraint. According to Houston & Brigham (2007), Receivable-turnover is a parameter used to measure firms frequency in turning accounts receivable. Low figures depict low frequency of turning debtors. This implies that Alexander restaurant has a higher efficiency in managing accounts receivable than BJ restaurant.

Additionally, profitability of BJ restaurant is higher than the Alexander corporation profitability. BJ restaurant shows a higher level of profitability than Alexander restaurant as evidenced by the ratios which indicate the performance of a given company in terms of profitability. For example, profitability as depicted by profit margin ratio for BJ Company using 2008 as the basis of comparison is higher by a material margin. According to Barry (2008), Profit margin is a parameter used in measurement of the net income generated from sales revenue after taking into account the normal expenses of the company. Therefore according to the profitability measure of performance BJ restaurant is seen to be performing better than Alexander limited. Additionally, leverage position of BJ is better than that of Alexander as inferred from ratios which relate total assets to total debt. A company is supposed to maintain an optimal mix of debt and equity to operate profitably.

Some of the factors to put into consideration not disclosed above include the average values for the overall hospitality industry. Overall performance of the industry has an effect in the performance of individual firms operating in the industry. Firms operating in perfect competitive markets (markets where there are a large number of buyers and sellers) have their prices dictated by industry prices. This implies that homogenous goods will have similar prices most often than not. Thus industry performance reflects directly into the performance of individual firms. The investor therefore can use industry averages to project into the future growth of the firm.

Conclusion

Based on liquidity strength, the investor should choose to invest in BJ restaurant since it has a stronger position. Additionally, using analysis of profitability, a potential investor should make a decision to invest in BJ restaurant since he will derive more returns from his investment due to the firm’s higher level of profitability than its competitor. Similarly, based on how well a firm uses its assets Alexander would be the optimal choice. However, BJ restaurant has many advantages compared to its competitor. Therefore, investing in this company yields more returns to the shareholder.