Question

You are an Analyst for the professional service firm, FINACC LLP. Your firm specializes in providing a wide variety of internal business solutions for different clients. It is your first day on the job and a Manager in the Consulting area asks you for some help with an investment decision for one of your large clients, Big Spenders Inc. Ready to make an impression on your first day, you start reading the background information provided by the Manager.

Additional Information

Big Spenders Inc. has been working on diversifying its portfolio of investments and requires accounting advice for a decision between two car cleaning and detailing companies. Your responsibility is to perform a comparative analysis of the profitability of two potential equity investments. Your engagement manager on this job has given you a brief background on the operations of the two companies:

Auto Wash Bot Ltd. (AWBL) has recently completed the research and development of a new touch screen app for all mobile devices. This new technology is both more user friendly than the current technology on the market. Auto Wash Bot Ltd has just signed a major contract to provide the Auto Wash Bot terminal to a major producer of mobile devices. The founder of the business would like to sell a 50% interest in the business for $100,000 in order to finance further expansion of operations.

Popeye’s Muscle Wash Ltd (PMWL) is a self-service, coin operated car wash located in a busy residential area. The company provides all of the services of a typical car wash, including soap, wax, vacuuming as well as pressure washing. PMWL has been long established and enjoys the loyalty and repeat business of many local residents. The current owner is getting up in age and would like to sell 100% ownership interest in the business for $100,000 to pursue retirement. The current year’s income statement is consistent with prior years.

One of the first tasks in the analysis of the potential equity acquisition is an assessment of each company’s current and future profitability. Your manager has provided you with copies of each company’s income statement (see below). Next, you are to calculate the expected return on the investment for each company. You have been asked to discuss any other issues that you believe are relevant to the investment decision.

The Consulting Manager would like you to prepare the report and have it on his desk for review first thing tomorrow morning. Once reviewed, this report will be submitted to Big Spenders Inc. in order to support their decision.

Auto Wash Bot Ltd.

Income Statement

For the Year Ended December 31, 2015

Revenue	$375,000
Cost of Goods Sold	86,250
Gross Profit	288,750
Other Expenses
Advertising	35,400
Office Expense	22,750
Research	195,000
Wages and Salaries	40,000
Total Other Expenses	293,150
Income Before Taxes	(4,400)
Income Tax	0
Net Income	$(4,400)

Popeye’s Muscle Wash Ltd

Income Statement

For the Year Ended December 31, 2015

Revenue	$375,000
Cost of Goods Sold	163,125
Gross Profit	211,875
Other Expenses
Advertising	5,200
Office Expense	17,400
Repairs and Maintenance	85,000
Wages and Salaries	50,000
Total Other Expenses	157,600
Income Before Taxes	54,275
Income Tax*	8,413
Net Income	$45,862

                                             

*Tax rate of 15.5% used.

Answer 1

To assess each of the two companies ie Auto Wash and Popeye's Muscle Wash let us have certian factors that delineate the two companies and help in our investment decision making.
a) Management
b) Market Size
c) Competitive advantage of products
d) Business Model
e) Research and development
f) Financials
a) Management
The founder of Popeyes Muscle Wash Ltd(PMWL) is looking to retire and exit the business completely. This would mean that investors will have the resposibiliy and accountability to run the business. This may not be right decision for a company like Big Spenders who is looking to diversify the investments. AWBL is only looking at 50% financing for expansion with the management intact.
b) Market Size and Potential
While there is more clarity on PWML's market as it is established and enjoys repeated customers, it does not show any case for expansion and scale for capturing other markets. This can stagnate the investment. AWBL's market faces uncertainty but it has signed a major contract with major producers of mobile services to provide Auto Wash Bot terminal . The market opportunity seems to be huge considering that is an exponential change and mobiles are the future of investments. The advantage and convenience of mobile app makes it all the more better proposition.
c) Competitive advantage of products
AWBL's product is unique and could provide the first mover advantage unlike PWML's which is already an established technology.
d) Business Model
Considering that the future is apps and technology, AWBL's product is advanced and robust
e) Research and Development
AWBL's increasing investment in R&D had caused the profits to dip. However, the investements are expected to payoff one AWBL signs contract with more companies.
f) Financials
AWBL commands a better Gross margin of 77% compared to 56.5% on same amount of revenues. However, the high research and adverysing expenses of AWBL had pulled down its Operating margins. As both marketing and reserach expenses are investment expenses, it is expected to yield higher payoffs in the future. The Gross Margin will be the major factor in comparison of the two companies and AWBL will command a better margin owing to its high technology use. If research expenses are taken out next year, the potential operating margins can be high
Based on the above, it is recommended to make investment in AWBL.