1. Task 1.............................................................................................................

3
Forecasting techniques to obtain information to decision making.............................................3
1.1. Introduction.....................................................................................................3
1.2. Quantitative methods & Qualitative methods............................................................4
2. Task 2............................................................................................................7
Identification of source of finance available to a business and various costs associated with obtaining
the finances...............................................................................................................7
2.1. Internal sources........................................................................................7
2.2. External sources.......................................................................................7
3. TASK 3........................................................................................................12
Examine and apply the financial appraisal techniques used to evaluate potential investment decisions
............................................................................................................................12
3.1. introduction.............................................................................................12
3.2. Accounting Rate of Return (ARR)............................................................12
3.3. Payback Period (PBP)..............................................................................13
3.4. Net Present Value Method (NPV).............................................................13
3.5. Internal Rate of Return (IRR)...................................................................13
3.6. Calculation of net present value (npv).............................................................16
3.7. Calcultion of internal rate of return.................................................................18
4. Task 4..........................................................................................................19
Interpretation of financial statements for planning and decision making...................................19
4.1. Analysis of Financial Statements.............................................................19
Balance sheet...........................................................................................................19
Profit & Loss account (Income statement).......................................................................19
Statement of Changes in Owner’s Equity or Retained Earnings.............................................20
Cash Flow & Funds Flow statements.............................................................................20
4.2. Ratio Analysis..........................................................................................20
Current ratio...........................................................................................................20
Quick Ratio 20
Gearing Ratio..........................................................................................................21
Earnings per Share (EPS)...........................................................................................21
Return on Capital Employed (ROCE).............................................................................21
Gross profit ratio......................................................................................................22
Net profit ratio.........................................................................................................22
Operating profit ratio.................................................................................................22
1
4.3. Value Addition Method............................................................................22
Abnormal Return......................................................................................................23
Cumulative abnormal Return (CAR)...............................................................................23
5. REFERENCE................................................................................................27

2
1. Task 1.

Forecasting techniques to obtain information to decision making

1.1. Introduction
Budgeting for future profit cash or cash flows requires the prediction, or forecasting, of
future revenues and costs at varying activity levels. A forecasting method is a systematic way
of organising information from the past to infer to occurrence of an event in future.
‘Systematic’ means following a distinct set of procedures in a prescribed sequence. A
forecasting model is one expression of a forecasting method. More specifically, it is a
simplified representation of reality, comprising a set of relationship, historical information on
these relationships, and procedures to project these relationships into future.

Components of forecasting

Data: Any forecast will take into consideration results which have been obtained in the past.
No situation is static and he most up-to-date results are the most relevant to the forecasting
model.

Models: The forecaster must try to make a model which ill fit the situation under review.
There is a need to plot graphs of past results to look for patterns, trends, seasonal fluctuations
and other cycles which might appear from past results, which must be reflected in the model.

Future conditions: The projections of the model must then be evaluated in the light o any
outside factors or changed conditions.

Errors: any forecast is, at best, a close approximation of an actual result, and the forecaster
will want to make allowances for Error. Statistical theory can be applied to errors in
forecasting by assuming that errors came from a normal distribution with a mean of zero. this
enables the forecaster to calculate the tolerances on the forecast.

Uses of forecasting:

Budgeting: Without being able to forecast revenues and costs, firms would be unable to
implement any budgetary control system. All budgets are based on forecasted figures, even if
these figures are based on intuition. Obviously, the more accurate the forecasts, the more
accurate and useful will be the budgets and hence the control on costs.

Setting of standards: if an organization uses standards costing as a control method, it needs

to set the standards as accurately as possible. Such costs and selling prics included in the
standard will all be forecast figures.

3
 Business forecasting methods fall into two major categories: quantitative and qualitative.

1.2. Quantitative methods & Qualitative methods

Quantitative methods organise post information about a phenomenon by mathematical rules.

These rules take the advantage of underlying patterns and relationships in the data of interest
to the forecaster. Objective numerical instruments consistent over some historical period are
required in these methods. The major subcategories of quantitative methods are extrapolative
and casual. Extrapolative, also called as time series methods, assume that the variables past
course is the key to predicting the future. The other subcategory of quantitative forecasting
method is casual methods.

In this particular task, we have used the casual methods to find the solution to the problem.
We have attempted to simulate cause-and- effect relationship. Determining the casual
variables (also called as explanatory variables) the effect the forecast variable and the
appropriate mathematical expression of this relationship is the central objective. (Makridakis,
Wheelright and Hyndman, 1998)

Forecasting tool chart

Forecasting
Techniques
Cost Prediction Sales Prediction

Scatter Diagram Forecasting

Techniques
High low method

Correlation
coefficient

Example: D & E ltd produces brakes for the motor industry. Its management accountant is
investing the relationship between electricity costs and volume of production. The following
data for the last ten quarters has been derived, the cost figures have been adjusted to take into
account price changes.

Quarter 1 2 3 4 5 6 7 8 9 10
Production
X ('000 30 20 10 60 40 25 13 50 44 28
units)
Electricity
Costs Y 10 11 6 18 13 10 10 20 17 15
('000)

4
 X Y XY X²
30 10 300 900
20 11 220 400
10 6 60 100
60 18 1,080 3,600
40 13 520 1,600
25 10 250 625
13 10 130 169
50 20 1,000 2,500
44 17 748 1,936
28 15 420 784
∑ ∑(Y)= ∑(XY)=4,72 ∑(X²)=12,61
(X)=320 130 8 4

Regression line

Regression Equation (y) = a + bx

Slope (b) = (NΣXY - (ΣX)(ΣY)) / (NΣX2 - (ΣX)2)
Intercept (a) = (ΣY - b(ΣX)) / N

b = (10*4728-320*130)/(10*12614-(320*320))

b = 0.239

a = (130-.239*320)/10

a = 5.34

so, the least squares regression line of electricity costs (y) on production (x) is

y = 5.34+0.239x

Where y is in £ (‘000) and x is in (‘000) units.

Assuming there is an approximately linear relationship between production and electricity

costs, which is shown to be reasonable by the Scatter graph, the electricity costs are made up
of two parts, a fixed cost (independent of the volume of production) of £5340 and a variable
cost per unit of production of £ 0.239 per unit.

If predict the electricity costs of D& E Ltd for the next two quarters( time periods 11 & 12) in
which production is planned to be 15,000 and 55,000 standard units respectively would be

5
For quarter 11, x=15, hence

Y= 5.34+(.239*15) = 8.93

The predicted electricity cost for quarter 11 is therefore £8930.

For quarter 12, x=55, hence

Y=5.34+(.239*55) = 18.5

The predicted electricity costs for quarter 12 is therefore £18,500.

6
2. Task 2

Identification of source of finance available to a business and various costs associated with
obtaining the finances
Internal sources of finance are available to the firm, but these may be more limited in scope
and for large projects, the firm may be forced to turn to banks or other institutions (external
sources) to help them raise sufficient funding. The main internal and external sources are:
2.1.Internal sources
Internal sources are often preferable to a firm as they will usually be cheaper and perhaps
easier to arrange at short notice. However, the potential for arranging large amounts of
finance may be low. The main internal sources are:
• Profit - the company of course has to be profitable for this to be a source, and it must
be available in cash. Often this is not viable as they may have paid the profit in
dividend to the shareholders, or perhaps already tied the money up for other reasons.
• Reduce working capital - the firm may be able to raise some money for investment
if they can reduce their stock level (through improved stock control) or perhaps
improve their credit control and ensure that they collect their debts more promptly and
delay payment to creditors for as long as is possible.
• Sale of assets or perhaps sale and leaseback - this will depend on the value of the
assets, but the firm may either be able to sell surplus assets (if they have any) or
perhaps sell existing assets that they use to a specialist leasing company and then
lease them back. This will give them access to some capital, though they are then
burdened with annual leasing costs.
2.1.External sources
• Loans - this is where the banks start to come into play. Banks will lend for either
short-term or long-term purposes, but the nature of the loan will tend to differ. The
main types are:
○ Overdrafts - this is a short-term facility where you can spend money, to an
agreed limit, as you want. The bank will charge interest on any overdraft
amount. They may only offer this as a short-term facility, but it can be very
valuable for firms to fill short-term shortages of working capital or any
possible brief cash flow problems.
○ Long-term loans - long-term loans usually refer to lending over five years.
The bank lends you a sum of money for a set time at an agreed rate of interest.
It is more expensive than an overdraft, but lasts longer. The bank may well
want some sort of guarantee for this type of loan to ensure that they get it
back. It could perhaps be secured against an asset of the business.
○ Debentures - a debenture is specialised form of loan. It is effectively a loan
from people to the firm that will be repaid at a fixed date. Between the issue of
the debenture and the maturity date, the firm will pay a set level of interest.
They are a common way for businesses to raise money and are relatively low
risk, though this will depend on the stability of the business.
7
 • Shareholders - limited companies or plcs can issue shares. These shares can be
issued at a certain price though this price will depend on the profitability of the
company and its prospects, so how successful the issue is will depend on how the
markets view this.
• Factoring debts - the firm may be able to sell their debts to a specialist debt-factoring
company. This means that the firm sells their debts to the factoring company who pay
them a proportion of the debts immediately. In this way the firm raises some
immediate finance. The debt factoring company make their money by collecting the
whole debt when it is due (having only paid the original firm a proportion of the
debt).
• Using trade credit- Trade credit (accounts payable) are balances owed by the
company to suppliers. It is a spontaneous (recurring) financing source for credit
worthy companies since it comes from normal operations. Trade credit is the least
expensive form of financing inventory. Its benefits are that it readily available, since
suppliers want business; it requires no collared; there is no interest charge or else a
minimal one; it is convenient; and it is likely to be extended if the company gets into
financial trouble.

2.1. Implication of the different sources of finance

Bank Loans and Overdrafts

A bank overdraft is a limit on borrowing on a bank current account. With an overdraft the
amount of borrowing may vary on a daily basis.

A bank loan is a fixed amount for a fixed term with regular fixed repayments. The interest on
a loan tends to be lower than an overdraft A fixed term means how many months or years
before the loan has to be repaid in full. Normally a fixed term loan will be for a greater
amount than an overdraft.
Overdrafts Loans
Advantages Flexible –any amount can be Larger amounts can be borrowed
borrowed within limits
Less interest rates than overdrafts
Interest is only paid on amounts
Regular repayments help plan cash
borrowed
flow
Disadvantages Cannot be used for large Less flexible than an overdraft
borrowing
Have to pay back in stated time or
Rates of interest higher than risk further financial problems
loans
8
 Bank can change limit at any
time or ask for money to be
paid back sooner than expected
Debentures

A debenture is a long term loan which is usually secured against a specific asset (e.g. the
factory) or the overall assets of a business. A debenture is repayable at a fixed date and has a
fixed rate of interest.

Leasing

Leasing is like renting a piece of equipment or machinery. The business pays a regular
amount for a period of time, but the item belongs to the leasing company.

Most company cars are leased to businesses. The business pays a monthly fee for the car and
at the end of the period (normally about two years), the business swaps the car for a newer
model and it is a legal ownership.

The advantages of leasing are:

• Cheaper in the short run than buying a piece of equipment outright.

• If technology is changing quickly or equipment wears out quickly it can be regularly
updated or replaced.
• Cash flow management easier because of regular payments.
• Businesses no need to pay whole amount of price.
The disadvantages of leasing are:

• More expensive in the long run, because the leasing company charges fees which
make the total cost greater than the original cost.
Hire Purchase

Business hires the equipment for a period of time making fixed regular payments. Once
payments have finished it then owns the piece of equipment. Hire purchase is different to
leasing in that the business owns the equipment when it has finished making payments. With
an equipment lease, the equipment is handed back to the leasing provider.

Issuing shares

The advantages of share issuing are:

9
 • There is no obligation to pay dividends
• Businesses don’t have to pay their total finance
• This is the main source of the finance to collect lot of money
The disadvantages of share issuing are:

• Administration is very high

• Businesses have to pay high dividends
• Businesses give up the ownership and they can’t control the company very easily
Retained profits

The advantages of share issuing are:

• There is no obligation to pay interest

• Available very quickly
• It carry didn’t cost, because the retained profit below the shareholders. They would
expect high dividends in the future.

2.1. Appropriate sources of finance for a business project

Bank overdraft
In order to continue our business we should identify cost less sources of finance. The most of
the organization willing to get bank overdraft because of less interest payment bank other
loans also it is flexible and simple to get in short time.

Shares issue
Ordinary shares
This source of finance is an own finance of the company. Where, we don’t need to pay until
find a profit. I.e. if the company get the profit it suppose to pay dividends. If lose no need to
pay dividends.
Preference shares
It is a share issue to get capital for the company. But this money has a pre-determined cost
which is interest in a fixed term in some times it may found less capital cost (interest) rather
than dividends.
Leasing
Leasing is an opportunity of buying mass valuable capital goods in terms of instalment basis.
Here we no need to pay whole amount of price on the buying time. Therefore the company
can manage the cash flow by paying smaller amount for the capital goods and it is a legal.

10
3. TASK 3

Examine and apply the financial appraisal techniques used to evaluate potential
investment decisions
3.1. introduction
from time to time most companies have to consider capital expenditure. Such capital
expenditure usually entails the outlay of very large sums in the expectation that the
investment will yield e economic benefits over a period of years. Companies invest on
projects in order to achieve a higher rate of return and to generate cash flow for future
development & expansion, to increase the value of the shareholders and to reserve it for
future in case the company runs into loss. The main objective of a company is to utilize
minimum resources and to get maximum return. So, investment appraisal is of utmost
importance for an organisation in order to assesses, evaluate and consider investing in the
best project which provides higher rate of return. It takes into account the time value of
money and discounted cash flow and helps the company to decide up to what extent a
particular project is feasible, to analyse the various risks attached to it and then to compare
with different project proposal in order to invest on the most profitable project. So it’s highly
imperative for companies to apply the correct tools and techniques before making an
investment decision otherwise it can prove detrimental for the company as it can suffer huge
losses.

Research shows that there are basically four methods of used in practice by businesses
throughout the world to evaluate proposals for capital expenditure.

These are

3.2. Accounting Rate of Return (ARR)

The ARR is calculated by taking the average accounting profit that the investment will
generate and expressing it as a percentage of the average investment.
The ARR has some advantages, it has some defects too. The most serious of which is that it
ignores the time factor. ARR is based on accounting profits rather than cash flow. It fails to
take account of the timing of cash inflows and outflows.

3.3.Payback Period (PBP)

11
The payback period is the length of the time it takes for the initial investment to be repaid out
of the next cash inflow from the project.
The bay back period seems to go some way to overcoming the timing problem of ARR
although it too has is limitations. Where total profitability is ignored.it ignores any casflows
that occur after the project has paid for itself.

3.4.Net Present Value Method (NPV)

What is needed is a method of appraisal that takes account of all the costs and benefits of
each investment opportunity but which also makes allowance for timing of those costs and
benefits. This is what the NPV offers decision makers. The problems with NPV method is as
follows. Some managers are unfamiliar with the concept of NPV. It can be difficult to
identify an appropriate discount rate. For simplicity cash flows are sometimes ll assumed to
occur at year ends: this assumption may be unrealistic.

3.5. Internal Rate of Return (IRR)

The IRR is the rate of return is the discount rate that, when applied to future cash flows, will
produce an NPV precisely zero. The project earns a return which is exactly equal to the cost
of the capital. In essence, it represents the yield from the project.

These are the various tools and techniques used in evaluating various project proposals which
would lead to growth and development of the company in the long run. (Arnold, 2002)

Expected Cash Flow

Year 1

Letters = 15000 * 0.53 * 5 * 52= £2,067,000

Parcels= 500 * 5.25 * 5 * 52= £682,500

Total Cash Flow = £2,067,000 + £682,500 = £2,749,500

Year 2

Letters = 20,000 * 0.53 * 5 * 52 = £2,756,000

12
Parcels = 750 * 5.25 * 5 * 52= £1,023,750

Total Cash Flow = £2,756,000 + £1,023,750 = £3,779,750

Year 3

Total Cash Flow = £3,779,750

Year 4

Total Cash Flow = £3,779,750

Year 5

Total Cash Flow = £3,779,750

Total Investment

100 Vans = £8000 * 100 = £800,000

20 Trucks = £18,000 * 20 = £360,000

180 Workers = £13000 * 180 = £2,340,000

5 Managers = £20,000 * 5 = £100,000

Market Research = £50,000

Annual Maintenance Cost of Van = £2000 * 100 = £200,000

Annual Maintenance Cost of Van = £4000 * 20 = £80,000

Advertising in Year 1 = £500,000

Premises = £150,000

Total Initial investment = £800,000 + £360,000 + £2,340,000 + £100,000 +

£50,000 + £200,000 + £80,000 + £500,000 + £150,000

13
 = £4,580,000

YEAR CASH FLOW £(000) CUMULATIVE NET

CASH FLOW £(000)

1 2,749,500 2,749,500
2 3,779,750 6,529,250
3 3,779,750 10,309,00
4 3,779,750 14,088,750
5 3,779,750 17,868,500

Payback Period = Initial Investment/Expected cash Flow

Since the Initial Investment i.e. £4,580,000 lies between year 1 and year 2,

Pay back period = 1+ [ (4,580,000-2,749,500) ÷ (6,529,250-4,580,000) ]

= 1+ (1,830,500÷1,949,250)

= 1+ 0.94

= 1.94 years

= 1 year 11 months and 13 days

Therefore, the Payback period of Project = 1 year 11 months and 13 days.

Payback method is one of the investment appraisal techniques used to calculate the number of
years in which a company can retrieve its initial investment. The main disadvantage of
Payback period is that it does not give any information about the profits which the company

14
can make by investing in a particular project. For example, in the above sum the payback
period of the Postal Project is 1 year 11 months and 13 days. From this figure we can only
analyse that by investing in Postal Project, the company can recover its initial amount (i.e.
£4,580,000) in 1 year 11 months and 13. But it fails to indicate the profits which may be
earned by the company in future and due which it is difficult for the company to take
investment decision on various projects having equal payback period. A company can decide
to invest in a project out of many proposals on the basis of lower Payback period but it make
out as to which investment have a higher rate of return in the long run. Moreover, it fails to
take into account the time value of money and so a company cannot anticipate what’s in store
in future by investing in a particular project. It is more inclined towards the short term
projects than on the long term projects and so it puts the company into dilemma as to select
which kind of project proposal. Therefore, the Payback method is not conclusive method of
selection of appropriate project.

3.6.Calculation of net present value (npv)

Discount Rate = 12%

Net Present Value

Discou Present
Year Cash flows
nt factor value
- 1.0 -
- 4,580,000 00 4,580,000
2,749 0.8 2,454,
1 ,500 93 911
3,779 0.7 3,013,
2 ,750 97 194
3,779 0.7 2,690,
3 ,750 12 351
3,779 0.6 2,402,
4 ,750 36 099
3,779 0.5 2,144,
5 ,750 67 732
8,125,
NPV
287

Therefore, the Net Present Value of Project = £8,125,287

15
The Postal Service Project should be accepted because the project have positive NPV which
means there are cash inflows and so it increases the funds of the company.

Net Present Value (NPV) is an important technique in the process of investment appraisal
used to find out whether there are cash inflows or cash outflow in a company from the
particular project. It is difference between the present value of cash flows & initial
investment and is used to evaluate the profitability of a project proposal. It takes into account
the time value of money and If NPV of a project proposal is negative, then there will be cash
outflows from the company and therefore the project should be rejected. If NPV of a project
proposal is positive, then there will be cash inflows to the company and therefore the project
should be accepted. And, if the NPV of a project is equal to zero, then there will be a break
even point where there will neither be cash inflows or outflows. In this case, the investment
offer may be selected on the basis of attaining the required rate of return for the shareholders.
It’s more logical and superior method than internal rate of return. (en.wikipedia.org)

3.7. Calcultion of internal rate of return

NPV of the project at 12% = £8,125,287

Let us assume NPV of the project at 30%

NPV

Cash Discoun Present

Year
flows t factor value
- -
0 1
4,580,000 4,580,000
2,749 0.76923 2,115,
1
,500 1 000
3,779 0.59171 2,236,
2
,750 6 538
3,779 0.45516 1,720,
3
,750 6 414
3,779 0.35012 1,323,
4
,750 8 396
3,779 0.26932 1,017,
5
,750 9 997
3,833,
NPV
345

16
Since the NPV of the Postal Service project is so high, the internal rate of return of the
project could not be determined.

The common basis to find the IRR is one positive NPV and negative NPV. But in the above
illustration both NPV are positive. Then finding IRR is irrelevant.

4. Task 4

Interpretation of financial statements for planning and decision making

4.1. Analysis of Financial Statements
The financial statements such as balance sheet, profit & loss account or income statement,
statements of changes in owner’s equity or retained earnings, cash flow statements and funds
flow statements are prepared with the objective to give a picture of the financial position of
the company. In this research, the financial statements of ArcelorMittal after the merger and
the statements of Arcelor & Mittal steel company prior to the merger should be examined in
order to judge the profitability and financial strength of the company. A proper analysis and
interpretation of financial statements will enable us to verify if value is added to shareholders
and the synergies gained out of the merger process. (Gupta & Mehra (2001))

Balance sheet
The balance sheet gives a summary of credit and debit balances of the company after the
closing of books of account. In this case study, the balance sheet should be reviewed for the
purpose showing the resources of ArcelorMittal such as assets & liabilities gained after
merger and the investments made for the growth and expansion of the company. The balance
sheet will give a clear idea of all the assets owned after the integration of Arcelor & Mittal
group of industries and all the liabilities it owes to the owners and the outsiders. (Gupta &
Mehra, 2001)

17
Profit & Loss account (Income statement)
The profit and loss account portrays the operational positions of the concern by illustrating
the revenues earned and the expenses incurred for earning the revenue. Income statement is
highly imperative for this research as it will show if ArcelorMittal as a single company has
gained excess of revenue over expenditure (profit) or the expenditures are excess than the
income. It will help to identify if it is making profit and the shareholder are getting their
dividends or the company is running into loss. (Gupta & Mehra, 2001)

Statement of Changes in Owner’s Equity or Retained Earnings

This statement is also called profit or loss appropriation account or income disposal statement
and basically consists of two elements such as paid up share capital (the initial amount of
funds invested by the shareholders) and retained earnings or reserves and surplus representing
undistributed profits. This statement is necessary for this study as it will give a clear idea
about the amount of profit ArcelorMittal has distributed to the shareholders and the amount
of profits retained for future growth and expansion. (Gupta & Mehra, 2001)

Cash Flow & Funds Flow statements

The cash flow statement gives the overall changes in financial position of the concern on cash
basis where as the funds flow statement provides the changes in the financial position of the
company between two intervals. These statements are helpful as it shows the movements of
funds and the working capital of the company (Gupta & Mehra, 2001)

4.2.Ratio Analysis
Ratio analysis in business is the process of establishing and interpreting the various
quantitative relationships between figures in financial statements and determines the position
of the firm in various aspects which helps in decision making and control over its operations.

Current ratio
Current ratio is the ratio between current assets and liabilities. It is beneficial for
interpretation of the short term financial position of ArcelorMittal after the merger and if the
company has enough capital for the payment of outstanding debts. Current assets include

18
inventories, marketable securities, work-in-progress, bills receivables where as current
liabilities include sundry creditors, short term advances, bills payable outstanding expenses,
etc. The optimum current ratio is 2:1 which means that the companies if the value of current
assets is double the value of its current liabilities, it has better financial position.

Quick Ratio
It is the ratio between quick or liquid assets and current liabilities of a firm. It is also known
as acid test or liquid ratio. It helps to determine the position of ArcelorMittal to pay its short
term obligations. Liquid assets are those assets which can be converted into cash in short
period without loss of value. It includes cash in hand, cash at bank, sundry debtors, short term
investments, bills receivables and marketable securities. High quick ratio will indicate that
the company is liquids and can pay off its short term liabilities where as a low quick ratio will
not indicate a good financial position of the company. The optimum quick ratio of the firm
should be 1:1 which means that the value of quick or liquid assets should be equal to current
liabilities and the company is generally in good shape to clear its short term liabilities. (Palan,
2007)

Gearing Ratio
It is the relationship between equity share capital including reserves & surplus and preference
share capital. A firm is said to be highly geared if the preference share capital and other
interest bearing loans are more than equity share capital including reserves and surplus where
as if the equity share capital including reserves is more than preference capital and interest
bearing loans, then the company is in low gear. Gearing ratio helps to analyze if the firm if a
firm has high gearing or low gearing ratio as high gearing ratio is harmful for the company.
(Palan, 2007)

Earnings per Share (EPS)

Earnings per share ratio are the difference between net profit after tax and preference
dividend divided by the number of equity shares. This ratio is vital in finding out the
profitability of ArcelorMittal as compared to Arcelor and Mittal taken individually and to
verify if the earning power of the company has increased or decreased after the merger.

19
Return on Capital Employed (ROCE)
Return on capital employed is the relationship between profits and capital employed and is
primarily used to measure the profitability of the firm and the efficiency of its operations.
Capital employed is the investments made in the business which are of three types. (1) Gross
capital employed- it includes the fixed a well as the current assets. (2) Net capital employed-
it includes the total assets of the company less its current liabilities. (3) Proprietor’s net
capital employed- it includes the fixed assets and the current assets less outside liabilities.
(Palan, 2007)

Gross profit ratio

Gross profit ratio establishes a relationship between gross profit and net sales and is generally
expressed in terms of percentage. It specifies the extent to which the selling prices of good
per unit may decline without resulting in loss of operations of the firm. It will help to
examine the current status of ArcelorMittal and if it has enough gross profit to cover the
operating & administrative expenses and to provide for fixed charges and dividends. (Palan,
2007)

Net profit ratio

Net profit ratio is the ratio between net profit after tax and net sales. In this research it will
indicate the efficiency of the management of ArcelorMittal especially in manufacturing of
steel, selling, administrative, and other activities of the firm.

Operating profit ratio

The operating profit ratio is the relationship between operating profit and sales and is
expressed in terms of percentage. Operating profit id the difference between net sales and
operating cost.

4.3. Value Addition Method

This research is conducted to find out if there is any value addition to the wealth of the
shareholders after the merger of Arcelor and Mittal steel company. The value addition
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methods are used to analyse the performance of ArcelorMittal after the merger and to state
that if the entire merger process was successful or unsuccessful. For this purpose abnormal
return and cumulative abnormal return are calculated by taking the share price of the
ArcelorMittal firm and comparing it with share prices of the individual firms to find out the
actual performance of the company.

Abnormal Return
“Abnormal return is the return generated by a given security or portfolio over a period of time
that is different from the expected rate of return”. (www.investopedia.com)

Abnormal Return= Actual Return- Normal Return

This analysis will indicate the performance of ArcelorMittal over and above the performance
of the market and if there is any value addition to the firm after the mergers.

Cumulative abnormal Return (CAR)

“Cumulative abnormal return is defined as the sum of differences between the expected
return on a stock (systematic risk multiplied by the realized market return) and the actual
return often used to evaluate the impact of news on a stock price.” (Financial-
dictionary.com). It will act as guide to find out if ArcelorMittal had taken the right decision to
merge and their performance after the merger.

Cumulative Abnormal Return (CAR) =Σ (Abnormal Return)

ARCELOR MITTAL

Financial and profitability ratios 31/12/07 31/12/06

Current Ratio 1.43 1.26

Liquidity Ratio 0.55 0.61
Price / Earnings ratio 10.43 7.32
Earnings Per Share $7.41 $5.76
Return on Capital Employed (%) 36.84 10.98
Operating Profit (%) 14.09 13.34
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Net Profit (%) 9.85 9.00
Profit Margin (%) 2.11 0.62
EBITDA Margin (%) 18.4 17.2
Interest Cover 10.52 2.30
Stock Turnover 12.43 7.86
Return on Total Assets (%) 4.07 1.30
(Source- Fama Database)

The current ratio for Arcelor Mittal for the year 2006 was 1.26 where as it was increased to
1.43 in 2007 due to swell in current assets from 39.362 million dollars to 45.510 million
dollars. The liquid ratio was reduced from 0.61 to 0.55. The price/earnings ratio increased
from 7.32 to 10.43. Earnings per share were $5.76 and $7.41 for the year 2006-07. The return
on capital also mounted from 10.98% to 36.84%. Operating profit rose slightly from 13.34%
to 14.09% and so was the net profit which were 9% and 9.85%. Profit margin fluctuated from
0.62% to 2.11% and EBITDA margin from 18.4% to 17.2%. Return on total assets also grew
from 1.3% to 4.07%.

(In millions of U.S. dollars except earnings per share and shipments data)

U.S Dollars

Q4 2007 Q3 2007 Q4 2006 FY 2007 FY 2006

Results
Actual Actual Pro forma Actual Pro forma

Shipments (Million MT) 28.0 26.0 26.7 109.7 110.5

Les 27,993 25,524 23,203 105,216 88,576

EBITDA 4,847 4,881 4,118 19,400 15,272

Operating income 3,290 3,853 3,243 14,830 11,824

Net income 2,435 2,960 2,371 10,368 7,973

Basic earnings per share $1.72 $2.10 $1.72 $7.41 $5.76

Source (http://www.arcelormittal.com)

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The above chart shows the quarterly and monthly results of ArcelorMittal for the 2006 and
2007. There was a slight decrease in shipments from 110.5 million metric ton to 109.7 metric
ton in 2007. Due to increase in customer base of combined ArcelorMittal, sales were up by
18.78% from 88.576 billion dollars to 105.216. There was an additional EBITDA of 4.128
billion dollars when it surged up to 19.40 billion dollar in 2007 in comparison to 15.272
billion dollars. Due to increase in sales, the operating income added 30% growth when it
jumped from 11.824 billion dollars to 14.83 billion dollars at the end of 2007. The net income
also showed a positive gain of 30% during 2007 as compared to 2006. The merger had led to
an increase in earning power of the share when it was raised from 5.76 dollars per share to
7.41 dollar per share. The above chart demonstrates a strong and positive return after the two
giants of steel industries integrated to become the world’s largest steel manufacturing
company.

The increase in Current ratio for Arcelor Mittal from 1.26 in 2006 to 1.43 in 2007 indicates
that the company has improved its liquidity position and its ability to pay its current
obligations in time. It also suggests that there is sufficient margin of safety or cushion
available to the creditors and other current liabilities. The current ratio of Arcelor before the
merger were 1.28, 0.64 & 0.56 for the year 2003, 2004 and 2005 where as for the Mittal steel
company, it was 1.84, 1.06 & 1.27 respectively. The fluctuating current ratios of Arcelor
were comparatively less efficient than Mittal steel before the merger which did not show a
good picture about the liquidity of the firm. But after the merger, current ratios of the
combined firm were amplified and the liquidity position became stronger. Even though the
current ratio of the company is not equivalent to the banker’s rule of thumb which is 2:1, the
company may have better liquidity position because the current ratio measures only the
quantity and not the quality of current assets. Moreover, iron and steel have more intrinsic
value and so a lower current ratio is relatively satisfactory. Quick ratio is the relationship
between quick assets and current liabilities.

The Quick ratio of Arcelor Mittal was initially 0.61 in 2006 but reduced to 0.55 at the end of
2007 primarily due to increase in current liabilities such as amount payable to banks and
current portion of long term debt which was almost doubled from 4.92 billion dollars to 8.54
billion dollars. Since Arcelor Mittal is rigorously making investments in mergers and
acquisition, there has not been significant increase in current assets such as cash & cash
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equivalents which was increased by paltry 1.96 billion dollars during 2007. The quick ratio of
Arcelor were 0.88, 0.42 & 0.41 where as for Mittal, it was 0.46, 0.43 & 1.23 for the year
2003, 2004 & 2005 respectively. The quick ratio of Arcelor in 2003 was 0.88 but it
deteriorated in the next few years to 0.41 which indicated that there was shortage of cash and
cash equivalents to pay back the short term debt on time. Where as on the other hand the
quick assets for Mittal group increased from 0.46 to 1.23 in 2005 which illustrated that it was
strengthening its liquidity position. So the merger helped Arcelor to improve its liquidity by
the addition of more liquid assets into its account. The merger has combined the superior
technology and expertise of two companies which has helped to achieve greater efficiency
and organisation in manufacturing process and optimum usage of raw materials. Due to the
perfection in manufacturing process and increase in production efficiencies, Arcelor Mittal
have fast moving inventories and therefore, even if the quick ratio does not comply with the
conventional quick ratio of 1:1, the firm has a good liquidity position.

The substantial increase in Return on Capital Employed (ROCE) was basically due to
increase in profit after tax which was up by 30% in 2007 which shows that the merger had led
to increase in efficiency of the various departments within the firm. The profitability has
increased in relation to the amount invested in it and this will satisfy the shareholders and
other investors of the firm that their money if profitably utilised. The stock turn over ratio
establishes the relationship between costs of goods sold and average stock of a particular
period. The increase in stock turn over ratio from 7.86 to 12.43 implies that there has been
more efficient utilisation of stock and there has been unnecessary blockage of stocks.

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5. REFERENCE

1. Gupta, S.K, Mehra, A., 2001, “Financial Statements”, Financial Analysis &
Reporting, Kalyani Publishers, third edition, pp 1-12.
2. Palan, S., 2007, Lecture Resources, School of Technology & Management.
3. http://www.arcelormittal.com/index.php?lang=en&page=438 (cited 24 October
2009).
4. Fame Database, City Business Library
5. http://www.arcelormittal.com/rls/data/upl/236-21-10-EN-2007-August-
ShareholdersApproveFirstStepOfMittalSteelIntoArcelormittal.pdf, (cited 25 October
2009)
6. http://www.investopedia.com/terms/a/abnormalreturn.asp, (cited 25 October 2009)
7. Makridakis, Wheelright and Hyndman, 1998, Forecasting Methods and Application,
Edition 3, pp 34-76.
8. Arnold Glen, 2002, “Project Appraisal: Net Present Value and Internal Rate of
Return”, Corporate Financial Accounting, Prentice Hall, pp-53-75.
9. http://en.wikipedia.org/wiki/Net_present_value (cited 25 October 2009)
10. Jae k. , Ship and Jeol G., Siegel,(2000), ‘financial Management’, 2nd edition, New
York, Barron’s Educational Series inc., p219-25
11. http://easycalculation.com/statistics/learn-regression.php (21 Jan 2010)

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