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part(s) in Section B
.

Fox Co

Orange is a publicly listed entity which has experienced rapid growth in recent years through the

acquisition and integration of other entities. Orange is interested in acquiring Fox, a retailing business,

which is one of several entities owned and managed by the same family, of which Lodan is the ultimate

parent.

The summarised financial statements of Fox for the year ended 30 September 20X4 are:

Statement of profit or loss

$000 Revenue 70,000 Cost of sales (45,000) Gross profit 25,000 Operating costs (7,000) Directors’ salaries (1,000) Profit before tax 17,000 Income tax expense (3,000) Profit for the year 14,000 Statement of financial position$000                                    $000 Assets Non‐current assets Property, plant and equipment 32,400 Current assets Inventory 7,500 Bank 100 7,600 Total assets 40,000 Equity and liabilities Equity Equity shares of$1 each                                                                                                                           1,000

Retained earnings                                                                                                                                     18,700

19,700

Non‐current liabilities

Directors’ loan accounts (interest free)                                                                                                            10,000

Current liabilities

Current tax payable                                                                                   2,800                                   10,300

Total equity and liabilities                                                                                                                     40,000

From the above financial statements, Orange has calculated for Fox the ratios below for the year

ended 30 September 20X4. It has also obtained the equivalent ratios for the retail sector average which

can be taken to represent Fox’s sector.

Fox                                       Sector average

Return on equity (ROE) (including

directors’ loan accounts)                                                           47.1%                                        22.0%

Net asset turnover                                                                      2.36 times                            1.67 times

Gross profit margin                                                                     35.7%                                        30.0%

Net profit margin                                                                         20.0%                                         12.0%

From enquiries made, Orange has learned the following information:

1. Fox buys all of its trading inventory from another of the family entities at a price which is 10% less than the market price for such goods.
2. After the acquisition, Orange would replace the existing board of directors and need to pay remuneration of $2.5 million per annum. 3. The directors’ loan accounts would be repaid by obtaining a loan of the same amount with interest at 10% per annum. 4. Orange expects the purchase price of Fox to be$30 million.

Required:

A. Recalculate the ratios for Fox after making appropriate adjustments to the financial statements for notes (i) to (iv) above. For this purpose, the expected purchase price of \$30 million should be taken as Fox’s equity and net assets are equal to this equity plus the loan. You may assume the changes will have no effect on taxation.
B. In relation to the ratios calculated in (a) above, and the ratios for Fox given in the question, comment on the performance of Fox compared to its retail sector average.
C. One of Orange’s directors has suggested that it would be wise to look at the Lodan group’s consolidated financial statements rather than Fox’s individual financial statements.
As an adviser to Orange, explain any concerns you would raise about basing an investment decision on the information available in Lodan’s consolidated financial statements and Fox’s entity financial statements.