ACC640 Week 6 Final Paper Company expansion

Name

ACC640

27/10/2022

Company expansion

Drax Group, the leading provider of renewable energy, Drax Group is currently meeting the 8% of UK’s electricity needs with its six power units, out of which it has converted three units on biomass (Clayton, 2019). The objective is to reduce the UK’s Greenhouse Gas Emissions by over 20% of their 1990 levels and to save over 2 million tons of CO2 emissions per annum.

The company is headquartered in Selby, North Yorkshire. The current shares in the market are 615p and the market capitalization is £5.24 billion, as estimated on October 27, 2006. The company’s primary business includes generating electricity through coal­fired power stations and they currently supply around 8% of UK’s electricity demands by burning its coal with licensed waste wood into a biomass fuel.

Cost Volume Profit analysis

Cost­Volume­Profit (CVP) Analysis

Total

Per Unit

Sales (200000 units)

1200000

60

Less: Variable costs

900000

45

Contribution margin

300000

15

Less: Fixed costs

240000

Net income

60000

Contribution margin ratio

25%

Variable expense ratio

75%

Break­even point

16000

What if analysis for target profit

Target profit

100000

# of units needed

22667

Margin of safety

240000

Degree of operating leverage

(DOL)

Income statement

Income statement

31/12/2021

31/12/2020

31/12/2019

31/12/2018

31/12/2017

£ (Millions)

Revenue

5088

4244

4744.60

4299

3684

Operating profit/

(loss)

196.50

(156.10)

48.4

59.90

137.90

Net interest

70.80

75.80

64.40

46.40

55.50

Profit before tax

121.5

234.7

15.6

13.8

204.

Profit after tax

55.10

194.6

9.7

20.20

167.9

Earnings per share

Basic

13.9p

­49.0p

­2.5p

5.00p

­41.3p

Diluted

13.5p

­49.0p

­0.25p

4.90p

­40.9p

Adjusted

22.3p

24.3p

24.9p

10.4p

0.7p

Dividend per share

18.80p

17.1p

15.9p

14.1p

12.3p

Balanced scorecard

The vision of Drax Group is to be the leader in sustainable, renewable electricity production and supply. Approximately 95% of the power stations come from long­term contracts with UK’s National Grid, and about 1/3 of its electricity is exported abroad (Clayton,2019). According to their website (draxgroup.co.uk ), Drax Group is a leader in coal­fired power and biomass generation, which includes three power stations (two in North Yorkshire and one in Selby), the first being started back in 1974. Its current share price has risen over threefold since its IPO nearly a decade ago, and they have grown into a global giant in the energy sector, mainly owing to its conversion of two stations to biomass­fueled generating facilities since 2003.

From a financial perspective, the company will expand by acquiring new and additional equipment to meet the increased demand. Currently, the company operates at capacity, so that expansion will be necessary. The estimated cost of this expansion is $10 million. In addition, this action will result in employment for 25 new employees and $150 million in growth for other companies related to the energy industry.

The net cash flow associated with this expansion is estimated to be positive as there is little or no effect on existing employees and a drop in expenditures. As the company grows, they need more human resources; hence, it will hire more people: five executives, six senior engineers and 15 junior engineers and operators.

The company uses the current assets to fund these new expansion projects, including cash and cash equivalents, for a total cost of $750 million (Drax Group PLC2018). This will reduce the assets by $750 million and increase the liabilities by $250 million. When the expenditure becomes due, it will be recorded as a liability on the balance sheet. After that, it will be fully operational when they have acquired its new equipment, which will be recorded as an asset in its book. In addition, an increase in working capital may occur due to the acquisition of expanded plants and additional equipment. The inventory is expected to grow gradually once production increases, and this growth in stock will be $1 million per month for four months or $4 million.

From the customer perspective, the company will expand by setting up a new power station in Sussex, UK. The new power station will help to meet the growing demand for electricity throughout the country. Drax Group will continue to operate at total capacity, as it has done so far, and this expansion will not affect its market share of electricity production. Also, the company may approach the UK government to devise a policy that permits burning surplus energy crops and making them into energy along with biomass. In that case, Drax Group can achieve additional market share. The company will also expand its clientele base by targeting to expand its clientele base from non­UK clients. The non­UK clients will comprise countries in Europe and the Middle East.

From the Internal­Business­Process perspective, the company will expand by expanding its facilities. Recently, one of the power stations in Selby was converted from coal to biomass. It also plans to convert six more power stations in North Yorkshire to dual fuel (coal &/or biomass) by 2009. In addition, the company is thinking of expanding into the global market with its current products. This plan of expansion will need additional equipment to be added. As a result, the company will add a new Integrated Resource Planning (IRP) department and plan to expand into the global market.

From the Learning­and­Growth perspective, the company will expand by taking two steps. The first is to make the transition from coal­fired resources to biomass­fueled. The other step is expanding into overseas markets in countries with many biomass resources. The first step requires a massive investment in research and development. The company will have to develop new products, as well as improve on the existing ones. The current biomass projects are generated through burning waste wood that is currently available, but the resource has limitations. This means that the company needs a new solution to create more wood energy to complete it. The second step includes expanding into overseas markets where more biomass resources are available than those in the UK.

Balance sheet

Balance sheet

31/12/2021

31/12/2020

31/12/2019

31/12/2018

31/12/2017

Assets

Non­current assets

£ (Millions)

Property, plant, equipment

2430.5

1970.1

2358.8

2347.6

1661.9

Intangible assets

604.9

430.0

455.1

477.0

401.9

Investments

5.5

1.5

3.0

2.40

1.30

Other non­current assets

435.1

178.6

204.6

348.6

213.4

Current assets

Inventories

199.1

208.2

292.0

222.5

272.1

Trade and other receivables

641.9

525.3

608.8

474.2

417.5

Cash at bank and in hand

317.4

289.8

404.1

289.0

222.3

Other current assets

1190

589.4

356.4

432.1

327.2

Total assets

5840.4

4192.9

4682.8

4593.4

3517.6

Liabilities

Current liabilities

Borrowings

55.7

7.0

6.30

0.1

18.60

Other current liabilities

2177.2

1301.0

1293.5

1730.1

846.1

Non­current

liabilities

Borrowings

1431.2

1088.9

1271.4

608.0

571.1

Provisions

311.7

313.2

323.1

366.7

266.3

Other non­current

liabilities

541.8

143.4

72.9

62.0

95.4

Total liabilities

4517.6

2853.5

2967.2

2766.9

1797.5

Net assets

1306.8

1339.4

1715.6

1826.5

1720.1

Capital and reserves

Share and capital

47.7

47.5

47.4

47.0

47.0

Share premium account

432.2

430.0

429.6

424.7

424.3

Other reserves

607.1

708.5

868.9

912.1

790.9

Retained earnings

198.3

153.4

369.7

442.7

457.9

Shareholders’ funds

1285.3

1339.4

1715.6

1826.5

1720.1

Minority interests

21.5

Total equity

1306.8

1339.4

1715.6

1826.5

1720.1

Constraint theory

The constraint theory is a financial analysis tool that is used to predict the total value of a company’s assets when the constraints against their use are known. This includes the allocation and control of production resources and investment, sales, taxes and pricing. In addition, the company must have adequate cash flow to expand and maintain their current level or growth. In Drax Group’s case, the company’s original objective was to maximize its value by selling the energy from its power stations, however, the constraint is carbon emission. The board of Drax Group will be considering the constraint theory, knowing that their current source of revenue has been a major contributor to their success and growth over the past 35 years.

The initial portion of this analysis will include a review of existing regulatory factors as they relate to capital budgeting analysis. These regulations are relevant as they pertain to economy, environment and competition. This will allow you to understand where the company stands with respect to government regulations and goals.

The first component of the regulatory analysis should include a review of Drax Group’s industry and environment. The company’s industry is highly regulated, as government regulations are enforced by authorities such as the European Union, the UK Government and United Nations. The industry has historically been dominated by large companies with high capital investments, however, recent regulatory policies have provided opportunities for smaller competition to enter the market. Regulatory agencies monitor environmental conditions through the use of test programs that require both an impact analysis and a control analysis to be completed (Wei,2021). These tests will be reviewed and their impact on business operations analyzed in order to gain insight about the type of regulations that may apply to its future market expansion plans.

The second component of regulatory factors will include a review of existing competition within the industry. Competition is an important component to consider when analyzing the company’s financial statements. Although there are many other companies operating in the same sector, Drax Group is considered to be one of the larger names in this industry. For Drax Group, their competitors include Royal Dutch Shell and EDF Energy, both of which are often considered some of Europe’s top multinational corporations. Competition among these global players can be found in every major European city and across the world.

For the third component, we will focus on the company’s policies, which is basically their current cost system. We will focus on their cost accounting policies and how they have gone from an ABC approach to a single­costing system. We will also look at how they are utilizing the activity based costing (ABC) approach and systems in order to help better estimate costs. In addition, we should review their capital budgeting policy as it pertains to allocating cash for expansion purposes.

Lastly, we will look at the financing decisions that Drax Group has made during its initial stages as a public company; this includes reviewing the existing financial structure of the firm, who provides financing to the firm and why that was done.

In the expansion of Drax Group, the importance of constraint theory is the ability to allocate resources effectively and efficiently. This includes both capital investment as well as the use of human resources. When the board of directors is reviewing Drax Group’s expansion options, they must consider the supply and demand curve and how it relates to their current operations (Wei,2021). As per the law of demand, in order for Drax Group to begin any new expansion project, there must be a clear and existing market for which to sell its products. In order for this theory to be feasible, there must be a need for its products that cannot be met by other competitors in their industry; in addition, there should not be any significant barriers to entry.

References

Clayton, C. (2019). Drax group’s bioenergy CCS (BECCS) project. Greenhouse Gases:

Science and Technology, 9(2), 130­133.

Drax Group PLC. (2018). Annual Report and Accounts 2018.

Zhongming, Z., Linong, L., Xiaona, Y., Wangqiang, Z., & Wei, L. (2021). Drax announces ambition to host world’s largest negative emissions project.