Larch Properties Limited (LPL) specialises in construction of high-rise city centre office accommodation. It is an unlisted company, in which a venture capital company and an insurance company have small stakes, totalling 15% of the equity share capital. There were several management changes in the company in 2021 and there was a new CEO appointed in July 2021. LPL has been badly impacted in 2021 by a lack of confidence in the city centre office property market following the continuing effects of the Covid-19 pandemic and many people being forced to work from home. All revenue arises in the UK. The Board of Directors believes that revenue is falling due to a lack of consumer confidence and fears of the pandemic impact not abating any time soon. The Board, however, thinks that the company has weathered the storm and the future looks a lot brighter. As a result, the Board plans to invest significantly over the next few months in new city centre land on which to build state-of-the-art office accommodation. The Board of Directors has produced a profit forecast and a cash flow forecast for 2022 that show revenue forecast at 68 million, and more land being purchased after 31 March 2022 using additional bank loan and overdraft facilities.

The financial statements for 2021 are as follows:

Income statement for the year to 31 December

2021 2020

m m

Revenue 77.26 82.84 Cost of sales 65.28 69.20 Gross profit 11.98 13.64

Operating expenses Administration 1.62 1.60 Sales and marketing 0.34 0.40 Depreciation - plant and vehicles 0.32 0.30 Total 2.28 2.30

Operating profit 9.70 11.34 Interest payable 1.40 0.20 Profit before taxation 8.30 11.14 Taxation 2.68 3.12

Profit after taxation 5.62 8.02 Dividends 3.36 3.28 Retained profit for financial year 2.26 4.74

Statement of financial position at 31 December

2021 2020

m m

Non-current assets Buildings 0.54 0.64 Plant and vehicle 2.34 1.58 Investments in joint ventures 2.22 3.02 Total 5.10 5.24

Current assets Inventory (note) 81.28 62.00 Trade receivables 4.58 2.54 Other receivables 1.18 0.78 Cash at bank and in hand 0.50 10.96

Total 87.54 76.28

Total assets 92.64 81.52

Current liabilities Bank overdraft 9.02 1.26 Trade payables 10.34 20.30 Other payables 5.62 5.42 Taxation payable 2.96 3.12

Dividends payable 2.24 2.18 Total 30.18 32.28

Non-current liabilities Bank loan 8.02 0.50 Total 8.02 0.50

Total liabilities 38.20 32.78

Equity

Share capital (1 nominal) 24.86 21.42

Share premium 11.74 11.74

Retained profits 17.84 15.58

Total equity 54.44 48.74

Total equity and liabilities 92.64 81.52

Note: 2021 2020

Inventory detail: m m

Building plots 45.78 40.50

Raw materials 1.84 0.06

Work-in-progress 28.04 18.52

Finished office blocks 5.62 2.92

Total 81.28 62.00

Cash flow statement for the year to 31 December

2021

m m

Cash flows from operating activities

Operating profit 9.70

Add back: Depreciation 0.32

Total 10.02

Movements in working capital

Increase in inventory (19.28)

Increase in receivables (2.44)

Decrease in payables (9.76)

(31.48)

Cash generated from operations (21.46)

Taxation paid (2.84)

Net cash from operating activities (24.30)

Cash flows from investing activities

Sale of buildings 0.10

Purchase of plant and vehicles (1.08)

Sale of investments in joint ventures 0.80

(0.18)

Cash flows from financing activities

Issue of ordinary share capital 3.44

New bank loans 7.52

Interest paid (1.40)

Dividends paid (3.30)

6.26

Net cash movement in the year (18.22)

Cash and cash equivalents at beginning

period 9.70

Cash and cash equivalents at end

of period (8.52)

Net cash movement in the year (18.22)

Additional information Inventory of land has been increased deliberately in the second half of 2021 despite the downturn in demand, as the building plots have been acquired at what the Board regards as bargain prices. LPL held 14 building plots on 31 December 2021 compared to just 6 plots on 01 January 2021. Some of the building plots do not yet have planning approval so that construction can begin.

A confidential professional valuation instructed by the Board in December 2021 indicated that the market value of the building plots held was some 5 million below their cost. No provision for this was made in the financial statements for the year to 31 December 2021 as the Board believes that the diminution in value is not permanent.

To provide resources for this land acquisition investment, the Board had in place maximum banking facilities of 20 million but this facility is due for renewal on 31 March 2022. Bank borrowing is secured by a fixed charge over all the land plots owned by LPL and a floating charge over all other assets.

Question:

Assume that you act for an institutional investor that is considering investing in Larch Properties Limited. Using whatever financial analysis you deem appropriate, prepare a report to evaluate whether you would recommend such an investment by the institutional shareholder. Show all workings. (35 marks - 800 max word count)