Assume you are purchasing an investment and decide to invest in a company in the

Question

Assume you are purchasing an investment and decide to invest in a company in the home remodeling business. You narrow the choice to Build it Right Inc or Structurally Sound Corp. You assemble the following selected data:

Selected income statement data for the current year follow:

Structurally Sound Corp

Income From Operation

Selected balance sheet and market price data at the end of the current year follow:

2,000

____________

1,000

___________

Perferred Stock 5%, $100 par

Common Stock, $1.00 Par 6,000 Shares

20,000

-----

----

6,000

Selected balance sheet data at the beginning of the current year follow:

Preferred Stock, 5%, $100 par

Common Stock, $1.00 Par, 6,000 Shares

20,000

------

----

6,000

Your investment strategy is to purchase the stock of the company that has a low price/earnings ratio but appears to be in good shape financially. Assume that you analyzed all other factors and your decision depends on the results of the ratio analysis to be performed.

Part A: Compute the following ratios for both companies for the current year, and decide which comapnys stock better fits your investment stratgey.

a) Quick ratio

b) Inventory turnover

c) Days sales in average recieveables

d) debt ratio

e) earnings per share of common stock

f) price/earnings ratio

PART B. Compute the EVA for each company, assuming a 10% cost of capital. Does the EVA confrim the opinion you formed as a result of the ratio analysis?

Build it Right Inc

Structurally Sound Corp

Net Sales $298,000 $223,000 Cost of Goods Sold 155,000 125,000

Income From Operation

83,000 47,000 Interest Expense 13,000 ------ Net Income 43,000 29,000

Explanation / Answer

Part A: Compute the following ratios for both companies for the current year, and decide which comapnys stock better fits your investment stratgey. Build It Right Structurally Sound a) Quick ratio Quick Ratio = (Current Assets - Inventory) / Current Liabilities           0.90                 0.78 b) Inventory turnover Inventory Turnover in no. of days = Average Inventory/Cost of Goods Sold X 365            133 days                  158 days c) Days sales in average recieveables Receivables Turnover Ratio = Average Receivables/Sales X 365               35 days                     40 days d) debt ratio Debt Ratio = Debt/Equity 26% N.A. e) earnings per share of common stock EPS = Profit after taxes/No. of shares of common stock         14.33 $                 4.83 $ f) price/earnings ratio P/E Ratio = Market Price/Earnings           4.68                 6.42 Based on the ratio analysis as shown above, it can be inferred that the stock of Build It Right, although low in price earnings ratio, better fits the investment strategy. This is owing to two main factors : (i) A decent quick ratio, thereby indicating enough quck assets to pay off immediate liabilities. (ii) A good inventory turnover and debtors turnover,showing immediate collection of sales amounts, and faster movement of inventory owing to better sales. PART B. Compute the EVA for each company, assuming a 10% cost of capital. Does the EVA confrim the opinion you formed as a result of the ratio analysis? Build It Right Structurally Sound $ $ EVA is worked out as Net Profit after Taxes - (Capital X Cost of Capital %) Net Profit after taxes 43,000 29,000 Capital Base 1,18,000 94,000 Cost of Capital 10% 10% EVA based on the above formula 31200 19600 Since the EVA of Build It Right is more than that of Structurally Sound, it further confirms the opinion formed as a result of the ratio analysis.

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