Acquisition Decision Diversified Industries is a large conglomerate that is cont

ID: 2492266 • Letter: A

Question

Acquisition Decision

Diversified Industries is a large conglomerate that is continually in the market for new acquisitions. The company has grown rapidly over the last ten years through buyouts of medium-size companies. Diversified does not limit itself to companies in any one industry, but looks for firms with a sound financial base and the ability to stand on their own financially.

The president of Diversified recently told a meeting of the company’s officers: ‘‘I want to impress two points on all of you. First, we are not in the business of looking for bargains. Diversified has achieved success in the past by acquiring companies with the ability to be a permanent member of the corporate family. We don’t want companies that may appear to be a bargain on paper but can’t survive in the long run. Second, a new member of our family must be able to come in and make it on its own—the parent is not organized to be a funding agency for struggling subsidiaries.’’

Required:

1. How liquid is Heavy Duty Tractors? Round current ratio to one decimal place and round average collection period and average number of day's in inventory to the nearest whole day. Assume 360 days.

Several measures give an indication as to the company’s liquidity. The working capital has - Select your answer -decreased increased slightly nearly doubledItem 1 over the two-year period. The current ratio for 2014 is to 1 and for 2013 to 1. One area of concern is the large - Select your answer -increasedecreaseItem 4 in both receivables and inventories from the prior year. The 2014 average collection period is days and the 2014 average number of days’ sales in inventory is days.

2. In light of the president's comments, should you be concerned about the solvency of Heavy Duty Tractors? Round the times interest ratio to two decimal places.

The company’s solvency can be examined by looking at the following factors. The debt-to-equity ratio has - Select your answer -decreased increased slightly nearly doubledItem 7 from the prior year: The times interest earned ratio is times. The company is carrying a - Select your answer -light heavyItem 9 debt burden even though the bonds are not due until 2021.

3. Has Heavy Duty demonstrated the ability to be a profitable member of the Diversified family? Use a tax rate of 40% in your computations. Round all computations (except asset turnover) to one decimal place. Round asset turnover to two decimal places.

Profitability can be assessed by looking at a number of ratios for 2014. The return on assets is % and the return on sales is %. The asset turnover is is times and the return on common Stockholders' Equity is %.

4. What will you tell your boss? Should he recommend to the board of directors that Diversified put in a bid for Heavy Duty Tractors? Round the profit margin to one decimal place.

Heavy Duty - Select your answer -has has notItem 14 demonstrated the ability to be a profitable member of the Diversified family over the long run. Disregarding the extraordinary gain, the profit margin before interest and taxes was %. Heavy Duty relies on a considerable amount of - Select your answer -stock issuance outside debtItem 16 for funding. This is further evidenced by the overall return on assets which is - Select your answer -higher lowerItem 17 than the return to the stockholders.

Explanation / Answer

Solution:

Current ratio =Current Assets/Current Liabilities

= 324120/162300 = 1.99 (2014)

= 215180/126250 =1.70 (2013)

2014

2013

Current ratio

1.99

1.70

inventory

135,850

96,780

Receivables

128,420

84,120

Working capital

168820

52930

Inventory turnover =Cost of inventory/Average inventory

=542750/ [(13850+96780)/2]

=9.8

Days of inventory holding =360/ inventory turnover = 360/9.8=36.7

The working capital has nearly doubled over the two-year period. The current ratio for 2014 is 1.99 and for 2013 to 1.7

One area of concern is the large increase in both receivables and inventories from the prior year. The 2014 average collection period is days and the 2014 average number of days’ sales in inventory is days

Debt/Equity ratio (2014) =Total debt/net worth = (162,300+275,000)/532,710 = 0.82

Debt/Equity ratio (2013) =Total debt/net worth = (126,250+275,000)/519,820=0.77

Debt to equity ratio increased has increased from 2013 to 2014

Interest Coverage ratio = EBIT/interest charges

(Net earnings before extraordinary item +all income tax + interest charges)/ interest charges

= ($23,140 + 9,250 +45,000)/ 45,000 =1.7

The debt-to-equity ratio has increased slightly nearly from the prior year. The times interest covered is 1.7 times. The company is carrying a heavy debt burden even though the bonds are not due until 2021.

3) ROI = EBIT (1-t)/Total assets

EBIT =[ ($23,140+9,250+4,500)*(1 – 0.4)]/total assets =$36,890*(0.6) =$22,134

Total assets (2014) = $970,010

ROI =$22,134/$970,010

=0.0228*100 =2.2%

ROE =PAT/net worth =

PAT =(EBIT- INT)(1-T) = ($22,134 - $9250)*(1 – 0.4) =$7730.4

Net worth =$532,710

ROE=$7730.4/$532,710 =1.45%

Return on sales = Operating profit/sales

=$68,140/$875,250 =7.7%

Not a great choice for acquistion as margin are low.

Heavy Duty relies on a considerable amount of stock issuance outside debt Item for funding. This is further evidenced by the overall return on assets which is higher than the return to the stockholders.