Koala Fun Case Study is attached. Please help answer questions 1. Using the data

ID: 2658412 • Letter: K

Question

Koala Fun Case Study is attached. Please help answer questions 1. Using the data in exhibits C2.1 and C3.3, calculate and analyze the firm’s 2012 and 2013 ratios. Enter the ratios in the table below in the 2012 and 2013 columns, respectively: Ratio Type 2012 2013 Current (times) Quick (times) Debt (%) Times interest earned (times) Inventory turnover (times) Total asset turnover (times) Average collections period (days) Return on equity (%) 2. Part of Owen’s evaluation will consist of comparing the firm’s ratios to the industry as shown in Exhibit C3.3 of the text. Discuss the limitations of such a comparative financial analysis. In view of these limitations, why are such industry comparisons so frequently made? (Note: Sales are forecast to be $8.25 million in 2014). Type a three- to four-sentence response below. 3. Owen thinks that the profitability of the firm has been hurt by Tessa’s reluctance to use much interest-bearing debt. Is this a reasonable position? Explain. Type a three- to four-sentence response below. 4. The case mentions that Tessa rarely takes trade discounts, which are typically 1½/10, net 30. Does this seem like a wise financial move? Explain. Type a three- to four-sentence response below. 5. Is the estimate of $35 to $40 for Owen’s shares a fair evaluation? Explain. Type a three- to four-sentence response below. CASE TWo Koala Fun LLION-DOLLAR COMPUTERGAME companies such as Activision Blizzard, and Zynga are unusual in the electronic arts industry, which consists primarily of small developers One such firm is Koala Fun (KF) located in Baltimore. MD. KF was started seven years ago by Owen Charles and Tessa Benjamin, who between them had over 15 years of experience with various computer systems design companies The partnership initially blended wery well Owen, reserved and introspec- tive. is creative with a air for designing games and spotting trends. Mainly as a result of his genius, the KF brand is synonymous with intriguing electronics with high graphic appeal. Tessa, more outpoing with a strong marketing focus has assumed the role of the firms chief operating officer THE PARTNERS' FIRST SUCCESS The first successful product the two partners developed was a game called Koala Fun. which they used as the company name. The game uses a cute image of a 223

Explanation / Answer

Solution to part 1:

Ratio Types

2012

2013

Current (times)

3.73

3.43

Quick (times)

2.39

1.83

Debt (%)

37.66%

35.32%

Times interest earned (times)

8.51

11.62

Inventory turnover (times)

6.40

4.80

Total asset turnover (times)

2.78

2.71

Average collections period (days)

54.96

50.99

Return on equity (%)

11.60%

10.81%

Current (times) = Current Assets / Current Liabilities

2012 = $2,136,800 / $573,200 = 3.73

2013 = 2,619,700 / $764,100 = 3.43

Quick (times) = (Total Current Assets – Inventory – Prepaid Expenses) / Current Liabilities

2012 = ($2,136,800 - $765,400 - $0) / 573,200 = 2.39

2013 = ($2,619,700 - $1,222,300 - $0) / $$764,100 = 1.83

Debt (%) = Total Labilities / Total Assets

2012 = ($2,361,200 - $948,000 - $524,000) / $2,361,200 = 37.66%

2013 = ($2,879,500 – $1,137,600 – $725,000) / $2,879,500 = 35.32%

Times Interest Earned (times) = EBIT / Interest Expense

2012 = $322,400 / $37,900 = 8.51

2013 = $367,100 / $31,600 = 11.62

Inventory Turnover (times) = Cost of Goods Sold / Average Inventory

2012 = $4,896,700 / $765,400 = 6.40

2013 = $5,866,200 / $1,222,300 = 4.80

Total Asset Turnover (times) = Net Sales / Average Total Assets

2012 = $6,572,800 / $2,361,100 = 2.78

2013 = $7,811,500 / $2,879,500 = 2.71

Average Collection Period (days) = 360 / Average Receivable Turnover Ratio

2012 = 360 / 6.55 = 54.96

2013 = 360 / 7.06 = 50.99

Average Receivable Turnover Ratio = Sales / Average Accounts Receivables

2012 = $6,572,800 / $1,004,200 =6.55

2013 = $7,811,500 / $1,106,600 = 7.06

Assuming no cash sales for average collection period and going off 360-day calendar.

Return on Equity (%) = Net Income / Shareholder’s Equity

2012 = $170,700 / ($948,000 + $524,000) = 11.60%

2013 = $201,300 / ($1,137,600 + $725,000) = 10.81%

When comparing Koala fun to the Electric Arts Industry, we see the company is very liquid. Both their current and quick ratio in both years is better than the industry average, which is positive. The company also has a lower debt % compared to the industry. Koala fun has a better times interest earned, meaning they can cover their obligations of paying interest on debt. Inventory turnover is average with the industry, as well as total asset turnover and average collection period. Where Koala fun can improve is the return on equity, where they are currently in bottom quartile. Using more debt instead of equity would help this % out.

Solution to part 2:

As our textbook states, the main difficulty in using financial statement data is that each business has its own unique characteristics, and when aggregated into an industry, data can lose meaning (CITATION). Companies can be strong in some ratios while weak in others, making it difficult to tell what the overall strength is of the company. Another problem is that the choice of actual fiscal year-end closing is at the discretion of the management. Balance Sheets are published on an “as of” date. Industry comparisons are frequently made because financial ratios provide a standardized method with which to compare companies and industries. It helps level the playing field, making the information strictly about performance and not the size of the company or what their market share is. It is by no means a perfect formula, but it provides a baseline.

Solution to part 3:

I think that the profitability of the firm has been hurt by Tessa’s reluctance to use interest-bearing debt. The debt financing would bring in needed cash to not only help cover their current obligations (especially since their accounts receivable is constantly delayed) but to help expand the business without giving up equity in the company. While the debt must be repaid, the lender has no claim on the future profits of the company; Tessa and Owen would receive a larger portion of the rewards since they didn’t give up equity to receive the same financing, thus helping the profitability of the firm.

Solution to part 4:

I do not think that it is a wise financial move for Tessa to not take the trade discounts. Tessa states “she wants to hold on the cash for as long as possible”. Regardless, she is going to have to pay the obligation. Getting into the habit of paying in the first 10 days will help the company save 1.5%; while that amount doesn’t seem significant standalone, overtime it will add up, creating seemingly new cash for the business. Additionally, Tessa should start offering these terms to her customers to receive cash quicker, lower the accounts receivable, and improve cash flow.

Solution to part 5:

I would say that the $35 to $40 for Owen’s share is a fair evaluation. In 2012, when we take the total equity (common stock and retained earnings) price of $1,472,000 and divide it by 62,000 common shares, we get $23.74 per share. In 2013, taking the total equity of $1,862,600 and divide it by 62,000 common shares, we get $0.04 per share. To fairly compensate Owen, he should receive a sum larger than the current share price he had as a founding partner. It should also be taken into consideration that sales are expected to increase to $8.25 million in 2014, making the company more valuable. This would make share price of $35-40 a fair value.