MINI CASE: The first part of the case, presented in Chapter 7, discussed the sit
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Question
MINI CASE:
The first part of the case, presented in Chapter 7, discussed the situation of Computron Industries after an expansion program. A large loss occurred in 2012, rather than the expected profit. As a result, its managers, directors, and investors are concerned about the firm's survival.
Jenny Cochran was brought in as assistant to Gary Meissner, Computron's chairman, who had the task of getting the company back into a sound financial position. Computron's 2011 and 2012 balance sheets and income statements, together with projections for 2013, are shown in the following tables. The tables also show the 2011 and 2012 financial ratios, along with industry average data. The 2013 projected financial statement data represent Cochran's and Meissner's best guess for 2013 results, assuming that some new financing is arranged to get the company “over the hump.”
Cochran must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions should be taken. Your assignment is to help her answer the following questions. Provide clear explanations, not yes or no answers!!!!
Mini Case: (Chapter 7). Financial Statement below:
Balance Sheet
2011
2012
2013
Assets
Cash
$9,000
$7,282
$14,000
Short-term investments
48,000
20,000
71,632
Accounts receivable
351,200
632,160
878,000
Inventories
751,200
1,287,360
1,716,480
Total current assets
$1,124,000
$1,946,802
$2,680,112
Gross fixed assets
491,000
1,202,950
1,220,000
Less: Accumulated depreciation
146,200
263,160
383,160
Net fixed assets
$344,800
$39,790
$36,840
Total assets
$1,468,800
$2,886,592
$,516,952
2011
2012
2013
Liabilities & Equity
Accounts payable
$145,600
$324,000
$359,800
Notes payable
200,000
720,000
300,000
Accruals
136,000
284,960
380,000
Total current liabilities
$481,600
$1,328,960
$1,039,800
Long-term debt
323,432
1,000,000
500,000
Common stock (100,000 shares)
460,800
460,000
1,680,936
Retained earnings’
203,768
97,632
296,216
Total equity
$663,768
$557,632
$1,977,152
Total liabilities & Equity
$1,468,800
$2,886,592
$3,516,952
Note: “E” denotes, “estimated”; the 2013 data for forecasts.
Income Statement
2011
2012
2013
Sales
$3,432,000
$5,834,400
$7,035,600
Cost of goods sold
2,864,000
4,980,000
5,800,000
Other expenses
340,000
720,000
612,960
Depreciation & Amortization
18,900
116,960
120,000
Total operating Cost
$3,222,900
$5,816,960
$6,532,962
EBIT
$209,100
$17,440
$502,640
Interest expense
62,500
176,000
80,000
EBT
$146,600
($158,560)
$422,640
Taxes (40%)
58,640
(63,424)
169,056
Net Income
$87,960
($95,136)
$253,584
Other Data
Stock price
$8.50
$6.00
$12.17
Shares outstanding
100,000
100,000
250,000
2011
2012
2013E
EPS
$0.880
($0.951)
$1.014
DPS
$0.220
0.110
0.220
Tax rate
40%
40%
40%
Book value per share
$6.638
$5.576
$7.909
Lease payment
$40,000
$40,000
$40,000
Note: “E” denotes “estimated”; the 2013 data are forecasts.
Ratio Analysis
2011
2012
2013E
Industry Average
Current
2.3
1.5
------------------
2.7
Quick
0.8
0.5
------------------
1.0
Inventory turnover
4.8
4.5
------------------
6.1
Days sales outstanding
37.3
39.6
------------------
32.0
Fixed assets turnover
10.0
6.2
-----------------
7.0
Total assets turnover
2.3
2.0
---------------
2.5
Debt ratio
54.8%
80.7%
--------------
50.0%
TIE
3.3
0.1
--------------
6.2
EBITDA Coverage
2.6
0.8
--------------
8.0
Profit margin
2.6%
-1.6%
--------------
3.6%
Basic earning power
14.2%
0.6%
--------------
17.8%
ROA
6.0%
-3.3%
--------------
9.0%
ROE
13.3%
-17.1%
--------------
17.9%
Price / Earnings (P/E)
9.7
-6.3
--------------
16.2
Price / Cash flow
8.0
27.5
-------------
7.6
Market / Book
1.3
1.1
-------------
2.9
Note: “E” denotes “estimated.”
Cochran must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions should be taken. Your assignment is to help her answer the following questions. Provide clear explanations, not yes or no answers.
a. Why are ratios useful? What three groups use ratio analysis and for what reasons?
b. Calculate the 2013 current and quick ratios based on the projected balance sheet and income statement data. What can you say about the company's liquidity position in 2011, 2012, and as projected for 2013? We often think of ratios as being useful (1) to managers to help run business, (2) to bankers for credit analysis, and (3) to stockholders for stock valuation. Would these different types of analysts have an equal interest in the liquidity ratios?
c. Calculate the 2013 inventory turnover, days sales outstanding (DSO), fixed assets turnover, and total assets turnover. How does Computron's utilization of assets stack up against that of other firms in its industry?
d. Calculate the 2013 debt, times-interest-earned, and EBITDA coverage ratios. How does Computron compare with the industry with respect to financial leverage? What can you conclude from these ratios?
e. Calculate the 2013 profit margin, basic earning power (BEP), return on assets (ROA), and return on equity (ROE). What can you say about these ratios?
f. Calculate the 2013 price/earnings ratio, price/cash flow ratio, and market/book ratio. Do these ratios indicate that investors are expected to have a high or low opinion of the company?
g. Perform a common size analysis and percentage change analysis. What do these analyses tell you about Computron?
h. Use the extended Du Pont equation to provide a summary and overview of Computron's financial condition as projected for 2013. What are the firm's major strengths and weaknesses?
i. What are some potential problems and limitations of financial ratio analysis?
j. What are some qualitative factors that analysts should consider when evaluating a company's likely future financial performance?
Answer each question complete and accurate as possible Please!
Balance Sheet
2011
2012
2013
Assets
Cash
$9,000
$7,282
$14,000
Short-term investments
48,000
20,000
71,632
Accounts receivable
351,200
632,160
878,000
Inventories
751,200
1,287,360
1,716,480
Total current assets
$1,124,000
$1,946,802
$2,680,112
Gross fixed assets
491,000
1,202,950
1,220,000
Less: Accumulated depreciation
146,200
263,160
383,160
Net fixed assets
$344,800
$39,790
$36,840
Total assets
$1,468,800
$2,886,592
$,516,952
2011
2012
2013
Liabilities & Equity
Accounts payable
$145,600
$324,000
$359,800
Notes payable
200,000
720,000
300,000
Accruals
136,000
284,960
380,000
Total current liabilities
$481,600
$1,328,960
$1,039,800
Long-term debt
323,432
1,000,000
500,000
Common stock (100,000 shares)
460,800
460,000
1,680,936
Retained earnings’
203,768
97,632
296,216
Total equity
$663,768
$557,632
$1,977,152
Total liabilities & Equity
$1,468,800
$2,886,592
$3,516,952
Note: “E” denotes, “estimated”; the 2013 data for forecasts.
Income Statement
2011
2012
2013
Sales
$3,432,000
$5,834,400
$7,035,600
Cost of goods sold
2,864,000
4,980,000
5,800,000
Other expenses
340,000
720,000
612,960
Depreciation & Amortization
18,900
116,960
120,000
Total operating Cost
$3,222,900
$5,816,960
$6,532,962
EBIT
$209,100
$17,440
$502,640
Interest expense
62,500
176,000
80,000
EBT
$146,600
($158,560)
$422,640
Taxes (40%)
58,640
(63,424)
169,056
Net Income
$87,960
($95,136)
$253,584
Other Data
Stock price
$8.50
$6.00
$12.17
Shares outstanding
100,000
100,000
250,000
2011
2012
2013E
EPS
$0.880
($0.951)
$1.014
DPS
$0.220
0.110
0.220
Tax rate
40%
40%
40%
Book value per share
$6.638
$5.576
$7.909
Lease payment
$40,000
$40,000
$40,000
Note: “E” denotes “estimated”; the 2013 data are forecasts.
Ratio Analysis
2011
2012
2013E
Industry Average
Current
2.3
1.5
------------------
2.7
Quick
0.8
0.5
------------------
1.0
Inventory turnover
4.8
4.5
------------------
6.1
Days sales outstanding
37.3
39.6
------------------
32.0
Fixed assets turnover
10.0
6.2
-----------------
7.0
Total assets turnover
2.3
2.0
---------------
2.5
Debt ratio
54.8%
80.7%
--------------
50.0%
TIE
3.3
0.1
--------------
6.2
EBITDA Coverage
2.6
0.8
--------------
8.0
Profit margin
2.6%
-1.6%
--------------
3.6%
Basic earning power
14.2%
0.6%
--------------
17.8%
ROA
6.0%
-3.3%
--------------
9.0%
ROE
13.3%
-17.1%
--------------
17.9%
Price / Earnings (P/E)
9.7
-6.3
--------------
16.2
Price / Cash flow
8.0
27.5
-------------
7.6
Market / Book
1.3
1.1
-------------
2.9
Note: “E” denotes “estimated.”
Explanation / Answer
a) Ratios are useful because of following reasons:-
1) Ratios are helpful to management in planning, forecasting, decision-making, controlling etc.
2) Ratios provides knowledge of business trend.
3) Ratios provides knowledge of Comparative results
4) Ratios are helpful in establishing the ideal stanadrds of various financial and accounting aspects of business.
5) Ratios are helpful in effective control over costs and the working result of firm.
6) Ratios analysis helps in making inter-firm and intra-firm comparison.
The following three groups uses the ratio analysis;-
1) Management:- Ratio anlysis helps management in their various functions such as planning, forecasting, decision making, controlling, directing,staffing etc.
2) Shareholders/Investors:- With the help of Ratio analysis, Shareholders can know about profitability, liquidity and efficiency of business (Earning per share, Dividend per share etc.)
2) Others:- External parties such as debtors, creditors, income tax department, Debentureholders, Bankers, government etc.
b) Year 2013
Current ratio = Current assets / Current liabilities
= 2680112 / 1039800
= 2.58
Quick ratio = Current assets - Inventory / Current liabilities
= 2680112 - 1716480 / 1144800
= 963632 / 1039800
= 0.93
c) Total asset turnover ratio = Sales / Total assets
Total asset = $ 3516952
Total asset turnover ratio for year 2013 = 7035600 / 3516952 = 2 Times
Inventory turnover ratio for year 2013 = Cost of goods sold / Average inventory
Average inventory = 1716480 + 1287360 / 2 = 3003840 /2 = $ 1501920
Inventory turnover ratio (Year 2013) = 5800000 / 1501920 = 3.86 Times
Daily Sales oustanding (Year 2013) = Accounts receivable / Sales per day
Sales per day = 7035600 / 365 = $ 19275.62
Daily Sales oustanding (Year 2015) =Daily Sales oustanding (Year 2015) = 878000 / 19275.62 = $ 45.55
d) Times interest earned ratio (Year 2013) = EBIT / Interest = 502640 / 80000 = 6.28 (approx)
Debt to capital ratio = Debt / Debt + equity = 500000 / 500000 + 1977152 = 500000 / 2477152 = 0.20
e) Year 2013
Operating margin ratio = Operating margin / Sales * 100 = 502640 / 7035600 * 100 = 7.14 %
Net profit margin ratio = Net profit / Sales * 100 = 253584 / 7035600 = 3.60 %
Return on total assets = Net income / total assets * 100 = 253584 / 3516952 * 100 = 7.21 %
Return on equity = Net income / Total equity * 100 = 253584 / 1977152 * 100 = 12.82 %
Return on invested capital = Net income / Total capital = 253584 / 2477152 * 100 = 10.24 %
Total capital = Debt + Equity = 500000 + 1977152 = $ 2477152
i) Problems and Limitations of Ratio analysis:-
1) Change in price level:- If we calculate the ratios without making adjustment of change in price levels, it will definitely give confusing or incorrect results.
2) Based on past data:- Through ratio anlysis, we estimate and compare present and past data. If we do not manage to revise figures according to changed situations, then it will not prove in correct details.
3) Limitations of accounting:- For using ratio anlysis, the data received from financial statements are basis pillars. Financial accounting itself suffers from certain limitations.
4) Lack of sufficient information:- For analysis, evaltion and conclusion, ratio analysis do not provide sufficient information.
5) Other limitations:- Lack of qualitative analysis, Lack of proper standards, etc.
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