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A Solution Guide
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Chapter 8 Mini Case
The first part of the case, presented in Chapter 7, discussed the situation that Computron Industries was in after and expansion program. Thus far, sales have not been up to the forecasted level, cost have been higher than were projected, and a large loss occurred in 2009, rather than the expected profit. As a result, its managagers, directors, and investors are concerned about the firm's survival. Donna Jamison was brought in as an assistant to Fred Campo, Computron's chairman, who had the task of getting the company back into a sound financial position. Computron's 2008 and 2009 balance sheets and income statements, together with projections for 2010, are shown in the following tables. Also, the tables show the 2008 and 2009 financial ratios along with industry average data. The 2010 projected financial statement data represent Jamison's and Campo's best guess for 2010 results, assuming that some new financing is arranged to get the company "over the hump." Input Data: Year-end common stock price Year-end shares outstanding Tax rate Lease payments Balance Sheets Assets Cash and equivalents Short-term investments Accounts receivable Inventories Total current assets Gross Fixed Assets Less Accumulated Dep. Net Fixed Assets Total Assets Liabilities and equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total liabilities Common stock (100,000 shares) Retained earnings Total common equity Total liabilities and equity Income Statements 2008 Net sales $3,432,000 Costs of Goods Sold $2,864,000 Other Expenses $340,000 Depreciation $18,900 Total Operating Cost $3,222,900 Earnings before interest and taxes (EBIT) $209,100 Less interest $62,500 Earnings before taxes (EBT) $146,600 Taxes (40%) $58,640 Net Income before preferred dividends $87,960 EPS $0.880 DPS $0.220 Book Value Per Share $6.638 2009 $5,834,400 $4,980,000 $720,000 $116,960 $5,816,960 $17,440 $176,000 ($158,560) ($63,424) ($95,136) ($0.951) $0.110 $5.576 2010E $7,035,600 $5,800,000 $612,960 $120,000 $6,532,960 $502,640 $80,000 $422,640 $169,056 $253,584 $1.014 $0.220 $7.909 2008 $9,000 $48,600 $351,200 $715,200 $1,124,000 $491,000 $146,200 $344,800 $1,468,800 2009 $7,282 $20,000 $632,160 $1,287,360 $1,946,802 $1,202,950 $263,160 $939,790 $2,886,592 2010E $14,000 $71,632 $878,000 $1,716,480 $2,680,112 $1,220,000 $383,160 $836,840 $3,516,952 2008 $8.50 100,000 40% $40,000 2009 $6.00 100,000 40% $40,000 2010E $12.17 250,000 40% $40,000
$145,600 $200,000 $136,000 $481,600 $323,432 $805,032 $460,000 $203,768 $663,768 $1,468,800
$324,000 $720,000 $284,960 $1,328,960 $1,000,000 $2,328,960 $460,000 $97,632 $557,632 $2,886,592
$359,800 $300,000 $380,000 $1,039,800 $500,000 $1,539,800 $1,680,936 $296,216 $1,977,152 $3,516,952
Jamison examined monthly data (not given in the case), and she detected an improving pattern during the year. Monthly sales were rising, costs were falling, and large losses in the early months had turned to a small profit by December. Thus, the annual data look somewhat worse than final monthly data. Also, it appears to be taking longer for the advertising program to get the message across, for the new sales offices to generate sales, and for the new manufacturing facilities to operate efficiently. In other words, the lags between spending money and deriving benefits were longer than Computron's managers had anticipated. For these reasons, Jamison and Campo see hope for the company--provided it can survive in the short run. Jamison 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 are the five major categories of ratios? Answer: See Chapter 08 Mini Case Show b. (1.) Calculate the current and quick ratios based on the projected balance sheet and income statement data. Calculated Data: Ratios 2008 Liquidity ratios Current Ratio Quick Ratio 2.33 0.85 2009 1.46 0.50 2010E 2.58 0.93 Industry Average 2.70 1.00
(2.) What can you say about the company's liquidity position? We often think of ratios as being useful (1) to managers to run help the 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? Answer: See Chapter 08 Mini Case Show
c. Calculate the inventory turnover, days sales outstanding (DSO), fixed assets turnover, operating capital requirement, and total assets turnover. How does Computron's utilization of assets stack up against other firms in its industry? Industry Asset Management ratios 2008 2009 2010E Average Inventory Turnover 4.80 4.53 4.10 6.10 Days Sales Outstanding 37.4 39.5 45.5 32.00 Fixed Asset Turnover 9.95 6.21 8.41 7.00 Total Asset Turnover 2.34 2.02 2.00 2.50 d. Calculate the 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? Industry Debt Management ratios 2008 2009 2010E Average Debt Ratio 54.8% 80.7% 43.8% 50.0% Times Interest Earned 3.35 0.10 6.28 6.20 EBITDA Coverage Ratio 2.61 0.81 5.52 8.00 e. Calculate the profit margin, basic earning power (BEP), return on assets (ROA), and return on equity (ROE). What can you say about these ratios? Industry Profitability ratios 2008 2009 2010E Average Profit Margin 2.6% -1.6% 3.6% 3.6% Basic Earning Power 14.2% 0.6% 14.3% 17.8% Return on Assets 6.0% -3.3% 7.2% 9.0% Return on Equity 13.3% -17.1% 12.8% 18.0% f. Calculate the 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? Industry Market Value ratios 2008 2009 2010E Average Price-to Earnings Ratio 9.66 -6.31 12.00 14.20 Price-to-Cash Flow Ratio 7.95 27.49 8.14 7.60 Market-to-Book Ratio 1.28 1.08 1.54 2.90 Book Value Per Share 6.64 5.58 7.91 na g. Perform a common size analysis and percent change analysis. What do these analyses tell you about Computron? See the worksheet with the TAB "Common Size and % Change"
h. Use the extended Du Pont equation to provide a summary and overview of Computron's projected financial condition. What are the firm's major strengths and weaknesses? Du Pont Analysis Computron 2008 Computron 2009 Computron 2010E Industry Average ROE = 13.3% -17.1% 12.8% 18.00% P.M. 2.6% -1.6% 3.6% 3.6% X T.A.T.O. Equity Multiplier X 2.3 2.21 2.0 5.18 2.0 1.78 2.5 2.00
i. What are some potential problems and limitations of financial ratio analysis? Answer: See Chapter 08 Mini Case Show j. What are some qualitative factors analysts should consider when evaluating a company's likely future financial performance? Answer: See Chapter 08 Mini Case Show Extra points: Please, run a trend analysis using the ratios for 2008, 2009 and 2010. Draw graphs for each group of ratios.
Common Size Analysis and Percent Change Analysis
In common size analysis, all income statement items are divided by sales, and all balance sheet items are divided by total items are divided by sales, and all balance sheet items are by total assets. assets. In percent change analysis, all items are expressed as a percent change from the first year, called the base year, of the analysis. as a percent change from the first year, called the base year, of the analysis.
Common Size Statements Balance Sheets 2008 2009 2010E Industry
Assets Cash and equivalents Short-term investments Accounts receivable Inventories Total Current Assets Net Fixed Assets Total Assets Liabilities and equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total common equity Total liabilities and equity
0.6% 3.3% 23.9% 48.7% 76.5% 23.5% 100.0%
0.3% 0.7% 21.9% 44.6% 67.4% 32.6% 100.0%
0.4% 2.0% 25.0% 48.8% 76.2% 23.8% 100.0%
0.3% 0.3% 22.4% 41.2% 64.1% 35.9% 100.0%
9.9% 13.6% 9.3% 32.8% 22.0% 45.2% 100.0%
11.2% 24.9% 9.9% 46.0% 34.6% 19.3% 100.0%
10.2% 8.5% 10.8% 29.6% 14.2% 56.2% 100.0%
11.9% 2.4% 9.5% 23.7% 26.3% 50.0% 100.0%
Income Statements
2008
2009
2010E
Industry
Net sales Costs of Goods Sold Other Expenses Depreciation EBIT Less interest Earnings before taxes (EBT) Taxes (40%) Net Income before preferred dividends
100.0% 83.4% 9.9% 0.6% 6.1% 1.8% 4.3% 1.7% 2.6%
100.0% 85.4% 12.3% 2.0% 0.3% 3.0% -2.7% -1.1% -1.6%
100.0% 82.4% 8.7% 1.7% 7.1% 1.1% 6.0% 2.4% 3.6%
100.0% 84.5% 4.4% 4.0% 7.1% 1.1% 5.9% 2.4% 3.6%
Percentage Change Analysis Balance Sheets 2008 2009 2010E
Assets Cash and equivalents Short-term investments Accounts receivable Inventories Total Current Assets Net Fixed Assets Total Assets Liabilities and equity Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total common equity Total liabilities and equity
0% 0% 0% 0% 0% 0% 0%
-19.1% -58.8% 80.0% 80.0% 73.2% 172.6% 96.5%
55.6% 47.4% 150.0% 140.0% 138.4% 142.7% 139.4%
0% 0% 0% 0% 0% 0% 0%
122.5% 260.0% 109.5% 175.9% 209.2% -16.0% 96.5%
147.1% 50.0% 179.4% 115.9% 54.6% 197.9% 139.4%
Income Statements
2008
2009
2010E
Net sales Costs of Goods Sold Other Expenses Depreciation EBIT Less interest Earnings before taxes (EBT) Taxes (40%) Net Income before preferred dividends
0% 0% 0% 0% 0% 0% 0% 0% 0%
70.0% 73.9% 111.8% 518.8% -91.7% 181.6% -208.2% -208.2% -208.2%
105.0% 102.5% 80.3% 534.9% 140.4% 28.0% 188.3% 188.3% 188.3%