Ratios
| Chapter 3 Mini Case | ||||
| The first part of the case, presented in Chapter 2, discussed the situation of Computron Industries after an expansion program. A large loss occurred in 2016, 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 Computron’s chairman, who had the task of getting the company back into a sound financial position. Cochran must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions to take. Your assignment is to help her answer the following questions, using the recent and projected financial information shown next. Provide clear explanations, not yes or no answers. | ||||
| Input Data: | ||||
| 2015 | 2016 | 2017E Bart Kreps: Projections |
||
| Year-end common stock price | $8.50 | $6.00 | $12.17 | |
| Year-end shares outstanding | 100,000 | 100,000 | 250,000 | |
| Tax rate | 40% | 40% | 40% | |
| Lease payments | $40,000 | $40,000 | $40,000 | |
| Balance Sheets | ||||
| Assets | 2015 | 2016 | 2017E | |
| Cash and equivalents | $9,000 | $7,282 | $14,000 | |
| Short-term investments | $48,600 | $20,000 | $71,632 | |
| Accounts receivable | $351,200 | $632,160 | $878,000 | |
| Inventories | $715,200 | $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 Dep. | $146,200 | $263,160 | $383,160 | |
| Net Fixed Assets | $344,800 | $939,790 | $836,840 | |
| Total Assets | $1,468,800 | $2,886,592 | $3,516,952 | |
| Liabilities and 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 bonds | $323,432 | $1,000,000 | $500,000 | |
| Total liabilities | $805,032 | $2,328,960 | $1,539,800 | |
| Common stock (100,000 shares) | $460,000 | $460,000 | $1,680,936 | |
| Retained earnings | $203,768 | $97,632 | $296,216 | |
| Total common equity | $663,768 | $557,632 | $1,977,152 | |
| Total liabilities and equity | $1,468,800 | $2,886,592 | $3,516,952 | |
| Income Statements | ||||
| 2015 | 2016 | 2017E | ||
| Net sales | $3,432,000 | $5,834,400 | $7,035,600 | |
| Costs of Goods Sold Except Depr. | $2,864,000 | $4,980,000 | $5,800,000 | |
| Depreciation and amortization | $18,900 | $116,960 | $120,000 | |
| Other Expenses | $340,000 | $720,000 | $612,960 | |
| Total Operating Cost | $3,222,900 | $5,816,960 | $6,532,960 | |
| Earnings before interest and taxes (EBIT) | $209,100 | $17,440 | $502,640 | |
| Less interest | $62,500 | $176,000 | $80,000 | |
| Pre-tax earnings | $146,600 | ($158,560) | $422,640 | |
| Taxes (40%) | $58,640 | ($63,424) | $169,056 | |
| Net Income before preferred dividends | $87,960 | ($95,136) | $253,584 | |
| EPS | $0.880 | ($0.951) | $1.014 | |
| DPS | $0.220 | $0.110 | $0.220 | |
| Book Value Per Share | $6.638 | $5.576 | $7.909 | |
| 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. (1.) Calculate the current and quick ratios based on the projected balance sheet and income statement data. | ||||
| Calculated Data: Ratios | Industry | |||
| 2015 | 2016 | 2017E | Average | |
| Liquidity ratios | ||||
| Current Ratio Bart Kreps: Current Assets divided by Current Liabilities. |
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| Quick Ratio Bart Kreps: Current Assets minus Inventories divided by Current Liabilities. |
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| (2.) What can you say about the company’s liquidity position? We often think of ratios as being useful (1) to managers to help run 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? | ||||
| 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 | 2015 | 2016 | 2017E | Average |
| Inventory Turnover Bart Kreps: COGS divided by Inventories. |
6.10 | |||
| Days Sales Outstanding Bart Kreps: Accounts Receivable divided by average daily sales. |
32.00 | |||
| Fixed Asset Turnover Bart Kreps: Sales divided by Net Fixed Assets. |
7.00 | |||
| Total Asset Turnover Bart Kreps: Sales divided by Total Assets. |
2.50 | |||
| d. Calculate the debt ratio, liabilities-to-assets ratio, 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 | 2015 | 2016 | 2017E | Average |
| Debt Ratio | 32.0% | |||
| Liabilities-to-assets Ratio Bart Kreps: Total Debt divided by Total Assets. |
50.0% | |||
| Times Interest Earned Bart Kreps: EBIT divided by interest charges. |
6.20 | |||
| EBITDA Coverage Ratio Bart Kreps: (EBITDA + Lease Payments) / (Interest + Loan Payments + Lease Payments) |
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 | 2015 | 2016 | 2017E | Average |
| Net Profit Margin Bart Kreps: Net Income divided by sales. |
3.6% | |||
| Operating Margin Bart Kreps: EBIT divided by sales. |
7.1% | |||
| Gross Profit Margin Bart Kreps: Net Income divided by (Sales – COGS). |
15.5% | |||
| Basic Earning Power Bart Kreps: EBIT divided by Total Assets. |
17.8% | |||
| Return on Assets Bart Kreps: Net Income divided by Total Assets. |
9.0% | |||
| Return on Equity Bart Kreps: Net Income divided by Common Equity. |
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 | 2015 | 2016 | 2017E | Average |
| Price-to Earnings Ratio Bart Kreps: Price per share divided by Earnings Per Share. |
14.20 | |||
| Price-to-Cash Flow Ratio Bart Kreps: P/CF ratio is calculated by dividing the price by the net cash flow per share. |
7.60 | |||
| Market-to-Book Ratio Bart Kreps: Market Price per share divided by Book value per share. |
2.90 | |||
| Book Value Per Share Bart Kreps: Common Equity divided by shares outstanding. |
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 DuPont equation to provide a summary and overview of Computron’s projected financial condition. What are the firm’s major strengths and weaknesses? | ||||
| DuPont Analysis | ROE = | P.M. X | T.A.T.O. X | Equity Multiplier |
| Computron | 2015 | |||
| Computron | 2016 | |||
| Computron | 2017E | |||
| Industry Average | 18.00% | 0.0% | 2.5 | 2.00 |
| i. What are some potential problems and limitations of financial ratio analysis? | ||||
| j. What are some qualitative factors analysts should consider when evaluating a company’s likely future financial performance? |
Common Size and % Change
| Common Size Statements | ||||
| Balance Sheets | 2015 | 2016 | 2017E | Industry |
| Assets Bart Kreps: Percentage of Total Assets. |
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| Cash and equivalents | 0.3% | |||
| Short-term investments | 0.3% | |||
| Accounts receivable | 22.4% | |||
| Inventories | 41.2% | |||
| Total Current Assets | 64.1% | |||
| Net Fixed Assets | 35.9% | |||
| Total Assets | 100.0% | 100.0% | 100.0% | 100.0% |
| Liabilities and equity Bart Kreps: Percentage of Total Liabilities and Equity. |
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| Accounts payable | 11.9% | |||
| Notes payable | 2.4% | |||
| Accruals | 9.5% | |||
| Total current liabilities | 23.7% | |||
| Long-term bonds | 26.3% | |||
| Total common equity | 50.0% | |||
| Total liabilities and equity | 100.0% | 100.0% | 100.0% | 100.0% |
| Income Statements | 2015 | 2016 | 2017E | Industry |
| Net sales Bart Kreps: Percentage of Net Sales. |
100.0% | |||
| COGS except depr. | 84.5% | |||
| Depreciation | 4.0% | |||
| Other Expenses | 4.4% | |||
| EBIT | 7.1% | |||
| Less interest | 1.1% | |||
| Pre-tax earnings | 5.9% | |||
| Taxes (40%) | 2.4% | |||
| Net Income before preferred dividends | 3.6% | |||
| Percentage Change Analysis | ||||
| Balance Sheets | 2015 | 2016 | 2017E | |
| Assets | ||||
| Cash and equivalents | 0% | |||
| Short-term investments | 0% | |||
| Accounts receivable | 0% | |||
| Inventories | 0% | |||
| Total Current Assets | 0% | |||
| Net Fixed Assets | 0% | |||
| Total Assets | 0% | |||
| Liabilities and equity | ||||
| Accounts payable | 0% | |||
| Notes payable | 0% | |||
| Accruals | 0% | |||
| Total current liabilities | 0% | |||
| Long-term bonds | 0% | |||
| Total common equity | 0% | |||
| Total liabilities and equity | 0% | |||
| Income Statements | 2015 | 2016 | 2017E | |
| Net sales | 0% | |||
| Costs of Goods Sold | 0% | |||
| Depreciation | 0% | |||
| Other Expenses | 0% | |||
| EBIT | 0% | |||
| Less interest | 0% | |||
| Pre-tax earnings | 0% | |||
| Taxes (40%) | 0% | |||
| Net Income before preferred dividends | 0% |
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 assets. In percent change analysis, all items are expressed as a percent change from the first year, called the base year, of the analysis.
