Jamison examined monthly data for 2016 (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 the final monthly data. Also, it appears to be taking longer for the advertising program to get the message out, 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 D’Leon’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.

Why are ratios useful? What are the five major categories of ratios?

Calculate D’Leon’s 2017 current and quick ratios based on the projected balance sheet and income statement data. What can you say about the company’s liquidity positions in 2015, in 2016, and as projected for 2017? 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 company’s liquidity ratios? Explain your answer.

Calculate the 2017 inventory turnover, days sales outstanding (DSO), fixed assets turnover, and total assets turnover. How does D’Leon’s utilization of assets stack up against other firms in the industry?

Calculate the 2017 debt-to-capital and times-interest-earned ratios. How does D’Leon compare with the industry with respect to financial leverage? What can you conclude from these ratios?

Calculate the 2017 operating margin, profit margin, basic earning power (BEP), return on assets (ROA), return on equity (ROE), and return on invested capital (ROIC). What can you say about these ratios?

Calculate the 2017 price/earnings ratio and market/book ratio. Do these ratios indicate that investors are expected to have a high or low opinion of the company?

Use the DuPont equation to provide a summary and overview of D’Leon’s financial condition as projected for 2017. What are the firm’s major strengths and weaknesses?

Use the following simplified 2017 balance sheet to show, in general terms, how an improvement in the DSO would tend to affect the stock price. For example, if the company could improve its collection procedures and thereby lower its DSO from 45.6 days to the 32-day industry average without affecting sales, how would that change “ripple through” the financial statements (shown in thousands below) and influence the stock price?

Does it appear that inventories could be adjusted? If so, how should that adjustment affect D’Leon’s profitability and stock price?

In 2016, the company paid its suppliers much later than the due dates; also, it was not maintaining financial ratios at levels called for in its bank loan agreements. Therefore, suppliers could cut the company off, and its bank could refuse to renew the loan when it comes due in 90 days. On the basis of data provided, would you, as a credit manager, continue to sell to D’Leon on credit? (You could demand cash on delivery—that is, sell on terms of COD—but that might cause D’Leon to stop buying from your company.) Similarly, if you were the bank loan officer, would you recommend renewing the loan or demanding its repayment? Would your actions be influenced if, in early 2017, D’Leon showed you its 2017 projections along with proof that it was going to raise more than $1.2 million of new equity?

In hindsight, what should D’Leon have done in 2015?

What are some potential problems and limitations of financial ratio analysis?

What are some qualitative factors that analysts should consider when evaluating a company’s likely future financial performance?

Transcribed Image Text:collection procedures and thereby lower its DSO from 45.6 days to the 32-day industry average without affecting sales, how would that change “ripple through" the financial statements (shown in thousands below) and influence the stock price? Accounts receivable $ 878 Current liabilities $ 845 Other current assets 1,802 Debt 700 Net fixed assets Equity Liabilities plus equity 1,952 $3,497 817 Total assets $3,497
Transcribed Image Text:Table IC 4.1 Balance Sheets 2017E 2016 2015 Assets Cash $ 85,632 7,282 $ 57600 Accounts receivable 878,000 632,160 351,200 Inventories 1,716,480 1,287,360 715,200 Total current assets $2,680,112 $1,926,802 $1,124,000 491,000 146,200 $ 344,800 Gross fixed assets 1,197,160 1,202,950 Less accumulated depreciation 380,120 $ 817,040 263,160 $ 939,790 $2,866,592 Net fixed assets Total assets $3497,152 $1,468,800 Liabilities and Equity Accounts payable $ 436,800 $ 524,160 $ 145,600 Асспuals 408,000 489,600 136,000 300,000 $1,144,800 636,808 $1,650,568 Notes payable 200,000 $ 481600 Total current liabilities Long-tem debt 400,000 723,432 323432 Common stock 1,721,176 460,000 460,000 Retained eamings Total equity 231,176 $1,952,352 $3497,152 203,768 $ 663,768 32,592 $ 492,592 $2,866,592 Total liabilities and equity $1,468.800 Note: E indicates estimated. The 2017 data are forccasts. Table IC 4.2 Income Statements 2017E 2016 2015 Sales $7,035600 $6,034,000 $3,432,000 Cost of goods sold Other expenses 5,875,992 5,528,000 2,864,000 550,000 519,988 _358,672 Total operating costs exduding depreciation and amortization $6,425,992 $ 6,047,988 $ 609,608 ($ $3,222,672 $ 209,328 EBITDA 13,988) Depreciation & amortization 116,960 116,960 18,900 $ 492,648 ($ 130,948) 70,008 $ 422,640 ($ 266,960) (106,784) $ 190,428 43,828 $ 146,600 58,640 EBIT Interest expense 136,012 EBT Taxes (40%) 169,056 Net income 253,584 ($ 160,176) $ 87,960 $ 1.014 $ 0.220 $ 7.809 $ 12.17 ($ 1.602) $ 0.110 $ 4.926 $ 2.25 EPS $ 0.880 DPS Book value per share Stock price Shares outstanding $ 0.220 $ 6.638 $ 8.50 250,000 100,000 100,000 Таx rate 40.00% 40.00% 40.00% Lease payments $40,000 $40,000 $40,000 Sinking fund payments Note: E indicates estimated. The 2017 data are forccasts. The firm had sufficient taxable income in 2014 and 2015 to obtain its full tax refund in 2016. Table IC 4.3 Ratio Analysis Industry Average 2017E 2016 2015 Current 1.2x 23x 2.7x Quick 0.4x 0.8x 1.0x Inventory turnover 4.7x 4.8 x 6.1x Days sales outstanding (DSOr 38.2 37.4 320 Fixed assets turnover 6.4x 10.0x 7.0x Total assets turnover 2.1x 2.3x 2.6x Debt-to-capital ratio 73.4% 44.1% 40.0% TIE -1.0x 4.3x 6.2x Operating margin Profit margin -2.2% 5.5% 7.3% -2.7% 2.6% 3.5% Basic earning power -4.6% 13.0% 19.1% ROA -5.6% 6.0% 9.1% ROE -32.5% 13.3% 182% ROIC -4.2% 9.6% 145% Price/earnings Market/book -1.4x 9.7 x 142x 0.5x 1.3x 24x Book value per share $4.93 $664 na. Note: E indicates estimated. The 2017 data are forecasts. a. Calculation is based on a 365-day year.

Question

Jamison examined monthly data for 2016 (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 the final monthly data. Also, it appears to be taking longer for the advertising program to get the message out, 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 D’Leon’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.

Why are ratios useful? What are the five major categories of ratios?
Calculate D’Leon’s 2017 current and quick ratios based on the projected balance sheet and income statement data. What can you say about the company’s liquidity positions in 2015, in 2016, and as projected for 2017? 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 company’s liquidity ratios? Explain your answer.
Calculate the 2017 inventory turnover, days sales outstanding (DSO), fixed assets turnover, and total assets turnover. How does D’Leon’s utilization of assets stack up against other firms in the industry?
Calculate the 2017 debt-to-capital and times-interest-earned ratios. How does D’Leon compare with the industry with respect to financial leverage? What can you conclude from these ratios?
Calculate the 2017 operating margin, profit margin, basic earning power (BEP), return on assets (ROA), return on equity (ROE), and return on invested capital (ROIC). What can you say about these ratios?
Calculate the 2017 price/earnings ratio and market/book ratio. Do these ratios indicate that investors are expected to have a high or low opinion of the company?
Use the DuPont equation to provide a summary and overview of D’Leon’s financial condition as projected for 2017. What are the firm’s major strengths and weaknesses?
Use the following simplified 2017 balance sheet to show, in general terms, how an improvement in the DSO would tend to affect the stock price. For example, if the company could improve its collection procedures and thereby lower its DSO from 45.6 days to the 32-day industry average without affecting sales, how would that change “ripple through” the financial statements (shown in thousands below) and influence the stock price?
Does it appear that inventories could be adjusted? If so, how should that adjustment affect D’Leon’s profitability and stock price?
In 2016, the company paid its suppliers much later than the due dates; also, it was not maintaining financial ratios at levels called for in its bank loan agreements. Therefore, suppliers could cut the company off, and its bank could refuse to renew the loan when it comes due in 90 days. On the basis of data provided, would you, as a credit manager, continue to sell to D’Leon on credit? (You could demand cash on delivery—that is, sell on terms of COD—but that might cause D’Leon to stop buying from your company.) Similarly, if you were the bank loan officer, would you recommend renewing the loan or demanding its repayment? Would your actions be influenced if, in early 2017, D’Leon showed you its 2017 projections along with proof that it was going to raise more than $1.2 million of new equity?
In hindsight, what should D’Leon have done in 2015?
What are some potential problems and limitations of financial ratio analysis?
What are some qualitative factors that analysts should consider when evaluating a company’s likely future financial performance?

collection procedures and thereby lower its DSO from 45.6 days to the 32-day industry average
without affecting sales, how would that change “ripple through" the financial statements (shown in
thousands below) and influence the stock price?
Accounts receivable
$ 878
Current liabilities
$ 845
Other current assets
1,802
Debt
700
Net fixed assets
Equity
Liabilities plus equity
1,952
$3,497
817
Total assets
$3,497

Table IC 4.1 Balance Sheets
2017E
2016
2015
Assets
Cash
$ 85,632
7,282
$ 57600
Accounts receivable
878,000
632,160
351,200
Inventories
1,716,480
1,287,360
715,200
Total current assets
$2,680,112
$1,926,802
$1,124,000
491,000
146,200
$ 344,800
Gross fixed assets
1,197,160
1,202,950
Less accumulated depreciation
380,120
$ 817,040
263,160
$ 939,790
$2,866,592
Net fixed assets
Total assets
$3497,152
$1,468,800
Liabilities and Equity
Accounts payable
$ 436,800
$ 524,160
$ 145,600
Асспuals
408,000
489,600
136,000
300,000
$1,144,800
636,808
$1,650,568
Notes payable
200,000
$ 481600
Total current liabilities
Long-tem debt
400,000
723,432
323432
Common stock
1,721,176
460,000
460,000
Retained eamings
Total equity
231,176
$1,952,352
$3497,152
203,768
$ 663,768
32,592
$ 492,592
$2,866,592
Total liabilities and equity
$1,468.800
Note: E indicates estimated. The 2017 data are forccasts.
Table IC 4.2 Income Statements
2017E
2016
2015
Sales
$7,035600
$6,034,000 $3,432,000
Cost of goods sold
Other expenses
5,875,992
5,528,000
2,864,000
550,000
519,988
_358,672
Total operating costs exduding depreciation and
amortization
$6,425,992 $ 6,047,988
$ 609,608 ($
$3,222,672
$ 209,328
EBITDA
13,988)
Depreciation & amortization
116,960
116,960
18,900
$ 492,648 ($ 130,948)
70,008
$ 422,640 ($ 266,960)
(106,784)
$ 190,428
43,828
$ 146,600
58,640
EBIT
Interest expense
136,012
EBT
Taxes (40%)
169,056
Net income
253,584
($ 160,176)
$ 87,960
$ 1.014
$ 0.220
$ 7.809
$ 12.17
($ 1.602)
$ 0.110
$ 4.926
$ 2.25
EPS
$ 0.880
DPS
Book value per share
Stock price
Shares outstanding
$ 0.220
$ 6.638
$ 8.50
250,000
100,000
100,000
Таx rate
40.00%
40.00%
40.00%
Lease payments
$40,000
$40,000
$40,000
Sinking fund payments
Note: E indicates estimated. The 2017 data are forccasts.
The firm had sufficient taxable income in 2014 and 2015 to obtain its full tax refund in 2016.
Table IC 4.3 Ratio Analysis
Industry
Average
2017E
2016
2015
Current
1.2x
23x
2.7x
Quick
0.4x
0.8x
1.0x
Inventory turnover
4.7x
4.8 x
6.1x
Days sales outstanding (DSOr
38.2
37.4
320
Fixed assets turnover
6.4x
10.0x
7.0x
Total assets turnover
2.1x
2.3x
2.6x
Debt-to-capital ratio
73.4%
44.1%
40.0%
TIE
-1.0x
4.3x
6.2x
Operating margin
Profit margin
-2.2%
5.5%
7.3%
-2.7%
2.6%
3.5%
Basic earning power
-4.6%
13.0%
19.1%
ROA
-5.6%
6.0%
9.1%
ROE
-32.5%
13.3%
182%
ROIC
-4.2%
9.6%
145%
Price/earnings
Market/book
-1.4x
9.7 x
142x
0.5x
1.3x
24x
Book value per share
$4.93
$664
na.
Note: E indicates estimated. The 2017 data are forecasts.
a.
Calculation is based on a 365-day year.

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