   Chapter 4, Problem 25SP Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

Solutions

Chapter
Section Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

RATIO ANALYSIS The Corrigan Corporation’s 2014 and 2015 financial statements follow, along with some industry average ratios. a. Assess Corrigan’s liquidity position, and determine how it compares with peers and how the liquidity position has changed over time. b. Assess Corrigan’s asset management position, and determine how it compares with peers and how its asset management efficiency has changed over time. c. Assess Corrigan’s debt management position, and determine how it compares with peers and how its debt management has changed over time. d. Assess Corrigan’s profitability ratios, and determine how they compare with peers and how its profitability position has changed over time. e. Assess Corrigan’s market value ratios, and determine how its valuation compares with peers and how it has changed over time. f. Calculate Corrigan’s ROE as well as the industry average ROE, using the DuPont equation. From this analysis, how does Corrigan’s financial position compare with the industry average numbers? g. What do you think would happen to its ratios if the company initiated cost-cutting measures that allowed it to hold lower levels of inventory and substantially decreased the cost of goods sold? No calculations are necessary. Think about which ratios would be affected by changes in these two accounts. Corrigan Corporation: Balance Sheets as of December 31   2015 2014 Cash $72,000$ 65,000 Accounts receivable 439,000 328,000 Inventories 894,000 813,000 Total current assets $1,405,000$1,206,000 Land and building 238,000 271,000 Machinery 132,000 133,000 Other fixed assets 61,000 57,000 Total assets $1,836,000$1,667,000 Accounts payable $80,000$ 72,708 Accrued liabilities 45,010 40,880 Notes payable 476,990 457,912 Total current liabilities $602,000$ 571,500 Long-term debt 404,290 258,898 Common stock 575,000 575,000 Retained earnings 254,710 261,602 Total liabilities and equity $1,836,000$1,667,000 Corrigan Corporation: Income Statements for Years Ending December 31 2015 2014 Sales $4,240,000$3,635,000 Cost of goods sold 368000000% $2,980,000 Gross operating profit$560,000.00 $655,000 General administrative and selling expenses$303,320 297,550 Depreciation 159,000 154,500 EBIT 97,680 $202,950 Interest 67,000 43,000 Earnings before taxes (EBT) 30,680$159,950 Taxes (40%) 12,272 63,980 Net income 18,408 95,970 Per-Share Data 2015 2014 EPS $1$4 Cash dividends $1.10$1 Market price (average) $12.34$24 P/E ratio 15.42× 5.65× Number of shares outstanding 23,000 23,000 Industry Financial Ratiosa 2015 Current ratio 2.7× Inventory turnoverb 7.0× Days sales outstandingc 32.0 days Fixed assets turnoverb 13.0× Total assets turnoverb 2.6× Return on assets 0 Return on equity 0 Return on invested capital 0 Profit margin 0 Debt-to-capital ratio 1 P/E ratio 6.0× aIndustry average ratios have been constant for the past 4 years.bBased on year-end balance sheet figures.cCalculation is based on a 365-day year.

a.

Summary Introduction

To determine: The liquidity position of C Corporation, comparison of liquidity position with peers and the changes in liquidity position over the time.

Ratio Analysis: Ratio is used to compare two arithmetical figures. In case of the ratio analysis of the company, the financial ratios are calculated. The financial ratios examines the performance of the company and are used in comparing with other same business. It indicates relationship of two or more parts of financial statements.

Liquidity Position: The liquidity position of the company is indicated by liquidity ratios, which gives the idea of whether the company has the ability to pay back its liabilities, which has less than one year maturity.

Explanation

Current ratio

2014

Given,

Current asset is $1,206,000. Current liabilities is$571,500.

The formula to calculate current ratio is,

Current Ratio=Current AssetsCurrent Liabilities

Substitute $1,206,000 for current assets and$571,500 for current liabilities.

Current Ratio=$1,206,000$571,500=2.11 times

Therefore, current ratio is 2.11 times.

2015

Given,

Current asset is $1,405,000. Current liabilities is$602,000.

The formula to calculate current ratio is,

Current Ratio=Current AssetsCurrent Liabilities

Substitute $1,405,000 for current assets and$602,000 for current liabilities in above formula

b.

Summary Introduction

To determine: The Assets management position of C Corporation, comparison of assets management position with peers and the changes in assets management position over the time.

Assets Management Position: The assets management position of the company is indicated by assets management ratios which give idea how well the company is using its assets.

c.

Summary Introduction

To determine: The debt management position of C Corporation, comparison of debt management position with peers and the changes in debt management position over the time.

Debt Management Position: Debt management position is indicated by the debt management ratios that give an idea how the company finances its assets as well as the capability to pay back its long-term debt.

d.

Summary Introduction

To determine: The profitability ratio of C Corporation, compare it with peers and the change in the profitability of the company over the time.

Profitability Ratios: These ratios give an idea whether the company is able to operate profitably and is efficient in using its assets.

e.

Summary Introduction

To determine: The market value ratios, comparison of ratios with peers and changes in market values over the time.

Market Value Ratios: The market value ratios give idea about the view of investors towards the company and company’s future scenario.

f.

Summary Introduction

To calculate: The ROE of the C company as well industry average ROE using DuPont equation and way of comparing of Company’s financial position with industry’s average numbers.

Return on Equity (ROE): Return on equity is the return from the equity. It is the ratio of net income and shareholders’ equity. This ratio measures the performance of the company and tells how well the company is performing. This ratio is used to compare own firm with competitors.

Du Pont Equation: Among all ratios, return on equity is very common. It shows the value of the firm. Improvement in the ROE is considered as valued addition to the firm. ROE can be linked with other ratios. Analysis of such ratios will indicate proper reason for change in ROE. The combination is known as Du Pont equation which is shown below:

ROE =Net IncomeCommon Equity=Net IncomeTotal Assets×Total AssetsCommon Assets=Net IncomeSales×SalesTotal Assets×Total AssetsTotal Common Equity=Profit Margin× Total Assets Turnover Ratio×Equity Multiplier

g.

Summary Introduction

To identify: The changes in the ratios, if the firm started cost-cutting measures, which allowed it to hold lower level of the inventory and substantially deceased the cost of goods sold.

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