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Fundamentals of Financial Manageme...

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

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

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

FINANCIAL STATEMENTS AND TAXES Part I of this case, presented in Chapter 3, discussed the situation of D’Leon Inc., a regional snack foods producer, after an expansion program. D’Leon had increased plant capacity and undertaken a major marketing campaign in an attempt to “go national.” Thus far, sales have not been up to the forecasted level; costs have been higher than were projected; and a large loss occurred in 2015 rather than the expected profit. As a result, its managers, directors, and investors are concerned about the firm’s survival.

Donna Jamison was brought in as assistant to Fred Campo, D’Leon’s chairman, who had the task of getting the company back into a sound financial position. D’Leon’s 2014 and 2015 balance sheets and income statements, together with projections for 2016, are given in Tables IC 4.1 and IC 4.2. In addition, Table IC 4.3 gives the company’s 2014 and 2015 financial ratios, together with industry average data. The 2016 projected financial statement data represent Jamison’s and Campo’s best guess for 2016 results, assuming that some new financing is arranged to get the company “over the hump.”

Jamison examined monthly data for 2015 (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 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.

  1. a. Why are ratios useful? What are the five major categories of ratios?
  2. b. Calculate D’Leon’s 2016 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 2014, in 2015, and as projected for 2016? 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.
  3. c. Calculate the 2016 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?
  4. d. Calculate the 2016 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?
  5. e. Calculate the 2016 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?
  6. f. Calculate the 2016 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?
  7. g. Use the DuPont equation to provide a summary and overview of D’Leon’s financial condition as projected for 2016. What are the firm’s major strengths and weaknesses?
  8. h. Use the following simplified 2016 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?

    images

  9. i. Does it appear that inventories could be adjusted? If so, how should that adjustment affect D’Leon’s profitability and stock price?
  10. j. In 2015, 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 2016, D’Leon showed you its 2016 projections along with proof that it was going to raise more than $1.2 million of new equity?
  11. k. In hindsight, what should D’Leon have done in 2014?
  12. l. What are some potential problems and limitations of financial ratio analysis?
  13. m. What are some qualitative factors that analysts should consider when evaluating a company’s likely future financial performance?

    TABLE IC 4.1 Balance Sheets

    images

    Note: E indicates estimated. The 2016 data are forecasts.

    TABLE IC 4.2 Income Statements

    images

Note: E indicates estimated. The 2016 data are forecasts.

aThe firm had sufficient taxable income in 2013 and 2014 to obtain its full tax refund in 2015.

Ratio Analysis TABLE IC 4.3

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a.

Summary Introduction

To explain: Usefulness of ratio and identify five major categories of ratio.

Ratio:

Ratio shows the relation between the two quantities. Ratio is calculated by dividing one quantity by another quantity.

Explanation

The usefulness of ratio are as follows:

Ratio gives various information about the business. On the basis of this information manager take decisions. Ratio help in understanding various aspect of the business like current ratio tells about the liquidity of the corporation, asset management ratio tells about how the asset is managed by the corporation and many others...

b.

Summary Introduction

To explain: The current and quick ratios of Company D in 2016.

Current ratio:

It shows the ability of the corporation to pay of its current liabilities. It is calculated by dividing current assets from current liabilities.

Summary Introduction

To discuss: The liquidity position of the company.

Summary Introduction

To discuss: The interest of manager, banker and shareholder in the current ratio.

c.

Summary Introduction

To determine: Inventory turnover, day sales outstanding, fixed asset turnover, total assets turnover and the comparison of the ratio with the industry average.

Asset management ratio:

It consists of different kind of ratio which tells the manager how effectively they are managing the firm.

d.

Summary Introduction

To determine: Debt to capital, times interest earned ratios and its comparison with industry average.

Debt management ratio:

It shows how good a company is, in managing its debt. It is calculated by dividing total debt from total capital.

e.

Summary Introduction

To determine: The operating margin, profit margin, basic earning power, return on assets, return on equity, return on invested capital and explain their performance.

Profitability ratio:

This ratio shows the total effect of other ratios on the operating results. It includes ratios like operating margin, profit margin and many others.

f.

Summary Introduction

To determine: Price/earnings ratio, market/book ratio and the effect of it on investor’s perception

Profitability ratio:

This ratio shows the total effect of other ratios on the operating results. It includes ratios like operating margin, profit margin and many others.

g.

Summary Introduction

To determine: The summary or overview of D using DuPont Analysis

Profitability ratio:

This ratio shows the total effect of other ratios on the operating results. It includes ratios like operating margin, profit margin and many others.

Summary Introduction

To discuss: The strength and the weakness of the company.

h.

Summary Introduction

To explain: Affect of reduction in DSO on stock price

Profitability ratio:

This ratio shows the total effect of other ratios on the operating results. It includes ratios like operating margin, profit margin and many others.

i.

Summary Introduction

To determine: Affect of the inventory on adjustment on the profitability and stock price of the company.

Profitability ratio:

This ratio shows the total effect of other ratios on the operating results. It includes ratios like operating margin, profit margin and many others.

j.

Summary Introduction

To determine: Bank manager action related to the loan renewal

Profitability ratio:

This ratio shows the total effect of other ratios on the operating results. It includes ratios like operating margin, profit margin and many others.

k.

Summary Introduction

To explain: The action taken by the D in the 2014.

Profitability ratio:

This ratio shows the total effect of other ratios on the operating results. It includes ratios like operating margin, profit margin and many others.

l.

Summary Introduction

To determine: Problem and limitations of financial ratios.

Ratio:

Ratio shows the relation between the two quantities. Ratio is calculated by dividing one quantity by another quantity.

m.

Summary Introduction

To determine: Qualitative factors that analyst should consider while evaluating company’s future prospect.

Qualitative factors:

Qualitative factors are those factors which cannot be measured but have significant effect on company’s performance.

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