FINANCIAL STATEMENTS AND TAXES Part I of this case, presented in Chapter 3, disc
ID: 2414443 • Letter: F
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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 2016 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 2015 and 2016 balance sheets and income statements, together with projections for 2017, are given in Tables IC 4.1 and IC 4.2. In addition, Table IC 4.3 gives the company’s 2015 and 2016 financial ratios, together with industry average data. The 2017 projected financial statement data represent Jamison’s and Campo’s best guess for 2017 results, assuming that some new financing is arranged to get the company “over the hump.”
Table IC 4.1 Balance Sheets 2017E 2016 2015 Assets Cash Accounts receivable Inventories $ 85,632 878,000 1,716,480 $2,680,112 1,197,160 380,120 817040 $ 7,282 632,160 1,287,360 $1,926,802 1,202,950 263,160 939,790 $2,866,592 57600 351,200 715200 1,124,000 491,000 146,200 344800 Total current assets Gross fixed assets Less accumulated depreciation Net fixed assets Total assets 152 $ 1468,800 Liabilities and Equity Accounts payable Accruals Notes payable 436,800 408,000 300,000 $1,144800 400,000 1,721,176 231,176 $1,952,352 524,160 489,600 636,808 1,650,568 723,432 460,000 32,592 $ 492,59.2 $ 145,600 136,000 200,000 481600 323432 460,000 203,768 663,768 2866 592 $1,468,800 Total current liabilities Long-term debt Common stock Retained eamings Total equity Total liabilities and equity $3,497,152S Note: E indicates estimated. The 2017 data are forecasts.Explanation / Answer
a) Ratios are useful because of following reasons:- 1) To evaluate company's operating and financial performance such as its efficiency, liquidity, profitability and solvency. 2) To help managers to improve the firm’s performance 3) To help stockholders to forecast future earnings and dividends 4) To help lenders to evaluate creditworthiness ,the firm’s ability of repaying debts. The five major categories of ratios are: liquidity, asset management, debt management, profitability, and market value b) Current Ratio 2017 = Current Assets/Current Liabilities Current Ratio 2017 = $2,680,112/$1,114,800 2.40 Times Quick Ratio 2017= (Current Assets – Inventory)/Current Liabilities Quick Ratio 2017= ($2,680,112 - $1,716,480)/$1,114,800 0.86 Times The company’s current and quick ratios are higher relative to its 2017 current and quick ratios but both ratios are below the industry average. Yes, these different types of analysis have an equal interest in the liquidity ratios. The liquidity ratios are important to manager to evaluate financial perfomance of the company so that he can take measures to maximize shareholders' wealth.. The liquidity ratios to creditors play important role to help evaluate the firm’s likelihood of repaying debts. The stockholders are interested in liquidity ratio to understand whether the company has an ability to meet current obligations or not and after meeting the obligations the company has sufficient funds to grow the company or not. c) Inventory Turnover 2017 = Sales/Inventory Inventory Turnover 2017 = $7,035,600/$1,716,480 4.10 times DSO 2017= Receivables/(Sales/365) DSO 2017 = = $878,000/($7,035,600/365) = 45.55 days Fixed Assets Turnover 2017 = Sales/Net Fixed Assets Fixed Assets Turnover 2017 = $7,035,600/$817,040 8.61 times Total Assets Turnover 2017 = Sales/Total Assets Total Assets Turnover 2017 = $7,035,600/$3,497,152 2.01 times The firm’s inventory turnover and total assets turnover are below the industryaverage. The firm’s days sales outstanding is above the industry average .The firm’s fixed assets turnover is above the industry average d.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? Debt-to-capital = (Current liabilities + long-term liabilities) / (short-term liabilities + long-term liabilities + total equity) Debt-to-capital = ($1,144,800 + $400,000)/($1,144,800 + $400,000 +$1,952,352) 44.17% Times-interest-earned = EBIT/Interest Times-interest-earned = $492,648/$70,008 7.04 times As compared to industry average D'leon's Capital to debt ratio and Times interest earned ratio both are above the industry average but firm’s debt capital ratio is much improved from 2016 and has sufficient earnings to cover the interest cost as compared to 2016 TIE. e.Calculate the 2017 profit margin, basic earning power (BEP), return on assets (ROA), and return on equity (ROE). What can you say about these ratios? Profit margin = Net income/Sales Profit margin = $253,584/$7,035,600 3.60% Basic earning power = EBIT/Total assets Basic earning power = $492,648/$3,497,152 14.09% ROA = Net income/Total assets ROA = $253,584/$3,497,152 7.25% ROE = Net income/Common equity ROE = $253,584/$1,952,352 12.99% The Firm's profit margin is approximately equal to the industry averages but as compared to year 2016 profit margin was negative and 2015 it was above the current profit margin. The Firm's basic earning power is below the industry averages but as compared to year 2016 basic earning power was negative and 2015 it was below the current earning power. The Firm's ROA is below the industry averages but as compared to year 2016 ROA was negative and 2015 it was below the current ROA. The Firm's ROE is below the industry averages but as compared to year 2016 ROE was negative and 2015 it was above the current ROE. f) 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? Price/Earnings = Price per share/Earnings per share Price/Earnings = $12.17/$1.0143 12.00 Market/Book Ratio = Market price per share/Book value per share Market.Book ratio = $12.17/$7.81 1.56 The price/earnings ratio and market/book ratio both are below the industry averages as well as above the 2016 and 2015 levels.
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