You have been hired as an analyst for Mellon Bank and your team is working on an
ID: 2658632 • Letter: Y
Question
You have been hired as an analyst for Mellon Bank and your team is working on an independent assessment of Daffy Duck Food Inc. (DDF Inc.) DDF Inc. is a firm that specializes in the production of freshly imported farm products from France Your assistant has provided you with the following data for Flipper Inc and their industry 2017 Ratie 2017 2016 2015Industry term debt 045 0.40 035 3.25 0.015 iation Total Assets Days" sales in receivables 11398 94 130.25 Debt to bE 085 0.90 0.88 0.40 1031 125 otal Asset Turnover 0.54 0.65 0.70 k Ratio urrent Ratio Times Interest Earned 0,94.375 44 1.75 185 1.90 188 In the annual report to the shareholders, the CEO of Flipper Inc wrote, "2015 was a good year for the firm with respect to our ability to meet our short-term obligations. We had higher liquidity largely due to an increase in highly liquid current assets (cash, account receivables and short-term marketable securities)" Is the CEO correct? Explain and use only relevant information in your analysis. b. What can you say about the firm's asset management? Be as complete as possible given the above information, but do not use any irrelevant information. C. You are asked to provide the shareholders with an assessment of the firm's solvency and leverage. Be as complete as possible given the above information, but do not use any irrelevant information.Explanation / Answer
a. According to the internal analysis of liquidity, it is evident from the quick ratio and current ratio that the company is in a sound position to pay off its short tern debts with the available short tern assets.
Considering,
Current Ratio = (cash + accounts receivable + short term marketable securities + inventory)/current liabilities
From the given information, it can be seen that Flipper Inc. has been able to increase its current ratio across all the three years from 1.15 to 1.21 to 1.33.
Considering Quick ratio = (cash + accounts receivable + short term marketable securities – inventory)/current liabilities
This indicated the capability of a company to pay off its short term debts with the most liquid assets (assets that can be converted to cash within 90 days). Flipper Inc. has been able to maintain a descent quick ratio thereby sustaining its liquidity.
According to the external analysis of liquidity, Flipper Inc. is line and sometimes above the industry average for both the above mentioned ratios, which shows a parity between the industry and the company
So, the CEO is completely correct in making its statement
b.Asset management is the process of effectively utilizing a firm’s assets to generate sales. The best measure of asset management is through ratio analysis which helps to determine its turnover and efficiency. Inventory turnover ratio, days inventory, receivables turnover, days receivables are some of the ratios that help in measuring this parameter.
Inventory Turnover = sales/average inventory -> this indicates the number of times a company sells its inventory and again restocks it. Flipper Inc. has managed to improve its inventory turnover across the three years and has been above the industry average in 2017. Although it is good to have improved inventory turnover, but too much high number can lead to stock outs.
Day’s Sales in Receivables: 365/(sales/average receivables) -> This indicates the number of days required to collect the payment after a sale has been made. In general, lower days receivables is desirable as it indicates less time taken to receive payments. Flipper Inc.’s days receivables has deteriorated across the three years from 2015 to 2017 indicating more time taken to take the payments. But, on the good side, Flipper is doing better than the industry as such because its days receivables is less than the industry average across all the years.
Asset Turnover ratio: Sales/Total assets-> it indicates the amount of sales generated relative to its assets. Higher ratio is desirable as it shows that the company is generating more sales per one unit of asset. Flipper Inc.’s asset turnover has deteriorated across the three years from 2015 to 2017 indicating less value of sales being generated per unit of assets. But, on the good side, Flipper is doing better than the industry as such because its asset turnover ratio is more than the industry average across all the years.
c.Solvency and Leverage: These parameters are measurable through the leverage and solvency ratios which indicates the ability of a company to meet its financial obligations.
Debt/Equity ratio = Debt/Equity ->It indicates the amount the debt that a company has taken to finance its assets in relative to its equity value. Higher value means the company is highly levered and using more of debt to finance itself. Flipper Inc.’s debt to equity ratio has decreased across the years indicating that the company is using less debt and more equity and has also managed to bring down the value below the industry average.
Times interest earned = EBIT/Interest Expense-> It is a measure of a company’s ability to meet its debt obligation. It indicated the number of times a company is capable to pay off its interest expenses with its pretax profit. Higher the ratio, it is better. Flipper Inc.’s ratio has deteriorated drastically in 2017 and is be quite below the industry average showing that the company is not in a viable position to meet its debt obligations.
Equity Multiplier = (Assets/Equity) -> this ratio indicates the percentage of asset that has been funded by equity. Higher ratio means, more assets are funded by debts and less by equity. For Flipper Inc., this ratio has reduced across the three years indication more of equity financed assets and has been below the industry average.
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