FIN 2984 Lecture 3: Class 3
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2. Balance sheet
The balance sheet provides a snapshot of the financial conditionof a company. Investors and analysts use the information given onthe balance sheet and other financial statements to make severalinterpretations regarding the company’s financial condition andperformance.
Blue Hamster Manufacturing Inc. is a hypothetical company.Suppose it has the following balance sheet items reported at theend of its first year of operation. For the second year, some partsare still incomplete. Use the information given to complete thebalance sheets for Blue Hamster Manufacturing Inc. for the yearsending December 31, Year 2 and 1, respectively.
Blue Hamster Manufacturing Inc. | |||||
|---|---|---|---|---|---|
Balance Sheet | |||||
For the Year ended December 31 | |||||
| Year 2 | Year 1 | Year 2 | Year 1 | ||
| Assets | Liabilities and equity | ||||
| Current assets: | Current liabilities: | ||||
| Cash and equivalents | $55,350 | Accounts payable | $0 | $0 | |
| Accounts receivable | $25,312 | $20,250 | Accruals | $3,516 | $0 |
| Inventories | $74,250 | $59,400 | Notes payable | $19,921 | $18,750 |
| Total current assets | $168,750 | $135,000 | Total current liabilities | $18,750 | |
| Net fixed assets: | Long-term debt | $70,312 | $56,250 | ||
| Net plant and equipment | $165,000 | Total debt | $93,750 | $75,000 | |
| Common equity: | |||||
| Common stock | $182,812 | $146,250 | |||
| Retained earnings | $78,750 | ||||
| Total common equity | $281,250 | $225,000 | |||
| Total assets | $375,000 | $300,000 | Total liabilities and equity | $375,000 | $300,000 |
Given the information in the preceding balance sheet—andassuming that Blue Hamster Manufacturing Inc. has 50 million sharesof common stock outstanding—read each of the following statements,then identify the selection that best interprets the informationconveyed by the balance sheet.
Statement #1: Blue Hamster’s pool of relatively liquid assets,which are available to support the company’s current and futuresales, decreased from Year 1 to Year 2.
This statement is , because:
Blue Hamster’s total current liabilities balance decreased by$33,750 between Year 1 and Year 2.
Blue Hamster’s total current liabilities balance increased from$20,250 to $25,312 between Year 1 and Year 2.
Blue Hamster’s total current asset balance actually increasedfrom $135,000 to $168,750 between Year 1 and Year 2.
Blue Hamster’s total current asset balance decreased from$168,750 to $135,000 between Year 1 and Year 2.
Statement #2: In Year 2, Blue Hamster Manufacturing Inc. wasprofitable.
This statement is , because:
Blue Hamster’s retained earnings account increased between theend of Years 1 and 2.
The cash and equivalents account increased between Years 1 and2.
Blue Hamster’s total assets increased between Years 1 and 2.
Statement #3: The book value per share of Blue Hamster’s stockin Year 2 was $5,625.
This statement is , because:
The per-share book value is calculated by dividing the company’stotal assets by the number of outstanding shares of commonstock.
The per-share book value is calculated by dividing the company’stotal debt by the number of outstanding shares of common stock.
The per-share book value is calculated by dividing the company’stotal common equity by the number of outstanding shares of commonstock.
Based on your understanding of the different items reported onthe balance sheet and the information they provide, if everythingelse remains the same, then the cash and equivalents item on thecurrent balance sheet is likely to if the firm issues$3 million of new common stock.
Based on your understanding of the different items reported inthe balance sheet and the information they provide, which statementregarding Blue Hamster Manufacturing Inc.’s balance sheet isconsistent with U.S. Generally Accepted Accounting Principles(GAAP)?
The company’s assets should be listed in alphabetical order.
The company’s assets should be listed in the order in which theyare to be converted into cash.
The company’s assets should be listed from those carrying thelargest balance to those with the smallest balance.
1. Use the attached balance sheet and income statement to compute the required financial ratios for 2012. Use 360 for the number of days in a year. The computations for 2011 are already done for you.
Current ratio_________________________
Quick ratio__________________________
Inventor turnover____________________
Average Collection Period_____________
Total asset turnover__________________
Net profit margin____________________
Operating profit margin_______________
Times Interest Earned_________________
Debt/Net Worth Ratio_________________
Return on Equity ratio__________________
2. Using the computed financial ratios from question 1, compare Grounds Keeper’s performance from 2011 to 2012. Address what areas the company has improved and what areas it has not
A.)Liquidity
B.) Activity / turnover / efficiency
C.) Profitability
D.) Leverage / use of debt / solvency
3. If you were the CEO of Grounds Keeper, what area(s) would you concentrate on to improve the performance of the company?
4. Define the terms capital structure, cost of capital, and working capital. Focus on how they are different from each other and impact both profitability and risk.
5. Determine Grounds Keeper’s capital structure and working capital.
6. If Grounds Keeper has a required rate of return on its long-term debt of 9% (before taxes) and a required rate of return on its common stock, a tax rate of 40%, what is its weighted average cost of capital (WACC) for 2012? How could Grounds Keeper lower its WACC? (HINT: you will need to look at the balance sheet to determine the weight of debt to equity.
7. What are the advantages to Grounds Keeper in using money market instruments as financing? How does this related to financing net working capital?
8. Explain what Grounds Keeper should consider when deciding whether to issue stocks or bonds? Answer using at least 3 different characteristics comparing and contrasting stocks and bonds.
9. Define money market instruments; list at least one type of security that would be considered a money market instrument. What are the advantages to Grounds Keeper in using money market instruments as financing? What are the disadvantages?
| Grounds Keeper | ||
| Consolidated Balance Sheets | ||
| (Dollars in thousands) | ||
| 2012 | 2011 | |
| Assets | ||
| Current assets: | ||
| Cash and cash equivalents | 78,240 | 44,395 |
| Receivables | 399,891 | 340,062 |
| Inventories | 844,737 | 736,677 |
| Total current assets | 1,322,868 | 1,121,133 |
| Fixed assets, net | 1,244,384 | 889,613 |
| Other long-term assets | 1,048,537 | 1,187,141 |
| Total assets | 3,615,789 | 3,197,887 |
| Liabilities and Stockholders’ Equity | ||
| Current liabilities: | ||
| Accounts payable | 309,222 | 319,465 |
| Accruals | 201,017 | 145,240 |
| Notes payable | 9,748 | 6,669 |
| Total current liabilities | 519987 | 471374 |
| Long-term debt | 834574 | 814298 |
| Total liabilities | 1,354,561 | 1,285,672 |
| Stockholders’ equity: | ||
| Common stock, $0.10 par value: | 15,268 | 15,447 |
| Additional paid-in capital | 1,464,560 | 1,499,616 |
| Retained earnings | 781400 | 397152 |
| Total stockholders’ equity | 2,261,228 | 1,912,215 |
| Total liabilities and stockholders’ equity | 3,615,789 | 3,197,887 |
| Grounds Keeper | |||||
| Consolidated Statements of Operations | |||||
| (Dollars in thousands except per share data) | |||||
| 2011 | ||||
| Net sales | 3,889,426 | 2,642,390 | |||
| Cost of sales | 2,589,799 | 1,746,274 | |||
| Gross profit | 1,299,627 | 896,116 | |||
| Selling and operating expenses | 481,493 | 348,696 | |||
| General and administrative expenses | 219,010 | 187,016 | |||
| Operating income | 599,124 | 360,404 | |||
| Interest expense | 22,983 | 57,657 | |||
| Income before income taxes | 576,141 | 302,747 | |||
| Income tax expense | 212,641 | 101,699 | |||
| Net Income | 363,500 | 201,048 | |||
| Basic income per share: | |||||
| Average shares outstanding | 154,933,948 | 146,214,860 | |||
| Earnings per common share | 2.35 | 1.38 |
| Current Ratio | Current assets/ Current liabilities |
| Quick Ratio | Current assets – inventory/ Current liabilities |
| Inventory Turnover | Cost of goods sold/ Inventory |
| Receivables Turnover | Sales/ Accounts receivables |
| Average Collection Period | Receivables/ Sales per day |
| Fixed Asset Turnover | Sales/ Fixed assets |
| Total Asset Turnover | Sales/ Total Assets |
| Gross Profit Margin | Revenues - Cost of goods sold/ Sales |
| Operating Profit Margin | Earnings before interest and taxes/ Sales |
| Net Profit Margin | Net income/ Sales |
| Return on Total Assets | Net income/ Total assets |
| Debt/Net Worth Ratio | Total Debt/ Total Equity |
| Times-Interest-Earned | Operating Income/ Interest expense |
| Return on Equity | Net income/ Total equity |
