ACTG 3000 Chapter Notes - Chapter 5: Corporate Finance, Gross Margin, Asset Turnover

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Goal of financial analysis: assess performance of a firm in context of its stated goal and strategy. 2 principal tools of financial analysis: ratio analysis, cash flow analysis. How firm is managing operating, investment, and financing cash flows. Value of firm determined by its profitability and growth which asre influenced by its: Product market: implemented through firms competitive strategy, operating policies, investment decisions. Financial market strategies: implemented through financing and dividend policies. 4 levers managers can use to achieve growth and profit targets: operating management, investment management, financing strategy, dividend policies. Objective of ratio analysis: evaluate effectiveness of firms policies in each of these areas. In ratio analysis analyst can: compare ratios for firm over several years (time-series comparison, compare ratios for firm and other firms in industry (cross-sectional comparison, compare ratios to some absolute benchmark. Time series comparison: analyst can hold firm-specific factors constant and examine effectiveness of firms strategy over time.

Related Questions

PROBLEM 15-15 Comprehensive Ratio Analysis (L015-2, L015-3, L015-4, L015-5, L015-6] You have just been hired as a financial analyst for Lydex Company, a manufacturer of safety hel- mets. Your boss has asked you to perform a comprehensive analysis of the company's financial statements, including comparing Lydex's performance to its major competitors. The company's financial statements for the last two years are as follows: Lydex Company Comparative Balance Sheet This Year Last Year $ 960,000 0 2,700,000 3,900,000 240,000 7,800,000 9,300,000 $17,100,000 $ 1,260,000 300,000 1,800,000 2,400,000 180,000 5,940,000 8,940,000 $14,880,000 Assets Current assets: Cash .... Marketable securities ......... Accounts receivable, net ........ Inventory .......... Prepaid expenses.......... Total current assets. ........ Plant and equipment, net ..... Total assets ............. Liabilities and Stockholders' Equity Liabilities: Current liabilities. Note payable, 10% ................. Total liabilities .... .......... Stockholders' equity: Common stock, $78 par value ......... Retained earnings .................. Total stockholders' equity .............. Total liabilities and stockholders' equity.... $ 3,900,000 3,600,000 7,500,000 $2,760,000 3,000,000 5,760,000 7,800,000 1,800,000 9,600,000 $17,100,000 7,800,000 1,320,000 9,120,000 $14,880,000 Lydex Company Comparative Income Statement and Reconciliation This Year Last Year Sales (all on account) $15,750,000 $12,480,000 Cost of goods sold .. 12,600,000 9,900,000 Gross margin ....................... 3,150,000 2,580,000 Selling and administrative expenses ...... 1,590,000 1,560,000 Net operating income.................. 1,560,000 1,020,000 Interest expense ...................... 360,000 300,000 Net income before taxes ............... 1,200,000 720,000 Income taxes (30%) 360,000 216,000 Net income ........................ 840,000 504,000 Common dividends .................. 360,000 252,000 Net income retained 480,000 252,000 Beginning retained earnings ........ 1,320,000 1,068,000 Ending retained earnings ............... $ 1,800,000 $1,320,000 To begin your assigment you gather the following financial data and ratios that are typical of companies in Lydex Company's industry: 2.3 1.2 Current ratio ...................... Acid-test ratio ..... Average collection period ...... Average sale period .... Return on assets .... Debt-to-equity ratio .......... Times interest earned ratio ......... Price-earnings ratio .......... 30 days 60 days 9.5% 0.65 5.7 10 Required: 1. You decide first to assess the company's performance in terms of debt management and profit- ability. Compute the following for both this year and last year: a. The times interest earned ratio. b. The debt-to-equity ratio. c. The gross margin percentage. d. The return on total assets. (Total assets at the beginning of last year were $12.960,000.) e. The return on equity. (Stockholders' equity at the beginning of last year totaled $9,048,000. There has been no change in common stock over the last two years.) f. Is the company's financial leverage positive or negative? Explain. You decide next to assess the company's stock market performance. Assume that Lydex's stock price at the end of this year is $72 per share and that at the end of last year it was $40. For both this year and last year, compute: a. The earnings per share. b. The dividend yield ratio. c. The dividend payout ratio. d. The price-earnings ratio. How do investors regard Lydex Company as compared to other companies in the industry? Explain. e. The book value per share of common stock. Does the difference between market value per share and book value per share suggest that the stock at its current price is a bargain? Explain. 3. You decide, finally, to assess the company's liquidity and asset management. For both this year and last year, compute: a. Working capital. b. The current ratio. The acid-test ratio. d. The average collection period. (The accounts receivable at the beginning of last year totaled $1,560,000.) e. The average sale period. (The inventory at the beginning of last year totaled $1,920,000.) f. The operating cycle. g. The total asset turnover. (The total assets at the beginning of last year totaled $14,500,000.) 4. Prepare a brief memo that summarizes how Lydex is performing relative to its competitors.

Investment and financing decisions, which may beshort-term or long-term decisions are best describedas:

financial decision making.

economic decision making.

accounting decision making.

Mutual funds, pension funds, investment dealers andinsurance companies are best described as examples of:

corporate finance.

market intermediaries.

financial intermediaries.

Farmers and Merchants Bank lends money to Ruth topurchase a car from Steven Toyota. Ruth is going to insure the carwith Allstate Insurance. Which party is best described as thecreditor?

Ruth

Steven Toyota

Allstate Insurance

Farmers and Merchants Bank

Which of the following would not be described as adebenture?

An unsecured loan

A loan secured by collateral

A loan secured by the âfull faith and creditâ of theissuer

Morgan Stanley was the investment banking firm that tookFacebook from being a closely held company to issuing stock to thepublic for the first time. Which of the following terms mostclosely describes this?

money market security.

issuing commercial paper.

initial public offering (IPO).

debt security backed by the general credit of theissuer.

Which of the following transactions does not take placein the primary market? An investor:

buying a newly issued municipal bond.

buying shares of an initial publicoffering.

selling one hundred shares of stock through a stockbroker.

buying a U.S. Treasury bill through the governmentauction.

The majority of home purchases in the U.S. are securedwith a mortgage. A mortgage is:

an unsecured loan.

an equity investment in the property.

a debt obligation secured by a specificproperty.

Which form of business would most likely describe thefollowing, a college student other students, a retired woman whobabysits children, a teenager who mows lawns, and a partyclown?

Partnership

Corporation

Sole proprietorship

Limited liability company

Flow-through taxation is a characteristic for all butthe following forms of business?

Partnership

Corporation

Sole proprietorship

Limited liability company

Your sister wants to start a tee shirt business on e-Baywith you to help pay for college tuition. All of the following areadvantages to partnerships that you should both consider, except____________?

Easy to form

Access to capital

Business income is taxed once, at the individualpartnerâs level

Which of the following takes into account takes intoaccount the opportunity cost of funds?

Net profit

Economic profit

Accounting profit

When we talk about capital structure, this refersto:

the cash, inventory, and accountsreceivable.

mix of debt and equity to finance anenterprise.

the investment in plant, property andequipment.

The uncertainty associated with the use of debt tofinance a business enterprise is best described as:

financial risk.

business risk.

operating risk.

The mix of debt and equity that is used to finance abusiness enterprise is best described as theenterpriseâs:

assets.

working capital.

capital structure.

capital expenditures

Generally accepted accounting principles (GAAP) are bestdescribed as a(n):

organization that establishes the accounting principlesfor U.S. financial reporting.

accounting standards promulgated by the InternationalAccounting Standards Board (IASB.)

set of basic principles and conventions that are appliedin the preparation of financial statements.

organization that establishes the accounting principlesfor business entities in the European EconomicCommunity.

Which reporting convention requires recording revenueand expenses when the transaction occurs, regardless of when cashchanges hands?

Cost basis

Cash basis

Accrual basis

The summary of the companyâs performance over a periodof time, typically a fiscal quarter or fiscal year

Balance sheet

Statement of stockholderâs equity

Income statement

Statement of cash flows

_______ is the cash flow from the day-to-day operationsof the business; the result of subtracting the increase in newworking capital from traditional cash flow.

Cash flow from investing

Cash flow from financing

Simple cash flow

Cash flow from operations

The debt ratio is classified as which type ofratio?

Owner

Liquidity

Efficiency

Productivity

Financial Leverage

Inventory turnover, accountsreceivable turnover, fixed asset turnover, and total asset turnoverare all classified as which type of ratio?

Owner

Liquidity

Efficiency

Productivity

Financial Leverage

ABC Company attempts tomanage its earnings by extending the useful life of all of itsequipment. Which of the following will not be an outcome of thischoice by management?

Income will be higher than it would have been underprior accounting methods.

Equipment values will be higher than they would havebeen without the change.

Depreciation expense will be lower than it would havebeen under prior accounting methods.

Depreciation expense will be higher than it would havebeen under prior accounting methods.

It is important for a companyto know the level of sales at which it covers all its variable andfixed operating costs. This level of sales is best described asthe:

gross profit margin.

contribution margin.

operating break even.

operating profit margin.

The minimum return thatinvestors expect to earn on the investment in stock is bestdescribed as:

growth rate.

risk premium.

capital gains yield.

required rate of return

If a company returns more than the required rate ofreturn on a stock, what happens to the value of thatstock?

The stock price falls.

The stock price rises.

The stock price stays the same.

When market rates are greaterthan the dividend rate, preferred shares will tradeat:

par.

a discount.

a premium.

Accounts receivables turnover(times)

Average Collection Period (days)

Inventory turnover (times)

Average days in inventory (days)

Current ratio (times)

Quick or Acid-test ratio (times)

Times interest earned (times)

Gross profit ratio (%)

Profit margin (%) [before tax]

Return on assets (%) [before tax]

7.5%

9.0%

8.0%

Return on equity (%) [before tax]

Price to earnings ratio

Cash, beginning of year

Minus increase in accounts receivable

$ (4,034.00)

$ (5,648.00)

Minus increase in inventory

$ (3,302.00)

$ (4,732.00)

Minus increase in prepaid expenses

$ (1,360.00)

$ (1,700.00)

Plus increase in accounts payable

$ 2,388.00

$ 3,997.00

Plus increase in income taxes payable

$ 252.00

$ -

Plus increase in accruals & other cur.Liab.

$ 1,365.00

$ 1,656.00

Net Cash from operating activities

$ (2,156.00)

$ (2,308.00)

Investment Activities

Fixed asset acquisitions

$ (2,780.00)

$ (3,838.00)

Change in intangible assets

$ (21.00)

$ (17.00)

Change in all other noncurrent activities

$ (467.00)

$ (195.00)

Net Cash from investing activities

$ (3,268.00)

$ (4,050.00)

Financing Activities

Change in notes payable

$ 2,038.00

$ 3,080.00

Change current maturities--L.T.D.

$ 452.00

$ 786.00

Change in long-term debt

$ 3,160.00

$ 3,250.00

Change in Com Stock & paid-in cap

Net Cash from financing Activities

4. What is your assessment of the manner in which HTCM ismanaging its assets? Pay attention to both trends and industryaverages.

SOLVENCY (Financing of Assets)

5. What is your assessment of the manner in which HTCM isfinancing its assets? Pay attention to both trends and industryaverages. What is the relationship between the debt to equity ratioand times interest earned as these relate to HTCM? And is there anyother possible explanation (outside of the firmâs financialstatements) for the observed trend in times interest earned?

PROFITABILITY

6. What can you say about HTCMâs gross profit ratio and netprofit ratio? Explain any patterns observed.

7. How are HTCMâs net profit ratio, and asset turnover ratioaffecting the firmâs pre-tax return on assets (ROA) and return onequity (ROE)? What is your overall assessment of the firmâsprofitability, including its earnings per share (EPS)?

CASH FLOW

8. Referring to HTCMâs statement of cash flow for 2016 and 2017,assess HTCMâs cash flow situation noting both inflows andoutflows?

OVERALL EVALUATION

9. Based on your answers to the questions above, what is youroverall evaluation of HTCMâs financial condition? (Pull all youranalysis together in answering this question.)

10. What is the marketâs assessment of HTCMâs financialcondition? Explain. Does the marketâs assessment confirm or refuteyour analysis?

11. Based on your evaluation of HTCM and the marketâs assessmentof the firm, would you accept employment with the company?Explain.

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ACTG 3000 Chapter Notes - Chapter 5: Corporate Finance, Gross Margin, Asset Turnover

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