Financial Management - Theory and Practice - Assignment Example

Part Question a) Current ratio = Current assets/ Current liabilities $14,651,000 19,539,000 = 0.75times Quick ratio = (Current assets – Inventory)/ Current liabilities ($14,651,000 - 6,136,000) / $19,539,000 = 0.44times Total asset turn over = (Sales/ Total assets) $167,310,000 / $108,615,000 = 1.54times Inventory turnover = Costs of goods sold/Inventory $117,910,000 / $6,136,000 =19.22times Receivables turnover = Sales/ Accounts receivables $167,310,000 / $5,473,000 = 30.57times Total debt ratio = (Total assets- Total equity)/ Total assets ($108,615,000  55,341,000) / $108,615,000 = 0.49times Debt-equity ratio = Total debt/ Total equity ($19,539,000 + 33,735,000) / $55,341,000 = 0.96times Equity multiplier = Total assets/ Total equity $108,615,000 / $55,341,000 = 1.96times Interest coverage= EBIT/ Interest $23,946,000 / $3,009,000 = 7.96 times Profit margin= Net incomes/ Sales $12,562,200 / $167,310,000 = 7.51% Return on assets = Net income/ Total equity $12,562,200 / $108,615,000 = 11.57% Return on equity = Net income/ Total equity $12,562,000 / $55,341,000 = 22.70% Question 2 a) Performance Compared to the Industry In reference to the liquidity ratios, the current ratio of East Coast Yachts current ratio is lower than the median industry ratio. This shows that the firm has less liquidity compared to the industry. Current ratio is greater than the lower quartile this implies that there exist other firms with less liquidity within the industry (Ehrhardt & Eugene, 91). The firm may posses more expected cash flows, or easier means to short-term debt. The turnover ratios appear to be greater compared to the industry median actually all are greater than the upper quartile. This implies that the firm utilizes its assets efficiently to generate sales. The financial leverage ratios appear to be lower than the industry median but higher than the lower quartile. This implies that the firm is less indebted compared to others in the industry, but still falls in the normal range. East Coast Yacht’s profit margin is almost equal to the industry’s median. Return on assets for the firm is greater than industry’s median but by a small margin. The Return on Equity is greater than the industry median. This implies that the profitability is high. East Coast Yachts’ has a satisfactory performance, although attention is needed in the liquidity ratios. c) Creating Inventory Ratio Inventory to current liabilities ratio East Coast Yachts is lower, the current ratio is lower, but the quick ratio is higher in comparison to the industry median. This means that East Coast Yachts has few stock to current liabilities compared to the industry median (Ehrhardt & Eugene, 92). Since the cash ratio is less compared to the industry median, East Coast Yachts has fewer stock compared to the industry median, but more accounts receivable. d)Interpretation of the Ratios Current ratio: Good (Well managed current accounts.) Bad (Liquidity issues) Quick ratio: Good (Well managed current accounts.) Bad (Liquidity issues) Total asset turnover: Good (Well utilized assets.) Bad (Old and depreciated assets) Inventory turnover: Good (Well managed inventory) Bad (Inventory shortages) Receivables turnover: Good (Well collected receivables) Bad (Strict credit terms) Total debt ratio: Good (Hard to get credit issues) Bad (Increase shareholder returns) Debt equity Ratio: Good (Hard to get credit issues) Bad (Increase shareholders equity) Equity multiplier: Good (Hard to get credit issues) Bad (Increase shareholders equity) Interest coverage: Good (Hard to get CREDIT ISSUES) Bad (Increase shareholders equity) Profit margin: Good (Good performance) (Bad: Good cost control) Question 3 a)Internal growth rate, ROE = (Net income)/(Total equity) = $12,562,200/$ 55,341,000 = 0.2270 or 22.70% b (Addition to Retained earnings)/(Net income) = $5,024,800/$12,562,200 = 0.40 or 40% Sustainable growth rate = (ROE × b)/(1-(ROE × b)) = (0.2270 × 0.40)/(1-(0.2270 × 0.40)) = 0.0999 or 9.99% Income Statement Sales $184,018,615 Cost of goods sold $ 129,685,224 Other expenses $ 21,990,720 Depreciation $ 5,400,000 EBIT $ 26,882,666 Interest $ 3,009,000 Taxable income $ 23,873,666 Taxes (40%) $ 9, 549,466 Net income $ 14,324,199 Dividends $ 8,594,520 Add to RE $ 5,729,680 Balance sheet Assets Liabilities Equity Current Assets Current Liabilities Cash $ 3,345,793 Accounts Payable $ 7,106,236 Accounts receivable $ 6,019,568 Notes Payable $ 14,384,050 Inventory $ 6,748,779 Total Current Assets $ 16,114,140 Total Current Liabilities $ 21,490,286 Long-term debt $ 33,735,000 Shareholder’s Equity Common stock $ 5,200,000 Fixed assets Retained earnings $ 55,870,680 Net Plant & Equipment $ 103,347,828 Total Equity $ 61,070,680 Total Assets $ 119,461,968 Total Liabilities & Equity $ 61,070,680 External Financing Needed (EFN) is: = Total assets – Total liabilities and equity = $119,461,968 – $61,070,680 = $ 3,166,002 c)Pro forma statements ratios Current ratio = ($ 16,114,140)/($ 21,490,286) = 0.75 times Quick ratio = ($ 16,114,140-6,748,779)/($ 21,490,286) = 0.44 times Total asset turnover = ($184,018,615)/($119,461,968) = 1.54 times Inventory turnover = ($ 129,685,224)/($ 6,748,779) = 19.22 times Receivables turnover = ($ 184,018,615)/($ 6,019,568) = 30.57times Total debt ratio = ($ 116,295,966-$ 61,070,680)/($ 116,295,966) = 0.49times Debt-equity ratio = ($ 21,490,286+$ 33,735,000)/($ 61,070,680) = 0.90 times Equity multiplier = ($ 119,460,968)/($ 61,070,680) = 1.96 times Interest coverage = ($ 26,882,666)/($ 3,009,000) = 8.93times Profit margin = ($ 14,324,199)/($ 184,018,615) = 7.78% Return on assets = ($ 14,324,199)/($ 119,461,968) = 11.99% Return on equity = ($ 14,324,199)/($ 61,070,680) = 23.45% Debt ratio, return on equity, the interest coverage ratio, returns on assets, and profit margin changed with a high margin. This was since long term debt is assumed to be constant. Slight changes occur in other ratios due to interest and depreciation which are also assumed to be constant. Question 4 Income Statement Sales $ 200,772,000 Cost of goods sold $ 141,492,000 Other expenses $ 23,992,800 Depreciation $ 5,460,000 EBIT $ 29,827,200 Interest $ 3,009,000 Taxable income $ 26,818,200 Taxes (40%) $ 10,727,280 Net income $ 16,090920 Dividends $ 9,654,552 Add to RE $ 6,436,368 Balance sheet Assets Liabilities Equity Current Assets Current Liabilities Cash $ 3,650,400 Accounts Payable $ 7,753,200 Accounts receivable $ 6,567,600 Notes Payable $ 15,693,600 Inventory $ 7,363,200 Total Current Assets $ 16,114,140 Total Current Liabilities $ 23,446,800 Long-term debt $ 33,735,000 Shareholder’s Equity Common stock $ 5,200,000 Fixed assets Retained earnings $ 56,577,368 Net Plant & Equipment $ 112,756,800 Total Equity $ 61,777,368 Total Assets $ 130,338,000 Total Liabilities & Equity $ 118,959,168 External Financing Needed (EFN) is: = Total assets – Total liabilities and equity = $130,338,000 – $118,959,168 = $ 8,753,040 A 20% rise in growth gives EFN as $ 8,753,040. More liability would push debt to equity ratio as well as to 1.12 and 0.53 respectively. With an interest rate of 6% EBIT would change to 7.84. Debt financing would put pressure on the firm as the already existing ratio is beyond 1. Therefore, further advancing may not happen as a result of more debt. Question 5 Depreciation = $5, 460,000/ $93,964,000 =0.0581 New fixed asset = $93,964,000 + 30,000,000 =$7,203,221 Income Statement Sales $ 200,772,000 Cost of goods sold $ 141,492,000 Other expenses $ 23,992,800 Depreciation $ 7,203,221 EBIT $ 28,083,979 Interest $ 3,009,000 Taxable income $ 25,074,979 Taxes (40%) $ 10,727,280 Net income $ 15,044,988 Dividends $ 9,026,993 Add to RE $ 6,017,995 Balance sheet Assets Liabilities Equity Current Assets Current Liabilities Cash $ 3,650,400 Accounts Payable $ 7,753,200 Accounts receivable $ 6,567,600 Notes Payable $ 15,693,600 Inventory $ 7,363,200 Total Current Assets $ 17,581,200 Total Current Liabilities $ 23,446,800 Long-term debt $ 33,735,000 Shareholder’s Equity Common stock $ 5,200,000 Fixed assets Retained earnings $ 56,158,995 Net Plant & Equipment $ 123,964,000 Total Equity $ 61,358,995 Total Assets $ 141,545,200 Total Liabilities & Equity $ 118,540,795 External Financing Needed (EFN) is: = Total assets – Total liabilities and equity = $141,545,200 – $118,540,795 = $ 23,004,405 Implication Fixed assets would rise up to $7,203,221 while new plant was 123,964,000, total EFN required would be 23,004,405. This would indicate that capacity for the following year will decline due to a higher rate of increase for fixed assets than sales. Part 2 Question 1 Benefits of mutual funds There is provision of full-time high value professional management services as there is pooling of the resources of several shareholders. The quality professional management is vital to intensely rewarding outcomes mutual funds benefit from in the current complex and unpredictable markets. The fund managers objectives are tied to the investors’ success as their paycheck depends on the fund performance compared to sales commissions. The fund manager has direct contact with real market situation, makes trades on extremely large and cost efficient securities packages (Ehrhardt & Eugene, 95). Mutual funds diversification confines risk as a decline in the worth of any security is compensated by the solidity or raises the value of other securities in the portfolio. Investors gain from a level of diversification made feasible by the sum of mutual investment dollars that the majority individual investors would find unattainable. A standard shareholder cannot create a proportionate portfolio holding an insufficient 50 stocks. This would be too costly. Classically, any investor can begin well-managed investment for fewer 1000 dollars. Fund managers analyze the market, study the securities, and decide on what to purchase and sell. They preserve the interest of the investor and are available to buy and trade in fund shares either online or on the phone. An investor may own just one security; he enjoys the returns of a broadly diversified portfolio. Additional services comprise automatic reinvestment of bonus and exchange privileges (Ehrhardt & Eugene, 98). Mutual Funds are redeemable at any time, therefore, it readily avails cash for emergency. An investor can redeem his funds through electronic transfer, written letter, calling or he can trade in funds. The cash will be in available to the investor in approximately three working days. Question 2 Stock funds oscillate in price as the economy goes through recession and boom. In the end, shareholders find themselves rewarded for coping with the uncertainty. This is the reason mutual funds are frequently striking to investors who are saving money for retirement and other lasting goals. A share of stock is a fractional share of rights in a company. It yields a return for investors in two ways. The rise in share price is the capital gain. In addition, several companies pay out a small proportion of earnings to shareholders every year. Some stock finances manage to capitalize on dividend income, others to capitalize on the amount of capital gains, and some to have total return, which is the best combination of both. More investment income represents less risk. Similarly, some stock mutual funds invest in an extensive variation of companies, while others invest only in under developed companies. Question 3 There is no ownership. Investors have a preference on individual stocks over to a stock fund; often argue that they disown rights in a stock fund. Diversification does not assure a profit or guard against loss. Foreign investments involve greater risks than other investments. Bonds are prone to get risk in interest rate, which may decline, its value (Ehrhardt & Eugene, 101). It is essential to evaluate every pro and con of investing in a stock fund before making a decision to invest. In most cases, what one investor sees as a pro, other views as a con and vice versa. Most shareholders would gain from understanding more about the disadvantages and advantages of stocks funds and how to avoid the pitfalls. Question 4 Small-cap stocks surpass their large-cap counterparts on a lasting historical basis. From 1927 to 2007, small-cap stocks have enlarged in worth by more than +12% annually while large-cap stocks rose by approximately +10% annually in the same period. The performance of small-cap stock against large-cap stocks is even more outstanding during periods of recession. Since small-cap corporations have modest or no visibility in the institutional investment category, they often disengage their stock prices and the basics of business. This provides smaller investors a great opening to take advantage and acquire rapidly increasing companies that the larger investors cannot. Most small-cap companies also obtain little or no exposure from the market analyst society. Hence, with the lack of analyst exposure for most small-cap companies, the benefit is enjoyed by the smaller investor (Ehrhardt & Eugene, 82). Question 5 Sharpe Ratio = (actual return - risk-free return) / standard deviation Index fund = (8.45% -0.15%)/21.85% =0.3798 Small Cap fund = (13.45%- 1.70%)/24.83% =0.4732 Company stock fund = (8.62%-1.50%)/22.93% =0.3105 Bond Fund = (6.25%- 1.40%)/9.20% =0.5271 Company Stock = 16% / 70% = 0.2286 The Sharpe ratio for all the assets above is optimal because they are all positive. Sharpe ratio is a measure of return that is risk-adjusted usually used to appraise the performance of a fund. The ratio is helpful in making comparison between performance of ones finance and another asset by adjusting for risk (Ehrhardt & Eugene, 99). The best optimal portfolio allocation that I would choose is investing in Bond fund. This is because it has the highest Sharpe ratio meaning portfolio is less volatile and less risky in terms of returns. It is in choosing the investment that an investor’s wealth maximization is most. Work Cited Ehrhardt, Michael C, and Eugene F. Brigham. Financial Management: Theory and Practice. Mason: South-Western Cengage Learning, 2011. Print. Read More