Question

The first part of the case, presented in Chapter 6, dis- cussed the situation of Computron Industries after an expansion program. A large loss occurred in 2015, rather than the expected profit. As a result, its man- agers, directors, and investors are concerned about the firm’s survival.

Jenny Cochran was brought in as assistant to Gary Meissner, Computron’s chairman, who had the task of getting the company back into a sound financial

position. Computron’s 2014 and 2015 balance sheets and income statements, together with projections for 2016, are shown in the following tables. The tables also show the 2014 and 2015 financial ratios, along with industry average data. The 2016 projected finan- cial statement data represent Cochran’s and Meiss- ner’s best guess for 2016 results, assuming that some new financing is arranged to get the company “over the hump.”

Balance Sheet
	2014		2015		2016
Assets
Cash	$9,000		$7,282		$14,000
Short-term investments	48,000		20,000		71,632
Accounts receivable	351,200		632,160		878,000
Inventories	751,200		1,287,360		1,716,480
Total current assets	$1,124,000		$1,946,802		$2,680,112
Gross fixed assets	491,000		1,202,950		1,220,000
Less: Accumulated depreciation	146,200		263,160		383,160
Net fixed assets	$344,800		$39,790		$36,840
Total assets	$1,468,800		$2,886,592		$,516,952
	2011		2012		2013
Liabilities & Equity
Accounts payable	$145,600		$324,000		$359,800
Notes payable	200,000		720,000		300,000
Accruals	136,000		284,960		380,000
Total current liabilities	$481,600		$1,328,960		$1,039,800
Long-term debt	323,432		1,000,000		500,000
Common stock (100,000 shares)	460,800		460,000		1,680,936
Retained earnings’	203,768		97,632		296,216
Total equity	$663,768		$557,632		$1,977,152
Total liabilities & Equity	$1,468,800		$2,886,592		$3,516,952
Note: “E” denotes, “estimated”; the 2013 data for forecasts.
Income Statement
	2014		2015		2016
Sales	$3,432,000		$5,834,400		$7,035,600
Cost of goods sold	2,864,000		4,980,000		5,800,000
Other expenses	340,000		720,000		612,960
Depreciation & Amortization	18,900		116,960		120,000
Total operating Cost	$3,222,900		$5,816,960		$6,532,962
EBIT	$209,100		$17,440		$502,640
Interest expense	62,500		176,000		80,000
EBT	$146,600		($158,560)		$422,640
Taxes (40%)	58,640		(63,424)		169,056
Net Income	$87,960		($95,136)		$253,584
Other Data
Stock price	$8.50		$6.00		$12.17
Shares outstanding	100,000		100,000		250,000
	2011		2012		2013E
EPS	$0.880		($0.951)		$1.014
DPS	$0.220		0.110		0.220
Tax rate	40%		40%		40%
Book value per share	$6.638		$5.576		$7.909
Lease payment	$40,000		$40,000		$40,000
Note: “E” denotes “estimated”; the 2013 data are forecasts.
Ratio Analysis
	2014	2015		2016E		Industry Average
Current	2.3	1.5		------------------		2.7
Quick	0.8	0.5		------------------		1.0
Inventory turnover	4.8	4.5		------------------		6.1
Days sales outstanding	37.3	39.6		------------------		32.0
Fixed assets turnover	10.0	6.2		-----------------		7.0
Total assets turnover	2.3	2.0		---------------		2.5
Debt ratio	54.8%	80.7%		--------------		50.0%
TIE	3.3	0.1		--------------		6.2
EBITDA Coverage	2.6	0.8		--------------		8.0
Profit margin	2.6%	-1.6%		--------------		3.6%
Basic earning power	14.2%	0.6%		--------------		17.8%
ROA	6.0%	-3.3%		--------------		9.0%
ROE	13.3%	-17.1%		--------------		17.9%
Price / Earnings (P/E)	9.7	-6.3		--------------		16.2
Price / Cash flow	8.0	27.5		-------------		7.6
Market / Book	1.3	1.1		-------------		2.9

Cochran must prepare an analysis of where the company is now, what it must do to regain its finan- cial health, and what actions to take. Your assignment is to help her answer the following questions. Provide clear explanations, not yes or no answers.

a. Why are ratios useful? What three groups use ratio analysis and for what reasons?

b. Calculate the 2016 current and quick ratios based on the projected balance sheet and income statement data. What can you say about the company’s liquidity position in 2014, 2015, and as projected for 2016? We often think of ratios as being useful: (1) to managers to help run the business, (2) to bankers for credit analysis, and

(3) to stockholders for stock valuation. Would these different types of analysts have an equal interest in the liquidity ratios?

c. Calculate the 2016 inventory turnover, days sales outstanding (DSO), fixed assets turnover, and total assets turnover. How does Computron’s utilization of assets stack up against that of other firms in its industry?

d. Calculate the 2016 debt ratio, liabilities-to- assets ratio, times-interest-earned ratio, and EBITDA coverage ratios. How does Computron compare with the industry with respect to fi- nancial leverage? What can you conclude from these ratios?

e. Calculate the 2016 profit margin, basic earning h. power (BEP), return on assets (ROA), and return
on equity (ROE). What can you say about these ratios?

f. Calculate the 2016 price/earnings ratio, price/ i. cash flow ratio, and market/book ratio. Do these
ratios indicate that investors are expected to j. have a high or low opinion of the company?

g. Perform a common size analysis and percent- age change analysis. What do these analyses tell you about Computron?

h. Use the extended DuPont equation to provide a summary and overview of Computron’s finan- cial condition as projected for 2016. What are the firm’s major strengths and weaknesses?

i. What are some potential problems and limita- tions of financial ratio analysis?

j. What are some qualitative factors that analysts should consider when evaluating a company’s likely future financial performance?

Answer 1