Question

Data for Barry Computer Co. and its industry averages follow. The firm's debt is priced at par, so the market value of its debt equals its book value. Since dollars are in thousands, number of shares are shown in thousands too.

Barry Computer Company:
Balance Sheet as of December 31, 2018 (In Thousands)
Cash	$64,750		Accounts payable	$181,300
Receivables	401,450		Other current liabilities	155,400
Inventories	349,650		Notes payable to bank	116,550
Total current assets	$815,850		Total current liabilities	$453,250
			Long-term debt	$271,950
Net fixed assets	479,150		Common equity (56,980 shares)	569,800
Total assets	$1,295,000		Total liabilities and equity	$1,295,000

Barry Computer Company: Income Statement for Year Ended December 31, 2018 (In Thousands)
Sales			$1,850,000
Cost of goods sold
Materials	$814,000
Labor	462,500
Heat, light, and power	111,000
Indirect labor	111,000
Depreciation	74,000		1,572,500

Gross profit	$	277,500
Selling expenses		166,500
General and administrative expenses	$	18,500
Earnings before interest and taxes (EBIT)	$	92,500
Interest expense		32,634
Earnings before taxes (EBT)	$	59,866
Federal and state income taxes (40%)		23,946
Net income	$	35,920
Earnings per share	$	0.63040
Price per share on December 31, 2018	$	14.00

1. Calculate the indicated ratios for Barry. Round your answers to two decimal places.

   Ratio	Barry	Industry Average
   Current	x	1.81x
   Quick	x	0.98x
   Days sales outstandinga	days	37.01 days
   Inventory turnover	x	5.78x
   Total assets turnover	x	1.70x
   Profit margin	%	1.81%
   ROA	%	3.08%
   ROE	%	7.00%
   ROIC	%	7.80%
   TIE	x	2.86x
   Debt/Total capital	%	41.64%
   M/B	%	4.40%
   P/E	%	24.59%
   EV/EBITDA	%	8.85%

   
   ^aCalculation is based on a 365-day year.
   
2. Construct the DuPont equation for both Barry and the industry. Round your answers to two decimal places.

   	FIRM	INDUSTRY
   Profit margin	%	1.81%
   Total assets turnover	x	1.70x
   Equity multiplier	x	x

3. Select the correct option based on Barry's strengths and weaknesses as revealed by your analysis.
   -Select-IIIIIIIVVItem 19
   1. The firm's days sales outstanding ratio is more than the industry average, indicating that the firm should tighten credit or enforce a more stringent collection policy. The total assets turnover ratio is well above the industry average so sales should be increased, assets increased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity, assets, and invested capital. However, the company seems to be in an above average liquidity position and financial leverage is similar to others in the industry.
   2. The firm's days sales outstanding ratio is comparable to the industry average, indicating that the firm should neither tighten credit nor enforce a more stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets increased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity, assets, and invested capital. However, the company seems to be in a below average liquidity position and financial leverage is similar to others in the industry.
   3. The firm's days sales outstanding ratio is more than twice as long as the industry average, indicating that the firm should tighten credit or enforce a more stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets decreased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity, assets, and invested capital. Finally, it's market value ratios are also below industry averages. However, the company seems to be in an average liquidity position and financial leverage is similar to others in the industry.
   4. The firm's days sales outstanding ratio is more than twice as long as the industry average, indicating that the firm should loosen credit or apply a less stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets increased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity, assets, and invested capital. However, the company seems to be in an average liquidity position and financial leverage is similar to others in the industry.
   5. The firm's days sales outstanding ratio is less than the industry average, indicating that the firm should tighten credit or enforce a more stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets decreased, or both. While the company's profit margin is lower than the industry average, its other profitability ratios are high compared to the industry - net income should be higher given the amount of equity, assets, and invested capital. However, the company seems to be in an average liquidity position and financial leverage is similar to others in the industry.
4. Suppose Barry had doubled its sales as well as its inventories, accounts receivable, and common equity during 2018. How would that information affect the validity of your ratio analysis? (Hint: Think about averages and the effects of rapid growth on ratios if averages are not used. No calculations are needed.)
   -Select-IIIIIIIVVItem 20
   1. If 2018 represents a period of normal growth for the firm, ratios based on this year will be distorted and a comparison between them and industry averages will have little meaning. Potential investors who look only at 2018 ratios will be misled, and a continuation of normal conditions in 2019 could hurt the firm's stock price.
   2. If 2018 represents a period of normal growth for the firm, ratios based on this year will be accurate and a comparison between them and industry averages will have substantial meaning. Potential investors who look only at 2018 ratios will be misled, and a return to supernormal conditions in 2019 could hurt the firm's stock price.
   3. If 2018 represents a period of supernormal growth for the firm, ratios based on this year will be distorted and a comparison between them and industry averages will have substantial meaning. Potential investors who look only at 2018 ratios will be well informed, and a return to normal conditions in 2019 could hurt the firm's stock price.
   4. If 2018 represents a period of supernormal growth for the firm, ratios based on this year will be distorted and a comparison between them and industry averages will have little meaning. Potential investors who look only at 2018 ratios will be misled, and a return to normal conditions in 2019 could hurt the firm's stock price.
   5. If 2018 represents a period of supernormal growth for the firm, ratios based on this year will be accurate and a comparison between them and industry averages will have substantial meaning. Potential investors need only look at 2018 ratios to be well informed, and a return to normal conditions in 2019 could help the firm's stock price.

Answer 1

a. Ratios

Current ratio = Current assets / Current liabilities

Current ratio = 815850 / 453250 = 1.8x

Quick ratio = (Current assets - Inventory) / Current liabilities

Quick ratio = (815850 - 349650) / 453250 = 1.03x

Days sales outstanding = (Accounts receivables / Sales) * 365

Days sales outstanding = (401450 / 1850000) * 365 = 79.2 days

Inventory turnover ratio = Cost of goods sold / Inventory

Inventory turnover ratio = 1572500 / 349650 = 4.50x

Total asset turnover ratio = Sales / Total assets

Total asset turnover ratio = 1850000 / 1295000 = 1.43x

Profit margin = Net income / Sales

Profit margin = 35920 / 1850000 = 0.0194 = 1.94%

Return on Assets = Net Income / Total assets

Return on assets = 35920 / 1295000 = 0.0277 = 2.77%

Return on Equity = Net Income / Total Equity

Return on Equity = 35920 / 569800 = 0.063 = 6.30%

Return on Invested capital = EBIT (1 - Tax rate) / Equity + Debt

Return on Invested capital = 92500 * (1 - 0.4) / (569800 + 271950) = 0.0659 = 6.59%

Times Interest earned = EBIT / Interest

Times Interest earned = 92500 / 32634 = 2.83x

Debt to total capital = Debt / Total capital

Debt to total capital ratio = 271950 / (271950 + 569800) = 0.3231 = 32.31%

Market/Book value ratio = Price per share / Book value per share

Market/Book value ratio = 14 / (569800 / 56980) = 14 / 10 = 1.4

Price/Earnings ratio = Price per share / Earnings per share

Price/Earnings ratio = 14 / 0.6304 = 22.21

EV/EBITDA ratio = (Equity + Debt + Notes payable - Cash) / EBITDA

EV/EBITDA ratio = (569800 + 271950 + 116550 - 64750) / (92500 + 74000)

EV/EBITDA ratio = 1023050 / 116500 = 8.78

b. Du Pont:

Return on Equity = Net profit margin * Total asset turnover * Equity multiplier

From above computations:

Net profit margin = 1.94%

Total asset turnover = 1.43x

Equity multiplier = Assets / Equity = 1295000 / 569800 = 2.27x

Return on equity = 1.94% * 1.43 * 2.27 = 6.30%

c. Correct option - III

Firm's days sales outstanding are more than double of industry average, thus, tighter credit policies are needed. Total asset turnover is below industry average, therefore, sales should be increased or assets decreased, or both.

d. correct option - IV

If 2018 was a period of super normal growth, then the ratios will mislead and have little meaning when compared to industry average. Eventually when growth returned to normalised conditions in 2019, the firm's stock price could be taking a hit.