Question

Chris Gumede was recently hired by S&S Air to assist the company with its financial planning and to evaluate the company’s performance. Chris graduated from university five years ago with a finance degree.

S&S Air was founded 10 years ago by friends Mark and Thandi. The company has manufactured and sold light aeroplanes over this period and the company’s products have received high reviews for safety and reliability. The company has a niche market in that it sells primarily to individuals who own and fly their own aeroplanes. The company has two models, the Birdie which sells for R2 530 000 and the Eagle which sells for R5 780 000.

While the company manufactures aircraft, its operations are different from commercial aircraft companies. S&S Air builds aircraft to order. By using prefabricated parts, the company is able to complete the manufacture of an aeroplane in only five weeks. The company also receives a deposit on each order, as well as another partial payment before the order is complete. In contrast, a commercial aeroplane may take one and a half to two years to manufacture once the order is placed.

Mark and Thandi have provided the following financial statements. Chris has gathered the industry ratios for the light aeroplane manufacturing industry.

S&S Air

2018 Financial Statements

Income Statement
Sales	R128 700 000
Cost of goods sold	90 700 000
Other expenses	15 380 000
Depreciation	4 200 000
PBIT	18 420 000
Interest	2 315 000
PBT	16 105 000
Tax (40%)	6 442 000
NPAT	R 9 663 000

Dividends	2 898 900
Add to retained profits	6 764 100

2018 Balance sheet
Ordinary shares	1 000 000			Net non-current assets	R72 280 000
Retained profits	41 570 000
Shareholders equity	R42 570 000			Inventory	4 720 000
Long-term debt	R25 950 000			Accounts receivable	4 210 000
				Cash	2 340 000
Accounts payable	4 970 000			Current assets	R11 270 000
Short-term debt	10 060 000
Current liabilities	R15 030 000
	R83 550 000				R83 550 000

Light Aeroplane Industry Ratios

	Lower Quartile	Median	Upper Quartile
Current ratio	0,50	1,43	1,89
Quick ratio	0,21	0,38	0,62
Cash ratio	0,08	0,21	0,39
Total asset turnover	0,68	0,85	1,38
Inventory days	74,6	59,3	33,5
Receivables days	58,2	37,2	25,9
Total debt ratio	0,44	0,52	0,61
Debt-equity ratio	0,79	1,08	1,56
Equity multiplier	1,79	2,08	2,56
Times interest earned	5,18	8,06	9,83
Cash coverage ratio	5,84	8,43	10,27
Profit margin	4,05%	6,98%	9,87%
Return on assets (after tax)	6,05%	10,53%	13,21%
Return on equity	9,93%	16,54%	26,15%

Questions

1. Calculate the internal growth rate and sustainable growth rate for S&S Air. What do these numbers mean?
2. S&S Air is planning for a growth rate of 20 per cent next year. Calculate EFN assuming the company operated at full capacity in 2018.
3. Although most assets can be increased as a percentage of sales, net non-current assets often must be increased in specific amounts since it is usually impossible or impractical to buy part of a new plant or machine. So, assume S&S Air cannot increase net non-current assets as a percentage of sales. Instead, whenever the company needs to purchase new manufacturing equipment, it must purchase in the amount of
   R30 000 000. Calculate the new EFN with this assumption. What does this imply about capacity utilization for the company next year?

Answer 1

The detailed answer for the above question is provided below:

Calculation of Ratios :

1) Current Ratio = Current Assets / Current Liabilities

Current Assets = Inventory + Accounts Receivable + Cash + Other Current Assets

Current Liabilities = Account Payable + Short Term Debt

Therefore, (47,20,000 + 42,10,000 + 23,40,000 +1,12,70,000) / (49,70,000 + 1,00,60,000)

= 2,25,40,000 / 1,50,30,000

Current Ratio = 1.5

2) Quick Ratio = (Current Asset - Inventory) / Current Liabilities

= (2,25,40,000 - 47,20,000) / 1,50,30,000

= 1,78,20,000 / 1,50,30,000

Quick Ratio = 1.186

3) Cash Ratio = (Cash + Marketable Securities) / Current Liabilities

Marketable securities are assets that can be liquidated to cash quickly. These short-term liquid securities can be bought or sold on a public stock exchange or a public bond exchange.

= (23,40,000 + 0) / 1,50,30,000

Cash Ratio = 0.156

4) Total Assets Turnover = Net Sales or Revenue / Avg. Total Assets

= 12,87,00,000 / 8,35,50,000

Total Assets Turnover = 1.54

5) Inventory Days = Avg. Inventory x 365 / Cost of Goods Sold

6) Receivable Days = Avg Account Reciavble x 365 / Total Value of Credit Sales

7) Total Debt Ratio = Total Debt / Total Assets

Total Debt = Long Term & Short Term Liabilities

8) Debt - Equity Ratio = Total Liabilities / Total Shareholder's Equity

9) Equity Multiplier = Total Assets / Total Shareholder's Equity

10) Times Interest Earned = EBITDA / Interest Expense

EBITDA = Earnings Before Interest, Tax, Depreciation & Amortization

11) Cash Coverage = Cash & Cash Equivalent / Total Current Liabilities

12) Profit Margin = Profit / Total Revenue

13) Return on Assets = Net Income / Total Assets

14) Return on Equity = Net Income / Shareholder's Equity