Question

R

efer to the following data:

Selected Ratios: SKI and Industry Average
	SKI	Industry
Current	1.75	2.25
Debt/Assets	58.76%	50.00%
Turnover of cash and securities	16.67	22.22
Days sales outstanding (365-day basis)	45.63	32
Inventory turnover	4.82	7
Fixed assets turnover	11.35	12
Total assets turnover	2.08	3
Profit margin	2.07%	3.50%
Return on equity (ROE)	10.45%	21.00%

Answer the following:

1. A. Find EVA using available data (make reasonable assumptions)

B. Analyze and Interpret

C. Examine factors in DuPont equation which could be modified to generate higher EVA for SKI

Answer 1

Ans 1 A. EVA (Economic Value Added) = Net Operating Profit after Tax (NOPAT) - Invested Capital *Weighted Average Cost of Capital (WACC). Essentially it is how much more the firm is earning than what is expected of it by the fund providers.

Our Assumptions here Sales of $100 mn ; Thus with the help of Profit Margin SKI NOPAT = $100 mn * 2.07% = $2.07 mn; Invested Capital is assumed as Total Assets in our Case thus with the help of Total Assets Turnover Ratio = 2.08 we have assumed Sales as $ 100 mn and Total Assets Turnover = Sales / Total Assets = 100 / Total Assets = 2.08 or Total Assets = 100 /2.08 = $ 48.07692 mn. Thus our Invested Capital is assumed as $ 48.07692. Moving on to WACC we are assuming it to be @ 10%.

With the variables: NOPAT= $2.07 mn ; Invested Capital = $48.07692 mn and WACC = 10% our EVA for SKI should be = 2.07 - (48.07692*0.10) = - $ 2.73769 mn.

Ans 1 B. We can now know from the above assumptions that the Return that SKI is generating on its Sales are way below the minimum expectation i.e. WACC (10%) by its Shareholders and Bondholders. This puts SKI in a difficult position to convince the capital providers to hold on with SKI for a possible turnaround in near future. The capital providers specially equity holders can be patient for the future but Debt Holders will need safety in terms of Capital & Interest Protection with high level of Debt in SKI portfolio the additional cost is not helping SKI much. SKI needs to rationalize its Debt and with it its financial costs to turn things around and add Economic Value to its firm.

Ans 1 C. DuPont Analysis factors are : Profit Margin; Asset Turnover and Financial Leverage. We will compare each of these factors of SKI with Industry Averages and find the action required from SKI. The analysis is as under:-

(i) Profit Margin: SKI= 2.07% vis a vis Industry Average = 3.50%. Action required from SKI is to improve its Profit Margin as it is close to half of what Industry players are making on their Sales. Needs massive Improvement.

(ii) Asset Turnover: SKI = 2.08 vis a vis Industry Average = 3.0. Action required from SKI is to improve its Total Asset Turnover too. It can be improved by the simple way of increasing sales or let go off the unnecessary Assets it has on its balance sheet. Needs Improvement.

(iii) Financial Leverage: This could be understood from Debt to Assets percentage i.e. SKI has =58.76% vis a vis Industry average of 50.00%. This shows that SKI is highly leveraged but it is not working in favor i.e. neither it is saving cost nor it is generating sufficient turnover when compared to Industry peers reflected by the above two factors. Course of action for SKI is to reduce the amount of Debt to improve its EVA.