3) If inventories could be reduced to industry standards, how should that affect the company's profitability...

3) If inventories could be reduced to industry standards, how should that affect the company's profitability and stock price?

	Year 2	Year 1	Year 0	Industry
Current Ratio	1,86x	1,1x	2,3x	2,7x
Quick Ratio	0,67x	0,4x	0,8x	1,0x
Inventory turnover	4,10x	4,5x	4,8x	6,1x
DSO	44,9	39	36,8	32
Fixed asset turnover	8,61	6.2x	10.0x	7.0x
Total asset turnover	2,01	2.0x	2.3x	2.5x
Debt ratio	55,61%	95,40%	54,80%	40,00%
TIE	6,3x	-3.9x	3,3x	6,2x
EBITDA coverage	5,5x	-2,5x	2,6x	8,0x
Profit margin	3,60%	-8,9%	2,60%	3,60%
Basic earning power	14,40%	-24,1%	14,20%	17,80%
ROA	7,25%	-18.1%	6,00%	9,00%
ROE	16,34%	-391,4%	13,30%	18,00%
Price/Earnings	12,01x	-0,4%	9,7x	14,2x
Price/Cash Flow	8,2x	0,6x	8,0x	7,6x
Market / Book	1,96x	1,7x	1,3x	2,9x
Book value per share	$6,21	$1,33	$6,64	N/A

Expert Solution

1)

The inventory turnover ratio for year 2 is 4.10 , whereas for the industry it is 6.1

On th income statement , the gross profit is calculated by subtracting cost of goods sold(COGS) from total revenue.

The COGS refers to the amount of inventory a company sold during the period.

COGS = Beginning invemtory + new inventory - ending inventory

If inventory is reduced, it means either new inventories are not purchased or existing inventories are sold off.

If new inventories are not purchased, COGS will be lower as will be total revenue

If inventories are sold at a faster rate , COGS will be higher as will be total revenue.

So Assuming the sale price per unit of inventory is greater than the cost price as normally it is for a company,

The gross profit will increase when inventory is reduced and inventory turnover will be high

2)

Now considering the net income has a considerable say in stock prices, net income should increase when invemtories are reduced as shown above that profitability should increase. However the motive of the company reducing inventory is the key here. If the company is selling off invemtory because it is becoming obsolete then it may reduce net income. If the company is not following industry standards of inventory valuation (FIFO or LIFO) then it may trigger a negative sentiment among investors and devalue the stocks.

But considering everything works fine, net income and stock price should increase.

jeff jeffy answered 1 year ago

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