Question

John Green, a recent graduate with four years of for-profit health management experience, was
recently brought in as assistant to the chairman of the board of Digital Diagnostics, a manufacturer of
clinical diagnostic equipment. The company had doubled its plant capacity, opened new sales offices outside its
home territory, and launched an expensive advertising campaign. Digital's results were not satisfactory,
to put it mildly. Its board of directors, which consisted of its president and vice president plus its major
stockholders (who were all local business people), was most upset when directors learned how the expansion
was going. Suppliers were being paid late and were unhappy, and the bank was complaining about the cut off
credit. As a result, Eddie Sanders, Digital’s president, was informed that changes would have to be made, and
quickly, or he would be fired. Also, at the board's insistence, John Green was brought in and given the job of
assistant to Wendy Smith, a retired banker who was Digital's chairwoman and largest stockholder. Sanders
agreed to give up a few of his golfing days and help nurse the company back to health, with Green's assistance.
Green began by gathering financial statements and other data, shown below. The data show the dire situation
that Digital Diagnostics was in after the expansion program. Thus far, sales have not been up to the
forecasted level, costs have been higher than were projected, and a large loss occurred in Year 2, rather than
the expected profit. Green examined monthly data for Year 2 (not given in the case), and he detected an
improving pattern during the year. Monthly sales were rising, costs were falling, and large losses in the early
months had turned to a small profit by December. Thus, the annual data look somewhat worse than final monthly
data. Also, it appears to be taking longer for the advertising program to get the message across, for the new
sales offices to generate sales, and for the new manufacturing facilities to operate efficiently. In other words,
the lags between spending money and deriving benefits were longer thanDigital's managers had anticipated.
For these reasons, Green and Sanders see hope for the company—provided it can survive in the short run.
Green must prepare an analysis of where the company is now, what it must do to regain its financial health,
and what actions should be taken.
Use an Excel Workbook to perform the quantitative parts of the analysis and include calculations.
				Digital Diagnostics
				Statement of Operations
				Yr 1 Actual	Yr 2 Actual	Yr 3 Projected
Revenue:
Net patient service revenue				$3,432,000	$5,834,400	$7,035,600
Other revenue				$0	$0	$0
Total revenues				$3,432,000	$5,834,400	$7,035,600
Expenses:
Salaries and benefits				$2,864,000	$4,980,000	$5,800,000
Supplies				$240,000	$620,000	$512,960
Insurance and other				$50,000	$50,000	$50,000
Drugs				$50,000	$50,000	$50,000
Depreciation				$18,900	$116,960	$120,000
Interest				$62,500	$176,000	$80,000
Total expenses				$3,285,400	$5,992,960	$6,612,960
Operating income				$146,600	-$158,560	$422,640
Provision for income taxes				$58,640	-$63,424	$169,056
Net income				$87,960	-$95,136	$253,584
				Digital Diagnostics
				Balance Sheet
				Yr 1 Actual	Yr 2 Actual	Yr 3 Projected
Assets
Current assets:
Cash				$9,000	$7,282	$14,000
Marketable securities				$48,600	$20,000	$71,632
Net accounts receivable				$351,200	$632,160	$878,000
Inventories				$715,200	$1,287,360	$1,716,480
Total current assets				$1,124,000	$1,946,802	$2,680,112
Property and equipment				$491,000	$1,202,950	$1,220,000
Less accumulated depreciation				$146,200	$263,160	$383,160
Net property and equipment				$344,800	$939,790	$836,840
Total assets				$1,468,800	$2,886,592	$3,516,952
Liabilities and shareholders' equity
Current liabilities:
Accounts payable				$145,600	$324,000	$359,800
Accrued expenses				$136,000	$284,960	$380,000
Notes payable				$120,000	$640,000	$220,000
Current portion of long-term debt				$80,000	$80,000	$80,000
Total current liabilities				$481,600	$1,328,960	$1,039,800
Long-term debt				$323,432	$1,000,000	$500,000
Shareholders' equity:
Common stock				$460,000	$460,000	$1,680,936
Retained earnings				$203,768	$97,632	$296,216
Total shareholders' equity				$663,768	$557,632	$1,977,152
Total liabilities and shareholders' equity				$1,468,800	$2,886,592	$3,516,952
Other data:
Stock price				$8.50	$6.00	$12.17
Shares outstanding				100,000	100,000	250,000
Tax rate				40%	40%	40%
Lease payments				$40,000	$40,000	$40,000
ANSWER THE FOLLOWING:
							Industry
				Yr 1 Actual	Yr 2 Actual	Yr 3 Projected	Average
Profitability ratios
Total margin							3.6%
Return on assets							9.0%
Return on equity							17.9%
Liquidity ratios
Current ratio							2.70
Days cash on hand							22.0
Debt management (capital structure) ratios
Debt ratio							50.0%
Debt to equity ratio							2.5
Times-interest-earned ratio							6.2
Cash flow coverage ratio							8.00
Asset management (activity) ratios
Fixed asset turnover							7.00
Total asset turnover							2.50
Days sales outstanding							32.0
Other ratios
Average age of plant							6.1
Earnings per share							n/a
Book value per share							n/a
Price/earnings ratio							16.20
Market/book ratio							2.90
				Digital Diagnostics
				Common Size Statement of Operations
							Industry
				Yr 1 Actual	Yr 2 Actual	Yr 3 Projected	Average
Revenue:
Net patient service revenue							100.0%
Other revenue							0.0%
Total revenues							100.0%
Expenses:
Salaries and benefits							84.5%
Supplies							3.9%
Insurance and other							0.3%
Provision for bad debts							0.3%
Depreciation							4.0%
Interest							1.1%
Total expenses							94.1%
Operating income							5.9%
Provision for income taxes							2.4%
Net income							3.5%
				Digital Diagnostics
				Common Size Balance Sheet			Industry
				Yr 1 Actual	Yr 2 Actual	Yr 3 Projected	Average
Assets
Current assets:
Cash							0.3%
Marketable securities							0.3%
Net accounts receivable							22.3%
Inventories							41.2%
Total current assets							64.1%
Property and equipment							53.9%
Less accumulated depreciation							18.0%
Net property and equipment							35.9%
Total assets							100.0%
Liabilities and shareholders' equity
Current liabilities:
Accounts payable							10.2%
Accrued expenses							9.5%
Notes payable							2.4%
Current portion of long-term debt							1.6%
Total current liabilities							23.7%
Long-term debt							26.3%
Shareholders' equity:
Common stock							20.0%
Retained earnings							30.0%
Total shareholders' equity							50.0%
Total liabilities and shareholders' equity							100.0%
*Please show calculations. Thank you! V/R

Answer 1

ANSWER THE FOLLOWING:
						Industry
		Yr 1 Actual	Yr 2 Actual	Yr 3 Projected	Average	Average
Profitability ratios	Formula
Total margin	net Income/Total Revenue*100	$87960/$3,432,000*100	-$95136/5834400*100	$253584/$7035600*100	($87960-95136+253584)/(3432000+5834400+7035600)	3.60%
		2.56%	-1.63%	3.60%	1.51%	3.60%
Return on assets	Earning Before Int & Tax/Total Asset* 100	(87960+58640+62500)/1468800	(-95136-158560+176000)/2886592	(253584+169056+80000)/3516952	(14.24-2.69+14.29)/3	9.00%
		14.24%	-2.69%	14.29%	16.31%
Return on equity	net Income/Avg Share Holders(including Pref Sh Holder)	87960/663768	-95136/557632	253584/1977152	(13.25-17.06+12.83)	17.90%
		13.25%	-17.06%	12.83%	0.46%
Liquidity ratios
Current ratio	Current Assets/Current Liabilities	(1124000/481600)	(1946802/1328960)	(2680112/1039800	(2.33+1.46+2.58)	2.7
		2.33	1.46	2.58	4.66