In: Accounting
Decision Case 13-5: Acquisition Decision | ||||||
Diversified Industries is a large conglomerate that is continually in the market for new acquisitions. The company has grown rapidly over the last ten years through buyouts of medium-size companies. Diversified does not limit itself to companies in any one industry, but looks for firms with a sound financial base and the ability to stand on their own financially. | ||||||
The president of Diversified recently told a meeting of the company’s officers: ‘‘I want to impress two points on all of you. First, we are not in the business of looking for bargains. Diversified has achieved success in the past by acquiring companies with the ability to be a permanent member of the corporate family. We don’t want companies that may appear to be a bargain on paper but can’t survive in the long run. Second, a new member of our family must be able to come in and make it on its own—the parent is not organized to be a funding agency for struggling subsidiaries.’’ | ||||||
Ron Dixon is the vice president of acquisitions for Diversified, a position he has held for five years. He is responsible for making recommendations to the board of directors on potential acquisitions. Because you are one of his assistants, he recently brought you a set of financials for a manufacturer, Heavy Duty Tractors Inc. Dixon believes that Heavy Duty is a ‘‘can’t-miss’’ opportunity for Diversified and asks you to confirm his hunch by performing basic financial statement analysis on the company. The most recent comparative balance sheets and income statement for the company follow. | ||||||
Heavy Duty Tractors Inc. | Heavy Duty Tractors Inc. | |||||
Comparative Statements of Financial Position | Statement of Income and Retained Earnings | |||||
(thousands omitted) | For the Year Ended December 31, 2017 | |||||
31-Dec-17 | 31-Dec-16 | (thousands omitted) | ||||
Assets | Sales revenue | 875,250 | ||||
Current assets: | Cost of goods sold | 542,750 | ||||
Cash | 48,500 | 24,980 | Gross profit | 332,500 | ||
Marketable securities | 3,750 | - | Selling, general, and administrative expenses | 255,360 | ||
Accounts receivable, net of allowances | 128,420 | 84,120 | Operating income | 77,140 | ||
Inventories | 135,850 | 96,780 | Interest expense | 45,000 | ||
Prepaid items | 7,600 | 9,300 | Net income before taxes | 32,140 | ||
Total current assets | 324,120 | 215,180 | Income tax expense | 9,250 | ||
Long-term investments | 55,890 | 55,890 | Net income | 22,890 | ||
Property, plant, and equipment: | Retained earnings, January 1, 2017 | 169,820 | ||||
Land | 45,000 | 45,000 | 192,710 | |||
Buildings and equipment, less accumulated depreciation of $385,000 in 2017 and $325,000 in 2016 | 545,000 | 605,000 | Dividends paid on common stock | 10,000 | ||
Total property, plant, and equipment | 590,000 | 650,000 | Retained earnings, December 31, 2017 | 182,710 | ||
Total assets | 970,010 | 921,070 | ||||
Liabilities and Stockholders’ Equity | ||||||
Current liabilities: | ||||||
Short-term notes | 80,000 | 60,000 | ||||
Accounts payable | 65,350 | 48,760 | ||||
Salaries and wages payable | 14,360 | 13,840 | ||||
Income taxes payable | 2,590 | 3,650 | ||||
Total current liabilities | 162,300 | 126,250 | ||||
Long-term bonds payable, due 2024 | 275,000 | 275,000 | ||||
Stockholders’ equity: | ||||||
Common stock, no par | 350,000 | 350,000 | ||||
Retained earnings | 182,710 | 169,820 | ||||
Total stockholders’ equity | 532,710 | 519,820 | ||||
Total liabilities and stockholders’ equity | 970,010 | 921,070 | ||||
Required | ||||||
4 | What will you tell your boss? Should he recommend to the board of directors that Diversified put in a bid for Heavy Duty Tractors? |
We recommed to the BOD to bid for Heay Duty Tractors.
We take this decision based on the following.
There are two stage of decisions to know whether to acquire the business or not:-
1) Financial condition
2) Non-financial condition
1) Financial condition of business can be checked using various ratios. Ratios can be financial ratio, liquidity ratio, profitability ratio. Ratio analysis for 12/31/2017 ios as follows:-
a) Current Ratio
- This ratio helps to know whether the company has enough assets with the to pay of the liabilities. The higher the ratio, more strong the company is.
- Current Asset/Current liabilities
= 324120/162300
= 1.99 times.
b) Debt to equity ratio:-
This ratio helps to know that how much external parties contribute to assets relative to owmers. The lower the ratio, more the stake of owners in the assets.
= Total debt/Total Equity
= Current Liab + Non current liab / Total Equity
= 437300/532710
= 0.82 times
c) Return on equity ratio:-
This is overall measure of rate of return on investment
= Net income/Total Equity * 100
= 22890/350000*100
= 6.54%
d) Cash ratio:-
Cash ratio is used to know whether company has enough financial stability to pay out the liabilities.
= Cash and cash equivlents/Current liability
= 48500 + 3750 / 162300
= 0.3219 times.
So, company can payout 0.32 % of liabilities without relying on accounts recaivable and inventory.
Based on the above analysis, it looks that the comapny is sound in its financial aspects. Based on these, we recommend to acquire the new company.
However, apart from the financial aspects, certain non-financial aspects also needs to be seen.
They can be buying capacity of the company, goodwill of the company, market where the company is operating, integrity of the management, its suppliers, customers etc.