Question

Using Financial Accounting Information (9th Edition)

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
3	Has Heavy Duty demonstrated the ability to be a profitable member of the Diversified family? Support your answer with the necessary ratios.

Answer 1

Yes, heavy duty has demonstrated the abillity to be a profitable member of diversified family.

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.