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The price per earning ratio has increased from 11.9 to 14.0 from year 1994 to

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(1) Market Value;The price per earning ratio has increased from 11.9 to 14.0 from year 1994 to;1996, which is close to the average P/E ratio for the industry. Generally, an increasing;P/E ratio means that investors are willing to pay more for stock per dollar of earnings.;Market/book ratio is decreasing from 2.5 to 1.1 from year 1994 to 1996. Its;considered a good investment opportunity.;Weaknesses;According to the historical data on table 3, we can see that from 1994 to year 1997;SDI firm is under an unhealthy condition.;(1) Liquidity;According to table 3, we can see the Swan-Davis Inc.s (SDI) quick ratio is;decreasing from 1.9 to 0.9 since year 1994 to year 1996, which means this company;has less ability to convert their assets to cash quickly when excluding inventory.;Furthermore, Swan-Davis, Inc.s current ratio is decreased from 2.8 to 1.6;from year 1994 to 1996, this situation indicates that SDIs short term assets, such as;cash, cash equivalents, marketable securities, receivables and inventory are losing;their ability to pay off their short-term liabilities. If the current ratio continues to;decrease SDI, will soon be unable to cover current liabilities with current assets;which is an unfavourable condition for a firm to have. (notes payable, current portion;of short-term debt, payables, accrued expenses and taxes).;(2) Asset Management;From the Table 3, we can see that Inventory turnover ratio is decreased from;8.1 to 5.7 from year 1994 to 1996, which indicates that this company is having a hard;time selling their inventory from year to year. This usually means sales are decreasing;which is not ideal for a company.;The Days sales outstanding ratio is increasing from 40.3 to 70.7 since year;1994 to 1996. A high DSO number shows that a company is selling its product to;customers on credit and taking longer to collect money. This is also not good for a;company, as it takes longer to receive sales income.;Fixed assets turnover decreased from 4.0 to 1.7 since year 1994 to 1996;which shows that the company has been not really effective in using the investment in;fixed assets to generate revenues.;The total asset turnover ratio is decreased from 1.6 to 1.0, which indicates the;company has less ability to use its assets to generate sales efficiently.;From above asset utilization ratios, we can see that company should improve their;management's ability to make the best use of its assets to generate revenue. Their;asset management must be improved in order to keep the firm healthy and profitable.;(3) Debt Management;The debt-to-equity ratio increased from 59.6% to 65.8% since year 1994 to;1996, which indicates that a company may not be able to generate enough cash to;satisfy its debt obligations.;The equity multiplier ratio increased from 2.5 to 2.9 since year 1994 to 1996;which indicates higher financial leverage, which means the company is relying more;on debt to finance its assets.;Times interest earned ratio is decreased from 7.1 to 3.4, which means less;earnings are available to meet interest payments and that the business is more;vulnerable to increases in interest rates.;The above financial leverage ratio indicate that this company relies on debt;financing and is losing its ability to meet interest payments. This makes it harder for;SDI to receive loans as we have seen, and also makes the loans more costly.;(4) Profitability;The profit margin ratio decreased from 5.4% to 2.6% since year 1994 to 1996.;This is an indication that costs are rising and need to be controlled better. This is not a;good sign for SDI as they will be unable to create profits soon if this trend continues.;The Basic Earning Power (BEP) decreased from 18% to 8.6% since year 1994;to 1996, which indicates that Swan-Davis company not effective at generating income;from its assets.;The return on asset ratio decreased from 8.6% to 2.6% from year 1994 to;1996, which indicates that the earnings are low for their amount of assets.;Return on equity decreased from 21.3% to 7.6% from year 1994 to 1996;which indicates that SDI needs to improve management to utilize its equity base and;give a better return to their investors.;(5) The Altmans Z Score, from year 1994 to 1996, has dropped from 4.47 to 2.53, at;this situation, SDI dont have enough credit score for the bank to loan the money, also;in this score point, SDI is facing bankruptcy in couple years if this financial trend is;continuing.;Part B;Yes, the managers are addressing the proper issues, and doing so correctly.;According to Table 7, we can see the liquidity is stable at 3.5, which indicates that;company has ability to convert their asset to cash quickly and steadily, it is reasonable;safe for an investor to invest in them. Also Asset management ratios are also stable;which indicate the managers management, have ability to make the best use of its;assets to generate revenue. From financial leverage aspect, the ratios indicates that;SDI is able to generate enough cash to satisfy its debt obligations, and less rely on;debt finance on assets, also their earnings are increasing to pay the cost.;Besides, the profitably is in increasing trend from year 1997 to year 1999, which;means SDIs cost is under control. Also they have a sufficient income from assets, and;pleasant equity dividends on the investors. Moreover, the market value is keep in;stable, which means that SDI is a company with steady expectations from investors;also has a good potential investment opportunity.;Question 2;a. The bank would not make a history loan at his time because SDI is currently;financially unhealthy based on its historical data. There are negative trends;occurring in their liquidity, asset management, debt management and;profitability ratios. The DuPont analysis also shows that SDI has been unable;to;b. The bank would make a forecast loan to SDI. According to table 7, Follow;the DuPont analysis, it indicates SDI has a good financial condition, and their;Z score is all above 6, which indicates that company is considered as safe;according to financial figures. This shows that SDI could pay back the loan;with a low risk of default. We expect this capital to cost more than SDIs;existing loan because the loan would be given based on forecasted numbers;which cannot be guaranteed.;c.;(1) Angel Investors;These angels is the people who are interested in making money with their;capital through non-traditional markets. They could be anyone someone you;know, your banker, your attorney, like-minded individuals, or an individuals who;for the love of business;(2) Venture Capital;Someone will provide funds to your company if your business can prove that it;has a solid track record and a potential return on investment.;(3) Public Capital;Take your business to the public. Capital equity is more risky than any other type;of funding. There are tons of legal points that surround this project, especially if;its for budding business enterprises.;Question 3;1. Companies' Balance Sheets are distorted by Inflation;A balance sheet is a statement of a firm's financial condition at a point in time. So;looking back on a balance sheet, people see historical data. Inflation may have;occurred since that data was gathered and the figures may be distorted.;2. Ratio analysis just gives people numbers, not causation factors.;Ratios are meaningless without comparison against trend data or industry data.;3. Different Divisions May Need Comparison to Different Industry Averages;Very large companies may be composed of different divisions manufacturing;different products or offering different services. To make ratio analysis mean;something, different industry averages may need to be used for each different;division.;4. Companies Choose Different Accounting Practices;Different companies may use different methods to value their inventory. If;companies are compared use different inventory valuation methods, the;comparisons won't be accurate. For example, different companies use different;depreciation methods. The use of different depreciation methods affects;companies' financial statements differently and won't lead to valid comparisons.;5. Companies can use Window Dressing to Manipulate Their Financial;Statements;If the financial statements for a company are not quite as good as they should be;and a company would like better numbers to show up in an annual report, the;company may use window dressing to manipulate the data in the financial;statements. For example, the company will perform some sort of transaction at the;end of its fiscal year that will impact its financial statements and make them look;better but is then taken care of as soon as the new fiscal year starts.;Question 4;SDIs financial forecasts are not completely believable. SDI is assuming their;sales will increase by 10% per year, when in the last 3 years they have seen their sales;decrease. The remainder of the assumptions used by SDI seem reasonable under the;circumstances.;In order determine the companys chances of actually achieving their forecasts;I would like to know more about their current business plan. Their business plan must;be able to generate the 10% increase in sales per year while reducing its aggressive;pricing and credit strategy. Reducing the amount of credit they are willing to give will;likely decrease sales, so the business plan should account for that.;Question 5;(a);In 1997, the sales = $629, and in 1996 the inventory turnover ratio = 5.7;so the Inventory = 629 / 5.7 = $110.35 million;(b);In 1996, Days sales outstanding = 70.7;Days sales outstanding = Accounts Receivable / (Sales * 360 days);Account Receivable = $123.53 million;Question 6;a) The assumption made by SDI in their forecast for 1997 is that they will reduce;their net plant and equipment from $329.6 (1996) million to $294 million.;They also assume that the current assets will decrease from $236.5 (1996);million to $138 million. The level of receivables and inventories will be;reduced so as to force turnover levels up to industry average levels in 1997.;b) The assumption made for the current assets is reasonable as they are much;more liquid and it is more likely for current assets to be changed to SDIs;desired levels. However the assumption made for the fixed assets is not;reasonable because it tends to be much more difficult to sell property, plant or;equipment.;Question 7;a) The equation for Economic Value Added is;Where NOPA is net operating profits after tax, c is the weighted average cost;of capital and K is the economic capital employed.;If sales remained at 1996 levels but SDI was able to decrease inventory to the;industry average level, economic value added (EVA) would increase due to an;increase in net operating profit after taxes. The increase is a result of a;decrease in holding costs for inventories.;b) Determine the right side of the equation (c*K) using the old EVA and the 1996;NOPA. Then you would take the 1997 NOPA and subtract c*K which was;determined first.;c) An improvement in the operating profit margin would also increase EVA as it;would increase NOPA.;d) Reducing the use of debt would decrease EVA because it will increase the;weighted average cost of capital. This occurs due to the fact that you would;have to use more equity, which generally costs more than using debt.;e) If SDI was judged to be less risky, EVA would increase due to the decrease in;WACC which decreases the value subtracted from NOPA (decreases K*c).;f) If 1996 data was used instead of forecasted data, the resulting EVA would be;smaller than the forecasted EVA. This is due to the fact that the assumptions;made by SDI have an overall increase in EVA, while the 1996 data does not.;g) If management compensation were based on EVA, this would seem to;motivate managers to do what stockholders want them to do. This is because;managers would be trying to add as much value to the firm as possible, which;would maximize share price.;Question 8;a) If sales increased from current assumptions, EPS and EVA would both;increase due to an increase in profits. If sales decreased from current;assumptions, EPS and EVA would both decrease due to a decrease in profits.;b) If the profit margin rose, EPS and EVA would both increase as profits would;increase. If the profit margin fell, EPS and EVA would decrease as profits;would decrease.;c) If the debt ratio were increased, EPS and EVA would both increase, as you;would decrease the amount of equity there is in the firm. The WACC would;decrease and the number of shares would decrease. If the debt ratio decreased;the opposite would occur.;d) If the turnover ratios were higher, EPS and EVA would increase due to an;increase in profits. If the turnover ratios lowered, EPS and EVA would;decrease due to a decrease in profits.;Question 9;The Times Interest Earned (TIE) ratio can be used by banks to assess a;companys ability to pay off interest obligations on their debt. The TIE ratio;determines how many times during the year your business has earned the annual;interest cost associated with the debt it carries. Moreover, the current ratio tells a;lender about the liquidity of your assets, and as a result says a lot about your ability to;pay your short-term debts.;A sensitivity analysis is useful to a bank because it allows them to see how the;effect changes in sales have on key financial ratios. If a small change in expected;sales causes a large change in the ratios, a bank will be less likely to offer a loan to a;firm. So if sales actually ended up being 9% but this caused the TIE ratio to decrease;way below 3.5 (say it decreased to 2.8), a bank would be less likely to provide a loan;to the firm. If the same change in sales caused TIE to only change to 3.4, then a bank;will probably be more comfortable in providing a loan to the firm.;Question 10;Management would use the forecasting model to create its plans and;budgeting for future years by determining the appropriate levels needed for each ratio;to be at their target level. If sensitivity analysis shows a lot of variability, their targets;for their ratios would have to be tailored to the variability.;Security analysts would use the forecasting model to determine the risk;associated with a company, which in turn allows them to determine the required return;needed for investors to invest in the company. A more volatile company requires more;return due to the added risk associated with the uncertainty of the forecast.;The only data an outside analyst could receive is any data that is made;publicly available by the firm. Data used for forecasts is unavailable to outside;analysts. This causes analysts to use their own data or to take the forecast received by;a firm for face value.;A company should be willing to share its assumptions with all stakeholders;involved in order to remain ethical. A company should let all stakeholders know their;assumptions about their forecasts in order to back up what their forecasts are showing.;Question 11;The outside members of the board of directors should be concerned with the;ratios as they can be used to evaluate the effectiveness of the managers currently;running the company. The board should be concerned with the ratios as they show the;financial health of a company. Trends in the ratios can be used to make changes and;decisions to the company in order to increase their profitability.

 

Paper#30197 | Written in 18-Jul-2015

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