Contemporary Financial Management, Loose-leaf Version
Contemporary Financial Management, Loose-leaf Version
14th Edition
ISBN: 9781337090636
Author: R. Charles Moyer, James R. McGuigan, Ramesh P. Rao
Publisher: South-Western College Pub
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Chapter 3, Problem 10P

a)

Summary Introduction

To evaluate: Liquidity position of Company J compared to industry averages by considering current, quick ratio and networking capital and give suggestions.

a)

Expert Solution
Check Mark

Explanation of Solution

Calculation of current ratio and quick ratio and net working capital:

Current ratio=$1,600,000$850,000=1.88x

Quick ratio=($1,600,000$1,040,000)$850,000=0.66x

Networking capital=$1,600,000$850,000=$750,000

Hence, the industry average current ratio is 2.5 as compared to Company J (1.88) which means that, the company maintains lower liquidity.

The quick ratio also indicates the same position. The problem is not sufficient liquidity to cover unforeseen situations wherein there may be a large cash outflow and the firm won’t be able to service it.

b)

Summary Introduction

To evaluate: Company J’s performance by examining key asset management ratios. Whether any problems seeming to this analysis.

b)

Expert Solution
Check Mark

Explanation of Solution

Calculation of asset management ratios:

Average collection period=Average accounts receivablesNetcreditsales×365=$320,000$3,000,000×365=38.93days

Inventory turnover=CostofgoodssoldAverageinventory=$1,800,000$1,040,000=1.73

Totalasset turnover=NetsalesTotalassets=$3,000,000$2,400,000=1.25

The average collection period of company J is 38.93 as compared to 35 days of industry showing that it takes longer period to collect receivables.

The inventory turnover is less and it is a good sign for company J and asset turnover is slightly lower than industry so it indicates a slight underperformance of company J.

c)

Summary Introduction

To evaluate: Company J’s financial risk by examining equity multiplier, times interest earned ratio as compared to industry averages.

c)

Expert Solution
Check Mark

Explanation of Solution

Calculation of times interest earned and equity multiplier:

Times interest earned=EBITInterestexpense=$340,000$117,800=2.88

Equitymultiplier=1+DE=1+$1,650,000$750,000=3.2

Hence, the times interest earned by company is lower than industry so it is a negative sign shows a higher interest payments and equity multiplier also indicates a higher debt.

d)

Summary Introduction

To evaluate: Profitability of Company J as compared to industry averages.

d)

Expert Solution
Check Mark

Explanation of Solution

Calculation of profit margin:

Profit margin=NetincomeNetsales=$133,320$3,000,000=4.44%

Hence, the profitability of company J is 4.4% as compared to profitability of industry with 4% which is a positive and able to generate higher profits.

Quick ratio=($3.0$1.0+$1.0)($1.5)=2.0x

Hence, the current ratio and quick ratios are 2.67x and 2.0x, both ratios rise.

e)

Summary Introduction

To discuss: Overall performance of Company J.

e)

Expert Solution
Check Mark

Explanation of Solution

An excessive inventory is being carried by company J and this results in a lesser asset turnover with a weak liquidity position. In all these areas a prospective development is required and the company has outperformed the average firm in the industry in doing this.

f)

Summary Introduction

To perform: DuPont analysis of Company J.

f)

Expert Solution
Check Mark

Explanation of Solution

Calculation of ROE:

ROE=Netprofitmargin×Totalassetturnover×Equitymultiplier=$133,320$3,000,000×$3,000,000$2,400,000×$2,400,000$750,000=17.8%

Hence, ROE is 17.8% and the main area for improvement is total asset turnover.

g)

Summary Introduction

To discuss: Factors most likely to account price earnings ratio of Company J compared to industry averages.

g)

Expert Solution
Check Mark

Explanation of Solution

The main factor is the advanced amount of financial risk possessed by firm and also may be supposed as having a lower growth potential than the average firm, although there is no direct proof provided in the information to suggest this.

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