Intermediate Financial Management (MindTap Course List)
Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN: 9781337395083
Author: Eugene F. Brigham, Phillip R. Daves
Publisher: Cengage Learning
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Chapter 6, Problem 4MC
Summary Introduction

Case summary:

Person J, a University of Tennessee alum with 4 years of investment analyst experience, recently joined Computron Industries ' board president, a computer device manufacturer. Computron had doubled its plant capacity during the previous year, opened new sales offices outside its home territory, and initiated an expensive advertising campaign. Person C was assigned to determine the changes ' effects. She started to collect financial statements and other information.

To discuss: The NOPAT, operating current assets, operating current liabilities, net operating working capital and total net operating capital.

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To illustrate the effects of financial leverage for PizzaPalace’s management, consider two hypothetical firms: Firm U (which uses no debt financing) and Firm L (which uses $4,000 of 8% interest rate debt). Both firms have $20,000 in net operating capital, a 25% tax rate, and an expected EBIT of $2,400. (1) Construct partial income statements, which start with EBIT, for the two firms. (2) Calculate NOPAT, ROIC, and ROE for both firms. (3) What does this example illustrate about the impact of financial leverage on ROE? (4) Why did leverage increase ROE in this example?
Now, to develop an example that can be presented to PizzaPalace’s management to illustratethe effects of financial leverage, consider twohypothetical firms: Firm U, which uses no debtfinancing, and Firm L, which uses $10,000 of 12%debt. Both firms have $20,000 in assets, a 40%tax rate, and an expected EBIT of $3,000.
A firm has been experiencing low profitability in recent years. Performan analysis of the firm’s financial position using the DuPont equation. The firm has no leasepayments but has a $2 million sinking fund payment on its debt. The most recent industryaverage ratios and the firm’s financial statements are as follows: a. Calculate the ratios you think would be useful in this analysis.b. Construct a DuPont equation, and compare the company’s ratios to the industry averageratios.c. Do the balance sheet accounts or the income statement figures seem to be primarilyresponsible for the low profits?d. Which specific accounts seem to be most out of line relative to other firms in the industry?e. If the firm had a pronounced seasonal sales pattern or if it grew rapidly during theyear, how might that affect the validity of your ratio analysis? How might you correctfor such potential problems?
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Financial leverage explained; Author: The Finance story teller;https://www.youtube.com/watch?v=GESzfA9odgE;License: Standard YouTube License, CC-BY