Case 11.19
Focus company-comprehensive financial statement analysis In Exercise 1.1 you were asked to obtain the most recent annual report of a company that you were interested in reviewing throughout the term.
Required:
Liquidity:
- Calculate working capital, the current ratio, and the acid-test ratio as of the most recent balance sheet date.
- Based on your calculations in (a), assess the company’s overall liquidity position. Explain which ratios indicate particular strengths and/or weaknesses within the company. Assume the following industry averages: current ratio = 2.0; acid-test ratio = 1.6.
- Explain how working capital and the current ratio are related. Would you expect a company with a large amount of working capital to always have a high current ratio?
Profitability:
- Calculate ROI, showing margin and turnover for the most recent year.
- Calculate ROE for the most recent year.
- Calculate the price/earnings ratio for the most recent year, using the company’s year-end market price per share of common stock in the numerator and diluted earnings per share in the denominator.
- Calculate the dividend payout and dividend yield ratios for the most recent year.
- Based on the results of your calculations in parts d, e, and f, assess the company’s overall profitability. Explain which ratios indicate particular strengths and/or weaknesses within the company. Assume the following industry averages: ROI = 15%; margin = 10%; turnover = 1.5; ROE = 20%; price/earnings = 14.0; dividend payout = 40%; dividend yield = 5%.
- As an investor in this company’s stock, would you be pleased with this year’s dividend yield? How would your dividend yield “expectations” change, if at all, if the company’s ROI was 5% higher? Explain
Financial leverage:
- Calculate the debt ratio and the debt/equity ratio as of the most recent balance sheet date.
- Based on the results of your calculations in j. assess the company’s overall leverage position. What would you estimate the industry averages to be for the debt ratio/equity ratio? Explain
- Explain the relationship between ROI and ROE, and the concept of financial leverage. Would you expect the percentage difference between ROI and ROE to be high or low for a firm that makes substantial use of financial leverage?
Activity measures:
- Calculate the accounts receivable turnover and number of days’ sales in accounts receivable (based on a 365-day year) for the most recent year.
- Based on your analysis in m, do you believe that the company is doing an effective job at managing accounts receivable? What would you estimate the industry averages to be for the accounts receivable turnover and number of days’ sales in accounts receivable? Explain.
- Calculate the inventory turnover and number of days’ sales in inventory (based on a 365-day year) for the most recent year.
- Based on your analysis in o, to what extent does the company need to be concerned about its inventory management policies? In assessing the inventory management policies? In assessing the inventory management policies, would you be more interested in knowing current ratio or acid-test ratio information? Explain
Overall assessment:
- Assume that you have $10,000 that you would like to invest in a single company. Evaluate the common stock of your focus company as a potential investment. From the data available in your focus company’s financial statements, identify the five most important criteria that you would use to make your investment decision, and explain why each is important.