Finance and Value Creation

11/23/2018 Capella: Corporate Finance: Core Principles and Applications

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Product Sales Do you think the company would have suffered the same fate if its product had been less popular? Why or why not?

Cash Flow The Grandmother Calendar Company clearly had a cash flow problem. In the context of the cash flow analysis we developed in Chapter 2, what was the impact of customers not paying until orders were shipped?

Corporate Borrowing If the firm was so successful at selling, why wouldn’t a bank or some other lender step in and provide it with the cash it needed to continue?

Cash Flow Which is the biggest culprit here: too many orders, too little cash, or too little production capacity?

Cash Flow What are some of the actions that a small company like The Grandmother Calendar Company can take (besides expansion of capacity) if it finds itself in a situation in which growth in sales outstrips production?

Comparing ROE and ROA Both ROE and ROA measure profitability. Which one is more useful for comparing two companies? Why?

Ratio Analysis Consider the ratio EBITDA/Assets. What does this ratio tell us? Why might it be more useful than ROA in comparing two companies?

QUESTIONS AND PROBLEMS

Basic (Questions 1–10)

1. DuPont Identity If Harley, Inc., has an equity multiplier of 1.35, total asset turnover of 2.15, and a profit margin of 6.08 percent, what is its ROE?

2. Equity Multiplier and Return on Equity Quinn Company has a debt–equity ratio of .75. Return on assets is 8.6 percent, and total equity is $975,000. What is the equity multiplier? Return on equity? Net income?

3. Using the DuPont Identity Y3K, Inc., has sales of $6,180, total assets of $3,680, and a debt– equity ratio of .45. If its return on equity is 15 percent, what is its net income?

4. EFN The most recent financial statements for Cornell, Inc., are shown here:

INCOME STATEMENT BALANCE SHEET

Sales $43,000 Assets $104,500 Debt $ 28,200

11/23/2018 Capella: Corporate Finance: Core Principles and Applications

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Costs   30,200     Equity     76,300

Taxable income $12,800 Total $104,500 Total $104,500

Taxes (34%)     4,352        

Net income $ 8,448        

Assets and costs are proportional to sales. Debt and equity are not. A dividend of $2,600 was paid, and the company wishes to maintain a constant payout ratio. Next year’s sales are projected to be $50,310. What is the external financing needed?

5. Sales and Growth The most recent financial statements for Weyland Co. are shown here:

INCOME STATEMENT BALANCE SHEET

Sales $67,400 Current assets $ 19,000 Long term debt $ 51,000

Costs 39,600 Fixed assets 141,000 Equity 109,000

Taxable income $27,800 Total $160,000 Total $160,000

Taxes (34%) 9,452        

Net income $18,348        

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Assets and costs are proportional to sales. The company maintains a constant 30 percent dividend payout ratio and a constant debt–equity ratio. What is the maximum increase in sales that can be sustained assuming no new equity is issued?

6. Sustainable Growth If the SGS Corp. has an ROE of 14.5 percent and a payout ratio of 25 percent, what is its sustainable growth rate?

7. Sustainable Growth Assuming the following ratios are constant, what is the sustainable growth rate?

Total asset turnover

Profit margin

Equity multiplier

Payout ratio

= 3.20

= 7.4%

= 1.45

= 60%

8. Calculating EFN The most recent financial statements for Incredible Edibles, Inc., are shown here (assuming no income taxes):

INCOME STATEMENT BALANCE SHEET

Sales $12,100 Assets $28,300 Debt $ 7,400

Costs 8,760     Equity    20,900

Net income $ 3,340 Total $28,300 Total $28,300

Assets and costs are proportional to sales. Debt and equity are not. No dividends are paid. Next year’s sales are projected to be $14,399. What is the external financing needed?

9. External Funds Needed Cheryl Colby, CFO of Charming Florist Ltd., has created the firm’s pro forma balance sheet for the next fiscal year. Sales are projected to grow by 15 percent to $211.6 million. Current assets, fixed assets, and short-term debt are 20 percent, 90 percent, and 15 percent of sales, respectively. The company pays out 40 percent of its net income in dividends. The company currently has $32 million of long-term debt, and $16 million in common stock par value. The profit margin is 10 percent.

a. Construct the current balance sheet for the firm using the projected sales figure. b. Based on the sales growth forecast, how much does the company need in external funds for the

upcoming fiscal year? c. Construct the firm’s pro forma balance sheet for the next fiscal year and confirm the external

funds needed that you calculated in part (b).

10. Sustainable Growth Rate The Dent Company has an ROE of 13.15 percent and a payout ratio of 30 percent.

a. What is the company’s sustainable growth rate? b. Can the company’s actual growth rate be different from its sustainable growth rate? Why or why

not? c. How can the company increase its sustainable growth rate?

Intermediate (Questions 11–23)

11/23/2018 Capella: Corporate Finance: Core Principles and Applications

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11. Return on Equity Firm A and Firm B have debt/total asset ratios of 35 percent and 30 percent and returns on total assets of 8 percent and 9 percent, respectively. Which firm has a greater return on equity?

12. Ratios and Foreign Companies Prince Albert Canning PLC had a net loss of £17,218 on sales of £153,875. What was the company’s profit margin? Does the fact that these figures are quoted in a foreign currency make any difference? Why? In dollars, sales were $223,180. What was the net loss in dollars?

13. External Funds Needed The Optical Scam Company has forecast a sales growth rate of 18 percent for next year. The current financial statements are shown below. Current assets, fixed assets, and short-term debt are proportional to sales.

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