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Financial Evaluation

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Question 1

Return on Equity using Dupont Formula

The DuPoint analysis is based on the argument that the conventional method of calculating return on equity is too simplistic and does not offer managers insight on areas for improvement. It therefore offers an alternative formula:

ROE= Profit margin* asset turnover* equity multiplier

For Advanced Energy, return on equity would be as follows

Profit margin= Net profit/ sales revenue

$46982/$583,098=8.06%

Asset turnover= Sales/total assets

$583,098/648569=0.899

Equity multiplier= Assets/ shareholder's equity

$648569/$474965=1.3655

ROE= 0.0806*1.3655*0.899=0.09894

The return on equity is 9.894%. In order to improve on these figures, the company needs to push sales more so that it earns more dollars for every unit of asset owned. Any efforts to reduce operating expenses would also help to increase the net profit margin, which currently stands at 8% of sales.

The business model can be summarized as investing in assets using funds from the equity shareholders and other sources. These assets are what enables the company to make sales of about $0.8 for every dollar invested in assets.

Question 2

Calculation of Ratios

The best way to analyze the company would be to calculate two ratios in every category of financial ratios for 2014.

Liquidity

Current ratio= 376754/ 112 570= 3.34

Quick ratio= (376574-95082)/ 112570= 2.500

Efficiency

Inventory turnover= cost of sales/ inventory

389069/ 95082= 4.09 times

Total assets turnover=$583,098/648569=0.899

Solvency ratios

Debt to Equity ratio

$209604/ $474 965= 0.4413

Debt to Assets ratio

$ 209604/ $684569= 0.3062

Profitability

Net profit margin

$46982/$583,098=8.06%

Return on assets= net profit/ total assets

$46982/ $684569=6.86%

The financial ratios of a company are useful when compared to ratios from previous year or those of another company in the industry. In this case, AEIS can be compared to MK Instruments, another listed company in the same line of business

The current and quick rations of AEIS reveal that the company can easily pay off its current liabilities and this points to a strong liquidity position. However, the company can still do better, given that MK instruments has a stronger or more favorable current ratio and quick ratio. According to Bloomberg (2015), MK's ratios stand at 6.5 and 4.6 respectively.

In terms of efficiency, an inventory turnover of 4.09 times is favorable because the items in stock only stay in the warehouse for a maximum period of 3months. This is rather favorable when compared to MK's 2.8 times. If possible, the company should seek to grow this value and if possible reduce the aer collection period for its receivables. The total asset turnover of AEIS is also stronger compared to that of MK instruments, which points to efficient management of company resources

The solvency ratios of the company also reveal that the company has been able to balance the composition of debt and equity. The proportion of assets that is financed through debt is only 30%, which serves to minimize the annual interest expense. MK instruments on the other hand have a lower debt to asset ratio, which currently stands at 11.60%. AEIS may choose to also lower the debt component if it will reduce the overall cost of capital.

In terms of profitability, MK instruments has a stronger showing, which means that AEIS can improve its figures slightly. The return on assets of MK instruments is 7.44%, which is 0.6% higher than what AEIS posted in 2014. The net profit margin for MK instruments was also slightly higher. These figures do not mean that AEIS is doing badly. Instead, the managers ought to note that the good performance can be improved by using industry peers as benchmarks.

Question 3

The day's working capital of a firm is important in pointing out the overall health of the company because it highlights efficiency in employing resources. In this case, comparing it to MK instruments will reveal how well the company is doing.

Days receivables= 124540 / (583,098 /365) = 77.9579

Days inventory= 95082/ 389069/365= 90.0

Days payables= 53040/ 389069/365= 49.76

The days working capital will be= $77.96+$90- $49.76= $118.2

The same figures can be calculated for MK Instruments

Days receivables= 116.7/ 780.9/365= 54.54

Days inventory= 155.2/ 443.1/365= 127.8

Days payables= 34.2/ 443.1/356= 28.17

Days working capital will be= $54.54+ $127.8- $28.17= $154.17

In this comparison, it is clear that AEIS has been able to tailor its operations so that it requires a lower amount of working capital per day to remain in operation. This is quite favorable for the company because the working capital needs are met without even taking into account cash and cash equivalents into consideration.

QUESTION 4

At the moment, AEIS uses a larger proportion of equity than debt to finance its assets. Debt to equity ratio currently stands at 0.4414 and this is considered healthy, given that the company is making profits and can comfortably pay its interest obligations. However, this is quite different from what MK instruments and other players in the industry are doing. MK's debt to equity ratio is about 0.13, which means the competitor has a lower annual interest obligation. Managers of Advance Energy should aim towards a 0.25 ratio while keeping watch on what happens to the overall cost of capital for the firm.

QUESTION 5

The Weighted Average Cost Capital for a firm is a good indicator of whether the firm is financing its assets efficiently. The Weighted average cost of capital is often used as the required rate of return for any investment the firm is undertaking. As such, the firm ought to minimize the cost of capital through using more of the affordable sources of capital.

Advanced Energy utilizes both debt and equity to finance its assets. The cost of each can be determined as follows:

Cost of debt

This can be determined by taking into account the interest expense for the year 2014 and the average debt for 2013 and 2014

The interest expense was 230,000 while the debt amounts for 2013 and 2014 were 209,604,000 and 188,515,000 respectively

Kd= 230,000/ 199,059,500= 0.1155%

Cost of equity

The cost of equity can be estimated using the capital asset pricing model

Ke= Market free rate+ company beta( Market premimu)

NASDAQ estimates Advanced energy's beta to be around 1.45, and this is the value to be used in the capm model

The risk free rate to be used is 2.24% while the market premium is 7.5%

Ke= 2.24%+ 1.45* 7.5%=

2.24%+ 10.875%= 13.115%

The respective weights for debt and equity can be determined through expressing each component as a fraction of total assets

D= 209064/684569

E= 474965/ 684569

Therefore WACC will be

(209064/684569*0.1155)+ (474965/684569*13.115) = 0.0352+9.099= 9.1342%

Indeed, there are practical ways for Advanced Energy to reduce its weighted average cost of capital. Currently, it is clear that the company is in a position to secure debt capital for a low cost. Therefore, the managers should seek to increase the proportion of debt in the capital mix. A restructuring of sorts would be a welcome change for the company.

QUESTION 6

Whenever making forecasts regarding the future of a company's performance, there are several assumptions that are held. First, one has to assume that the values of various balance sheet and income statements will maintain their proportionality during the forecast period. The growth rate forecasted should also remain constant for that period. It is assumed that external business environment factors will not affect the forecast or will remain as they are currently. The company is expected to maintain its growth rate for the coming periods. It is expected that the company will continue having a strong liquidity position.

Areas for improvement include the net profit margin and the cost of sales. The company should find ways to reduce its purchasing costs so that gross profit margin improves. The net profit margin can be improved by minimizing the amount the company spends on operating expenses.

QUESTION 7

The company is not paying dividends at the moment even though it is making profits and is in a strong liquidity position. Strong liquidity means that paying dividends would not hurt the company's financial health. However, withholding dividends means that managers think that there are investment opportunities that can be exploited using retained earnings. If all the shareholders are comfortable with such a position, there would be no need to distribute dividends. A rapidly growing company needs to save as much as possible on its profits to maintain sustainable growth rate.

QUESTION 8

The current composition of the Board of Managers at the company represents strength. All of the board members are experienced enough and can be trusted to conduct a proper oversight role on the executive leadership of the company. It is also interesting to note their ages vary from early fifties up to late seventies and one member is actually past their eightieth birthday. This means that such a board will be open to various ideologies regarding how best to manage the company's affairs. Some of the members have served the company for over a decade and therefore understand the company's culture. It would therefore be proper to expect them to continue protecting this culture.

One weakness of the Board is that it has no female representation and this may not suit the company's image well in the eyes of external stakeholders. The lack of female representation could lead the company to remain incognizant to ideas that a female member would advocate. For instance, the board may be unable to discuss impartially issues of equitable pay for workers at the company. Such a board may also act as an obstacle for a female that wants to join it in its current composition.

QUESTION 9

The top leadership of the company should note that the company is performing well generally but there remains numerous opportunities to improve. The company has to find ways to grow sales to realize a strong total asset turnover. Further, the company should minimize its operational costs with a view of translating a great portion of sales revenue into net income. In the area of financing, it would be advisable for the CEO to push the board to sanction a capital restructuring so that the company leverages on affordable debt financing. Such a move would lower the cost of capital and allow the company to take on more projects due to a lower required rate of return.

References

Advanced Energy Inds (2015) 10K Annual Report

Bloomberg Inc (2015) MK Instruments Financials

NASDAQ (2015) MK Instruments Financial Information