fin 405 assignment 1

In the mini case in our textbook we were given an account balance sheet for Jaeden Industries as of December 31, 2010 along with their income statement and balance sheet from the previous year. It also stated that the firm’s dividend payout ratio is 25% and the tax rate is 34%. The firm’s stock price on December 31, 2009, was $ 42.89 and on December 31, 2010, it was $ 56.82. In part A of our assignment it asks us to use the financial statements in the text to determine Jaeden’s free cash flow, liquidity, debt and profitability ratios, and market ratios for year 2010.

Part A

Jaeden’s Free Cash Flow

The measure of free cash flow (FCF) is the amount of cash flow available to investors; the providers of debt and equity capital. It represents the net amount of cash flow remaining after the firm has met all operating needs and has made all required payments on both long- term (fixed) and short- term (current) investments (Graham, Megginson, Smart pg. 34). However, in order to determine the free cash flow you have to obtain the operating cash flow (OCF), which are cash inflows and outflows directly related to the production and sale of products or services.

OCF = [Earnings before interest and taxes (EBIT) × (1 - T)] + Depreciation (T=.34%)

OCF = (42000000-26460000-1621000-800000) x (1 – T) + Depreciation

OCF = 13119000 x (1 - .34) + 800000

OCF = 9458540

Now that we have the OCF we can solve for the FCF

FCF = OCF – Capital Expenditures + Depreciation – Networking Capital

FCF = 9458540 – 2932000 – (4530181-190000-150000)

FCF = 9458540 – 2932000 – 4190181

FCF = 2336359

Jaeden’s free cash flow is 2336359

Jaeden’s Liquidity

Our textbook states that liquidity ratios measure a firm’s ability to satisfy its short-term obligations as they come due. Current ratio and quick ratio are two measures of liquidity. Current Ratio is defined as current assets divided by current liabilities and it is used to measure a firm’s ability to meet short-term obligations. Current assets include cash, marketable securities, accounts receivable, and inventory. Current liabilities include accounts payable, notes payable, and accruals. Quick ratio is somewhat similar except it excludes a certain asset that is, inventory. Inventory turnover provides a measure of how quickly a firm sells its goods (Graham, Megginson, Smart pg. 43). Inventory turnover can be converted into average age turnover simply by dividing the turnover figure by the amount of days in a year.

Current Ratio = Current Assets / Current Liabilities

Current Ratio = (3689000 + 5423000 + 1836000 + 4118000) / (3136000 + 706000 + 500000)

Current Ratio = 15066000 / 4342000

Current Ratio = 3.469829572

Quick Ratio = Current Assets – Inventory / Current Liabilities

Quick Ratio = (3689000 + 5423000 + 1836000) – 4118000 / (3136000 + 706000 + 500000)

Quick Ratio = (10948000 – 4118000) / (3136000 + 706000 + 500000)

Quick Ratio = 2.521418701

Inventory Turnover = Cost of Goods Sold (COGS) / Inventory

Inventory Turnover = (42000000 x .63) / 4118000

Inventory Turnover = 26460000 / 4118000

Inventory Turnover = 6.425449247

Average Age Turnover = 365 / 6.425448247

Average Age Turnover = 56.80536659

Jaeden’s Debt and Profitability Ratios

In the previous equations, we dealt with current assets and current liabilities. However now, we will deal with total assets and total liabilities. Total assets include current assets plus fixed assets minus accumulated depreciation. To get the total liabilities, we will use their current liabilities

plus their long-term debt. In this section, we will be determining Jaeden’s debt ratio, debt-to-equity ratio, assets-to-equity ratio, and times interest earned for the year 2010. The debt ratio measures the proportion of total assets financed by the firm’s creditors. To obtain the debt ratio, you would divide total liabilities by total assets. Assets-to-equity ratio is a measurement of the proportion of total assets financed by a firm’s equity. It is calculated as total assets divided by common stock equity. It is an alternative measure that focuses solely on the firm’s long- term debt is the debt-to- equity ratio. Debt-to- equity ratio is calculated as long-term debt divided by stockholder’s equity. The times interest earned ratio measures the firm’s ability to make contractual interest payments. Times interest earned equals earnings before interest and taxes (EBIT) divided interest expense (Graham, Megginson, Smart pg. 45).

Debt Ratio = Total Liabilities / Total Assets

Debt Ratio = 4342000 + 3046000 /15066000 + (14811000 – 5160000)

Debt Ratio = (7388000 / 24717000) x 100

Debt Ratio = 29.89035886

Assets-to-equity Ratio = Total Assets / Common Stock Equity (common stock, paid-in capital excess, and retained earnings)

Assets-to-equity Ratio = 24717000 / (4000000 + 4500000 + 1628819)

Assets-to-equity Ratio = (24717000 / 10128819)

Assets-to-equity Ratio = 2.440264753

Debt-to-equity ratio = Long-term debt / Stockholder’s equity (common stock equity plus preferred stock)

Debt-to-equity ratio = (3046000) / (10128819 + 100000) x 100

Debt-to-equity ratio = 29.77860885

Time interested earned = EBIT / Interest Paid (.10%)

Time interested earned = 13119000 / 1311900

Time interested earned = 10

Jaeden’s Market Ratios

Market ratios relate the firm’s market value, as measured by its current share price, to certain accounting values. These ratios provide insight into how investors think the firm is performing, and they also reflect the common stockholders’ assessment of the firm’s past and expected future performance (Graham, Megginson, Smart pg. 49). The market tends to focus two which are the price/earnings (P/E) ratio and the market/book (M/B) ratio. The price/ earnings (P/ E) ratio measures the amount investors are willing to pay for each dollar of the firm’s earnings. The market/book ratio relates the market value of the firm’s shares to their book value.

Price/earnings (P/E) ratio = Market price per share of common stock / Earnings per share

Price/earnings (P/E) ratio = 56.82 / 7.79

Price/earnings (P/E) ratio = 7.293966624

Market/book ratio = Market Value per share of common stock / Book value per share of common stock

Market/book (M/B) ratio = 56.82 / (10128819 / 100000)

Market/book (M/B) ratio = 56.82 / 10.128819

Market/book (M/B) ratio = 5.609735943

Part B

In this part of the assignment, we will look at the strengths and weaknesses of Jaeden’s Industries. There was an increase in Jaeden’s earnings per share from 2009 to 2010. This shows that they earned more in 2010 on each outstanding share of common stock. The higher the operation profits margin, the better and, in this case, their profit margin was much higher in 2010 than 2009. This was also the case with their gross margin profit. The increase in their sales was also a great thing for their industries. The above statements are a few of Jaeden’s strengths. Times interested earned ratio is an area that they could improve in. Instead of this number increasing it actually dropped. The higher this number indicates a greater capacity for them to meet scheduled payments. Another weak area is their inventory balance turnover. Jaeden’s Industries has to figure out a way to lower its balance turnover instead of increasing it.

Reference

Graham, J. R., Smart, S. B., & Megginson, W. L. (2010). Corporate finance. Australia: South-Western Cengage Learning.