Finance homework

Analysis of Financial Statements – Practice Case

Rev. Oct 2016 – AFP Workshop ©2016 – The Treasury Academy, Inc. – All Rights Reserved 1

Medical Technology Company Medical Technology Company (MTC) is a New Jersey-based company specializing in manufacturing electronic medical equipment. MTC’s products are used in hospitals, clinics and doctors offices. The company was founded by two doctors, Jose Garcia and Steve Picou and began operations in 2004, initially selling their products to local clinics and hospitals, then expanding to the broader U.S. market. They have expanded significantly in recent years and now sell a small portion of annual sales to companies in Canada, Mexico, and Europe. Due to the high level of demand for their products, they are able to price all of their sales in US Dollars and sales have been growing rapidly (about 25% per year). For the last three years (2013-2015) their profits have been exceptionally strong, but there always seems to be a shortage of cash for their operations. Even though Jose and Steve have put in extra equity capital, reinvested all net profit back in the business, and used long-term borrowing as much as possible for the expansion of production facilities, they are continually having to make short-term borrowing arrangements with their bank to cover funds shortfalls, sometimes with very little notice. Examine MTC’s current financial position and see if you can determine why they are having these liquidity problems. The firm’s current financial statements, calculation of key ratios and industry averages are provided on the following pages. Assume a tax rate of 35% and a weighted average cost of capital (WACC) of 10%. Specific Questions:

1. Analyze the financial statements and ratios and assess the company’s financial situation and viability as potential lending opportunity (banker’s view) or equity investment (portfolio manager’s view).

2. Why may companies with high growth rates have liquidity problems? 3. How does the fact that this company is a manufacturer affect its liquidity needs as

it grows? 4. Are revenues, profits and cash flows all basically the same thing? 5. What liquidity problems does this firm have? 6. Are the liquidity problems related to the company’s growth and capital structure? 7. What would you do to solve this company’s problems? 8. Forecasting Question: Assuming a net profit margin of 4.0%, a total asset to sales

ratio of 125% and a spontaneous liability to sales ratio of 6.5%, what would the need for additional funding be at sales increase levels of 10%, 15%, and 25%?

Analysis of Financial Statements – Practice Case

Rev. Oct 2016 – AFP Workshop ©2016 – The Treasury Academy, Inc. – All Rights Reserved 2

Medical Technology Company - Income Statements All figures in $1,000

2013 2014 2015 Revenues 35,435 44,294 55,367 Cost of Goods Sold 21,071 25,690 31,006 Gross Profit 14,364 18,603 24,362 General Operating Expenses 4,846 5,594 6,642 Management Salaries 2,964 3,531 3,833 Insurance 1,053 1,214 1,364 Depreciation 1,243 1,561 1,645 Misc. and Other Expenses 993 1,138 1,340 Operating Profit 3,265 5,566 9,538 Interest Expense 2,122 3,825 6,642 Net Profit Before Taxes 1,143 1,741 2,895 Income Tax (35%) 400 609 1,013 Net Profit After Taxes 743 1,132 1,882

Analysis of Financial Statements – Practice Case

Rev. Oct 2016 – AFP Workshop ©2016 – The Treasury Academy, Inc. – All Rights Reserved 3

Medical Technology Company - Year-End Balance Sheet All figures in $1,000

Assets 2013 2014 2015 Cash & Equivalents 787 524 72 Accounts Receivable 3,531 5,001 6,983 Inventory 7,166 9,579 12,014 Prepaid Expenses 730 1,053 1,231 Total Current Assets 12,214 16,157 20,300

Fixed Assets (net) 21,351 35,618 51,845

Total Assets 33,565 51,775 72,144

Liabilities & Equity Accounts Payable 1,750 2,029 2,281 Deferred Taxes & Wages 733 1,021 1,325 Notes Payable 1,052 2,236 3,508 Current Liabilities 3,535 5,286 7,114

Long-Term Debt 13,477 22,804 33,463

Total Liabilities 17,012 28,090 40,577

Common Stock 15,000 21,000 27,000 Retained Earnings 1,553 2,685 4,567 Total Equity 16,553 23,685 31,567

Total Liabilities & Equity 33,565 51,775 72,144

Analysis of Financial Statements – Practice Case

Rev. Oct 2016 – AFP Workshop ©2016 – The Treasury Academy, Inc. – All Rights Reserved 4

Medical Technology Co. - Statement of Cash Flows – 2014-2015 All figures in $1,000 2014 2015 Cash Flows from Operations Net Income 1,132 1,882 Adjustments to Reconcile NI to Cash Depreciation 1,561 1,645 Increase in Accounts Receivable (1,470) (1,983) Increase in Inventories (2,413) (2,435) Increase in Pre-Paid Expenses (323) (177) Increase in Accounts Payable 279 252 Increase in Accrued Taxes/Wages 288 304 Net Cash from Operating Activities (947) (511) Cash Flows from Investing Capital Expenditures (Net) (14,266) (16,227) Depreciation Adjustment (1,561) (1,645) Net Cash from Investing (15,827) (17,872) Cash Flows from Financing Increase in Notes Payable 1,184 1,272 Increase in Long-Term Debt 9,327 10,659 Increase in Common Stock 6,000 6,000 Net Cash from Financing 16,511 17,931 Net Change in Cash (263) (452)

Analysis of Financial Statements – Practice Case

Rev. Oct 2016 – AFP Workshop ©2016 – The Treasury Academy, Inc. – All Rights Reserved 5

Medical Technology Company – Key Financial Ratios – 2013-2015

2013 2014 2015 Ind. Avg. Current Ratio (CA/CL) 3.46 3.06 2.85 3.50 Quick Ratio (Cash+AR/CL) 1.22 1.05 0.99 1.25 Cash Flow to Total Debt 0.14 0.11 0.10 0.15 Times Interest Earned (OP/Int Exp) 1.54 1.46 1.44 1.65 LT Debt to Capital (LTD/LTD+TE) 44.9% 49.1% 51.5% 45% Total Liabilities to Total Assets 50.7% 54.3% 56.2% 50% Return on Sales (NI/Sales) 2.1% 2.6% 3.4% 5.0% Total Asset Turnover (Sales/TA) 1.06 0.86 0.77 0.90 Return on Total Assets 2.2% 2.2% 2.6% 4.5% Equity Multiplier (TA/Eq) 2.03 2.19 2.29 1.25 Interest/Total Debt 14.6% 15.3% 18.0% 12.5% Return on Common Equity 4.5% 4.8% 6.0% 5.6% Economic Value Added (EVA) -$880,750 -$1,031,000 -$303,300 +$2.0 M Days’ Inventory 124 136 141 110 Days’ Receivables 36 41 46 32 Days’ Payables 30 29 27 33 Cash Conversion Cycle 130 148 161 109 Industry Averages are for similar sized companies in same industry as Medical Technology Company.