BADM 2001 Introduction to Business

Dr. Randa El Bedawy

Assignment (3)

MODEL ANSWER

Look at the financial statements excerpted from the Foundation FastTrack and answer
the following questions, explaining the reasons and justification for your answers.

1) Look at the cashflow statement survey.

a. Which companies got an emergency loan? How much? (4 points)
*Andrews and Chester
*Andrews got $17,102,000, Chester got $2,833,000
b. For each company you mentioned in (a) explain why it got an emergency loan(8
points)
Andrews has net loss (probably due to high VC, SG&A, and interest
expense). Plus, it has a very high amount of cash outflow for the inventory
item. This means that it had lots of ending inventory due to overestimating
its sales forecasts.
Though less, Chester still had a large cash outflow for the inventory item.
This means that Chester, too, has overestimated its sales forecasts, and
hence, ended up with a large amount of inventory. Besides, Chester had
made plant improvements that were matched with neither long-term debt,
nor issuance of common stock.

c. How could each company you mentioned in (a) and (b) have avoided the
emergency loan? (6 points)
*Andrews should have made profits by increasing prices or selling more or
decrease VC to have higher contribution margin, decrease fixed costs to have
higher net margin
*Chester should have had a better forecasting so that it wont end with high
inventory costs
Both Andrews and Chester should have made better sales forecasts. Plus,
Chester should have matched its plant improvements with long-term debt
or issuance of common stock.

d. For the rest of the companies (those that did not get an emergency loan)
evaluate how well each company is managing its cash by looking at the
following:
Ending cash position (BS)
Net change in cash position (CF)
Compare investment with financing (CF)
Net Income (CF)
Any huge cash outflow/inflow (CF)
Compare ending cash balance (BS) with Sales (IS) (is this a good cash
buffer?) (24 points)

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 BADM 2001 Introduction to Business
Dr. Randa El Bedawy

Baldwin Digby Erie Ferris

Ending 4671 4127 5289 7628
cash Very good Very good Very Good The highest
position ending cash
(BS) position. A
bit too high.
Net change 4671 (3952) (6707) 1561
in cash Positive, Very Negative, not good Negative, not good Positive,
position good which proves that which proves that good.
(CF) the company is not the company is not
managing its managing its
finances well. finances well.
Compare Higher than Higher than Higher than Higher than In all there was a
investment investment investment investment investment negative cash
with Baldwin Digby made huge Erie made Ferris made outflow in the
financing financed its investments in investments in investments investment while
positive inflow
(CF) plant plant plant in plant
from financing
improvements improvements. It improvements improvemen activities
with a mix of had borrowed a which it partially ts which it
long term long-term debt and covered with long- partially
loans and issued common term debt and covered
issuance of stocks. However, it issuance of with long-
common invested common stocks. term debt
stocks. $19,500,000 in The uncoveredpart and
plant of the investment issuance of
improvements and caused Digby to common
only financed it end up with a stocks.
with a total of negative change in
$12,300,000. The cash position.
difference caused
Digby to end up
with a negative
change in cash
position.

Net 3273 3524 3242 2189

Income Very Very Very Very
(CF) good,comparab good,comparable good,comparable to good,compa
le to other to other well- other well- rable to
well- performing performing other well-
performing companies. companies. performing
companies. companies

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 BADM 2001 Introduction to Business
Dr. Randa El Bedawy

though the
lowest
among
them.
Any huge Only the plant Has a huge cash Net cash from The hugest
cash improvements. outflow in Operations was cash outflow
outflow/in investment which negative because of for Ferris
flow (CF) means it is the the cash outflow in was for the
highest company in the inventory item, plant
investing. ALSO , which means that improvemen
the highest cash the company ended ts. And the
inflow from up with lots of largest cash
financing activities inventory due to inflow was
which means that overestimating its from log-
its investment was sales forecasts. term debt.
mostly leveraged. There was a a
Net cash from considerable
Operations was amount of cash
negative because of outflow in plant
the cash outflow in improvements that
the inventory item, was, mostly but not
which means that fully, covered by
the company ended long-term debt and
up with lots of issuance of
inventory due to common stocks.
overestimating its
sales forecasts.
There was a huge
cash outflow in
plant
improvements that
was, mostly but not
fully, covered by
long-term debt and
issuance of
common stocks.

Compare Sales :55483 Sales:73457 Sales:54580 Sales:6859

ending Ending Ending cash:4127 Ending cash:5289 4
cash cash:4671 5.6% 9.6% Ending
balance 8.4% cash:7628
(BS) with Ending cash is Ending cash is 11.11%
Sales (IS) Ending cash is 5.6% of the sales, 9.6% of the sales,
(is this a 8.4% of the which is really which is really Ending

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 BADM 2001 Introduction to Business
Dr. Randa El Bedawy

good cash sales, which is good. Its not too good. Its not too cash is
buffer?) really good. much, because, it much, because, it 11.12% of
Its not too would then be would then be idle the sales,
much, idle non invested non invested cash. which is a
because, it cash. And it is also And it is also not bit high
would then be not too little so, it too little so, it did considering
idle non did not leave the not leave the that this is
invested cash. company in the company in the idle cash
And it is also risk of getting an risk of getting an that
not too little emergency loan. emergency loan. remains
so, it did not uninvested
leave the and could
company in have
the risk of contributed
getting an to the
emergency companys
loan. growth had
it been
efficiently
allocated.

2) Which company has the largest asset base? How big? (Hint: look at the BS) (2 points)

Digby

70012, more than 2 times of its liability

Digby, it is $70,012,000

3) Evaluate the capital structure of the company you picked in (2) above. Calculate the
leverage ratio (Assets/Equity) and the percentage of equity to debt in the companys
assets. Comment on your findings. (6 points)
Leverage ratio of Digby: 70012/36829 =1.9 almost 2
Acceptable Range(1.5-3)

Leverage Ratio: Assets/Equity = 70,012/36,829= 1.90 which is acceptable because, it

is less than 3.0

Equity/Assets = 36,829/ 70,012 = 52.6%

Debt/Assets = 33,182/ 70,012 = 47.4%

So, the company seems to be financed equally by equity and debt, almost 50-50. This
is not bad because none of them is exceeding the maximum limit.

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 BADM 2001 Introduction to Business
Dr. Randa El Bedawy

Hint:

A company with too much debt (over 70% of assets) is too risky as it may not be able to
pay back all of this debt and its interest. For banks, this company is a risky borrower
very few banks will be willing to lend it and those that do will charge a very high interest
rate to match the risk of the company.

On the other hand a company with too much equity (over 70% of assets) is at risk of being
taken over (i.e. bought out by another company). The company is an attractive target for
acquisition because there is an opportunity for whoever acquires this company to borrow
debt easily using all the equity as collateral, and to use all of this borrowing to expand the
company and make more profits. The fact that the current management is not making use
of this opportunity indicates that current management is out of profitable growth ideas. If
the company is acquired, the top management will normally be fired.

Total points (50 points)

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 BADM 2001 Introduction to Business
Dr. Randa El Bedawy

Financial Summary: Cash Flow Statement

Financial Summary: Balance Sheet Survey

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 BADM 2001 Introduction to Business
Dr. Randa El Bedawy

Financial Summary: Income Statement Survey

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