1. Calculate all of the ratios listed in the industry table for East Cost Yachts.

Ans.

Ratios Calculation 2006

a) Current Ratio 0.75
b) Quick Ratio 0.44
c) Total Asset Turnover 1.54
d) Inventory Turnover 19.22
e) Receivables Turnover 30.57
f) Debt Ratio 0.49
g) Debt to Equity Ratio 0.96
h) Equity Multiplier 1.96
i) Interest Coverage 7.96
j) Profit Margin 7.51%
k) Return on Assets 11.57%
l) Return on Equity 22.70%

Working Notes:

a) Current ratio = $11,270,000 / $15,030,000

= 0.75 times

b) Quick ratio = ($11,270,000 – 4,720,000) / $15,030,000

= 0.44 times

c) Total asset turnover = $128,700,000 / $83,550,000

= 1.54 times

d) Inventory turnover = $90,070,000 / $4,720,000

= 19.22 times

e) Receivables turnover = $128,700,000 / $4,210,000

= 30.57 times

f) Total debt ratio = ($83,550,000 – 42,570,000) / $83,550,000

= 0.49 times

g) Debt-equity ratio = ($15,030,000 + 25,950,000) / $42,570,000

= 0.96 times

h) Equity multiplier = $83,550,000 / $42,570,000

= 1.96 times

i) Interest coverage = $18,420,000 / $2,315,000

= 7.96 times

j) Profit margin = $9,663,000 / $128,700,000

= 7.51%
 k) Return on assets = $9,663,000 / $83,550,000
= 11.57%

l) Return on equity = $9,663,000 / $42,570,000

= 22.70%

2. Compare the performance of East Cost Yacht to the industry as a hole. For each ratio,
comment on why it might be viewed as positive or negative relative to the industry.
Suppose you create an inventory ratio calculated as inventory divided by current
liabilities. How do you interpret this ratio? How does East Cost Yacht compare to the
industry average?

The liquidity ratio of East Coast is below the industrial average for current ratio. This means
that its liquidity is lower as compared to industry, however, the current ratio is above the
lower quartile, and this indicates that there are companies with still lower liquidity than
East Coast. This is negative since the liquidity is less than the industry

The turnover ratios are all higher than the industry median. The ratios are in the above
quartile. This would imply that east coast is more efficient in the use of assets as compared
to industry average. This is positive.

The financial leverage ratios are all below the industry median though they are above the
lower quartile. This implies that East Coast Yachts has less debt than the industry average
companies. This is positive

The profit margin for the company is about the same as the industry median, the ROA is
slightly higher than the industry median, and the ROE is quite above the industry median.
East Coast Yachts seems to be performing well in the profitability area. This is positive.

Overall, East Coast Yachts’ performance seems good, although the liquidity ratios indicate
that a closer look may be needed in this area.

Inventory / Current Liabilities. This ratio would imply the amount of current liabilities that
can be paid for from the sale of inventory. The ratio for East Coast is 0.31. Since the
industry average is not known for this ratio, it cannot be compared.

3. Calculate the sustainable growth rate of East Cost Yachts. Calculate external fund needed
and prepare pro forma income statement and balance sheets assuming growth at
precisely this rate. Recalculate the ratios in the previous questions? What do you
observe?

The sustainable growth rate is given as

SGR = Return on equity X Retention ratio
Return on equity = Net Income/Total Equity
ROE is calculated as 22.7%

Retention ratio = 3,865,200/9,663,000= 40%

SGR = 22.7%X0.4 = 9.08%

EFN = Increase in Assets – Increase in spontaneous liabilities – retained earnings

Increase in assets = 7,586,034

Increase in spontaneous liabilities = 451,258

Retained earnings = 4,266,592

EFN = 2,868,184

Ratios Calculation 2006

a) Current Ratio 0.75
b) Quick Ratio 0.44
c) Total Asset Turnover 1.54
d) Inventory Turnover 19.22
e) Receivables Turnover 30.57
f) Debt Ratio 0.49
g) Debt to Equity Ratio 0.96
h) Equity Multiplier 1.96
i) Interest Coverage 7.96
j) Profit Margin 7.51%
k) Return on Assets 11.57%
l) Return on Equity 22.70%

4. As a practical matter, East Coast Yacht is unlikely to be willing to raise external equity
capital, in part because the owners don’t want to dilute their existing ownership and
control positions. However, ECY is planning for a growth rate of 20% net year. What are
your conclusions and recommendations about the feasibility of ECY expansion plans?

The growth rate of 20%indicates that the EFN is $10,966,640. Taking on so much debt
would result in the debt to equity increasing to 1.12 and the debt ratio to increase to 0.53.
The EBIT, assuming an interest rate of 6%, would be 7.84. While the financing from the
debt look alright, this would constrain further issue of debt since the debt to equity is
already above 1. Further expansion may not be possible by debt.

5. Most assets can be increased as a percentage of sales. For instance, cash can be
increased by any amount. However, fixed assets often must be increased in specific
amounts since it is impossible, as a practical matter, to buy part of a new plant of
 machine. In this case, a company has a “staircase” or “lumpy” fixed cost structure.
Assume that East Coast Yachts is currently producing at 100% of capacity. As a result, to
expand production, the company must set up an entirely new line at a cost of
$25,000,000. Calculate the new EFN with this assumption. What does this imply about
capacity utilization for East Coast Yachts next year?

Increase in fixed assets at SGR was 6,562,759. The new plant would cost $25,000,000. The
additional EFN would be $18,437,241. The total EFN would become $21,305,424. This
would imply that the capacity utilization would be lower next year, since the new plant
would expand capacity much more than the required under SGR.