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1 04problem 9/15/2021 1:33 1/28/2021

2
3 Chapter 4. Solution to End-of-Chapter Comprehensive/Spreadsheet Problem
4 Problem 4-25
5
6 Corrigan Corporation's December 31 Balance Sheets
7
8 Assets 2021 2020
9 Cash $ 72,000 $ 65,000
10 Accounts receivable 439,000 328,000
11 Inventories 894,000 813,000
12 Total current assets $ 1,405,000 $ 1,206,000
13 Land and building 238,000 271,000
14 Machinery 132,000 133,000
15 Other fixed assets 61,000 57,000
16 Total assets $ 1,836,000 $ 1,667,000
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18 Liabilities and equity
19 Accounts payable $ 80,000 $ 72,708
20 Accrued liabilities 45,010 40,880
21 Notes payable 476,990 457,912
22 Total current liabilities $ 602,000 $ 571,500
23 Long-term debt 399,688 258,898
24 Common stock 575,000 575,000
25 Retained earnings 259,312 261,602
26 Total liabilities and equity $ 1,836,000 $ 1,667,000
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28 Corrigan Corporation's December 31 Income Statements
29 2021 2020
30 Sales $ 4,240,000 $ 3,635,000
31 Cost of goods sold 3,680,000 2,980,000
32 Gross operating profit $ 560,000 $ 655,000
33 General admin. and selling expenses 303,320 297,550
34 Depreciation 159,000 154,500
35 EBIT $ 97,680 $ 202,950
36 Interest 67,000 43,000
37 EBT $ 30,680 $ 159,950
38 Taxes (25%) 7,670 39,988
39 Net income $ 23,010 $ 119,963
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41 Per-Share Data 2021 2020
42 EPS $1.00 $5.22
43 Cash dividends $1.10 $0.95
44 Market price (average) $12.34 $23.57
45 P/E ratio 12.33 4.52
46 Number of shares outstanding 23,000 23,000
47
48 Once we have this information set, we can calculate the necessary ratios for this analysis.
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50 Ratio Analysis 2021 2020 Industry Avg a

51 Liquidity
52 Current ratio 2.33 2.11 2.7
53 Asset Management
54 Inventory turnoverb 4.12 3.67 7.0
55 Days sales outstandingc 37.79 32.94 32
56 Fixed assets turnover b
9.84 7.89 13.0
57 Total assets turnoverb
2.31 2.18 2.6
58 Profitability
59 Return on assets 1.25% 7.20% 11.4%
60 Return on equity 2.76% 14.34% 18.2%
61 Return on invested capital 4.28% 9.80% 14.5%
62 Profit margin 0.54% 3.30% 4.4%
63 Debt Management
64 Debt-to-capital ratiod 51.24% 46.14% 50.0%
65 Market Value
66 P/E ratio 12.33 4.52 6.0
67 M/B ratio 0.34 0.65 1.5
68 EV/EBITDA ratio 4.24 3.34 6.0
69
70 a
Industry average ratios have been constant for the past 4 years.
71 b
Based on year-end balance sheet figures.
72 c
Calculation is based on a 365-day year.
73 d
Measured as (Short-term debt + Long-term debt)/(Short-term debt + Long-term debt + Common equity).
74
75 a. Assess Corrigan's liquidity position, and determine how it compares with peers and how the liquidity
76 position has changed over time.
77 Corrigan's liquidity position has improved from 2020 to 2021; however, its current ratio is still
78 below the industry average of 2.7.
79
80 b. Assess Corrigan's asset management position, and determine how it compares with peers and
81 how its asset management efficiency has changed over time.
82 Corrigan's inventory turnover, fixed assets turnover, and total assets turnover have improved from
83 2020 to 2021; however, they are still below industry averages. The firm's days sales outstanding ratio
84 has increased from 2020 to 2021--which is bad. In 2020, its DSO was close to the industry average.
85 In 2021, its DSO is somewhat higher. If the firm's credit policy has not changed, it needs to
86 look at its receivables and determine whether it has any uncollectible receivables. If it does have
87 uncollectible receivables, this will make its current ratio look worse than what was calculated above.
88
89 c. Assess Corrigan's debt management position, and determine how it compares with peers and how its
90 debt management has changed over time.
91 Corrigan's debt-to-capital ratio has increased from 2020 to 2021, which is bad. In 2020, its debt-to-capital
92 ratio was slightly better than the industry average, but in 2021 it is higher (worse) than the industry
93 average. Given its weak current and assets management ratios, the firm should strengthen its balance
94 sheet by paying down its interest-bearing debt.
95
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96 d. Assess Corrigan's profitability ratios, and determine how they compare with peers and how its
97 profitability position has changed over time.
98 Corrigan's profitability ratios have declined substantially from 2020 to 2021, and they are substantially
99 below the industry averages. Corrigan needs to reduce its costs, increase sales, or both.
100
101 e. Assess Corrigan's market value ratios, and determine how its valuation compares with peers
102 and how it has changed over time. Assume the firm's debt is priced at par, so the market value
103 of its debt equals its book value.
104 Corrigan's P/E ratio has increased from 2020 to 2021, but only because its net income has declined
105 significantly from the prior year. Corrigan's M/B ratio has declined substantially from 2020 to 2021 due
106 to the large decrease in its share price. Its EV/EBITDA ratio improved from 2020 to 2021 largely due
107 to the decline in the firm's EBITDA. Both the M/B and EV/EBITDA ratios are below the industry
108 averages. The market value ratios reflect the same information as Corrigan's profitability ratios.
109 Corrigan needs to reduce costs to increase profit, lower its debt-to-capital ratio, increase sales, and
110 improve its assets management.
111
112 f. Calculate Corrigan's ROE as well as the industry average ROE, using the DuPont equation.
113 From this analysis, how does Corrigan's financial position compare with the industry
114 average numbers?
115 ROE = PM x TA Turnover x Equity Multiplier
116 2021 2.76% 0.54% 2.31 2.20
117 2020 14.34% 3.30% 2.18 1.99
118 Industry Avg. 18.20% 4.40% 2.60 1.60
119
120 Looking at the DuPont equation, Corrigan's profit margin is significantly lower than the industry
121 average and it has declined substantially from 2020 to 2021. The firm's total assets turnover has
122 improved slightly from 2020 to 2021, but it's still below the industry average. The firm's equity
123 multiplier has increased from 2020 to 2021 and is higher than the industry average. This
124 indicates that the firm's debt level is increasing.
125
126 Corrigan should increase its net income by reducing costs, lower its debt-to-capital ratio, and improve its
127 assets management by either using less assets for the same amount of sales or by increasing sales.
128
129 g. What do you think would happen to its ratios if the company initiated cost-cutting measures that
130 allowed it to hold lower levels of inventory and substantially decreased the cost of goods sold? No
131 calculations are necessary. Think about which ratios would be affected by changes in these
132 two accounts.
133 If Corrigan initiated cost-cutting measures, this would increase its net income. This would improve its
134 profitability ratios and market value ratios. If Corrigan also reduced its inventory levels, this would
135 improve its current ratio--as this would also reduce current liabilities. Reducing inventory would also
136 improve its inventory turnover and total assets turnover ratios. Reducing costs and lowering inventory
137 would also improve its debt-to-capital ratio.