Case: Analysis of Financial Statements

EXHIBITS: INPUT DATA (for D'Leon)

Table IC4.1 Balance Sheets

Year 3 Year 2 Year1
Assets
Cash $ 85,632 $ 7,282 $ 57,600
Accounts receivable 878,000 632,160 351,200
Inventories 1,716,480 1,287,360 715,200
Total current assets $ 2,680,112 $ 1,926,802 $ 1,124,000
Gross fixed assets 1,197,160 1,202,950 491,000
Less: accumulated depreciation 380,120 263,160 146,200
Net fixed assets $ 817,040 $ 939,790 $ 344,800
Total assets $ 3,497,152 $ 2,866,592 $ 1,468,800

Liabilities and equity

Accounts payable $ 436,800 $ 524,160 $ 145,600
Accruals 408,000 489,600 136,000
Notes payable 300,000 636,808 200,000
Total current liabilities $ 1,144,800 $ 1,650,568 $ 481,600
Long-term bonds 400,000 723,432 323,432
Common stock (100,000 shares) 1,721,176 460,000 460,000
Retained earnings 231,176 32,592 203,768
Total common equity $ 1,952,352 $ 492,592 $ 663,768
Total liabilities and equity $ 3,497,152 $ 2,866,592 $ 1,468,800

Table IC4.2 Income Statements Year 3 Year 2 Year1

Sales $ 7,035,600 $ 6,034,000 $ 3,432,000

Cost of goods sold 5,875,992 5,528,000 2,864,000
Other expenses 550,000 519,988 358,672
Total operating exp. excl. depreciation and amortization $ 6,425,992 $ 6,047,988 $ 3,222,672
EBITDA $ 609,608 $ (13,988) $ 209,328
Depreciation and amortization 116,960 116,960 18,900
Earnings before interest and taxes (EBIT) $ 492,648 $ (130,948) $ 190,428
Interest expense 70,008 136,012 43,828
Earnings before taxes (EBT) $ 422,640 $ (266,960) $ 146,600
Taxes (40%) 169,056 (106,784) 58,640
Net Income $ 253,584 $ (160,176) $ 87,960
Earnings per share (EPS) $ 1.014 $ (1.602) $ 0.880
Dividends per share (DPS) $ 0.220 $ 0.110 $ 0.220
Book value per share (BVPS) $ 7.809 $ 4.926 $ 6.638
Stock price $ 12.17 $ 2.25 $ 8.50
Shares outstanding 250,000 100,000 100,000
Tax rate 40.00% 40.00% 40.00%
Lease payments $ 40,000 $ 40,000 $ 40,000

TABLE IC4.3 Ratio Analysis Industry

Year 3 Year 2 Year1 Average
Current 1.17 2.33 2.70
Quick 0.39 0.85 1.00
Inventory turnover 4.29 4.00 6.10
Days sales outstanding (DSO) 38.24 37.35 32.00
Fixed assets turnover 6.42 9.95 7.00
Total assets turnover 2.10 2.34 2.60
Debt ratio 82.82% 54.81%
Debt -to-equity 4.82 1.21 0.40
Times interest earned (TIE) -0.96 4.34 6.20
Operating margin -2.17% 5.55% 7.30%
Profit margin -2.65% 2.56% 3.50%
Basic earning power (BEP) = ROI -4.57% 12.96% 19.10%
Return on assets (ROA) -5.59% 5.99% 9.10%
Return on equity (ROE) -32.52% 13.25% 18.20%
Return on invested capital (ROIC) -4.24% 9.62% 14.50%
Price/earnings (P/E) -1.40 9.66 14.20
Market/book (M/B) 0.46 1.28 2.40
Book value per share (BVPS) $4.93 $6.64 n.a.

PART B

Calculate D’Leon’s year 3 current and quick ratios based on the projected balance sheet and income statement data.
 PART C
Calculate the year 3 inventory turnover, days sales outstanding (DSO), fixed assets turnover, and total assets
turnover.

PART D
Calculate the year 3 debt ratio, debt-to-equity and times-interest-earned ratios.
 PART E
Calculate the year 3 operating margin, profit margin, basic earning power (BEP), return on assets (ROA), return on
equity (ROE), and return on invested capital (ROIC).

PART F
Calculate the year 3 price/earnings ratio and market/book ratio.
 PART G

Use the DuPont equation to provide a summary and overview of D’Leon’s financial condition as projected for year 3.

PART H
Use the following simplified year 3 balance sheet to show, in general terms, how an improvement in the DSO would
tend to affect the stock price. For example, if the company could improve its collection procedures and thereby lower
its DSO from 45.6 days to the 32-day industry average without affecting sales, how would that change “ripple through”
the financial statements (shown in thousands below) and influence the stock price?

Accounts receivable $878 Current liabilities $845

Other current assets 1,802 Debt 700
Net fixed assets 817 Equity 1,952
Total assets $3,497 Liabilities plus equity $3,497
 Case: Analysis of Financial Statements

EXHIBITS: INPUT DATA (for D'Leon)

Table IC4.1 Balance Sheets

Year 3 % Year 2 % Year1 %
Assets
Cash $ 85,632 2.45% $ 7,282 0.25% $ 57,600 3.92%
Accounts receivable 878,000 25.11% 632,160 22.05% 351,200 23.91%
Inventories 1,716,480 49.08% 1,287,360 44.91% 715,200 48.69%
Total current assets $ 2,680,112 76.64% $ 1,926,802 67.22% $ 1,124,000 76.53%
Gross fixed assets 1,197,160 34.23% 1,202,950 41.96% 491,000 33.43%
Less: accumulated depreciation 380,120 10.87% 263,160 9.18% 146,200 9.95%
Net fixed assets $ 817,040 23.36% $ 939,790 32.78% $ 344,800 23.47%
Total assets $ 3,497,152 100.00% $ 2,866,592 100.00% $ 1,468,800 100.00%

Liabilities and equity

Accounts payable $ 436,800 12.49% $ 524,160 18.29% $ 145,600 9.91%
Accruals 408,000 11.67% 489,600 17.08% 136,000 9.26%
Notes payable 300,000 8.58% 636,808 22.21% 200,000 13.62%
Total current liabilities $ 1,144,800 32.74% $ 1,650,568 57.58% $ 481,600 32.79%
Long-term bonds 400,000 11.44% 723,432 25.24% 323,432 22.02%
Common stock (100,000 shares) 1,721,176 49.22% 460,000 16.05% 460,000 31.32%
Retained earnings 231,176 6.61% 32,592 1.14% 203,768 13.87%
Total common equity $ 1,952,352 55.83% $ 492,592 17.18% $ 663,768 45.19%
Total liabilities and equity $ 3,497,152 100.00% $ 2,866,592 100.00% $ 1,468,800 100.00%

Table IC4.2 Income Statements Year 3 % Year 2 % Year1 %

Sales $ 7,035,600 100.00% $ 6,034,000 100.00% $ 3,432,000 100.00%

Cost of goods sold 5,875,992 83.52% 5,528,000 91.61% 2,864,000 83.45%
Other expenses 550,000 7.82% 519,988 8.62% 358,672 10.45%
Total operating exp. excl. depreciation and amortization $ 6,425,992 91.34% $ 6,047,988 100.23% $ 3,222,672 93.90%
EBITDA $ 609,608 8.66% $ (13,988) -0.23% $ 209,328 6.10%
Depreciation and amortization 116,960 1.66% 116,960 1.94% 18,900 0.55%
Earnings before interest and taxes (EBIT) $ 492,648 7.00% $ (130,948) -2.17% $ 190,428 5.55%
Interest expense 70,008 1.00% 136,012 2.25% 43,828 1.28%
Earnings before taxes (EBT) $ 422,640 6.01% $ (266,960) -4.42% $ 146,600 4.27%
Taxes (40%) 169,056 2.40% (106,784) -1.77% 58,640 1.71%
Net Income $ 253,584 3.60% $ (160,176) -2.65% $ 87,960 2.56%

Earnings per share (EPS) $ 1.014 $ (1.602) $ 0.880

Dividends per share (DPS) $ 0.220 $ 0.110 $ 0.220 Dividends 55,000 11,000 22,000
Book value per share (BVPS) $ 7.809 $ 4.926 $ 6.638
Stock price $ 12.17 $ 2.25 $ 8.50
Shares outstanding 250,000 100,000 100,000
Tax rate 40.00% 40.00% 40.00%
Lease payments $ 40,000 $ 40,000 $ 40,000

TABLE IC4.3 Ratio Analysis Industry

Year 3 Year 2 Year1 Average
Current 2.34 1.17 2.33 2.70
Quick 0.84 0.39 0.85 1.00
Inventory turnover 3.42 4.29 4.00 6.10
Days sales outstanding (DSO) 45.55 38.24 37.35 32.00
Fixed assets turnover 8.61 6.42 9.95 7.00
Total assets turnover 2.01 2.10 2.34 2.60
Debt ratio 44.17% 82.82% 54.81%
Debt -to-equity 0.79 4.82 1.21 0.40
Times interest earned (TIE) 7.04 -0.96 4.34 6.20
Operating margin 7.00% -2.17% 5.55% 7.30%
Profit margin 3.60% -2.65% 2.56% 3.50%
Basic earning power (BEP) = ROI 14.09% -4.57% 12.96% 19.10%
Return on assets (ROA) 7.25% -5.59% 5.99% 9.10%
Return on equity (ROE) 12.99% -32.52% 13.25% 18.20%
Return on invested capital (ROIC) 11.14% -4.24% 9.62% 14.50%
Price/earnings (P/E) 12.00 -1.40 9.66 14.20
Market/book (M/B) 1.56 0.46 1.28 2.40
Book value per share (BVPS) $7.81 $4.93 $6.64 n.a.

ROE breakdown
EBIT/Sales 7.00% -2.17% 5.55%
Sales/Assets 2.01 2.10 2.34
ROI 14.09% -4.57% 12.96%
Assets/Equity 1.79 5.82 2.21
EBT/EBIT 0.86 2.04 0.77
Leverage effect 1.54 N/A 1.70
Net Income/EBT 0.60 0.60 0.60

ROE 12.99% -32.52% 13.25%

PART B
Calculate D’Leon’s year 3 current and quick ratios based on the projected balance sheet and income statement data.

CR = CA / CL
CR = 2,680,112 / 1,144,800
CR = 2.34

QR = ( CA − Inv ) / CL
QR = ( 2,680,112 − 1,716,480 ) / 1,144,800
QR = 0.84

PART C
Calculate the year 3 inventory turnover, days sales outstanding (DSO), fixed assets turnover, and total assets turnover.

Inv TO = CoGS / Inv

Inv TO = 5,875,992 / 1,716,480
Inv TO = 3.42

DSO = AR / (Sales / 365 )

DSO = 878,000 / ( 7,035,600 / 365 )
DSO = 45.55

FATO = Sales / NFA

FATO = 7,035,600 / 817,040
FATO = 8.61
 TATO = Sales / TA
TATO = 7,035,600 / 3,497,152
TATO = 2.01

PART D
Calculate the year 3 debt ratio, debt-to-equity and times-interest-earned ratios.

Debt ratio = Total liabilities / Total equity & liabilities

Debt ratio = 1,544,800 / 3,497,152
Debt ratio = 44.17%

Debt -to-equity = Total liabilities / Equity

Debt -to-equity = 1,544,800 / 1,952,352
Debt -to-equity = 0.79

TIE = EBIT / Int exp

TIE = 492,648 / 70,008
TIE = 7.04

PART E
Calculate the year 3 operating margin, profit margin, basic earning power (BEP), return on assets (ROA), return on equity (ROE), and return on invested
capital (ROIC).
OM = EBIT / Sales
OM = 492,648 / 7,035,600
OM = 7.00%

PM = NI / Sales
PM = 253,584 / 7,035,600
PM = 3.60%

BEP or ROI = EBIT / TA

BEP or ROI = 492,648 / 3,497,152
BEP or ROI = 14.09%

ROA = NI / TA
ROA = 253,584 / 3,497,152
ROA = 7.25%

ROE = NI / Equity
ROE = 253,584 / 1,952,352
ROE = 12.99%

ROIC = EBIT x (1 - T) / Total invested capital

ROIC = 295,589 / 2,652,352
ROIC = 11.14%

PART F
Calculate the year 3 price/earnings ratio and market/book ratio.

P/E = Price / ( NI / # of shares )

P/E = $12.17 / ( $253,584 / 250,000 )
P/E = 12.00

BVPS = BV Eq / # of shares
BVPS = $1,952,352 / 250,000
BVPS = $7.81

M/B = Price / BVPS

M/B = $12.17 / $7.81
M/B = 1.56

PART G

Use the DuPont equation to provide a summary and overview of D’Leon’s financial condition as projected for 2015.

ROE = Profit margin x Total assets turnover x Equity multiplier

ROE = 3.60% x 2.01 x 1.7913
ROE = 12.99%

PART H

Use the following simplified year 3 balance sheet to show, in general terms, how an improvement in the DSO would tend to affect the stock price. For
example, if the company could improve its collection procedures and thereby lower its DSO from 45.6 days to the 32-day industry average without
affecting sales, how would that change “ripple through” the financial statements (shown in thousands below) and influence the stock price?

Accounts receivable $878 Current liabilities $845

Other current assets 1,802 Debt 700
Net fixed assets 817 Equity 1,952
Total assets $3,497 Liabilities plus equity $3,497

First, we need to calculate D'Leon's daily sales.

Daily sales = Sales / 365

Daily sales = $7,035,600 / 365
Daily sales = $19,275.62

Target A/R = Daily sales × Target DSO

Target A/R = $19,276 × 32
Target A/R = $616,820

Freed-up cash = old A/R – new A/R

Freed-up cash = $878,000 – $616,820
Freed-up cash = $261,180
 Case: Analysis of Financial Statements

EXHIBITS: INPUT DATA (for D'Leon)

Table IC4.1 Balance Sheets

Year 3 Difference Year 2 Difference Year1
Assets
Cash $ 85,632 $ 78,350 $ 7,282 $ (50,318) $ 57,600
Accounts receivable 878,000 245,840 632,160 280,960 351,200
Inventories 1,716,480 429,120 1,287,360 572,160 715,200
Total current assets $ 2,680,112 $ 753,310 $ 1,926,802 $ 802,802 $ 1,124,000
Gross fixed assets 1,197,160 (5,790) 1,202,950 711,950 491,000
Less: accumulated depreciation 380,120 116,960 263,160 116,960 146,200
Net fixed assets $ 817,040 $ (122,750) $ 939,790 $ 594,990 $ 344,800
Total assets $ 3,497,152 $ 630,560 $ 2,866,592 $ 1,397,792 $ 1,468,800

Liabilities and equity

Accounts payable $ 436,800 $ (87,360) $ 524,160 $ 378,560 $ 145,600
Accruals 408,000 (81,600) 489,600 353,600 136,000
Notes payable 300,000 (336,808) 636,808 436,808 200,000
Total current liabilities $ 1,144,800 $ (505,768) $ 1,650,568 $ 1,168,968 $ 481,600
Long-term bonds 400,000 (323,432) 723,432 400,000 323,432
Common stock (100,000 shares) 1,721,176 1,261,176 460,000 - 460,000
Retained earnings 231,176 198,584 32,592 (171,176) 203,768
Total common equity $ 1,952,352 $ 1,459,760 $ 492,592 $ (171,176) $ 663,768
Total liabilities and equity $ 3,497,152 $ 630,560 $ 2,866,592 $ 1,397,792 $ 1,468,800

Table IC4.2 Income Statements Year 3 Year 2 Year1

Sales $ 7,035,600 $ 6,034,000 $ 3,432,000

Cost of goods sold 5,875,992 5,528,000 2,864,000
Other expenses 550,000 519,988 358,672
Total operating exp. excl. depreciation and amortization $ 6,425,992 $ 6,047,988 $ 3,222,672
EBITDA $ 609,608 $ (13,988) $ 209,328
Depreciation and amortization 116,960 116,960 18,900
Earnings before interest and taxes (EBIT) $ 492,648 $ (130,948) $ 190,428
Interest expense 70,008 136,012 43,828
Earnings before taxes (EBT) $ 422,640 $ (266,960) $ 146,600
Taxes (40%) 169,056 (106,784) 58,640
Net Income $ 253,584 $ (160,176) $ 87,960

Earnings per share (EPS) $ 1.014 $ (1.602) $ 0.880

Dividends per share (DPS) $ 0.220 $ 0.110 $ 0.220
Book value per share (BVPS) $ 7.809 $ 4.926 $ 6.638
Stock price $ 12.17 $ 2.25 $ 8.50
Shares outstanding 250,000 100,000 100,000
Tax rate 40.00% 40.00% 40.00%
Lease payments $ 40,000 $ 40,000 $ 40,000

CASH FLOW STATEMENT

Year 3 Year 2

Net Income $ 253,584 $ (160,176)

Depreciation and amortization 116,960 116,960
Accounts receivable (245,840) (280,960)
Inventories (429,120) (572,160)
Accounts payable (87,360) 378,560
Accruals (81,600) 353,600
Cash Flow from Operating $ (473,376) $ (164,176)

Gross fixed assets 5,790 (711,950)

Cash Flow from Investing $ 5,790 $ (711,950)

Notes payable (336,808) 436,808

Long-term bonds (323,432) 400,000
Common stock (100,000 shares) 1,261,176 -
Dividends (55,000) (11,000)
Cash Flow from Financing $ 545,936 $ 825,808

Total Cash Flow $ 78,350 $ (50,318)

Initial cash $ 7,282 $ 57,600

Ending cash $ 85,632 $ 7,282

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