SOLUTION FAR670 SEPT 2020

QUESTION 1

a. The changes in the statement of profit or loss items using 2017 as the base year
measure are as follows:

2019 2018 2017

Revenue 83.005% 99.978% 100
Cost of revenue 89.132% 99.189% 100
Gross profit 74.323% 101.095% 100
Operating expenses 131.397% 112.518% 100
Other income 91.076% 104.728% 100
Financing costs 108.235% 100.830% 100
Profit before tax 69.602% 100.608% 100
Tax expense 55.562% 97.609% 100
Profit after tax 74.283% 101.608% 100

(18√ x 1/3 = 6 marks)

The gross profit in 2018 has increased slightly√ and it is significantly decrease in
2019√. The significant decrease in gross profit is due to material decrease in revenue√
of 83% in 2019. There has been a faster decrease in revenue than in cost of revenue√.

The profit before tax has increased immaterially in 2018√ and substantially decrease to
69.602% in 2019√. This is mainly due to substantial increase in operating expenses√,
moderate increase in financing cost√ and moderate decrease in other income√.

Tax expense is slightly increased in 2018 √ due to slight increase in profit before tax √
before it is significantly declined in 2019√ as profit before tax in 2019 has declined√.

(any 12√ x ½ mark = 6 marks)

b. It seems that profitability ratios of Maroon Bhd, except for total asset turnover, are
better than Beige Bhd √. Gross profit margin of Maroon Bhd is 69.487% which is
substantially higher√ than Beige Bhd (31.422%). This ratio indicates that Maroon Bhd
is able to control its cost of sales at a lower amount √.
Net profit margin of Maroon Bhd (21.651%) is significantly higher√ than Beige Bhd
(3.397%) showing that Maroon Bhd is able to manage its operating cost effectively √.
Similar to other profitability ratios, return on asset of Maroon (13.497%) is materially
better√ than Beige Bhd (9.446%). It suggests that Maroon Bhd has more efficiently
utilised its assets to create profit√ as compared to Beige Bhd.
Total asset turnover of Maroon Bhd (0.623 times) is substantially lower than Beige Bhd
(2.781 times) √. Even though the net revenue of Maroon Bhd is slightly higher than
Beige Bhd, the average total assets of Marron Bhd is substantially higher than Beige
Bhd. This will result in lower total asset turnover in Maroon Bhd√.
(7√ from any 3 ratios = 7 marks)
 Maroon Bhd Beige Bhd
GPM 69.487 √ 31.422 √
NPM 21.651 √ 3.397 √
ROA 13.497 √ 9.446 √
TAT 0.623 √ 2.781 √
(Any 3 ratios = 3 marks)
(Total: 22 marks)

QUESTION 2

A. Calculation of ratios

i. The ratios show that the liquidity position of the company is inconsistent√.
Increasing trend√ on the current ratio√ from 1.9 to 2.5√ suggests that the
company has improving liquidity√. Nevertheless, the declining trend√ in the acid
test ratio√ from 1.2 to 0.9 indicates that its liquidity appears to be worsening√.
The difference could be due increasing√ level of inventory√ which is not included
in the quick ratio.
(10√ x 1 = 10 marks)

ii. The inventory has turnover has decreased√ from 12 times a year to 7 times√. It
indicates that the company has increasingly higher level√ of inventory relative to
sales√. The increasing trend√ in accounts receivable turnover√ indicates that
the receivables pay the company faster√. There would be no effect√ on the
current or quick ratio√ if the money received from receivables were kept as
cash√, However if the money received was used to acquire more inventory, there
would be no effect on the current ratio and a decrease in the acid test ratio as
shown in this company√. Both ratios show that liquidity of the company is
deteriorating√. Deteriorating acid test ratio in 2019 is inconsistent with
increasing trend in current ratio is explained by lower inventory turnover√ that
company may have an inventory problem√.
(14√ X 1 =14 marks)

b. In the event that Anaqi is investing in company for capital gain, it is suggested that he
invests in Black Bhd. The reasons for the suggestion are as follows:
i. Black Bhd has lower P/E ratio (11.8) than the P/E multiple of Copper Bhd (13.8).
This shows that the investment return of shares in Black Bhd is higher and that
the company could be undervalued. It is expected the shares’ value of Black Bhd
could appreciate in the future.
ii. Black Bhd has higher earnings per share growth (5.57%) than Copper Bhd
(4.65%).
(4 marks)
(Total: 28 marks)
QUESTION 3

(a)

Sales 4,000,000
Operating expenses 3,620,000
380,000

Interest payable 120000

1 TIE 3.17

Current assets 1,870,000

Tangible assets, net 1,600,000
Intangible assets 40,000
Investments 120,000
Other assets 90,000
3,720,000
Shareholders' equity 1,800,000
Total Liabilities 1,920,000

2 Debt ratio 51.61%

Shareholders' equity 1800000

Total Liabilities 1920000
3 106.67%

Shareholders' equity 1,800,000

Intangible assets 40,000
Debt/equity ratio 1,760,000

4 Debt to TNW 109.09%

20 x 1 m = 20 marks

(a) explain the changes

Marking guideline:

Indicate changes in figures 2 points for each ratio x 4 ratios x 1 m = 8m

Brief explanation on the possible 4 ratios x 1 m = 4m

changes

Total 12 m
 Sample answer:

TIE

 The times interest earned has increased from 2.08 to 4.94 times in 2016 to 2018,
however, TIE has dropped to 3.17 in 2019. This might due to new mortgage note
payable and dropped in sales. 

Debt ratio
 Debt ratio has dropped from 56% to 47% from 2016 to 2018, but it shows
significant increase in 2019 at 53.61%. This is might due to increase in total
liabilities 

Debt/equity ratio
 Debt/equity ratio is significantly decreased from 103% to 87% from 2016 to 2018.
The ratio is climbed up to 106.67% in 2019 as the equity increases

Debt to TNW
 Debt to TNW is significantly decreased from 136% to 91% from 2016 to 2019.
However, the figure shows an increase in 2019 to 109.09%, might be due to
increase in equity and intangible assets 
** any suitable answers are acceptable.

12 x 1 m = 12m
(c) Comment on the debt position of the company.

Marking guideline:

Marks

Define the compared ratios 4 ratios x 1 m = 4m

Comparing the ratios 4 ratios x 3 points x 1 m = 12m

Conclusion 2 points x 1 m = 2m

18m

Sample answer:
TIE

 used to measure a company's ability to meet its debt obligations. 

 TIE are reported as significantly increased in three years in a row, but decreasing in 2019,
indicating better ability to cover interest in prior years compared to less interest coverage in
2019.
 This might relate to additional bond payable that subsequently increase an interest expense
that caused a decline in interest coverage.
Debt ratios

 to determine how well creditors are protected in case of insolvency. 

 A rise in the debt ratio in 2019 caused by changes in TIE. Although 3 prior years indicate
decreasing figure which is less than 50% of debt being used in 2018, the ratio is climbing in
2019 due to additional bonds payable to cover the operational of the company. 

Debt/equity ratio
 Same objective as debt ratio, which is to determine how well creditors are protected in case of
insolvency. 
 The declining trend in debt/equity ratio for 3 years is similar to debt ratio as this ratio is
alternative measure to ability of the company to protect shareholders.
 In 2016, this ratio indicates unfavorable figure as the company is not able to protect SH
interest as the ratio is more than 1. However, this ratio is improved in 2 consecutive years,
where the figures show lesser than 1, indicating company was having some funds to protect
SH in a case of solvency. 
 The ratio more than 1 in 2019 indicating company is having difficulty in managing its debt
obligation as SH will lose their investment if in a case of solvency. 

Debt to TNW
 Similar to debt ratio, but more conservative than debt ratio or debt/equity ratio due to
exclusion of intangibles as they do not provide resources to pay creditors. 
 Overall trends of this ratio are unsatisfactory, indicating intangible assets being held more
than other financial assets that can be resources to pay the creditors. 
 All ratios indicating high in percentage, which are almost 1 to more than 1 that show company
need to add more tangible assets to meet debt obligation

Conclusion:

 The overall debt position is unfavorable in 2019 compared to 3 prior years. 

 However, the company still able to cover its interest payment in 2019. 
 In a a case of solvency, the company is able to protect its SH as the operation is being funded in
a balance of debt and equity. 
 For all the reasons stated above, the company could be considered for investment purpose. 

** any suitable answers are acceptable. 18 x 1m = 18m

(b) How to improve its debt position

(6 marks)
Marking guideline:

Marks

Any 2 Ways to improve 2 points x 1 m = 2m

Explanation each way 2 points x 2 m = 4m

6m
Sample answer:

Any two points below:

 issue additional new shares 

o The company can issue new or additional shares to increase its cash flow. This
cash can be used to repay the existing liabilities and in turn, reduce the debt
burden. The reduction in debt will lower the debt to total asset ratio. 
 Reduce debt by increasing the equity
o company can make a debt holder an equity shareholder in the company. This will
cancel the debt owed to him and in turn, reduce the debt of the company and
improve the ratio. If planned, convertible debentures can be issued. 
 Lease the assets
o The company can sell its assets and then lease them back. This will induce a
cash flow that can be used to pay off some debts. 
 Increase the sales
o focus heavily on increasing sales but without any increase in overhead expenses.
The increase in sales can be used to reduce the debt and improve the debt to
total asset ratio. 
** any suitable answers are acceptable.

6 x 1m = 6m