Assignment:
In this assignment, you are expected to:
1. Compute and interpret financial ratios
2. Evaluate investment proposals
3. Apply knowledge to decide appropriate financing plan and dividend policy
Modern Furnitures was established in 2000. Its products include household and office furniture. It has grown organically with new designs of furniture as well as through acquisition of other furniture companies. It has high cash balance in order to provide funds for these opportunities. Its financial statements are shown in Exhibit 1 and 2.
Exhibit 1 Income Statement for the year ending December 31, 2016
|
Sales Revenue
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6,000,000
|
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Cost of goods sold
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-1,800,000
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Gross Profit
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4,200,000
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Operating expenses
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-2,000,000
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Depreciation
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-200,000
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EBIT
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2,000,000
|
|
Interest
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-120,000
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Earnings before tax
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1,880,000
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Tax (20%)
|
-376000
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Net income
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1,504,000
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Dividend payment
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-601600
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Addition to retained earnings
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902,400
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Exhibit 2 Balance Sheet as at December 31, 2016
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Assets
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|
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Cash and Cash Equivalents
Receivables
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1,200,000
560,000
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Inventory
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500,000
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Total current assets
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2,260,000
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Gross Fixed assets
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1,350,000
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Accumulated Depreciation
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-550,000
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Net fixed assets
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800,000
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Total assets
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3,060,000
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Assignment:
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Liabilities and Shareholder equity
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|
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Payables
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400,000
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Short-term debt
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150,000
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Current Liabilities
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550,000
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Long-term debt
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1,000,000
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Total Liabilities
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1,550,000
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Paid up capital
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1,000,000
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Retained Earnings
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510,000
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Total equity
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1,510,000
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Equity + Liabilities
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3,060,000
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|
|
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The number of shares outstanding is 1,000,000.
The company expects that its dividend will grow at 6% every year indefinitely. The long-term debt is made up of 10-year 10% bonds issued 5 years back. The coupon will be paid once a year. The current yield to maturity on these bonds is 8%
The beta of furniture industry is 1.2; the risk free rate is 4% and the expected market risk premium is 7%.
The current credit terms offered by Modern Furnitures is 2/15 net 45. Under these terms, 30% of the customers take the discount and the expected bad debt is 2% of total sales.
Question 1
(a) Calculate the market price per share using dividend growth model.
(b) Compute the market value of bonds.
Question 2
Typically, most companies use line of credit with a bank to finance its working capital needs as opposed to taking out a bank loan. Line of credit costs 8% per annum while term loan for 6 months costs 6% per annum. Modern Furnitures has worked out the working capital for the next 6 months as follows:
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Month
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Working Capital
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|
1
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60,000
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2
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70,000
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3
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100,000
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4
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80,000
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5
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60,000
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6
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40,000
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|
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Assignment -
(a) Explain how line of credit will work for Modern Furnitures, indicating the amount of line of credit that will be taken from the bank.
(b) Calculate the amount of interest that the company will pay if line of credit is taken up.
(c) Calculate the amount of interest that the company will pay if term loan is taken up.
(d) Compare the two (2) financing methods and discuss which of these alternatives will be good for the company.
Question 3
Modern Furnitures is considering a change in credit policy to 2/10 net 30. Under these terms, sales are expected to decrease by 10%; bad debt is expected to reduce to 1%; 20% of the customers are expected to take credit. This will lead to an increase in receivables turnover to 12. The opportunity cost of investing in receivables is the cost of equity.
Analyse the change in credit policy.
Question 4
Cash conversion cycle is an important concept in working capital management. Analyse the importance of cash conversion cycle and explain the strategies to manage the cash conversion cycle.
Question 5
Analyse why Modern Furnitures' ROE is different from that of the industry using Du Pont Identity and other ratios. The relevant ratios are shown in Exhibit 3.
Exhibit 3 Relevant Ratios
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Ratios
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Modern
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Industry average
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Current ratio
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4.11
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5.20
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Quick ratio
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3.20
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3.80
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Total asset turnover
Fixed asset turnover
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1.96
7.50
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1.75
7.00
|
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Working capital turnover
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9.09
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10.45
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Inventory turnover
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3.60
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4.50
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|
|
|
|
|
|
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Assignment:
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Ratios
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Modern
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Industry average
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Receivables turnover
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10.71
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12.42
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Payables turnover
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4.50
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3.90
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Gross profit margin
|
70.00%
|
60.00%
|
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Operating profit margin
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33.33%
|
38.00%
|
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Net profit margin
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25.07%
|
28.00%
|
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Return on assets
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49.15%
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50.00%
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|
Return on equity
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99.60%
|
85.00%
|
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Total debt/Total assets
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37.58%
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32.00%
|
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LTD/Total assets
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32.68%
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28.00%
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LTD/(LTD+Equity)
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39.84%
|
35.00%
|
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Equity multiplier
|
2.03
|
1.735
|
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Interest Coverage
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16.67
|
22.10
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