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Problem Set #2

1. a) Increase and decrease values of assets and liabilities are calculated comparing
the 2013 and 2014 numbers for Microhard.
Microhard Corporation
2014 Sources and Uses of Cash (numbers in millions)
Cash, beginning of year
Sources of cash
Operations:
Net income
Depreciation
Working capital:
Increase in accounts
payable
Decrease in accounts
receivable
Long-term financing:
Increase in common stock
Total sources of cash
Uses of cash
Working capital:
Increase in inventory
Change in notes payable
Long-term financing:
Decrease in long-term debt
Fixed asset acquisitions
Dividends paid
Total uses of cash
Net addition to cash
Cash, end of year $

3000

9804
1400

200
100
1097
12600

200
0
500
2400
9000
12100
500
3500

b) Net Purchase of fixed assets was 1000 million. But since we wrote of 1400 as
depreciation, the amount Microhard actually spent on fixed assets is 1000 + 1400 =
2400 million. So statement of cash flows

Microhard Corporation
2014 Statement of Cash Flows (numbers in millions)
Cash, beginning of year
Operating activity
Net income
Plus:
Depreciation
Increase in accounts payable
Decrease in accounts
receivable
Less:
Increase in inventory
Net cash from operating
activity
Investment activity
Fixed asset acquisitions
Net cash from investment
activity
Financing activity
Change in notes payable
Decrease in long-term debt
Dividends paid
Increase in common stock
Net cash from financing
activity
Net increase in cash
Cash, end of year

3000
9804
1400
200
100
-200
11304
-2400
-2400
0
-500
-9000
1097
-8404
500
3500

c) Internal and Sustainable Growth Rates


Dividend payout ratio = Cash dividends/Net income
= 9000/9804
= 0.92

Plowback or Retention Ratio = (1 - Dividend payout ratio)


= 0.08
ROA = Net Income/Total Assets
= 9804/19600
= 0.50
Internal Growth Rate = (ROA * b) / (1- ROA * b)
Where b is the plowback or retention ratio
= (0.50 * 0.08)/(1-(0.5*0.08))
= 0.04/0.96

= 0.0417
Internal Growth Rate = 4.17%
ROE = Net Income/Total Equity
= 9804/12700
= 0.77
Sustainable Growth Rate = (ROE * b) / ( 1- ROE * b)
= (0.77 * 0.08)/ (1 (0.77 * 0.08))
= 0.06/ 0.9384
= 0.0656
Sustainable Growth Rate = 6.56%
2) Evaluate the financial position of Microhard in areas of liquidity, solvency,
profitability and asset management. Write a paragraph summarizing your
evaluation as supported by ratio analysis that you have performed.
Short-term solvency, or liquidity, ratios
Current ratio = Current Assets/ Current Liabilities
= (238,700 + 37,500 + 136,600)/ (28,200 + 73,200)
= 412800 / 101400
Current ratio = 4.07
Quick ratio = (Current assets Inventory) / Current liabilities
= (412800 136600) / 101400
Quick ratio = 2.72
Cash ratio = Cash/ Current Liabilties
= 238700/101400
Cash ratio = 2.35
Net working capital to total assets = Networking capital/total assets
= (Current Assets Current Liabilities)/ Total
Assets
= (412800 101400)/ 1359900
= 311 400/ 1359900
Net working capital to total assets = 0.23
Long-term solvency, or financial leverage, ratios
Total debt ratio = Total assets -Total equity/total assets
= (1359900 1163500) / 1359900

= 0.14
Debtequity ratio = Total debt/Total equity
= 196400/ 1163500
= 0.17
Equity multiplier = Total assets/Total equity
= 1359900/1163500
= 1.17
Long-term debt ratio = Long-term debt/ Long-term debt + Equity
= 95000/ (95000 + 1163500)
= 0.08
Times interest earned ratio = EBIT/ interest earned
= (Sales COGS Depreciation)/ 5700
= 1435178/ 5700
= 251.79
Cash coverage ratio = EBIT + Depreciation / Interest
= (1435178 + 94710)/ 5700
= 268.4
Asset management, or turnover, ratios
Inventory turnover = Cost of goods sold/ Inventory
= 1869863/ 136600
= 13.69
Days sales in inventory = 365/ Inventory turnover
= 365/ 13.69
= 26.66
Receivables turnover = Sales/ Accounts Receivable
= 3399750/ 37500
= 90.66
Days sales in receivables = 365/ Receivables turnover
= 365/90.66
= 4.03
NWC turnover = Sales / NWC
= 3399750/311400
= 10.92
Fixed asset turnover = Sales/ Net Fixed Assets
= 3399750/947100
= 3.59

Total asset turnover = Sales/ Total Assets


= 3399750/1359900
= 2.5
Profitability ratios
Profit margin = Net Income/Sales
= 1072108/3399750
= 0.32
Return on assets (ROA) = Net Income/Total Assets
= 1072108/1359900
= 0.79
Return on equity (ROE) = Net Income/Total Equity
= 1072108/1163500
= 0.92
Also ROE = Net Income/ Total Sales * Sales/ Assets * Assets/Equity
Ratios at a glance
Liquidity Ratios

Asset Management Ratios

Current ratio = 4.07


Quick ratio = 2.72
Cash ratio = 2.35
Net working capital to total assets =
0.23

Inventory turnover = 13.69


Days sales in inventory = 26.66
Receivables turnover = 90.66
Days' sales in receivables = 4.03
NWC turnover = 4.03
Fixed Asset turnover = 3.59
Total Asset turnover = 2.5

Long-term solvency ratios


Total Debt ratio = 0.14
Debt-Equity ratio = 0.17
Equity multiplier = 1.17
Long term debt ratio = 0.08
Times interest earned ratio = 251.79
Cash coverage = 268.4

Profitability Ratios
Profit Margin = 0.32
Return on Assets (ROA) = 0.79
Return on Equity (ROE) =0.92

Since the quick ratio of Microhard is half of its current ratio, we can see that
Microhard carries a lot of inventory. The company carries a smaller amount of debt
compared to equity. So the company is heavily financed by equity (owner financed)
compared to debt. It has a high cash coverage and times interest earned ratio, so it
is well placed to pay its interests on the debts it has borrowed. The company has a
relatively high inventory turnover though it has a high inventory. It means that it is
selling off its products quickly and that is a good sign. The receivable turnover ratio

is very high, which indicates that the company is really good with collecting the
cash on sales. Microhards asset turnover ratios are all high which means that it is
generating more from its assets. The profitability ratios focus on net income.
Microhards profit margin of 32% is desirable. Higher the ROA and ROE, the better.
Microhards ROE and ROA are very high which is great. From the ratios, Microhard
seems like a highly profitable company.
Using the ratios, we were able to analyze the companys performance but we
had to limit our analysis since we dont know how Microhards competitors are
performing and the industry in which it is in. All of the above ratios are based on
accounting numbers, so calculating the market ratios would also give us some
valuable information on the state of Microhards operations.
3) Given depreciation and interest cost will grow at 50% of sales growth (given as
20%), so growth in depreciation and interest cost = 10%.
Pro Forma Income Statement 2015
Millions

Sales (Projected 20% increase)


Cost of Goods Sold (60% of sales as in
2014)
Depreciation (10% increase)
EBIT
Interest Cost (10 % increase)
EBT
Taxes @30% of 16974
Net Income
Dividends (same divident payout ratio
as 2014)
Addition to Retained Earnings

47,040
28,224
1,540
17,276
303
16,974
5,092
11,881
10,
907.64
974

Given assets and current liabilities will grow at same rate as sales 20% and long
term debt will grow at 50% of sales growth = 10%

Proforma Balance Sheet


Millions
2014
Assets
Cash
Accounts Receivable
Inventory
Net Fixed Assets
Total
Liabilities & Equity
Notes Payable
Accounts Payable
Long-Term Debt
Total Liabilities
Common Stocks
Accumulated Retained Earnings

2015

3500.0
400.0
1700.0
14000.0
19600.0

4200
480
2040
16800
23520

300.0
1100.0
5500.0
6900.0

360
1320
6050
7730
10596.
5
3077.3
1
13673.
8
21403.
8
2116.2

10596.5
2103.5

Total Equity

12700.0

Total
EFN

19600.0

Change
20
20
20
20

%
%
%
%

growth
growth
growth
growth

20 % growth
20 % growth
10 % growth

Adding 974
RE

So External Financing Need = 2116.2 which is the amount the company has to
borrow.