NORTH SOUTH UNIVERSITY

BUS 625 (Managerial Finance)

Section- 04
Assignment- 02 (Mini Case)

Submitted to,
Dr. Gazi Mohammad Hasan Jamil
Department of Accounting and Finance

Submitted by,
Group no. 3 (iNEXT)
1. Imranul Hassan – 191 5292 660
2. Saiful Islam – 203 5135 660
3. Kasih Ahmed Pranto – 211 5124 660
4. Muhammad Tamzeed Amin – 211 5209 660
5. Md. Sazzad Khan – 211 5301 660

Submission Date: March 12, 2021

a. Why are ratios useful? What three groups use ratio analysis and for what reasons?
Answer:
Ratios are used by managers to help improve the firm’s performance, by lenders to help evaluate the firm’s
likelihood of repaying debts, and by stockholders to help forecast future earnings and dividends. The three
major categories of ratios are: liquidity, activity or efficiency, and profitability ratios.

b. Calculate the 2017 current and quick ratios based on the projected balance sheet and income
statement data.
Answer:
Current Ratio2017 = Current Assets2017/Current Liabilities2017 = $2,680,112/$1,039,800 = 2.58×.
Quick Ratio2017 = (Current Assets2017 – Inventory2017)/ Current Liabilities2017
= ($2,680,112 - $1,716,480)/ $1,039,800 = 0.93×.
What can you say about the company’s liquidity position in 2015, 2016, and as projected for 2017? We
often think of ratios as being useful: (1) to managers to help run the business, (2) to bankers for credit
analysis, and (3) to stockholders for stock valuation. Would these different types of analysts have an
equal interest in the liquidity ratios?
Liquidity Ratios

Description 2015 2016 2017E Industry Average Comments

Current Ratio=(C.A./C.L.) 2.33 1.46 2.58 2.7 Poor
Quick Ratio=((C.A.-Inv)/C.L.) 0.85 0.50 0.93 1 Poor

The company’s current and quick ratios in 2016 are low relative to its 2015 current and quick ratios. They
have improved in 2017. However, both of the ratios have below industry average’s liquidity. The company is
poorly liquid.
These ratios have different types of interest according to their respective fields. Such-
(1) To Managers: It helps managers to identify the liquid portion of the business.
(2) To Bankers or Creditors: It helps bankers and creditors to calculate whether a business is able to pay off
their money on due time.
(3) To Stockholders: It helps stockholders to understand whether the stock price is under/overvalued.
c. Calculate the 2017 inventory turnover, days sales outstanding (DSO), fixed assets turnover, and total
assets turnover. How does Computron’s utilization of assets stack up against that of other firms in its
industry?
Answer:
Activity Ratios or Efficiency Ratios

Description 2015 2016 2017E Industry Average Comments

Inventory Turnover Ratio=(Sales/Inv) 4.00 3.87 3.38 6.10 Poor
Days Sales Outstanding (DSO)= A.R./(Sales/360) 36.84 39.01 44.93 32.00 Poor
Fixed Asset Turnover= Sales/ F.A. 9.95 6.21 8.41 7.00 Efficient
Total Asset Turnover Ratio=(Sales/Total Asset) 2.34 2.02 2.00 2.50 Poor

Inventory Turnover2017 = COGS/inventory = $5,800,000/$1,716,480 = 3.38×.

DSO2017 = receivables/(sales/360) = $878,000/ ($7,035,600/360) = 44.9 days.
Fixed Assets Turnover2017 = sales/net fixed assets = $7,035,600/$836,840 = 8.41×
Total Assets Turnover2017 = sales/total assets = $7,035,600/$3,516,952 = 2.0×.
The firm’s inventory turnover ratio has been steadily declining, while its days sales outstanding has been
steadily increasing. While the firm’s fixed assets turnover ratio is below its 2015 level, it is above the 2016
level. the firm’s total assets turnover ratio is below its 2015 level and 2016 level.
The firm’s inventory turnover and total assets turnover are below the industry average.
The firm’s days sales outstanding is above the industry average (which is bad).
However, the firm’s fixed assets turnover is above the industry average. (This might be due to the fact that
Computron is an older firm than most other firms in the industry, in which case, its fixed assets are older and
thus have been depreciated more, or that Computron’s cost of fixed assets were lower than most firms in the
industry.)
d. Calculate the 2017 debt ratio, liabilities-to-assets ratio, times-interest-earned ratio, and EBITDA
coverage ratios. How does Computron compare with the industry with respect to financial leverage?
What can you conclude from these ratios?
Answer:
Debt Ratios or Leverage Ratios

Description 2015 2016 2017E Industry Average Comments

Debt Ratio=(all short-term & long-term debts)/T.A. 35.64% 59.59% 22.75% 32.00% Low (Risky)
Liabilities to Total Asset Ratio= T.L./T.A. 54.81% 80.68% 43.78% 50.00% Low (Risky)
EBITDA Coverage=(EBITDA+Lease Payments)/(Interest+Loan Repayments+Lease) 2.61 0.81 5.52 8.00 High (Risky)
Time Interest Earned Ratio= EBIT/Interest Expense 3.35 0.10 6.28 6.20 Low (Risky)

Debt Ratio2017 = (All short & long-term debts/Total Assets) = ($300,000 + $500,000)/$3,516,952 = 22.75%.
The firm’s Debt ratio is much increased in 2016 which makes the firm very risky. However, it decreases by
37% in 2017 which makes the firm low risky. Comparing with the industry average, the firm’s Debt ratio is
low which means the firm is doing good in risk management.

Liabilities to Total Asset Ratio2017= Total Liabilities/Total Assets= $1,539,800/$3,516,952 = 43.78%

The firm’s Liabilities to Total Asset Ratio2017 is much increased in 2016 which makes the firm very risky.
However, it decreases by 40% in 2017 which makes the firm low risky. Comparing with the industry average,
the firm’s Liabilities to Total Asset Ratio is low which means the firm is doing good in risk management.

Times-interest-earned2017 = EBIT/Interest Expense = $502,640/$80,000 = 6.28×

The firm’s TIE has decreased from 2015 to 2016 by 3.15 units which is bad news for the firm. However, the
firm manages to improve its TIE in 2017 by 6.18 units which makes the firm low risky as it’s above the
industry average.

EBITDA coverage2017 = (EBIT+Depri.&Amort.+lease payments)/(interest+loan repayments+lease payments)

= (EBITDA + lease payments) / (interest + loan repayments + lease payments)
= ($502,640 + $120,000 + $40,000)/($80,000 + $40,000) = 5.52×
The firm’s EBITDA coverage has decreased from 2015 to 2016 by 1.8 units which is bad news for the firm.
However, the firm manages to improve its TIE in 2017 by 4.71 units which makes the firm high risky as it’s
below the industry average.
e. Calculate the 2017 profit margin, basic earning power (BEP), return on assets (ROA), and return on
equity (ROE). What can you say about these ratios?
Answer:
Profitability Ratios

Description 2015 2016 2017E Industry Average Comments

Net Profit Margin= Net Profit/Sales 2.56% -1.63% 3.60% 3.60% Good
Basic Earning Power= EBIT/T.A. 14.24% 0.60% 14.29% 17.80% Poor
ROA (Return on Asset)= Net Profit/Asset 5.989% -3.296% 7.210% 9.00% Poor
ROE (Return on Equity)= Net Profit/Equity 13.25% -17.06% 12.83% 17.90% Poor

Profit Margin2017 = net income/sales = $253,584/$7,035,600 = 3.6%.

The firm’s profit margin is above 2015 and 2016 levels and is at the industry average which is very good.

Basic Earning power2017 = EBIT/Total Assets = $502,640/$3,516,952 = 14.29%.

ROA2017 = net income/total assets = $253,584/$3,516,952 = 7.21%.
ROE2017 = net income/common equity = $253,584/$1,977,152 = 12.83%.
However, the basic earning power, ROA, and ROE ratios are above both 2015 and 2016 levels, but below the
industry average due to poor asset utilization.
f. Calculate the 2017 price/earnings ratio, price/cash flow ratio, and market/book ratio. Do these ratios
indicate that investors are expected to have a high or low opinion of the company?
Answer:
Profitability Ratios

Description 2015 2016 2017E Industry Average Comments

EPS= (Net Income/ C.S. Outstanding) $ 0.88 $ (0.951) $ 1.014
Price Earnings Ratio, P/E Ratio= (Market Price Per Share of C.S./ EPS) 9.66 -6.31 12.00 16.20 Low
Price/Cash flow= Share Price/((N.I+Dep.&Amort)/no. of Shares outstanding) 7.95 27.49 8.14 7.60 Low
Market Book Ratio= (Market Price Per Share of C.S./Book Value Per Share) 1.28 1.08 1.54 2.90 Low
Book Value Per Share (BVPS)= Common Equity/ No. of shares outstanding $6.64 $ 5.576 $ 7.909

EPS2017 = net income/shares outstanding = $253,584/250,000 = $1.0143.

Price/Earnings2017 = price per share/ EPS2017 = $12.17/$1.0143 = 12.0×
Price/cash flow2017= Price/ ((NI + Dep. & Amort.)/shares) = $12.17/ (($253,584 + $120,000)/250,000) = 8.14.
BVPS = common equity/shares outstanding = $1,977,152/250,000 = $7.909.
market/book = market price per share/book value per share = $12.17/$7.909 = 1.54x.
Here, the price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its
current share price relative to its per-share earnings (EPS). The firm has been doing well in 2017 as it has
increased its P/E to 12. However, the company’s P/E is below the industry average which indicates it has low
growth prospect in the future.
g. Perform a common size analysis.
g. Perform a percentage change analysis.
g. What do these analyses tell you about Computron?
Answer:
Vertical Analysis or Common Size:
Computron has higher proportion of inventories which is not good. Computron has less equity (which means
more debt). Computron has more short-term debt, but less long-term debt than industry. Computron has higher
COGS due to high inventory, but lower depreciation.
Horizontal Analysis or Percentage Change:
We see that 2017 sales grow 105% from 2015, and that NI grows 188% in 2017. So, Computron has become
more profitable. We see that total assets grow at a rate of 139%, while sales grow at a rate of only 105%. So,
asset utilization remains a problem.

h. Use the extended DuPont equation to provide a summary and overview of Computron’s financial
condition as projected for 2017. What are the firm’s major strengths and weaknesses?
Answer:
Industry
Description 2015 Comments 2016 Comments 2017 Comments Comments
Averager
Net Profit Margin 2.56% Indicates Natural Growth. -1.63% Firm incur loss 3.60% Incur Profit 3.60% Good
Inefficient
Indicates Natural Growth Inefficient Asset
Total Asset Turnover 2.34 2.02 2.00 Asset 2.5 Poor
and Asset Utilization. Utilization
Utilization
Abnormally high
It has fallen
indicates most
which indicates
Leverage Ratio 2.21 Indicates Abnormal Growth. 5.18 of the assets 1.78
the firm has
have purchase
payoff its loan.
on debt.

It mostly depends on Natural Risky due to

Risky due to
ROE 13.25% Growth so, satisfactory -17.06% 12.83% inefficient asset 17.90% Risky
high leverage.
ROE. utilization

Du Pont Equation = profit margin × total assets turnover × leverage ratio

= 3.6% × 2.01 × 1.78 = 12.8%.

Strengths: The firm’s fixed assets turnover was above the industry average. however, if the firm’s assets were
older than other firms in its industry this could possibly account for the higher ratio. (Computron’s fixed assets
would have a lower historical cost and would have been depreciated for longer periods of time.)
The firm’s profit margin is equal the industry average, despite its higher debt ratio. this would indicate that
the firm has kept costs down, but, again, this could be related to lower depreciation costs.

Weaknesses: The firm’s liquidity ratios are low; most of its asset management ratios are poor (except fixed
assets turnover); its debt management ratios are poor, most of its profitability ratios are low (except profit
margin); and its market value ratios are low.
i. What are some potential problems and limitations of financial ratio analysis?
Answer:
Some potential problems are listed below:
1. Comparison with industry averages is difficult if the firm operates many different divisions.
2. Different operating and accounting practices distort comparisons.
3. Sometimes hard to tell if a ratio is “good” or “bad.”
4. Difficult to tell whether company is, on balance, in a strong or weak position.
5. “Average” performance is not necessarily good.
6. Seasonal factors can distort ratios.

j. What are some qualitative factors that analysts should consider when evaluating a company’s likely
future financial performance?
Answer:
Top analysts recognize that certain qualitative factors must be considered when evaluating a company. Some
of them are-
1. Management Discussion and Analysis: Management Performance in past, present and what they will do
in future
2. Notes available in the financial statements
3. Auditor’s report: whether is there any material misstatement in the financial statements
4. Are the company’s revenues tied to one key customer?
5. To what extent are the company’s revenues tied to one key product?
6. To what extent does the company rely on a single supplier?
7. What percentage of the company’s business is generated overseas?
8. Competition with the competitors
9. Future prospects
10. Legal and regulatory environment
 Recommendations

Short-term Investment:
Computron’s stocks are very much attractive for short-term investors. Through 2015 to 2017, all the ratios are
fluctuating and unstable indicating unpredictable.
It has a P/E ratio = 12.00 which is below the industry average means, it has a low future growth prospect.
Also, the shares are underpriced. Investors who are looking for short-term gain can ‘short-sell’ Computron’s
stock and make profit out of it. On the other hand, investors can wait for some time have fluctuation effect on
the stock and make profit from it.

Long-term Investment:
Long-term investors should never go for Computron’s stock. Computron’s both ROA and ROE are below the
industry average by 2% and 5% respectively. Also, the TATO (Total asset turn over) is below the industry
average by 0.5x. Under these circumstances stated above, Computron’s inefficiency in managing assets and
equity has been quite evident.
Also, a low P/E ratio indicates other investors are not confident about Computron’s stock. Therefore, market
has a low demand and a bad perception about Computron. It will affect Computron negatively in future.