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Answer to part (a) and (b):

Liquidity Ratio:

a. Current Ratio:

Current ratio measures the number of dollars of current assets for each dollar of current
liabilities. It helps to estimate the capacity of the firm to meet its maturing obligations,

Current Ratio: (Current Asset/Current Liabilities)

Current Ratio Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company 1.7 1.8 2.5 1.5

Interpretation:

• In 2009, the company’s current assets were 2.5 times of their current liabilities.

• In 2007, the company’s current assets were 1.7 times of their current liabilities. The
current ratio increased to 1.8 times in 2008 whereas in 2009 current ratio increased
rapidly to 2.5 times. Throughout the period of three years, the company’s current ratio
was above industry average of 1.5 times which is quite favorable.

• In 2009, the relative decrease in current liabilities was more than that of current asset for
which the current ratio increases rapidly.

b. Quick (Acid Test) Ratio

The quick ratio or the acid-test ratio is a liquidity indicator that further refines the current
ratio by measuring the amount of the most liquid current assets there are to cover current
liabilities. The quick ratio excludes inventory and other current assets, which are more
difficult to turn into cash.
Quick Ratio: (Current Asset – Inventories) / Current Liabilities

Quick Ratio Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company 1.0 0.9 1.3 1.2

Interpretation:

• In 2009, company’s current assets excluding inventory was 1.3 times of current
liabilities.

• In 2007, the company’s quick ratio was 1 times whereas in 2008 it dropped slightly to 0.9
times but in 2009 the quick ratio was 1.3 times. In 2007 and 2008. Quick ratio was below
Industry average but in 2009 quick ratio increased more than industry average, which is
quite favorable for the company.

• This is because in 2009, the relative decrease in current liabilities was more than that of
current asset excluding inventories.

c. Working Capital

It is the capital needed for day to day business operations of the company.

Working Capital Ratio: (Current Asset-Current Liabilities)

Working Capital Ratio Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company - $680043 $ 915181 -

Interpretation:

• In 2009, their liquidity position seems quite strong as it has enough cash to meet
its current liabilities.

• From 2008 to 2009, the working capital ratio increases from $ 680043 to $
915181

• This is because relative change in current liabilities is more than that of current
assets.
Asset Management Ratio:
a. Inventory turnover:

The ratio is regarded as a test of Efficiency and indicates the rapidity with which
company can move its merchandise.

Inventory Turnover: Cost of goods sold/ Inventory

Inventory Turnover Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company 5.2 5.0 5.3 10.2

Interpretation:

• In 2009, the company has sold out and restocked its inventory 5.3 times.

• In 2007, the company’s inventory turnover was 5.2 times in 2007 whereas in 2008,
inventory turnover decreased to 5.0 times and in 2009, inventory turnover increased to
5.3 times. Throughout the period of three years, the company’s inventory turnover was
below the industry average of 10.2 which is quite unfavorable.

b. Average Collection period (Days Sale Outstanding):

The Days Sales Outstanding ratio shows both the average time it takes to turn the
receivables into cash i.e. how much time it takes to collect money from collectors and the
age, in terms of days, of a company's accounts receivable. This ratio is of particular
importance to credit and collection associates.

Average Collection period: Receivables/ (Annual Sales/365)

Average collection Period Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company 50.7 days 55.8 days 57.9 days 46 days
Interpretation:

• In 2009, it took the company on an average of 57.9 days to collect accounts receivables.

• From 2007 to 2009, average collection period gradually increased from 50.7 days on an
average to 57.9 days on an average and throughout the period of three years, from 2007
to 2009, the company’s average collection period was well above the industry average of
46 days.

• The relative change in accounts receivables was more than that of sales per day for which
average collection period increased.

c. Average payment period( It is not part of asset management ratio) :

The Average payment period ratio shows the average time it takes to pay off the
accounts payables to its creditors.

Average Payment period: Accounts payable/ (Cost of Goods sold (or Purchase) /365)

Average Payment Period Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company - 40 23 -

Interpretation:

• In 2009, it took the company on an average of 23 days to pay its accounts payables.

• From 2008 to 2009, average collection period gradually decreased from 40 days on an
average to 23 days on an average.

• This is because accounts payable decreased rapidly from 2008 to 2009 for which average
payment period declines.

d. Cash Conversion Cycle (It is a part of Liquidity ratio):

It measures the average time it takes for the company to convert all its accounts
receivables, inventories etc into cash.

Cash Conversion Cycle: Days sales Outstanding + Days in Inventory – Average


payment period

Cash conversion Cycle Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company - 89.3 days 104 days -
Interpretation:

• On an average, it takes 104 days for the company to recover its invested
capital in the inventory.

• From 2008 to 2009, the cash conversion cycle increases from 89.3 days to 104
days.

• The relative change in Days Sales outstanding and Days in Inventory is more
than that of average payment period for which cash conversion cycle
increases.

e. Total Asset Turnover:

The total asset turnover illustrates how much of sales have been generated from the total
assets used. Total Asset Turnover evaluates the efficiency of managing all of the
company's assets.

Total Asset turnover: Sales / Total Asset

Total Asset Turnover Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company 1.5 1.5 1.6 2.0

Interpretation:

• In 2009, every $ 1 total assets generates $ 1.6 sales.

• In 2007 and 2008, Company’s total asset turnover was very stable to 1.5 and in 2009 it
increased to 1.6 times but the company’s total asset turnover is below the industry
average of 2.0 times which is quite unfavorable.

• The increase in company’s total asset turnover in 2009 was because the relative change
in total asset was less than that of sales.

f. Fixed Asset turnover ratio :


The Fixed asset turnover illustrates how much of sales have been generated from the
total assets used.

Fixed Asset turnover: Sales / Fixed Asset

Fixed Asset Turnover Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company - 3.18 3.2 -

Interpretation:

• In 2009, every $ 1 fixed assets generates $ 3.2 sales.

• From 2008 to 2009, Fixed Asset Turnover ratio falls from 3.8 times to 3.2 times.

• The fixed asset increased from 2008 to 2009 by $ 250112 for which fixed asset turnover
ratio falls.

Debt management Ratio:


a. Debt to asset ratio

The debt-to-asset ratio tells us how much of the total assets are financed by the overall liability
of the company.

Debt to Asset Ratio: Total Liability/ Total Asset

Debt ratio Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company 45.8% 54.3% 57% 24.5%

Interpretation:

• In 2009, the company’s 57% total assets were financed by debt.


• From 2007 to 2009, the company’s debt to asset ratio increased gradually from 45.8% to
57% and is well above the industry average of 24.5%.

• In 2009, debt to asset ratio increased to 57% because relative changes (increase) in total
liabilities were more than that of total assets.

b. Total debt to total equity ratio (Capital Structure ratio) :

Capital Structure ratio: Asset = Debt +Equity

Capital Structure ratio Year Year 2008 Year 2009 Industry


2007 Average
Martin Manufacturing - 54.3% debt and 57% debt and -
company 47.7% equity 43% equity

Interpretation:

• In 2009. The company’s capital structure consists of 57% debt and 43%
equity.

• From 2008 to 2009, Company’s capital structure changed from 54.3% debt
and 47.7% equity to 57% debt and 43.0% equity showing that company’s debt
financing has increased.

c. Times Interest earned (TIE) ratio:

The interest coverage ratio is used to determine how easily a company can pay interest expenses
on outstanding debt. The lower the ratio, the more the company is burdened by debt expense.

Times Interest Earned: Earnings before Interest and Income Taxes / Interest Charges

Times interest earned Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company 2.2 1.9 1.6 2.5

Interpretation:

• In 2009, the company can cover interest expenses 1.6 times with their operating profits
(EBIT).
• From 2007 to 2009, TIE ratio dropped from 2.2 to 1.6 times and is well below the
industry average which is considered unfavorable.

• This is because; relative change in EBIT was less than that of interest expense for which
TIE ratio decreased.

Profitability Ratio

a. Gross Profit Margin:

The gross profit margin is used to analyze how efficiently a company is using its raw
materials, labor and manufacturing-related fixed assets to generate profits. A higher margin
percentage is a favorable profit indicator

Gross Profit Margin: (Sales- Cost of Goods sold) /sales

Gross Profit Margin Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company 27.5% 28.0% 27% 26.0%

Interpretation:

• In 2009, out of every $ 100 sales, company earned a gross profit of $ 27.

• From 2007 to 2008, Gross profit margin increased slightly from 27.5% to 28% but in
2009, gross profit margin decreased to 27% but throughout the period of three years,
gross profit margin was above Industry average of 26% which is quite favorable.

• In 2009, the relative change in gross profit was less than that of sales for which gross
profit margin decreased.

b. Operating Margin:

Operating Profit Margin: Operating profit (or EBIT) /sales


Operating Profit Margin Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company - - 3.01% -

Interpretation:

• The Company earns $ 3.01 of EBIT out of every $ 100 sales.

c. Net Profit Margin:

Investors can easily see from a complete profit margin analysis that there are several income and
expense operating elements in an income statement that determine a net profit margin. It allows
investors to take a comprehensive look at a company's profit margins on a systematic basis.

Net Profit Margin: Net income / Sales

Net Profit Margin Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company 1.1% 1.0% 0.7% 1.2%

Interpretation:

• In 2009, out of every $ 100 sales, the company earns a net profit of $ 0.7.

• From 2007 to 2009, net profit margin decreased gradually from 1.1% to 0.7 % and is
below the industry’s average which is not considered favorable for the company.

• This is because, relative change in sales was more than that of net profit after taxes for
which net profit margin decreased.

d. Return on Total Asset:


The Return on Total Assets, also called return on investment measures the overall effectiveness
of management in generating profits with its available assets. The higher the firm’s return on
total assets, the better it is considered.

Return on Asset: Net Income / Total Asset

Return on total asset (ROA) Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company 1.7% 1.5% 1.2% 2.4%

Interpretation:

• In 2009, every $ 100 assets earns a net income of $ 1.2.

• From 2007 to 2009, the return on total assets decreased gradually from 1.7% to 1.2% and
throughout the period of three years the company’s return on total asset were below
industry average of 2.4% which is not favorable for the company.

• The relative change (increase) in total asset was more than that of net income (Net profit
after tax) for which return on total assets decreases.

e. Return on Equity

The return on common equity measures the return earned on the common stockholders’
investment in the firm. Generally, the higher the return, the better it is for the owners.

Return On Equity: Net Income / Total Common Equity

Return on common equity Year Year Year Industry


(ROE) 2007 2008 2009 Average
Martin Manufacturing company 3.1% 3.3% 2.8% 3.2%

Interpretation:
• In 2009, common shareholders earned a net income of $ 2.8 on every $ 100 investment.

• From 2007 to 2008, ROE increases from 3.1% to 3.3% but falls to 2.8% in 2009 and is
below industry average of 3.2%.

• In 2009, the relative change in net income is less than that of total common equity for
which net income falls drastically.

Stock market Ratio

a. Price/ earnings Ratio:

The price/earnings (P/E) ratio is the best known of the investment valuation indicators. The P/E
ratio has its imperfections, but it is nevertheless the most widely reported and used valuation by
investment professionals and the investing public.

Price Earnings Ratio: Market Price per Share / Earnings per Share

Price –Earnings ratio (P/E) Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company 33.5 38.7 34.5 43.4

Interpretation:

• In 2009, the shareholders were willing to pay $ 34.5 for every $ 1of reported earnings.

• P/E ratio increases from 33.5 to 38.7 but falls to 34.5 in 2009. Throughout the period of
three years, P/E ratio was below industry average of 43.4.

• The relative change in earning per share is less than the relative change in market price
per share for which P/E ratio falls.

b. Market to Book value ratio (M/B ratio)


The Market to Book value of the share compares the book value of the share which is the internal
or face value of the share with the market price of the share.

Market to Book Value Ratio: Market Price per Share / Book Value per Share

Book Value per Share = Total Common Equity/ No. of total Share outstanding

Market/Book (M/B)ratio Year 2007 Year 2008 Year 2009 Industry Average
Martin Manufacturing company 1.0 1.1 0.88 1.2

Interpretation:

• In 2009, the market price per share is 0.88 times higher than book value per share.

• In 2007, market to book ratio was 1.o whereas it increased to 1.1 in 2008 and falls to 0.88
in 2009 which is also below industry average of 1.2.

• The relative change in market price per share is lower than the relative change in book
value per share.

Du-Pont Equation

ROA = Profit Margin * Total Asset Turnover

So, Net Income/ Total Asset = (Net Income/ Sales) * (Sales/ Total Asset)

In 2009, 1.2% = 0.7% * 1.6

In2008, 1.5% = 1.0% * 1.5

Interpretation:

• Du –pon’t analysis reveals that profit margin declines drastically for which return on
asset declines.
• This is because, relative change (decline) in profit margin is greater than the relative
change of total asset

Modified Du-Pont Equation: ROE= PM*TATO* EM

In 2009, 2.8%= 0.7%*1.6*2.33

In 2008, 3.3%= 1%*1.5*2.19

Interpretation:

• Relative change (decline) in profit margin is greater than the relative change in TATO
and Equity multiplier (EM)

• As a result, ROE declines. Profit margin declines because relative change in sales was
more than that of net profit after taxes.

Answer to part c:

Overall Financial Position:

1) Liquidity Position: The Company has a very good liquidity position which can be
explained by the favorable current ratio of 2.5 times and quick ratio of 1.3 times, both of
which are above the industry averages. In 2009, there is an increase in working capital as
well. This tells us that the company is in a very good position to pay off its current
liabilities with time compared to its competitors.

2) Asset Management Position: The Company is relatively in a poor asset management


position that can be explained by its inventory turnover ratio, total asset turnover ratio
and average collection period. Both the industry turnover ratio and asset turnover ratio is
below the industry average of 10.2 and 2.0 times which is quite unfavorable. The
inventory turnover ratio of the company is half of the industry average that tells us that
the company’s competitors sold and restock their inventory twice than that of Martin
Manufacturing Company. Moreover, the asset turnover ratio tells us that the company’s
asset does not generate enough sales compared to its competitors. Moreover, in 2009
fixed asset ratio declines. This is not a good sign for the company which can be explained
by profitability position as well. The average collection period of the company is well
above the industry average. This means, Company takes more days to collect its
receivables than its competitors. On the other hand, Company’s average payment period
is less than average collection period. This also tells more that the company is in an
unfavorable position to collect all its receivables and pay off the liabilities in cash.

3) Debt Management Position: The Company’s debt management position can be explained
by the debt to asset ratio and Times Interest Earned (TIE) ratio. The debt to asset ratio is
increasing gradually from 2007 to 2009 and in 2009, which is above the industry average,
tells us that the company has 57% of its asset financed by debt whereas its major
competitors have 24.5% assets financed by debts. On the other hand, the TIE ratio is
decreasing gradually and is below industry average. Moreover, capital structure ratio
shows increase in debt financing by company in the year 2009. So the company is not in
a favorable debt management position which is quite risky.

4) Profitability Position: The Company’s profitability position can be explained by Gross


Profit Margin, Net Profit Margin, Return on asset and Return on equity. Even though the
company has a favorable gross profit margin, it does not have a favorable net profit
margin, return on asset and return on equity which are below industry average. This tells
us that the company has a poor profitability position. Even debt financing could not help
the Company to earn reasonable amount of profit.

5) Market Value: The Company has lower P/E ratio and market to book ratio compared to
industry averages. This tells us that the company does not have favorable stock market
ratios.