Hesham Mohammed Ali Ali Mansour Financial Reporting MBA – Mansoura Group

Registration Number: 19125725

Mini Case
Dan Ervin was recently hired by East Coast Yachts to assist the company with its short-term financial
planning and also to evaluate the company’s financial performance. Dan graduated from college five
years ago with a finance degree, and he has been employed in the treasury department of a Fortune
500 company since then. East Coast Yachts was founded 10 years ago by Larisa Warren. The
company’s operations are located near Hilton Head Island, South Carolina, and the company is
structured as an LLC. The company has manufactured custom midsize, high-performance yachts for
clients over this period, and its products have received high reviews for safety and reliability. The
company’s yachts have also recently received the highest award for customer satisfaction. The yachts
are primarily purchased by wealthy individuals for pleasure use. Occasionally, a yacht is
manufactured for purchase by a company for business purposes. The custom yacht industry is
fragmented, with a number of manufacturers. As with any industry, there are market leaders, but the
diverse nature of the industry ensures that no manufacturer dominates the market. The competition
in the market, as well as the product cost, ensures that attention to detail is a necessity. For instance,
East Coast Yachts will spend 80 to 100 hours on hand-buffing the stainless steel stem-iron, which is
the metal cap on the yacht’s bow that conceivably could collide with a dock or another boat. To get
Dan started with his analyses, Larisa has provided the following financial statements. Dan has
gathered the industry ratios for the yacht manufacturing industry.

1. Calculate all of the ratios listed in the industry table for East Coast Yachts.
Dec 31,2006 Lower Quartile Median Upper Quartile
Current ratio 0.75 0.5 1.43 1.89
Quick ratio 0.44 0.21 0.38 0.62
Total asset turnover 1.54 0.68 0.85 1.38
Inventory turnover 19 4.89 6.15 10.89
Receivables turnover 30.67 6.27 9.82 14.11
Debt ratio 0.49 0.44 0.52 0.61
Debt–equity ratio 0.96 0.79 1.08 1.56
Equity multiplier 1.96 1.79 2.08 2.56
Interest coverage 7.95 5.18 8.06 9.83
Profit margin 7.50% 4.05% 6.98% 9.87%
ROA 11.56% 6.05% 10.53% 13.21%
ROE 22.70% 9.93% 16.54% 26.15%
Hesham Mohammed Ali Ali Mansour Financial Reporting MBA – Mansoura Group
Registration Number: 19125725

2. Compare the performance of East Coast Yachts to the industry as a whole. For each ratio, comment
on why it might be viewed as positive or negative relative to the industry. Suppose you create an
inventory ratio calculated as inventory divided by current liabilities. How do you interpret this ratio?
How does East Coast Yachts compare to the industry average?
1. CR is Negative, less than Median but it is also above Lower Quartile
so it has chance to be positive through analysis of QR.
2. QR is Positive, more than Median.
It indicated Inventory isn't a lot or has high turnover.
3. TATO is so Positive, more than Upper Quartile.
It indicate the best use of assets.
4. Inventory turnover is so Positive, more than Upper Quartile
It indicate good Inventory management and reason of positive QR.
5. AR turnover is so Positive. (Assumed all sales in credit)
It indicate company's effectiveness in collecting its receivables is high.
6. Debt ratio is Positive, lower than Median. (Near)
It indicate almost half of assets is Liabilities and it will be clear by analyzing D/E ratio
7. Debt-Equity ratio is Positive, less than Median.
It indicate assets based on debt almost equal shareholder's equity. (Not more a lot)
8. EM is Positive, less than Median
Every 1.96 dollar of assets is financed by 1 dollar of Equity.
9. Interest coverage is Negative, less than Median. (Near)
Its available earnings can cover its current interest expenses almost eight times.
10. Profit margin is Positive, more than Median.
Every one dollar of sales generate .075 dollar of net income.
11. ROA is Positive. More than Median.
Every one dollar of total assets generate .1156 dollar of net income.
12. ROE is Positive, more than Median.
Every one dollar of Equity generate .227 dollar of net income.
13. ROD = 9,663,000 / 25,950,000 = 37.23 %
Every one dollar of LTD generate .37 dollar of net income.
14. ROE = EM * PM * TATO, it indicate good performance.
Although EM is Positive but less than Median so it reduced ROE.
Hesham Mohammed Ali Ali Mansour Financial Reporting MBA – Mansoura Group
Registration Number: 19125725

3. Calculate the sustainable growth rate of East Coast Yachts. Calculate external funds needed (EFN)
and prepare pro forma income statements and balance sheets assuming growth at precisely this rate.
Recalculate the ratios in the previous question. What do you observe?
1. SGR = (.227*.4/(1-.227*.4) = 9.98%
2. EFN = Assets*1.0998 - (NI *1.0998*.4+RE) - (LTD + CS + NP ) - AP *1.0998
(assume operation at full capacity) EFN = $ 3,591,337
3. Pro forma income statement (9.98% increase)
Sales $ 128,700,000 $ 141,544,260
Cost of goods sold $ 90,700,000 $ 99,751,860
Other expenses $ 15,380,000 $ 16,914,924
Depreciation $ 4,200,000 $ 4,619,160
(EBIT) $ 18,420,000 $ 20,258,316
Interest $ 2,315,000 $ 2,546,037
Taxable income $ 16,105,000 $ 17,712,279
Taxes (40%) $ 6,442,000 $ 7,084,912
Net income $ 9,663,000 $ 10,627,367
4. Pro forma Balance sheet (9.98% increase)
Current assets
Cash $ 2,340,000 $ 2,573,532
Accounts receivable $ 4,210,000 $ 4,630,158
Inventory $ 4,720,000 $ 5,191,056
Total $ 11,270,000 $ 12,394,746
Fixed assets
Net plant and equipment $ 72,280,000 $ 79,493,544
Total assets $ 83,550,000 $ 91,888,290
Current liabilities
Accounts payable $ 4,970,000 $ 5,466,006
Notes payable $ 10,060,000 $ 10,060,000
Total $ 15,030,000 $ 15,526,006
Long-term debt $ 25,950,000 $ 25,950,000
Shareholders’ equity
Common stock $ 4,000,000 $ 4,000,000
Retained earnings $ 38,570,000 $ 42,820,947
Total equity $ 42,570,000 $ 46,820,947
Total liabilities and equity $ 83,550,000 $ 88,296,953
EFN $ 3,591,337
Hesham Mohammed Ali Ali Mansour Financial Reporting MBA – Mansoura Group
Registration Number: 19125725

5. Recalculate the ratios in the previous question.

Dec 31,2006 Pro forma
Current ratio 0.75 0.80 Increase
Quick ratio 0.44 0.46 Increase
Total asset turnover 1.54 1.54 Constant
Inventory turnover 19 19 Constant
Receivables turnover 30.6 30.6 Constant
Debt ratio = TD+EFN / TA 0.49 0.49 Constant
Debt–equity ratio 0.96 0.96 Constant
Equity multiplier 1.96 1.96 Constant
Interest coverage 7.96 7.96 Constant
Profit margin 7.5% 7.5% Constant
ROA 11.56% 11.57% Constant
ROE 22.70% 22.70% Constant
4. As a practical matter, East Coast Yachts is unlikely to be willing to raise external
equity capital, in part because the owners don’t want to dilute (‫ )يخفف‬their existing
ownership and control positions. However, East Coast Yachts is planning for a growth
rate of 20 percent next year. What are your conclusions and recommendations about
the feasibility of East Coast’s expansion plans?
1. We can increase retention ratio ( Current b = .4 )
2. IGR = 4.85% without EFN
5. Most assets can be increased as a percentage of sales. For instance, cash can be
increased by any amount. However, fixed assets often must be increased in specific
amounts because it is impossible, as a practical matter, to buy part of a new plant or
machine. In this case, a company has a “staircase” or “lumpy” fixed cost structure.
Assume that East Coast Yachts is currently producing at 100 percent of capacity. As a
result, to expand production, the company must set up an entirely new line at a cost of
$25,000,000. Calculate the new EFN with this assumption. What does this imply about
capacity utilization for East Coast Yachts next year?
Net plant and equipment $ 72,280,000 25,000,000 $ 97,280,000

Capacity 100% 134.5%

Increase 0 34.50%

EFN = (CA *1.345) + 97, 280,000 - (NI *1.345*.4+RE) - (LTD + CS + NP) - AP *1.345

EFN = 112,438,150 - 43,768,694 - 40,010,000 - 6,684,650 = $ 21,974,806