Cases in Finance

Name: Elna Titto

Subject: Cases in Finance

Student Id: SBSA-19090605

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 EXECUTIVE SUMMARY
We commissioned this report to inspect the importance of cases in finance. A company that
would be mainly focused on is ratios. Issues, such as the reason it is significant for managers to
recognize the sustainability and the impact of sustainability, would be discussed. The research
brings attention to the fact that sustainability, which comprises economic, environmental and
social aspect, has become more challenging for organizations today compared to the past.
Balancing the three aspects is crucial for organizations that want to be profitable, able to protect
the environment and sorting out problems which are socially related simultaneously. The
manager plays the role of decision-makers, thus contributes to the organizations. The transition
towards a sustainable path.

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 TABLE OF CONTENTS

Sr.No Topic Pages

1 Introduction 4
2 Part A 5
3 Part B 15
4 References 22

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 INTRODUCTION
The significant financial statements of a company are the balance sheet, income statement and
cash flow statement (statement of sources and applications of funds). These statements present
an overview of the financial position of a firm to both the stakeholders and the management we
analyze the information provided by these statements. We cannot understand the right financial
situation of the firm. The analysis of financial statements plays an essential role in determining
the financial strengths and weaknesses of a company relative to that of other companies in the
same industry. The analysis also reveals whether the company's financial position has been
improving or deteriorating.

FINANCIAL RATIO ANALYSIS

Financial ratio analysis involves the calculation and comparison of ratios which are derived from
the information given in the company's financial statements. The historical trends of these ratios
can make inferences about a company's financial condition, its operations and its investment
attractiveness.

Financial ratio analysis groups the ratios into categories that tell us about the different facets of
a company's financial state of affairs. They describe some types of rates below:

• Liquidity Ratios give a picture of a company's short term financial situation or solvency.
• Operational/Turnover Ratios show how efficient a company's operations and how well
it is using its assets.
• Leverage/Capital Structure Ratios show the quantum of debt in a company's capital
structure.
• Profitability Ratios use margin analysis and show the return on sales and capital used.
• Valuation Ratios show the performance of a company in the capital market.

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 Part A

Q1) Explain various problems associated with financial statement analysis.

While financial statement analysis is an excellent tool, there are several issues to be aware
of that can interfere with the interpretation of the analysis results. These issues are:

• Comparability between periods. The company preparing the financial statements may have
changed the accounts in which it stores financial information, so that results may differ from
period to period. For example, an expense may appear in the cost of goods sold in one
period, and in administrative costs in another period.

• Comparability between companies. An analyst frequently compares the financial ratios of

different companies to see how they match up against each other. However, each compa ny
may aggregate financial information differently, so that the results of their ratios are not
comparable. Can lead an analyst to draw incorrect conclusions about the effects of a
company in comparison to its competitors.

• Operational information. The financial analysis only reviews a company's financial

information, not its operational data, so you cannot see a variety of key indicators of future
performance, such as the size of the order backlog, or changes in warranty claims. Thus, the
financial analysis only presents part of the total picture.

Q2) Discuss various types of capital budgeting techniques. Also, identify the most
appropriate technique and justify with logical reasoning.

• Capital budgeting is used by companies to evaluate significant projects and investments,

such as new plants or equipment.
• The process involves analyzing a project's cash inflows and outflows to determine
whether the expected return meets a set benchmark.

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 • The significant methods of capital budgeting include throughput, discounted cash flow,
and payback analyses
• Types of Capital Budgeting
▪ Throughput Analysis
Throughput analysis is the most complicated form of capital budgeting analysis but also the most
accurate in helping managers decide which projects to pursue. Under this method, the entire
company is considered as a single profit-generating system. Throughput is measured as an
amount of material passing through that system.

The analysis assumes that nearly all costs are operating expenses, that a company needs to
maximize the throughput of the entire system to pay for expenses, and that the way to maximize
profits is to maximize the performance passing through a bottleneck operation. A bottleneck is
a resource in the system that requires the longest time in activities.

This means that managers should always place a higher priority on capital budgeting projects
that will increase throughput passing through the bottleneck.

▪ DCF Analysis
Discounted cash flow (DCF) analysis looks at the initial cash outflow needed to fund a project,
the mix of cash inflows in the form of revenue, and other future flows in the way of maintenance
and additional costs.

These costs, except for the initial outflow, are discounted back to the present date. The resulting
number from the DCF analysis is the net current value (NPV). Projects with the highest NPV
should rank over others unless one or more are mutually exclusive.

▪ Payback Analysis

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Payback analysis is the purest form of capital budgeting analysis, but it's also the least accurate.
It's still widely used because it's quick and can give managers a "back of the envelope"
understanding of the real value of a proposed project.

This analysis calculates how long it will take to recoup the costs of an investment. The payback
period is identified by dividing the initial investment in the project by the average yearly cash
inflow that the project will generate.

Q3) List and describe the three general areas of responsibility for a financial manager.

1. Forecasting and Planning:

The financial manager must interact with other executives as they look ahead and lay the plans
which will shape the firm's future.

2. Significant Investment and Financing Decisions:

A successful firm usually has rapid growth in sales, which requires investments in plant,
equipment and inventory. It is the task of the financial manager to help determine the optimal
sales growth rate, and he (she) must help decide what specific assets to acquire and the best way
to finance those assets. For example, should the firm finance with debt, Equity, or some
combination of the two, and if the debt is used, how much should be long term and how much
should be short term?

3. Coordination and Control:

The financial manager must interact with other executives to ensure that the firm is operated as

efficiently as possible. All business decisions have financial implications, and all managers

financial and otherwise need to take this into account.

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4. Dealing with Financial Markets:
The financial manager must deal with the money and capital markets. Each firm affects and is
affected by the general financial markets where funds are raised, where the firm's shares and
debentures are traded, and where its investors either make or lose money.

5. Risk Management:
All business face risks, including natural disasters such as fires and floods, uncertainties in
commodity and share prices, changing interest rates and fluctuating foreign exchange rates.
However, many of these risks can be reduced by purchasing insurance or by hedging.

Q4) The managers of a firm wish to expand the firm's operations and are trying to
determine the amount of debt financing the firm should obtain versus the amount of equity
financing that should be raised. The managers have asked you to explain the effects that
both of these forms of investment would have on the cash flows of the firm. Write a short
response to this request.

Debt Financing
When a firm raises money for capital by selling debt instruments to investors, it is known as debt
financing. In return for lending the money, the individuals or institutions become creditors and
receive a promise that the principal and interest on the debt will be repaid on a regular schedule.

Equity Financing
Equity financing is the process of raising capital through the sale of shares in a company. With
equity financing comes an ownership interest for shareholders. Equity financing may range from
a few thousand dollars raised by an entrepreneur from a private investor to an initial public
offering (IPO) on a stock exchange running into the billions.

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Q5) Assume you are a credit manager in charge of approving commercial loans to business
firms. Identify three aspects of a firm's cash flows you would review and explain the type
of information you hope to gain from studying each of those five aspects.

Types of cash flow include:

Cash from Operating Activities – Cash that is generated by a company's core business activities
– does not include CF from investing. This is found on the company's Statement of Cash
Flows (the first section).

Free Cash Flow to Equity (FCFE) – FCFE represents the cash that's available after reinvestment
back into the business (capital expenditures). Read more about FCFE.

Free Cash Flow to the Firm (FCFF) – This is a measure that assumes a company has no leverage
(debt). It is used in financial modelling and valuation. Read more about FCFF.

Net Change in Cash – The change in the amount of cash flow from one accounting period to the
next. This is found at the bottom of the Cash Flow Statement.

Q6) Give some examples of ways in which a manager's goals can differ from those of
shareholders.

Value

Profitability is the bottom line in the business world and both the manager and shareholders are
typically in agreement on this point, in principle. However, the way that a manager tries to
achieve profitability won't always be in line with the shareholders' ideas. For example,
shareholders may be focused on cost-cutting while the manager seeks additional resources to
improve productivity. Managers may find their hands tied from time to time regarding what they
can do to increase productivity.

Time

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Performance levels measured by both managers and shareholders in various increments of time.
Long-term profitability and sustainability are generally more important than the short-term
bottom line -- but not to investors who buy and sell frequently, trying to time the rise and fall of
the market. Managers must also be focused on short-term and intermediate goals -- because these
results affect their employment in the present -- while remaining mindful of the company's long-
term prospects.

Employees

Although profitability is the bottom line and affects everyone within a company, managers who
get the most out of their employees generally have some type of ongoing relationship with those
employees. In some cases, it may be merely an artificial working relationship, but in other cases,
managers do get deeply involved in the lives of their workers. Shareholders do not necessarily
align their goals with this type of relationship in mind. The shareholder does not have to be
involved in the lives of employees and may make decisions about his holdings within the
company based on numbers alone.

Risk

A manager's goals based on calculated risks that the manager is willing to take. This is true of
shareholders as well, but agency theory suggests that managers will sometimes set personal goals
and make decisions based on what they believe they can do to meet the goals of shareholders.
The manager sometimes finds that she cannot realistically achieve the shareholders' goals and,
therefore, acts in her self-interest based on the calculated risk that she can meet the needs of
shareholders by doing things her way, rather than theirs. While shareholders may set goals that
require a considerable amount of risk, the manager may decide to scale back and avoid some of
that risk for the good of herself, her workers and the company as a whole.

Q7) Describe the major differences between individual and institutional investors.
1. Access to resources

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Institutional investors are substantial companies and can take advantage of numerous resources
such as financial professionals to oversee their portfolio daily, allowing them to enter and exit
the market at the right time. Individual investors need to do the same on their own through
research and available data.

2. Decision-making

With institutional investors, the investments are usually overseen by different individuals in the
organization. For example, the board of directors makes the decision-making process more
challenging as people are likely to propose different ideas on what trades to make. As an
individual investor, you are your boss and the sole decision-maker when it comes to buying and
selling shares.

3. Identifying investment opportunities

Since institutional investors can access a large number of resources and capital, they are privy to
investment structures and products available before anyone else. By the time investment
opportunities reach from the hedge fund or private equity funds to the individual investor level,
the rest can use second-hand investment strategies that have already been implemented by the
large institutions.

Q8) What issues are involved in ratio analysis? Explain the impact of those issues on
financial planning.

One of the most critical limitations of ratio analysis include:

Historical Information: Information used in the report is based on real past results that are
released by the company. Therefore, ratio analysis metrics do not necessarily represent future
company performance.

Inflationary effects: Financial statements are released periodically and, therefore, there are time
differences between each release. If inflation has occurred in between periods, then real prices

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are not reflected in the financial statements. Thus, the numbers across different periods are not
comparable until they are adjusted for inflation.

Changes in accounting policies: If the company has changed its accounting policies and
procedures, this may significantly affect financial reporting. In this case, the critical business
metrics utilized in ratio analysis are altered, and the financial results recorded after the change
are not comparable to the findings recorded before the turn. It is up to the analyst to be up to date
with changes to accounting policies. Changes made are generally found in the notes to the
financial statements section.

Operational changes: A company may significantly change its functional structure, anything
from their supply chain strategy to the product that they are selling. When significant operational
changes occur, the comparison of financial metrics before and after the functional change may
lead to misleading conclusions about the company's performance and prospects.

Seasonal effects: An analyst should be aware of seasonal factors that could potentially result in
limitations of ratio analysis. The inability to adjust the ratio analysis to the seasonality effects
may lead to false interpretations of the results from the study.

Manipulation of financial statements: Ratio analysis is based on information that is reported by

the company in its financial statements. This information may be manipulated by the company's
management to report a better result than its actual performance. Hence, ratio analysis may not
accurately reflect the true nature of the business, as the misrepresentation of information is not
detected by simple analysis. It is essential that an analyst is aware of these possible manipulations
and always complete extensive due diligence before reaching any conclusions.

Q9) Compare and contrast various methods of capital budgeting.

Capital budgeting is a set of techniques used to decide which investments to make in

projects. There are many capital budgeting techniques available, which include the
following:

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Discounted cash flows. Estimate the amount of all cash inflows and outflows associated
with a project through its estimated useful life, and then apply a discount rate to thes e
cash flows to determine their present value. If the current value is positive, accept the
funding proposal.

Internal rate of return. Determine the discount rate at which the cash flows from a
projected net to zero. The project with the highest internal rate of return is selected.

Constraint analysis. Examine the impact of a proposed project on the bottleneck

operation of the business. If the proposal either increases the capacity of the bottleneck
or routes works around the bottleneck, thereby increasing throughput, then accept the
funding proposal.

Breakeven analysis. Determine the required sales level at which a proposal will result in
positive cash flow. If the sales level is low enough to be reasonably attainable, then
accept the funding proposal.

Discounted payback. Determine the amount of time it will take for the discounted cash
flows from a proposal to earn back the initial investment. If the period is sufficiently
short, then accept the project.

Accounting rate of return. This is the ratio of an investment's average annual profits to
the amount invested in it. If the outcome exceeds a threshold value, then financing is
approved.

Real options. Focus on the range of profits and losses that may be encountered
throughout the investment period. The analysis begins with a review of the risks to which
a project will be subjected, and then models for each of these risks or combinations of
risks. The result may be more exceptional care in placing large bets on a single
likelihood of probability.

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 When analyzing a possible investment, it is useful also to analyze the system into which
the investment will be inserted. If the order is unusually complex, it is likely to take
longer for the new Asset to function as expected within the system. The reason for the
delay is that there may be unintended consequences that ripple through the system,
requiring adjustments in multiple areas that must be addressed before any gains from the
initial investment can be achieved.

9. Lincoln Industries' current ratio is 0.5. Considered alone, which of the following actions
would increase the company's current ratio? Explain your choice.
a. Use cash to reduce long-term bonds outstanding.
b. Borrow using short-term notes payable and use the cash to increase inventories.
c. Use cash to reduce accruals.
d. Use cash to reduce accounts payable.
e. Use cash to reduce short-term notes payable.

Current Ratio = 0.5

Given that the CR is less than 1, then an increase in the current assets and current liabilities
would result in an increase in the CR
Original CR= ½= 0.5
Increase in CA and CR= 1+1/2+1= 2/3= 0.67
Hence borrowing on short termbasis to increaseinventories is advisable. Hence Option B.

11. Brodax has $20 million in current assets and $10 million in current liabilities,
while Smaland's current assets are $10 million versus $20 million of current liabilities. Both
firms would like to "window dress" their end-of-year financial statements, and to do so
each plans to borrow $10 million on a short-term basis and to then hold the borrowed funds
in their cash accounts. Which of the statements below best describes the results of these
transactions? Justify your choice with logical arguments.
a. The transaction would improve both firms' financial strength as measured by
their current ratios.
b. The transactions would raise Broadax's financial strength as measured by its
current ratio but lower Smaland's current ratio.
c. The transactions would lower Brodax 's financial strength as measured by its
current ratio but raise Smaland's current ratio.
d. The transaction would have no effect on the firm' financial strength as
measured by their current ratios.

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e. The transaction would lower both firm' financial strength as measured by their
current ratios.

Brodax = 20/10= 2
Smaland = 10/20 = 0.5
Borrowing $10 million will lead to CR being :
Broadax = 20+10/10+10= 30/20 = 1.5
Smaland = 10+10/20+10= 20/30 = 0.67
Option C is the right one

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 Part B

Exercise 1
A firm generated net income of $862. The depreciation expense was $47 and dividends were
paid in the amount of $25. Accounts payables decreased by $13, accounts receivables
increased by $28, inventory decreased by $14, and net fixed assets decreased by $8. There
was no interest expense. What is the net cash flow from operating activity? Explain the
usefulness of the net cash flow from operating activities in decision making.

Net Income = $862

Depreciation Expense = $47

Dividends = $ 25

Accounts Payable-= $13

Accounts receivable = $28

Inventory = $14

Net Fixed assets = $8

Int Exp = 0

Net cash flow from operating activities = 862+47-13-28+14= $882

Exercise 6
Hutchinson Corporation has zero debt-it is financed only with common Equity. Its total
assets are $410,000. The new CFO wants to employ enough debt to bring the debt/assets
ratio to 40%, using the proceeds from the borrowing to buy back common stock at its book
value. How much must the firm borrow to achieve the target debt ratio? Show all
calculations.

Total Assets = 410,000

Debt / Assets Ratio = 40%
Debt = ?

40% = Debt/ 410,000 = 410,000 X 40%

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 = 164,000
Exercise 2
Following information is extracted from the books of Brox Ltd:

a. Current Accounts
▪ 2017: CA = 18,900; CL = 11,300
▪ 2016: CA = 14,700; CL = 11,600
b. Fixed Assets and Depreciation
▪ 2017: NFA = 88,100; 2016: NFA = 85,700
▪ Depreciation Expense = 1500
c. Long-term Debt and Equity (R.E. not given)
▪ 2017: LTD = 17,000; Common stock & APIC = 1,400
▪ 2016: LTD = 15,650; Common stock & APIC = 1,400
d. Income Statement
▪ EBIT = 16,000; Taxes = 1400
▪ Interest Expense = 1,240; Dividends = 1,700
Required:
i. Compute the cash flow from Asset for Brox Ltd.

Cash Flow From Assets (CFFA) = Operating Cash flow (OCF) - Net Capital Spending
(NCS) - Change in Net Working Capital (NWC)

OCF = EBIT + Depreciation - Tax

= 16,000 + 1,500 - 1,400 = 16,100

NCS= Ending NFA - Beginning NFA + depreciation =

NCS= 88,100 - 85,700 + 1,500 = 3,900

Change in NWC= Ending WC - Beginning WC = Ending(CA - CL) - Beginning(CA -

CL)

NWC= (18,900 - 11,300) - (14,700 - 11,600) = 4,500

CFFA = 16,100 - 3,900 - 4,500 = 7,700

ii. Comment on usefulness of cash flow from Asset in financial decision making.
- Figuring out any shortage in cash early, that will help us to take the right decision for future
financing

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 - While preparing business plan, or project strategy to solid the credit request
- If the balance is positive in any period, we can use some of this cash and invest in the capital
to make new source of income.

Exercise 3
Following financial information is related to Glow Corporation and Blue Corporation:
Glow Corporation Blue Corporation
2001 2000 2001 2000
Current ratios 1.16 .95 2.25 2.17
Working capital $11 ($2) $30 $28
A/R turnover 31.7 times 45 times 30 times 30 times
Inventory Turnover 16.6 times 22.5 times 15 times 15 times
Asset turnover 2.4 times 3.2 times 3.6 times 3.8 times
Total debt to total assets 86.9% 81.7% 14.2% 15.4%
Sh. Equity to total assets 13.1% 18.3% 85.8% 84.6%
Gross margin ratio 30% 33% 25% 25%
Return on sales 10% 11.9% 10% 10%
Return on assets 24.5% 38.5% 35.5% 38.5%
Return on equity 186.3% 210.5% 41.4$ 45.5%

Required: Conduct financial analyses of the two companies based on the above data and deduct,
which is performing better, and why?

Current ratio: the higher ratio, the better results,

We can see here that the ration of Glow Corporation is (1,160.95 both years) times, while the
current quota of Blue Corporation is (2,25-2,17 both years) times, so the short term liquidity of
blue corporation is much better than Glow corporation.

Working Capital: the number of current assets in excess to current liabilities of the company.
In the above giving figures, we notice that Glow Corporation has working capital of (11$-2$ both
years) while Blue Corporation has (30$-28$ both years) as working capital. Higher working capital
of Blue Corporation would enable the company to address the short term financial needs effectively.

A/R Turnover: effectiveness of providing credit to the end-user and collecting cash.
As per the above details, the Glow Corporation has an A/R turnover of (31.7-45 both years) times,
against (30-30 both years) times A/R turnover for the Blue Corporation, that's mean, the Glow
Corporation in a better position to give their end-user longer period of credit and cash collection.

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Inventory Turnover: the ability to convert the company's inventory into cash.
The Glow Corporation has an inventory turnover of (16.6-22.5 both years) times, against (15 -15
both years)times inventory turnover for Blue Corporation. That's mean, the Blue Corporation has
less inventory turnover, and can help to turn these inventory faster into cash, and has a better
short term liquidity position.

Asset Turnover: the assets used by the company to generate its revenue.
The Glow Corporation has an asset turnover of (2.4-3.2 both years) times, and Blue Corporation
has (3.6-3.8 both years), and that's higher utilization on the Asset to generate revenue.

Total debt to total assets: to pay off the liability of the company in the event of bankruptcy, higher
ratio means higher risk.
The Glow Corporation has a total debt of (86.9%-81.7% both years), and Blue Corporation has
(14.2%-15.4% both years) it's clear that Glow Corporation has higher ratio and means higher risk to
the amount of debt.

Sh.Equity to Total Assets Ratio: the number of assets funded through the Equity, the higher the best.
Glow Corporation shows (13.1%-18.3% both years) and Blue Corporation shows (85.8%-84.6% both
years) and the Blue Corporation has a lower risk in terms of the amount of Equity as against the
value of its assets

Gross margin ratio: the profitability of the business at the operating level.
Glow Corporation has a gross ratio of (30%-33% both years) while Blue Corporation has (25% both
years) and that's mean the Glow Corporation has better gross profit in the asset operations.

Return on Sales: is the ratio of operating income to net sales, the higher the best.
The Glow Corporation making (10%-11.9% both years) and Blue Corporation making (10% both
years), we can see that both companies doing almost the same, while Glow Corporation made a bit
better on the year of 2000.

Return on Asset: the percentage of how profitable the company's assets are in generating revenue.
Glow Corporation shows (24.5%-38.5% both years) and Blue Corporations (35.5%-38.5% both
years) in comparison, we see that Blue Corporation has a higher ratio and the assets making higher
revenue.

Return on Equity: is a measure of the profitability of business concerning the Equity

Glow Corporation was doing (186.3%-210.5% both years) and Blue Corporation doing (41.4%-
45.5% both year) it is clear that Glow Corporation was having a much higher return on Equity.

Exercise 4
Using the following information, answer the questions listed below:

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 Dana Dairy Products Key Ratios

Income Statement
Dana Dairy Products
For the Year Ended December 31, 2013

Balance Sheet
Dana Dairy Products
December 31, 2013

Required:

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i. Calculate the following ratios for 2013:
a. Current ratio.
Current Ratio = current asset / current liabilities
= 14,750 / 15,675 = 0.94
Quick ratio = (Current asset – inventory) /current liabilities
= (14,250 – 4,350) / 15,675 = 0.63

b. Net working capital

NWC = Current Asset – Current liabilities
= 14,250 – 15,675 = - (1,425)

c. Inventory turnover
Inventory Turnover = Cost of goods sold / inventory
= 87,000 / 4,350 = 20

d. Average collection period

Avg. collection period = (Account receivable / Sales )*365
= (8,900 / 100,000) * 365
= 32.48 days
e. Gross profit margin

Gross profit margin = (Gross profit / Net Sales)*100

= (13,000 / 100,000)*100 = 13%

f. Net profit margin

Net profit margin = NPBT / Sales
= (1,500 / 100,000) *100 = 1.5%

g. Return on assets
Return on assets = (Net income / total asset)*100
= (900 / 36,000)*100 = 2.5%

h. Return on Equity

Return on equity = (Net income / shareholder equity)*100

= 900 / 16,200 = 5.5%

ii. Based on the calculations in part (i) above, comment on the performance of the company as
compared to its industry and its own last year results.
In general we can notice that the company has increased the profits and efficiency such as net profit
increased to 1.5% and return on asset to 2.5% and return on Equity to 5.5% that's mean the company
has improved in the current year compering with the previous one.

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