INTRODUCTION

Anthony Cruz owns Zapatoes, Inc., a home-grown Filipino shoe company. His company
has experienced tremendous growth since it started its operations in 2009. With a growing
demand for his products, Anthony Cruz is considering expanding his operations by opening his
first production. Furthermore, since 2013, the sales of the company have been growing by
36.03%, and Anthony is very confident that his sales volume will still grow for the next 5 years.
Therefore, Anthony is planning an expansion to lessen the cost of production.

With the help of this production facility, Zapatoes, Inc. will be able to reduce their cost of
sales by 36.85%, from 475 to 300. However, opening a new production facility will increase
operating expenses (including depreciation) by 30%.

In order to execute his plan successfully, Anthony needs $10 million worth of funds. He
has three choices: 1. Accept a PHP 10 million equity investment from his friend, Alex. Alex will
hold 45% ownership of the business afterwards. Alex does not demand any specific return. 2. A
short-term loan for 1 year for PHP 10 million at 6% per annum from Shortime Bank; 3. A long-
term loan for 5 years for PHP 10 million at 10% per annum from Longly Bank.

STATEMENT OF THE PROBLEM

 He is paying another company to manufacture the shoes he designs.
 The company needs ₱10 million worth of fund.
 The company is in a tight cash position.
 Where to get the funds needed — invite an investor or personally borrow from a bank.

ZAPATOES, INC FINANCIAL RATIOS:

Profitability, Leverage and Liquidity

ZAPATOES INCORPORATION
LIQUIDITY RATIO
FOR THE YEAR ENDED, 2013, 2014 and, 2015

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 CURRENT RATIO FOR YEAR 2013, 2014 and, 2015

FORMULA:
CURRENT ASSETS
=
CURRENT LIABILITIES
2013 2014 2015
6,170,000 8,610,000 11,380,000
= = =
1,000,000 2,200,000 2,400,000
= 6.17 = 3.91 = 4.74
QUICK RATIO FOR YEAR 2013, 2014 and, 2015

FORMULA:
CURRENT ASSETS −(PREPAID EXPENSE + INVENTORY )
=
CURRENT LIABILITIES

2013 2014 2015

6,170,000−(2,000,000) 8,610,000−(3,000,000) 11,380,000−( 3,400,000)

= = =
1,000,000 2,200,000 2,400,000
4,170,000 5,610,000 7,980,000
= = =
1,000,000 2,200,000 2,400,000
= 4.17 = 2.55 = 3.33

Base on the data shown above, the Zapatoes, Inc is liquid. Looking on their current ratio,
for every ₱1 of their current liabilities, can be paid for ₱6.17 of their current assets. Additionally,
the company can pay its ₱1 current liabilities for ₱4.17 of their current assets even after
deducting its inventories. Having this liquidity will put the company in a greater image when
borrowing from a bank.

ZAPATOES INCORPORATION
SOLVENCY/LEVERAGE/DEBT RATIO
FOR THE YEAR ENDED 2013, 2014 and, 2015

DEBT RATIO FOR YEAR 2013, 2014 and, 2015

FORMULA:
TOTAL LIABILITIES
=
TOTAL ASSETS

2013 2014 2015

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 3,000,000 4,200,000 4,400,000
= = =
6,170,000 8,610,000 11,380,000
= 0.49 or 49% = 0.49 or 49% = 0.39 or 39%
DEBT-TO-EQUITY RATIO FOR YEAR 2013, 2014 and, 2015

FORMULA:
TOTAL LIABILITIES
=
TOTAL EQUITY

2013 2014 2015

3,000,000 4,200,000 4,400,000

= = =
3,170,000 4,410,000 6,980,000
= 0.95 or 95% = 0.95 or 95% = 0.63 or 63%
TIMES INTEREST EARNED RATIO FOR YEAR 2013, 2014 and, 2015

FORMULA:
NET PROFIT BEFORE INTEREST
=
INTEREST EXPENSE

2013 2014 2015

1,024,986 2,019,428.57 3,919,428.57

= = =
0 248,000 248,000
=0 = 8.14 = 15.80

1. Debt Ratio

For 3 consecutive years, the incorporation couldn’t keep their debt ratio under 30%, as this is the
least debt ratio a company should have for it to be considered a low leveraged company.
Although for the year 2015, it reduced by 10%, which indicates that their debt remained almost
the same from the previous and their assets increased.

2. Debt-to-equity Ratio

From 2013 to 2014, their liabilities took up almost their equity, showing that equity is just 5%
more than their liabilities, which is a bad sign. It clearly shows that the business is at high risk
that they are less likely to receive loans or have an investor come on board. It means that there is
0.95 peso to pay for every 1peso of equity. Though as for 2015, it got better somehow.
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3. Interest Coverage Ratio

For year 2014 and 2015, it shows that they have the ability to pay interest on its outstanding debt.
It is even way more than the bare minimum interest coverege ratio a company should have. But
the 2013's ability to meet the interest expenses is a bit questionable.

ZAPATOES INCORPORATION
PROFITABILITY RATIO
FOR THE YEAR ENDED 2013, 2014 and, 2015

RETURN ON EQUITY (ROE) FOR YEAR 2013,2014 and 2015

FORMULA 2013, 2014 &, 2015

2,570,000
= ( 6,980,000+4,410,000+3,170,000 )
3
2,570,000
NET INCOME
=
AVERAGE TOTAL EQUITY
= ( 14,560,000 )
3
2,570,000
= 4,853,333.33
= 0.53 or 53%

RETURN ON ASSETS (ROA) FOR YEAR 2013,2014 and 2015

FORMULA 2013, 2014 &, 2015

2,570,000
= (
11,380,000+8,610,000+6,170,000
)
3
2,570,000
NET INCOME
=
AVERAGE TOTAL ASSETS
= ( 26,160,000
)
3
2,570,000
= 8,720,000
= 0.29 or 29%
GROSS PROFIT RATE FOR YEAR 2013,2014 and 2015

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 FORMULA:
GROSS PROFIT
=
REVENUE

2013 2014 2015

48,487,686 4,319,428.57 6,269,428.57

= = =
50,403,000 6,856,235.83 9,219,747.90
= 0.962 or 96.2% = 0.63 or 63% = 0.68 or 68%

OPERATING RATIO FOR YEAR 2013,2014 and 2015

FORMULA:
COST OF SALES + EXPENSES
=
REVENUE

2013 2014 2015

4,015,314 4,836,807.26 5,300,319.33

= = =
50,403,000 6,856,235.83 9,219,747.90
= 0.08 or 8% = 0.71 or 71% = 0.57 or 57%
NET PROFIT MARGIN FOR YEAR 2013,2014 and 2015

FORMULA:
NET INCOME
=
REVENUE

2013 2014 2015

717,490.20 1,240,000 2,570,000

= 50,403,000 = 6,856,235.83 = 9,219,747.90
= 0.01 or 1% = 0.18 or 18% = 0.28 or 28%

1. ROE

There is 0.53 pesos for every 1 peso of net income, which indicates that the company's
net income takes a larger part in the total average equity. This is a good sign because it only
means that the company does not only focuses on the outer generation of equity but also secures

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the profitability of the company. The company should continue generating net income and
maximize their assets in order to lessen the costs and inventory.

2. ROA

Their assets situation in the company indicates that with every 0.29 centavos in their 1
peso asset production, 29% percent of it came from their Net Income. The amount may be
minimal, but it indicates that they are able to manage their assets producing a 29% net income
from it.

3. Gross Profit Margin

The company knows how to strategically lessen their production cost, because their gross
profit rate for the three years shows that they are able to minimize their cost of goods sold which
enable their gross profit to attain a larger share from their revenues.

4. Operating Profit Margin

The company should look back and attain their 8% operating profit margin in 2013
because as observed, when time progresses the company wasn’t able to minimize the
capitalization of their expenses and cost of goods sold. If this continues the company will face a
huge problem in acquiring a higher net income. The company should make precautionary actions
to avoid these certain circumstances.

5. Net Profit Margin

For the past 3 years the company shows minimal improvement regarding their net profit
margin. Acquiring less than 30% shares of net income to its revenue indicates that the company
produces more production costs rather than minimizing it. A large operating costs and cost of
good sold greatly affects the output of their net income. Therefore, the company should
strategize on how they will lessen their production costs. Although the company proves that they
are resilient despite the minimal changes the company still demonstrates progress that they
should continue.

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 GUIDE QUESTIONS:
1. What is the Zapatoes Inc’s capital structure? What is the effect of an additional debt?
Additional equity?

Zapatoes, Inc.'s capital structure has the capability to pay its liabilities. Improving their
debt-to-equity ratio from 0.95 in 2014 to 0.63 in 2015, we can say that Zapatoes, Inc. is in a
healthy state when it comes to their debt. Zapatoes, Inc.'s additional debt will not cause any harm
to the company, for the reason that the company has enough resources to pay it. On the other
hand, additional equity is an opportunity for the company to grow its business and generate more
income.

2. Assess the profitability of Zapatoes Inc’s. What is the effect of issuing debt to its profitability?
Effect of equity?

The ability of the company to generate profit has improved from 2013 to 2015, as shown
by their profitability ratios, and Anthony is confident that his sales will still grow for the next 5
years. Issuing debt may not affect their profitability negatively because their company is good at
handling its debts. They have enough resources to take care of their liabilities without affecting
their ability to generate profit. Issuing debt to offset the profitability effect of equity has a
positive effect on Zapatoes, Inc. The ₱10 million debt will be used for the expansion of their
business. This production facility will be one of their assets; it is a good asset when borrowing
from a bank. Because of this production facility, the company has the ability to lower its cost of
sales, which is one of the factors they can use to generate more profit.

3. What factors are considered in deciding whether to take long-term or short-term financing?

According to chron.com, as a business owner there are 3 factors to be considered

including the repayment terms, the total cost of capital and the requirements of the lender or
investor. This will help a business entity to decide on how they will finance their business. It is
best to know the total cost of capital especially longer loans can build up a significant amount of
interest over time, but loans with shorter terms can require larger periodic payments. Consider
the amount of the periodic payment and how often you are required to pay. Also take into
account the allocation of each payment to principal and interest; look for loans with a higher

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allocation to principal to minimize the total long-term cost. Additionally, add up all of the costs
associated with each financing method before making a decision. Common costs for loans
include interest rates, origination fees and brokers' fees. Financing through investment can carry
much different costs. This will help you to look more thoroughly into your accounts and
strategically manage your capital allocation. Furthermore, Consider the personal requirements
each lender and investor places on applicants. Pursue financing from sources whose
requirements you meet in full. Common financing requirements include credit score
requirements and specific financial ratio tests, such as the debt-to-equity or interest coverage
ratios because this will tell you if your company is capable enough to cover your payables and
still fulfill your lenders/investor’s purpose.

4. What financing should Anthony Cruz take?

Despite knowing the fact that short-term financing holds large periodic payments,
Anthony Cruz’ company is very much stable enough to cover their payables within a year. The
company is liquid meaning they can pay their payables with or without their current assets. Also,
the company tries their best to maximize their resources to produce profit. Lastly, short-term
financing is known to be flexible and steadfast, maintaining a good credit history will help you in
assessing this kind of financing. However, pros and cons of this financing decision should
always be looked upon.

RECOMMENDATIONS:
 The company is advisable to sell their inventories, and to collect their accounts receivable
immediately to generate more profit.
 In the next 5 years, the company should be able to lessen their cost of sales to recover
from their long-term debt.
 Zapatoes, Inc should come up with new designs and marketing strategies to attract new
buyers and generate more profit.
 The firm needs to make sure that their expansion would not be a waste of money by
making sure that it generates more profit, and to utilize it effectively as their asset.

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