Thunder Electronics Company - Assignment Example

Student’s Name Professor’s Name Course Name Date Corporate Finance Case Study Analysis: Thunder Electronics Company SA (TEC) Question 1 i) Strengths: There are numerous areas where the company has continued to portray significant level of performance in relation to its underlying industry averages. The company has ensured to keep its financial ratios way above the required industry average. Some of these strengths are perceived in the firm’s sales growth level that remains at 25% for both 2011 and 2012 financial periods. The industry averages at these two periods stand at 10% and 12% respectively. The favourable sales growth ratio is attributed to the company’s capacity to promote its current product and service base at fair and affordable prices hence promoting intensive purchases from existing and potential customers. The positive growth is also attributed to improved selling practices like intensive marketing campaigns as can be noted by the increase in the level of selling and administrative expenses from $239,900 to $304,700 in the two periods. Consequently, the firm’s inventory turnover increases from 5.22 to 6.74 in the three year period between 2010 and 2012 respectively. The improvement is fairly positioned above the industry averages indicating that the firm has an effective purchasing function as well as devised effective ways of translating current stocks into sales revenues. In fact, this is portrayed by the increased sales from $1.2M to $1.875M in the period between 2010 and 2012 respectively. ii) Weaknesses First, the company’s profit margin decreases in the three-year period from 7.35% to 6.38% in 2010 and 2012 respectively. The decrease in the ratios falls below the recommended industry averages of 7.71% and 7.96% respectively. The drop in the ratio indicates that Thunder Electronics Company has poor capacity to translate sales revenues into significant earnings per each dollar of sales. In fact, this decrease can be fairly expounded by the rather significant increase in the amounts incurred to sell goods from a low of about $800,000 to a higher of $1.31M in the period between 2010 and 2012 respectively. The increase in the cost of goods sold has increased in in-proportionate manner as compared to the increase in sales revenues within the same period. Secondly, the company’s return on assets decreases tremendously within the three year period from a high of 8.02% to 5.70% in comparison to 7.94% and 8.95% recommended industry averages. The decrease ascertains that the management team of the firm has lost its capacity to optimally use the current asset base to post sufficient sales revenues. In fact, the company’s total asset base increases within the three-financial period from $1.1M to $2.1M but the increase is not reflected in the level of revenues earned within that period. Thus, the poor performance is attributed to the management team being inefficient in its sales duties. Third, the company’s return on equity, just like ROA, drops from 15.9% to 13.98% in the three year period as opposed to an improved industry average. The decrease in the ratio in comparison to recommended industry averages is attributed to inability to utilise the existing stockholders’ equity base to post sufficient sales revenues. As from can be seen in the balance sheet (Exhibit 2), total stockholders’ equity has increased substantially from $554,600 to $856,100 in 2010 and 2012 respectively and with greater margins in comparison to sales amounts within that period. Fourth, the company’s average collection period increases significantly from 51 to 69 days within the three-year period. The increase however; does not conform to the decreasing recommended industry average that is placed at only 38.7days in 2012. It means that Thunder Electronics Company’s credit collection policies are inefficient and also, it has relatively lesser amount of funds available for other uses as portrayed by the decrease in the level of cash assets from $40,000 to $30,000 in 2011 and 2012 respectively. Consequently, it means that the company is exposed to a higher level of risks that emanates from customers taking longer periods before they can conduct payments. Fifth, the company’s fixed asset turnover ratio has continued to decrease in the three year period from 1.85 to 1.35 despite an increased industry average of 1.6 and 1.75 between 2010 and 2012 respectively. The decrease ascertains that the company does not have the capacity to utilise the current fixed asset base to affect substantial sales earnings within the period at hand. Sixth, the firm’s liquidity position portrays an unfavourable operational environment. For instance, current ratio has decreased from 2.04 to 1.31 against 1.96 and 2.40 industry averages meaning that its capacity to pay off short term obligations as and whenever they fall due has decreased immensely. In fact, this fall can be fairly expounded by the consistent reduction in the amount of cash and other cash equivalents from $40,000 to $30,000 in the period between 2011 and 2012 respectively. The same trend is also depicted by its quick ratio. Sixth, the company has an unfavourable leverage ratio for these three year period. For instance, the debt to total assets increases from 49.58% to 59.23% against the 43.47% and $44.10 in 2010 and 2012 respectively. It thus means that the company is not positioned at a fair position in regards to balancing its debt and equity funds and therefore, relies intensively on borrowings. This over-reliance on debt funds as opposed to equity exposes the company to such risks as the possibility of losing both ownership and control in the future. It can also fail to attract additional funds from such prospective financial institutions like Middle-State Bank due to the already burgeoned debt structure. Notably, the company’s times-interest earned ratio decreases significantly from 4.57% to 3.06% against 6.50% and 6.61% in the period between 2010 and 2012 respectively. The decrease indicates that the firm’s capacity to pay off interest on its debt funds is weak and unstable hence a higher possibility of not continuing with future payments. In fact, despite the company’s interest expense increasing at a tremendous rate from $35,000 to $85,000 in 2010 and 2012 respectively; it still falls below recommended industry averages. Seventh, the firm’s market-investors ratio has decreased significantly within the three year period. In fact, the growth in earnings per share has decreased from 4.1% to 2.9% in 2011 and 2012 against the recommended 10.1% and 13.3% industry averages respectively. Question 2 Yes. I believe more ratios will be needed in order to make effective assessment. Some of the additional ratios required for this purpose include; first, the price-to-earnings ratio, which will help such stakeholders as Investment Trust to make relevant and reliable company analysis for its immediate potential clients. The ratio will allow this stakeholder to correctly identify the cost of acquiring a single share of the firm’s earnings at any given moment and thus, advise its potential client on the same. Secondly, there is need to compute the dividend yield ratio because it informs the potential stakeholders in Investment Trust on whether the company has the capacity to pay a stream of dividend income for all level of stocks held. Thirdly, there is also a need to establish the debt ratio, which is useful to ascertain the level of debt funds that have been used to finance assets. Such stakeholders like Middle-Sate Bank to ascertain whether they can offer further debt finance. Fourth, there will be a need to conduct accounts payable turnover ratio in order to ascertain the pace at which Thunder Electronics Company can pay off its suppliers like Majestic Company. In fact, Majestic Company will rely on this ratio to ascertain whether or not they can include Thunder Electronics Company as a strategic client in the future. Fifth, it will be important to compute cash ratio in order to ascertain on whether the company is able to meet its short term commitments in time using the existing cash and short term marketable securities at hand. Question 3 Middle-State Bank i) Debt-to-total assets ratio: the bank will need this ratio in order to ascertain the level of debts in relation to the asset base of the company. For this case at hand, Thunder Electronics Company is positioned high above the recommended industry average which signifies an unhealthy operational environment due to high financial risks involved with the company debt structure. ii) Times interest earned ratio: the bank will also need this ratio in order to establish whether Thunder Electronics Company is fairly positioned to pay-off interest expenses at recommended periods within a financial year as required by other providers of debt funds. Majestic Company: This is a potential supplier of the firm and will need to analyze the following ratios; i) Current ratio Thunder Electronics Company, which is deemed important to the supplier since it provides information on whether Thunder Electronics Company will be able to meet its short term obligations as when they fall due. Investment Trust: i) Growth in EPS. The information pertaining to this ratio will help the Investment Trust to ascertain whether there is future possibility of receiving substantial earnings from the operations. ii) Profit margin; is a ratio that this stakeholder will need in order to evaluate whether the firm will be able to pay for such items as dividends for its potential clientele. Question 4 The statements made by the CEO are only inclined towards a single-side of the truth that favours him and other management team on the financial performance of the firm. In fact, the CEO only focuses on the sales revenues but fails to go deeper into the amounts of profits that arise thereafter. From the ratio analysis above, it can be noted that despite Thunder Electronics Company posting increased sales in the three year period little of the amounts are translated to gross profit margin due to increased cost of goods sold as well as increased expenses like selling and administrative as well as interest expenses both which have effects on EBIT. All of the other ratios indicate that the company is operating below the industry averages in regards to liquidity and activity ratios hence it is irresponsible for the CEO to conclude that the firm experienced an overall improvement in its financial performance. Question 5 In case i was an analyst with Investment Trust, i will not encourage potential investment in TEC because it is operating below industry averages especially in regards to poor profitability and market-investors ratios. It is a likelihood that most of the potential investments would go into paying off the already burgeoning interest expense due to expanded debt finances. Read More