Martin Manufacturing's Financial Position - Math Problem Example

Contents Part A: 2 1.Case: Martin Manufacturing’s Current Financial Position 2 1.1.Martin Manufacturing Financial Ratios Analysis 2 1.1.1.Calculations 2 1.1.2.Periodic Historic Ratios 2 1.2.Firms Financial Position 3 1.2.1.Liquidity Position 3 1.2.2.Activity Position 3 1.2.3.Debt Position 3 1.2.4.Profitability Position 3 1.2.5.Market Position 4 1.3.Martin Manufacturing: Financial Position Summary 4 2.Debt Ratio Discussion 4 3.Comparison with All Ordinaries 15.75 2010 5 Part B: 6 1.Problem 5-37: Portfolio Return and Beta 6 1.1.Portfolio Beta Based on Original Cost 6 1.2.Percentage Return of Each Asset in the Portfolio 6 1.3.Percentage Return of Portfolio Based on Original Cost, & Income Gains 6 1.4.Expected Rate of Share Return Based on Beta, Market Expectation and Risk Free Return 6 1.5.Discussion of Portfolio Performance 6 Part C: 8 1.Case: Suez Manufacturing 8 1.1.Current Value of Suez Manufacturing Bonds 8 1.2.Current Value of Suez Manufacturing Shares 8 1.3.Bonds with Risky Investment 8 1.4.Shares with Risky Investment 8 1.5.Discussion of Results under Risky Condition 9 1.6.Reworked Results for Change in Annual Dividend of 2007-2011 9 Part A: 1. Case: Martin Manufacturing’s Current Financial Position 1.1. Martin Manufacturing Financial Ratios Analysis 1.1.1. Calculations Current Ratio = 1,531,181 / 616,000 = 2.5 Quick Ratio = (1,531,181 – 700,625) = 1.3 Inventory Turnover = 3,704,000 / 700,625 = 5.3 times Average Collection Period = 805,556 / (5,075,000 / 360) = 57 days Total Asset Turnover = 5,075,000 / 3,125,000 = 1.6 times Debt Ratio = 1,781,250 / 3,125,000 = 57% Times Interest Earned = 153,000 / 93,000 = 1.6 Gross Profit Margin = 36,000 / 5,075,000 = 0.71% Return on Total Assets = 36,000 / 3,125,000 = 1.2% Return on Equity = 36,000 / 1,343,750 = 2.7% 1.1.2. Periodic Historic Ratios The tabulated ratios are as follows:   2009 2010 2011 Industry Average Current Ratio 1.7 1.8 2.5 1.5 Quick Ratio 1 0.9 1.3 1.2 Inventory Turnover 5.2 times 5.0 times 5.3 times 10.2 times Average Collection Period 50 days 55 days 57 days 46 days Total Asset Turnover 1.5 times 1.5 times 1.6 times 2.0 times Debt Ratio 45.80% 54.30% 57% 24.50% Times Interest Earned 2.2 1.9 1.6 2.5 Gross Profit Margin 27.50% 28% 27% 26% Net Profit Margin 1.10% 1.00% 0.71% 1.20% Return on Total Assets 1.70% 1.50% 1.20% 2.40% Return on Equity 3.10% 3.30% 2.70% 3.20% Price Earnings Ratio 33.5 38.7 34.48 43.4 Marker/Book 1 1.1 0.89 1.2 1.2. Firms Financial Position 1.2.1. Liquidity Position The liquidity ratios of the firm show an increasing year on year trend. The current ratio for 2011 is at 2.5 which is much higher than that of the Industry Averages. The quick ratio, which is at par with the industry average and much more stable than the current ratio, indicates that much of the weight in the current ratio is held by the inventory. This means that firm is operating unfavorably holding excess funds stuck in inventory. 1.2.2. Activity Position The year on year similar inventory turnover trend indicates that the turnover of the firm is lower than the Industry Averages and does not fluctuating much. This supports the fact that excess is held in inventory by the firm without rotating it. The period for inventory collected computed is also higher than industry averages confirming that the firm faces problem when it comes to managing receivables. On the other hand the ratios for fixed asset turnover and total asset turnover are also quite less than the Industry Averages. This depicts that the firm’s sales level does not spread fully enough to cover the assets. 1.2.3. Debt Position It is observed over the years, that the firm is facing increasing debt ratio which is also much higher than the Industry Averages. This hints at the firm borrowing more each year for its business and operations. Combined with the operating risk identifies above, the increasing level borrowing puts the firm at a financial risk position as well. 1.2.4. Profitability Position From the profitability ratios it was determined that the firm has a year on year favorable gross profit margin which shows an increasing trend and also depicts a positive result when compared with the lower Industry Averages. However when the Net profit margin for the firm is compared with the industry, it shows that it is much lower than the Industry Averages and depicts a decreasing year on year trend as well. From the analysis it can be deduced that the lower net profit is due to the increased interest payments being made to creditors and for debt. Therefore overall the firm depicts a low level of profitability specially when compared to the Industry Averages. 1.2.5. Market Position The market position of the firm is such that the market price depicts a fluctuating year on year trend with a drastic decrease in 2011. Comparing this to the Industry Averages also reveals that the company has a much lower market price in 2011 than the Industry Averages. This depicts that the perception of the company in the market in terms of profitability is negatively impacting the market position of the firm. 1.3. Martin Manufacturing: Financial Position Summary Through the ratio and financial position analysis conducted for Martin Manufacturing, it has been observed that the firm is facing some major issues. The over all profitability of the business is suffering. This is due to the lack of proper management of receivables as indicated by the unfavorable inventory and receivables position thus increasing its operating risk. Similarly the firm has also significantly increased its gearing taking on more borrowing to finance its activities. This has negatively effected the profitability position of the company putting it at a financial risk. This has resulted in the changing perception of the market and shareholders in the market relative to the future profitability of the firm, which is perceived as uncertain and is reflected in the decreasing market position for the firm in 2011. 2. Debt Ratio Discussion The debt ratio 1 that is used in the book is a ratio of total liabilities over total assets or represented as: Debt Ratio 1= Total Liabilities / Total Assets This ratio indicates the coverage of the total liabilities by the total assets. Using this ratio a firm can determine how well the assets of the company are able to spread over and sustain the liabilities of the company. In short it is an indicator of financial risk for a firm and is applied when the firm wants to determine what portions of the assets of the company are being financed by the debt. Debt Ratio 2= Short Term Debt + Long term Debt / Total Equity This is also a measure of financial risk for the firm and indicates what portion of the equity of the firm is being financed by the debt undertaken by the firm. It is a rough measure of gearing for the a firm and is used when the firms want to know their financial position relative to how much of the liabilities of the firm are effecting the financial position of the company. Debt Ratio 3= Long term Debt / Total Equity While this measure is also a metric used for determining the financial position and the financial risk for the firm, it is a more accurate ratio for determining the gearing for the company. This ratio shows what portion of the equity is being financed by borrowing therefore. This ratio is used when the firm wants to evaluate the financial leverage for the firm. 3. Comparison with All Ordinaries 15.75 2010 From the historical data available on the All Ordinaries, it was determined that in 2010, the average Price/Earnings ratio for the All Ordinaries stood at approximately 15.75. As it is one of the market indicators, the Price Earning for All Ordinaries depicts can be employed to determine the favorable and unfavorable position of the market and economy. The increasing trend in the Price Earning, with a relatively stable Price Earning reported between 15 and 16, shows that there is growth taking place in the market however at a slow rate. When this is compared with the Price Earnings for Martin Manufacturing it depicts that the firm is experiencing very fluctuating Price Earnings. The PE for All ordinaries increased from 2009 to 2010 to 15.75 and decreased slightly from 2010 to 2011 to arrive at 15.5. This change in the market is reflected in the PE for the firm with its increasing PE from 2009 to 2010 which goes on to decrease to 34.48 in 2011. However the change in the firms PE is more drastic and comparing with the Industry Averages for the period in an unfavorable position. Part B: 1. Problem 5-37: Portfolio Return and Beta 1.1. Portfolio Beta Based on Original Cost ΒP = (0.2*0.8) + (0.35*0.95) + (0.3*1.5) + (0.15*1.25) = 1.13 1.2. Percentage Return of Each Asset in the Portfolio KA = ((20,000 – 20,000) + 1,600) / 20,000 = 8% KB = ((36,000 – 35,000) + 1,400) / 35,000 = 6.86% KC = ((34,500 – 30,000) + 0) / 30,000 = 15% KD = ((16,500 – 15,000) + 375) / 15,000 = 12.5% 1.3. Percentage Return of Portfolio Based on Original Cost, & Income Gains KP = ((107,000 – 100,000) + 3,375) / 100,000 = 10.36% 1.4. Expected Rate of Share Return Based on Beta, Market Expectation and Risk Free Return KA = 0.04 + (0.8*(0.10-0.04)) = 0.088 = 8.8% KB = 0.04 + (0.95*(0.10-0.04)) = 0.097 = 9.7% KC = 0.04 + (1.5*(0.10-0.04)) = 0.130 = 13.0% KD = 0.04 + (1.25*(0.10-0.04)) = 0.115 = 11.5% 1.5. Discussion of Portfolio Performance The Expected Return as per CAPM is at 15%, and amongst the investments analyzed Investment C reported an Expected Return of more than 15%. The rest of the investments reported Expected Return which fell below that of the CAPM. The reasons for this performance of the portfolio can be attributed to the unsystematic factor or even changes in the firm that may have changed the beta over the time period. Aside from this lack of complete information available for analysis could be leading to this performance as well. Part C: 1. Case: Suez Manufacturing 1.1. Current Value of Suez Manufacturing Bonds The current value of the bond can be found as: PV = Par * CR *(PIVFARRR, N) + Par *(PIVFRRR, N) Therefore current value of bond is: PV= $1000*0.09*(PIVFA8%, 18) + $1000*(PIVF8%, 18) = $1093.67 1.2. Current Value of Suez Manufacturing Shares G is determined with the Gordon growth formula as GSTOCK Dividend = ((DIVIDENDn / DIVIDEND0)^1/n) - 1 G = ($1.9/$1.3)^0.25 - 1 = 0.0995 = 10% VALUESTOCK = DIVIDENDn * (1+ gSTOCK Dividend)) / (RRRSTOCK - gSTOCK Dividend) Therefore the value of the stock is: D1 / (K – G) = (1.9*(1.10))/ (0.14-0.10) = $52.25 1.3. Bonds with Risky Investment The current value of bond under risky investment is: PV= $1000*0.09*(PIVFA10%, 18) + $1000*(PIVF10%, 18) = $918.03 This depicts that if the firm undertakes the risky investment, the value of the bond will decrease today from $1093.67 to $918.03. 1.4. Shares with Risky Investment Under the risky investment value of the stock is: D1 / (K – G) = (1.9*(1.13))/ (0.16-0.13) = $71.67 This is due to the increase in the growth rate under the risky condition which has a positive effect on the overall stock value. 1.5. Discussion of Results under Risky Condition By determining the value of the common stock, it was observed that under the proposed risky project, the stock value increases from $52.25 to $71.67. This is due the high rate of growth realized due to the higher risk undertaken, which appreciated the value of the overall stock. Therefore it is recommended that Suez Manufacturing should undertake the risky project. 1.6. Reworked Results for Change in Annual Dividend of 2007-2011 The annual dividends with the proposed changes as highlighted are listed as D1 = $2.15 D2 = $2.15 * (1.13) = $2.43 D3 = $2.43 * (1.13) = $2.75 D4 = $2.75 * (1.10) = $3.11 Therefore: Pn = D4 / (K - G) = $3.11 / (0.16-0.10) = $51.83 Therefore computing the cash flows and using PVIF it can be seen that PV = (2.75 + 51.83) * 0.641 = $38.65. This indicates that when the risky project is undertaken using this scenario; the project becomes unfavorable as reflected by the decrease in the stock value from $52.25 to $38.65. Read More