Business 2019, Fall 2003 Assignment 2 Due Friday, October 17, 2003 Can be done in groups of at most FOUR 1. Ratio Analysis Using the 2002 audited financial statements for Sleeman Breweries Ltd and Unibroue, Inc., that you can find at www.sedar.com, answer the following questions. (a) (5 points) For each of the two companies, calculate operating cash flow as seen in class, i.e. OCF = EBIT + Depreciation Current Taxes. Can you directly compare the two figures obtained? Why? By what value would you divide each firm s OCF in order to make them Comparable? Explain. Using these ratios, what can you say about Unibroue and Sleeman? (b) (5 points) For each of the two companies, calculate cash flow from assets as seen in class, i.e. CF(A) = OCF NCS NWC. By what value would you divide each firm s CF(A) in order to make them comparable? Explain. Using these ratios, what can you say about Unibroue and Sleeman? (c) (5 points) Which ratio do you think is more important? Earnings per share or cash flow per share? Explain. 1
2. Cash Budget Kota Fibres produces nylon fiber at its only plant in Kota, India, and is preparing its cash budget for the month of September 2003 through December 2003. Expected sales from September 2003 to February 2004, as well as realized sales in July and August 2003 are depicted in Table 1 (in thousands of rupees (Rs)). For delivery and manufacturing reasons, Kota s purchases, which usually amount to 70% of sales, have to be made two months in advance and the material has to be paid in cash, i.e. Kota s actual supplier does not provide any credit at all. Collections of accounts receivables, on the other hand, are as follows: The cash from 40% of sales is collected after one month and the remaining 60% is collected after two months. Kota has a line of credit with Bank of India but no other type of debt. The interest it pays each month is computed as 1.25% Line of Credit Balance at the End of the Previous Month. Other cash expenses are as follows: Wages are 35% of the previous month purchases (there are no other salaries). That is, the production cycle is as follows: Raw material is purchased in a given month, processed by the employees in the following month and sold the month after (this could be improved, of course). Rent is Rs10,000 per month. A dividend of Rs20,000 will be paid to Kota s shareholders (mainly family members) at the end of September and at the end of December. A tax payment of Rs25,000 will be made in November. A fixed asset outlay of Rs150,000 is expected in October. In order to keep its line of credit with Bank of India, Kota must clear it before the end of December. Failure to do so would result in the termination of the line of credit, which would severly hamper Kota s activities. Kota s minimum cash balance is Rs25,000 and its line of credit balance at the end of August is Rs45,000. 2
Month Jul-03 Aug-03 Sep-03 Oct-03 Nov-03 Dec-03 Jan-04 Feb-04 Sales 210 220 440 500 380 320 220 200 Table 1: Sales expectations for Kota Fibres (in Rs000) (a) (10 points) Complete Kota s monthly cash budget from September 2003 to December 2003 using the above figures. Under the current assumptions, is Kota repaying its line of credit by the end of December? (b) (20 points) Using sensitivity analysis, compare Kota s debt at the end of December under (i) different credit arrangements with its current supplier, (ii) different credit policies with its customers, (iii) a more efficient manufacturing and delivery process (i.e. some of the raw material could be purchased one month before being sold (note that this would affect how wages are calculated)), (iv) different sales levels. (c) (10 points) Using what you found in (a) and (b) what recommendations would you make to Kota to help it repay its debt by the end of December? 3. Financial Planning Using the financial statements for Brick Enterprises in Table 2, answer the following questions. (a) (10 points) Suppose that sales in 2003 are expected be 25 percent greater than in 2002. Complete Brick s pro forma financial statements for 2003 using the following assumptions and guidelines: COGS, depreciation and all assets are a constant fraction of sales. The tax rate (40%) and dividends paid (i.e. 31) in 2003 will be as in 2002. The interest expense is equal to 8% of long-term debt. Accounts payable are a constant fraction of sales. The current ratio must be at least 2 and the total debt ratio must not exceed 0.5. 3
Note that the answer to this question is not unique. The current ratio does not have to be equal to 2 and the total debt ratio does not have to be equal to 0.5. Carefully explain each step of your solution and describe how Brick will finance its expansion. (b) (10 points) Suppose now that the firm was operating at 70% of its capacity in 2002 but it wants to operate at 80 percent of capacity in 2003. Compute Brick s pro forma statements using the assumptions in (a) for all variables other than fixed assets. Carefully explain each step of your solution and describe how Brick will finance its expansion. (c) (5 points) Under all of the assumptions in (a), i.e. when all assets increase in proportions with sales, what is the maximum growth rate Brick can achieve without raising external funds (i.e. without increasing notes payable, long-term debt and common stock)? 4
Assets Brick Enterprises Balance Sheet as of December 31, 2002 Liabilities and Owners Equity Cash 160 Accounts payable 300 Accounts receivable 440 Notes payable 100 Inventory 600 Total current liabilities 400 Total current assets 1,200 Long-term debt 800 Net fixed assets 1,800 Common stock 800 Accum. retained earnings 1,000 Total assets 3,000 Total liabilities and equity 3,000 Brick Enterprises 2002 Income Statement Sales 1,267 COGS (798) Depreciation (250) EBIT 219 Interest (64) Taxable income 155 Taxes (40%) (62) Net income 93 Dividends 31 Earnings retained 62 Table 2: Financial statements for Question 3. 5