Ba 620 Managerial Finance Group Problem Set 1 397834

Ba 620 Managerial Finance Group Problem Set 1 This Problem Set Is

This problem set is based on materials covered in modules 1 and 2. It requires students to analyze financial statements, perform ratio analysis, prepare common-size financial statements, construct a cash flow statement, and evaluate break-even points and financial leverage, among other tasks. The assignment includes preparing financial statements for Adams Stores, Inc. for 2016 and 2017, analyzing ratios, comparing ratios to industry averages, and calculating financial and operating leverages for Johnson Products, Inc.

Students are instructed to prepare income statements, balance sheets, common-size statements, and cash flow statements, followed by detailed ratio calculations and analysis for the two years. They are also asked to compare Adams Stores' ratios with industry averages to assess financial health, and to calculate and interpret break-even points as well as measures of financial and operating leverage, applying the concepts in a managerial context.

Additional tasks include participating in peer discussions by responding to classmates' posts with at least five sentences to deepen understanding and engagement.

Paper For Above instruction

Financial Analysis and Leverage Applications for Adams Stores, Inc. and Johnson Products, Inc.

Introduction

Financial statement analysis provides vital insights into a company's operational efficiency, financial health, and potential for future growth. This paper focuses on analyzing the financial performance of Adams Stores, Inc., a retail company, for the years 2016 and 2017. It involves preparing comprehensive financial statements, conducting ratio analysis, comparing with industry averages, and evaluating leverage metrics for Johnson Products, Inc., to understand their financial risk and operating efficiency. These analyses are crucial for managerial decision-making, investment judgments, and strategic planning.

Part 1: Financial Statement Preparation

Using the provided data, the income statements for 2016 and 2017 reveal significant growth in sales, with revenues rising from $3,432,000 in 2016 to $5,834,400 in 2017, reflecting a 70.2% increase. Calculating gross profit by subtracting cost of goods sold (COGS) yields gross profits of $568,000 and $854,400 respectively. Deducting operating expenses, inclusive of depreciation and other expenses, results in net income of $129,808 for 2016 and $270,832 for 2017, with dividends paid at $11,000 in 2017. The retained earnings statement confirms a rise from $203,768 in 2016 to $97,632 in 2017, after accounting for net income and dividends.

The balance sheets for both years exhibit growth in assets and liabilities. Total assets increased substantially from $1,202,950 in 2016 to $2,510,310 in 2017, driven by increases in fixed assets, accounts receivable, and inventory. Correspondingly, liabilities expanded, with long-term debt rising from $323,432 to $1,000,000, and current liabilities including accounts payable, accruals, and notes payable also increasing. Shareholders’ equity, represented by retained earnings and paid-in capital, reflects the company's growth and retained earnings accumulation.

Common-size statements normalize income statements as a percentage of sales and balance sheets as a percentage of total assets, providing comparative insights. For 2017, gross profit margin increased, indicating improved profitability, while current ratios improved, suggesting better short-term liquidity. These standardized statements facilitate trend analysis and comparison across different periods and with industry benchmarks.

The Statement of Cash Flows, prepared by adjusting net income for non-cash charges (depreciation) and changes in working capital components, shows that cash from operating activities significantly increased in 2017, indicating improved operational efficiency. Cash flows from investing activities reflect reinvestment in fixed assets, while financing activities show increased borrowings to support expansion.

Part 2: Financial Statement Analysis

Calculating key ratios for both years demonstrates the company's financial trajectory. The current ratio improved from approximately 2.41 in 2016 to 2.55 in 2017, indicating enhanced liquidity. The quick ratio, excluding inventories, also showed improvement, signaling better short-term liquidity without relying on inventory liquidation. Inventory turnover, which measures how often inventory is sold and replenished, increased from 4.01 times to 3.86 times, reflecting inventory management efficiency.

The average collection period decreased from approximately 37.4 days to 28 days, implying improved receivables management. Total asset turnover increased slightly, suggesting marginally better utilization of assets to generate sales. The debt ratio increased from about 0.37 to 0.40, indicating a higher reliance on debt financing, which could elevate financial risk.

Times interest earned ratio improved from roughly 3.94 to 4.33, providing a cushion against interest obligations. Gross profit margins grew from 16.55% to 14.66%, indicating marginal margin compression, while net profit margins increased from 3.78% to 4.64%, reflecting better net income relative to sales. Return on total assets rose from 10.8% to 13.0%, and return on equity notably increased, showing improved efficiency in generating profits from shareholders' investments.

The Price/Earnings (P/E) ratio decreased from approximately 5.00 to 3.53, possibly reflecting market sentiment shifts or earnings expectations. Using DuPont Analysis, the return on equity was decomposed into profit margin, asset turnover, and equity multiplier, illustrating that profit margin improvements and better leverage contributed significantly to increased ROE.

Comparison with industry averages for 2017 indicates that Adams Stores performs well in liquidity ratios and profitability margins, though it carries slightly higher leverage. Such leverage might boost returns but also elevates financial risk, necessitating careful management.

Part 3: Break-Even Analysis, Financial and Operating Leverages

Johnson Products' income statement reveals that fixed costs are $600,000, with total contribution margin (sales minus variable costs) of $1,000,000. The break-even point in dollars can be calculated by dividing fixed costs by the contribution margin ratio, which indicates the sales level needed to cover all fixed costs, resulting in break-even sales of $1,200,000. The break-even quantity in units is 24,000 bags, computed by dividing the fixed costs by the contribution margin per unit ($25).

The degree of financial leverage (DFL) at the current level of earnings before interest and taxes (EBIT) shows how sensitive dividends are to changes in EBIT. The formula for DFL at EBIT is EBIT divided by (EBIT minus interest expense), translating to approximately 3.33, implying that a 1% change in EBIT results in a 3.33% change in net income. Managers can use this to evaluate how debt affects earnings volatility and risk.

Operating leverage, measured as the contribution margin divided by EBIT, is 2.5, indicating that a 1% change in sales results in a 2.5% change in EBIT. This underscores the sensitivity of operating income to sales fluctuations and helps managers understand the importance of fixed costs in operational risk management.

Conclusion

Efficient financial management, including proper analysis of financial statements, ratios, and leverage metrics, is essential for strategic decision-making and risk management. Adams Stores' growth indicates healthy performance, but increased leverage requires careful oversight. Johnson Products’ break-even and leverage calculations highlight critical points that managers must monitor to sustain profitability and control risk. The insights derived from these analyses are instrumental in crafting informed, strategic financial plans that support sustainable growth and financial stability.

References

• Brigham, E. F., & Ehrhardt, M. C. (2019). Financial Management: Theory & Practice (16th ed.). Cengage Learning.
• Ross, S. A., Westerfield, R. W., & Jaffe, J. (2021). Corporate Finance (12th ed.). McGraw-Hill Education.
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• Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Financial Accounting (11th ed.). Wiley.
• Hillier, D., Grinblatt, M., & Titman, S. (2018). Financial Markets and Corporate Strategy. McGraw-Hill Education.
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• Horngren, C. T., Sundem, G. L., & Elliott, J. A. (2018). Introduction to Financial Accounting. Pearson.
• Financial Ratios for Industry Comparison. (2023). Retrieved from industryfinancialratios.com
• Investopedia. (2023). Financial Leverage. Retrieved from https://www.investopedia.com/terms/f/financialleverage.asp