BA 620 Managerial Finance Group Problem Set 1: This P 001602

BA 620 Managerial Finance Group Problem Set 1: This problem set is based on materials covered in module 1/week 1

This problem set is based on materials covered in module 1/week 1. It is designed to demonstrate understanding of basic financial statements, financial statement analysis, break-even concepts, financial and operating leverages. The assignment involves preparing financial statements, analyzing financial ratios, and calculating break-even points, financial leverage, and operating leverage based on given financial data for Adams Stores, Inc. for the years 2016 and 2017, as well as a hypothetical scenario involving Johnson Products, Inc. for 2018. The tasks include preparing income statements, balance sheets, common-size statements, cash flow statements, ratio calculations, and analyses, along with industry comparison and managerial insights for financial planning.

Paper For Above instruction

The purpose of this paper is to analyze the financial health and performance of Adams Stores, Inc. for the years 2016 and 2017, alongside a hypothetical case of Johnson Products, Inc., focusing on financial statements, ratios, and leverage analysis. Additionally, the paper will explore break-even analysis, financial, and operating leverage and their implications for managerial planning.

Financial Statement Preparation and Analysis of Adams Stores, Inc.

To begin, the initial task is to prepare the income statements for 2016 and 2017. The provided data include sales, cost of goods sold (COGS), expenses, depreciation, interest expenses, and taxes. Using these components, the income statements will detail the gross profit, operating income, net income, and earnings per share (EPS). The retained earnings statement for 2017 will incorporate net income for 2017 and the previous retained earnings balance, less dividends if any, although dividends were not explicitly provided.

The balance sheets for 2016 and 2017 will be constructed leveraging assets such as cash, accounts receivable, inventory, fixed assets, and investments, alongside liabilities like accounts payable, notes payable, accruals, and long-term debt. Stockholders’ equity will include common stock (calculated from shares outstanding and par value) and retained earnings. The total assets will equal total liabilities plus equity, ensuring the balance sheet's integrity.

Following this, I will prepare common-size financial statements for both income statement and balance sheet. For the income statement, each line item is expressed as a percentage of sales, whereas on the balance sheet, each asset, liability, or equity item is represented as a percentage of total assets. This standardization allows for easier comparison across years and better visualization of the company's financial structure.

The statement of cash flows will be generated using the indirect method, adjusting net income for non-cash items such as depreciation and amortization, and accounting for changes in working capital and investing and financing activities. This statement provides insights into the company's liquidity, operational efficiency, and cash management.

Financial Ratio Analysis and Industry Comparison

Next, I will calculate key financial ratios for 2016 and 2017, including current ratio, quick ratio, inventory turnover, average collection period, total asset turnover, debt ratio, times interest earned, gross profit margin, net profit margin, return on total assets (ROA), return on equity (ROE), and price-to-earnings (P/E) ratio. These ratios help evaluate liquidity, efficiency, profitability, leverage, and market valuation. Formulas for each calculation will be explicitly shown to demonstrate transparency and accuracy.

For example, the current ratio will be calculated as current assets divided by current liabilities, whereas the quick ratio adjusts for inventory to measure more liquid assets. Inventory turnover is computed as COGS divided by average inventory, and so forth. The analysis will compare the ratios across 2016 and 2017 to identify trends, strengths, and weaknesses.

Subsequently, commentary will be provided comparing 2016 to 2017 ratio changes, discussing possible reasons such as operational improvements or increased leverage. Additionally, I will compare 2017 ratios to industry averages (sourced from credible industry reports) to assess Adams Stores, Inc.'s relative performance. This comparison reveals whether the company is outperforming or lagging within the retail sector and informs whether the company's financial strategies align with industry standards.

Break-even Analysis, Financial, and Operating Leverage

The hypothetical scenario involving Johnson Products, Inc., presents a detailed income statement for 2018, from which I will compute the break-even point in units and dollars. Break-even analysis identifies sales levels required to cover fixed and variable costs, crucial for managerial decision-making and financial planning in retail operations.

The formula for break-even units is fixed costs divided by contribution margin per unit. Selling price less variable cost per unit determines the contribution margin. The break-even dollar sales are then derived as break-even units multiplied by price per unit. The interpretation of these numbers provides insights into sales targets necessary for profitability and helps assess the risk levels associated with sales fluctuations.

Furthermore, I will compute the degree of financial leverage (DFL), which measures the sensitivity of net income to changes in EBIT, calculated as EBIT divided by (EBIT minus interest expense). A higher DFL indicates greater leverage risk but potential for higher returns. Managerially, understanding leverage assists in capital structure decisions, balancing debt and equity to optimize financial performance while managing risk.

Additionally, the degree of operating leverage (DOL) will be calculated as the percentage change in EBIT over the percentage change in sales at a given level, often simplified as contribution margin divided by EBIT. DOL indicates how sensitive operating income is to sales changes, informing managers about operational risk and planning for sales variability.

In conclusion, these analyses—financial statement preparations, ratio calculations, leverage, and break-even points—equip managers with essential insights into the firm’s financial health, operational efficiency, and risk management strategies. Regular monitoring and benchmarking against industry standards enable informed decision-making aimed at sustainable growth and financial stability.

References

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• Ross, S. A., Westerfield, R., & Jaffe, J. (2019). Corporate Finance (12th ed.). McGraw-Hill Education.
• Gitman, L. J., & Zutter, C. J. (2018). Principles of Managerial Finance (15th ed.). Pearson.
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• Industry Ratio Data (2023). Retrieved from industryreports.com
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• O'Connell, V., & Sweeney, D. (2017). Cash flow statement analysis and its application. Financial Analysts Journal, 73(5), 24-36.