Business 5200 Homework Assignment For Week 4

Busn 5200homework Assignment For Week 4for Week 4 Please Complete Th

Please complete the ratio analysis for Joe’s Fly-By-Night Oil Company for the fiscal year ended December 31, 2012, based on the provided financial statements. Organize your analysis into the following sections: (1) Liquidity - including current ratio and quick ratio with comments on liquidity; (2) Asset management - including total asset turnover and average collection period with comments; (3) Debt management - including debt ratio and times interest earned, with comments; (4) Profitability - including net profit margin, return on assets, return on equity, and an extended Du Pont analysis, with your insights on the sources of ROE; (5) Market value ratios - including PE ratio and market-to-book ratio with comments. Assume the stock price on Dec 31, 2012 is $50.00, with 1,000 shares outstanding.

Paper For Above instruction

Financial ratio analysis serves as a crucial tool for evaluating a company's operational efficiency, financial health, and market prospects. In the case of Joe’s Fly-By-Night Oil Company, an in-depth ratio analysis based on the 2012 financial statements provides insight into its liquidity, asset management, debt management, profitability, and market valuation.

Liquidity Analysis

Liquidity ratios measure a company's ability to meet its short-term obligations. The current ratio, calculated as current assets divided by current liabilities, for Joe’s Fly-By-Night Oil is 1.47 ($25,000 / $17,000). This ratio suggests that the company has $1.47 in current assets for every dollar of current liabilities, indicating adequate short-term financial health. Generally, a current ratio above 1.0 is viewed as acceptable, but too high a ratio might imply inefficient use of assets.

The quick ratio, or acid-test ratio, refines this view by excluding inventory and other less liquid current assets. It is calculated as (cash + accounts receivable) divided by current liabilities. Here, it equals ($5,000 + $3,000) / $17,000 = 0.47. This indicates that less than half of the current liabilities could be immediately covered with highly liquid assets, revealing some liquidity constraints, particularly given the company's substantial inventory holdings. While the company appears solvent, its quick ratio suggests reliance on inventory liquidation for short-term liabilities.

Overall, the liquidity position shows a moderate capacity to meet short-term obligations, with room for improvement in quick assets to reinforce liquidity.

Asset Management

Asset management ratios evaluate how effectively a company utilizes its assets to generate sales. The total asset turnover ratio measures sales generated per dollar of assets. It is calculated as sales divided by total assets: $10,000 / $40,000 = 0.25. This implies that the company generates a quarter of its sales for each dollar invested in assets, which is typical for a capital-intensive industry like oil and energy.

The average collection period (ACP) assesses the efficiency of receivables collection. Calculated as (accounts receivable / sales) × 365, results in (3,000 / 10,000) × 365 ≈ 109.5 days. This indicates that, on average, it takes about 110 days to collect receivables. Such a lengthy collection period may suggest lenient credit terms or collection inefficiencies, which could impact cash flow management.

In summary, while asset turnover appears standard for the sector, the extended collection period signals potential areas for process improvements to enhance cash flows and reduce credit risk.

Debt Management

Debt management ratios assess the company's leverage and interest coverage. The debt ratio, calculated as total liabilities divided by total assets, is $20,000 / $40,000 = 0.50 or 50%. This indicates half of the company's assets are financed through debt, reflecting a balanced leverage position.

Times interest earned (TIE) ratio evaluates the company's ability to service its interest obligations. It is calculated as EBIT ($3,000) / interest expense ($200) = 15.0. A TIE of 15 signifies a comfortable cushion over interest obligations, suggesting strong coverage and manageable debt levels.

These ratios demonstrate that Joe’s Fly-By-Night Oil maintains a moderate debt level with ample earnings to cover interest expenses, aligning with prudent debt management practices.

Profitability Analysis

Profitability ratios reveal the firm's ability to generate profit from sales and assets. The net profit margin, computed as net income divided by sales, is $1,800 / $10,000 = 0.18 or 18%. This reflects a healthy profit relative to sales.

Return on Assets (ROA), analyzing how efficiently assets generate earnings, is net income ($1,800) / total assets ($40,000) = 4.5%.

Return on Equity (ROE), indicating the return generated on shareholders' investments, is net income ($1,800) / equity ($20,000) = 9%.

The extended Du Pont analysis decomposes ROE into profitability, asset efficiency, and leverage: ROE = (Net profit margin) × (Asset turnover) × (Equity multiplier). Calculating the equity multiplier as total assets / equity = 2, the Du Pont formula yields: 0.18 × 0.25 × 2 = 0.09 or 9%, consistent with the direct ROE calculation.

This analysis shows that the company's ROE is primarily driven by profitability and leverage. Although the profit margin is robust, the relatively low ROA suggests room for operational improvements to generate higher returns.

Market Value Ratios

The Price-to-Earnings (PE) ratio is computed as market price per share divided by earnings per share (EPS). EPS is $1.80, and the stock price is $50.00, so PE ratio = $50.00 / $1.80 ≈ 27.78. A PE ratio of approximately 28 indicates investors’ expectations of future growth and profitability.

The Market-to-Book ratio compares the market value to the book value of equity: ($50.00 × 1,000 shares) / $20,000 equals ($50,000 / $20,000) = 2.5. This ratio suggests the market values the company at 2.5 times its book value, reflecting favorable growth prospects or intangible assets not captured on the balance sheet.

The market value ratios indicate that investors have a positive outlook on Joe’s Fly-By-Night Oil, with the PE ratio suggesting expectations of future profit growth, and the market-to-book ratio showing substantial premium over book value.

Conclusion

In sum, Joe’s Fly-By-Night Oil exhibits a balanced financial profile with adequate liquidity, effective asset utilization, manageable leverage, and strong market valuation. The liquidity constraints reflected in quick ratios might require strategic attention to enhance immediate solvency. Operational efficiencies could be improved to increase asset turnover and cash flows, while the market’s high valuation indicates investor confidence. Overall, these ratios provide valuable insights for stakeholders aiming to evaluate financial stability and growth potential, and they serve as a foundation for strategic planning and decision-making.

References

  • Brigham, E. F., & Ehrhardt, M. C. (2016). Financial Management: Theory & Practice (15th ed.). Cengage Learning.
  • Gibson, C. H. (2013). Financial Reporting & Analysis (13th ed.). South-Western College Pub.
  • Penman, S. H. (2012). Financial Statement Analysis and Security Valuation. McGraw-Hill Education.
  • Ross, S. A., Westerfield, R., & Jaffe, J. (2016). Corporate Finance (11th ed.). McGraw-Hill Education.
  • U.S. Securities and Exchange Commission. (2023). Financial Reports & Filings. https://www.sec.gov/edgar.shtml
  • Office of Personnel Management. (2023). About OPM. https://www.opm.gov/about-us/
  • Federal Reserve. (2023). Economic Data & Analysis. https://www.federalreserve.gov/
  • Investopedia. (2023). Financial Ratios. https://www.investopedia.com/terms/f/financialratio.asp
  • Yahoo Finance. (2023). Stock Data. https://finance.yahoo.com/
  • Company Annual Report 2012, Joe’s Fly-By-Night Oil Company.

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