Question

# QUESTION 4 (25 marks) Diversified Industries is a large conglomerate that is continually in the market...

• Current ratio =Current Assets/Current Liabilities
• = 324120/162300 = 1.99 (2014)
• = 215180/126250 =1.70 (2013)
 2014 2013 Current ratio 1.99 1.70 inventory 135,850 96,780 Receivables 128,420 84,120 Working capital 168820 52930
• Inventory turnover =Cost of inventory/Average inventory
• =542750/ [(13850+96780)/2]
• =9.8
• Days of inventory holding =360/ inventory turnover = 360/9.8=36.7
• The working capital has nearly doubled over the two-year period. The current ratio for 2014 is 1.99 and for 2013 to 1.7
• One area of concern is the large increase in both receivables and inventories from the prior year. The 2014 average collection period is days and the 2014 average number of days’ sales in inventory is days
• 2)
• Debt/Equity ratio (2014) =Total debt/net worth = (162,300+275,000)/532,710 = 0.82
• Debt/Equity ratio (2013) =Total debt/net worth = (126,250+275,000)/519,820=0.77
• Debt to equity ratio increased has increased from 2013 to 2014
• Interest Coverage ratio = EBIT/interest charges
• (Net earnings before extraordinary item +all income tax + interest charges)/ interest charges
• = (\$23,140 + 9,250 +45,000)/ 45,000 =1.7
• The debt-to-equity ratio has increased slightly nearly from the prior year. The times interest covered is 1.7 times. The company is carrying a heavy debt burden even though the bonds are not due until 2021.

3.

Let us analyse the brief income statement of Heavy Duty Tractors Inc. to assess the financial performance of the company:

 Heavy Duty Tractors Inc. Particulars Amount (\$) Revenue from sales 875250 Less: Cost of goods sold 542750 Gross Profit 332500 Earnings before interest and tax 77140 Less: Interest 45000 Earnings before tax (EBT) 32140
 Earnings before tax (EBT) 32140 Less: Tax 9250 Net income 22890

As can be seen from the above table that the company has earned significant amount of gross profit in the latest accounting period ending on December 31, 2017. However, compare to gross profit of \$332,500 the company has merely earned a net income of \$22,890.

Profitability ratios:

The profitability ratios of the company will help us to assess the profitability of the company strategically. Let us analyse the ability of the company to generate profit from its business activities.

 Gross profit ratio (All ratios are in %) Revenue from sales 875250 Gross Profit 332500 Gross profit ratio 37.98915 EBIT ratio Revenue from sales 875250 Earnings before interest and tax 77140 EBIT ratio 8.813482 EBT ratio Revenue from sales 875250 Earnings before tax (EBT) 32140 EBT ratio 3.672094 Net income ratio Revenue from sales 875250 Net income 22890 Net income ratio 2.615253

The gross profit of ratio of 37.99%, i.e. almost 38% suggests that the company has earned a gross profit of \$38 for sale of each \$100. Thus, the company has been quite successful in managing its core business operations and in generating revenue from its core business operations. However, the company has suffered very badly with its EBIT and EBT of 8.81% and 3.67% respectively. In-fact the net profit ratio of the company is quite low at 2.61%. Thus, the company though demonstrate ability to be a profitable member of the diversified family however, the management of the company must take necessary steps to improve its profitability in the future.

4.

We recommed to the BOD to bid for Heay Duty Tractors.

We take this decision based on the following.

There are two stage of decisions to know whether to acquire the business or not:-

1) Financial condition

2) Non-financial condition

1) Financial condition of business can be checked using various ratios. Ratios can be financial ratio, liquidity ratio, profitability ratio. Ratio analysis for 12/31/2017 ios as follows:-

a) Current Ratio

- This ratio helps to know whether the company has enough assets with the to pay of the liabilities. The higher the ratio, more strong the company is.

- Current Asset/Current liabilities

= 324120/162300

= 1.99 times.

b) Debt to equity ratio:-

This ratio helps to know that how much external parties contribute to assets relative to owmers. The lower the ratio, more the stake of owners in the assets.

= Total debt/Total Equity

= Current Liab + Non current liab / Total Equity

= 437300/532710

= 0.82 times

c) Return on equity ratio:-

This is overall measure of rate of return on investment

= Net income/Total Equity * 100

= 22890/350000*100

= 6.54%

d) Cash ratio:-

Cash ratio is used to know whether company has enough financial stability to pay out the liabilities.

= Cash and cash equivlents/Current liability

= 48500 + 3750 / 162300

= 0.3219 times.

So, company can payout 0.32 % of liabilities without relying on accounts recaivable and inventory.

Based on the above analysis, it looks that the comapny is sound in its financial aspects. Based on these, we recommend to acquire the new company.

However, apart from the financial aspects, certain non-financial aspects also needs to be seen.

They can be buying capacity of the company, goodwill of the company, market where the company is operating, integrity of the management, its suppliers, customers etc.