Question

Question 6

The Territory Holiday Extravaganza Company Ltd had a bad year in 2016 when it suffered a net loss. Some of the measures of return deteriorated due to the loss. The management of the company are wondering how they can improve their ratios for the following year to keep their jobs and the banks and the shareholders happy. They have come up with the following ideas. 1 Borrow $100 million on long-term debt. 2 Buy back shares for $500 million cash. 3 Expense one-quarter of the goodwill carried on the books. 4 Create a new holiday planning division at a cash cost of $300 million. 5 Purchase a new travel app from “Where do we holiday now?” Ltd, paying $20 million cash.

Requirement Write a short report to the management showing whether the ideas that they have suggested will cause the current ratio, the debt ratio and the rate of return on ordinary shareholders' equity to either increase, decrease or have no effect, giving your reasons for your decision.

Current ratio = current assets / current liabilities, Debt ratio = total liabilities / total assets Rate of return on ordinary shareholders' equity = net income / ordinary shareholders' equity

Answer 1

Yes this may help to improve the position to keep their Jobs, Banks and Sharedholders happy. They are borrowing $100 Million for long term, reducing the liability by $500 Million doing buy back, depleting the non cash asset which will not impact the profit in cash, creating new holiday package by expensing $300 Million along with purchase of $20 Million in cash. So as per the Ratios mentioned in questions it will generate favorable results, so in isolation we can assume it will improve the indicators