Question

Green Penguin did not issue new shares during these three years and has faced some operational difficulties. The company has thus piloted some new forecasting strategies to improve its operations management. You have collected the relevant data, made reasonable assumptions based on the information available, and calculated the following ratios. Ratios Calculated

Year 1 Year 2 Year 3

Price to cash flow 4.60 5.98 6.70

Inventory turnover 9.20 11.04 12.37

Debt to equity 0.60 0.64 0.77

Based on the preceding information, your calculations, and your assumptions, which of the following statements can be included in your analysis report? Check all that apply.

(a)A plausible reason why Green Penguin’s price-to-cash-flow ratio has decreased is that investors expect lower cash flow per share in the future.

(b)A decline in the inventory turnover ratio can be explained by the new inventory management system that the company recently adopted, which led to more efficient inventory management.

(c)A decline in the debt-to-equity ratio implies a decline in the creditworthiness of the firm.

(d)A decline in the inventory turnover ratio could likely be explained by operational difficulties that the company faced, which led to duplicate orders placed to vendors.

Answer 1

Option a is right. Lower expectation of cash flows will lower the price of the shares. Price to cash flow is computed as Market cap/ operating cash flow. Since the share price and hence market cap is lowered, the Price to cash flow ratio will also decline.

Option b is wrong. Lower inventory turnover implies less efficiency in management of assets duet o which the inventory is not being rotated faster.

Option cis incorrect. Lower debt/equity means higher equity as compared to debt. This will mean higher creditworthiness.

Option d is right. Issues with inventory management system which created duplicate orders will result in a higher amount of inventory. This will result in a decline in inventory turnover.