Foundations of Financial Management, 14e, Block, Hirt and Danielsen. Page 150.
a. Analyze Ryan Boot Company, using ratio analysis. Compute the ratios on the bottom of the next page for Ryan and compare them to the industry data that is given. Discuss the weak points, strong points, and what you think should be done to improve the company's performance.
b. In your analysis, calculate the overall break-even point in sales dollars and teh cash break-even point. Also compute the degree of operating leverage, degree of financial leverage, and degree of combined leverage.
c. Use the information in parts a and b to discuss teh risk associated with this company. Given the risk, decide whether a bank should loan funds to Ryan Boot. Ryan Boot Company is trying to plan the funds needed for 2011. The management anticipates an increase in sales of 20 percent, which can be absorbed without increasing fixed assets.
d. What would be Ryan's needs for external funds based on the current balance sheet? Compute RNF (required new funds). Notes payable (current) and bonds are not part of the liability calculation.
Ryan Boot Company Balance Sheet December 31, 2010
Marketable Securities $80,000
Accounts Receivable $3,000,000 Inventory $1,000,000 Gross Plant & Equipment $6,000,000 Less: Accumulated Depreciation $2,000,000 Total Assets $8,130,000 Liabilities & Stockholders' Equity Accounts Payable $2,200,000 Accrued Expenses $150,000 Notes Payable $400,000 Bonds (10%) $2,500,000 Common Stock (1.7 million shares, par value $1) $1,700,000 Retained Earnings $1,180,000 Total Liabilities & SE $8,130,000 Income Statement Sales (credit) $7,000,000 Fixed Costs* $2,100,000 Variable Costs (0.60) $4,200,000 EBIT $700,000 Less: Interest $250,000 EBT $450,000 Less: Taxes @35% $157,500 EAT $292,500 Dividends (40% Payout) $117,000 Increased Retained Earnings $175,500
*Fixed costs include (a) lease expense of $200,000 and (b) depreciation of $500,000. Note Ryan Boots also has $650,000 per year in sinking fund obligations associated with its bond issue.
The sinking fund represents an annual repayment of the principal amount of the bond. It is not tax-deductable.
Ratios that need to be calculated for Ryan Boot Company. The ratios shown are for the industry. Profit Margin 5.75% Return on Assets 6.90% Return on Equity 9.20% Receivables Turnover 4.35 Inventory Turnover 6.50 Fixed Assets Turnover 1.85 Total Assets Turnover 1.20 Current Ratio 1.45 Quick Ratio 1.10 Debt to Total Assets 25.05% Interest Coverage 5.35 Fixed Charge Coverage 4.62
Page 363. Garner Data Systems is a very large company with common stock listed on the New York Stock Exchange and bonds traded over-the-counter. As of the current balance sheet, it has three bond issues outstanding: $50 million of 9% series, expiration 2019. $100 million of 6% series, expiration 2016. $150 million of 4% series, expiration 2013. The vice-president of finance is planning to sell $150 million of bonds to replace the debt due to expire in 2013. At present, market yields on similar Baa bonds are 11.2 percent. Garner also has $60 million of 6.9 percent noncallable preferred stock outstanding, and it has no intentions of selling any preferred stock at any time in the future. The preferred stock is currently priced at $68 per share, and its dividend per share is $6.30. The company has had very volatile earnings, but its dividends per share have had a very stable growth rate of 8.5 percent and this will continue. The expected (D1) is $2.10 per share, and the common stock is selling for $60 per share. The company's investment banker has quoted the following flotation costs to Garner: $1.80 per share for preferred stock and $3 per share for common stock. On the advice of its investment banker, Garner has kept its debt at 50 percent of assets and its equity at 50 percent. Garner sees no need to sell either common or preferred stock in the foreseeable future as it has generated enough internal funds for its investment needs when these funds are combined with debt financing. Garner's corporate tax rate is 35 percent.
Compute the cost of capital for the following:
a. Bond (debt) (Kd). b. Preferred stock (Kp). c. Common equity in the form of retained earnings (Ke). d. New common stock (K pie). e. Weighted average cost of capital.