Melinda McKay, CFA, an analyst at Integrity Equity, is considering an investment in Earthmovers Inc., whose most recent financial data is provided below.
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Earthmovers Inc.
Income Statement
Year ended Dec 31, 2006
($U.S. thousands) |
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Revenues |
20,152 |
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Gross profit |
10,022 |
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Operating income |
4,819 |
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Depreciation |
823 |
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Interest expense |
1,040 |
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Income before taxes |
2,956 |
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Taxes |
887 |
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Net Income |
2,069 |
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Earthmovers Inc.
Balance Sheet
Year ended Dec 31, 2006
($U.S. thousands) |
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Assets |
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Liabilities & Owner’s Equity |
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Cash |
600 |
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Accounts payable |
5,500 |
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Marketable Securities |
200 |
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Notes payable |
3,500 |
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Accounts Receivable |
8,500 |
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Total current liabilities |
9,000 |
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Inventories |
3,500 |
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Total current assets |
12,800 |
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Long-term debt |
13,000 |
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Net P,P&E |
17,000 |
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Preferred stock (100,000 shares) |
1,000 |
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Pension Asset |
1,500 |
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Common Stock (500,000 shares) |
2,000 |
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Intangible Assets |
1,000 |
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Retained earnings |
8,300 |
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Goodwill |
1,000 |
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Total stockholder’s equity |
11,300 |
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Total Assets |
33,300 |
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Total liabilities & Equity |
33,300 |
The footnotes to Earthmovers Inc. include the following information:
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Inventories are valued at cost under the last in, first out (LIFO) method, the LIFO reserve is $1.2 million, up $120,000 from the previous year.
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Capitalized interest for 2006 is $550,000.
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Earthmovers recently sold $400,000 worth of accounts receivable with recourse. To date only $100,000 has been collected.
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The funded status of the pension fund is a pension liability of $1,000,000.
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Due to an increase in yields on corporate debt, the market value of the long-term debt is $12.35 million.
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The preferred stock is redeemable at the option of the preferred stockholder.
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The market value of the preferred stock is $9.50.
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Management viewed the potential liability of $5 million associated with a pending lawsuit as an improbable event. There is no insurance in place to cover any potential loss.
Following the release of the financial statements, Earthmovers publicly acknowledged that the loss related to the lawsuit was a probable event and was working out a settlement for $3 million.
What is the value of the times interest earned ratio (earnings before interest, tax, depreciation and amortization (EBITDA) / interest expense) using the adjusted data?
The income statement needs the following adjustments:
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Capitalized interest should be included on the income statement. Inclusion will not affect EBITDA but will increase interest expense to 1,590,000 (1,040,000 + 550,000).
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EBITDA should be reduced by $300,000 ($400,000 ? $100,000) to $4,519,000 due to the sale of accounts receivable that are yet to be collected.
Therefore, EBITDA / interest expense is 2.8 (= 4,519,000 / 1,590,000).
What is the value of the current ratio using the adjusted data?
Current assets need the following adjustments:
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Increase accounts receivable by $300,000 for the uncollected receivables sold with recourse.
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Increase inventories by the amount of the LIFO reserve or $1.2 million to reflect first in, first out (FIFO) accounting.
Current liabilities should increase by $300,000 to reflect the “borrowing” related to the sale of the receivables.
The adjusted current ratio is 1.54 [(12,800,000 + 300,000 + 1,200,000) / (9,000,000 + 300,000)]
What is the value of the leverage ratio (liabilities / equity) using the adjusted data?
The following balance sheet adjustments are indicated in the footnotes:
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Adjustment |
Long-term Assets |
Long-term Liabilities |
Equity |
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Pre-adjustment value |
20,500,000 |
13,000,000 |
11,300,000 |
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FIFO adjustment (1) |
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1,200,000 |
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Capitalized interest (2) |
(550,000) |
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(550,000) |
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Funded status of pension fund (3) |
(1,500,000) |
1,000,000 |
(2,500,000) |
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Market value of debt (4) |
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(650,000) |
650,000 |
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Redeemable preferred stock (5) |
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950,000 |
(950,000) |
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Lawsuit liability (6) |
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3,000,000 |
(3,000,000) |
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Goodwill (7) |
(1,000,000) |
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(1,000,000) |
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Post-adjustment values |
17,450,000 |
17,300,000 |
5,150,000 |
Notes:
(1) FIFO accounting gives the best estimate of the economic value of the inventory. Therefore, inventory and equity will increase by the LIFO reserve amount of $1.2 million.
(2) Capitalized interest should be removed from the balance sheet by reducing long-term assets and equity.
(3) The underfunded pension plan requires a compound adjustment. First, reduce assets and equity by the amount shown on the asset side of the balance sheet. Next, increase liabilities and decrease equity to reflect the amount of underfunding.
(4) The reduction in the value of the debt (650,000) is offset by an increase to equity.
(5) Because the preferred stock is redeemable it should be treated as a liability. Therefore, a liability of 950,000 (100,000 × 9.50) will reflect the market value of the preferred shares. The equity account is adjusted by 1) reducing equity by 1,000,000 to reflect the reclassification of the preferred stock to a liability and 2) increase equity by 50,000 to reflect the reduction in the value of the preferred shares (1,000,000 – 950,000). Therefore, the total adjustment is a reduction of 950,000.
(6) Because the settlement associated with the lawsuit is a probable event, that is measurable, it must be included in liabilities. The settlement amount of $3 million is used for the adjustment. A more aggressive stance would be to recognize the potential loss of $5 million if the analyst believed the settlement would not be accepted.
(7) Goodwill is eliminated and equity is reduced as an offset to the elimination.
The adjusted (liabilities / equity) ratio is 3.36 (= 17,300,000 / 5,150,000).
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发表于 2010-4-15 11:32
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500 average P/E of 15.3. The financial statements reported net earnings of $126 million, or $4.00 per share. The notes to the financial statements included a statement that income for the year included a $31.5 million (after-tax) gain from the reclassification of certain assets from its investment portfolio to its trading portfolio. What would be the normalized P/E?