Question 6 Kammel Capital Management is an institutional money manager that oversees over $12 billion in client assets. Most of its assets under management are invested in the Kammel Funds, a family of 12 mutual funds encompassing 9 growth and value equity funds, and 3 fixed income funds. Linda Karazim is an analyst for the Kammel Strategic Income Fund, a flexible fixed-income fund benchmarked to the Lehman Brothers Aggregate Index. The fund owns a substantial portion of subordinated debentures that were issued by Gernot Incorporated to finance the acquisition of a major competitor in 2002. Karazim has been assigned by the Strategic Income Senior Portfolio Manager, Mark Davidson, to analyze the subordinated debt of Gernot, Inc. Karazim decides that the best way to assess the credit quality of the Gernot’s bonds is to analyze the firm’s financial statements and calculate ratios that will identify trends in the firm’s operations and financing decisions. Karazim searches online and pulls up Gernot’s financial statements for the last three years. The statements Karazim uses for her analysis are shown below: Gernot, Inc.
Financial Statements
(in $ millions except per share data)
|
| 2002
| 2003
| 2004
| Revenues | 10,424 | 11,718 | 11,606 | COGS | 6,541 | 7,183 | 7,150 | Selling, General, and Admin. Expense | 3,223 | 3,763 | 3,600 | Int. Exp. | 147 | 133 | 340 | Pre-tax Income | 513 | 639 | 516 | Taxes | 185 | 224 | 212 | Net Income | 328 | 415 | 304 | Dividends paid | 0 | 0 | 100 |
| 2002
| 2003
| 2004
| Cash | 375 | 322 | 456 | Accounts Receivable | 625 | 798 | 1294 | Inventory | 937 | 1342 | 1552 | Current Assets | 1937 | 2462 | 3302 | Fixed Assets | 3075 | 4061 | 4334 | Total Assets | 5012 | 6523 | 7636 | | Accounts Payable | 544 | 620 | 597 | Short Term Debt | 650 | 733 | 672 | Other Current Liabilities | 350 | 767 | 551 | LT Debt | 1893 | 2488 | 3524 | Equity | 1575 | 1915 | 2292 | Total L&EQ | 5012 | 6523 | 7636 |
As Karazim is working on her project, Jacob Cannon, an analyst for Kammel’s Large Cap Growth Fund, stops by Karazim’s office to chat. When Karazim tells him that she is working on a ratio analysis project to assess Gernot Inc.’s subordinated debt, Cannon tells her that Kammel’s growth equity team is potentially looking to purchase Gernot’s stock for their fund. Karazim tells Cannon that the return on assets ratio that she has calculated for evaluating Gernot’s debt rating would also be considered one of the most effective ratios for use in valuing Gernot’s stock. Cannon replies that he has been doing his own ratio analysis to assess Gernot’s systematic risk and one of the most useful ratios for identifying relationships between accounting variables and beta is the current ratio, which would also be useful in forecasting the possibility of Gernot, Inc. going bankrupt. After Karazim completes her analysis, she has a meeting with Davidson to discuss her findings. At the meeting, Karazim tells Davidson that Gernot’s Inc.’s sustainable growth rate based on 2004 data is 9 percent, and that a growing company has a much lower chance of defaulting on its debt. Davidson, always critical of the work of the analysts that work for him, concludes the meeting by telling Karazim that she did good work, but one of the major limitations of the cross-sectional analysis she has performed is that comparisons are made difficult due to different accounting treatments. Part 1)
What is Gernot's total asset turnover for 2004 and the change in the ratio from 2002 to 2004?
| 2004 Ratio | Change in Ratio |
Part 2)
What is the change in Gernot Inc.’s cash conversion cycle from 2003 to 2004? The cash conversion cycle has: A) | increased by 17 days. | B) | increased by 33 days. | C) | increased by 25 days. | D) | decreased by 13 days. |
Part 3)
Karazim has noted in her analysis that Gernot Inc.’s return on equity has fallen significantly from 2002 to 2004. Using the extended DuPont system, which of the following components had the most impact on Gernot’s ROE decline? A) | Financial leverage multiplier. | B) | Operating profit margin. | C) | Interest coverage ratio. | D) | Tax retention rate. |
Part 4)
Regarding Karazim’s conversation with Cannon regarding the most useful ratios for various tasks: A) | Karazim’s statement is incorrect; Cannon’s statement is incorrect. | B) | Karazim’s statement is incorrect; Cannon’s statement is correct. | C) | Karazim’s statement is correct; Cannon’s statement is correct. | D) | Karazim’s statement is correct; Cannon’s statement is incorrect. |
Part 5)
Karazim decides to enhance her analysis by creating common size statements for Gernot, Inc. Which of the following statements is CORRECT? A common size balance sheet expresses all balance sheet accounts as a percent of: A) | total assets, and a common size income statement expresses all items as a percentage of net income. | B) | sales, and a common size income statement expresses all items as a percentage of net income. | C) | sales, and a common size income statement expresses all items as a percentage of total assets. | D) | total assets, and a common size income statement expresses all items as a percentage of sales. |
Part 6)
Regarding the comments made at the meeting with Davidson: A) | Karazim’s statement is correct; Davidson’s statement is correct. | B) | Karazim’s statement is incorrect; Davidson’s statement is incorrect. | C) | Karazim’s statement is correct; Davidson’s statement is incorrect. | D) | Karazim’s statement is incorrect; Davidson’s statement is correct. |
答案如下 Question 6 Part 1)
Your answer: B was correct! The total asset turnover ratio = sales/assets. In 2002, the ratio was (10,424/5,012) = 2.08. In 2004, the ratio was (11,606/7,636) = 1.52. From 2002 to 2004 the ratio declined by (2.08 – 1.52) = 0.56. Part 2)
Your answer: B was incorrect. The correct answer was C) increased by 25 days. The cash conversion cycle = (average receivables collection period) + (average inventory processing period) – (payables payment period).
For 2003:
Receivables turnover = (sales/average receivables) = 11,718/((625+798)/2) = 11,718/712 = 16.46
Average receivables collection period = (365/receivables turnover) = 365/16.46 = 22.17 days
Inventory turnover = (COGS/average inventory) = 7183/((1342+937)/2) = 7183/1140 = 6.3
Average inventory processing period = (365/inventory turnover) = 365/6.3 = 57.94 days.
Payables turnover = (COGS/average payables) = 7183/((620 + 544)/2) = 7183/582 = 12.34
Payables payment period = (365/12.34) = 29.58 days
2003 cash conversion cycle = 22.17 + 57.94 – 29.58 = 50.53 days.
For 2004:
Receivables turnover = (sales/average receivables) = 11,606/((1294+798)/2) = 11,606/1046 = 11.10
Average receivables collection period = (365/receivables turnover) = 365/11.10 = 32.88 days
Inventory turnover = (COGS/average inventory) = 7150/((1342+1552)/2) = 7150/1447 = 4.94
Average inventory processing period = (365/inventory turnover) = 365/4.94 = 73.89 days.
Payables turnover = (COGS/average payables) = 7150/((620 + 597)/2) = 7150/609 = 11.74
Payables payment period = (365/11.74) = 31.09 days
2004 cash conversion cycle = 32.88 + 73.89 – 31.09 = 75.68 days.
From 2003 to 2004, the cash conversion cycle increased by (75.68-50.53) = 25.15 days.
Part 3)
Your answer: C was incorrect. The correct answer was D) Tax retention rate. From 2002 to 2004, ROE declined from (328/1575) = 20.8% to (304/2292) = 13.3%.
The extended DuPont formula states that ROE = [(operating profit margin)(total asset turnover) – (interest expense rate)](financial leverage multiplier)(tax retention rate)
For 2002:
Operating profit margin = (EBIT/sales) = (513 + 147)/10,424 = 0.0633 = 6.33%.
Total Asset Turnover = (sales/assets) = 10424/5012 = 2.08x
Interest Expense rate = (interest expense/assets) = 147/5012 = 2.93%
Financial leverage multiplier = (assets/equity) = 5012/1575 = 3.18
Tax retention rate = (1-tax rate) = 1 – (185/513) = 1 – 0.36 = 64%.
For 2004:
Operating profit margin = (EBIT/sales) = (516 + 340)/11,606 = 0.0738 = 7.38%.
Total Asset Turnover = (sales/assets) = 11,606/7,636 = 1.52x
Interest Expense rate = (interest expense/assets) = 340/7,636 = 4.45%
Financial leverage multiplier = (assets/equity) = 7,636/2,292 = 3.33
Tax retention rate = (1-tax rate) = 1 – (212/516) = 1 – 0.41 = 59%.
Since the operating profit margin and the financial leverage multiplier both increased, these did not have an adverse impact on the ROE. The interest coverage ratio is not part of the DuPont formula. The only viable answer is the tax retention rate, which, in fact did decline significantly.
Part 4)
Your answer: D was incorrect. The correct answer was B) Karazim’s statement is incorrect; Cannon’s statement is correct. Although return on assets is one of the ratios that bond agencies rely on heavily for deriving their debt ratings, it is not one of the ratios that is deemed most useful for stock valuation, therefore Karazim’s statement is incorrect. Return on equity, (not ROA), is a ratio that is deemed to be very effective for both stock valuation and determining credit ratings. Cannon’s statement is correct – the current ratio is considered to be one of the most effective ratios for both determining systematic risk (beta) based on accounting variables and for forecasting bankruptcy. Part 5)
Your answer: C was incorrect. The correct answer was D) total assets, and a common size income statement expresses all items as a percentage of sales. Common size statements normalize balance sheet items by expressing each item as a percentage of total assets, and normalize income statements by expressing each item as a percentage of sales. Using common size statements allows the analyst to make easier comparisons of different sized firms. Part 6)
Your answer: C was correct! The sustainable growth rate = ROE × retention rate. Based on 2004 data:
Retention rate = 1 – (100/304) = 1- 0.33 = 0.67.
ROE = (304/2292) = 0.133
Sustainable growth rate = 0.133 × 0.67 = 0.8911, or 9%.
It is true that a growing company typically has a lower chance of financial distress, so Karazim’s statement is correct.
Although it is true that different accounting treatments across firms can be a major challenge of cross-sectional analysis (comparing firms with similar characteristics), the analysis that Karazim performed was a time-series analysis (comparing ratios of the same company over time), therefore Davidson’s statement is incorrect.
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发表于 2007-5-13 13:18
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