Case 1 - Ratios and Financial Planning

Case 1 - Ratios and Financial Planning [Chapter 3, page 81] In 1969, Tom Warren founded East Coast Yachts. The company’s operations are located near Hilton Head Island, South Carolina, and the company is structured as a sole proprietorship. The company has manufactured custom midsize, high-performance yachts for clients, and its products have received high reviews for safety and reliability. The company’s yachts have also recently received the highest award for customer satisfaction. The yachts are primarily purchased by wealthy individuals for pleasure use. Occasionally, a yacht is manufactured for purchase by a company for business purposes. The custom yacht industry is fragmented, with a number of manufacturers. As with any industry, there are market leaders, but the diverse nature of the industry ensures that no manufacturer dominates the market. The competition in the market, as well as the product cost, ensures that attention to detail is a necessity. For instance, East Coast Yachts will spend 80 to 100 hours on hand-buffing the stainless-steel stem-iron, which is the metal cap on the yacht’s bow that conceivably could collide with a dock or another boat. Several years ago, Tom retired from the day-to-day operations of the company and turned the operations of the company over to his daughter, Larissa. Because of the dramatic growth at East Coast Yachts, Larissa decided that the company should be reorganized as a corporation and, today, the company is publicly traded under the ticker symbol “ECY.” Dan Ervin was recently hired by East Coast Yachts to assist the company with its short-term financial planning and also to evaluate the company’s financial performance. Dan graduated from college five years ago with a finance degree, and he has been employed in the treasury department of a Fortune 500 company since then. The company’s past growth has been somewhat hectic, in part due to poor planning. In anticipation of future growth, Larissa has asked Dan to analyze the company’s cash flows. The company’s financial statements are prepared by an outside auditor. After Dan’s analysis of East Coast Yachts’ cash flow (at the end of our previous chapter), Larissa approached Dan about the company’s performance and future growth plans. First, Larissa wants to find out how East Coast Yachts is performing relative to its peers. Additionally, she wants to find out the future financing necessary to fund the company’s growth. In the past, East Coast Yachts experienced difficulty in financing its growth plan, in large part because of poor planning. In fact, the company had to turn down several large jobs because its facilities were unable to handle the additional demand. Larissa hoped that Dan would be able to estimate the amount of capital the company would have to raise next year so that East Coast Yachts would be better prepared to fund its expansion plans. To get Dan started with his analyses, Larissa provided the following financial statements. Dan then gathered the industry ratios for the yacht manufacturing industry. East Coast Yachts 2023 Income Statement Item Income Sales $495,381,600 Cost of goods sold $357,466,500 Selling, general, and administrative $ 59,200,300 Depreciation $ 16,166,700 EBIT $ 62,548,100 Interest expense $ 8,910,000 EBT $ 53,638,100 Taxes (25%) $ 13,409,525 Net Income $ 40,228,575 Dividends $ 17,437,050 Retained earnings $ 22,791,525 East Coast Yachts 2023 Balance Sheet Current Assets Amount Current Liabilities Amount Cash and equivalents $ 9,096,300 Accounts payable $ 36,146,575 Accounts receivable $ 15,131,900 Accrued expenses $ 5,151,400 Inventory $ 16,322,100 Total current liabilities $ 41,297,975 Other $ 949,400 Total current assets $ 41,499,700 Fixed assets Long-term debt $137,200,000 Property, plant, and equipment $370,828,800 Total long-term liabilities $137,200,000 Less accumulated depreciation (92,206,700) Net property, plant, and equipment $278,622,100 Intangible assets and others $ 6,094,800 Stockholders' equity Total fixed assets $284,716,900 Preferred stock $ 1,595,700 Common stock $ 29,057,000 Capital surplus $ 24,178,000 Accumulated retained earnings $131,382,725 Less treasury stock (38,494,800) Total equity $ 147,718,625 Total assets $326,216,600 Total liabilities and shareholders' equity $326,216,600 Yacht Industry Ratios Ratio Lower Quartile Median Upper Quartile Current ratio .86 1.51 1.97 Quick ratio .43 .75 1.01 Total asset turnover 1.10 1.27 1.46 Inventory turnover 12.18 14.38 16.43 Receivables turnover 10.25 17.65 22.43 Debt ratio .32 .56 .61 Debt-equity ratio .83 1.13 1.44 Equity multiplier 1.83 2.13 2.44 Interest coverage 5.72 8.21 10.83 Profit margin 5.02% 7.48% 9.05% Return on assets 7.05% 10.67% 14.16% Return on equity 14.06% 19.32% 26.41% Assignment Directions: Write a case analysis of 2,000 – 2,500 words (8 to 10 pages), content (title page and reference page not included) in proper APA format, covering the Guiding Questions. Submission Guidelines: 1. Prepare this Assignment according to the APA guidelines, including a title page, an introduction, and a conclusion. An abstract is required. Use in-text citations and include a References section. 2. In your report, make certain that you include at least eight (08) credible outside references from search engines or scholarly academics and Journal sources. Questions to Answer In This Deep Dive East Coast Yachts uses a small percentage of preferred stock as a source of financing. In calculating the ratios for the company, should preferred stock be included as part of the company’s total equity? ______________________________________________________________________ Calculate all of the ratios listed in the industry table for East Coast Yachts for 2023. (Use Excel to do the calculations, then copy and paste them into your paper). _______________________________________________________________________ Compare the performance of East Coast Yachts to the industry as a whole. For each ratio, use decision criteria and comment on why it might be viewed as positive or negative relative to the industry. Suppose you create an inventory ratio calculated as inventory divided by current liabilities. How would you interpret this ratio? How do East Coast Yachts compare to the industry average for this ratio? _______________________________________________________________________ Calculate the sustainable growth rate for East Coast Yachts. Calculate external funds needed (EFN) and prepare pro forma income statements and balance sheets assuming growth at precisely this rate. Recalculate all of the ratios in the previous question given these new criteria. What does your analysis conclude? (Use Excel to do the calculations, then copy and paste them into your paper). ______________________________________________________________________ As a practical matter, East Coast Yachts is unlikely to be willing to raise external equity capital, in part because the shareholders don’t want to dilute their existing ownership and control positions. However, East Coast Yachts are planning for a growth rate of 20 percent next year. What are your conclusions and recommendations about the feasibility of East Coast’s expansion plans? _______________________________________________________________________ Most assets can be increased as a percentage of sales. For instance, cash can be increased by any amount. However, fixed assets must be increased in specific amounts because it is impossible, as a practical matter, to buy part of a new plant or machine. In this case, a company has a “staircase” or “lumpy” fixed cost structure. Assume that East Coast Yachts are currently producing at 100 percent of capacity and sales are expected to grow at 20 percent. As a result, to expand production, the company must set up an entirely new line at a cost of $75 million. Prepare the pro forma income statement and balance sheet given these new criteria. What is the new EFN with these assumptions? What does this imply about capacity utilization for East Coast Yachts next year? (Use Excel to do the calculations, then copy and paste them into your paper).