The Signal Cable Company, located in Tarrytown NY, is a cable manufacturer for analog and digital interconnects, speaker, video and home theater cables. The company is well known for “highest standard in quality and customer service” and their “superior design” and “No-Hype approach resulted in one of the best price/performance ratio in the industry” (www.signalcable. com). After steady growth over the last few years, the management decided to enter the fiber optics business. The market was growing, the demand increased and the competition was not too severe.
Thus the company established two additional manufacturing facilities and increased its inventory to meet the rising number of orders. Current Situation But despite or because of these investments the results showed a lower net profit margin, furthermore the cash balance and the stock price had fallen recently. Jay Smith, Assistant of the President, has now the challenge to prepare some feasible answers and suggestions for his boss, Joe Mathis, who has to inform the shareholders about the current situation. Questions of Case Study 1.Why has the stock price fallen despite the fact that the net income has increased? The stock price has fallen from $7 to $5. 50 despite the fact that the net income has increased.
The reason for the decrease in the stock price is that the shareholders are concerned about the increasing debts and liabilities, caused by the recent investments in two additional manufacturing facilities and a significant increase in its inventory. The concerns are based on the belief that the increased amount of debts and liabilities will result in lower future n...
et income, because of the interests, which the company will have to pay. So the negative effects of these recent investments are visible in some severe changes in the balance sheet, the income statement and the financial ratios. For example from 2003 to 2004 the amount of interest paid increased from 44,000 to 155,000, the total current liabilities increased from 355,000 to 895,000, the long-term debt increased from 200,000 to 1,226,280. These changes can also be seen in the following financial ratios. The long-term debt ratio increased from 22% to 61%.
long-term debt ratio =Long-term debt Long-term debt + equity 2004: LTDR =1,226,280= 0. 61 2,018,450 2003: LDTR =200,000= 0. 2 892,000. The total dept ratio increased from 45% to 73%.
total debt ratio =total liabilities total assets 2004: TDR =2,121,280= 0. 73 2,913,450 2003: TDR =555,000= 0.
45 1,247,000 the times interest earned decreased from 5. 72 to 2. 54. times interest earned =EBIT interest payments 2004: TIE =393,500= 2.
54 155,000 2003: TIE =251,833. 8= 5. 72 44,000
In addition, the shareholders might be worried about the arising liquidity problems, which are also caused by the recent investments. The liquidity problems will be discussed in detail in Answer 2. How liquid would you say that this company is? Calculate the absolute liquidity of the firm.
How does it compare with the previous year’s liquidity position? The cash balance decreased from 40,000 to 5,000, while the accounts receivable increased from 200,000 to 540,000. In addition, the inventory amount increased from 650,000 to 1,300,450. This means that the increase in sales did not flow in the
cash balance but in the accounts receivable position. That means that many customers have not paid their bills directly. This liquidity situation might cause severe liquidity problems if the company has to pay for a couple of major bills.
So the actual liquidity of the Signal Cable Company is not satisfying, which can be seen in the following ratios. The networking capital to asset deteriorated from 43% to 33%. NWC to total assets ratio = Net working capital Total assets 2004: NWC to TAR = 950,450=0. 33 2,913,450 2003: NWC to TAR = 535,000=0.
43 1,247,000 the current ratio deteriorated from 2. 51 to 2. 06. Current Ratio = Current Assets Current Liabilities 2004: CR = 1,845,450=2.
06 95,000 2003: CR = 890,000=2. 51 355,000 the cash ratio decreased dramatically from 11. 3% to 0. 56%.
Cash Ratio = Cash Current Liabilities 2004: CashR = 5,000=0. 0056 895,000 2003: CashR = 40,000=0. 113 355,000
The absolute liquidity of the firm can be seen in the change of net working capital (NWC) and is $ 415,450. In the case of Signal Cable Company, the change in networking capital is a negative sign for liquidity, because the amount is based on high accounts payable and low cash. Thus the capital can not be used in the short term.
Change NWC = NWC 2004 – NWC 2003Change NWC = 950,450 – 535,000 = 415,450
How does the market value of the stock compare with its book value? Is the book value accurately reflecting the true condition of the company? The book value regards past costs of assets. The market value is the price of the share multiplied by the number of outstanding shares. The current book value of the company is 792,170 in 2004 and 692,000 in 2003 (equity of every year).
The current market value of the company is 1,100,000 (price per share x amount of outstanding shares). The book values per share increased from $ 3. 46 in 2003 to $ 3. 96 in 2004.
The stock price shows the market value per share and increased in the last period to $ 5. 50. This figure shows that the market values the Signal Cable Company higher as it really is, which is not unusual. Book value per share = Equity outstanding shares 2004: BV per share = 792,170=3. 96 200,000 2003: BV per share = 692,000=3.
46 200,000 although the book value increased the market regards the company still better than it really is, because of this the book value does not reflect the true condition of the company accurately. Besides the book value does not consider the intangible assets, e. g. now-how and image, because it is difficult to calculate its value precisely.
The board of directors is not clear as to why the cash balance has dropped so much in spite of the increase in sales and the gross profit margin. What should Jay tell the board? Jay should tell the board that the reason for the low cash balance is justified by the fact that many customers have not paid their bills directly, which can be seen in the accounts receivable position in the balance sheet, where the amount
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