[treetribe]

Ok guys,

I had this as an accounting group project with 1 other member, and she conveniently dropped the class a week ago! So now I'm stuck! Any help would be DEEEPLY APPRECIATED!

Background:

You have been retained by the professional services firm, Dewey Cheatum & How to provide financial expertise to their client, Creative Services, Inc. The company lacks any financial expertise and would like some feedback on several different issues facing the company.

In additional to the financial information attached, the following may be helpful. The company currently has 1,000,000 shares of stock issued and outstanding. The company has bonds payable and notes payable to the bank at an annual rate of 6%. Additionally, the company has several long-term lease arrangements at a rate of 9%.

The company provides commercial services that require significant labor and materials to complete the sales. The owners do not suspect any foul play and have their books audited annually.


Issue # 1:
Since the company has had no formal financial expertise afforded them, they would like for you to assess their financial performance and stability. With your experience in financial statement analysis, discuss at least four financial ratios or performance indicators and their significance to the organization. In your discussion, determine whether you feel these are “good” or “bad” even though you lack any specific industry comparisons. You may use comparisons from year to year or create hypothetical scenarios such as “if A/R turnover goes to X, you will experience Y”.


Issue #2:
Miguel, the president has become concerned that little attention is focused on cash management. His two biggest concerns are 1.) Collections are slower that he would like to see, since many of his customers are from outside of the area and as far away as California, Texas, Maine and Florida. 2.) When cash collections are slow, he simply does not pay his bills to vendors on time and he never takes advantage of cash discounts on his accounts payable (which are often extended at 2/10, net 30). Provide Miguel some insight and solutions into how he can improve his collections and disbursement practices, so as to more efficiently manage his cash.


Issue #3:
Miguel is happy with the current investments his company has undertaken. Scotia, a new operations manager has proposed a new cost savings piece of equipment for Miguel to consider. The initial cost of the equipment is $50,000 with no salvage value and a five year life (straight-line depreciation). The equipment is expected to generate $14,000 of savings per year for the next five years (the life of the equipment). Miguel has the cash to invest but would like for you to make the final recommendation. Use capital budgeting practices to determine whether Miguel should accept Scotia’s offer. The owners have always required an 11% required return.


Issue #4
The current stock price is $12.50 based upon an estimated dividend in the coming year of $1.25 per share and a growth rate of 6%. The risk free rate for the market currently stands at 4% and the risk premium the market places on stocks in this industry is 8%. Using the dividend pricing model, calculate Creative Services, Inc.’s expected rate of return. With this expected rate of return, calculate the Beta for Creative Services, Inc. relative to its market. What does this beta tell you about the company’s riskiness compared to the industry?


Creative Services, Inc (figures in 000’s)

Cash_____________________$_____1,242_____$_____5,3 13
Accounts Receivable________$___174,645_____$___111,756
Inventory_________________$____19,450_____$____26, 452
Total Current Assets________$___195,337_____$___143,521

Furniture & Fixtures_________$____57,700_____$____18,531
Equipment_________________$___143,887_____$____99, 769
Trucks____________________$___157,914_____$____74, 000
Less: Depreciation__________$___(98,294)_____$____(36,09 3)
Total Net Fixed Assets______$____261,207_____$____156,207

Goodwill___________________$_____2,450_____$_____2 ,450
Total Assets_______________$___458,994_____$___302,178


Accounts Payable__________$___125,966_____$____115,403
Sales Tax Payable__________$_____1,873_____$_______552
Payroll Taxes Payable_______$____15,882_____$_____14,056
Total Current Assets________$___143,721_____$____130,011

Bonds Payable_____________$____32,582_____$__________-
Long Term Notes Payable____$____62,436_____$_____83,707
Lease Payable_____________$___129,652_____$_____48,945
Total Long-Term Payables___$___224,670_____$____132,652

Common Stock____________$______1,175____$_______1,175
Retained Earnings__________$_____38,340____$______17,668
Dividends ________________$_____(1,400)____$______(1,200)
Net Income_______________$_____52,488____$______21,872
Total Stockholders' Equity___$_____90,603____$______39,515

Total Liabilities and Equity___$____458,994____$_____302,178

Sales____________________$___1,660,566____$___1,16 6,464

Cost of Goods_____________$___1,135,330____$_____809,025

Gross Margin______________$_____525,236___$______357,439

Selling, General & Admin_____$_____388,673___$______292,192

Earnings before Interest/Taxes$_____136,563___$______65,247

Interest___________________$______8,752____$______ _1,814

Depreciation_______________$______62,201___$______ _36,093

Earnings Before Tax_________$______65,610___$_______27,340

Tax (20%)_________________$______13,122___$________5,4 68

Earnings After Tax__________$______52,488___$_______21,872



I KNOW IT'S LONG, BUT PLEASE HELP, IT'S DUE FRIDAY!!!

[CaptainForest]

Hey. Sorry I don't have time right now to look over all 4 issues...

But...

Issue 2.
How about he offeres his clients a cash discount as well? That will help to get them to pay their debts faster, which in turns solves his cash flow problem and allows him to take advatage of the cash discounts his creditors offerer him

[treetribe]

Hey CaptainForest,

Thanks for your reply... Here is some additional info:


Issue 1: Discuss the general categories of financial ratios:
profitability, efficiency, leverage, liquidity and return on equity.

Issue 2: Cash budgeting, short term financing, receivables and
inventory management principles.

Issue 3: Determine Present Value of cash flows from either tables or
calculators. Apply net present valuation to decision-making on
capital projects, such as Accounting payback, Net Present Value and
Internal Rate of Return.

Issue 4: Determine stock valuation from either the Dividend Pricing
Model or Capital Asset Pricing Model. Discuss the impact of risk and
return to evaluation of firm value.


Would really appreciate it if you could help me further with this!

Thanks!

[Tony2005]

Issue #3

Capital Budgeting tools used for this problem is NPV (Net Present Value)

the investment outlay is of $50,000
The annual cash-inflow is of $14,000
The project is for 5 years
Required rate of return is 11% (in other words discount rate)

Check with the Present value interest factor table.
14000(PVIF)1 + 14000(PVIF)2 + 14000(PVIF)3 + 14000(PVIF)4 + 14000(PVIF)5
therefore, PVIF of 5 years with 11% discount rate
14000(0.901) + 14000(0.812) + 14000(0.731) + 14000(0.659) + 14000(0.593)

12614 + 11368 + 10234 + 9226 + 8302 = 51,744
51744 - 50000 = 1744

The project is having a positive NPV, therefore, it will be profitable to invest.

[Tony2005]

There are various financial ratios that can be used to get the information on the performance of the company. Use those and you can draw a reasonable conclusion comparing both the years. I am not so sure about the dividend pricing model even though I have learnt it earlier. Anyway, the formulas will surely be given in your textbook which can be used here.

[treetribe]

Thanks Tony2005 for your clear explanation of Issue #3. I've got the ratio's pretty much figured out for Issue #1.

I'm having problems with determining the stock valuation (issue #4). I'm very unclear on both the models.

[Tony2005]

Issue #4

I am not so sure about this, let me try.

Current stock price- $12.50
Dividend in coming year - $1.25 per share
Expected growth in dividend - 6%
Risk free rate of return - 4%
Risk premium - 8%

Expected rate of return
r = D/P + g
r = $1.25/12.50 + 0.06
r = 16 percent

I do not know about Beta calculation. Calculating Beta is cumbersome and a long tedious formula to follow. I think Beta will comprise the risk premium return that is 8% and the expected return that is 16%.

[CaptainForest]

I thought your assignment was due last Friday, but perhaps you meant next Friday.

Issue 4:

Tony is correct in saying that the expected rate of return is 16%

Expected rate of return
r = D/P + g
r = $1.25/12.50 + 0.06
r = 16 percent

Now for Beta. To calculate Beta, you use a regression analysis. However, that is not what is asked for in this case. So here is a quick and dirty method for your case.

It is based on the CAPM (Capital Asset Pricing Model)

expected return = risk free + beta (risk premium - risk free)
16% = 4% + beta (8%-4%)
.16 = .04 + beta(.04)

Now divide all by .04

4 = 1 + beta
beta = 3

So what does a Beta of 3.0 tell you about the stock?

Your question states:
What does this beta tell you about the company’s riskiness compared to the industry?

The market has a beta of 1.0, and individual stocks are ranked according to how much they deviate from the market.

High-beta stocks are supposed to be riskier but provide a potential for higher returns; low-beta stocks pose less risk but also lower returns.

Therefore, with a 3.0 beta, it produces a higher rate of return (16%) than the market, but it is also much riskier to have.

[CaptainForest]

Issue 3:

I agree with Tony.

I calculated a positive NPV of 1,742.56

Therefore, the manager should make the purchase.

[treetribe]

CaptainForest,

It was due on Friday, but I was able to get an extension till the middle of next week.

Thanks a lot both you guys for your time and help... Owe you guys big time!!

- - THE TREE TRIBE --