Case 4: Financial Statement Analysis pt 2

Summary

Now that you have been introduced to the basics of financial statement analysis you are ready to try it on your own. In this case, you will assume the role of a financial analyst trying to help a client determine where to invest his money. Basically we are moving from the pure mechanics that we covered in the last case to using those mechanics to make a recommendation for our clients (or to make investment decisions for ourselves).

This part of the project requires you to differentiate between two firms within an industry, and to then use the information about those firms to make a specific buy, sell, or hold recommendation. Your work will be graded based on 1) correctly identifying each company, 2) making the correct recommendation, 3) effectively communicating and supporting your findings, and 4) formatting.

The assignment will be due in BBLearn at 11:00pm on the date specified in the course schedule (as always late work will be accepted following the policy in the syllabus). This is not an English class, so I will accept any paper than shows at least a minimal level of editing (i.e. running spell check and grammar check, reading through the paper at least once, following the formatting instructions below, etc.). Papers returned because of editing problems can still be turned in late for partial credit (see the policy on late work in the syllabus).

Please submit your work as one (1) file. Include a title page similar to the one for this packet. Make sure that you include the course title, my name, your name, and the time your class begins on the title page. Your paper should be between 1 and 2 pages. The pages should have normal 1" margins. Use a traditional 12 point, or equivalent, font. You should also use the traditional formatting for a business letter. Do not include any part of this packet in your submission!

You may work with a partner if you wish! If you do work with a partner, make sure both of your names appear on the title page.

Introduction

The attached table presents the common-sized financial statements of two firms in the pharmaceutical industry, Wyeth and Cardinal Health. As your client, I am trying to decide what I should do with my investment in Wyeth. I would like to you to write me a formal business letter that tells me which of the two companies is Wyeth and what I should do with my current investment (increase it, sell it, or hold it).

Wyeth engages in the development, manufacture, and sale of prescription drugs. The drugs produced by Wyeth primarily represent mixtures of chemical compounds. As with all prescription drug companies, Wyeth must get FDA approval of their drugs before selling them. Once they have a successful drug, patents protect their drugs until either the patent expires or an alternative drug is developed.

Cardinal Health, on the other hand, distributes drugs as a wholesaler to drugstores, hospitals, and mass merchandisers. The company also provides pharmaceutical benefit management services through a series of computer programs that help customers order more efficiently, contain costs, and monitor purchases. Cardinals COGS consists of the cost of the drugs the company sells as well as the salaries of the personnel providing the management services.

Although the two companies are not really close competitors (their places within the pharmaceutical industry are too different), you should use Cardinals numbers for comparison in making your recommendation.

Required

Your letter must include three, easily identifiable parts. First, you must provide one paragraph that tells me which company (A or B) you believe to be Wyeth and why. Second, you must provide one short paragraph that clearly informs me of your recommendation regarding Wyeths stock. Third, you must provide at least one or two paragraphs clearly supporting your recommendation. A strong recommendation will include some basic ratios (such as those you calculated in the first FSA case) in an attached appendix.^[1]

In order to calculate the basic ratios, you will need to first convert the common-sized financial statements provided in Table 1 back into dollar values. Remember that common-sized financial statements present all of the numbers after dividing by total sales revenue. Company A reported total sales of $22,400 in Year 3, $20,351 in Year 2, and $18,756 in Year 1. Company B reported total sales of $86,852 in Year 3, $79,664 in Year 2, and $72,666 in Year 1.^[2]

Table 1 - Common-sized Financial Statements
		Company A				Company B
Year		Year 3	Year 2	Year 1		Year 3	Year 2	Year 1
Income Statement Info.
Sales		100.0%	100.0%	100.0%		100.0%	100.0%	100.0%
COGS		28.2%	27.5%	29.0%		94.0%	94.0%	93.9%
Sell & Admin		30.2%	31.9%	32.6%		3.5%	3.6%	3.4%
R & D		14.5%	15.3%	14.7%		0.0%	0.0%	0.0%
Interest		0.0%	0.0%	0.4%		0.1%	0.1%	0.2%
Income Taxes		8.2%	6.1%	6.0%		0.5%	0.7%	0.8%
Other Gains		1.7%	1.4%	2.1%		0.0%	0.0%	0.0%
Other Losses		0.0%	0.0%	0.0%		0.9%	0.1%	0.2%
Net Income		20.6%	20.6%	19.5%		1.0%	1.5%	1.5%
Balance Sheet Info.
Cash and Cash Equivalents		60.0%	42.9%	43.9%		1.7%	2.1%	2.1%
Accounts Receivable		15.8%	16.6%	16.2%		5.4%	4.8%	4.3%
Inventories		13.6%	12.2%	12.4%		8.5%	9.4%	10.0%
Other Current		13.3%	14.4%	23.7%		1.2%	4.5%	2.3%
PPE (net)		49.4%	49.9%	49.9%		1.9%	1.9%	3.4%
Other Assets		38.7%	43.3%	45.0%		8.0%	6.7%	8.1%
Total Assets		190.7%	179.3%	191.1%		26.7%	29.4%	30.1%
Current Liabilities		32.7%	35.5%	53.0%		13.2%	14.5%	13.6%
Long-term Debt		51.3%	44.7%	49.2%		4.0%	3.2%	3.2%
Other noncurrent Liabilities		25.4%	27.1%	24.9%		1.0%	1.0%	1.4%
Shareholder's Equity		81.3%	72.0%	64.0%		8.5%	10.7%	11.8%
Total Liabilities & Equities		190.7%	179.3%	191.1%		26.7%	29.4%	30.1%

^[1] Please note that an appendix will not count as part of your 2 page maximum.

^[2]These numbers are in millions of dollars, so Company As actual total sales in 2007 were $22,400,000,000.