FINANCIAL STATEMENTS AND TAXES Part I of this case, presented in Chapter 3, discussed the situation of DLeon Inc., a regional snack foods producer, after an expansion program. DLeon had increased plant capacity and undertaken a major marketing campaign in an attempt to go national. Thus far, sales have not been up to the forecasted level, costs have been higher than were projected, and a large loss occurred in 2021 rather than the expected profit. As a result, its managers, directors, and investors are concerned about the firms survival.

Donna Jamison was brought in as assistant to Fred Campo, DLeons chairman, who had the task of getting the company back into a sound financial position. DLeons 2020 and 2021 balance sheets and income statements, together with projections for 2022, are given in Tables IC 4.1 and IC 4.2. Note that DLeon is exempt from the interest deduction limitation because its average gross receipts for the prior 3 years was less than . So 100% of its interest expense is deductible. Also, many of DLeons assets have lives greater than 20 years and thus qualify for the alternative depreciation system (straight line) rather than the 100% bonus depreciation. In addition, Table IC 4.3 gives the companys 2020 and 2021 financial ratios, together with industry average data. The 2022 projected financial statement data represent Jamisons and Campos best guess for 2022 results, assuming that some new financing is arranged to get the company over the hump.

1. Calculate DLeons 2022 current and quick ratios based on the projected balance sheet and income statement data. What can you say about the companys liquidity positions in 2020, in 2021, and as projected for 2022? We often think of ratios as being useful

   • (1)

     to managers to help run the business,

   • (2)

     to bankers for credit analysis, and

   • (3)

     to stockholders for stock valuation.

   Would these different types of analysts have an equal interest in the companys liquidity ratios? Explain your answer.

2. Calculate the 2022 inventory turnover, days sales outstanding (DSO), fixed assets turnover, and total assets turnover. How does DLeons utilization of assets stack up against other firms in the industry?

3. Calculate the 2022 debt-to-capital and times-interest-earned ratios. How does DLeon compare with the industry with respect to financial leverage? What can you conclude from these ratios?

4. Calculate the 2022 operating margin, profit margin, basic earning power (BEP), return on assets (ROA), and return on equity (ROE). What can you say about these ratios?

5. Calculate the 2022 price/earnings ratio and market/book ratio. Do these ratios indicate that investors are expected to have a high or low opinion of the company?

6. Use the DuPont equation to provide a summary and overview of DLeons financial condition as projected for 2022. What are the firms major strengths and weaknesses?

7. Use the following simplified 2022 balance sheet to show, in general terms, how an improvement in the DSO would tend to affect the stock price. For example, if the company could improve its collection procedures and thereby lower its DSO from 46.4 days to the 32-day industry average without affecting sales, how would that change ripple through the financial statements (shown in thousands in the following table) and influence the stock price?

Information:

Accounts receivable Other current assets Net fixed assets Total assets $ 878 1,802 817 $3,497 Current liabilities Debt Equity Liabilities plus equity $ 845 700 1,952 $3,497 Table IC 4.1 Balance Sheets 2022E Assets Cash $ 85,632 Accounts receivable 878,000 Inventories 1,716,480 Total current assets $2,680,112 Net fixed assets 817,040 Total assets $3,497,152 Liabilities and Equity Accounts payable $ 436,800 Accruals 408,000 Notes payable 300,000 Total current liabilities $1,144,800 Long-term debt 400,000 Common stock 1,718,986 Retained earnings 233,366 $1,952,352 Total equity Total liabilities and equity $3,497,152 Note: E indicates estimated. The 2022 data are forecasts. 2021 $ 7,282 632,160 1,287,360 $1,926,802 939,790 $2,866,592 $ 524,160 489,600 636,808 $1,650,568 723,432 460,000 32,592 $ 492,592 $2,866,592 2020 $ 57,600 351,200 715,200 $ 1,124,000 344,800 $ 1,468,800 $ 145,600 136,000 200,000 $ 481,600 323,432 460,000 203,768 $ 663,768 $ 1,468,800 Table IC 4.2 Income Statements 2022E 2021 2020 $3,432,000 Sales $ 6,126,796 Cost of goods sold $ 6,900,600 5,875,992 550,000 5,528,000 2,864,000 358,672 Other expenses 519,988 Total operating costs excluding depreciation and amortization $ 6,425,992 $ 6,047,988 $ 3,222,672 EBITDA $ 78,808 $ 209,328 Depreciation and amortization 116,960 18,900 EBIT $ 190,428 $ 474,608 116,960 $ 357,648 70,008 $ 287,640 31,866 ($ 38,152) 122,024 Interest expense 43,828 EBT ($ 160,176) $ 146,600 36,650 Taxes (25%) 0 Net income $ 255,774 ($ 160,176) $ 109,950 EPS $ 1.023 ($ 1.602) $ 1.100 DPS $ 0.110 $ 0.275 $ 0.220 $7.809 Book value per share $ 4.926 $ 6.638 Stock price Shares outstanding $ 12.17 250,000 25.00% $ 2.25 100,000 25.00% $ 8.50 100,000 25.00% Tax rate Lease payments $ 40,000 $ 40,000 $ 40,000 Sinking fund payments 0 0 0 "The firm had sufficient taxable income in 2022 (the 2021 loss wasn't greater than 80% of its 2022 taxable income before the loss was deducted) to carry forward its 2021 loss in its entirety. As a result, its 2022 taxes were reduced by 0.25 X the loss amount. + Table IC 4.3 Ratio Analysis Current Quick Inventory turnover Days sales outstanding (DSO) Fixed assets turnover Total assets turnover Debt-to-capital ratio TIE Operating margin Profit margin Basic earning power ROA ROE Price/earnings Market/book Book value per share EV/EBITDA *Calculation is based on a 365-day year. 2022E 2021 1.2X 0.4x 4.3X 37.7 6.5X 2.1X 73.4% -0.3x -0.6% -2.6% -1.3% -5.6% -32.5% -1.4x 0.5X $4.93 20.02X 2020 2.3X 0.8X 4.0X 37.4 10.0X 2.3X 44.1% 4.3X 5.5% 3.2% 13.0% 7.5% 16.6% 7.7X 1.3X $6.64 6.29X Industry Average + 2.7X 1.0X 5.5X 32.0 7.0X 2.6X 40.0% 6.2X 7.3% 4.3% 19.1% 11.2% 18.2% 14.2X 2.4x n.a. 8.0X Accounts receivable Other current assets Net fixed assets Total assets $ 878 1,802 817 $3,497 Current liabilities Debt Equity Liabilities plus equity $ 845 700 1,952 $3,497 Table IC 4.1 Balance Sheets 2022E Assets Cash $ 85,632 Accounts receivable 878,000 Inventories 1,716,480 Total current assets $2,680,112 Net fixed assets 817,040 Total assets $3,497,152 Liabilities and Equity Accounts payable $ 436,800 Accruals 408,000 Notes payable 300,000 Total current liabilities $1,144,800 Long-term debt 400,000 Common stock 1,718,986 Retained earnings 233,366 $1,952,352 Total equity Total liabilities and equity $3,497,152 Note: E indicates estimated. The 2022 data are forecasts. 2021 $ 7,282 632,160 1,287,360 $1,926,802 939,790 $2,866,592 $ 524,160 489,600 636,808 $1,650,568 723,432 460,000 32,592 $ 492,592 $2,866,592 2020 $ 57,600 351,200 715,200 $ 1,124,000 344,800 $ 1,468,800 $ 145,600 136,000 200,000 $ 481,600 323,432 460,000 203,768 $ 663,768 $ 1,468,800 Table IC 4.2 Income Statements 2022E 2021 2020 $3,432,000 Sales $ 6,126,796 Cost of goods sold $ 6,900,600 5,875,992 550,000 5,528,000 2,864,000 358,672 Other expenses 519,988 Total operating costs excluding depreciation and amortization $ 6,425,992 $ 6,047,988 $ 3,222,672 EBITDA $ 78,808 $ 209,328 Depreciation and amortization 116,960 18,900 EBIT $ 190,428 $ 474,608 116,960 $ 357,648 70,008 $ 287,640 31,866 ($ 38,152) 122,024 Interest expense 43,828 EBT ($ 160,176) $ 146,600 36,650 Taxes (25%) 0 Net income $ 255,774 ($ 160,176) $ 109,950 EPS $ 1.023 ($ 1.602) $ 1.100 DPS $ 0.110 $ 0.275 $ 0.220 $7.809 Book value per share $ 4.926 $ 6.638 Stock price Shares outstanding $ 12.17 250,000 25.00% $ 2.25 100,000 25.00% $ 8.50 100,000 25.00% Tax rate Lease payments $ 40,000 $ 40,000 $ 40,000 Sinking fund payments 0 0 0 "The firm had sufficient taxable income in 2022 (the 2021 loss wasn't greater than 80% of its 2022 taxable income before the loss was deducted) to carry forward its 2021 loss in its entirety. As a result, its 2022 taxes were reduced by 0.25 X the loss amount. + Table IC 4.3 Ratio Analysis Current Quick Inventory turnover Days sales outstanding (DSO) Fixed assets turnover Total assets turnover Debt-to-capital ratio TIE Operating margin Profit margin Basic earning power ROA ROE Price/earnings Market/book Book value per share EV/EBITDA *Calculation is based on a 365-day year. 2022E 2021 1.2X 0.4x 4.3X 37.7 6.5X 2.1X 73.4% -0.3x -0.6% -2.6% -1.3% -5.6% -32.5% -1.4x 0.5X $4.93 20.02X 2020 2.3X 0.8X 4.0X 37.4 10.0X 2.3X 44.1% 4.3X 5.5% 3.2% 13.0% 7.5% 16.6% 7.7X 1.3X $6.64 6.29X Industry Average + 2.7X 1.0X 5.5X 32.0 7.0X 2.6X 40.0% 6.2X 7.3% 4.3% 19.1% 11.2% 18.2% 14.2X 2.4x n.a. 8.0X