just question 1

Ratio Analysis ? The Knee Depot Case

Knee Depot, a building supplies company, has been lagging the rest of the industry in its performance. So the board has brought in a new CEO, Milo T. Barnsworth to fix things. Since he had a strong financial background, the first item on his todo list was to develop a financial planning section to an overall strategic plan.

Barnsworth began by comparing KD?s financial ratios to the rest of the industry. Whenever he encountered a substandard ratio, he would meet with the manager responsible to develop a plan to fix it. You have been hired to help Barnsworth finish his analysis of the company so that he can start implementing solutions. To do so, you must answer the following questions based on the financial data provided:

• Given the data provided in Exhibit 1, how well run is KD compared to it industry peers? What are its primary strengths and weaknesses? Be specific, using ratios in your answer. Be sure to also use the DuPont equation in your analysis.
• Use the AFN (or External Capital Required as shown in Table 29.9 in the textbook) equation to estimate KD?s required external capital for 2013 if the expected 15% growth rate takes place. Assume the 2012 ratios (listed in question 6) will stay the same.
• How would the following items impact AFN, holding everything else constant: capital intensity, growth rate, increase in A/P, profit margin, payout ratio.
• What is KD?s internal growth rate (aka self-supporting growth rate)?
• Forecast the Balance Sheet and Income Statement for 2013. In this scenario (call it the SteadyScenario) operations are not changed in any way. What is the AFN? Calculate the following items: FCF, ROIC, EPS, DPS and ROE. Use the following assumptions:
  • Operating ratios stay the same (use the ratios that appear in question 6).
  • No additional long-term debt or equity is issued
  • Interest rate on all debt is 10%
  • Any additional funding will be acquired through a line of credit on the last day of the year (thus no interest for 2013)
  • Dividends will grow by 15%
  • Sales will grow by 15%
• (15 points) Now assume that KD changes its operations such that it achieves industry averages for the following items:
  • Operating costs / Sales
  • Receivables / Sales
  • Fixes Assets / Sales

Under this scenario (call it the Improved Scenario), what is the AFN, FCF, ROIC, EPS, DPS and ROE?

Knee Depot Case
Exhibit 1 - Financial Statements and Selected Ratios
Balance Sheet 12/31/12
Assets	Liabilities & Equity
Cash and securities	20	Accounts pay. + accruals	100
Accounts receivable	290	Notes payable	80
Inventories	390	Total current liabilities	180
Total current assets	700	Long-term debt	520
Net fixed assets	500	Total liabilities	700
Common stock	300
Retained earnings	200
Total common equity	500
Total assets	1200	Total liab. & equity	1200
Income Statement 2012
Sales	2000
Total operating costs	1900
EBIT	100
Interest	60
EBT	40
Taxes (40%)	16
Net income	24
Dividends	9
Add. to retain. earnings	15
Shares outstanding	10
EPS	2.4
DPS	0.9
Year-end stock price	24
Selected Ratios and Other Data, 2012	KD	Industry
Sales, 2012 (S0):	2000	2000
Expected growth in sales:	0.15	0.15
Profit margin (M):	0.012	0.0274
Assets/Sales (A0*/S0):	0.6	0.5
Payout ratio (POR):	0.375	0.35
Equity multiplier (Assets/Equity):	2.4	2.13
Total liability/Total assets	0.583333	0.53
Times interest earned (EBIT/Interest):	1.666667	5.2
Increase in sales (?S = gS0):	300	300
(Payables + Accruals)/Sales (L0*/S0):	0.05	0.04
Operating costs/Sales:	0.95	0.93
Cash/Sales:	0.01	0.01
Receivables/Sales:	0.145	0.11
Inventories/Sales:	0.195	0.15
Fixed assets/Sales:	0.25	0.23
Tax rate:	0.4	0.4
Interest rate on all debt:	0.1	0.095
Price/Earning (P/E):	10	12
ROE (Net income/Common equity):	0.048	0.1164

Ratio Analysis - The Knee Depot Case Knee Depot, a building supplies company, has been lagging the rest of the industry in its performance. So the board has brought in a new CEO, Milo T. Barnsworth to fix things. Since he had a strong financial background, the first item on his todo list was to develop a financial planning section to an overall strategic plan. Barnsworth began by comparing KD's financial ratios to the rest of the industry. Whenever he encountered a substandard ratio, he would meet with the manager responsible to develop a plan to fix it. You have been hired to help Barnsworth finish his analysis of the company so that he can start implementing solutions. To do so, you must answer the following questions based on the financial data provided: 1. Given the data provided in Exhibit 1, how well run is KD compared to it industry peers? What are its primary strengths and weaknesses? Be specific, using ratios in your answer. Be sure to also use the DuPont equation in your analysis. Knee Depot's net profit margin (1.2%) is below the industry average of 2.74% 2. Use the AFN (or External Capital Required as shown in Table 29.9 in the textbook) equation to estimate KD's required external capital for 2013 if the expected 15% growth rate takes place. Assume the 2012 ratios (listed in question 6) will stay the same. 3. How would the following items impact AFN, holding everything else constant: capital intensity, growth rate, increase in A/P, profit margin, payout ratio. 4. What is KD's internal growth rate (aka self-supporting growth rate)? 5. Forecast the Balance Sheet and Income Statement for 2013. In this scenario (call it the Steady Scenario) operations are not changed in any way. What is the AFN? Calculate the following items: FCF, ROIC, EPS, DPS and ROE. Use the following assumptions: a. Operating ratios stay the same (use the ratios that appear in question 6). b. No additional long-term debt or equity is issued c. Interest rate on all debt is 10% d. Any additional funding will be acquired through a line of credit on the last day of the year (thus no interest for 2013) e. Dividends will grow by 15% f. Sales will grow by 15% 6. (15 points) Now assume that KD changes its operations such that it achieves industry averages for the following items: a. Operating costs / Sales b. Receivables / Sales c. Fixes Assets / Sales Under this scenario (call it the Improved Scenario), what is the AFN, FCF, ROIC, EPS, DPS and ROE? Knee Depot Case Exhibit 1 - Financial Statements and Selected Ratios Balance Sheet 12/31/12 Assets Cash and securities Accounts receivable Inventories Total current assets Net fixed assets Liabilities & Equity Accounts pay. + accruals Notes payable Total current liabilities Long-term debt Total liabilities Common stock Retained earnings Total common equity Total liab. & equity 20 290 390 700 500 Total assets Income Statement 2012 Sales Total operating costs EBIT Interest EBT Taxes (40%) Net income Dividends Add. to retain. earnings Shares outstanding EPS DPS Year-end stock price Selected Ratios and Other Data, 2012 1200 2000 1900 100 60 40 16 24 9 15 10 2.4 0.9 24 KD Sales, 2012 (S0): 2000 Expected growth in sales: 0.15 Profit margin (M): 0.012 Assets/Sales (A0*/S0): 0.6 Payout ratio (POR): 0.375 Equity multiplier (Assets/Equity): 2.4 Total liability/Total assets 0.583333 Times interest earned (EBIT/Interest): 1.666667 Increase in sales (S = gS0): 300 (Payables + Accruals)/Sales (L0*/S0): 0.05 Operating costs/Sales: 0.95 Industry 2000 0.15 0.0274 0.5 0.35 2.13 0.53 5.2 300 0.04 0.93 100 80 180 520 700 300 200 500 1200 Cash/Sales: Receivables/Sales: Inventories/Sales: Fixed assets/Sales: Tax rate: Interest rate on all debt: Price/Earning (P/E): ROE (Net income/Common equity): 0.01 0.145 0.195 0.25 0.4 0.1 10 0.01 0.11 0.15 0.23 0.4 0.095 12 0.048 0.1164