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SKI EQUIPMENT INCORPORATED (SKI) Dan Barnes is the financial manager of SKI. The company's founder recently sold his 51% controlling block of stock to Mike Lafaro, who is a big fan of EVA Economic Value Added), EVA is found by taking the after tax operating profit and then subtracting the dollar cost of all the capital the firm uses. EVA = NOPAT-CAPITAL COSTS = EBIT(1-T)- WACC(CAPITAL EMPLOYED) If EVA is positive, then the firm is creating value. On the other hand, if EVA is negative, the firm is not covering its cost of capital and stockholders' value is eroded. Lofaro rewards managers randomly if they create value, but those whose operations create negative EVA is soon looking for work. Lofaro frequently points out that if a company can generate its current level of sales with less assets, it would need less capital. That would, holding all else constant, lower capital costs and increase its EVA. Shortly after he took control of SKI, he met with SKI's senior executives to tell them of his plans for the company. First he presented some EVA data which he convinced everyone that SKI had not been creating value in recent years. He then stated that this situation should change. He noted that SKI's design of skis, boots, and clothing are acclaimed throughout the industry, but something is seriously amiss elsewhere in the company. Costs are too high prices are too low, or the company uses too much capital and he wants SKI's managers to correct the problem or alco Kronk has long felt that SKI's net working capital situation has to be studied- the company may have the optimal amounts of cash , securities, receivables, and inventories, but it may also have too much or too little of these items. In the past, the production manager resisted Phil's efforts to question his holdings of raw materials, inventories, the marketing manager resisted questions about finished goods, the sales staff resisted questions about credit policy (which affects accounts receivable) and the treasurer did not want to talk about her cash and securities balances. Lofaro's speech made it clear that such resistance would no longer be tolerated Following are some ratios for SKI : SKI INDUSTRY Current 1.75 2.25 Quick 0.83 1.20 Debt/Assets 58.76% 50.00% Turnover of cash and securities 16.67 22.22 Days sales outstanding 45.00 32.00 Inventory turnover 4.82 7.00 Fixed assets turnover 11.35 12.00 Total assets turnover 2.08 3.00 Profit margin on sales 2.07 % 3.50% Return on equity 10.45 % 21.00% Payables deferral period 30.0 33.0 QUESTIONS SKI- 1.Is there any reason to think that SKI may be holding too much inventory? If so, how would that affect EVA and ROE? 2.SKI sells on the same credit terms as other firms in the industry.Using the above ratios a.explain whether SKI's customers pay less or more promptly than the industry. b. If there are differences, does this suggest that SKI should tighten or loosen its credit policy? c.What four variables make up a firm's credit policy, and in what direction should each be changed by SKI d.Does Ski face any risks if it tightens its credit policy? 3.If the company reduces its DSO without seriously affecting sales, .a.what effect would this have on its cash position (1) In the short run and (2) In the long run? Answer in terms of the cash budget and the balance sheet. b.what effect would this have on EVA in the long run? 4.SKI has excessive investments in current assets but it still has low current ratio. Why? 5. State some characteristics of this firm that may cause its managers to keep high levels of current assets. 6. The company uses higher leverage than the industry yet its ROE lower than industry average. Explain the reasons. 7. Calculate Cash Conversion cycle. Compare it with industry