Welcome to your first-course case study: Genuine Motor Products. In this case, you will use the provided financial statement information and data to determine if the company should change its current automation process. The purpose of this case study is to apply the concepts of financial statement analysis in corporate financial decision-making.
Instructions:
- Genuine Motor Products: Using concepts from the module, analyze financial statement information and calculate combined leverage to determine if the firm should change its current automation
- Access BADM 530 Case Study 1 Genuine Motor Products.pdf
Actions
- Read the case study information
- Follow the instructions in the case
- Complete each step as instructed
- Show your work by creating tables or calculating formulas, depending on the instructions in each step
- Prepare your report
- Your ability to present a professional report is crucial in business and therefore evaluated in this case study
- Write a one (1) page report summarizing your findings and your recommendation(s)
- Your case study should be of professional quality including a cover page, free from spelling and grammatical errors, and written as a proposal to the firm
- Your proposal must include your recommendation(s) as well as support for your suggestions using material from the course and case
- Be sure to include your recommendations for the firm; suggest what they do and why you're making those suggestions. The "why" must include evidence from the case and finance concepts from the modules.
- Recommendations can be for the firm to follow Harry's plan, Mike's plan, neither, or both. The intent of the case is not to choose a "right" answer but to show understanding of the case and content as well as the financial concepts involved.
- Include your recommendations written as a proposal to the firm from the perspective of a financial manager
- Your final report should be about three (3) pages in length: two (2) pages for answering the questions in the case and one (1) page for your recommendations to the firm
- Save your report as either a Word document or PDF file; Excel files are also accepted
Genuine Motor Products located in Northern Ohio, manufactures precision measuring devices to monitor exhaust emission systems for new and used automobiles. Its products are sold worldwide. The firm hired Mike Anton in January of 2014 as vice president in charge of manufacturing operations. Mike had a bachelor's degree in industrial engineering from Case Western Reserve University and an MBA from Ohio State University, He had spent the last 15 years working for General Motors (Arlington, Texas division), Toyota Motor Corp., and Volvo. At age 38, he had established a good reputation for innovation within the auto and auto parts industry, Upon being hired, he began looking over the financial statements, particularly the balance sheet as of December 31, 2013 and the pro forma income statement for 2014 as shown in Figure 1 and 2, respectively. His immediate reaction was that the firm had not made the move to automation that others in the industry had. The company's manufacturing process was highly labor intensive as indicated by the fact that fixed assets (net plant and equipment) represented only $8 million out of total assets of $24 million (Figure 1) and that variable costs per un it were $25 in comparison to a sales price of $30 per unit (Figure 2). Although he thought the pro forma in come statement for 2014 as shown in Figure 2 looked reasonably good, he believed returns could be better if the firm went to greater automation and was less dependent on labor and expensive materials. When he shared his thoughts with Harry Engle, the chief financial officer, the response he received was lukewarm. Harry had been with the firm in good times as well as bad over the last 20 years and was quick to point out the advantages of not being tied up with a lot of fixed costs and debt during a slow down in sales in the auto industry. As Harry was fond of saying, "Genuine Motor Products does not have a labor union and when business is bad, we lay people off. By gosh, you can't lay machinery and equipment off. Figure 1 GENUINE MOTOR PRODUCTS Balance Sheet As of December 31, 2013 Assets Current assets $16,000,000 8,000,000 $24,000,000 10,000,000 Fixed assets Plant and equipment $20,000,000 Less: accumulated depreciation 12,000,000 Net plant and equipment Total assets.. Liabilities and Stockholders' Equity Current liabilities Long-term liabilities: Bonds payable 10.75% Total liabilities..... Stockholders' equity: Common stock, $1 par value, 2,000,000 shares... Capital in excess of par Retained earnings. Total stockholders' equity...... Total liabilities and stockholders' equity.. 2,000,000 $12,000,000 $ 2,000,000 4,000,000 6.000.000 $12,000,000 $24.000.000 Figure 2 GENUINE MOTOR PRODUCTS GENUINE MOTOR PRODUCTS Pro Forma Income Statement For 2014 Sales (1,000,000 units @ $30 per unit) - Fixed costs*....... - Total variable costs (1,000,000 units @ $25 per unit Operating income (EBIT). - Interest (10.75% x $2,000,000) Earnings before taxes Taxes (35%).... Earnings after taxes... Shares Earnings per share..... * Fixed costs include $1,000,000 in depreciation $30,000,000 2,000,000 25,000,000 $ 3,000,000 215,000 $ 2,785,000 974,750 $ 1,810,250 2,000,000 $ .91 Genuine Motor Products In spite of Harry's arguments, Mike Anton was determined to show the impact of both operating and financial leverage on Genuine Motor Products operations. He reconstructed the year-end balance sheet for 2013 (previously shown in Figure 1), and the results are shown in Figure 3 based on the following assumptions. 1. That the firm would increase fixed assets by $14 million. 2. That $ 10 million of the $14 million would be funded through long-term debt in the form of additional bonds payable at an interest rate of 10.75%. 3. The remaining $4 million would come from the sale of additional common stock at a net price to the corporation of $12.50. This would require the issuance of 320,000 new shares ($4 million/$12.50 = 320,000 shares). The impact of these values on the balance sheet in Figure 3 shows substantially greater leverage both on the asset and liability side. Figure 3 GENUINE MOTOR PRODUCTS Revised Balance Sheet For the year ended December 31, 2013 Assets Current assets $16,000,000 Fixed Assets Plant and equipment... $34,000,000 Less: Accumulated depreciation 12,000,000 Net plant and equipment 22,000,000 Total assets..... $38.000.000 Liabilities and Stockholders' Equity Current liabilities. 10,000,000 Long-term liabilities: Bonds payable 10.75% 12,000,000 Total liabilities.. $22,000,000 Stockholders' equity: Common stock, $ 1 par value, 2,320,000 shares $ 2,320,000* Capital in excess of par. 7,680,000** Retained earnings....... 6,000,000 Total stockholders' equity ...... $16,000,000 Total liabilities and stockholders' equity... $38,000,000 *2,000,000 old shares + 320,000 new shares = 2,320,000 shares ** 4,000,000 old capital in excess of par + 320,000 new shares x ($12.50 price $ 1 par value) = 4,000,000 + 320,000 ($11.50) = $7,680,000 Genuine Motor Products The intent of using more leverage was to increase the potential profitability of the firm. You are called in as a financial analyst to rework the 2014 pro forma income statement based on the assumptions stated in Table 1. These primarily relate to the fact there are now more fixed assets, long-term debt, and shares outstanding. Table 1 Assumptions for Revised Pro Forma Income Statement 1. Sales will remain constant at 1,000,000 units at $30 per unit. 2. Fixed costs will increase from $2,000,0000 to $5,800,000, a gain of $3,800,000. (Depreciation expense will be $2,800,000 and this will be shown as a footnote in the 2014 pro forma income statement). 3. Variable cost per unit will be reduced from $25 to $18.80. A total of 1,000,000 units will still be sold. The reduction in variable costs per unit is a direct result of the increased fixed costs and the associated automation. 4. Interest expense will reflect that there is now $12 million in long-term debt in the form of bonds payable at 10.75%. Ten million dollars of new debt is being added to $2 million of old debt. 5. Shares outstanding are now at a level of 2,320,000. Three hundred and twenty thousand new shares are being added to the 2,000,000 old shares currently outstanding. Required 1. Complete the revised pro forma income statement below. In the process, refer back to Figure 2, the original pro forma income statement for 2014 and the assumptions in Table 1. The new statement you are developing below will be referred to as Figure 4 for purposes of reference. Figure 4 GENUINE MOTOR PRODUCTS Revised Pro forma Income Statement For 2014 $30,000,000 5,800,000 Sales (1,000,000 units @ $30 per unit) - Fixed costs* Total variable costs (1,000,000 units @ $18.80 per unit Operating in come (EBIT) ....... Interest (10.75% x $12,000,000).. Earnings before taxes. - Taxes (35%) Earnings after taxes. Shares ....... Earnings per share..... * Fixed costs include $2,800,000 in depreciation 2,320,000 1.15 $ 2. Explain the primary reasons for the change in earnings per share between Figure 2 and Figure 4. 3. To determine the extent the company is more leveraged than it was prior to changes suggested by Mike Anton, compute degree of operating leverage (DOL), degree of financial leverage (DFL), and degree of combined leverage (DCL) both for Figure 2 (before changes) and Figure 4 (after changes). Use equations 53, 55, and 57 from the text. 4. Using the same financial statements (Figure 2 and Figure 4), compute the breakeven point before and after the changes. Use equation 5-1 from the text. 5. Assume you use a different measure of break-even an alysis. The answer to question 4 tells you the number of units the firm needs to sell to cover fixed costs. Assume you are interested in covering all cash out flows and, furthermore, will use only cash flow numbers rather than accounting numbers. The cash out flows to be covered are (Fixed costs depreciation) plus interest payments. The formula for the revised break-even (BE) point is: (Fixed costs-depreciation)+ Interest Revised BE = Price (P)-(VC) variable cost per unit Apply this formula to Figure 2 to get the revised break-even point before the changes and Figure 4 to get the revised break-even point after the changes. (Note the value for depreciation can be found as a footnote at the bottom of the two figures). 6. Harry Engle suggests that the company could be in trouble if Mike Anton's changes are put in place (as reflected in Figure 4) and sales volume is only 300,000 units. Using your revised break-even answers from question 5, do you agree? 7. Finally, assume sales volume reaches 1,500,000 units after Mike Anton's changes are put into place. What will the new figure be for earnings per share? Under the old plan, earnings per share at 1,500,000 units would be $1.72. Genuine Motor Products $45,000,000 5,800,000 Sales (1,500,000 units @ $30 per unit) Fixed costs. - Total variable costs (1,500,000 units @ $18.80 per unit) Operating in come... Interest (10.75% x $12,000,000). Earnings before taxes. - Taxes (35%) Earnings after taxes. Shares .... 2,320,000 Earnings per share.. 8. After computing all the numbers in the case, are you inclined to agree with Mike Anton that the changes to automation would be a good idea or Harry Engle, the chieffinancial officer, that they wouldnot be? What is likely to be the key variable in determining the success or failure of the new plan? Genuine Motor Products located in Northern Ohio, manufactures precision measuring devices to monitor exhaust emission systems for new and used automobiles. Its products are sold worldwide. The firm hired Mike Anton in January of 2014 as vice president in charge of manufacturing operations. Mike had a bachelor's degree in industrial engineering from Case Western Reserve University and an MBA from Ohio State University, He had spent the last 15 years working for General Motors (Arlington, Texas division), Toyota Motor Corp., and Volvo. At age 38, he had established a good reputation for innovation within the auto and auto parts industry, Upon being hired, he began looking over the financial statements, particularly the balance sheet as of December 31, 2013 and the pro forma income statement for 2014 as shown in Figure 1 and 2, respectively. His immediate reaction was that the firm had not made the move to automation that others in the industry had. The company's manufacturing process was highly labor intensive as indicated by the fact that fixed assets (net plant and equipment) represented only $8 million out of total assets of $24 million (Figure 1) and that variable costs per un it were $25 in comparison to a sales price of $30 per unit (Figure 2). Although he thought the pro forma in come statement for 2014 as shown in Figure 2 looked reasonably good, he believed returns could be better if the firm went to greater automation and was less dependent on labor and expensive materials. When he shared his thoughts with Harry Engle, the chief financial officer, the response he received was lukewarm. Harry had been with the firm in good times as well as bad over the last 20 years and was quick to point out the advantages of not being tied up with a lot of fixed costs and debt during a slow down in sales in the auto industry. As Harry was fond of saying, "Genuine Motor Products does not have a labor union and when business is bad, we lay people off. By gosh, you can't lay machinery and equipment off. Figure 1 GENUINE MOTOR PRODUCTS Balance Sheet As of December 31, 2013 Assets Current assets $16,000,000 8,000,000 $24,000,000 10,000,000 Fixed assets Plant and equipment $20,000,000 Less: accumulated depreciation 12,000,000 Net plant and equipment Total assets.. Liabilities and Stockholders' Equity Current liabilities Long-term liabilities: Bonds payable 10.75% Total liabilities..... Stockholders' equity: Common stock, $1 par value, 2,000,000 shares... Capital in excess of par Retained earnings. Total stockholders' equity...... Total liabilities and stockholders' equity.. 2,000,000 $12,000,000 $ 2,000,000 4,000,000 6.000.000 $12,000,000 $24.000.000 Figure 2 GENUINE MOTOR PRODUCTS GENUINE MOTOR PRODUCTS Pro Forma Income Statement For 2014 Sales (1,000,000 units @ $30 per unit) - Fixed costs*....... - Total variable costs (1,000,000 units @ $25 per unit Operating income (EBIT). - Interest (10.75% x $2,000,000) Earnings before taxes Taxes (35%).... Earnings after taxes... Shares Earnings per share..... * Fixed costs include $1,000,000 in depreciation $30,000,000 2,000,000 25,000,000 $ 3,000,000 215,000 $ 2,785,000 974,750 $ 1,810,250 2,000,000 $ .91 Genuine Motor Products In spite of Harry's arguments, Mike Anton was determined to show the impact of both operating and financial leverage on Genuine Motor Products operations. He reconstructed the year-end balance sheet for 2013 (previously shown in Figure 1), and the results are shown in Figure 3 based on the following assumptions. 1. That the firm would increase fixed assets by $14 million. 2. That $ 10 million of the $14 million would be funded through long-term debt in the form of additional bonds payable at an interest rate of 10.75%. 3. The remaining $4 million would come from the sale of additional common stock at a net price to the corporation of $12.50. This would require the issuance of 320,000 new shares ($4 million/$12.50 = 320,000 shares). The impact of these values on the balance sheet in Figure 3 shows substantially greater leverage both on the asset and liability side. Figure 3 GENUINE MOTOR PRODUCTS Revised Balance Sheet For the year ended December 31, 2013 Assets Current assets $16,000,000 Fixed Assets Plant and equipment... $34,000,000 Less: Accumulated depreciation 12,000,000 Net plant and equipment 22,000,000 Total assets..... $38.000.000 Liabilities and Stockholders' Equity Current liabilities. 10,000,000 Long-term liabilities: Bonds payable 10.75% 12,000,000 Total liabilities.. $22,000,000 Stockholders' equity: Common stock, $ 1 par value, 2,320,000 shares $ 2,320,000* Capital in excess of par. 7,680,000** Retained earnings....... 6,000,000 Total stockholders' equity ...... $16,000,000 Total liabilities and stockholders' equity... $38,000,000 *2,000,000 old shares + 320,000 new shares = 2,320,000 shares ** 4,000,000 old capital in excess of par + 320,000 new shares x ($12.50 price $ 1 par value) = 4,000,000 + 320,000 ($11.50) = $7,680,000 Genuine Motor Products The intent of using more leverage was to increase the potential profitability of the firm. You are called in as a financial analyst to rework the 2014 pro forma income statement based on the assumptions stated in Table 1. These primarily relate to the fact there are now more fixed assets, long-term debt, and shares outstanding. Table 1 Assumptions for Revised Pro Forma Income Statement 1. Sales will remain constant at 1,000,000 units at $30 per unit. 2. Fixed costs will increase from $2,000,0000 to $5,800,000, a gain of $3,800,000. (Depreciation expense will be $2,800,000 and this will be shown as a footnote in the 2014 pro forma income statement). 3. Variable cost per unit will be reduced from $25 to $18.80. A total of 1,000,000 units will still be sold. The reduction in variable costs per unit is a direct result of the increased fixed costs and the associated automation. 4. Interest expense will reflect that there is now $12 million in long-term debt in the form of bonds payable at 10.75%. Ten million dollars of new debt is being added to $2 million of old debt. 5. Shares outstanding are now at a level of 2,320,000. Three hundred and twenty thousand new shares are being added to the 2,000,000 old shares currently outstanding. Required 1. Complete the revised pro forma income statement below. In the process, refer back to Figure 2, the original pro forma income statement for 2014 and the assumptions in Table 1. The new statement you are developing below will be referred to as Figure 4 for purposes of reference. Figure 4 GENUINE MOTOR PRODUCTS Revised Pro forma Income Statement For 2014 $30,000,000 5,800,000 Sales (1,000,000 units @ $30 per unit) - Fixed costs* Total variable costs (1,000,000 units @ $18.80 per unit Operating in come (EBIT) ....... Interest (10.75% x $12,000,000).. Earnings before taxes. - Taxes (35%) Earnings after taxes. Shares ....... Earnings per share..... * Fixed costs include $2,800,000 in depreciation 2,320,000 1.15 $ 2. Explain the primary reasons for the change in earnings per share between Figure 2 and Figure 4. 3. To determine the extent the company is more leveraged than it was prior to changes suggested by Mike Anton, compute degree of operating leverage (DOL), degree of financial leverage (DFL), and degree of combined leverage (DCL) both for Figure 2 (before changes) and Figure 4 (after changes). Use equations 53, 55, and 57 from the text. 4. Using the same financial statements (Figure 2 and Figure 4), compute the breakeven point before and after the changes. Use equation 5-1 from the text. 5. Assume you use a different measure of break-even an alysis. The answer to question 4 tells you the number of units the firm needs to sell to cover fixed costs. Assume you are interested in covering all cash out flows and, furthermore, will use only cash flow numbers rather than accounting numbers. The cash out flows to be covered are (Fixed costs depreciation) plus interest payments. The formula for the revised break-even (BE) point is: (Fixed costs-depreciation)+ Interest Revised BE = Price (P)-(VC) variable cost per unit Apply this formula to Figure 2 to get the revised break-even point before the changes and Figure 4 to get the revised break-even point after the changes. (Note the value for depreciation can be found as a footnote at the bottom of the two figures). 6. Harry Engle suggests that the company could be in trouble if Mike Anton's changes are put in place (as reflected in Figure 4) and sales volume is only 300,000 units. Using your revised break-even answers from question 5, do you agree? 7. Finally, assume sales volume reaches 1,500,000 units after Mike Anton's changes are put into place. What will the new figure be for earnings per share? Under the old plan, earnings per share at 1,500,000 units would be $1.72. Genuine Motor Products $45,000,000 5,800,000 Sales (1,500,000 units @ $30 per unit) Fixed costs. - Total variable costs (1,500,000 units @ $18.80 per unit) Operating in come... Interest (10.75% x $12,000,000). Earnings before taxes. - Taxes (35%) Earnings after taxes. Shares .... 2,320,000 Earnings per share.. 8. After computing all the numbers in the case, are you inclined to agree with Mike Anton that the changes to automation would be a good idea or Harry Engle, the chieffinancial officer, that they wouldnot be? What is likely to be the key variable in determining the success or failure of the new plan
