Does the company operate beyond a break-even revenue level?

BUS 311 Checkpoint Project

The checkpoint discussion can be extended around a series of questions from the perspective of owners, managers, short-term creditors, long-term creditors, market, and investors. Financial ratios are important tools to answer those questions and interpret the financial health of the company.
The ratio calculation is done through the excel template. You can copy the results into this template the work the the rest. You need to carefully read through the the ratios along the time and work out the answers in small paragraphs for the related questions in each major topic.
This exercise prepare you for the writing of the checkpoint project. Once completing part 1 and 2, you can organize the your answers on the relevant questions into the final paper.
Usually, financial analysis should be conducted both along the time and against peers or industry benchmarks. Our study does not require industry benchmark comparison. You can focus ratio changes over time, the underlying business decisions and transactions that caused the change, and their implications upon the financial health and investment value of the company
The grade grade is based on both the financial calculations and the interpretation.

STEP 1:

Q0: Conduct an environmental scan, indicating future prospect for a company.

Q0-1. Short description of the company background.
Q0-2. Industry analysis on the Strength / Weakness / Opportunities / Threats of the company

Strength
Weakness
Opportunities
Threats

Q0-3. Comment on recent stock performance (price chart)

Return from last year
52-Week Price Change 10.75%
Dividend Yield n/a

Price history

Q1: Overview of the company financials

Q1-1. What is the size, revenue, profit, revenue, and free cash flow for the last 5 years?
Q1-2. How the stock performed over the recent 5 years?

Question:
• Is the company of large, small, or medium size?
• Is the company profitable?
• Does the company generate positive free cash flow to investors?
• Does the market return reflect positive on the company performance?

Q2. From shareholder or investor perspective
2-1. How well has management utilized the company’s assets?
2-2. How well is the return over the stockholder’ equity?

Return on Assets = Net Income / Total assets
Return on Equity = Net Income / Equity

Question:
• Is the company profitable?
• How has the profitability changed over time?
• Any reason for such a change?

2-3. Cash flow analysis

Free cash flow = Cash flow from operation – CAPEX

Questions
• Is the company operations profitable?
• Is there any financing need? For what purpose, investment or financing?
• Is there any major investment spending? For what purpose?
• Does the company provide healthy free cash flows to investors?
• Cash is the “King”. How does the cash flow situation related the stock performance?

Q3. From Manager’s perspective

3-1. DuPont Identity

DuPont Identity decompose the ROE into three different sources: profitability, management efficiency, and financial leverage.
Net profit margin = Net Income / Sales
Total asset turnover ratio = Sales / Total assets
Equity multiplier = Assets / Equity
Return on Equity = (Net Profit Margin) * (Total asset turnover) * (Equity Multiplier)

Questions:
• Profit margin: Are profits high enough, given the level of sales?
• Total asset turnover: Are sales higher enough, given the level of assets?
• Equity multiplier: How did the financial leverage change the return on equity?
• What has been the main driving factors for the change of ROE in recent years, profitability, asset turnover, or financial leverage, or mix of the three?

3-2. Management efficiency

Account collection period = (Account Receivable) / (Credit Sales / 365)
Notes: If there is no data on “credit sales”, use “sales” data instead.
Inventory holding period = (Inventory) / (Cost of goods sold / 365)

Questions:
• Are receivables coming in too slowly?
• Is there too much cash tied up in inventories?

3-3. [Cost-volume analysis for EBDAT breakeven]
How does current revenue compare with the breakeven level?

VC = Variable cost = cogs
CFC = (Admin + marketing + other operating expense) + (interest expense)
R = Revenue
SR = Survival revenue = CFC / (1 – VC / R)

When actual revenue > Survival Revenue, the company can achieve profit over the fixed and variable cost combined. The ratio of R/SR shows the overall profitability for the company.

Questions:
• Does the company operate beyond a break-even revenue level?
• How did the Revenue / Survival revenue ratio change recently?
• What is the implication?

Q4. Short-term Creditors

4-1. Does this customer have sufficient cash or other liquid assets to cover its short-term obligations?
The Current Ratio and Quick Ratio measure the short-term liquidity of the firm?
The Current Ratio [Current Assets / Current Liabilities]
The Quick Ratio [(Current Asset – Inventories) / (Current Liabilities)]

Questions:
• Is the company facing liquidity issues for operation?
• How the company liquidity situation changed over time?

Q5. Long-term creditors

Debt-to-Equity (D/E) = [Total liabilities] / [Total Equity]
The Times Interest Earned (TIE) [Income + (Interest + Taxes)] ÷ [Interest Expense]

Questions
• As a potential or present long-term borrower, how heavy is debt financing over equity financing?
• Are earnings and cash flow sufficient to cover interest payments and provide for some principal repayment?

Q6. Market

6-1. How is the financial performance priced in the financial markets?

Price-book ratio = [price per share] / [book value per share]
Price-earnings ratios = [price per share] / [earnings per share]
Dividend Yield = [Dividend per share / [price per share]

Questions:
• How has the financial health changed over time, better or worse, for the past 5 years?
• Is the market reacting favorably to the company’ business performance?

6-2. Market value added
Market value added = (Price per share – book value per share) * (# of shares)
Enterprise value = market value of equity + short & long-term debt – cash

Q7. Potential investors
Note: for this section, no detailed calculations are needed.
Questions:
• Research at least two the recent investment initiative taken by the company.
• How such initiatives could affect the company’s future cash and value?
• What are the potential risks associated with the investment activities?
• What are the implication for investors?

STEP 2:

Q8. Cost of capital

Note: if there is no allocation to preferred stocks, you can ignore the component from preferred stocks.

8-1 Weighted average cost of capital

What does the WACC mean?
1) The average cost of financing or hurdle rate for the business
2) The average return required by the capital providers
3) The opportunity cost for the capital providers

8-2. Economic value added
The business need to make higher return than the WACC to be profitable. The WACC is the opportunity cost of the capital from the capital providers.
The dollar amount business can achieve beyond the opportunity cost of capital is called economic value added.

EBIT = ??
Assume T = Tax rate = 35%
Total capital from financing = (Debt + Preferred + Equity)
Economic value added = EBIT * (1-T) – (Total capital) * WACC.

Question:
• Is the economic value added positive or negative?
• What is the implication from the result?

Q9. Summary (detailed analysis is required)
9-1. List your overall conclusion on the financial analysis.
9-2. Were the financial ratios and indicators accurate reflection of business performance?
9-3. Comment on the company’s financial condition: excellent, healthy, or ill.
9-4. Is the stock over, under, or fairly-priced?
9-5. Is the stock a good investment candidate? Buy or Sell?