Case Study 1: Saffron City Conglomerates, Inc.

Situation:

June Holburn, a graduate of the University of Oregon with 5 years of experience as an equities analyst, was recently brought in as assistant to the chairman of the board of Saffron City Conglomerates, Inc. (SCC), a multinational conglomerate corporation with fifteen major subsidiaries.

In an effort to streamline operations and stay competitive, SCC has recently spun off 100% of its augmented reality subsidiary at a price of $2.50/share, resulting in dramatic changes to the corporation’s financial statements. As a result, its managers, directors, and investors are concerned about the firm’s survival. At the board’s insistence, June Holburn was given the job of assistant to Geralt River, a retired banker who was SCC’s chairman and largest stockholder. River agreed to give up a few of his hunting days and to help assuage the fears of the investors, with Holburn’s assistance.

SCC’s 2015 and 2016 balance sheets and income statements, projections for 2017, and industry average data are shown in the following tables. The 2017 projected financial statement data represent Holburn’s and River’s best guess for 2017 results.

Input Data:

2015

2016

2017E

Year-end common stock price

$12.75

$10.00

$11.25

Year-end shares outstanding

100,000

100,000

100,000

Tax rate

40%

40%

40%

Lease payments

$50,000

$50,000

$50,000

Balance Sheets (thousands)

Assets

2015

2016

2017E

Cash and equivalents

$87,350

$42,740

$56,780

Accounts receivable

$192,620

$216,950

$223,620

Inventories

$529,820

$404,940

$380,620

Total current assets

$809,790

$664,630

$661,020

Gross Fixed Assets

$1,515,760

$1,207,240

$1,150,360

Less Accumulated Dep.

$334,930

$285,110

$247,750

Net Fixed Assets

$1,180,830

$922,130

$902,610

Total Assets

$1,990,620

$1,586,760

$1,563,630

Liabilities and equity

Accounts payable

$180,620

$130,540

$140,280

Accruals

$112,600

$90,520

$82,760

Notes payable

$175,260

$132,680

$127,790

Total current liabilities

$468,480

$353,740

$350,830

Long-term bonds

$680,440

$540,640

$460,720

Total liabilities

$1,148,920

$894,380

$811,550

Common stock (100,000 shares)

$640,000

$640,000

$640,000

Retained earnings

$201,700

$52,380

$112,080

Total common equity

$841,700

$692,380

$752,080

Total liabilities and equity

$1,990,620

$1,586,760

$1,563,630

Case Study 1: Saffron City Conglomerates, Inc.

June Holburn, a graduate of the University of Oregon with 5 years of experience as an equities analyst, was recently brought in as assistant to the chairman of the board of Saffron City Conglomerates, Inc. (SCC), a multinational conglomerate corporation with fifteen major subsidiaries.

In an effort to streamline operations and stay competitive, SCC has recently spun off 100% of its augmented reality subsidiary at a price of $2.50/share, resulting in dramatic changes to the corporation’s financial statements. As a result, its managers, directors, and investors are concerned about the firm’s survival. At the board’s insistence, June Holburn was given the job of assistant to Geralt River, a retired banker who was SCC’s chairman and largest stockholder. River agreed to give up a few of his hunting days and to help assuage the fears of the investors, with Holburn’s assistance.

SCC’s 2015 and 2016 balance sheets and income statements, projections for 2017, and industry average data are shown in the following tables. The 2017 projected financial statement data represent Holburn’s and River’s best guess for 2017 results.

Income Statements

2015

2016

2017E

Net sales

$5,723,000

$3,834,400

$4,035,600

Costs of Goods Sold

$3,891,000

$2,847,500

$2,943,830

Other Expenses

$1,413,000

$720,000

$612,960

Depreciation and amortization

$170,540

$131,820

$124,000

Total Operating Cost

$5,474,540

$3,699,320

$3,680,790

Earnings before interest and taxes (EBIT)

$248,460

$135,080

$354,810

Less interest

$54,430

$43,250

$36,860

Earnings before taxes (EBT)

$194,030

$91,830

$317,950

Taxes (40%)

$77,612

$36,732

$127,180

Net Income before preferred dividends

$116,418

$55,098

$190,770

EPS

$1.164

$0.551

$1.908

DPS

$1.250

$1.260

$1.280

Book Value Per Share

$8.417

$6.924

$7.521

Ratio

Current

1.8

Quick

0.9

Inventory Turnover

8.5

Days sales outstanding

22

Fixed assets turnover

4.5

Total assets turnover

2.8

Debt-to-capital ratio

48%

TIE

28

Operating margin

5.50%

Profit Margin

3.60%

Basic earning power

12.40%

ROA

10.70%

ROE

16.10%

ROIC

14.00%

Price/earnings

15.4x

Market/book

1.6x

Book value per share

7.2

Industry Average

Holburn must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions should be taken. Your assignment is to help her answer the following questions. Provide clear explanations, not yes or no answers.

e. Calculate the profit margin, basic earning power (BEP), return on assets (ROA), return on equity (ROE), and return on invested capital (ROIC) for 2015, 2016, and 2017E. What can you say about these ratios?

Holburn must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions should be taken. Your assignment is to help her answer the following questions. Provide clear explanations, not yes or no answers.

a. Briefly list the five major categories of ratios and why ratios are helpful.

b. (1.) Calculate the current and quick ratios for 2015, 2016, and 2017E based on the projected balance sheet and income statement data.

(2.) What can you say about the company’s liquidity position? 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 liquidity ratios?

c. Calculate the inventory turnover, days sales outstanding (DSO), fixed assets turnover, and total assets turnover for 2015, 2016, and 2017E. How does SCC’s utilization of assets stack up against other firms in its industry?

d. Calculate the debt-to-capital and times-interest earned ratios for 2015, 2016, and 2017E. How does Celadon compare with the industry with respect to financial leverage? What can you conclude from these ratios?

e. Calculate the profit margin, basic earning power (BEP), return on assets (ROA), return on equity (ROE), and return on invested capital (ROIC) for 2015, 2016, and 2017E. What can you say about these ratios?

f. Calculate the price/earnings ratio, price/cash flow ratio, and market/book ratio for 2015, 2016, and 2017E. Do these ratios indicate that investors are expected to have a high or low opinion of the company?

g. Use the extended Du Pont equation to provide a summary and overview of SCC’s projected financial condition. What are the firm’s major strengths and weaknesses?

h. What are some potential problems and limitations of financial ratio analysis?

i. What are some qualitative factors analysts should consider when evaluating a company’s likely future financial performance?

j. Describe the overall effects of the spinoff. Ultimately, was this a good move for SCC? Explain.

k. Provide recommendations on how SCC might achieve their desired goals in the future

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