9-1

Module 9Finishing the Ratios

35. Retention rate

Earnings attributable to common shares – common shares dividends / Net income attributable to common shares = 1 – payout ratio

2018 2019

36. Sustainable growth rate

Retention rate X Return on equity

2018 2019

38. Book Value per share

Common stock equity / total shares of common stock outstanding

(Total Owners’ Equity – Preferred share amounts) / total shares outstanding

2018 2019

Total stock outstanding is as of the date. It is not a weighted average!

39. Free cash flow to equity (FCFE)

9-2

Cash flow from operating activities – investment in fixed capital + Net borrowing

2018 2019

40. Free cash flow to the firm (FCFF)

Cash flow form operating activities + interest expense X (1 – tax rate) – investment in fixed capital.

2018 2019

9-3

9-4

9-5

Hermi’s Bumbles, Inc.

Hermi’s Bumbles is a company that has been in business for three years. The company is a wholesaler of Bumbles. Bumbles are bulbs which grow into beautiful, sweet smelling plant-trees. They are a cross between a hyacinth and a buckeye. They are refrigerated and must be planted within one year of when they are harvested. Hermi buys the bumbles from a grower when they are one month old. Hermi has one location in Columbus, Ohio. It has three refrigerated trucks which deliver the Bumbles throughout Ohio. The financial statements on the previous page summarize Hermi’s operations for its first three years.

Hermi began operations with individuals investing $120,000 for 12,000 shares of common stock and a small business loan of $200,000 from the bank. The loan carries interest at 12%. Hermi must pay the interest plus $10,000 on the principal on January 1 of each year. Hermi sells using terms of 2/10 n/30. The latest sale of stock between individuals was yesterday at $85.00 per share. There are more shares available from the other investors for this amount. The tax rate is 30%.

The financial statements for Hermi’s are on the following page.

Calculate and comment on each of the following ratios for 2018 and 2019.

1. Current Ratio

2018 2019

272,140 382,770 192,000 248,000

1.42 1.54 You have $1.42 and $1.54 in short-term assets to cover short term liabilities

2. The Quick or “Acid Test” ratio

2018 2019

272,140 - 160,000 382,770 – 200,000 192,000 248,000

.584 .737

9-6

3. Accounts Receivable Turn and Average Collection Period

2018 2019

700,000 1,100,00060,000 + 40,000 110,000 + 60,000

2 2

Receivable Turn 14 12.94

365 365 14 12.94

Average collection period 26.07 Days 28.20 Days

People are not taking advantage of discount – that is worrisomeThe collection period has decreased while sales have increased!!!

2/10, n/30 means you may take a 2% discount if you pay within 10 days, otherwise you must pay within 30 days. So you are “paying” 2% by paying in 30 days. Means you are paying 2% for 20 days (30 – discount time), which equals a return (loss to the customer) of 365/20 or 18.25 X 2%, equals 36.5% interestIf don’t take discount, means:

1) Short of Cash2) Don’t understand business math.

4. Inventory Turn and Average Days Sales in Inventory

2018 2019

360,000 687,500 80,000 + 160,000 160,000 + 200,000

2 2

Inventory Turn 3 3.82

365 365 3 3.82

Average Days Sales in Inventory

121.67 95.55

Sales have increased substantially and the handling of inventory has gotten much more efficient!This is important because Bumbles rot!

9-7

5. Book Value Per Share

2018 2019

130,140 214,770 12,000 12,000

$10.84 $17.90

6. Return on Assets (ROA)

2018 2019

70,140 84,630 402,000 + 502,140 502,140 + 632,770

2 2

15.52% 14.91%

7. Return on Equity (ROE)

2018 2019

70,140 84,63064,000 + 130,140 130,140 + 214,770

2 2

72.26% 49.07%

8. Debt Ratio Liabilities / Assets

(Note CFA ratio uses only debt on which interest is paid)

2018 2019

372,000 418,000 502,140 632,770

74.08% 66.06%

9-8

9. Debt to Equity

2018 2019

372,000 418,000 130,140 214,770

2.86 1.95

9-9

Balance Sheet Assets 2019 2018 2017

Current Assets Cash 64,770$ 44,140$ 87,000$ Accounts Receivable - Net 110,000 60,000 40,000 Inventories 200,000 160,000 80,000 Other current assets 8,000 8,000 5,000 Total Current Assets 382,770 272,140 212,000

Net Fixed Assets 240,000 220,000 180,000

Other Assets 10,000 10,000 10,000

Total Assets 632,770$ 502,140$ 402,000$

Current Liabilities Accounts Payable 210,000$ 150,000$ 100,000$ Other Payables 28,000 32,000 38,000 Current Portion- Long Term Debt 10,000 10,000 10,000 Total Current Liabilities 248,000 192,000 148,000

Long-Term Debt- Net of Current Maturities 170,000 180,000 190,000

Total Liabilities 418,000 372,000 338,000

Owners' Equity Common Stock $10 Par 120,000 120,000 120,000 Retained Earnings 94,770 10,140 (56,000) Total Owners' Equity 214,770 130,140 64,000

Total Liabilities and Owners' Equity 632,770$ 502,140$ 402,000$ - - -

Income StatementSales 1,100,000$ 700,000$ 400,000$ Cost of sales 687,500 360,000 240,000 Gross Margin 412,500 340,000 160,000

Operating Expenses Salaries and wages 110,000 100,000 80,000 Rent 48,000 48,000 48,000 Utilities 20,000 19,000 18,000 Advertising 25,000 20,000 15,000 Vehicle expenses (Gas, oil etc) 29,000 26,000 13,000 Depreciation 15,000 10,000 10,000 Other Operating Expenses 23,000 18,000 12,000 Total Operating Expenses 270,000 241,000 196,000

Income From Operations 142,500 99,000 (36,000) Other Expenses Interest (21,600) (22,800) (24,000) Income Before Taxes 120,900 76,200 (60,000) Income Tax Expense 36,270 6,060 - Net Income 84,630$ 70,140$ (56,000)$

9-10

Brighthouse Financial

9-11

Zach’s is saying that the company will earn $8.50 per share this year. The stock is selling for $36.74 which gives a current yield of 23.13%!! What the hell is going on?!?

9-12

9-13

Why would another company which had sufficient cash buy this company up and just liquidate it. Would seem the buying company would net between $100 and $150 per share.

https://seekingalpha.com/

9-14

https://www.investopedia.com/ask/answers/071415/why-would-company-perform-reverse-stock-split.asp

9-15

9-16

Now we in order to go forward toward

“But I think that there’s no magic to evaluating any financial asset. A financial asset means, by definition, that you lay out money now to get money back in the future. If every financial asset were valued properly, they would all sell at a price that reflected all of the cash that would be received from them forever until Judgment Day, discounted back to the present at the same interest rate.”

Warren Buffett

We go back to Fixed Income Instruments

The coupon rate of a bond is: The % of the face that the bond pays in interest each year.

On January 1, 2020, Isabella Company of Las Vegas, Nevada, issues $100,000 of 8% bonds. The bonds pay interest annually and mature in three years. Interest is to be paid on December 31 of each year. (First interest is to be paid 12/31/20)Remember these are unreal examples! Bonds mature in many, many years, not 3!

Applied PrincipalDate Payment Interest

8%Principal Balance

1/1/20120

100,000.00

12/31/20 8,000.00 8,000.00 0.00 100,000.00 12/31/21 8,000.00 8,000.00 0.00 100,000.00 12/31/20 8,000.00 8,000.00 0.00 100,000.00 12/31/20 100,000.00 100,000.0

0 0.00

What if by the time it got to the market, interest rates had risen to 10%?

The purpose of education isn’t knowledge, it is action.

9-17

Kirch’s 3rd law of the Universe…. You Can’t Change the Deal!!!!

How much does Isabella receive?2nd clr tvm8,000 pmt

100,000 fv 3 N

10 I/YCpt pv95,026.30

Bonds issued for less than the face are said to be issued at discount.

Amortize the bond

https://smile.amazon.com/HP-10bII-Financial-Calculator-NW239AA/dp/B0002ABA8E/ref=sr_1_3?crid=16VIM6JBO8FD3&dchild=1&keywords=ti+ba2+plus+financial+calculator&qid=1591717299&sprefix=ti+ba2%2Caps%2C323&sr=8-3

Show how the Bond Accounts appear on the Balance Sheet for each year.What about current portion?

Balance Sheet2020 2021 2020

Bond Pay 100,000 100,000 Less Discount (3,471) (1,818)  

96,529 98,182

What if the current interest rate was 6%? (3rd law applies!!!)

Applied PrincipalDate Payment Interest

10%Principal Balance

1/1/20 95,026.30 12/31/20 8,000.00 9,502.63 (1,502.63) 96,528.93 12/31/21 8,000.00 9,652.89 (1,652.89) 98,181.82 12/31/22 8,000.00 9,818.18 (1,818.18) 100,000.01 12/31/22 100,000.00 100,000.00 0.01

9-18

calculate issuance amount, and amortize

Bonds sold for an amount higher than the face are said to sell at a p________________.

Are you listening, or just reloading?

A zero coupon bond is

9-19

Also called a D________ D_____________ B________

Why issue/buy?

Malcom Co. issues a $100,000 zero on December 31, 2018, interest rate 10% per annum, bond is due in three years. How much do they get? Amortize it

Module 9, Homework

9-20

Problem 1 Brynnie Company issues a $100,000 on 12/31/19, 15%, bond that matures in 3 years. Interest is paid on December 31st of each year. Calculate how much would be received and amortize this bond issue if it was priced to yield: 10% 15% 20%

Problem 2 Charleigh Company issued 8% zero on 12/31/19, due in 3 years, face amount of $100,000. How much would you pay? Amortize it.

Problem 3 Ryan Company issues a $100,000 on 8/31/19, 10%, bond that matures in 5 years. Interest is paid on August 31st of each year. How much would you pay to yield:

8% 10% 14% Amortize each of these

Problem 4 Still Ryan Company - How about a zero issued on 5/31/19, due in 4 years, face amount of $100,000. Current market rates are 11%. How much would you pay?Amortize it.

Problem 5 Extra Hard!! Go back to the Isabella Company bonds, 8% coupon, issued to yield 10%, – What if the date of issuance is April 1st and not December 31st? What would be the interest expense for the second year?

Now do same bonds, 8% coupon, issued to yield 6%. What would be the interest expense for the second year?