Question

The summarised financial statements of Swordfish plc for the three years ended 31st December 2006, 2007 and 2008 are shown below, in millions of pounds:

	2006	2007	2008
INCOME STATEMENT
Sales turnover (i.e. Revenue)	360.0	400.0	450.0
Operating Income (i.e. Operating Profit)	28.8	33.6	40.5
Interest (i.e. Finance costs)	(1.4)	(1.8)	(3.5)
Earnings before tax (i.e. Profit before tax)	27.4	31.8	37.0
Taxation	(8.2)	(9.6)	(11.0)
Net Income (i.e. Profit for the year)	19.2	22.2	26.0
BALANCE SHEET
ASSETS
Total Current Assets	80.0	116.0	171.0
Net Fixed Assets	40.0	44.0	54.0
Total Assets	120.0	160.0	225.0
DEBT & EQUITY
Total Current Liabilities	50.0	74.6	115.8
Long Term Debt	20.0	33.0	50.0
Equity
- Common Stock (i.e. Share Capital)	20.0	20.0	20.0
- Retained Earnings	30.0	32.4	39.2
Total Liabilities & Equity	120.0	160.0	225.0

The company’s common stock consists of 40 million ordinary shares with a face value of 50 pence each. The share price at the end of each of the last three years was as under:

	2006	2007	2008
Market price of share	240 pence	333 pence	455 pence

Required

(a)  Does the “Operating return on assets” (OROA) ratio of Swordfish plc indicate that the managers are generating adequate operating profits on the assets? Analyse the apparent reasons for the variation in the OROA ratio over the three years by breaking the ratio down into its two component ratios.

(b)  Assess whether the firm is providing value for shareholders, using the following additional ratios:

• Return on equity
• Earnings per share
• Price/Earnings ratio
• Price/Book ratio

Answer 1

Question is based on calculation of various ratios based on financial statements and Its interpretation.

A B C D E F G H I J K L M N O P a) Operating return on Assets(OROA) = Earning before Interest and Taxes/Total Assets 2008 450 Particulars Sales/ Revnue Operating Income/ EBIT Total Assets 2006 360 28.8 120 2007 400 33.6 160 40.5 225 18% OROA Operating Margin Asset Turnover ratio 24% 8% 3.00 21% 8% 2.50 2.00 OROA ratio of Swordfish plc indicate that managers are not generating adequate operating profit on the assets as OROA is decreasing over three year period as total assets are increasing over the same period. It indicates that assets are not efficently utilised. OROA can be broken down into components: 1. Operating Margin = Operating Income/ Sales 2. Asset Turnover Ratio = Sales/Total Assets OROA= Operating Margin x Asset Turnover Ratio From analysis of above components calculated above operating margin is increasing which indicates that company is making enough money from its ongoing operations to pay for its variable costs as well as its fixed costs. On the other decrease in assets turover ratio indicate that company is not efficiently utilising its assets to generate enough sales. As per total assets avilable with company, turnover should be higher. Company is not generating enough revenue per dollae of assets.

А B C D E F G H I J K L M N O 21 b) Return on Equity= Net Income Shareholders Equity Earning per share(EPS) = Earning attributable to Equity share holders/ Outstanding number of shares Price/ Earnings ratio= Market price per share/ EPS Price/ Book ratio = Market price per share/ Book value per share 2008 2006 19.2 26 50 59.2 Particulars Net Income (in millions of pounds) Shareholders Equity (in millions of pounds) Outstaning number of shares (In millions) Market price per share (Pounds) Total Assets (in millions of pounds) Total Liabilities (in millions of pounds) Book Value per share 2007 22.2 52.4 40 3.33 160 107.6 4.55 225 2.4 120 70 1.25 165.8 1.31 1.48 Return on Equity EPS Price/ Earnings ratio Price/Book Ratio 38.40% 0.48 5.00 1.92 42.37% 0.56 5.95 2.54 43.92% 0.65 7.00 3.07 Firm is providing value to shareholders as all ratios calculated above are increasing as return on equity indicate that shareholders are getting good return on their money. Increasing EPS indicates that company makes more money for each share of its stock. Increasing P/E and P/B ratio indicate that value of shareholder is increasing.