Question

P25 Samsonite Corporation: Review the time-series of various financial leverage and coverage ratios for Sam- sonite Corporation in Exhibit P2.5. (Samsonite designs, develops, manufactures, and sells luggage and travel related consumer products.) a Discuss the change in Samsonite's financial leverage and coverage ratios over the time-series. b. Using its financial leverage and coverage ratios, discuss what you know about its common equity. C. Which is larger interest expense or preferred stock dividends for each year in the time series (Assume that an income tax rate of zero was used to measure the financial ratios.) Year 9 Year 7 0.9 EXHIBIT P2.5 Financial Leverage and Coverage Ratios for Samsonite Corporation Samsonite Corporation Year 1 Year 2 Year 3 Year 4 Year 5 Total debt to total assets ........... 0.5 0.5 0.3 0.8 0.8 Preferred stock to total assets..... 0.0 0.0 0.0 0.3 0.4 Total debt to common equity. 12.7 10.8 0.9 NMF NMF Preferred stock to common equity........ 0.0 0.0 NMF NMF EBIT coverage (interest only) ......... 3.6 0.5 1.1 EBIT coverage (interest + preferred stock dividends)..... 3.6 0.4 0.7 Year 6 0.8 0.4 NMF NMF 1.2 0.5 Year 8 0.7 0.6 NMF NMF 1.5 NMF NMF 0.7 0.3 NMF NMF 1.7 -0.2 0.7 0.9 0.7 0.5 0.8 1.0 "NMF - not a meaningful figure

Please answer P2.5 (first pic) and P.2.9 (second and third pic)

Answer 1

Year	1	2	3	4	5	6	7	8	9
Total debt/Total assets	0.5	0.5	0.3	0.8	0.8	0.8	0.9	0.7	0.7
Debt fuding of assets=	50%	50%	30%	80%	80%	80%	90%	70%	70%
So, Pref.& equity funding	50%	50%	70%	20%	20%	20%	10%	30%	30%

a. Financial leverage:

Debt funding assets decreased in Year 3(30%) , after being on par with equity(50%) in yrs. 1&2.

After yr.3, it increased to 80% in Yr.4 & remained so in the yrs. 5&6 , showing a further increase to 90% in Yr.7 , after which , the level of funding decreased to 70%

Coverage ratios

Interest coverage:

Year 1 shows a negative EBIT, when interest expenses are not covered at all.Interest coverage expressed as no.of times the EBIT, has increased in Yrs. & 3--the maximum being in Yr. 3 --when debt funding of assets , is also at the lowest(30%).It slumped to 0.5 times when the proportion of debt funding increased heavily, again to increase in yrs. 5&6. After a slight decrease in Yr. 7, the interest coverage increased in the last 2 yrs.

Pref. div. coverage:

There is no preference capital upto Year 3. From yr. 4, the total coverage ratio is decreased in all the years, showing declaration of preference dividends , in all the years.

b.
Year	1	2	3	4	5	6	7	8	9
Debt fuding of assets=	50%	50%	30%	80%	80%	80%	90%	70%	70%
Preferred funding				30%	40%	40%	50%	60%	30%
Equity funding(the balance)	50%	50%	70%	-10%	-20%	-20%	-40%	-30%	0%

From the above,it is clearly that from Year 4 , equity has not participated in asset formation. Equity might have been very negligible in the capital structure.Instead, preferred capital had been used to fund asset acquisitions.

c.

Interest expenses are larger -- as the debt amount is more than preferred capital ,in all the years(given 0 tax rate)

Also, the combined coverage ratios ,not only, follow the same pattern as for interest coverage of EBIT, but also , the difference between the two coverage times is very small, in all the years except the last 2 yrs.

2.b&c.. Year	1	2	3	4	5	6
Return on Assets:(Net Income+((1-Av.Tax rate)*Int.exp.))Av.Total assets
Pretax Income	1.2	3.93	1.24	1.72	1.03	0.95
Income Tax	0.42	1.38	0.43	0.6	0.36	0.33
Av.IT Rate(2/1)	35%	35%	35%	35%	35%	35%
1.Net Income		2.53	0.81	1.12	0.67	0.62
Int.exp.		3.62	3.83	3.9	4.52	3.97
2.((1-35%)*Int.exp.)		2.35	2.49	2.54	2.94	2.58
Beg. Total assets		86.52	108.25	112.47	112.4	106.21
End. Tot. assets		108.25	112.47	112.4	106.21	103.18
3.AV.=(Beg.+End.)/2		97.39	110.36	112.44	109.31	104.70
Return on assets=(1+2)/3		5.01%	2.99%	3.25%	3.30%	3.06%
Return on Equity=Net Income/Av. Common equity
1.Net Income		2.53	0.81	1.12	0.67	0.62
Beg. Total equity		27.38	40.49	40.21	29.61	29.1
End. Tot.equity		40.49	40.21	29.61	29.1	29.29
2.AV.=(Beg.+End.)/2		33.94	40.35	34.91	29.36	29.20
Return on Equity=(1/2)		7.46%	2.01%	3.21%	2.28%	2.12%
a.The return on assets formula used by the analyst measures the operating income generated against the average total used during the year.
The return on equity formula measures the final net income generated & available to common equity, against the average equity funds employed & used during the year.