Question

First, restructure the balance sheet into a managerial balance sheet by re-arranging it to include the working capital requirement. Then answer the questions that follow. Treat pre-paid expenses the same as you would accounts receive-able. As a check on your work. You should arrive at a capital employed (left hand side of the managerial balance sheet) of $1,090).

The balance sheet of a firm is (in millions of $):

Cash		75		Short term debt		50
A/R		65		A/P		35
Pre-paid expense		10		Long term debt		900
Inventory		75		Owner's equity		140
Net fixed assets		900
		1125				1125

The income statement is (in millions of $):

Revenue				1600
Cost of goods sold				-1160
Sales and administration expenses				-200
Depreciation				-55
EBIT				185
Net interest expense				-65
Earnings before tax (EBT)				120
Income tax expense				-95
Earnings after tax (EAT)				25
Dividends				-10
Retained earnings				15

(A) What WCR to you calculate?

(B) What is the Invested Capital?

(C)Looking at the combined debt (short and long term), what average interest rate is the firm paying on debt?

(D)Calculate the firms ROIC before taxes

(E) What is the firm’s ROE?

(F) What is the firms operating profit margin?

(G)What is the firm’s cash flow (BEFORE it pays a dividend and BEFORE it pays taxes but AFTER it pays interest on the debt)?

(H)What is the self-sustainable growth rate ?

(I)What concerns you about the firm’s financial condition (there is more than one correct answer)?

(A) It doesn’t have enough long term debt

(B) It has a lot of debt. This means that if its cash flow drops too much it will not be able to meet the interest payments on the debt and risks bankruptcy

(C)It has a lot of debt. This means that if its cash flow drops too much it will not be able to meet the dividend payments because it has to make the interest payments ahead of the interest payments. If it cuts the dividend payment it will shake investor confidence in the stock

(D)Nothing, the balance sheet is in fine shape

Answer 1

Below is the managerial balance sheet:

Managerial Balance Sheet
Invested Capital of net assets		Capital Employed
Particulars	Amount (in million of $)	Particulars	Amount (in million of $)
Cash:	75	Short term debt:	50
Working Capital Requirement:		Long term financing:
A/R	65	Long term debt	900
Prepaid expenses	10	Owner's equity	140
Inventory	75
A/P	-35
Net fixed assets:	900
Grand Total	1090	Grand Total	1090

Q.1  What WCR to you calculate?

Answer: Working Capital Requirement = Operating assets - Operating liabilities

...............................................................= (A/R + Prepaid expenses + Inventory) - A/P

...............................................................= (65 + 10 + 75) - 35

...............................................................= $ 115 million

Q.2 What is the Invested Capital?

Answer: Invested Capital = short term debt + long term debt + Owner's equity

..........................................= 50 + 900 + 140

..........................................= $ 1,090 million

Q.3 Looking at the combined debt (short and long term), what average interest rate is the firm paying on debt?

Answer: Average interest rate = Net interest expense / (short term debt + long term debt)

..................................................= 65 / (50 + 900)

..................................................= 65 / 950

..................................................= 6.84%

Q.4 Calculate the firms ROIC before taxes?

Answer: Return on Invested Capital before taxes = Earning before tax / Invested Capital

................................................................................= 120 / 1,090

................................................................................= 11.01%