Question

After Dan’s analysis of East Coast Yachts’ cash flow (at the end of our previous chapter), Larissa approached Dan about the company’s performance and future growth plans. First, Larissa wants to find out how East Coast Yachts is performing relative to its peers. Additionally, she wants to find out the future financing necessary to fund the company’s growth. In the past, East Coast Yachts experienced difficulty in financing its growth plan, in large part because of poor planning. In fact, the company had to turn down several large jobs because its facilities were unable to handle the additional demand. Larissa hoped that Dan would be able to estimate the amount of capital the company would have to raise next year so that East Coast Yachts would be better prepared to fund its expansion plans.

To get Dan started with his analyses, Larissa provided the following financial statements. Dan then gathered the industry ratios for the yacht manufacturing industry

EAST COAST YACHTS 2017 Income Statement
Sales	$611,582,000
Cost of goods sold	431,006,000
Selling, general, and administrative	73,085,700
Depreciation	19,958,400
EBIT	$ 87,531,900
Interest expense	11,000,900
EBT	$ 76,531,000
Taxes	30,612,400
Net income	$ 45,918,600
Dividends	$ 17,374,500
Retained earnings	$ 28,544,100

EAST COAST YACHTS 2017 Balance Sheet
Current assets		Current liabilities
Cash and equivalents	$ 11,119,700	Accounts payable	$ 44,461,550
Accounts receivable	18,681,500	Accrued expenses	6,123,200
Inventory	20,149,650	Total current liabilities	$ 50,584,750
Other	1,172,200
Total current assets	$ 51,123,050
Fixed assets		Long-term debt	$169,260,000
Property, plant, and equipment	$457,509,600	Total long-term liabilities	$169,260,000
Less accumulated depreciation	(113,845,900)
Net property, plant, and equipment	$343,663,700
Intangible assets and others	6,772,000	Stockholders’ equity
Total fixed assets	$350,435,700	Preferred stock	$ 1,970,000
		Common stock	37,583,700
		Capital surplus	28,116,300
		Accumulated retained earnings	161,564,000
		Less treasury stock	(47,520,000)
		Total equity	$181,714,000
Total assets	$401,558,750	Total liabilities and shareholders’ equity	$401,558,750

LOWER QUARTILE MEDIAN UPPER QUARTILE

Current ratio .86 1.51 1.97

Quick ratio .43 .75 1.01

Total asset turnover 1.10 1.27 1.46

Inventory turnover 12.18   14.38   16.43  

Receivables turnover 10.25   17.65   22.43  

Debt ratio .32 .56 .61

Debt–equity ratio .83 1.13 1.44

Equity multiplier 1.83 2.13 2.44

Interest coverage 5.72 8.21 10.83   

Profit margin 5.02% 7.48% 9.05%

Return on assets 7.05% 10.67% 14.16%

Return on equity 14.06% 19.32% 26.41%

1. East Coast Yachts uses a small percentage of preferred stock as a source of financing. In calculating the ratios for the company, should preferred stock be included as part of the company’s total equity?

Answer 1

IN CALCULATING THE RATIOS OF THE THE COMPANY THE PREFERRED STOCK INCLUSION IS A DEBATABLE ISSUE. LIKE DEBT IT HAS A FIXED RETURN. ITS RETURN IS NOT INTEREST BUT DIVIDEND SO TAX SHIELD IS ABSENT AND THE PREFERENCE SHAREHOLDER DON'T HAVE PRIORITY LIKE DEBT HOLDERS.

SO THE GUIDING PRINCIPAL BECOME THE OBJECTIVE OF CALCULATING THE RESPECTIVE RATION.

FOR EXAMPLE, IF THE OBJECTIVE IS TO KNOW THE FINANCIAL SOLVENCY THE PREFERENCE SHARE SHOULD BE INCLUDED IN THE EQUITY WHEREAS IF TE PURPOSE IS OF EVALUATING THE GEARING EFFECT OF THE FIXED DIVIDEND ON THE EARNING, IT SHOULD BE A PART OF DEBT.