Question

LEON INC., PART II presented in Chapter 3, discussed the situation of r. D'Leon had increased plant capacity up 26 FINANCIAL STATEMENTS AND TAXES Part I of this case, presen D'Leon Inc., a regional snack foods producer, after an expansion program undertaken a major marketing campaign in an attempt to "go national." Thus far, sales have not been to the forecasted le the forecasted level,costs have been higher than were projected, and a large loss occurred in 2018 rather the expected profit. As a result, its mana ult, its managers, directors, and investors are concerned about the firm's surv Donna Jamison was brought i as assistant to Fred Campo, DLeon's chairman, who had the task of ge balance sheets an 0 getting the company back soun income statements, together with projections for 2019, are given in Tables IC 4.1 and IC 4.2. In additi Table IC 4.3 gives the company's 2017 and 2018 financial ratios, together with industry average data. The 2019 projected financial statement data represent Jamison's and Campo's best guess for 2019 results assuming that some new financing is arranged to get the company "over the hump Jamison examined monthly data for 2018 (not given in the case), and she detected an improving pat tern during the year. Monthly sales were rising, costs were falling, and large losses in the early months had turned to a smaíl profit by December. Thus, the annual data look somewhat worse than final monthly data. Also, it appears to be taking longer for the advertising program to get the message out, for the new sales offices to generate sales, and for the new manufacturing facilities to operate efficiently. In other words, the lags between spending money and deriving benefits were longer than D'Leon's managers had anticipated. For these reasons, Jamison and Campo see hope for the company-provided it can survive in the short run. Jamison must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions should be taken. Your assignment is to help her answer the following questions. Provide clear explanations, not yes or no answers. rotitability andhstocn uld be adjusted? If so, how should that adjustment affect D/1aon's j In 2018, the company paid its suppliers much later than the due dates; also, it was not maintaining financial ratios at levels called for in its bank loan agreements. Therefore, suppliers could cut the com- pany off, and its bank could refuse to renew the loan when it comes due in 90 days. On the basis of data provided, would you, as a credit manager, continue to sell to D'Leon on credit? (You could demand cash on delivery-that is, sell on terms of COD-but that might cause D'Leon to stop buying from your company,) Similarly, if you were the bank loan officer, would you recommend renewing the loan or demanding its repayment? Would your actions be influenced if, in early 2019, D'Leon showed you its 2019 projections along with proof that it was going to raise more than $1.2 million of new equity? Balance Sheets 2019E 2018 2017 Assets s 7,282 57.600 Cash 85,632 Accounts receivable 151,200 878,000 632,160 Inventories ㎜1,287d60 sur 715,200 1,926,802 1,124,000 1,202,950 01.1171 6480 $2.680, 112 Total current assets 401,000 1,197,160 Gross fixed assets 1 46,200 Less accumulated depreciation 263,160 380,120 344,800 817,040 $3,497,152 939,790 Net fixed assets 1,468,800 $2,866,592 Total assets Liabilities and Equity 436,800 524,160 145,600 489,600 Accounts payable 136,000 408,000 Accruals 200,000 636,808 300,000 Notes payable $ 481,600 $1,650,568 $1,144,800 Total current liabilities 323,432 723,432 400,000 Long-term debt 460,000 460,000 1,721,176 Common stock 203,768 32,592 231,176 Retained earnings Total equity 663,768 $ 492,592 $1,952,352 $1,468,800 $2,866,592 $3,497,152 Total liabilities and equity Note: E indicates estimated. The 2019 data are forecasts. tal Concepts in Financial 2018 2019E 6034000 3432000 Income Statements $7,035,600 5.528,000 519.988 Cost of goods sold 6047.988 3.222672 5 209,328 Other expenses 5645992 Total operating costs excluding depreciation and S 13,988 116.960 s 609.608 116.960 18.900 5 190,428 130,948) 492.648 43,828 136.012 5 42640 169.06 (106.784 5422640 s 266.960)146,600 (106,7841 Interest expense 87,960 Taxes (40%) Net income $0.880 0.220 5 1.602) 1.014 0.220 7 809 12.17 s 0.110 4926 s 225 6.638 DPS Book value per share $ 850 Stock price 100,000 Shares outstanding 40.00% Tax rate 5 40,000 $ 40,000 Lease payments Sinking fund payments Note: E indicates estimated. The 2019 data are forecasts The firm had sufficient taxable income in 2016 and 2017 to obtain its full tax refund in 2018 Ratio Analysis industry Average 2017 2019E 2018 23x 27× 12x 04x 1.0× Inventory turnover 6.1X Days sales outstanding (DSO 38.2 374 32.0 Fixed assets turnover 64x 100x 7.0x Total assets tunover 21x 23x 734% 44, 1% 40.0% TIE 43× 62× Operating margin Profit margin 55% 73% 27% 25% Basic eaming power 3.5% 13.0% ROA 19.7% ROE 9.1% -325% 13.3% ROIC 18.2% 14,5% -14x 142x Book value per share 0.5x 2.4x Note E indicates estimated. The 2019 data are forecasts 56.64

Answer 1

Answer i)

The inventory turnover ratio of the company is low in comparison to the industry average, which means company either posses’ obsolete inventory or excess inventory. If inventory is taken care and is reduced/ addressed properly, this in turn will result in improvement the company’s performance by improving Asset turnover, Current asset ratio, decrease the debt ratio. All in turn would result in better profitability and increase the share price of the company.

Answer j) As a credit manager, I would not continue to extend credit to the firm under its current arrangement, particularly if I didn’t have any excess capacity. Since, the firm’s current asset ratio is low despite the firm’s ratios based on the projected data appear to be improving. Terms of COD might be a little harsh and might push the firm into bankruptcy. Likewise, if the bank demanded repayment this could also force the firm into bankruptcy.

Creditors’ actions would definitely be influenced by an infusion of equity capital in the firm, which could result in reduction of Credit risk exposure of the company along with decrease in debt ratio of the company.

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