James Madison was brought in as assistant to Computron’s chairman, who had the task of getting the company back into a sound financial position. Madison must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions to take. Your assignment is to help her answer the following questions, using the recent and projected financial information shown next. Provide clear explanations, not yes or no answers.
- Why are ratios useful? What three groups use ratio analysis and for what reasons?
- Calculate the profit margin, operating profit margin, basic earning power (BEP), return on assets (ROA), and return on equity (ROE). What can you say about these ratios?
- Calculate the inventory turnover, days sales outstanding (DSO), fixed assets turnover, operating capital requirement, and total assets turnover. How does Computron’s utilization of assets stack up against other firms in its industry?
- Calculate the current and quick ratios based on the projected balance sheet and income statement data. What can you say about the company’s liquidity position and its trend?
- Calculate the debt ratio, liabilities-to-assets ratio, times-interest-earned, and EBITDA coverage ratios. How does Computron compare with the industry with respect to financial leverage? What can you conclude from these ratios?
- Calculate the price/earnings ratio and market/book ratio. Do these ratios indicate that investors are expected to have a high or low opinion of the company?
- Use the extended DuPont equation to provide a summary and overview of Computron’s projected financial condition. What are the firm’s major strengths and weaknesses?
- What are some potential problems and limitations of financial ratio analysis?
- What are some qualitative factors analysts should consider when evaluating a company’s likely future financial performance?