ACC501 Business Finance Assignment 1 Solution Spring 2013

ABC Company is engaged in manufacturing of electronic products since many years. It is
listed at Regional Stock Exchange (RSE) and its shares are traded at Rs. 37 each
currently. Capital structure of electronics industry is highly relying on debt. So, the
industry average for debt to equity ratio is 60:40. Following financial statements relate to
ABC:

ABC Company
Balance Sheet
As on December 31, 2012
Assets
Rs. In
Millions
Liabilities & Owner’s Equity
Rs. In
Millions
Current Assets Current Liabilities
Cash 60 Accounts Payable 375
Accounts Receivable 50 Notes Payable 300
Inventory 450 Total Current Liabilities 675
Total Current Assets 560 Long-term Debt 545
Stockholders’ Equity
Fixed Assets Common Stock and Paid-in-
surplus
535
Plant and Equipment
(Net)
2,980 Retained Earning 1,785
Total Stockholders’ Equity 2,320
Total Assets 3,540 Total Liabilities & Equity 3,540
ABC Company
Income Statement
For the year ended 31st
December, 2012
Particular
Rs. In
millions
Net Sales 2,450
Cost of Goods Sold (1,400)
Depreciation (270)
Earnings before interest and taxes (EBIT) 780
Interest (145)
Taxable Income 635
Taxes (216)
Net Income 419
Dividends (40% of Net Income) 167.6
Retained Earnings 251.4

Additional information:
 Management of the company is planning to take loan of Rs. 51 million from a local financial institution to purchase new plant for expansion in its existing plant.
 A & N Company – a buyer of ABC Company has recently made an agreement to purchase electronic products for Rs. 20 million on credit basis. The inventory for this deal will cost Rs. 11 million for ABC Company.
 Share price of the company will be increased by Rs. 3 owing to good expectations perceived by stock market investors.

Required
1. Compute current ratio of ABC Company before and after the credit sales have been made to A & N Co. (3+4=7 Marks)

2. Analyze how the liquidity position of ABC Company will be affected after making credit sales to A&N Co. (3 Marks)

Solution:

Current Ratio = Current Asset / Current Liabilities

                        =560/675

=0.83 times
Debt equity ratio = total debts/total equity

                                  =34% / 66%

                                  = 0.515

 

3. Calculate Debt-Equity Ratio of ABC Company before and after taking loan. (3+4=7 Marks)

Formula:

Debt to Equity Ratio:

Definition:

Debt-to-Equity ratio indicates the relationship between the external equities or outsiders funds and the internal equities or shareholders funds.

It is also known as external internal equity ratio. It is determined to ascertain soundness of the long term financial policies of the company.

Formula of Debt to Equity Ratio:

Following formula is used to calculate debt to equity ratio

 [Debt Equity Ratio = External Equities / Internal Equities]

Or

[Outsiders funds / Shareholders funds]

As a long term financial ratio it may be calculated as follows:

[Total Long Term Debts / Total Long Term Funds]

Or

[Total Long Term Debts / Shareholders Funds]

ANSWER:-

 

Given Data:

Other caculations:

Total Debt ratio = total assets – total equity /total assets

Total debt ratio = 3, 540 – 2, 320 / 3, 540*100

Total debt ratio = 1, 220 / 3, 540*100

Total debt ratio = 0.344*100

Total debt ratio = 34%

 

So, the company uses 34% debt.

 

And,

100 % – 34% = 66%

 

 

Total Stockholders’ Equity = 2, 320

Debt-Equity Ratio = Long term liabilities / Equity

Debt-Equity Ratio = 34% / 66% = 0.515

Debt –Equity Ratio (before loan) = 0.515

4. Comment on as how the change in Debt to Equity Ratio would affect the decision of the financial institution if the company requests for a further loan. (3 Marks)

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