D’Leon INC. Case Study Analysis (1,500 words).
D’LEON INC., PART I.
a. What effect did the expansion have on sales, after-tax operating income, net operating working capi-tal (NOWC), and net income?
b. What effect did the company’s expansion have on its free cash flow?
c. D’Leon purchases materials on 30-day terms, meaning that it is supposed to pay for purchases with-in 30 days of receipt. Judging from its 2018 balance sheet, do you think that D’Leon pays suppliers on time? Explain, including what problems might occur if suppliers are not paid in a timely manner.
d. D’Leon spends money for labor, materials, and fixed assets (depreciation) to make products—and spends still more money to sell those products. Then the firm makes sales that result in receivables, which eventually result in cash inflows. Does it appear that D’Leon’s sales price exceeds its costs per unit sold? How does this affect the cash balance?
e. Suppose D’Leon’s sales manager told the sales staff to start offering 60-day credit terms rather than the 30-day terms now being offered. D’Leon’s competitors react by offering similar terms, so sales remain constant. What effect would this have on the cash account? How would the cash account be affected if sales doubled as a result of the credit policy change?
f. Can you imagine a situation in which the sales price exceeds the cost of producing and selling a unit of output, yet a dramatic increase in sales volume causes the cash balance to decline? Explain.
g. Did D’Leon finance its expansion program with internally generated funds (additions to retained earnings plus depreciation) or with external capital? How does the choice of financing affect the company’s financial strength?
h. Refer to Tables IC 3.2 and IC 3.4. Suppose D’Leon broke even in 2018 in the sense that sales revenues equaled total operating costs plus interest charges. Would the asset expansion have caused the com-pany to experience a cash shortage that required it to raise external capital? Explain.
i. If D’Leon starts depreciating fixed assets over 7 years rather than 10 years, would that affect (1) the phys-ical stock of assets, (2) the balance sheet account for fixed assets, (3) the company’s reported net income, and (4) the company’s cash position? Assume that the same depreciation method is used for stockholder reporting and for tax calculations and that the accounting change has no effect on assets’ physical lives.
j. Explain how earnings per share, dividends per share, and book value per share are calculated and what they mean. Why does the market price per share not equal the book value per share?
k. Explain briefly the tax treatment of (1) interest and dividends paid, (2) interest earned and dividends received, (3) capital gains, and (4) tax loss carrybacks and carryforwards. How might each of these items affect D’Leon’s taxes?
D’LEON INC., PART II.
a. Why are ratios useful? What are the five major categories of ratios?
b. Calculate D’Leon’s 2019 current and quick ratios based on the projected balance sheet and income statement data. What can you say about the company’s liquidity positions in 2017, in 2018, and as projected for 2019? We often think of ratios as being useful (1) to managers to help run the business, (2) to bankers for credit analysis, and (3) to stockholders for stock valuation. Would these different types of analysts have an equal interest in the company’s liquidity ratios? Explain your answer.
c. Calculate the 2019 inventory turnover, days sales outstanding (DSO), fixed assets turnover, and total assets turnover. How does D’Leon’s utilization of assets stack up against other firms in the industry?
d. Calculate the 2019 debt-to-capital and times-interest-earned ratios. How does D’Leon compare with the industry with respect to financial leverage? What can you conclude from these ratios?
e. Calculate the 2019 operating margin, profit margin, basic earning power (BEP), return on assets (ROA), return on equity (ROE), and return on invested capital (ROIC). What can you say about these ratios?
f. Calculate the 2019 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?
g. Use the DuPont equation to provide a summary and overview of D’Leon’s financial condition as projected for 2019. What are the firm’s major strengths and weaknesses?
h. Use the following simplified 2019 balance sheet to show, in general terms, how an improvement in the DSO would tend to affect the stock price. For example, if the company could improve its collection procedures and thereby lower its DSO from 45.6 days to the 32-day industry average without affecting sales, how would that change “ripple through” the financial statements (shown in thou-sands below) and influence the stock price?
i. Does it appear that inventories could be adjusted? If so, how should that adjustment affect D’Leon’s profitability and stock price?
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 company 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?
k. In hindsight, what should D’Leon have done in 2017?
l. What are some potential problems and limitations of financial ratio analysis?
m. What are some qualitative factors that analysts should consider when evaluating a company’s likely future financial performance?