FINANCIAL
MANAGEMENT II
AGREEMENT
Professor Sirousse Tabriztchi
E-mail Cyrus1315@aol.com
This is an
agreement between
The
Consultant:_______________________
The Company:
_______________________
You will select
a company (“the Company”) from the latest issue of Value Line Investment
Survey. As a financial consultant to
that Company, you are requested to prepare a report on various consulting tasks
that are described in this agreement.
Your report will
be evaluated on the following basis:
1.
Whether the
required tasks were performed competently and on time. As the course progresses and you are
introduced to various subjects, you are required to apply your knowledge and
skills you have acquired to analysis of the financial conditions of the
Company.
2.
How effectively
and clearly the work is presented. You
should prepare and submit a clear, concise, well-structured report. The report should have a detailed outline, sections,
and subsections, formally presented tables and schedules, and a list of
references. The report should not be
cluttered with schedules and graphs.
Only the major schedules and charts should be presented in the body of
the report. Other schedules and graphs
should be presented as supplemental information.
3. How well the
theoretical materials from the text and other sources are integrated with the
discussion of the computational work.
CONSULTING TASK 1
ANALYSIS
A
major reason for retaining your consulting firm is to receive an insightful
analysis of the Company’s financial conditions.
The Company should be in existence for at least 20 years. Although, we are primarily interested in
finance we want you to consider all aspects of our operations in preparing your
reports. Your first task is to analyze the strength and weaknesses of the
Company, and the opportunities and threats that it faces. This analysis will involve the following four
tasks:
1.
Background
Report
Prepare and present a report about the Company’s:
1.1.
Growth, mergers
and acquisitions,
1.2.
Major products
or services.
1.3.
Markets and
competitors.
1.4.
Investment
plans.
1.5.
Profitability of
operations.
2.
Analysis of the
Company’s Statements
For the latest three years conduct:
2.1.
Sources and uses
of funds analysis. Summarize your analysis and comments in one
page.
2.2.
Ratio analysis.
Do the following analysis for five years:
2.2.1.
Horizontal
analysis- annual rates of change in assets, liabilities, revenues and expenses.
2.2.2.
Vertical analysis
– Common size ratios for balance sheet and income statements
2.2.3.
Liquidity
ratios: Current ratio and quick ratio.
2.2.4.
Asset management
ratio: The total assets turnover and the turnover ratios for inventories,
accounts receivable, and fixed assets.
Determine the average collection period.
2.2.5.
Debt management
ratios: debt to total assets, debt to net worth, total assets to net worth, and
times interest earned.
2.2.6.
Profitability
ratios: Net income over sales, net income to total assets, earnings before
interest and taxes to total assets, and net income over net worth.
2.2.7.
Evaluation
ratios: Market price to earnings per share, market price over book value per
share, and dividends over net income.
2.3.
Use the industry
averages that are provided in Robert Morris Annual Statement Studies and Dun
and Bradstreet Key Business Ratios for comparative purposes. Create charts showing the changes in major
ratios in comparison to the industry, for the past five years. Summarize your findings in two pages.
2.4.
Review and analysis of Value Line Data. Study and report on all of the data and other information
provided in the Value Line regarding the Company and the industry. Make sure to explain how value line has
computed its figures.
3.
Analysis of the
Working Capital
3.1.
Analyze the
Company’s cash conversion cycle.
3.2.
Prepare a table
that shows the sales, current assets, current liabilities, and net working
capital of the Company, in the past five years.
3.3.
Comment on the
risks and returns of the Company’s working capital policy.
4.
Modified DuPont
analysis
Prepare
DuPont Charts for the past three years and a summary analysis of the Company’s
return on equity in two pages.
4.1.
Make sure you
include the effects of the industrial and economic factors in changes in the
return on equity of the Company.
4.2.
Discuss the
Company strength and weaknesses of the Company in relation to the opportunities
and threats that it faces.
4.3.
Finally, the
DuPont Chart should be used to relate your analysis of liquidity, asset
management, debt management, profitability, and market position, to the return
on equity.
CONSULTING TASK
2
PLANS AND
PROJECTIONS
The
second task involves developing a financial plan for the Company. This task involves creative thinking of
certain strategies and preparing projected financial plans that will show the
future effects of those strategies.
5.
Set Targets
5.1.
Review your
analysis the statements of the Company’s management regarding its future
plans. Develop target financial ratios
for the Company.
5.2.
Explain the
activities that the Company has to undertake to achieve the target ratios.
5.3.
Use the modified
DuPont analysis to show how the strategy that you suggest will affect total
assets turnover, profit margin on sales, and the equity multiplier.
6.
Prepare Pro
Forma Financial Statements
6.1.
Use regression
analysis to prepare sales forecast for the next year.
6.2.
Use percentage
of sales method and prepare pro forma balance sheet, statement of income, and statement
of cash flows for the next year.
6.3.
Summarize and
explain your financial strategies and projections in one page.
CONSULTING TASK
3
RISK AND RETURN
7.
Measurement of
Risk
Perform the
analysis of the Company’s total and market risk.
7.1.
Compute return
on the Company stock, for 1969-1998.
Construct a table showing the annual realized dividend yields, capital
gain rates, and the rates of return.
Make sure to adjust the figures for the stock splits.
7.2.
Measure the
standard deviation of the annual rate of return, for the two periods 1969-1981
and 1982-1999. Comment on the changes in
the riskiness of the Company’s operations.
7.3.
Update the
S&P 500 returns table and compute the Company’s betas for two separate
periods: 1969-1981 and 1982-1999.
7.4.
Compare the beta
figures that you have obtained with the beta in the value line. What are some possible reasons for the
difference between the betas?
7.5.
Determine
whether the beta coefficient has been stable or not. If the market risk has increased or decreased. Explain the possible reasons for the change
in the market risk. Refer to your
analysis of the Company strength and weaknesses to find the possible reasons.
The
Annual Rates of Return on Standard and Poor 500 Stocks
Year
|
Rate of Return
|
Year
|
Rate of
Return |
|
1969 |
-8.40% |
1986 |
18.55% |
|
1970 |
3.90% |
1987 |
5.23% |
|
1971 |
14.30% |
1988 |
17.07% |
|
1972 |
19.00% |
1989 |
0.3153 |
|
1973 |
-14.70% |
1990 |
-3.18% |
|
1974 |
-26.40% |
1991 |
35.51% |
|
1975 |
-37.20% |
1992 |
? |
|
1976 |
-23.80% |
1993 |
? |
|
1977 |
-7.20% |
1994 |
? |
|
1978 |
-6.60% |
1995 |
? |
|
1979 |
-18.40% |
1996 |
? |
|
1980 |
32.40% |
1997 |
? |
|
1981 |
-4.90% |
1998 |
? |
|
1982 |
-0.76% |
1999 |
? |
|
1983 |
22.38% |
|
|
|
1984 |
6.10% |
|
|
|
1985 |
31.57% |
1997
|
1998
|
1999
SOURCE: Computed from data
from Wall Street Journal (Various Dates)
CONSULTING TASK 4
CAPITAL STRUCTURE
Briefly
discuss capital structure theories and how they are used in this consulting
work.
8.
Capital Structure-Book
and Market Values
8.1.
Determine the
Book Value Proportions of the Components of the Capital. Compute the proportion of each capital
component in total capitalization from the data in the financial statements for
the past five years.
8.2.
Determine the
Market Value Proportions of the Components of the Capital. If new capital were
raised in the same proportions as existing capital, the weights applied to the
costs of capital would be the market-value proportions of capital—the firm’s
use of each source of capital, based on its market value.
8.2.1.
Market value of
Debt. The Company may have several
different debt issues that are publicly traded, with several other issues that
are privately placed. If the firm has
securities that are not publicly traded, their market values may not be
available. The market values of publicly
traded issues are obtained from Moody’s Bond Record, using January issues of
each subsequent year to arrive at year-end prices of the debt of the previous
year. The market value of privately
placed debt is estimated from the information on the coupon and maturity dates
which can be obtained from Moody’s Industrial Manual and the required yield on
similar publicly issued debt.
8.2.2.
The market value
of the preferred and common stock. The
market values of these securities are calculated from information provided in
Standard and Poor’s Daily Price Record.
8.3.
Compare the book
and market value proportions. Explain
the reasons for differences. Determine
the retained earnings and depreciation break points.
8.4.
Determine if
additional debt will significantly increase the financial risk of the firm
thereby increasing the cost of capital.
Refer to the financial ratios, value line, and beta analysis to
determine if the risk of the Company has changed over time. Determine if the use of the tax-deductible
debt may decrease the cost of capital.
Determine the optimal proportions for the components of the capital. Determine the retained earnings’ and
depreciation’s breaking points.
CONSULTING TASK
5
COST OF CAPITAL
Compute the cost
of each component of the capital and the weighted average cost of capital for
the optimal capital.
9.1.
The Cost of
Debt. Estimate the cost of raising
additional debt. Use the following three
methods:
9.1.1.
Determine the
yields on recent debt offerings of other companies with similar risk. Find the ratings of the Company’s debt by
Moody and Standard & Poor. For the
recent debt offerings of similar rating find the yield. If the debentures have sinking fund
protection, investors demand a lower yield than if the debt does not have the
sinking fund.
9.1.2.
Determine the
yields on recent debt offerings made by the Company.
9.1.3.
Determine the
yields on outstanding debt of the Company.
Obtain the information from Moody’s Bond Record.
9.2.
Cost of
Preferred Stock. The cost of preferred
stock can be estimated in a manner similar to that of debt. The cost may be based on:
9.2.1.
The yield on a
newly issued preferred stock.
9.2.2.
The dividend yield
for similar preferred stock issues presented in Moody’s Industrial Manual.
9.2.3. The yield on the existing preferred stock of the Company. The current market value of the preferred stock and the amount of the dividend for the preferred stock can be obtained from Standard & Poor’s Daily Stock