Case Study 2

CASE STUDY
WORKING WITH FINANCIAL STATEMENTS, AND

PLANNING FOR GROWTH AT S&S AIR
The income statement and balance sheet are shown here:

S&S AIR, INC
2011 Income Statement
($)
Sales 30,499,420
Cost of goods sold 22,224,580
Other expenses 3,867,500
Depreciation 1,366,680
EBIT 3,040,660
Interest 478,240
Taxable Income 2,562,420
Taxes (40%) 1,024,968
Net income 1,537,452
Dividend $560,000
Add to retained Earning 977,452
S&S AIR, INC.

2011 Balance Sheet
Assets ($) Liabilities and Equities ($)
Current Assets Current liabilities
Cash 441,000 Account payable 889,000
Account receivable 708,400 Notes payable 2,030,000
Inventory 1,037,120 Total current 2,919,000
liabilities
Total current assets. 2,168,520 Long-term debt 5,320,000
Fixed assets Shareholder equity
Net plan and equipment 16,122,400 Common stock 350,000
Retained earning 9,719,920
Total Equity 10,069,920
Total assets 18,308,920 Total liabilities and equity 18,308,920
======== ========
Light Airplane Industry Ratios

Lower Median Upper
quartile quartile
Current ratio 0.50 1.43 1.89
Quick ratio 0.21 0.38 0.62
Cash ratio 0.08 0.21 0.39
Total asset turnover 0.68 0.85 1.38
Inventory turnover 4.89 6.15 10.89
Receivable turnover 6.27 9.82 14.11
Total debt ratio 0.44 0.52 0.61
Debt-equity ratio 0.79 1.08 1.56
Equity multiplier 1.79 2.08 2.56
Times interest earned 5.18 8.06 9.83
Cash coverage ratio 5.84 8.43 10.27
Profit margin 4.05% 6.98% 9.87%
Return on assets 6.05% 10.53% 13.21%
Return on equity 9.93% 16.54% 26.15%
Questions:
1. Using financial statements provided for S&S Air, calculate each of the ratios listed in
the table for the light aircraft industry
2. Compare the performance of S&S Air to the industry. For each ratio comment on why
it might be viewed as positive or negative relative to the industry!
3. Calculate the internal growth rate and sustainable growth rate for S&S Air. What do
these numbers mean?
4. Calculate the internal growth rate and sustainable growth rate for S&S Air. What do
these numbers mean?
5. S&S Air is planning for a growth rate of 12% next year. Calculate the EFN for the
company assuming the company is operating at full capacity?
-oOo-
Answers:
1. The calculation for the ratios listed:
Current ratio = $2,168,520 / $2,919,000 = 0.75 times
Quick ratio = ($2,186,250 – 1,037,120) / $2,919,000 = 0.39 times
Cash ratio = $441,000 / $2,919,000 = 0.15 times
Total asset turnover = $30,499,420 / $18,308,920 = 1.67 times
Inventory turnover = $22,224,580 / $1,037,120 = 21.43 times
Receivables turnover = $30,499,420 / $708,400 = 43.05 times
Total debt ratio = ($18,308,920 – 10,069,920) / $18,308,920 = 0.45 times
Debt-equity ratio = ($2,919,000 + 5,320,000) / $10,069,920 = 0.82 times
Equity multiplier = $18,308,920 / $10,069,920 = 1.82 times
Times interest earned = $3,040,660 / $478,240 = 6.36 times
Cash coverage = ($3,040,660 + 1,366,680) / $478,420 = 9.22 times
Profit margin = $1,537,452 / $30,499,420 = 5.04%
Return on assets = $1,537,452 / $18,308,920 = 8.40%
Return on equity = $1,537,452 / $10,069,920 = 15.27%
2. S&S is below the median industry ratios for the current and cash ratios. This implies the
company has less liquidity than the industry in general. However, both ratios are above the
lower quartile, so there are companies in the industry with lower liquidity ratios than S&S
Air. The company may have more predictable cash flows, or more access to short-term
borrowing. If you created an Inventory to Current liabilities ratio, S&S Air would have a
ratio that is lower than the industry median. The current ratio is below the industry median,
while the quick ratio is above the industry median. This implies that S&S Air has less
inventory to current liabilities than the industry median.
S&S Air has less inventory than the industry median, but more accounts receivable than
the industry since the cash ratio is lower than the industry median.
The turnover ratios are all higher than the industry median; in fact, all three turnover ratios
are above the upper quartile. This may mean that S&S Air is more efficient than the
industry.
The financial leverage ratios are all below the industry median, but above the lower quartile.
S&S Air generally has less debt than comparable companies, but still within the normal
range.
The profit margin, ROA, and ROE are all slightly below the industry median, however, not
dramatically lower. The company may want to examine its costs structure to determine if
costs can be reduced, or price can be increased.
Overall, S&S Air’s performance seems good, although the liquidity ratios indicate that a
closer look may be needed in this area.
3. The internal growth can be calculated if we know the retention ration and ROA (already
calculated in no. 1)
Return on Asset (ROA) = 8.40%
b = (addition to retain earnings / net income) = $977.452 / $1.537.452 = 0.64
Internal growth rate = (ROA × b) / [1 – (ROA × b)]

Internal growth rate = [0.0840(.64)] / [1 – 0.0840(.64)]
Internal growth rate = .0564 or 5.64%
The internal growth rate represents the growth rate of the company achieved without
any outside financing support.
The sustainable growth can be calculated if we know the retention ration and ROE (already
Return in Equity (ROE) = 15.27%
b = 0.64
Sustainable growth rate = (ROE × b) / [1 – (ROE × b)]

Sustainable growth rate = [0.1527(.64)] / [1 – 0.1527(.64)]
Sustainable growth rate = .1083 or 10.83%
The sustainable growth rate represents the growth rate of the company achieved with
the help of outside debt that was based on its retained earnings and current capital
structure.
4. The same answer as number 3.
The internal growth can be calculated if we know the retention ration and ROA (already
Return on Asset (ROA) = 8.40%
b = (addition to retain earnings / net income) = $977.452 / $1.537.452 = 0.64
Internal growth rate = (ROA × b) / [1 – (ROA × b)]

Internal growth rate = [0.0840(.64)] / [1 – 0.0840(.64)]
Internal growth rate = .0564 or 5.64%
The internal growth rate represents the growth rate of the company achieved without
any outside financing support.
The sustainable growth can be calculated if we know the retention ration and ROE (already
Return in Equity (ROE) = 15.27%
b = 0.64
Sustainable growth rate = (ROE × b) / [1 – (ROE × b)]

Sustainable growth rate = [0.1527(.64)] / [1 – 0.1527(.64)]
Sustainable growth rate = .1083 or 10.83%
The sustainable growth rate represents the growth rate of the company achieved with the
help of outside debt that was based on its retained earnings and current capital structure.
5. The income statement and balance sheet for next year with 12% growth rate are shown
here:
S&S AIR, INC

2012 Income Statement
($)
Sales 34,159,350
Cost of goods sold 24,891,530
Other expenses 4,331,600
Depreciation 1,366,680
EBIT 3,569,541
Interest 478,240
Taxable Income 3.091,301
Taxes (40%) 1,236,520
Net income 1,854,780
Dividend $
Add to Retained Earning
S&S AIR, INC.

2012 Balance Sheet
Assets ($) Liabilities and Equities ($)
Current Assets Current liabilities
Cash 493,920 Account payable 995,680
Account receivable 793,408 Notes payable 2,030,000
Inventory 1,161,574 Total current 3,025,680
liabilities
Total current assets. 2,448,902 Long-term debt 5,320,000
Fixed assets Shareholder equity
Net plan and equipment 18,057,088 Common stock 350,000
Retained earning 10,899,117
Total Equity 11,249,117
Total assets 20,505,990 Total liabilities and equity 19,594,787
======== ========
So, the EFN is:

EFN = Total assets – Total liabilities and equity
EFN = $20,505,990 – 19,594,797
EFN = $911,193

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CASE STUDY

WORKING WITH FINANCIAL STATEMENTS, AND

The income statement and balance sheet are shown here:

S&S AIR, INC.

Light Airplane Industry Ratios

Quick ratio = ($2,186,250 – 1,037,120) / $2,919,000 = 0.39 times

Cash ratio = $441,000 / $2,919,000 = 0.15 times

Total asset turnover = $30,499,420 / $18,308,920 = 1.67 times

Inventory turnover = $22,224,580 / $1,037,120 = 21.43 times

Receivables turnover = $30,499,420 / $708,400 = 43.05 times

Total debt ratio = ($18,308,920 – 10,069,920) / $18,308,920 = 0.45 times

Debt-equity ratio = ($2,919,000 + 5,320,000) / $10,069,920 = 0.82 times

Equity multiplier = $18,308,920 / $10,069,920 = 1.82 times

Times interest earned = $3,040,660 / $478,240 = 6.36 times

Cash coverage = ($3,040,660 + 1,366,680) / $478,420 = 9.22 times

Profit margin = $1,537,452 / $30,499,420 = 5.04%

Return on assets = $1,537,452 / $18,308,920 = 8.40%

Return on equity = $1,537,452 / $10,069,920 = 15.27%

b = (addition to retain earnings / net income) = $977.452 / $1.537.452 = 0.64

Internal growth rate = (ROA × b) / [1 – (ROA × b)]

Sustainable growth rate = (ROE × b) / [1 – (ROE × b)]

4. The same answer as number 3.

b = (addition to retain earnings / net income) = $977.452 / $1.537.452 = 0.64

Internal growth rate = (ROA × b) / [1 – (ROA × b)]

Sustainable growth rate = (ROE × b) / [1 – (ROE × b)]

S&S AIR, INC

S&S AIR, INC.

So, the EFN is:

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