Question 1: Profitability analysis                                                                                                             

Return on Assets

It can be calculated by using the formula as

ROA =  (Peterson & Fabozzi, 1999)

McPhersons Return on Assets
Years	Net Income	Average Total Assets	ROA
2012	17,028	318535	5%
2013	-33,319	309707	-11%
2014	-66,557	289555	-23%

 

The average total assets are computed by adding beginning and closing total assets and dividing them by 2.  It is computed in the table below.

Years	Beginning Assets	Ending Assets	Average Total Assets
2012	330,288	306,782	318535
2013	306,782	312,631	309707
2014	312,631	266,478	289555

 

Net Profit Margin

It can be computed as

Net Profit Margin =  (Peterson & Fabozzi, 1999)

McPhersons Net Profit Margin Ratio
Years	Net Income	Net Sales	Net Profit Margin
2012	17,028	276,319	6%
2013	-33,319	299,263	-11%
2014	-66,557	353,413	-19%

 

Question 2: Asset efficiency                                                                                                                      

Days Inventory

It can be calculated as:

Inventory Days =  (White, Sondhi, & Fried, 2003)

Whereas inventory turnover is computed by:

Inventory Days =  (White, Sondhi, & Fried, 2003)

The average inventory is computed by adding beginning and closing inventory and dividing it by 2.  It is computed in the table below.

 

Years	Beginning Inventory	Ending Inventory	Average Inventory
2012	59,672	53,360	56516
2013	53,360	67,577	60469
2014	67,577	45,489	56533

 

McPhersons Inventory Days and Turnover
Years	Cost of Goods Sold	Average Inventory	Inventory Turnover	Days in Period	Inventory Days
2012	146,485	56,516	3	365	141 days
2013	163,823	60,469	3	365	135 days
2014	205,685	56,533	4	365	100 days

 

Days Debtors

It can be calculated as:

Receivable Days =

Whereas inventory turnover is computed by:

Receivable Days =

The average receivables are computed by adding beginning and closing receivables and dividing it by 2.  It is computed in the table below (White, Sondhi, & Fried, 2003).

Years	Beginning Receivables	Ending Receivables	Average Receivables
2012	57,930	55,550	56740
2013	55,550	56,762	56156
2014	56,762	63,272	60017

 

McPhersons
Years	Sales	Average Receivables	Receivables Turnover	Days in Period	Receivable Days
2012	276,319	56,740	5	365	75 days
2013	299,263	56,156	5	365	68 days
2014	353,413	60,017	6	365	62 days

 

Question 3: Liquidity                                                                                                                                    

Current Ratio

It can be calculated as:

Current Ratio =  (Stickney, Brown, & Wahlen, 2004)

McPhersons Current Ratio
Years	Current Assets	Current Liabilities	Current Ratio
2012	110,258	41,383	2.66
2013	131,263	58,346	2.25
2014	166,162	86,191	1.93

 

Quick Ratio

It can be calculated as:

Current Ratio =  (Stickney, Brown, & Wahlen, 2004)

McPhersons Quick Ratio
Years	Current Assets	Inventories	Current Assets – Inventories	Current Liabilities	Current Ratio
2012	110,258	53,360	56,898	41,383	1.37
2013	131,263	67,577	63,686	58,346	1.09
2014	166,162	45,489	120,673	86,191	1.40

 

Question 4: Capital structure                                                                                                                    

Debt to Equity Ratio

It can be calculated as:

Debt-to-Equity Ratio =  (Gibson, 2010)

 

McPhersons Debt-to-equity Ratio
Years	Total Liabilities	Shareholders’ Equity	Debt-to-Equity Ratio
2012	133,841	172,941	0.77
2013	143,539	169,092	0.85
2014	171,934	94,544	1.82

 

Debt Ratio

It can be calculated as:

Debt Ratio =  (Gibson, 2010)

McPhersons Debt Ratio
Years	Total Liabilities	Total Assets	Debt-to-Equity Ratio
2012	133,841	306,782	0.44
2013	143,539	312,631	0.46
2014	171,934	266,478	0.65

 

Question 5                                                                         

Explain what each of the eight ratios in questions 1 to 4 above reflect or measure. In other words, what does each of these ratios tell us about the performance, position and operations of an entity?

 

• Return on assets is an indicator of cents earned each dollar of asset(Meigs, 1975).
• The net profit margin is the measure of percentage of net income of an entity to its net sales. It reflects the proportion of sales that is left over by the entity after paying for all relevant expenses(Meigs, 1975).
• Inventory days’ measures the time which a company takes to sell its average balance of inventory(Stickney, Brown, & Wahlen, 2004).
• Days’ debtors is also known as average collection period or days receivables. It shows how much time a company takes to convert its receivables into cash. It means that the number of days’ company takes to collect the debts and trade receivables from its customers(Meigs, 1975).
• It measures the ability of the firm to repay the current liabilities with its current assets. It matches the current assets with current liabilities and shows that whether the firm is able to cover its current liabilities or not(White, Sondhi, & Fried, 2003).
• Quick ratio is the ratio of the sum of cash and cash equivalents, marketable securities and accounts receivables to the current liabilities. It shows the ability of a company to pay off all its debts by using its most liquid assets(Meigs, 1975).
• It is the ratio of total liabilities of a business to its shareholders’ equity. It measures the leveraged degree of a business and calculates the level of assets that are financed by the debts and by shareholders’ equity(Meigs, 1975).
• Debt ratio measures the ratio of total liabilities to total assets. It measures the portion of assets that are financed by debts(Gibson, 2010).

 

Question 6

Analyse the trends from 2012 to 2014 in all eight ratios you calculated in questions 1 to 4 above and discuss whether each of the eight ratios has improved or deteriorated. Please do not state if the ratio has increased or decreased but state if it has improved or deteriorated. Also provide two reasons for the change in each of the eight ratios.

 

• ROA has deteriorated by 28% over the period because of falling net income, high purchases of fixed assets and poor collection of accounts receivables.
• Net profit margin has also deteriorated by 25% over the period because of falling net income, high expenses costs and increased net sales.
• Inventory days’ has been improved over three years’ time period due to improved inventory turnover. The days has improved by 41 days in three years’ time. It can be due to increased demand of products.
• The current ratio of McPhersons has deteriorated by 0.73 during 3 years. This is due to huge increase in derivative financial instruments and provisions as current liabilities during 2014.
• The quick ratio has improved by 0.03 due to significant decrease in inventories and increase in cash and cash equivalents during 2014.
• The debt-to-equity ratio has deteriorated by 1.05 during three years due to decrease in shareholders equity and trade and other payables.
• The debt ratio has also deteriorated by 0.21 during three years due to increased trade payables, provisions and borrowings.

 

Question 7

Based on your calculations in questions 1 to 4 above and your answers to questions 5 and 6, would you buy shares (invest) in McPherson’s Ltd? Justify your answer by discussing each of the following categories separately:

• Profitability:

Based on profitability analysis through calculation of return on assets and net profit margin, I would rather not invest in McPherson’s Ltd. Since both the ratios have deteriorated due to falling net income. The net income has decreased by $17,028 to net loss of $66,557. This is a huge fall and shows that McPherson’s Ltd is facing problems in meeting its expenses. The net profit margin has deteriorated by 25% in these three years. This is indicating that McPherson’s Ltd has been facing problems in converting its net sales into net profit and retaining it. By looking at the financial statements we can realize that the other income has fallen considerably and the expenses have risen which have converted the net profit worth $17,028 of 2012 into net loss worth $66,557 in 2014.

Decision:

Investing in McPherson’s Ltd isn’t appropriate if only profitability ratios are concerned since the company is going through rough phase of deteriorating net profits.

• Asset efficiency

Based on the asset efficiency calculations we can see that McPherson’s Ltd is improving in its recent year operations. If we check the inventory days of McPherson’s Ltd, it can be analysed that the inventory days have improved indicating that now the firm is able to sell its inventory in a faster way. It means that McPherson’s Ltd is now converting its inventory into cash in accelerated way. The receivable days have also been improved by 13 days which means that the debt collection process of McPherson’s Ltd has improved. This is mainly due to efficient working behaviour of the debt collection department of McPherson’s Ltd.

Decision:

The asset efficiency indicates that the investor can invest in the company as there is improvement in both inventory and receivable days.

• Liquidity

Liquidity ratios show a deteriorating yet a strong position of McPherson’s Ltd. Current ratio has been deteriorating but still shows that company has strong liquidity position as it has $1.93 of current assets to cover $1 of its current liabilities. This has deteriorated from $2.66, but still any ratio above 1 shows the company’s strength to cover its current obligations. Quick ratio has improved by $0.03 and is also indicating a strong position of McPherson’s Ltd. It is also considered that the current ratio which is very high is not lucrative to an investor because idle cash drives no income and high current ratio means that the company holds the cash and do not reinvest. In other way McPherson’s Ltd might have faced falling current ratio but it is a good indicator for the investors (Gibson, 2010).

Decision:

Based on liquidity analysis, McPherson’s Ltd is in a strong position to cover its current obligations. In light of liquidity position, I will choose to invest in the company because of low risk as it can meet its current obligations easily.

 

• Capital structure

The capital structure ratios are indicating a risky situation of McPherson’s Ltd. Debt-to-equity ratio has deteriorated from 0.77 to 1.82 indicating that now the company is more financed by debts. Debt is a risky option as compared to equity financing. For investors the ratio below 1 is a good and attractive indicator. Debt to asset ratio has also deteriorated from 0.44 to 0.65 indicating that total assets of McPherson’s Ltd are now being financed more by debts. It shows that company is more leveraged and might become risky in the future. However, the overall leverage is still below 1.

Decision:

Based on capital structure analysis, I would suggest or choose not to invest in McPherson’s Ltd because of its more inclination towards debt financing as compared to equity financing.