Ch 14 financial management notes

1. Case 14.1: Central Equipment Company
Central Equipment Company (CEC)
The objective of the case is to analyse the interaction between operating risk and financial
risk. It also focuses on the practical considerations of managers in understanding the
operating conditions and risks that have a bearing on a firm's borrowing decision (capital
structure). From the facts of the case, one can argue that a low debt-equity ratio might prove
to be risky for a firm with high operating risk. The instructor can focus on break-even
analysis and EPS analysis to ilustrate the concepts of and interaction between operating and
financial risks. The instructor can close the case by pointing out the inadequacy of this
analysis, and set the background for the need for analysing the impact of capital structure on
the value of the firm.
`
(1) Operating risk: It helps to undrstand the operting risk faced by the firm.
(4) Balance Sheet & P&L Analysis: His
Sales 4,032.3 Balance Sheet
PBIT 125.0 2.14 -3.88 Cash
Total cost 3,907.3 Debtors
Variable cost 45% 1,758.3 Inventory
Fixed cost 55% 2,149.0 OCA
Variable cost ratio 43.6% CA
Contribution ratio 56.4% G Block
B/E sales 3,810.6 94.5% Acc dep
N Block
(2) EPS Analysis (vis-à-vis changes in sales and EBIT/PBIT) TA
EPS Crs
Interest 10% 200.00 Debt Equity D/E Tax prov
Debt 2,000 B/E PBIT 380 6.50 6.50 6.50 OCL
Tax 35% CL
Equity option Debt option Debt-Equity Mix Paid up
Change in sales -0.05 Expect. 0.05 -0.05 Expect. 0.05 -0.05 Expect. 0.05 R&S
Sales 3,830.7 4,032.3 4,233.9 3,830.7 4,032.3 4,233.9 3,830.7 4,032.3 4,233.9 NW
Varible cost 1,670.4 1,758.3 1,846.2 1,670.4 1,758.3 1,846.2 1,670.4 1,758.3 1,846.2 TL
Contribution 2,160.3 2,274.0 2,387.7 2,160.3 2,274.0 2,387.7 2,160.3 2,274.0 2,387.7
Fixed cost 2,149.0 2,149.0 2,149.0 2,149.0 2,149.0 2,149.0 2,149.0 2,149.0 2,149.0 Shares
PBIT 11.3 125.0 238.7 11.3 125.0 238.7 11.3 125.0 238.7 No equity
Interest 0.0 0.0 0.0 200.0 200.0 200.0 100.0 100.0 100.0 New equity
PBT 11.3 125.0 238.7 -188.7 -75.0 38.7 -88.7 25.0 138.7 Year
Tax 4.0 43.8 83.5 -66.0 -26.3 13.5 -31.0 8.8 48.5 1990
PAT 7.3 81.3 155.2 -122.7 -48.8 25.2 -57.7 16.3 90.2 1991
Debt repayment 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1992
Uncommited profit 6.3 80.3 154.2 -123.7 -49.8 24.2 -58.7 15.3 89.2 1993
Number of shares 38 38 38 18 18 18 28 28 28 1994
EPS 0.19 2.14 4.08 -6.81 -2.71 1.40 -2.06 0.58 3.22 1995
Uncommited EPS 0.17 2.11 4.06 -6.87 -2.76 1.34 -2.09 0.54 3.18 1996
1997
1998
PBIT-EPS Chart 1999
2000
1 2000#
0.9
0.8
Financial analysis: Th
0.7

2. 0.7
great varibility as well
0.6 B/E PBIT and 17.5% in 1997.Ma
EPS If the company realise
0.5
dependence on external funds. The firm is
0.4
532
0.3
0.2
0.1
0
0
0
0
0
0
0
0
0
0
0
0
0
0
PBIT 1
2
(3) Operating & Financial Leverage Analysis 3
Break-even sales 3,810.6 94.5% 4
Change in sales -0.05 0.05 -0.05 0.05 5
Change in PBIT -0.91 0.91 -0.91 0.91 6
DOL 18.19 18.19 18.19 18.19 18.19 7
Change in EPS -0.91 0.91 1.52 -1.52 8
DFL 1.00 1.00 -1.67 -1.67 -1.67 9
DCL 18.19 18.19 -30.32 -30.32 -30.32 10
11

3. alance Sheet & P&L Analysis: Historical Perspective
(E + D) E
8% 89.0 Estd. Projected Projected
16% 180.7 Sales 3,376.9 4,032.3 4,032.3
4% 41.1 PBIT 94.6 125.0 125.0
4% 47.1 PAT 50.3 -101 81.3
31% 357.9 (E + D) E
71% 819.9 Estd. Projected Projected
2% 23.5 S/TA 4.07 4.86 4.86
69% 796.4 PBIT/S 0.03 0.03 0.03
100% 1,154.3 PBIT/TA 11.4% 15.1% 15.1%
2% 15.2 PAT/PBIT 0.53 -0.81 0.65
4% 30.3 TA/NW 1.54 4.67 1.13
15% 121.5 PAT/NW 9.3% -56.7% 11.1%
21% 167.0
22% 180.0
57% 459.6
79% 639.6 640 2,640
100% 807
18.00
38.00
Sales PBIT PAT DIV EPS Sales g PBIT/S PBIT EPS EPS
1,804.0 34.3 17.1 9.0 0.95 1.9% -140 -2.39 -12.28
1,707.8 15.5 7.8 9.0 0.43 -5.3% 0.9% 0 0.00 -7.22
1,894.0 41.2 20.6 9.0 1.14 10.9% 2.2% 140 2.39 -2.17
2,270.8 52.2 26.1 9.0 1.45 19.9% 2.3% 280 4.79 2.89
2,520.0 58.0 29.0 10.8 1.61 11.0% 2.3% 420 7.18 7.94
2,775.0 66.6 33.3 10.8 1.85 10.1% 2.4% 560 9.58 13.00
2,949.2 76.8 38.4 14.4 2.13 6.3% 2.6% 700 11.97 18.06
2,433.8 -5.3 -5.3 9.0 -0.29 -17.5% -0.2% 840 14.37 23.11
3,042.3 82.1 43.5 18.0 2.42 25.0% 2.7% 980 16.76 28.17
3,376.9 94.6 50.3 18.0 2.79 11.0% 2.8% 1,120 19.16 33.22
3,579.5 85.0 55.2 18.0 3.07 6.0% 2.4% 1,260 21.55 38.28
4,032.3 125.0 81.3 38.0 2.14 12.6% 3.1% 1,400 23.95 43.33
AVG 7.5% 1.9% 1,540 26.34 48.39
SD 12.7% 1.0%
: The company sales have grown at an average rate of 7.5%. But its shows

4. varibility as well. Twice during last decade sales growth was negative, a drop of 5.7% in 1991
7.5% in 1997.Margin has hovered around 2%. The company has high level of current assets.
company realises its debtorand uses surplus cash balance, it can perhaps reduce its
dence on external funds. The firm is very conservatively financed.
S ATM Dep*.35
4,335 -97 699 245 147 100 47
4,660 -91 524 184 92 100 -8
5,009 -84 393 138 53 100 -47
5,385 -77 295 103 26 100 -74
5,789 -69 221 77 8 100 -92
6,223 -61 166 58 -3 100 -103
6,690 -52 124 44 -8 100 -108
7,192 -42 93 33 -9 1,300 -1,309
7,731 -31 70 24 -7
8,311 -20 52 18 -2
8,934 -8 39 14 6