The Signal Cable Company, located in Tarrytown NY, is a cable manufacturer for analog and digital interconnects, speaker, video and home theater cables. The company is well known for “highest standard in quality and customer service” and their “superior design” and “No-Hype approach resulted in one of the best price/performance ratio in the industry” (www.signalcable.com).
After a steady growth over the last few years, the management decided to enter in the fiber optics business. The market was growing, the demand increased and the competition was not too severe. Thus the company established two additional manufacturing facilities and increased its inventory to meet the raising number of orders.
But despite or because of these investments the results showed a lower net profit margin, furthermore the cash balance and the stock price had fallen recently.
Jay Smith, Assistant of the President, has now the challenge to prepare some feasible answers and suggestions for his boss, Joe Mathis, who has to inform the shareholders about the current situation.
Questions of the Case Study
1. Why has the stock price fallen despite the fact that the net income has increased?
The stock price has fallen from $7 to $5.50 despite the fact that the net income has increased. The reason for the decrease of the stock price is that the shareholders are concerned about the increasing debts and liabilities, caused by the recent investments in two additional manufacturing facilities and a significant increase of its inventory. The concerns are based on the belief that the increased amount of debts and liabilities will result in lower future net income, because of the interests, which the company will have to pay. So the negative effects of these recent investments are visible in some severe changes in the balance sheet, the income statement and the financial ratios. For example from 2003 to 2004 the amount of interest paid increased from 44,000 to 155,000, the total current liabilities increased from 355,000 to 895,000, the long term debt increased from 200,000 to 1,226,280. These changes can also be seen in the following financial ratios.
The long-term dept ratio increased from 22% to 61%.
long-term debt ratio =Long-term debt
Long-term debt + equity
2004: LTDR =1,226,280= 0.61
2003: LDTR =200,000= 0.22
The total dept ratio increased from 45% to 73%.
total debt ratio =total liabilities
2004: TDR =2,121,280= 0.73
2003: TDR =555,000= 0.45
The Times interest earned decreased from 5.72 to 2.54.
times interest earned =EBIT
2004: TIE =393,500= 2.54
2003: TIE =251,833.8= 5.72
In addition the shareholders might be worried about the arising liquidity problems, which are also caused by the recent investments. The liquidity problems will be discussed in detail in Answer 2.
2. How liquid would you say that this company is? Calculate the absolute liquidity of the firm. How does it compare with the previous year’s liquidity position?
The cash balance decreased from 40,000 to 5,000, while the accounts receivable increased from 200,000 to 540,000. In addition the inventory amount increased from 650,000 to 1,300,450. This means that the increase of sales did not flow in the cash balance but in the accounts receivable position. That means that many customers have not paid their bills directly (this can also be seen in the cash flow statement of answer 4). This liquidity situation might cause severe liquidity problems, if the company has to pay for a couple of major bills. So the actual liquidity of the Signal Cable Company is not satisfying, which can be seen in the following ratios.
The net working capital to asset deteriorated from...