Solution to Case 1
Cash Flow Analysis
Signal Cable Company*
Note to Instructors: When assigning this case, inform the students that the firm’s stock price has recently dropped from $7 per share to $5.50 per share. Case objective: The objective of this case is to cover financial statement analysis and cash flow analysis, with a particular emphasis on liquidity and net working capital. Student Preparation time: Approximately 2 hours. Answers to questions: 1. Why has the stock price fallen despite the fact that the net income has increased? Although Signal has made a net profit that is higher than that of the previous year, its net profit margin is lower (6.98% vs 7.43%). Most of this decrease has been caused by the significant increase in debt in 2001 resulting in much higher interest expenses ($111,000 higher than 2000). Higher debt is not necessarily bad, if profitability is proportionately higher as well. However, the interest coverage ratio of this firm has dropped considerably from 5.72 in 2000 to 2.53 in 2001. Stock prices are affected by earnings as well as by risk expectations. The drop in price is an indication that investors are concerned about the increased risk of high debt.
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? Liquidity is defined as the ability of converting an asset into cash without significant loss of value. A firm’s liquidity refers to its ability to pay its short-term bills and current liabilities by converting its current assets into cash. Liquidity is also referred to a firm’s short-term solvency. There are various measures of liquidity such as the current ratio, the quick ratio, the cash ratio, the ratio of net working capital to total assets, and the interval measure. 2001 2000 0.113 1.50 0.68 0.43 236.072555 535,000
Cash Ratio Current Ratio Quick Ratio NWC to TA Interval Ratio Absolute...
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