Sepracor, Inc., a drug company, reported the following information. The company prepares its financial statements in accordance with GAAP.
2007 (,000)
Current liabilities ...........$ 554,114
Convertible subordinated debt ......648,020
Total liabilities ............1,228,313
Stockholders’ equity ............176,413
Net income ..............58,333
Analysts attempting to compare Sepracor to drug companies that issue debt with detachable warrants may face a challenge due to differences in accounting for convertible debt.
Instructions
(a) Compute the following ratios for Sepracor, Inc. (Assume that year-end balances approximate annual averages.)
(1) Return on assets.
(2) Return on stockholders’ equity.
(3) Debt to assets ratio.
(b) Briefly discuss the operating performance and financial position of Sepracor. Industry averages for these ratios in 2007 were: ROA 3.5%; return on equity 16%; and debt to assets 75%. Based on this analysis, would you make an investment in the company’s 5% convertible bonds? Explain.
(c) Assume you want to compare Sepracor to an IFRS company like Merck (which issues nonconvertible debt with detachable warrants). Assuming that the fair value of the equity component of Sepracor’s convertible bonds is $150,000, how would you adjust the analysis above to make valid comparisons between Sepracor and Merck?