This problem asks you to evaluate a major increase in financial leverage on the part of Nova

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This problem asks you to evaluate a major increase in financial leverage on the part of Nova Products, Inc. The company’s financial statements for 2015–2017 and specific questions are available for download through McGraw-Hill’s Connect or your course instructor.

Using the financial statements provided below to answer the following questions:

 

NOVA PRODUCTS
INCOME STATEMENT ($ millions)

201520162017
Sales5,957.86,228.36,876.0
Cost of Goods Sold2,156.92,217.62,481.8
Gross Profit3,800.94,010.74,394.2




Selling, General, & Administrative Expense2,889.52,979.63,213.6
Operating Income Before Depreciation911.41,031.11,180.6




Depreciation, Depletion, & Amortization109.0124.8123.5
Operating Profit802.4906.31,057.1




Interest Expense71.159.749.0
Non-Operating Income/Expense36.325.3(0.3)
Special Items(77.9)(36.3)(14.3)
Pretax Income689.7835.6993.5




Total Income Taxes240.3292.3318.9
Minority Interest4.58.79.8
Income Before Extraordinary Items & Discontinued Operations444.9534.6664.8




Extraordinary Items(0.3)0.00.0
Discontinued Operations0.00.00.0
Adjusted Net Income444.6534.6664.8




BALANCE SHEET ($ millions)

201520162017
ASSETS


Cash & Short-Term Investments508.5606.8694.0
Net Receivables519.5555.4599.8
Inventories612.5614.7653.4
Other Current Assets248.6271.3278.9
Total Current Assets1,889.12,048.22,226.1




Gross Plant, Property & Equipment1,552.41,548.41,728.9
Accumulated Depreciation779.7779.3873.3
Net Plant, Property & Equipment772.7769.1855.6
 Intangibles0.020.646.2
 Deferred Charges0.00.00.0
Other Assets530.8489.6434.4




TOTAL ASSETS3,192.63,327.53,562.3




LIABILITIES


Long Term Debt Due In One Year1.23.14.4
Notes Payable87.6602.1239.7
Accounts Payable404.1379.9400.1
Taxes Payable375.9353.0321.9
Other Current Liabilities592.2637.4621.6
Total Current Liabilities1,461.01,975.51,587.7




Long Term Debt1,236.3767.0877.7
Deferred Taxes30.635.450.6
Investment Tax Credit0.00.00.0
Minority Interest29.037.046.0
Other Liabilities510.8640.3629.0




TOTAL LIABILITIES3,267.73,455.23,191.0




EQUITY






Common Stock89.189.690.3
Capital Surplus938.01,019.51,188.4
Retained Earnings899.9943.91,473.0
Less: Treasury Stock2,002.12,180.72,380.4




TOTAL EQUITY(75.1)(127.7)371.3




TOTAL LIABILITIES & EQUITY3,192.63,327.53,562.3

a. What was the book value of Nova’s shareholders’ equity from 2015 to 2017? What were Nova’s debt-to-assets and times-interest-earned ratios in these years? (Use pretax income plus interest expense as EBIT.) What do these figures suggest about Nova’s use of financial leverage? Consulting Table 6-5 in the text, what bond rating would Nova have in 2016 if the rating were based solely on the firm’s coverage ratio?

b. What percentage decline in EBIT could Nova have suffered in each year before Nova would have been unable to make its interest payments out of operating income?                                      

c. Assuming a 35 percent corporate tax rate, and 2016 earnings before interest and taxes of $895 million, by how much did Nova’s $60 million interest expense reduce taxes?                                         

d. Answer question (a) and (b) again for 2016 assuming the company had borrowed an additional $3 billion in debt at 8 percent interest at the start of the year and distributed the proceeds to shareholders as a special dividend. You may ignore the effect of added interest expense on Nova’s balance sheet. Might shareholders benefit from such an increase in financial leverage? Explain.                                         

e. Based on your analysis, is Nova heavily or modestly indebted? Should the company acquire more debt, or shed existing debt? Why?

Financial Statements
Financial statements are the standardized formats to present the financial information related to a business or an organization for its users. Financial statements contain the historical information as well as current period’s financial...
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