Case:

When Jay Smith took over the job of aide to the President two years ago, things were going well at the Signal Cable company. The company was on an expansionary path and had branched out into the fiber optic business. Expectations and prospects were good and the economy very strong. The threat of competition was not too serious. Due to the expectation of increasing demand for fiber optic communications, the company had established two additional manufacturing facilities and significantly increased its inventory.

Signal Cable had enjoyed a high performance run in recent years. However, when the financial statements were prepared for the current year, the results showed a lower net profit margin. More importantly, there was a severe drop in the company's cash balance and the price had recently dropped from $ 7 to $ 5.50 per share.

Jay knew that the shareholders would be very concerned and possibly angry. He was also convinced that his boss, Joe Mathis, would have to find some viable answers and suggestions on how liquidity problems could be mitigated. This concern was primarily important as the company had been hoping to raise some short-term capital in the immediate future. Jay's expectations were met when Joe called him and asked him to prepare a report explaining the company's financial situation. Table 1 and 2 presents the Income Statement and Balance Sheet for the last two years.

1. Why has the share price decreased despite the fact that net income has increased?

 

 

2. How liquid would you say this company is? Calculate the absolute liquidity of the company. How does it compare to the liquidity position of the previous year? * Hint: Calculate some of the financial ratios that measure liquidity and compare the results of the last 2 years *

 

 

3. How does the market value of the shares compare to their book value? Is the book or book value accurately reflecting the true condition of the business?

 

 

4. The Board of Directors is unclear as to why the cash balance has declined sharply despite increased sales and gross profit margin. What should Jay say to the Board? * Hint: In order to identify the items that have caused such a drastic decline, you need to prepare the Cash Flow Statement for 2004 *

 

 

 

5. Measure the company's free cash flow. Which indicates?

 

 

6. Calculate the net working capital of the company for each of the two years. What can you conclude about the company's net working capital? 2003 ______ 2004 Current Assets? ? - Current liabilities? ? = Net Working Capital? ?

 

  7. Should shareholders be concerned about the decrease in cash flow or should they be happy that earnings per share have increased? Explain your answer.