$$ Chapter $6$ Problem $15$

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

a$.$ What was the book value of Nova$$s shareholders$$ equity from $2019$ to $2021?$ 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 $6\mathrm{.}5$ in the text, what bond rating would Nova have in $2020$ 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 $2020$ 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 $2020$ 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?

NOVA PRODUCTS

INCOME STATEMENT $($$ millions$)$

$201920202021$

Sales $5,957\mathrm{.}86,228\mathrm{.}36,876\mathrm{.}0$

Cost of Goods Sold $2,156\mathrm{.}92,217\mathrm{.}62,481\mathrm{.}8$

Gross Profit $3,800\mathrm{.}94,010\mathrm{.}74,394\mathrm{.}2$

Selling, General, & Administrative Expense $2,889\mathrm{.}52,979\mathrm{.}63,213\mathrm{.}6$

Operating Income Before Depreciation $911\mathrm{.}41,031\mathrm{.}11,180\mathrm{.}6$

Depreciation, Depletion, & Amortization $109\mathrm{.}0124\mathrm{.}8123\mathrm{.}5$

Operating Profit $802\mathrm{.}4906\mathrm{.}31,057\mathrm{.}1$

Interest Expense $71\mathrm{.}159\mathrm{.}749\mathrm{.}0$

Non$-$Operating Income$/$Expense $36\mathrm{.}325\mathrm{.}3(0\mathrm{.}3)$

Special Items $(77\mathrm{.}9)(36\mathrm{.}3)(14\mathrm{.}3)$

Pretax Income $689\mathrm{.}7835\mathrm{.}6993\mathrm{.}5$

Total Income Taxes $240\mathrm{.}3292\mathrm{.}3318\mathrm{.}9$

Minority Interest $4\mathrm{.}58\mathrm{.}79\mathrm{.}8$

Income Before Extraordinary Items & Discontinued Operations $444\mathrm{.}9534\mathrm{.}6664\mathrm{.}8$

Extraordinary Items $(0\mathrm{.}3)0\mathrm{.}00\mathrm{.}0$

Discontinued Operations $0\mathrm{.}00\mathrm{.}00\mathrm{.}0$

Adjusted Net Income $444\mathrm{.}6534\mathrm{.}6664\mathrm{.}8$

BALANCE SHEET $($$ millions$)$

$201920202021$

ASSETS

Cash & Short$-$Term Investments $508\mathrm{.}5606\mathrm{.}8694\mathrm{.}0$

Net Receivables $519\mathrm{.}5555\mathrm{.}4599\mathrm{.}8$

Inventories $612\mathrm{.}5614\mathrm{.}7653\mathrm{.}4$

Other Current Assets $248\mathrm{.}6271\mathrm{.}3278\mathrm{.}9$

Total Current Assets $1,889\mathrm{.}12,048\mathrm{.}22,226\mathrm{.}1$

Gross Plant, Property & Equipment $1,552\mathrm{.}41,548\mathrm{.}41,728\mathrm{.}9$

Accumulated Depreciation $779\mathrm{.}7779\mathrm{.}3873\mathrm{.}3$

Net Plant, Property & Equipment $772\mathrm{.}7769\mathrm{.}1855\mathrm{.}6$

Intangibles $0\mathrm{.}020\mathrm{.}646\mathrm{.}2$

Deferred Charges $0\mathrm{.}00\mathrm{.}00\mathrm{.}0$

Other Assets $530\mathrm{.}8489\mathrm{.}6434\mathrm{.}4$

TOTAL ASSETS $3,192\mathrm{.}63,327\mathrm{.}53,562\mathrm{.}3$

LIABILITIES

Long Term Debt Due In One Year $1\mathrm{.}23\mathrm{.}14\mathrm{.}4$

Notes Payable $87\mathrm{.}6602\mathrm{.}1239\mathrm{.}7$

Accounts Payable $404\mathrm{.}1379\mathrm{.}9400\mathrm{.}1$

Taxes Payable $375\mathrm{.}9353\mathrm{.}0321\mathrm{.}9$

Other Current Liabilities $592\mathrm{.}2637\mathrm{.}4621\mathrm{.}6$

Total Current Liabilities $1,461\mathrm{.}01,975\mathrm{.}51,587\mathrm{.}7$

Long Term Debt $1,236\mathrm{.}3767\mathrm{.}0877\mathrm{.}7$

Deferred Taxes $30\mathrm{.}635\mathrm{.}450\mathrm{.}6$

Investment Tax Credit $0\mathrm{.}00\mathrm{.}00\mathrm{.}0$

Minority Interest $29\mathrm{.}037\mathrm{.}046\mathrm{.}0$

Other Liabilities $510\mathrm{.}8640\mathrm{.}3629\mathrm{.}0$

TOTAL LIABILITIES $3,267\mathrm{.}73,455\mathrm{.}23,191\mathrm{.}0$

EQUITY

Common Stock $89\mathrm{.}189\mathrm{.}690\mathrm{.}3$

Capital Surplus $938\mathrm{.}01,019\mathrm{.}51,188\mathrm{.}4$

Retained Earnings $899\mathrm{.}9943\mathrm{.}91,473\mathrm{.}0$

Less: Treasury Stock $2,002\mathrm{.}12,180\mathrm{.}72,380\mathrm{.}4$

TOTAL EQUITY $(75\mathrm{.}1)(127\mathrm{.}7)371\mathrm{.}3$

TOTAL LIABILITIES & EQUITY $3,192\mathrm{.}63,327\mathrm{.}53,562\mathrm{.}3$

EXPLAIN THE ANSWERS