S&S Air, Inc.

Case questions

1. What problem does S&S Air, Inc. face in this case?

2. What does an extended DuPont analysis (ROE) indicate about the performance of the company?

3. What do the rates of growth (IGR and SGR) indicate about the company’s performance?

4. What do the financial planning results show about the external financing needed (EFN)?

What is the problem?

The company wants to grow - -

• They need to compare their performance to that of other companies in the industry to identify their strengths and weaknesses.

• They need to develop alternative financial plans to evaluate how best to finance the anticipated growth.

Income Statement 2008 (not 2009)

Balance Sheet, 2008 (not 2006)

Industry financial data, 2008

Extended DuPont analysis

ROE = PM * ATO * EM

= (1,537,452 / 30,499,420) * (30,499,420 / 18,308,920) * (18,308,920 / 10,069,920)

= .0504 * 1.666 * 1.818 = 0.1527

What are the strengths of S&S Air relative to the aircraft industry?

Ratio S&S Air

25% 50% 75%

PM .0504 .0405 .0698 .0987

ATO 1.666 .68 .85 1.38

ROA 0.084 0.061 .105 .132

EM 1.818 1.79 2.08 2.56

ROE 0.1527 .0993 .1654 .2615

Rates of growth

• Internal growth rate - -

IGR = (b*ROA) / [1 – (b*ROA)]

ROA = EAT / A = 1,537,452 / 18,308,920 = 0.084

b = Add to R.E. / EAT = 977,452 / 1,537,452 = .6358

IGR = (.6358 * .084) / [1 – (.6358 * .084)] = .0564

• Sustainable growth rate - -

SGR = (b*ROE) / [1-(b*ROE)]

ROE = ROA * EM = EAT / E = 1,537,452 / 10,069,920 = .1527

SGR = (.6358 * .1527) / [1 – (.6358 * .1527)] = .1075

EFN

• Graph of EFN - - the external financing required for 12% sales growth assuming full capacity utilization

• EFN = Chge. Assets – Chge. Liab. – Chge. Ret. Earn.

• Chge. Assets = .12 * 18,308,920 = 2,197,070• Chge. Liab. = .12 * 889,000 = 106,680• Chge. Ret. Earn. - -

EBIT(1) = (30,499,420 – 22,224,580 – 3,867,500)* 1.12 – 1,366,680 = 3,569,541

EBT(1) = EBIT(1) – I = 3,569,541 – 478,240 = 3,091,301Chge. Ret. Earn. = EBT* (1- t) * (b)

= 3,091,301 * (1-.40) * .6358 = 1,179,270• EFN = 2,197,070 – 106,680 – 1,179,270 = 911,120

• Let’s look at the pro-forma statements to verify our EFN result.

Pro forma Income Statement (12 percent growth rate)

  Income statement      

  Sales $ 34,159,350        COGS 24,891,530      

  Other expenses 4,331,600        Depreciation 1,366,680      

  EBIT $ 3,569,541        Interest 478,240      

  Taxable income $ 3,091,301        Taxes (40%) 1,236,520      

  Net income $ 1,854,780      

             Dividends $ 675,583        Add to RE 1,179,197      

Pro-forma BaIance Sheet (12 percent growth rate)

  Balance sheet

  Assets   Liabilities & Equity  Current Assets     Current Liabilities  

  Cash $ 493,920   Accounts Payable $ 995,680   Accounts rec. 793,408   Notes Payable 2,030,000

  Inventory 1,161,574   Total CL $ 3,025,680   Total CA $ 2,448,902      

        Long-term debt $ 5,320,000

         

    Shareholder Equity  

        Common stock $ 350,000   Fixed assets     Retained earnings 10,899,117

  Net PP&E $ 18,057,088    Total Equity $ 11,249,117            

  Total Assets $ 20,505,990   Total L&E $ 19,594,787

So, the EFN is:EFN = Total assets – Total liabilities and equityEFN = $20,505,990 – 19,594,797 EFN = $911,193 (a small difference due to rounding error)

What happens to EFN when assets are purchased in increments of $5 million? (Handout)

Because fixed assets increase more rapidly, the depreciation expense will increase at a rate that

is faster than sales growth - - => Sales, profits and retained earnings contribute

proportionately less to the total financing required (Ret. Earn. declines), and

=> Liabilities (spontaneous liability growth) will contribute less to the total financing required.

=> So, EFN has to increase.