"COMPREHENSIVE PROBLEMASPEN SKI COMPANYBalance SheetDecember 31, 2008Assets Liabilities and Stockholders’ EquityCash ..........................................$ 40,000 Accounts payable ......................$1,800,000Marketable securities ...............60,000 Accrued expenses .....................100,000Accounts receivable .................1,000,000 Notes payable (current) .............600,000Inventory ..................................3,000,000 Bonds (10%) .............................2,000,000Gross plant Common stock (1.5 million and equipment ......................5,000,000shares, par value $1) ..............1,500,000Less: AccumulatedRetained earnings ......................1,100,000 depreciation .......................2,000,000 Total liabilities andTotal assets ...............................$7,100,000stockholders’ equity ...............$7,100,000Income Statement—2008Sales (credit)............................................................. $6,000,000Fixed costs* .............................................................. 1,800,000Variable costs (0.60) ................................................3,600,000Earnings before interest and taxes............................ 600,000Less: Interest ........................................................200,000Earnings before taxes ............................................... 400,000Less: Taxes @ 40% ..............................................160,000Earnings after taxes .................................................. 240,000Dividends ................................................................. 43,200Increased retained earnings ...................................... $196,800*Fixed costs include (a) lease expense of $190,000 and (b)depreciation of $400,000.Note: Aspen Ski also has $100,000 per year in sinking fundobligations associated with its bond issue. The sinking fund representsan annual repayment of the principal amount of the bond. It is not tax-deductible.S5-43 Ratios Aspen Ski(to be filled in) IndustryProfit margin ............................_____ 6.1%Return on assets ......................._____ 6.5%Return on equity ......................._____ 8.9%Receivables turnover ................_____ 4.9xInventory turnover ...................._____ 4.4xFixed-asset turnover ................._____ 2.1xTotal-asset turnover .................._____ 1.06xCurrent ratio ............................._____ 1.4xQuick ratio ................................_____ 1.1xDebt to total assets ..................._____ 27%Interest coverage ......................_____ 4.2xFixed charge coverage.............._____ 3.0x a. Analyze Aspen Ski Company, using ratio analysis. Compute the ratios above forAspen and compare them to the industry data that is given. Discuss the weak points,strong points, and what you think should be done to improve the company’sperformance. b. In your analysis, calculate the overall break-even point in sales dollars and the cashbreak-even point. Also compute the degree of operating leverage, degree of financialleverage, and degree of combined leverage. c. Use the information in parts a and b to discuss the risk associated with this company.Given the risk, decide whether a bank should loan funds to Aspen Ski.Aspen Ski Company is trying to plan the funds needed for 2009. The managementanticipates an increase in sales of 20 percent, which can be absorbed withoutincreasing fixed assets. d. What would be Aspen’s needs for external funds based on the current balance sheet?Compute RNF (required new funds). Notes payable (current) are not part of theliability calculation. e. What would be the required new funds if the company brings its ratios into line withthe industry average during 2009? Specifically examine receivables turnover,inventory turnover, and the profit margin. Use the new values to recompute thefactors in RNF (assume liabilities stay the same). f. Do not calculate, only comment on these questions. How would required new fundschange if the company:1. Were at full capacity?2. Raised the dividend payout ratio?3. Suffered a decreased growth in sales?4. Faced an accelerated inflation rate?S5-44 CP 5-1 Solution:Aspen Ski Companya. Ratio analysisAspen IndustryProfit margin $240,000/$6,000,000 4.00% 6.1%Return on assets $240,000/$7,100,000 3.38% 6.5%Return on equity $240,000/$2,600,000 9.23% 8.9%Receivable turnover $6,000,000/$1,000,000 6x 4.9xInventory turnover $6,000,000/$3,000,000 2x 4.4xFixed asset turnover $6,000,000/$3,000,000 2x 2.1xTotal asset turnover $6,000,000/$7,100,000 .85x 1.06xCurrent ratio $4,100,000/$2,500,000 1.64x 1.4xQuick ratio $1,100,000/$2,500,000 .44x 1.1xDebt to total assets $4,500,000/$7,100,000 63.4% 27.0%Interest coverage $600,000/$200,000 3x 4.2xFixed charge coverage See calculation below* 1.42x 3.0x$600,000 + $190,000 Lease ( ) =1.42x$200,000+ $190,000+ $100,000 / 1-.4 ( ) The company has a lower profit margin than the industry andthe problem is further compounded by the slow turnover ofassets (.85x versus an industry norm of 1.06x). This leads to amuch lower return on assets. The company has a higher returnon equity than the industry, but this is accomplished through thefirm’s heavy debt ratio rather than through superior profitability.The slow turnover of assets can be directly traced to theunusually high level of inventory. The firm’s inventory turnoverratio is only 2x, versus an industry norm of 4.4x. Actually thefirm does quite well with receivable turnover and is onlyslightly below the industry in fixed asset turnover.S5-45 CP 5-1 (Continued):The previously mentioned heavy debt position becomes moreapparent when we examine times interest earned and fixedcharge coverage. The latter is particularly low due to leaseexpenses and sinking fund obligations.b. Break-even in salesSales = Fixed Costs + Variable costs(variable costs are expressed as a percentage of sales)Sales = $1,800,000 + .60 SalesBE.40 S = $1,800,000S = $2,800,000/.40S = $4,500,000Cash break-evenSales = (Fixed costs – Non cash expenses*) + Variable costsSales = ($1,800,000 – $400,000) + .60 SalesBESales = $1,400,000 + .60 SalesBE.40 S = $1,400,000S = $1,400,000/.40S = $3,500,000*DepreciationS -TVC DOL = S-- TVC FC $6,000,000 - $3,600,000 =$6,000,000- $3,600,000- $1,800,000 $2,400,000 = = 4x $600,000 S5-46 CP 5-1 (Continued):EBIT DFL = EBIT -I $600,000 =$600,000 - $200,000 $600,000 = =1.5x $400,000 S -TVC DCL = S-TVCF-- CI $6,000,000 - $3,600,000 =$6,000,000- $3,600,000-- $1,800,000 $200,000 $2,400,000 = = 6x $400,000 c. Aspen is operating at a sales volume that is $1,500,000 abovethe traditional break-even point and $2,500,000 above the cashbreak-even point. This can be viewed as somewhat positive.However, the firm has a high degree of leverage, whichindicates any reduction in sales volume could have a verynegative impact on profitability. The DOL of 4x is associatedwith heavy fixed assets and relatively high fixed costs. The DFLof 1.5x is attributed to high debt reliance. Actually, if we wereto include the lease payments of $190,000 with the interestpayments of $200,000, the DFL would be almost 3x.The banker would have to question the potential use of thefunds and the firm’s ability to pay back the loan. Actually, thefirm already appears to have an abundant amount of assets, sohopefully a large expansion would not take place here. Thereappears to be a need to reduce inventory rather than increase thelevel.S5-47 "