UNIVERSITY OF ECONOMICS AND LAW

INTERNATIONAL ECONOMIC RELATIONS

CASE STUDY 1: Signal Cable Company

Subject : Financial Management

Lecturer : Ms. Ho Thi Hong Minh
Class: K17408C

Student’s name Student ID

Phan Tiến Linh K174080945
Trần Gia Linh K174080946
Đỗ Thu Ngân K174080948
Phùng Thị Mai Nguyên K174080952
Đinh Thị Thanh Thanh K174080958
 APPENDIX

Financial Status of Signal Cable Company..........................................................................3

Question 1: Why has the stock price fallen despite the fact that the net income has
increased?...............................................................................................................................5
Question 2: How liquid would you say that this company is? Calculate the absolute liquidity
of the firm. How does it compare with the previous year’s liquidity
position?..................................................................................................................................5
Question 3: How does the Market Value of the Stock compare with its Book Value? Is the
Book Value accurately reflecting the true condition of the
company?................................................................................................................................6
Question 4: The board of directors is not clear as to why the cash balance has dropped so
much in spite of the increase in sales and the gross profit margin. What should Jay tell the
board?.....................................................................................................................................7
Question 5: Measure the free cash flow of the firm. What does it
indicate?..................................................................................................................................8
Question 6: Calculate the net working capital of the company for each of the two years. What
can you conclude about the firm’s net working
capital?....................................................................................................................................8
Question 7: Should the shareholders be concerned about the drop in cash flow or should
they be happy that the earnings per share have increased ? Explain
yourself....................................................................................................................................9

2
SIGNAL CABLE COMPANY

The company was on an expansion path and had branched off into the fiber
optics business.The competition was not too serious. Due to the expectation of
increased demand for fiber optic communications, the company had established two
additional manufacturing facilities, and increased its inventory.
Over the past few years, Signal Cable Company had quite a run up in profits,
and then when the accounting statement were prepared for the current year, the results
were not like they expected, they showed a lower profitability.
Not only the profit was low, but there was a serious drop in the cash balance,
and also the company stock price had fallen from 7$ to 5.50$ per share.
This concern was primarily important since the firm had been expecting to raise
some short-term capital in the immediate future. The president of the Signal Cable
Company asked from Jay to prepare a report explanation for the financial condition of
the firm.
INCOME STATEMENT

2001 2000
Net Sales 2,050,000 1,678,894
Cost of Goods sold 1,537,500 1,343,115
Depreciation 79,000 51,000
Selling & Administrative expenses 40,000 32,945
Earnings Before Interest and Taxes 393,500 251,833.8

Interest Paid 155,000 44,000

Taxable Income 238,500 207,833.8
Taxes (40%) 95,400 83,133.52
Net Income 143,100 124,700.3
Dividends 42,930 37,410.08
Addition to Retained Earnings 100,170 87,290.2

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 BALANCE SHEET
2001 2000

ASSETS

Cash 5,000 40,000

Accounts Receivable 540,000 200,000
Inventories 1,300,450 650,000
Total Current Assets 1,845,450 890,000
NWC 950,450 535,000
Gross Fixed Assets 1,300,000 510,000
Accumulated Depreciation 232,000 153,000
Net Fixed Assets 1,068,000 357,000
Total Assets 2,913,450 1,247,000
LIABILITIES & EQUITY

Accounts Payable 145,000 55,000

Notes Payable 750,000 300,000
Total Current Liabilities 895,000 355,000
Long-term Debt 1,226,280 200,000
Common-stock and Paid in 600,000 600,000
Surplus (200,000 shares
outstanding)
Retained Earnings 192,170 92,000
Total 2,913,450 1,247,000

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Question 1: Why has the stock price fallen despite the fact that the net income has
increased?
The stock price does not depend on the net income. Signal has made a net profit
that is higher than that of the previous year, but its net profit margin is lower ( In 2003,
net profit margin is $124,700.3 / $1,678,894 = 7.43% and in 2004, it is $143,100 /
$2,050,000 = 6,98%).
Most of this decrease has been caused by the increase in debt in 2004 resulting
in much higher interest expenses (155,000 - 44,000 = 111,000 higher than 2003). The
stock price has fallen because the liability of the company is high, they have money
but on account receivable, still waiting for the customers to pay. Higher debt is not
necessarily bad, if profitability is proportionately higher as well.
However, the interest coverage ratio of this firm has dropped considerably from
5.72 in 2003 to 2.54 in 2004. Stock prices are affected by earnings as well as by risk
expectations. The drop in price is an indication that investors are concerned
about the increased risk of high debt. And also the stock price depends on the prices
of the stock market (How they grow or fall), also from the demand for those stocks.

Question 2: How liquid would you say that this company is? Calculate the absolute
liquidity of the firm. How does it compare with the previous year’s liquidity position?
Liquidity is defined as the ability of converting an asset into cash without
significant loss of value. A firm’s liquidity refers to its ability to pay its short-term
bills and current liabilities by converting its current assets into cash. Liquidity is also
referred to a firm’s short-term solvency. There are various measures of liquidity such
as the current ratio, the quick ratio, the cash ratio, the ratio of net working capital to
total assets, and the interval measure.
Absolute liquidity is represented by the cash and near cash items such as cash,
bank and marketable securities.

2004 2003
Cash ratio = 5000 / 895,000 = 40,000 / 355,000
= Cash / Current Liability = 0.0056 = 0.113
Current ratio
= 1,845,450 / 895,000 = 890,000 / 355,000
= Current Assets / Current
= 2.06 = 2.51
Liability

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 Quick Ratio = (1,845,450 – 1,300,450)/ = (890,000 – 650,000)/
= (Current Assets – 895,000 350,000
Inventory)/ Current Liability = 0.61 = 0.68
Net working capital to total = 950,450 / 2,913,450 = 535,000 / 1,247,000
asset = 0.33 = 0.43
Interval Ratio
= Current Assets / Average = 426.99 = 236.07
Daily Expenditures

The above ratios indicate that although the Absolute Liquidity (Net working
Capital) of the firm has increased in 2004 (535,000 compared to 950,450), the relative
liquidity of the firm has decreased. The current ratio has significantly declined (2.51
to 2.06).
However, the liquidity situation is not critical because, as the interval measure
indicates, the firm could continue operating for at least another 427 days if its cash
inflows began to dry up. This interval coverage has increased significantly from its
level in 2003. Thus one can conclude that although the relative liquidity condition of
the company has deteriorated since 2003, it is not critically low.

Question 3: How does the Market Value of the Stock compare with its Book Value?
Is the Book Value accurately reflecting the true condition of the company?
The Market Value = Current Stock Price x 200,000 shares
The Book Value in 2003 = (Total Assets - Total Liabilities)
= Shareholders’ Equity
= 1,247,000 - 550,000 =692,000.
The 2003 Book Value Per Share = 692,000 / 200,000 shares
=3,46.
The Book Value in 2004 = Total Assets - Total Liabilities
= Shareholders’ Equity
= 2,913,450 - 2,121,280 = 792,170.
The 2004 Book Value Per Share = 792,170 / 200,000 shares
= 3,96.
In this case, The Stock Price is higher than its Book Value since it has been
growing and has had a run up of Sales and Profits over the past few years. The drop
in Price recently reflects the increased risk due to higher Debt levels and the

6
lower relative Liquidity position of the company. Although the book value per
share has increased slightly in 2004 ($3.96 vs. $3.46), it is the market value that
reflects the true condition of the company.

Question 4: The board of directors is not clear as to why the cash balance has
dropped so much in spite of the increase in sales and the gross profit margin. What
should Jay tell the board ?
Jay should show the board of director the 2004 Statement of Cash Flow
Signal Cable Company
2004 Statement of Cash Flows
Cash at the beginning of the year 40,000
Operating Activity
Net income: 143,100

Depreciation 79,000
Increase in Accounts Payable 90,000

Increase in Accounts Receivable (340,000)

Increase in Inventories (650,450)
Net cash from operating activity (678,350)

Investment Activity
Increase in Fixed Assets (790,000)
Net cash from investment activity (790,000)

Financing Activity
Increase in Notes Payable 450,000
Increase in long-term debt 1,026,280
Dividends paid (42,930)
Net cash from Financing Activity 1,433,350
Net decrease in Cash (35000)
Cash at the end of the year 5000

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 Jay should present to the board that as the Statement of cash flow shows,
although there was an increase in sales and the gross profit margin, the acquisition of
assets and business expansion activities led to a reduction in the cash balance.
The firm has invested much on fixed assets, caused the Net cash from Investing
Activity to reduce by 790,000.
Also, the firm has invested heavily in Accounts Receivable, Inventories; made
the Net cash from Operating Activity reduce by 678,350.
These investments were funded by an increase in payables and retained
earnings. Signal Cable borrowed about $1.47 million worth of long-term debt
and drew down on its cash reserves to fund the balance.

Question 5: Measure the free cash flow of the firm. What does it indicate?
Free cash flow (FCF) = Net income + Depreciation - Changes in Working
Capital - Capital Expidenture
Changes in Working Capital = CA – CL
= (1,845,450 - 890,000) - (895,000 - 355,000)
= 415,450
=> FCF = 143,100 + 79,000 - 415,450 - 40,000 = -233,350

Free cash flow represents the cash a company generates after cash outflows to
support operations and maintain its capital assets. Free cash flow is the cash flow
available to all the investors in a company, including common stockholders, preferred
shareholders, and lenders.
The negative free cash flows shows that the firm has more outgoing than
incoming money. There are several reasons in this case:
- Poor timing of income and expenses (accounts receivable is raised by
thoroughly 37%)
- Their investment in the long run (fixed assets are raised by thoroughly 39%)
- Expenses on inventories (inventories are raised by thoroughly 50%).
Therefore, a negative free cash flow could not be negative as it sounds, it also
depends on how the company spends money.

Question 6: Calculate the net working capital of the company for each of the two
years. What can you conclude about the firm’s net working capital?
Net working capital (NWC) = Total current assets - Total current liabilities
NWC(2004) = 1,845,450 - 890,000 = 950,450
NWC(2003) = 895,000 - 355,000 = 535,000

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 We can see a sharp rise in NWC. It means that the business is able to continue
its operations and that it has sufficient funds to satisfy both maturing short-term debt
and upcoming operational expenses. It is also considered a sign of a well-managed
company with the potential for growth.

Question 7: Should the shareholders be concerned about the drop in cash flow or
should they be happy that the earnings per share have increased ? Explain yourself.
Net income as reported on the income statement is not cash; and in finance,
“Cash is King” Management goal is to maximize the price of the firm’s stock; and the
value of any asset, including a share of stock, is based on the cash flows the asset is
expected to produce. Therefore, managers strive to maximize the cash flows available
to investors.
Therefore, shareholders should be greatly concerned about cash flow, especially
there’s a drop in cash flow and net profit margin. The decline in cash flow is usually
an early warning signal and the managers should take the necessary steps to alleviate
the resulting deterioration of the firm’s liquidity.