Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 49

Business Analysis and Business Valuation Gordon Supply Company manufactures high quality gardening supplies for sale primarily to nursery and landscaping companies. Gordon Supply is a business that has continued to grow because of its commitment to quality and service to a relatively small number of large, loyal customers. The financial statements for Gordon for the most recent two years are shown below, together with selected industry information.

Balance Sheet, Dec 31,
	2010	2009
Cash	$ 382,000	$ 200,000
Accounts receivable	90,000	120,000
Inventory	90,000	100,000
Total current assets	562,000	420,000
Long-lived assets	1,840,000	1,900,000
Total assets	$2,402,000	$2,320,000
Current liabilities	$ 200,000	$ 250,000
Long-term debt	650,000	650,000
Shareholders’ equity	1,552,000	1,420,000
Total debt and equity	$2,402,000	$2,320,000

 

Income Statement, for year ended Dec 31,
	2010	2009
Sales	$2,000,000	$1,800,000
Cost of sales	1,400,000	1,300,000
Gross margin	600,000	500,000
Operating expense	400,000	350,000
Operating income	200,000	150,000
Tax expense	68,000	51,000
Net income	$ 132,000	$ 99,000

 

Cash Flow from Operations
	2010	2009
Net income	$132,000	$ 99,000
Plus depreciation expense	60,000	50,000
+Decrease (-inc) in accounts receivable
and inventory	40,000	—
+ Increase (-dec) in current liabilities	(50,000)	—
Cash Flowfrom Operations	$182,000	$149,000

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Industry Benchmark Information 2010
Sales multiplier	2.50
Free cash flow multiplier	15.00
Earnings multiplier	22.00
Accounts receivable turnover	10.00
Inventory turnover	12.00
Current ratio	2.00
Quick ratio	1.50
Cash flowfrom operations ratio	1.20
Free cash flow ratio	1.10
Gross margin percentage	30.0%
Return on assets (net bookvalue)	10.0%
Return on equity	15.0%
Number of outstanding shares in both 2009 and 2010 is 1,650,000
Weighted average cost of capital for Gordon’s Supply is 5%
Year-end stock price, $3.00

Required

1. Calculate and interpret the liquidity, cash flow, and profitability ratios for Gordon’s Supply for 2009 and 2010. For simplicity, you may calculate the 2009 ratios with the assumption that receivables, inventory, and total assets are the same in 2009 as 2008.

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2. Develop a business valuation for Gordon Supply Company for 2010 using the following methods: (a) book value of equity, (b) market value of equity, (c) discounted cash flow (DCF), (d) enterprise value, and (e) all the multiples-based valuations for which there is an industry average multiplier. For the calculation of the DCF valuation, you may use the simplifying assumption that free cash flows will continue indefinitely at the amount in 2010.

Step 1 of 25

Business Analysis:

Business analysis means analysing the financial and non-financial information of an entity. Focus is placed on analysis of financial information through analysis of balance sheet, income statement, cash flow statement and analysis of financial ratios of the company. These ratios are analysed by comparing the result of these ratios with the industry standards.