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The financial information presented in the case forms the basis for my recommendation: I would buy this company. The company’s financial position has dipped in the year 2007 but however the composition of the costs of selling and operating the business have favorable ratios that support the decision to buy the company. The net income has dropped from being 25% of net sales in 2005 to 14% of net sales in 2007; however, there seems to be great potential for efficiency in the future of the company.
Part B A conservative discount rate of 15% yields a Net Present Value of $64,721. I would be willing to buy the company for approximately $400,000 assuming that the company will grow in future and there will be considerably a growth rate in the range of 10-11%. The amount I am willing to buy consists of the NPV of the net income of the three years plus a perpetuity income assuming that the 2007 net income is used for the growth projections.
One of the major strengths of this company is its large gross profit – its cost of goods sold has been between 28% and 36% of the net sales throughout the three years. This implies a significant contribution margin and potential future growth in net income by cost-cutting strategies focused on operating expenses. The legal expenses are zero in 2007 and there is a 90% reduction in taxes and licensing fees in 2007 as compared to 2005. These factors play an important role in the future projection of cash flows and thus are an important strength (Business Credit 2008, 35).
However, at the same time the weakness lies in the wages expense that increase by more than 100% over the three years. The constant increase in wages expense may also mean employee inefficiency and potential over-running costs – this is a major weakness because the sales of the company have actually decreased as compared to 2005 while the employee base has almost doubled almost halving the sales per employee ratio. References Advanced Issues in Financial Statement Analysis. (Sep 2008). Business Credit , 35.
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