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Question 1 Total marks for Q1. (15 marks)
Attached as Appendix 1 are the financial statements for Super Cheap Auto Limited, a public company in Australia which operates two chains of retail shops which sell equipment and accessories for motor cars, boats and camping. Most sales are cash sales to retail consumers.
Using the information provided in these financial statements answer the following questions.
Note that the earnings per share are provided on the income statement.
Please also note the following data;
Dividends declared in 2006 were 8 cents per share and in 2007 10.5 cents per share.
- Calculate the Current ratio and the Quick ratio for 2007. Comment on the liquidity of this company. For comparison purposes, other firms in this industry sector have an average Current ratio of 1.76 and an average Quick ratio of 0.78. (3 marks)
- From the information provided about dividends and earnings and from the Cash flow statement and Balance sheet, comment on long term and short sources of finance that Super Cheap Auto has used to expand the business from 2006 to 2007. (3 marks)
- Calculate a ratio that will tell you how many times a year Super Cheap Auto turns over its inventory in 2007 (or, calculate the ratio that tells you the number of days it takes to turn over inventory). Comment on this aspect of working capital management. (3 marks)
- Do you think Super Cheap should borrow more money to expand faster? Why? Explain you reasoning. (3 marks)
- Assuming a share price of $4.50, calculate a Price Earnings (PE) ratio and a Dividend Yield ratio for Super Cheap Auto. Interpret these ratios and comment on the value of shares in Super Cheap Auto, given that sector average PE is 16.7 and sector average dividend yield is 3.7%. What does this tell us about the market's expectations about growth in Super Cheap Autos share price? (3 marks)
Question 2 Total marks for Q5. (5 marks)
a) List 4 different types (groups) of people who are users of general purpose financial statements. (1 mark)
b) Select 2 different groups from your list in part a) then compare and contrast their financial information needs. Discuss the benefits they would gain by reading and analyzing the financial statements. What limitations might each group find with this source of information? (1 mark)
c) For each of the following items, state whether it is either;
Revenue or Expense or Asset or Liability or Equity.
- A loan to another company
- Shares issued to the public
- Inventory purchased last week
- Depreciation of equipment
- Provision for long service leave
- Excess payment to the tax department
- Shares owned in another company
- Accounts payable
- Prepaid insurance premiums
- Deposit paid by a customer for work yet to be done
- Credit sales
- Cash sales
- Retained profit
- Bad debts
- Dividend declared, not yet paid
The current ratio of Super Cheap Auto Ltd is 1.72:1. It means for a unit dollar of current liability, Super Cheap Auto ltd has $1.72 to pay. This ratio is less than the rule of thumb, which is 2:1 (ACCA, 2017). The industry ratio is 1.76:1, which shows that the industry has $1.76 of current assets for each dollar of current liability. So the current asset position of the company is nearly equal to the industry average.
The quick ratio of the company is very poor as it 0.20:1, which is very much less than the rule of thumb ratio, which is 1:1 (ACCA, 2017). The quick ratio of the industry 0.78:1. It means the proportion of quick assets of the company as compared to its current liability is much less than the industry proportion.
Overall the liquidity position of the company is not good. It does not have a sufficient amount of liquid funds to pay off its current liabilities. Though the current ratio is near to the standard ratio, the difference between the current ratio and the quick ratio shows that the current ratio is high due to non-liquid assets like inventory or debtors.
(b) Changes in long term and short term sources of finance from 2006 to 2007
The short term sources of finance increased by $30065 in 2007, as shown in the balance sheet. There has been an increase in long term borrowings in 2007 by $3601. The payment of interest increased in 2007 from $3927 to $6284. This huge increase in interest depicts that the rate of interest increased in 2007. The internal source of long term funds, i.e. retained earnings, has also increased by $12753. The payment of the dividend is more in 2007, which means that the dividend was declared at a high rate in 2007 as the paid-up capital is the same. Overall the increase in short term sources of finance is greater than the increase in the long term source of finance.