Susan Burke, president of Triple A Office Mart, studied her notes for the afternoon meeting with the bank’s commercial loan committee. The profitable company, organized in 1978, sold a complete line of office equipment, furniture, and supplies. Two stores operated in two adjoining states in the southwestern United States. Budgetary control of the two stores was centralized in the store and office complex which operated in the larger of the two cities. In preparation for the meeting, Burke wondered about the type of information the bank might have with which to make a decision on her loan. She was also concerned about how the bank would view a profitable company that needed to borrow funds.
The stores had operated profitably since their inception. Triple A was organized by Burke and a college roommate, Virginia Best, one year after their graduation. Best left the company after only three years to participate in an overseas venture. Her interest was sold to Burke at that time.
With the advent of the personal computer, a major component of company sales, and a general trend in the economy toward specialty stores, Triple A had experienced excellent growth in revenue and earnings. Table 1 illustrates a portion of the firm’s sales and earnings history. Table 2 provides balance sheets for selected years.
The firm had issued no common stock or long-term debt in the recent past. In fact, the second store was opened in 1990 without any additional long-term financing. In the case of the new store, however, there was an increase in inventory and bank borrowing. The company’s financial staff wondered if this were a normal state of affairs for an expansion situation. Triple A had traditionally handled its credits well, and the stockholders were generally satisfied with the firm’s return on equity. (Stock was offered to the public for the first time in 1980).
The primary benefit to the company was the strong local economy. Although it was primarily a service economy, it supported Triple A almost perfectly. A nearby college of business administration, which published an economic report and forecast concerning the local economy, stated that since 1987 the growth of the local GNP had been in the range of 8-10 percent. Susan Burke had, as a long-range plan, every intention of participating in the region’s growth and of contributing to it through the efficient operation of her firm.
In recent months during early 1992, there had been cause for concern on the part of company management. Prices from suppliers had risen and the firm’s financial managers wondered about the effect of this upon profitability and the general operation of the business. The suppliers to the firm were varied, since the firm carried a wide range of office equipment and supplies. As a result, it was not possible to develop a strong and mutually supportive relationship with any one supplier. In general, the company had to deal with the vagaries of the economy.
Foremost in Burke’s thinking was to maintain a sensible payout ratio for the equity investors, one which reflected the operational reality of the company. Firms that were similar in product line and sales pattern to Triple A paid a dividend which amounted to 30-60 percent of earnings. Growth in sales volume beyond the nominal growth in the economy usually came about as a result of market share being taken away from competitors. Triple A’s management intended to survive in the region in which they operated. The relatively stable payout ratio which the company had maintained for several years seemed appropriate given revenue growth.
In preparation for her meeting with the bank, Susan Burke had concerns about the financial condition of her firm and whether there was a trend in the financial statements that might cause the bank to become wary of Triple A as a continuing customer.
TABLE 1
Triple A Office Mart
Income Statement (selected years)
1990
1989 1990 1991 1992
Sales $3,800,000 $4,180,000 $4,850,000 $6,000,000
Cost of goods sold (2,460,000) (2,975,000) (3,200,000) (4,180,000)
Gross profit $1,340,000 $1,205,000 $1,650,000 $1,820,000
Selling, admin, and
Depreciation expenses ($684,000) ($820,000) ($898,408) ($1,015,467)
Interest (30,780) (30,780) (42,372) (35,313)
Profit before tax $625,220 $354,220 $709,220 $769,220
Taxes (187,566) (106,266) (212,766) (230,766)
Net income $437,654 $247,954 $496,454 $538,454
TABLE 2
Triple A Office Mart
Balance Sheet
1989 1990 1991 1992
Cash $295,000 $326,040 $378,300 $468,000
Accounts receivable 11,400 12,540 20,700 18,000
Inventory 950,000 1,028,595 1,559,407 1,735,207
Total current assets $1,256,400 $1,367,175 $1,958,407 $2,221,207
Property, plant, equip… 450,000 501,600 501,600 503,000
Total assets $1,706,400 $1,868,775 $2,460,007 $2,724,207
Accounts payable $152,000 $167,200 $190,000 $300,000
Notes payable-bank ……… …… 289,776 113,326
Accrued wages & taxes 114,000 125,000 145,500 180,000
Total current liabilities 266,000 292,200 625,276 593,326
Long term debt 342,200 342,000 342,200 342,200
Common stock 600,000 600,000 600,000 600,000
(120,000 shares)
Retained earnings 498,200 634,575 892,731 1,188,881
Total liabilities and equity $1,706,400 $1,868,775 $2,460,007 $2,724,207
QUESTIONS
1. What are Triple A’s earnings per share for year 1991 and 1992, respectively?
2. Calculate some financial ratios for the company for 1990, 1991 and 1992 (including ROE, net profit margin, total asset turnover, financial leverage, current ratio, and number of days of receivables)
1990 1991 1992
ROE
Net profit margin
Total asset turnover
Financial leverage
Current ratio
Number of days of receivables
3. Comment on the trend of ROE you got in part 2, what are the reasons for the trend of Roe based on the Dupont Analysis?
4. If the typical firm in the industry in which Triple A operates has a debt to equity ratio of 42 percent, what advice would you give Triple A concerning its debt ratio? Show the work.