Signal Cable Company

1. Why has the stock price fallen despite the fact that the net income has increased?

Based on Signal Cable Company case, from the income statement can see that net profit
margin from 2004 is lower than previous year (6.78% vs 7.43%) even though net profit of
the company is higher from 2003 to 2004. Increase a debt load to interest rise and cash
flow need to cover interest expense also rise. If a debt higher become the company will no
able to cover financial responsibilities with the debt that they issuing. This situation give
effect to the stock price. Based on this case, stock price fallen due to increasing debt in
2004 that result increase in interest expense. If the coverage interest ratio in 2004 is higher
than previous year, so higher debt is not bad if the company still can cover the interest.
However, this firm has a coverage interest ratio in 2004 is 2.54 lower than 2003 is 5.72. It
show that this firm possibilities cannot cover the interest expense. The investor are concern
about the risk in term of debt and give effect to the stock price.

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 the asset or security can be quickly bought or sold in the market
without affecting the asset's price. A firms liquidity refers to its ability to pay its short-term
bills and current liabilities by converting its current assets into cash. There are several
measure in liquidity such as current ratio, cash ratio, quick ratio and net working capital
ratio.

The liquidity calculation that measures a companys ability to pay off its current liabilities
with current assets is call as net working capital. It shows the firms short-term liquidity as
well as managements ability to use its assets efficiently and this measurement is important
to management, vendors, and general creditors because. In other term, net working capital
ratio is the absolute liquidity of the firm.

2003 2004
Current ratio
Current asset 2.51 2.06
Current liabilities
Cash ratio
Cash + cash equivalent 0.113 0.006
 Current Liabilities
Quick ratio
Current asset inventory prepaid expenses 0.68 0.61
Current liabilities
Absolute liquidity = NWC
Current asset current liabilities 535000 950450

The current ratio is measure the ability of the firm to pay off liabilities with its current
asset. The table above show that the current ratio declined in 2004. It means that for the
year 2004, the ability of the firm to pay off short term liabilities is declined. The cash
ratio also decline from 0.113 in 2003 to 0.006 in 2004. It means that the ability firm to
pay off current liabilities with cash is low in 2004 compare to the previous year. The table
above also shows that the quick ratio decline (0.68 vs 0.61). The firm ability to pay
current liabilities when they come due with quick asset or current asset is low. However,
there declined in smaller number. The firm can cover their current liabilities. The relative
liquidity of the firm has decreased however the absolute liquidity or net working capital
of the firm has increased in 2004.

It can conclude that although the relative liquidity of the company has declined since
2003, it is not critically low. The liquidity condition is not critical because high ratio is
not necessarily good and low ratio is not necessarily bad.

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?

Multiply shares outstanding number by the current stock price to determine the market
value. In other word, market value = Current Stock Price X 200,000 shares

Book value also known as shareholders equity.

2003 2004
Book value
Total asset Total 692 000 792 100
liabilities
Book value per share
Book value 3.46 3.96
Share outstanding
 Market value per share is $5.50 in 2004 and book value in 2004 is $3.96. In this case, the
stock price higher than book value per share because of increasing sales and profit for the
past few year. The fallen stock price due to the risk of higher debt lever and lower
liquidity of the company. However, the book price per share increase from $3.26 in 2003
to $3.96 in 2004. The market value reflect the true condition of the company.

4. The board of directors is not clear as to why the cash balance has dropped so much
despite the increase in sales and the gross profit margin. What should Jay tell the
board?

To make the board of directors clear about decline of cash balance, it must be do
statement of cash flow for 2004.

Signal Cable Company

Statement of Cash Flows

Operating Activities $
Net income 143 100
(+) Depreciation expense 79 000
(+) Increase in account payable 90 000
(-) Increase in inventory (650 450)
(-) Increase in account receivables (340 000)
Net cash from operating
activities (678 350)

Investing
Activities
Fixed Asset acquisition (790 000)
Net cash from investing
activities (790 000)

Financing
Activities
(+) Increase in notes payable 450 000
(+) Increase in long term debt 1 026 280
(-) Dividend paid (42 930)
Net cash from financing
activities 1 433 350

Net increase in
cash (35 000)
Cash at beginning of the year 40 000
Cash at 2004 5 000
Net increase in cash is negative due to the firm has invested in account receivables, fixed
asset and inventories. In term of financing activities, the firm borrowed $1476280 that
consist short and long term debt. Thus, even sales increase, the cash balance will reduce due
to the acquisition asset and business expansion expenses.

5. Measure the free cash flow of the firm. What does it indicate?

The free cash flow (FCF) of a firm (also known as cash flow from assets) measure of how
much cash a business generates after accounting for capital expenditures such as buildings or
equipment. It is cash that is not needed for working capital or fixed asset investments. Free
cash flow is measured as follows:

The cash flow from operating activities minus the amount of capital expenditures. Other
variations are also used.

FCF = Operating cash flow Net capital spending Change in net working capital

Where: Operating Cash flow (OCF) = EBIT + Depreciation -Taxes

= $393 500 + $79 000 - $95 400

= $377 100

Net Capital Spending (NCS) = Ending Net Fixed Assets - Beginning Net Fixed
Assets + Depreciation

= $1 068 000 - $357 000 + $79 000

= $790 000

Change in Net Working Capital = Ending NWC Beginning NWC

= [($1845450 - $895000) ($890 000 - $355

000)]
= $950 450 - $535 000
= $415 450

Free Cash Flow = OCF NCS Changes in NWC

= $377 100 - $790 000 - $415 450
= -$828,350

The free cash flow of Signal Cable is negative due to the increase in capital expenditure and
net working capital. Its mean amount of net new borrowing and equity is increase. Its show
 in balance sheet of Signal Cable company that increase long term debt, net fixed asset and
net working capital.

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 is measure a company ability to pay current liabilities with current asset.

NWC = Current asset Current Liabilities

Where
2003: NWC = $890 000 - $355 000
= $535 000

2004: NWC = $1 845 450 - $895 000

= $950 450

Signal Cable has significantly increased its net working capital (almost 78% higher) in 2004.
It show that the ability of the firm to pay off its current liabilities with current asset is higher
than previous year.

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 your answer.

Look at cash flow statement its care about whether company has drop or rise in cash flow.
Having a positive or rise in cash flow is important because it means that the company has
some liquidity and may be solvent. Thus, the decline in cash flow is usually an early warning
signal and the shareholders must concerned about drop in cash flow and net profit margin.
The manager must take the steps to resolve the problem that arise from the firms liquidity.