Diversified Industries is a large conglomerate and is continually in the market for new acquisitions. The company has grown rapidly over the last 10 years through buyouts of medium-size companies. Diversified does not limit itself to companies in any one industry but looks for firms with a sound financial base and the ability to stand on their own financially.
The president of Diversified recently told a meeting of the company's officer: "I want to impress two points on all of you. First, we are not in business of looking for bargains. Diversified has achieved success in the past by acquiring companies with the ability to be a permanent member of the corporate family. We don't want companies that may appear to be a bargain on paper but can't survive in the long run. Second, a new member of our family must be able to come in and make it on its own - the parent is not organized to be a funding agency for struggling subsidiaries."
Ron Dixon is the vice president of acquisitions for Diversified, a position he has held for five years. He is responsible for making recommendations to the board of directors on potential acquisitions. Because you are one of his assistants, he recently brought you a set of financials for a manufacturer, Heavy-Duty Tractors, Inc. Dixon believes that Heavy-Duty is a "can't-miss" opportunity for Diversified and asks you to confirm his hunch by performing basic financial statement analysis on the company. The most recent comparative balance sheets and income statement for the company follow:
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Dec 31,2007
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Dec 31, 2006
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Assets
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Current assets:
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Cash
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$48,500
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$24,980
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Marketable securities
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3,750
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0
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Account receivable, net of allowances
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128,420
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84,120
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Inventories
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135,850
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96,780
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Prepaid items
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7,600
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9,300
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Total current assets
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$324,120
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$215,180
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Long term investment
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$55,890
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$55,890
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Property, plant, and equipment:
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Land
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$45,000
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$45,000
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Building and equipment, less accumulated depreciation Of $385,000 in 2007 and $325,000 in 2006
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545,000
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605,000
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Total property, plant, and equipment
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$590,000
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$650,000
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Total assets
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$970,010
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$921,070
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Liabilities and Stockholders' Equity
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Current Liabilities:
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Short-term notes
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$80,000
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$60,000
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Accounts payable
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65,350
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48,760
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Salaries, wages, and other
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14,360
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13,840
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Income taxes payable
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2,590
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3,650
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Total current liabilities
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$162,300
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$126,250
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Long-term bonds payable, due 2014
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$275,000
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$275,000
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Stockholders' equity:
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Common stock, no par
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$350,000
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$350,000
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Retained earnings
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182,710
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169,820
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Total stockholders' equity
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$532,710
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$519,820
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Total liabilities and stockholders' equity
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$970,010
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$921,070
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Heavy-Duty Tractors Inc. Statement of Income and Retained Earnings For the Year Ended December 31, 2007 (thousands omitted)
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Sales revenue
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$875,250
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Cost of goods sold
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542,750
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Gross profit
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$332,500
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Selling, general, and administrative expenses
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264,360
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Operating income
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$68,140
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Interest expense
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45,000
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Net income before taxes and extraordinary items
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$23,140
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Income tax expense
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9,250
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Income before extraordinary items
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$13,890
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Extraordinary gain, less taxes of $6,000
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9,000
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Net income
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$22,890
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Retained earnings, January 1, 2007
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169,820
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$192,710
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Dividends paid on common stock
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10,000
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Retained earnings, December 31, 2007
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$182,710
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1) How liquid is Heavy-Duty Tractors? Support your answer with any ratios that you believe are necessary to justify your conclusion. Also indicate any other information that you would want to have in making a final determination on its liquidity.
2) In light of the president's comments, should you be concerned about the solvency of Heavy-Duty Tractors? Support your answer with the necessary ratios. How does the maturity date of the outstanding debt affect your answer?
3) Has Heavy-Duty demonstrated the ability to be a profitable member of the Diversified family? Support your answer with the necessary ratios.