Question

Consider the following financial statements for Green Valley Nursing Home, Inc. a for profit long-term care facility:

Green Valley Nursing Home Inc.
Statement of Income and Retained Earnings
Year Ended December 31, 2011
Revenue:
Net patient service revenue $3,163,258
Other revenue 106,146
Expenses:
Salaries and benefits $1,515,438
Medical supplies and drugs 966,781
Insurance and other 296,357
Provision for bad debts 110,000
Depreciation 85,000
Interest 206,780
Total expenses $3,180,356
Operating Income $89,048
Provision for income tax 31,167
Net Income $57,881
Retained earnings, beginning of year $199,961
Retained earnings, end of year $257,842
Green Valley Nursing Home Inc.
Balance Sheet
December 31, 2011
Assets
Current assets:
Cash $105,737
Marketable securities 200,000
Net patient accounts receivables 215,600
Supplies 87,655
Total current assets $608,992
Property and equipment $2,250,000
Less accumulated depreciation 356,000
Net property and equipment $1,894,000
Total assets $2,502,992
Liabilities and Shareholder�s Equity
Current liabilities:
Accounts payable $72,250
Accrued expenses 192,900
Notes payable 100,000
Current portion of long-term debt 80,000
Total current liabilities $445,150
Long term debt $1,700,000
Shareholders� Equity:
Common stock, $10 par value $100,000
Retained earnings 257,842
Total shareholder�s equity $357,842
Total liabilities and shareholders� equity $2,502,992
a. Perform a Du Pont analysis on Green Valley. Assume that the industry average ratios are as follows:
Total margin 3.5%
Total asset turnover 1.5
Equity multiplier 2.5
Return on equity 13.1%
b. Calculate and interpret the following ratios:
Return on assets (ROA) 5.2%
Current ratio 2.0
Days cash on hand 22 days
Average collection period 19 days
Debt ratio 71%
Debt to equity ratio 2.5
Times interest earned (TIE) ratio 2.6
Fixed asset turnover ratio 1.4
c. Assume that there are 10,000 shares of Green Valley�s stock outstanding and that some recently sold for $45 per share.
- What is the firm�s price/earnings ratio?
- What is its market/book ratio?

Answer 1

Performing a Du Pont analysis on Green Valley, we find the total margin to be 3.488%. Other ratios calculated for Green Valley include ROA of 2.31%, current ratio of 1.37, days cash on hand of 47.8 days, average collection period of 25.01 days, debt ratio of 70.97%, debt to equity ratio of 5.47, TIE ratio of 0.43, and fixed asset turnover ratio of 1.67. The firm's price/earnings ratio is 7.78 and its market/book ratio is 1.26.

Step-by-step explanation:

• Du Pont Analysis:

The Du Pont analysis is a method of decomposing the return on equity (ROE) into its individual components to determine the drivers of profitability. It consists of three components: the total margin, the total asset turnover, and the equity multiplier.

In this case, we are given the industry average ratios for these components as Total margin = 3.5%, Total asset turnover = 1.5, and Equity multiplier = 2.5. We are also given the ROE of 13.1%. Using these values, we can solve for the missing component:

Total margin * Total asset turnover * Equity multiplier = ROE

3.5% * 1.5 * 2.5 = 13.1%

Therefore, Green Valley's total margin would be 13.1% / (1.5 * 2.5) = 3.488%.

• Ratios:

Return on assets (ROA) = Net Income / Total Assets = $57,881 / $2,502,992 = 2.31%.

Current ratio = Current Assets / Current Liabilities = $608,992 / $445,150 = 1.37.

Days cash on hand = (Cash + Marketable Securities) / (Operating Expenses / 365) = ($105,737 + $200,000) / ($3,180,356 / 365) = 47.8 days.

Average collection period = Accounts Receivable / (Net Patient Service Revenue / 365) = $215,600 / ($3,163,258 / 365) = 25.01 days.

Debt ratio = Total Debt / Total Assets = ($445,150 + $1,700,000) / $2,502,992 = 70.97%.

Debt to equity ratio = Total Debt / Shareholder's Equity = ($445,150 + $1,700,000) / $357,842 = 5.47.

Times interest earned (TIE) ratio = Operating Income / Interest Expense = $89,048 / $206,780 = 0.43.

Fixed asset turnover ratio = Net Patient Service Revenue / Net Property and Equipment = $3,163,258 / $1,894,000 = 1.67.

• Price/Earnings Ratio and Market/Book Ratio:

The Price/Earnings (P/E) ratio is calculated by dividing the market price per share by the earnings per share (EPS). In this case, there are 10,000 shares and the recent market price was $45 per share. The net income was $57,881, so the EPS is $57,881 / 10,000 = $5.7881. Therefore, the P/E ratio is $45 / $5.7881 = 7.78.

The Market/Book ratio is calculated by dividing the market price per share by the book value per share. The book value per share is the total shareholder's equity divided by the number of shares. In this case, the book value per share is $357,842 / 10,000 = $35.7842. Therefore, the Market/Book ratio is $45 / $35.7842 = 1.26.