Financial Statement Analysis
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Recently, your Uncle Carlos Beltran, who knows that you always have your eye out for a profitable investment, has discussed the possibility of your purchasing some corporate bonds. He suggests that you may wish to get in on the "ground floor" of this deal. The bonds being issued by Neville Corp. are 10-year debentures which promise a 40% rate of return. Neville manufactures novelty/party items.
You have told Neville that, unless you can take a look at its financial statements, you would not feel comfortable about such an investment. Believing that this is the chance of a lifetime, Uncle Carlos has procured a copy of Neville's most recent, unaudited financial statements which are a year old. These statements were prepared by Mrs. Andy Neville. You peruse these statements, and they are quite impressive. The balance sheet showed a debt-to-equity ratio of 0.10 and, for the year shown, the company reported net income of $2,424,240.
The financial statements are not shown in comparison with amounts from other years. In addition, no significant note disclosures about inventory valuation, depreciation methods, loan agreements, etc. are available.
Write a letter to your uncle regarding your concerns with the statements presented.
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Solution Summary
Recently, your Uncle Carlos Beltran, who knows that you always have your eye out for a profitable investment, has discussed the possibility of your purchasing some corporate bonds. He suggests that you may wish to get in on the "ground floor" of this deal. The bonds being issued by Neville Corp. are 10-year debentures which promise a 40% rate of return. Neville manufactures novelty/party items.
You have told Neville that, unless you can take a look at its financial statements, you would not feel comfortable about such an investment. Believing that this is the chance of a lifetime, Uncle Carlos has procured a copy of Neville's most recent, unaudited financial statements which are a year old. These statements were prepared by Mrs. Andy Neville. You peruse these statements, and they are quite impressive. The balance sheet showed a debt-to-equity ratio of 0.10 and, for the year shown, the company reported net income of $2,424,240.
The financial statements are not shown in comparison with amounts from other years. In addition, no significant note disclosures about inventory valuation, depreciation methods, loan agreements, etc. are available.
Write a letter to your uncle regarding your concerns with the statements presented.
Solution Preview
Dear Uncle Carlos,
Thank you for providing the Neville Corp. financial statements to me to review regarding my possible investment in the company's debentures. However, at this point, I am still uncomfortable making this investment. First, bonds are debts secured by the company's assets. These are debentures; debentures are unsecured debt which have low priority in case the company is liquidated or goes bankrupt. Given today's low interest rates, the promised return of 40 percent appears unreasonably high. This tells me that either it is untrue, or the investment is extremely risky. I suspect that the reason ...
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