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Decision Case 13-5 Acquisition Decision

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Decision Case 13-5 Acquisition Decision

Diversified Industries is a large conglomerate that 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 officers: "I want to impress two points on all of you. First, we are not in the 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. 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.

Heavy Duty Tractors Inc.
Comparative Statements of Financial Position
(Thousands omitted)
December 31, 2008 December 31, 2007
Current assets:
Cash $48,500 $24,980
Marketable securities 3,750 0
Accounts receivable, net of allowance 128,420 84,120
Inventories 135,850 96,780
Prepaid items 7,600 9,300
Total current assets $324,120 $215,180
Long-term investments $55,890 $55,890
Property, plant, and equipment:
Land $45,000 $45,000
Buildings and equipment, less accumulated
Depreciation of $385,000 in 2008 and
$325,000 in 2007 545,000 605,000
Total property, plant, and equipment $590,000 $650,000
Total assets $970,010 $921,070

December 31, 2008 December 31, 2007
Liabilities and Stockholder's Equity
Current Liabilities:
Short-term notes $80,000 $60,000
Accounts payable 65,350 48,760
Salaries and wages payable 14,360 13,840
Income taxes payable 2,590 3,650
Total current liabilities $162,300 $126,250
Long-term bonds payable, due 2015 $275,000 $275,000
Stockholder's equity:
Common stock, no par $350,000 $350,000
Retained earnings 182,710 169,820
Total stockholders' equity $532,710 $519,820
Total liabilities and stockholder's equity $970,010 $921,070
Heavy Duty Tractors Inc.
Statement of Income and Retained Earnings
For the Year Ended December 31, 2008
(Thousands omitted)
Sales revenue $875,250
Cost of goods sold 542, 750
Gross profit $332,500
Selling, general, and administrative expenses 264,360
Operating income $68,140
Interest expense 45,000
Net income before taxes and extraordinary items $23,140
Income tax expense 9,250
Income before extraordinary items $13,890
Extraordinary gain, less taxes of $6,000 9,000
Net income $22,890
Retained earnings, January 1, 2008 $169,820

Dividends paid on common stock 10,000
Retained earnings, December 31, 2008 $182,710

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.
4. What will you tell your boss? Should he recommend to the board of directors that Diversified put in a bid for Heavy duty Tractors?

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Solution Summary

Your tutorial is 318 words plus ratio analysis of current ratio, quick ratio, inventory turnover, AR turnover, return on sales, return on asset, return on equity, debt to equity and times interest earned. The ratios are done in excel so you have a template to assist with other projects. Each ratio is defined and then the numerator and denominator are shown for you.

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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.

See Excel for ratio formulas and computations that support the discussion. Click in cells to see computations.

Their liquidity is solid with a current ratio clearly above 1 and quick ratio near or over 1. Working capital (current assets less current liab) has nearly doubled! The average collection period is 44 days, which is a bit long if their credit terms are net 30 days. The inventory sells, on average, every 77 days. You can see if this is reasonable against industry standards but that data is not available in this case. Slow payment from customers and slow moving inventory can be a threat ...

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