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Liquidity Risk Assessment for a Company: A Case Study

   

Added on  2020-03-13

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Question 1 solutionsPart aCurrent ratio = CurrentAssetsCurrentLiabilities=80,742105,064 =1.7203Quick ratio= Cash+CashEquivalents+MarketableSecurities+AccountsReceivablesCurrentLiabilities =6,271+14,591105,064 =0.1985CommentsBoth of these ratios are used to assess the liquidity risk of a company. The higher the ratio, the greater assurance that current liabilities will be paid using current assets [CITATION Sub09 \p 530 \l1033 ].In this scenario, we note that Super Cheap Auto has a low current ratio in comparison to the industry norm. This implies that the company may be faced with liquidity problems. Furthermore, we also note their quick ratio is way below the industry’s norm, again implying the company does not have enough liquid assets to cover current liabilities. Hence, the ratio analysisshows that the liquidity risk for this company is high.Part b- Short and long term financingShort termTrade credit- This is evidenced by the increase in trade and other payables in the balance sheetShort term debt/loans- We note the borrowings under the current liabilities also increased significantly implying Super Auto took out short term debt
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Long termRetained profits- Also the retained profits increased implying financing was done using their profitsIssuance of Shares- We note in 2017 ownership has been diluted implying Super cheap Auto have issued new equityThere is no evidence of the company utilizing long term debt over this periodPart cDay’ssales in inventory ratio calculatesthe number of days it takes to turn over inventory.Day Sales in inventory = InventoriesCostofGoodsSold/360=159,880376,733/360 =152.8 daysCommentsThis ratio measures the quality and liquidity of inventory i.e. the ability of a company to turn its inventory into sales. A high number indicates a company has slow moving items and that their inventory is not a liquid asset.Part dBased on their liquidity ratios calculated in part a and b (current ratio and quick ratio), we noted Super Cheap Auto have a liquidity risk problem. Therefore, it may be costly for the company to borrow money because it has a higher cost of debt[ CITATION Lex17 \l 1033 ]. Therefore, Super Cheapmay need to consider other ways to expand such as using their retained profits, maximizing assets etc.Part ePE ratio = MarketpriceperShareEarningsperShare
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=4.50/0.21= 21.43Dividend yield = CashDividendspershareMarketpricepershare =0.105/4.50= 2.33%CommentsIn this scenario, we note that Super Cheap Auto has a higher PE ratio in comparison to the sector’s average. This implies that investors have confidence in the future companyand/or the company is entering its growth phase. The dividend yieldratio is lower than the sector average implying the company does not issue dividends regularly, but rather reinvest profits back into company[ CITATION MyA17 \l 1033 ].
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