Case 14.

1: Central Equipment Company

Central Equipment Company (CEC)
The objective of the case is to analyse the interaction between operating risk and financial
risk. It also focuses on the practical considerations of managers in understanding the
operating conditions and risks that have a bearing on a firm's borrowing decision (capital
structure). From the facts of the case, one can argue that a low debt-equity ratio might prove
to be risky for a firm with high operating risk. The instructor can focus on break-even
analysis and EPS analysis to ilustrate the concepts of and interaction between operating and
financial risks. The instructor can close the case by pointing out the inadequacy of this
analysis, and set the background for the need for analysing the impact of capital structure on
the value of the firm.
`
(1) Operating risk: It helps to undrstand the operting risk faced by the firm.
Sales
PBIT
Total cost
Variable cost
Fixed cost
Variable cost ratio
Contribution ratio
B/E sales

4,032.3
125.0
3,907.3
45% 1,758.3
55% 2,149.0
43.6%
56.4%
3,810.6

2.14

-3.88

94.5%

(2) EPS Analysis (vis--vis changes in sales and EBIT/PBIT)

EPS
Interest
10%
200.00
Debt
Equity
D/E
Debt
2,000 B/E PBIT
380
6.50
6.50
6.50
Tax
35%
Equity option
Debt option
Change in sales
-0.05 Expect.
0.05
-0.05 Expect.
3,830.7 4,032.3 4,233.9
3,830.7 4,032.3
Sales
1,670.4 1,758.3 1,846.2
1,670.4 1,758.3
Varible cost
2,160.3 2,274.0 2,387.7
2,160.3 2,274.0
Contribution
2,149.0 2,149.0 2,149.0
2,149.0 2,149.0
Fixed cost
11.3
125.0
238.7
11.3
125.0
PBIT
0.0
0.0
0.0
200.0
200.0
Interest
11.3
125.0
238.7
-188.7
-75.0
PBT
4.0
43.8
83.5
-66.0
-26.3
Tax
7.3
81.3
155.2
-122.7
-48.8
PAT
1.0
1.0
1.0
1.0
1.0
Debt repayment
6.3
80.3
154.2
-123.7
-49.8
Uncommited profit
38
38
38
18
18
Number of shares
0.19
2.14
4.08
-6.81
-2.71
EPS
0.17
2.11
4.06
-6.87
-2.76
Uncommited EPS

PBIT-EPS Chart
1

0.05
4,233.9
1,846.2
2,387.7
2,149.0
238.7
200.0
38.7
13.5
25.2
1.0
24.2
18
1.40
1.34

(4) Balance Sheet & P&L Analysis: His

Balance Sheet
Cash
Debtors
Inventory
OCA
CA
G Block
Acc dep
N Block
TA
Crs
Tax prov
OCL
CL
Paid up
Debt-Equity Mix
-0.05 Expect.
0.05 R&S
3,830.7 4,032.3 4,233.9 NW
1,670.4 1,758.3 1,846.2 TL
2,160.3 2,274.0 2,387.7
2,149.0 2,149.0 2,149.0 Shares
11.3
125.0
238.7 No equity
100.0
100.0
100.0 New equity
-88.7
25.0
138.7
Year
-31.0
8.8
48.5
1990
-57.7
16.3
90.2
1991
1.0
1.0
1.0
1992
-58.7
15.3
89.2
1993
28
28
28
1994
-2.06
0.58
3.22
1995
-2.09
0.54
3.18
1996
1997
1998
1999
2000
2000#

0.9
0.8
0.7

Financial analysis: Th

0.7

EPS

0.6

great varibility as well

and 17.5% in 1997.Ma
If the company realise
dependence on external funds. The firm is

B/E PBIT

0.5

532

0.4
0.3
0.2
0.1
0

0
PBIT

(3) Operating & Financial Leverage Analysis

Break-even sales
3,810.6 94.5%
Change in sales
-0.05
0.05
Change in PBIT
-0.91
0.91
DOL
18.19
18.19
Change in EPS
-0.91
0.91
DFL
1.00
1.00
DCL
18.19
18.19

-0.05
-0.91
18.19
1.52
-1.67
-30.32

0.05
0.91
18.19
-1.52
-1.67
-30.32

18.19
-1.67
-30.32

1
2
3
4
5
6
7
8
9
10
11

alance Sheet & P&L Analysis: Historical Perspective

8%
16%
4%
4%
31%
71%
2%
69%
100%
2%
4%
15%
21%
22%
57%
79%
100%

18.00
38.00
Sales
1,804.0
1,707.8
1,894.0
2,270.8
2,520.0
2,775.0
2,949.2
2,433.8
3,042.3
3,376.9
3,579.5
4,032.3

89.0
180.7
41.1
47.1
357.9
819.9
23.5
796.4
1,154.3
15.2
30.3
121.5
167.0
180.0
459.6
639.6
807

(E + D)
E
Projected
Projected
3,376.9
4,032.3 4,032.3
94.6
125.0
125.0
50.3
-101
81.3
(E + D) E
Estd.
Projected Projected
S/TA
4.07
4.86
4.86
PBIT/S
0.03
0.03
0.03
PBIT/TA
11.4%
15.1%
15.1%
PAT/PBIT
0.53
-0.81
0.65
TA/NW
1.54
4.67
1.13
PAT/NW
9.3%
-56.7%
11.1%
Estd.

Sales
PBIT
PAT

640

2,640

PBIT PAT
34.3 17.1
15.5
7.8
41.2 20.6
52.2 26.1
58.0 29.0
66.6 33.3
76.8 38.4
-5.3 -5.3
82.1 43.5
94.6 50.3
85.0 55.2
125.0 81.3

DIV
9.0
9.0
9.0
9.0
10.8
10.8
14.4
9.0
18.0
18.0
18.0
38.0

EPS
0.95
0.43
1.14
1.45
1.61
1.85
2.13
-0.29
2.42
2.79
3.07
2.14
AVG
SD

Sales g
-5.3%
10.9%
19.9%
11.0%
10.1%
6.3%
-17.5%
25.0%
11.0%
6.0%
12.6%
7.5%
12.7%

PBIT/S
1.9%
0.9%
2.2%
2.3%
2.3%
2.4%
2.6%
-0.2%
2.7%
2.8%
2.4%
3.1%
1.9%
1.0%

: The company sales have grown at an average rate of 7.5%. But its shows

PBIT
-140
0
140
280
420
560
700
840
980
1,120
1,260
1,400
1,540

EPS
-2.39
0.00
2.39
4.79
7.18
9.58
11.97
14.37
16.76
19.16
21.55
23.95
26.34

EPS
-12.28
-7.22
-2.17
2.89
7.94
13.00
18.06
23.11
28.17
33.22
38.28
43.33
48.39

varibility as well. Twice during last decade sales growth was negative, a drop of 5.7% in 1991
7.5% in 1997.Margin has hovered around 2%. The company has high level of current assets.
company realises its debtorand uses surplus cash balance, it can perhaps reduce its
dence on external funds. The firm is very conservatively financed.

ATM
4,335
4,660
5,009
5,385
5,789
6,223
6,690
7,192
7,731
8,311
8,934

-97
-91
-84
-77
-69
-61
-52
-42
-31
-20
-8

Dep*.35
699
524
393
295
221
166
124
93
70
52
39

245
184
138
103
77
58
44
33
24
18
14

147
92
53
26
8
-3
-8
-9
-7
-2
6

100
100
100
100
100
100
100
1,300

47
-8
-47
-74
-92
-103
-108
-1,309