Case-1: Loren Seguara and Dale Johnson both work for Sports Products, Inc.

, a major producer
of boating equipment and accessories. Loren works as a clerical assistant in the Accounting
Department and Dale works as a packager in the Shipping Department. During their lunch break
one day, they began talking about the company. Dale complained that he had always worked
hard trying not to waste packing materials and efficiently and cost-effectively performing his job.
In spite of his efforts and those of his co-workers in the department, the firm's stock price had
declined nearly $2 per share over the past 9 months. Loren indicated that she shared Dale's
frustration, particularly because the firm's profits had been rising. Neither could understand why
the firm’s stock price was falling as profits rose.
Loren indicated that she had seen documents describing the firm's profit-sharing plan under
which all managers were partially compensated on the basis of the firm's profits. She suggested
that maybe it was profit that was important to management, because it directly affected their pay.
Dale said, "That doesn't make sense, because the stockholders own the firm. Shouldn't
management do what's best for stockholders?
Something's wrong!" Loren responded, "Well, maybe that explains why the company hasn't
concerned itself with the stock price. Look, the only profits that stockholders receive are in the
form of cash dividends, and this firm has never paid dividends during its 20-year history. We as
stockholders therefore don't directly benefit from profits. The only way we benefit is for the
stock price to rise." Dale chimed in, "That probably explains why the firm is being sued by state
and federal environmental officials for dumping pollutants in the adjacent stream. Why spend
money for pollution control? It increases costs, lowers profits, and therefore lowers
management's earnings!"
Loren and Dale realized that the lunch break had ended and they must quickly return to work.
Before leaving, they decided to meet the next day to continue their discussion.

a. What should the management of Sports Products, Inc., pursue as its overriding goal? Why?
b. Does the firm appear to have an agency problem? Explain.
c. Evaluate the firm's approach to pollution control. Does it seem to be ethical?
Why might incurring the expense to control pollution be in the best interests of the firm's owners
despite its negative effect on profits?
d. Does the firm appear to have an effective corporate governance structure?
Explain any shortcomings.
e. On the basis of the information provided, what specific recommendations would you offer the
firm?

Solution

a. What should the management of Sports Products, Inc. pursue as its overriding
goal? Why?
Sports Products Inc. will definitely want to maximize their shareholders wealth, which
should be the most important goal of an organization although; profit is required to
 increase the dividends of the company. The managers in Sports Products Inc. must focus
on how the organization will continue to profit however; shareholders wealth will
increase or maximize while they focus on maintaining their status of providing excellent
boating equipment and accessories to their clientele.

The firm will also need to come up with a way to incorporate pollution control for the existing
problems and a way to pay the additional cost it will incur.

The study indicates that the firm has never paid any cash dividends in their twenty-year history
and this is how stockholders receive their profit from the organizations earnings. Shareholders
fall secondary when it comes to receiving cash dividends or profit because, a shareholder only
profits after everyone else in line has received their payments such as the organizations creditors,
or suppliers which explains why Sports Products Inc. is being sued by various officials for
dumping waste in adjacent streams. The company has chosen not invest in paying for pollution
control as this will increase cost to the company and lower the company profit margin. By the
shareholders, owning the firm places them at a greater risk and by them owing other companies
for risking pollution no one will want to invest in the company although, the profits are rising
there is no increase in the firm’s stock price.

b. Does the firm appear to have an agency problem? Explain.

There does appear to be an agency problem because, regardless of Dales and Loren efforts to
manage their jobs by trying not to waste packaging material and performing their job as cost-
effective as possible the stock price is still declining $2 per share over a 9 month period which is
a large decline under a year time-frame. The company also, does not seem to be concerned about
incorporating a pollution control program because; the company is concerned over the cost to
themselves and their company profit margin.

c. Evaluate the firm’s approach to pollution control. Does it seem to be ethical? Why might
incurring the expense to control pollution be in the best interests of the firm’s owners
despite its negative effect on profits?

To be honest, I am unsure why this would happen ethically. Sports Products Inc. will eventually
have to take responsibility on a higher level if these other companies go through with the
lawsuits. Therefore, the organization will be forced into either incorporating a pollution control
plan or paying fines, which will reduce shareholders wealth even more because, at this point the
shareholders cannot receive anything until their creditors are paid in full.

d. Does the firm appear to have an effective corporate governance structure? Explain any
shortcomings.
The structure of Sports Products Inc. appears poorly structured. The management teams are not
focused on the shareholders wealth at all. The management structure wants to maintain company
profit to break even however, they are not concerned about dumping waste into streams or,
creating a pollution control plan. The company is not assuring their stockholders wealth is
maximized and if they have not paid cash dividends in 20 years they are just trying to stay in
business however, they are not taking care of their employees who work from them everyday
nor, does the company have the shareholders best interest at heart.

e. On the basis of the information provided, what specific recommendations would You
offer the firm?

Based on the case study I would recommend Sports Products Inc. forming a better plan that will
not just break even however, strategize how to incorporate a pollution control program that will
be cost-effective and not affect profits if possible. I would recommend that they incorporate
better ethical values that will show integrity to their constituents and internal employees. The
organization will need to continue to profit but they also, need to ensure that the shareholders get
a piece of the pie in addition, to changing the standards that have been in place for 20 years.
Case-2: Terri Spiro, an experienced budget analyst at Martin 11anufacturing Company, has been
charged with assessing the firm's financial performance during 2009 and its financial position at
year-end 2009. To complete this assignment, she gathered the firm's 2009 financial statements
(below and on page 99). In addition, Terri obtained the firm's ratio values for 2007 and 2008,
along with the 2009 industry average ratios (also applicable to 2007 and 2008).
Required
a. Calculate the firm’s 2003 financial ratios, and then fill in the preceding table.
b. Analyze the firm’s current financial position from both a cross-sectional and a time-series
viewpoint. Break your analysis into evaluations of the firm’s liquidity, activity, debt,
profitability, and market.
c. Summarize the firm’s overall financial position on the basis of your findings in part b.

Solution:

Martin Manufacturing Company is an integrative case study addressing financial analysis

techniques. The company is a capital-intensive firm which has poor management of accounts
receivable and inventory. The industry average inventory turnover can fluctuate from 10 to 100
depending on the market.
b. Liquidity: The firm has sufficient current assets to cover current liabilities. The trend is
upward and is much higher than the industry average. This is an unfavorable position,
since it indicates too much inventory.

Activity: The inventory turnover is stable but much lower than the industry average.
This indicates the firm is holding too much inventory. The average collection period is
increasing and much higher than the industry average. These are both indicators of a
problem in collecting payment.

The fixed asset turnover ratio and the total asset turnover ratios are stable but
significantly lower than the industry average. This indicates that the sales volume is not
sufficient for the amount of committed assets.

Debt: The debt ratio has increased and is substantially higher than the industry average.
This places the company at high risk. Typically industries with heavy capital investment
and higher operating risk try to minimize financial risk. Martin Manufacturing has
positioned itself with both heavy operating and financial risk. The times-interest-earned
ratio also indicates a potential debt service problem. The ratio is decreasing and is far
below the industry average.

Profitability: The gross profit margin is stable and quite favorable when compared to
the industry average. The net profit margin, however, is deteriorating and far below the
industry average. When the gross profit margin is within expectations but the net profit
margin is too low, high interest payments may be to blame. The high financial leverage
has caused the low profitability.

Market: The market price of the firm’s common stock shows weakness relative to both
earnings and book value. This result indicates a belief by the market that Martin’s ability
to earn future profits faces more and increasing uncertainty as perceived by the market.

c. Martin Manufacturing clearly has a problem with its inventory level, and sales are not at
an appropriate level for its capital investment. As a consequence, the firm has acquired a
substantial amount of debt which, due to the high interest payments associated with the
large debt burden, is depressing profitability. These problems are being picked up by
investors as shown in their weak market ratios.
Case-3: To improve its competitive position, Martin Manufacturing is planning to implement a
major equipment modernization program. Included will be replacement and modernization of
key manufacturing equipment at a cost of $400,000 in 2010. Planned program is expected to
lower the variable cost per unit of finished product. Terri Spiro, an experienced budget analyst,
has been charged with preparing a fore~ cast of the firm's 2010 financial position, assuming
replacement and modernization of manufacturing equipment. She plans to use the 2009 financial
statements presented on pages 98 and 99, along with the key projected financial data summarized
in the following table.

a. Use the historical and projected financial data provided to prepare a pro forma income
statement for the year ended December 31,2010. (Hint: Use the percent~ of~ sales
method to estimate all values except depreciation expense and interest expense, which
have been estimated by management and included in the table.)
b. Use the projected financial data along with relevant data from the pro forma income
statement prepared in part a to prepare the pro forma balance sheet at December 31,2010.
(Hint: Use the judgmental approach.)
c. Will Martin Manufacturing Company need to obtain external financing to fund the
proposed equipment modernization program? Explain.
Solution:
In this case, the student prepares pro forma financial statements, using them to determine
whether Martin Manufacturing will require external funding in order to embark on a major
expansion program.