CORPORATE FINANCE

[CORPORATE FINANCE]July 5, 2015

Dhaka Electric Supply Company Limited (DESCO)RATIO ANALYSIS (YEAR 2013)

a. Liquidity Ratios: 1. Current Ratio= 2.73 Interpretation: This ratio is mainly used to give an idea of the company's ability to pay back its short term liabilities with its short-term assets. The higher the current ratio, the more capable the company is of paying its obligations. DESCO has 2.73 times current asset to their current liabilities. If there is any need to pay their short term debt they can pay it 2.73 times with cash or liquidating other current asset.2. Quick Ratio= 2.43Interpretation: Desco has 2.43 times quick ratio means they can pay their debt 2.43 times without inventory. Inventory is the least liquid current asset. So if they need to pay their short term debt they can pay it 2.43 times without inventories.3. Cash Ratio= 1.2 Interpretation: This ratio measures a company's total cash and cash equivalents to its current liabilities. The cash ratio is most commonly used as a measure of company liquidity. It can therefore determine if, and how quickly, the company can repay its short-term debt. DESCOs cash ratio 1.2 implies that they have the ability to meet their debt obligations with their cash and cash equivalents in hand.

Comparison and Decision making:Higher industry average: In terms of current ratio, If the industry average is significantly high than this company that means this company should stop borrowing short term funds/loans. In terms of quick ratio, if the industry average is significantly high in this case that means other company has less inventories and more other liquid asset. DESCO may go out of inventory at the time of need while generating sales if they will maintain lower inventory than others in the industry. In terms of cash ratio, if the IA is higher, DESCO should increase more Cash on hand.Lower industry average: In terms of current ratio, If the industry average is significantly low that means this company have more current assets than others and they have the opportunity increase their short term debt.In terms of quick ratio, if the industry average is significantly lower than this company that means the company has more inventories and they can generate more sales compared to others. In terms of cash ratio, If the IA is lower than the company DESCO can invest this cash to generate more money.

b. Activity Ratios 1. Inventory turnover Ratio= 10.78 Interpretation: Desco can convert their inventories in to finish goods 10.78 times in a year. That means they have completed their inventories into finish goods and sold 10.78 times in a year.2. Asset Turnover Ratio = 0.64.Interpretation: Desco can generate sales by using their 64 percent asset. 64 percent total asset has been used to generate 2013 sales.3. Capital intensity ratio= 33%Interpretation: DESCO have 33% fixed assets of their total assets.Comparison and Decision making: Higher Industry Average: In terms of inventory turnover ratio. If the industry average is significantly higher than DESCO 10.78 times that mean DESCO have more inventories than others in the industry. In this case DESCO have to decrease inventories.In terms of total asset turnover ratio, DESCOS objective would be to reach as close as possible to the IA. Because they are underutilizing their assets than others and increase in asset utilization. In terms of Capital intensity ratio, DESCO should acquire more fixed assets.

Lower Industry Average: If DESCO has more inventory turnover than industry average that means this company has less inventories than others and if there is any large amount of order they will not be able to deliver goods. So DESCO have to increase inventories.If DESCO is higher in Asset turnover ratio compared to the industry than they are over utilizing their assets. They are running at their full capacity when the others are generating equal sales using less capacity. So in this case DESCO should also try to be as close as possible to IA.If DESCO have higher capital intensity ratio than others it means they have more fixed assets to finance their long term debts and also short term obligations.c. Debt ratios:Debt ratio= is 0.68Interpretation: Descos total asset is financed by 68% debt for every $1 in assets. Therefore, there is $0.32 in equity (= $1-$0.68) for every $.68 in debt.Times Interest Earned ratio= 1.52Interpretation: The times interest ratio is stated in numbers as opposed to a percentage. The ratio indicates how many times Desco could pay the interest with its before tax income, so obviously the larger ratios are considered more favorable than smaller ratios. 1.52 times is DESCO capable of covering their interest obligations.

Cash coverage ratio= 0.11Interpretation: A measure of a company's ability to meet its financial obligations. In broad terms, the higher the coverage ratio, the better the ability of the enterprise to fulfill its obligations to its lenders. Comparison and decision making: This ratio indicates if DESCO can borrow money but only debt ratio can answer the question. The time interest earned ratio and Fixed payment coverage ratio answers if DESCO should borrow money or not.Higher than Industry average: in terms of debt ratio DESCO cannot borrow money because they have more debts compared to assets. In terms of TIE ratio, If industry average is significantly higher than desco, means that they are able to meet its interest obligations because earnings are significantly greater than annual interest obligations.In terms of coverage ratio, Desco is at a better position to fulfill their obligations to its lenders.Lower than Industry average: In this case of debt ratio ,DESCO can borrow money because they have more assets than debt compared to others in the industry.According to lower TIE ratio, DESCO have lower capability to meet their interest obligations compared to others in the industry.In terms of coverage ratio, DESCO is at a bad position to fulfill their obligations to their lenders.*BUT this is not enough to make a decision on debt ratios. DESCO have to consider additional factors like FPCR ( Fixed payment coverage ratio) which will tell DESCO that after meeting their 5 fixed payment obligations (interest, principal amount, lease payment, Preferred dividend and tax), if they are still able to take loan or not. Taking the FPCR ratio under consideration if DESCO finds that they are able to borrow more money, than they should borrow, otherwise they shouldnt.d. Profitability Ratios:Rate of Return on Assets: 7.2Interpretation: DESCO can earn 7.2 dollars from every 1 dollar asset.Rate of Return on Common Stock equity: 7.47Interpretation: Desco can earn 7.47 dollars for every 1 dollar investment of the common stock holders. Payout ratio: -0.32Interpretation: Descos pays -32% of their net income as dividends.Comparison and decision making:Higher than industry average:In terms of ROA, if the industry average is higher than Descoss 7.2, it means Desco is less efficient in turning their assets into income and has a higher amount of unused asset. In this case, Desco should lower their amount of assets by investing in marketable securities or take more loans.In terms of Return on Common Stock equity ratio, if the industry average is significantly higher than Descos 7.47, it means the company is earning lower from their investors than other companies. In this case, the company could lower their common stock holders equity by issuing lesser stocks. In terms of the Payout ratio, if the industry average is significantly higher than Descos -0.32, it means Desco is paying less from their net incomes as dividends than other companies. Which means Desco is retaining more net income than other companies and should re invest to generate more money. Or they can increase their dividend amounts in order to maximize their share holders profit.Lower than Industry Average:In terms of ROA, it the industry average is lower than Descos 7.2, it means Desco is more efficient than most of the companies in truning assets to net income.In terms of Return on Common Stock equity ratio, if the industry average is significantly lower than Descos 7.47, it means the company is earning more than other companies and investors are willing to pay more for their income. Which means their stocks will highly absorbent in the market, so they should issue more stocks. In terms of the Payout ratio, if the industry average is significantly lower than Descos -0.32, it means Desco is paying higher from their net income and retaining less than other companies. In this case, they should try to decrease the dividend amount as they are paying more dividend than other companies, or they should look for gaps in other ratios to increase net income or the earnings per share.

e. Market Ratios:1. Earnings per share= BDT. 2.69 Interpretation: This ratio measures how many dollars of net income have been earned by each share of common stock. Desco earns BDT. 2.69 for each of their stock.2. Book value per share= 10Interpretation: A measure used by owners of common shares in a firm to determine the level of safety associated with each individual share after all debts are paid accordingly. The book value per common share indicates the dollar value remaining for common shareholders after all assets are liquidated and all debtors are paid. In simple terms it would be the amount of money that a holder of a common share would get if a company were to liquidate. This is the amount/ minimum price Desco should accept.3. Price to earnings ratio= 15.4 Interpretation: This is a valuation ratio of a company's current share price compared to its per-share earnings. For BDT.1 of Descos earnings the share holders are ready to spend BDT.15.Comparison and decision making: The main purpose of market ratio is if Desco is actually in a position of issuing shares or not. If Desco is able to sell the shares more than the face value , it will generate profit. But being able to issue shares doesnt mean they can issue shares, for that they have to make comparison with industry average.Higher than Industry average: if the book value per share is greater than IA than Desco should plan to issue shares because their selling price is more than the intended price. If the Price to earnings ratio its greater than IA than the demand of their share is very high in the market. If earning per share is greater than IA than they are earning more compared to others in terms of per share. So keeping all these factors in mind DESCO should issue shares.Lower than Industry average: if the book value per share is lower than IA than Desco shouldnt plan to issue shares because their selling price is less than the intended price. If the Price to earnings ratio is lower than IA than the demand of their share is very low in the market. If earning per share is lower than IA than they are earning less compared to others in terms of per share. So keeping all these factors in mind DESCO shouldnt issue new shares in the market .EXTERNAL FINANCING NEEDED (EFN INTERPRETED)The final step is to determine how the EFN is to be raised. Firms can choose to raise the EFN by borrowing on short-term basis (Notes Payable), borrowing on a long-term basis (Long-Term Debt), issuing equity (Common Stock), or some combination of the above.Without a feasible comparison with the industry average it is hard to accurately make the decision but if we portray a closer look into the ratio analysis of DESCO than we can see that 68% of DESCOS total assets is financed with short term debt on the other hand DESCO is doing well with their stocks. The Times interest earned ratio is approximately close to 2 which means they can deal with their debt obligations at least 2 times. So rather than putting pressure only on Debt financing only, DESCO should make a portfolio of short term borrowing, long-term debt, notes payable, issuing more stocks and bonds. By managing this PLUG successfully, DESCO should take the initiative to meet their EFN (External Financing Need).

1 | Page