After being a Financial Manager for 20 years in one of the medical equipment companies, Jane Hill resigned from her firm and started InSample, Inc. a Qatar-based company whose main activity is aimed to develop a sophisticated Healthcare IT solution that became InSample’s initial product offering. In the three years prior her resignation, Jane had spent nights and weekends developing a detailed business plan and financial workout for establishing and running InSample, Inc. As the firm grew, Jane planned to develop and expand the company’s healthcare software offerings.
Although InSample experienced losses during its first two years of operation—2016 and 2017—its profit has increased steadily from 2016 to 2022. The firm’s profit history, including
dividend payments, is summarized in Table 1 below.
Table 1: Profits and dividends, 2016–2022
InSample, Inc.
Year
Net income after taxes ($)
Dividends paid ($)
2016
2017
2018
2019
2020
2021
2022
(60,000)
(30,000)
25,000
45,000
43,000
179,000
248,000
0
0
0
0
1,500
2,000
5,500
Jane started the firm with a $150,000 investment—her savings of $75,000 as equity and a $75,000 long-term loan from the bank. She had hoped to maintain her initial 100%
ownership in the corporation, but after experiencing a $60,000 loss during the first year of operation (2016), she sold 60% of the business to a group of investors to obtain needed funds. Since then, no other common share transactions have taken place. Although she
owns only 40% of the firm, Jane actively manages all aspects of its activities; the other shareholders are not active in management of the firm.
Jane has just prepared the firm’s 2022 income statement and balance sheet, shown in Tables 2 and 3. The 2021 income statement and balance sheet are also provided. In
addition, she has collected 2022 industry average ratio values, which are applicable to
both 2021 and 2022 and summarized in Table 4. She is quite pleased to have achieved record earnings of $248,000 in 2022, but she is concerned about the firm’s cash flows. She plans to complete a ratio analysis to evaluate the company’s financial position.
Specifically, she is finding it more and more difficult to pay the firm’s bills in a timely
manner.
Table 2: Income Statement ($000), InSample, Inc. For the year ended December 31.
Sales revenue
Less: Cost of goods sold
Gross margin
Less: Operating expenses
Selling expense
General and administrative expense
Depreciation expense
Total operating expenses
Operating profits
Less: Interest expense
Earnings before taxes
Less: Taxes (20%)
Net income after taxes
2021
$1,637
980
$657
2022
$1,750
980
$770
$130
267
10
$407
$250
26
$224
$44.80
$179
$150
270
11
$431
$339
29
$310
$62.00
$248
Table 3: Balance Sheet ($000), InSample, Inc. December 31.
2021
2022
Cash
Marketable securities
Accounts receivable
Inventories
Total current assets
Gross fixed assets
Less: Accumulated amortization
Net fixed assets
Total assets
$56
82
104
145
$387
$180
52
$128
$515
$37
66
152
191
$446
$195
63
$132
$578
Liabilities and shareholders’ equity
Current liabilities
Accounts payable
Line of credit
Accruals
Total current liabilities
Long-term debt
Total liabilities
$126
190
25
$341
$40
$381
$136
200
27
$363
$38
$401
Shareholders’ equity
Common shares (150,000 shares outstanding)
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders’ equity
$75
59
$134
$515
$75
102
$177
$578
Assets
Current assets
Table 4: Industry Averages for 2022
RATIO
CURRENT RATIO
QUICK RATIO
AVERAGE AGE OF INVENTORY
AVERAGE COLLECTION PERIOD
AVERAGE PAYMENT PERIOD
TOTAL ASSET TURNOVER
DEBT RATIO
TIMES INTEREST EARNED RATIO
INDUSTRY AVERAGE (2022)
1.62
1.05
77.4 days
30.5 days
41.1 days
4.2
45.2%
5.6
COMMON SIZE ANALYSIS
SALES
COGS
GROSS MARGIN
OPERATING EXPENSES
OPERATING PROFIT
INTEREST EXPENSES
EBT
TAXES
NI
RETURN ON TOTAL ASSETS
RETURN ON EQUITY
100.0%
57.7%
42.3%
29.9%
12.4%
2.2%
10.2%
2.0%
8.2%
26.2%
58.4%
Jane is further frustrated by the firm’s inability to afford to hire a healthcare software developer to complete development of a “Digital Health Automation Package” that is believed to have “bestseller” sales prospective. Jane began development of this
package 2 years ago, but the firm’s growing complexity has forced her to devote more
of her time to administrative duties, thereby halting the development of this product.
Jane’s reluctance to fill this position stems from her concern that the added $90,000 per
year in salary and benefits for the position would lower the firm’s earnings per share (EPS) over the next couple of years. Although the project’s success is in no way guaranteed,
Jane believes that if the money were spent to hire the software developer, the firm’s sales
and earnings would significantly rise once the 2-to-3-year development, production, and
marketing process was completed.
Another of Jane’s concerns is the firm’s rising interest expense. Because the firm relies heavily on short-term borrowing to maintain financial flexibility, recent rises in interest rates have caused InSample’s interest expense to increase. In an attempt to get a feel for interest rates, Jane researched the rates of interest on loans of varying maturities. These are shown in Table 5 below.
Table 5: Interest Rates for Various Loan Maturities as of January 2023
Loan Maturity
Interest rate (%)
3 months
6 months
1 year
3 years
5 years
10 years
20 years
11
12.7
12.5
12.0
10.5
9.7
9.3
With all of these concerns in mind, Jane set out to review the various data to develop
strategies that would help to ensure a bright future for InSample. As part of this process,
Jane believed that a thorough analysis of the firm’s 2021 and 2022 results would provide
important additional insights. Jane also wanted to prepare pro forma financial
statements for 2023. Table 6 provides the assumptions Jane feels are appropriate for the 2023-forecast year. Jane also feels she should complete a ratio analysis once she has
finalized the 2023 pro forma statements.
TABLE 6: Projections for the 2023 Forecast Year
(1) Sales are expected to increase by 32%.
(2) Jane wishes to reduce COGS to 52% of sales. The company will hold the increase in selling, general, and administrative expenses to 10% from the 2022 amounts. In addition, Jane plans to recommend to InSample’s Board of Directors that the company hire the new Healthcare developer at a salary of $90,000. This amount will be added to the general and administrative expense.
(3) Given that InSample plans to hire the new software developer, Jane would like to keep fixed asset
acquisitions to a minimum. However, the company has delayed acquiring certain fixed assets in the past and must now invest $245,000 in fixed assets in 2023. In 2023, depreciation will be $20,000.
(4) The interest expense is dependent on the amount of debt InSample will have outstanding in 2023 and the maturity of the loan. Jane must determine the total amount of costly debt InSample must secure in 2023 and use Table 5 to determine the cost of the debt. The long-term debt of $38,000 currently outstanding can be renegotiated.
(5) InSample’s tax rate will remain unchanged for 2023. Jane will recommend to InSample’s Board that no dividends be paid in 2023.
(6) Jane feels the liquidity of the company must be improved. She plans to increase cash to $45,000 and maintain the current level of marketable securities unless external financing is required in which case they will be sold. Jane has recognized the problem with the activity ratios and for 2023, she wants to reduce InSample’s average collection period to 25.5 days, average age of inventory to 56 days, and average payment period, based on COGS, to 33 days.
(7) Accruals will increase at the same rate as sales. No changes are anticipated with long-term debt
and common shares. Once the need for financing is determined, a decision will be made regarding
the form of financing.
REQUIRED:
a. (1) Upon what financial goal does Jane seem to be focusing? Is it the correct goal? Why or why not?
Elaborate on your answer.
(2) Could a potential agency problem exist in this firm? Provide a detailed explanation.
b. Calculate the firm’s earnings per share (EPS) for each year, recognizing that the number of common shares outstanding has remained unchanged since 2017. Comment on the EPS performance in view of your response in a.
c. What do we mean by Common-size analysis presented in Table 4? What was the base amount used for the calculations in this table?
d. Use the financial data presented to calculate the operating cash flows and the free cash flows for the year ended December 31, 2022. Discuss the results in light of InSample’s current cash flow difficulties.
e. Analyze the firm’s financial condition in 2021 and 2022 as it relates to (1) liquidity, (2) activity, (3)
leverage, and (4) profitability using the financial statements provided in Tables 2 and 3 and the ratio data included in Table 4. Be sure to evaluate the firm on both a cross-sectional and a time-series basis. Fully discuss the company’s financial strengths and weaknesses, and provide some recommendations to help Jane rectify the financial difficulties highlighted by the ratios.
f. Describe the Healthcare sector in Qatar and its outlook for the upcoming years (2023 onward).
Are the projection given in Table 6 in line with your research on the future of this sector. If not which assumptions or projections, would you change and what would be the new value to use.
g. In view of your ratio analysis and the data provided in Table 5, what financing strategy would you recommend for InSample?
i. Using the forecasts provided in Table 6 as well as any changes you suggested in f., prepare a pro forma income statement and balance sheet for InSample for the 2023-forecast year. Remember that in order to complete the pro forma income statement, you must decide on the amount and type of debt InSample
should use for the 2023-forecast year, and it should be consistent with your answer in g.
General Instructions
1. The submission date is April 10, 2024
2. Each group consists of five students.
3. To write an appropriate report, student should know how to interpret the results, to
develop the strengths and weaknesses for each company and to come up with
recommendations if it is needed.
The recommended layout of your project is suggested to be as follows:
Cover page
Introduction Firm overview
Description of the company
Analysis
Valuation & recommendation
Conclusion (summary of your results)
General Guidelines
1- Reserve the first page (cover page) to group member names, student ID, course name, and
university. All group member names should be on the cover page to earn marks.
2- You should write in times new roman font, size 12, with 1.5 spaces.
4- Failure to submit the group members list by the deadline is subject to mark deductions.
5- Failure to submit the soft copy online or the hard copy in class by the due date is subject to
mark deductions.
6- Maximum similarity index allowed is 15%.