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Integrated Case 1: D’Leon Inc., Part I
Trish Halder
LDR 640 – Financial Systems Management
Siena Heights University
Professor Cynthia Jones
April 13, 2011
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Integrated Case 1: D’Leon Inc., Part I
3/23/11 Dear Journal: Good news and bad news today. The good news (I think) is that I
was chosen to assist a woman named Donna Jamison in her attempt to analyze the financial
status of a company called D’Leon Inc. The bad news is that I have absolutely no financial
management background and I don’t know what I’m doing! I do have a book I can refer to
(Fundamentals of Financial Management by Brigham and Houston) which should be a big help.
I will try to keep an open mind and offer as much insight into the D’Leon case as I am able . . .
wish me luck!
3/25/11 Dear Journal: Today I met Donna Jamison and learned a little more about the
task set before us. Donna has been brought on board to assist Fred Campo, Chairperson of
D’Leon’s Board, in nursing D’Leon Inc. back to health. Up until 2007 D’Leon was a relatively
successful small producer of high quality pecan products, whose net income in 2007 was
$87,960. Then the company’s president, Al Watkins, decided to undertake a major expansion to
compete nationally with large snack food companies such as Frito Lay. The expansion involved
doubling its plant capacity, opening new sales offices outside their home territory of north
Florida, and launching an expensive ad campaign. Even without a financial background, I can
imagine that this expansion would be very costly, and that D’Leon would have to sell a lot of
pecan products to recoup their costs, not to mention make a profit to help ensure the wealth of
their stockholders – which is, of course, their ultimate goal.
3/28/11 Dear Journal: Donna and I began digging into D’Leon’s financial statements
today, focusing on their Balance Sheet and Income Statement. Thankfully, we were aided
considerably by some pertinent information provided to us by supervisor Cindy Jones. We
learned several things. The company’s sales increased by $2,602,000 in 2008, however, their
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after tax operating income went from $114,257 in 2007 to -$78,569 in 2008 – a decrease of
$192,826. Also, D’Leon’s net working capital increased by $70, 642, but their net income
dropped $248,136 from 2007 to 2008. Their free cash flow was a dismal -$744,201 in 2008. So
far, we’ve deduced that D’Leon sold a lot of product, but didn’t make a lot of money doing it.
3/29/11 Dear Journal: After further review of D’Leon’s financial statements, we have
determined that the company is most likely not paying its suppliers on time. Its accounts
payables increased from $145,600 in 2007 to $524,160 in 2008 – an increase of 360%, while its
sales only increased 176%. If they indeed are not timely with their payments to their suppliers,
D’Leon risks losing their suppliers’ trust and the suppliers may no longer wish to work with
D’Leon. Since industries network among themselves, word would get out to other potential
suppliers, and D’Leon could find itself having lost credibility with an entire industry, leading to
bankruptcy. We also determined that, according to the income statement, D’Leon’s 2008 sales
were $6,034,000, but their total operating costs were $6,047,988. This indicates that their sales
price does not exceed their costs per unit sold. D’Leon is spending more than it’s bringing in,
resulting in a decreased cash balance.
3/30/11 Dear Journal: Today Donna proposed a couple of hypothetical questions to me.
First she wondered how the cash account would be affected if D’Leon began offering 60-day
credit terms rather than their current 30-day terms. I rationalized that bringing money in over an
even longer period of time would make D’Leon even more delinquent in paying their own bills
because they would have less money coming in. If sales doubled as a result of changing their
credit terms, and if D’Leon starts paying its bills on time, cash would eventually increase, but not
immediately. Donna also asked me to imagine a situation in which the sales price exceeds the
cost of producing and selling a unit of output, yet a dramatic increase in sales volume causes the
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cash balance to decline. I could only figure that, as in her first question, if lengthy credit terms
were offered, the company would have less money coming in over a longer period of time, and
the cash balance could decline. Wow – days like this make me realize that not everyone’s cut
out for financial management, and heighten my appreciation for those who are!
3/31/11 Dear Journal: A good night’s sleep helped my morale, and I arrived at work
ready to tackle the D’Leon case again. Donna and I determined that D’Leon financed its
expansion program with external capital as opposed to internally generated funds such as
additions to retained earnings. We arrived at this conclusion based on the fact that both
D’Leon’s notes payable and long-term debt increased by approximately $400,000 from 2007 to
2008. This financing option weakened D’Leon’s financial strength because they now have loans
to pay and aren’t covering those payments with sufficient sales.
4/1/11 Dear Journal: Today Donna and I worked another hypothetical question together.
We compared D’Leon’s income statement and statement of cash flows to determine if D’Leon’s
asset expansion would have caused them a cash shortage even if they had broken even in 2008 in
the sense that their sales revenues equaled their total operating costs plus interest charges. By
adding their 2008 operating costs to their interest charges and then subtracting their sales, we
determined they would have had to increase their sales by $150,000 to equal operating costs plus
interest. The extra $150,000 in sales still would not be near enough to cover the increases in
additions to property, plant, and equipment, notes payable and long-term debt they incurred
through the expansion as indicated on the 2008 statement of cash flows.
4/4/11 Dear Journal: Donna and I had a discussion today and hypothesized about what
would happen if D’Leon began depreciating their fixed assets – also known as property, plant
and equipment – over seven years as opposed to 10 years. Since depreciation is “on paper” and
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addresses an intangible, we knew that the actual physical stock of assets would not be affected
by this proposed change. Donna explained that the balance sheet account for fixed assets would
be affected because there would be larger depreciation amounts reflected over fewer years. Net
income would be reduced because a larger amount of income would be taken away to address the
larger depreciation costs. D’Leon’s cash position would not be affected because, again,
depreciation is an intangible “on the books”.
4/5/11 Dear Journal: Donna took some time today to teach me some important
calculations. She explained that to determine earnings per share (EPS) we divide net income by
common shares outstanding to reach a dollar amount. I learned that the EPS is found on the
income statement and is often referred to as “the bottom line” because it is the most important
piece of information to the stockholders (Brigham & Houston, 2009, p.61). Dividends per share
(DPS) are found by dividing dividends paid to common stockholders by common shares
outstanding to also reach a dollar amount. The DPS is the amount of dividend that a stockholder
will receive for each share of stock they hold. The next calculation Donna explained was that to
reach the book value per share we must divide common equity by shares outstanding. The book
value only shows what the stock is worth on the accounting books, and will not equal the market
price per share because the market price per share takes into consideration inflation which might
have caused the value of assets purchased previously to rise (Brigham & Houston, 2009, p.100).
4/6/11 Dear Journal: Whew – this financial management stuff is not for the faint of
heart! I have concluded it is not my calling, but I’ll do my best to fulfill my commitment by
writing this final journal entry regarding taxes. “A firm . . . can finance its operations with either
debt or stock. If a firm uses debt, it must pay interest, whereas if it uses stock, it is expected to
pay dividends. Interest paid can be deducted from operating income to obtain taxable income,
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but dividends paid cannot be deducted.” (Brigham & Houston, 2009, p.73) For D’Leon, this
means that since they financed their expansion with loans, they can deduct the interest from
those loans from their operating income. As far as interest earned and dividends received, this
should benefit D’Leon’s investors because the rate of return to investors is much higher when
debt is used (Brigham & Houston, 2009, p.73). Regarding the tax treatment of capital gains,
currently “corporations’ capital gains are taxed at the same rates as their operating income”
(Brigham & Houston, 2009, p.74). A capital gain, as defined by Brigham & Houston, is “the
profit from the sale of a capital asset for more than its purchase price” p.70. For D’Leon, since
their tax rate for their operating income – also called their earnings before interest and taxes
(EBIT) – is 40%, their capital gains would also be taxed at 40%. Finally, the term tax loss carryback or carry-forward means that “ordinary corporate operating losses can be carried backward
for 2 years and carried forward for 20 years to offset taxable income in a given year” (Brigham
& Houston, 2009, p.74). For D’Leon, since they experienced an operating income loss in 2008,
they could apply the carry-back to 2006, and the carry-forward to 2028 or until the losses have
been used up, whichever comes first.
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References
Brigham, E. F., Houston, J. F. (2009). Fundamentals of financial management (6th ed.). Mason,
OH: South-Western Cengage Learning.