Dragon Soup and Earnings Management Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

Dragon Soup and Earnings Management Case Solution

Clearing Inventory

The company is using LIFO method for the valuation of the inventory and it is expected that company is using conservative policy with respect to managing the inventory levels. The company is using 15% to sales ratio for inventory levels while its competitors are using 12% to sales ratio for managing inventory. Therefore the company has tied up greater cash into the inventory, which could be used for maximizing the company’s value, hence maintaining 12% inventory just like its competitors will be an appropriate level for the company in order to have a better utilization of its working capital.

Allowances and Provisions for Bad Debts

The company is not managing its receivables efficiently and J.N. &C., one of the largest customers of the company is delaying the payments and the receivable account of the customers is increasing by almost 100,000 dollars per year. Following this, the company is using greater provision estimates for allowances and bad debts.

At the end of the previous year; there was $300,000 in the account of unused provisions. It is expected that the company has positive collection experience of last year, which will further improve. Provision account consists of $150,000 related to the J.N.C. customer, which is not required anymore as the CEO is taking responsibility for that and projected write offs are of just $75000, therefore ending balance for provisions reduce to $100,000from $300,000.

Selling and Valuation Decision of Mortgage-Backed Securities

Asset side of the company’s balance sheet contains two held for sale investments, which include shares and mortgage-backed securities. It is expected that the investment in shares would increase by $25000 than its original purchased value, and meanwhile the current market value of the mortgage backed security would decrease by 50% of the original investment.

But unrealized gain and losses will affect the income statement only if the investment is sold.Selling the shares is not an appropriate step as it is expected that there are chances of further appreciation while selling of mortgage backed security will devalue the earnings for the year and similarly the valuation of the company as well. Therefore, in order to maximize the value of the company; both the investments are as it is in the balance sheet of the company but are valued according to the quoted prices in the active markets for a fair representation of financial statements.

Recommendation based on Valuation

It is expected that the potential investors would use multiple of earnings for valuation instead of an in-depth financial analysis; therefore, it is supposed that the presence of mortgage backed investment will not affect the valuation because the gain or loss will only be realized upon selling of these investments.

Moreover it is expected that lowering the inventory levels, decrease in provisions, leasing machinery, increasing the minor selling price per soup and conducting promotional activities would increase the profit from $133815 to $375269 for the year. By assuming 100$ as the per share price; the company’s EPS and P/E ratio are calculated, which shows that potential buyers could offer a value which is ten times greater than the existing P/E multiple.

Legal Concerns about Recommendation

It is expected that all the recommended actions are legal and are qualifying the three basic principle’s objectives of SEC’s and MD & A. It is expected that the current financials of the company include explanation of the financial statements for the convenience of investors, disclosures of financial statements has also increased for a better analysis of the financial statements and providing quality information about the company’s earnings and cash flows for better comparison, and it is expected that the current financials are the real performance indicator of the company instead of misrepresenting the financial statement by utilizing accounting loopholes as mortgage backed securities which are measures at quoted market price instead of valuing at Jason’s estimates, although that was also an appropriate method with respect to the accounting standards..........................

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Dragon Soup and Earnings Management Harvard Case Solution & Analysis