Escolar Documentos
Profissional Documentos
Cultura Documentos
CHAPTER 12
ANALYSIS OF FINANCIAL STATEMENTS
SUGGESTED ANSWERS TO THE REVIEW QUESTIONS AND PROBLEMS
I. Questions
1. The emphasis of the various types of analysts is by no means uniform
nor should it be. Management is interested in all types of ratios for two
reasons.
First, the ratios point out weaknesses that should be
strengthened; second, management recognizes that the other parties are
interested in all the ratios and that financial appearances must be kept up
if the firm is to be regarded highly by creditors and equity investors.
Equity investors (stockholders) are interested primarily in profitability,
but they examine the other ratios to get information on the riskiness of
equity commitments. Credit analysts are more interested in the debt,
TIE, and EBITDA coverage ratios, as well as the profitability ratios.
Short-term creditors emphasize liquidity and look most carefully at the
current ratio.
2. The inventory turnover ratio is important to a grocery store because of
the much larger inventory required and because some of that inventory is
perishable. An insurance company would have no inventory to speak of
since its line of business is selling insurance policies or other similar
financial productscontracts written on paper and entered into between
the company and the insured. This question demonstrates that the
student should not take a routine approach to financial analysis but rather
should examine the business that he or she is analyzing.
3. Differences in the amounts of assets necessary to generate a dollar of
sales cause asset turnover ratios to vary among industries. For example,
a steel company needs a greater number of dollars in assets to produce a
dollar in sales than does a grocery store chain. Also, profit margins and
turnover ratios may vary due to differences in the amount of expenses
incurred to produce sales. For example, one would expect a grocery
store chain to spend more per dollar of sales than does a steel company.
Often, a large turnover will be associated with a low profit margin, and
vice versa.
12-1
Chapter 12
Chapter 12
11. The fixed charge coverage ratio measures the firms ability to meet all
fixed obligations rather that interest payments alone, on the assumption
that failure to meet any financial obligation will endanger the position of
the firm.
12. No rule-of-thumb ratio is valid for all corporations. There is simply too
much difference between industries or time periods in which ratios are
computed. Nevertheless, rules-of-thumb ratios do offer some initial
insight into the operations of the firm, and when used with caution by the
analyst can provide information.
13. a. Return on investment = Net income/Total assets
Inflation may cause net income to be overstated and total assets
to be understated. Too high a ratio could be reported.
b. Inventory turnover = Sales/Inventory
Inflation may cause sales to be overstated. If the firm uses FIFO
accounting, inventory will also reflect inflation-influenced
pesos and the net effect will be nil. If the firm uses LIFO
accounting, inventory will be stated in old pesos and too high a
ratio could be reported.
c. Fixed asset turnover = Sales/Fixed assets
Fixed assets will be understated relative to sales and too high a
ratio could be reported.
d. Debt to total assets = Total debt/Total assets
Since both are based on historical costs, no major inflationary
impact will take place in the ratio.
14. Disinflation tends to lower reported earnings as inflation-induced income
is squeezed out of the firms income statement. This is particularly true
for firms in highly cyclical industries where prices tend to rise and fall
quickly.
15. Because it is possible that prior inflationary pressures will no longer
seriously impair the purchasing power of the peso. Lessening inflation
also means that the required return that investors demand on financial
assets will be going down, and with this lower demanded return, future
earnings or interest should receive a higher current evaluation.
12-3
Chapter 12
II. Problems
Problem 1 (Day Sales Outstanding)
DSO = 40 days; S = 7,300,000; AR = ?
DSO =
AR
S
365
AR
40 = 7,300,000
365
40 = AR/20,000
A
A/E
D
1
= 1
A
2.4
D
= 0.5833= 58.33%.
A
6,000,000,000
800,000,000
= 7.50
32.00
7.50 = 4.2667
12-4
AR
S
365
Chapter 12
= 1.2
= 1.2
= (20) (
= 24.00
1.2)
Chapter 12
1,148,077
225,000
923,077
323,077
600,000
(225,000 + 923,077)
Given
(600,000/0.65)
BEP = EBIT/TA
= 1,148,077/7,500,000
= (0.1531)
BEP = 15.31%
Problem 8 (Ratio Calculations)
We are given ROA = 3% and Sales/Total assets = 1.5
From the DuPont equation:
ROA = Profit margin x Total assets turnover
3% = Profit margin (1.5)
Profit margin = 3%/1.5
Profit margin = 2%
We can also calculate the companys debt-to-assets ratio in a similar
manner, given the facts of the problem. We are given ROA (NI/A) and
ROE (NI/E); if we use the reciprocal of ROE we have the following
equation:
12-6
Chapter 12
E
NI
E
D
E
=
and =1
, so
A
A
NI
A
A
E
1
= 3%
A
0.05
E
= 60%.
A
D
=1 0.60= 0.40= 40%.
A
Chapter 12
TIE = 2.25
Problem 10 (Return on Equity)
ROE= Profit margin x TA turnover x Equity multiplier
= NI/Sales x Sales/TA x TA/Equity
Now we need to determine the inputs for the DuPont equation from the
data that were given. On the left we set up an income statement, and we
put numbers in it on the right:
Sales (given)
Cost
EBIT (given)
INT (given)
EBT
Taxes (34%)
NI
10,000,000
N/A
1,000,000
300,000
700,000
238,000
462,000
1,312,500
525,000 = 2.5
1,312,500 + NP
525,000 + NP
12-8
= 2.0
Chapter 12
Chapter 12
Industry
average
Current
ratio
Current assets
Current liabilities
655,000
330,000
1.98
2.0
Quick ratio
Current assets
Inventories
Current liabilities
655,000
241,500
330,000
1.25
1.3
DSO
Accounts receivable
Sales/365
336,000
4,404.11
76.3
days
35 days
Inventory
turnover
Sales
Inventories
1,607,500
241,500
6.66
6.7
T.A.
turnover
Sales
Total assets
1,607,500
947,500
1.70
3.0
Profit
margin
Net income
Sales
27,300
1,607,500
1.7%
1.2%
ROA
Net income
Total assets
27,300
947,500
2.9%
3.6%
ROE
Net income
Common equity
27,300
361,000
7.6%
9.0%
Debt ratio
Total debt
Total assets
586,500
947,500
61.9%
60.0%
12-10
Chapter 12
947,500
361,000
= 7.6%
2011
2010
Industry Average
2.33
2.11
2.7
4.74
37.79
9.84
2.31
4.47
32.94
7.89
2.18
7.0
32
13.0
2.6
1.00%
2.22%
0.43%
5.76%
11.47%
2.64%
9.1%
18.2%
3.5%
12-11
Chapter 12
Debt Management
Debt-to-assets ratio
Market Value
P/E ratio
Price/cash flow ratio
54.81%
49.81%
50.0%
15.43
1.60
5.65
2.16
6.0
3.5
a. Mangos liquidity position has improved from 2010 to 2011; however, its
current ratio is still below the industry average of 2.7.
b. Mangos inventory turnover, fixed assets turnover, and total assets
turnover have improved from 2010 to 2011; however, they are still below
industry averages. The firm's days sales outstanding ratio has increased
from 2010 to 2011which is bad. In 2010, its DSO was close to the
industry average. In 2011, its DSO is somewhat higher. If the firm's
credit policy has not changed, it needs to look at its receivables and
determine whether it has any uncollectibles. If it does have uncollectible
receivables, this will make its current ratio look worse than what was
calculated above.
c. Mangos debt ratio has increased from 2010 to 2011, which is bad. In
2010, its debt ratio was right at the industry average, but in 2011 it is
higher than the industry average. Given its weak current and asset
management ratios, the firm should strengthen its balance sheet by
paying down liabilities.
d. Mangos profitability ratios have declined substantially from 2010 to
2011, and they are substantially below the industry averages. Mango
needs to reduce its costs, increase sales, or both.
e. Mangos P/E ratio has increased from 2010 to 2011, but only because its
net income has declined significantly from the prior year. Its P/CF ratio
has declined from the prior year and is well below the industry average.
These ratios reflect the same information as Corrigan's profitability
ratios. Corrigan needs to reduce costs to increase profit, lower its debt
ratio, increase sales, and improve its asset management.
f.
2011
2010
Industry Avg.
ROE =
2.22%
11.47%
18.20%
Chapter 12
Sales
Total asset turnover
960,000
2.4
400,000
Net income
Sales
Profit margin
960,000
0.07
67,200
Net income
Total assets
67,200
400,000
16.80%
ROA(invest=
ment)
Current assets
Current liabilities
12-13
570,000
300,000
1.90
Chapter 12
b. Quick ratio
(Current assets
Inventory)
Profit margin
c. Debt to total
assets
Total debt
Total assets
d. Asset
turnover
Sales
Total assets
Accounts
receivable
Average daily
credit sales
280,000
6,333 per day
e. Average
collection
period
330,000
300,000
1.10
418,000
950,000
44%
3,040,000
950,000
3.20
280,000
(3,040,000 x 0.75)
360 days
44.21 days
x
x
=
Profit margin
?
8.4%/1.4
=
=
=
b.
7%
8.4%
12
It did not change at all because the increase in profit margin made up for
the decrease in the asset turnover.
Problem 19 (DuPont System of Analysis)
King Company
a. Return on
equity
Return on assets
(investment)
=
(1 Debt /Assets)
=
12%
0.60
12-14
12%
(1 0.40)
20%
Chapter 12
Accounts
receivable
Average daily
credit sales
180,000
3,000 per day
180,000
(1,200,000 x 0.90)
360 days
60 days
Credit sales
360
1,080,000
360
3,000
=
=
=
Stockholders equity
Total assets
Total assets
=
=
=
Sales
4,000,000
140,000
=
x
x
Total assets
Profit margin
3.5%
12-15
Total liabilities
Chapter 12
Total liabilities
Total liabilities
Stockholders equity
Return on
stockholders
equity
1,600,000
1,200,000
=
=
Net income
Stockholders
equity
400,000
140,000
1,200,000
11.67%
14%
Sales
= Total assets
= 1,600,000
Sales = 4,800,000
Net income
Net income
Return on
stockholders
equity
= Sales
= 4,800,00
0
= 168,000
=
Profit margin
3.5%
Net income
Stockholders
equity
168,000
1,200,000
Medical supplies
Heavy machinery
6.0%
Electronics
3.8%
8.0%
Medical supplies
Heavy machinery
15.0%
2.375%
12-16
Electronics
10.67%
Chapter 12
Return on assets
1,710,000
19,000,000
9.0%
Return on assets
2,720,000
19,000,000
14.32%
Inventory
Current assets
=
=
Accounts receivable
Cash
=
=
2 x 80,000
160,000
=
=
(420,000/360) x 36
42,000
Current assets
Cash
58,000
42,000
Accounts receivable
12-17
Chapter 12
60,000
160,00
0
Inventory
Total current assets
= 2.5 times
= 750,000/2.5 = 300,000
Cash
Cash
= 2% of total assets
= 2% x 300,000 = 6,000
Sales/Accounts receivable
Accounts receivable
= 10 times
= 750,000/10 = 75,000
Sales/Inventory
Inventory
= 15 times
= 750,000/15 = 50,000
Fixed assets
Total current asset
Fixed assets
= 2
= Current assets/2 = 131,000/2 = 65,500
= 45%
= .45 x 300,000 = 135,000
Long-term debt
Long-term debt
Net worth
Net worth
12-18
Chapter 12
Cash
6,000 Current debt
Accounts receivable
75,000 Long-term debt
Inventory
50,000
Total debt
Total current assets
131,000 Net worth
Fixed assets
169,000 Total debt and
Total assets
300,000 Stockholders equity
Problem 26 (Using Ratios to Determine Account Balances)
65,500
69,500
135,000
165,000
300,000
Cathy Corporation
a. Accounts receivable
= Sales/Receivables turnover
= 3,000,000/6x = 500,000
b. Marketable securities
Current assets
Marketable securities
Marketable securities
c. Fixed assets
Total assets
= Sales/Asset turnover
= 3,000,000/1.2x = 2,500,000
Fixed assets
d. Long-term debt
Total debt
Long-term debt
12-19
Chapter 12
Sales/Total assets
Total assets
= 2
= 20,000,000/2 = 10,000,000
= 30%
= 10,000,000 x .3 = 3,000,000
Sales/Inventory
Inventory
= 5.0x
= 20,000,000/5x = 4,000,000
= 20,000,000/360 days
= 55,556 per day
Accounts receivable
Fixed assets
= 20,000,000/5x = 4,000,000
Current assets
Cash
Cash
Current liabilities
Current liabilities
= Current assets/3x
= 6,000,000/3 = 2,000,000
Long-term debt
Long-term debt
Equity
Equity
Cash
Accounts receivable
Inventory
Total current assets
Current debt
1,000,000
1,000,000 Long-term debt
4,000,000
Total debt
6,000,000
12-20
2,000,000
1,000,000
3,000,000
Fixed assets
Total assets
4,000,000 Equity
10,000,00 Total debt and equity
0
Chapter 12
7,000,000
10,000,000
Profit margin
Return on assets
Return on equity
Receivable turnover
Average collection period
Inventory turnover
Fixed asset turnover
Total asset turnover
Current ratio
Quick ratio
Debt to total assets
Times interest earned
Fixed charge coverage
Fixed charge coverage
calculation
Black Corporation
7.4%
18.5%
28.9%
15.63x
23.04 days
25x
3.57x
2.5x
1.5x
1.0x
36%
24.13x
13.33x
White Corporation
5.25%
12.00%
34.4%
14.29x
25.2 days
13.3x
4x
2.29x
2.5x
1.5x
65.1%
6x
4.75x
(200/15)
(133/28)
a. Since suppliers and short-term lenders are more concerned with liquidity
ratios, White Corporation would get the nod as having the best ratios in
this category. One could argue, however, that White had benefited from
having its debt primarily long term rather than short term. Nevertheless,
it appears to have better liquidity ratios.
b. Stockholders are most concerned with profitability. In this category,
Black Corporation has much better ratios than White Corporation. White
does have a higher return on equity than Black, but this is due to its much
12-21
Chapter 12
larger use of debt. Its return on equity is higher than Blacks because it
has taken more financial risk. In terms of other ratios, Black has its
interest and fixed charges well covered and in general its long-term ratios
and outlook are better than White. Black has asset utilization ratios equal
to or better than White and its lower liquidity ratios could reflect better
short-term asset management, and that point was covered in part (a).
Note: Remember that to make actual financial decisions, more than one
years comparative data is usually required. Industry comparisons should
also be made.
12-22