Solutions to Chapter 17
Solutions to Chapter 17
Financial Statement Analysis
1.a.Long-term debt ratio
b.Total debt ratio
c.Times interest earned
d.Cash coverage ratio
e.Current ratio
f.Quick ratio
g.Operating profit margin
h.Inventory turnover
i.Days sales in inventory
j.Average collection period
k.Return on equity
l.Return on assets
m.Payout ratio
2. Gross investment during the year
= Increase in net property, plant, equipment + depreciation
= ($19,973 $19,915) + $2,518 = $2,576
3.Market-to-book ratio = $17.2 billion/$9.724 billion = 1.77
Earnings per share = $1,311 million/205 million = $6.40
Price-earnings ratio = $17.2 billion/$1.311 billion = 13.1
4. Balance sheets for Phone Corp:
Dollar amountsCommon-size (% amounts)
End of yearStart of yearEnd of yearStart of year
Assets
Cash & marketable securities
$ 89
$ 158
0.32%
0.57%
Receivables
2,382
2,490
8.59%
9.05%
Inventories
187
238
0.67%
0.87%
Other current assets
867
932
3.13%
3.39%
Total current assets
3,525
3,818
12.72%
13.88%
Net property, plant, and equipment
19,973
19,915
72.07%
72.41%
Other long-term assets
4,216
3,770
15.21%
13.71%
Total assets
$27,714
$27,503
100.00%
100.00%
Liabilities and Shareholders Equity
Payables
$ 2,564
$ 3,040
9.25%
11.05%
Short-term debt
1,419
1,573
5.12%
5.72%
Other current liabilities
811
787
2.93%
2.86%
Total current liabilities
4,794
5,400
17.30%
19.63%
Long-term debt and leases
7,018
6,833
25.32%
24.84%
Other long-term liabilities
6,178
6,149
22.29%
22.36%
Shareholders equity
9,724
9,121
35.09%
33.16%
Total Liabilities & Shareholders equity
$27,714
$27,503
100.00%100.00%
5.
Asset turnover
Operating profit margin
Asset turnover ( Operating profit margin = 0.4779 ( 0.1513 =
0.0723 = ROA
6.a.ROE
b.
(Notice that we have used average assets and average equity in
this solution.)
7.a.The consulting firm has relatively few assets. The major
asset is the know-how of its employees. The consulting firm has the
higher asset turnover ratio.
b.The Catalog Shopping Network generates far more sales relative
to assets since it does not have to sell goods from stores with
high expenses and probably can maintain relatively lower
inventories. The Catalog Shopping Network has the higher asset
turnover ratio.
c.The supermarket has a far higher ratio of sales to assets. The
supermarket itself is a simple building and the store sells a high
volume of goods with relatively low mark-ups (profit margins).
Standard Supermarkets has the higher asset turnover.
8.a.Debt-equity ratio
b.Return on equity
c.Profit margin
d.Inventory turnover
e.Current ratio
f.Average collection period
g.Quick ratio
9. If Pepsi borrows $300 million and invests the funds in
marketable securities, both current assets and current liabilities
will increase.
a.Liquidity ratios
Current ratio
Quick ratio
Cash ratio
The transaction would result in a slight decrease in the current
ratio and an increase in the quick ratio and the cash ratio, so
that the company might appear to be more liquid. However, a
financial analyst would be very unlikely to conclude that the
company is actually more liquid after engaging in such a
transaction.
b.Leverage ratios
The long-term debt ratio and the debt-equity ratio would be
unaffected since current liabilities are not included in these
ratios. The total debt ratio will increase slightly, however:
The very slight increase in the total debt ratio (from 0.601 to
0.607) indicates that the company would appear to be very slightly
more leveraged. However, a financial analyst would conclude that
the company is actually no more leveraged than prior to the
transaction.
10.a.Current ratio will be unaffected. Inventories are replaced
with either cash or accounts receivable, but total current assets
are unchanged.
b.Current ratio will be unaffected. Accounts due are replaced
with the bank loan, but total current liabilities are
unchanged.
c.Current ratio will be unaffected. Receivables are replaced
with cash, but total current assets are unchanged.
d.Current ratio will be unaffected. Inventories replace cash,
but total current assets are unchanged.
11.The current ratio will be unaffected. Inventories replace
cash, but total current assets are unchanged. The quick ratio
falls, however, since inventories are not included in the most
liquid assets.
12.Average collection period equals average receivables divided
by average daily sales:
Average collection period
13.Days sales in inventories
14.Annual cost of goods sold = $10,000 ( 365/30 = $121,667
Inventory turnovertimes per year
15.a.Interest expense = 0.08 ( $10 million = $800,000
Times interest earned = $1,000,000/$800,000 = 1.25
b.Cash coverage ratio
c.Fixed payment coverage
16.a.ROA = Asset turnover ( Operating profit margin = 3 ( 0.05 =
0.15 = 15%
b.If debt/equity = 1, then debt = equity, so total assets are
twice equity.
ROEDebt burden
17.Total sales = $3,000 ( 365/20 = $54,750
Asset turnover ratio = $54,750/$75,000 = 0.73
ROA = Asset turnover ( Operating profit margin = 0.73 ( 0.05 =
0.0365 = 3.65%
18.Debt-equity ratio
( Long-term debt = 0.4 ( $1,000,000 = $400,000
and Current assets = $200,000
Therefore, Current liabilities = $200,000/2 = $100,000 = Notes
payable
Total liabilities = $500,000
Total assets = total liabilities + equity = $500,000 +
$1,000,000 = $1,500,000
Total debt ratio = $500,000/$1,500,000 = 0.33
19.
20.EBIT = Revenues COGS Depreciation
= $3,000,000 $2,500,000 $200,000 = $300,000
Interest = 8% of face value = $80,000
Times interest earned = $300,000/$80,000 = 3.75
21. The firm has less debt relative to equity than the industry
average but its ratio of (EBIT plus depreciation) to interest
expense is lower. Perhaps the firm has a lower ROA than its
competitors, and is therefore generating less EBIT per dollar of
assets. Perhaps the firm pays a higher interest rate on its debt.
Or perhaps its depreciation charges are lower because it uses less
capital or older capital.
22.A decline in market interest rates will increase the value of
the fixed-rate debt and thus increase the market-value debt-equity
ratio. By this measure, leverage will increase. The decline in
interest rates will also reduce the firms interest payments on the
floating rate debt, which will increase the times-interest-earned
ratio. By this measure, leverage will decrease. The impact of the
lower rates on leverage is thus ambiguous. The firm has higher
indebtedness relative to assets, but greater ability to cover its
cash flow obligations.
23.a.The shipping company, which has more tangible assets, will
tend to have the higher debt-equity ratio. (See Chapter 15,
Sections 15.3 and 15.4, for a discussion of the reasons that firms
holding tangible assets with active secondary markets tend to
maintain higher debt-equity ratios.)
b. United Foods is in a more mature industry and probably has
fewer favorable opportunities for reinvesting income. We would
expect United Foods to have the higher payout ratio.
c. The paper mill will have higher sales per dollar of assets.
It is less capital intensive (that is, has less capital per dollar
of sales) than the integrated firm.
d. The discount outlet sells many of its goods for cash. The
power company bills monthly and usually gives customers a month to
pay bills and therefore will have the longer collection period.
e. Fledging Electronics will have the higher price-earnings
multiple, reflecting its greater growth prospects. (Recall from
Chapter 6, Section 6.5, that the P/E ratio is an indicator of the
firm's growth prospects.)
24.Leverage ratios are of interest to banks or other investors
lending money to the firm. They want to be assured that the firm is
not borrowing more than it can reasonably be expected to repay.
Liquidity ratios are also of interest to creditors who prefer
that a firms current assets are well in excess of its current
liabilities. Liquidity ratios are especially important to those who
lend to the firm for short periods, for example, by extending trade
credit. If a firm buys goods on credit, the seller wants to know
that, when the bill comes due, the firm will have enough cash on
hand to pay it.
Efficiency ratios might be of interest to stock market analysts
who want to know how well the firm is being run. These ratios are
also of great concern to the firms own management, which needs to
know if it is running as tight a ship as its competitors.
25.Income Statement
Millions of dollars
Net sales$199.93
Cost of goods sold120.00
Selling, general & administrative expenses10.00
Depreciation20.00EBIT49.93
Interest expense 6.27Income before tax43.66
Tax30.13Net income$ 13.53
Balance Sheet
Millions of dollars
This yearLast year
Assets
Cash and marketable securities$ 11$ 20
Receivables4434
Inventories 22 26
Total current assets7780
Net property, plant, equipment3825
Total assets$115$105
Liabilities & Shareholders Equity
Accounts payable$ 25$ 20
Notes payable 30 35
Total current liabilities5555
Long-term debt 2420
Shareholders equity 36 30
Total liabilities &
Shareholders equity$115$105
Solution Procedure:
1.Total current liabilities = 25 + 30 = 55
2.Total current assets = 55 ( 1.4 = 77
3.Cash = 55 ( 0.2 = 11
4.Accounts receivable + cash = 55 ( 1.0 = 55
5.Accounts receivable = 55 cash = 55 11 = 44
6.Inventories = 77 11 44 = 22
7.Total assets = Total liabilities and Shareholders equity =
115
8.Net Property, plant, equipment = 115 77 = 38
9.Cost of goods sold = Inventory turnover ( Avg. inventory = 5.0
( (22 + 26)/2 = 120
10.Sales = (365/Collection period) ( Average receivables
= (365/71.2) ( [(44 + 34)/2] = 199.93
11.EBIT = 199.93 120 10 20 = 49.93
12.EBIT tax = ROA ( (Average total assets) = 0.18 ( (115 +
105)/2 = 19.8
13.Tax = 49.93 19.8 = 30.13
14.LT Debt + equity = 115 Current liabilities = 115 55 = 60
15.LT debt = LT debt ratio ( 60 = 0.4 ( 60 = 24
16.Shareholders equity = 60 24 = 36
17.Net income = ROE ( Average equity = 0.41 ( [(36+30)/2] =
13.53
18. Income before tax = 30.13 + 13.53 = 43.66
19. Interest expense = EBIT Income before taxes = 49.93 43.66 =
6.27
Solution to Minicase for Chapter 17
You will find an Excel spreadsheet solution to this minicase at
the Online Learning Center (www.mhhe.com/bmm4e).17-9
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