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Exam 4: Analysis of Financial Statements

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Question 1

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Profitability ratios show the combined effects of liquidity,asset management,and debt management on a firm's operating results.

A) True
B) False

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True

Question 2

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Suppose you are analyzing two firms in the same industry.Firm A has a profit margin of 10% versus a margin of 8% for Firm B.Firm A's total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is 70% versus 20% for Firm B.Based only on these two facts,you cannot reach a conclusion as to which firm is better managed,because the difference in debt,not better management,could be the cause of Firm A's higher profit margin.

A) True
B) False

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Question 3

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The return on common equity (ROE)is generally regarded as being less significant,from a stockholder's viewpoint,than the return on total assets (ROA).

The market/book (M/B)ratio tells us how much investors are willing to pay for a dollar of accounting book value.In general,investors regard companies with higher M/B ratios as less risky and/or more likely to enjoy higher growth in the future.

Song Corp's stock price at the end of last year was $28.75 and its earnings per share for the year were $1.30.What was its P/E ratio?

Other things held constant,the more debt a firm uses,the lower the firm's profit margin will be.

The more conservative a firm's management is,the higher the firm's total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is likely to be.

Last year Jandik Corp.had $295,000 of assets (which is equal to its total invested capital) ,$18,750 of net income,and a debt-to-total-capital ratio of 37%.Now suppose the new CFO convinces the president to increase the debt-to-total-capital ratio to 48%.Sales,total assets and total invested capital will not be affected,but interest expenses would increase.However,the CFO believes that better cost controls would be sufficient to offset the higher interest expense and thus keep net income unchanged.By how much would the change in the capital structure improve the ROE? Do not round your intermediate calculations.

Brookman Inc's latest EPS was $2.75,its book value per share was $22.75,it had 275,000 shares outstanding,and its debt/total invested capital ratio was 44%.The firm finances using only debt and common equity,and its total assets equal total invested capital.How much debt was outstanding? Do not round your intermediate calculations.

Quigley Inc.is considering two financial plans for the coming year.Management expects sales to be $300,000,operating costs to be $265,000,assets (which is equal to its total invested capital) to be $200,000,and its tax rate to be 35%.Under Plan A it would finance the firm using 25% debt and 75% common equity.The interest rate on the debt would be 8.8%,but under a contract with existing bondholders the TIE ratio would have to be maintained at or above 5.5.Under Plan B,the maximum debt that met the TIE constraint would be employed.Assuming that sales,operating costs,assets,total invested capital,the interest rate,and the tax rate would all remain constant,by how much would the ROE change in response to the change in the capital structure? Do not round your intermediate calculations.

Which of the following statements is CORRECT?

The advantage of the basic earning power ratio (BEP)over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes.

Exhibit 4.1 The balance sheet and income statement shown below are for Koski Inc.Note that the firm has no amortization charges,it does not lease any assets,none of its debt must be retired during the next 5 years,and the notes payable will be rolled over. $\begin{array}{lc}\text { Assets } & 2018 \\\text { Cash and securities } & \$ 3,000 \\\text { Accounts receivable } & 15,000 \\\text { Inventories } & 18,000 \\\text { Total current assets } & \$ 36,000 \\\text { Net plant and equipment } & \$ 24,000 \\\text { Total assets } & \$ 60,000\\\text { Liabilities and Equity }\\\text { Accounts payable } & \$ 18,630 \\\text { Accruals } & 8,370 \\\text { Notes payable } & 6,000 \\\text { Total current liabilities } & \$ 33,000\\\\\text { Long-term bonds } & \$ 9,000 \\\text { Total liabilities } & \$ 42,000 \\\text { Common stock } & \$ 5,040 \\\text { Retained earnings } & 12,960 \\\text { Total common equity } & \$ 18,000\\\text { Total liabilities and equity }&\$60,000\end{array}$ $\begin{array}{lr}\text { Income Statement (Millions of } \$ \text { ) } & {2018} \\ \text { Net sales } & \$ 84,000 \\\text { Operating costs except depreciation } & 78,120 \\\text { Depreciation } & 1,680 \\\text { Earnings before interest and taxes (EBIT) } & \$ 4,200 \\\text { Less interest } & 900\\\text { Earnings before taxes (EBT) } &{\$ 3,300} \\\text { Taxes } & 1,320 \\\text { Net income } & \$ 1,980\\\\\text { Other data: }\\\text { Shares outstanding (millions) } & 500.00 \\\text { Common dividends (millions of } \$ \text { ) } & \$ 693.00 \\\text { Int rate on notes payable \& L-T bonds } & 6 \% \\\text { Federal plus state income tax rate } & 40 \% \\\text { Year-end stock price } & \$ 47.52\end{array}$ -Refer to Exhibit 4.1.What is the firm's operating margin? Do not round your intermediate calculations.

Exhibit 4.1 The balance sheet and income statement shown below are for Koski Inc.Note that the firm has no amortization charges,it does not lease any assets,none of its debt must be retired during the next 5 years,and the notes payable will be rolled over. $\begin{array}{lc}\text { Assets } & 2018 \\\text { Cash and securities } & \$ 3,000 \\\text { Accounts receivable } & 15,000 \\\text { Inventories } & 18,000 \\\text { Total current assets } & \$ 36,000 \\\text { Net plant and equipment } & \$ 24,000 \\\text { Total assets } & \$ 60,000\\\text { Liabilities and Equity }\\\text { Accounts payable } & \$ 18,630 \\\text { Accruals } & 8,370 \\\text { Notes payable } & 6,000 \\\text { Total current liabilities } & \$ 33,000\\\\\text { Long-term bonds } & \$ 9,000 \\\text { Total liabilities } & \$ 42,000 \\\text { Common stock } & \$ 5,040 \\\text { Retained earnings } & 12,960 \\\text { Total common equity } & \$ 18,000\\\text { Total liabilities and equity }&\$60,000\end{array}$ $\begin{array}{lr}\text { Income Statement (Millions of } \$ \text { ) } & {2018} \\ \text { Net sales } & \$ 84,000 \\\text { Operating costs except depreciation } & 78,120 \\\text { Depreciation } & 1,680 \\\text { Earnings before interest and taxes (EBIT) } & \$ 4,200 \\\text { Less interest } & 900\\\text { Earnings before taxes (EBT) } &{\$ 3,300} \\\text { Taxes } & 1,320 \\\text { Net income } & \$ 1,980\\\\\text { Other data: }\\\text { Shares outstanding (millions) } & 500.00 \\\text { Common dividends (millions of } \$ \text { ) } & \$ 693.00 \\\text { Int rate on notes payable \& L-T bonds } & 6 \% \\\text { Federal plus state income tax rate } & 40 \% \\\text { Year-end stock price } & \$ 47.52\end{array}$ -Refer to Exhibit 4.1.What is the firm's BEP? Do not round your intermediate calculations.

Han Corp's sales last year were $440,000,and its year-end receivables were $52,500.The firm sells on terms that call for customers to pay 30 days after the purchase,but some delay payment beyond Day 30.On average,how many days late do customers pay? Base your answer on this equation: DSO - Allowed credit period = Average days late,and use a 365-day year when calculating the DSO.Assume all sales to be on credit.Do not round your intermediate calculations.

River Corp's total assets at the end of last year were $390,000 and its net income was $32,750.What was its return on total assets?

Royce Corp's sales last year were $250,000,and its net income was $23,000.What was its profit margin?

Which of the following statements is CORRECT?

The return on invested capital measures the total return that a company has provided for its investors.

If a firm sold some inventory on credit,its current ratio would probably not change much,but its quick ratio would increase.