Home work 5

4.1 Baxley Brothers has a DSO of 23 days, and its annual sales are $3,650,000. What is its
accounts receivable balance? Assume that it uses a 365-day year

𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
We have: 𝐷𝑆𝑂 𝐴𝑛𝑛𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠
= 365

↔ 23 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
= ↔ 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 = $230,000
$3,650,000
365

4.2 Kaye’s Kitchenware has a market/book ratio equal to 1. Its stock price is $12 per share and it has
4.8 million shares outstanding. The firm’s total capital is $110 million and it finances with only
debt and common equity. What is its debt-to-capital ratio?
𝑇𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡
We have: 𝐷𝑒𝑏𝑡 − 𝑡𝑜 − 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑟𝑎𝑡𝑖𝑜 =
𝑇𝑜𝑡𝑎𝑙 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑇𝑜𝑡𝑎𝑙 𝑐𝑎𝑝𝑖𝑡𝑎𝑙−𝐶𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦
= 𝑇𝑜𝑡𝑎𝑙 𝑐𝑎𝑝𝑖𝑡𝑎𝑙

𝐶𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦 = $12 × 4,800,000 = $57,600,000

𝐷𝑒𝑏𝑡 − 𝑡𝑜 − 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑟𝑎𝑡𝑖𝑜 𝑇𝑜𝑡𝑎𝑙 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 − 𝐶𝑜𝑚𝑚𝑜𝑛 $110,000,000 − $57,600,000

= =
𝑒𝑞𝑢𝑖𝑡𝑦 $110,000,000
𝑇𝑜𝑡𝑎𝑙 𝑐𝑎𝑝𝑖𝑡𝑎𝑙
= 47.64%

4.3 Henderson’s Hardware has an ROA of 11%, a 6% profit margin, and an ROE of 23%. What is its
total assets turnover? What is its equity multiplier?
𝑅𝑂𝐸 23%
We have: 𝐸𝑞𝑢𝑖𝑡𝑦 𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 = = = 2.09 times
𝑅𝑂𝐴 11%

𝑅𝑂𝐸 = 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 × 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 × 𝐸𝑞𝑢𝑖𝑡𝑦 𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟

↔ 23% = 6% × 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 × 2.09 → 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 1.83

4.4 Edelman Engines has $17 billion in total assets —of which cash and equivalents total $100
million. Its balance sheet shows $1.7 billion in current liabilities—of which the notes payable
balance totals $1 billion. The firm also has $10.2 billion in long-term debt and $5.1 billion in
common
 equity. It has 300 million shares of common stock outstanding, and its stock price is $20 per
share. The firm’s EBITDA totals $1.368 billion. Assume the firm’s debt is priced at par, so the
market value of its debt equals its book value. What are Edelman’s market/book and its
EV/EBITDA ratios?

𝐶𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦 $5,100,000,000

𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = = $17
= 𝑆ℎ𝑎𝑟𝑒𝑑 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 300,000,000

𝑀𝑎𝑟𝑘𝑒𝑡/𝐵𝑜𝑜𝑘 (𝑀/𝐵) 𝑟𝑎𝑡𝑖𝑜 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 $20

= = = 1.18
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 $17

𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑣𝑎𝑙𝑢𝑒
= 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 + 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡
+ 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑜𝑡ℎ𝑒𝑟 𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝑐𝑙𝑎𝑖𝑚𝑠 − 𝐶𝑎𝑠ℎ 𝑎𝑛𝑑 𝑐𝑎𝑠ℎ 𝑒𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡

𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 = $20 × 300,000,000 = $6,000,000,000

𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡 = $10,200,000,000 + $1,000,000,000 = $11,200,000,000

𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑣𝑎𝑙𝑢𝑒 = $6,000,000,000 + $11,200,000,000 − $100,000,000 = $17,100,000,000

𝐸𝑉/𝐸𝐵𝐼𝑇𝐷𝐴 = 𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑣𝑎𝑙𝑢𝑒 $17,100,000,000

= = 12.5
𝐸𝐵𝐼𝑇𝐷𝐴 $1,368,000,000

4.5 A company has an EPS of $2.40, a book value per share of $21.84, and a market/book ratio of
2.73. What is its P/E ratio?

𝑀𝑎𝑟𝑘𝑒𝑡/𝐵𝑜𝑜𝑘 𝑟𝑎𝑡𝑖𝑜 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
↔ 2.73 =
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 $21.84
↔ 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = $59.62

𝑃𝑟𝑖𝑐𝑒/𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 (𝑃/𝐸) 𝑅𝑎𝑡𝑖𝑜 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 $59.62

= = = $24.84
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 $2.4

4.6 A firm has a profit margin of 3% and an equity multiplier of 1.9. Its sales are $150 million, and it
has total assets of $60 million. What is its ROE?

𝑆𝑎𝑙𝑒𝑠 $150,000,000
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = = = 2.5 𝑡𝑖𝑚𝑒𝑠
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 $60,000,000
𝑅𝑂𝐸 = 𝑃𝑟𝑜𝑓𝑖𝑡 𝑚𝑎𝑟𝑔𝑖𝑛 × 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 × 𝐸𝑞𝑢𝑖𝑡𝑦 𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 = 3% × 2.5 × 1.9 = 0.1425
= 14.25%

4.7 Baker Industries’s net income is $24,000, its interest expense is $5,000, and its tax rate is 40%. Its
notes payable equals $27,000, long-term debt equals $75,000, and common equity equals
$250,000. The firm finances with only debt and common equity, so it has no preferred stock. What
are the firm’s ROE and ROIC?

𝑅𝑂𝐸 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 $24,000

= = = 0.096 = 9.6%
𝐶𝑜𝑚𝑚𝑜𝑛 $250,000
𝐸𝑞𝑢𝑖𝑡𝑦

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 = (𝐸𝐵𝐼𝑇 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒) − [(𝐸𝐵𝐼𝑇 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒) × 40%]

↔ $24,000 = (𝐸𝐵𝐼𝑇 − $5,000) − [(𝐸𝐵𝐼𝑇 − $5,000) × 40%] ↔ 𝐸𝐵𝐼𝑇 = $45,000

𝑇𝑜𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 = 𝑁𝑜𝑡𝑒𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒 + 𝐿𝑜𝑛𝑔 − 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡 + 𝐶𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦
= $27,000 + $75,000 + $250,000 = $352,000

𝑅𝑂𝐼𝐶 𝐸𝐵𝐼𝑇 × (1 − 𝑇) $45,000 × (1 −

= 40%) = 0.0767 = 7.67%
𝑇𝑜𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 =
$352,000

4.8 Precious Metal Mining has $17 million in sales, its ROE is 17%, and its total assets turnover is 3.23.
Common equity on the firm’s balance sheet is 50% of its total assets. What is its net income?

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝑆𝑎𝑙𝑒𝑠 $17,000,000

↔ 3.23 = ↔ 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 = $5,230,769.231
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

𝐶𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦 = $5,230,769.231 × 50% = $2,615,384.62

𝑅𝑂𝐸 𝑁𝑒𝑡 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

= 𝑖𝑛𝑐𝑜𝑚𝑒 × 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
× 𝐶𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦
𝑆𝑎𝑙𝑒𝑠

↔ 17% 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 $5,230,769.231

= × 3.23 × ↔ 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 = $447,368.42
$17,000,000 $2,615,384.62
4.9 Broward Manufacturing recently reported the following information:

Net income $615,000

ROA 10%

Interest expense $202,950

Accounts payable and accruals $950,000

Broward’s tax rate is 30%. Broward finances with only debt and common equity, so it has no preferred
stock. 40% of its total invested capital is debt, and 60% of its total invested capital is common equity.
Calculate its basic earning power (BEP), its return on equity (ROE), and its return on invested capital
(ROIC).

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 $615,000

𝑅𝑂𝐴 ↔ 10% ↔ 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 = $6,150,000
= 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 = 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 = (𝐸𝐵𝐼𝑇 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒) − [(𝐸𝐵𝐼𝑇 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒) × 40%]

↔ $615,000 = (𝐸𝐵𝐼𝑇 − $202,950) − [(𝐸𝐵𝐼𝑇 − $202,950) × 30%] ↔ 𝐸𝐵𝐼𝑇 = $1,081,521.43

𝐵𝑎𝑠𝑖𝑐 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑜𝑤𝑒𝑟 𝐸𝐵𝐼𝑇 $1,081,521.43

= = = 0.1759 = 17.59%
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 $6,150,000

𝑅𝑂𝐸 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 $615,000

= = = 0.1667 = 16.67%
𝐶𝑜𝑚𝑚𝑜𝑛 $6,150,000 × 60%
𝑒𝑞𝑢𝑖𝑡𝑦

𝑅𝑂𝐼𝐶 𝐸𝐵𝐼𝑇 × (1 − 𝑇) 𝐸𝐵𝐼𝑇 × (1 − 𝑇)

= =
𝑇𝑜𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 𝑎𝑛𝑑 𝐴𝑐𝑐𝑟𝑢𝑎𝑙𝑠

$1,081,521.43 × (1 − 30%)
= = 0.1456 = 14.56%
$6,150,000 − $950,000

4.10 You are given the following information: Stockholders’ equity as reported on the firm’s
balance sheet = $6.5 billion, price ∕ earnings ratio = 9, common shares outstanding = 180 million,
and market/book ratio = 2.0. The firm’s market value of total debt is $7 billion, the firm has cash
and equivalents totaling $250 million, and the firm’s EBITDA equals $2 billion. What is the price of
a share of the company’s common stock? What is the firm’s EV/EBITDA?
 𝑀𝑎𝑟𝑘𝑒𝑡/𝐵𝑜𝑜𝑘 𝑟𝑎𝑡𝑖𝑜 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
𝑒𝑞𝑢𝑖𝑡𝑦 ↔2
= $6,500,000,000
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦
↔ 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 = $13,000,000,000

𝑆ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 $13,000,000,000

= = = $72.22
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 180,000,000

𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑣𝑎𝑙𝑢𝑒
= 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 + 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡
+ 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑜𝑡ℎ𝑒𝑟 𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝑐𝑙𝑎𝑖𝑚𝑠 − 𝐶𝑎𝑠ℎ 𝑎𝑛𝑑 𝑐𝑎𝑠ℎ 𝑒𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡

= $13,000,000,000 + $7,000,000,000 − $250,000,000 = $19,750,000,000

𝐸𝑉/𝐸𝐵𝐼𝑇𝐷𝐴 = 𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑣𝑎𝑙𝑢𝑒 $19,750,000,000

= = 9.875
𝐸𝐵𝐼𝑇𝐷𝐴 $2,000,000,000

4.11 Assume the following relationships for the Caulder Corp.:

Sales/Total assets 1.33

Return on assets (ROA) 4.0%

Return on equity (ROE) 8.0%

Calculate Caulder’s profit margin and debt-to-capital ratio assuming the firm uses only debt and
common equity, so total assets equal total invested capital.

We have: 𝑅𝑂𝐴 = 𝑃𝑟𝑜𝑓𝑖𝑡 𝑚𝑎𝑟𝑔𝑖𝑛 × 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 ↔ 4.0% = 𝑃𝑟𝑜𝑓𝑖𝑡 𝑚𝑎𝑟𝑔𝑖𝑛 × 1.33

↔ 𝑃𝑟𝑜𝑓𝑖𝑡 𝑚𝑎𝑟𝑔𝑖𝑛 = 0.03 = 3%

𝑅𝑂𝐸 = 𝑅𝑂𝐴 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

× ↔ 8.0% = 4.0%
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑚𝑚𝑜𝑛 × 𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦
𝑒𝑞𝑢𝑖𝑡𝑦
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
↔ =2
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦

𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑚𝑚𝑜𝑛 1 1
𝑒𝑞𝑢𝑖𝑡𝑦 = → 𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑚𝑚𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦 = × 𝑇𝑜𝑡𝑎𝑙
→ 2 𝑎𝑠𝑠𝑒𝑡𝑠 2
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
𝐷𝑒𝑏𝑡 − 𝑡𝑜 − 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑟𝑎𝑡𝑖𝑜 𝑇𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡
= = 50%
𝑇𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡 + 𝑇𝑜𝑡𝑎𝑙 𝑒𝑞𝑢𝑖𝑡𝑦
4.12 Thomson Trucking has $16 billion in assets, and its tax rate is 40%. Its basic earning
power (BEP) ratio is 10%, and its return on assets (ROA) is 5%. What is its times-interest-
earned (TIE) ratio?

𝐸𝐵𝐼𝑇 𝐸𝐵𝐼𝑇
𝐵𝐸𝑃 ↔ 10% ↔ 𝐸𝐵𝐼𝑇 = $1,600,000,000
= 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 = $16,000,000,000

𝑅𝑂𝐴 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒

= ↔ 5% ↔ 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 = $800,000,000
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 = $16,000,000,000

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 = 𝐸𝐵𝑇 × (1 − 𝑇) ↔ $800,000,000 = 𝐸𝐵𝑇 × (1 − 40%) ↔ 𝐸𝐵𝑇 = $1,333,333,333

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 = 𝐸𝐵𝐼𝑇 − 𝐸𝐵𝑇 = $1,600,000,000 − $1,333,333,333 = $266,666,667

𝑇𝑖𝑚𝑒 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝐸𝑎𝑟𝑛𝑒𝑑 𝑟𝑎𝑡𝑖𝑜 𝐸𝐵𝐼𝑇 $1,600,000,000

= = = 5.9%
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 $266,666,667

4.13 The W.C. Pruett Corp. has $600,000 of interest-bearing debt outstanding, and it pays an
annual interest rate of 7%. In addition, it has $600,000 of common stock on its balance sheet. It
finances with only debt and common equity, so it has no preferred stock. Its annual sales are $2.7
million, its average tax rate is 35%, and its profit margin is 7%. What are its TIE ratio and its
return on invested capital (ROIC)?

𝐴𝑛𝑛𝑢𝑎𝑙 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 = 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐷𝑒𝑏𝑡 × 𝐴𝑛𝑛𝑢𝑎𝑙 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒 = $600,000 × 7% =

$42,000

𝑃𝑟𝑜𝑓𝑖𝑡 𝑚𝑎𝑟𝑔𝑖𝑛 𝑁𝑒𝑡 𝑁𝑒𝑡

= 𝑖𝑛𝑐𝑜𝑚𝑒 ↔ 7% 𝑖𝑛𝑐𝑜𝑚𝑒 ↔ 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 = $189,000
=
𝑆𝑎𝑙𝑒𝑠 $2,700,000

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 = 𝐸𝐵𝑇 × (1 − 𝑇) ↔ $189,000 = 𝐸𝐵𝑇 × (1 − 35%) ↔ 𝐸𝐵𝑇 = $290,769.23

𝐸𝐵𝐼𝑇 = 𝐸𝐵𝑇 + 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 = $290,769.23 + $42,000 = $332,769.23

𝑇𝑖𝑚𝑒 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝐸𝑎𝑟𝑛𝑒𝑑 𝑟𝑎𝑡𝑖𝑜 𝐸𝐵𝐼𝑇 $332,769.23

= = = 7.92
𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 $42,000

𝑅𝑂𝐼𝐶 𝐸𝐵𝐼𝑇 × (1 − 𝑇) $332,769.23 × (1 −

= = = 0.1801 = 18.02%
𝐷𝑒𝑏𝑡 + 𝐸𝑞𝑢𝑖𝑡𝑦 35%)
$600,000 + $600,000
4.14 Pacific Packaging’s ROE last year was only 5%, but its management has developed a new
operating plan that calls for a debt-to-capital ratio of 40%, which will result in annual interest
charges of $561,000. The firm has no plans to use preferred stock and total assets equal total
invested capital. Management projects an EBIT of $1,258,000 on sales of $17,000,000, and it
expects to have a total assets turnover ratio of 2.1. Under these conditions, the tax rate will
be 35%. If the changes are made, what will be the company’s return on equity?

𝐸𝐵𝑇 = 𝐸𝐵𝐼𝑇 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 = $1,258,000 − $561,000 = $697,000

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 = 𝐸𝐵𝑇 × (1 − 𝑇) = $697,000 × (1 − 35%) = $435,050

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝑆𝑎𝑙𝑒𝑠 $17,000,000

↔ 2.1 ↔ 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 = $8,095,238.09
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

We have: 𝐷𝑒𝑏𝑡
= 0.4
𝐶𝑎𝑝𝑖𝑡𝑎𝑙

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝑇𝑜𝑡𝑎𝑙 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 = 𝐷𝑒𝑏𝑡 + 𝐸𝑞𝑢𝑖𝑡𝑦

𝐷𝑒𝑏𝑡 = 0.4 × $8,095,238.09 = $3,238,095.24

𝐸𝑞𝑢𝑖𝑡𝑦 = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐷𝑒𝑏𝑡 = $8,095,238.09 − $3,238,095.24 = $4,857,142.85

𝑅𝑂𝐸 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 $435,050

= = = 0.0896 = 8.96%
𝐶𝑜𝑚𝑚𝑜𝑛 $4,857,142.85
𝐸𝑞𝑢𝑖𝑡𝑦

4.25 The Corrigan Corporation’s 2017 and 2018 financial statements follow, along with some
industry average ratios.
a) Assess Corrigan’s liquidity position, and determine how it compares with peers and how the
liquidity position has changed over time.
b) Assess Corrigan’s asset management position, and determine how it compares with peers and
how its asset management efficiency has changed over time.
c) Assess Corrigan’s debt management position, and determine how it compares with peers and
how its debt management has changed over time.
d) Assess Corrigan’s profitability ratios, and determine how they compare with peers and how its
profitability position has changed over time.
e) Assess Corrigan’s market value ratios, and determine how its valuation compares with peers
and how it has changed over time. Assume the firm’s debt is priced at par, so the market
value of its debt equals its book value.
f) Calculate Corrigan’s ROE as well as the industry average ROE, using the DuPont equation.
From this analysis, how does Corrigan’s financial position compare with the industry average
numbers?
g) What do you think would happen to its ratios if the company initiated cost-cutting measures
that allowed it to hold lower levels of inventory and substantially decreased the cost of goods
sold? No calculations are necessary. Think about which ratios would be affected by changes in
these two accounts.