FUNDAMENTALS REVIEW 14.11.

23
 Financial Statement Analysis
1. As a short-term creditor concerned with a company's ability to meet its financial obligation to
you, which one of the following combinations of ratios would you most likely prefer?
Current Debt
ratio TIE ratio
a. 0.5 0.5 0.33
b. 1.0 1.0 0.50
c. 1.5 1.5 0.50
d. 2.0 1.0 0.67
e. 2.5 0.5 0.71
FSA
• A firm has a profit margin of 15 percent on sales of $20,000,000. If
the firm has debt of $7,500,000, total assets of $22,500,000, and an
after-tax interest cost on total debt of 5 percent, what is the firm's
ROA?

• Net income = 0.15($20,000,000) = $3,000,000.

• ROA = $3,000,000/$22,500,000 = 13.3%.
• 34. Alumbat Corporation has $800,000 of debt outstanding, and it pays an interest
rate of 10 percent annually on its bank loan. Alumbat's annual sales are $3,200,000;
its average tax rate is 40 percent; and its net profit margin on sales is 6 percent. If the
company does not maintain a TIE ratio of at least 4 times, its bank will refuse to renew
its loan, and bankruptcy will result. What is Alumbat's current TIE ratio?
• TIE = EBIT/I, so find EBIT and I.
• Interest = $800,000  0.1 = $80,000.
• Net income = $3,200,000  0.06 = $192,000.
• Taxable income = EBT = $192,000/(1 – T) = $192,000/0.6 = $320,000.
• EBIT = $320,000 + $80,000 = $400,000.
• TIE = $400,000/$80,000 = 5.0 times.
• 38. Selzer Inc. sells all its merchandise on credit. It has a profit margin of 4 percent, days
sales outstanding equal to 60 days, receivables of $150,000, total assets of $3 million, and a
debt ratio of 0.64. What is the firm's return on equity (ROE)?
• (Sales per day)(DSO) = A/R
• (Sales/360)(60) = $150,000
• Sales = $900,000.
• Profit margin = Net profit after tax/Sales.
• Net profit = 0.4($900,000) = $36,000.
• Debt ratio = 0.64 = Total debt/$3,000,000.
• Total debt = $1,920,000.
• Total equity = $3,000,000 – $1,920,000 = $1,080,000.
• ROE = $36,000/$1,080,000 = 3.3%.
• Cannon Company has enjoyed a rapid increase in sales in recent years, following a decision to sell
on credit. However, the firm has noticed a recent increase in its collection period. Last year, total
sales were $1 million, and $250,000 of these sales were on credit. During the year, the accounts
receivable account averaged $41,664. It is expected that sales will increase in the forthcoming
year by 50 percent, and, while credit sales should continue to be the same proportion of total
sales, it is expected that the days sales outstanding will also increase by 50 percent. If the
resulting increase in accounts receivable must be financed by external funds, how much external
funding will Cannon need?
• DSO = ($41,664/$250,000)/360 = 60 days.
• New A/R = (($250,000)(1.5)/(360))(60)(1.5) = $93,750.
• DSO (ACP)=60*1.5=90 days
• Credit sales= 250*1.5=375
• AR= (375/360) *90= 93,750
• Hence, increase in receivables = $93,750 – $41,664 = $52,086.
The Meryl Corporation's common stock currently is selling at $100 per share, which represents a P/E ratio of
10. If the firm has 100 shares of common stock outstanding, a return on equity of 20 percent, and a debt ratio of
60 percent, what is its return on total assets (ROA)?

• P/E = 10 = $100/EPS
• EPS = $100/10 = $10.
• Earnings = NI = $10(100 shares) = $1,000.
• ROE = NI/Equity = $1,000/Equity = 20%
• Equity = $1,000/0.20 = $5,000.
• Debt ratio = 60%, so Equity ratio = 40% = Equity/TA
• TA = Equity/0.40 = $5,000/0.40 = $12,500.
• ROA = NI/TA = $1,000/$12,500 = 0.08 = 8%.
• Lloyd Inc. has sales of $200,000, a net income of $15,000, and the following balance sheet:
• Cash 10,000 Accounts payable 30,000
• Receivables 50,000 Other current liabilities 20,000
• Inventories 150,000 Long term debt 50,000
• Net fixed assets 90,000 Common equity 200,000
• Total assets 300,000 Total liabilities & equity 300,000
•
• The new owner thinks that inventories are excessive and can be lowered to the point where
the current ratio is equal to the industry average, 2.5X, without affecting either sales or net
income. If inventories are sold off and not replaced thus reducing the current ratio to 2.5X,
and if the funds generated are used to reduce common equity (stock can be repurchased at
book value) and if no other changes occur, by how much will the ROE change? What will be
the firm’s new quick ratio?
•
• 1. Below data, belongs to Datashow company:
• 2009 2010 sources uses
• Cash & M.Securities 57,600 52,000 5600
• Acc. Receivable 351,200 402,000 50800
• Inventories 715,200 836,000 120800
• Total C.A. 1,124,000 1,290,000
• Gross F.A. 491,000 527,000 36000
• -Accumulated depr. 146,200 166,200 20000
• Net Fixed Assets 344,800 360,800
• Total Assets 1,468,800 1,650,800
• Accounts payable 145,600 175,200 29600
• ST bank debt 200,000 225,000 25000
• Accuals 136,000 140,000 4000
• Total C.L. 481,600 540,200
• LT debt 323,432 424,612 101180
• C. stock 460,000 460,000 0
• Retained earnings 203,768 225,988
• Total Laibilities& Eq. 1,468,800 1,650,800
• Net Income: 44,220 Dividends: 22,000
• Please prepare a cash flow statement for Datashow.
CASH FLOW STATEMENT

I- CASH FROM OPERATING ACTIVITIES (73,780)

Net İncome 44,220

Depreciation 20,000

Sources of cash: 33,600

Increase in AP 29600

Increase in accruals 4,000

Uses of cash (171,600)

Increase in AR (50,800)

Increase in inv. (120,800)

II. CASH FROM INVESTMENTS (36,000)

FA acquisitions (36,000)

III- CASH FROM FINANCING 104,180

Increase in ST bank credit 25,000

Increase in LT debt 101,180

Dividends paid (22,000)

NET CASH POSITION

I- (73780)

II-(36,000)

III-104,180

(5600)

5600 Decline in cash & MS

0
Complete the balance sheet and sales information that follows using the following financial
data:
Debt ratio: 50%
Current ratio: 1.8X
Total asset turnover: 1.5X
Average collection period: 36.5 days
Gross margin on sales: 25%
Inventory turnover: 5X
Balance Sheet
Cash ………. Accounts payable ……..
AR ………. LT debt 60,000
Inventory ………. Common stock ………
Fixed assets ………. Retained earnings 97,500
TA 300,000 TL + Equity ………
Sales ……….. CGS ………
• The probability distributions of stocks R and S, are given below:
• Prob. Stock R (%) Stock S(%)
0.5 -2 20
0.1 10 12
0.4 15 2
a. Please find mean standard deviation for returns of R and S.
b. Please find the mean and standard deviation for the return of the
portfolio consisting of 50% of each stock.
c. Would you invest in R, or S or the portfolio? Support your decision with
coefficient of variation calculation.
RISK WITH CAPM
• Suppose you are the money manager of a $4 mıllıon ınvestment
fund. The fund consısts of four stocks for whıch the followıng data ıs
presented:
• Stock ınvestment exp. Return% beta req. return%
• A 400,000 20 1.50
• B 600,000 5 -0.50
• C 1,000,000 14 1.25
• D 2,000,000 10 0.75
• Rm=14% RF=6%
• Required return for ındıvıdual stocks, for the fund, whıch stock to keep/sell,
ınvest ın the fund?
RISK & STANDARD DEVIATION
• 41. Assume that a new law is passed which restricts investors to holding only one asset. A risk-
averse investor is considering two possible assets as the asset to be held in isolation. The assets'
possible returns and related probabilities (i.e., the probability distributions) are as follows:

• Asset X Asset Y
• Pr r Pr r
• 0.10 -3% 0.05 -3%
• 0.10 2 0.10 2
• 0.25 5 0.30 5
• 0.25 8 0.30 8
• 0.30 10 0.25 10
• Which asset should be preferred?
= 0.10 (-3%) + 0.10 (2%) + 0.25 (5%) + 0.25 (8%) + 0.30 (10%) = 6.15%
= 0.05 (-3%) + 0.10 (2%) + 0.30 (5%) + 0.30 (8%) + 0.25 (10%) = 6.45%

= 0.10 (-3% - 6.15%)2 + 0.10 (2% - 6.15%)2 + 0.25 (5% - 6.15%)2 + 0.25 (8% - 6.15%)2
+ 0.30 (10% - 6.15%)2
=15.73; = 3.97.

= 3.97/6.15 = 0.645.
 = 0.05 (-3 - 6.45%)2 + 0.10 (2% - 6.45%)2 + 0.30 (5% - 6.45%)2 + 0.30 (8% - 6.45)2
+ 0.25 (10% - 6.45%)2
= 10.95; = 3.31.

= 3.31/6.45 = 0.513.
Therefore, Asset Y has a higher expected return and lower coefficient of variation and hence
it would be preferred.