Chapter 3, Solutions

Cornett, Adair, and Nofsinger

CHAPTER 3 ANALYZING FINANCIAL STATEMENTS Questions LG1-LG5 1. Classify each of the following ratios according to a ratio category (liquidity ratio, asset anage ent ratio, de!t anage ent ratio, profita!ility ratio, or ar"et #alue ratio$. a. Current ratio % liquidity ratio !. &n#entory turno#er ratio % asset anage ent ratio c. 'eturn on assets % profita!ility ratio d. (ccounts paya!le period % asset anage ent ratio e. )i es interest earned % de!t anage ent ratio f. Capital intensity ratio % asset anage ent ratio g. *quity ultiplier % de!t anage ent ratio h. +asic earnings power ratio % profita!ility ratio LG1 ,. -or each of the actions listed !elow, deter ine what would happen to the current ratio. (ssu e nothing else on the !alance sheet changes and that net wor"ing capital is positi#e. a. (ccounts recei#a!le are paid in cash % Current ratio does not change !. .otes paya!le are paid off with cash % Current ratio increases c. &n#entory is sold on account % Current ratio does not change d. &n#entory is purchased on account% Current ratio decreases e. (ccrued wages and ta/es increase % Current ratio decrease f. Long-ter de!t is paid with cash % Current ratio decreases g. Cash fro a short-ter !an" loan is recei#ed % Current ratio decreases LG1-LG5 3. */plain the eaning and significance of the following ratios

a. 0uic" ratio - &n#entories are generally the least liquid of a fir 1s current assets. -urther, in#entory is the current asset for which !oo" #alues are the least relia!le easures of ar"et #alue. &n practical ter s, what this eans is that if the fir ust sell in#entory to pay upco ing !ills, the fir is ost li"ely to ha#e to discount in#entory ite s in order to liquidate the , and so therefore they are the assets on which losses are ost li"ely to occur. )herefore, the quic" (or acid-test$ ratio easures a fir 1s a!ility to pay off short-ter o!ligations without relying on in#entory sales. )he quic" ratio easures the dollars of ore liquid assets (cash and ar"eta!le securities and accounts recei#a!le$ a#aila!le to pay each dollar of current lia!ilities. !. (#erage collection period - )he a#erage collection period ((C2$ easures the nu !er of days accounts recei#a!le are held !efore the fir collects cash fro the sale. &n general, a fir wants to produce a high le#el of sales per dollar of accounts recei#a!le, i.e., it wants to collect its accounts recei#a!le as quic"ly as possi!le to reduce any cost of financing in#entories and accounts recei#a!le, including interest e/pense on lia!ilities used to finance in#entories and accounts recei#a!le, and defaults associated with accounts recei#a!le.

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

c. 'eturn on equity - 'eturn on equity ('3*$ easures the return on the co on stoc"holders1 in#est ent in the assets of the fir . '3* is the net inco e earned per dollar of co on stoc"holders1 equity. )he #alue of a fir 1s '3* is affected not only !y net inco e, !ut also !y the a ount of financial le#erage or de!t that fir uses. d. 4ays1 sales in in#entory - . )he days sa es in in!ento"y ratio easures the nu !er of days that in#entory is held !efore the final product is sold. &n general, a fir wants to produce a high le#el of sales per dollar of in#entory, that is, it wants to turn in#entory o#er (fro raw aterials to finished goods to sold goods$ as quic"ly as possi!le. ( high le#el of sales per dollar of in#entory i plies reduced warehousing, onitoring, insurance, and any other costs of ser#icing the in#entory. So, a high in#entory turno#er ratio or a low days1 sales in in#entory is a sign of good anage ent. e. 4e!t ratio - )he de!t ratio easures the percentage of total assets financed with de!t. )he de!t-to-equity ratio easures the dollars of de!t financing used for e#ery dollar of equity financing. )he equity ultiplier ratio easures the dollars of assets on the !alance sheet for e#ery dollar of equity financing. (s you ight suspect, all three easures are related. So, the lower the de!t, de!t-to-equity, or equity ultiplier ratios, the less de!t and ore equity the fir uses to finance its assets (i.e., the !igger the fir 1s equity cushion$. f. 2rofit argin - )he profit argin is the percent of sales left after all fir e/penses are paid.

g. (ccounts paya!le turno#er - )he accounts paya!le turno#er ratio easures the dollar cost of goods sold per dollar of accounts paya!le. &n general, a fir wants to pay for its purchases as slowly as possi!le. )he ore slowly it can pay for its supply purchases, the less the fir will need other costly sources of financing such as notes paya!le or long-ter de!t. )hus, a high (22 or a low accounts paya!le turno#er ratio is generally a sign of good anage ent. h. 5ar"et-to-!oo" ratio - )he ar"et-to-!oo" ratio co pares the ar"et (current$ #alue of the fir 1s equity to their historical costs. &n general, the higher the ar"et-to-!oo" ratio, the !etter the fir . LG, 6. ( fir has an a#erage collection period of 17 days. )he industry a#erage (C2 is ,5 days. &s this a good or poor sign a!out the anage ent of the fir 1s accounts recei#a!le8 &f the (C2 is e/tre ely low, the fir 1s accounts recei#a!le policy ay !e so strict that custo ers prefer to do !usiness with co peting fir s. -ir s offer accounts recei#a!le ter s as an incenti#e to get custo ers to !uy products fro their fir rather than a co peting fir . +y offering fir custo ers the accounts recei#a!le pri#ilege, anage ent allows custo ers to !uy ( ore$ now and pay later. 9ithout this incenti#e, that is, if anagers require custo ers to pay for their purchases #ery quic"ly, custo ers ay chose to !uy the goods fro the fir 1s co petitors who offer !etter credit ter s. So e/tre ely low (C2 le#els ay !e a sign of !ad fir anage ent. LG3 5. ( fir has a de!t ratio of ,7:. )he industry a#erage de!t ratio is ;5:. &s this a good or poor sign a!out the anage ent of the fir 1s financial le#erage8 9hen a fir issues de!t to finance its assets, it gi#es the de!tholders first clai to a fi/ed a ount of its cash flows. Stoc"holders are entitled to any residual cash flows<those left after

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

de!tholders are paid. 9hen a fir does well, financial le#erage increases the reward to shareholders since the a ount of cash flows pro ised to de!tholders is constant and capped. So when fir s do well, financial le#erage creates ore cash flows to share with stoc"holders=it agnifies the return to the stoc"holders of the fir . )his agnification is one reason that fir stoc"holders encourage the use of de!t financing. >owe#er, financial le#erage also increases the fir 1s potential for financial distress and e#en failure. &f the fir has a !ad year and can not a"e pro ised de!t pay ents, de!tholders can force the fir into !an"ruptcy. )hus, a fir 1s current and potential de!tholders (and e#en stoc"holders$ loo" at equity financing as a safety cushion that can a!sor! fluctuations in the fir 1s earnings and asset #alues and guarantee de!t ser#ice pay ents. Clearly, the larger the fluctuations or #aria!ility of a fir 1s cash flows, the greater the need for an equity cushion. 5anagers1 choice of capital structure<the a ount of de!t #ersus equity to issue<affects the fir 1s #ia!ility as a long-ter entity. &n deciding the le#el of de!t #ersus equity financing to hold on the !alance sheet, anagers ust consider the trade-off !etween a/i i?ing cash flows to the fir 1s stoc"holders #ersus the ris" of !eing una!le to a"e pro ised de!t pay ents. LG6 ;. ( fir has an '3* of ,7:. )he industry a#erage '3* is 1,:. &s this a good or poor sign a!out the anage ent of the fir 8 Generally, a high '3* is considered to !e a positi#e sign of fir perfor ance. >owe#er, if perfor ance co es fro a high degree of financial le#erage, a high '3* can indicate a fir with an unaccepta!ly high le#el of !an"ruptcy ris" as well. LG; @. 9hy is the 4u2ont syste of analysis an i portant tool when e#aluating fir perfor ance8

5any of the ratios discussed in the chapter are interrelated. So a change in one ratio ay well affect the #alue of se#eral ratios. 3ften these interrelations can help e#aluate fir perfor ance. 5anagers and in#estors often perfor a detailed analysis of '3( ('eturn on (ssets$ and '3* ('eturn on *quity$ using the 4u2ont analysis syste . 2opulari?ed !y the 4u2ont Corporation, the 4u2ont analysis syste uses the !alance sheet and inco e state ent to !rea" the '3( and '3* ratios into co ponent pieces. LG; A. ( fir has an '3* of 17:. )he industry a#erage '3* is 15:. >ow can the 4u2ont syste analysis help the fir 1s anagers identify the reasons for this difference8 of

)he !asic 4u2ont equation loo"s at the fir 1s o#erall profita!ility as a function of the profit the fir earns per dollar of sales (operating efficiency$ and the dollar of sales produced per dollar of assets on the !alance sheet (efficiency in asset use$. 9ith this tool, anagers can see the reason for any changes in '3( in ore detail. -or e/a ple, if '3( increases, the 4u2ont equation ay show that the net profit argin was constant, !ut the total asset turno#er (efficiency in using assets$ increased, or that total asset turno#er re ained constant, !ut profit argins (operating efficiency$ increased. 5anagers can then !rea" down operating efficiency and efficiency in asset use further using the ratios descri!ed a!o#e to ore specifically identify the reasons for an '3( change. LG; B. 9hat is the difference !etween the internal growth rate and the sustaina!le growth rate8

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

)he internal growth rate is the growth rate a fir can sustain if it uses only internal financing=that is, retained earnings=to finance future growth. ( pro!le arises when a fir relies only on internal financing to support asset growthC )hrough ti e, its de!t ratio will fall !ecause as asset #alues grow, total de!t stays constant=only retained earnings finance asset growth. &f total de!t re ains constant, as assets grow the de!t ratio decreases. (s we noted a!o#e shareholders often !eco e disgruntled if, as the fir grows, a decreasing de!t ratio (increasing equity financing$ dilutes their return. So as fir s grow, anagers ust often try to aintain a de!t ratio that they #iew as opti al. &n this case, anagers finance asset growth with new de!t and retained earnings. )he a/i u growth rate that can !e achie#ed this way is the sustaina!le growth rate. LG@ 17. 9hat is the difference !etween ti e series analysis and cross-sectional analysis8 )i e series analysis e#aluates the perfor ance of the fir o#er ti e. Cross-sectional analysis e#aluates the perfor ance of the fir against one or ore co panies in the sa e industry. LG@ 11. 9hat infor ation does ti e series and cross-sectional analysis pro#ide for fir analysts, and in#estors8 anagers,

(naly?ing ratio trends o#er ti e, along with a!solute ratio le#els, gi#es anagers, analysts, and in#estors infor ation a!out whether a fir 1s financial condition is i pro#ing or deteriorating. -or e/a ple, ratio analysis ay re#eal that the days1 sales in in#entory is increasing. )his suggests that in#entories, relati#e to the sales they support, are not !eing used as well as they were in the past. &f this increase is the result of a deli!erate policy to increase in#entories to offer custo ers a wider choice and if it results in higher future sales #olu es or increased argins that ore than co pensate for increased capital tied up in in#entory, the increased relati#e si?e of the in#entories is good for the fir . 5anagers and in#estors should !e concerned, on the other hand, if increased in#entories result fro declining sales !ut steady purchases of supplies and production. Loo"ing at one fir 1s financial ratios, e#en through ti e, gi#e anagers, analysts, and in#estors only a li ited picture of fir perfor ance. 'atio analysis al ost always includes a co parison of one fir 1s ratios relati#e to the ratios of other fir s in the industry, or cross-sectional analysis. Dey to cross-sectional analysis is identifying si ilar fir s in that they co pete in the sa e ar"ets, ha#e si ilar assets si?es, and operate in a si ilar anner to the fir !eing analy?ed. Since no two fir s are identical, o!taining such a co parison group is no easy tas". )hus, the choice of co panies to use in cross-sectional analysis is at !est su!Eecti#e. LGA 1,. 9hy is it i portant to "now a fir 1s accounting rules !efore its perfor ance fro ratios analysis8 a"ing any conclusions a!out

-ir s use different accounting procedures. -or e/a ple, in#entory ethods can #ary. 3ne fir ay use -&-3 (first-in, first-out$, transferring in#entory at the first purchase price, while another uses L&-3 (last-in, first-out$, transferring in#entory at the last purchase price. Li"ewise, the depreciation ethod used to #alue a fir 1s fi/ed assets o#er ti e ay #ary across fir s. 3ne fir ay use straight-line depreciation while another ay use an accelerated depreciation

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

ethod (e.g., 5(C'S$. 2articularly when re#iewing cross-sectional ratios, differences in accounting rules can affect !alance sheet #alues and financial ratios. &t is i portant to "now which accounting rules the fir s under consideration are using !efore a"ing any conclusions a!out its perfor ance fro ratio analysis. LGA 13. 9hat does it ean when a fir window dresses its financial state ents8

-ir s often window dress their financial state ents to a"e annual results loo" !etter. -or e/a ple, to i pro#e liquidity ratios calculated with year-end !alance sheets, fir s often delay pay ents for raw aterials, equip ent, loans, etc. to !uild up their liquid accounts and thus their liquidity ratios. &f possi!le, it is often ore accurate to use other than year-end financial state ents to conduct perfor ance analysis. P"o# e$s +asic 3-1 Li%uidity Ratios Fou are e#aluating the !alance sheet for Good an1s +ees Corporation. -ro the 2ro!le s !alance sheet you find the following !alancesC Cash and ar"eta!le securities G H677,777, (ccounts recei#a!le G H1,,77,777, &n#entory G H,,177,777, (ccrued wages and ta/es G H577,777, LG1 (ccounts paya!le G HA77,777, and .otes paya!le G H;77,777. Calculate Good an +ee1s Current ratio, 0uic" ratio, and Cash ratio.
H677,777 I H1,,77,777 I H,,177,777 Current ratio G ================ G 1.B6@6 ti es H577,777 I HA77,777 I H;77,777 H677,777 I H1,,77,777 I H,,177,777 - H,,177,777 0uic" ratio (acid-test ratio$ G ====================== G 7.A6,11 ti es H577,777 I HA77,777 I H;77,777 H677,777 Cash ratio G ============== G 7.,1753 ti es H577,777 I HA77,777 I H;77,777

LG1

3-, Li%uidity Ratios )he top part of 'a a"rishnan &nc,1s ,77A and ,77B !alance sheets is listed !elow (in illions of dollars$.
Current assetsC Cash and ar"eta!le securities (ccounts recei#a!le &n#entory )otal ,77A H 15 @5 117 H,77 ,77B H ,7 A6 1,1 H,,5 Current lia!ilitiesC (ccrued wages and ta/es (ccounts paya!le .otes paya!le )otal ,77A H 1A 65 67 H173 ,77B H 1B 51 65 H115

Calculate 'a a"rishnan &nc.1s Current ratio, 0uic" ratio, and Cash ratio for ,77A and ,77B.
&''( Current ratio G H,77 . === G 1.B61@ ti es H173 . H,77 . - H117 . &'') H,,5 . ==== G 1.B5;5 ti es H115 . H,,5 . - H1,1 .

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

0uic" ratio (acid-test ratio$ G ======= G 7.A@3A ti es ======== G 7.B7635 ti es H173 . H115 . Cash ratio G H15 . ==== G 7.165;3 ti es H173 . H,7 . ====== G 7.1@3B1 ti es H115 .

LG,

3-3 Asset Mana*e$ent Ratios )ater and 2epper Corp. reported sales for ,77A of H,3 illion. )ater and 2epper listed H5.; illion of in#entory on its !alance sheet. Calculate )ater and 2epper1s ,77A *+&). Jsing a 3;5 day year, how any days did )ater and 2epper1s in#entory stay on the pre ises8 >ow any ti es per year did )ater and 2epper1s in#entory turn o#er8 H5.; . / 3;5 4ays1 sales in in#entory G ====== G AA.A;B; days H,3 . H,3 . &n#entory turno#er ratio G ==== G 6.17@1 days H5.; .

LG,

3-6 Asset Mana*e$ent Ratios 5r. >us"er1s )u/edos, Corp. ended the year ,77A with an a#erage collection period of 3, days. )he fir 1s credit sales for ,77A were H33 illion. 9hat is the year-end ,77A !alance in accounts recei#a!le for 5r. >us"er1s )u/edos8 (ccounts recei#a!le / 3;5 (#erage collection period ((C2$ G =========== G 3, days H33 . GK (ccounts recei#a!le G 3, days / H33 .L3;5 G H,.AB .

LG3

3-5 +e#t Mana*e$ent Ratios )iggie1s 4og )oys, &nc. reported a de!t-to-equity ratio of 1.@5 ti es at the end of ,77A. &f the fir 1s total de!t at year-end was H,5 illion, how uch equity does )iggie1s ha#e8
)otal de!t H,5 . 4e!t-to-equity ratio G ===== G 1.@5 G ===== GK )otal equity G H,5 .L1.@5 G 16.,B . )otal equity )otal equity

LG3

3-; +e#t Mana*e$ent Ratios Fou are considering a stoc" in#est ent in one of two fir s (Lotsof4e!t, &nc. and Lotsof*quity, &nc.$, !oth of which operate in the sa e industry. Lotsof4e!t, &nc. finances its H,5 illion in assets with H,6 illion in de!t and H1 illion in equity. Lotsof*quity, &nc. finances its H,5 illion in assets with H1 illion in de!t and H,6 illion in equity. Calculate the de!t ratio, equity ultiplier, and de!t-to-equity ratio for the two fir s. Lotsof4e!t H,6 . 4e!t ratio G === G B;.77: H,5 . Lotsof *quity H1 === G 6.77: H,5

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

*quity

H,5 . ultiplier ratio G === G ,5 ti es H1 .

H,5 . === G 1.76, ti es H,6 . H1 . === G .76, ti es H,6 .

H,6 . 4e!t-to-equity ratio G === G ,6 ti es H1 . LG6

3-@ P"o,ita#i ity Ratios 5aggie1s S"un" 'e o#al, Corp.1s ,77A inco e state ent listed net sales G H1,.5 illion, *+&) G H5.; illion, net inco e a#aila!le to co on stoc"holders G H3., illion, and co on stoc" di#idends G H1., illion. )he ,77A year-end !alance sheet listed total assets G H5,.5 illion, and co on stoc"holders equity G H,1 illion with , illion shares outstanding. Calculate the profit argin, !asic earnings power ratio, '3(, '3*, and di#idend payout ratio. H3., . - H1., . argin G ======= G 1;.77: H1,.5 . H5.; . +asic earnings power ratio (+*2$ G === G 17.;@: H5,.5 . 2rofit H3., . 'eturn on assets ('3($ G === G ;.7B5: H5,.5 . H3., . 'eturn on equity ('3*$ G === G 15.,6: H,1 . H1., . 4i#idend payout ratio G === G 3@.57: H3., .

LG6

3-A P"o,ita#i ity Ratios &n ,77A, Ma"e1s Ma ing 5usic, &nc. announced an '3( of A.5;:, '3* of 16.5:, and profit argin of ,7.5:. )he fir had total assets of H1;.5 illion at year-end ,77A. Calculate the ,77A #alues of net inco e a#aila!le to co on stoc"holders1, co on stoc"holders1 equity, and net sales for Ma"e1s Ma ing 5usic, &nc. .et inco e a#aila!le to co on stoc"holders 'eturn on assets ('3($ G 7.7A5; G =================== H1;.5 . GK .et inco e a#aila!le to co on stoc"holders G 7.7A5; / H1;.5 . G H1,61,,677

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

H1,61,,677 'eturn on equity ('3*$ G 7.165 G ============ Co on stoc"holders1 equity GK Co 2rofit LG5 on stoc"holders1 equity G H1,61,,677L7.165 G HB,@67,;B7 H1,61,,677 argin G 7.,75 G ===== GK Sales G H1,61,,677L7.,75 G H;,AAB,@5; Sales

3-B Ma"-et .a ue Ratios Fou are considering an in#est ent in 'o/ie1s +ed N +rea"fast, Corp. 4uring the last year the fir 1s inco e state ent listed addition to retained earnings G H6.A illion and co on stoc" di#idends G H,., illion. 'o/ie1s year-end !alance sheet shows co on stoc"holders1 equity G H35 illion with 17 illion shares of co on stoc" outstanding. )he co on stoc"1s ar"et price per share G HB.77. 9hat is 'o/ie1s +ed N +rea"fast1s !oo" #alue per share and earnings per share8 Calculate the ar"et-to-!oo" ratio and 2* ratio. +oo" #alue per share G H35 .L17 . G H3.57 per share *arnings per share G (H6.A . I H,., .$L17 . G H7.@7 per share HB.77 5ar"et-to-!oo" ratio G === G ,.5@ ti es H3.57 HB.77 2rice-earnings (2*$ ratio G === G 1,.A; ti es H7.@7

LG5

3-17 Ma"-et .a ue Ratios Ga !it Golf1s ar"et-to-!oo" ratio is currently ,.5 ti es and 2* ratio is ;.@5 ti es. &f Ga !it Golf1s co on stoc" is currently selling at H1,.57 per share, what is the !oo" #alue per share and earnings per share8
H1,.57 5ar"et-to-!oo" ratio G ,.57 G ========= GK +oo" #alue per share G H1,.57L,.57 G H5.77 +oo" #alue per share H1,.57 2rice-earnings (2*$ ratio G ;.@5 ti es G ========= GK *arnings per share G H1,.57L;.@5 G H1.A5 *arnings per share

LG;

3-11 +uPont Ana ysis &f Silas 6-9heeler, &nc. has an '3* G 1A:, equity ultiplier G ,, a profit argin of 1A.@5:, what is the total asset turno#er ratio and the capital intensity ratio8 '3* G .1A G .1A@5/ )otal asset turno#er / , GK )otal asset turno#er G .1AL(.1A@5 / ,$ G 6A.77: Capital intensity ratio G 1L6A: G ,.7A3333 ti es

LG;

3-1, +uPont Ana ysis Last year >assan1s 5adhatter, &nc. had an '3( of @.5:, a profit 1,:, and sales of H17 illion. Calculate >assan1s 5adhatter1s total assets.

argin of

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

'3( G 7.7@5 G .1, / (H17 .L)otal assets$ GK )otal assets G .1, / H17 .L.7@5 G H1; . LG; 3-13 Inte"na G"o/t0 Rate Last year La"esha1s Lounge -urniture Corporation had an '3( of @.5: and a di#idend payout ratio of ,5:. 9hat is the internal growth rate8 7.7@5 / (1 - .,5$ &nternal growth rate G ========= G A.11: (1 - 7.7@5$ / (1 - .,5$ LG; 3-16 Sustaina# e G"o/t0 Rate Last year La"esha1s Lounge -urniture Corporation had an '3* of 1,.5: and a di#idend payout ratio of ,7: 9hat is the sustaina!le growth rate8 7.1,5 / (1 - .,7$ Sustaina!le growth rate G ========= G B.16: (1- 7.1,5$ / (1 - .,7$ &nter ediate 3-15 Li%uidity Ratios +renda1s +ar and Grill has current lia!ilities of H15 illion. Cash a"es up 17 percent of the current assets and accounts recei#a!le a"es up another 67 percent of current assets. 2ro!le s +renda1s current ratio G ,.1 ti es. Calculate the #alue of in#entory listed on the fir 1s !alance sheet. LG1 Current ratio G ,.1 G Current assetsLH15 . GK Current assets G ,.1 / H15 . G H31.5 . Cash G 7.17 / H31.5 . G H3.15 . (ccounts recei#a!le G 7.67 / H31.5 . G H1,.; . GK &n#entory G H31.5 . - H3.15 . - H1,.; . G H15.@5 . LG1-LG, 3-1; Li%uidity and Asset Mana*e$ent Ratios 5andesa, &nc. has current lia!ilities G H5 illion, current ratio G , ti es, in#entory turno#er ratio G 1, ti es, a#erage collection period G 37 days, and sales G H67 illion. Calculate the #alue of cash and ar"eta!le securities. Current assets Current ratio G , ti es G ======== GK Current assets G , / H5 . G H17 . H5 . H67 . &n#entory turno#er ratio G 1, ti es G ==== GK &n#entory G H67 .L1, G H3,333,333 &n#entory (ccounts recei#a!le / 3;5 (#erage collection period ((C2$ G 37 days G =========== H67 . GK (ccounts recei#a!le G 37 / H67 .L3;5 G H3,,A@,;@1 GK Cash and ar"eta!le securities G H17 . - H3,333,333 - H3,,A@,;@1 G H3,3@A,B;

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

LG, LG6

3-1@ Asset Mana*e$ent and P"o,ita#i ity Ratios Fou ha#e the following infor ation on *ls1 2utters, &nc.C sales to wor"ing capital G 6.; ti es, profit argin G ,7:, net inco e a#aila!le to co on stoc"holders G H5 illion, and current lia!ilities G H; illion. 9hat is the fir 1s !alance of current assets8 2rofit argin G ., G H5 .LSales GK Sales G H5 .L., G H,5 SalesL(Current assets % Current lia!ilities$ G 6.; G H,5 .L(Current assets - H; .$ GK Current assets G (H,5 .L6.;$ I ; . G H11.63 .

LG, LG3

3-1A Asset Mana*e$ent and +e#t Mana*e$ent Ratios Jse the following infor ation to co plete the !alance sheet !elow. Sales G H5., illion, capital intensity ratio G ,.17 ti es, de!t ratio G 55:, and fi/ed asset turno#er ratio G 1., ti es. Step 1C Capital intensity ratio G ,.17 G )otal assetsLH5., . GK )otal assets G ,.1 / H5., . G H17.B, . and )otal lia!ilities and equity G H17.B, . Step ,C 4e!t ratio G .55 G )otal de!tLH17.B, . GK )otal de!t G .55 / H17.B, . G H;.77; . Step 3C )otal equity G H17.B, . - H;.77; . G H6.B16 . Step 6C -i/ed asset turno#er G 1., G H5., .L-i/ed assets GK -i/ed assets G H5., .L1., G H6.333 . Step 5C Current assets G H17.B,, . - H6.333 . G H;.5A@ .
(ssets Current assets Step 5 -i/ed assets Step 6 )otal assets H;.5A@ . H6.333 . Lia!ilities and *quity )otal lia!ilities )otal equity Step , Step 3 HOOOOH;.77; .OOOOO OOOOH6.B16 .OOOOO

Step 1 H OOH17.B, .OOO

)otal lia!ilities and equity HOOOOH17.B, .OOOO

LG3

3-1B +e#t Mana*e$ent Ratios )iggie1s 4og )oys, &nc. reported a de!t to equity ratio of 1.@5 ti es at the end of ,77A. &f the fir 1s total assets at year-end were H,5 illion, how uch of their assets are financed with de!t and how uch with equity8 4e!t to equity G 1.@5 G )otal de!tL)otal equity G )otal de!tL()otal assets % )otal de!t$ 1.@5 G )otal de!tL(H,5 . % )otal de!t$ GK 1.@5 / (H,5 . % )otal de!t$ G )otal de!t GK (1.@5 / H,5 .$ % (1.@5 / )otal de!t$ G )otal de!t GK H63.@5 . G ,.@5 / )otal de!t GK )otal de!t G H63.@5 .L,.@5 G H15.B1 . GK )otal equity G H,5 . - H15.B1 . G HB.7B .

LG3

3-,7 +e#t Mana*e$ent Ratios Calculate the ti es interest earned ratio for La)onya1s -lop Shops, &nc. using the following infor ation. Sales G H1 illion, cost of goods sold G H;77,777, depreciation e/pense G H177,777, addition to retained earnings G HB@,577, di#idends per share G H1, ta/ rate G 37:, and nu !er of shares of co on stoc" outstanding G ;7,777. La)onaya1s -lop Shops has no preferred stoc" outstanding.

17

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

.et sales (all credit$ LessC Cost of goods sold Gross profits LessC 4epreciation *arnings !efore interest and ta/es (*+&)$ LessC &nterest *arnings !efore ta/es (*+)$ LessC )a/es .et inco e LessC Co on stoc" di#idends (ddition to retained earnings

step 6. step 5. step ;. step 3. step ,. step 1.

H1,777,777 ;77,777 H677,777 177,777 H377,777 H@5,777 H,,5,777 H15@,577 H;7,777 HB@,577

Step 1. Co

on stoc" di#idends G H1 / ;7,777 G H;7,777 on stoc" di#idends I (ddition to retained earnings G H;7,777 I HB@,577

Step ,. .et inco e G Co G H15@,577

Step 3. *+) (1 % ta/ rate$ G .et inco e GK *+) G .et inco eL(1 % ta/ rate$ G H15@,577L(1-.3$ G H,,5,777 Step 6. Gross profits G .et sales % Cost of goods sold G H1,777,777 % H;77,777 G H677,777 Step 5. Gross profits % 4epreciation G *+&) G H677,777 - H177,777 G H377,777 Step ;. *+&) % &nterest G *+) GK &nterest G *+&) - *+) G H377,777 - H,,5,777 G H@5,777 GK )i es interest earned G H377,777LH@5,777 G 6.77 ti es LG, LG6 3-,1 P"o,ita#i ity and Asset Mana*e$ent Ratios Fou are thin"ing of in#esting in .i""i )1s, &nc. Fou ha#e only the following infor ation on the fir at year-end ,77AC net inco e G H,57,777, total de!t G H,.5 illion, de!t ratio G 55:. 9hat is .i""i )1s '3* for ,77A8 4e!t ratio G .55 G H,.5 .L)otal assets GK )otal assets G H,.5 L.55 G H6.565 . GK )otal equity G H6.565 . - H,.5 . G H,.765 . GK '3* G H,57,777LH,.765 . G 1,.,,: LG6 3-,, P"o,ita#i ity Ratios 'ic"1s )ra#el Ser#ice has as"ed you to help piece together financial infor ation on the fir for the ost current year. 5anagers gi#e you the following infor ationC sales G H6.A illion, total de!t G H1.5 illion, de!t ratio G 67:, '3* G 1A:. Jsing this infor ation, calculate 'ic"1s '3(. 4e!t ratio G .67 G H1.5 .L)otal assets GK )otal assets G H1.5 .L.6 G H3.@5 . GK )otal equity G H3.@5 . - H1.5 . G H,.,5 . GK '3* G .1A G .et inco eLH,.,5 . GK .et inco e G .1A / H,.,5 . G H675,777 GK '3( G H675,777LH3.@5 . G 17.A:

11

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

LG5

3-,3 Ma"-et .a ue Ratios Leonatti La!s1 year-end price on its co on stoc" is H35. )he fir has total assets of H57 illion, the de!t ratio is ;5:, no preferred stoc", and there are 3 illion shares of co on stoc" outstanding. Calculate the ar"et-to-!oo" ratio for Leonatti La!s. 4e!t ratio G .;5 G )otal de!tLH57 . GK )otal de!t G .;5 / H57 . G H3,.5 . GK )otal equity G H57 . - H3,.5 . G H1@.5 . GK +oo" #alue of equity G H1@.5 .L3L . G H5.A3333 per share GK 5ar"et to !oo" ratio G H35LH5.A3333 G ; ti es

LG5

3-,6 Ma"-et .a ue Ratios Leonatti La!s1 year-end price on its co on stoc" is H15. )he fir has a profit argin of A:, total assets of H,5 illion, a total asset turno#er ratio of 7.@5, no preferred stoc", and there are 3 illion shares of co on stoc" outstanding. Calculate the 2* ratio for Leonatti La!s. )otal asset turno#er G .@5 G SalesLH,5 . GK Sales G H,5 . / .@5 G H1A.@5 . GK 2rofit argin G .7A G .et inco eLH1A.@5 . GK .et inco e G .7A / H1A.@5 . G H1.5 GK *2S G H1.5 .L3 . G H7.57 per share GK 2* ratio G H15LH7.57 G 37 ti es

LG;

3-,5 +uPont Ana ysis Last year, Stu !le-on-&nn, &nc. reported an '3* G 1A:. )he fir 1s de!t ratio was 55:, sales were H15 illion, and the capital intensity ratio was 1.,5 ti es. Calculate the net inco e for Stu !le-on-&nn last year. Capital intensity ratio G 1.,5 G )otal assetsLH15. GK )otal assets G 1.,5 / H15 . G H1A.@5 . GK 4e!t ratio G .55 G )otal de!tLH1A.@5 . GK )otal de!t G .55 / H1A.@5 . G H17.31,5 . GK )otal equity G H1A.@5 . - H17.31,5 . G HA.63@5 . GK '3* G .1A G .et inco eLHA.63@5 . GK .et inco e G .1A / HA.63@5 . G H1,51A,@57

LG;

3-,; +uPont Ana ysis Fou are considering in#esting in .uran Security Ser#ices. Fou ha#e !een a!le to locate the following infor ation on the fir C total assets G H1; illion, accounts recei#a!le G H,., illion, (C2 G ,5 days, net inco e G H,.5 illion, and de!t-to-equity ratio G 1., ti es. Calculate the '3* for the fir . 4e!t-to-equity G 1., G )otal de!tL)otal equity G )otal de!tL()otal assets % )otal de!t$ 1., G )otal de!tL(1; . % )otal de!t$ GK (1., / 1; .$ % 1., / )otal de!t G )otal de!t GK 1B., . G ,., / )otal de!t GK )otal de!t G 1B., .L,., G HA.@,@ . GK )otal equity G H1B., . - HA.@,@. G H@.,@3 . GK '3* G H,.5 .LH@.,@3 . G 36.3@5:

LG;

3-,@ Inte"na G"o/t0 Rate 4ogs ' Js reported a profit argin of 17.5:, total asset turno#er ratio of 7.@5 ti es, de!t-to-equity ratio of 7.A7 ti es, net inco e of H577,777, and di#idends paid to co on stoc"holders of H,77,777. )he fir has no preferred stoc" outstanding. 9hat is 4ogs ' Js1 internal growth rate8 '3( G 2rofit 5argin / )otal asset turno#er G 17.5: / 7.@5 G @.A@5: '' G (H577,777 - H,77,777$LH577,777 G .;7

1,

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

'3( / '' &nternal growth rate G ====== G (1-'3($ / '' LG;

7.7@A@5 / .;7 ======= G A.56A: (1 - 7.7@A@5$ / .;7

3-,A Sustaina# e G"o/t0 Rate Fou ha#e located the following infor ation on 9e!!1s >eating N (ir ConditioningC de!t ratio G 56:, capital intensity ratio G 1.17 ti es, profit argin G 1,.5:, and di#idend payout ratio G 67:. Calculate the sustaina!le growth rate for 9e!!. *quity ultiplier G )otal assetsL)otal equity GK 1L*quity ultiplier G )otal equityL)otal assets 4e!t ratio G )otal de!tL)otal assets G ()otal assets % )otal equity$L)otal assets G 1 % ()otal equityL)otal assets$ .56 G 1- ()otal equityL)otal assets$ GK )otal equityL)otal assets G 1 - .56 G .6; G 1L*quity ultiplier GK *quity ultiplier G 1L.6; G ,.1@3B '3* G 2rofit 5argin / )otal asset turno#er / *quity G .1,5 / 1L1.17 / ,.1@3B G ,6.@7: ultiplier

'etention ratio (''$ G 1 - di#idend payout ratio G 1 - .67 G .;7 .,6@7 / .;7 Sustaina!le growth rate G ======= G 3,.A1: (1 - .,6@7$ / .;7 LG1-LG@ 1se t0e ,o o/in* ,inan2ia state$ents ,o" La-e o, E*y3t Ma"ina to ans/e" 3"o# e$s 34&) t0"ou*0 343&5
La"e of *gypt 5arina, &nc. +alance Sheet as of 4ece !er 31, ,77@ and ,77A (in illions of dollars$ &''6 &''( Lia#i ities 7 E%uity &''6 Current lia!ilities (ccrued wages and ta/es (ccounts paya!le .otes paya!le )otal Long-ter H 6@1 H 5A7 177 117 H 3@1 H 6@7 6B 57 H 6,7 H 5,7 H @A5 H B17 de!tC C H 63 H 67 A7 B7 @7 A7 H 1B3 H ,17 H 377 H 5 ;5

Assets Current assetsC Cash and ar"eta!le securities (ccounts recei#a!le &n#entory )otal -i/ed assetsC Gross plant and equip ent LessC 4epreciation .et plant and equip ent 3ther long-ter assets )otal )otal assets

&''(

;5 117 1B7 H 3;5

@5 115 ,77 H 3B7

H ,A7 H 5 ;5

Stoc"holders1 equityC 2referred stoc" (5 illion shares$ Co on stoc" and paid-in surplus (;5 illion shares$ 'etained earnings )otal )otal lia!ilities and equity

,6, 337 H 31, H 677 H @A5 H B17

13

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

La"e of *gypt 5arina, &nc. &nco e State ent for Fears *nding 4ece !er 31, ,77@ and ,77A (in illions of dollars$ &''6 &''( .et sales (all credit$ H 63, H 515 LessC Cost of goods sold ,77 ,;7 Gross profits ,3, ,55 LessC 4epreciation ,7 ,, *arnings !efore interest and ta/es (*+&)$ ,1, ,33 LessC &nterest 37 33 *arnings !efore ta/es (*+)$ 1A, ,77 LessC )a/es 55 5@ .et inco e H 1,@ H 163 LessC 2referred stoc" di#idends .et inco e a#aila!le to co on stoc"holders LessC Co on stoc" di#idends (ddition to retained earnings 2er (co on$ share dataC *arnings per share (*2S$ 4i#idends per share (42S$ +oo" #alue per share (+P$ 5ar"et #alue (price$ per share (5P$ H 5 H 1,, H ;5 H 5@ H1.A@@ H1.777 H6.@,3 H1,.557 H 5 H 13A H ;5 H @3 H,.1,3 H1.777 H;.7@@ H16.@57

3-,B S3"eadin* t0e Finan2ia State$ents Spread the !alance sheets and inco e state ents of La"e of *gypt 5arina, &nc. for ,77@ and ,77A. Spread the !alance sheetC
La"e of *gypt 5arina, &nc. +alance Sheet as of 4ece !er 31, ,77@ and ,77A (in illions of dollars$ &''6 &''( Lia#i ities 7 E%uity &''6 Current lia!ilitiesC (ccrued wages and A.,A: A.,6: ta/es 16.71 1,.;6 (ccounts paya!le ,6.,1 ,1.BA .otes paya!le 6;.57 6,.A; )otal Long-ter ;7.77 1,.@6 ;3.@6 1,.7B de!tC

Assets Current assetsC Cash and ar"eta!le securities (ccounts recei#a!le &n#entory )otal -i/ed assetsC Gross plant and equip ent LessC 4epreciation .et plant and equip ent 3ther long-ter assets )otal )otal assets

&''(

5.6A: 6.67: 17.1B B.AB A.B, A.@B ,6.5B ,3.7A 35.;@ 3,.B@

Stoc"holders1 equityC 2referred stoc" (5 illion shares$ 7.;3 7.55 Co on stoc" and 6@.,; 51.;5 paid-in surplus A.,A @.16 ;.,6 5.6B (;5 illion shares$ 53.57 5@.16 'etained earnings 37.A3 3;.,; )otal 3B.@6 63.B5 177.77: 177.77: )otal lia!ilities and equity 177.77: 177.77:

16

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

Spreading the inco e state entC

La"e of *gypt 5arina, &nc. &nco e State ent for Fears *nding 4ece !er 31, ,77@ and ,77A (in illions of dollars$ &''6 &''( .et sales (all credit$ 177.77: 177.77: LessC Cost of goods sold 6;.37 57.6B Gross profits 53.@7 6B.51 LessC 4epreciation 6.;3 6.,@ *arnings !efore interest and ta/es (*+&)$ 6B.7@ 65.,6 LessC &nterest ;.B6 ;.61 *arnings !efore ta/es (*+)$ 6,.13 3A.A3 LessC )a/es 1,.@3 11.7@ .et inco e ,B.67: ,@.@;:

3-37 Ca 2u atin* Ratios Calculate the following ratios for La"e of *gypt 5arina, &nc. as of year-end ,77A.
a. Current ratio !. 0uic" ratio c. Cash ratio d. &n#entory turno#er ratio e. 4ays1 sales in in#entory f. (#erage collection period g. (#erage pay ent period h. -i/ed asset turno#er ratio i. Sales to wor"ing capital E. )otal asset turno#er ratio ". Capital intensity ratio l. 4e!t ratio . 4e!t-to-equity ratio n. *quity ultiplier o. )i es interest earned p. Cash co#erage ratio q. 2rofit argin r. +asic earnings power ratio s. '3( t. '3* u. 4i#idend payout ratio #. 5ar"et-to-!oo" ratio w. 2* ratio La"e of *gypt 5arina, &nc. 3B7L,17G1.A; ti es (3B7-,77$L,17G7.B7 ti es @5L,17G.3; ti es 515L,77G,.5A ti es (,77/3;5$L515G161.@5 days (115/3;5$L515GA1.57 days (B7/3;5$L,;7G1,;.35 days 515L5,7G7.BB ti es 515L(3B7-,17$G,.A; ti es 515LB17G7.5@ ti es B71L515G1.@@ ti es (,17I377$LB17G5;.76: (,17I377$L677G1.,A ti es B17L677G,.,A ti es ,33L33G@.7; ti es (,33I,,$L33G@.@3 ti es 13AL515G,;.A7: ,33LB17G,5.;7: 13ALB17G15.1;: 13AL677G36.57: ;5L13AG6@.17: 16.@57L;.7@@G,.63 ti es 16.@57L,.1,3G;.B5 ti es &ndustry ,.7 ti es 1., ti es 7.,5 ti es 3.;7 ti es 171.3B days 3,.57 days 65 days 1.,5 ti es 6.,5 ti es 7.A5 ti es 1.1A ti es ;,.57: 1.;@ ti es ,.;@ ti es A.57 ti es A.@5 ti es ,A.@5: 3,.57: 1B.@5: 3;.AA: 35: ,.55 ti es 15.;7 ti es

3-31 +uPont Ana ysis Construct the 4u2ont '3( and '3* !rea"downs for La"e of *gypt 5arina, &nc. '3( G 2rofit 5argin / )otal asset turno#er G ,;.A7: / 7.5@ ti es G 15.1;: '3* G 2rofit 5argin / )otal asset turno#er / *quity ultiplier G ,;.A7: / 7.5@ ti es / ,.,A ti es G 36.57:

15

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

3-3, Inte"na and Sustaina# e G"o/t0 Rates Calculate the internal and sustaina!le growth rate for La"e of *gypt 5arina, &nc. 7.151; / (1 - .6@17$ &nternal growth rate G =========== G 1@.A@;: (1 - 7.151;$ / (1 - .6@17$ .3657 / (1 - .6@17$ Sustaina!le growth rate G ========== G 5,.;@: (1 - .3657$ / (1 - .6@17$ 3-33 C"oss4se2tiona Ana ysis Jsing the ratios fro question 3-37 for La"e of *gypt 5arina, &nc. and the industry, what can you conclude a!out La"e of *gypt 5arina1s financial perfor ance for ,77A. La"e of *gypt 5arina is perfor ing !elow the industry in all areas. Liquidity is lower, asset anage ent is poorer, and profit ratios are lower. (d#anced 3-36 Ratio Ana ysis Jse the following infor ation to co plete the !alance sheet !elow. 2ro!le s LG1-LG5 Step 1C Current 'atio G ,.5 ti es G Current assetsLH3@7 . GK Current assets G ,.5 / H3@7 . G HB,5 . Step ,C 2rofit 5argin G 17: G .et inco eLH,,177 . GK .et inco e G .17 / H,,177 . G H,17 . '3* G ,7: G H,17 .L)otal equity GK )otal equity G H,17 .L.,7 G H1,757 . Step 3C Long-ter de!tLLong-ter 4e!t and *quity G 55: GK .55(Long-ter 4e!t I H1,757 .$ G Long-ter 4e!tGK (.55/ Long-ter 4e!t$ I (.55 / H1,757 .$ G Long-ter 4e!t GK H5@@.5 . G (1- .55$ / Long-ter 4e!t GK Long-ter 4e!t G H5@@.5 .L(1- .55$ G H1,,A3 .
Current (ssets Step 1 -i/ed (ssets Step 5 HB,5 . 1,@@A . Current Lia!ilities Long-ter 4e!t Step 3 H3@7 . H1,,A3 . 1,757 . H,,@73 .

Stoc"holders1 *quity Step , )otal (ssets H,,@73 . Step 6 )otal Lia!ilities N *quity

LG1-LG5 3-35 Ratio Ana ysis Jse the following infor ation to co plete the !alance sheet !elow. Step 1C Current ratio G ,., ti es G Current assetsLH577 . GK Current assets G ,., / H577 . G H1,177 . Step ,C (#erage collection period G ;7 days G ((ccounts recei#a!le / 3;5$LH1,,77 . (ccounts recei#a!le G (;7 / H1,,77 .$L3;5 G H1B@ . Step 3C &n#entory turno#er G 1.5 ti es G H1,,77 .L&n#entory GK &n#entory G H1,,77 .L1.5 G HA77 .
1;

Chapter 3, Solutions

Cornett, Adair, and Nofsinger

Step 6C Cash G H1,177 . - H1B@ . - HA77 . G H173 . Step 5C )otal asset turno#er G 7.@5 ti es G H1,,77 .L)otal assets GK )otal assets G H1,,77 .L7.@5 G H1,;77 . Step ;C -i/ed assets G H1,;77 . - H1,177 . G H577 . Step @C 4e!t ratio G ;7: G )otal de!tLH1,;77 . GK )otal de!t G .;7 / H1,;77 . G HB;7 .
Cash Step 6 (ccounts recei#a!le Step , &n#entory Step 3 Current assets Step 1 -i/ed assets Step ; )otal assets H173 1B@ A77 H1,177 577 . . . . . Current lia!ilities Long-ter de!t )otal de!t Stoc"holders1 equity )otal lia!ilities N equity H577 6;7 HB;7 ;67 . . . .

Step B Step @ Step A Step 5

H1,;77 .

H1,;77 .

1@