Solutions to Tutorial 1

11. Presumably, the current stock value reflects the risk, timing, and
magnitude of all future cash flows, both short-term and long-term. If this is
correct, then the statement is false.

14. The goal of management should be to maximize the share price for the
current shareholders. If management believes that it can improve the
profitability of the firm so that the share price will
exceed $35, then they should fight the offer from the outside company. If
management believes that this bidder or other unidentified bidders will
actually pay more than $35 per share to acquire the company, then they
should still fight the offer. However, if the current management cannot
increase the value of the firm beyond the bid price, and no other higher bids
come in, then management is not acting in the interests of the shareholders
by fighting the offer. Since current managers often lose their jobs when the
corporation is acquired, poorly monitored managers have an incentive to
fight corporate takeovers in situations such as this.

Pg 84
22. The solution requires substituting two ratios into a third ratio.
Rearranging D/TA:
Firm A Firm B
D / TA = .60 D / TA = .40
(TA – E) / TA = .60 (TA – E) / TA = .40
(TA / TA) – (E / TA) = .60 (TA / TA) – (E / TA) = .40
1 – (E / TA) = .60 1 – (E / TA) = .40
E / TA = .40 E / TA = .60
E = .40(TA) E = .60(TA)
Rearranging ROA, we find:
NI / TA = .20 NI / TA = .35
NI = .20(TA) NI = .35(TA)
Since ROE = NI / E, we can substitute the above equations into the ROE
formula, which yields:
22. The solution requires substituting two ratios into a third ratio. Rearranging D/TA: Firm A Firm B D / TA = .
60 (TA – E) / TA = .60 (TA / TA) – (E / TA) = .60 1 – (E / TA) = .60 E / TA = .40 E = .40(TA) D / TA = .40 (TA
– E) / TA = .40 (TA / TA) – (E / TA) = .40 1 – (E / TA) = .40 E / TA = .60 E = .60(TA) Rearranging ROA, we
find: NI / TA = .20 NI = .20(TA) NI / TA = .35 NI = .35(TA) Since ROE = NI / E, we can substitute the above
equations into the ROE formula, which yields: ROE = .20(TA) / .40(TA) = .20 / .40 = 50% ROE = .35(TA) / .60
(TA) = .35 / .60 = 58.33%

ROE = .20(TA) / .40(TA) = .20 / .40 = 50% ROE = .35(TA) / .60 (TA) = .
35 / .60 = 58.33%

23. This problem requires you to work backward through the income
statement. First, recognize that
Net income = (1 – t)EBT.
Plugging in the numbers given and solving for EBT, we get:
EBT = €9,200 / 0.66 = €13,939.39
Now, we can add interest to EBT to get EBIT as follows:
EBIT = EBT + Interest paid = €13,939.39 + 3,250 = €17,189.39
Thus, the cash coverage ratio:
CCR = (EBIT + Depreciation) / Interest = (€17,189.39 + 2,125) / €3,250 =
5.94 times

Pg 85
26. Short-term solvency ratios:
Current ratio = Current assets / Current liabilities
Current ratio 2006 = ZAR 7,828 / ZAR 1,808 = 4.33 times
Current ratio 2007 = ZAR 8,322 / ZAR 2,320 = 3.59 times

Quick ratio = (Current assets – Inventory) / Current liabilities

Quick ratio 2006 = (ZAR 7,828 – 4,608) / ZAR 1,808 = 1.78 times
Quick ratio 2007 = (ZAR 8,322 – 4,906) / ZAR 2,320 = 1.47 times

Cash ratio = Cash / Current liabilities

Cash ratio 2006 = ZAR 815 / ZAR 1,808 = 0.45 times
Cash ratio 2007 = ZAR 906 / ZAR 2,320 = 0.39 times
 Asset utilization ratios:
Total asset turnover = Sales / Total assets
Total asset turnover = ZAR 33,500 / ZAR 27,489 = 1.22 times

Inventory turnover = Cost of goods sold / Inventory

Inventory turnover = ZAR 18,970 / ZAR 4,906 = 3.87 times

Receivables turnover = Sales / Accounts receivable

Receivables turnover = ZAR 33,500 / ZAR 2,510 = 13.35 times

Long-term solvency ratios:

Total debt ratio
Total debt ratio 2006
0.29
Total debt ratio 2007
0.26
= (Total assets – Total equity) / Total assets
= (ZAR 22,992 – 16,367) / ZAR 22,992 =
= (ZAR 27,489 – 20,209) / ZAR 27,489 =

Debt-equity ratio = Total debt / Total equity

Debt-equity ratio 2006 = (ZAR 1,808 + 4,817) / ZAR 16,367 = 0.40
Debt-equity ratio 2007 = (ZAR 2,320 + 4,960) / ZAR 20,209 = 0.36

Equity multiplier = 1 + D/E

Equity multiplier 2006 = 1 + 0.40 = 1.40
Equity multiplier 2007 = 1 + 0.36 = 1.36

Times interest earned = EBIT / Interest

Times interest earned = ZAR 12,550 / ZAR 486 = 25.82 times

Cash coverage ratio = (EBIT + Depreciation) / Interest

Cash coverage ratio = (ZAR 12,550 + 1,980) / ZAR 486 = 29.90
times

Profitability ratios:
Profit margin = Net income / Sales
Profit margin = ZAR 7,842 / ZAR 33,500 = 23.41%

Return on assets = Net income / Total assets

Return on assets = ZAR 7,842 / ZAR 27,489 = 28.53%

Return on equity = Net income / Total equity

Return on equity = ZAR 7,842 / ZAR 20,209 = 38.80%

27. The DuPont identity is:

ROE = (Profit Margin) (Total Asset Turnover)(Equity
Multiplier)
ROE = (0.2341) (1.22) (1.36) = 0.3880 or 38.80%
22. The solution requires substituting two ratios into a third ratio. Rearranging D/TA: Firm A Firm B D / TA = .
60 (TA – E) / TA = .60 (TA / TA) – (E / TA) = .60 1 – (E / TA) = .60 E / TA = .40 E = .40(TA) D / TA = .40 (TA
– E) / TA = .40 (TA / TA) – (E / TA) = .40 1 – (E / TA) = .40 E / TA = .60 E = .60(TA) Rearranging ROA, we
find: NI / TA = .20 NI = .20(TA) NI / TA = .35 NI = .35(TA) Since ROE = NI / E, we can substitute the above
equations into the ROE formula, which yields: ROE = .20(TA) / .40(TA) = .20 / .40 = 50% ROE = .35(TA) / .60
(TA) = .35 / .60 = 58.33%