VIII. Questions and Problems
Basic
4.1 Liquidity ratios: Explain why the quick ratio or acid-test ratio is a better measure of a
firm’s liquidity than the current ratio?
Solution:
The quick ratio is a better or more conservative measure of liquidity than the current
ratio. The difference in the measurement of the two is that for the quick ratio we exclude
the inventory in accounting of the short term assets. Thus the quick ratio is measured as:
sliabilitieCurreent
Inventory - assetsCurrent
ratio Quick =
This measure includes only the most liquid of the current assets and hence gives a better
measure of liquidity.
4.2. Liquidity ratio: Flying Penguins Corp. has total current assets of $11,845,175, current
liabilities of $5,311,020, and a quick ratio of 0.89. What is its level of inventory?
Solution:
Current assets = $11,845,175
Current liabilities = $5,311,020
Quick ratio = 0.89
$7,118,367=∗−= −=∗
−
=
=
)020,311,5$89.0(175,845,11$
175,845,11$020,311,589.0
020,311,5$
175,845,11$
89.0
sliabilitieCurrent
Inventory - assetsCurrent
ratioQuick
Inventory
Inventory
Inventory
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4.3 Efficiency ratio: If Newton Manufacturers have an accounts receivable turnover of 4.8
times, and net sales of $7,812,379, what is its level of receivables?
Solution:
Accounts receivable turnover = 4.8x
Net sales = $7,812,379
$1,627,579==
=
=
8.4
379,812,7
sreceivable Accounts
sreceivable Accounts
379,812,7
x8.4
sreceivable Accounts
salesNet
turnoversreceivable Accounts
4.4 Efficiency ratio: Bummel and Strand Corp. has a gross profit margin of 33.7 percent,
sales of $47,112,365, and inventories of $14,595,435. What is its inventory turnover
ratio?
Solution:
Gross profit margin = 33.7%
Sales = $ 47,112,365
Inventory = $14,595,435
498,235,31
)365,112,47337.0(365,112,47$sold goods of Cost
365,112,47
COGS365,112,47$
337.0
SalesNet
sold goods ofCost -salesNet
rgin Profit MaGross
=∗−=
−
=
=
2.14x
==
==
435,595,14
498,235,31
Ratio turnover Inventory
Inventory
sold goods ofCost
?atioTurnover R Inventory
4.5 Efficiency ratio: Sorenson Inc. has sales of $3,112,489, a gross profit margin of 23.1
percent, and inventory of $833,145. What are the company’s inventory turnover ratio and
days’ sales in inventory?
2
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Solution:
Sales = $3,112,489
Gross profit margin = 23.1%
Inventory= $833,145
days 127.1
2.873x
=
==
=
==
=∗−=
−
=
=
873.2
365
ratio turnover Inventory
365
inventory in sales s'Day
145,833$
504,393,2$
Inventory
sold goods of Cost
ratio turnover Inventory
504,393,2$
)489,112,3231.0(489,112,3sold goods of Cost
3,112,489
Sold Goods of Cost489,112,3
231.0
Sales
sold goods ofCost -Sales
marginprofit Gross
4.6 Leverage ratios: Breckenridge Ski Company has total assets of $ 422,235,811, and a
debt ratio of 29.5 percent. Calculate the company’s debt to equity ratio and the equity
multiplier.
Solution:
Total assets=$422,235,811
Debt ratio= 29.5%
3
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42.1
811,235,297$
811,235,422$
equity Total
assets Total
multiplier Equity
42.0
274,676,297$
564,559,124$
ratioequity toDebt
47$297,676,264$124,559,5-11$422,235,8
debt Total -assets Totalequity Total
64$124,559,50.29511$422,235,8debt Total
=
==
==
==
==∗=
4.7 Leverage ratios: Norton Company has a debt to equity ratio of 1.65, ROA of 11.3
percent, total equity of $1,322,796. What are the company’s equity multiplier, debt ratio,
and ROE?
Solution:
Debt equity ratio = 1.65
ROA= 11.3%
Total equity = $1,322,796
494,505,3$
796,322,1$65.2
equity Total multiplier Equityassets Total
equiity Total
assets Total
multiplier Equity
1.651ratioequity Debt to1multiplier Equity
=×= ×=
=
=+=+=
2.65
111,396$
494,505,30.113assets TotalROAincome Net
assets Total
income Net
ROA
=×=×=
=
29.9%=== 796,322,1$
111,396$
Equity
income Net
ROE
4
Created by: Babu G. Baradwaj Instructor Manual Created on: May 7, 2009
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For: Kidwell & Parrino Fundamental of Corporate Finance Revised IM # 02
0.623=−=
−==
65.2
1
1
multiplier Equity
1
1
assets Total
Equity
-1ratio Debt
4.8. DuPont equation: The Rangoon Timber Company has the following relationships:
Sales/Total assets=2.23; ROA=9.69%; ROE=16.4%.
What are Rangoon’s profit margin and debt ratio?
Solution:
Total assets turnover = 2.23
ROA = 9.69%
ROE= 16.4%
ROA = Profit margin x Total assets turnover
4.35%=
== 23.2
0969.0
turnoverassets Totoal
ROA
marginProfit
ROE = ROA x Equity multiplier
69.1
0969.0
164.0
ROA
ROE
multiplierEquity
===
0.41=−=
−=−=
69.1
1
1
multiplierEquity
1
1
assets Total
Equity
1 ratioDebt
4.9 Benchmark analysis: List the ways a company’s financial manager can benchmark their
own performance.
5
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Solution:
Financial managers can bench mark their firm’s performance by collecting data in three
ways: through time trend analysis, industry average analysis, and peer group analysis.
4.10 Benchmark analysis: Trademark Corp.’s financial manager collected the following
information for its peer group so that it can compare its own performance against the
peers.
Ratios Trademark Peer Group
DSO 33.5 days 27.9 days
Total assets turnover 2.3 X 3.7 X
Inventory turnover 1.8 X 2.8 X
Quick ratio 0.6 X 1.3 X
a. Explain how Trademark is doing relative to its peers.
b. How do the industry ratios help Trademark’s management?
Solution:
a. One can see that Trademark is not doing as well as its competitors. The turnover ratio
indicates that the firm either needs to increase its sales relative to its level of assets or
reduce its assets relative to its level of sales. In addition, the lower quick ratio indicates a
lower lever of liquidity, perhaps because of too much inventory. A reduction in the
inventory would help Trademark improve its performance to a level that is comparable to
its peer group.
b. Average industry ratios server as benchmarks for the firm’s management to measure its
own performance. While no two firms are identical in any industry, the average ratios
across the industry are good target ratios for a firm.
6
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4.11. Market value ratios: Rockwell Jewelers has announced net earnings of $6,481,778 for
this year. The company has 2,543,800 shares outstanding and the year-end stock price is
$54.21. What are the company’s earnings per share and P/E ratio?
Solution:
Net earnings = $6,481,778
Shares outstanding= 2,543,800
Year-end stock price= $54.21
$2.55=
=== 800,543,2
778,481,6$
goutstandin Shares
earningsNet
EPS shareper Earnings
times 21.26
=
==
55.2$
21.54$
Earnings
Price
ratio earnings-Price
Intermediate
4.12. Liquidity ratio: Laurel Electronics has a quick ratio of 1.15, current liabilities of
$5,311,020, and inventories of $7,121,599. What is the firm’s current ratio?
Solution:
Quick ratio= 1.15
Current liabilities= $5,311,020
Inventory= $7,121,599
2$13,229,27assetsCurrent
599,121,7)020,311,515.1(assets Current
$5,311,020
$7,121,599 -asset Current
15.1
$5,311,020
7,121,599 - assetsCurrent
sliabilitieCurrent
Inventory -asset Current
ratioQuick
=+×=
==
==
7
Created by: Babu G. Baradwaj Instructor Manual Created on: May 7, 2009
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For: Kidwell & Parrino Fundamental of Corporate Finance Revised IM # 02
2.49=
== 020,311,5$
272,229,13$
sliabilitieCurrent
assetsCurrent
ratioCurrent
4.13. Efficiency Ratio: Payton Corp. has total sales of $31,115,964, inventories of $4,412,933,
cash and equivalents of $2,469,050, and days’ sales outstanding of 39 days. If the firm’s
management wanted its DSO to be 30 days, by how much will the accounts receivable
have to change?
Solution:
Sales= $31,115,964; Inventory= $4,412,933
Cash= $2,469,050; DSO= 39 Days
44.719,324,3$
365
964,115,31$39
365
salesNet DSO
srecievable Accounts
salesNet
srecievable Accounts365
DSO
recievable untssales/AccoNet
365
turnoverrecievable Accounts
365
DSO
=
×
=
×
=
∗
=
==
5$767,242.9-
$2,557,477-$3,324,719srecievable Accounts
49.476,557,2$
365
964,115,3130
365
salesNet DSO
srecievable accountsNew
Days30 Target DSO
=∆ =
×
=
×
=
=
4.14. Efficiency ratio: Norwood Corp. currently has accounts receivable of $1,223,675 on net
sales of $6,216,900. What are its accounts receivable turnover ratio and days’ sales
outstanding?
Solution:
Accounts receivable= $1,223,675
Net sales= $6,216,900
8
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times 5.08=
== 675,223,1$
900,216,6$
srecievable Accounts
salesNet
turnoversrecievable Accounts
days 71.8
===
08.5
365
turnoverrecievable Accounts
365
DSO
4.15. Efficiency ratio: If Norwood Corp.’s management wants to reduce the DSO from that
calculated in the above problem to an industry average of 56.3 days and its net sales are
expected to decline by about 12 percent, what would be the new level of receivables?
Solution:
Target DSO = 56.3 days
New level of sales= $6,216,900 x 0.88 = $5,470,872
$843,863=
∗
=
∗
=
==
365
872,470,53.56
365
salesNet DSO
recievable Accounts
recievable untssales/AccoNet
365
Days56.3 DSO
4.16. Coverage ratios: Nimitz Rental Company had depreciation expenses of $108,905,
interest expenses of $78,112, and an EBIT of $1,254,338 for the year ended June 30,
2009. What are the times interest earned and cash coverage ratios for this company?
Solution:
Depreciation= $108,905
Interest expenses= $78,112
EDIT= $1,254,338
9
Created by: Babu G. Baradwaj Instructor Manual Created on: May 7, 2009
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For: Kidwell & Parrino Fundamental of Corporate Finance Revised IM # 02
times 16.1=
== 112,78$
338,254,1$
expenseInterest
EBIT
earnedinterest Times
times 17.5=
=
+
==
112,78
243,363,1$
expenset Interes
onDepreciatiEBIT
expenseInterest
EBITDA
rates coverage Cash
4.17. Leverage ratios: Conseco, Inc. has a debt ratio of 0.56. What are the company’s debt to
equity ratio and equity multiplier?
Solution:
Debt ratio= 0.56
1.27
2.27
==
=+=
=−
=
−
=
==
1-2.27
1-multiplierEquity ratioequity Debt to
equity) (Debt to1multiplier Equity
56.01
1
assets Debt/Total1
1
assets Total/Equity
1
Equity
assets Total
multiplierEquity
4.18. Profitability ratios: Cisco Systems has total assets of $35.594 billion, total debt of
$9.678 billion and net sales of $22.045 billion. Their net profit margin for the year is 20
percent, while the operating profit margin was 30 percent. What are Cisco’s net income,
EBIT ROA, ROA, and ROE?
Solution:
Total assets= $35.594 billion
Total debt= 9.678 billion
Net sales= $22.045 billion
10
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Net profit margin= 20%
Operating profit margin= 30%
billion $4.409
=∗=
=
045.22$2.0incomeNet
Sales
incomeNet
marginprofit Net
billion $6.613=∗=
=
045.22$3.0BITE
Sales
EBIT
marginprofit Operating
18.6%
===
594.35$
613.6$
assets Total
EBIT
ROAEBIT
12.4%
===
594.35$
409.4$
assets Total
incomeNet
ROA
Total equity = Total assets – Total debt
= $35.594 - $9.678 = $25.916 billion
37.1
916.25$
594.35$
equity Total
assets Total
multiplierEquity
=
==
17% 1.37 0.124
EM ROA ROE
=×= ×=
4.19. Profitability ratios: Procter & Gamble reported the following information for year-end
2004. On net sales of $51.407 billion, the company earned a net income after taxes of
$6.481 billion. It had a cost of goods sold of $25.076 billion and an EBIT of $ 9.827
billion. What is the company’s (a) gross profit margin, (b) operating profit margin, and
(c) net profit margin?
Solution:
Net sales = $51.407 billion
11
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Net income = $6.481 billion
Cost of goods sold = $25.076 billion
EBIT = $9.827 billion
(a)
51.2%=
−
=
=
407.51$
076.25$407.51$
salesNet
sold goods ofCost - salesNet
marginprofit Gross
(b)
19.1%
===
407.51$
827.9$
salesNet
EBIT
marginprofit Operating
(c)
12.6%
===
407.51$
481.6$
sales Net
incomeNet
marginprofit Net
4.20. Profitability ratios: Wal-Mart, Inc. has net income of $9,054,000 on net sales of
$256,329,812. The company has total assets of $104,912,112 and shareholders’ equity of
$43,623,445. Use the extended DuPont identity to find the return on assets and return on
equity for the firm.
Solution:
4.20
Net income = $9,054,000
Net sales = $256,329,812
Total assets = $104,912,112
Shareholder equity = $43,623,445
%53.3
812,329,256$
000,054,9$
salesNet
incomeNet
marginProfit ===
X44.2
112,912,104$
812,329,256$
assets Total
salesNet
turnover assets Total ===
8.63%
=×= ×=
44.20353.0
turnoverassets TotalmarginProfit assets on Return
12
Created by: Babu G. Baradwaj Instructor Manual Created on: May 7, 2009
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20.75%=
×=
×=
×=
445,623,43$
112,912,104$
0863.0
equity Total
assets Total
0863.0
EMROAROE
4.21. Profitability ratios: Xtreme Sports Innovations has disclosed the following information:
EBIT $25,664,300 Net income $13,054,000 Net sales $83,125,336
Total debt $20,885,753 Total assets $71,244,863.
Compute the following ratios for this firm using the DuPont Identity – debt to equity
ratio, EBIT ROA, ROA, and ROE.
Solution:
EBIT = $25,664,300
Net income = $13,054,000
Net sales = $83,125,336
Total debt = $20,885,753
Total assets = $71, 244,863
1.41
0.411
ratioequity toDebt1rmultiplieEquity
)753,885,20$863,244,71($
753.885,20$
debt) Total-assets Total(
Debt
Equity
Debt
equity toDebt
=+= +=
=−
=
==
0.41
36.02%=
== 863,244,71$
300,664,25$
assets Total
EBIT
ROA EBIT
13
Created by: Babu G. Baradwaj Instructor Manual Created on: May 7, 2009
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18.32%=
== 863,244,71$
000,054,13$
assets Total
income Net
ROA
25.9%
=×= ×=
41.11832.0
EMROAROE
4.22. Market value ratios: Cisco Systems had net income of $4.401 billion and at year end
6.735 billion shares outstanding. Calculate the earnings per share for the company.
Solution:
Net income = $4.401 billion
Shares outstanding = $6.735 billion
$0.65
=
==
735.6$
401.4$
goutstandin Shares
incomeNet
shareper Earnings
4.23. Market value ratios: Use the information for Cisco Systems in the last problem. In
addition, the company’s EBITDA was $6.834 billion and its share price was $22.36.
Compute the firm’s price-earnings ratio and the price-EBITDA ratio.
Solution:
EBITDA = $6.834 billion
Share price = $22.36
times 34.4== 65.0$
$22.36
ratio earnings- Price
$1.015
==
735.6
$6.834
shareper EBITDA
14
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times 22.04
==−
015.1$
$22.36
ratio EBITDAPrice
4.24 DuPont equation: Carter, Inc., a manufacturer of electrical supplies, has a ROE of 23.1
percent, a profit margin of 4.9 percent and a total assets turnover ratio of 2.6 times. Its
peer group also has a ROE of 23.1 percent, but has outperformed Carter with a profit
margin of 5.3 percent and a total assets turnover ratio of 3.0 times. Explain how Carter
managed to achieve the same level of profitability as reflected by the ROE.
Solution:
Carter Inc: ROE = 23.1%, PM = 4.9%, TATO = 2.6x
1274.0
6.2049.0
TATOPMROA
=×= ×=
times 81.1
1274.0
231.0
EM
EMROA231.0ROE
==
×==
Peer Group: ROE = 23.1%, PM = 5.3%, TATO = 3 times
times45.1
3053.0
231.0
EM
EMTATOPM231.0ROE
=
×
=
××==
Carter matched its peer group’s ROE by using a higher degree of financial leverage as
indicated by its higher equity multiplier.
4.25 DuPont equation: Grossman Enterprises has an equity multiplier of 2.6 times, total
assets of $2,312,000, a ROE of 14.8 percent and a total assets turnover of 2.8 times.
Calculate the firm’s sales and ROA.
15
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Solution:
EM = 2.6x, TA = $2,312,000, ROE=14.8%, TATO=2.8x
$6,473,600=×=
=
=
000,312,2$8.2Sales
000,312,2$
Sales
8.2
assets Total
Sales
turnoverassets Total
231,889$
6.2
000,312,2$
Equity
Equity
000,312,2$
6.2
Equity
assets Total
EM
==
=
=
606,131$
231,889$148.0
EquityROENI
Equity
NI
ROE
=×= ×=
=
5.7%=== 000,312,2$
606,131$
assets Total
NI
ROA
16
