Chapter 4 Q&A

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San Francisco State University *

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Finance

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Jan 9, 2024

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1. Financial ratio analysis is conducted by three main groups of analysts: credit analysts, stock analysts, and managers. What is the primary emphasis of each group, and how would that emphasis affect the ratios on which they focus? A: Each group does look at every ratio, however, -Management is interested in all types of ratios because the ratios point out weaknesses that should be strengthened. They also recognize that the other parties are interested in all the ratios and the financial appearance must be kept up if the firm is to be regarded highly by creditors and equity investors -Equity investors (stockholders) are interested primarily in profitability , but they examine the other ratios to obtain information on the riskiness of equity commitments. -Credit analysts are more interested in debt to capital , TIE , and EBITDA coverage ratios, as well as profitability ratios. Short-term creditors emphasize liquidity and a current ratio 2 Why would the inventory turnover ratio be more important for someone analyzing a grocery store chain than an insurance company? A: -The inventory turnover ratio is important for a grocery store because they have a larger inventory needed and some of it is perishable -An insurance company would have no inventory since its line of business is selling insurance or other financial products -Depending on the business different ratios are more important as shown here

3. Over the past year, M.D. Ryngaert & Co. had an increase in its current ratio and a decline in its total assets turnover ratio. However, the company’s sales, cash and equivalents, DSO, and fixed assets turnover ratio remained constant . What balance sheet accounts must have changed to produce the indicated changes? A: -Sales have not changed and total asset turnover decreased, the company's assets have increased -Fixed asset turnover ratio is constant which means its current assets must be the ones increasing -Current ratio increased, and cash and equivalents and DSO are unchanged which means that the company has increased its inventories 8. Why is it sometimes misleading to compare a company’s financial ratios with those of other firms that operate in the same industry? A: -Different accounting techniques may be used making stuff like depreciation different -Investments may be different for example, Pepsi and Coca-Cola while both making soft drinks, and Pepsi also owns other businesses like Quaker Problems 1. DAYS SALES OUTSTANDING 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. DSO = 23 Sales = 3,650,000 AR = ? DSO = AR / Avg. Sales Avg. Sales = 3,650,000/365 = 10000 23*10,0000 = AR = 230,000

2. DEBT TO CAPITAL RATIO 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? M/B = 1 MP = 12 Outstanding = 4,800,000 TC = 110,000,000 TIC = TE + TD 110,000,000 = 12*4,800,000 + x TD = X = 52,000,000 52,000,000 / 110,000,000 = 47.64 DC = TD TotalCapital 3. DuPONT ANALYSIS 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? ROA = .11 Proft Margin = .06 ROE = 0.23 TAT =? TAT = S/TA EM = ? EM = TA/TE PM = NI/S NI = PM*S ROA = NI/TA ROA = PM*S/TA .11 = .06*S/TA .11/.06 = TAT = 1.83 ROE = PM * TAT *EM .23 = .06 * 1.83 * x X = 2.091

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4. MARKET/BOOK RATIO Edelman Engines has $17 billion in total assets. Its balance sheet shows $1.7 billion in current liabilities, $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. What is Edelman’s market/book ratio? TA = 17000000000 CL = 1700000000 LD = 10200000000 CE = 5100000000 Outstanding = 300000000 Price 20 BV = CE / Out BV = 17 M/B = Market Price / BV M/B = 20 / 17 = 1.1765 8. DuPONT AND NET INCOME Precious Metal Mining has $17 million in sales, its ROE is 17%, and its total assets turnover is 3.2×. Common equity on the firm’s balance sheet is 50% of its total assets. What is its net income? Sales = 17000000 ROE = .17 TAT = 3.2 CE = TA/2 NI? TAT = Sales/TA 3.2 = 17000000/x X = 17000000/3.2 5,312,500 Equity (CE) = 5,312,500*.5 = 2,656,250.00 ROE = NI/S * S/TA * TA/TE .17 = x/17000000 * 3.2 * 2

.17 = x/17000000 * 6.4 (.17/6.4) * 17000000 = x = $451,562.50 12. RATIO CALCULATIONS 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? Asset = 16000000000 TR = 0.4 BEP = 0.1 ROA = .05 TIE ? 0.1= x/16000000000 $1,600,000,000.00 = EBIT ROA = NI/TA .05 = x/16000000000 x= $800,000,000 = NI NI = EBT(1-TR) 800000000 = EBT * 0.6 EBT = 800000000 / 0.6 EBT = $1,333,333,333.33 Interest Expense = EBIT - EBT X = 1600000000 - 1333333333.33 = $266,666,666.67 1600000000 / 266666666.67 = TIE TIE = 6 18.

TIE RATIO MPI Incorporated has $6 billion in assets, and its tax rate is 35%. Its basic earning power (BEP) ratio is 11%, and its return on assets (ROA) is 6%. What is MPI’s times-interest-earned (TIE) ratio? Assets = 6000000000 TR = .35 BEp = 0.11 ROA = 0.06 TIE? 0.11 = x / 6000000000 = 660000000 EBIT ROA = NI/TA .06 * 6000000000 = NI = 360,000,000 NI = EBT(1-TR) 360000000 = EBT * .65 360000000 / 0.65 = 553,846,154 Interest = EBIT - EBT 106,153,846 = Interest TIE = 660000000 / 106,153,846 = 6.22 19. CURRENT RATIO The Stewart Company has $2,392,500 in current assets and $1,076,625 in current liabilities. Its initial inventory level is $526,350, and it will raise funds as additional notes payable and use them to increase inventory. How much can its short-term debt (notes payable) increase without pushing its current ratio below 2.0? CA = 2392500 CL = 1076625 Beg. inv = 526350 NP increase to increase inventory CR = CA CL CR = 2392500 / 1076625 = 2.22 (2392500 +) / (1076625 + x) = 2 2392500 + x = 2(1076625 + x) 2153250 + 2x = 2392500 + x

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X = $239,250.00 20. DSO AND ACCOUNTS RECEIVABLE Ingraham Inc. currently has $205,000 in accounts receivable, and its days sales outstanding (DSO) is 71 days. It wants to reduce its DSO to 20 days by pressuring more of its customers to pay their bills on time. If this policy is adopted, the company’s average sales will fall by 15%. What will be the level of accounts receivable following the change? Assume a 365-day year. AR = 205,00 DSO = 71 Target DSO = 20 Avg. sales drop .15 AR at target DSO 71 = 205,00 / x X = 205,00 / 71 = 2887.32 New Avg. 2453.23 20 = x / 2453.23 20 * 2453.23 = x 49084.51 21

P/E AND STOCK PRICE Ferrell Inc. recently reported net income of $8 million. It has 540,000 shares of common stock, which currently trades at $21 a share. Ferrell continues to expand and anticipates that 1 year from now, its net income will be $13.2 million. Over the next year, it also anticipates issuing an additional 81,000 shares of stock so that 1 year from now it will have 621,000 shares of common stock. Assuming Ferrell’s price/earnings ratio remains at its current level, what will be its stock price 1 year from now? EPS = ¿ SharesOutstanding Beg End NI = 8000000 Shares = 540000 Price = $21 P/E NI = 13200000 Share = 621000 P/E Same Price ? EPS = 8000000/540000 = 14.81 P/E = 21/14.81 = 1.42 EPS = 13200000/621000 = 21.26 1.42 = x / 21.26 1.42 * 21.26 = x = 30.19