Chapter 10, Problem 10.6AP

(a-1)

To determine

Liquidity ratios

Liquidity ratios measure the short-term capacity of a company to pay its maturing obligations and to meet unanticipated requirements for cash. Liquidity ratios are current ratio, working capital ratio, acid test ratio and more.

Solvency ratios

Solvency ratios measure the capacity of a company to sustain over a long period of time. Solvency ratios are debt to assets ratio, time interest earned ratio, debt to equity ratio, and more.

To Calculate: The Current ratio for the year 2017 and 2016 of Company SA.

Answer to Problem 10.6AP

Calculate current ratio for the year 2017 of Company SA as shown below:

  $\begin{array}{c}\text{Current ratio for the year 2017 = }\frac{\text{Current assets}}{\text{Current liabilites}}\\ =\frac{\$2,893\text{Million}}{2,806\text{Million}}\\ =1.03:1\end{array}$

Hence, the current ratio for the year 2017 is 1.03:1.

Calculate current ratio for the year 2016 of Company SA as shown below:

$\begin{array}{c}\text{Current ratio for the year 2016}\text{=}\frac{\text{Current assets}}{\text{Current liabilites}}\\ =\frac{\$4,443\text{Million}}{\$4,836\text{Million}}\\ =0.92:1\end{array}$

Hence, the current ratio for the year 2016 is 0.92:1.

Explanation of Solution

Current ratio is calculated by dividing current assets by current liabilities. Hence, the current ratio for the year 2017 is 1.03:1 and current ratio for the year 2016 is 0.92:1.

(a-2)

To determine

To Calculate: The Free cash flow for the year 2017 and 2016 of Company SA.

Answer to Problem 10.6AP

Calculate free cash flow for the year 2017 of Company SA as shown below:

$\begin{array}{c}\text{Free cash flow for the year 2017 = }\left[\begin{array}{l}\text{Net cash flows from operating activites }-\\ \left(\text{Dividends +}\text{Capital expenditure}\right)\end{array}\right]\\ =(\$1,521\text{Million)}-(\$923\text{Million}+\$13\text{Million})\\ =2,457\text{Million}\end{array}$

Hence, the free cash flow for the year 2017 is 2,457million.

Calculate free cash flow for the year 2016 of Company SA as shown below:

$\begin{array}{c}\text{Free cash flow for the year 2016}\text{=}\left[\begin{array}{l}\text{Net cash flows from operating activites }-\\ \left(\text{Dividends +}\text{Capital expenditure}\right)\end{array}\right]\\ =\$2,845\text{Million}-(\$1,331\text{Million}+\$14\text{Million})\\ =1,500\text{Million}\end{array}$

Hence, the free cash flow for the year 2016 is 1,500 million.

Explanation of Solution

Free cash flow is calculated by deducting cash dividends and capital expenditure from net cash flow from operating activities. Hence, the free cash flow for the year 2017 is 2,457million, and for the year 2016 is 1,500 million.

(a-3)

To determine

To Calculate: The debt to assets ratio for the year 2017 and 2016 of Company SA.

Answer to Problem 10.6AP

Calculate debt to assets ratio for the year 2017 of Company SA as shown below:

  $\begin{array}{c}\text{Debt to assets ratio = }\frac{\text{Total liabilites}}{\text{Total assets }}\times 100\\ =\frac{\$9,355\text{Million}}{\$14,308\text{Million}}\times 100\\ =65\%\end{array}$

Hence, debt to assets ratio for the year 2017 is 65%.

Calculate debt to assets ratio for the year 2016 of Company SA as shown below:

  $\begin{array}{c}\text{Debt to assets ratio = }\frac{\text{Total liabilites}}{\text{Total assets }}\times 100\\ =\frac{\$9,831\text{Million}}{\$16,772\text{Million}}\times 100\\ =59\%\end{array}$

Hence, debt to assets ratio for the year 2016 is 59%.

Explanation of Solution

Debt to assets ratio for the Company SA is calculated by dividing total liabilities with total assets and then multiplying with 100. Hence, debt to assets ratio for the year 2017 is 65%, and debt to assets ratio for the year 2016 is 59%.

(a-4)

To determine

To Calculate: The times interest earned ratio for the year 2017 and 2016 of Company SA.

Explanation of Solution

Calculate the times interest earned ratio for the year 2017 as shown below:

  $\begin{array}{c}\begin{array}{l}\text{Times interest earned ratio }\\ \text{for the year 2017}\end{array})\text{=}\frac{\text{Earnings before interest expense and taxes}}{\text{Interest expense}}\\ =\frac{\left(\$178\text{Million}\text{+}\text{\$100}\text{Million}\text{+}\text{130}\text{Million}\right)}{\$130\text{Million}}\\ =\frac{\$408\text{Million}}{\$130\text{million}}\\ =3.14\text{Times}\end{array}$

Hence, times interest earned ratio for the year 2017 is 3.14 times.

Calculate the times interest earned ratio for the year 2016 as shown below:

  $\begin{array}{c}\begin{array}{l}\text{Times interest earned ratio }\\ \text{for the year 2016}\end{array})\text{=}\frac{\text{Earnings before interest expense and taxes}}{\text{Interest expense}}\\ =\frac{\left(\$645\text{Million}\text{+}\text{\$413}\text{Million}\text{+}\text{119}\text{Million}\right)}{\$119\text{Million}}\\ =\frac{\$1,117\text{Million}}{\$119\text{million}}\\ =9.89\text{Times}\end{array}$

Hence, times interest earned ratio for the year 2017 is 9.89 times.

(b)

To determine

To Comment: trend in ratios of Company SA.

Explanation of Solution

• The company’s current ratio for 2017 is 1.03: 1which is higher than 2016 current ratio is 0.92: 1. It indicates that the company has high ability to pay its debts in 2017 as compare to 2016.
• The company’s free cash flow for 2017 is $(2,457) million which is greater than 2016 is $1,500 million. It shows that the company has sufficient cash in 2017 than in 2016.
• The company’s debt to assets ratio for 2017 is 65.38%, which is higher than debt to assets ratio of 58.26% of 2016. It shows that the company has less ability to meet its obligations in 2017 as compare to 2016.
• The company times interest earned ratios for 2017 is 3.14 times is lower than 2016 is 9.89 times. It shows that the company has less ability to meet its interest payments in 2017 as compare to 2016.

(c)

To determine

Calculate: The debt to assets ratio, after adjustment for Off-balance sheet lease for the year 2017 of Company SA and discuss the implication for analysis.

Answer to Problem 10.6AP

Calculate deb debt to assets ratio, after adjustment for Off-balance sheet lease for the year 2017 of Company SA as shown below:

  $\begin{array}{c}\text{Debt to assets ratio =}\frac{\text{Total liabilities}}{\text{Total assets}}\times 100\\ =\frac{\$9,355\text{million +\$1,600 million}}{\$14,308\text{million+\$1,600 million}}\times 100\\ =\frac{\$10,955\text{milllion}}{\$15,908\text{million}}\times 100\\ =69\%\text{(Rounded off)}\end{array}$

Hence, the value of debt to assets ratio, after adjustment for Off-balance sheet lease is 69%.

Explanation of Solution

Debt to assets ratio after adjustment for off-balance sheet lease of the year 2017 for Company SA is calculated by dividing total liabilities with total assets, and then multiplying with 100. Hence, the value of debt to assets ratio, after adjustment for Off-balance sheet lease is 69%.

After adjustment for Off-balance sheet lease, the company has debt-to assets ratio of 68.86% in contrast to 65.38% before. It shows that every dollar of assets, 68.86% is funded by debt