Chapter 12, Problem 12.5BYP

(a)

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 so on.

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, and debt to equity ratio, and so on.

Current ratio:

It is a liquidity ratio that measures the relationship of current assets to current liabilities. This is calculated by dividing current assets by current liabilities. The formula is as follows:

$\text{Current ratio = }\frac{\text{Current assets}}{\text{Current liabilities}}$

Current cash debt coverage ratio:

It is a liquidity ratio which measures the relationship between net cash provided from operating activities and average current liabilities during the year. This ratio would be helpful in indicating the ability of the business to pay off its current liabilities from its ongoing business operations.

$\text{Current cash debt coverage ratio = }\frac{\text{Net cash provided by operating activities}}{\text{Average current liabilities}}$

Cash debt coverage ratio:

It is a solvency ratio which defines the relationship between operating cash flow to its total liabilities. This ratio would be helpful in indicating the ability of the business to pay off the total liabilities from the total business operations.

$\text{Cash debt coverage ratio = }\frac{\text{Net cash provided by operating activities}}{\text{Average total liabilities}}$

Debt to assets ratio:

It is a solvency ratio which measures the percentage of total assets or financing provided by creditors. It is computed by dividing total debts by total assets. The formula is:

$\text{Debt to assets ratio = }\frac{\text{Total debts}}{\text{Total assets}}$

Free cash flow: It describes the net cash provided from operating activities after making required adjustments for dividends and capital expenditures. In other words, it is the cash flow arrived after making payment for capital expenditures and dividend payments.

To calculate: the current ratio and current cash debt coverage ratio of Company A and discuss the liquidity position.

(b)

To determine

To calculate: the cash debt coverage ratio of Company A and discuss the solvency position.

(c)

To determine

To discuss: ability of Company A to purchase. the warehouses and to finance the expansion from internally generated cash.

(d)

To determine

To explain: if the company A’s stock price is reasonably justified.