Chapter 2, Problem 2.3EYCT

(a)

To determine

Working capital: This is the financial metric which evaluates the ability of a company to pay off the short-term debt obligations. It is the balance of current assets, after current liabilities are deducted.

Formula of working capital:

$\text{Working capital = Current assets – Current liabilities}$

Current ratio: The financial ratio which evaluates the ability of a company to pay off the debt obligations which mature within one year or within completion of operating cycle is referred to as current ratio. This ratio assesses the liquidity of a company.

Formula of current ratio:

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

Debt to assets ratio: This financial ratio evaluates the ability of a company to pay off long-term debt obligations owed to creditors. This ratio assesses the solvency of a company.

Formula of debt to assets ratio:

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

Free cash flow: This measure evaluates the cash-generating capacity of a company from its operating activities, after paying capital expenditures and dividends.

Formula of free cash flow:

$\text{Free cash flow = }\left\{\begin{array}{l}\text{Net cash provided by operating activities–}\\ \text{Capital expenditures–}\\ \text{Dividends}\end{array}\right\}$

To compute: (1) Working capital, (2) Current ratio (3) Debt to assets ratio, (4) Free cash flow of Incorporation A and Incorporation W for 2014

(b)

To determine

To analyze: The liquidity and solvency position of two companies based on the computed ratios