Chapter 4, Problem 5EYK

1)

To determine

Calculate the company’s return on sales ratio for 2009, 2010, and 2011. Explain the return on sales trend.

Explanation of Solution

Return on sales ratio: The ratio which evaluates the amount of net income earned for every dollar of net sales is referred to as return on sales ratio.

$\text{Return on sales ratio = }\frac{\text{Net income}}{\text{Net sales}}$

Compute the return on sales ratio for Incorporation G for the year 2009.

Net income = $1,304.4 million

Net sales = $14,555.8 million

$\begin{array}{c}\text{Return on sales ratio = }\frac{\text{Net income}}{\text{Net sales}}\\ \text{= }\frac{\text{\$1,304}\text{.4 million}}{\text{\$14,555}\text{.8 million}}\\ \text{= 0}\text{.896 or 8}\text{.96\%}\end{array}$

Compute the return on sales ratio for Incorporation G for the year 2010.

Net income = $1,530.5 million

Net sales = $14,635.6 million

$\begin{array}{c}\text{Return on sales ratio = }\frac{\text{Net income}}{\text{Net sales}}\\ \text{= }\frac{\text{\$1,530}\text{.5 million}}{\text{\$14,635}\text{.6 million}}\\ \text{= 0}\text{.104 or 10}\text{.4\%}\end{array}$

Compute the return on sales ratio for Incorporation G for the year 2011.

Net income = $1,798.3 million

Net sales = $14,880.2 million

$\begin{array}{c}\text{Return on sales ratio = }\frac{\text{Net income}}{\text{Net sales}}\\ \text{= }\frac{\text{\$1,798}\text{.3 million}}{\text{\$14,880}\text{.2 million}}\\ \text{= 0}\text{.121 or 12}\text{.1\%}\end{array}$

Trends:

• Profitability of Incorporation G is measured by return on sales ratio.
• The ratio is has increased from 8.96% in 2009 to 10.4% in 2010 to 12.1% in 2011.
• This shows that the company’s profitability has increased.

2)

To determine

Calculate the company’s Current ratio for 2010 and 2011. Explain the current ratio’s trend.

Explanation of Solution

Current ratio: Current ratio is one of the liquidity ratios, which measures the capacity of the company to meet its short-term obligations using its current assets. The ideal current ratio is 2:1. The following formula is used to calculate current ratio.

$\text{Current ratio}\text{=}\frac{\text{Current}\text{Assets}}{\text{Current}\text{Liabilities}}$

Compute current asset ratio for Incorporation G for the year 2010.

Current assets = $3,480.0 million

Current liabilities = $3,769.1 million

$\begin{array}{c}\text{Current Ratio=}\frac{\text{Current assets}}{\text{Current}\text{liabilities}}\\ \text{=}\frac{\text{\$3,480}\text{.0 million}}{\text{\$3,769}\text{.1 million}}\\ \text{=}\text{0}\text{.92 times}\end{array}$

Compute current asset ratio for Incorporation G for the year 2011.

Current assets = $3,902.0 million

Current liabilities = $3,659.2 million

$\begin{array}{c}\text{Current Ratio}=\frac{\text{Current assets}}{\text{Current}\text{liabilities}}\\ =\frac{\text{\$3,902}\text{.0 million}}{\text{\$3,659}\text{.2 million}}\\ =\text{1}\text{.1 times}\end{array}$

Trends:

• Liquidity of Incorporation G is evaluated by current ratio.
• The ratio shows an increasing trend from 0.92 in 2010 to 1.1 in 2011.
• This shows that the capacity to pay for short-term liabilities has increased.

3)

To determine

Calculate the Company’s debt-to-total-assets ratio for 2010 and 2011. Explain the trend in debt-to-total-assets ratio.

Explanation of Solution

Compute debt-to-total-assets ratio for Incorporation G for the year 2010.

Total assets = $17,678.9 million

Total liabilities = $12,030.9 million

$\begin{array}{c}\text{Debt-to-total-assets ratio = }\frac{\text{Total liabilities}}{\text{Total assets}}\\ \text{=}\frac{\text{\$12,030}\text{.9 million}}{\text{\$17,678}\text{.9 million}}\\ \text{= 0}\text{.68 or 68\%}\end{array}$

Compute debt-to-total-assets ratio for Incorporation G for the year 2011.

Total assets = $18,674.5 million

Total liabilities = $12,062.3 million

$\begin{array}{c}\text{Debt-to-total-assets ratio = }\frac{\text{Total liabilities}}{\text{Total assets}}\\ \text{=}\frac{\text{\$12,062}\text{.3 million}}{\text{\$18,674}\text{.5 million}}\\ \text{= 0}\text{.65 or 65\%}\end{array}$

Trends:

• Liquidity of Incorporation G is measured by debt-to-total-assets ratio.
• The ratio shows a decreasing trend from 68% in 2010 to 65% in 2011.
• This shows that the repaying capacity of the corporation has increased.

4)

To determine

Calculate the Company’s free cash flow for 2009, 2010, and 2011. Explain the free cash flows trend.

Explanation of Solution

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

$\text{Free cash flow = Cash flows from operations – Capital expenditures}$

Particulars	2009	2010	2011
Free cash flows:
Cash flow from operating activities	$1,828.2	$2,181.2	$1,526.8
Less: Cash investment in property, plant and equipment	562.6	649.9	648.8
Free cash flow	$1,265.6	$1,531.3	$878.0

Table (1)

Trends:

• The ratio shows a mixed trend from 2009 to 2011.
• Incorporation G had a healthy free cash flow in the years to repay its lenders, pay dividends to stockholders.