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Chapter 03: Financial Analysis
3-17. Solution:
Cable Corporation and Multi-Media, Inc.
a. Cable Multi-
Corporation Media, Inc.
Net income $30,000 $100,000
12% 22.2%
Stockholders' equity $250,000 $450,000
= = =
Multi-Media Inc. has a much higher return on stockholders’
equity than Cable Corporation.
3-17. (Continued)
b. Cable Multi-
Corporation Media, Inc.
Net income $30,000 $100,000
10% 5%
Sales $300,000 $2,000,000
Net income $30,000 $100,000
7.5% 11.1%
Total assets $400,000 $900,000
Sales $300,000 $2,000,000
.75x 2.2x
Total assets $400,000 $900,000
Debt
Total assets
= = =
= = =
= = =
=$150,000 $450,000
37.5% 50%
$400,000 $900,000
==
c. As previously indicated, Multi-Media, Inc. has a substantially
Chapter 03: Financial Analysis
3-22
However, Multi-Media, Inc. has a higher return than Cable
Corporation on total assets (11.1% vs 7.5%). The reason is
assets.
Multi-Media, Inc.’s superior return on stockholders’ equity is
further enhanced by a higher debt ratio than Cable Corporation
3-17. (Continued)
Although not requested in the question, one could show the
following:
Net income Net income / TotalAssets
Stockholders' equity (1- debt/assets)
=
Multi-Media, Inc. = 11.1%(1–.05) = 11.17%/.50 = 22.2%
Cable Corporation = 7.5%(1–.375) = 7.5%/.625 = 12%
18. Average collection period (LO2) A firm has sales of $1.2 million, and 10 percent of the
sales are for cash. The year-end accounts receivable balance is $180,000. What is the
average collection period?
(Use a 360-day year.)
Chapter 03: Financial Analysis
3-18. Solution:
Accounts receivable
Average collection period Average daily credit sales
($1,200,000 90%)
$180,000 360 days
$180,000
$3,000 per day
60 days
=
=
=
=
19. Average daily sales (LO2) The Chamberlain Corporation has an accounts receivable
turnover equal to 12 times. If accounts receivable are equal to $90,000, what is the value
for average daily credit sales?
3-19. Solution:
Chamberlain Corporation
Credit sales
Average daily credit sales 360
=
Chapter 03: Financial Analysis
3-24
20. Inventory turnover (LO2) Kamin Corporation has the following financial data for the
years 2009 and 2010:
2009
2010
Sales…………………………
$4,000,000
$5,000,000
Cost of goods sold……………
3,000,000
4,500,000
Inventory……………………..
400,000
500,000
a. Compute inventory turnover based on ratio number 6, Sales/Inventory, for each year.
b. Compute inventory turnover based on an alternative calculation that is used by many
financial analysts, Cost of goods sold/Inventory, for each year.
c. What conclusions can you draw from part a and part b?
3-20. Solution:
Kamin Corporation
2009 2010
a.
Sales $4,000,000 $5,000,000
10x 10x
Inventory 400,000 500,000
= = =
b.
Cost of goods sold $3,000,000 $4,500,000
7.5x 9x
Inventory 400,000 500,000
= = =
c. Based on the sales to inventory ratio, the turnover has
remained constant at 10x. However, based on the cost of
goods sold to inventory ratio, it has improved from
7.5x to 9x.
The latter ratio may be providing a false picture of
improvement in this example simply because cost of goods
sold has gone up as percentage of sales (from 75 percent to
90 percent). Inventory is not really turning over any faster.
Chapter 03: Financial Analysis
3-25
3-20. (Continued)
Nevertheless, cost of goods sold is used by many analysts in
the numerator of the inventory turnover ratio because it is
stated on a “cost” basis as is inventory. This is an important
theoretical consideration.
21. Turnover ratios (LO2) Jim Short’s Company makes clothing for schools. Sales in 2010
were $4,000,000. Assets were as follows:
Cash……………………………………….
$ 100,000
Accounts receivable……………………….
800,000
Inventory…………………………………..
400,000
Net plant and equipment…………………..
500,000
Total assets……………………………
$1,800,000
a. Compute the following:
1. Accounts receivable turnover
2. Inventory turnover
3. Fixed asset turnover
4. Total asset turnover
b. In 2011, sales increased to $5,000,000 and the assets for that year were as follows:
Cash………………………………………...
$ 100,000
Accounts receivable………………………..
900,000
Inventory…………………………………...
975,000
Net plant and equipment…………………...
500,000
Total assets……………………………..
$2,475,000
Once again, compute the four ratios.
c. Indicate if there is an improvement or decline in total asset turnover, and based on the
other ratios, indicate why this development has taken place.
Chapter 03: Financial Analysis
3-21. Solution:
Jim Short’s Company
a. 1. Accounts receivable turnover = Sales/Accounts
Receivable
$4,000,000 5
800,000 x=
2. Inventory turnover = Sales/Inventory
$4,000,000 10
400,000 x=
3-21. (Continued)
3. Fixed asset turnover = Sales/(Net Plant & Equipment)
$4,000,000 8
500,000 x=
4. Total asset turnover = Sales/Total Assets
$4,000,000 2.22
1,800,000 x=
b. 1. Accounts receivable turnover
$5,000,000 5.56
Chapter 03: Financial Analysis
3-27
$5,000,000 10.00
500,000 x=
4. Total asset turnover
$5,000,000 2.02
2,475,000 x=
c. There is a decline in total asset turnover from 2.22 to 2.02.
This development has taken place because of the slowdown in
inventory turnover (10x down to 5.13x). The other two ratios
are slightly improved.
22. Overall ratio analysis (LO2)The balance sheet for the Bryan Corporation is shown below.
Sales for the year were $3,040,000, with 75 percent of sales sold on credit.
BRYAN CORPORATION
Balance Sheet 201X
Assets
Liabilities and Stockholders’ Equity
Cash……………………
$ 50,000
Accounts payable……………..
$220,000
Accounts receivable…...
280,000
Accrued taxes…………………
80,000
Inventory………………
240,000
Bonds payable
(long-term)……………………
118,000
Plant and equipment…...
380,000
Common stock………………..
100,000
Paid-in capital…………………
150,000
Retained earnings……………..
282,000
Total assets………...
$950,000
Total liabilities and
stockholders’ equity…
$950,000
Compute the following ratios:
a. Current ratio.
b. Quick ratio.
c. Debt-to-total-assets ratio.
d. Asset turnover.
e. Average collection period.
Chapter 03: Financial Analysis
3-22. Solution:
Bryan Corporation
a.
Current assets
Current ratio Current liabilities
$570,000
$300,000
1.9x
=
=
=
3-22. (Continued)
b.
(Current assets inventory)
Quick ratio Current liabilities
$330,000
$300,000
1.1x
−
=
=
=
c.
Total debt
Debt to total assets Total assets
$418,000
$950,000
44%
=
=
=
d.
Sales
Asset turnover Total assets
$3,040,000
$950,000
3.2x
=
=
=
Chapter 03: Financial Analysis
e.
Accounts receivable
Average collection period Average daily credit sales
($3,040,000 0.75)
$280,000 360 days
$280,000
$6,333 per day
44.21 days
=
=
=
=
23. Debt utilization ratios (LO2) The Lancaster Corporation’s income statement is given
below.
a. What is the times-interest-earned ratio?
b. What would be the fixed-charge-coverage ratio?
LANCASTER CORPORATION
Sales .......................................................................... $200,000
Cost of goods sold ...................................................... 116,000
Gross profit ................................................................ 84,000
Fixed charges (other than interest) .............................. 24,000
Income before interest and taxes ................................ 60,000
Interest ....................................................................... 12,000
Income before taxes ................................................... 48,000
Taxes (35%) ............................................................... 16,800
Income after taxes ...................................................... $ 31,200
3-23. Solution:
Lancaster Corporation
a.
Income before interest and taxes
Times interested earned Interest
$60,000
12,000
5x
=
=
=
Chapter 03: Financial Analysis
b.
Income before fixed charges and taxes
Fixed charge coverage Fixed charges
$60,000 24,000
$12,000 24,000
$84,000
$36,000
2.33x
=
+
=
+
=
=
24. Debt utilization and Du Pont system of analysis (LO3) Using the income statement for
J. Lo Wedding Gowns, compute the following ratios:
a. The interest coverage.
b. The fixed charge coverage.
The total assets for this company equal $160,000. Set up the equation for the Du Pont
system of ratio analysis, and compute the answer to part c below using ratio 2 b on
page 59.
c. Return on assets (investment).
J.LO WEDDING GOWNS
Income Statement
Sales .......................................................................... $200,000
Less: Cost of goods sold .......................................... 90,000
Gross profit ................................................................ 110,000
Less: Selling and administrative expense ................. 40,000
Less: Lease expense ................................................ 10,000
Operating profit* ........................................................ $ 60,000
Less: Interest expense .............................................. 5,000
Earnings before taxes ................................................. $ 55,000
Less: Taxes (40%) ................................................... 22,000
Earnings after taxes .................................................... $ 33,000
*Equals income before interest and taxes.
3-24. Solution:
