Chapter 03: Financial Analysis
J. Lo Wedding Gowns
a.
Income before interest and taxes
Times interest earned Interest
$60,000
5,000
12x
=
=
=
3-24. (Continued)
b.
Income before fixed charges and taxes
Fixed charge coverage Fixed charges
$60,000 10,000
$5,000 10,000
$70,000
$15,000
4.67x
=
+
=
+
=
=
c.
Net Income Sales
Return on assets (Investment) Sales Total assets
$33,000 $200,000
$200,000 $160,000
16.5% 1.25x
= 20.625%
=
=
=
Chapter 03: Financial Analysis
25. Debt utilization (LO2) A firm has net income before interest and taxes of $96,000 and
interest expense of $24,000.
a. What is the times-interest-earned ratio?
b. If the firm’s lease payments are $40,000, what is the fixed charge coverage?
3-25. Solution:
a.
Income before interest and taxes
Times interest earned Interest
$96,000
$24,000
4x
=
=
=
b.
IBIT + Before tax fixed charges
Fixed charge converage Interest Fixed charges
$96,000 $40,000
$24,000 $40,000
$136,000
$64,000
2.13x
=
−
+
=
+
=
=
26. Return on assets analysis (LO2) In January 2001, the Status Quo Company was formed.
Total assets were $500,000, of which $300,000 consisted of depreciable fixed assets. Status
Quo uses straight-line depreciation of $30,000 per year, and in 2001 it estimated its fixed
assets to have useful lives of 10 years. Aftertax income has been $26,000 per year each of
the last 10 years. Other assets have not changed since 2001.
a. Compute return on assets at year-end for 2001, 2003, 2006, 2008, and 2010.
(Use $26,000 in the numerator for each year.)
b. To what do you attribute the phenomenon shown in part a?
c. Now assume income increased by 10 percent each year. What effect would this have
on your above answers (A comment is all that is necessary.)
Chapter 03: Financial Analysis
3-33
3-26. Solution:
Status Quo Company
a.
Income after taxes
Return on assets (investment)= Total Assets
Income after taxes
Return on assets (investment)= Current assets + Fixed assets
3-26. (Continued)
operations.
Chapter 03: Financial Analysis
3-34
Financial analysts should be aware of the effect of overall
more profitable operations.
27. Trend analysis (LO4) Jodie Foster Care Homes, Inc., shows the following data:
Year Net Income Total Assets Stockholders’ Equity Total Debt
2007 $118,000 $1,900,000 $ 700,000 $1,200,000
2008 131,000 1,950,000 950,000 1,000,000
2009 148,000 2,010,000 1,100,000 910,000
2010 175,700 2,050,000 1,420,000 630,000
a. Compute the ratio of net income to total assets for each year and comment on the trend.
b. Compute the ratio of net income to stockholders’ equity and comment on the trend.
Explain why there may be a difference in the trends between parts a and b.
3-27. Solution:
Jodie Foster Care Homes, Inc.
a.
Net income
Total assets
assets over the four year period.
Chapter 03: Financial Analysis
3-35
b.
Net income
Stockholders’ equity
stockholders’ equity as opposed to debt.
3-27. (Continued)
Optional: This can be confirmed by computing total debt to
total assets for each year.
Total debt
Total assets
Chapter 03: Financial Analysis
3-36
28. Trend analysis (LO4) Quantum Moving Company has the following data. Industry
information also is shown.
Industry Data on
Company Data Net Income/Total Assets
Year Net Income Total Assets
2008 $350,000 $2,800,000 11.5%
2009 375,000 3,200,000 8.4
2010 375,000 3,750,000 5.5
Industry Data on
Year Debt Total Assets Debt/Total Assets
2008 $1,624,000 $2,800,000 54.1%
2009 1,730,000 3,200,000 42.0
2010 1,900,000 3,750,000 33.4
As an industry analyst comparing the firm to the industry, are you likely to praise or
criticize the firm in terms of:
a. Net income/Total assets.
b. Debt/Total assets.
3-28. Solution:
Quantum Moving Company
a. Net income/total assets
Year
Quantum Ratio
Industry Ratio
2008
12.5%
11.5%
2009
11.7%
8.4%
2010
10.0%
5.5%
Although the company has shown a declining return on assets
since 2008, it has performed much better than the industry.
Praise may be more appropriate than criticism.
Chapter 03: Financial Analysis
3-37
3-28. (Continued)
b. Debt/total assets
Year
Quantum Ratio
Industry Ratio
2008
58.0%
54.0%
2009
54.1%
42.0%
2010
50.7%
33.4%
While the company’s debt ratio is declining, it is not
declining nearly as rapidly as the industry ratio. Criticism
may be more appropriate than praise.
29. Analysis by divisions (LO2) The Global Products Corporation has three subsidiaries.
Medical Supplies Heavy Machinery Electronics
Sales ………………………………. $20,000,000 $5,000,000 $4,000,000
Net income (after taxes) …….. 1,200,000 190,000 320,000
Assets …………………………….. 8,000,000 8,000,000 3,000,000
.
a. Which division has the lowest return on sales?
b. Which division has the highest return on assets?
c. Compute the return on assets for the entire corporation.
d. If the $8,000,000 investment in the heavy machinery division is sold off and
redeployed in the medical supplies subsidiary at the same rate of return on assets
currently achieved in the medical supplies division, what will be the new return on
assets for the entire corporation?
3-29. Solution:
Global Products Corporation
a. Medical Heavy
Supplies Machinery Electronics
Chapter 03: Financial Analysis
b. Medical Heavy
Supplies Machinery Electronics
3-29. (Continued)
c.
Corporate net income $1,200,000 $190,000 $320,000
Corporate total assets $8,000,000 $8,000,000 $3,000,000
$1,710,000
$19,000,000
9.0%
++
=
++
=
=
d. Return on redeployed assets in heavy machinery.
Chapter 03: Financial Analysis
3-39
30. Analysis by affiliates (LO1) Omni Technology Holding Company has the following three
affiliates:
Personal Foreign
Software Computers Operations
Sales ………………………….. $40,000,000 $60,000,000 $100,000,000
Net income (after taxes) … 2,000,000 2,000,000 8,000,000
Assets ………………………… 5,000,000 25,000,000 60,000,000
Stockholders’ equity …….. 4,000,000 10,000,000 50,000,000
a. Which affiliate has the highest return on sales?
b. Which affiliate has the lowest return on assets?
c. Which affiliate has the highest total asset turnover?
d. Which affiliate has the highest return on stockholders’ equity?
e. Which affiliate has the highest debt ratio? (Assets minus stockholders’ equity
equals debt.)
f. Returning to question b, explain why the software affiliate has the highest return on
total assets.
g. Returning to question d, explain why the personal computer affiliate has a higher
return on stockholders’ equity than the foreign operations affiliate even though it has
a lower return on total assets.
3-30. Solution:
Omni Technology Holding Company
a. Net income/sales
Personal Foreign
Software Computers Operations
5.0% 3.3% 8.0%
The foreign operation affiliate has the highest return on sales.
b. Net income/total assets
Personal Foreign
Software Computers Operations
40.0% 8.0% 13.3%
The personal computer affiliate has the lowest return on
assets.
Chapter 03: Financial Analysis
3-40
3-30. (Continued)
c. Sales/total assets
Personal Foreign
Software Computers Operations
8.0x 2.4x 1.7x
The software affiliate has the highest return on total asset
turnover.
Personal Foreign
Software Computers Operations