3-20. Solution:
Perez Corporation
20X1 20X2
a.
Sales $8,000,000 $10,000,000
10x 10x
Inventory 8,00,000 1,000,000
= = =
b.
Cost of goods sold $6,000,000 $9,000,000
7.5x 9x
Inventory 800,000 1,000,000
= = =
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 has (from 75 percent
to 90 percent). Inventory is not really turning over any faster.
21. Turnover ratios (LO2) Jim Short’s Company makes clothing for schools. Sales in 20X1
were $4,820,000. Assets were as follows:
Cash………………………………………. $ 163,000
Accounts receivable………………………. 889,000
Inventory………………………………….. 411,000
Net plant and equipment………………….. 520,000
Total assets…………………………… $1,983,000
a. Compute the following:
1. Accounts receivable turnover.
2. Inventory turnover.
3. Fixed asset turnover.
4. Total asset turnover.
b. In 20X2, sales increased to $5,740,000 and the assets for that year were as follows:
Cash………………………………………..
.
$ 163,000
Accounts receivable……………………….. 924,000
Inventory…………………………………… 1,063,000
Net plant and equipment…………………… 520,000
Total assets…………………………….. $2,670,000
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.
3-21. Solution:
Jim Short’s Company
a. 1. Accounts receivable turnover = Sales/Accounts
Receivable
$4,820,000 5.42
889,000 x=
2. Inventory turnover = Sales/Inventory
$4,820,000 11.73
411,000 x=
3-21. (Continued)
3. Fixed asset turnover = Sales/(Net Plant & Equipment)
$4,820,000 9.27
520, 000 x=
4. Total asset turnover = Sales/Total assets
$4,820,000 2.43
1,983, 000 x=
b. 1. Accounts receivable turnover
$5,740,000 6.21
924,000 x=
2. Inventory turnover
$5,740,000 5.4
1,063, 000 x=
3. Fixed asset turnover
$5,740,000 11.04
520, 000 x=
4. Total asset turnover
$5,740,000 2.15
2,670,000 x=
c. There is a decline in total asset turnover from 2.43 to 2.15.
This development has taken place because of the slowdown in
inventory turnover (11.73 down to 5.4). The other two ratios
are slightly improved.
22. Overall ratio analysis (LO2) The balance sheet for Stud Clothiers is shown next. Sales for
the year were $2,400,000, with 90 percent of sales sold on credit.
STUD CLOTHIERS
Balance Sheet 20X1
Assets Liabilities and Equity
Cash…………………… $ 60,000 Accounts payable…………….. $ 220,000
Accounts receivable…… 240,000 Accrued taxes………………… 30,000
Inventory……………… 350,000 Bonds payable
(long-term)……………………
150,000
Plant and equipment…… 410,000 Common stock……………….. 80,000
Paid-in capital………………… 200,000
Retained earnings…………….. 380,000
Total assets………… $1,060,000 Total liabilities and equity… $1,060,000
Compute the following ratios:
a. Current ratio.
b. Quick ratio.
c. Debt-to-total-assets ratio.
d. Asset turnover.
e. Average collection period.
3-22. Solution:
Stud Clothiers
a.
Current assets
Current ratio Current liabilities
$650,000
$250,000
2.6x
=
=
=
3-22. (Continued)
b.
(Current assets inventory)
Quick ratio Current liabilities
$650,000 $350,000
$250,000
$300,000
$250,000
1.2x
–
=
–
=
=
=
c.
Total debt
Debt to total assets Total assets
$400,000
$1,060,000
37.74%
=
=
=
d.
Sales
Asset turnover Total assets
$2,400,000
$1,060,000
2.26x
=
=
=
e.
Accounts receivable
Average collection period Average daily credit sales
($2,400,000 0.90)
$240,000 / 360 days
$240,000
$6,000 per day
40 days
=
´
=
=
=
23. Debt utilization ratios (LO2) The Lancaster Corporation’s income statement is given
next.
a. What is the times-interest-earned ratio?
b. What would be the fixed-charge-coverage ratio?
LANCASTER CORPORATION
Sales…………………………………………………………………… $246,000
Cost of goods sold………………………………………………… 122,000
Gross profit…………………………………………………………. 124,000
Fixed charges (other than interest)………………………….. 27,500
Income before interest and taxes…………………………….. 96,500
Interest………………………………………………………………… 21,800
Income before taxes……………………………………………… 74,700
Taxes (35%)………………………………………………………… 26,145
Income after taxes………………………………………………… $ 48,555
3-23. Solution:
Lancaster Corporation
a.
Income before interest and taxes
Times interested earned Interest
$96,500
21,800
4.43x
=
=
=
b.
Income before fixed charges and taxes
Fixed charge coverage Fixed charges
$96,500 27,500
$21,800 27,500
$124, 000
$49,300
2.52x
=
+
=+
=
=
24. Debt utilization and Du Pont system of analysis (LO3) Using the income statement for
Times Mirror and Glass Co., compute the following ratios:
a. The interest coverage.
b. The fixed charge coverage.
The total assets for this company equal $80,000. Set up the equation for the Du Pont
system of ratio analysis, and compute c, d, and e.
c. Profit margin.
d. Total asset turnover.
e. Return on assets (investment).
PASTE MANAGEMENT COMPANY
Sales…………………………………………………………………… $126,000
Less: Cost of goods sold……………………………………….. 93,000
Gross profit…………………………………………………………. 33,000
Less: Selling and administrative expense………………… 11,000
Less: Lease expense……………………………………………… 4,000
Operating profit*………………………………………………….. $ 18,000
Less: Interest expense…………………………………………… 3,000
Earnings before taxes……………………………………………. $ 15,000
Less: Taxes (30%)………………………………………………… 4,500
Earnings after taxes………………………………………………. $ 10,500
*Equals income before interest and taxes.
3-24. Solution:
Times Mirror and Glass Co.
a.
Income before interest and taxes
Times interest earned Interest
$18,000
$3,000
6x
=
=
=
3-24. (Continued)
b.
Income before fixed charges and taxes
Fixed charge coverage Fixed charges
$18,000 4,000
$3,000 $4,000
$22,000
$7,000
3.14x
=
+
=+
=
=
c.
Net income
Profit margin Sales
$10,500
$126,000
8.33%
=
=
=
d.
Sales
Total asset turnover Total assets
$126,000
$80,000
1.575x
=
=
=
e.
Net income Sales
Return on assets (investments) Sales Total assets
8.33% 1.575x
13.12%
= ´
= ´
=
25. Debt utilization (LO2) A firm has net income before interest and taxes of $193,000 and
interest expense of $28,100.
a. What is the times-interest-earned ratio?
b. If the firm’s lease payments are $48,500, what is the fixed charge coverage?
3-25. Solution:
a.
Income before interest and taxes
Times interest earned Interest
$193,000
$28,100
6.87x
=
=
=
b.
IBIT + Before tax fixed charges
Fixed charge coverage Interest + Fixed charges
$193,000 $48,500
$28,100 $48,500
$241,500
$76,600
3.15x
=
+
=+
=
=
26. Return on assets analysis (LO2) In January 2007, the Status Quo Company was formed.
Total assets were $544,000, of which $306,000 consisted of depreciable fixed assets. Status
Quo uses straight-line depreciation of $30,600 per year, and in 2007 it estimated its fixed
assets to have useful lives of 10 years. Aftertax income has been $29,000 per year each of
the last 10 years. Other assets have not changed since 2007.
a. Compute return on assets at year-end for 2007, 2009, 2012, 2014, and 2016.
(Use $29,000 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 preceding answers? (A comment is all that is necessary.)
3-26. Solution:
Status Quo Company
a.
Income after taxes
Return on assets (investment)= Total assets
The return on assets for Status Quo will increase over time as
the assets depreciate and the denominator gets smaller. Fixed
assets at the beginning of 2007 equal $306,000 with a 10-year
life, which means the depreciation expense will be $30,600
per year. Book values at year-end are as follows:
2007 = $275,400;
2009 = $214,200;
2012 = $122,400;
2014 = $ 61,200;
2016 = -0-
Income after taxes
Return on assets (investment) = Current assets + Fixed assets
2007 = $29,000/$513,400 = 5.65%
2009 = $29,000/$452,200 = 6.41%
2012 = $29,000/$360,400 = 8.05%
2014 = $29,000/$299,200 = 9.69%
2016 = $29,000/$238,000 = 12.18%
3-26. (Continued)
b. The increasing return on assets over time is due solely to the
fact that annual depreciation charges reduce the amount of
investment. The increasing return is in no way due to
operations.
Financial analysts should be aware of the effect of overall
asset age on the return-on-investment ratio and be able to
search elsewhere for indications of operating efficiency when
ROI is very high or very low.
c. As income rises, return on assets will be higher than in part
(b) and would indicate an increase in return partially from
more profitable operations.
27. Trend analysis (LO4) Jolie Foster Care Homes Inc. shows the following data:
Year Net Income Total Assets Stockholders’ Equity Total Debt
20X1 $155,000 $2,390,000 $ 761,000 $1,629,000
20X2 191,000 2,700,000 966,000 1,734,000
20X3 208,000 2,730,000 1,770,000 960,000
20X4 192,000 2,470,000 2,220,000 250,000
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.