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Chapter 14 - Financial Statement Analysis
CHAPTER 14
FINANCIAL STATEMENT ANALYSIS
1.
a. Inventory turnover ratio in 2018
= Cost of Goods Sold
Average Inventories = $2,850
($490 + $480)/2 = 5.876
Chapter 14 - Financial Statement Analysis
h. Return on equity
k. Net cash provided by operating activities. See answer to part c.
2.
a.
Purchase of Bus $ (33,000)
Sale of old equipment 72,000
Cash from Investments $ 39,000
b.
Cash dividend $ (80,000)
Repurchase of stock (55,000)
Cash from financing $ (135,000)
c.
Cash dividend $ (80,000)
Purchase of bus (33,000)
Interest paid on debt (25,000)
Sales of old equipment 72,000
Repurchase of stock (55,000)
Cash payments to suppliers (95,000)
Cash collections from customers 300,000
Total cash flow $ 84,000
3. ROA = (EBIT/Sales) (Sales/Average Total Assets) = Return on Sales ATO
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
4. ABC’s asset turnover must be above the industry average.
5. This transaction would increase the current ratio. The transaction reduces both current
assets and current liabilities by the same amount, but the reduction has a larger
proportionate impact on current liabilities than on current assets. Therefore, the current
ratio would increase.
This transaction would increase the asset turnover ratio. Sales should remain
unaffected, but assets are reduced.
6. c. Inventory increases due to a new (internally developed) product line.
7. c. Interest paid to bondholders.
8. a. Lower bad debt expense will result in higher operating income.
b. Lower bad debt expense will have no effect on operating cash flow until Galaxy
actually collects receivables.
9. a. Certain GAAP rules can be exploited by companies in order to achieve specific
goals, while still remaining within the letter of the law. Aggressive assumptions, such
as lengthening the depreciable life of an asset (which are utilized to boost earnings),
result in a lower quality of earnings.
10. a. Off balance-sheet financing through the use of operating leases is acceptable when
11. a. A warning sign of accounting manipulation is abnormal inventory growth as
13. Use Equation 14.1 to solve for operating ROA:
14. ROE = Tax Burden Interest Burden Margin Turnover Leverage
= .75 .6 .1 2.4 1.25 = .135 = 13.5%
15.
Value of Common Stock
20,000 $20 =
$ 400,000
Retained Earnings
5,000,000
Addition to Retained Earnings
70,000
Book Value
$5,470,000
Book value per share = $5,470,000/20,000 = $273.50
16. a. Economic Value Added = (ROC – Cost of Capital) Total Assets
CFA 1
Answer:
CFA 2
Answer:
CFA 3
Answer:
SmileWhite has the higher quality of earnings for several reasons:
i. SmileWhite amortizes its goodwill over a shorter period than does QuickBrush.
SmileWhite therefore presents more conservative earnings because it has greater
Chapter 14 - Financial Statement Analysis
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
iii. SmileWhite’s bad debt allowance, as a percent of receivables, is greater.
SmileWhite therefore recognizes higher bad-debt expense than does
QuickBrush. If the actual collection experience for the two firms is comparable,
then SmileWhite has the more conservative recognition policy.
CFA 4
Answer:
a. Quick Ratio = Cash + receivables
Current liabilities = $325 + $3,599
$3,945 = .99
d. Earnings Per Share
77.1$
2/)550829(
45$265,1$ =
+
−
=
Average Equity =
2/)803,3$868,2($
+
Chapter 14 - Financial Statement Analysis
CFA 5
Answer:
a. QuickBrush has had higher sales and earnings growth (per share) than
SmileWhite. Margins are also higher. But this does not necessarily mean that
QuickBrush is a better investment. SmileWhite has a higher ROE, which has been
b. QuickBrush’s recent EPS growth has been achieved by increasing book value
per share, not by achieving greater profits per dollar of equity. Since EPS is
equal to (Book value per share ROE), a firm can increase EPS even if ROE is
Chapter 14 - Financial Statement Analysis
CFA 6
Answer:
a. ROE
== Equity
profit Net
Equity
Assets
Assets
Sales
Sales
EBIT
EBIT
profitPretax
profitPretax
profitNet
= Tax burden Interest burden Profit margin Asset turnover Leverage
Tax burden
6335.
805$
510$
ProfitPretax
=== profitNet
805$
Pretax === profit
CFA 8 Answer:
2016
2019
Operating margin = Operating income － Depreciation
Sales
$38 － $3
$542 = 6.45%
$76 － $9
$979 = 6.84%
Asset turnover =
Assets Total
Sales
$542
$245 = 2.2122
$979
$291 = 3.3643
Interest Burden =
onDepreciatincomei Operating
incomePretax
−
$32
$38 － $3 = 0.9143
$67
$76 － $9 = 1.00
Financial Leverage =
Equity 'rsShareholde
Assets Total
$245
$159 = 1.5409
$291
$220 = 1.3227
Income tax rate =
income etaxPr
taxes Income
$13
$32 = 40.63%
$37
$67 = 55.22%
* As ROE can be defined as either (Net Income/Average Equity) or (Net Income/Year-
end Equity), here we use the latter definition for this problem.
Chapter 14 - Financial Statement Analysis
a. Using the DuPont formula:
i. Asset turnover measures the ability of a company to minimize the level of
assets (current or fixed) to support its level of sales. The asset turnover
increased substantially over the period, thus contributing to an increase in the
ROE.
ii. Financial leverage measures the amount of financing, not including equity,
