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Chapter 4: Analysis of Financial Statements
Comprehensive/Spreadsheet Problem
63
Comprehensive/Spreadsheet Problem
Note to Instructors:
The solution to this problem is not provided to students at the back of their text. Instructors
can access the
Excel
file on the textbook’s website.
4-25
Ratio Analysis
2015
2014
Industry
Avga
Liquidity
Current ratio
2.33
2.11
2.7
Asset Management
a. Corrigan's liquidity position has improved from 2014 to 2015; however, its current ratio is still
b. Corrigan's inventory turnover, fixed assets turnover, and total assets turnover have improved
64
Comprehensive/Spreadsheet Problem
Chapter 4: Analysis of Financial Statements
d. Corrigan's profitability ratios have declined substantially from 2014 to 2015, and they are
f. ROE = PM × TA Turnover × Equity Multiplier
2015 2.22% 0.43% 2.31 2.21
g. If Corrigan initiated cost-cutting measures, this would increase its net income. This would
Chapter 4: Analysis of Financial Statements
Integrated Case
65
Integrated Case
4-26
D’Leon Inc., Part II
Financial Statements and Taxes
Part I of this case, presented in Chapter 3, discussed the situation of D’Leon
Inc., a regional snack foods producer, after an expansion program. D’Leon
66
Integrated Case
Chapter 4: Analysis of Financial Statements
Table IC 4.1. Balance Sheets
2016E 2015 2014
Assets
Cash $ 85,632 $ 7,282 $ 57,600
Liabilities and Equity
Accounts payable $ 436,800 $ 524,160 $ 145,600
Chapter 4: Analysis of Financial Statements
Integrated Case
67
Table IC 4.2. Income Statements
2016E 2015 2014
Sales $ 7,035,600 $ 6,034,000 $ 3,432,000
68
Integrated Case
Chapter 4: Analysis of Financial Statements
Table IC 4.3. Ratio Analysis
Industry
2016E 2015 2014 Average
Current 1.2 2.3 2.7
A. Why are ratios useful? What are the five major categories of
ratios?
Answer: [S4-1 through S4-5 provide background information. Then, show
Chapter 4: Analysis of Financial Statements
Integrated Case
69
B. Calculate D’Leon’s 2016 current and quick ratios based on the
projected balance sheet and income statement data. What can
you say about the company’s liquidity positions in 2014, in 2015,
and as projected for 2016? We often think of ratios as being
useful (1) to managers to help run the business, (2) to bankers for
credit analysis, and (3) to stockholders for stock valuation. Would
these different types of analysts have an equal interest in these
liquidity ratios? Explain your answer.
Answer: [Show S4-8 and S4-9 here.]
Current ratio16 = Current assets/Current liabilities
C. Calculate the 2016 inventory turnover, days sales outstanding
(DSO), fixed assets turnover, and total assets turnover. How does
D’Leon’s utilization of assets stack up against other firms in the
industry?
Answer: [Show S4-10 through S4-15 here.]
70
Integrated Case
Chapter 4: Analysis of Financial Statements
D. Calculate the 2016 debt-to-capital and times-interest-earned
ratios. How does D’Leon compare with the industry with respect
to financial leverage? What can you conclude from these ratios?
Answer: [Show S4-16 and S4-17 here.]
Debt-to-capital ratio16 = Total debt/Total invested capital
Chapter 4: Analysis of Financial Statements
Integrated Case
71
E. Calculate the 2016 operating margin, profit margin, basic earning
power (BEP), return on assets (ROA), return on equity (ROE), and
return on invested capital (ROIC). What can you say about these
ratios?
Answer: [Show S4-18 through S4-24 here.]
Operating margin16 = EBIT/Sales
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Integrated Case
Chapter 4: Analysis of Financial Statements
F. Calculate the 2016 price/earnings ratio and market/book ratio.
Do these ratios indicate that investors are expected to have a high
or low opinion of the company?
Answer: [Show S4-25 and S4-26 here.]
EPS16 = Net income/Shares outstanding
G. Use the DuPont equation to provide a summary and overview of
D’Leon’s financial condition as projected for 2016. What are the
firm’s major strengths and weaknesses?
Answer: [Show S4-27 and S4-28 here.]
DuPont equation =
margin
Profit
turnover
assets Total
multiplier
Equity
Chapter 4: Analysis of Financial Statements
Integrated Case
73
H. Use the following simplified 2016 balance sheet to show, in
general terms, how an improvement in the DSO would tend to
affect the stock price. For example, if the company could improve
its collection procedures and thereby lower its DSO from 45.6 days
to the 32-day industry average without affecting sales, how would
that change “ripple through” the financial statements (shown in
thousands below) and influence the stock price?
Accounts receivable $ 878 Current liabilities $ 845
Other current assets 1,802 Debt 700
Net fixed assets 817 Equity 1,952
Total assets $3,497 Liabilities plus equity $3,497
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Integrated Case
Chapter 4: Analysis of Financial Statements
Answer: [Show S4-29 through S4-32 here.]
I. Does it appear that inventories could be adjusted? If so, how
should that adjustment affect D’Leon’s profitability and stock
price?
Answer: The inventory turnover ratio is low. It appears that the firm either
has excessive inventory or some of the inventory is obsolete. If
Chapter 4: Analysis of Financial Statements
Integrated Case
75
J. In 2015, the company paid its suppliers much later than the due
dates; also, it was not maintaining financial ratios at levels called
for in its bank loan agreements. Therefore, suppliers could cut the
company off, and its bank could refuse to renew the loan when it
comes due in 90 days. On the basis of data provided, would you,
as a credit manager, continue to sell to D’Leon on credit? (You
could demand cash on delivery—that is, sell on terms of COD—but
that might cause D’Leon to stop buying from your company.)
Similarly, if you were the bank loan officer, would you recommend
renewing the loan or demanding its repayment? Would your
actions be influenced if in early 2016 D’Leon showed you its 2016
projections along with proof that it was going to raise more than
$1.2 million of new equity?
Answer: While the firm’s ratios based on the projected data appear to be
improving, the firm’s current asset ratio is low. As a credit
K. In hindsight, what should D’Leon have done in 2014?
Answer: Before the company took on its expansion plans, it should have
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Integrated Case
Chapter 4: Analysis of Financial Statements
L. What are some potential problems and limitations of financial ratio
analysis?
Answer: [Show S4-33 and S4-34 here.] Some potential problems are listed
below:
M. What are some qualitative factors analysts should consider when
evaluating a company’s likely future financial performance?
Answer: [Show S4-35 here.] Top analysts recognize that certain qualitative
factors must be considered when evaluating a company. These
Chapter 4: Analysis of Financial Statements
Integrated Case
77
