04 Answers to All Problems (1)

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Chapter 4, 13th editionAnalysis of Financial Statements

Learning Objectives

After reading this chapter, students should be able to:

Explain what ratio analysis is.

List the 5 groups of ratios and identify, calculate, and interpret the key ratios in each

group.

Discuss each ratio’s relationship to the balance sheet and incoe stateent.

Discuss why !"E is the key ratio under anageent’s control, how the other ratios

ipact !"E, and explain how to use the Du#ont e$uation for ipro%ing !"E.

&opare a 'r’s ratios with those of other 'rs (bencharking) and analy*e a gi%en

'r’s ratios o%er tie (trend analysis).

Discuss the tendency of ratios to +uctuate o%er tie (which ay or ay not be

probleatic), explain how they can be in+uenced by accounting practices as well asother factors, and why they ust be used with care.

Chapter 4 Analysis of Financial Statements Learning Objectives 4!

" #$13 Cengage Learning% All &ights &eserved% 'ay not be copied, scanned, or d(plicated, in )hole or in part, e*ceptfor (se as permitted in a license distrib(ted )ith a certain prod(ct or service or other)ise on a pass)ord+protected)ebsite for classroom (se%



Lect(re S(ggestions

&hapter shows how 'nancial stateents are analy*ed to deterine the 'r’ strengths andweaknesses. "n the basis of this inforation, anageent can take actions to exploit the

'r’s strengths and correct its weaknesses.At -lorida, we 'nd a signi'cant dierence in preparation between our accounting and

non/accounting students. 0he accountants are relati%ely failiar with 'nancial stateents,and they ha%e co%ered in depth in their 'nancial accounting course any of the ratiosdiscussed in &hapter . 1e pitch our lectures to the non/accountants, which eansconcentrating on the use of stateents and ratios, and the 2big picture,3 rather than ondetails such as seasonal ad4ustents and the eects of dierent accounting procedures.Details are iportant, but so are general principles, and there are courses other than theintroductory 'nance course where details can be addressed.

1hat we co%er, and the way we co%er it, can be seen by scanning the slides andntegrated &ase solution for &hapter , which appears at the end of this chapter’s solutions.-or other suggestions about the lecture, please see the 2Lecture 6uggestions3 in &hapter 7,where we describe how we conduct our classes.

A-S O. C/A02& 3 OF ! A-S !$+min(te periods5

4 Lecture Suggestions Chapter 4 Analysis of Financial Statements




Ans)ers to 2nd+of+Chapter 6(estions

4+1 0he ephasis of the %arious types of analysts is by no eans unifor nor should itbe. 8anageent is interested in all types of ratios for two reasons. -irst, the ratios

point out weaknesses that should be strengthened9 second, anageent recogni*esthat the other parties are interested in all the ratios and that 'nancial appearancesust be kept up if the 'r is to be regarded highly by creditors and e$uity in%estors.E$uity in%estors (stockholders) are interested priarily in pro'tability, but theyexaine the other ratios to get inforation on the riskiness of e$uity coitents.&redit analysts are ore interested in the debt, 0E, and E0DA co%erage ratios, aswell as the pro'tability ratios. 6hort/ter creditors ephasi*e li$uidity and look ostcarefully at the current ratio.

4+# 0he in%entory turno%er ratio is iportant to a grocery store because of the uchlarger in%entory re$uired and because soe of that in%entory is perishable. Aninsurance copany would ha%e no in%entory to speak of since its line of business isselling insurance policies or other siilar 'nancial products;contracts written on

paper and entered into between the copany and the insured. 0his $uestiondeonstrates that the student should not take a routine approach to 'nancialanalysis but rather should exaine the business that he or she is analy*ing beforeconducting a ratio analysis.

4+3 <i%en that sales ha%e not changed, a decrease in the total assets turno%er eansthat the copany’s assets ha%e increased. Also, the fact that the 'xed assetsturno%er ratio reained constant iplies that the copany increased its currentassets. 6ince the copany’s current ratio increased, and yet, its cash ande$ui%alents and D6" are unchanged eans that the copany has increased itsin%entories. 0his is also consistent with a decline in the total assets turno%er ratio.

4+4 Dierences in the aounts of assets necessary to generate a dollar of sales cause

asset turno%er ratios to %ary aong industries. -or exaple, a steel copany needsa greater nuber of dollars in assets to produce a dollar in sales than does a grocerystore chain. Also, pro't argins and turno%er ratios ay %ary due to dierences inthe aount of expenses incurred to produce sales. -or exaple, one would expect agrocery store chain to spend ore per dollar of sales than does a steel copany."ften, a high turno%er will be associated with a low pro't argin, and %ice %ersa.

4+! n+ation will cause earnings to increase, e%en if there is no increase in sales %olue. =et, the book %alue of the assets that produced the sales and the annual depreciationexpense reain at historic %alues and do not re+ect the actual cost of replacingthose assets. 0hus, ratios that copare current +ows with historic %alues becoedistorted o%er tie. -or exaple, !"A will increase e%en though those assets aregenerating the sae sales %olue.

1hen coparing dierent copanies, the age of the assets will greatly aect theratios. &opanies with assets that were purchased earlier will re+ect lower asset%alues than those that purchased assets later at in+ated prices. 0wo 'rs withsiilar physical assets and sales could ha%e signi'cantly dierent !"As. >nderin+ation, ratios will also re+ect dierences in the way 'rs treat in%entories. As canbe seen, in+ation aects both incoe stateent and balance sheet ites.

Chapter 4 Analysis of Financial Statements Answers and Solutions 47




4+ !"E is calculated as the return on assets ultiplied by the e$uity ultiplier. 0hee$uity ultiplier, de'ned as total assets di%ided by coon e$uity, is a easure ofdebt utili*ation9 the ore debt a 'r uses, the lower its e$uity, and the higher thee$uity ultiplier. 0hus, using ore debt will increase the e$uity ultiplier, resultingin a higher !"E.

4+7 a% &ash, recei%ables, and in%entories, as well as current liabilities, %ary o%er the yearfor 'rs with seasonal sales patterns. 0herefore, those ratios that exainebalance sheet 'gures will %ary unless a%erages (onthly ones are best) are used.

b% &oon e$uity is deterined at a point in tie, say Deceber ?@, 7@7. #ro'tsare earned o%er tie, say during 7@7. f a 'r is growing rapidly, year/ende$uity will be uch larger than beginning/of/year e$uity, so the calculated rate of return on e$uity will be dierent depending on whether end/of/year, beginning/of/year, or a%erage coon e$uity is used as the denoinator. A%erage coone$uity is conceptually the best 'gure to use. n public utility rate cases, peopleare reported to ha%e deliberately used end/of/year or beginning/of/year e$uity toake returns on e$uity appear excessi%e or inade$uate. 6iilar probles canarise when a 'r is being e%aluated.

4+8 -irs within the sae industry ay eploy dierent accounting techni$ues thatake it diBcult to copare 'nancial ratios. 8ore fundaentally, coparisons aybe isleading if 'rs in the sae industry dier in their other in%estents. -orexaple, coparing #epsico and &oca/&ola ay be isleading because apart frotheir soft drink business, #epsi also owns other businesses, such as -rito/Lay.

4+9 0he three coponents of the Du#ont e$uation are pro't argin, assets turno%er, andthe e$uity ultiplier. "ne would not expect the three coponents of the discounterchandiser and high/end erchandiser to be the sae e%en though their !"Es areidentical. 0he discount erchandiser’s pro't argin would be lower than the high/end erchandiser, while the assets turno%er would be higher for the discounterchandiser than for the high/end erchandiser.

4+1$ A re%iew of =ahooC -inance on @?@@ showed that the trailing twel%e/onth #E ratiofor Apple was @5.@7 copared to @.5 for 1alart. 0he #E ratio indicates howuch in%estors are willing to pay per dollar of reported pro'ts. Apple’s higher #Eratio indicates that it has strong growth prospects, while 1alart’s lower #E ratioindicates that it is a slower growing 'r. 1alart is a ature copany in a atureindustry so the fact that its #E ratio is lower than Apple’s is not surprising.

4+11 0otal &urrent Eect on&urrent Assets !atio Fet ncoe

a% &ash is ac$uired through issuance of additionalcoon stock. G G

b% 8erchandise is sold for cash. G G G

c% -ederal incoe tax due for the pre%ious year is paid. H G

d% A 'xed asset is sold for less than book %alue. G G H

e% A 'xed asset is sold for ore than book %alue. G G G

f% 8erchandise is sold on credit. G G G

48 Answers and Solutions Chapter 4 Analysis of Financial Statements




g% #ayent is ade to trade creditors forpre%ious purchases. H G

h% A cash di%idend is declared and paid. H H

0otal &urrent Eect on&urrent Assets !atio Fet ncoe

i% &ash is obtained through short/ter bank loans. G H

j% 6hort/ter notes recei%able are sold at a discount. H H H

:% 8arketable securities are sold below cost. H H H

l% Ad%ances are ade to eployees.

m% &urrent operating expenses are paid. H H H

n% 6hort/ter proissory notes are issued to trade creditorsin exchange for past due accounts payable.

o% @/year notes are issued to pay o accounts payable. G

p% A fully depreciated asset is retired. ;% Accounts recei%able are collected.

r% E$uipent is purchased with short/ter notes. H

s% 8erchandise is purchased on credit. G H

t% 0he estiated taxes payable are increased. H H

Chapter 4 Analysis of Financial Statements Answers and Solutions 49




Sol(tions of 2nd+of+Chapter 0roblems

4+1 D6" I days9 6 I JK,?,9 A! I

D6"I

?M5

6A!

I?M5,?,KJ

A!

I A!J7,A! I JN,.

4+# AE I 7.9 DA I

5N.??OI.5N??IA

D

7.

@ @I

A

DAE

@ @I

A

D

−

−

4+3 !"A I @O9 #8 I 7O9 !"E I @5O9 60A I 9 0AE I !"A I F0A9 #8 I F69 !"E I FE.

!"A I #8 × 60A

F0A I F6 × 60A

@O I 7O× 60A60A I 5.

!"E I #8 × 60A × 0AE

FE I F6 × 60A × 0AE

@5O I 7O × 5 × 0AE

@5O I @O × 0AE

0AE I @.5.

4+4 0A I J@,,,9 &L I J@,,,9 L0 debt I J?,,,9 &E IJM,,,9 6hares outstanding I N,,9 # I J?79 8 I

ook %alue I ,,N

,,,MJ I JK.5.

8 I5.KJ

.?7J I .7MMK.

!$ Answers and Solutions Chapter 4 Analysis of Financial Statements




4+! E#6 I J7.9 P#6 I J79 8 I @.7×9 #E I

8 I @.7Q#J7 I @.7Q

# I J7..

#E I J7.J7. I @7.×.

4+ F6 I 7O9 0AE I 7.9 6ales I J@,,9 Assets I J5,,9 !"E I

!"EI F6 × 60A × 0AE

I 7O × J@,,J5,, × 7

I NO.

4+7 6tep @:&alculate total assets fro inforation gi%en.6ales I JM illion.

?.7× I 6ales0A

?.7× IAssets

,,MJ

Assets I J@,NK5,.

6tep 7:&alculate net incoe.

0here is 5O debt and 5O e$uity, so E$uity I J@,NK5, × .5 I J?K,5.

!"E I F6 × 60A × 0AE

.@7 I FJM,, × ?.7 × J@,NK5,J?K,5

.@7 I,,MJ

F.M

JK7, I M.FJ@@7,5 I F.

4+8 !"A I NO9 Fet incoe I JM,9 0A I

!"AI 0A

F

NOI 0A

,MJ

0A I JK,5,.

0o calculate E#, we still need E0. 0o calculate E0 construct a partial incoestateent:

E0 J@,@N,KK J775, G J7?,KKnterest 775, (<i%en)E0 J 7?,KK JM,.M5

0axes (?5O) ?7?,KKF J M,

Chapter 4 Analysis of Financial Statements Answers and Solutions !1




E# I 0A

E:0

I,5,KJ

KK,@N,@J

I .@5?@ I @5.?@O.

4+9 6tockholders’ e$uity I J?,K5,,9 8 I @.9 # I 0otal arket %alue I J?,K5,,(@.) I JK,@75,,.8arket %alue per share I JK,@75,,5,, I [email protected].

Alternati%e solution:6tockholders’ e$uity I J?,K5,,9 6hares outstanding I 5,,9 # I ook %alue per share I J?,K5,,5,, I JK5.8arket %alue per share I JK5(@.) I [email protected].

4+1$ 1e are gi%en !"A I ?O and 6ales0otal assets I @.5×.

-ro the Du#ont e$uation: !"A I #ro't argin × 0otal assets turno%er

?O I #ro't argin(@.5)#ro't argin I [email protected] I 7O.

1e can also calculate the copany’s debt/to/assets ratio in a siilar anner, gi%enthe facts of the proble. 1e are gi%en !"A(FA) and !"E(FE)9 if we use thereciprocal of !"E we ha%e the following e$uation:

O.I.I.M@IA

D

.MOIA

E

.5

@ ?OI

A

E

so,A

E @I

A

D and

F

E

A

F I

A

E

−

×

−×

Alternati%ely, using the Du#ont e$uation:

!"E I !"A × 0AE

5O I ?O × 0AE

0AE I 5O?O I 5?.

0ake reciprocal: E0A I ?5 I MO9 therefore, DA I @ H .M I . I O.

0hus, the 'r’s pro't argin I 7O and its debt/to/assets ratio I O.

!# Answers and Solutions Chapter 4 Analysis of Financial Statements




4+11 0A I J@7,,,9 0 I O9 E00A I @5O9 !"A I 5O9 0E I

,,,@7J

E:0I .@5

E0 I J@,N,,.

,,,@7JF I .5

F I JM,,.

Fow use the incoe stateent forat to deterine interest so you can calculate the'r’s 0E ratio.

E0 J@,N,, 6ee abo%e.

F0 N,,

E0 J@,,, E0 I JM,,.M

0axes (O) ,,

F J M,, 6ee abo%e.

0E I E0F0I J@,N,,JN,,I 7.75Q.

4+1# 0E I E0F0, so 'nd E0 and F0.

nterest I J5, × .@ I J5,.

Fet incoe I J7,, × .5 I J@,.

#re/tax incoe (E0) I J@,(@ H 0) I J@,.K I J@7,N5K.E0 I E0 G nterest I J@7,N5K G J5, I J@7,N5K.

0E I J@7,N5KJ5, I ?.NM×.

4+13 !"EI #ro't argin × 0A turno%er × E$uity ultiplier

I F6ales × 6ales0A × 0AE$uity.

Fow we need to deterine the inputs for the Du#ont e$uation fro the data thatwere gi%en. "n the left we set up an incoe stateent, and we substitute %alues onthe right:

6ales (gi%en) J@,,H &ost naE0 (gi%en) J @,,H F0 (gi%en) ?,E0 J K,

H 0axes (?O) 7?N,F J M7,

Fow we can use soe ratios to get additional data:

0otal assets turno%er I 7 I 60A9 0A I 67 I J@,,7 I J5,,.

DA I MO9 so EA I O9 and, therefore,

E$uity ultiplier I 0AE I @(EA) I @. I 7.5.



F0I E0 H E0I J@,N,, H J@,,,



Fow we can coplete the Du#ont e$uation to deterine !"E:

!"E I JM7,J@,, × J@,,J5,, × 7.5 I .7?@ I 7?.@O.

4+14 &urrently, !"E is !"E@ I J@5,J7, I K.5O.

0he current ratio will be set such that 7.5 I &A&L. &L is J5,, and it will notchange, so we can sol%e to 'nd the new le%el of current assets: &A I 7.5(&L) I7.5(J5,) I J@75,. 0his is the le%el of current assets that will produce a

current ratio of 7.5×.

At present, current assets aount to J7@,, so they can be reduced byJ7@, H J@75, I JN5,. f the JN5, generated is used to retire coone$uity, then the new coon e$uity balance will be J7, H JN5, IJ@@5,.

Assuing that net incoe is unchanged, the new !"E will be !"E7 IJ@5,J@@5, I @?.O. 0herefore, !"E will increase by @?.O H K.5O I5.5O.

0he new &A le%el is J@75,9 &L reain at J5,9 and the new n%entory le%elI J@5, H JN5, I JM5,. 0hus, the new $uick ratio is calculated as follows:

Few $uick ratio I&L

5n%&A−

I,5J

,M5J,@75J −

I @.7×.

4+1! Rnown data:

0A I J@,,9 nt. rate I NO9 0 I O9 E# I .7 I E00otal assets, so E0 I.7(J@,,) I J7,9 DA I .5 I 5O, so E$uity I J5,.

DA I O DA I 5O

E0 J7, J7,nterest ,SE0 J7, J@M,

0ax (O) N, M,F J@7, J M,

!"E IE$uity

F I

J@,,

J@7, I @7O

J5,

JM, I @.7O

Dierence in !"E I @.7O H @7.O I K.7O.

Sf DA I 5O, then half of the assets are 'nanced by debt, so Debt I J5,. Atan NO interest rate, F0 I J5, Q .N I J,.

4+1 6tateent a is correct. !efer to the solution setup for #roble /@5 and think aboutit this way: (@) Adding assets will not aect coon e$uity if the assets are 'nancedwith debt. (7) Adding assets will cause expected E0 to increase by the aount E0I E#(added assets). (?) nterest expense will increase by the aount nt.rate(added assets). () #re/tax incoe will rise by the aount (added assets)(E# Hnt. rate). Assuing E# T nt. rate, if pre/tax incoe increases so will net incoe.(5) f expected net incoe increases but coon e$uity is held constant, then the

!4 Answers and Solutions Chapter 4 Analysis of Financial Statements




expected !"E will also increase. Fote that if nt. rate T E#, then adding assets'nanced by debt would lower net incoe and thus the !"E. 0herefore, 6tateent ais true;if assets 'nanced by debt are added, and if the expected E# on thoseassets exceeds the interest rate on debt, then the 'r’s !"E will increase.

6tateents b, c, and d are false, because the E# ratio uses E0, which iscalculated before the eects of taxes or interest charges are felt. "f course,

6tateent e is also false.

4+17 0A I J5,,,9 0 I O9 E00A I @O9 !"A I 5O9 0E

.AAA,AAA,5AAJE:0

@A.A,AAAJ5,AAA,AAA

E:0

=

=

.AAA,AAA,75AJF

A5.A,AAAJ5,AAA,AAA

F

=

=

Fow use the incoe stateent forat to deterine interest so you can calculate the'r’s 0E ratio.

E0 J5,, 6ee abo%e.F0 N?,???,???E0 J@M,MMM,MMK E0 I J75,,.M

0axes (O) @MM,MMM,MMKF J75,, 6ee abo%e.

0E I E0F0I J5,,JN?,???,???I M.Q.

4+18 #resent current ratio IJ575,

J@,?@7,5 I 7.5.

8iniu current ratio IF#GJ575,

F#GJ@,?@7,5

∆∆

I 7..

J@,?@7,5 G ∆F# I J@,5, G 7∆F#

∆F# I J7M7,5.

6hort/ter debt can increase by a axiu of J7M7,5 without %iolating a 7/to/@current ratio, assuing that the entire increase in notes payable is used to increasecurrent assets. 6ince we assued that the additional funds would be used to

increase in%entory, the in%entory account will increase to JM?K,5 and currentassets will total J@,5K5,, and current liabilities will total JKNK,5.

Chapter 4 Analysis of Financial Statements Answers and Solutions !!


F0 I E0 H E0I J5,, H



4+19 6tep @:6ol%e for current annual sales using the D6" e$uation:

55 I JK5,(6ales?M5)556ales I J7K?,K5, 6ales I J,KK,7K7.K?.

6tep 7:f sales fall by @5O, the new sales le%el will be J,KK,7K7.K?(.N5) I

J,7?,[email protected]. Again, using the D6" e$uation, sol%e for the new accountsrecei%able 'gure as follows:

?5I A!(J,7?,[email protected]?M5)?5I A!J@@,5.@A! I J5,[email protected] ≈ J5,MN7.

4+#$ 0he current E#6 is J7,,5, shares or J.. 0he current #E ratio is thenJJ I @.. 0he new nuber of shares outstanding will be M5,. 0hus, thenew E#6 I J?,75,M5, I J5.. f the shares are selling for @ ties E#6,then they ust be selling for J5.(@) I J5.

4+#1 @. 0otal debt I (.5)(0otal assets) I (.5)(J?,) I J@5,.

7. Accounts payable I 0otal debt H Long/ter debt I J@5, H JM,I J,.

?. &oon stock Ie$uityand

sliabilitie 0otal H 0otal debt H !etained earnings

I J?, H J@5, H JK,5 I J57,5.

. 6ales I (@.5)(0otal assets) I (@.5)(J?,) I J5,.

5. n%entories I 6ales5 I J5,5 I J,.

M. Accounts recei%able I (6ales?M5)(D6") I (J5,?M5)(?M.5) I J5,.

K. &ash G Accounts recei%able G n%entories I (@.N)(Accounts payable)&ash G J5, G J, I (@.N)(J,)

&ash G J@?5, I J@M7,&ash I J7K,.

N. -ixed assets I 0otal assets H (&ash G Accts rec. G n%entories)I J?, H (J7K, G J5, G J,)I J@?N,.

. &ost of goods sold I (6ales)(@ H .75) I (J5,)(.K5) I J??K,5.

! Answers and Solutions Chapter 4 Analysis of Financial Statements




4+## a% (Dollar aounts in thousands.)ndustry

-ir A%erage

ratio&urren

Isliabilitie&urrent

assets&urrentI

,??J

,M55JI @.N× 7.×

ratioUuick Isliabilitie&urrent

5n%entoriassets&urrent−

I,??J

5,7@J5,M5J − I @.75Q @.?Q

D6" I5?M6ales

recei%ablAccountsI

@@.J,

,??MJI

KM.?days

?5days

turno%e5n%entor

Is5n%entorie

6alesI

5,7@J

5,MK,@JI M.MM× M.K×

turno%e A. 0.

Iasset 0otal

6alesI

5,DKJ

5,MK,@JI @.K× ?.×

argi#ro't

I

6ales

incoeFetI

J@,MK,5

J7K,?I @.KO @.7O

!"A Iasset 0otal

incoeFetI

5K,DJ

?,7KJI 7.O ?.MO

!"E Ie$uity&oon

incoeFetI

,?M@J

?,7KJI K.MO .O

ratiDeb

Iasset 0otal

debt 0otalI

5,DKJ

5,5NMJI [email protected] M.O

b% -or the 'r,

!"E I F6 × 60A × 0AE I @.KO × @.K × J?M@,

JK,5 I K.MO.

-or the industry, !"E I @.7O × ? × 7.5 I O.

Fote: 0o 'nd the industry ratio of assets to coon e$uity, recogni*e that @ H(0otal debt0otal assets) I &oon e$uity0otal assets. 6o, &oon e$uity0otalassets I O, and @. I 7.5 I 0otal assets&oon e$uity.

c% 0he 'r’s days sales outstanding ratio is ore than twice as long as the industrya%erage, indicating that the 'r should tighten credit or enforce a ore stringentcollection policy. 0he total assets turno%er ratio is well below the industrya%erage so sales should be increased, assets decreased, or both. 1hile thecopany’s pro't argin is higher than the industry a%erage, its other pro'tability

ratios are low copared to the industry;net incoe should be higher gi%en theaount of e$uity and assets. Vowe%er, the copany sees to be in an a%erageli$uidity position and 'nancial le%erage is siilar to other 'rs in the industry.

d% f 7@7 represents a period of supernoral growth for the 'r, ratios based onthis year will be distorted and a coparison between the and industry a%erageswill ha%e little eaning. #otential in%estors who look only at 7@7 ratios will beisled, and a return to noral conditions in 7@? could hurt the 'r’s stockprice.





4+#3 a% ndustry-ir A%erage

&urrent ratio Isliabilitie&urrent

assets&urrentI

J@@@

J??I 7.K?× 7×

assetstotal

todebt 0otalI

assets 0otal

debt 0otalI

J5

J@?5I ?.O

?.

O

earnedinteres 0ies

I5nterest

E:50I

J.5

JD.5I @@× K×

co%eragE:50DA

I

pyLeas

pyts#rinc. 5F0

pyLeaseE:50DA

++

+

I5.MJ

5.M@JI .M× ×

turno%er5n%entor

Is5n%entorie

6alesI

J@5

JK5I 5× @×

D6" I

5?M6ales

recei%ablAccountsI

JK5?M

JMMI

?.?

days

7

days

turno%e A.-.

Iassets'xedFet

6alesI

J@K

JK5I 5.@× M×

turno%e A. 0.

Iassets 0otal

6alesI

J5

JK5I @.KK× ?×

#ro't argin I6ales

incoeFetI

JK5

J7KI ?.O ?.O

assettotal

on!eturnI

assets 0otal

incoeFetI

J5

J7KI M.O .O

e$uitcoonon!eturn

I!"A × E8

IMO ×

@.7NMI N.5KO

@7.NMO

Alternati%ely, !"E IE$uity

incoFetIJ?@5

J7K I N.5KO ≈ N.MO.

b% !"EI #ro't argin × 0otal assets turno%er × E$uity ultiplier

I6ales

incoFet×

asset 0otal

6ales ×

e$uity&oon

assets 0otal

IJK5

J7K × J5

JK5 × J?@5

J5 I ?.O × @.KK × @.7NM I N.MO.

!8 Answers and Solutions Chapter 4 Analysis of Financial Statements




-ir ndustry &oent#ro't argin ?.O ?.O <ood

0otal assets turno%er @.KK× ?.× #oor

E$uity ultiplier @.7NM @.7NMS ".R.

S @ H 0A

DI 0A

E

@ H .? I .K

E8 IE

0AI

K.

@ I @.7NM ≈ @.?.

Alternati%ely, E8 I !"E!"A I @7.NMOO I @.7N ≈ @.?.

c% Analysis of the Du#ont e$uation and the set of ratios shows that the turno%er ratioof sales to assets is $uite low. Either sales should be higher gi%en the presentle%el of assets, or the 'r is carrying ore assets than it needs to support itssales.

d% 0he coparison of in%entory turno%er ratios shows that other 'rs in the industrysee to be getting along with about half as uch in%entory per unit of sales as

the 'r. f the copany’s in%entory could be reduced, this would generate fundsthat could be used to retire debt, thus reducing interest charges and ipro%ingpro'ts, and strengthening the debt position. 0here ight also be soe excessin%estent in 'xed assets, perhaps indicati%e of excess capacity, as shown by aslightly lower/than/a%erage 'xed assets turno%er ratio. Vowe%er, this is notnearly as clear/cut as the o%erin%estent in in%entory.

e% f the 'r had a sharp seasonal sales pattern, or if it grew rapidly during the year,any ratios ight be distorted. !atios in%ol%ing cash, recei%ables, in%entories,and current liabilities, as well as those based on sales, pro'ts, and coone$uity, could be biased. t is possible to correct for such probles by usinga%erage rather than end/of/period 'gures.





Comprehensive<Spreadsheet 0roblem

Note to Instructors:he sol(tion to this problem is not provided to st(dents at the bac: of their te*t%

=nstr(ctors can access the Excel >le on the te*tboo:?s )ebsite or the =nstr(ctor?s&eso(rce C%

4+#4

Ratio Analysis 2012 2011 Industry Avga

Liquidity

Current ratio 2.33 2.11 2.7

Asset Management

Inventory turnoverb 4.74 4.47 7.0

Days sales outstandingc 37.79 32.94 32

Fied assets turnoverb 9.!4 7.!9 13.0

"otal assets turnoverb 2.31 2.1! 2.#

Profitability

Return on assets 1.00$ %.7#$ 9.1$

Return on e&uity 2.22$ 11.47$ 1!.2$

'ro(it )argin 0.43$ 2.#4$ 3.%$

Debt Management

Debt*to*assets ratio %4.!1$ 49.!1$ %0.0$

Market Value

'+, ratio 1%.43 %.#% #.0

a Industry average ratios -ave been constant (or t-e ast 4 years.

b

/ased on year*end balance s-eet (igures.c Calculation is based on a 3#%*day year.

a% &orriganWs li$uidity position has ipro%ed fro 7@@ to 7@79 howe%er, its currentratio is still below the industry a%erage of 7.K.

b% &orriganWs in%entory turno%er, 'xed assets turno%er, and total assets turno%erha%e ipro%ed fro 7@@ to 7@79 howe%er, they are still below industrya%erages. 0he 'rWs days sales outstanding ratio has increased fro 7@@ to7@7;which is bad. n 7@@, its D6" was close to the industry a%erage. n 7@7,its D6" is soewhat higher. f the 'rWs credit policy has not changed, it needsto look at its recei%ables and deterine whether it has any uncollectibles. f itdoes ha%e uncollectible recei%ables, this will ake its current ratio look worse

than what was calculated abo%e.

c% &orriganWs debt ratio has increased fro 7@@ to 7@7, which is bad. n 7@@, itsdebt ratio was right at the industry a%erage, but in 7@7 it is higher than theindustry a%erage. <i%en its weak current and asset anageent ratios, the 'rshould strengthen its balance sheet by paying down liabilities.

$ ComprehensiveSpreadsheet !roblem Chapter 4 Analysis of FinancialStatements




d% &orriganWs pro'tability ratios ha%e declined substantially fro 7@@ to 7@7, andthey are substantially below the industry a%erages. &orrigan needs to reduce itscosts, increase sales, or both.

e% &orriganWs #E ratio has increased fro 7@@ to 7@7, but only because its netincoe has declined signi'cantly fro the prior year. ts #E ratio re+ects the

sae inforation as &orriganWs pro'tability ratios. &orrigan needs to reduce coststo increase pro't, lower its debt ratio, increase sales, and ipro%e its assetanageent.

f% &O2 @ 0' A (rnover 2;(ity '(ltiplier7@7 7.77O .?O 7.?@ 7.7@7@@ @@.KO 7.MO 7.@N @.ndustry A%g. @N.7O ?.5O 7.M 7.

Looking at the Du#ont e$uation, &orriganWs pro't argin is signi'cantly lowerthan the industry a%erage and it has declined substantially fro 7@@ to 7@7.

0he 'rWs total assets turno%er has ipro%ed slightly fro 7@@ to 7@7, but itWsstill below the industry a%erage. 0he 'rWs e$uity ultiplier has increased fro7@@ to 7@7 and is higher than the industry a%erage. 0his indicates that the'rWs debt ratio is increasing.

&orrigan should increase its net incoe by reducing costs, lower its debt ratio,and ipro%e its asset anageent by either using less assets for the saeaount of sales or by increasing sales.

g% f &orrigan initiated cost/cutting easures, this would increase its net incoe. 0his would ipro%e its pro'tability ratios and arket %alue ratios. f &orrigan alsoreduced its in%entory le%els, this would ipro%e its current ratio;as this wouldreduce liabilities as well. 0his would also ipro%e its in%entory turno%er and totalassets turno%er ratios. !educing costs and lowering in%entory would also ipro%eits debt ratio.

Chapter 4 Analysis of Financial StatementsComprehensiveSpreadsheet !roblem1




=ntegrated Case

4+#!

?Leon =nc%, 0art =="inancial Statements and #axes

0art = of this case, presented in Chapter 3, disc(ssed the sit(ation of

?Leon =nc%, a regional snac: foods prod(cer, after an e*pansion

program% ?Leon had increased plant capacity and (nderta:en a

major mar:eting campaign in an attempt to Bgo national% h(s far,

sales have not been (p to the forecasted level, costs have been

higher than )ere projected, and a large loss occ(rred in #$1# rather

than the e*pected pro>t% As a res(lt, its managers, directors, and

investors are concerned abo(t the >rm?s s(rvival%

onna Damison )as bro(ght in as assistant to Fred Campo,

?Leon?s chairman, )ho had the tas: of getting the company bac:

into a so(nd >nancial position% ?Leon?s #$11 and #$1# balance

sheets and income statements, together )ith projections for #$13,

are given in ables =C 4%1 and =C 4%#% =n addition, able =C 4%3 gives

the company?s #$11 and #$1# >nancial ratios, together )ith

ind(stry average data% he #$13 projected >nancial statement data

represent Damison?s and Campo?s best g(ess for #$13 res(lts,

ass(ming that some ne) >nancing is arranged to get the company

Bover the h(mp%

Damison e*amined monthly data for #$1# not given in the case5,

and she detected an improving pattern d(ring the year% 'onthly

sales )ere rising, costs )ere falling, and large losses in the earlymonths had t(rned to a small pro>t by ecember% h(s, the ann(al

data loo: some)hat )orse than >nal monthly data% Also, it appears

to be ta:ing longer for the advertising program to get the message

o(t, for the ne) sales oEces to generate sales, and for the ne)

# Integrated Case Chapter 4 Analysis of Financial Statements




man(fact(ring facilities to operate eEciently% =n other )ords, the

lags bet)een spending money and deriving bene>ts )ere longer

than ?Leon?s managers had anticipated% For these reasons,

Damison and Campo see hope for the companyprovided it can

s(rvive in the short r(n%

Damison m(st prepare an analysis of )here the company is no),

)hat it m(st do to regain its >nancial health, and )hat actions

sho(ld be ta:en% -o(r assignment is to help her ans)er the

follo)ing ;(estions% 0rovide clear e*planations, not yes or no

ans)ers%

able =C 4%1% Galance Sheets

#$132 #$1# #$11

Assets

Cash H 8!,3# H 7,#8# H !7,$$

Acco(nts receivable 878,$$$ 3#,1$ 3!1,#$$

=nventories 1,71,48$ 1,#87,3$ 71!,#$$

otal c(rrent assets H#,8$,11# H1,9#,8$# H1,1#4,$$$

Iross >*ed assets 1,197,1$ 1,#$#,9!$ 491,$$$

Less acc(m(lated depreciation 38$,1#$ #3,1$ 14,#$$

.et >*ed assets H 817,$4$ H 939,79$ H 344,8$$otal assets H 3,497,1!# H #,8,!9# H

1,48,8$$

Liabilities and E$uit%

Acco(nts payable H 43,8$$ H !#4,1$ H 14!,$$

.otes payable 3$$,$$$ 3,8$8 #$$,$$$

Accr(als 4$8,$$$ 489,$$13,$$$

otal c(rrent liabilities H1,144,8$$ H1,!$,!8 H481,$$

Long+term debt 4$$,$$$ 7#3,43# 3#3,43#

Common stoc: 1,7#1,17 4$,$$$ 4$,$$$

&etained earnings #31,17 3#,!9# #$3,78

otal e;(ity H 1,9!#,3!# H 49#,!9# H3,78

otal liabilities and e;(ity H 3,497,1!# H #,8,!9# H1,48,8$$

Chapter 4 Analysis of Financial Statements Integrated Case 3




.ote B2 indicates estimated% he #$13 data are forecasts%

4 Integrated Case Chapter 4 Analysis of Financial Statements




able =C 4%#% =ncome Statements

#$132 #$1# #$11

Sales H7,$3!,$$ H,$34,$$$ H3,43#,$$$

Cost of goods sold !,87!,99# !,!#8,$$$#,84,$$$

Other e*penses !!$,$$$ !19,988 3!8,7#

otal operating costse*cl(ding deprec% J amort% H ,4#!,99# H ,$47,988 H3,###,7#

2G=A H $9,$8 H 13,9885 H#$9,3#8

eprec% J amort% 11,9$ 11,9$ 18,9$$

2G= H 49#,48 H 13$,9485 H19$,4#8

=nterest e*pense 7$,$$8 13,$1# 43,8#8

2G H 4##,4$ H #,9$5 H14,$$

a*es 4$K5 19,$! 1$,7845a !8,4$

.et income H #!3,!84 H 1$,175 H 87,9$

20S H 1%$14 H 1%$#5 H$%88$

0S H $%##$ H $%11$ H $%##$

Goo: val(e per share H 7%8$9 H 4%9# H %38

Stoc: price H 1#%17 H #%#! H 8%!$

Shares o(tstanding #!$,$$$ 1$$,$$$ 1$$,$$$a* rate 4$%$$K 4$%$$K 4$%$$K

Lease payments 4$,$$$ 4$,$$$ 4$,$$$

Sin:ing f(nd payments $ $ $


a he >rm had s(Ecient ta*able income in #$1$ and #$11 to obtain its f(ll ta* ref(ndin #$1#%

Chapter 4 Analysis of Financial Statements Integrated Case !




able =C 4%3% &atio Analysis

=nd(stry

#$132 #$1# #$11Average

C(rrent 1%#

#%3

#%7

6(ic: $%4 $%8 1%$

=nventory t(rnover 4%7 4%8 %1

ays sales o(tstanding SO5a 38%# 37%4 3#%$

Fi*ed assets t(rnover %4 1$%$ 7%$

otal assets t(rnover #%1 #%3 #%

ebt+to+assets ratio 8#%8K !4%8K !$%$K

=2 +1%$ 4%3 %#

Operating margin +#%#K !%K 7%3K

0ro>t margin +#%7K #%K 3%!K

Gasic earning po)er +4%K 13%$K 19%1K&OA +!%K %$K 9%1K

&O2 +3#%!K 13%3K 18%#K

0rice<earnings +1%4 9%7 14%#

'ar:et<boo: $%! 1%3 #%4

Goo: val(e per share H4%93 H%4 n%a%


a Calc(lation is based on a 3!+day year%

A% hy are ratios (sef(lM hat are the >ve major categories

of ratiosM

Ans)er NS4+1 thro(gh S4+! provide bac:gro(nd information% hen,

sho) S4+ and S4+7 here% &atios are (sed by managers to

help improve the >rm?s performance, by lenders to help

eval(ate the >rm?s li:elihood of repaying debts, and by

stoc:holders to help forecast f(t(re earnings and

dividends% he >ve major categories of ratios are li;(idity,

asset management, debt management, pro>tability, and

mar:et val(e%

Integrated Case Chapter 4 Analysis of Financial Statements




G% Calc(late ?Leon?s #$13 c(rrent and ;(ic: ratios based on

the projected balance sheet and income statement data%

hat can yo( say abo(t the company?s li;(idity positions

in #$11, in #$1#, and as projected for #$13M e often

thin: of ratios as being (sef(l 15 to managers to help r(n

the b(siness, #5 to ban:ers for credit analysis, and 35 to

stoc:holders for stoc: val(ation% o(ld these diPerent

types of analysts have an e;(al interest in these li;(idity

ratiosM

Ans)er NSho) S4+8 and S4+9 here%

C(rrent ratio13 @ C(rrent assets<C(rrent

liabilities

@ H#,8$,11#<H1,144,8$$ @ #%34 %

6(ic: ratio13 @ C(rrent assets Q =nventories5<C(rrent

liabilities

@ H#,8$,11# Q H1,71,48$5<H1,144,8$$

@ H93,3#<H1,144,8$$ @ $%84# %

he company?s c(rrent and ;(ic: ratios are identical toits #$11 c(rrent and ;(ic: ratios, and they have improved

from their #$1# levels% /o)ever, both the c(rrent and

;(ic: ratios are )ell belo) the ind(stry averages%

C% Calc(late the #$13 inventory t(rnover, days sales

o(tstanding SO5, >*ed assets t(rnover, and total assets

t(rnover% /o) does ?Leon?s (tiliRation of assets stac: (p

against other >rms in the ind(stryM

Ans)er NSho) S4+1$ thro(gh S4+1! here%

=nventory t(rnover13 @ Sales<=nventory

@ H7,$3!,$$<H1,71,48$ @ 4%1$ %





SO13 @ &eceivables<Sales<3!5

@ H878,$$$<H7,$3!,$$<3!5 @ 4!%!! days%

Fi*ed assets t(rnover13@ Sales<.et >*ed assets

@ H7,$3!,$$<H817,$4$ @ 8%1 %

otal assets t(rnover13 @ Sales<otal assets

@ H7,$3!,$$<H3,497,1!# @ #%$1 %

he >rm?s inventory t(rnover and total assets t(rnover

ratios have been steadily declining, )hile its days sales

o(tstanding has been steadily increasing )hich is bad5%

/o)ever, the >rm?s #$13 total assets t(rnover ratio is only

slightly belo) the #$1# level% he >rm?s >*ed assetst(rnover ratio is belo) its #$11 level ho)ever, it is above

the #$1# level%

he >rm?s inventory t(rnover and total assets t(rnover

are belo) the ind(stry average% he >rm?s days sales

o(tstanding ratio is above the ind(stry average )hich is

bad5 ho)ever, the >rm?s >*ed assets t(rnover is above

the ind(stry average% his might be d(e to the fact that

?Leon is an older >rm than most other >rms in the

ind(stry, in )hich case, its >*ed assets are older and th(s

have been depreciated more, or that ?Leon?s cost of >*ed

assets )ere lo)er than most >rms in the ind(stry%5

% Calc(late the #$13 debt+to+assets and times+interest+

earned ratios% /o) does ?Leon compare )ith the ind(stry

)ith respect to >nancial leverageM hat can yo( concl(defrom these ratiosM





Ans)er NSho) S4+1 and S4+17 here%

ebt ratio13 @ otal debt<otal assets

@ H1,144,8$$ T H4$$,$$$5<H3,497,1!# @

44%17K%

=213 @ 2G=<=nterest @ H49#,48<H7$,$$8 @ 7%$4 %

he >rm?s debt ratio is m(ch improved from #$1# and

#$11, and it is belo) the ind(stry average )hich is good5%

he >rm?s =2 ratio is also greatly improved from its #$11

and #$1# levels and is above the ind(stry average%

2% Calc(late the #$13 operating margin, pro>t margin, basic

earning po)er G205, ret(rn on assets &OA5, and ret(rn

on e;(ity &O25% hat can yo( say abo(t these ratiosM

Ans)er NSho) S4+18 thro(gh S4+#4 here%

Operating margin13 @ 2G=<Sales

@ H49#,48<H7,$3!,$$ @ 7%$$K%

0ro>t margin13 @ .et income<Sales

@ H#!3,!84<H7,$3!,$$ @ 3%$K%

Gasic earning po)er13 @ 2G=<otal assets

@ H49#,48<H3,497,1!# @ 14%$9K%

&OA13 @ .et income<otal assets

@ H#!3,!84<H3,497,1!# @ 7%#!K%

&O213 @ .et income<Common e;(ity

@ H#!3,!84<H1,9!#,3!# @ 1#%99K 13%$K%

he >rm?s operating margin is above #$11 and #$1#

levels b(t slightly belo) the ind(stry average% he >rm?s

pro>t margin is above #$11 and #$1# levels and slightly

above the ind(stry average% hile the >rm?s basic earning





po)er and &OA ratios are above #$11 and #$1# levels,

they are still belo) the ind(stry averages% he >rm?s &O2

ratio is greatly improved over its #$1# level ho)ever, it is

slightly belo) its #$11 level and still )ell belo) the

ind(stry average%

F% Calc(late the #$13 price<earnings ratio and mar:et<boo:

ratio% o these ratios indicate that investors are e*pected

to have a high or lo) opinion of the companyM

Ans)er NSho) S4+#! and S4+# here%

20S13 @ .et income<Shares o(tstanding@ H#!3,!84<#!$,$$$ @ H1%$143%

0rice<2arnings13@ 0rice per share<2arnings per share

@ H1#%17<H1%$143 @ 1#%$ %

Chec: 0rice @ 20S 0<2 @ H1%$1431#%$5 @ H1#%17%

GU0S13 @ Common e;(ity<Shares o(tstanding

@ H1,9!#,3!#<#!$,$$$ @ H7%81%

'ar:et<Goo: 13 @ 'ar:et price per share<Goo: val(e per

share

@ H1#%17<H7%81 @ 1%! %

he 0<2 and '<G ratios are above the #$1# and #$11

levels b(t belo) the ind(stry average%

I% Vse the (0ont e;(ation to provide a s(mmary and

overvie) of ?Leon?s >nancial condition as projected for#$13% hat are the >rm?s major strengths and

)ea:nessesM

7$ Integrated Case Chapter 4 Analysis of Financial Statements




Ans)er NSho) S4+#7 and S4+#8 here%

(0ont e;(ation @ margi0ro>t

t(rnover

asset1otal

m(ltiplie2;(ity

@ 3%$K #%$1 1<1 Q $%44175

@ 1#%9K 13%$K%

Strengths he >rm?s >*ed assets t(rnover )as above the

ind(stry average% /o)ever, if the >rm?s assets )ere older

than other >rms in its ind(stry this co(ld possibly acco(nt

for the higher ratio% ?Leon?s >*ed assets )o(ld have a

lo)er historical cost and )o(ld have been depreciated for

longer periods of time%5 he >rm?s pro>t margin is slightly

above the ind(stry average, and its debt ratio has been

greatly red(ced, so it is no) belo) the ind(stry average

)hich is good5% his improved pro>t margin co(ld

indicate that the >rm has :ept operating costs do)n as

)ell as interest e*pense as sho)n from the red(ced debt

ratio5% =nterest e*pense is lo)er beca(se the >rm?s debt

ratio has been red(ced, )hich has improved the >rm?s =2

ratio so that it is no) above the ind(stry average%

ea:nesses he >rm?s c(rrent asset ratio is lo) most of

its asset management ratios are poor e*cept >*ed assets

t(rnover5 most of its pro>tability ratios are lo) e*cept

pro>t margin5 and its mar:et val(e ratios are lo)%

/% Vse the follo)ing simpli>ed #$13 balance sheet to sho), in

general terms, ho) an improvement in the SO )o(ld tendto aPect the stoc: price% For e*ample, if the company

co(ld improve its collection proced(res and thereby lo)er

its SO from 4!% days to the 3#+day ind(stry average

)itho(t aPecting sales, ho) )o(ld that change Bripple





thro(gh the >nancial statements sho)n in tho(sands

belo)5 and inW(ence the stoc: priceM

Acco(nts receivable H 878 ebt H1,!4!

Other c(rrent assets 1,8$#

.et >*ed assets 817 2;(ity 1,9!#otal assets H3,497 Liabilities pl(s e;(ity

H3,497

Ans)er NSho) S4+#9 thro(gh S4+3# here%

Sales per day @ H7,$3!,$$<3! @ H19,#7!%#%

Acco(nts receivable (nder ne) policy @ H19,#7!%# 3#

days@ H1,8#$%

Freed cash @ old A<& Q ne) A<&

@ H878,$$$ Q H1,8#$ @ H#1,18$%

&ed(cing acco(nts receivable and its SO )ill initially

sho) (p as an addition to cash% he freed (p cash co(ld

be (sed to rep(rchase stoc:, e*pand the b(siness, and

red(ce debt% All of these actions )o(ld li:ely improve the

stoc: price%

=% oes it appear that inventories co(ld be adj(stedM =f so,

ho) sho(ld that adj(stment aPect ?Leon?s pro>tability

and stoc: priceM

Ans)er he inventory t(rnover ratio is lo)% =t appears that the

>rm either has e*cessive inventory or some of the

inventory is obsolete% =f inventory )ere red(ced, this

)o(ld improve the c(rrent asset ratio, the inventory and

total assets t(rnover, and red(ce the debt ratio even

7# Integrated Case Chapter 4 Analysis of Financial Statements




f(rther, )hich sho(ld improve the >rm?s stoc: price and

pro>tability%

D% =n #$1#, the company paid its s(ppliers m(ch later than

the d(e dates also, it )as not maintaining >nancial ratios

at levels called for in its ban: loan agreements% herefore,

s(ppliers co(ld c(t the company oP, and its ban: co(ld

ref(se to rene) the loan )hen it comes d(e in 9$ days% On

the basis of data provided, )o(ld yo(, as a credit manager,

contin(e to sell to ?Leon on creditM -o( co(ld demand

cash on deliverythat is, sell on terms of COb(t that

might ca(se ?Leon to stop b(ying from yo(r company%5Similarly, if yo( )ere the ban: loan oEcer, )o(ld yo(

recommend rene)ing the loan or demand its repaymentM

o(ld yo(r actions be inW(enced if in early #$13 ?Leon

sho)ed yo( its #$13 projections along )ith proof that it

)as going to raise more than H1%# million of ne) e;(ityM

Ans)er hile the >rm?s ratios based on the projected data appear

to be improving, the >rm?s c(rrent asset ratio is lo)% As a

credit manager, yo( )o(ld not contin(e to e*tend credit to

the >rm (nder its c(rrent arrangement, partic(larly if yo(r

>rm didn?t have any e*cess capacity% erms of CO might

be a little harsh and might p(sh the >rm into ban:r(ptcy%

Li:e)ise, if the ban: demanded repayment this co(ld also

force the >rm into ban:r(ptcy%

Creditors? actions )o(ld de>nitely be inW(enced by an

inf(sion of e;(ity capital in the >rm% his )o(ld lo)er the

>rm?s debt ratio and creditors? ris: e*pos(re%





X% =n hindsight, )hat sho(ld ?Leon have done in #$11M

Ans)er Gefore the company too: on its e*pansion plans, it sho(ld

have done an e*tensive ratio analysis to determine the

ePects of its proposed e*pansion on the >rm?s operations%

/ad the ratio analysis been cond(cted, the company )o(ld

have Bgotten its >nancial ho(se in order before

(ndergoing the e*pansion%

L% hat are some potential problems and limitations of

>nancial ratio analysisM

Ans)er NSho) S4+33 and S4+34 here% Some potential problems

are listed belo)

1% Comparison )ith ind(stry averages is diEc(lt if the

>rm operates many diPerent divisions%

#% iPerent operating and acco(nting practices distort

comparisons%

3% Sometimes hard to tell if a ratio is Bgood or Bbad%

4% iEc(lt to tell )hether company is, on balance, in a

strong or )ea: position%

!% BAverage performance is not necessarily good%

% Seasonal factors can distort ratios%

7% Bindo) dressing techni;(es can ma:e statements

and ratios loo: better than they act(ally are%

8% =nWation has badly distorted many >rms? balance

sheets, so a ratio analysis for one >rm over time, or a

comparative analysis of >rms of diPerent ages, m(st

be interpreted )ith j(dgment%





'% hat are some ;(alitative factors analysts sho(ld consider

)hen eval(ating a company?s li:ely f(t(re >nancial

performanceM

Ans)er NSho) S4+3! here% op analysts recogniRe that certain

;(alitative factors m(st be considered )hen eval(ating a

company% hese factors, as s(mmariRed by the American

Association of =ndivid(al =nvestors AA==5, are as follo)s

1% Are the company?s reven(es tied to one :ey c(stomerM

#% o )hat e*tent are the company?s reven(es tied to one

:ey prod(ctM

3% o )hat e*tent does the company rely on a single

s(pplierM

4% hat percentage of the company?s b(siness is

generated overseasM

!% /o) m(ch competition does the >rm faceM

% =s it necessary for the company to contin(ally invest in

research and developmentM

7% Are changes in la)s and reg(lations li:ely to have

important implications for the >rmM

Chapter 4 Analysis of Financial Statements Integrated Case 7!

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04 Answers to All Problems (1)