FinMan Cabrera SM (Vol1)

8/10/2019 FinMan Cabrera SM (Vol1)

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Solutions Manual

CHAPTER 12

ANALYSIS OF FINANCIAL STATEMENTS

SUGGESTED ANSWERS TO THE R EVIEW Q UESTIONS AND P ROBLEMS

I. Questions

1. The emphasis of the various types of analysts is by no means uniformnor should it be. Management is interested in all types of ratios for tworeasons. First, the ratios point out weaknesses that should bestrengthened; second, management recognizes that the other parties areinterested in all the ratios and that financial appearances must be kept upif the firm is to be regarded highly by creditors and e uity investors.! uity investors "stockholders# are interested primarily in profitability,

but they e$amine the other ratios to get information on the riskiness of e uity commitments. %redit analysts are more interested in the debt,T&!, and !'&T() coverage ratios, as well as the profitability ratios.*hort+term creditors emphasize li uidity and look most carefully at thecurrent ratio.

. The inventory turnover ratio is important to a grocery store because of the much larger inventory re uired and because some of that inventory is

perishable. )n insurance company would have no inventory to speak of since its line of business is selling insurance policies or other similar financial products-contracts written on paper and entered into betweenthe company and the insured. This uestion demonstrates that thestudent should not take a routine approach to financial analysis but rather should e$amine the business that he or she is analyzing.

. (ifferences in the amounts of assets necessary to generate a dollar of sales cause asset turnover ratios to vary among industries. For e$ample,a steel company needs a greater number of dollars in assets to produce adollar in sales than does a grocery store chain. )lso, profit margins andturnover ratios may vary due to differences in the amount of e$penses

incurred to produce sales. For e$ample, one would e$pect a grocerystore chain to spend more per dollar of sales than does a steel company./ften, a large turnover will be associated with a low profit margin, andvice versa.

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Analysis of Financial Statements Cha t!" #$

11. The fi$ed charge coverage ratio measures the firm8s ability to meet allfi$ed obligations rather that interest payments alone, on the assumptionthat failure to meet any financial obligation will endanger the position of the firm.

1 . =o rule+of+thumb ratio is valid for all corporations. There is simply toomuch difference between industries or time periods in which ratios arecomputed. =evertheless, rules+of+thumb ratios do offer some initialinsight into the operations of the firm, and when used with caution by theanalyst can provide information.

1 . a. eturn on investment > =et income?Total assets

&nflation may cause net income to be overstated and total assetsto be understated. Too high a ratio could be reported.

b. &nventory turnover > *ales?&nventory&nflation may cause sales to be overstated. &f the firm uses F&F/accounting, inventory will also reflect @inflation+influencedA

pesos and the net effect will be nil. &f the firm uses 9&F/accounting, inventory will be stated in old pesos and too high aratio could be reported.

c. Fi$ed asset turnover > *ales?Fi$ed assetsFi$ed assets will be understated relative to sales and too high a

ratio could be reported.

d. (ebt to total assets > Total debt?Total assets*ince both are based on historical costs, no maBor inflationaryimpact will take place in the ratio.

10. (isinflation tends to lower reported earnings as inflation+induced incomeis s ueezed out of the firm8s income statement. This is particularly truefor firms in highly cyclical industries where prices tend to rise and falluickly.

12. 'ecause it is possible that prior inflationary pressures will no longer

seriously impair the purchasing power of the peso. 9essening inflationalso means that the re uired return that investors demand on financialassets will be going down, and with this lower demanded return, futureearnings or interest should receive a higher current evaluation.

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Cha t!" #$ Analysis of Financial Statements

II. Problems

P"o%l!& # 'Da( Sal!s Outstan)in*+

(*/ > 0< days; * > 5, C

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) *

42

(*/ >)

5, . 0. 445


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P"o%l!& / 'P"i0! Ea"nin*s Ratio+

!E* > . 1. ; E?! > C

M?' > 1.E? < > 1.

E > "


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P"o%l!& 3 'Basi0 Ea"nin* Po4!"+

/) > 6G; =& > 4


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40%.=0.40=0.601=A

D

.60%=AE

0.051

3%=AE

so,A

E 1=

A

D and

NI

E

A

NI =

A

E

)lternatively, using the (uEont e uation7

/! > /) x !M

2G > G x !M!M > 2G? G > 2? > T)?!

Take reciprocal7 !?T) > ?2 > 4 1 0


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T&! > . 2

P"o%l!& #7 'R!tu"n on E8uit(+

/!> Erofit margin x T) turnover x ! uity multiplier > =&?*ales x *ales?T) x T)?! uity

=ow we need to determine the inputs for the (uEont e uation from thedata that were given. /n the left we set up an income statement, and we

put numbers in it on the right7

*ales "given# 1 1? .2

=ow we can complete the (uEont e uation to determine /!7

/! > 04 ,


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*hort+term debt can increase by a ma$imum of 4 ,2


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5. %ash H )ccounts receivable H &nventories > "1.6# ")ccounts payable#

%ash H 02,


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b. For the firm;

/! > EM $ T) turnover $ !M > 1.5G $ 1.5 $

For the industry, /! > 1. G $ $ .2 > :G =ote7 To find the industry ratio of assets to common e uity, recognizethat 1 "Total debt?Total assets# > %ommon e uity?Total assets. *o,%ommon e uity?Total assets > 0 Totalassets?%ommon e uity.

c. The firm8s days sales outstanding ratio is more than twice as long as theindustry average, indicating that the firm should tighten credit or enforcea more stringent collection policy. The total assets turnover ratio is well

below the industry average so sales should be increased, assets decreasedor both. Jhile the company8s profit margin is higher than the industryaverage, its other profitability ratios are low compared to the industry net income should be higher given the amount of e uity and assets.owever, the company seems to be in average li uidity position andfinancial leverage is similar to others in the industry.

d. &f


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Debt Management

(ebt+to+assets ratio 20.61G 0:.61G 2


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9ooking at the (uEont e uation, MangoNs profit margin is significantly

lower than the industry average and it has declined substantially from

=et incomeTotal assets >

45,


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b. Kuick ratio >

"%urrent assets L

&nventory#Erofit margin

>

eturn on assets"investment#

"1 (ebt ?)ssets#> 1 G

"1


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b. The same as return on assets "1 G#.

P"o%l!& $7 'A9!"a*! Coll!0tion P!"io)+

)veragecollection

period>

)ccountsreceivable

)verage dailycredit sales

> 16a. =et income > *ales x Erofit margin> 0,


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The medical supplies division has the highest return on assets.

c. %orporate net income > 1,


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&nventory

4


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%ash 4,


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*ales?Total assets >

Total assets >


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Fi$ed assets 0,


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larger use of debt. &ts return on e uity is higher than 'lacks8 because it

has taken more financial risk. &n terms of other ratios, 'lack has itsinterest and fi$ed charges well covered and in general its long+term ratiosand outlook are better than Jhite. 'lack has asset utilization ratios e ualto or better than Jhite and its lower li uidity ratios could reflect better short+term asset management, and that point was covered in part "a#.

=ote7 emember that to make actual financial decisions, more than oneyear8s comparative data is usually re uired. &ndustry comparisons shouldalso be made.

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FinMan Cabrera SM (Vol1)