University College of the Cayman Islands

FIN301 Financial Management

 

Tutorial #3 - Financial Statement Analysis - Chapter 3

Note - For all the questions that come from the textbook, use the formula sheet on page 92.

 

  1. Why do analysts calculate financial ratios?

  2. Which ratios would a banker be most interested in when considering whether to approve an application for a short-term business loan? Explain.

  3. Which ratios would a potential long-term bond investor be most interested in? Explain.

  4. The balance sheet and income statement for Penn Mfg. Co are as follows:

Income Statements for the year ended June 30, 2000
($)
Net Sales (all credit) 8,000
Less: Cost of Sales 3,300
Gross Profit 4,700
Less Operating Expenses: 3,000
EBIT 1,700
Less: Interest 367
Earnings before taxes 1,333
Less: Taxes 533
Net Income 800
Balance Sheet as at June 30, 2000......
($)
Cash 500
Accounts receivable 2,000
Inventories 1,000
Total current assets 3,500
Net Fixed Assets 4,500
Total Assets 8,000
Accounts Payable 1,100
Accrued expenses 600
Short-term loans 300
Current Liabilities 2,000
Long-term debt 2,000
Owner's Equity 4,000
8,000

Required: Calculate the following ratios for Penn Mfg. Co

Current ratio Average collection period
Debt ratio Inventory turnover
Times Interest Earned Fixed asset turnover
Total asset turnover Gross profit margin
Operating profit margin Net profit margin
Return on assets Return on equity

        

  1. The Miles Marble Ltd. has a target current ratio of 2:1 but has experienced some difficulties financing its expanding sales in the past few months. At present the current ratio of 2.5:1 is based on current assets of $2.5m. If Miles expands its receivables and inventories using a short-term line of credit, how much additional funding can it borrow before its current ratio target is reached?

 

  1. The Smithers Corp. earned a net profit margin of 5% based on sales of $10M and total assets of $5M last year.

 a.             What was Smithers’ rate of return on total assets?

b.             During the coming year the company president has set a goal of attaining a 12% return on total assets. How much must the firm’s sales rise, other things being the same, for the goal to be achieved? (State your answer as an annual growth rate in sales.)

c.             If Smithers finances 30% of its assets by borrowing, what was its return on common equity for last year? What will it be next year if the return on total assets of 12% is achieved?

 

  1. The Mona Sales Co. had a gross profit margin of 30% and sales of $9m last year.Seventy-five percent of the firm’s sales are on credit while the remainder are cash sales.Mona’s current assets equal $1,500,000, its current liabilities equal $300,000, and it has $100,000 in cash and marketable securities.

 a.             If Mona’s accounts receivable are $562,500, what is its average collection period?

b.             If Mona reduces its average collection period to 20 days, what will be its new level of accounts receivables?

c.             Mona’s inventory turnover ratio is 9 times. What is the level of Mona’s inventories?

 

  1. 3-7

 

  1. Given the partial financial statement information from La Strada Corp., a circus equipment supplier, calculate the return on equity ratio:

  Total Assets   $10,000         Total Sales     $5,000
Total Liabilities   $6,000   Net Profit Margin       10%

                                                                                                        
                                                                                                              

  1.  What is the current ratio of Wilderness! Corp., given the following information from their end of 2000 balance sheet?

   Current Assets     $ 5,000     Total Liabilities   $20,000
Long-term Liabilities   $18,000    Total Equity    $30 ,000

                                                                                                                                    

  1. Rocinante Inc., manufactures windmills. What is Rocinante’s total asset turnover if their return on assets is 12% and their net profit margin is 4%?  

  1. 3-8

  2. Thunder Alley Corp., supplies parts for racing cars. Current market price per share of Thunder Alley’s common stock is $40. The latest annual report showed net income of $2,250,000 and total common equity is $15m. The report also listed 1,750,000 shares of common stock outstanding. No common dividends are paid.

 a.                Calculate Thunder Alley’s earnings per share.

b.                Calculate Thunder Alley’s price to earnings ratio.

c.                Calculate Thunder Alley’s book value per share.

d.             What is Thunder Alley’s market to book ratio?  

  1. 3-21   (Use turnover ratio = Sales/Inventory )

 

  1. From the values of the different ratios given below, calculate the missing balance sheet items and complete the balance sheet. (Note - Use 365 days = 1 year and Inventory Turnover = Sales/Inventory)

Selected Ratios
Sales $100,000 Current Ratio 3x
Average Collection Period 55 days Total Asset Turnover 1.6x
Inventory Turnover 15x Fixed Asset Turnover 2.9x
Debt to Asset Ratio 40%

Balance Sheet
Cash $6,000   Accounts Payable $6,000
Accounts receivable ?   Short-term loans ?
Inventory ?   Accrued expenses 600
Prepaid expenses       ?          Total Current Liabilities      ?       
Total Current Assets ?  
  Bonds Payable ?
Fixed Assets       ?         
  Common Stock  16,000
  Retained Earnings ?
 
Total Assets    ?       Total Liabilities + Equity      ?       

 

  1. On February 3, 2001, the chief financial officer (CFO) for G & S Industries, contacted the firm's bank regarding a loan. The loan is to be used to repay notes payable and to finance current assets. The CFO wants to repay the loan plus interest in one year. On receiving the loan request the bank asked the firm to supply it with complete statements for the past two years. These statements are presented below:

Income Statements for the year ended December 31,.....
1999($) 2000($)
Sales 125,000 160,000
Less: Cost of Sales 75,000 96,000
Gross Profit 50,000 64,000
Less Operating Expenses:
Fixed cash operating expense 21,000 21,000
Variable operating expenses 12,500 16,000
Depreciation 4,500 10,000
EBIT 12,000 17,000
Less: Interest 3,000 6,100
Earnings before taxes 9,000 10,900
Less: Taxes 4,500 5,450
Net Income 4,500 5,450
Balance Sheet as at December 31,......
1999($) 2000($)
Cash 9,000 500
Accounts receivable 12,500 16,000
Inventories 29,000 45,500
Total current assets 50,500 62,000
Land 20,000 26,000
Buildings & equipment 70,000 100,000
Less: Provision for Depreciation 28,000 38,000
Total Net Fixed Assets 62,000 88,000
112,500 150,000
Accounts Payable 10,500 22,000
Notes Payable 17,000 47,000
Total current liabilities 27,500 69,000
Long-term Debt 28,750 22,950
Common stock 31,500 31,500
Retained Earnings 24,750 26,550
Long-term debt + Equity 85,000 81,000
112,500 150,000

Required: 

a. Based on the preceding statements, complete the table below: ( Note - use 360 days = 1 year and year-end figures)   

Industry Averages Actual 1999 Actual 2000
Current ratio 1.80x
Acid test ratio 0.70x
Average collection period 37 days
Inventory turnover 2.50x
Debt to total assets 58%
Long-term debt to total capitalization (total capital employed) 33%
Times interest earned/Interest cover 3.8x
Gross profit margin 38%
Operating profit margin 10%
Net profit margin 3.5%
Total asset turnover 1.14x
Fixed asset turnover 1.40x
Return on assets 4.0%
Return on common equity 9.5%

b. Analyse the CFO's loan request. Would you grant the loan? Explain.

 

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