Chapter 4 (12e)

Analysis of Financial Statements

Solutions of End-of-Chapter Problems

4-2

A/E = 2.4; D/A = ?

D
1
= 1

A
A/E
D
1
= 1

A
2.4
D
= 0.5833= 58.33%.
A
4-3

ROA = 10%; PM = 2%; ROE = 15%; S/TA = ?; TA/E = ?

ROA = NI/A; PM = NI/S; ROE = NI/E.
ROA
NI/A
10%
S/TA

=
=
=
=

PM S/TA
NI/S S/TA
2% S/TA
TATO = 5.

ROE
NI/E
15%
15%
TA/E

=
=
=
=
=

PM S/TA TA/E
NI/S S/TA TA/E
2% 5 TA/E
10% TA/E
EM = 1.5.

4-6

PM = 2%; EM = 2.0; Sales = $100,000,000; Assets = $50,000,000; ROE = ?

4-23

ROE =
=
=
=
a.

PM TATO EM
NI/S S/TA A/E
2% $100,000,00/$50,000,000 2
8%.
Industry
Firm
Average

Current ratio

Currentassets
Currentliabilitie
s

$303
$111

= 2.73

Debtto
totalassets

Debt
Total assets

$135
$450

= 30.00%

30.00
%

Timesinterest
=
earned

EBIT
Interest

EBITDA
coverage

EBITDA Leasepymts
$61.5
=
$6.5
INT Princ. Lease
pymts pymts

Inventory
turnover

Sales
Inventorie
s

DSO

Accountsreceivable
$66
=
Sales/365
$795/365

F. A.
turnover

Sales
Net fixedassets

$795
$147

= 5.41

T. A.
turnover

Sales
Total assets

$795
$450

= 1.77

Profit margin

Netincome
Sales

$27
$795

= 3.40%

3.00%

Returnon
totalassets

Net income
Total assets

$27
$450

= 6.00%

9.00%

6%
1.4286

= 8.57%

12.86
%

ROA EM
Returnon
commonequity =
Alternatively, ROE =

$49.5
$4.5

$795
$159

= 11

= 9.46

= 5

10

30.3
days

$27
Netincome
=
= 8.57% 8.6%.
Equity
$315

b. ROE = Profit margin Total assets turnover Equity multiplier

Total assets
Net income
Sales
=

Sales
Total assets Commonequity
$27
$795 $450
=

= 3.4% 1.77 1.4286 = 8.6%.

$795 $450 $315
Profit margin
Total assets turnover
Equity multiplier

Firm
3.4%
1.77
1.4286

Industry
3.0%
3.0
1.4286*

Comment
Good
Poor
O.K.

D
E
=
TA
TA
1 0.30 = 0.7
TA
1
EM =
=
= 1.4286 1.43.
0.7
E

*1

Alternatively, EM = ROE/ROA = 12.86%/9% = 1.4289 1.43.

c. Analysis of the DuPont equation and the set of ratios shows that the
turnover ratio of sales to assets is quite low. Either sales should be higher

24
days

given the present level of assets, or the firm is carrying more assets than it
needs to support its sales.
d. The comparison of inventory turnover ratios shows that other firms in the
industry seem to be getting along with about half as much inventory per
unit of sales as the firm. If the companys inventory could be reduced, this
would generate funds that could be used to retire debt, thus reducing
interest charges and improving profits, and strengthening the debt
position. There might also be some excess investment in fixed assets,
perhaps indicative of excess capacity, as shown by a slightly lower-thanaverage fixed assets turnover ratio. However, this is not nearly as clearcut as the overinvestment in inventory.
e. If the firm had a sharp seasonal sales pattern, or if it grew rapidly during
the year, many ratios might be distorted. Ratios involving cash,
receivables, inventories, and current liabilities, as well as those based on
sales, profits, and common equity, could be biased. It is possible to
correct for such problems by using average rather than end-of-period
figures.