Exam 4: Analysis of Financial Statements

Last year Ann Arbor Corp had $155,000 of assets, $305,000 of sales, $20,000 of net income, and a debt-to-total-assets ratio of 37.5%. The new CFO believes a new computer program will enable it to reduce costs and thus raise net income to $33,000. Assets, sales, and the debt ratio would not be affected. By how much would the cost reduction improve the ROE?

The inventory turnover and current ratio are related. The combination of a high current ratio and a low inventory turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged.

Brookman Inc's latest EPS was $2.75, its book value per share was $22.75, it had 315,000 shares outstanding, and its debt ratio was 44%. How much debt was outstanding?

A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?

Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, a zero debt ratio and therefore an equity multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the firm borrow money, use it to buy back stock, and raise the debt ratio to 50% and the equity multiplier to 2.0. She thinks that operations would not be affected, but interest on the new debt would lower the profit margin to 4.5%. This would probably be a good move, as it would increase the ROE from 7.5% to 13.5%.

What is the firm's profit margin?

What is the firm's BEP?

Last year Harrington Inc. had sales of $325,000 and a net income of $19,000, and its year-end assets were $250,000. The firm's total-debt-to-total-assets ratio was 45.0%. Based on the DuPont equation, what was the ROE?

Helmuth Inc's latest net income was $1,250,000, and it had 225,000 shares outstanding. The company wants to pay out 45% of its income. What dividend per share should it declare?

Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more difficult than if all firms used the same or similar accounting methods.

Ratio analysis involves analyzing financial statements to help appraise a firm's financial position and strength.

You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both below the industry average. Which of the following statements is CORRECT?

Since the ROA measures the firm's effective utilization of assets without considering how these assets are financed, two firms with the same EBIT must have the same ROA.

Suppose all firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. However, firms face different operating conditions because, for example, the grocery store industry is different from the airline industry. Under these conditions, firms with high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios.

Wie Corp's sales last year were $315,000, and its year-end total assets were $355,000. The average firm in the industry has a total assets turnover ratio (TATO) of 2.4. The firm's new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to the industry average without affecting sales. By how much must the assets be reduced to bring the TATO to the industry average, holding sales constant?

Other things held constant, a decline in sales accompanied by an increase in financial leverage must result in a lower profit margin.

Royce Corp's sales last year were $280,000, and its net income was $23,000. What was its profit margin?

A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid.

In general, it's better to have a low inventory turnover ratio than a high one, as a low ratio indicates that the firm has an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of stock.

The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed.