Exam 4: Analysis of Financial Statements

The basic earning power ratio (BEP)reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects.

Exhibit 4.1 The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. -Refer to Exhibit 4.1.What is the firm's equity multiplier?

Which of the following statements is CORRECT?

Suppose a firm wants to maintain a specific TIE ratio.It knows the amount of its debt,the interest rate on that debt,the applicable tax rate,and its operating costs.With this information,the firm can calculate the amount of sales required to achieve its target TIE ratio.

Faldo Corp sells on terms that allow customers 45 days to pay for merchandise.Its sales last year were $325,000,and its year-end receivables were $60,000.If its DSO is less than the 45-day credit period,then customers are paying on time.Otherwise,they are paying late.By how much are customers paying early or late? Base your answer on this equation: DSO − Credit Period = Days early or late,and use a 365-day year when calculating the DSO.A positive answer indicates late payments,while a negative answer indicates early payments.

Song Corp's stock price at the end of last year was $23.50 and its earnings per share for the year were $1.30.What was its P/E ratio?

Last year Hamdi Corp.had sales of $500,000,operating costs of $450,000,and year-end assets (which is equal to its total invested capital)of $395,000.The debt-to-total-capital ratio was 17%,the interest rate on the debt was 7.5%,and the firm's tax rate was 35%.The new CFO wants to see how the ROE would have been affected if the firm had used a 50% debt-to-total-capital ratio.Assume that sales,operating costs,total assets,total invested capital,and the tax rate would not be affected,but the interest rate would rise to 8.0%.By how much would the ROE change in response to the change in the capital structure?

Last year Jandik Corp.had $295,000 of assets (which is equal to its total invested capital),$18,750 of net income,and a debt-to-total-capital ratio of 37%.Now suppose the new CFO convinces the president to increase the debt-to-total-capital ratio to 48%.Sales,total assets,and total invested capital will not be affected,but interest expenses would increase.However,the CFO believes that better cost controls would be sufficient to offset the higher interest expense and thus keep net income unchanged.By how much would the change in the capital structure improve the ROE?

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.

Companies HD and LD have the same sales,tax rate,interest rate on their debt,total assets,and basic earning power.Both firms finance using only debt and common equity and total assets equal total invested capital.Both companies have positive net incomes.Company HD has a higher total debt to total capital ratio and,therefore,a higher interest expense.Which of the following statements is CORRECT?

Last year Kruse Corp had $305,000 of assets (which is equal to its total invested capital),$403,000 of sales,$28,250 of net income,and a debt-to-total-capital ratio of 39%.The new CFO believes the firm has excessive fixed assets and inventory that could be sold,enabling it to reduce its total assets and total invested capital to $252,500.The firm finances using only debt and common equity.Sales,costs,and net income would not be affected,and the firm would maintain the same capital structure (but with less total debt).By how much would the reduction in assets improve the ROE?

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

Even though Firm A's current ratio exceeds that of Firm B,Firm B's quick ratio might exceed that of A.However,if A's quick ratio exceeds B's,then we can be certain that A's current ratio is also larger than B's.

Companies E and P each reported the same earnings per share (EPS),but Company E's stock trades at a higher price.Which of the following statements is CORRECT?

Last year Blease Inc had a total assets turnover of 1.33 and an equity multiplier of 1.75.Its sales were $295,000 and its net income was $10,600.The firm finances using only debt and common equity and its total assets equal total invested capital.The CFO believes that the company could have operated more efficiently,lowered its costs,and increased its net income by $10,250 without changing its sales,assets,or capital structure.Had it cut costs and increased its net income by this amount,how much would the ROE have changed?

Garcia Industries has sales of $200,000 and accounts receivable of $18,500,and it gives its customers 25 days to pay.The industry average DSO is 27 days,based on a 365-day year.If the company changes its credit and collection policy sufficiently to cause its DSO to fall to the industry average,and if it earns 8.0% on any cash freed-up by this change,how would that affect its net income,assuming other things are held constant?

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.

Walter Industries' current ratio is 0.5.Considered alone,which of the following actions would increase the company's current ratio?

Companies HD and LD are both profitable,and they have the same total assets (TA),total invested capital,sales (S),return on assets (ROA),and profit margin (PM).Both firms finance using only debt and common equity.However,Company HD has the higher total debt to total capital ratio.Which of the following statements is CORRECT?

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.