Study Guide Chapter 4

This chapter deals with financial ratio analyzing using information contained in financial statements. Financial ratios enable interested parties to take the information contained in financial statements and make relative comparisons of firm performance over time and also compare performance across different firms. Financial ratios are statistical yardsticks that relate two numbers generally taken from a firm’s income statements and balance sheets. Financial ratios fall into five categories: liquidity ratios, asset management ratios, profitability ratios, and market-based ratios.Trend analysis introduces the element of time into financial ratio analysis. It gives the analyst a more dynamic view of the company’s situation than a pure comparative financial ratio analysis alone.

The relationship of the return on investment (ROI) to margin and turnover can be used to determine if one or both of the two is deficient in contributing to the profitability of the firm.Common-sized financial statements, which express financial items in percentages, are helpful in detecting and monitoring financial trends.To gain further insight into the relative financial position of a firm, the analyst must compare the financial ratios with industry averages. The more diversified the firm, the more difficult it will be to make such a comparison.The Economic Value Added is a measure of performance that compares the dollar return generated by the firm to the return expected by the investors in the various sources of capital utilized by the firm.

Chapter Outline

I. Financial ratio analysis is used to measure the relative performance and creditworthiness of a business entity. Some specific uses for ratio analysis include:

A. Ratios are used as an analytical tool to assist management in identifying strengths and weaknesses in the firm.

B. Ratios are used as a monitoring device that may uncover problems in the firm’s operations.

C. Ratios are used internally by management for planning and for evaluating performance. Financial ratios allow management to translate goals into operational objectives.

49

CHAPTER

44 Evaluation of Firm Performance

Contemporary Financial Management Fundamentals

II. Successful financial ratio analysis requires that an analyst keep in mind the following points:

A. Any discussion of financial ratios is likely to include only a representative sample of possible ratios

B. Financial ratios serve only as “flags” indicating potential areas of strength or weakness.

C. Frequently a financial ratio must be dissected to discover its true meaning.

D. A financial ratio is meaningful only when it is compared with some standard, such as an industry ratio trend, a ratio trend for the specific firm being analyzed, or a stated management objective.

E. When financial ratios are used to compare one firm with another, it is important to remember that differences in accounting techniques may result in substantial differences in financial ratios.

III. A financial ratio is a relationship that indicates something about a firm's activities, such as the ratio between the firm's current assets and current liabilities or between its accounts receivable and annual sales. Financial ratios are frequently grouped into six types of ratios.

A. Liquidity ratios indicate the ability of the firm to meet short-term financial obligations.

B. Asset management ratios indicate how efficiently the firm is utilizing its resources.

C. Financial leverage management ratios indicate the firm's capacity to meet its debt obligations, both short-term and long-term.

D. Profitability ratios measure the total effectiveness of management in generating profits on sales, assets, and owners' investment.

E. Market-based ratios measure the financial market's assessment of a company's performance.

F. The effective use of financial ratio analysis requires some experience and effort. There are some basic approaches to financial ratio analysis, some basic interrelationships among ratios, and sources of information that can enhance the analyst’s effectiveness. Two common types of ratio analysis are, comparative and trend analysis.

1. Comparative analysis—The analyst compares the ratios of the firm to the industry norms or other individual firms in the industry.

2. Trend analysis—This requires the analyst to examine the ratios of a firm for several periods. This shows whether the firm’s financial condition is improving or deteriorating over time.

IV. The data for constructing ratios generally comes from a firm's balance sheet, income statement, and statement of cash flows.

A. Liquidity ratios:

50

Chapter 4/Evaluation of Firm Performance

The quick ratio can also be adjusted downward by removing accounts receivable over 90 days old from the numerator of the quick ratio.

B. Asset Management Ratios:

C. Financial Leverage Management Ratios:

Debt ratio = Total debt

Total assets

Fixed charge coverage =

EBIT + Lease payments

Interest + Lease payments+Preferred dividends

before tax+

Before tax

sinking fund

D. Profitability Ratios:

51


E. Market-Based Ratios

F. Market-to-Book Value or Pierce-to-Book Value (P/BV) Ratio:

V. Analysis of profitability

A. Return on Investment = Net Profit Margin x Total Asset Turnover.

ROI = EAT

Sales

Sales

Total assets =

EAT

Total assets

B. Dupont analysis—Dupont charts, such as the one in the textbook, present the major ratios in a logical, organized fashion. This Dupont chart provides a good starting point for analyzing the firm. For example, suppose a firm's return on stockholders' equity is considered low. Is this because of a low ROI or a low equity multiplier (or both)? If the ROI is too low, is this due to a low net profit margin or low total asset turnover (or both)? If the net profit margin is low, which expenses are out of line?

C. Return on Stockholders' Equity = Return on Investment x Equity Multiplier. (The equity multiplier is the ratio of assets to equity).

52


D. Computerized databases are available to assist in financial statement analysis. Standard and Poors provides the Research Insight database, which contains balance sheet, income statement, stock price and dividend information. Value Line provides financial information on a large number of firms. Additional financial data may be access via the Internet.

1. www.yahoo.com 2. www.altavista.com 3. www.google.com 4. www.lycos.com

V. Even though ratios can provide valuable information, they can be misleading for a number of reasons.

A. Ratios are only as reliable as the accounting data on which they are based.

B. Industry “average” ratios may not be very meaningful if there is significant dispersion in the ratio for the industry.

C. Industry classifications may be defined too broadly to make reliable comparative analysis between a firm and a particular industry average.

D. Financial ratios provide a historical assessment of performance, which may or may not be a useful basis for making future projections.

E. A comparison of a firm’s ratios with industry norms provides a relative measure of performance, not an absolute measure. For example, a firm’s profitability ratios may be relatively better than its industry average, but on an absolute basis it may be poor compared to the universe of firms.

VI. A recent innovation in performance measurement is the economic value added.

A. Economic Value Added (EVA) is a measure of operating performance that indicates how successful the firm has been at increasing its MVA in a given year. EVA is defined as:

where

53

http://www.lycos.com/

http://www.google.com/

http://www.altavista.com/

http://www.yahoo.com/


k = average cost of capital,invested capital = amount of invested capital at the beginning of the year.

B. A positive EVA signifies that management has generated earnings over and above what the capital holders require.

C. MVA is a cumulative measure of EVA since the invention of the firm.

VII. Common-size statements are also helpful in financial analysis.

A. A common-size balance sheet shows the firm’s assets and liabilities as a percentage of total assets (rather than as dollar amounts).

B. A common-size income statement shows the firm’s income and expense items as a percentage of net sales (rather than as dollar amounts).

VIII. Sources of comparative financial data—The most popular sources of financial information for business and industries are:

A. Industry Norms and Key Business Ratios published by Dun and Bradstreet (D&B)

B. Risk Management Association (RMA)

C. Reports of the Federal Trade Commission (FTC) and the Securities and Exchange

Commission (SEC)

D. Prentice-Hall’s Almanac of Business and Industrial Financial Ratios

E. Financial Studies of Small Business from Financial Research Associates

F. Moody’s or Standard and Poor’s Industrial, Financial, Transportation, and Over-the-

Counter manuals.

G. Annual reports and 10K’s from corporations

H. Trade associations and trade journals

I. Publications of some commercial banks

IX. Even though ratios can provide valuable information, they can be misleading for a number of reasons.

A. Ratios are only as reliable as the accounting data on which they are based.

B. Industry “average” ratios may not be very meaningful if there is significant dispersion in the ratio for the industry.

C. Industry classifications may be defined too broadly to make reliable comparative analysis between a firm and a particular industry average.

D. Financial ratios provide a historical assessment of performance, which may or may not be a useful basis for making future projections.

E. A comparison of a firm’s ratios with industry norms provides a relative measure of

54


performance, not an absolute measure. Fore example, a firm’s profitability ratios may be relatively better than its industry average, but on an absolute basis it may be poor compared to the universe of firms.

55

Contemporary Financial Management Fundamentals56

Chapter Formulas:

1. Liquidity ratios:

2. Asset Management Ratios:

3. Financial Leverage Management Ratios:

Debt ratio = Total debt

Total assets


True And False Questions

Agree with each of the statements or reject it and modify it so that it is acceptable.

57

Chapter Formulas:

4. Profitability Ratios:

5. Market-Based Ratios:

6. Market-to-Book Value or Pierce-to-Book Value (PTBV) Ratio:

7. Return on Investment = Net Profit Margin x Total Asset Turnover:

ROI = EAT

Sales

Sales

Total assets =

EAT

Total assets

8. Economic Value Added (EVA):


1. The current ratio will never exceed the quick ratio.

2. Assuming a current ratio greater than one, the purchase of raw materials on credit decreases the current ratio.

3. The gross profit margin is greater than the net profit margin.

4. The average collection period is found by dividing a firm's year-end accounts receivable by its average daily credit sales.

5. Because total assets exceed net fixed assets, the total asset turnover must exceed the fixed asset turnover.

6. A short average collection period is a sign of efficient accounts receivable management.

7. The return on total equity equals the net profit margin times the total asset turnover.

8. Free cash flow often is viewed as a better measure than earnings of the financial soundness of the firm.

9. The book value per share of common stock is determined by dividing the total common stockholders’ equity for a firm by the number of shares outstanding.

10. Firms with a current ratio below 2.0 are having liquidity problems.

11. The basic rational for historical cost is that it is a measure of current value.

12. Revenues increase net worth, while expenses decrease net worth.

13. Leverage rations measure how efficiently the firm is employing its resources.

14. No external sources of information are required to do a trend analysis.

15. A firm’s ROI examines profit margin as it plays a major role in contributing to profitability.

Multiple Choice Questions

1. ______________ ratios measure the total effectiveness of management in generating profits on sales, assets, and owners’ investment. A. LiquidityB. Asset managementC. Financial leverage managementD. ProfitabilityE. Market-based ratios

2. A common-size balance sheet shows a firm’s assets and liabilities, and shareholders’ equity as a percentage of A. total sales.B. net income.

58


C. total shareholders’ equity.D. total assets.E. total liabilities.

3. In comparative analysis, the financial analyst compares the ratios of the firmA. for several reporting periods.B. to industry norms or other firms in the industry.C. to the firm’s ratios under ideal operating conditions.D. to the industry leader’s ratios.E. to governmental standards of acceptable accounting performance.

4. To assess the ability of the firm to meet current financial obligations, a potential lender would most likely be most concerned with the firm’sA. payout ratio.B. price-to-earnings ratio.C. average collection period.D. fixed charge coverage ratio.E. total asset turnover.

5. If a firm’s net profit margin declines and the CEO wants to maintain the return on shareholder equity, he mustA. increase the firm’s utilization of assets.B. reduce the amount of debt in the firm’s capital structure.C. increase the firm’s total sales.D. increase the firm’s total shareholder equity.E. increase the firm’s average collection period.

6. Financial ratios are used by management for ________________.A. analysis.B. analysis and monitoring.C. monitoring and planning.D. analysis, monitoring, and planning.

7. _______________ is a measure of operating performance that indicates how successful the firm has been at increasing its MVA in a given year.A. Economic value added (EVA)B. After-tax cash flow (ATCF)C. Earnings after taxes (EAT)D. Market value added (MVA)E. Earnings before interest and taxes (EBIT)

8. Which of the following utilize financial ratio analysis?.A. credit managersB. unionsC. security analysts

59


D. bankersE. all of the above

9. Which of the following is not an asset management ratio?A. average collection periodB. inventory turnover ratioC. sales-to-inventory ratioD. fixed-asset turnover ratioE. total asset turnover ratio

10. In general, the lower a firm’s risk, the higher its _______ ratio should be.A. market-to-book ratioB. average collection periodC. PIE ratioD. debt ratioE. price to book ratio

11. What are the primary sources of historical financial information about the firm?A. balance sheetB. income statementC. income statement and balance sheetD. sources and uses of funds

12. A ________ liability is one that arises automatically when a firm buys goods and services to produce its product.A. spontaneousB. fundedC. currentD. long-term

13. What is not included in a firm’s expenses?A. costs of goods soldB. depreciationC. interest expenseD. dividends

14. ROI can be viewed as a function of the net profit margin times A. sales.B. EAT.C. the total asset turnover.D. equity multiplier.

15. If a significant portion of the assets of a firm has a market value ________ book value, the quality of the firm’s balance sheet is reduced.A. equal toB. substantially below

60


C. substantially aboveD. none of the above

16. Profitability ratios measure how effectively a firm’s management is generating profits on _____.A. salesB. sales & total assetsC. total assets and stockholders’ investmentD. sales and stockholders’ investmentE. sales, total assets, and stockholders’ investment

17. Which of the following is not a profitability ratio?A. profitability ratioB. net profit margin ratioC. times interest earned ratioD return on investment ratioE. return on stockholders’ equity ratio

18. The ratio of EBIT to total assets measures the ________ in a firm.A. stockholders’ equity rate of returnB. operating profit rate of returnC. profitability before considering the effects of financing decisionsD. profitability after the cost of salesE. all of the above

19. The gross profit margin ratio measures the ________ in a firm.A. stockholders’ equity rate of returnB. operating profit rate of returnC. profitability before considering the effects of financing decisionsD. profitability after the cost of salesE. all of the above

20. The ________ ratio analysis and the ________ analysis in combination provide the financial analyst with a fairly clear picture of a firm’s performance.A. market-based; profitabilityB. liquidity; asset managementC. financial leverage management; market-basedD. liquidity; profitabilityE. comparative financial; trend

21. Which of the following variable does ROI examine?A. EATB. salesC. total assetsD. all of the above

22. Which of the following variable does return on stockholders’ equity examine?A. EAT, sales, EBIT, and total assetsB. EAT, EBIT, total assets, and stockholders’ equityC. EBIT, total assets, sales, and stockholders’ equity

61


D. EAT, sales, total assets, and stockholders’ equityE. EAT, total assets, total debt, and net fixed assets

23. The ________ compares the dollar return generated by the firm to the return expected by the investors of the capital invested by them in the firm. A. EBITB. EVAC. ROID. DuPont chartE. ROE

24. _________ prepares a series of fourteen key business ratios for 800 different lines of businesses based on SIC codes.A. RMAB. Dun and BradstreetC. 10K reportsD. Quarterly Financial Reports for Manufacturing CompaniesE. Almanac of Business and Financial ratios

25. __________ uses information from loan applications to compile sixteen ratios for over 250 lines of business based on SIC codes.A. RMAB. Dun and BradstreetC. 10K reportsD. Quarterly Financial Reports for Manufacturing CompaniesE. Almanac of Business and Financial ratios

Problems

1. Please supply the missing figures:

(NPM) (TAT) (ROI) Return on Net Profit Total Asset Return on Equity Stockholders'

Margin Turnover Investment Multiplier Equity

a. 20.0% 0.75 ____ 1.00 ____

b. ____ 2.00 8.0% 1.50 ____

c. 2.5% 4.00 ____ ____ 25.0%

d. 6.0% ____ 9.0% ____ 14.4%

2. Find the sales of the Franklin Company using the following information:

Current ratio 2.0Quick ratio 1.6

62


Current liabilities $200,000 Inventory turnover 8.0Gross profit margin 10%

3. Minor Motors has a net profit margin of 3 percent, a total asset turnover of 2.2, and an equity multiplier of 2.5. What is Minor's return on investment and return on stockholders' equity?

4. Tom Putnam forecasts sales of $4,000,000 for his firm next year. If the firm maintains its average collection period at 40 days and its inventory turnover at 8, what should be the firm's receivables and inventory levels? The gross profit margin is 22 percent.

5. Joyce Tilleman is planning for a small distributing firm she will operate after graduation. Her best guesses about several relevant financial variables are:

Sales $100,000

63


Gross profit margin 40%Average collection period (365 day year) 97 daysInventory turnover 4.0Minimum cash balance $5,000Investment in fixtures and equipment $10,000Long-term bank loan $15,000Current ratio 2.76All other required assets are to be leasedAll sales are credit sales

Complete the following pro forma balance sheet and indicate how much equity capital Joyce must invest in her firm.

BALANCE SHEET

Cash $ Accounts payable $Accounts receivable $ Bank loan $_______

Inventory $_______ TOTAL CURRENT TOTAL LIABILITIES $ASSETS $ Stockholders' equity $_______ Long-term assets $_______ TOTAL LIABILITIESTOTAL ASSETS $ & EQUITY $

64


6. From the financial statements of the Jackson Products Company, please provide a common-size balance sheet and common-size income statement.

JACKSON PRODUCTS COMPANYBalance Sheet

December 31, 20X5

Cash and securities $ 240,000 Accounts payable $ 380,000Accounts receivable 320,000 Notes payable 420,000Inventory 1,040,000 Other current

liabilities 50,000Total current assets $1,600,000 Total current

liabilities $ 850,000Net plant & equipment 800,000 L-T debt (10%) $ 800,000Total assets $ 2,400,000 Common stock 400,000

Retained earnings 350,000Total liabilitiesand equity $ 2,400,000

INCOME STATEMENTfor the Year Ended December 31, 20X5

Net sales (all on credit) $ 3,000,000Cost of sales 1,800,000

Gross profit $ 1,200,000Selling, general, and administrative expenses 860,000Earnings before interest and taxes $ 340,000Interest: Notes $ 37,800

Long-term debt 80,000Total interest charges 117,800Earnings before tax $ 222,200Federal income tax (40%) 88,880Earnings after tax $ 133,320

65


The following data apply to problems 7 – 11.Rich Corporation

Balance Sheet ($000)12/31/05 and 12/31/06

2005 2006ASSETS

Cash 200 240.0Accounts Receivable 310 440.8

Inventories 1,200 1,250.0Total Current Assets 1,710 1,930.8Plant and Equipment 900 1,000.0Accumulated Depreciation 150 200.0Net Fixed Assets 750 800.0Total Assets 2,460 2730.8

LIABILITIES AND STOCKHOLDER’S EQUITYAccounts Payable 390 400.0Notes Payable (8%) 340 400.0Accruals 50 50.0Total Current Liabilities 780 850.0Long-Term Debt (9%) 900 1,000.0Common Stock 10,000 Shares 200 200.0Retained Earnings 580 680.8Total Liabilities and Stockholders’ Equity 2,460 2,730.8

Rich CorporationIncome Statement ($000)

2005 and 20062005 2006

Sales 2,700.00 3,000.00COGS 1,620.00 1,800.00Gross Profit 1,080.00 1,200.00

Selling and Administrative Expenses 774.00 860.00Interest Expense 108.20 122.00Depreciation 40.00 50.00EBT 157.80 168.00Tax @ 40% 63.12 67.20EAT 94.68 100.80Market Price of Common Stock 94.70 100.80EPS 9.47 10.08

7. Calculate the net worth of Rich Corporation.

66


8. What did Rich Corporation spend to increase plant and equipment in (2006)?

9. If Rich Corporation has a cost of capital of 12%, what is the EVA for 2005?

10. Calculate the key financial ratios for Rich Corporation (2005 and 2006).

67


11. Given the following industrial norms, what are Rich Corporation’s strengths and weaknesses?

Industrial AverageLiquidity:

Current Ratio 2.5Acid Test Ratio 1.0

Activity:Average Collection Period 35Inventory Turnover 2.5Fixed Asset Turnover 1.4Total Asset Turnover 1.5

Leverage:Debt Ratio 0.6Times Interested Earned 4.0Times Fixed Charges Earned 4.0

Profitability:Debt-to-Equity Ratio 200%Net Margin 4.0%Return on Investment 4.5%Return on Equity 17%Earnings Per Share $12.00

Market-Based:Price-to-Earnings Ratio 12Market-to-Book Ratio 1.5

Internet Exercises

The P/E ratio and dividend payout for the S&P 500 Index can be found at this Web site. Write a one-page paper discussion your findings.

http://cpcug.org/user/invest/pepayout.html

The Value Point Analysis Model at this Web site gives you insight into evaluating a stocks risk with the P/E ratio. Once you are at this Web site chick on VPA and do an analysis. Be prepared to discuss your analysis in class.

http://www.eduvest.com/vparisk.html

The Motley Fool examines the importance of combining the P/E ratio with a company’s growth rate. Check out this Web site and be ready to comment on the “Fool Ratio” examined here.

http://www.fool.com

68

http://www.fool.com/

http://www.eduvest.com/vparisk.html

http://cpcug.org/user/invest/pepayout.html


Answers

True and False Questions

1. The current ratio exceeds the quick ratio for all firms with an inventory. 2. True. 3. True. 4. True. 5. Because total assets exceed net fixed assets, the total asset turnover must be less than the fixed

asset turnover. 6. A short average collection period is not necessarily a sign of efficient accounts receivable

management. It could also result from overly strict credit terms that can reduce the firm's sales and profitability.

7. The return on total assets equals the net profit margin times the total asset turnover. 8. True. 9. True.10. The appropriate current ratio for a given firm can be substantially above or below 2.0 depending

on the industry and circumstances relevant to the specific firm.11. Historical cost is not a measure of current value.12. True.13. Leverage ratios measure the degree to which a company is employing financial leverage.14. True.15. Margin and turnover both play a major role in contributing to profitability.

Multiple Choice Questions

1. D 6. D 11. C 16. E 21. D2. D 7. A 12. A 17. C 22. D3. B 8. E 13. D 18. B 23. B4. D 9. C 14. C 19. D 24. B5. A 10. C 15. B 20. E 25. A

Problem Solutions

1.

a. ROI = NPM x TAT = 20.0%(.75) = 15.0%Return on Equity = ROI x Equity Multiplier = 15.0%(1.00) = 15.0%

b. NPM = ROI/TAT = 8.0%/2.00 = 4%Return on Equity = ROI x Equity Multiplier = 8%(1.5) = 12.0%

c. ROI = NPM x TAT = 2.5%(4.00) = 10%Equity Multiplier = Return on Equity/ROI =25%/10% = 2.50

d. TAT = ROI/NPM = 9%/6% = 1.50Equity Multiplier = Return on Equity/ROI = 14.4%/9% = 1.60

69


2. Current assets = 2.0(200,000) = $400,000Current assets minus inventory = 1.6(200,000) = $320,000Inventory = 400,000 - 320,000 = $80,000Inventory Turnover = Sales / Inventory = 8.0 = sales/$80,000Sales = $640,000

3. Return on investment = Net profit margin x Total asset turnoverReturn on investment = 3% x 2.2 = 6.6%Return on stockholders' equity = Return on investment x Equity multiplierReturn on stockholders' equity = 6.6 % x 2.5 = 16.5%

4. Accounts receivable = (40/365) 4,000,000 = $444,444Cost of sales = (100%-gross profit margin) SalesCost of sales = 78% (4,000,000) = $3,120,000Inventory = $3,120,000/8 = $390,000

5. Cash = $5,000Long-term assets = $10,000Bank loan = $15,000Accounts receivable = 100,000(97/365) = $26,575Cost of sales = (100% - 40%)sales = (60%)100,000 = $60,000Inventory = 60,000/4.0 = $15,000Total current assets = 5,000 + 26,575 + 15,000 = $46,575Total assets = 46,575 + 10,000 = $56,575Current assets/current liabilities = 2.76Accounts payable = current assets/2.76 = 46,575/2.76 = $16,875Total liabilities = 16,875 + 15,000 = $31,875Stockholders' equity = total assets - total liabilities = 56,575 - 31,875 = $24,700

BALANCE SHEET

Cash $ 5,000 Accounts payable $ 16,875Accounts receivable 26,575 Bank loan 15,000Inventory 15,000TOTAL TOTALCURRENT ASSETS $ 46,575 LIABILITIES $ 31,875Long-term assets 10,000 Stockholders' equity 24,700TOTAL TOTAL LIABILITIESASSETS $ 56,575 & EQUITY $ 56,575

Joyce must invest $24,700 of equity capital in her business.

70


6. JACKSON PRODUCTS COMPANYCommon-Size Balance Sheet

December 31, 20X5

Cash and Securities 10.00% Accounts payable 15.83%Accounts Receivable 13.33 Notes payable 17.50Inventory 43 .33 Other current liabilities 2 .08 Total current assets 66.67 Total current liabilities 35.42%Net plant and Long-term debt 33.33equipment 33 .33 Common stock 16.67Total assets 100.00% Retained earnings 14 .58

Total liabilities andstockholders' equity 100.00%

JACKSON PRODUCTS COMPANYCommon-Size Income Statement

Net sales 100.00%Cost of sales 60 .00 Gross profit 40.00%Selling, general, and administration expenses 28 .67 Earnings before interest and taxes 11.33%Total interest charges 3 .93 Earnings before tax 7.40%Federal income tax 2 .96 Earnings after tax 4.44%

7. Net Worth = Total Assets – Total Liabilities2005 $780 = $2,460 – $1680 2006 $880.0 = $2,730.8 – $1,850

8. Increase in plant and equipment 2006 ($000):Change in net fixed assets + depreciation 2006(800 – 750) + (200 – 150) = $100

9.= 266.0 (1-.40) - .12 x 295.20= 148.13 in ($000)= $148,130

71


10. Key financial ratios: Industrial Average 2005 2006

Liquidity:Current Ratio 2.5 2.19 2.27Acid Test Ratio 1.0 0.65 0.80

Activity:Average Collection Period 35 41.3 52.9Inventory Turnover 2.5 1.35 1.44Fixed Asset Turnover 1.4 3.60 3.75Total Asset Turnover 1.5 1.10 1.10

Leverage:Debt Ratio 0.6 0.683 0.677Debt-to-Equity Ratio 200% 215.4% 210.0%Times Interested Earned 4.0 2.46 2.38Times Fixed Charges Earned 4.0 2.46 2.38

Profitability:Gross Profit Margin 40% 40% 42%Net Margin 4.0% 3.5% 3.36%Return on Investments 4.5% 3.85% 3.69%Return on Equity 17% 12.1% 11.4%Market-Based:

Price-to-Earnings ratio 12 10 10

11. Most ratios are weak.a. The current ration and acid test ratio are weak but moving towards the industrial average.

Investors like companies moving towards the industrial average and dislike companies moving away from the average.

b. The debt ratio is close and moving closer to the industrial average.c. Gross margin is equal to the industrial average.d. Earnings per share are increasing and moving towards the industrial average.e. P/E ratio is below the industry average, which is reflected in the lower ROI and ROE then

the industry average.f. Market-to-book value is below average.

72

Study Guide Chapter 4

Documents

Transcript of Study Guide Chapter 4