Chapter 3 Analysis of Financial Statement

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Chapter 3
Analysis of Financial Statements

SOLUTIONS TO END-OF-CHAPTER PROBLEMS

3-1DSO = 40 days; S = $7,300,000; AR = ?

DSO =
40 =
40 = AR/$20,000
AR = $800,000.

3-2A/E = 2.4; D/A = ?

3-3ROA = 10%; PM = 2%; ROE = 15%; S/TA = ?; TA/E = ?
ROA = NI/A; PM = NI/S; ROE = NI/E.

ROA= PM  S/TA
NI/A= NI/S  S/TA
10%= 2%  S/TA
S/TA= 5.

ROE= PM  S/TA  TA/E
NI/E= NI/S  S/TA  TA/E
15%= 2%  5  TA/E
15%= 10%  TA/E
TA/E= 1.5.

3-4TA = $10,000,000,000; CL = $1,000,000,000; LT debt = $3,000,000,000; CE = $6,000,000,000; Shares outstanding = 800,000,000; P0 = $32; M/B = ?

Book value = = $7.50.

M/B = = 4.2667.

3-5TA = $12,000,000,000; T = 40%; EBIT/TA = 15%; ROA = 5%; TIE = ?

= 0.15
EBIT= $1,800,000,000.

= 0.05
NI= $600,000,000.

Now use the income statement format to determine interest so you can calculate the firm’s TIE ratio.

EBIT$1,800,000,000See above.
INT 800,000,000
EBT$1,000,000,000EBT = $600,000,000/0.6
Taxes (40%) 400,000,000
NI$ 600,000,000See above.

TIE = EBIT/INT
= $1,800,000,000/$800,000,000
= 2.25.

3-6We are given ROA = 3% and Sales/Total assets = 1.5.

From Du Pont equation: ROA = Profit margin  Total assets turnover 3% = Profit margin(1.5)
Profit margin = 3%/1.5 = 2%.

We can also calculate the company’s debt ratio in a similar manner, given the facts of the problem. We are given ROA(NI/A) and ROE(NI/E); if we use the reciprocal of ROE we have the following equation:

Alternatively,

ROE = ROA  EM
5% = 3%  EM
EM = 5%/3% = 5/3 = TA/E.

Take reciprocal:

E/TA = 3/5 = 60%;

therefore, D/A = 1 - 0.60 = 0.40 = 40%.

Thus, the firm’s profit margin = 2% and its debt ratio = 40%.

3-7Present current ratio = = 2.5.

Minimum current ratio = = 2.0.

$1,312,500 + NP = $1,050,000 + 2NP
NP = $262,500.

Short-term debt can increase by a maximum of $262,500 without violating a 2 to 1 current ratio, assuming that the entire increase in notes payable is used to increase current assets. Since we assumed that the additional funds would be used to increase inventory, the inventory account will increase to $637,500 and current assets will total $1,575,000.

3-8TIE = EBIT/INT, so find EBIT and INT.
Interest = $500,000  0.1 = $50,000.

Net income = $2,000,000  0.05 = $100,000.
Pre-tax income (EBT) = $100,000/(1 - T) = $100,000/0.7 = $142,857. EBIT = EBT + Interest = $142,857 + $50,000 = $192,857.

TIE = $192,857/$50,000 = 3.86.

3-9TA = $30,000,000,000; EBIT/TA = 20%; TIE = 8; DA = $3,200,000,000; Lease payments = $2,000,000,000; Principal payments = $1,000,000,000; EBITDA coverage = ?

EBIT/$30,000,000,000 = 0.2
EBIT = $6,000,000,000.

8 = EBIT/INT
8 = $6,000,000,000/INT
INT = $750,000,000.

EBITDA = EBIT + DA
= $6,000,000,000 + $3,200,000,000
= $9,200,000,000.

EBITDA coverage ratio =
=
= = 2.9867.

3-10ROE = Profit margin  TA turnover  Equity multiplier = NI/Sales  Sales/TA  TA/Equity.

Now we need to determine the inputs for the equation from the data that were given. On the left we set up an income statement, and we put numbers in it on the right:

Sales (given) $10,000,000
- Cost na
EBIT (given) $ 1,000,000
- INT (given) 300,000
EBT $ 700,000
- Taxes (34%) 238,000
NI $ 462,000

Now we can use some ratios to get some more data:
Total assets turnover = 2 = S/TA; TA = S/2 = $10,000,000/2 = $5,000,000.

D/A = 60%; so E/A = 40%; and, therefore,...
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