Chapter 3 Finance

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Nicole Morrissey CQ 4, 7
BUS2215Problems 1-8, 12, 17, 18
February 8, 2012

4. Financial Ratios Fully explain the kind of information the following financial ratios provide about a firm:

Quick Ratio | This ratio measures a company’s ability to meet its short-term obligations with its most liquid assets, which is why inventory is omitted.| Cash Ratio| This assesses a company’s financial durability by examining whether it is at least profitable enough to pay off its interest expenses.| Total Asset Turnover| Tells us the amount of sales generated for every dollar worth of assets.| Equity Multiplier| Tells us how a company uses debt to finance its assets.| Long-term Debt Ratio| Measures the percentage of the overall company’s assets that are owned by the equity and debt.| Times Interest Earned Ratio| (TIE) Tells us about a company’s ability to meet it’s debt obligations. This could force a company into bankruptcy.| Profit Margin| Measures how much out of every dollar of sales a company actually keeps in earnings.| Return on Assets| Displayed as a percentage. An indicator of how profitable a company is relative to its total assets.| Return on Equity| Displayed as a percentage. Measures a company’s profitability by revealing how much profit a company generates with the money shareholders have invested.| Price-Earnings Ratio| A valuation ratio of a company’s current share price compared to its per-share earnings. A high P/E suggests investors are expecting higher earning growth in the future.|

7. Du Pont Identity Why is the Du Pont identity a valuable tool for analyzing the performance of a firm? Discuss the types of information it reveals compared to ROE considered by itself.

The Du Pont identity is a valuable tool for analyzing the performance of a firm because it breaks return on equity (ROE) into three parts: operating efficiency, asset use efficiency, and financial leverage. If ROE is unsatisfactory, the Du Pont identity helps locate the part of the business that is underperforming.

1.
Current Ratio = Current Assets/Current Liabilities= $5,090/$3,720 = 1.37 times

NWC = CA – CL
NWC = 1370CL = 3720
1370 = CA – 3720
5090 = CA

Quick Ratio = (CA – Inventory)/CL = ($5,090 – $1,950)/$3,720 = 0.84 times

2.
Profit Margin = Net Income/SalesROA = Net Income/Total Assets

8% = ??? . = $2,320,000/$17,500,000
$29,000,000

Net Income = $2,320,000ROA = 13%

ROE = Net Income/Total Equity
= $2,320,000/$11,200,000
ROE = 21%

3.
Receivables Turnover = Sales/Accounts Receivable

9.14 times = $3,943,709/$431,287

Days in Receivables = 365/RT= 365 Days/9.14 = 36.25 Days

4.
Inventory Turnover = COGS/Inventory = 4,105,612/407,534 = 10.07 times Days in Inventory = 365/Inventory TO= 365 Days/10.07 = 36.25 Days

5.
Total Debt Ratio = 0.63 times($1-$0.63 = $0.37) $0.37 In debt for every $1 in assets. Debt-Equity Ratio = 0.63/$0.37
= 1.70 times

Equity Multiplier = $1 + $1.70 = $2.70
OR
= $1/$0.37 = $2.70

6.
EPS = Net Income/ Total Shares OutstandingAdd to R/E = Net Income – Dividends = $605,000/210,000 430,000 = Net Income – 175,000 = $2.88 605,000 = Net Income

DPS = Total Dividends/Total Shares Outstanding.
= $175,000/210,000
= $0.83

BVPS = TE/Total Shares Outstanding
= $5,300,000/210,000
= $25.24/Share

Market to Book = Market Value per Share/Book Value per share
= $63/$25.24
= 2.50 times

P/E = Price per Share/EPS
= $63/$2.88
= 21.88 times

Price to Sales = Price per Share/Sales per Share
= $63/($4,500,000/210,000)
= $63/$21.43
= 2.94 times

7.
ROE = Profit Margin * TA...
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