Principles of Managerial Finance
Principles of Managerial Finance FIN 301
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LGlLGS LGlLGS Chapter 3 Solutions Comett Adair and No inger CHAPTER 3 ANALYZING FINANCIAL STATEMENTS Questions 1 Classify each of the following ratios according to a ratio category liquidity ratio asset management ratio debt management ratio pro tability ratio or market value ratio a Current ratio 7 liquidity ratio b Inventory turnover ratio 7 asset management ratio c Return on assets 7 pro tability ratio d Accounts payable period 7 asset management ratio e Times interest earned 7 debt management ratio f Capital intensity ratio 7 asset management ratio g Equity multiplier 7 debt management ratio h Basic earnings power ratio 7 pro tability ratio 2 For each of the actions listed below determine what would happen to the current ratio Assume nothing else on the balance sheet changes and that net working capital is positive a Accounts receivable are paid in cash 7 Current ratio does not change b Notes payable are paid off with cash 7 Current ratio increases c Inventory is sold on account 7 Current ratio does not change d Inventory is purchased on account7 Current ratio decreases e Accrued wages and taxes increase 7 Current ratio decrease f Longterm debt is paid with cash 7 Current ratio decreases g Cash from a shortterm bank loan is received 7 Current ratio decreases 3 Explain the meaning and signi cance of the following ratios a Quick ratio Inventories are generally the least liquid of a rm s current assets Further inventory is the current asset for which book values are the least reliable measures of market value In practical terms what this means is that if the rm must sell inventory to pay upcoming bills the rm is most likely to have to discount inventory items in order to liquidate them and so therefore they are the assets on which losses are most likely to occur Therefore the quick or acidtest ratio measures a rm s ability to pay off shortterm obligations without relying on inventory sales The quick ratio measures the dollars of more liquid assets cash and marketable securities and accounts receivable available to pay each dollar of current liabilities b Average collection period The average collection period ACP measures the number of days accounts receivable are held before the rm collects cash from the sale In general a rm wants to produce a high level of sales per dollar of accounts receivable ie it wants to collect its accounts receivable as quickly as possible to reduce any cost of nancing inventories and accounts receivable including interest expense on liabilities used to nance inventories and accounts receivable and defaults associated with accounts receivable LG2 Chapter 3 Solutions Comett Adair and No inger c Return on equity Return on equity ROE measures the return on the common stockholders investment in the assets of the rm ROE is the net income earned per dollar of common stockholders equity The value of a rm s ROE is affected not only by net income but also by the amount of nancial leverage or debt that rm uses d Days sales in inventory The days sales in inventory ratio measures the number of days that inventory is held before the nal product is sold In general a rm wants to produce a high level of sales per dollar of inventory that is it wants to turn inventory over from raw materials to nished goods to sold goods as quickly as possible A high level of sales per dollar of inventory implies reduced warehousing monitoring insurance and any other costs of servicing the inventory So a high inventory turnover ratio or a low days sales in inventory is a sign of good management e Debt ratio The debt ratio measures the percentage of total assets nanced with debt The debttoequity ratio measures the dollars of debt nancing used for every dollar of equity nancing The equity multiplier ratio measures the dollars of assets on the balance sheet for every dollar of equity nancing As you might suspect all three measures are related So the lower the debt debttoequity or equity multiplier ratios the less debt and more equity the rm uses to nance its assets ie the bigger the rm s equity cushion f Pro t margin The pro t margin is the percent of sales left after all rm expenses are paid g Accounts payable turnover The accounts payable turnover ratio measures the dollar cost of goods sold per dollar of accounts payable In general a rm wants to pay for its purchases as slowly as possible The more slowly it can pay for its supply purchases the less the rm will need other costly sources of nancing such as notes payable or longterm debt Thus a high APP or a low accounts payable turnover ratio is generally a sign of good management h Markettobook ratio The markettobook ratio compares the market current value of the rm s equity to their historical costs In general the higher the markettobook ratio the better the rm 4 A rm has an average collection period of 10 days The industry average ACP is 25 days Is this a good or poor sign about the management of the rm s accounts receivable If the ACP is extremely low the rm s accounts receivable policy may be so strict that customers prefer to do business with competing rms Firms offer accounts receivable terms as an incentive to get customers to buy products from their rm rather than a competing rm By offering rm customers the accounts receivable privilege management allows customers to buy more now and pay later Without this incentive that is if managers require customers to pay for their purchases very quickly customers may chose to buy the goods from the rm s competitors who offer better credit terms So extremely low ACP levels may be a sign of bad rm management 5 A rm has a debt ratio of 20 The industry average debt ratio is 65 Is this a good or poor sign about the management of the rm s nancial leverage When a rm issues debt to nance its assets it gives the debtholders rst claim to a xed amount of its cash ows Stockholders are entitled to any residual cash ows those left after LG6 Chapter 3 Solutions Comett Adair and No inger debtholders are paid When a rm does well nancial leverage increases the reward to shareholders since the amount of cash ows promised to debtholders is constant and capped So when rms do well nancial leverage creates more cash ows to share with stockholdersiit magni es the return to the stockholders of the rm This magni cation is one reason that rm stockholders encourage the use of debt nancing However nancial leverage also increases the rm s potential for nancial distress and even failure If the rm has a bad year and can not make promised debt payments debtholders can force the rm into bankruptcy Thus a rm s current and potential debtholders and even stockholders look at equity nancing as a safety cushion that can absorb uctuations in the rm s earnings and asset values and guarantee debt service payments Clearly the larger the uctuations or variability of a rm s cash ows the greater the need for an equity cushion Managers choice of capital structure the amount of debt versus equity to issue affects the rm s viability as a longterm entity In deciding the level of debt versus equity nancing to hold on the balance sheet managers must consider the tradeoff between maximizing cash ows to the rm s stockholders versus the risk of being unable to make promised debt payments 6 A rm has an ROE of 20 The industry average ROE is 12 Is this a good or poor sign about the management of the rm Generally a high ROE is considered to be a positive sign of rm performance However if performance comes from a high degree of nancial leverage a high ROE can indicate a rm with an unacceptably high level of bankruptcy risk as well 7 Why is the DuPont system of analysis an important tool when evaluating rm performance Many of the ratios discussed in the chapter are interrelated So a change in one ratio may well affect the value of several ratios Often these interrelations can help evaluate rm performance Managers and investors often perform a detailed analysis of ROA Return on Assets and ROE Return on Equity using the DuPont analysis system Popularized by the DuPont Corporation the DuPont analysis system uses the balance sheet and income statement to break the ROA and ROE ratios into component pieces 8 A rm has an ROE of 10 The industry average ROE is 15 How can the DuPont system of analysis help the rm s managers identify the reasons for this difference The basic DuPont equation looks at the rm s overall pro tability as a function of the pro t the rm earns per dollar of sales operating ef ciency and the dollar of sales produced per dollar of assets on the balance sheet ef ciency in asset use With this tool managers can see the reason for any changes in ROA in more detail For example if ROA increases the DuPont equation may show that the net pro t margin was constant but the total asset turnover ef ciency in using assets increased or that total asset turnover remained constant but pro t margins operating ef ciency increased Managers can then break down operating ef ciency and ef ciency in asset use further using the ratios described above to more speci cally identify the reasons for an ROA change 9 What is the difference between the internal growth rate and the sustainable growth rate Chapter 3 Solutions Comett Adair and No inger The internal growth rate is the growth rate a rm can sustain if it uses only internal nancingithat is retained eamingsito nance future growth A problem arises when a rm relies only on internal nancing to support asset growth Through time its debt ratio will fall because as asset values grow total debt stays constantionly retained earnings nance asset growth If total debt remains constant as assets grow the debt ratio decreases As we noted above shareholders often become disgruntled if as the rm grows a decreasing debt ratio increasing equity nancing dilutes their return So as rms grow managers must often try to maintain a debt ratio that they view as optimal In this case managers nance asset growth with new debt and retained earnings The maximum growth rate that can be achieved this way is the sustainable growth rate 10 What is the difference between time series analysis and crosssectional analysis Time series analysis evaluates the performance of the rm over time Crosssectional analysis evaluates the performance of the rm against one or more companies in the same industry 11 What information does time series and crosssectional analysis provide for rm managers analysts and investors Analyzing ratio trends over time along with absolute ratio levels gives managers analysts and investors information about whether a rm s nancial condition is improving or deteriorating For example ratio analysis may reveal that the days sales in inventory is increasing This suggests that inventories relative to the sales they support are not being used as well as they were in the past If this increase is the result of a deliberate policy to increase inventories to offer customers a wider choice and if it results in higher future sales volumes or increased margins that more than compensate for increased capital tied up in inventory the increased relative size of the inventories is good for the rm Managers and investors should be concerned on the other hand if increased inventories result from declining sales but steady purchases of supplies and production Looking at one rm s nancial ratios even through time give managers analysts and investors only a limited picture of rm performance Ratio analysis almost always includes a comparison of one rm s ratios relative to the ratios of other rms in the industry or crosssectional analysis Key to crosssectional analysis is identifying similar rms in that they compete in the same markets have similar assets sizes and operate in a similar manner to the rm being analyzed Since no two rms are identical obtaining such a comparison group is no easy task Thus the choice of companies to use in crosssectional analysis is at best subjective 12 Why is it important to know a rm s accounting rules before making any conclusions about its performance from ratios analysis Firms use different accounting procedures For example inventory methods can vary One rm may use FIFO rstin rstout transferring inventory at the rst purchase price while another uses LIFO lastin rstout transferring inventory at the last purchase price Likewise the depreciation method used to value a rm s xed assets over time may vary across rms One rm may use straightline depreciation while another may use an accelerated depreciation Basic Problems LGl Chapter 3 Solutions Comett Adair and No inger method e g MACRS Particularly when reviewing crosssectional ratios differences in accounting rules can affect balance sheet values and nancial ratios It is important to know which accounting rules the rms under consideration are using before making any conclusions about its performance from ratio analysis 13 What does it mean when a firm window dresses its financial statements Firms often window dress their financial statements to make annual results look better For example to improve liquidity ratios calculated with yearend balance sheets firms often delay payments for raw materials equipment loans etc to build up their liquid accounts and thus their liquidity ratios If possible it is often more accurate to use other than yearend financial statements to conduct performance analysis Problems 31 Liquidity Ratios You are evaluating the balance sheet for Goodman s Bees Corporation From the balance sheet you find the following balances Cash and marketable securities 400000 Accounts receivable 1200000 Inventory 2100000 Accrued wages and taxes 500000 Accounts payable 800000 and Notes payable 600000 Calculate Goodman Bee s Current ratio Quick ratio and Cash ratio 400000 1200000 2100000 Current ratio 19474 times 500000 800000 600000 400000 1200000 2100000 2100000 Quick ratio acidtest ratio 084211 times 500000 800000 600000 400000 Cash ratio 021053 times 500000 800000 600000 32 Liquidity Ratios The top part of Ramakrishnan Inc s 2008 and 2009 balance sheets is listed below in millions of dollars Current assets 2008 2009 Current liabilities 2008 2009 Cash and marketable Accrued wages and securities 15 20 taxes 18 19 Accounts receivable 75 84 Accounts payable 45 51 Inventory H E Notes payable A A Total 200 225 Total 103 115 Calculate Ramakrishnan Inc s Current ratio Quick ratio and Cash ratio for 2008 and 2009 2008 2009 200m 225m Current ratio 19417 times 7 19565 times 103m 115m 200m 110m 225m 121m LG3 Chapter 3 Solutions Comett Adair and No inger Quick ratio acidtest ratio 7 08738 times 7 090435 times 103m 1 15m l5m 20m Cash ratio 7 014563 times 7 017391 times 103m 1 15m 33 Asset Management Ratios Tater and Pepper Corp reported sales for 2008 of 23 million Tater and Pepper listed 56 million of inventory on its balance sheet Calculate Tater and Pepper s 2008 EBIT Using a 365 day year how many days did Tater and Pepper s inventory stay on the premises How many times per year did Tater and Pepper s inventory turn over 56m X 365 Days sales in inventory 888696 days 23m 23m Inventory turnover ratio 7 41071 days 56m 34 Asset Management Ratios Mr Husker s Tuxedos Corp ended the year 2008 with an average collection period of 32 days The rm s credit sales for 2008 were 33 million What is the yearend 2008 balance in accounts receivable for Mr Husker s Tuxedos Accounts receivable X 365 Average collection period ACP 7 7 32 days 33m gt Accounts receivable 32 days X 33 m365 289m 35 Debt Management Ratios Tiggie s Dog Toys Inc reported a debttoequity ratio of 175 times at the end of 2008 If the rm s total debt at yearend was 25 million how much equity does Tiggie s have Total debt 25 In D 14 quih ratio 7 I75 7 7 7 gt Total equity 25ml75 1429m Total equity Total equity 36 Debt Management Ratios You are considering a stock investment in one of two rms LotsofDebt Inc and Lotsoquuity Inc both of which operate in the same industry LotsofDebt Inc nances its 25 million in assets with 24 million in debt and 1 million in equity Lotsoquuity Inc nances its 25 million in assets with 1 million in debt and 24 million in equity Calculate the debt ratio equity multiplier and debttoequity ratio for the two rms LotsofDebt Lotsof Equity 24m 1m Debt ratio 9600 77 400 25m 25m LG4 Chapter 3 Solutions Comett Adair and No inger 25m 25m Equity multiplier ratio 25 times if 1042 times 1m 24m 24m 1m Debttoequity ratio if 24 times if 042 times 1m 24m 37 Pro tability Ratios Maggie s Skunk Removal Corp s 2008 income statement listed net sales 125 million EBIT 56 million net income available to common stockholders 32 million and common stock dividends 12 million The 2008 yearend balance sheet listed total assets 525 million and common stockholders equity 21 million with 2 million shares outstanding Calculate the pro t margin basic earnings power ratio ROA ROE and dividend payout ratio 32m 12m Pro t margin 777 1600 125m 56m Basic earnings power ratio BEP if 1067 525m Return on assets ROA if 6095 525m Return on equity ROE 1524 21m 12m Dividend payout ratio if 3750 32m 38 Pro tability Ratios In 2008 Jake s Jamming Music Inc announced an ROA of 856 ROE of 145 and pro t margin of 205 The rm had total assets of 165 million at yearend 2008 Calculate the 2008 values of net income available to common stockholders common stockholders equity and net sales for Jake s Jamming Music Inc Net income available to common stockholders Return on assets ROA 00856 165m gt Net income available to common stockholders 00856 X 165 m 1412400 LG5 LG6 LG6 Chapter 3 Solutions Comett Adair and No inger 1412400 Return on equity ROE 0145 77777 Common stockholders equity gt Common stockholders equity 14124000145 9740690 1412400 gt Sales 14124000205 6889756 Pro t margin 0205 Sales 39 Market Value Ratios You are considering an investment in Roxie s Bed amp Breakfast Corp During the last year the rm s income statement listed addition to retained earnings 48 million and common stock dividends 22 million Roxie s yearend balance sheet shows common stockholders equity 35 million with 10 million shares of common stock outstanding The common stock s market price per share 900 What is Roxie s Bed amp Breakfast s book value per share and earnings per share Calculate the markettobook ratio and PE ratio Book value per share 35m10m 350 per share Earnings per share 48m 22m10m 070 per share 900 Markettobook ratio 257 times Priceeamings PE ratio 1286 times 310 Market Value Ratios Gambit Golf s markettobook ratio is currently 25 times and PE ratio is 675 times If Gambit Golf s common stock is currently selling at 1250 per share what is the book value per share and earnings per share 1250 Markettobook ratio 250 7 gt Book value per share 1250250 500 Book value per share 1250 Priceearnings PE ratio 675 times Earnings per share gt Earnings per share 1250675 185 311 DuPont Analysis If Silas 4Wheeler Inc has an ROE 18 equity multiplier 2 a pro t margin of 1875 what is the total asset turnover ratio and the capital intensity ratio ROE 18 1875 Total asset turnover X 2 gt Total asset turnover 181875 X 2 4800 Capital intensity ratio 148 2083333 times 312 DuPont Analysis Last year Hassan s Madhatter Inc had an ROA of 75 a pro t margin of 12 and sales of 10 million Calculate Hassan s Madhatter s total assets Intermediate Problems LGl LGl LG2 Chapter 3 Solutions Comett Adair and No inger ROA 0075 12 X 10mTotal assets gt Total assets 12 X 10m075 16m 313 Internal Growth Rate Last year Lakesha s Lounge Furniture Corporation had an ROA of 75 and a dividend payout ratio of 25 What is the internal growth rate 0075 X 1 25 Internal growth rate 7 7 811 1 0075 X 1 25 314 Sustainable Growth Rate Last year Lakesha s Lounge Furniture Corporation had an ROE of 125 and a dividend payout ratio of 20 What is the sustainable growth rate 0125 X 1 20 Sustainable growth rate 7 7 914 1 0125 X 1 20 315 Liquidity Ratios Brenda s Bar and Grill has current liabilities of 15 million Cash makes up 10 percent of the current assets and accounts receivable makes up another 40 percent of current assets Brenda s current ratio 21 times Calculate the value of inventory listed on the rm s balance sheet Current ratio 21 Current assets15m gt Current assets 21 X 15m 315m Cash 010 X 315m 315m Accounts receivable 040 X 315m 126m gt Inventory 315m 315m 126m 1575m 316 Liquidity and Asset Management Ratios Mandesa Inc has current liabilities 5 million current ratio 2 times inventory turnover ratio 12 times average collection period 30 days and sales 40 million Calculate the value of cash and marketable securities Current assets Current ratio 2 times 7 77 gt Current assets 2 X 5m 10m 5m 40m Inventory turnover ratio 12 times 77 gt Inventory 40m 12 3333333 Inventory Accounts receivable X 365 Average collection period ACP 30 days 7 40m gt Accounts receivable 30 X 40m365 3287671 gt Cash and marketable securities 10m 3333333 3287671 337896 LG2 LG2 LG3 Chapter 3 Solutions Comett Adair and No inger 317 Asset Management and Pro tability Ratios You have the following information on Els Putters lnc sales to working capital 46 times pro t margin 20 net income available to common stockholders 5 million and current liabilities 6 million What is the firm s balance of current assets Pro t margin 2 5mSales gt Sales 5m2 25m Sales Current assets 7 Current liabilities 46 25mCurrent assets 6m gt Current assets 25m46 6m 1143m 318 Asset Management and Debt Management Ratios Use the following information to complete the balance sheet below Sales 52 million capital intensity ratio 210 times debt ratio 55 and f1Xed asset turnover ratio 12 times Step 1 Capital intensity ratio 210 Total assets52m gt Total assets 21 X 52m 1092m and Total liabilities and equity 1092m Step 2 Debt ratio 55 Total debt1092m gt Total debt 55 X 1092m 6006m Step 3 Total equity 1092m 6006m 4914m Step 4 Fixed asset turnover 12 52mFiXed assets gt Fixed assets 52m12 4333m Step 5 Current assets 10922m 4333m 6587m Assets Liabilities and Equity Current assets Step 5 6587m Total liabilities Step 2 6006m Fixed assets Step 4 4333m Total equity Step 3 49l4m Total assets Step 1 1092m Total liabilities and equity 1092m 319 Debt Management Ratios Tiggie s Dog Toys Inc reported a debt to equity ratio of 175 times at the end of 2008 If the firm s total assets at yearend were 25 million how much of their assets are financed with debt and how much with equity Debt to equity 175 Total debtTotal equity Total debtTotal assets 7 Total debt 175 Total debt25m 7 Total debt gt 175 X 25m 7 Total debt Total debt gt 175 X 25m 7 175 X Total debt Total debt gt 4375m 275 X Total debt gt Total debt 4375m275 1591m gt Total equity 25m 1591m 909m 320 Debt Management Ratios Calculate the times interest earned ratio for LaTonya s Flop Shops Inc using the following information Sales 1 million cost of goods sold 600000 depreciation eXpense 100000 addition to retained earnings 97500 dividends per share 1 taX rate 30 and number of shares of common stock outstanding 60000 LaTonaya s Flop Shops has no preferred stock outstanding LG2 LG4 Chapter 3 Solutions Comett Adair and No inger Net sales all credit 1000000 Less Cost of goods sold 600 000 Gross profits step 4 400000 Less Depreciation 100 000 Earnings before interest and taxes EBIT step 5 300000 Less Interest step 6 75 000 Earnings before taxes EBT step 3 225000 Less Taxes Net income step 2 157 500 Less Common stock dividends step 1 60 000 Addition to retained earnings 97500 Step 1 Common stock dividends 1 X 60000 60000 Step 2 Net income Common stock dividends Addition to retained earnings 60000 97500 157500 Step 3 EBT 1 7taX rate Net income gt EBT Net income1 7taX rate 15750013 225000 Step 4 Gross pro ts Net sales 7 Cost of goods sold 1000000 7 600000 400000 Step 5 Gross pro ts 7 Depreciation EBIT 400000 100000 300000 Step 6 EBIT 7 Interest EBT gt Interest EBIT EBT 300000 225000 75000 gt Times interest earned 30000075000 400 times 321 Pro tability and Asset Management Ratios You are thinking of investing in Nikki T s Inc You have only the following information on the rm at yearend 2008 net income 250000 total debt 25 million debt ratio 55 What is Nikki T s ROE for 2008 Debt ratio 55 25mTotal assets gt Total assets 25m55 4545m gt Total equity 4545m 25m 2045m gt ROE 2500002045m 1222 322 Pro tability Ratios Rick s Travel Service has asked you to help piece together nancial information on the rm for the most current year Managers give you the following information sales 48 million total debt 15 million debt ratio 40 ROE 18 Using this information calculate Rick s ROA Debt ratio 40 15mTotal assets gt Total assets 15m4 375m gt Total equity 375m 15m 225m gt ROE 18 Net income225m gt Net income 18 X 225m 405000 gt ROA 405000375m 108 LG5 LG5 Chapter 3 Solutions Comett Adair and No inger 323 Market Value Ratios Leonatti Labs yearend price on its common stock is 35 The rm has total assets of 50 million the debt ratio is 65 no preferred stock and there are 3 million shares of common stock outstanding Calculate the markettobook ratio for Leonatti Labs Debt ratio 65 Total debt50m gt Total debt 65 X 50m 325m gt Total equity 50m 325m 175m gt Book value of equity 175m3m 583333 per share gt Market to book ratio 35583333 6 times 324 Market Value Ratios Leonatti Labs yearend price on its common stock is 15 The rm has a pro t margin of 8 total assets of 25 million a total asset turnover ratio of 075 no preferred stock and there are 3 million shares of common stock outstanding Calculate the PE ratio for Leonatti Labs Total asset turnover 75 Sales25m gt Sales 25m X 75 1875m gt Pro t margin 08 Net income1875m gt Net income 08 X 1875m 15m gt EPS 15m3m 050 per share gt PE ratio 15050 30 times 325 DuPont Analysis Last year StumbleonInn Inc reported an ROE 18 The rm s debt ratio was 55 sales were 15 million and the capital intensity ratio was 125 times Calculate the net income for StumbleonInn last year Capital intensity ratio 125 Total assets15 gt Total assets 125 X 15m 1875m gt Debt ratio 55 Total debt1875m gt Total debt 55 X 1875m 103125m gt Total equity 1875m 103125m 84375m gt ROE 18 Net income84375m gt Net income 18 X 84375m 1518750 326 DuPont Analysis You are considering investing in Nuran Security Services You have been able to locate the following information on the rm total assets 16 million accounts receivable 22 million ACP 25 days net income 25 million and debttoequity ratio 12 times Calculate the ROE for the rm Debttoequity 12 Total debtTotal equity Total debtTotal assets 7 Total debt 12 Total debt16m 7 Total debt gt 12 X 16m 7 12 X Total debt Total debt gt 192m 22 X Total debt gt Total debt 192m22 8727m gt Total equity 192m 8727 7273m gt ROE 25m7273m 34375 327 Internal Growth Rate Dogs R Us reported a pro t margin of 105 total asset turnover ratio of 075 times debttoequity ratio of 080 times net income of 500000 and dividends paid to common stockholders of 200000 The rm has no preferred stock outstanding What is Dogs R Us internal growth rate ROA Pro t Margin X Total asset turnover 105 X 075 7875 RR 500000 200000500000 60 LG6 LG1LG7 Chapter 3 Solutions Comett Adair and No inger ROA X RR 007875 X 60 Internal growth rate 8548 1ROAX RR 1 007875 x 60 328 Sustainable Growth Rate You have located the following information on Webb s Heating amp Air Conditioning debt ratio 54 capital intensity ratio 110 times pro t margin 125 and dividend payout ratio 40 Calculate the sustainable growth rate for Webb Equity multiplier Total assetsTotal equity gt 1Equity multiplier Total equityTotal assets Debt ratio Total debtTotal assets Total assets 7 Total equityT0ta1 assets 1 7 Total equity Total assets 54 1 Total equityTotal assets gt Total equityTotal assets 1 54 46 1Equity multiplier gt Equity multiplier 146 21739 ROE Pro t Margin X Total asset turnover X Equity multiplier 125 X 1110 X 21739 2470 Retention ratio RR 1 dividend payout ratio 1 40 60 2470 X 60 Sustainable growth rate 777 3281 1 2470 X 60 Use the following nancial statements for Lake of Egypt Marina to answer problems 3 29 through 3 32 Lake of Egypt Marina lnc Balance Sheet as of December 31 2007 and 2008 in millions of dollars Assets 2007 2008 Liabilities amp Equity 2007 2008 Current assets Current liabilities Cash and marketable Accrued wages and securities 65 75 taxes 39 43 40 Accounts receivable 110 115 Accounts payable 80 90 Inventory 190 M Notes payable 70 80 Total 365 390 Total 193 210 Fixed assets Longterm debt 39 280 300 Gross plant and equipment 219 471 580 Stockholders equity Less Depreciation 100 110 Preferred stock 5 million shares 39 5 5 Net plant and Common stock an equipment 219 371 470 paidin surplus 65 65 Other longterm assets 49 50 65 million shares Total 420 520 Retained earnings 242 330 Total 312 400 Total assets 785 910 Total liabilities and equity E 785 E 910 Chapter 3 Solutions Comett Adair and No inger Lake of Egypt Marina Inc Income Statement for Years Ending December 31 2007 and 2008 in millions of dollars 2007 2008 Net sales all credit 432 515 Less Cost of goods sold 200 260 Gross profits 232 255 Less Depreciation 20 22 Earnings before interest and taxes EBIT 212 233 Less Interest 30 i Earnings before taxes EBT 182 200 Less Taxes 55 57 Net income 127 143 Less Preferred stock dividends 5 5 Net income available to common stockholders 122 138 Less Common stock dividends 65 65 Addition to retained earnings 57 73 Per common share data Earnings per share EPS 1877 2123 Dividends per share DPS 1000 1000 Book value per share BV 4723 6077 Market value price per share MV 12550 14750 329 Spreading the Financial Statements Spread the balance sheets and income statements of Lake of Egypt Marina Inc for 2007 and 2008 Spread the balance sheet Lake of Egypt Marina Inc Balance Sheet as of December 31 2007 and 2008 in millions of dollars Assets 2007 2008 Liabilities amp Equity 2007 2008 Current assets Current liabilities Cash and marketable Accrued wages and securities 828 824 taxes 548 440 Accounts receivable 1401 1264 Accounts payable 1019 989 Inventory 2421 2198 Notes payable 892 879 Total 4650 4286 Total 2459 2308 Fixed assets Longterm debt 3567 3297 Gross plant and equipment 6000 6374 Stockholders equity Less Depreciation 1274 1209 Preferred stock 5 million shares 063 055 Net plant and Common stock an equipment 4726 5165 paidin surplus 828 714 Other longterm assets 624 549 65 million shares Total 5350 5714 Retained earnings 3083 3626 Total 397 395 Total assets 10000 10000 Total liabilities and equity 10000 10000 Chapter 3 Solutions Comett Adair and Nofringer Spreading the income statement Lake of Egypt Marina Inc Income Statement for Years Ending December 31 2007 and 2008 in millions of dollars 2007 Net sales all credit 10000 Less Cost of goods sold 4630 Gross profits 5370 Less Depreciation 463 Earnings before interest and taxes EBIT 4907 Less Interest 694 Earnings before taxes EBT 4213 Less Taxes 1273 Net income 2940 2008 10000 5049 4951 427 4524 641 3883 1107 2776 330 Calculating Ratios Calculate the following ratios for Lake of Egypt Marina Inc as of yearend 2008 a Current ratio b Quick ratio c Cash ratio d Inventory turnover ratio e Days sales in inventory f Average collection period g Average payment period h Fixed asset turnover ratio i Sales to working capital j Total asset turnover ratio k Capital intensity ratio 1 Debt ratio In Debttoequity ratio n Equity multiplier 0 Times interest earned p Cash coverage ratio q Profit margin r Basic earnings power ratio s ROA t ROE u Dividend payout ratio v Markettobook ratio w PE ratio Lake of Egypt Marina Inc Industry 390210186 times 20 times 390200210090 times 12 times 7521036 times 025 times 515200258 times 360 times 200x36551514175 days 10139 days 115x3655158150 days 3250 days 90X36526012635 days 45 days 515520099 times 125 times 515390210286 times 425 times 515910057 times 085 times 901515177 times 118times 2103009105604 6250 210300400128 times 167 times 910400228 times 267 times 23333706 times 850 times 2332233773 times 875 times 1385152680 2875 2339102560 3250 1389101516 1975 1384003450 3688 651384710 35 147506077243 times 255 times 147502123695 times 1560 times 331 DuPont Analysis Construct the DuPont ROA and ROE breakdowns for Lake of Egypt Marina Inc ROA Pro t Margin X Total asset turnover 2680 X 057 times 1516 ROE Pro t Margin X Total asset turnover X Equity multiplier 2680 X 057 times X 228 times 3450 Advanced Problems LG1LG5 LGlLG5 Chapter 3 Solutions Comett Adair and No inger 332 Internal and Sustainable Growth Rates Calculate the internal and sustainable growth rate for Lake of Egypt Marina Inc 01516 X 1 4710 Internal growth rate 7 1 01516 X 1 4710 17876 3450 X 1 4710 Sustainable growth rate 7 7 5267 1 3450 X 1 4710 333 Cross sectional Analysis Using the ratios from question 330 for Lake of Egypt Marina Inc and the industry what can you conclude about Lake of Egypt Marina s nancial performance for 2008 Lake of Egypt Marina is performing below the industry in all areas Liquidity is lower asset management is poorer and pro t ratios are lower 334 Ratio Analysis Use the following information to complete the balance sheet below Step 1 Current Ratio 25 times Current assets370m gt Current assets 25 X 370m 925m Step 2 Pro t Margin 10 Net income2100m gt Net income 10 X 2100m 210m 51gt ROE 20 210mTotal equity gt Total equity 210m20 1050m Step 3 Longterm debtLongterm Debt and Equity 55 gt 55Longterm Debt 1050m Longterm Debtgt 55X Longterm Debt 55 X 1050m Longterm Debt gt 5775m 1 55 X Longterm Debt gt Longterm Debt 5775m1 55 1283m Current Assets Step 1 925m Current Liabilities 370m Fixed Assets Step 5 1778m Longterm Debt Step 3 1283m Stockholders Equity Step 2 1 050m Total Assets 2 703m Step 4 Total Liabilities amp Equity 2 703m 335 Ratio Analysis Use the following information to complete the balance sheet below Step 1 Current ratio 22 times Current assets500m gt Current assets 22 X 500m 1100m Step 2 Average collection period 60 days Accounts receivable X 3651200m 51gt Accounts receivable 60 X 1200m365 197m 9 Step 3 Inventory turnover 15 times 1200mInventory gt Inventory 1200m15 800m Chapter 3 Solutions Comett Adair and No inger Step 4 Cash 1100m 197m 800m 103m Step 5 Total asset turnover 075 times 1200mT0tal assets gt Total assets 1200m075 1600m Step 6 Fixed assets 1600m 1100m 500m Step 7 Debt ratio 60 Total debt1600m gt Total debt 60 X 1600m 960m Cash Step 4 3 103m Accounts receivable Step 2 197m Current liabilities 500m Inventory Step 3 800m Longterm debt Step 9 460m Current assets Step 1 1100m Total debt Step 7 960m Fixed assets Step 6 500m Stockholders equity Step 8 640m Total assets i1 600m Total liabilities amp equity Step 5 i1 600m