Chapter 4

Analyzing Financial Statements

Questions and Problems

BASIC

4.2 Liquidity ratios: Flying Penguins Corp. has total current assets of $11,845,175, current
liabilities of $5,311,020, and a quick ratio of 0.89. How much inventory does it have?
LO 3

Solution:
Current assets = $11,845,175
Current liabilities = $5,311,020
Quick ratio = 0.89

4.3 Efficiency ratio: If Newton Manufacturers have an accounts receivable turnover of 4.8
times and net sales of $7,812,379, what is its receivables?
LO 3

Solution:
 Accounts receivable turnover = 4.8 times

Net sales = $7,812,379

4.4 Efficiency ratio: Bummel and Strand Corp. has a gross profit margin of 33.7 percent,
sales of $47,112,365, and inventory of $14,595,435. What is its inventory turnover ratio?
LO 3

Solution:
Gross profit margin = 33.7%
Sales = $ 47,112,365
Inventory = $14,595,435
4.5 Efficiency ratio: Sorenson Inc. has sales of $3,112,489, a gross profit margin of 23.1
percent, and inventory of $833,145. What are the company’s inventory turnover ratio and
days’ sales in inventory?
LO 3

Solution:
Sales = $3,112,489
Gross profit margin = 23.1%
Inventory = $833,145

4.6 Leverage ratios: Breckenridge Ski Company has total assets of $422,235,811 and a debt
ratio of 29.5 percent. Calculate the company’s debt-to-equity ratio and the equity
multiplier.
LO 3

Solution:
 Total assets = $422,235,811
Debt ratio = 29.5%

4.7 Leverage ratios: Norton Company has a debt-to-equity ratio of 1.65, ROA of 11.3
percent, and total equity of $1,322,796. What are the company’s equity multiplier, debt
ratio, and ROE?
LO 3

Solution:
Debt-equity ratio = 1.65
ROA = 11.3%
Total equity = $1,322,796

Equity multiplier=1+ Debt to equity ratio=1+1 . 65

=2 .65
Total assets
Equity multiplier=
Total equiity
Total assets=Equity multiplier× Total equity
=2 .65×$ 1, 322, 796
=$ 3 ,505 , 494
 Net income
ROA=
Total assets
Net income=ROA×Total assets=0 .113×3 , 505 , 494
=$ 396 , 111

Net income $ 396 , 111

ROE= = =29 . 9%
Equity $ 1 ,322 , 796

Debt ratio=1-
Equity
Total assets [
= 1−
1
Equity multiplier ]
1
=1− =0 . 623
2. 65

4.8 DuPont equation: The Rangoon Timber Company has the following ratios:
Sales/Total assets = 2.23; ROA = 9.69%; ROE = 16.4%

What are Rangoon’s profit margin and debt ratio?

LO 4

Solution:
Total assets turnover = 2.23
ROA = 9.69%
ROE = 16.4%

ROA = Profit margin × Total assets turnover

ROE = ROA x Equity multiplier

 ROE 0 . 164
Equity multiplier = = =1 .69
ROA 0. 0969

Equity 1
Debt ratio =1− =1−
Total assets Equity multiplier
1
=1− =0 . 41
1. 69

4.9 DuPont Equation: Lemmon Enterprises has a total asset turnover of 2.1 and a net profit
margin of 7.5%. If its equity multiplier is 1.90, what is the ROE for Lemmon
Enterprises?
LO 4

Solution:

ROE = ROA × Equity multiplier

ROA = Net profit margin × Total asset turnover = 2.1 × 7.5% = 15.75%

ROE = 15.75% × 1.9 = 29.93%

4.12 Market-value ratios: Rockwell Jewelers has announced net earnings of $6,481,778 for
this year. The company has 2,543,800 shares outstanding, and the year-end stock price is
$54.21. What are the company’s earnings per share and P/E ratio?
LO 3

Solution:
Net earnings = $6,481,778
Shares outstanding = 2,543,800
Year-end stock price = $54.21
 Net earnings $ 6 ,481 ,778
Earnings per share = EPS = =
Shares outstanding 2 ,543 , 800

=$2 .55
Price $ 54 . 21
Price-earnings ratio = =
Earnings $ 2 .55
=21 . 26 times

4.13 Market-value ratios: Chisel Corporation has 3 million shares outstanding at a price per
share of $3.25. If the debt-to-equity ratio is 1.7 and total book value of debt equals
$12,400,000, what is the market-to-book ratio for Chisel Corporation?
LO 3

Solution:

Market value of equity = 3,000,000 × $3.25 = $9,750,000

$12,400,000
Book value of equity =
1.7
=$ 7 , 294 ,117. 65

$9,750,000
Market-to-book ratio =
$7,294,117 .65
=1 . 34

INTERMEDIATE
4.14 Liquidity ratios: Laurel Electronics has a quick ratio of 1.15, current liabilities of
$5,311,020, and inventories of $7,121,599. What is the firm’s current ratio?
LO 3
Solution:
Quick ratio = 1.15
Current liabilities = $5,311,020
Inventory = $7,121,599

Current assets $ 13 ,229 ,272

Current ratio = =
Current liabilities $ 5 ,311 ,020
=2 . 49

4.15 Efficiency Ratio: Lambda Corporation has current liabilities of $450,000, a quick ratio
of 1.8, inventory turnover of 5.0 and a current ratio of 3.5. What is the cost of goods sold
for Lambda Corporation?
LO 3

Solution:
Current assets = 3.5 × $450,000 = $1,575,000
4.16 Efficiency ratio: Norwood Corp. currently has accounts receivable of $1,223,675 on net
sales of $6,216,900. What are its accounts receivable turnover ratio and days’ sales
outstanding (DSO)?
LO 3

Solution:
Accounts receivable = $1,223,675
Net sales = $6,216,900

Net sales $ 6 , 216 , 900

Accounts receivables turnover= =
Accounts receivables $ 1 ,223 , 675
=5 . 08 times

365 365
DSO= = =71 . 8 days
Accounts receivable turnover 5. 08

4.17 Efficiency ratio: If Norwood Corp.’s management wants to reduce the DSO from that
calculated in the above problem to an industry average of 56.3 days and its net sales are
expected to decline by about 12 percent, what would be the new level of receivables?
LO 3

Solution:
Target DSO = 56.3 days
New level of sales = $6,216,900 x 0.88 = $5,470,872
4.18 Coverage ratios: Nimitz Rental Company had depreciation expenses of $108,905,
interest expenses of $78,112, and an EBIT of $1,254,338 for the year ended June 30,
2011. What are the times interest earned and cash coverage ratios for this company?
LO 3

Solution:
Depreciation = $108,905
Interest expenses = $78,112
EDIT = $1,254,338

EBIT $ 1 ,254 ,338

Times interest earned = =
Interest expense $ 78 ,112
=16 . 1 times

EBITDA EBIT + Depreciation

Cash coverage rates= =
Interest expense Interes t expense
$ 1 , 363 ,243
=
78 , 112
=17 . 5 times

4.19 Leverage ratios: Conseco, Inc., has a debt ratio of 0.56. What are the company’s debt-to-
equity ratio and equity multiplier?
LO 3
Solution:
Debt ratio = 0.56

4.20 Profitability ratios: Cisco Systems has total assets of $35.594 billion, total debt of
$9.678 billion, and net sales of $22.045 billion. Its net profit margin for the year was 20
percent, while the operating profit margin is 30 percent. What are Cisco’s net income,
EBIT ROA, ROA, and ROE?
LO 3

Solution:
Total assets = $35.594 billion
Total debt = 9.678 billion
Net sales = $22.045 billion
Net profit margin = 20%
Operating profit margin = 30%
 EBIT $ 6 . 613
EBIT ROA= = =18 . 6%
Total assets $ 35 .594

Net income $ 4 . 409

ROA= = =12 . 4%
Total assets $ 35 .594

Total equity = Total assets – Total debt

= $35.594 - $9.678 = $25.916 billion

Total assets $ 35. 594

Equity multiplier = =
Total equity $ 25. 916
=1 . 37

ROE = ROA × EM
= 0 . 124 × 1. 37=17%

4.21 Profitability ratios: Procter & Gamble reported the following information for its fiscal
year end: On net sales of $51.407 billion, the company earned a net income after taxes of
$6.481 billion. It had a cost of goods sold of $25.076 billion and an EBIT of $9.827
billion. What are the company’s gross profit margin, operating profit margin, and net
profit margin?
LO 3

Solution:
Net sales = $51.407 billion
Net income = $6.481 billion
Cost of goods sold = $25.076 billion
 EBIT = $9.827 billion

Net sales - Cost of goods sold

Gross profit margin =
Net sales
$ 51 . 407−$ 25 . 076
= =51 . 2%
$ 51 . 407

EBIT $ 9 . 827
Operating profit margin= = =19 .1%
Net sales $ 51 . 407

Net income $ 6 . 481

Net profit margin= = =12 . 6%
Net sales $ 51. 407

4.22 Profitability ratios: Wal-Mart, Inc., has net income of $9,054,000 on net sales of
$256,329,812. The company has total assets of $104,912,112 and shareholders’ equity of
$43,623,445. Use the extended DuPont identity to find the return on assets and return on
equity for the firm.
LO 3

Solution:
Net income = $9,054,000
Net sales = $256,329,812
Total assets = $104,912,112
Shareholder equity = $43,623,445

Net income $ 9 , 054 , 000

Profit margin= = =3 .53 %
Net sales $ 256 ,329 , 812
4.23 Profitability ratios: Xtreme Sports Innovations has disclosed the following information:

EBIT = $25,664,300 Net income = $13,054,000 Net sales = $83,125,336

Total debt = $20,885,753 Total assets = $71,244,863

Compute the following ratios for this firm using the DuPont Identity—debt-to-equity
ratio, EBIT ROA, ROA, and ROE.
LO 3

Solution:
EBIT = $25,664,300
Net income = $13,054,000
Net sales = $83,125,336
Total debt = $20,885,753
Total assets = $71, 244,863
 EBIT $ 25 , 664 ,300
EBIT ROA= =
Total assets $ 71 , 244 , 863
=36 .02%

Net income $ 13 ,054 , 000

ROA= =
Total assets $ 71 , 244 , 863
=18 . 32%

4.24 Market-value ratios: Cisco Systems had net income of $4.401 billion and at year end
6.735 billion shares outstanding. Calculate the earnings per share for the company.
LO 3

Solution:
Net income = $4.401 billion
Shares outstanding = $6.735 billion
4.25 Market-value ratios: Use the information for Cisco Systems in the last problem. In
addition, the company’s EBITDA was $6.834 billion and its share price was $22.36.
Compute the firm’s price-earnings ratio and the price-EBITDA ratio.
LO 3

Solution:
EBITDA = $6.834 billion
Share price = $22.36

$22. 36
Price -earnings ratio= =34 . 4 times
$ 0. 65

$6 . 834
EBITDA per share= =$1. 015
6 . 735

$22 . 36
Price− EBITDA ratio= =22 . 04 times
$ 1. 015

4.26 DuPont equation: Carter, Inc., a manufacturer of electrical supplies, has a ROE of 23.1
percent, a profit margin of 4.9 percent, and a total assets turnover ratio of 2.6 times. Its
peer group also has a ROE of 23.1 percent, but has outperformed Carter with a profit
margin of 5.3 percent and a total assets turnover ratio of 3.0 times. Explain how Carter
managed to achieve the same level of profitability as reflected by the ROE.
LO 4

Solution:
Carter Inc: ROE = 23.1%, PM = 4.9%, TATO = 2.6x
 ROA=PM ×TATO
=0. 049×2. 6
=0. 1274

ROE=0 . 231=ROA×EM
0 . 231
EM = =1. 81 times
0 . 1274

Peer Group: ROE = 23.1%, PM = 5.3%, TATO = 3 times

ROE=0 . 231=PM ×TATO×EM

0 . 231
EM = =1 . 45 times
0 . 053×3

Carter matched its peer group’s ROE by using a higher degree of financial leverage as
indicated by its higher equity multiplier.

4.27 DuPont equation: Grossman Enterprises has an equity multiplier of 2.6 times, total
assets of $2,312,000, a ROE of 14.8 percent, and a total assets turnover of 2.8 times.
Calculate the firm’s sales and ROA.
LO 4

Solution:
EM = 2.6×, TA = $2,312,000, ROE = 14.8%, TATO = 2.8x

Sales
Total assets turnover =
Total assets
Sales
2 .8=
$ 2 ,312 , 000
Sales=2 . 8×$ 2 ,312 , 000=$6,473,600
ADVANCED
4.28 Complete the balance sheet of Flying Roos Corp., given all of the following information.
Flying Roos Corp. Balance Sheet as of 12/31/2011
Assets Liabilities and Stockholders’ Equity
Cash and marketable securities Accounts payable
Accounts receivable Notes payable $ 300,000
Inventories
Total current assets Total current liabilities
Long-term debt $2,000,000
Net plant and equipment Common stock
Retained earnings $1,250,000
Total liabilities and stockholders’
Total assets $8,000,000 equity

You are also given the following information:

Debt ratio = 40% Current ratio = 1.5 Sales = $2.25 million

DSO = 39 days Inventory turnover ratio = 3.375
Cost of goods sold = $1.6875 million
LO 3

Solution:
Total debt =0 . 4 ×Total assets
= 0 . 4 × $8,000,000 = $3,200,000
Accounts payable = Total debt - (Long term debt + Notes payable )
= $3,200,000 - (2,000,000 + 300,000 )
= $900,000

Cost of goods sold

Inventory turnover ratio =
Inventory

Cost of goods sold $ 1 , 687 ,500

Inventory= =
ITO 3 . 375
=$ 500 , 000
 Flying Roos Corp. Balance Sheet as of 12/31/2011

Assets Liabilities and Stockholders’ Equity

Cash and marketable securities $1,060,000 Accounts payable $ 900,000
Accounts receivable 240,000 Notes payable 300,000
Inventories 500,000
Total current assets $1,800,000 Total current liabilities $1,200,000
Long-term debt 2,000,000
Net plant and equipment 6,200,000 Common stock 3,550,000
Retained earnings 1,250,000
Total liabilities and stockholders’
Total assets $8,000,000 equity $8,000,000

4.29 For the year ended June 30, 2011, Northern Clothing Company has total assets of
$87,631,181, ROA of 11.67percent, ROE of 21.19 percent, and a profit margin of 11.59
percent. What are the company’s net income and net sales? Calculate the firm’s debt-to-
equity ratio.
LO 3, LO 4

Solution:
Total assets = $87,631,181
ROA = 11.67%, ROE = 21.19%, PM = 11.59%

Net income $ 10 , 226 , 559

Net sales = = =$88,236,055
Profit margin 0 . 1159
 Total equity = NI/ROE
=$ 10 , 226 , 559/ 0 .2119
=$ 48 ,261 , 250

Total debt = Total assets - Total equity

= $87,631,181 - $48,261,250
=$39,369,931

Debt $ 39 ,369 , 931

Debt to equity ratio = =
Equity $ 48 , 261 ,250
=81. 6%

4.30 Blackwell Automotive’ s balance sheet at the end of its most recent fiscal year shows the
following information:

Assets Liabilities and Stockholders’

Equity
Cash and marketable $ 23,015 Accounts payable $ 163,257
securities
Accounts receivable 141,258 Notes payable 21,115
Inventories 212,444
Total current assets $ 376,717 Total current liabilities $ 184,372
Long-term debt 168,022
Total liabilities $ 352,394
Net plant and equipment 711,256 Common stock 313,299
Goodwill and other assets 89,879 Retained earnings 512,159
Total liabilities and
Total assets $1,177,852 stockholders’ equity $1,177,582

In addition, it was reported that the firm had a net income of $156,042 on sales of
$4,063,589.
 a. What are the firm’s current ratio and quick ratio?
b. Calculate the firm’s days’ sales outstanding (DSO), total asset turnover ratio, and
the current fixed asset turnover ratio.
LO 3

Solution:

a.

b.

365 Net sales/Ac ounts receivables¿ 365×Ac ounts receivables 365×141,258

DS O = =365¿ ¿= = ¿=12.69 days ¿
Ac ounts receivables turnover ¿ Net sales $4,063,589
Net sales $ 4 ,063 ,589
Total asset turnover = =
Total assets 1 ,177 ,852
=3 . 45 times

Net sales $ 4 , 063 , 859

Fixed asset turnover = =
Net fixed assets $ 711 ,256
=5 . 71 times

4.34 Nugent, Inc., has a gross profit margin of 31.7 percent on sales of $9,865,214 and total
assets of $7,125,852. The company has a current ratio of 2.7 times, accounts receivable
 of $1,715,363, cash and marketable securities of $315,488, and current liabilities of
$870,938.
LO 3

a. What is Nugent’s level of current assets?

b. How much inventory does the firm have? What is the inventory turnover ratio?
c. What is Nugent’s days’ sales outstanding?
d. If management wants to set a target DSO of 30 days, what should Nugent’s
accounts receivable be?

Solution:
Cash & marketable securities = $ 173,488; Accounts receivables = $1,115,363
Current liabilities = $870,938; Total assets = $7,125,852
Sales = $9,865,214; Gross profit margin = 31.7%
Current ratio = 2.7

a.

b. Current assets = Cash + Accounts receivables + Inventory

$2,351,533 = $173,488 + 1,115,363 + Inventory
Inventory = $2,353,533 – ($173,488 + $1,115,363)
= $1,062,682

Cost of goods sold = Sales x (1 – Gross PM)

= $9,865,214 × (1 – 0.317)
= $6,737,941
 Cost of goods sold
Inventory turnover ratio=
Inventory
$ 6 , 737 , 941
= =6 . 34 times
$ 1 , 062 ,682

c.

d. Target DSO = 30 days

The firm has to limit its accounts receivables to $810,840 at its current sales level to
achieve its target DSO of 30 days.

4.35 Recreational Supplies Co. has net sales of $11,655,000, an ROE of 17.64 percent, and a
total asset turnover of 2.89 times. If the firm has a debt-to-equity ratio of 1.43, what is the
company’s net income?
LO 4

Solution:
EM =1+D/ E ratio
=1+1 . 43=2. 43
4.36 Nutmeg Houseware, Inc., has an operating profit margin of 10.3 percent on revenues of
$24,547,125 and total assets of $8,652,352.
a. Find the company’s total asset turnover ratio and its operating profit (EBIT).
b. If the company’s management has set a target for the total asset turnover ratio to
be 3.25 next year without any change in the total assets of the company, what will
have to be the new sales level for the next year? Calculate change in sales
necessary and the percentage sales necessary.
c. If the operating profit margin now shrinks to 10 percent, what will be the EBIT at
the new level of sales?
LO 3

Solution:
Operating PM = 10.3%
Sales = $24,547,125
Total assets = $8,652,352

Sales $ 24 , 547 , 125

TATO= =
Total assets $ 8 , 652 ,352
a. =2 . 84 times
b. New TATO = 3.25 times = New sales/TA

$ Change in Sales = $28,120,144 - $24,547,125

=$3,573,019

% Change in sales = $3,573,019/ $24,547,125

=14 .6%

Operating PM = 10%
c. Sales = $28,120,144

New EBIT = Profit margin × Sales

=0.10 ∗$28,120,144
=$2,812,014