Chapter 3

Discussion Questions
3-1. Short-term lenders - liquidity because their concern is with the firm's ability to pay shortterm obligations as they come due. Long-term lenders - leverage because they are concerned with the relationship of debt to total assets. They also will e amine profitability to insure that interest payments can be made. Shareholders - profitability! with secondary consideration given to debt utili"ation! liquidity! and other ratios. Since shareholders are the ultimate owners of the firm! they are primarily concerned with profits or the return on their investment. 3-#. a. $eturn on investment % &et income Total assets

'nflation may cause net income to be overstated and total assets to be understated. Too high a ratio could be reported. b. 'nventory turnover % Sales or ()*S 'nventory

'nflation may cause sales to be overstated. 'f the firm uses +'+) accounting! inventory will also reflect ,inflation-influenced, dollars and the net effect will be nil. 'f the firm uses L'+) accounting! inventory will be stated in old dollars and too high a ratio could be reported. c. (apital asset turnover % Sales . (apital assets

(apital assets will be understated relative to sales and too high a ratio could be reported. d. -ebt to total assets % Total debt . Total assets

Since both are based on historical costs! no ma.or inflationary impact will ta/e place in the ratio. 0ssets are li/ely understated! however! causing ratio to be overstated.

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3-3.

The -u 2ont system of analysis brea/s out the return on assets between the profit margin and asset turnover. ROA &et income Total assets % Profit Margin % &et income Sales 3 3 Asset Turnover Sales . Total assets

'n this fashion! we can assess the .oint impact of profitability and asset turnover on the overall return on assets. This is a particularly useful analysis because we can determine the source of strength and wea/ness for a given firm. +or e ample! a company in the capital goods industry may have a high profit margin and a low asset turnover! while a food-processing firm may suffer from low profit margins! but en.oy a rapid turnover of assets. The modified -u 2ont formula shows4 ROE % ROA 3 Equity multiplier Total assets 7quity

$eturn on equity % $eturn on assets 5investment6 3

This indicates that return on shareholders' equity may be influenced by return on assets! the debt-to-assets ratio or a combination of both. 0nalysts or investors should be particularly sensitive to a high return on shareholders' equity that is influenced by large amounts of debt. 3-8. The fi ed charge coverage ratio measures the firm's ability to meet all fi ed obligations rather that interest payments alone! on the assumption that failure to meet any financial obligation will endanger the position of the firm. 'n both instances! we would not reflect a very significant cost of doing business. )f course! one could argue that! to the e tent that differential ta rates of financing plans 5and associated interest costs6 did not reflect the operating capability of the firm! omission of these changes could provide new insights. &o rule-of-thumb ratio is valid for all corporations. There is simply too much difference between industries or time periods in which ratios are computed. &evertheless! rules-ofthumb ratios do offer some initial insight into the operations of the firm! and when used with caution by the analyst can provide information. Trend analysis allows us to compare the present with the past and evaluate our progress through time. 0 profit margin of 9 percent may be particularly impressive if it has been running only 3 percent in the last ten years. Trend analysis must also be compared to industry patterns of change.

3-9.

3-:.

3-;.

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3-1.

-isinflation tends to lower reported earnings as inflation-induced income is squee"ed out of the firm's income statement. This is particularly true for firms in highly cyclical industries where prices tend to rise and fall quic/ly. =ecause it is possible that prior inflationary pressures will no longer seriously impair the purchasing power of the dollar. Lessening inflation also means that the required return that investors demand on financial assets will be going down! and with this lower demanded return! future earnings or interest should receive a higher current valuation.

3-<.

3-1>. There are many different methods of financial reporting accepted by the accounting profession as promulgated by the (anadian 'nstitute of (hartered 0ccountants. Though the industry has continually tried to provide uniform guidelines and procedures! many options remain open to the reporting firm. 7very item on the income statement and balance sheet must be given careful attention. Two apparently similar firms may show different values for sales! research and development! e traordinary losses! and many other items.

"nternet #esources and Questions

1. www.adviceforinvestors.com #. www.sedar.com?search?search@form@pc@en.htm 3. www.bmo.com www.rbc.com

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$ro%le&s 3'(. a. b.
Return on assets =

)eon *ight Co&pan+

Net income B1>>!>>> = = .1> = 1>A Total assets B1!>>>!>>>

!"are"olders equity =Total asssets - total debt = B1!>>>!>>> B:>>!>>> = B8>>!>>> Net income B1>>!>>> Return on equity = = = .#9 = #9A !"are"olders equity B8>>!>>>

,#
Total assets B1!>>>!>>> Equity multiplier = = = #.9 Equity B8>>!>>> ROE = ROA Equity multiplier = 1>A #.9 = #9A

c.

!ales = total assets asset turnover = B1!>>>!>>> 3 = B3!>>>!>>>

Profit margin = Net income B1>>!>>> = = .>33 = 3.3A !ales B3!>>>!>>>

3'-. &et income

Bass Che&icals "nc. % % % Sales profit margin B#!>>>!>>> 9A B1>>!>>> % % % &et income Total assets B1>>!>>> B1>>!>>> >.1#9 % (-../

$eturn on assets 5investment6

3'3.

Fonda $istol and 0un !hop &et income % % Sales profit margin B;9>!>>> >.>:

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%
Assets =

B89!>>>

!ales Total asset turnover

% %

B;9>!>>>? #.9 B3>>!>>>

Return on Assets $investments# =

Net income B89!>>> = = >.19 = 19A Total assets B3>>!>>>

3'1. Sales % % %

Bill+2s Cr+stal !tores Total assets 3 total asset turnover B9!>>>!>>> 3 1.# B:!>>>!>>> Total assets 3 return on assets B9!>>>!>>> 3 1A B8>>!>>>

&et income % % %
Profit margin =

Net income B8>>!>>> = = >.>::; = :.:;A Sales B:!>>>!>>>

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3'.. a.
Equity multiplier =

0ates 3ppliances
Total assets 1>>A = = 1.::; Equity 1 8>A

ROE = ROA Equity multiplier = 1A 1.::; = 13.33A

b. Cith no debt $)7 % $)0. 'n this case 4/. 3'6. Butters Corporation

a. Total asset turnover 2rofit margin % $eturn on total assets 5$)06 D ;A % #9.#A
Total asset turnover = #9.#A = 3.: ;A

b.

Equity multiplier =

Total assets 1>>A = =# Equity 1 9>A

ROE = ROA Equity multiplier = #9.#A # = 9>.8>A

c.

Equity multiplier =

Total assets 1>>A = = 1.9319 Equity 1 39A

ROE = ROA Equity multiplier = #9.#A 1.931 = 31.;;A

3'5.

Baker ,ats

a. Total asset turnover 2rofit margin % $eturn on total assets 5$)06 1.: D % 11.#A
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Profit margin =

11.#A = ;.>A 1.:

b. Total asset turnover 2rofit margin % $eturn on total assets 5$)06 1.8 1A % 11.#A 't did not change at all because the increase in profit margin made up for the decrease in the asset turnover. 3'4. a. &et income 6oe 6ackson2s !hoe !tores, "nc. % Sales profit margin % B#!>>>!>>> 3.1A % B;:!>>> % Total assets total liabilities % Sales?Total asset turnover % B#!>>>!>>>?#.9 % B1>>!>>> % (urrent liabilities E long-term liabilities % B:>!>>> E B18>!>>> % B#>>!>>>

Shareholders equity Total assets

Total liabilities

Shareholders' equity % B1>>!>>> B#>>!>>> % B:>>!>>>

Return on equity $ROE# = Net income B;:!>>> = = .1#:; = 1#.:;A !"are"olders equity B:>>!>>>

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b. Sales

% % % % % %

Total assets total asset turnover B1>>!>>> 3 B#!8>>!>>> Sales 2rofit margin B#!8>>!>>> 3.1A B<1!#>>

&et income

Return on equity$ROE# =

Net income B<1!#>> = = >.19# = 19.#A !"are"olders equity B:>>!>>>

3'7. a.
b.

Ca%le Corp. 8 Multi'Media Corp. Ca%le

Net income B3>!>>> ROE = = = 1#A Equity B#9>!>>> Net income B3>!>>> = = 1>A !ales B3>>!>>> Net income B3>!>>> = = ;.9A Total assets B8>>!>>>

Multi'Media
B1>>!>>> = ##.#A B89>!>>> B1>>!>>> = 9A B#!>>>!>>> B1>>!>>> = 11.1A B<>>!>>>

!ales B3>>!>>> = = >.;9 Total assets B8>>!>>>

%ebt B19>!>>> = = 3;.9A Total assets B8>>!>>>

B#!>>>!>>> = #.# B<>>!>>>

B89>!>>> = 9>A B<>>!>>>

c. Fulti Fedia (orp. has a significantly higher return on equity 5##.#A versus 1#A6. This is despite a lower return on sales 51>A vs. 9A6. Gowever Fulti-Fedia has achieved a higher return on total assets 511.1A vs. ;.9A6 through a strong total asset turnover 5#.#3 vs. >.;936. The superior return on equity is further enhanced with higher use of debt 59>A vs. 3;.9A6. This is called leverage and can magnify shareholder returns.

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3'(9.

3 Fir&
Average collection period = Accounts receivable Average daily credit sales B#19!>>> = ( B3!>>>!>>> <>A ) ? 3:9 B#19!>>> = = 3< days B;!3<;

3'((.

Martin Electronics
Average credit sales = &redit sales 3:9

To determine credit sales! multiply accounts receivable by accounts receivable turnover. B1>!>>> 19 % B1!#>>!>>>
Average credit sales = B1!#>>!>>> = B3!#11 3:9

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3'(-. a.
'nventory turnover =

:a&in Corporation -99(

!ales B8!>>>!>>> = = 1> 'nventory B8>>!>>> &O(! B3!>>>!>>> = = ;.9 'nventory B8>>!>>>

-99-

B9!>>>!>>> = 1> B9>>!>>> B8!9>>!>>> = < B9>>!>>>

b.
'nventory turnover =

c. =ased on the sales to inventory ratio the turnover ratio has remained constant at 1> 3. Gowever based on the cost of goods sold to inventory ratio! it has improved from ;.9 3 to < 3. The later ratio may be providing a false picture of improvement in this e ample simply because ()*S has gone up as a percentage of sales 5from ;9 percent to <> percent6. 'nventory is not really turning over any faster. &evertheless! ()*S is used by many analysts in the numerator of the inventory turnover ratio because it is stated on a HcostI basis as inventory. This is an important theoretical consideration. -un and =radstreet! the most widely quoted source for ratio analysis uses sales in the numerator. +urthermore! for private companies! information may be only available for sales and net ()*S.

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3'(3. a. &urrent ratio = b. )uic* ratio = c.

!tud Clothiers
&urrent assets B9;>!>>> = = 1 .< &urrent liabilities B3>>!>>>

&urrent assets - inventory B33>!>>> = = 1.1 &urrent liabilities B3>>!>>>

Total debt B811!>>> = = 88A Total assets B<9>!>>>

%ebt to total assets =

d. Asset turnover = e.

!ales B3!>8>!>>> = = 3.# Total assets B<9>!>>>

Average collection period = =

Accounts receivable Average daily credit sales B#1>!>>> B#1>!>>> = = 88.1 days ( B3!>8>!>>> ;9A ) ? 3:9 :!#8;

3'(1.
Times interest earned =

)eele+ ,ffice !upplies

'ncome before interest and ta,es $E+'T# 'nterest B:>!>>> = = 8 B19!>>>
'ncome before fi,ed c"arges and ta,es -i,ed c"arges B:>!>>> + B#9!>>> B19!>>> = = = #.1#9 B19!>>> + B#9!>>> B8>!>>>

a.

-i,ed c"arge coverage =

b.

3'(..

$aste Manage&ent Co&pan+

E+'T B11!>>> = = : 'nterest B3!>>>

a. Times interest earned = b.

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'ncome before fi,ed c"arges and ta,es -i,ed c"arges B11!>>> + B8!>>> B##!>>> = = = 3.183 B3!>>> + B8!>>> B;!>>> -i,ed c"arge coverage =

c.

Profit margin =

Net income B1>!9>> = = .>133 = 1.33A Sales B1#:!>>>

d. Asset turnover =

!ales B1#:!>>> = = 1.9;9 Total assets B1>!>>>

Net income B1>!9>> = = >.131#9 = 13.1#9A ,# Total assets B1>!>>>

e. Return on assets $ROA# =

$)0 % 2rofit margin 3 asset turnover % 1.33A 3 1.9;9 % 13.1#A 3'(6. a. Times interest earned = b. 3 Fir&
E+'T B1#>!>>> = = 9 'nterest B#8!>>>

'ncome before fi,ed c"arges and ta,es -i,ed c"arges B1#>!>>> + B8>!>>> B1:>!>>> = = = #.9 B#8!>>> + B8>!>>> B:8!>>> -i,ed c"arge coverage =

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3'(5.

!tatus Quo Co&pan+

a. The return on assets for Status Juo will increase over time as the assets are amorti"ed and the denominator gets smaller. (apital assets at the beginning of 1<<3 equal B3>>!>>> with a ten-year life which means the amorti"ation e pense will be B3>!>>> per year. =oo/ values at year-end are as follows4 ;ear 1<<3 1<<9 1<<1 #>>> #>># Capital B#;>!>>> B#1>!>>> B1#>!>>> B:>!>>> > Current E B#>>!>>> E B#>>!>>> E B#>>!>>> E B#>>!>>> E B#>>!>>>
'ncome afterta,es Total assets

<otal % B8;>!>>> % B81>!>>> % B3#>!>>> % B#:>!>>> % B#>>!>>>

Return on assets =

1<<3 1<<9 1<<1 #>>> #>>3

B#:!>>>?B8;>!>>> B#:!>>>?B81>!>>> B#:!>>>?B3#>!>>> B#:!>>>?B#:>!>>> B#:!>>>?B#>>!>>>

% 9.93A % :.38A % 1.13A % 1>.>>A % 13.>>A

b. The increasing return on assets over time is due solely to the fact that annual amorti"ation charges reduce the amount of investment. The increasing return is in no way due to operations. +inancial analysts should be aware of the effect of overall asset age on the return-on-investment ratio and be able to search elsewhere for indications of operating efficiency when $)' is very high or very low. c. 0s income rises! return on assets will be higher than in part 5b6 and would indicate an increase in return partially from more profitable operations.

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3'(4.

6odie Foster Care

o&es Corp.

a. &et income? total assets 1<<< B111!>>>? B1!<>>!>>> % >.>:#1 % :.#1A #>>> B131!>>>? B1!<9>!>>> % >.>:;# % :.;#A #>>1 B181!>>>? B#!>1>!>>> % >.>;3: % ;.3:A #>># B1;9!;>>? B#!>9>!>>> % >.>19; % 1.9;A
(omment4 There is a strong upward trend in return on assets over the period.

b. &et income? shareholdersI equity 1<<< B111!>>>? B ;>>!>>> % >.1:1: % 1:.1:A #>>> B131!>>>? B <9>!>>> % >.13;< % 13.;<A #>>1 B181!>>>? B1!1>>!>>> % >.1389 % 13.89A #>># B1;9!;>>? B1!8#>!>>> % >.1#3; % 1#.3;A
(omment4 The return on shareholdersI equity is going down each year. The difference in trends from a to b is due to the increasing portion of assets financed with shareholdersI equity. This can be confirmed =not re>uired? with4

Total debt? total assets #>>3 B1!#>>!>>>? B1!<>>!>>> % >.:31: % :3.1:A #>>8 B1!>>>!>>>? B1!<9>!>>> % >.91#1 % 91.#1A #>>9 B <1>!>>>? B#!>1>!>>> % >.89#; % 89.#;A #>>: B :3>!>>>? B#!>9>!>>> % >.3>;3 % 3>.;3A

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3'(7.

Callo@a+ $roducts 'ndustry $atio 11.>A 1.>A 9.>A

a. &et income?total assets Kear (alloway $atio #>>> #>>1 #>># 1#.>A 11.#A 1>.>A

0lthough the company has shown a declining return on assets since #>>>! it has performed much better than the industry. 2raise may be more appropriate than criticism.

b. -ebt?total assets Kear (alloway $atio #>>> #>>1 #>># 93.3A 91.9A 9>.>A

'ndustry $atio 9#.>A 8>.>A 31.>A

Chile the company's debt ratio is improving! it is not improving nearly as rapidly as the industry ratio. (riticism may be more appropriate than praise.

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3'-9. a.

Anited Borld Corporation &et income?sales (omputers :.#9A Faga"ines (able TL 8.>>A ;.9>A

The maga"ine division has the lowest return on sales. b. (omputers &et income?total assets #>.>>A Faga"ines (able TL 1.>>A 1#.>>A

The computer division has the highest return on assets. c. (orporate net income % B1!>>>!>>> E B1:>!>>> E B:>>!>>> % B1!;:>!>>> (orporate total assets % B9!>>>!>>> E B#!>>>!>>> E B9!>>>!>>> %B1#!>>>!>>>
ROA = Net income B1!;:>!>>> = = >.18:; = 18.:;A Total assets B1#!>>>!>>>

d. $eturn on redeployed assets in computers4 #>A B9!>>>!>>> % B1!>>>!>>> $eturn on assets for the entire corporation4 &ew corporate net income % B1!>>>!>>> E B1:>!>>> E B1!>>>!>>> % B#!1:>!>>>
ROA = Net income B#!1:>!>>> = = >.11>> = 11A Total assets B1#!>>>!>>>

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Bard Corporation "nco&e !tate&ent for Dec. 3(, -993 Sales................................... B##>!>>> 51>!>>> units at B##6 (ost of goods sold.............. 1>>!>>> 51>!>>> units at B1>6 *ross profit.................. 1#>!>>> Selling and adm. 7 pense... 11!>>> 59A of sales6 0morti"ation ...................... #>!>>> )perating profit............ 1<!>>> Ta es 53>A6........................ #:!;>> 0fterta income.................. C 6-,399

b. *ain in afterta income % B:#!3>> B8<!>>> % B13!3>> 'ncrease % B13!3>> =ase value 5#>>#6 B8<!>>> % -5.(1/

0fterta income increased much more than sales because of F"F, inDentor+ policy 5in this case! the cost of old inventory did not go up at all6! and because of historical cost amorti"ation 5which did not change6.

c.

"nco&e !tate&ent for Dec. 3(, -991

Sales.................................. B11;!>>> 51>!>>> units at B11.;>M6 (ost of goods sold............11>!>>> 51>!>>> units at B11.>>6 *ross profit................ ;;!>>> Selling and adm. e pense.. <!39> 59A of sales6 0morti"ation ................... #>!>>> )perating profit......... 8;!:9> Ta es 53>A6..................... 18!#<9 0fterta income................ C 33,3.. MB## >.19 % B11.;>
The low profits indicate the effect of inflation followed by disinflation.

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3'--. 'nventory (urrent assets 0ccount rec. (ash

Current assets % % % % % % % % B;3>!>>>?: B1#1!::; # B1>9!>>> B#1>!>>> 5B;3>!>>>? 3:96 39 B;>!>>> B#1>!>>> B1#1!::; B;>!>>> B11!333 B 11!333 ;>!>>> 1#1!::; C-(9,999

(ash 0ccounts receivable 'nventory Total current assets 3'-3.

0riggs Corporation Sales?total assets Total assets Total assets (ash (ash % #.8 times % B1!#>>!>>>? #.8 % B9>>!>>>

% #A of total assets % #A B9>>!>>> % B1>!>>>

Sales? accounts receivable % 1 times 0ccounts receivable % B1!#>>!>>>? 1 0ccounts receivable % B19>!>>> Sales? inventory 'nventory 'nventory % 1> times % B1!#>>!>>>? 1> % B1#>!>>>

(urrent asset % B1>!>>> E B19>!>>> E B1#>!>>> % B#1>!>>>

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(apital assets % Total assets current assets % B9>>!>>> B#1>!>>> % B##>!>>> (urrent assets? current debt % (urrent debt % (urrent debt % (urrent debt % Total debt?total assets Total debt Total debt Long-term debt Long-term debt Long-term debt &et worth &et worth &et worth # (urrent assets? # B#1>!>>>? # B18>!>>>

% :1A % :1A B9>>!>>> % B3>9!>>> % Total debt current debt % B3>9!>>> B18>!>>> % B1:9!>>> % Total assets total debt % B9>>!>>> B3>9!>>> % B1<9!>>>

Balance !heet Dec. 3(, -99(ash....................... 0?$........................ 'nventory................ Total current assets (apital assets.......... Total assets............. B 1>!>>> B19>!>>> B1#>!>>> B#1>!>>> B##>!>>> B9>>!>>> (urrent debt.......... Longterm debt.... Total debt........... 7quity.................... B18>!>>> B1:9!>>> B3>9!>>> B1<9!>>>

Total debt and B9>>!>>> shareholdersI equity

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3'-1.

Cole&an Machine <ools % Sales? receivables turnover % B;!#>>!>>>? 13 % B<>>!>>> % (urrent ratio current liabilities % #.9 B1!8>>!>>> % B3!9>>!>>> % (urrent assets 5cash E accts rec.E inventory6 % B3!9>>!>>> 5B3>>!>>> E B<>>!>>> E B#!19>!>>>6 % B3!9>>!>>> 3!39>!>>> % C(.9,999 % Total assets current assets % Sales? asset turnover % B;!#>>!>>>? 1.# % B:!>>>!>>> % B:!>>>!>>> - B3!9>>!>>> % C-,.99,999 % -ebt to assets total assets % 8>A B:!>>>!>>> % B#!8>>!>>> % Total debt current liabilities % B#!8>>!>>> B1!8>>!>>> % B1!>>>!>>> !tone Cold Corporation
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a. 0ccounts receivable

b. (urrent 0ssets

Far/etable securities

c. (apital assets Total assets

(apital assets d. Total debt

Long-term debt

3'-..
Foundations of Fin. Mgt.

Sales?total assets Total assets Total assets

% 3.> % B:> million? 3 % B#> million

Total debt?total assets % 8>A Total debt % B#> million .8 Total debt % B 1 million Sales?inventory 'nventory 'nventory 0verage daily sales % 1>.> % B:> million? 1>.> % B: million B:> million? 3:9 days B1:8!318 per day 11 days B1:8!318 B#!<91!<>8 5or6

% % 0ccounts receivable % %
!ales

. of days 11 = B:> million = B#!<91!<>8 3:9 3:9

(apital assets (urrent assets

% % % % %

B:> million? ;.9 B 1 million Total asset (apital assets B#> million B1 million B1# million

(ash

% Total assets inventory accounts receivable capital assets % B#> million B: million B#!<91!<>8 - B1 million % B3!>81!><: % (urrent assets? # % B1# million? #
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(urrent liabilities

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% B: million Long-term debt % Total debt current debt % B1 million B: million % B# million % Total assets total debt % B#> million B1 million % B1# million

7quity

!tone Cold Corporation Dece&%er 3(, -99=Millions? (ash........................... B 3.>81 (urrent debt........ 0ccounts receivable... #.<9< Long-term debt... 'nventory.................... :.>>> Total debt............ Total current assets.... 1#.>>> 7quity.................. (apital assets............. 1.>>> Total Total debt assets................... B#>.>>> N equity...........

B :.>>> #.>>> 1.>>> 1#.>>>

B#>.>>>

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3'-6. Profitability ratios

ot 3ir Co&pan+

2rofit margin % B1:1!>>>? B#!>>>!>>> % 1.8>A $eturn on assets 5investment6 % B1:1!>>>? B;:>!>>> % ##.1A $eturn on equity % B1:1!>>>? B81>!>>> % 39A Assets utilization ratios $eceivables turnover % B#!>>>!>>>? B1#>!>>> % 0verage daily sales % B#!>>>!>>>? 3:9 % 0verage collection period % B1#>!>>>? B9!8;< % 'nventory turnover % B#!>>>!>>>? B11>!>>> % ,# % B1!3>>!>>>? B11>!>>> % 0verage daily ()*S % B1!3>>!>>>? 3:9 % 'nventory holding period % B11>!>>>? B3!9:# % 1:.:: 3 B9!8;< ## days 11.11 3 ;.## 3 B3!9:# 91 days

0ccounts payable turnover % B1!3>>!>>>? B<>!>>> % 18 3 0ccounts payable period % B<>!>>>? B3!9:# % #9 days (apital asset turnover % B#!>>>!>>>? B39>!>>> % Total asset turnover % B#!>>>!>>>? B;:>!>>> % Liquidity ratio (urrent ratio % B3;>!>>>? B11>!>>> % Juic/ ratio % B1<>!>>>? B11>!>>> % Debt utilization ratios -ebt to total assets % B#1>!>>>? B;:>!>>> % Times interest earned % B3>>!>>>? B#>!>>> % +i ed charge coverage % B31>!>>>? B3>!>>> % 3'-5. 6et Boat *td. 3:.18A 19 3 1>.33 3 3.3: 3 1.;# 3 9.;1 3 #.:3 3

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Profitability ratios 2rofit margin % B;#!1>>? B#!<>>!>>> % #.9A $eturn on assets 5investment6 % B;#!1>>? B1!#>>!>>> % :.1A $eturn on equity % B;#!1>>? B89>!>>> % 1:.11A Assets utilization ratios $eceivables turnover % B#!<>>!>>>? B1>>!>>> % 0verage daily sales % B#!<>>!>>>? 3:9 % 0verage collection period % B1>>!>>>? B;!<89% 'nventory turnover % B#!<>>!>>>? B3;9!>>> % ,# % B#!8:9!>>>? B3;9!>>> % 0verage daily ()*S % B#!8:9!>>>? 3:9 % 'nventory holding period % B3;9!>>>? B:!;93 % #< 3 B;!<89 1#.9< days ;.;3 3 :.9; 3 B:!;93 9: days

0ccounts payable turnover % B#!8:9!>>>? B1>>!>>> % #9 3 0ccounts payable period % B1>>!>>>? B:!;93 % 19 days (apital asset turnover % B#!<>>!>>>? B:>>!>>> % Total asset turnover % B#!<>>!>>>?B1!#>>!>>> % Liquidity ratio (urrent ratio % B:>>!>>>? B#9>!>>> % Juic/ ratio % B##9!>>>? B#9>!>>> % Debt utilization ratios -ebt to total assets % B;9>!>>>? 1!#>>!>>> % Times interest earned % B119!>>>? B<8!>>> % +i ed charge coverage % B119!>>>? B188!>>> %
&ote4 Sin/ing fund provision included.

8.13 3 #.8# 3

#.8> 3 .<> 3

:#.9>A 1.<; 3 1.#1 3

Co&&entsE
Oet =oat is a good vehicle to introduce seasonal and location considerations into ratio analysis. &ote that the year-end is -ecember 31st. =ased on that and

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assuming that Oet =oat is a retailer! the receivable and inventory turnover that loo/ promising at first glance may indicate potentially devastating write-offs? downs. 'f Oet =oat is located on *eorgian =ay! for e ample! it would be in mid-off season. 'f it is located in Sydney! 0ustralia! the threat of stoc/-outs might be a concern as it would be in mid-selling season. Oet =oat Ltd. has a low profit margin! but a reasonable return on equity. This comes from a strong asset turnover and a high debt load. -u 2ont analysis shows return on equity as #.9A 5profit margin6 3 #.8# 5asset turnover6 3 #.:; 5equity multiplier6 % 1:.#A. 7quity multiplier % Total assets? equity % 1? 51 debt?assets6 % 1? 51 .:#96 % #.:;. The asset utili"ation ratios show good efficiency but perhaps hint at over utili"ation. Sales may be lost if the firm is under capitali"ed and is trying to ma/e due by overusing e isting assets. The average collection period is very good. 's a discount offeredD The liquidity ratios also appear good! with a heavy reliance on inventory. The debt utili"ation ratios reveal that Oet =oat Ltd. has only a small margin for error. The debt load is heavy.

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3'-4.

<urner and Brad+ Co&parison

)ne way of analy"ing the situation for each company is to compare the respective ratios for each one! e amining those ratios which would be most important to a supplier or short-term lender and a shareholder.

Turner (orp. 2rofit margin $eturn on assets 5investments6 $eturn on equity $eceivable turnover 0verage collection period 'nventory turnover 'nventory holding period 0ccount payable turnover 0ccounts payable period (apital asset turnover Total asset turnover (urrent ratio Juic/ ratio -ebt to total assets Times interest earned +i ed charge coverage +i ed charge calculation ;.<A 1<.;9A #1.<A 1:.:; 3 ## days 11 3 or #; 3 #> days <3 8# days 3.33 3 #.9 3 1.8 3 >.1: 3 3#A #9.; 3 1#.: 3 5#18.9? 1;6

=rady (orp. 9.1A 11.1:A 39.#A 18.#< 3 #: days < 3 or 18 3 81 days <3 8# days 83 #.33 3 #.8 3 1.83 3 ::A 9.1 3 8.# 3 511#? #;6

a. Since suppliers and short-term lenders are most concerned with liquidity ratios! =rady (orporation would get the nod as having the best ratios in this

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category. )ne could argue! however! that =rady had benefited from having its debt primarily long term rather than short term. &evertheless! it appears to have better liquidity ratios. b. Shareholders are most concerned with profitability. 'n this category! Turner has much better ratios than =rady. =rady does have a higher return on equity than Turner! but this is due to its much larger use of debt. 'ts return on equity is higher than Turners because it has ta/en more financial ris/. 'n terms of other ratios! Turner has its interest and fi ed charges well covered and in general its long-term ratios and outloo/ are better than =rady's. Turner has asset utili"ation ratios equal to or better than =rady and its lower liquidity ratios could reflect better short-term asset management! and that point was covered in part a. &ote4 $emember that to ma/e actual financial decisions more than one year's comparative data is usually required. 'ndustry comparisons should also be made.

3'-7.

#etail Co&pan+
*ross margin is healthy. 2rofit is wea/ening. This suggests higher fi ed costs reducing profitability. $eceivable and inventory turnovers are good indicating good management! but asset turnover ratios have wea/ened. This suggests a concern with sales volume. Gas the company e panded too fastD 's an intensified sales effort requiredD Liquidity is good. -ebt coverage is good. Cea/ return on equity is a combination of less than satisfactory profit margin and asset turnover.

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3'39. Profitability Ratios 2rofit margin $eturn on assets $eturn on equity Asset Utilization Ratios

BiFard "ndustries -99-99( -999 >.8A >.;A #.>A "ndustr+ 9.1A 1.1A #>.3A

>.1A 9.1A >.1A 1>.#A >.8A #<.8A

$eceivable turnover 0vg. (ollection period 'nventory turnover 'nventory turnover 5sales6 'nventory holding period 0ccounts payable turnover 0ccounts payable period (apital asset turnover Total asset turnover Liquidity Ratios (urrent ratio Juic/ ratio Debt Utilization Ratios -ebt to total assets Times interest earned +i ed charge coverage

3.<3 <3 8.<3 :.33 ;9 1.:3 8# <.<3 1.13

9.13 ;# 8.#3 9.:3 1; ;.13 91 1>.:3 #.>3

9.#3 ;> 8.13 9.33 1< 9.:3 :9 1.83 1.<3

:.33 91 8.33 9.;3 19 1.13 89 1.>3 1.;3

1.;# 1.>1

1.;1 .<3

1.99 >.1#

1.: 1.1

;1.8A :9.3A :8.;A 1.>#3 3.8#3 1.193 1.>#3 3.8#3 1.193

:>A 8.33

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The profitability ratios do not appear healthy. 7ven in #>>1 the profit margin did not reach the industry average. The relatively good performance in year #>>1 seems to be dependent on strong sales. *ood return on assets results from high asset turnover and the high return on equity is due to high debt levels. Chen sales arenIt maintained the results are evident in year #>>#. The asset utili"ation ratios reveal problems. The slowdown in the collection of accounts receivable is of considerable concern. The wor/ing capital position has become more dependent on 0?$ and we must question the quality of these receivables. Turnover is far below the industry average. The accounts payable period is now below the industry average which suggests Ci"ard is not ta/ing advantage of supplier credit to the full e tent possible or suppliers are starting to cut bac/ on credit to Ci"ard. (apital asset turnover is above the industry average and probably reveals that Ci"ard is overtrading and may not be reinvesting in assets. The increased inventory turns may also indicate overtrading. The liquidity ratios appear to be good. Ce should as/ why. Ce have already identified the increasing 0?$ position. This would increase the liquidity ratios but it is hardly a healthy position. +urthermore! the long-term debt position has been increasing! perhaps as a substitute for short-term borrowings. The debt utili"ation ratios suggest an increasingly precarious position. The profit failure has severely impacted on the debt load. 'nterestingly! dividends have been maintained! (reditors are increasingly holding the bag. -o not grant creditP -ebt loads are increasing and shareholders are not showing a full commitment to the firm. 0n equity contribution and reduction of dividends is required. +urthermore sales are wea/ and this is impacting on profitability measures. Those sales that are made are being collected in a longer time. 0re they less creditworthyD There is also evidence of a reluctance to reinvest in equipment 5capital assets6.

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3'3(. *rowth in sales 2rofit margin $eturn on assets $eturn on equity $eceivable turnover 0verage collection period 'nventory turnover (apital asset turnover Total asset turnover (urrent ratio Juic/ ratio
Foundations of Fin. Mgt.

*a&ar !@i&@ear -995(ompany6 5'ndustry6 5(ompany6 5'ndustry6 5(ompany6 5'ndustry6 5(ompany6 5'ndustry6 5(ompany6 5'ndustry6 5'ndustry6 5(ompany6 5'ndustry6 5(ompany6 5'ndustry6 5(ompany6 5'ndustry6 5(ompany6 5'ndustry6 5(ompany6 #9A 1#A :.31A ;.<:A 9.;>A 1.<9A 13.<1A 1:.>1A 9.#1 3 <.31 3 -99( #9A 1>A :.1#A ;.1#A :.1>A 1.:1A 18.#>A 19.#:A 9.;< 3 1.1: 3 ;.39A ;.;1A 1.>#A 1.><A 19.<>A 18.31A ;.>: 3 <.># 3 91.; days 3<.< days 9.## 3 or 3.81 3 8.#8 3 1.19 3 1.:> 3 1.>< 3 1.>9 3 #.>> 3 1.<: 3 1.>> 3
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-999

5(ompany6 ;>.1 days :3.> days 31.; days 8>.: days :.8; 3 or 8.9# 3 9.11 3 1.39 3 1.;9 3 >.1< 3 1.1# 3 1.31 3 #.8> 3 >.;1 3
S-9;

9.;9 3 or 3.<1 3 9.1> 3 1.<: 3 1.:8 3 1.11 3 1.1> 3 1.;# 3 #.#9 3 .<9 3

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5'ndustry6 -ebt to total assets Times interest earned +i ed charge coverage *rowth in 7.2.S. 5(ompany6 5'ndustry6 5(ompany6 5'ndustry6 5(ompany6 5'ndustry6 5(ompany6 5'ndustry6

1.31 3 9<.#3A 88.1>A 3.>: 3 :.:1 3 #.;9 3 8.;3 3 #.<A 13.3A

1.81 3 9#.1#A 83.11A 8.13 3 9.<< 3 3.39 3 8.:< 3 8.1A 1>.1A

1.3; 3 8<.91A 83.8;A 8.9; 3 :.9> 3 3.9> 3 8.;> 3

Discussion of #atios

Chile Lamar Swimwear is e panding its sales much more rapidly than others in the industry! there are some clear deficiencies in their performance. These can be seen in terms of a trend analysis over time as well as a comparative analysis with industry data. 'n terms of profitability! the profit margin is declining over time. This is surprising in light of the 9:A increase in sales over two years 5#9A per year6. There obviously are no economies of scale for this firm. Gigher costs of goods sold and interest e pense appear to be causing the problem. The return on asset ratio starts out in #>>> above the industry average 51.># percent versus 1.>< percent6 and ends up well below it 59.;> percent versus 1.<9 percent6 in #>>#. The decline in return on assets is serious! and can be attributed to the previously mentioned declining profit margin as well as a slowing total asset turnover 5going from 1.>< 3 to >.1< 36. $eturn on equity is higher than the industry average the first year! and then also falls far below it. This decline is particularly significant in light of the progressively larger debt that the firm is using. Gigh debt utili"ation tends to contribute to high return on equity! but not in this case. There is simply too much deterioration in return on assets translating into low return on equity. The previously mentioned slower turnover of assets can be analy"ed through the turnover ratios. 0 problem can be found in accounts receivable where turnover has
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gone from ;.>: 3 to 9.#1 3. This can also be stated in terms of an average collection period that has increased from 91 days to :< days. Chile inventory turnover has been and remains superior to the industry! the same cannot be said for fi ed asset turnover. 0 decline from 1.19 3 to 1.39 3 was caused by an increase of 118 percent in capital assets 5representing B;8>!>>>6. Ce can summari"e the discussion of the turnover ratios by saying that despite a 9:A increase in sales! assets grew even more rapidly causing a decline in total asset turnover from 1.>< 3 to >.1< 3. The liquidity ratios also are not encouraging. =oth the current and quic/ ratios are falling against a stable industry norm of appro imately two to one and one to one respectively. The debt to total assets ratio is particularly noticeable in regard to industry comparisons. Lamar Swimwear has gone from being ;A over the industry average to 19A above the norm 59<A versus 88A6. Their heavy debt position is clearly out of line with their competitors. Their downtrend in times interest earned and fi ed charge coverage confirms the heavy debt burden on the company. +inally! we see that the firm has a slower growth rate in earnings per share than the industry. This is a function of less rapid growth in earnings as well as an increase in shares outstanding 5with the sale of 1!>>> shares in #>>#6. )nce again! we see that the rapid growth in sales is not being translated down into significant earnings gains. This is true in spite of the fact that there is a very stable economic environment. 't does not appear that this is an attractive investment opportunity. "nDest&ent Co&&ents Ge would probably have difficulty .ustifying such an investment based on the performance of the firm. There is no dividend payout! so return to the investor would have to come in the form of capital appreciation if and when he was able to resell the shares. The prospects! at this point! would not appear to .ustify the purchase. This is particularly true when one considers that Fr. 0d/ins would be buying a minority interest 519A6 and would not have control of the firm.

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