Assignment 4

What is consider to be the least liquid?

Inventories

Co's that use debt funding are called: Riskier!!!

Leveraged companies

Net Income x Sales x Total Assets

ROE

Is there a difference between computation and analysis?

Yes

ROE does not incorporate the component of

risk

An increase in the operating margin would mean that either:

sales increased, operating costs decreased, or both

An increase in ROE would _______ imply an increase in SH wealth

sometimes

An increase in ROE does not necessarily mean...

that the firm's stock price will increase

Examples of asset management ratios include:

the average collection period (days sales outstanding ratio), the inventory turnover ratio, the fixed asset turnover ratio, and the total asset turnover ratio

If a company's operating margin increases but its profit margin decreases, it could mean that... (profitability ratio truth)

the company paid more in interest or taxes

Ratios are mostly calculated using data drawn from...

the financial statements of a firm.

If you were conducting a comparative analysis, you would compare:

the firm's financial ratios with other firms in the industry

Managers may turn down profitable projects because...

they focus too much on generating a higher ROE

Decision makers and analysts look deeply into profitability ratios to identify:

trends in a company's profitability // give insights into both the survivability of a company and the benefits the SH's receive

A low P/E ratio could also mean that investors are...

uncertain about the company's future earnings - which is reflected by low price relative to the company's current earnings

Ratios serve as...

Indicators of certain aspects of a company's performance, do not give answers to the performance!

Many investors and analysts in the financial community pay particular attention to a company's

ROE

The P/E ratio is equal to...

The market price of a company's shares divided by the the shares' EPS

Which of the following is true about the leveraging effect?

Under economic growth conditions, firms with relatively more leverage will have higher expected returns.

Generally, companies with low P/E ratios are considered to be...

Undervalued (but this isn't always true)

Companies that function without the use of border money are said to have no leverage and are called:

Unleveraged companies

Profitability ratios help in the analysis of the:

combined impact of liquidity ratios, asset management ratios, and debt management ratios on the operating performance of a firm

Analysts and investors often use ROE to...

compare profitability of a co. with other firms in the industry

The current ratio compares:

current assets expected to be converted to cash in the next year to current liabilities expected to be due in the next year

If a firm's earnings (net income) rise by 10% while its sales rise by 15%, the profit margin (net income divided by sales) will actually:

decrease

If the company's costs and expenses increase at a faster rate than the rate at which sales are increasing, profit margin will:

decrease

Interest paid on debt is tax _____

deductible aka it can be removed from the earnings before taxes are calculated

A higher operating margin than the industry average indicates: (profitability ratio truth)

either lower operating costs, higher product pricing, or both

Unleveraged co's are financed by

equity alone and have no debt in their capital structures

If you were conducting a trend analysis, you would analyze the firm's:

financial ratios over time - which helps in estimating the likelihood of improvement or deterioration in its financial condition

Weaknesses/limitations of ratio analysis?

A firm's ratio can lead to conflicting conclusions, some ratios may be good and some bad Inflation can distort balance sheet dat

An increase in ROE would sometimes, but not always imply:

An increase in SH wealth

Suppose you are trying to decide whether to invest in a company that generates a high expected ROE, and you want to conduct further analysis on the company's performance - if you wanted to conduct a trend analysis, you would:

Analyze the firm's financial ratios over time

Ratios that help determine the efficiency with which a company manages its day to day tasks and assets are called: Exs: a company's sales outstanding or average collection period, the inventory turnover ratio, and the fixed asset and total asset turnover ratios

Asset Management or Activity Ratio

Ratios are calculated using a company's...

Balance sheet, income statement, and other financial statements.

The process of comparing a company with a set of other companies is called:

Benchmarking

A liquid asset can be converted quickly to:

Cash with little sacrifice in its value

Company A uses long-term debt to finance its assets and company B uses capital generated from shareholders to finance its assets. Which co. would be considered a financially averaged firm?

Company A

Generally a higher opening margin would imply that the company was able to:

Cut costs rather than charge more for products

Ratios that help assess a company's ability to service the interest and repayment obligations on its long-term debt and the degree to which is uses borrowed vs invested financial capital are called *Exs: debt ratio, the debt-to-equity ratio, the times interest earned ratio

Debt or financial leverage management ratios

The ROE can be calculated simply by:

Dividing a firm's net income by the firm's SH equity, and it can be subdivided into the key factors that drive the ROE

Corporate decision makers and analysts often use a particular technique called ______, to better understand the factors that drive a company's financial performance, as reflected by its return on equity (ROE)

DuPoint analysis

For a negative P/E ratio to exist...

Either the share price but be less than zero or the shares' EPS must be negative

The US tax structure influences a firm's willingness to finance with debt. The tax structure ____ more debt.

Encourages

Low P/E ratios could mean that the company...

Has a great deal of uncertainty in its future earnings

From ratios, you can:

Interpret the info the ratios provide, analyze trends in the co's performance, and draw conclusions about the factors driving those trends

The quick ratio adjusts current assets by subtracting:

Inventories

Ratios that help determine whether a company can access its cash and pay its short-term obligations are called: Exs: current ratio, the quick or acid-test ratio

Liquidity Ratio

When the economy is growing and if the company is doing well, leverage helps firms benefit from:

Lower taxable income and generates higher expected returns for it SH's

Lower earnings before tax leads to:

Lower taxes and thus higher expected earnings for SH

ratios that examine the market value of a company's share price, its profits and cash dividends, and the book value of the firm's assets and relate them to other data items to determine how the firm is perceived in the stock market

Market value or market based Ratios

Relate to a firm's observable market value, stock prices, and book values, integrating info from both the market and the firm's financial statements.

Market-Based Ratios

You decide also to conduct a qualitative analysis based on the factors summarized by the American Association of Individual Investors - according to your understanding, a company with one key customer is considered to be _____ risky than companies with several customers.

More

Share prices cannot be...

Negative (But the companies can incur negative earnings - a loss)

Negative earnings can lead to....

Negative EPS, therefore a negative P/E ratio

means that investors are willing to buy a share of a company that has been losing money on every share of its stocks

Negative P/E ratio

If the operating margin is high, it is probably because...

Of either high product prices, which will lead to increase sales revenue, or lower operating costs - or both.

Ratios that help measure a company's ability to generate income and profits based on its invested capital ratios that measure the rate of return a firm is earning on various measures of investment ratios that measure the rate of return a firm is earning on various measures of investment Exs: diff types of profit margins, return on assets, return on equity

Profitability ratios

Based on your understanding of the uses and limitations of ROE, which project should be chosen if they have the same risk and cost of capital Project Y, with 40% ROE and a small investment, generating low expected cash flows Project X, with 35% ROE and a large investment, generating high expected cash flows

Project X, with 35% ROE and a large investment, generating high expected cash flows

Profit Margin x Total Assets Turnover x Equity Multipler

ROE

Sales x Total Assets x Total Assets/Total Common Equity

ROE

The amount of invested capital is not considered in...

ROE calculations

the ratio of net income and a company's common equity

Return on Common Equity (ROE)

Shareholder value depends on:

Return on equity, risk, and capital invested

Unleveraged firms are less ____, but they might also lose out on the opps they could otherwise pursue if they used borrowed money

Risky

the company's net profit margin or earnings after taxes // tells you about the firm's operational efficiency - which means how much after-tax income a firm is making on each dollar of sales earned - calculated by dividing net income by the corresponding year's net sales

The first term of the DuPont Equation

the firm's total assets turnover - tells you how efficiently the co is using its total assets to generate sales - calculated by dividing the company's net sales by its corresponding total assets

The second term of the DuPont Equation

the equity multiplier - reflects the company's financial leverage - aka the adjustment factor - calculated by dividing the co's total assets by its total common equity

The third term of the DuPont Equation

The DuPoint equation disaggregates the ROE into 3 components - so, analysts can see: why a company's ROE may have changed for the better or worse, and identify particular company strengths and weaknesses

Why a company's ROE may have changed for the better or worse and identify particular company strengths and weaknesses

Is it possible for a company to exhibit a negative EPS and thus a negative P/E ratio?

Yes

Interest from leverage is deducted as:

an expense from a company's earnings, or the earnings before interest and taxes (EBIT) *Results in a lower taxable income compared to unleveraged firm, as well as lower taxes

Companies have the opportunity to use varying amounts of different sources of financing to acquire their:

assets, including internal and external sources, and debt (borrowed) and equity funds

If the profit margin decreased, it would mean that:

higher deductions were made from the operating income

When a firm takes on leverage aka borrowed funds, it has to make:

interest payments on its debt

If a company issues new common shares...

its total shares outstanding will increase, which means that the equity base increases

The quick ratio asks what would happen if the firm were:

liquidated today and whether it would have enough liquid assets to meet short-term creditors

ROE is calculated by dividing...

net income by shareholder's equity (does not consider the amount of invested capital)

Operating margin is the ratio of a company's...

operating income, or earnings before interest and taxes (EBIT) and its sales

If the company's operating margin increased but its profit margin decreased, it could mean that the co...

paid more in interest or taxes

Asset management ratios are used to measure how effectively a firm manages its assets, by:

relating the amount a firm has invested in a particular type of asset to the amount of revenues the asset is generating