Finance - Test 3
Quick Ratio (Acid Test) =
(Current Assets - Inventory) / Current Liabilities
A firm's ability to sustain growth depends explicitly on the following four factors:
1. profit margin 2. total asset turnover 3. financial policy 4. dividend policy
financial ratios are traditionally grouped into the following categories
1. short-term solvency, or liquidity, ratios 2. long-term solvency, or financial leverage, ratios 3. asset management, or turnover, ratios 4. profitability ratios 5. market value ratios
suppose you find that a particular company generates $0.40 in sales for every dollar in total assets. How often does this company turn over its total assets?
1/.4 = 2.5 years to turn assets over completely
An angel investor is willing to give you $250,000 to help your company explode. In return the investor wants $60,000 next year, and then a smaller amount every year, forever. The amount will shrink by 10% each year. What discount rate is your angel investor using?
14%
if a stock cost $37 and its next dividend is expected to be $4.50 (dividends are expected to grow by 2% indefinitely), what is the discount rate?
14.16%
A firm has net income of $197,400, a return on assets of 8.4 percent, and a debt-equity ratio of .72. What is the return on equity?
14.45 percent
Use the following information to answer this question. Bayside, Inc.2017 Income Statement($ in thousands)Net sales$6,090 Cost of goods sold 4,300 Depreciation 410 Earnings before interest and taxes$1,380 Interest paid 34 Taxable income$1,346 Taxes 404 Net income$942 Bayside, Inc.2016 and 2017 Balance Sheets($ in thousands) 2016 2017 2016 2017 Cash$125 $230 Accounts payable$1,630 $1,580 Accounts rec. 1,030 870 Long-term debt 830 630 Inventory 1,745 2,060 Common stock 3,280 3,300 Total$2,900 $3,160 Retained earnings 900 1,150 Net fixed assets 3,740 3,500 Total assets$6,640 $6,660 Total liab. & equity$6,640 $6,660 What is the return on equity for 2017?
21.17%
Rogers Radiators has net income of $48,200, sales of $947,100, a capital intensity ratio of .87, and an equity multiplier of 1.53. What is the return on equity?
8.95 percent
Lee Sun's has sales of $3,500, total assets of $3,200, and a profit margin of 5 percent. The firm has a total debt ratio of 41 percent. What is the return on equity?
9.27 percent
Inventory Turnover
cost of goods sold/inventory
Net Working Capital =
current assets - current liabilities
EBIT
earnings before interest and taxes
EBITD
earnings before interest, taxes, and depreciation
A common-size balance sheet helps financial managers determine:
if changes are occurring in a firm's mix of assets
a firm has two broad sources of financing:
internal and external
Return on Equity
is a measure of how the stockholders fared during the year
Return on Assets
is a measure of profit per dollar of assets
why is it often necessary to standardize financial statements?
its almost impossible to directly compare the financial statements for two companies because of differences in size
the cash ratio is used to evaluate the:
liquidity of a firm
Market to Book Ratio
market value per share/book value per share
operating efficiency
measured by profit margin
profit margin
net income/net sales
Earnings Per Share (EPS) =
net income/shares outstanding
Price/Earnings (P/E) Ratio =
price per share/earnings per share
Price-Sales Ratio =
price per share/sales per share
Short-Term Solvency Ratio
provide information about a firm's liquidity. focus of current assets and current liabilities
what is the difference between EAR and APR that compounds weekly and rate of 4.20%
104.29-104.2 =0.09 or 9 basis points
A firm has sales of $1,080, net income of $212, net fixed assets of $516, and current assets of $272. The firm has $87 in inventory. What is the common-size balance sheet value of inventory?
11.04%
Mercier United has net income of $128,470. There are currently 32.67 days' sales in receivables. Total assets are $1,419,415, total receivables are $122,306, and the debt-equity ratio is .40. What is the return on equity?
12.67 percent
Computer Geeks has sales of $618,900, a profit margin of 13.2 percent, a total asset turnover rate of 1.54, and an equity multiplier of 1.06. What is the return on equity?
21.55 percent
Baker Boy will set aside $1,000 at the end of each quarter to save for retirement. He expects a 9% return and already has $5,000 saved up. How much will Baker Boy have in his retirement account in ten years?
$75,962.12
For prufrock corporation, we earlier calculated ROA as 13.06 percent. We also saw that the retention ratio is 66.67 percent, so the internal growth rate is:
(.1306 x .6667) / (1 - .1306 x .6667) = .0954 or 9.54%
we earlier calculated ROE as 18.06 percent, adn we know that the retion ratio is 66.67 percent, so we can easily calculate sustainable growth as:
(.1806 x .6667) / (1 - .1806 x .6667) = .1369 or 13.69%
Cash Coverage Ratio =
(EBIT + Depreciation) / Interest
sustainable growth rate =
(ROE x b) / (1 - ROE x b)
total debt ratio =
(Total Assets - Total Equity) / Total Assets
Use the following information to answer this question. Bayside, Inc.2017 Income Statement($ in thousands)Net sales$6,220 Cost of goods sold 4,540 Depreciation 390 Earnings before interest and taxes$1,290 Interest paid 42 Taxable income$1,248 Taxes 437 Net income$811 Bayside, Inc.2016 and 2017 Balance Sheets($ in thousands) 2016 2017 2016 2017 Cash$140 $245 Accounts payable$1,685 $1,735 Accounts rec. 1,110 950 Long-term debt 870 670 Inventory 1,785 2,120 Common stock 3,360 3,340 Total$3,035 $3,315 Retained earnings 940 1,190 Net fixed assets 3,820 3,620 Total assets$6,855 $6,935 Total liab. & equity$6,855 $6,935 How many dollars of sales were generated from every dollar of fixed assets during 2017?
$1.72
Around 1984 I was with my dad when he went to purchase a new Fiat. My dad wanted to discuss the terms for a car payment, the interest rate and length of the loan, but the salesman said those terms were unimportant. He said that only the price of the car mattered. So, my dad offered one million dollars for the car, one dollar a year for the next million years. That would be a zero percent interest rate and one million years to pay off the loan. The salesman did not like those terms, even though the price was extreme. If the Fiat dealership had a 10% discount rate, how much was my dad's offer worth?
$10
Why evaluate financial statements? external use
- short-term and long-term creditors and potential investors - evaluate suppliers, and suppliers would use our statements before deciding to extend credit to us.
problems with financial statement analysis
- there is no underlying theory to help us identify which quantities to look at and to guide us in establishing benchmarks - this is why we can't say which ratios matter the most and what a high or low value might be - many firms own more or less unrelated lines of business - always works best when the firms are strictly in the same line of business - major competitors and peer groups may be scattered all around the globe
Use the following information to answer this question. Windswept, Inc.2017 Income Statement($ in millions)Net sales$12,650 Cost of goods sold 7,900 Depreciation 490 Earnings before interest and taxes$4,260 Interest paid 98 Taxable income$4,162 Taxes 1,457 Net income$2,705 Windswept, Inc.2016 and 2017 Balance Sheets($ in millions) 2016 2017 2016 2017 Cash$250 $280 Accounts payable$1,780 $1,730 Accounts rec. 1,090 990 Long-term debt 1,060 1,380 Inventory 1,970 1,720 Common stock 3,340 3,030 Total$3,310 $2,990 Retained earnings 640 890 Net fixed assets 3,510 4,040 Total assets$6,820 $7,030 Total liab. & equity$6,820 $7,030 What is the fixed asset turnover for 2017?
3.13 times
Days' Sales in Inventory
365/inventory turnover
Days' Sales in Receivables
365/receivables turnover
Al's Markets earns $.12 in profit for every $1 of equity and borrows $.65 for every $1 of equity. What is the firm's return on assets?
7.27 percent
common-size statement
A standardized financial statement presenting all items in percentage terms. Balance sheet items are shown as a percentage of assets and income statement items as a percentage of sales.
Rainy is making a plan to save for retirement, which is fifteen years away. She wants $350,000 in the account and only has $32,000 today. Rainy will make her first monthly contribution of $800 today. What rate of return does Rainy need to earn?
APR = 7.1%
An angel investor is willing to give you $250,000 to help your company explode. In return the investor wants $60,000 next year, and then a smaller amount every year, forever. The amount will shrink by 10% each year. The investor is using a discount rate of 14%. Although the angel states the cash flows should continue forever, the angel wants a buy-out in seven years, this will require you to give the angel the value of the remaining perpetuity in seven years. How much cash will you give to the angel investor each of the next seven years?
CF1: $60,000 CF2: $54,000 CF3:$48,600 CF4: $43,740 CF5: $39,366 CF6: $35429.40 CF7: $31,886.46 PV7=$119,574.23 Angel7=$151,460.69
cash ratio =
Cash / Current Liabilities
Dividend payout ratio =
Cash Dividends/Net Income
Peer Group Analysis
Compare to similar companies or within industries
times interest earned ratio =
EBIT/Interest
EBITDA
Earnings before interest, taxes, depreciation, and amortization
EBITDA ratio
Enterprise Value / EBITDA
long term solvency ratios
Intended to address the firm's long-term ability to meet its obligations, or more generally, its financial leverage.
return on equity =
Net Income/Total Equity
Why Evaluate Financial Statements? Internal uses
Performance evaluation - compensation and comparison between divisions Planning for the future - guide in estimating future cash flows
Receivables Turnover
Sales / Accounts Receivable
Total Asset Turnover
Sales/Total Assets
Average Collection Period
The average amount of time that a receivable is outstanding, calculated by dividing 365 days by the accounts receivable turnover.
aspirant group
Top firms in an industry because we aspire to be like them
Equity Multiplier =
Total Assets/Total Equity
debt-equity ratio =
Total Debt/Total Equity
Standard Industrial Classification (SIC)
U.S. government code used to classify a firm by its type of business operations
Time-Trend Analysis
Used to see how the firm's performance is changing through time
Amortization
a non-cash deduction similar conceptually to depreciation, except it applies to an intangible asset (such as a patent) rather than a tangible asset (such as a machine)
liquidity measures
ability to meet current maturing debts
Retention Ratio (Plowback Ratio)
addition to retained earnings / net income
financial leverage
as measured by the equity multiplier
asset use efficiency
as measured by total asset turnover
external financing
refers to funds raised by either borrowing money or selling stock
Financial Ratios
relationships determined from a firm's financial information and used for comparison purposes
If a firm has an inventory turnover of 15, the firm:
sells its entire inventory an average of 15 times each year
Twenty-five dollars a week for twenty-five years and you can be a millionaire with an APR of 20.26%. If you started with $100 and could only get ten percent, how much would you need to invest each week to reach one million dollars in twenty-five years? What if you started with $1,000? Or, $10,000? Or, even $100,000?
start with $1000: $170.33 start with $10000: $151.47 start with $100,000: $37.13
Total Debt Ratio
takes into account all debts of all maturities to all creditors
inventory is
the least liquid current asset
Sustainable Growth Rate
the maximum growth rate a firm can achieve without external equity financing while maintaining a constant debt-equity ratio
internal growth rate
the maximum growth rate a firm can achieve without external financing of any kind
capital intensity ratio
the reciprocal of (that is 1 divided by) total asset turnover
Common-size financial statements present all balance sheet account values as a percentage of:
total assets
enterprise value =
total market value of the stock + book value of all liabilities - cash
if interest rates do not change and the dividends continue to rise as expected, what will be the stock price next year? discount rate = 7.25% C0 = $210 g = 4.1%
$72.25
we assume that prufrock has $33 million shares outstanding and the stock sold for $115 per share at the end of the year. If we recall that Prufrock's net income was $474 million, then we can calculate that its earnings per share were:
$14.36 million
Twenty-five dollars a week for twenty-five years and you can be a millionaire with an APR of 20.26%. If you started with $100 and could only get ten percent, how much would you need to invest each week to reach one million dollars in twenty-five years?
$172.21
A four-year car loan of $23,000 has an interest rate of 6.00%. Suppose Grover Girl will make $600 payments, all that is required is $540.16, to pay it off early. How much will she owe after three years?
$3,921.99
Suppose that a dying man purchases a perpetuity to pass on to his wife and children after his death. He has $650,000 and interest rates are 8.00%. He would like the cash flows to keep up with inflation, 2.30%. How large would the first cash flow be?
$37,050
Suppose that a dying man purchases a perpetuity to pass on to his wife and children after his death. He has $650,000 and interest rates are 8.00%. How large of a perpetuity can he purchase?
$52,000
A woman is considering purchasing a growing perpetuity that just made an annual payment of $4,500. These payments will grow by 3.2% each year. If she puts a discount rate of 11.00% on these payments, how much is she willing to pay for them?
$59,538.46
how much should a stock sell if the appropriate discount rate is 7.25%. If just paid a dividend of $2.10 and the dividends are expected to rise by 4.1% each year.
$69.40
A firm has total debt of $1,380 and a debt-equity ratio of .23. What is the value of the total assets?
$7,380.00
Prufrock had a cost of goods sold of $1,344. Inventory at the end of the year was $422. With there numbers, inventory turnover is
3.18 times
Profrock's net income was $474, of which $158 was paid out in dividends. If we express dividends paid as a percentage of net income, the result is the dividend payout ratio:
=.3333, or 33.33%
internal growth rate =
ROA x b /( 1 - ROA x b)
internal financing
Refers to what the firm earns and subsequently plows back into the business
Payables Turnover =
cost of goods sold / accounts payable
Current Ratio =
current assets / current liabilities
asset utilization ratios
measures of turnover
Rainy decides she is willing to wait until she has $500,000 to retire. She only has $32,000 right now and will make monthly contributions of $800, starting immediately. If Rainy hopes to earn 7.50% interest, how many years will she need to wait to retire?
months = 218.87 years = 18.24
return on assets =
net income/total assets
DuPont Identity
popular expression breaking ROE into three parts: operating efficiency, asset use efficiency, and financial leverage