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Chapter3: Financial Statements Analysis and Financial Models

Questions and Problems

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BASIC (Questions 1–10)

  1. Du Pont Identity If Roten, Inc., has an equity multiplier of 1.35, total asset turnover of 2.15, and a profit margin of 5.8 percent, what is its ROE?

  2. Equity Multiplier and Return on Equity Thomsen Company has a debt–equity ratio of .90. Return on assets is 10.1 percent, and total equity is $645,000. What is the equity multiplier? Return on equity? Net income?

  3. Using the Du Pont Identity Y3K, Inc., has sales of $3,100, total assets of $1,580, and a debt–equity ratio of 1.20. If its return on equity is 16 percent, what is its net income?

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  1. EFN The most recent financial statements for Martin, Inc., are shown here:

    <a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077333403/student/pg78_1.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

    p. 79

    Assets and costs are proportional to sales. Debt and equity are not. A dividend of $1,841.40 was paid, and Martin wishes to maintain a constant payout ratio. Next year's sales are projected to be $30,960. What external financing is needed?

  2. Sales and Growth The most recent financial statements for Fontenot Co. are shown here:

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    Assets and costs are proportional to sales. The company maintains a constant 30 percent dividend payout ratio and a constant debt–equity ratio. What is the maximum increase in sales that can be sustained assuming no new equity is issued?

  3. Sustainable Growth If the Layla Corp. has a 15 percent ROE and a 10 percent payout ratio, what is its sustainable growth rate?

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  1. Sustainable Growth Assuming the following ratios are constant, what is the sustainable growth rate?

    Total asset turnover = 1.90

    Profit margin = 8.1%

    Equity multiplier = 1.25

    Payout ratio = 30%

  2. Calculating EFN The most recent financial statements for Bradley, Inc., are shown here (assuming no income taxes):

    <a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077333403/student/pg79_2.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

    Assets and costs are proportional to sales. Debt and equity are not. No dividends are paid. Next year's sales are projected to be $6,669. What is the external financing needed?

  3. External Funds Needed Cheryl Colby, CFO of Charming Florist Ltd., has created the firm's pro forma balance sheet for the next fiscal year. Sales are projected to grow by 10 percent to $390 million. Current assets, fixed assets, and short-term debt are 20 percent, 120 percent, and 15 percent of sales, respectively. Charming Florist pays out 30 percent of its net income in dividends. The company currently has $130 million of long-term debt and $48 million in common stock par value. The profit margin is 12 percent.

    1. Construct the current balance sheet for the firm using the projected sales figure.

    2. Based on Ms. Colby's sales growth forecast, how much does Charming Florist need in external funds for the upcoming fiscal year?

    3. Construct the firm's pro forma balance sheet for the next fiscal year and confirm the external funds needed that you calculated in part (b).

    p. 80

  4. Sustainable Growth Rate The Steiben Company has an ROE of 10.5 percent and a payout ratio of 40 percent.

    1. What is the company's sustainable growth rate?

    2. Can the company's actual growth rate be different from its sustainable growth rate? Why or why not?

    3. How can the company increase its sustainable growth rate?

INTERMEDIATE
(Questions 11–23)

  1. Return on Equity Firm A and Firm B have debt–total asset ratios of 40 percent and 30 percent and returns on total assets of 12 percent and 15 percent, respectively. Which firm has a greater return on equity?

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  1. Ratios and Foreign Companies Prince Albert Canning PLC had a net loss of £15,834 on sales of £167,983. What was the company's profit margin? Does the fact that these figures are quoted in a foreign currency make any difference? Why? In dollars, sales were $251,257. What was the net loss in dollars?

  2. External Funds Needed The Optical Scam Company has forecast a 20 percent sales growth rate for next year. The current financial statements are shown here:

    <a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077333403/student/pg80_1.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

    1. Using the equation from the chapter, calculate the external funds needed for next year.

    2. Construct the firm's pro forma balance sheet for next year and confirm the external funds needed that you calculated in part (a).

    3. Calculate the sustainable growth rate for the company.

    4. Can Optical Scam eliminate the need for external funds by changing its dividend policy? What other options are available to the company to meet its growth objectives?

  3. Days' Sales in Receivables A company has net income of $205,000, a profit margin of 9.3 percent, and an accounts receivable balance of $162,500. Assuming 80 percent of sales are on credit, what is the company's days' sales in receivables?

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p. 81

  1. Ratios and Fixed Assets The Le Bleu Company has a ratio of long-term debt to total assets of .40 and a current ratio of 1.30. Current liabilities are $900, sales are $5,320, profit margin is 9.4 percent, and ROE is 18.2 percent. What is the amount of the firm's net fixed assets?

  2. Calculating the Cash Coverage Ratio Titan Inc.'s net income for the most recent year was $9,450. The tax rate was 34 percent. The firm paid $2,360 in total interest expense and deducted $3,480 in depreciation expense. What was Titan's cash coverage ratio for the year?

  3. Cost of Goods Sold Guthrie Corp. has current liabilities of $270,000, a quick ratio of 1.1, inventory turnover of 4.2, and a current ratio of 2.3. What is the cost of goods sold for the company?

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  1. Common-Size and Common–Base Year Financial Statements In addition to common-size financial statements, common–base year financial statements are often used. Common–base year financial statements are constructed by dividing the current year account value by the base year account value. Thus, the result shows the growth rate in the account. Using the following financial statements, construct the common-size balance sheet and common–base year balance sheet for the company. Use 2009 as the base year.

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    Use the following information for Problems 19, 20, and 22:

    The discussion of EFN in the chapter implicitly assumed that the company was operating at full capacity. Often, this is not the case. For example, assume that Rosengarten was operating at 90 percent capacity. Full-capacity sales would be $1,000/.90 = $1,111. The balance sheet shows $1,800 in fixed assets. The capital intensity ratio for the company is

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    This means that Rosengarten needs $1.62 in fixed assets for every dollar in sales when it reaches full capacity. At the projected sales level of $1,250, it needs $1,250 × 1.62 = $2,025 in fixed assets, which is $225 lower than our projection of $2,250 in fixed assets. So, EFN is only $565 – 225 = $340.

    p. 82

  2. Full-Capacity Sales Thorpe Mfg., Inc., is currently operating at only 85 percent of fixed asset capacity. Current sales are $630,000. How much can sales increase before any new fixed assets are needed?

  3. Fixed Assets and Capacity Usage For the company in the previous problem, suppose fixed assets are $580,000 and sales are projected to grow to $790,000. How much in new fixed assets are required to support this growth in sales?

  4. Calculating EFN The most recent financial statements for Moose Tours, Inc., appear below. Sales for 2010 are projected to grow by 20 percent. Interest expense will remain constant; the tax rate and the dividend payout rate will also remain constant. Costs, other expenses, current assets, fixed assets, and accounts payable increase spontaneously with sales. If the firm is operating at full capacity and no new debt or equity is issued, what external financing is needed to support the 20 percent growth rate in sales?

  5. Capacity Usage and Growth In the previous problem, suppose the firm was operating at only 80 percent capacity in 2009. What is EFN now?

    <a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077333403/student/pg82_1.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

    p. 83

  6. Calculating EFN In Problem 21, suppose the firm wishes to keep its debt–equity ratio constant. What is EFN now?

CHALLENGE (Questions 24–30)

  1. EFN and Internal Growth Redo Problem 21 using sales growth rates of 15 and 25 percent in addition to 20 percent. Illustrate graphically the relationship between EFN and the growth rate, and use this graph to determine the relationship between them.

  2. EFN and Sustainable Growth Redo Problem 23 using sales growth rates of 30 and 35 percent in addition to 20 percent. Illustrate graphically the relationship between EFN and the growth rate, and use this graph to determine the relationship between them.

  3. Constraints on Growth Bulla Recording, Inc., wishes to maintain a growth rate of 12 percent per year and a debt–equity ratio of .30. Profit margin is 5.9 percent, and the ratio of total assets to sales is constant at .85. Is this growth rate possible? To answer, determine what the dividend payout ratio must be. How do you interpret the result?

  4. EFN Define the following:

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    Hint: Asset needs will equal A × g. The addition to retained earnings will equal PM(S)b × (1 + g).

  5. Sustainable Growth Rate Based on the results in Problem 27, show that the internal and sustainable growth rates can be calculated as shown in Equations 3.23 and 3.24. Hint: For the internal growth rate, set EFN equal to zero and solve for g.

  6. Sustainable Growth Rate In the chapter, we discussed one calculation of the sustainable growth rate as:

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    In practice, probably the most commonly used calculation of the sustainable growth rate is ROE × b. This equation is identical to the sustainable growth rate equation presented in the chapter if the ROE is calculated using the beginning of period equity. Derive this equation from the equation presented in the chapter.

  7. Sustainable Growth Rate Use the sustainable growth rate equations from the previous problem to answer the following questions. No Return, Inc., had total assets of $310,000 and equity of $183,000 at the beginning of the year. At the end of the year, the company had total assets of $355,000. During the year the company sold no new equity. Net income for the year was $95,000 and dividends were $68,000. What is the sustainable growth rate for the company? What is the sustainable growth rate if you calculate ROE based on the beginning of period equity?

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