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CHAPTER 5
USING FINANCIAL STATEMENT INFORMATION
BRIEF EXERCISE
BE5–1
Coke
Pepsi
(a) ROE = Net Income/Average Stockholders Equity
33.6%
33.3%
ROA = (Net Income +[Interest Expense (1Tax Rate)])/
Average Total Assets
17.3%
15.1%
Common Equity Leverage = Net Income/(Net Income +
[Interest Expense(1Tax Rate)])
96.9%
96.9%
Capital Structure Leverage = Average Total Assets/
Average Stockholders Equity
2.00
2.28
Return on Sales = Net Income + [Interest Expense
(1 Tax Rate)]/Net Sales
21.3%
13.7%
Asset Turnover = Sales/Average Total Assets
.81
1.11
Coke and Pepsi return similar percentages on equity, but Coke is slightly better at generating a
return from assets.
Leverage is similar with Pepsi showing higher relative debt levels,
according to the Capital Structure Leverage ratio.
Coke shows a large advantage on its margin
on converting sales into profits, but Pepsi generates more sales from each dollar of assets.
(b) ROA x Common Equity Leverage x Capital Structure Leverage
=
ROE
Coke:
.173
x
..969
x
2.00
=
.335 (rounding)
Pepsi:
.151
x
.969 x
2.28
=
.334 (rounding)
(c) Profit Margin x Asset Turnover
=
ROA
Coke:
.213
x
.81
=
.173
Pepsi:
.137
x 1.11
=
.152 (rounding)
(d) Coke has only a slight edge in ROE, but its ROA is over two points higher than that of Pepsi.
The advantage in ROA is driven by the much higher profit margin (21.3% versus 13.7%) of
Coke.
Coke is better at converting sales into profits.
EXERCISES
E5–1
1
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View Full Document Profitability Ratios:
Return on Equity
=
Net Income
÷
Average Stockholders’ Equity
2002:
$1,893
÷
27,888
=
.068
2003:
$3,578
÷
28,342.5
=
.126
Return on Sales
=
(Net Income + [Interest Expense (1 – Tax Rate)]) ÷ Net Sales
2002:
($1,893
+ [0 x (1  .29)])
÷
$18,915
=
.100
2003:
($3,578
+ [0 x (1  .29)])
÷
$18,878
=
.190
Solvency Ratios:
Current Ratio
=
Current Assets
÷
Current Liabilities
2002:
$
17,433
÷
$
8,375
=
2.08
2003:
$
13,415
÷
$
8,294
=
1.62
Leverage Ratios:
Capital Structure Leverage Ratio
=
Average Total Assets
÷
Average Total Stockholders’
Equity
2002:
$36,516.5
÷
$27,888
=
1.31
2003:
$37,451
÷
$28,342.5 =
1.32
Overall, by examining the above computed ratios, it appears that Cisco would be a good
investment. Profitability increased substantially from 2002 to 2003, while leverage remained
constant.
The only ratio that would be somewhat negative is the decrease in solvency, but the
current ratio is still adequate.
2
E5–2
Profitability Ratios:
Return on Equity
=
Net Income
÷
Average Stockholders’ Equity
2002:
$3,117
÷
35,649
=
.087
2003:
$5,641
÷
36,657
=
.154
Return on Sales
=
(Net Income + [Interest Expense (1 – Tax Rate)]) ÷ Net Sales
2002:
($3,117 + [194 x (1  .24)])
÷
$26,764
=
.122
2003:
($5,641 + [192 x (1  .24)])
÷
$30,141
=
.192
Solvency Ratios:
Current Ratio
=
Current Assets
÷
Current Liabilities
2002:
$18,925
÷
$6,595
=
2.87
2003:
$22,882
÷
$6,879
=
3.33
Leverage Ratios:
Capital Structure Leverage Ratio
=
Average Total Assets
÷
Average Total Stockholders’
Equity
2002:
$44,309.5
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This note was uploaded on 03/25/2009 for the course FIN FIN504 taught by Professor Byungjinkwak during the Spring '09 term at Korea Advanced Institute of Science and Technology.
 Spring '09
 ByungjinKwak
 Interest, Leverage

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