ch05 - CHAPTER 5 USING FINANCIAL STATEMENT INFORMATION...

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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 (1-Tax Rate)])/ Average Total Assets 17.3% 15.1% Common Equity Leverage = Net Income/(Net Income + [Interest Expense(1-Tax 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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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
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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 ÷ $35,649 = 1.24 2003: $45,683.5 ÷ $36,657 = 1.25 Overall, by examining the above computed ratios, it appears that Intel would be a good investment. The ROE and Return on Sales have increased from 2002 to 2003, as has solvency. Leverage has remained low. E5–3 Based on the information provided by Ginny’s Fashions, we can compute the following ratios: 1. Return on Equity = Net Income ÷ Average Stockholders’ Equity 2005: $17,000 ÷ $31,000 = .548 2006: $18,000 ÷ $35,500 = .507 2. Return on Sales = (Net Income + [Interest Expense (1 – Tax Rate)]) ÷ Net Sales 2005: $17,000 + [2000 (1 - .3)] ÷ $70,000 = .263 2006: $18,000 + [2000 (1 - .3)] ÷ $74,000 = .262 3
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E5–3 Concluded 3. Current Ratio = Current Assets ÷
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