# ch04 - Chapter 4 Solutions Overview: Problem Length {S} {M}...

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Chapter 4 Solutions Overview: Problem Length Problem #s {S} 1, 9-12 {M} 3, 5, 6, 13-18, 22, 24 {L} 2, 4, 7, 8, 19-21, 23, 25-27 1.{S} a. (i) The identical amount is subtracted from both numerator (CA) and denominator (CL). Since the ratio (before subtraction) is greater than 1 , the effect will be to increase the ratio. (ii) The ratio will increase since the denominator (assets) will decrease. (iii)The ratio will decrease since the numerator (cash) will decrease (iv) The ratio will decrease since the numerator (debt) will decrease. b. All the answers will be the same as in A except for {i} Current ratio. Since the ratio now is less than 1, the effect will be to decrease the ratio. 2.{L} The Walt Disney Company (i) Accounts receivable turnover = Revenue / Receivables = \$25,402 / \$3,599 = 7.06 This ratio measures the effectiveness of the firm's credit policies and the capital required to maintain the firm's sales level. (ii) Total asset turnover = Sales / Total assets = \$25,402 / \$45,027 = 0.56 This ratio is designed to evaluate the efficiency of long-term capital investment in productive capacity by measuring sales generated by investments in total assets. (iii)Current ratio = current assets /current liabilities = \$10,007 / \$8,402 = 1.19 The current ratio is the broadest measure of current and potential resources available to meet short-term obligations. 4-1

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(iv) CFO to current liabilities = \$6,434 / \$8,402 = 0.77 Unlike the current ratio, this measure compares actual cash flows to current obligations. (v) Debt to equity = \$6,959 / \$24,100 = 0.29 A measure of risk compared to the owners' investment in the firm. Note that this ratio should include the current portion of financial obligations in the numerator. An alternative computation is based on the sum of operating and financial obligations: (\$8,402 + \$6,959) / \$24,100 = 0.64 (vi) The times interest earned ratio = EBIT/interest expense = (\$2,526 + \$558) / \$558 = 5.53 is an indicator of safety for creditors as it measures the extent to which earnings are available to meet interest charges. (vii)Operating income to sales = \$2,848 / \$25,402 = 0.11 This is a measure of the profitability of a firm's "core" business. (viii)Return on sales = net income / sales = \$920 /\$25,402 = 3.62% An indicator of overall profitability. (ix) Return on assets = (Net income + after-tax interest)/total assets = (\$920 + \$203 1 ) /\$ 45,027 = 2.49% This ratio measures the efficiency of the use of assets in generating operating profits and of the return accruing to capital used in the operations. It may also be measured on a pretax basis to exclude the impact of differences in tax position and financial policy: EBIT / total assets = \$ 3,084 / \$ 45,027 = 6.85% 1 The tax-rate is estimated as (income tax expense)/(pretax income) = \$1,606/\$2,526 = 63.6%. Thus after-tax interest expense = 36.4% x \$558 = \$203 4-2
3.{M}a. Five component disaggregation of ROE: 1997 2000 1. Operating margin EBIT/Sales = 18.16% 12.14% x 2. Interest burden Pretax income/EBIT = 0.83X 0.82X x 3. Tax burden Net income/Pretax income = 0.58X 0.36X x 4. Asset turnover Sales/Average assets = 0.59X 0.56X x 5. Leverage Average assets/Average equity = 22 .50X 1 .87X = Return on equity Net income/Average equity = 117.09% 3.82% Note: Due to rounding errors, ROE computed by multiplying out the components does not equal actual ROE b. The primary causes of the decline in ROE are the lower

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## This note was uploaded on 04/15/2009 for the course ACCOUNTING BUSI0027 taught by Professor Guan during the Spring '09 term at HKU.

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ch04 - Chapter 4 Solutions Overview: Problem Length {S} {M}...

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