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HOMEWORK solutions 14c

# HOMEWORK solutions 14c - Homework solutions Ch 14 part c...

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Homework solutions : Ch. 14, part c P14–5. Req. 1 Ratio Armstrong Company Blair Company Tests of profitability: 1. Return on equity \$45,000 ÷ \$240,000 = 19% \$90,000 ÷ \$680,000 = 13% 2. Return on assets [\$45,000 + (\$60,000 x 10% x.70)] ÷ \$400,000 = 12% [\$90,000 + (\$70,000 x 10% x .70)] ÷ \$800,000 = 12% 3. Financial leverage percentage 19% – 12% = 7% 13% – 12% = 1% 4. Earnings per share \$45,000 ÷ 15,000 sh. = \$3.00 \$90,000 ÷ 50,000 sh. = \$1.80 5. Profit margin \$45,000 ÷ \$450,000 = 10% \$90,000 ÷ \$810,000 = 11% 6. Fixed asset turnover \$450,000 ÷ \$140,000 = 3.21 \$810,000 ÷ \$400,000 = 2.03 Tests of liquidity: 7. Cash ratio \$35,000 ÷ \$100,000 = .35 \$22,000 ÷ \$50,000 = .44 8. Current ratio \$175,000 ÷ \$100,000 = 1.75 \$92,000 ÷ \$50,000 = 1.84 9. Quick ratio \$75,000 ÷ \$100,000 = .75 \$52,000 ÷ \$50,000 = 1.04 10. Receivable turnover \$150,000 ÷ [(\$20,000 + \$40,000) ÷ 2] = 5.00 \$270,000 ÷ [(\$38,000 + \$30,000) ÷ 2] = 7.94 11. Inventory turnover \$245,000 ÷ [(\$92,000 + \$100,000) ÷ 2] = 2.55 \$405,000 ÷ [(\$45,000 + \$40,000) ÷ 2] = 9.53 Solvency and equity position: 12. Debt/equity ratio \$160,000 ÷ \$240,000 = .67 \$120,000 ÷ \$680,000 = .18 Market tests: 13. Price/earnings ratio \$18 ÷ \$3.00 = 6.0 \$15 ÷ \$1.80 = 8.33 14. Dividend yield ratio (\$36,000 ÷ 15,000 shares) ÷ \$18 = 13.3% (\$150,000 ÷ 50,000 shares) ÷ \$15 = 20% Req. 2 Recommended choice: Armstrong Company Basis for recommendation: 1. The reported information for Armstrong Company is audited; therefore, it has more credibility. 2. Profitability in the future has a higher probability for Armstrong Company because the return on equity is 19% (compared with 13%) although return on assets is the same (12%). The resulting leverage advantage of 7% (compared with 1%) is because of the use of debt. Armstrong Company obtains 40% of its total resources by borrowing compared with 15% by Blair Company (see the ratio: creditors’ equity to total equities). Both companies can borrow at 7% net of tax while earning a 12% rate on assets (debt plus owners’ equity). Armstrong Company is taking better advantage of this leverage. The

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HOMEWORK solutions 14c - Homework solutions Ch 14 part c...

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