HOMEWORK solutions 14c

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

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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...

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