FM8e- EOC Sol Ch07

FM8e- EOC Sol Ch07 - Chapter 7 Analysis of Financial...

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Chapter 7 Analysis of Financial Statements ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS The answers to these questions are all contained in the BOC Excel model for this chapter, where they are illustrated with actual data and the ratios are calculated. Answers and Solutions: 7 - 1 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 A B C D E F G H I 2. Suppose Company X has the data shown in the following financial statements. Answer the following questions, giving numbers if all the required data are available or in general terms if the necessary data are not available. Note that additional data are provided in the chapter BOC model. (a) What is X’s DSO? If the industry average DSO is 30 days, and if X could reduce its accounts receivable to the point where its DSO became 50 without affecting its sales or operating costs, how would this affect: (b) Its free cash flow? (c) Its ROE? (d) Its debt ratio? (e) Its TIE ratio? (f) Its Loan/EBITDA ratio? (g) Its P/E ratio? (h) Its M/B ratio? Balance Sheets 2003 2004 Income Statements 2003 2004 Cash in bank $5 $6 Sales (net of discounts) 90.00 $ 100.00 $ Marketable securities $5 $6 Cost of goods sold (COGS) 73.00 76.00 Accounts receivable $10 $12 Admin and credit costs 5.00 6.00 Inventories $25 $26 Deprn and amortization 4.00 5.00 Current assets $45 $50 Operating Income (EBIT) 8.00 $ 13.00 $ Net fixed assets $45 $50 Interest expense 3.00 3.00 Total assets $90 $100 Taxable income 5.00 $ 10.00 $ Taxes (40%) 2.00 4.00 Accounts payable $35 $36 Net income 3.00 $ 6.00 $ Notes payable $9 $8 Dividends 1.00 $ 2.00 $ Accrued wages & taxes $5 $6 Additions to R.E. 2.00 $ 4.00 $ Current liabilities $49 $50 Long-term debt $25 $30 Total liabilities $74 $80 Common stock $1 $1 Retained earnings $15 $19 Total common equity $16 $20 Total liabilities & equity $90 $100 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 A B C D E F G H I DSO: Days sales outstanding = Receivables/(sales/363) = 43.80 2-b. FCF30 = Receivables/(sales/365) Receivables = 30(Sales/365) = 8.22 $ vs. $12 Originally Difference = -$3.78 This would be an addition to FCF in the year the change was made. Also, going forward, FCF would be higher each year because receivables would increase less than under the old situation. 2-c. ROEThe effect on the ROE would depend on what was done with the extra FCF. If it were used to repurcha stock, then equity would decline, earnings would presumably remain constant, and thus ROE would increase. Similarly, if the FCF were used to retire debt, interest would decline, earnings would increase, and ROE would again rise. Alternatively, the FCF could be reinvested in the business, which then the future net income and equity would remain unchanged, hence there would be no effect on ROE. Overall, though, the change would probably increase ROE under the assumed conditions. See question 5 for the results if stock were repurchased; the ROE rises sharply.
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Answers and Solutions: 7 - 2 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 A B C D E F G H I 2-d.D/A: If the FCF were used to retire debt, then the assets and the debt would both decline by the same amount The result would be a decline in the debt ratio: Old ratio: $80/$100 = 80% New ratio: (80-3.78)/(100-3.78) = 79%
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FM8e- EOC Sol Ch07 - Chapter 7 Analysis of Financial...

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