Finance solutions ch. 3

Finance solutions ch. 3 - ANSWERS TO END-OF-CHAPTER...

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ANSWERS TO END-OF-CHAPTER QUESTIONS 3-1. In learning about ratios, we could simply study the different types or categories of ratios. These categories have conventionally been classified as follows: Liquidity ratios are used to measure the ability of a firm to pay its bills on time. Example ratios include the current ratio and acid-test ratio. Efficiency ratios reflect how effectively the firm has utilized its assets to generate sales. Examples of this type of ratio include accounts receivable turnover, inventory turnover, fixed asset turnover, and total asset turnover. Leverage ratios are used to measure the extent to which a firm has financed its assets with outside (non-owner) sources of funds. Example ratios include the debt ratio and times interest earned ratio. Profitability ratios serve as overall measures of the effectiveness of the firm’s management relative to sales and/or to investment. Examples of profitability ratios include the net profit margin, return on total assets, operating profit margin, operating income return on investment, and return on common equity. Instead, we have chosen to cluster the ratios around important questions that may be addressed to some extent by certain ratios. These questions, along with the related ratios may be represented as follows: 1. How liquid is the firm? Current ratio Quick ratio Accounts receivable turnover (average collection period) Inventory turnover 2. Is management generating adequate operating profits on the firm’s assets? Operating income return on investment Operating profit margin Gross profit margin Asset turnover ratios, such as for total assets, accounts receivable, inventory, and fixed assets
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3. How is the firm financing its assets? Debt to total assets Debt to equity Times interest earned 4. Are the owners (stockholders) receiving an adequate return on their investment? Return on common equity
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Finance solutions ch. 3 - ANSWERS TO END-OF-CHAPTER...

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