Chapter3solutions

Chapter3solutions - CHAPTER 3 WORKING WITH FINANCIAL...

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CHAPTER 3 WORKING WITH FINANCIAL STATEMENTS Answers to Concepts Review and Critical Thinking Questions 2. The firm has increased inventory relative to other current assets; therefore, assuming current liability levels remain unchanged, liquidity has potentially decreased. 5. Common size financial statements express all balance sheet accounts as a percentage of total assets and all income statement accounts as a percentage of total sales. Using these percentage values rather than nominal dollar values facilitates comparisons between firms of different size or business type. Common-base year financial statements express each account as a ratio between their current year nominal dollar value and some reference year nominal dollar value. Using these ratios allows the total growth trend in the accounts to be measured. 7. Return on equity is probably the most important accounting ratio that measures the bottom-line performance of the firm with respect to the equity shareholders. The Du Pont identity emphasizes the role of a firm’s profitability, asset utilization efficiency, and financial leverage in achieving an ROE figure. For example, a firm with ROE of 20% would seem to be doing well, but this figure may be misleading if it were marginally profitable (low profit margin) and highly levered (high equity multiplier). If the firm’s margins were to erode slightly, the ROE would be heavily impacted. Solutions to Questions and Problems
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This note was uploaded on 07/01/2010 for the course ECON 393 taught by Professor D during the Summer '10 term at Rutgers.

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Chapter3solutions - CHAPTER 3 WORKING WITH FINANCIAL...

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