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Unformatted text preview: Chapter 17 “How Well Am I Doing?” Financial Statement Analysis Solutions to Questions 17-1 Horizontal analysis involves examining how a particular item on a financial statement such as sales or cost of goods sold behaves over time. Vertical analysis involves analysis of items on an income statement or balance sheet for a single year. In vertical analysis, all the items on the financial statement are stated as a percentage of a single item such as sales revenues or total assets. 17-2 By looking at trends, an analyst hopes to get some idea of whether a situation is improving, remaining the same, or deteriorating. Such analyses can provide insight into what is likely to happen in the future. Rather than looking at trends, an analyst may compare one company to another or to industry averages using common-size financial statements. 17-3 Price-earnings ratios reflect investors’ expectations concerning future earnings. The higher the price-earnings ratio, the greater the growth in earnings expected by investors. For this reason, two companies might have the same current earnings and yet have quite different price-earnings ratios. By definition, a stock with current earnings of $4 and a price-earnings ratio of 20 would be selling for $80 per share. 17-4 A company in a rapidly growing technological industry probably would have many opportunities to invest its 23723 723723723723723723723723723723723723723723723723723723723723723723723723723723723723 723723723723723723723723723723723723723723723723723723723723723723723723723723723723 7237237237237 237 237237237237237237237237237237237237237237237237237237237237237237237 237237237237237237237237 238 earnings at a rate of return higher than stockholders could earn in other investments. From the stockholders’ perspective, in this situation it would be better for the company to reinvest its earnings rather than pay out its earnings in the form of dividends. Thus, one would expect the company to have a low dividend payout ratio. 17-5 The dividend yield is the return on an investment from simply collecting dividends. The other source of return on an investment in stock is increases in market value. The dividend yield is computed by dividing the dividend per share by the current market price per share of common stock. 17-6 Financial leverage results from borrowing funds at an interest rate that differs from the rate of return on assets acquired using those funds. If the rate of return on the assets is higher than the interest rate at which the funds were borrowed, financial leverage is...
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This note was uploaded on 04/19/2011 for the course ACC 2302 taught by Professor Hooreman during the Spring '10 term at Al Akhawayn University.
- Spring '10