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1B2010s2wk10HomeQ - Suggested solutions to homework...

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Unformatted text preview: Suggested solutions to homework questions – Week 10 Problem 14.17 Problem 14.21 (As noted in the lecture note, change “Days inventory on hand (2008)” in the question from 32.8 to 54.5) (1) a. Financial performance: ROE, ROA, Gross margin b. Liquidity and solvency: Quick ratio, current ratio and interest coverage c. Financial Structure: Debt‐to‐equity d. Operating Efficiency: Inventory turnover, receivables turnover, days inventory on hand (2) a. The company’s ROA and ROE appear to be high. Gross margin and ROA have increased in 2009. The fact that ROE is greater than ROA in both years indicate that leverage is being employed to the advantage of shareholders, though this was done to a greater extent in 2008 than in 2009. b. The company’s current ratio is well above 1 for both years and this suggests it is quite liquid, though this depends on the industry Ratio Ltd is in and the industry norm. Both the current and quick ratios have dropped in 2009 however, indicating the company is currently less liquid than it was in 2008. c. The company’s debt‐to‐equity ratio shows that it is financed by debt. The drop in the interest coverage ratio in 2009 suggests that the company is less comfortable in covering its interest obligations in 2009 compared to in 2008. d. The company is operating more efficiently than it did in 2008. The modest increase in receivables turnover suggests that customers are paying the company a little faster. Also inventory turnover has increased indicating that inventory is being turned over at a quicker rate (recall that there is an error in 2008 days inventory on hand as it should be 54.5.) Limitations: lack of information about the company – e.g., what industry is it in? What are the industry norms? What kind of inventory does it stock (e.g., perishables)? (3) a. ROA shows the return managers are earning on the assets under their control. In contrast, ROE indicates how much return the company is generating on the historically accumulated shareholder’s investment. It captures the combined effect of assets and leverage that the company uses to create shareholder returns (ROE = ROA X Leverage). b. Because it enables managers to analyse where shareholder returns are being derived from (e.g., is it from the company’s sales and the use of its assets, or is it from leverage), and to identify the areas for improvement. (4) a. These ratios show how efficiently the company’s inventory is being managed. More specifically, inventory turnover shows how much sales volume is associated with a dollar of inventory (i.e., normally, the greater the better), while days inventory on hand calculates how many days, on average, inventory is held (i.e., the smaller the better). b. A limitation of these ratios is that they don’t necessarily reflect how well a company is performing. For a company whose operations are based on a premise of low turnover and high profit margin, a low inventory turnover ratio may be sustainable. Therefore, these ratios must be interpreted having regard to the nature of the business and norm for companies in the same industry which compete in a similar way. (5) Debt‐to‐equity Inventory turnover Quick ratio Gross margin Interest coverage Current ratio Receivables turnover Days inventory on hand Return on Assets Return on Equity Decrease No effect No effect No effect No effect No effect No effect No effect Decrease Decrease ...
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