pratt_8e_chapter_5_solns - CHAPTER 5 USING FINANCIAL...

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CHAPTER 5USING FINANCIAL STATEMENT INFORMATIONBRIEF EXERCISEBE5–1CokePepsi(a)ROE = Net Income/Average Stockholders Equity27.3%34.8%ROA = (Net Income +[Interest Expense (1-Tax Rate)])/Average Total Assets14.7%15.2%Common Equity Leverage = Net Income/(Net Income +[Interest Expense(1-Tax Rate)])94.4%95.5%Capital Structure Leverage = Average Total Assets/Average Stockholders’ Equity1.972.39Return on Sales = Net Income + [Interest Expense(1- Tax Rate)]/Net Sales19.3%12.4%Asset Turnover = Sales/Average Total Assets.761.22Pepsi earns considerably more relative to its equity base and slightly more relative to its assets. Coke, however, has a higher return on sales (profits relative to sales). Pepsi shows higher use of leverage (Capital Structure Leverage ratio) and is much more efficient generating sales from its asset base (Asset Turnover ratio). (b)ROA x Common Equity Leverage x Capital Structure Leverage = ROECoke: .147 x .944 x 1.97 = .273 Pepsi:.152 x .955 x 2.39 = .347 (rounding)(c)Return on Sales x Asset Turnover = ROACoke:.193 x .76 = .147Pepsi:.124 x 1.22 = .151 (rounding)(d)Pepsi’s advantage in producing a return for shareholders’ equity investment is driven by more aggressive use of leverage and better returns from its asset base (ROA). Pepsi’s advantage in ROA is driven by its ability to generate sales from its assets; Pepsi’s lower return on sales is offset by higher sales volume. Given the higher returns on equity and the companies’ respective costs of capital, both companies are creating value for their shareholders.BE5–21
(c) Based on 2008 results, the consumer division generated the highest percentage of sales outside the U.S. at 56.8% (with medical devices next at 54.4%).EXERCISESE5–1Profitability Ratios:Return on Equity = Net Income ÷ Average Stockholders’ Equity2008: $6,134 ÷ 36,500= 2007: $8,052 ÷ 32,916.5= Return on Sales = (Net Income + [Interest Expense (1 – Tax Rate)]) ÷ Net Sales2008: ($6,134 + [346 x (1 - .20)]) ÷ $29,131 = 2007: ($8,052 + [319 x (1 - .20)])÷ $33,099 = Solvency Ratios:Current Ratio = Current Assets ÷ Current Liabilities2008: $ 44,177 ÷$13,655 =2007: $ 35,699 ÷ $13,858 =Leverage Ratios:Capital Structure Leverage Ratio = Average Total Assets ÷ Average Total Stockholders’ Equity2008: $63,431 ÷ $36,500 = 2007: $56,037 ÷ $32,916.5 = Overall, by examining the above computed ratios, it appears that Cisco would be a good investment. Profitability declined but still remained strong, while solvency improved. Leverage is up only slightly.
.168
.245
.220
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2.58
1.74
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E5–2Profitability Ratios:Return on Equity = Net Income ÷ Average Stockholders’ Equity2008:$5,292÷40,925=.1292007:$6,976÷39,757=.176Return on Sales = (Net Income + [Interest Expense (1 – Tax Rate)]) ÷ Net Sales 2008:($5,292 + [8 x (1 - .31)]) ÷ $37,586 = .1412007:($6,976 + [15 x (1 - .31)]) ÷ $38,334 = .182Solvency Ratios:Current Ratio = Current Assets ÷ Current Liabilities2008:$19,871÷$7,818=2.542007:$23,885÷$8,571=2.79Leverage Ratios:Capital Structure Leverage Ratio = Average Total Assets ÷ Average Total Stockholders’ Equity2008:$53,183÷$40,925=1.302007:$52,009.5 ÷$39,757=1.31Profitability numbers are down significantly, solvency is down slightly and leverage is steady. The trends are due to the economic environment of 2008; the company is still quite strong and would

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