CHAPTER 5
USING FINANCIAL STATEMENT INFORMATION
BRIEF EXERCISE
BE5–1
Coke
Pepsi
(a)
ROE = Net Income/Average Stockholders Equity
27.3%
34.8%
ROA = (Net Income +[Interest Expense (1-Tax Rate)])/
Average Total Assets
14.7%
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’ Equity
1.97
2.39
Return on Sales = Net Income + [Interest Expense
(1- Tax Rate)]/Net Sales
19.3%
12.4%
Asset Turnover = Sales/Average Total Assets
.76
1.22
Pepsi 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
=
ROE
Coke:
.147
x
.944
x
1.97
=
.273
Pepsi:
.152
x
.955
x
2.39
=
.347 (rounding)
(c)
Return on Sales x Asset Turnover
=
ROA
Coke:
.193
x
.76
=
.147
Pepsi:
.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.
BE5–2
1

(a) With $24.6 billion in 2008 revenues, J & J’s pharmaceutical business is the largest.
From
2006 to 2008, the consumer division showed the largest percentage growth at 64.25%.
(b)
2006
2007
2008
55.8%
53.1%
50.7%
(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%).
EXERCISES
E5–1
Profitability Ratios:
Return on Equity
=
Net Income
÷
Average Stockholders’ Equity
2008:
$6,134
÷
36,500
=
.168
2007:
$8,052
÷
32,916.5
=
.245
Return on Sales
=
(Net Income + [Interest Expense (1 – Tax Rate)]) ÷ Net Sales
2008:
($6,134
+ [346 x (1 - .20)])
÷
$29,131
=
.220
2007:
($8,052
+ [319 x (1 - .20)])
÷
$33,099
=
.251
Solvency Ratios:
Current Ratio
=
Current Assets
÷
Current Liabilities
2008:
$
44,177
÷
$13,655
=
3.24
2007:
$
35,699
÷
$13,858
=
2.58
Leverage Ratios:
Capital Structure Leverage Ratio
=
Average Total Assets
÷
Average Total Stockholders’
Equity
2008:
$63,431
÷
$36,500
=
1.74
2007:
$56,037
÷
$32,916.5 =
1.70
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.
2

E5–2
Profitability Ratios:
Return on Equity
=
Net Income
÷
Average Stockholders’ Equity
2008:
$5,292
÷
40,925
=
.129
2007:
$6,976
÷
39,757
=
.176
Return on Sales
=
(Net Income + [Interest Expense (1 – Tax Rate)]) ÷ Net Sales
2008:
($5,292 + [8 x (1 - .31)])
÷
$37,586
=
.141
2007:
($6,976 + [15 x (1 - .31)])
÷
$38,334
=
.182
Solvency Ratios:
Current Ratio
=
Current Assets
÷
Current Liabilities
2008:
$19,871
÷
$7,818
=
2.54
2007:
$23,885
÷
$8,571
=
2.79
Leverage Ratios:
Capital Structure Leverage Ratio
=
Average Total Assets
÷
Average Total Stockholders’
Equity
2008:
$53,183
÷
$40,925
=
1.30
2007:
$52,009.5
÷
$39,757
=
1.31
Profitability 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