Financial Management Assignment No.2
Dead-line: 2022/10/11
1) Answer the following questions based on the information in the table. The tax
rate is 40% and all dollars are in millions. Assume that the companies have no
other liabilities other than the debt shown below.
A Corp.
P Corp.
Earnings before interest and taxes (EBIT)
$450
$470
Debt at 8% interest
$290
$1490
Equity
$910
$370
a. Calculate each company’s ROE, ROA, and ROIC.
b. Why is P ‘s ROE so much higher than A’s? Does this mean P is a better company?
Why or why not?
c. Why is A’s ROA higher than P’s? What does this suggest about the 2 companies?
d. How do the 2 companies’ ROICs compare? What does this suggest about the two
companies?
Answers: a)
($ in millions)
A Corp.
P Corp.
EBIT
$450
$470
Debt at 8% interest
$290
$1,490
Equity
$910
$370
Assets = Debt + Equity
$1,200
$1,860
Interest = debt @8%
$23.2
$119.2
EBT = EBIT - Int.
($450-23.2=)$426.8
($470-119.2=)$350.8
EAT = EBT*(1-40%)
426.8(0.6)=$256.08
$210.48
ROE = EAT/Equity
28.14%
56.89%
ROA = EAT/Total assets
21.34%
11.32%
ROIC= EBIT(1-tax)/ (Equity +LTF)
450(60%)/(1200)=22.5%
470(60%)/1860=15.16%
b. P’s higher ROE is caused by higher financial leverage. It does not mean that P is
the better company.
c. This is also due to P’s higher leverage. ROA penalizes levered companies by
comparing the net income available to equity to the capital provided by owners
and creditors. It does not mean that P is a worse company than A.
d. ROIC abstracts from differences in leverage to provide a direct comparison of the
earning power of the 2 companies assets. On this aspect, A is the superior
performer, although both percentages are quite attractive. Before drawing any
firm conclusion, however, it is important to ask how the business risks faced by
the companies compare and whether the observed ratios reflect long-run
capabilities or transitory events.
2) You are trying to prepare financial statement for B company but seems to be
missing its balance sheet. You have B’s income statement, which shows sales last
year were $420 million with gross profit margin of 40%. You also know that credit
sales equaled 3/4 of B’s total revenues last year. In addition, B had a collection
period of 55 days, a payable period of 40 days, and an inventory turnover of 8
times based on Cost of goods sold. Calculate B’s year-ending balance for account
receivable (AR), inventory and accounts payable (AP).
Answers:
($ in millions)
B Corp.
Sales
$420
Credit sales = 3/4 (total revenues)
Credit sales = 420(3/4) = $315
Collection period = AR/sales per day
55 days
Payable period = AP/purchase per day
40 days
Inventory turnover = CGS/inventory
8xCGS
Gross profit = 1 – CGS/Sales
AR = 55(315/365) = $47.47
40%
CGS/Sales = 60%
Purchase per day
CGS/365 = $252/365
Cost of goods sold (CGS)
$420(0.6)
$252
Accounts receivable (AR)
$47.47
Accounts payable (AP)
$27.61
40*CGS/365 = 40(252)/365
Inventory
CGS/8
$252/8 = $31.5
3) Given the following information, complete the balance sheet shown below.
Collection period
71 days
Current ratio
2.6
Days’ sales in cash
34 days
Liabilities to assets
75%
Inventory turnover
5 times
Payable period
36 days
All sales are on credit. All calculations assume a 365 days year. Payables period is
based on cost of goods sold.
Assets
Liabilities & Equity
Current assets
Current Liabilities
Cash
$1,100,000
Accounts payable
$
Account receivable
$
Short-term debt
$
Inventory
$1,900,000
Total current Liab.
$
Total current assets
$
Long-term debt
$
Net fixed assets
$
Shareholder equity
$
Total assets
$8,000,000
Total Liab. & Equity
$
Answers:
Collection period
71 dyas
AR/sales per day
Days’ sales in cash
34 days
Cash/sales per day
Inventory turnover
5 times
CGS/Inventory
Current ratio
2.6
CA/CL
Liabilities to assets
75%
TL/TA
36 days
AP/credit purchase per day
Payable period
Answers:
As all sales are on credit, it implies that cash sales = total sales.
Days’ sales in cash =34 days; sales per day = $1.1/34 = $32,353*
Total (yearly) sales = (1,100,000/34) x 365 = $11,808,824 ＃
AR = 71x(sales per day) = 71x $32,353 = $2,297.059*＃
CGS = 5(inventory) = 5x($1,900,000) = $9,500,000
Payable period is based on cost of goods sold, hence credit purchase per day
=CGS/365 = $26,037
AP = 36x($26,037) = $936,986＃
Current liabilities = $5,297,059/2.6 =$2,037,330
Total liabilities = TA (75%) = $8,000,000(75%) = $6,000,000＃
Long-term debt = $6,000,000 - $2,037,330 = $3,962,670
Assets
Liab. & Equity
Current assets
Current Liabilities
Cash
$1,100,000
Accounts payable
$ 936,986
Account receivable
$2,297,059
Short-term debt
$1,100,344
Inventory
$1,900,000
Total current Liab.
$2,037,330
Total current assets
$5,297,059
Long-term debt
$3,962,670
Net fixed assets
$2,702,941
Shareholder equity
$2,000,000
Total assets
$8,000,000
Total Liab. & Equity
$8,000,000
Figures may have rounding errors*.