Solutions to Homework Problems

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Week-­‐2: Solutions to HW Problems CA - I
CA
3-7
CA = $3,000,000;
= 1.5;
= 1.0;
CL
CL
CL = ?; I = ?
CA
= 1.5
CL
$3,000,000
= 1.5
CL
1.5 CL = $3,000,000
CL = $2,000,000.
CA - I nv
= 1.0
CL
$3,000,000 - I nv
= 1.0
$2,000,000
$3,000,000 - I nv = $2,000,000
I nv = $1,000,000.
3-8
We are given ROA = 4%, ROE = 7%, and TAT = Sales/Total assets = 1.2×.
From Du Pont equation: ROA = Profit margin × Total assets turnover
4% = Profit margin (1.2)
Profit margin = 4%/1.2 = 3.33%.
We can also calculate the company’s liabilities-to-assets (L/TA) ratio in a similar
manner, given the facts of the problem. We are given ROA = NI/TA and ROE=
NI/E. We begin by finding the percentage of assets financed by equity, E/TA:
E
⎛ NI ⎞ ⎛ E ⎞
⎛ 1 ⎞
= ⎜
⎟ ⎜ ⎟ = ROA ⎜
⎟ = ROA/ROE
TA ⎝ TA ⎠ ⎝ NI ⎠
⎝ ROE ⎠
E
= ROA/ROE = 4%/7% = 57.14%.
TA
By definition, L + E = Total liabilities & Equity = TA. Therefore, the percentage
of the firm financed by liabilities is equal to 1 minus the percentage financed by equity:
L
E
=1−
= 1 −57.14% = 42.86%.
TA
TA
To find the debt-to-total asset (i.e., the debt ratio), begin with the total liabilitiesto-assets ratio of 42.86%. We are given that half of the liabilities are debt, so the
debt ratio is:
Debt ratio = Debt-to-total assets = (0.5)(L/TA) = (0.5)(42.86%) = 21.43%.
3-10
TIE = EBIT/INT, so find EBIT and INT.
Interest = $600,000 × 0.08 = $48,000.
Net income = $3,000,000 × 0.03 = $90,000.
Pre-tax income = $90,000/(1 - T) = $90,000/0.6 = $150,000.
EBIT = $150,000 + $48,000 = $198,000.
TIE = $198,000/$48,000 = 4.125×.
The loan will not be renewed and they will go bankrupt!
3-14
Here are the firm’s base case ratios and other data as compared to the industry:
Quick
Current
Inventory turnover
Days sales outstanding
Fixed assets turnover
Total assets turnover
Return on assets
Return on equity
Profit margin on sales
Debt ratio
Liabilities-to-assets
EPS
Stock Price
P/E ratio
P/CF ratio
M/B ratio
$511,000/$602,000
$1,405,000/$602,000
$3,739,000/$894,000
$439,000/$11,753
$4,290,000/$431,000
$4,290,000/$1,836,000
$108,408/$1,836,000
$108,408/$829,710
$108,408/$4,290,000
$504,290/$1,836,000
$1,006,290/$1,836,000
$4.71
$23.57
$23.57/$4.71
$23.57/$11.63
$23.57/$36.07
Firm
= 0.8
= 2.3
= 4.2
= 37 days
= 10.0
= 2.3
= 5.9%
= 13.1%
= 2.5%
= 27.5%
= 54.8%
= 5.0
= 2.0
= 0.65
Industry Comment
1.0
Weak
2.7
Weak
7.0
Poor
32 days
Poor
13.0
Poor
2.6
Poor
9.1%
Bad
18.2%
Bad
3.5%
Bad
21.0%
High
50.0%
High
n.a.
-n.a.
-6.0
Poor
3.5
Poor
n.a.
--
The firm appears to be badly managed--all of its ratios are worse than the industry
averages, and the result is low earnings, a low P/E, P/CF ratio, a low stock price,
and a low M/B ratio. The company needs to do something to improve.
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