Chapter 4 Sample Problems

Chapter 4 Sample Problems 1. TCBW last year had an average collection period (days sales outstanding) of 35 days based on accounts receivable of $460,000. All of the firm's sales are made on credit. The firm expects sales this year to be the same as last year. However, the company has begun a new credit policy that should lower the average collection period to 28 days. If the new average collection period is attained, what will the firm's accounts receivable balance equal? a. $427,800 b. $460,000 c. $338,928 d. $368,000 e. $505,632 2. The RRR Company has a target current ratio of 3.2. Presently, the current ratio is 4.4 based on current assets of $6,556,000. If RRR expands its inventory using short-term liabilities (maturities less than one year), how much additional funding can it obtain before its target current ratio is reached? a. $855,802 b. $558,750 c. $666,182 d. $812,727 e. $913,749 3. AAA's inventory turnover ratio is 22.30 based on sales of $25,200,000. The firm's current ratio equals 10.21 with current liabilities equal to $290,000. If the firm's cash and marketable securities equal $732,342, what is the firm's days sales outstanding? a. 26.52 b. 32.28 c. 42.89 d. 15.91 e. 14.53 4. U KNO, Inc. uses only debt and common equity funds to finance its assets. This past year the firm's return on total assets was 19%. The firm financed 39% percent of its assets using equity. What was the firm's return on common equity? a. 38.95% b. 31.15% c. 48.72% d. 53.46% e. 27.95% 5. Last year YYY Company had a 5.00% net profit margin based on $21,000,000 in sales and $14,000,000 of total assets. During the coming year, the president has set a goal of attaining a 8% return on total assets. If YYY finances 56% of its assets by borrowing, what will its return on common equity be next year if the return on assets goal is achieved? a. 19.95% b. 14.29% c. 16.02% d. 18.18% e. 12.82% 114

6. The RRR Company has a target current ratio of 3.6. Presently, the current ratio is 4.5 based on current assets of $8,505,000. If RRR expands its fixed assets using short-term liabilities (maturities less than one year), how much additional funding can it obtain before its target current ratio is reached? a. $654,231 b. $472,500 c. $549,372 d. $688,905 e. $735,552 7. AAA's inventory turnover ratio is 22.30 based on sales of $25,200,000. The firm's current ratio equals 10.21 with current liabilities equal to $290,000. What is the firm's quick ratio? a. 10.21 b. 6.31 c. 8.57 d. 3.58 e. 12.60 8. Use the information below to calculate the firm's return on common equity. (State your answer as a percentage with two decimal places.) Net profit margin = 11.88%; Debt ratio = 44.29%; Fixed asset turnover = 7.54; Total asset turnover = 3.50 ; Inventory turnover = 22.3. a. 38.88% b. 41.58% c. 56.46% d. 32.14% e. 74.64% 9. U KNO, Inc. uses only debt and common equity funds to finance its assets. This past year the firm's return on total assets was 19%. The firm financed 30% percent of its assets using debt. What was the firm's return on common equity? a. 24.36% b. 63.33% c. 47.26% d. 69.50% e. 27.14% 10. Last year YYY Company had a 7.00% net profit margin based on $24,000,000 in sales and $13,000,000 of total assets. During the coming year, the president has set a goal of attaining a 14% return on total assets. How much must firm sales equal, other things being the same, for the goal to be achieved? a. $28,529,800 b. $24,000,000 c. $29,777,020 d. $26,000,000 e. $21,535,200 11. Russell Securities has $267 million in total assets and its corporate tax rate is 40%. The company recently reported that its basic earning power (BEP) ratio was 50% and its return on assets (ROA) was 13%. What was the company's interest expense? (Answers are in millions.) a. $98.79 b. $75.65 c. $133.50 d. $160.20 e. $23.14 115

12. You are given the following information: Stockholders' equity = $205 million; price/earnings ratio = 43; shares outstanding = 11,080,000; and market/book ratio =6.75. Calculate the market price of a share of the company's stock.. a. $133.93 b. $18.50 c. $106.39 d. $124.89 e. $17.05 13. Strack Houseware Supplies Inc. has $866 million in total assets. The other side of its balance sheet consists of $95.26 million in current liabilities, $251.14 million in long-term debt, and $519.60 million in common equity. The company has 16,100,000 shares of common stock outstanding, and its stock price is $59 per share. What is Strack's market-to-book ratio? a. 9.63 b. 8.81 c. 1.67 d. 1.83 e. 1.37 14. Moss Motors has $108 million in assets, and its tax rate is 40%. The company's basic earning power (BEP) ratio is 42%, and its return on assets (ROA) is 11%. What is Moss' times-interest-earned (TIE) ratio? a. 0.77 b. 0.46 c. 1.77 d. 2.00 e. 0.36 15. The Wilson Corporation has the following relationships: Sales/Total assets = 3;Return on assets (ROA) = 15%; Return on equity (ROE) = 17%. What is Wilson's profit margin? a. 7.16% b. 5.67% c. 5.00% d. 8.89% e. 4.66% 16. Cleveland Corporation has 13,240,000 shares of common stock outstanding, its net income is $241 million, and its P/E is 15.1. What is the company's stock price? a. $13.37 b. $3,639.10 c. $15.96 d. $4,379.29 e. $274.86 17. A fire has destroyed a large percentage of the financial records of the Carter Company. You have the task of piecing together information in order to release a financial report. You have found the return on equity to be 25%. If sales were $61,000,000, the debt ratio was 40%, and total liabilities were $12,000,000, what would be the return on assets (ROA)? a. 8.33% b. 10.00% c. 16.56% d. 19.94% e. 15.00% 116

18. Peterson Packaging Corp. has $2,072 million in total assets. The company's basic earning power (BEP) ratio is 13%, and its times-interest-earned ratio is 4.32. Peterson's depreciation and amortization expense totals $73 million. It has $55 million in lease payments and $39 million must go towards principal payments on outstanding loans and long-term debt. What is Peterson's EBITDA coverage ratio? a. 1.94 b. 7.03 c. 4.11 d. 2.54 e. 3.45 19. The Wilson Corporation has the following relationships: Sales/Total assets = 5; Return on total assets (ROA) = 13%; Return on common equity (ROE) = 16%. What is Wilson's debt ratio? a. 93.25% b. 81.25% c. 6.75% d. 18.75% e. 103.51% Use the following information to answer questions 20, 21, 22, and 23. Balance Sheet Current assets Cash 960,000 Acc receivable Inventories 1,440,000 Fixed assets 4,800,000 TOTAL ASSETS 8,000,000 Current liabilities Acc payable Long-term debt 3,200,000 Common stock 640,000 Retained earnings 3,160,000 TOTAL LIAB and EQUITY 8,000,000 Income Statement Sales 24,000,000 Operating expense 18,240,000 EBIT 5,760,000 Interest expense 416,000 EBT 5,344,000 Taxes 2,138,000 Net income 3,206,000 20. What is the firm's days sales outstanding? a. 9.53 b. 36.50 c. 48.67 d. 12.17 e. 43.29 117

21. What is the firm's debt ratio? a. 87.50% b. 40.00% c. 47.50% d. 52.50% e. 92.00% 22. What is the firm's quick ratio? a. 0.42 b. 3.20 c. 2.40 d. 1.76 e. 0.76 23. What is the firm's return on common equity? a. 40.08% b. 500.94% c. 101.46% d. 84.37% e. 45.80% Answers: 1. d 2. d 3. d 4. c 5. d 6. b 7. b 8. e 9. e 10. d 11. b 12. d 13. d 14. c 15. c 16. e 17. e 18. d 19. d 20. d 21. d 22. d 23. d 118

1. DSO = REC/(Sales/365) Last year 35 = (460,000)/(sales/365) 35(sales/365) = 460,000 (35/365)(Sales) = 460,000 Sales = 460,000/(35/365) Sales = 4,797,143 New 28 = (REC)/[(4,797,143)/(365)] (28)[(4,797,143)/(365)] = REC 368,000 = REC 2. CR = CA/CL Presently 4.4 = (6,556,000)/CL 4.4CL = 6,556,000 CL = (6,556,000)/(4.4) CL = 1,490,000 Expand inventory (so current assets go up by X) Using short-term liabilities (current liabilities) so CL go up by same amount (X) Target 3.2 = (6,556,000+X)/(1,490,000+X) 3.2(1,490,000+X) = 6,556,000 + X 4,768,000 + 3.2X = 6,556,000 + X 2.2X = 1,788,000 X = (1,788,000)/(2.2) = 812,727 3. ITR = Sales/INV 22.3 = (25,200,000)/(INV) 22.3INV = 25,200,000 INV = (25, 200,000)/(22.3) = 1,130,045 CR=CA/CL 10.21 = CA/(290,000) (10.21)(290,000) = 2, 960,900 We are given that cash and marketable securities = 732,342 Current assets = cash and marketable securities + receivables + inventory 2,960,900 = 732,342 + REC + 1,130,045 REC = 1,098,513 DSO = REC/(Sales/365) DSO = (1,098,513)/(25,200,000/365) DSO = 15.91 119

4. ROE = ROA(1/(1-DR)) 39% of assets financed with equity, so 61% of assets financed with debt. The debt ratio tells us what % of assets are financed with debt so debt ratio = 61%. ROE = (19%)(1/(1-0.61)) = 48.72% 5. ROE = ROA(1/(1-DR)) 56% of assets are financed with debt (this is the debt ratio) ROE = (8%)(1/(1-0.56)) = 18.18% 6. CR = CA/CL Presently 4.5 = (8,505,000)/CL 4.5CL = 8,505,000 CL = (8,505,000)/(4.5) CL = 1,890,000 Expand fixed assets (so current assets do not change) Using short-term liabilities (current liabilities) so CL go up by X Target 3.6 = (8,505,000)/(1,890,000+X) 3.6(1,890,000+X) = 8,505,000 6,804,000 + 3.6X = 8,505,000 3.6X = 1,701,000 X = (1,701,000)/(3.6) = 472,500 7. ITR = Sales/INV 22.30 = (25,200,000)/(INV) 22.30INV = 25,200,000 INV = 1,130,045 CR = CR/CL 10.21 = CA/(290,000) CA = 2,960,900 QR = (CA INV)/(CL) QR = (2,960,900 1,130,045)/(290,000) QR = 6.31 120

8. ROE = (NPM)(TATR)(1/(1-DR)) ROE = (11.88%)(3.50)(1/(1-0.4429)) = ROE = 74.64% 9. ROE = ROA(1/(1-DR)) Debt ratio = 30% since that % of assets are financed with debt ROE = (19%)(1/(1-0.30)) = 27.14% 10. ROA = NI/TA 0.14 = (NI)/(13,000,000) (0.14)(13,000,000) = NI NI = 1,820,000 NPM = NI/Sales 0.07 = (1,820,000)/Sales 0.07Sales = 1,820,000 Sales = (1,820,000)/(0.07) = 26,000,000 11. ROA = NI/TA 0.13 = (NI)/(267,000,000) NI = (0.13)(267,000,000) = 34,710,000 BEP = EBIT/TA 0.50 = (EBIT)/(267,000,000) EBIT = (0.50)(267,000,000) = 133,500,000 NI = (EBIT INT)(1 T) 34,710,000 = (133,500,000 INT)(1 0.40) (34,710,000)/(1-0.40) = 133,500,000 INT 57,850,000 = 133,500,000 INT 75,650,000 = INT 12. mkt-to-book = (market value of equity)/(book value of equity) Market value of equity = (shares outstanding)(price per share) Book value of equity = total value of equity on balance sheet = stockholder s equity Mkt-to-book = [(shares)(price)]/(book value of equity) 6.75 = [(11,080,000)(price)]/(205,000,000) (6.75)(205,000,000) = (11,080,000)(price) 1,383,750,000 = (11,080,000)(price) Price = (1,383,750,000)/(11,080,000) = 124.89 13. mkt-to-book = [(shares)(price)]/(book value of equity) Mkt-to-book = [(16,100,000)(59)]/(519,600,000) = 1.83 121

14. BEP = EBIT/TA 0.42 = (EBIT)/(108,000,000) EBIT = (0.42)(108,000,000) = 45,360,000 ROA = NI/TA 0.11 = (NI)/(108,000,000) NI = (0.11)(108,000,000) = 11,880,000 NI = (EBIT INT)(1 T) 11,880,000 = (45,360,000 INT)(1-0.40) (11,880,000)/(1-0.40) = 45,360,000 INT 19,800,000 = 45,360,000 INT INT = 25,560,000 TIE = EBIT/INT TIE = (45,360,000)/(25,560,000) = 1.77 15. ROA = (NPM)(TATR) 0.15 = (NPM)(3) NPM = (0.15)/(3) = 0.05 = 5% 16. PE ratio = (price per share)/(earnings per share) Earnings per share = EPS = (net income)/(shares outstanding) EPS = (241,000,000)/(13,240,000) = 18.2024 PE ratio = (price)/(eps) 15.1 = (price)/(18.2024) Price = (15.1)(18.2024) = 274.86 17. ROE = ROA(1/(1-DR)) 0.25 = ROA(1/(1 0.40)) ROA = (0.25)(1 0.40) = 0.15 = 15% 18. BEP = EBIT/TA 0.13 = (EBIT)/(2,072,000,000) EBIT = (0.13)(2,072,000,000) = 269,360,000 TIE = EBIT/INT 4.32 = (269,360,000)/INT 4.32INT = 269,360,000 INT = (269,360,000)/(4.32) = 62,350,000 EBITDA = EBIT + DA = 269,360,000 + 73,000,000 = 342,360,000 EBITDA coverage ratio = (EBITDA + lease pmts)/(int + prin pmts + lease pmts) EBITDA cov = (342,360,000 + 55,000,000)/(62,350,000 + 39,000,000 + 55,000,000) = 2.54 122

19. ROE = ROA(1/(1-DR)) 0.16 = (0.13)(1/(1-DR)) (0.16)/(0.13) = (1/(1-DR)) 1.2308 = (1/(1-DR)) (1.2308)(1-DR) = 1 1.2308 1.2308DR = 1-1.2308DR = -0.2308 DR = (-0.2308)/(-1.2308) = 0.1875 = 18.75% 20. DSO = REC/(Sales/365) In this problem: TA = Cash + REC + INV + FA 8,000,000 = 960,000 + REC + 1,440,000 + 4,800,000 REC = 800,000 DSO = (800,000)/[(24,000,000)/(365)] = 12.17 21. DR = (total debt)/(total assets) = (total liabilities)/(total assets) In this problem: TL&Eq = AccPay + LTD + Common stock + RE Total liabilities = AccPay + LTD TL&Eq = total liabilities + Common stock + RE 8,000,000 = total liabilities + 640,000 + 3,160,000 Total liabilities = 4,200,000 DR = (4,200,000)/(8,000,000) = 0.5250 = 52.50% 22. QR = (CA INV)/CL Total assets = current assets + fixed assets 8,000,000 = current assets + 4,800,000 Current assets = 3,200,000 TL&Eq = CL +LTD + total equity 8,000,000 = CL + 3,200,000 + 640,000 + 3,160,000 CL = 1,000,000 QR = (3,200,000 1,440,000)/(1,000,000) = 1.76 23. ROE = NI/CE CE = total common equity = sum of all equity accounts In this problem: CE = common stock + RE = 640,000 + 3,160,000 = 3,800,000 ROE = (3,206,000)/(3,800,000) = 0.8437 = 84.37% 123