SELF-TEST QUESTIONS AND PROBLEMS
(Solutions Appear in Appendix A)
ST-1 Key terms Define each of the following terms:
a. Liquidity ratios: current ratio; quick ratio
b. Asset management ratios: inventory turnover ratio; days sales outstanding (DSO);
fixed assets turnover ratio; total assets turnover ratio
c. Financial leverage: debt ratio; times-interest-earned (TIE) ratio; EBITDA coverage
ratio
d. Profitability ratios: profit margin on sales; basic earning power (BEP) ratio; return
on total assets (ROA); return on common equity (ROE)
e. Market value ratios: price/earnings (P/E) ratio; price/cash flow ratio; market/
book (M/B) ratio
f. Trend analysis; comparative ratio analysis; benchmarking
g. Basic and extended Du Pont equations; book value per share
h. “Window dressing”; seasonal effects on ratios
ST-2 Debt ratio Last year, K. Billings worth & Co. had earnings per share of $4 and dividends per share of $2. Total retained earnings increased by $12 million during the year, while book value per share at year-end was $40. Billings worth has no preferred stock, and no new common stock was issued during the year. If its year-end total debt was $120 million, what was the company’s year-end debt/assets ratio?
ST-3 Ratio analysis The following data apply to A.L. Kaiser & Company (millions of dollars): Cash and equivalents $100.00
Fixed assets $283.50
Sales $1,000.00
Net income $50.00
Current liabilities $105.50
Current ratio 3.0
DSO a 40.55 days
ROE 12%
a This calculation is based on a 365-day year.
Kaiser has no preferred stock—only common equity, current liabilities, and long-term debt.
a. Find Kaiser’s (1) accounts receivable, (2) current assets, (3) total assets, (4) ROA,
(5) common equity, (6) quick ratio, and (7) long-term debt.
The primary purpose of this chapter was to discuss techniques investors
and managers use to analyze financial statements. The five main categories
of ratios were discussed using data for Allied Foods, and we explained how
trend analysis and benchmarking are used. It is important to realize ratio
analysis is useful, but it must be done intelligently and with good judgment
if it is to provide useful insights into firms’ operations.
Tying It All TogetherTying It All Together
Define each of the following terms: a. Liquidity ratios: current ratio; quick ratio
b. In part a, you should have found Kaiser’s accounts receivable (A/R) $111.1million. If Kaiser could reduce its DSO from 40.55 days to 30.4 days while holding other things constant, how much cash would it generate? If this cash were used to buy back common stock (at book value), thus reducing common equity, how would this affect (1) the ROE, (2) the ROA, and (3) the total debt/total assets ratio?
