Exam 4: Statement Analysis

Which of the following statements is CORRECT?

What is the firm's EPS?

Faldo Corp sells on terms that allow customers 45 days to pay for merchandise. Its sales last year were $325,000, and its year-end receivables were $60,000. If its DSO is less than the 45-day credit period, then customers are paying on time. Otherwise, they are paying late. By how much are customers paying early or late? Base your answer on this equation: DSO - Credit Period = Days early or late, and use a 365-day year when calculating the DSO. A positive answer indicates late payments, while a negative answer indicates early payments.

Suppose all firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. However, firms face different operating conditions because, for example, the grocery store industry is different from the airline industry. Under these conditions, firms with high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios.

One problem with ratio analysis is that relationships can be manipulated. For example, we know that if our current ratio is less than 1.0, then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger.

If a firm finances with only debt and common equity, and if its equity multiplier is 3.0, then its debt ratio must be 0.667.

In general, it's better to have a low inventory turnover ratio than a high one, as a low ratio indicates that the firm has an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of stock.

High current and quick ratios always indicate that the firm is managing its liquidity position well.

What is the firm's ROE?

The more conservative a firm's management is, the higher its debt ratio is likely to be.

Other things held constant, the more debt a firm uses, the lower its return on total assets will be.

The operating margin measures operating income per dollar of assets.

If a firm sold some inventory on credit as opposed to cash, there is no reason to think that either its current or quick ratio would change.

Last year Kruse Corp had $305,000 of assets, $403,000 of sales, $28,250 of net income, and a debt-to-total-assets ratio of 39%. The new CFO believes the firm has excessive fixed assets and inventory that could be sold, enabling it to reduce its total assets to $252,500. Sales, costs, and net income would not be affected, and the firm would maintain the same debt ratio (but with less total debt). By how much would the reduction in assets improve the ROE?

A new firm is developing its business plan. It will require $615,000 of assets, and it projects $450,000 of sales and $355,000 of operating costs for the first year. Management is reasonably sure of these numbers because of contracts with its customers and suppliers. It can borrow at a rate of 7.5%, but the bank requires it to have a TIE of at least 4.0, and if the TIE falls below this level the bank will call in the loan and the firm will go bankrupt. What is the maximum debt ratio (measured as debt/assets) the firm can use? (Hint: Find the maximum dollars of interest, then the debt that produces that interest, and then the related debt ratio.)

If a firm's fixed assets turnover ratio is significantly higher than its industry average, this could indicate that it uses its fixed assets very efficiently or is operating at over capacity and should probably add fixed assets.

The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed.

The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes.

Which of the following statements is CORRECT?

What is the firm's days sales outstanding? Assume a 365-day year for this calculation.