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Solutions to Questions and Problems
1. We need to find net income first. So:
Profit margin = Net income/Sales Net income = Profit margin(Sales) Net income = .05($16,700,000) Net income = $835,000
ROA = Net income/TA
ROA = $835,000/$12,900,000 ROA = .0647, or 6.47%
To find ROE, we need to find total equity. Since TL & OE equals TA: TA = TD + TE TE = TA – TD TE = $12,900,000 – 5,700,000 TE = $7,200,000
ROE = Net income/TE
ROE = $835,000/$7,200,000 ROE = .1160, or 11.60%
2. Net income = Addition to RE + Dividends = $415,000 + 220,000 = $635,000 Earnings per share = NI/Shares = $635,000/170,000 = $3.74 per share Dividends per share= Dividends/Shares = $220,000/170,000 = $1.29 per share Book value per share= TE/Shares = $5,600,000/170,000 = $32.94 per share Market-to-book ratio = Share price/BVPS = $65/$32.94 = 1.97 times PE ratio = Share price/EPS = $65/$3.74 = 17.40 times Sales per share= Sales/Shares= $7,450,000/170,000 = $43.82 P/S ratio = Share price/Sales per share = $65/$43.82 = 1.48 times
3.The average time to pay suppliers is the days’ sales in payables, so:
Payables turnover = COGS/Accounts payable
Payables turnover = $68,314/$15,486 CHAPTER 3 C-2
Payables turnover = 4.41 times
Days’ sales in payables = 365 days/Payables turnover
Days’ sales in payables = 365/4.41 Days’ sales in payables = 82.74 days
The company left its bills to suppliers outstanding for 82.74 days on average. A large value for this ratio could imply that either (1) the company is having liquidity problems, making it difficult to pay off its short-term obligations, or (2) that the company has successfully negotiated lenient credit terms from its suppliers.
4. This is a multistep problem involving several ratios. The ratios given are all part of the DuPont Identity. The only DuPont Identity ratio not given is the profit margin. If we know the profit margin, we can find the net income since sales are given. So, we begin with the DuPont Identity:
ROE = .11 = (PM)(TAT)(EM) = (PM)(S/TA)(1 + D/E)
Solving the DuPont Identity for profit margin, we get:
Rearranging ROA = Net income/Total assets, we find:
NI/TA = .05 NI/TA = .09
NI = .05(TA) NI = .09(TA)
Since ROE = Net income/Equity, we can substitute the above equations into the ROE formula, which yields:
ROE = .05(TA)/.35(TA) ROE = .09(TA)/.55 (TA)
ROE = .05/.35 ROE = .09/.55 ROE = .1429, or 14.29% ROE = .1636, or 16.36%
6. Short-term solvency ratios:
Current ratio = Current assets/Current liabilities Current ratio 2017 = $88,496/$75,594 = 1.17 times Current ratio 2018 = $108,235/$83,416 = 1.30 times
Quick ratio = (Current assets – Inventory)/Current liabilities
Quick ratio 2017 = ($88,496 – 36,310)/$75,594 = .69 times Quick ratio 2018 = ($108,235 – 42,632)/$83,416 = .79 times
Cash ratio = Cash/Current liabilities
Cash ratio 2017 = $34,385/$75,594 = .45 times Cash ratio 2018 = $37,837/$83,416 = .45 times
Asset utilization ratios:
Total asset turnover = Sales/Total assets Total asset turnover = $506,454/$627,868 = .81 times
Inventory turnover = Cost of goods sold/Inventory
CHAPTER 3 C-4
Inventory turnover = $359,328/$42,632 = 8.43 times
Receivables turnover = Sales/Accounts receivable
Receivables turnover = $506,454/$27,766 = 18.24 times
Long-term solvency ratios:
Total debt ratio = (Total assets – Total equity)/Total assets Total debt ratio 2017 = ($552,811 – 362,217)/$552,811 = .34 times Total debt ratio 2018 = ($627,868 – 399,452)/$627,868 = .36 times
Debt-equity ratio = Total debt/Total equity
Debt-equity ratio 2017 = ($75,594 + 115,000)/$362,217 = .53 times Debt-equity ratio 2018 = ($83,416 + 145,000)/$399,452 = .57 times
Equity multiplier = 1 + D/E
Equity multiplier 2017 = 1 + .53 = 1.53 times Equity multiplier 2018 = 1 + .57 = 1.57 times
Times interest earned = EBIT/Interest
Times interest earned = $102,663/$19,683 = 5.22 times
Cash coverage ratio = (EBIT + Depreciation)/Interest
Cash coverage ratio = ($102,663 + 44,463)/$19,683 = 7.47 times
Profitability ratios: Profit margin = Net income/Sales Profit margin = $62,235/$506,454 = .1229, or 12.29%
Return on assets = Net income/Total assets
Return on assets = $62,235/$627,868 = .0991, or 9.91%
Return on equity = Net income/Total equity
Return on equity = $62,235/$399,452 = .1558, or 15.58% CHAPTER 3 C-5
Case Solution RATIO ANALYSIS AT S&S AIR 1. The calculations for the ratios listed are:
Current ratio = $2,603,218/$3,507,909
Current ratio = .74 times
Quick ratio = ($2,603,218 – 1,235,161)/$3,507,909
Quick ratio = .39 times
Cash ratio = $524,963/$3,507,909
Cash ratio = .15 times
Total asset turnover = $46,298,115/$22,985,163
Total asset turnover = 2.01 times
Inventory turnover = $34,536,913/$1,235,161
Inventory turnover = 27.96 times
Receivables turnover = $46,298,115/$843,094
Receivables turnover = 54.91 times
Total debt ratio = ($22,985,163 – 13,177,254)/$22,985,163
Total debt ratio = .43 times
Debt-equity ratio = ($3,507,909 + 6,300,000)/$13,177,254
Debt-equity ratio = .74 times
Equity multiplier = $22,985,163/$13,177,254
Equity multiplier = 1.74 times
Times interest earned = $3,815,484/$725,098
Times interest earned = 5.26 times
Cash coverage = ($3,815,484 + 2,074,853)/$725,098
Cash coverage = 8.12 times
Profit margin = $2,317,789/$46,298,115
Profit margin = .0501, or 5.01%
Return on assets = $2,317,789/$22,985,163
Return on assets = .1008, or 10.08%
Return on equity = $2,317,789/$13,177,254
Return on equity = .1759, or 17.59% CHAPTER 3 C-6
2. Boeing is probably not a good aspirant company. Even though both companies manufacture airplanes, S&S Air manufactures small airplanes, while Boeing manufactures large, commercial aircraft. These are two different markets. Additionally, Boeing is heavily involved in the defense industry, as well as Boeing Capital, which finances airplanes.
Bombardier is a Canadian company that builds business jets, short-range airliners and fire-fighting amphibious aircraft and also provides defense-related services. It is the third largest commercial aircraft manufacturer in the world. Embraer is a Brazilian manufacturer that manufactures commercial, military, and corporate airplanes. Additionally, the Brazilian government is a part owner of the company. Bombardier and Embraer are probably not good aspirant companies because of the diverse range of products and manufacture of larger aircraft.
Cirrus is the world's second largest manufacturer of single-engine, piston-powered aircraft. Its SR22 is the world's best-selling plane in its class. The company is noted for its innovative small aircraft and is a good aspirant company.
Cessna is a well-known manufacturer of small airplanes. The company produces business jets, freight- and passenger-hauling utility Caravans, personal and small-business single engine pistons. It may be a good aspirant company, however, its products could be considered too broad and diversified since S&S Air produces only small personal airplanes.
3. S&S is below the median industry ratios for the current and cash ratios. This implies the company has less liquidity than the industry in general. However, both ratios are above the lower quartile, so there are companies in the industry with lower liquidity ratios than S&S Air. The company may have more predictable cash flows, or more access to short-term borrowing. If you created an inventory to current liabilities ratio, S&S Air would have a ratio that is lower than the industry median. The current ratio is below the industry median, while the quick ratio is above the industry median. This implies that S&S Air has less inventory to current liabilities than the industry median. S&S Air has less inventory than the industry median, but more accounts receivable than the industry since the cash ratio is lower than the industry median.
The turnover ratios are all higher than the industry median; in fact, all three turnover ratios are above the upper quartile. This may mean that S&S Air is more efficient than the industry. The deposit on orders may be the reason that the receivables turnover is much larger than the upper quartile.
The financial leverage ratios are generally below the industry median, but above the lower quartile. S&S Air generally has less debt than comparable companies, but still within the normal range.
The profit margin is below the industry median, however, not dramatically lower. The ROE is higher than the industry median, due in large part to the company’s high total asset turnover.
Overall, S&S Air’s performance seems good, although the liquidity ratios indicate that a closer look may be needed in this area. CHAPTER 3 C-7
Below is a list of possible reasons it may be good or bad that each ratio is higher or lower than the industry. Note that the list is not exhaustive, but merely one possible explanation for each ratio.
Ratio Good Bad
Current ratio Better at managing current May be having liquidity problems. accounts. Quick ratio Better at managing current May be having liquidity problems. accounts. Cash ratio Better at managing current May be having liquidity problems. accounts. Total asset turnover Better at utilizing assets. Assets may be older and depreciated, requiring extensive investment soon. Inventory turnover Better at inventory management, Could be experiencing inventory possibly due to better procedures. shortages. Receivables turnover Better at collecting receivables. May have credit terms that are too strict. Decreasing receivables turnover may increase sales. Total debt ratio Less debt than industry median Increasing the amount of debt can means the company is less likely increase shareholder returns. to experience credit problems. Especially notice that it will increase ROE. Debt-equity ratio Less debt than industry median Increasing the amount of debt can means the company is less likely increase shareholder returns. to experience credit problems. Especially notice that it will increase ROE. Equity multiplier Less debt than industry median Increasing the amount of debt can means the company is less likely increase shareholder returns. to experience credit problems. Especially notice that it will increase ROE. TIE Higher quality materials could be The company may have more increasing costs. difficulty meeting interest payments in a downturn. Cash coverage Less debt than industry median Increasing the amount of debt can means the company is less likely increase shareholder returns. to experience credit problems. Especially notice that it will increase ROE. Profit margin The PM is slightly below the Company may be having trouble industry median. It could be a controlling costs. result of higher quality materials or better manufacturing. ROA Company may have newer assets Company may have newer assets than the industry. than the industry. ROE Lower profit margin may be a Profit margin and EM are lower result of higher quality. than industry, which results in the lower ROE. CHAPTER 3 C-8
