Handout -Analysis of Financial Statements-Chapter Three

Q-1: Data for Dawlance is given above and its industry averages are current ratio=2, DSO=35
days, ITO=6.7, FATO=12.1, ATO=3, NPM=1.2%, ROA=3.6%, ROE=9% and DA=60%.
A. Calculate the indicated ratios for Dawlance.
2010 2009
Current ratio 3.225806 3.681818
Average sales 8.219178 7.808219
DSO 45.625 40.34211
ITO 4.878049 6.86747
FATO 33.275862
ATO 1.51.696429
NPM 0.037833 0.041333
ROA 5.68% 7.01%
ROE 12.67% 14.02%
DA 53.20% 47.62%

B. Construct the extended Du Pont equation for both Dawlance and the industry.
ROE= PM*TATO*EM
For Dawlance =
2010 2009
ROE 12.67% 14.02%

C. Outline Dawlance’s strengths and weaknesses as revealed by your analysis.

 Although Dawlance is taking more time to collect the cash than the industry average
but still their current ratio that depicts their cash position is higher than the industry
average. So late collection of funds is not really problematic.
 Dawlance inventory turnover is very low than the industry. This shows that they
are making less sales to inventory intake. They need to increase sales
 Despite of lower sales, profit margins of Dawlance are significantly higher than the
industry average. This could be because of high prices at Dawlance.
 Assets turn over are significantly lower than the industry average because of lesser
sales. However return on asset is significantly higher than the industry average this
could be because of higher net income ( higher prices lower cost of sales) and lower
other expenses
 The dawlance is slightly more inclined towards Equity than debt compared to the
industry. And they are doing it very good by earning almost 4 to 5% more returns
on equity compared to industry.
 Asset management is poor at dawlance but profitability management is good
D. Suppose Dawlance had doubled its sales as well as its inventories, accounts receivable, and
common equity during 2010. How would that information affect the validity of your ratio
analysis? (Hint: Think about averages and the effects of rapid growth on ratios if averages
are not used. No calculations are needed.)
Answer:
The positive effect will be set off. At Dawlance, sales are very important concern. If there is
increase in sales, it will positively affect ratio analyses and company’s position will be better.
 But increasing other factors along with sales will set of the positive impact. For example,
increasing sales will increase the inventory turn over, but also increasing inventory with same
proportion will set of that impact..

Q-2: Dell Corporation has an equity multiplier of 2.5. The company’s assets are financed with
some combination of long-term debt and common equity. What is the company’s debt ratio?
Equity multiplier = total assets/common equity
Debt ratio = total liabilities / total assets
1 = 1/EM + debt ratio
1= 1/ 2.5 + debt ratio
1= 0.4 +debt ratio
Debt ratio = 1- 0.4
Debt ratio = 0.6

Q-3: FFC’s stock price is Rs. 75 per share. FFC has Rs. 10 billion in total assets. Its balance sheet
shows Rs. 1 billion in current liabilities, Rs. 3 billion in long-term debt, and Rs. 6 billion in
common equity. It has 800 million shares of common stock outstanding. What is FFC’s
market/book ratio?
MARKET/ BOOK RATIO = market price per share/ Book value per share
Book value per share = common equity/ Shares outstanding
Book value per share = 6000000000/800000000 = 0.75
M/B Ratio= 75/0.75 = 100
Q-4: A company has an EPS of Rs. 1.50, a cash flow per share of Rs. 3.00, and a price/cash flow
ratio of 8.0. What is its P/E ratio?
Answer: P/E ratio = Price per share/ Earning per share
Price per share = cash flow per share*price/cash flow ratio
Price per share = 3*8 = 24
P/E ratio = 24/1.5
P/E ratio = 16
Q-5: Getz Pharmaceuticals has a profit margin of 3% and an equity multiplier of 2.0. Its sales are
Rs. 100 million and it has total assets of Rs. 50 million. What is its ROE?
ROE = PM*TATO*EM
TATO = 100/50 = 2
ROE = 0.03*2*2 = 0.12 = 12%

Q-6: Khan& Son has an ROA of 10%, a 2% profit margin, and a return on equity equal to 15%.
What is the company’s total assets turnover? What is the firm’s equity multiplier?
ROE = PM*TOTA*EM
ROE= ROA* Financial leverage
Equity multiplier = 15%/10%
Equity multiplier = 1.5
ROE = PM*TATO*EM
15%= 2%*TOTA*1.5
15% = 0.03 *TOTA
TATO= 0.15/0.03
TATO = 5
Q-7: Fecto Industries has current assets equal to Rs. 3 million. The company’s current ratio is 1.5,
and its quick ratio is 1.0. What is the firm’s level of current liabilities? What is the firm’s level of
inventories?
Current ratio = current asset/current liabilities
Current liabilities = current asset/current ratio
Current liabilities = 3000000/1.5
Current liabilities = 2000000
Quick ratio = current assets – inventories / current liabilities
Quick ratio*current liabilities = current assets – inventories
1*2000000 = current assets – inventories
2000000= 3000000 – inventories
Inventories = 3000000-2000000
Inventories = 1000000
Q-8: Assume you are given the following relationships for the Nestle Corporation: Sales/total
assets 1.5, Return on assets (ROA) 3%, Return on equity (ROE) 5%.
Calculate Nestle’s profit margin and debt ratio.
ROE = ROA*EM
5%= 3% *EM
EM = 5%/3% = 1.667
ROE = PM*TATO* EM
5% = PM* 1.5*1.667
PM = 0.02 = 2%
Debt ratio = total liabilities /total assets
EM= Total assets / total equity
1/EM = Total equity/ total assets
1= Total liabilities/ total assets + total equity / total assets
1 = debt ratio + 1/EM
1 = debt ratio + 0.6
Debt ratio = 1-0.6
Debt ratio = 0.4
Q-9: The Nelson Company has Rs. 1,312,500 in current assets and Rs. 525,000 in current
liabilities. Its initial inventory level is Rs. 375,000, and it will raise funds as additional notes
payable and use them to increase inventory. How much can Nelson’s short-term debt (notes
payable) increase without pushing its current ratio below 2.0? What will be the firm’s quick ratio
after Nelson has raised the maximum amount of short-term funds?
Answer: =2.5 – 2.0/ 2.5
= 0.20 0r 20% increase in inventory and notes payable
1312500*0.20 = 262500
Increase in inventory and increase in notes payable = 262500
Current ratio = 1575000/787500
Current ratio = 2
Quick ratio = 1575000 – (375000+262500) / 787500
Quick ratio = 1.19
Q-10: The Pepsi Corporation has Rs. 500,000 of debt outstanding, and it pays an interest rate of
10% annually: Pepsi’s annual sales are Rs. 2 million, its average tax rate is 30%, and its net profit
margin on sales is 5%. If the company does not maintain a TIE ratio of at least 5 to 1, then its bank
will refuse to renew the loan and bankruptcy will result. What is Pepsi’s TIE ratio?

TIE = EBIT/interest expense

Interest expense = 500000*0.10
Interest expense = 50000

Net profit margin = net income/ sales

Net income = sales * net profit margin
Net income = 2000000*5%
Net income = 100000
EBT = net income / 1- tax rate
EBT = 100000/ 0.7
EBT = 142857
EBT = EBIT – INTEREST EXPENSE
EBIT = EBT + INTEREST EXPENSE
EBIT = 142857 +50000
EBIT = 192857
TIE = 192857/ 50000
TIE= 3.857
So bankruptcy will result
Q-11: The Honda Company had a quick ratio of 1.4, a current ratio of 3.0, and an inventory
turnover of 6 times, total current assets of Rs. 810,000, and cash and marketable securities of Rs.
120,000. What were Honda’s annual sales and its DSO? Assume a 365-day year

Current liabilities = current assets/ Current ratio

Current liabilities = 810000/3
Current liabilities = 270000
Cash and Accounts receivable= current liabilities * Quick ratio
Cash and AR = 270000*1.4 = 378000
AR= 378000- 120000
AR= 258000
Inventory + AR = 810000- 120000 = 690000
Inventory = 690000-258000
Inventory = 432000
Sales = inventory turnover * inventory
Sales = 6*432000
Sales = 2592000
DSO = accounts receivable / (2592000/365)
DSO = 258000/ 7101.37
DSO = 36.33 = 37 days

Q-12: Engro has a DSO of 20 days. The company’s average daily sales are Rs. 20,000. What is
the level of its accounts receivable? Assume there are 365 days in a year.
DSO = Accounts receivable/ average sales per day
A/R = 20*20000
A/R = 400000

Q-13:
Selected ratios for Benton Industries are
Current ratio 2.5
Average collection period (360 days in a year) 54 days
Total debts to total assets 40%
Total assets turnover 2
Inventory turnover 5
Gross profit rate 20%
Based upon the information above, complete the following balance sheet for Belmont:

Cash 100000 Current liabilities 288000

Account receivable 300000 Long term debt 112000
Inventory 320000 Total debt 400000
Plant and equipment 280000 Common stock 600000
Total assets 1000000 Total equities 1000000

Q-14:
Total debt to total shareholder’s equity 0.5:1
Total assets turnover 2
Gross profit 30%
Average collection period (360 days) 40 days
Inventory turnover 3 times
Quick ratio 0.75:1

Cash ------------- Current liabilities -----------

Account receivable 16667 Long term debt -----------
Inventory 35000 Total debt 25000
Fixed assets ------------- Shareholder’s equity 50,000
Total assets 75000 Total equities 75000

Q-15:
Selected ratios for Paper Industries are:
Current ratio 3.3
Quick ratio 1.3
Average collection period 20 days
Total debt to equity 1.3
Total assets turnover 3
Inventory turnover 9
Gross profit rate 20%
Based upon the information above, complete the following balance sheet for Paper industries:

Cash ------------- Current liabilities -----------

Account receivable 264658 Long term debt -----------
Inventory 429334 Total debt 910000
Plant and equipment ------------- Common stock 700000
Total assets 1610000 Total equities 1610000

Q-16:
Selected ratios for Paper Industries are

Gross profit (20 % of sale) Rs60, 000

Shareholder’s equity 50,000
Credit sale to total sale 80 %
Total asset turnover 3 times
Inventory turnover 8 times
Average collection period (360 days in year) 18 days
Current ratio 1.6
Long term debt to equity 40%
Based upon the information above, complete the following balance sheet for Paper industries:

Cash ------------- Current liabilities

Account receivable Long term debt
Inventory Total debt
Fixed assets ------------- Shareholder’s equity
Total assets Total equities

Q-17:
Cash Rs200, 000 Accounts payable 300,000
Marketable securities 100,000 Notes payable 100,000
Account receivable -------------- Long term debt ----------
Inventory -------------- Common Stock ----------
Retained earnings 400,000
Net plant and equipment -------------- Total liabilities and stockholder’s
equity
Total assets 2,000,000 ----------
Additional information

Sales Rs2, 400,000 Current ratio 2

Cost of goods sold ---------------- Quick ratio 1.5
Gross profit ---------------- Time interest earned 6
Fixed cost (depreciation) ---------------- Debt to equity 1
Operating income ---------------- Gross profit margin 0.3
Interest ---------------- Book return on equity 0.02
Taxes 80,000
Net income ----------------

Required: Calculate the missing figures and complete the financial statements.