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51. The following data pertains to a company’s common-size financial statements. Current assets 40% Total debt 40% Net income 16% Total assets $2,000 Sales $1,500 Total asset turnover ratio 0.75 The firm has no preferred stock in its capital structure The company’s after-tax return on common equity is closest to: A. 15%. B. 20%. C. 25%

Ans: B. ROE===0.2 If the debt ratio (TD/TA) is equal to 40% and the firm has no preferred stock, the percentage of equity is 1-0.4, or 60%.

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52. Which of the following statements about financial ratios is most accurate? A. A company with a high debt-to-equity ratio will have a return on assets that is greater than its return on equity. B. Any firm with a high net profit margin will have a high gross profit margin and vice versa. C. A company that has an inventory turnover of 6 times, a receivables turnover of 9 times, and a payables turnover of 12 times will have a cash conversion cycle of approximately 71 days.

Ans: C. The cash conversion cycle is: Cash conversion cycle = Days of inventory on hand (DOH) + Days Sales Outstanding (DSO) – payables payment period =+ – =+- =60.8+40.6-30.4 =71 days. ROA is lower than ROE when net income is positive and debt is present. Just the fact that a company has a high gross profit margin does not necessary mean it will have a high net profit margin. For example, the company could have very high operating expenses and end up with a low net profit margin.

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53. Nan Chen, CFA, calculates the following ratios for Bao Company: 2012 2011 2010 Debt-to-capital ratio 56.3% 56.4% 56.2% Fixed charge coverage ratio 3.3x 3.4x 3.5x Interest coverage ratio 4.0x 3.9x 3.8x These ratios most likely suggest that during the period shown, Bao’s: A. use of operating leases increased. B. interest obligations increased faster than earnings. C. capital structure became more reliant on equity financing.

Ans: A. Operating lease payments distinguish the fixed charge coverage ratio from the interest coverage ratio. The fixed charge coverage ratio is decreasing at the same time the interest coverage ratio is increasing, which means the company’s operating lease payments are increasing. (Note that the years are presented right-to-left.) B is incorrect. The increasing interest coverage ratio suggests earnings before interest and taxes are increasing more (or decreasing less) than the interest payments on the company’s debt. C is incorrect. The debt-to-capital ratio is essentially unchanged in the period shown, which implies that the company has not changed its capital structure significantly.

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54. Yang Liu, CFA, gathered the following data about a company: 2011 2012 EBIT margin(EBIT/revenue) 0.15 0.10 Asset turnover (revenue/assets) 1.5 1.8 Leverage multiplier 1.5 1.6 Tax burden(net income/ EBT) 0.7 0.7 Interest burden (EBT/EBIT) 0.85 0.85 The company’s return on equity: A. decreased because the company’s profit margin decreased. B. increased because the company’s asset turnover and leverage increased. C. remained constant because the company’s decreased profit margin was just offset by increases in asset turnover and leverage.

Ans: A. ROE 2011=0.7x0.85x0.15x1.5x1.5=0.2008 ROE 2012=0.7x0.85x0.10x1.8x1.6=0.1714x Profit margin fell, and the increase in the total asset turnover ratio and the leverage multiplier were not enough to offset the decline, so ROE decreased.

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55. Bao Company’s common-size financial statements show the following information: Earnings after taxes 15% Current liabilities 20% Equity   45% Sales $800 Cash 10% Total assets $2,000 Accounts receivable 15% Inventory 20% Bao’s long-term debt-to-equity ratio and current ratio are closest to: long-term debt-to-equity ratio current ratio A. 78% 2.25 B. 88% 2.50 C. 98% 2.75

Ans: A. If equity equals 45% of assets and current liabilities equal 20%, long-term debt must be 35%. long-term debt-to-equity ratio ===0.778=77.8% CA=0.1+0.15+0.20 Current ratio===2.25

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56. Zhan Wang, CFA, compiles the following information for a company: Net sales $100,000 COGS 50,000 Avg. payables 20,000 Avg. inventory 45,000 Avg. receivables 20,000 The cash conversion cycle (CCC) for the company is closest to: A. 143. B. 207. C. 256.

Ans: C. The cash conversion cycle (CCC) is calculated as: cash conversion cycle (CCC) = days of inventory on hand (DOH)+days of sales outstanding (DSO) – number of days of payables DOH = = = 328.5 DSO = = = 73 number of days of payables = = = 146 cash conversion cycle (CCC) = 328.5 + 73 – 146 = 255.5. Note that purchases should be used in the calculation of number of days of payables if given or if the necessary information is available (i.e., purchases = COGS – beginning inventory + ending inventory).