1215

Wells Incorporated reported the following common size data for the year ended December 31, 20X7:

Income Statement	%
Sales	100.0
Cost of goods sold	58.2
Operating expenses	30.2
Interest expense	0.7
Income tax	5.7
Net income	5.2

Balance sheet	%			%
Cash	4.8		Accounts payable	15.0
Accounts receivable	14.9		Accrued liabilities	13.8
Inventory	49.4		Long-term debt	23.2
Net fixed assets	30.9		Common equity	48.0
Total assets	100.00		Total liabilities & equity	100.0

For 20X6, Wells reported sales of $183,100,000 and for 20X7, sales of $215,600,000. At the end of 20X6, Wells’ total assets were $75,900,000 and common equity was $37,800,000. At the end of 20X7, total assets were $95,300,000. Calculate Wells’ current ratio and return on equity ratio for 20X7.

Current ratio

Return on equity

A) 2.4 26.4%

B) 2.4 26.8%

C) 4.6 25.2%

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The current ratio is equal to 2.4 [(4.8% cash + 14.9% accounts receivable + 49.4% inventory) / (15.0% accounts payable + 13.8% accrued liabilities)]. This ratio can be calculated from the common size balance sheet because the percentages are all on the same base amount (total).

Return on equity is equal to net income divided by average total equity. Since this ratio mixes an income statement item and a balance sheet item, it is necessary to convert the common-size inputs to dollars. Net income is $11,211,200 ($215,600,000 × 5.2%) and average equity is $41,772,000 [($95,300,000 × 48.0%) + $37,800,000] / 2. Thus, 2007 ROE is 26.8% ($11,211,200 net income / $41,772,000 average equity).

1215

To calculate the cash ratio, the total of cash and marketable securities is divided by:

A) total liabilities.

B) current liabilities.

C) total assets.

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Current liabilities are used in the denominator for the: current, quick, and cash ratios.

1215

Earnings before interest and taxes (EBIT) is also known as:

A) gross profit.

B) operating profit.

C) earnings before income taxes.

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Operating profit = earnings before interest and taxes (EBIT)

Gross profit = net sales – COGS

Net income = earnings after taxes = EAT

1215

A company has a receivables turnover of 10, an inventory turnover of 5, and a payables turnover of 12. The company’s cash conversion cycle is closest to:

A) 79 days.

B) 30 days.

C) 37 days.

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Cash conversion cycle = receivables days + inventory processing days – payables payment period.
Receivables days = 365 / receivables turnover = 365 / 10 = 36.5 days.
Inventory processing days = 365 / inventory turnover = 365 / 5 = 73.0 days.
Payables payment period = 365 / payables turnover = 365 / 12 = 30.4 days.
Cash collection cycle = 36.5 + 73.0 – 30.4 = 79.1 days.

1215

An analyst has gathered the following information about a firm:

• Net sales of $500,000.
• Cost of goods sold = $250,000.
• EBIT of $150,000.
• EAT of $90,000.

What is this firm’s operating profit margin?

A) 18%.

B) 50%.

C) 30%.

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Operating profit margin = (EBIT / net sales) = ($150,000 / $500,000) = 30%

1215

Use the following data from Delta's common size financial statement to answer the question:

Earnings after taxes	=	18%
Equity	=	40%
Current assets	=	60%
Current liabilities	=	30%
Sales	=	$300
Total assets	=	$1,400

What is Delta's after-tax return on equity?

A) 18.0%.

B) 5.0%.

C) 9.6%.

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Net income after taxes = 300 × 0.18 = 54
Equity = 1400 × 0.40 = 560
ROE = Net Income / Equity = 54 / 560 = 0.0964 = 9.6%

1215

A firm has a cash conversion cycle of 80 days. The firm's payables turnover goes from 11 to 12, what happens to the firm's cash conversion cycle? It:

A) shortens.

B) may shorten or lengthen.

C) lengthens.

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CCC = collection period + Inv Period – Payment period.

Payment period = (365 / payables turnover) = (365 / 11) = 33; (365 / 12) = 30. This means the CCC actually increased to 83.

1215

Paragon Company's operating profits are $100,000, interest expense is $25,000, and earnings before taxes are $75,000. What is Paragon's interest coverage ratio?

A) 1 time.

B) 3 times.

C) 4 times.

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ICR = operating profit ÷ I = EBIT ÷ I
= 100,000 ÷ 25000 = 4

1215

Assume a firm with a debt to equity ratio of 0.50 and debt equal to $35 million makes a commitment to acquire raw materials with a present value of $12 million over the next 3 years. For purposes of analysis the best estimate of the debt to equity ratio should be:

A) 0.671.

B) 0.500.

C) 0.573.

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The original debt / equity ratio = 35 / 70 = 0.5. Now adjust the numerator but not the denominator. Why? You have commitments (liabilities) but no new equity because (non-current) liabilities and assets are increased by the same amount. D/E = (35 + 12) / 70 = 0.671.

1215

Given the following income statement and balance sheet for a company:

Balance Sheet
Assets	Year 2003	Year 2004
Cash	500	450
Accounts Receivable	600	660
Inventory	500	550
Total CA	1300	1660
Plant, prop. equip	1000	1250
Total Assets	2600	2910
Liabilities
Accounts Payable	500	550
Long term debt	700	700
Total liabilities	1200	1652
Equity
Common Stock	400	400
Retained Earnings	1260	1260
Total Liabilities & Equity	2600	2910
Income Statement
Sales		3000
Cost of Goods Sold		(1000)
Gross Profit		2000
SG&A		500
Interest Expense		151
EBT		1349
Taxes (30%)		405
Net Income		944

What is the operating profit margin?

A) 0.45.

B) 0.67.

C) 0.50.

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Operating profit margin = (EBIT / sales) = (1,500 / 3,000) = 0.5