spartan1

Kellen Harris is a credit analyst with the First National Bank. Harris has been asked to evaluate Longhorn Supply Company’s cash needs. Harris began by calculating Longhorn’s turnover ratios for 2007. After a discussion with Longhorn’s management, Harris decides to adjust the turnover ratios for 2008 as follows:

	2007 Actual Turnover	Expected Increase / (Decrease)
Accounts receivable	5.0	10%
Fixed asset	3.0	7%
Accounts payable	6.0	(20%)
Inventory	4.0	(5%)
Equity	5.5	—
Total asset	2.3	8%

Longhorn’s expected cash conversion cycle for 2008, based on the expected changes in turnover and assuming a 365 day year, is closest to:

A) 82 days.

B) 46 days.

C) 86 days.

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2008 expected days of sales outstanding is 66 [365 / (5.0 × 1.1)], 2008 days of inventory on hand is 96 [365 / (4.0 × 0.95)], and 2008 days of payables is 76 [365 / (6.0 × 0.8)]. Expected cash conversion cycle is 86 days [66 days of sales outstanding + 96 days of inventory on hand – 76 days of payables].

spartan1

Selected financial information gathered from the Matador Corporation follows:

	2007	2006	2005
Average debt	$792,000	$800,000	$820,000
Average equity	$215,000	$294,000	$364,000
Return on assets	5.9%	6.6%	7.2%
Quick ratio	0.3	0.5	0.6
Sales	$1,650,000	$1,452,000	$1,304,000
Cost of goods sold	$1,345,000	$1,176,000	$1,043,000

Using only the data presented, which of the following statements is most correct?

A) Leverage has declined.

B) Gross profit margin has improved.

C) Return on equity has improved.

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Leverage increased as measured by the debt-to-equity ratio from 2.25 in 2005 to 3.68 in 2007. Gross profit margin declined from 20.0% in 2005 to 18.5% in 2007. Return on equity has improved since 2005. One measure of ROE is ROA × financial leverage. Financial leverage (assets / equity) can be derived by adding 1 to the debt-to-equity ratio. In 2005, ROE was 23.4% [7.2% ROA × (1 + 2.25 debt-to-equity)]. In 2007, ROE was 27.6% [5.9% ROA × (1 + 3.68 debt-to-equity)].

spartan1

Assume that Q-Tell Incorporated is in the communications industry, which has an average receivables turnover ratio of 16 times. If the Q-Tell’s receivables turnover is less than that of the industry, Q-Tell’s average receivables collection period is most likely:

A) 20 days.

B) 25 days.

C) 12 days.

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Average receivables collection period = 365 / receivables turnover, which is 22.81 days for the industry (= 365 / 16). If Q-Tell’s receivables turnover is less than 16, its average days collection period must be greater that 22.81 days.

spartan1

Comparative income statements for E Company and G Company for the year ended December 31 show the following (in $ millions):

	E Company	G Company
Sales	70	90
Cost of Goods Sold	(30)	(40)
Gross Profit	40	50
Sales and Administration	(5)	(15)
Depreciation	(5)	(10)
Operating Profit	30	25
Interest Expense	(20)	(5)
Earnings Before Taxes	10	20
Income Taxes	(4)	(8)
Earnings after Taxes	6	12

The financial risk of E Company, as measured by the interest coverage ratio, is:

A) higher than G Company's because its interest coverage ratio is less than G Company's, but at least one-third of G Company's.

B) higher than G Company's because its interest coverage ratio is less than one-third of G Company's.

C) lower than G Company's because its interest coverage ratio is at least three times G Company's.

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E Company’s interest coverage ratio (EBIT / interest expense) is (30 / 20) = 1.5.
G Company’s interest coverage ratio is (25 / 5) = 5.0. Higher interest coverage means greater ability to cover required interest and lease payments. Note that 1.5 / 5.0 = 0.30, which means the interest coverage for E Company is less than 1/3 that of G Company.

spartan1

An analyst has gathered the following information about a company:

Balance Sheet
Assets
	Cash	100
	Accounts Receivable	750
	Marketable Securities	300
	Inventory	850
	Property, Plant & Equip	900
	Accumulated Depreciation	(150)
Total Assets		2750
Liabilities and Equity
	Accounts Payable	300
	Short-Term Debt	130
	Long-Term Debt	700
	Common Equity	1000
	Retained Earnings	620
Total Liab. and Stockholder's equity		2750
Income Statement
Sales		1500
COGS		1100
Gross Profit		400
SG&A		150
Operating Profit		250
Interest Expense		25
Taxes		75
Net Income		150

What is the ROE?

A) 10.7%.

B) 9.9%.

C) 9.3%.

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ROE = 150(NI) / [1000(common) + 620(RE)] = 150 / 1620 = 0.0926 or 9.3%

spartan1

What is the net income of a firm that has a return on equity of 12%, a leverage ratio of 1.5, an asset turnover of 2, and revenue of $1 million?

A) $360,000.

B) $36,000.

C) $40,000.

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The traditional DuPont system is given as:
ROE = (net profit margin)(asset turnover)(leverage ratio)
Solving for the net profit margin yields:
0.12 = (net profit margin) × (2) × (1.5)
0.04 = (net profit margin)
Recognizing that the net profit margin is equal to net income / revenue we can substitute that relationship into the above equation and solve for net income:0.04 = net income / revenue = net income / $1,000,000  
$40,000 = net income.

spartan1

What is a company’s equity if their return on equity (ROE) is 12%, and their net income is $10 million?

A) $120,000,000.

B) $83,333,333.

C) $1,200,000.

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One of the many ways ROE can be expressed is: ROE = net income / equity
0.12 = $10,000,000 / equity
Equity = $10,000,000 / 0.12 = $83,333,333

spartan1

The traditional DuPont equation shows ROE equal to:

A) net income/sales × sales/assets × assets/equity.

B) EBIT/sales × sales/assets × assets/equity × (1 – tax rate).

C) net income/assets × sales/equity × assets/sales.

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Profit margin × asset turnover × financial leverage. Although net income/assets × sales/equity × assets/sales also yields ROE, it is not the DuPont equation.

spartan1

An analyst has gathered the following information about a company.

• The total asset turnover is 1.2.

• The after-tax profit margin is 10%.

• The financial leverage multiplier is 1.5.

Given this information, the company’s return on equity is:

A) 12%.

B) 9%.

C) 18%.

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ROE = profit margin × total asset turnover × financial leverage
ROE = (0.1)(1.2)(1.5) = 0.18 or 18.0%

spartan1

If a firm has a net profit margin of 0.05, an asset turnover of 1.465, and a leverage ratio of 1.66, what is the firm's ROE?

A) 12.16%.

B) 3.18%.

C) 5.87%.

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One of the many ways to express ROE = net profit margin × asset turnover × leverage ratio
ROE = (0.05)(1.465)(1.66) = 0.1216