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).
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
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.
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.
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.
50. A company has a Cash conversion cycle of 70 days. If the company’s payables turnover decreases from 11 to 10 and days of sales outstanding increase by 5, the company’s Cash conversion cycle will:
A. decreases by approximately 8 days.
B. decreases by approximately 3 days.
C. increases by approximately 2 days.
Ans: C.
Cash conversion cycle (CCC)
= Days of inventory on hand (DOH) + Days Sales Outstanding (DSO) – payables payment period
Payables payment period
===33.18days
=36.5days
Since the payables payment period increases by 3.32 days and receivables days increases by 5, CCC increases by 1.68 days.
49. Bao Corp. has a current ratio above 1 and a quick ratio less than 1. Which of the following actions will increase the current ratio and decrease the quick ratio? Bao Corp.:
A. buys fixed assets on credit.
B. uses cash to purchase inventory.
C. pays off accounts payable from cash.
Ans: C.
Paying off accounts payable from cash lowers current assets and current liabilities by the same amount. Because the current ratio started off above 1, the current ratio will increase. Because the quick ratio started off less than 1, it will decrease further.
A is incorrect. Buying fixed assets on credit decreases both ratios because the denominator increases, with no change to the numerator.
C is incorrect. Using cash to purchase inventory would result in no change in the current ratio but would decrease the quick ratio by decreasing the numerator.
48. The presentation format of balance sheet data that standardizes the first-year values to 1.0 and presents subsequent year’s amounts relative to 1.0 is a(n):
A. indexed balance sheet.
B. vertical common-size balance sheet.
C. horizontal common-size balance sheet.
Ans: C.
On horizontal common-size balance sheet, the divisor is the first year values so they are all standardized to 1.0 by construction. Trends in the values of these items as well as the relative growth in these items are readily apparent. A vertical common-size balance sheet expresses all balance sheet accounts as a percentage of total assets and does not standardize the initial year.