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17. The following selected information is from a company’s most recent financial statements: (￡ millions) 2009 2008 Sales 2,801 2,885 Cost of Goods Sold 1,969 2,071 Interest Expense 123 110 Cash & Marketable Securities 108 105 Accounts Receivable 318 286 Inventories 248 285 Accounts Payable 361 346 Notes Payable 50 99 The 2009 cash conversion cycle, in days, is closest to: A. 23. B. 26. C. 28.

Ans: A. Activity Ratios Calculation Inventory Turnover 7.39 COGS/Average Inventory 1969/(248+285)/2 DOH (days on hand) 49.4 365/Inventory Turnover 365/7.39 Receivable Turnover 9.27 Sales/Average Receivables 2801/(318+286)/2 DSO (days sales o/s) 39.4 365/Receivables Turnover 365/9.27 Payables Turnover 5.57 COGS/Average Payables 1969/(361+346)/2 Days in Payables 65.5 365/Payables Turnover 365/5.57 Cash Conversion Cycle 23.3 DOH + DSO – Days In Pay 49.4 + 39.4 – 65.5

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16. The following information (U.S. $ millions) for two companies operating in the same industry during the same time period is available: Company A Company B Net sales 120 300 Total assets 70 140 Total liabilities 25 40 If both companies achieve a return on equity of 15% for the period, which of the following statements is most likely correct? Compared to Company B, Company A has a: A. higher net profit margin. B. higher total asset turnover. C. lower financial leverage multiplier.

Ans: A. The DuPont system can be used to break down the ROE into three components: ROE = Profit margin x total asset turnover x financial leverage multiplier. Component Company A Company B Total asset turnover (sales/total assets) 120/170 1.71 300/140 2.14 Company A has a lower total asset turnover, not higher Equity (total assets – total liabilities) 70-25 $45 140-40 $100 Financial leverage multiplier (assets/equity) 70/45 1.56 140/100 1.40 Company A has a higher financial leverage multiplier, not lower Company A’s Net Profit Margin from ROE: = 15% = (net profit margin) x 1.71 x 1.56 Company A’s net profit margin = 5.6% Company A’s Net Profit Margin from ROE: = 15% = (net profit margin) x 2.14 x 1.40 Company A’s net profit margin = 5.0% The net profit margin could also be computed by computing net income for each company from the basic ROE definition: ROE = Net Income/Common Equity For Company A: ROE = 15% = net income/ (70-25); net income is 6.75, and net profit margin = net income/Sales = 6.75/ 120 = 5.6%.) For Company B: ROE = 15% = net income/ (140-40); net income is 15, and net profit margin = net income/Sales = 15/ 300 = 5.0%.) Company A has a higher net profit margin than Company B

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15. An analyst calculates the following ratios for a firm: Sales/Total Assets Net Profit Margin (%) Return on Total Assets (%) Equity/ Total Assets 2.8 4 11.2 0.625 The return on equity (in %) for this firm is closest to: A. 6.4. B. 7.0. C. 17.9.

Ans: C. ROE = Net Profit Margin x Sales/Total Assets x Total Assets/Equity = 4.0 x 2.8 x 1/0.625 = 17.9%. Alternatively, ROE = Return on Total Assets x Total Assets/Equity = 11.2 x 1/0.625 = 17.9%

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14. The table below contains selected data from the common-size balance sheets for three different industries: utilities, financials and consumer discretionary products. % of Total Assets Industry 1 Industry 2 Industry 3 Inventories 6.9 2.6 19.4 PPE 1.9 57.5 25.4 LT Debt 18.2 31.9 19.1 Total Equity 19.5 23.2 42.3 LT = Long Term; PPE = Property, plant and equipment Which of the following statements is most accurate? A. Industry 1 is the utility industry and Industry 2 is the financial industry. B. Industry 2 is the utility industry and Industry 3 is the consumer discretionary products industry. C. Industry 1 is the consumer discretionary products industry and Industry 3 is the financial industry.

Ans: B. The utility industry [2] has a large percentage of PPE and long term debt and low inventories; the consumer discretionary products industry [3] would have high inventories.

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13. An analyst gathered the following data for two companies in the same industry: Company A Company B Days in sales outstanding 28 32 Days of inventory on hand 32 35 Days of payables 42 40 Current assets $203,000 $189,000 Total assets 581,000 469,000 Current liabilities 73,000 71,000 Total liabilities 429,000 350,000 Shareholders' equity 152,000 119,000 Which of the following is the most appropriate conclusion the analyst can make? Compared to Company B, Company A: A. is more liquid. B. has more financial risk. C. has a longer time between cash outlay and cash collection.

Ans: A. Company A has a higher current ratio and shorter cash conversion cycle and it therefore more liquid. The lower financial leverage ratio indicates that it has less financial risk, not more, and it has less time between cash outlay and cash collection. Measure Definition Company A Company B Current ratio CA/CL 2.78 2.66 Cash conversion cycle DOS + DOH – Days payable 28 + 32 – 42 = 18 32 + 35 – 40 = 27 Financial Leverage Total assets/Sh equity 3.82 3.94

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12. The use of financial ratio analysis is most likely limited in which of the following situations? When: A. providing a means of evaluating management’s ability. B. comparing companies using different accounting methods. C. providing insights into microeconomic relationships within a company that help analysts project earnings and free cash flow.

Ans: B. Financial ratio analysis is limited by the use of alternative accounting methods. Accounting methods play an important role in the interpretation of financial ratios. The lack of consistency across companies makes comparability difficult to analyze and limits the usefulness of ratio analysis.

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11. Which of the following will most likely result in an increase in a company’s sustainable growth rate? A. Higher tax burden ratio B. Lower interest burden ratio C. Higher dividend payout ratio

Ans: A. Sustainable growth rate = Retention ratio × ROE. The higher a company’s ROE and its ability to finance itself from internally generated funds (a higher retention ratio), the greater its sustainable growth rate. In the five-factor ROE, any factor that increases ROE will increase sustainable growth: ROE = Tax burden × Interest burden × EBIT margin × Asset turnover × Leverage. A higher tax burden ratio (Net income/Earnings before tax) implies that the company can keep a higher percentage of pretax profits; this implies a lower tax rate and a higher ROE. B is incorrect. The interest burden ratio is earnings before tax to EBIT, and a lower ratio means that the company has higher borrowing costs (it gets to keep a lower pre-tax income from a given EBIT), implying a lower ROE and sustainable growth. C is incorrect.  Dividend payout ratio=1-retention ratio A higher dividend payout ratio will lead to a lower retention ratio, which will in turn result in a decrease in a company’s sustainable growth rate.

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10. Selected information from a company’s recent income statement and balance sheets is presented below. Selected Income Statement Data for the year ended December 31st (Can $ thousands) 2011 Sales $2,240,000 Cost of goods sold 1,320,000 Gross profit 920,000 Net Income $316,600 Selected Balance Sheet Data as of December 31st (Can $ thousands) 2011 2010 Assets Cash & investments $210,700 $191,600 Accounts receivable 212,800 201,900 Inventories 63,000 71,500 Total current assets $486,500 $465,000 Liabilities Accounts payable $129,600 $157,200 Other current liabilities 130,700 182,700 Total current liabilities $260,300 $339,900 The company operates in an industry in which suppliers offer terms of 2/10, net 30. The payables turnover for the average company in the industry is 8.5 times. Which of the following statements is most accurate? In 2011, the company on average: A. took advantage of early payment discounts. B. paid its accounts within the payment terms provided. C. paid its accounts more promptly than the average firm in the industry.

Ans: C. Purchases = COGS + End inventory – Beginning inventory = 1,320,000 + (63,000 – 71,500) = 1,311,500 Average payables = ? × (129,600 + 157,200) = 143,400 Payables turnover = Purchases ÷ Average payables = 1,311,500 ÷ 143,400 = 9.15 times Days in payables = 365 ÷ Payables turnover ratio Firm: 365 days ÷ 9.15 = 39.9 days Industry: 365 days ÷ 8.5 times = 42.9 days The firm’s days in payables is 39.9 days; therefore, it appears the firm does not normally take supplier-provided discounts (paying in 10 days) nor pay its accounts within the 30-day terms provided. However, on average, the firm is paying faster than the average firm in the industry (42.9 days).

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9. An analyst has calculated the following ratios for a company: Operating Profit Margin 17.5% Net Profit Margin 11.7% Total Asset Turnover 0.89times Return on Assets 10.4% Financial Leverage 1.46 Debt to Equity 0.46 The company’s return on equity (ROE) is closest to: A. 4.8%. B. 15.2%. C. 22.7%.

Ans: B. Using DuPont analysis, there are two ways to calculate ROE from the information provided: ROE = Net profit margin × Asset turnover × Financial leverage = 11.7 × 0.89 × 1.46 = 15.2 ROE = ROA × Financial leverage =10.4×1.46 =15.2

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8. The following information is available: Income Statement Items ($) Sales 421,000 Cost of goods sold (COGS) 315,000 Balance Sheet Items Cash 30,000 Accounts receivable 40,000 Inventories 36,000 Accounts payable 33,000 The company’s cash conversion cycle (in days) is closest to: A. 38.2. B. 45.2. C. 76.4.

Ans: A. Cash conversion cycle = DOH + DSO – Days of payables Formula Calculation Days DOH: Days of inventory on hand 41.7 Inventory turnover = =8.75 DSO: Days of sales outstanding 34.7 Receivables turnover = =10.53 Number of days of payables: -38.2 Payables turnover = =9.55 * When purchases are not available (as in this case), the COGS can be used to estimate payables turnover. Cash conversion cycle 38.2