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7. Selected information for a company and the common size data for its industry are provided below. Company (￡) Common Size Industry Data (% of sales) EBIT 76,000 28.0 Pretax profit 66,400 19.6 Net income 44,500 13.1 Sales 400,000 100.0 Total assets 524,488 140.0 Total equity 296,488 74.0 ROE 15% 17.7% Which of the following is most likely a contributor to the company’s inferior ROE compared to that of the industry? The company’s: A. Tax burden ratio. B. Interest burden ratio. C. Financial leverage ratio.

Ans. C. Calculation Company Industry Tax burden ratio Net Inc/EBT 44,500/66,400= 0.67 13.1/19.6=0.67 Financial leverage Total assets/Equity 524,488/296,488=1.77 140/74 = 1.89 Interest burden ratio EBT/EBIT 66,400/76,000= 0.87 19.6/28.0=0.70 The company has a lower financial leverage ratio relative to the industry, which is one of the causes of the company’s lower relative ROE performance. The tax burden ratio is the same as the industry and the interest burden ratio is higher, which would increase ROE. EBT: Pretax profit (earnings before tax) Net Inc: Net income

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6. A company’s days of sales outstanding (DSO) decreased, while its cost of goods sold (COGS) relative to sales and receivable remain unchanged. The company’s gross profit will: A. Decline. B. Increase. C. Remain unchanged.

Ans. B. A decrease in DSO means that receivables turnover increased. For receivables turnover to increase while receivables remained stable means that revenues must have increased. This will result in higher gross profits because the gross margin remained the same.

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5. The cash conversion cycle (CCC) decreases if there is an increase in the number of: A. Days of payables. B. Days of sales outstanding (DSO). C. Days of inventory on hand (DOH).

Ans: A. The cash conversion cycle shoes how long it takes a firm to convert resource inputs into cash flows. Increasing the number of days of payables reduces the cash conversion cycle. B. Increasing  the DSO increases the CCC. C. Increasing  the DOH increases the CCC.

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4. Three companies operating in the same industry produced the following results during the same year: Company Avg. inventory ($millions) Sales($millions) Days of inventory on hand (DOH) A 1.8 25 60 days B 2.0 26 60 days C 2.3 27 65 days Which company produced the highest gross profit margin during the year? A. Company A B. Company B C. Company C

Ans: A. The days of inventory on hand (DOH) can be deconstructed into: → Cost of goods sold = 365 * So the cost of goods sold for the three companies: A =365 *(1.8/60) =10.95 B =365 *(2.0/60) =12.17 C= 365 *(2.3/65) =12.92 The formula for gross profit margin is: Gross profit margins for the three companies are: A= 1- (10.95/25) =0.562 B= 1- (12.17/26) =0.532 C= 1- (12.92/27) =0.522 (This could also be solved somewhat intuitively by recognizing that company A achieved roughly comparable sales results on proportionately much less inventory in both dollar amount and in days of inventory on hand. Its profit margin must have been higher!)

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3. A company collected $57,500 in accounts receivable and repaid $37,500 in interest bearing short-term loans. The combined effect that transactions will invrease CFO for the company is: A. $20,000 B. $57,500 C. 95,000

Ans: B Collecting account receivable will increase CFO by $57,500. Repaying short-term loan is a financing activities, which reduces CFF (rather than CFO) by $37,500.

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2. The following is the information on Company A: Debt ratio 0.175 Total liabilities $5,000 Total interest bearing debt $3,500 Return on equity (ROE) 16.0% The firm’s return on assets (ROA) is closest to: A. 11% B. 12% C. 25%

Ans: B →Asset=3,500/Debt ratio=3,500/0.175=20,000 Equity=Asset –Liabilities=20,000-5,000=15,000 ROA =            = 0.12