a.
To determine: The liquidity position of C Corporation, comparison of liquidity position with peers and the changes in liquidity position over the time.
Ratio Analysis: Ratio is used to compare two arithmetical figures. In case of the ratio analysis of the company, the financial ratios are calculated. The financial ratios examines the performance of the company and are used in comparing with other same business. It indicates relationship of two or more parts of financial statements.
Liquidity Position: The liquidity position of the company is indicated by liquidity ratios, which gives the idea of whether the company has the ability to pay back its liabilities, which has less than one year maturity.
a.
Explanation of Solution
Solution:
Current ratio
2013
Given,
Current asset is $1,206,000.
Current liabilities is $571,500.
The formula to calculate current ratio is,
Substitute $1,206,000 for current assets and $571,500 for current liabilities.
Thus, current ratio is 2.11 times.
2014
Given,
Current asset is $1,405,000.
Current liabilities is $602,000.
The formula to calculate current ratio is,
Substitute $1,405,000 for current assets and $602,000 for current liabilities in above formula.
Thus, current ratio is 2.33times.
Comparison:
Ratios | Year 2013 | Year 2014 | Industry |
Current ratio | 2.11 times | 2.33 times | 2.7 times |
Table (1)
The current ratio of the company in year 2014 has been increased so it can be said that the liquidity position of the company is improved.
Therefore, the liquidity position is improved in year 2014 as comparison to year 2013 but it is lower than industry average.
b.
To determine: The Assets management position of C Corporation, comparison of assets management position with peers and the changes in assets management position over the time.
Assets Management Position: The assets management position of the company is indicated by assets management ratios which give idea how well the company is using its assets.
b.
Explanation of Solution
Solution:
Inventory turnover ratio:
2013
Given,
Total sale is $3,635,000.
Total inventory is $813,000.
The formula of inventory turnover ratio is,
Substitute $3,635,000 for total sales and $813,000 for total inventory.
Thus, inventory turnover ratio is 4.47 times.
2014
Given,
Total sale is $4,240,000
Total inventory is $894,000.
The formula of inventory turnover ratio is:
Substitute $4,240,000 for total sales and $894,000 for total inventory.
Thus, inventory turnover ratio is 4.74 times.
Days sales outstanding
2013
Given,
Receivables are $328,000.
Annual sale is $3,635,000.
The formula to calculate days sales outstanding is,
Substitute $328,000 for account receivables and $3,635,000 for annual sales.
Thus, days sales outstanding is 32.94 days.
2014.
Given,
Receivables are $439,000.
Annual sale is $4,240,000.
The formula to calculate days sales outstanding is,
Substitute $439,000 for account receivables and $4,240,000 for annual sales.
Thus, days sales outstanding is 37.79 days.
Fixed assets turnover
2013
Given,
Sales are $3,635,000.
Total fixed assets are $461,000.
The formula to calculate fixed assets turnover is,
Substitute $3,635,000 for total sales and $461,000 for fixed assets.
Thus, fixed assets turnover is 7.89times.
Working notes:
Compute total fixed assets.
Given,
Land and building is$271,000.
Machinery is $133,000.
Other fixed assets are $57,000.
Calculation of total fixed assets,
Thus, total amount of fixed assets is $461,000.
2014
Given,
Sales are $4,240,000.
Total fixed assets are $431,000.
The formula to calculate fixed assets turnover is,
Substitute $4,240,000 for total sales and $431,000 for fixed assets.
Thus, fixed assets turnover is 9.84times.
Working notes:
Compute total fixed assets.
Given,
Land and building is $238,000.
Machinery is $132,000.
Other fixed assets are $61,000.
The total amount of the fixed assets is:
Thus, total amount of fixed assets is $431,000.
Total assets turnover
2013
Given,
Total sales are $3,635,000.
Total assets are $1,667,000.
The formula of total assets turnover is,
Substitute $3,635,000 for total sales and $1,667,000 for total assets.
Thus, total assets turnover is 2.18 times.
2014
Given,
Total sales are $4,240,000.
Total assets are $1,836,000.
The formula of total assets turnover is,
Substitute $4,240,000 for total sales and $1,836,000 for total assets.
Thus, total assets turnover is 2.31 times.
Comparison
Ratios | Year 2013 | Year 2014 | Industry |
Inventory turnover ratio | 4.47 times | 4.74 times | 7 times |
Days sales outstanding | 32.94 days | 37.79 days | 32 days |
Fixed assets turnover | 7.89 times | 9.84 times | 13 times |
Total assets turnover | 2.18 times | 2.31 times | 2.60times |
Table (2)
- The inventory turnover ratio has been improved in year 2014 comparing to 2013. However it is lower than industry average.
- Days sales outstanding is higher in 2014, the company should look over the receivables to be collected if the credit policy is same. It is somehow close to the industry average.
- Fixed assets turnover has been increased in 2014 comparing to 2013. But it is still below the industry average.
- Total assets turnover is increased in 2014 comparing it to 2013. The industry average seems higher than company however.
Therefore, the assets management ratios are improved in 2014 comparing 2013 but ratios are still below the industry’s average.
c.
To determine: The debt management position of C Corporation, comparison of debt management position with peers and the changes in debt management position over the time.
Debt Management Position: Debt management position is indicated by the debt management ratios which give an idea how the company finances its assets as well as the capability to pay back its long-term debt.
c.
Explanation of Solution
Solution:
Debt-to capital ratio
2013
Given,
Total debt is $716,810.
Equity is $836,602.
The formula of debt-to-capital ratio is,
Substitute $716,810 for total debt and $836,602 for equity in above formula.
Thus, debt-to-capital ratio is 46.41%.
Working notes:
Compute total debt.
Given,
Long term debt is $258,898.
Notes payable is $457,912.
Calculation of total debt,
Thus, total debt is $716,810.
Compute the total value of equity.
Common stock is $575,000.
Calculation of total equity value,
Thus, total equity value is $836,602.
2014
Given,
Total debt is $881,280.
Equity is $829,710.
The formula of debt-to-capital ratio is,
Substitute $881,280 for total debt and $829,710 for equity.
Thus, debt-to-capital ratio is 51.50%.
Working notes:
Compute total debt.
Long term debt is $404,290.
Notes payable is 476,990.
Calculation of total debt,
Thus, the total debt is $881,280.
Compute the total value of equity.
Common stock is $575,000.
Retained earnings are $254,710.
Calculation of total equity value
Thus, total equity value is $829,710.
Compute total debt.
Long term debt is $404,290.
Notes payable is 476,990.
Calculation of total debt,
Thus, the total debt is $881,280.
Comparison:
Ratios | Year 2013 | Year 2014 | Industry |
Debt-to-capital ratio | 46.41% | 51.50% | 50% |
Table (3)
The debt ratio of the company has been increased in year 2014 which is not good. In 2013 it was lower than industry average but in 2014 it is higher than industry average.
Therefore, the debt management position of the company is not good in year 2014 the company should improve its position by paying the liabilities.
d.
To determine: The profitability ratio of C Corporation, compare it with peers and the change in the profitability of the company over the time.
Profitability Ratios: These ratios give an idea whether the company is able to operate profitably and is efficient in using its assets.
d.
Explanation of Solution
Solution:
2013
Given,
Net income is $95,970.
Total asset is $1,667,000.
The formula of return on asset is,
Substitute $95,970 for net income and $1,667,000 for total value of assets.
Thus, return on assets is 5.76%.
2014
Given,
Net income is $18,408.
Total asset is $1,836,000.
The formula of return on asset is,
Substitute $18,408 for net income and $1,836,000 for total value of assets.
Thus, return on assets is 1%.
2013
Given,
Net income is $95,970.
Equity is $836,602.
The formula of return on equity is,
Substitute $95,970 for net income and $836,602 for equity.
Thus, return on equity is 11.47%.
Working notes:
Compute the total value of equity.
Common stock is $575,000.
Retained earnings are $261,602.
Calculation of total equity value,
Thus, total equity value is $836,602.
2014
Given,
Net income is $18,408.
Equity is $829,710.
The formula of return on equity is,
Substitute $18,408 for net income and $829,710 for equity.
Thus, return on equity is 2.21%.
Working note:
Compute the total value of equity.
Common stock is $575,000.
Retained earnings are $254,710.
Calculation of total equity value,
Thus, total equity value is $829,710.
Return on invested capital
2013
Given,
Earnings before interest and tax (EBIT) is $202,950.
Tax rate is 40%.
Total debt is $ 716,810.
Total equity is $836,602.
The formula of return on invested capital is,
Substitute $202,950 for EBIT, $716,810 for debt and $836,602 for equity.
Thus, return on invested capital is 7.83%.
Working note:
Compute total debt.
Long term debt is $258,898.
Notes payable is 457,912.
Calculation of total debt,
Thus, the total debt is $716,810.
2014
Given,
Earnings before interest and tax (EBIT) are $97,680.
Tax rate is 40%.
Total debt is $881,280.
Total equity is $829,710.
The formula of return on invested capital is,
Substitute $97,680 for EBIT, $881,280 for debt and $829,710 for equity.
Thus, return on invested capital is 3.42%.
Working note:
Compute total debt.
Long term debt is $404,290.
Notes payable is 476,990.
The total debt of the company is,
Thus, the total debt is $881,280.
Compute the total value of equity.
Common stock is $575,000.
Retained earnings are $254,710.
Calculation of total equity value,
Thus, total equity value is $829,710.
Profit margin
2013
Given,
Net income is $95,970.
Sales are $3,635,000.
The formula to calculate profit ratio is,
Substitute $95,970 for net income and $3,635,000 for sales.
Thus, profit ratio is 2.64%.
2014
Given,
Net income is $18,408.
Sales are $4,240,000.
The formula to calculate profit ratio is,
Substitute $18,408 for net income and $4,240,000 for sales.
Thus, profit ratio is 0.43%.
Comparison
Ratios | Year 2013 | Year 2014 | Industry |
Return on assets | 5.76% | 1% | 9.1% |
Return on equity | 11.47% | 2.21% | 18.2% |
Return on invested capital | 7.83% | 3.42% | 14.5% |
Profit margin | 2.64% | 0.43% | 3.5% |
Table (4)
- Return on assets has been declined in year 2014 comparing to 2013 and it I lower than industry average.
- Return on equity has been declined in year 2014 comparing to 2013 and it is lower than industry average
- Return on invested capital is declined in year 2014 comparing to 2013 and it is lower than industry average.
- The profit margin has fallen in 2014 comparing to 2013 and it is loer than industry average.
Therefore, the profitability ratios have been declined in year 2014 comparing to 2013 and are lower than the industry’s average.
e.
To determine: The market value ratios, comparison of ratios with peers and changes in market values over the time.
Market Value Ratios: The market value ratios give idea about the view of investors towards the company and company’s future scenario.
e.
Explanation of Solution
Solution:
Comparison
Ratios | Year 2013 | Year 2014 | Industry |
P/E ratio | 5.65 | 15.42 | 6 |
Table (5)
P/E ratio of 2013 is 5.65 times and P/E ratio in 2014 is 15.42. The P/E ratio has been increased in the year 2014 comparing to 2013. It is higher than industry average.
Therefore, the market value ratios have been improved in year 2014 and higher than industry average.
f.
To calculate: The ROE of the C company as well industry average ROE using DuPont equation and way of comparing of Company’s financial position with industry’s average numbers.
Return on Equity (ROE): Return on equity is the return from the equity. It is the ratio of net income and shareholders’ equity. This ratio measures the performance of the company and tells how well the company is performing. This ratio is used to compare own firm with competitors.
Du Pont Equation: Among all ratios, return on equity is very common. It shows the value of the firm. Improvement in the ROE is considered as valued addition to the firm. ROE can be linked with other ratios. Analysis of such ratios will indicate proper reason for change in ROE. The combination is known as Du Pont equation which is shown below:
f.
Explanation of Solution
Solution:
The formula of ROE is,
Year 2013
Given,
Net income of the company is $95,970.
Sales of the company are $3,635,000.
Total asset is $1,667,000
Total common equity is $836,602.
The Du point relation of the company’s ratios is shown below,
Simplify the above equation to get
2014
Given,
Net income of the company is $18,408.
Sales of the company are $4,240,000.
Total asset is $1,836,000.
Total common equity is $879,710.
The Du point relation of the company’s ratios is shown below,
Simplify the above equation to get
Industry average
The industry has return on equity 18.2%.
- The ROE calculated on the basis of Du Pont Equation shows the profit margin lower in comparison to 2013 in year 2014 and also lower than industry average.
- The firms total assets turnover has been improved comparing to 2013 in year 2014.
- The equity multiplier has been increased in 2014 comparing to the 2013.
Therefore, return on equity on year 2013,2014 and of industry are 11.47% 2.21%and 18.2% and the return on equity has been decreased in year 2014 comparing to 2013 and is lower than industry average.
g.
To identify: The changes in the ratios, if the company initiated cost-cutting measures that allowed it to hold lower level of the inventory and substantially deceased the cost of goods sold.
g.
Answer to Problem 25SP
Solution:
The profitability ratios and market value ratios will be improved. Similarly, there will be decrease in level of the inventory, which would improve the current ratio liability as well
There would be improvement in inventory turnover and total asset turnover ratios. The reduction in cost will also improve debt ratio.
If the C Corporation initiated the cost-cutting measures this would increase its net income.
Explanation of Solution
If the C Corporation initiated the cost-cutting measures this would increase its net income because the cost will get decreased. And also the liabilities will get decreased.
Therefore, if the company initiated the cost cutting measures that allowed holding lower level of inventory and substantially decreased cost of goods sold, the ratios of the company will be improved and net income will increase.
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Chapter 4 Solutions
Fundamentals of Financial Management, Concise Edition (with Thomson ONE - Business School Edition, 1 term (6 months) Printed Access Card) (MindTap Course List)
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