Page 82 - Financial Statement Analysis

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Chapter One | Overview of Financial Statement Analysis 59

At December 31: For year ended December 31:
a. Current ratio. d. Gross profit margin ratio.
b. Acid-test ratio. e. Days to sell inventory.
c. Book value per common share. f. Times interest earned.
CHECK
g. Common stock price-to-earnings ratio (end-of-year value). (g) Year 5 PE, 17.5
h. Gross capital expenditures.

(AICPA Adapted)

Selected ratios for three different companies that operate in three different industries (merchan- PROBLEM 1–10
dising, pharmaceuticals, utilities) are reported in the table below: Identifying Industries

Ratio Co. A Co. B Co. C from Financial
Statement Data
Gross profit margin ratio . . . . . . . . . . . . . . . 18% 53% n.a.
Net profit margin ratio . . . . . . . . . . . . . . . . 2% 14% 8%
Research and development to sales . . . . . . 0% 17% 0.1%
Advertising to sales . . . . . . . . . . . . . . . . . . . 7% 4% 0.1%
Interest expense to sales . . . . . . . . . . . . . . . 1% 1% 15%
Return on assets . . . . . . . . . . . . . . . . . . . . . 11% 12% 7%
Accounts receivable turnover . . . . . . . . . . . 95 times 5 times 11 times
Inventory turnover . . . . . . . . . . . . . . . . . . . . 9 times 3 times n.a.
Long-term debt to equity . . . . . . . . . . . . . . . 64% 45% 89%

n.a. not applicable
Required:
Identify the industry that each of the companies, A, B, and C, operate in. Give at least two reasons
supporting each of your selections.

The Tristar Mutual Fund manager is considering an investment in the stock of Best Computer and PROBLEM 1–11
asks for your opinion regarding the company. Best Computer is a computer hardware sales and Ratio Interpretation—
service company. Approximately 50% of the company’s revenues come from the sale of computer Industry Comparisons
hardware. The rest of the company’s revenues come from hardware service and repair contracts.
Below are financial ratios for Best Computer and comparative ratios for Best Computer’s indus-
try. The ratios for Best Computer are computed using information from its financial statements.
Best Computer Industry Average
Liquidity ratios
Current ratio . . . . . . . . . . . . . . . . . . . . 3.45 3.10
Acid-test ratio . . . . . . . . . . . . . . . . . . . 2.58 1.85
Collection period . . . . . . . . . . . . . . . . . 42.19 36.60
Days to sell inventory . . . . . . . . . . . . . 18.38 18.29
Capital structure and solvency
Total debt to equity . . . . . . . . . . . . . . . 0.674 0.690
Long-term debt to equity . . . . . . . . . . . 0.368 0.400
Times interest earned . . . . . . . . . . . . . 9.20 9.89
Return on investment
Return on assets . . . . . . . . . . . . . . . . . 31.4% 30.0%
Return on common equity . . . . . . . . . . 52.6% 50.0%