FIN 201 H.W

3-1
ABC
XYZ
CA
60
110
CL
20
90
60/20= 3
110/90=1.2
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3-2

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3-4
CHAPTER 3
Analysis of Financial Statements
Ratio analysis
Du Pont system
Effects of improving ratios
Limitations of ratio analysis
Qualitative factors
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3-5
Balance Sheet: Assets
Cash
AR
Inventories
Total CA
Gross FA
Less: Deprec.
Net FA
Total assets
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2002E
85,632
878,000
1,716,480
2,680,112
1,197,160
380,120
817,040
3,497,152
2001
7,282
632,160
1,287,360
1,926,802
1,202,950
263,160
939,790
2,866,592
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3-6
Liabilities and Equity
2002E
Accounts payable
436,800
Notes payable
300,000
Accruals
408,000
Total CL
1,144,800
Long-term debt
400,000
Common stock
1,721,176
Retained earnings
231,176
Total equity
1,952,352
Total L & E
3,497,152
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2001
524,160
636,808
489,600
1,650,568
723,432
460,000
32,592
492,592
2,866,592
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3-7
Income Statement
Sales
COGS
Other expenses
EBITDA
Depreciation
EBIT
Interest exp.
EBT
Taxes (40%)
Net income
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2002E
2001
7,035,600 6,034,000
5,875,992 5,528,000
550,000
519,988
609,608
(13,988)
116,960
116,960
492,648 (130,948)
70,008
136,012
422,640 (266,960)
169,056 (106,784)
253,584 (160,176)
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3-8
Other Data
2002E
2001
Shares out.
250,000
100,000
EPS
$1.014
($1.602)
DPS
$0.220
$0.110
Stock price
$12.17
$2.25
Lease pmts
$40,000
$40,000
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3-9
Why are ratios useful?
Standardize numbers; facilitate
comparisons
Used to highlight weaknesses and
strengths
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3 – 10
What are the five major categories of
ratios, and what questions do they
answer?
Liquidity: Can we make required
payments?
Asset management: Right amount
of assets vs. sales?
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3 – 11
Debt management: Right mix of
debt and equity?
Profitability: Do sales prices exceed
unit costs, and are sales high
enough as reflected in PM, ROE, and
ROA?
Market value: Do investors like what
they see as reflected in P/E and M/B
ratios?
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3 – 12
STC
Mobaily
Which is better
CR
1.394
0.589
STC
QR
1.36
0.583
STC
INT TO
58.4
191.53
Mobaily
DSO
99.5
101.22
STC
FA TO
1.23
0.65
STC
TA TO
0.48
0.36
STC
D/TA
0.46
0.62
STC
TIE
20.4
2.4
STC
PM
18.97%
5.57%
STC
BEP
0.1043
0.0355
STC
ROA
0.091
0.0203
STC
ROE
0.171
0.054
STC
P/E
5.69
26.89
MOBILY
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3 – 13
STC
Mobaily
Which is better
CR
1.394
0.589
STC
QR
1.36
0.583
STC
INT TO
58.44
191.5
Mobily
DSO
99.58
101.22
stc
FA TO
1.23
0.658
stc
TA TO
1.2855
0.365
stc
D/A
0.46
0.623
STC
TIE
20.4
2.435
STC
PM
0.189
0.055
STC
BEP
0.1043
0.0355
STC
ROA
0.091
0.0203
STC
ROE
0.171
0.054
STC
P/E
5.69
26.77
MOBILY
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3 – 14
Calculate D’Leon’s forecasted
current and quick ratios for 2002.
$2,680
CA
CR02 = CL = $1,145 = 2.34x.
CA – Inv.
QR02 =
CL
$2,680 – $1,716
=
=
0.84x.
$1,145
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3 – 15
Comments on CR and QR
2002
2001
2000
Ind.
CR
2.34x
1.2x
2.3x
2.7x
QR
0.84x
0.4x
0.8x
1.0x
 Expected to improve but still below
the industry average.
 Liquidity position is weak.
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3 – 16
A company has current liabilities of $800
million, and its current ratio is 2.5. What is
its level of current assets? If this firm’s quick
ratio is 2, how much
inventory does it have?
1. ($2,000 million)
2. ($400 million)
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3 – 17
What is the inventory turnover ratio vs.
the industry average?
Sales
Inv. turnover = Inventories
$7,036
=
= 4.10x.
$1,716
2002
2001
2000
Ind.
Inv. T. 4.1x
4.7x
4.8x
6.1x
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3 – 18
Comments on Inventory Turnover
Inventory turnover is below
industry average.
D’Leon might have old inventory,
or its control might be poor.
No improvement is currently
forecasted.
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3 – 19
Days sales outstanding (DSO),DSO is
the average number of days after
making a sale before receiving cash.
Receivables
DSO = Average sales per day
Receivables
$878
= Sales/365 = $7,036/365 = 45.5
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3 – 20
Appraisal of DSO
DSO
2002
45.6
2001
38.2
2000
37.4
Ind.
32.0
 D’Leon collects too slowly, and is getting
worse.
 D’Leon has a poor credit policy.
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3 – 21
A firm has annual sales of $200 million, $40
million of inventory, and $60 million of
accounts receivable. What is its inventory
turnover ratio? What is its DSO based
on a 365-day year?
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3 – 22
A firm has annual sales of $200 million, $40
million of inventory, and $60 million of
accounts receivable. What is its inventory
turnover ratio? What is its DSO based
on a 365-day year?
(5)
(109.5 days)
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3 – 23

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3 – 25
F.A. and T.A. Turnover versus
Industry Average
Fixed assets
Sales
=
turnover
Net fixed assets
$7,036
=
= 8.61x.
$817
Total assets
=
turnover
Sales
Total assets
$7,036
=
= 2.01x.
$3,497
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3 – 26
2002
FA TO 8.6x
TA TO 2.0x
2001
6.4x
2.1x
2000
10.0x
2.3x
Ind.
7.0x
2.6x
FA turnover projected to exceed
industry average. Good.
TA turnover not up to industry
average. Caused by excessive
current assets (A/R and Inv.)
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3 – 27
Calculate the debt ratio, Time-interestearned (TIE) ratio, and EBITDA
coverage ratios.
Total debt
Debt ratio = Total assets
= $1,145 + $400 = 44.2%.
$3,497
EBIT
TIE =
Int. expense
= $492.6 = 7.0x.
$70
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3 – 28
EBITDA coverage =
EBITDA + Lease payments (in cash)
Interest Lease
Principal
expense + pmt. + repayments
$609.6
+
$40
=
= 5.9x.
$70 + $40 + $0
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3 – 29
How do the debt management ratios
compare with industry averages?
D/A
TIE
EBITDA
coverage
2002 2001 2000
Ind.
44.2% 82.8% 54.8% 50.0%
7.0x -1.0x 4.3x 6.2x
5.9x
0.1x
3.0x
8.0x
D/A and TIE are better than industry
average but EBITDA still below industry
average.
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3 – 30
Profit margin vs. industry average?
NI
$253.6
P.M. = Sales = $7,036 = 3.6%.
P.M.
2002
3.6%
2001
-2.7%
2000 Ind.
2.6% 3.5%
Very bad in 2001, but projected to
exceed industry average in 2002.
Looking good.
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3 – 31
Basic Earning Power (BEP) vs.
industry average?
EBIT
BEP =
Total assets
$492.6
= $3,497 = 14.1%.
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3 – 32
BEP
2002
14.1%
2001
-4.6%
2000
13.0%
Ind.
19.1%
BEP removes effect of taxes and
financial leverage. Useful for
comparison.
Projected to be below average.
Room for improvement.
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3 – 33
Return on Assets
Net
income
ROA =
Total assets
$253.6
= $3,497 = 7.3%.
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3 – 34
Net income
ROE = Common equity
= $253.6 = 13.0%.
$1,952
ROA
ROE
2002
7.3%
13.0%
2001 2000
Ind.
-5.6% 6.0% 9.1%
-32.5% 13.3% 18.2%
Both below average but improving.
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3 – 35
Effects of Debt on ROA and ROE
ROA is lowered by debt–interest
lowers NI, which also lowers ROA =
NI/Assets.
But use of debt lowers equity,
hence could raise ROE = NI/Equity.
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3 – 36
Typical Industry Average P/E Ratios
Industry
P/E ratio
Banking
16.58
Computer Software Services
84.28
Drug
43.89
Electric Utilities (Eastern U.S.) 25.28
Internet Services*
326.53
Semiconductors
85.44
Steel
12.38
Tobacco
11.07
Water Utilities
22.30
* Because many internet companies have negative earnings and no
P/E, there was only a small sample of internet companies.
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3 – 37
Price per share
P/E =
Earning per share
$12.17
= $1.48 = 8.21x.
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3 – 38
Com. equity
BVPS =
Shares out.
$1,952
=
= $7.81.
250
Mkt. price per share
M/B =
Book value per share
$12.17
= $7.81 = 1.56x.
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3 – 39
P/E
2002
12.0x
2001
-1.4x
2000
9.7x
Ind.
14.2x
M/B
1.56x
0.5x
1.3x
2.4x
 P/E: How much investors will pay for
$1 of earnings. High is good.
 M/B: How much paid for $1 of BV.
Higher is better.
 P/E and M/B are high if ROE is high,
risk is low.
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3 – 40
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3 – 41
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3 – 42
The Du Pont system focuses on:
Expense control (P.M.)
Asset utilization (TATO)
Debt utilization (Eq. Mult.)
It shows how these factors combine
to determine the ROE.
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3 – 43
ROE= NI/E
ROA*E multiplier
NI/T.A*T.A/E
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3 – 44
Profit
margin
TA
turnover
NI
Sales
Sales
TA
2000 2.6% x 2.3
2001 -2.7% x 2.1
2002 3.6% x 2.0
Ind.
3.5% x 2.6
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Equity
multiplier
TA
CE
x
x
x
x
2.2 = 13.3%
5.8 = -32.5%
1.8 = 13.0%
2.0 = 18.2%
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3 – 45
1. Explain how the extended, or modified,
Du Pont equation can be used to reveal
the basic determinants of ROE.
What is the equity multiplier?
2. A company has a profit margin of 6%, a
total asset turnover ratio of 2, and an
equity multiplier of 1.5. What is its ROE?
18%
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3 – 46
Simplified D’Leon Data
A/R
878 Debt
Other CA
1,802 Equity
Net FA
817
Total assets $3,497 L&E
Sales
day
1,545
1,952
$3,497
$7,035,600
=
= $19,275.62.
365
Q. How would reducing DSO to 32
days affect the company?
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3 – 47
Effect of reducing DSO from
45.6 days to 32 days:
Old A/R = 19,275.62 x 45.6 = 878,000
New A/R = 19,275.62 x 32.0 = 616,820
Cash freed up:
261,180
Initially shows up as additional cash.
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3 – 48
New Balance Sheet
Added cash
A/R
Other CA
Net FA
Total assets
$
261 Debt
$1,545
617 Equity
1,952
1,802
817
$3,497 Total L&E $3,497
What could be done with the new
cash? Effect on stock price and risk?
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3 – 49
Potential use of freed up cash
Repurchase stock
Expand business
Reduce debt
All these actions would improve
stock price.
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3 – 50
What are some potential problems and
limitations of financial ratio analysis?
Comparison with industry averages
is difficult if the firm operates many
different divisions.
“Average” performance not
necessarily good.
Seasonal factors can distort ratios.
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3 – 51
“Window dressing” techniques can
make statements and ratios look
better.
Different operating and accounting
practices distort comparisons.
Sometimes hard to tell if a ratio is
“good” or “bad.”
Difficult to tell whether company is,
on balance, in strong or weak
position.
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3 – 52
What are some qualitative factors
analysts should consider when
evaluating a company’s likely future
financial performance?
Are the company’s revenues tied to
1 key customer, product, or
supplier?
What percentage of the company’s
business is generated overseas?
Competition
Future prospects
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Legal
and
regulatory
environment

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