Principles of

Chapter 8 Corporate Finance

Tenth Edition

Financial Analysis

Slides by
Matthew Will

Copyright © 2011 by the McGraw-Hill Companies,

Inc. All rights reserved.
McGraw-Hill/Irwin
12-2

Before-Class Assignment (Day 11)

Q1:
Burnside's has accounts receivable of
$33,700, inventory of $54,200, sales of
$364,200, and cost of goods sold of $193,400.
How long does it take the firm to sell its
inventory and collect payment on the sale?
12-3

Before-Class Assignment (Day 11)

Inventory turnover = $193,400/$54,200 = 3.57

Days in inventory = 365/3.57 = 102.29 days
Accounts receivable turnover = $364,200/$33,700 = 10.81
Days' sales in receivables = 365/10.81 = 33.77 days
Total days in inventory and receivables = 102.29 + 33.77 = 136.06 days
12-4

Before-Class Assignment (Day 11)

Calculate financial ratios:

Balance Sheet
Assets 2019 2018 Liabilities and Shareholders' Equity 2019 2018
Current assets
Current liabilities
Cash and marketable securities 661 530
Debt due for repayment 1,021 1,104
Accounts receivable 166 247 Accounts payable 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long term debt 5,039 5,576
Deferred income taxes 660 670
Fixed assets Other long-term liabilities 910 774
Tangible fixed assets
Property, plant, and equipment 31,477 28,836 Total liabilities 14,631 14,771

Less accumulated depreciation 8,755 7,475

Common Stock and other paid-in- 735 729
Net tangible fixed assets 22,722 21,361 capital
Retained earnings and capital surplus 17,320 15,369
Long term investments 253 509
Other long-term assets 460 313 Total shareholders' equity 18,055 16,098
Total assets 32,686 30,869 Total liabilities and shareholders' 32,686 30,869
equity
12-5

Before-Class Assignment (Day 11)

Calculate financial ratios:

Income Statement 2019

Net sales 48,230

Cost of goods sold 31,729

Selling, general, and administrative expenses 11,158

Depreciation 1,539

Earnings before interest and taxes (EBIT) ?

Interest expense 298

Earnings before taxes (EBT) ?

Tax (20%) ?
Net Income ?

Dividends (30%) ?
Addition to retained earnings (70%) ?
12-6

Before-Class Assignment (Day 11)

Calculate financial ratios:

Look up the latest financial statement for a
company:
1. Fill in the blank (?) of Income statement.
2. Calculate the following financial ratios of year -
2019:
➢ Return on asset (ROA), return on equity (ROE)
➢ Current ratio, quick ratio
➢ Cash cycle (Average Days in Inventory, Average
collection period, Average payment period)
12-7

Before-Class Assignment (Day 11)

Income Statement 2018

a. Net sales 48,230
Cost of goods sold 31,729
Selling, general, and administrative 11,158
expenses
Depreciation 1,539
Earning before interest and taxes (EBIT) 3,804
Interest expense 298
Earning before taxes (EBT) 3,506
Tax (20%) 701
Net Income 2,805

Dividends (30%) 841.44

Addition to retained earnings (70%) 1,963.36
12-8

Before-Class Assignment (Day 11)

b. Financial ratios
ROE 15.53%
ROA 8.58%
Current Ratio 1.15
Quick Ratio 0.13
Inventory turnover 4.01 times
Average Days in Inventory 89.75 days
Account receivable turnover 233.56 times
Average collection period 1.54 days
Account payable turnover 7.31 times
Average payment period 49.24 days
Cash cycle 42.05 days
12-9

Before-Class Assignment (Day 11) (con’t)

Here are simplified financial statements for AAG

Corporation in a recent year:
Liabilities and Shareholders' Equity 2020 2019
1.Balance Sheet
Assets 2020 2019 Current liabilities
Current assets Debt due for repayment 15,739 18,170
Cash and cash equivalents 9,334 9,522
Accounts payable 8,309 8,616
Marketable securities 7,647 9,464
Other current liabilities 4,768 5,097
Accounts receivable 8,339 8,164
Inventories 13,461 15,047 Total current liabilities 28,816 31,883
Other current assets 832 896
Total current assets 39,613 43,093 Long term debt 7,694 7,743
Deferred income taxes 0 0
Fixed assets Other long term liabilities 22,607 20,975
Tangible fixed assets
Property, plant, and equipment 47,869 56,341 Total liabilities 59,117 60,601

Less accumulated depreciation 8,755 7,475

Common Stock and other paid-in-
Net tangible fixed assets 39,114 48,866 32,201 37,969
capital
Retained earnings 4,916 8,636
Long term investments 8,723 8,897
Other long-term assets 8,784 6,350 Total shareholders' equity 37,117 46,605
Total assets 96,234 107,206 Total liabilities and shareholders' 107,20
96,234
equity 6
12-10

Before-Class Assignment (Day 11) (con’t)

Here are simplified financial statements for AAG

Corporation in a recent year:
Income Statement 2020
Net sales 58,035

Cost of goods sold 38,284

Selling, general, and administrative expenses 3,783

Depreciation 8,150
Earnings before interest and taxes (EBIT) 7,818
Interest expense 2,500
Earning before taxes (EBT) 5,318
Tax (20%) 1063.6
Net Income 4,254
12-11

Before-Class Assignment (Day 11) (con’t)

Here are simplified financial statements for AAG

Corporation in a recent year:
Look up the latest financial statement for a
company:
Calculate the following financial ratios
and analyze each ratio for the year - 2020:
a) Return on equity (ROE)
b) Current ratio
c) Cash Conversion Cycle (Average Days in
Inventory, Average collection period, Average
payment period)
12-12

Before-Class Assignment (Day 11) (con’t)

Net Income 4,254.40

Total Shareholder Equity 37,117.00
ROE 11.46%
Comment
Current asset 39,613.00
Current liability 28,816.00
Current ratio 1.37
Comment

Sale 58,035.00
Average AR 8,251.50
AR turnover 7.03
Average collection period 51.90
12-13

Before-Class Assignment (Day 11) (con’t)

COGS 38,284.00
Average inventory 14,254.00
Inventory turnover 2.69
Average days in inventory 135.90

COGS 38,284.00
Average account payable 8,462.50
Payable turnover 4.52
Average days in AP 80.68

Cash cycle 107.11

Comments
12-14

Topics Covered
➢Financial Statements
➢Measuring Profitability
➢Measuring Efficiency
➢Measuring Leverage
➢Measuring Liquidity
➢Interpreting Financial Ratios
12-15
12-16
Lowe’s Companies
12-17

Balance sheet ($mil) Balance sheet ($ mil)

2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Current liabilities
Cash and marketable securities 661 530 Debt due for repayment 1,021 1,104
Accounts receivable 166 247 Accounts payable 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
TangiNet working
ble fixed assets capital = Current Asset
Other long-term liabilities– Current Liabilities
910 774
property plant and equipment 31,477 28,836 Total liabilities 14,631 14,771
Less accumulated depreciation 8,755 7,475
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
Lowe’s Companies
12-18

Balance sheet ($mil) Balance sheet ($ mil)

2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Current liabilities
Cash and marketable securities 661 530 Debt due for repayment 1,021 1,104
Accounts receivable 166 247 Accounts payable 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
TangibleNet
fixed assets working capital = Current Asset
Other long-term liabilities – Current910Liabilities
774
property plant and equipment 31,477NWC28,836
(2008)Total=liabilities
1,229 ($mil) 14,631 14,771
Less accumulated depreciation 8,755 NWC7,475(2007) = 935 ($mil)
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
Lowe’s Companies
12-19

Balance sheet ($mil) Balance sheet ($ mil)

2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Current liabilities
Cash and marketable securities 661 530 Debt due for repayment 1,021 1,104
Accounts receivable Total capital
166 =247 Long-term
Accounts payable debt + Equity 4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
Tangible fixed assets Other long-term liabilities 910 774
property plant and equipment 31,477 28,836 Total liabilities 14,631 14,771
Less accumulated depreciation 8,755 7,475 Book value of equity
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
Lowe’s Companies
12-20

Balance sheet ($mil) Balance sheet ($ mil)

2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Total capital = Long-term
Current liabilitiesdebt + Equity
Cash and marketable securities Total661Capital530 (2007)
Debt due= 21,674 ($mil)1,021
for repayment 1,104
Accounts receivable Total166Capital Accounts=
247 (2008) payable
23,094 ($mil)4,543 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
Tangible fixed assets Other long-term liabilities 910 774
property plant and equipment 31,477 28,836 Total liabilities 14,631 14,771
Less accumulated depreciation 8,755 7,475
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
Lowe’s Companies
12-21

Net Income = ( EBIT – Interest ) x (1 – Tax rate)

Income ($ mil)
2008
Net sales 48,230
Cost of goods sold 31,729
Selling, general, and administrative expenses 11,158
Depreciation 1,539
Earnings before interest and taxes (EBIT) 3,804
Interest expense 298
Taxable income 3,506
Tax 1,311
Net income 2,195

Dividends 491
Addition to retained earnings 1,704
Lowe’s Companies
12-22

Balance sheet ($mil) Balance sheet ($ mil)

2008 2007 2008 2007
Assets Liabilities and Shareholders’ Equity
Current assets Current liabilities
Cash and marketable securities 661 530 Debt due for repayment 1,021 1,104
Accounts receivTotal
able long-term
166 capital
247 =Accounts
Long-term
payable debt + 4,543
Equity 4,137
Inventories 8,209 7,611 Other current liabilities 2,458 2,510
Other current assets 215 298 Total current liabilities 8,022 7,751
Total current assets 9,251 8,686
Long-term debt 5,039 5,576
Fixed assets Deferred income taxes 660 670
Tangible fixed assets Other long-term liabilities 910 774
property plant and equipment 31,477 28,836 Total liabilities 14,631 14,771
Less accumulated depreciation 8,755 7,475 Book value of equity
Net tangible fixed assets 22,722 21,361 Common stock and other paid-in capital 735 729
Retained earnings and capital surplus 17,320 15,369
Long -term investments 253 509 Total shareholders' equity 18,055 16,098
Other long-term assets 460 313
Total assets 32,686 30,869 Total liabilities and shareholders’ equity 32,686 30,869
12-23

Measuring Profitability
Lowe’s Profitability Measurements
12-24

Measuring Efficiency
12-25

Measuring Efficiency

Efficiency ratios indicate:

I) How productively is the firm utilizing its
assets.
II) How liquid is the firm.
III) How profitable is the firm.
IV) How highly is the firm valued by investors.
a/ I only
b/ II only
c/ III only
d/ III and IV only
12-26

Measuring Efficiency

Efficiency ratios indicate:

I) How productively is the firm utilizing its
assets.
II) How liquid is the firm.
III) How profitable is the firm.
IV) How highly is the firm valued by investors.
*a/ I only
b/ II only
c/ III only
d/ III and IV only
12-27

Measuring Efficiency

Given the following data: Sales = 3200; Cost

of goods sold = 1600; Average total assets =
1600; Average inventory = 200, calculate the
asset turnover ratio:
*a/ 2.0
b/ 0.9375
c/ 1.33
d/ 0.5
12-28

Measuring Efficiency

Given the following data: Sales = 3200; Cost

of goods sold = 1600; Average total assets =
1600; Average inventory = 200, calculate the
days in inventory:
*a/ 45.6
b/ 18.3
c/ 22.8
d/ 37.4
12-29

Measuring Efficiency (cont)

12-30

Measuring Efficiency

When a firm improves (lowers) its days in

inventories it generally:
*a/ Releases cash locked up in inventory
b/ Requires additional cash investment in
inventory
c/ Does not alter its cash position
d/ A firm cannot reduce its inventories
12-31

Measuring Efficiency

When a firm improves (lowers) its average

collection period it generally:
*a/ Releases cash locked up in accounts
receivables
b/ Requires additional cash investment in
inventory
c/ Does not alter its cash position
d/ A firm cannot reduce its inventories
12-32

Measuring Efficiency

ABC has the beginning accounts receivable

balance is $75,534 and the ending accounts
receivable balance is $76,209. It takes 44.24
days to collect its receivables. What is the
sales? (Assume the year has 365 days)
*a/ $626,000
b/ $536,000
c/ $716,000
d/ $613,000
12-33

Measuring Efficiency

Given the following data: Sales = 3200; Cost

of good sold = 1600; Average receivables =
200, calculate the average collection period:
*a/ 22.8
b/ 24.3
c/ 137
d/ 32.5
12-34

Measuring Leverage
long term debt
Long term debt ratio =
long term debt + equity
Balance long term debt
Debt equity ratio =
Sheet equity

Income
Statement
12-35

Measuring Leverage

Which of the following is an example of

leverage ratios?
a/ Debt-Equity ratio
b/ Quick ratio
c/ Payout ratio
d/ Return on equity
12-36

Measuring Leverage

Which of the following is an example of

leverage ratios?
*a/ Debt-Equity ratio
b/ Quick ratio
c/ Payout ratio
d/ Return on equity
12-37

Measuring Leverage

If the debt ratio is 0.5 what is the debt-equity

ratio? (assume no leases)
*a/ 1.0
b/ 0.5
c/ 2.0
d/ 4.0
12-38

Measuring Leverage

Given the following data: Long term debt =

100; Value of leases = 20; Book value of
equity = 80; Market value of equity = 100,
calculate the debt ratio.
*a/ 0.60
b/ 0.56
c/ 0.50
d/ 0.55
12-39

Measuring Leverage

Given the following data: Long term debt =

100; Value of leases = 20; Book value of
equity = 80; Market value of equity = 100,
calculate the debt-equity ratio.
*a/ 1.50
b/ 0.50
c/ 0.60
d/ 1.0
12-40

Measuring Leverage

Given the following data: EBIT = 100;

Depreciation = 40; Interest = 20; Dividends =
10; calculate the Times Interest Earned (TIE)
ratio.
*a/ 7.0
b/ 5.0
c/ 4.7
d/ 14.0
12-41

The DuPont System

Net income
ROE =
Equity

Assets Sales NOPAT Net income

ROE = X X X
Equity Assets Sales NOPAT

ROE = Leverage Asset Operating Debt

ratio turnover profit burden
margin
12-42

Measuring Liquidity

Net working capital Net working capital

=
to total assets ratio Total assets

Cash & Marketable securities

Receivables
Inventory
Other current assets
current assets
Current ratio =
current liabilities
12-43

Measuring Liquidity
Balance Sheet

Net working capital Net working capital

=
to total assets ratio Total assets

current assets
Current ratio =
current liabilities
12-44

Before-Class Assignment (Day 12)