1. Define each of the following terms:
a. Liquidity ratios: current ratio; quick, or acid test, ratio
b. Asset management ratios: inventory turnover ratio; days sales outstanding (DSO);
fixed assets turnover ratio; total assets turnover ratio
c. Financial leverage: debt ratio; times-interest-earned (TIE) ratio; coverage
ratio
d. Profitability ratios: profit margin on sales; basic earning power (BEP) ratio; return on
total assets (ROA); return on common equity (ROE)
e. Market value ratios: price/earnings (P/E) ratio; price/cash flow ratio; market/book
(M/B) ratio; book value per share
f. Trend analysis; comparative ratio analysis; benchmarking
g. Du Pont equation; “Window dressing”; seasonal effects on ratios
Financial ratio analysis is conducted by four groups of analysts: managers, equity in-vestors, long-term creditors, and short-term creditors. What is the primary emphasis of
each of these groups in evaluating ratios?
Over the past year, M. D. Ryngaert & Co. has realized an increase in its current ratio
and a drop in its total assets turnover ratio. However, the company’s sales, quick ratio,
and fixed assets turnover ratio have remained constant. What explains these changes?
Profit margins and turnover ratios vary from one industry to another. What differences
would you expect to find between a grocery chain such as Safeway and a steel company?
Think particularly about the turnover ratios, the profit margin, and the Du Pont equation.
How might (a) seasonal factors and (b) different growth rates distort a comparative ratio
analysis? Give some examples. How might these problems be alleviated?
Why is it sometimes misleading to compare a company’s financial ratios with other firms
that operate in the same industry?
PROBLEMS:
Greene Sisters has a DSO of 20 days. The company’s annual sales are $20,000. What
is the level of its accounts receivable? Assume there are 365 days in a year.
Vigo Vacations has an equity multiplier of 2.5. The company’s assets are financed with
some combination of long-term debt and common equity. What is the company’s debt
ratio?
Winston Washer's stock price is $75 per share. Winston has $10 billion in total assets. The left side of its balance sheet consists of $1 billion in current liabilities, $3 billion in long-term debt, and $6 billion in common equity. It has 800 million shares of common stock outstanding. What is Jaster’s market/book ratio?
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