FIN101/102/103/105: Exercises on Analysis of Financial Statements
1. Ruth Company currently has $1,000,000 in accounts receivable. Its days sales outstanding (DSO) is 50 days. The
company wants to reduce its DSO to the industry average of 32 days by pressuring more of its customers to pay
their bills on time. The companys CFO estimates that if this policy is adopted the companys average sales will
fall by 10 percent. Assuming that the company adopts this change and succeeds in reducing its DSO to 32 days
and does lose 10 percent of its sales, what will be the level of accounts receivable following the change? Assume
a 365-day year.
2. Collins Company had the following partial balance sheet and complete income statement information for
2002:
Partial Balance Sheet:
Cash
A/R
Inventories
Total current assets
Net fixed assets
Total assets
$ 20
1,000
2,000
$ 3,020
2,980
$ 6,000
Income Statement:
Sales
Cost of goods sold
EBIT
Interest (10%)
EBT
Taxes (40%)
Net income
$10,000
9,200
$ 800
400
$ 400
160
$ 240
The industry average DSO is 30 (assuming a 365-day year). Collins plans to change its credit policy so as to
cause its DSO to equal the industry average, and this change is expected to have no effect on either sales or
cost of goods sold. If the cash generated from reducing receivables is used to retire debt (which was
outstanding all last year and has a 10 percent interest rate), what will Collins debt ratio (Total debt/Total
assets) be after the change in DSO is reflected in the balance sheet?
3. Taft Technologies has the following relationships:
Annual sales
Current liabilities
Days sales outstanding (DSO) (365-day year)
Inventory turnover ratio
Current ratio
$1,200,000.00
$ 375,000.00
40.00
4.80
1.20
The companys current assets consist of cash, inventories, and accounts receivable. How much cash does Taft
have on its balance sheet?
4. Roland & Company has a new management team that has developed an operating plan to improve upon last
years ROE. The new plan would place the debt ratio at 55 percent, which will result in interest charges of
$7,000 per year. EBIT is projected to be $25,000 on sales of $270,000, it expects to have a total assets
turnover ratio of 3.0, and the average tax rate will be 40 percent. What does Roland & Company expect its
return on equity to be following the changes?
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5. Lone Star Plastics has the following data:
Assets
Profit margin
Tax rate
Debt ratio
Interest rate
Total assets turnover
$100,000
6.0%
40%
40.0%
8.0%
3.0
What is Lone Stars EBIT?
6. Georgia Electric reported the following income statement and balance sheet for the previous year:
Balance Sheet:
Cash
Inventories
Accounts receivable
Current assets
$ 100,000
1,000,000
500,000
$1,600,000
Net fixed assets
Total assets
4,400,000
$6,000,000
Income Statement:
Sales
Operating costs
Operating income (EBIT)
Interest
Taxable income (EBT)
Taxes (40%)
Net income
Total debt
Total equity
Total claims
$4,000,000
2,000,000
$6,000,000
$3,000,000
1,600,000
$1,400,000
400,000
$1,000,000
400,000
$ 600,000
The companys interest cost is 10 percent, so the companys interest expense each year is 10 percent of its
total debt.
While the companys financial performance is quite strong, its CFO (Chief Financial Officer) is always looking for
ways to improve. The CFO has noticed that the companys inventory turnover ratio is considerably weaker
than the industry average, which is 6.0. As an exercise, the CFO asks what would the companys ROE have
been last year if the following had occurred:
The company maintained the same sales, but was able to reduce inventories enough to achieve the
industry average inventory turnover ratio.
The cash that was generated from the reduction in inventories was used to reduce part of the
companys outstanding debt. So, the companys total debt would have been $4 million less the freed-up
cash from the improvement in inventory policy. The companys interest expense would have been 10
percent of new total debt.
Assume equity does not change. (The company pays all net income as dividends.)
Under this scenario, what would have been the companys ROE last year?
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