Examples of Questions on Ratio Analysis

A: Multiple Choice Questions

1. Which of the following is considered a profitability measure?
a. Days sales in inventory
b. Fixed asset turnover
c. Price-earnings ratio
d. ash coverage ratio
e. !eturn on "ssets
#. Firm " has a !eturn on $%uity &!'$( e%ual to #)*+ while firm , has an !'$ of 1-*
during the same year. ,oth firms have a total debt ratio &D./( e%ual to 0.1. Firm " has
an asset turnover ratio of 0.2+ while firm , has an asset turnover ratio e%ual to 0.).
From this we 3now that
a. Firm " has a higher profit margin than firm ,
b. Firm , has a higher profit margin than firm "
c. Firm " and , have the same profit margin
d. Firm " has a higher e%uity multiplier than firm ,
e. 4ou need more information to say anything about the firm5s profit margin
6. 7f a firm has 8100 in inventories+ a current ratio e%ual to 1.#+ and a %uic3 ratio e%ual
to 1.1+ what is the firm5s 9et Wor3ing apital?
a. 80
b. 8100
c. 8#00
d. 81+000
e. 81+#00
). :o measure a firm5s solvency as completely as possible+ we need to consider
a. :he firm5s relative proportion of debt and e%uity in its capital structure
b. :he firm5s capital structure and the li%uidity of its current assets
c. :he firm5s ability to use 9et Wor3ing apital to pay off its current liabilities
d. :he firms leverage and its ability to ma3e interest payments on its long-term debt
e. :he firm leverage and its ability to turn its assets over into sales
B: Problem Solving Questions
4ou have been hired as an analyst for ;ellon ,an3 and your team is wor3ing on an
independent assessment of Daffy Duc3 Food 7nc. &DDF 7nc.( DDF 7nc. is a firm that
speciali<es in the production of freshly imported farm products from France. 4our
assistant has provided you with the following data for Flipper 7nc and their industry.
Ratio !!! !!" !!#
!!!$
%n&ustry
Average
=ong-term debt 0.)- 0.)0 0.6- 0.6-
7nventory :urnover >#.>- )#.)# 6#.#- -6.#-
Depreciation.:otal "ssets 0.#- 0.01) 0.011 0.01-
Days? sales in receivables 116 21 2) 160.#-
Debt to $%uity 0.@- 0.1- 0.20 0.11
Profit ;argin 0.01# 0.0@ 0.0> 0.0@-
:otal "sset :urnover 0.-) 0.>- 0.@0 0.)0
Auic3 !atio 1.0#1 1.06 1.0#2 1.061
urrent !atio 1.66 1.#1 1.1- 1.#-
:imes 7nterest $arned 0.2 ).6@- ).)- ).>-
$%uity ;ultiplier 1.@- 1.1- 1.20 1.11
a. 7n the annual report to the shareholders+ the $' of Flipper 7nc wrote+ B122@ was a
good year for the firm with respect to our ability to meet our short-term obligations.
We had higher li%uidity largely due to an increase in highly li%uid current assets
&cash+ account receivables and short-term mar3etable securities(.C 7s the $'
correct? $xplain and use only relevant information in your analysis.
b. What can you say about the firm5s asset management? ,e as complete as possible
given the above information+ but do not use any irrelevant information.
c. 4ou are as3ed to provide the shareholders with an assessment of the firm5s solvency
and leverage. ,e as complete as possible given the above information+ but do not use
any irrelevant information.
A'S(ERS:
"nswer 1D e
"nswer #D b &Profit margin of firm "E-.66* and for firm ,E@.-* - use Du Pont 7dentity(
"nswer 6D ".=E1.# and &"-100(.=E1.1 EF solve and find =E1+000 and
"E1+#00EF answer c
"nswerD d
A'S(ERS )* PR*B+EM: ,note that these are -ust examples of a goo& ans.er/
a. :he answer should be focused on using the current and %uic3 ratios. While the current
ratio has steadily increased+ it is to be noted that the li%uidity has not resulted from
the most li%uid assets as the $' proposes. 7nstead+ from the %uic3 ratio one could
note that the increase in li%uidity is caused by an increase in inventories. For a fresh
food firm one could argue that inventories are relatively li%uid when compared to
other industries. "lso+ given the information+ the industry-benchmar3 can be used to
derive that the firm5s %uic3 ratio is very similar to the industry level and that the
current ratio is indeed slightly higher - again+ this seems to come from inventories.
b. 7nventory turnover+ days sales in receivables+ and the total asset turnover ratio are to
be mentioned here. 7nventory turnover has increased over time and is now above the
industry average. :his is good - especially given the fresh food nature of the firm5s
industry. 7n 1222 it means for example that every 6>-.>#.>- E -.2 days the firm is
able to sell its inventories as opposed to the industry average of >.2 days. Days5 sales
in receivables has gone down over time+ but is still better than the industry average.
Go+ while they are able to turn inventories around %uic3ly+ they seem to have more
trouble collecting on these sales+ although they are doing better than the industry.
Finally+ total asset turnover is went down over time+ but it is still higher than the
industry average. 7t does tell us something about a potential problem in the firm5s long
term investments+ but again+ they are still doing better than the industry.
c. Golvency and leverage is captured by an analysis of the capital structure of the firm
and the firm5s ability to pay interest. apital structureD ,oth the e%uity multiplier and
the debt-to-e%uity ratio tell us that the firm has become less levered. :o get a better
idea about the proportion of debt in the firm+ we can turn the D.$ ratio into the D./
ratioD 1222D )6*+ 1221D )>*+ 122@D)@*+ and the industry-average is )@*. Go based
on this+ we would li3e to 3now why this is happening and whether this is good or bad.
From the numbers it is hard to give a %ualitative Hudgement beyond observing the
drop in leverage. 7n terms of the firm5s ability to pay interest+ 1222 loo3s pretty bad.
Iowever+ remember that times interest earned uses $,7: as a proxy for the ability to
pay for interest+ while we 3now that we should probably consider cash flow instead of
earnings. ,ased on a relatively large amount of depreciation in 1222 &see info(+ it
seems that the firm is doing Hust fine.