ACC741: CORPORATE FINANCIAL MANAGEMENT I

TOPIC THREE: FINANCIAL STATEMENTS ANALYSIS

TUTORIAL QUESTIONS

1. Differentiate between trend analysis and comparative ratio analysis?

2. Why is it necessary to conduct both trend and comparative ratio analysis?

3. Identify two ratios that relate a firm’s stock price to its earnings and book
value per share, and write out the equations.

4. If a typical firm reports $20 million of retained earnings on its balance sheet,
could its directors declare a $20 million cash dividend without any qualms
whatsoever? Explain why or why not.
SOLUTION:
Yes , directors may distribute the entire profits as dividends if they wish. However, this
is most unlikely. The directors have a responsibility to operate in the best interests of
the shareholders. One of their major responsibilities is to help the company grow it
business, thereby creating shareholder wealth. Most companies will have incorporated
in their rules one that determines what proportion of annual profits will be distributed as
dividends ( usually around 50-60%). The balance is retained in the business as capital
for further expansion.

5. Describe the changes in balance sheet accounts that would constitute sources
of funds. What changes would be considered uses of funds?

6. Profit margins and turnover ratios vary from one industry to another. What
differences would you expect to find between a grocery chain like Bulk Shop
and a metal sheet company? Think particularly about the turnover ratios and
the profit margin, and think about the DuPont equation.

7. If a firm’s ROE is low and management wants to improve it, explain how
using more debt might help. Could using debt be a detriment?

8. A company had earnings per share of $4 last year, and it paid a $2 dividend.
Total retained earnings increased by $12 million during the year, while book
value per share at year-end was $40. The company has no preferred stock,
and no new common stock was issued during the year. If the company’s
year-end debt was $120 million, what was the company’s year-end
debt/assets ratio?

9. The following data apply to AK Company:

Cash and marketable securities $100.00

Fixed assets $283.50
Sales $1,000.00

1
Net income $50.00
Quick ratio 2 times
Current ratio 3 times
DSO 40 days
ROE 12%

AK Company has no preferred stock – only common equity, current

liabilities and long-term debt.
Required:
1) Find the company’s following:
a. Accounts receivable (A/R)
b. Current liabilities
c. Current assets
d. Total assets
e. ROA
f. Common equity
g. Long-term debt

2) In part (1) above, you should have found the accounts receivable to
be $111.1 million. If the company could reduce its DSO from 40 days
to 30 days while holding other things constant, how much cash would
it generate? If this cash were used to buy back common stock (at
book value) and thus reduced the amount of common equity, how
would this affect:
i. The ROE
ii. ROA
iii. Total debt/total assets ratio