FAR670 – DEC 2018

ANSWER SCHEME FAR 670 – DEC 2018

PART A

Question Answer Question Answer

1 B 7 C
2 A 8 B
3 D 9 B
4 B 10 B
5 D 11 D
6 B 12 C

PART B

QUESTION 1

a. i. The ratio captures only the amount of current assets, but the components of current
assets differ significantly in their nearness to cash (e.g. marketable securities versus
inventory).
ii. Determining whether a ratio for a company is within a reasonable range for an
industry.
iii. Whether A ratio signifies a persistent condition or reflects only a temporary
condition
iv. Overall, evaluating specific ratios requires an examination of the entire operations of
a company, its competitors, and the external economic and industry setting in which
it is operating.

b. i. Companies that have naturally slow-moving inventories and receivables

ii. Companies that highly speculative

c. i. Investing public is interested in specific types of analysis. They are concerned with
the financial position√ of the entity and its ability to earn future profit√. The investor
uses an analysis of past trends√ and current position √to project the future
prospects √of the entity.
ii. Short term creditors are interested in the current resources that appear on the
financial statement√ to determine if an entity has the ability to pay their short term
obligation when it is due√ and to determine if credit should be extended

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 FAR670 – DEC 2018

QUESTION 2

a. 2017 2016
Net sales 100 100
Other income 1.41 1.61

Manufacturing cost of products sold 40.99 36.00

Research and development 8.51 8.73
General and selling expenses 33.14 34.45
Interest 1.18 0.89
Other expenses 0.98 0.56

Earnings before tax and NCI 16.60 20.97

Income tax 7.21 9.40

Net earnings 8.70 10.59

b. i. Net profit margin = NI/Net sales

2017 2016
476,408 274,220
3,178,300 2,589,932
= 8.70% = 10.59%

ii. Return on Assets = Net income before MI

and non-recurring items
Ending Total Assets
2017 2016
276,408 274,220
2,875,272 2,364,220
= 9.61% = 11.60%

iii. Total Asset Turnover = Net Sales

Ending Total Assets
2017 2016
3,178,300 12,589,962
2,875,272 12,364,220
= 1.11 times = 1.10 times

iv. DuPont Analysis

Return on Assets = Net profit margin x Total Asset Turnover
2017: 9.66 = 9.70% x 1.11
2016: 11.65 = 10.59% x 1.10

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 FAR670 – DEC 2018

c. Liquidity – with exception of the inventory turnover ratio, the company liquidity ratios were
adequate to good. The current ratio is above 2.0 and higher than industry average. The
company also collects their accounts receivable faster√ than average industry i.e 21.9 days in
comparison to 25 days taken by industry (or higher receivable turnover than industry). Even
though the current ratio is much higher than industry, the company quick ratio is however
lower than 1 √and almost similar to industry average. The lower quick ratio is explained by
the lower inventory turnover of the company which resulted in higher current assets in
terms of inventory.

Financial leverage – the company used more debts to finance investments than the peer
group, which we saw in higher-than- average debt ratio (53.8%) and below average TIE of
5.67 times. This suggests that the firm is exposing itself to a higher degree of financial risk
than is the norm for firms in its industry. In other words, there’s a greater risk it might not be
able to meet its debt obligations.

QUESTION 3

a. These ratios indicate that the company has improved on all three measures of activity over
the four years period. The company appears to be managing its inventory more efficiently, is
collecting receivables faster, and is generating a higher level of revenues relative to total
assets. The overall trend appears good.

b. Because the relative size of a firm may be expanding or contracting, comparing the WC is
meaningless because of size differences.

c. Credit terms is the number of days credit is given to customers. A change in terms can be by
shortening or lengthening the credit terms. Shortening the credit terms indicates there will
be less risk√ in the collection of future receivables and lengthening the credit terms indicates
a greater risk√. Lower credit terms indicates higher quality receivable and longer credit
terms indicates lower quality receivables.

QUESTION 4

2017 2016
RM RM
Income before tax and extraordinary items 35 68
Plus: Interest expense 28 22
63 90

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 FAR670 – DEC 2018

i. TIE = EBIT/Interest expense

2017 2016
TIE 63/28 90/22
= 2.25 times = 4.09 times

The ability of the firm to cover its interest has declined substantially as shown by TIE
of 4.09 times in 2016 drops to 2.25 in 2017. The decline is due both to rising interest
and falling income.

ii. The statement by the firm representative is false. The only reason that net income was at
RM20,000 in 2016 was because of the extraordinary fire loss. Recurring profits dropped from
RM38,000 to RM20,000.

QUESTION 5

a. EPS = Net income – Pref share dividends

Weighted average no. of common shares
= 2,500,000 – 200,000
1,125,000
= RM2.04

Months shares are Shares outstanding Fraction of year Weighted average

outstanding outstanding
Jan – March 1,000,000 3/12 250,000
April – Sept 1,200,000 6/12 600,000
Oct - Dec 1,100,000 3/12 275,000
1,125,000

b. All major segments of cash flows were negative. Net cash outflow from operating activities
was negative by RM3,000, and yet dividends were paid√ in the amount of RM21,000. Also,
the company had a negative cash flow from investing activities due to purchases of plant
assets.

The net negative cash flow would have been higher than RM22,000 had the mortgage not
acquired and common stock were not issued, without these the net negative cash would
have been RM 39,000 (22,000 + 11,000 + 6,000).

END OF SOLUTION