ISB FADM 2022

Practice Set 5: Financial Statement Analysis Part 1 and 2

QUESTION 1

SOLUTION

a. 2015 ROE = $14,694/ [($80,546 + $81,394)/2] = 18.1%

2014 ROE = $16,363/ [($81,394 + $76,255)/2] = 20.8%

Wal-Mart’s ROE decreased from 2014 to 2015, and is below the median ROE of 18.9%
for other companies in the Dow Jones average.

b. 2015 ROA = $14,694/ [($199,581 + $203,490)/2] = 7.3%

2014 ROA = $16,363/ [($203,490 + $204,751)/2] = 8.0%

Wal-Mart’s ROA decreased slightly from 2014 to 2015 but it is above the median 7.1% for
other Dow Jones companies.

c. Wal-Mart does not sell products with a high level of technology and specialization, and it,
therefore, is not protected by patents or other legal barriers to entry. It does, however,
have considerable market power over suppliers as a result of its considerable size, which
may result in product cost savings. Wal-Mart is also able to use its considerable
advertising budget to its advantage.
QUESTION 2

SOLUTION

($ millions)
a.
ROA ROE
2016 3.43% 6.72%
$3,538/[($99,782+$106,685)/2] $3,538/[($52,063+$53,230)/2]

2015 3.70% 7.36%

$2,675/[($106,685+$37,943)/2] $2,675/[($53,230+$19,443)/2]

Profit Margin (PM) Asset Turnover (AT)

2016 12.3% 0.279
($3,538/$28,833) $28,833/[($99,782+$106,685)/2]

2015 13.2% 0.280

($2,675/$20,261) $20,261/[($106,685+$37,943)/2]

Both ROA and ROE weakened from 2015 to 2016.

b. The decrease in ROA is a result of a decline in profit margin (from 13.2% to 12.3%).
Compounding this is the fact that the asset turnover also decreased (from 0.280 to 0.279),
the decrease was very small so we conclude that the prime reason for the decline in ROA
in 2016 was due to decreased profitability.
c. If we use year-end assets instead of average, the ROA in 2015 is 2.51% instead of 3.70%
($2,675/$106,685). The two ratios are markedly different because of the huge increase in
assets during 2015. This shows the importance of using averages in the denominator
especially when the balance change significantly during the year.

a. The repurchase of common stock reduces both the numerator (net income) and
denominator (stockholders’ equity) of the return on equity calculation. Repurchases
reduce net income by the forgone profit on the cash that is used to buy the stock on the
open market. This is likely very small in the current economic environment. The bigger
effect is that the repurchase of common stock reduced stockholders’ equity by almost
$2.83 billion, thus decreasing the denominator by that amount. Generally, the denominator
effect dominates: its reduction is greater than the reduction of the numerator. Therefore,
it is reasonable to predict that the repurchase would increase ROE.
QUESTION 3

SOLUTION

a.
2015 2014

ROA $4,529.3 / [($37,938.7 + $4,757.8 / [($34,227.4 +

$34,227.4) / 2] $36,626.3) / 2]
= 12.6% = 13.4%

Profit Margin $4,529.3 / $16,488.3 $4,757.8 / $18,169.3

= 27.5% = 26.2%

Asset Turnover $16,488.3 / [($37,938.7 + $18,169.3 / [($34,227.4 +

$34,227.4) / 2] $36,626.3) / 2]
= 0.46 = 0.51

b. McDonald’s ROA decreased from 2014 to 2015, due to a decrease in asset turnover (0.51
to 0.46). McDonald’s profitability increased during the year (from 26.2% to 27.5%) but the
increase in profitability was insufficient to outweigh the decrease in productivity.
QUESTION 4

SOLUTION

a.
Accounts Receivable Turnover for 2015
Procter & Gamble ..................... $76,279 / [($4,861 + $6,386) / 2] = 13.56
$365 / 13.56 = 26.9 days

Colgate-Palmolive .................... $16,034 / [($1,427 + $1,552) / 2] = 10.76

$365 / 10.76 = 33.9 days

b. P&G collects its accounts receivable 7 days more quickly than Colgate-Palmolive.
Differences can arise due to variations in the product mix of competitors, the types of
customers they sell to, their willingness to offer discounts for early payment, and their
relative bargaining strength vis-à-vis the companies or individuals owing them money.
Both of these companies sell a significant amount of their product to Walmart. P&G is a
sizable company, and may have greater bargaining power with Walmart than does the
smaller Colgate-Palmolive.
QUESTION 5

SOLUTION

a.
Inventory Turnover rates for 2015
ANF............................................... $1,361 / [ ($437 + $461) / 2 ] = 3.03
TJX ............................................... $22,035 / [($3,695 + $3,218) /2] = 6.37

b. TJX’s inventory turnover rate is higher than ANF’s. TJX concentrates on the value-priced
end of the clothing spectrum. Thus, it realizes a lower profit margin that must be offset
with higher turnover to yield an acceptable return on net operating assets (see discussion
of profitability and turnover in Module 4).

c. Inventory turnover improves as the volume of goods sold increases relative to the dollar
value of goods available for sale. Retailers must balance the cost savings from inventory
reductions against the marketing implications of lower inventory levels. Companies can
lower inventory levels by reducing the depth and breadth of product lines carried (such as
not carrying every style, size and color), eliminating slow-moving product lines, working
with suppliers to arrange for delivery when needed, and marking down goods for sale at
the end of product seasons.
QUESTION 6

SOLUTION

a.
PPE turnover for 2015
Intel Corporation .................. $55,355 / [($31,858 + $33,238) /2] = 1.70
Texas Instruments ............... $13,000 / [($2,596 + $2,840) / 2] = 4.78

Texas Instruments generates more revenue from its PPE than does Intel. This is an efficiency
measure and thus, we would conclude, that TI is more efficient with its PPE.

b. PPE turnover increases with sales volume relative to the dollar amount of PPE on the
balance sheet. The PPE turnover is often very difficult to improve because doing so typically
requires creative thinking. Many companies are off-loading the manufacturing process in
whole or in part to others in the supply chain. This is productive so long as the benefits
realized by the reduction of manufacturing assets more than offset the higher cost of the
goods that are now purchased rather than manufactured. Another approach is to utilize long-
term operating assets in partnership with another firm, say in a joint venture.
QUESTION 7

SOLUTION

2015 Cash conversion cycle 25.5 days + 47.1 days - 13.9 days = 58.7 days
2014 Cash conversion cycle 19.1 days + 48.9 days – 13.3 days = 54.7 days

Winnebago’s cash conversion cycle weakend by 4 days in 2015 (58.7 – 54.7 = 4.0). The
days sales outstanding is the main cause— the company collected its receivables 6 days
more slowly in 2015. Countering that trend, is the fact that inventory sold one day more
quickly in 2015 while payable days stayed about the same.
QUESTION 8

SOLUTION

2015 Autozone O'Reilly

Sales $10,187,340 $7,966,674
Cost of goods sold 4,860,309 3,804,031
Gross margin $5,327,031 $4,162,643
Gross margin percentage 52.3% 52.3%

2014
Sales $9,475,313 $7,216,081
Cost of goods sold 4,540,406 3,507,180
Gross margin $4,934,907 $3,708,901
Gross margin percentage 52.1% 51.4%

In 2015, the two companies were equally profitable selling their inventory. In 2014, Autozone had
a slight edge. In 2015, O’Reilly’s gross profit margin increased whereas Autozone’s decreased.

2015 Autozone O'Reilly

Cost of goods sold $4,860,309 $3,804,031
Average inventory 3,280,868 2,592,902
Days inventory outstanding 246.4 248.8
 2014
Cost of goods sold 4,540,406 3,507,180
Average inventory 3,000,557 2,464,918
Days inventory outstanding 241.2 256.5

In both 2015 and 2014, Autozone sold its inventory more quickly than O’Reilly did. But while
O’Reilly improved its inventory efficiency in 2015 as compared to 2014, Autozone did not.
QUESTION 9

SOLUTION

$ millions
a. Average useful life = Average Depreciable asset cost / Depreciation expense
= [($10,972 - $114 - $345) + ($11,217 - $120 - $530)/2] / $692 = 15.2 years

Note: We eliminate land and construction in progress from the numerator because land
is never depreciated and construction in progress represents assets that are not in service
yet and are, consequently, not yet depreciable. We use the average depreciable cost
because depreciation expense is FOR the year so the asset cost should be the cost
DURING the year and we use the average as an estimate.

b. Percent used up = Accumulated depreciation/ Depreciable asset cost

= $5,846 / ($10,972 - $114 - $345) = 55.6%

Assuming that assets are replaced evenly as they are used up, we would expect assets
to be 50% “used up,” on average. Deere’s 55.6% is higher than this average. The
implication is that Deere’s equipment is on the older side and the company will require
higher capital expenditures in the near future to replace aging assets.

Note: We do not use averages here because both the numerator and denominator are
measured at a point in time.