Chapter 4 - All Solutions From Text

Introduction to Corporate Finance Booth, Cleary
Chapter 4: Financial Statement Analysis and Forecasting

Multiple Choice Questions
1. The generally accepted accounting principles in Canada are prescribed by:
A. GAAP
B. CICA
C. IFRS
D. ASBJ
Level of difficulty: Easy
Solution: B
GAAP is practised in the United States. International Financial Reporting Standards (IFRS)
were issued by the International Accounting Standards Board (IASB). Accounting Standards
Board of Japan (ASBJ) is the Japanese GAAP.
2. Which of the following ratios is not in the DuPont System?

A. Net Profit Margin
B. Leverage
C. Asset Turnover
D. Return on investment
Level of difficulty: Medium
Solution: D
NI NI Sales Assets
= × × = (Net Profit Margin)(Asset Turnover)(Leverage)
E Sales Assets Equity
3. Which of the following components of the DuPont System for Hill Inc. is correct? sales =
$5,600; earnings before tax (EBT) = $2,090; T = 40 percent; total liability = $30,900; Equity
= $16,500.
A. Net profit margin = 37.32%
B. Asset turnover = 11.81%
C. Leverage = 1.87
D. Leverage = 0.53
Level of difficulty: Difficult
Solution: B
Net profit margin = NI/Sales = (2,090)(1 – 0.4)/(5,600) = 1,254/5,600 = 22.39%
Asset Turnover = Sales/Assets = 5,600/ (30,900 + 16,500) = 5,600/47,400 = 11.81%
Leverage = Assets/Equity = 47,400/16,500 = 2.87
4. To increase return on equity (ROE),

A. increase equity, all else being unchanged.
B. decrease debt outstanding, all else being unchanged.
C. decrease corporate tax rate, all else being unchanged.
D. decrease earnings after tax, all else being unchanged.
Solution: C
To increase Return on Equity (ROE), we could decrease equity, increase debt level, decrease
Solutions Manual 1 Chapter 4

Copyright © 2008 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.
corporate tax rate (increase NI), or increase earnings after tax (NI), holding all the others
unchanged.
Use the following information to answer Questions 5 to 10.
Balance Sheet as of December 31, 2005

$million $million
Cash 400,000Accounts payable 500,000
Marketable securities 500,000Accrued liabilities 90,000
Inventory 250,000Wage payable 150,000
Equipment 1,000,000Long-term Debt 2,000,000

Land 2,500,000
Common shares 2,800,000
Patent 980,000Retained earnings 90,000
Total assets 5,630,000Total liab. and equity 5,630,000
Income Statement 2005

$million
Sales 1,090,000
COGS 380,000
Wages 200,000
Interest 150,000
EBT 360,000
Tax 108,000
NI 252,000
5. What is the debt ratio?

A. 0.36
B. 0.94
C. 0.55
D. 0.49
Solution: D
Liabilities 500,000 + 90,000 + 150,000 + 2,000,000 2,740,000
Debt Ratio = = = = 0.49
TA 5,630,000 5,630,000
6. Calculate the debt-equity ratio and times interest earned ratio.

A. 3.4; 0.36

B. 0.95; 2.4
C. 0.69; 3.4
D. 2.4; 0.95
Solution: C
D 2,000,000
Debt-Equity Ratio = = = 0.69
SE 2,800,000 + 90,000
EBIT 360,000 + 150,000
Times Interest Earned Ratio = = = 3.4
I 150,000
7. What are the gross profit margin and operating margin? (Use EBIT as operating income.)
A. 60 percent; 35 percent
B. 65 percent; 47 percent
C. 55 percent; 30 percent
D. 70 percent; 49 percent
Solution: B
Sales − COGS 1,090,000 − 380,000 710,000
Gross Profit Margin = = = = 65%
Sales 1,090,000 1,090,000
EBIT 1,090,000 − 380,000 − 200,000 510,000
Operating Margin = = = = 47%
Sales 1,090,000 1,090,000
8. Which of the following is average days sales in inventory?

A. 84 days
B. 70 days
C. 66 days
D. 80 days
Solution: A
INV 250 , 000
Days Sales in Inventory = = = 84 days
ADS 1, 090 , 000 / 365
9. Which of the following is the working capital ratio?

A. 24 percent
B. 18.5 percent
C. 20.4 percent
D. 155 percent
Solution: C
CA 400,000 + 500,000 + 250,000
Working Capital Ratio = = = 20.4%
TA 5,630,000
10. Which of the following is invested capital?

A. $5,630,000

B. $2,890,000
C. $4,800,000
D. $4,890,000
Solution: D
Invested Capital = Interest-bearing debt+ SE = 2,000,000 + (2,800,000 + 90,000) =
$4,890,000
Practice Problems
Finns’ Fridges is a company created by twin brothers, David and Douglas Finn, to rent small
refrigerators to other students in their college dormitory. Use these statements to answer the
questions about Finns’ Fridges.
Balance Sheets for Finns’ Fridges

(End of the year indicated)
Year 1 Year 2
Assets
Current assets (Cash) 1,150 493
Property and equipment (net) 3,840 3,888
Total Assets 4,990 4,381
Liabilities and Owners’ Equity
Interest payable 200 160
Tax payable 177 182
Dividends payable 200 210
Long-term debt 3,200 2,400
Total liabilities 3,777 2,952
Common shares 1,000 1,000
Retained earnings 213 429
Total owners’ equity 1,213 1,429
Total liabilities and owners’ equity 4,990 4,381
Income Statements for Finns’ Fridges

(For the full-year indicated)
Year 1 Year 2
Revenues (net of bad debts) 1,950 2,200
Selling and administrative expenses 0 220
Loss (stolen equipment) 160 0
EBITDA 1,790 1,980
Amortization expense 1,000 1,212
EBIT 790 768
Interest expense 200 160
Earnings before tax 590 608
Tax (30%) 177 182
Net Income 413 426

Earnings Per Share (100 shares) $4.13 $4.26

Dividends Per Share $2.00 $2.10
11. At the end of 2005, Corine’s Candies Inc. had total shareholders’ equity of $13.8 million. In
2006, the company had net income of $5.2 million and paid out half of this amount in
dividends, resulting in shareholders’ equity at the end of 2006 of $16.4 million. Use the
average amount of shareholders’ equity to determine Corine’s ROE for 2006.
Topic: Return on Equity
Solution: The average shareholders’ equity is (13.8 + 16.4)/2 = $15.1 million. The return on
equity, ROE = NI / Average SE = 5.2 / 15.1 = 34.4%
12. Find Finns’ Fridges’ Return on Equity (ROE) for Years 1 and 2 using the Owners’ Equity
figure at the end of each year. Did this ratio improve or get worse between Year 1 and Year
2?
Topic: DuPont System (ROE)
Solution: The financial statements for Finns’ Fridges refer to “Owners’ Equity,” but this is
equivalent to shareholders’ equity.
For Year 1, ROE = NI / SE = 413/1,213 = 34.0%.
For Year 2, ROE = 426/1,429 = 29.8%.
The higher the ROE, the better, so Finns’ Fridges did worse in Year 2 than in Year 1.
13. Use the definition of the leverage ratio in the DuPont System to determine if Finns’ Fridges
has become more or less leveraged between Year 1 and Year 2.
Topic: DuPont System (Leverage)
Solution: For Year 1, Leverage Ratio = TA / SE = 4,990 / 1,213 = 4.114, while at the end of
Year 2, Leverage Ratio = TA / SE = 4,381 / 1,429 = 3.066. Thus, Finns’ Fridges is
leveraging its owners’ equity much less in Year 2.
14. One key part of ROE in the DuPont System is the return on assets (ROA). Find the ROA for
Finns’ Fridges and determine if it is increasing or decreasing.
Topic: DuPont System (ROA)
Solution: ROA = NI / TA
For Year 1, ROA = 413 / 4,990 = 8.28% and for Year 2, ROA = 426 / 4,381 = 9.72%. The
return on assets for Finn’s Fridges has improved (increased) from Year 1 to Year 2.
15. The most recent financial statements for a large, Canadian furniture and appliance rental
chain show that its debt ratio was 0.256 and its debt-to-equity ratio was 0.073. At the end of
Year 2, was Finns’ Fridges more or less leveraged than this major competitor? (Remember to
use only the interest bearing liabilities, i.e. long-term debt, when calculating the D/E ratio.)
Topic: Leverage Ratios

Solution: From the Year 2 Balance Sheet, Debt Ratio = TL / TA = 2,952 / 4,381 = 0.674 and
the Debt-Equity Ratio = D / SE = 2,400 / 1,429 = 1.679. Using either ratio, Finns’ Fridges is
much more highly leveraged than its competitor.
16. The large competitor firm mentioned in Problem 15 had net operating income of $4.426
million and sales of $30.16 million in its most recent accounting period. Find the operating
margin for this competitor. Comment on Finns’ Fridges level of operating efficiency
compared to this real-world business.
Topic: Efficiency Ratios
Solution: Operating Margin = NOI / S = 4.426 / 30.16 = 0.147 for the large competitor firm.
Given the results in Problem 20, Finns’ Fridges has been much more efficient at creating
income from its sales.
17. Corine’s Candies Inc. registered a gross profit margin of 75 percent on sales of $16 million in
2006. What would the company’s income statement show for the value of cost of goods sold?
Solution: Gross Profit Margin = (S – CGS) / S, so we have 0.75 = (16 – CGS) / 16.
Therefore, CGS = 16 – (16 x 0.75) = 4. The company’s income statement would show $4
million for the cost of goods sold.
18. In the DuPont System, there are two components of ROA. Determine whether efficiency or
productivity (or both) is responsible for the increase in ROA for Finns’ Fridges from Year 1
to Year 2.
Topic: DuPont System (Efficiency and Productivity)
Solution:
Year 1 Year 2
Efficiency Ratio = NI / 413 / 1,950 = 21.2% 426 / 2,200 = 19.4%
Sales
Productivity Ratio = Sales / 1,950 / 4,990 = 39.1% 2,200 / 4,381= 50.2%
TA
Efficiency fell slightly from Year 1 to Year 2, but productivity increased significantly; the
ROA increased because Finns’ Fridges is generating more sales per dollar of assets
(productivity).
19. We can calculate cash flow from operations (CFO) as net income + amortization expense +
change in working capital. In Year 2, the change in working capital for Finns’ Fridges was –
$25. Find the CFO, and use this figure to calculate the cash flow to debt ratio. How many
years it would take for the company to pay off its entire debt load if it devoted its cash flow
to debt repayment?
Topic: Leverage Ratios

Solution: For Year 2, CFO = 426 + 1,212 + (–25) = 1,613. The cash flow to debt ratio = CFO
/ D = 1,613 / 2,400 = 0.672. In other words, the annual cash flow from operations is
approximately two-thirds of the total (interest bearing) debt of the company. If we invert this
ratio, 1/ 0.672= 1.488, we find that it would take about one and a half years for the firm to
repay its debt.
20. Find the operating margin for Finns’ Fridges for both Year 1 and Year 2 (you may assume
that the net operating income is equal to the firm’s EBIT). Was there an increase or a
decrease in the operating margin, and is this a good trend or a bad one?
Solution:
In Year 1, the Operating Margin = NOI / S = 790 / 1,950 = 0.405, while in Year 2, Operating
Margin = 768 / 2,200 = 0.349. Decreasing operating margins is a bad sign but a change from
one year to the next may not indicate a trend.
21. Calculate the fixed asset turnover for Finns’ Fridges for Years 1 and 2 (note that net fixed
assets corresponds to “property and equipment (net)” on the company’s balance sheet). Has
the company become more or less productive in terms of generating sales from assets?
Topic: Productivity Ratios
Solution: For Year 1, fixed asset turnover = S / NFA = 1,950 / 3,840 = 0.508, while for Year
2, fixed asset turnover = 2,200 / 3,888 = 0.566. Finns’ Fridges seems to be getting more
productive in terms of generating sales from its assets (but two years is insufficient to call
this change a trend).
22. At the end of its most recent fiscal period, the large appliance rental company mentioned in
Problem 15 had a working capital ratio of 4.3 percent and a current ratio of 18.2 percent.
Calculate these ratios for Finns’ Fridges at the end of Year 1 and Year 2. Is the company
more or less liquid than its competitor?
Topic: Liquidity
Solution:
Year 1 Year 2
Working Capital Ratio = CA 1,150 / 4,990 = 23.0% 493 / 4,381 = 11.3%
/ TA
1,150 / 493 / (160+182+210)
Current Ratio = CA / CL (200+177+200) = 0.893 = 89.3%
= 1.993 = 199.3%
Although Finns’ Fridges experienced a drop in liquidity from Year 1 to Year 2, it is still
much more liquid than its competitor based on either of these two ratios.
23. The Finn brothers are planning their third year of operations. As a first step in the process,
create a “percentage of sales” balance sheet for Finns’ Fridges as of the end of Year 2.

Topic: Financial Forecasting

Solution:
Percentage of Sales Balance Sheet for Finns’ Fridges
% of
Year 2
Sales
Sales 2,200
Assets
Current Assets (Cash) 493 22.4%
Property and Equipment (net) 3,888 176.7%
Total Assets 4,381 199.1%
Interest Payable 160 7.3%
Tax Payable 182 8.3%
Dividends Payable 210 9.5%
Long-term Debt 2,400 109.1%
Total Liabilities 2,952 134.2%
Common Shares 1,000 45.5%
Retained Earnings 429 19.5%
Total Owners’ Equity 1,429 65.0%
Total Liabilities and Owners’ Equity 4,381 199.1%
24. A. Suppose the Finns believe they can increase revenues to $2,600 in Year 3. Use this figure
and the Percentage of Sales balance sheet (Problem 23) to forecast the company’s balance
sheet at the end of Year 3. Remember that the “financing” components (long-term debt, and
total owners’ equity) should be left unchanged from the Year 2 figures.
B. The forecast balance sheet does not balance! Determine the amount of external financing
required by Finns’ Fridges based on the initial forecast.
Solution:
A.
Forecast of Balance Sheet for Finns’ Fridges
% of Year 3
Sales Forecast
Sales 2,600
Assets
Current Assets (Cash) 22.4% 582
Property and Equipment (net) 176.7% 4,595
Total Assets 199.1% 5,177
Interest Payable 7.3% 189
Tax Payable 8.3% 215
Dividend Payable 9.5% 248

Long-term Debt - 2,400

Total Liabilities - 3,052
Common Shares - 1,000
Retained Earnings - 429
Total Owners’ Equity - 1,429
Total Liabilities and Owners’ - 4,481
Equity
B. External financing will be needed to make up the difference between total assets, and
total liabilities and owners’ equity on the initial forecast of the balance sheet. The amount
required is therefore $5,177 – $4,481 = $696.
25. To achieve the target level of revenues in Year 3 ($2,600), Finns’ Fridges will have to buy
some more equipment. This will increase the amortization expense to $1,422. Selling costs
will be the same percentage of sales as in Year 2 and the interest expense for the year will be
$120. Use this information to determine the amount of net income the company should
expect to earn in Year 3.
Solution: In Year 2, selling expenses were $220 / $2,200 = 10% of revenues. With revenues
of $2,600 for Year 3, we can forecast selling expenses to be $260. The other information
given is sufficient to create a forecast of the company’s income statement from which we
find that the company can expect net income of $559 in Year 3.
Forecast of Income Statement for Finns’ Fridges

Year 3
Revenues (net of bad debts) 2,600
Selling & Admin Expenses (Variable Costs) 260
EBITDA 2,340
Amortization Expense 1,422
EBIT 918
Interest Expense 120
Earnings Before Tax 798
Tax (30%) 239
Net Income 559
26. Use the average dividend payout ratio from Years 1 and 2, and the forecast net income figure
from Problem 25, to estimate the total amount of dividends that will be paid by the company
in Year 3.
Solution: For Year 1, Dividend Payout = DPS / EPS = 2.00 / 4.13 = 48.43%, and for Year 2,
Dividend Payout = 2.10 / 4.26 = 49.30%. The average value is therefore 48.86%.
With the forecast net income figure of $559, we can estimate the Year 3 dividends as:

48.86% x 559 = $273.13 or $2.73 per share (approximately) as there are 100 shares
outstanding.
27. Suppose that Finns’ Fridges will actually pay $270 in dividends in Year 3. Determine the
value of the retained earnings account at the end of Year 3 based on the forecast net income
in Problem 25.
Level of Difficulty: Easy
Solution:
Retained Earnings (Year 3) = Retained Earnings (Year 2) + Net Income - Dividends
= 429 + 559 − 270
= 718
28. The forecast for retained earnings (Problem 27) changes the Year 3 forecast for total
liabilities and owners’ equity to $4,770. With total assets forecast to be $5,177 determine
how much external financing will be required in Year 3.
Level of Difficulty: Easy
Solution: The external financing requirement is now $5,177 – $4,770 = $407.
29. What is the current ratio and quick ratio for GG Co.? Inventories = $650,000; current assets
= $1,200,000; total liabilities = $3,500,096; long-term debt = $2,099,000.
Solution:
Current Liabilities = Total Liabilities – Long-term Debt

= $3,500,096 – $2,099,000
= $1,401,096
Current Ratio = Current Assets ÷ Current Liabilities
= $1,200,000 ÷ $1,401,096
= 0.86
Quick Ratio = (Current Assets – Inventories) ÷ Current Liabilities
= ($1,200,000 – $650,000 ) ÷ $1,401,096
= $550,000 ÷ $1,401,096
= 0.39
30. Calculate the degree of total leverage (DTL) and break-even point given the following
information: sales = $400,088; variable cost = $120,000; NI = $180,000; T = 40 percent. fixed
cost (FC) = $80,000.
Solution:

EBT × (1 − T ) = NI
NI 180,000
EBT (TI ) = = = 300,000
1 − T (1 − 0.4)
CM Sales − VC 400,088 − 120,000
DTL = = = = 0.93
TI EBT 300,000
FC 80,000
Break-Even Point = = = 114,275
CM (400,088 − 120,000) / 400,088
31. Use the following information to create a revised forecast of the Year 3 balance sheet for
Finns’ Fridges. Cash will increase by the forecast EBITDA amount (see Problem 25); it will
be reduced by $1,050 to purchase new equipment, $552 for Year 2 payables, and $800 for
debt repayment. The property and equipment (net) account will increase by $1,050 (new
fridges purchased) but must be reduced by the $1,422 amortization expense. Interest and tax
payable will reflect the respective expenses on the forecast income statement (again, see
Problem 25Error! Reference source not found.). Dividends payable will be $270. Long-
term debt will be reduced by $800, and the retained earnings figure is $718. With this revised
forecast, is any additional external financing required?
Solution:
Cash (Year 3) = Cash (Year 2) + EBITDA – New Equipment – Year 2 Payables – Debt
Repayment = 493 + 2,340 – 1,050 – 552 – 800 = $431.
Equipment (Year 3) = Equipment (Year 2) + New Equipment – Amortization Expense =
3,888 + 1,050 – 1,422 = $3,516.
Interest and Tax Payable are $120 and $239 respectively (see Problem 25). Long-term debt
will be 2,400 – 800 = $1,600.
Based on these values the following revised balance sheet can be created.
Forecast Balance Sheet for Finns’ Fridges

(Revised)
Year 3
Assets
Current Assets (Cash) 431
Property and Equipment (net) 3,516
Total Assets 3,947
Interest Payable 120
Tax Payable 239
Dividends Payable 270
Long-term Debt 1,600
Total Liabilities 2,229
Common Shares 1,000
Retained Earnings 718

Total Owners’ Equity 1,718

Total Liabilities and Owners’ Equity 3,947
Total assets now equal total liabilities and owners’ equity. Therefore, no external financing is
required.
32. Use the Year 2 financial statements for Finns’ Fridges to determine the company’s
sustainable growth rate.
Topic: Formula Forecasting
Level of Difficulty: Difficult
Solution: We can use formula 4-34 from the text, but we will need to compute the values of
the variables from the Year 2 financial statements.
i) Invested capital as a percentage of sales, a = (Long-Term Debt + Owners Equity) /
Revenues = (2,400 + 1,429) / 2,200 = 174.0%
ii) Retention Ratio, b = (Net Income – Dividends) / Net Income = (426 – 210) / 426 = 50.7%
iii) Net Profit Margin, PM = Net Income / Revenues = 426 / 2,200 = 19.4%
b × PM 0.507 × 0.194
g* = = = 0.0599 ≅ 6%
(a − b × PM ) (1.740 − 0.507 × 0.194)
33. Calculate receivable turnover, inventory turnover, and average collection period given the
following accounting data: accounts receivable = $500,000; accounts payable = $305,000;
inventory = $650,000; gross profit = $550,000; sales = $950,000. Interpret the collection
period.
Solution:
Sales 950,000
Receivable Turnover = = = 1.9
AR 500,000
COGS Sales − GrossProfit 950,000 − 550,000
Inventory Turnover = = = = 0.62
INV INV 650,000
AR 500,000
Collection Period = = = 192 days
ADS 950,000 / 365
Interpretation: On average, it takes 192 days for the customers to pay their bills after
purchase, an unusually high number. Note we use cost of goods sold instead of sales since
the data is available. If we use sales for the inventory turnover ratio it is 950,000/650,000
= 1.46X.
34. Calculate BVPS, dividend yield, dividend payout, and market to book ratio given the
following information: shareholders’ equity = $945,000; number of shares outstanding =
500,000; total dividend = $150,000; market price of each share = $9.50; net income =
$433,000.
Solution:

SE 945,000
BVPS = = = 1.89
# 500,000
DPS 150,000 / 500,000
Dividend yield = = = 3.2%
P 9.5
DPS 150,000 / 500,000
Dividend Payout = = = 34.6%
EPS 433,000 / 500,000
P 9.5
Market-to-Book Ratio = = = 5.03
BVPS 1.89
35. GG Co. has the following information from its financial statements: interest-bearing debt =
$900,000; shareholders’ equity (SE) = $2,500,000; sales = $1,050,000; NI = $670,000;
dividend = $200,000; sales growth (g) = 5 percent. Calculate EFR/S and discuss the
relationship between dividend payout and EFR. Calculate sustainable growth rate for GG Co.
Solution:
InvestedCapital 900,000 + 2,500,000
a= = = 3.24
Sales 1,050,000
NI 670,000
PM = = = 0.64
Sales 1,050,000
dividend 200,000
b = 1 − payout = 1 − =1− = 1 − 0.30 = 0.70
NI 670,000
EFR
S
= −b * PM + (a − b * PM ) g
= −(0.70) × (0.64) + (3.24 − 0.70 × 0.64) × 0.05
= −0.448 + 0.140
= −0.308
We can re-write the above formula as follows:
EFR
= −b * PM + (a − b * PM ) g = −(1 − payout ) * PM * (1 + g ) + ag
S
Therefore, dividend payout ratio is positively related to EFR, i.e. the higher the payout, the
higher the EFR.
EFR
= −b * PM + (a − b * PM ) g = 0
S
− 0.7 × 0.64 + (3.24 − 0.7 × 0.64) g = 0
g = 16%

36. Suppose that GG Co. (see Problem 35) would like to grow its sales by 20 percent, which is
greater than its sustainable growth rate. If all the other financial information remains
unchanged, how much external financing will the company require?
Topic: Formula Forecasting
Solution:
Use formula 4-32 from the text. The parameter values were computed in Problem 35:
a = 3.24; profit margin = 0.64; b = 0.70. With the growth rate specified as 20 percent, we
have:
EFR = a × S × g − b × PM × (1 + g ) × S
= 3.24 × $1,050,000 × 0.20 − 0.70 × 0.64 × (1 + 0.20) × $1,050,000
= $115,920
G.G. Co. will need an additional $115,920 to finance its growth.
37. The shares of Corine’s Candies Inc. are currently trading at $18.20 and there are 4 million
shares outstanding. The company’s 2006 net income was $5.2 million. Find the market value
of equity for the company and the P/E ratio of the shares.
Topic: Valuation Ratios
Solution: The market value of equity is simply the market price of a share of stock times the
number of shares outstanding. MVE = $18.20/share x 4 million shares = $72.8 million.
The P/E ratio can be found with the net income and MVE figures, but it is usually calculated
using per share amounts. The earning per share, EPS = $5.2 million / 4 million shares =
$1.30 per share. Therefore, P/E = Price / EPS = $18.20 / $1.30 = 14.0
38. Other candy-making firms have an average Forward P/E ratio of 12.0 at this time. With a
share price of $18.20, what are the expected 2007 EPS for Corine’s Candy if its Forward P/E
ratio is the same as the industry average?
Solution: Re-arranging the P/E ratio equation, we find EPS = P / (P/E ratio). To find the
expected EPS (EEPS) for 2007 with this equation, we must use the Forward P/E ratio: EEPS
= P / (Forward P/E ratio) = $18.20 / 12.0 = $1.52 (rounded to the nearest cent). Thus, if
Corine’s Candies has the same Forward P/E as the industry, it is expected to earn $1.52 per
share in 2007.
39. The managers of Corine’s Candies like to use the EBITDA Multiple to value the firm.
EDITDA was approximately $10 million in 2006. Use the market value of equity from
Problem 37 and a debt value of $20 million to find the total enterprise value (TEV). Next,
calculate the EBITDA Multiple. Suppose the industry-average EBITDA Multiple for candy
producers is 8.65. Is the market valuing Corine’s Candies Inc. more or less highly than its
competitors?

Solution: We know (see Problem 37) that the market value of equity, MVE = $72.8 million.
So, the total enterprise value, TEV = MVE + Market Value of Debt = 72.8 + 20 = $92.8
million.
EBITDA Multiple = TEV / EBITDA = 92.8 / 10 = 9.28.

The EBITDA Multiple tells us how much value the market is placing on the firm for each
dollar of EBITDA. As this multiple is somewhat higher for Corine’s Candies than for other
candy producers, the market is valuing Corine’s more highly than its competitors.

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Copyright © 2008 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.
The data contained in this file is protected by copyright. This manual is furnished under licence and may
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The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified,
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Introduction to Corporate Finance Booth, Cleary

Chapter 4: Financial Statement Analysis and Forecasting

2. Which of the following ratios is not in the DuPont System?

4. To increase return on equity (ROE),

Solutions Manual 1 Chapter 4

Use the following information to answer Questions 5 to 10.

Balance Sheet as of December 31, 2005

Equipment 1,000,000Long-term Debt 2,000,000

Total assets 5,630,000Total liab. and equity 5,630,000

Income Statement 2005

5. What is the debt ratio?

6. Calculate the debt-equity ratio and times interest earned ratio.

Solutions Manual 2 Chapter 4

8. Which of the following is average days sales in inventory?

9. Which of the following is the working capital ratio?

10. Which of the following is invested capital?

Solutions Manual 3 Chapter 4

Balance Sheets for Finns’ Fridges

Income Statements for Finns’ Fridges

Solutions Manual 4 Chapter 4

Earnings Per Share (100 shares) $4.13 $4.26

Solutions Manual 5 Chapter 4

Solutions Manual 6 Chapter 4

Solutions Manual 7 Chapter 4

Topic: Financial Forecasting

Solutions Manual 8 Chapter 4

Long-term Debt - 2,400

Forecast of Income Statement for Finns’ Fridges

Solutions Manual 9 Chapter 4

Current Liabilities = Total Liabilities – Long-term Debt

Solutions Manual 10 Chapter 4

Forecast Balance Sheet for Finns’ Fridges

Solutions Manual 11 Chapter 4

Total Owners’ Equity 1,718

Solutions Manual 12 Chapter 4

We can re-write the above formula as follows:

Solutions Manual 13 Chapter 4

G.G. Co. will need an additional $115,920 to finance its growth.

Solutions Manual 14 Chapter 4

EBITDA Multiple = TEV / EBITDA = 92.8 / 10 = 9.28.

Solutions Manual 15 Chapter 4

Solutions Manual 16 Chapter 4

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