Suggested Answers to IRA Exercise No.

2: Financial Statement and Ratios Analysis

Problem No. 1:

ROE (present) = ROA x Equity Multiplier

= (10% x 2.5%) x 1 / 0.50
= 2.5% x 2
ROE (present) = 5%

ROE (desired) = ROA x Equity Multiplier

10% = (14% x 2.5) x EM
EM = 10% / 3.5%
Equity Multiplier = 2.857

2.857 = 1 / Equity Ratio

Equity Ratio = 1 / 2.857
= 35%

Therefore, New Debt Ratio = 65%.

Problem No. 2:
P/E ratio = Price / EPS EPS = Net income – pref. dividends / WACSO
8 = Price / 2.50 = P 50 / 20 shares
Price = P20 / share EPS = P 2.50

Industry Ave. Inventory TO = Cost of goods sold / Ave. Inventory

5 = 855 / Inventory
Inventory = 171

Original Inventory New Inventory Funds Available

P300 171 P129 ➔ Frees up P129 in funds to buy
back shares

No. of shares to buy-back = P129 / P20

= 6.45 or 7 shares for repurchase

Create New EPS:

EPS = Net income – pref. dividends / WACSO
= 50 / 20 – 6.45
EPS = P3.69 or P3.70

New Stock Price:

P/E ratio = Price / EPS
8 = Price / 3.70
Price = P29.60

You may not under any circumstances, transmit, reproduce, distribute, display, or lend, in whole or part, any of the contents provided in this document.
Change in Price:
Old Price = P20.00
New Price = 29.60
Change in Price = P 9.60
======
Problem No. 3:
Current ratio = CA / CL
2.25 = CA / 80,000
CA = P180,000

Equity-Debt ratio = Stockholders’ Equity / Total liabilities

3 = SE / 80,000
SEquity = P240,000

Inventory turnover = CGS / Ave. Inventory

14.4 = CGS / 80,000
CGS = P1,152

% Amount
Sales ? P1,536
CGS 75% 1,152 (1,152 / 75%)
GP 25%

Days sales in receivables = # of working days / Receivable TO

15 = 360 / RTO
RTO = 2.4

Receivable Turnover = Net Sales / Ave. Receivables

24 = 1,536 / Ave. Receivables
Ave. Receivables = P64,000

Balance Sheet

Cash ? } 36,000 Current liabilities 80,000

Accounts Receivable 64,000 } 180,000 Common stock 100,000} 240,000
Inventory 80,000 } Retained earnings ? }140,000
Fixed assets, net ? 140,000 _______
Total Assets P320,000 Total Liab./ Equity P320,000
====== ======

You may not under any circumstances, transmit, reproduce, distribute, display, or lend, in whole or part, any of the contents provided in this document.
Problem No. 4:
Answer: (d)

Industry average inventory turnover = 6 = Sales/Inventory.

Therefore: Inventory = Sales/6
P3,000,000/6 = P500,000.

Current inventory = P1,000,000. Reduction in inventory = P1,000,000 - 500,000 = 500,000.

New debt level = P4,000,000 - 500,000 = 3,500,000. Interest on this level of debt = P3,500,000  0.1 = 350,000.

To get net income:

EBIT P1,400,000
Int 350,000
EBT P1,050,000
Tax 420,000
NI P 630,000

ROE = Net income/Equity = 630,000/2,000,000 = 0.3150 or 31.50%.

You may not under any circumstances, transmit, reproduce, distribute, display, or lend, in whole or part, any of the contents provided in this document.