FINANCIAL MANAGEMENT

CHAPTER 4: PROBLEM 20-24

JOHN JERALD G. TOMAS ACCOUNTNG 2-1

4-20 DSO and accounts receivable Harrelson Inc. currently has $205,000 in accounts receivable,
and its days sales outstanding (DSO) is 71 days. It wants to reduce its DSO to 20 days by pressuring
more of its customers to pay their bills on time. If this policy is adopted the company’s average sales
will fall by 15 percent. What will be the level of accounts receivable following the change? Assume a
365-day year.

GIVEN INFORMATION:

Accounts Receivable &205,000

Days sales outstanding (DSO) 71 days, 20 days
Company’s average sales 15%

Days sales outstanding (DSO) = Receivables/ Average sales per day

71= 205,000/ (X/365)

71(X/365) = 205,000 × 365

71X = 74,825,000/ 71X

= 1,053,873.24 × 0.85

= 895, 792.25

Days sales outstanding (DSO) = Receivables/ Average sales per day

20 = Receivables/ (895,792.25/365)

20= Receivables/ 2453.23

Receivable= 20× 2454.23

= 49,084. 51
4-21 P/E and stock price

Price to earnings ratio = Price per share/ earning per share

Year 1

Earnings per share = Net income/ shares outstanding

= 8,000,000/ 540,000

= 14.81

Price to earnings ratio = Price per share/ earning per share

= 21/14.81

= 1.42

Year 2

Earnings per share = Net income/ common shares

= 13,200,000/ (540,00+81,000)

= 13,200,000/ 621,000

= 21.26

Price to earnings ratio = Price per share/ earning per share

1.42 = Price per share/ 21.26

Price per share = 21.26 × 1.42

= 30.19
4-22 Balance sheet analysis

Sales = Total Asset turnover × Total Assets

= 1.5 × 300,000

= 450,000

Accounts Receivable = Sales/ (365×DSO)

= 450,000/ (365×36.5)

= 45,000

Inventories = COGS/ Inventory turnover Ratio

= COGS/ Inventory turnover ratio

= 337,500/3.75

= 90,000

Fixed Asset = Sales/ Fixed ASSET TURNOVER

= 450,000/3.0

= 150,000

Cash = Total Asset- (Accounts receivable + Inventory + fixed assets)

= 300,000 – (45,000 + 90,000 +150,000)

= 15,000

Current Liabilities = (Cash + Accounts Receivable + inventory)/ Current Ratio

= (15,000+45,000+90,000)/2.0

= 75,000

Common stock = Total liabilities and Equity – (Current liability + Retained earnings)

= 300,000- (75,000+ 60,000+97,500)

= 67,500
 Cost of Goods sold = Sales – (Sales× 25%)

= 450,000-(450,000×25%)

= 337,500

Cash ₱ 15,000 Current liabilities ₱ 75,000

Accounts receivable 45,000 Long term debt 60,000
Inventories 90,000 Common stock 67,500
Fixed assets 150,000 Retained earnings 97,500
Total assets 300,000 Total liabilities & EQT 300,000
Sales 450,000 Cost of goods sold 337,500

4-23 Ratio Analysis

a. Calculate the indicated ratios for Barry.

Ratio Barry Industry Average

Current 1.98x 2.0x

Quick 1.25x 1.3x
DSO 76.29 days 35 days
Inventory Turnover 5.59x 5.7x
Total Assets Turnover 1.7x 3.0x
Profit Margin 2.29% 1.6%
ROA 3.88% 4.8%
ROE 10.18% 12.1%
ROIC 10% 9.4%
TIE 3.33x 3.5x
Debt/Total Capital 48.53% 47%
M/B 1.076x 4.22x
P/E 11.79 13.27
EV/EBITDA 8.45 9.14
 Current Ratio = Current Asset/Current Liability

= 655,000/330,000

= 1.98

Quick Ratio = Current Assets – Inventory/Current Liability

= 655,000-241,000/330,000

= 1.25

DSO = Receivables/Average Sales per day

= 336,000/ (1,607,500/365)

= 76.29 or 76 days

Inventory Turnover = COGS/Inventory

= 1, 351,000/241,500

= 5.59

Total Assets Turnover = Sales/Total Assets

= 1,607,500/947,500

= 1.70

Profit Margin = Net Income/Sales

= 36,750/1,607,500

= 2.29%

ROA = Net Income/Total Assets

= 36,750/947,500

= 3.88%
 ROE = Net Income/Common Equity

= 36,750/361,000

= 10.18%

ROIC = EBIT(1-T)/ Total Invested Capital

= 70,000(1-0.25)/701,000

= 7.48%

TIE = EBIT/Interest Expense

= 70,000/21,000

= 3.33

Debt to Capital Ratio = Total Debt/Total Capital

= (84,000+256,500)/ (84,000+256,500+361,000)

= 48.54%

M/B Ratio= Market Value/Book Value

= 12/10

= 1.2

Book value per share = common equity/ share outstanding

= 361,000/ 36100

=10

P/E Ratio = Price per Share/Earnings per Share

= 12/1.02

= 11.76

Earnings per share = NI/ common share outstanding

= 36,750/36100

= 1.02
 EV/EBITDA ratio = Enterprise value/ EBITDA

=696,200/ 70,000+41,500

=696,200/ 111,000

= 6.24

Enterprise value = (12×36100) + (84,000+ 256,000) +0 – 77,500

= 696,200

b. Construct the extended Du Pont equation for both Barry and the industry

Barry
ROE= Profit Margin x Total Asset Turnover x Equity Multiplier
= (Net Income/Sales) x (Sales/Total Asset) x (Total Asset/Common Equity)
= (36,750/1,607,500) x (1,607,500/947,500) x (947,500/361,000)
= 2.286% x 1.697 x 2.625
= 10.18%

Industry Average
ROE= Profit Margin x Total Assets Turnover × Equity Multiplier

= 1.6% x 3.0 x 2.520

= 12.1%

c. Outline Barry’s strengths and weaknesses as revealed by your analysis.

Ratio Barry Industry Average

Current 1.98x 2.0x Good

Quick 1.25x 1.3x Good
DSO 76.29 days 35 days Bad
Inventory Turnover 5.59x 5.7x Good
Total Assets Turnover 1.7x 3.0x Bad
Profit Margin 2.29% 1.6% Good
 ROA 3.88% 4.8% Good
ROE 10.18% 12.1% Good
ROIC 7.48% 9.4% Good
TIE 3.33x 3.5x Good
Debt/Total Capital 48.54% 47% Good

d. Suppose Barry had doubled its sales as well as its inventories, accounts receivable, and
common equity during 2005. How would that information affect the validity of your ratio
analysis? (Hint: Think about averages and the effects of rapid growth on ratios if averages
are not used. No calculations are needed

If Barry doubled its sales, inventories, accounts receivable, and common equity during 2005
without using averages in the ratio analysis, the rapid growth would likely distort the ratios.
This sudden increase in values could skew the ratios significantly, making it challenging to
accurately assess the financial performance and stability of the company. Averages are
essential in such cases to provide a more balanced and reliable representation of the
financial health of the business amidst rapid growth.

4-24 Du PONT Analysis

a. Calculate those ratios that you think would be useful in this analysis.

Current ratio = current asset/ current liability

= 303,000,000/ 85,000,000

= 3.56

Debt to capital ratio = total debt/ total capital

= 50,000,000+ 29,000,000 / 79,000,000+ 315,000,000

= (1.200507 × 100%)

= 20.05%

TIE = EBIT/ INT charges

= 49,500,000/ 4,500,000

=11
 EBITDA average = EBITDA/ INT charges

=61,500,000/4,500,00

= 13.67

Inventory turnover= COGS/ Inventories

= 660,000,000/ 159,000,000

= 4.15

DSO= Receivable/ Average sales Per day

=66,000,000/ (795,000,000/365)

= 30 DAYS

Fixed asset turnover = sales/ net fixed assets

= 795,000,000/147,000,000

= 5.41

Total assets turnover= sales/ total assets

=795,000,000/450,000,000

=1.77

Profit margin= NI/ sales

= 33,750,000/ 795,000,000

= 0.42452×100%

= 4.25%

ROA= net income/ total assets

= 33,750,000/450,000,000

=0.075×100%

= 7.5%
 ROE= Net income/ Common equity

= 33,750,000/315,000,000

= 0.107142×100%

= 10.71%

ROIC = EBIT (1-t)/ Total Investment capital

= 49,500,000 × 0.75/ 29,000,000 + 50,000,000 + 315,000,000

= 0. 094225 × 100%

= 9.42%

b. Construct an extended Du Pont equation, and compare the company’s ratios to the
industry average ratios.

COMPANY

ROE = Profit Margin × Total assets turnover × (Total assets/ total common equity)

= 4.25% × 1.77× (450,000,000/315,000,000)

= 10.75%

INDUSTRY

ROE= Profit margin × Total assets turnover ×(ROE/ROA)

= 3.75% × 3 × (16.1%/11.25%)

= 16.1%

c. Do the balance sheet account or the income statement figures seem to be primarily
responsible for the low profits?
According to the DUPONT equation, the primary factor contributing to low profit is the asset
turnover, with sales and total assets being the key determinants. Total assets are derived
from the balance sheet, while sales are sourced from the income statement, making both
financial statements accountable. However, the balance sheet figure appears to have a
greater impact on low profit compared to the income statement figure.
d. Which specific accounts seem to be most out of line relative to other firms in the industry?

Upon examination of the ratios, it is evident that the return on assets, return on equity, and
total asset turnover are significantly deviating from industry norms when compared to other
firms.

e. If the firm had a pronounced seasonal sales pattern, or if it grew rapidly during the year,
how might that affect the validity of your ratio analysis? How might you correct for such
potential problems?

Ratios are prone to distortion in cases where a firm exhibits distinct seasonal sales patterns
or experiences rapid growth within a year. This issue can be rectified by utilizing average
financial statements and benchmarking the calculated ratios against those of other firms.