Problems on Ratio Analysis

Problem 1:

You are a bank loan officer and have been told that you can make a loan to onl
For confidentiality reasons, the companies are identified only as Applicant X an
The following information is extracted from the financial statements of the two a
Particulars Applicant X Applicant Y
Total assets 400,000 350,000
Net Income 25,000 32,500
Total Debt 150,000 250,000
Interest expense 7,000 29,500
Income tax expense 15,000 19,500
Total owners equity 250,000 100,000

Required:
1. For each of the two applicants, compute the following:
a.Debt ratio
b.Debt to equity ratio
c. Times interest earned

2. To which one of the two applicants would you recommend making a loan? Explain

Solution

Debt Ratio = Total Liabilities / Total Assets or

Total Liabilities / Total Liabilities + Equity

X= 150,000 / 400,000
37.50%

Y= 250,000 / 350,000
71.50% Recommend X for the loan

Debt-Equity Ratio = Total Liabilites / Total Equity

X= 150,000 / 250,000
60%
Y= 250,000/350,000
71.42%

Times interest earned EBIT / Interest Expense

X= (25,000+7,000+15,000)/7000
6.71 times

Y= (32,500+29,500+19,500)/29,500
2.76 times
 can make a loan to only one of two companies.
d only as Applicant X and Applicant Y.
statements of the two applicants.

Applicant X Applicant Y x
DEBT RATIO (TOTAL DEBT / TOTAL ASSETS) 0.375 0.71 LOW
DEBT EQUITY RATIO (TOTAL DEBT / OWNERS EQUITY 0.6 2.5
TIMES INTEREST RATIO (EBIT /INTEREST) 6.71 2.76 HIGH

PAT+INTEREST+TAX=EBIT
 y
HIGH

LOW
Problem 2:

The following information is for the year 2006 for Millard Company and Granstville Company, which are in the same industry:

Particulars Millard
Current assets 20,000
Long term assets 40,000
Current liabilities 8,000
Long term liabilities 15,000
Sales 200,000
Net income 4,000
Market price per share 15
Number of shares O/S 6,000

Required :

1. Compute the following:

a. Current ratio d. Asset turnover
b. Debt ratio e. Return on equity
c. Return on sales f. Price earnings ratio

2. Analysis
The stockholders of Millard Company have come to you for consulting help bec
their concern that the managers they've hired are not managing Millard aggress
From the ratios computed in (1), is there evidence that Millard is not being man
Are there any signs that, at least in this industry, there may be problems associ
aggressive strategy?

Solution Millard

a Current Ratio = CA/CL 20,000/8000 = 2.5

b Debt Ratio = LTL/Total Assets 15,000/80000 = 0.1875

c Return on Sales = Net Income/Sales 4000/200,000 = 2%

d Asset T.O = Sales/ LTA 200,000/40,000 = 5 times

e ROE = Net Income / Equity 4000/57000 = 7.017%
(note : equity = TA - TL)

f P- E ratio = MPS/EPS 15/0.666 = 22.52

mpany, which are in the same industry:

Granstville
75,000
140,000
60,000
110,000
850,000
10,000
50
3,000

ou for consulting help because of

managing Millard aggressively enough.
Millard is not being managed aggressively?
may be problems associated with a more

Granstville

75,000/60,000 = 1.25

1,10,000/215,000 = 0.5116

10,000/850,000 = 1.185%

850,000/140,000 = 6.07 times

10,000/45000 = 22.22%

50/3.333 = 15.00
Problem 3:

You have obtained the following data for the Marigold Company for the year ended
December 31, 2006. (Some income statement items are missing)

Particulars Amount
Cost of goods sold 500,000
Gen & Admn Exp 55,000
Interest Exp 5,000
Net Income 66,000
Sales 830,000
Tax expense 16,500

Required:
1. What is the total gross profit?
2. What is the amount of operating income?
3. What is the gross profit percentage (that is, GP as a % of sales)
4. If the return on assets is 2.5%, what are the total assets?
5. If the return on stockholders' equity is 5 percent, what is the stockholders equity?
6. What is the return on sales?
7.What is the income tax rate? (Tax Expense/Income before Taxes)

Solution
Construct the income statement

Sales 830,000 Grossprofit margin = GP/Sales 39.75%

Cost of Goods Sold 500,000
Gross Profit 330,000 Return on Assets = NI/Assets 26,400
Operating Expenses :
Gen Admin Expense 55,000 ROE = NI/Equity 13,200
Other operating expense 187,500
EBIT / Operating Income 87,500 ROS = NI/Sales 7.95%
Interest expense 5,000
PBT 82,500 I.T Rate = Tax Expense/PBT 20%
Tax Expense 16,500
PAT/NI 66,000
stockholders equity?

Sales 830,000
COGS 500,000
Gross Profit 330,000
Gen & Admin Expenses 55,000
Other Operating Expenses 187,500
EBIT 87,500
Interest 5,000
PBT 82,500
Tax 16,500
PAT / Net Income 66,000

ROA = EBIT (1-Tax Rate) [NOPAT] / Total Assets

Total Asset 28,00,000
Total Share Equity (NI/Share Equity = ROE) 13,20,000
NPM (NI / Sales) 7.95%
Tax Rate 20%
Problem 4: A Limited B Limited
Particulars (Rs. In million) (Rs. In million)
Sales 834 680
COGS 670 550
Trade Receivables 132 120
Closing Inventory 89 64
Trade Payables 62 55
Opening Inventory 35 27
1. Which co. is managing its receivables better?
2. Which co. is managing its inventories better?
3. What is the Cash Conversion Cycle of both firms?

B. Comment on favorable and unfavorable trends

Solution 2005 2006

Gross Profit = Credit Sales- COGS/ Sales 34% 33.11%

ITO = COGS/Avg Inventory 4.5 times 4 times

ARTO - Credit Sales/ Avg AR 5 times 6.1 times

n million)

A Limited B Limited
ITO (COGS/Inv) 7.50 Times 8.59 Times
DHP (365/ITO) 49 Days 43 Days
ARTO (Credit Sales/Arec) 6.31 Times 5.66 Times
ACP (365/ARTO) 58 Days 64 Days
APTO (Credit Purchase/Apayable) .56 Times .49 Times
DPP (365/APTO) 652 Days 745 Days
CCC (DHP+ACP-DPP) (545) Days (638) Days
Problem No. 5
Zing Limited has current assets of Rs. 4,650,000 and current liabilitie
The current assets include inventories amount to Rs. 1,100,000

a. Calculate the current ratio and liquid ratio for the company

b. What will be the impact of the following transactions on the current

i) Goods costing Rs.800,000 are purchased on credit
ii) Machine purchased for Rs. 1,000,000 and is paid for in cash
iii) Cash collected from sundry debtors Rs. 500,000
iv) Goods are sold for cash for Rs. 750,000
and current liabilities of Rs.1,850,000
Rs. 1,100,000

e company

ions on the current ratio:

id for in cash
Problem No. 6
Rising Stars Limited reported a profit after tax of Rs. 38 million for the year 2011.
The company's share capital consists of 2.5 million shares of face value of Rs. 10 each.
The company declared a dividend at 50% for the year. The current market price of the com
You are required to calculate:

a. EPS
b. DPS
c. PE ratio
d. Divident payout ratio
e. Retention ratio
f. Divident Yield
g. Market capitalization

a. EPS = (NI / Total no.equity o/s shares 15.2

b. DPS = (Total Dividend / Total no. of equity o/s shares) 5
c. PE ratio = (MPS / EPS) 13.82 times
d. Divident payout ratio = (DPS/EPS) 0.33
e. Retention ratio = 1 - Payout Ratio 0.66
f. Divident Yield = (DPS / MPS) 0.02
g. Market capitalization = (MPS x Total no. equity o/s shares Rs. 525 million
 year 2011.
ue of Rs. 10 each.
arket price of the company is Rs. 210.

25 million
Problem No. 7
The financial information about two competing firms Black Limited and White Limited is give

Particulars Black Ltd White Ltd

Shareholders funds 500 250
Borrowed funds at 10% 500 750
Total capital employed 1000 1000
EBIT 120 120
Tax rate 30% 30%
ROCE 12% 12%
ROE 9.80% 12.60%
D/E Ratio 1.00 3.00
a. Compute ROCE and ROE
b. Both firms have the same ROCE but they differ in ROE. Why?

D/E 1 3
Black Ltd White Ltd
ROCE (EBIT / Capital Employed) 12% 12%
ROE (PAT /Shareholder funds) 9.80% 12.60%

Cost of Debt 10% 10%

Levearge Effect 2% 6%

Levearge Effect Spread * Leverage Magnifier

Spread ROCE - Interest Rate
Leverage Magnifier D/E Ratio
mited and White Limited is given as follows:

ROCE- Interest Spread

D/E Ratio Leverage Magnifier

Overall Rate of Return

Black
White

PBT * TR
Capital Equity
Capital Employed SHF + BE+LTD
EBIT -Interest - Taxes
120 - 50 - 21 = 49 PAT
120-75 -13.5 = 31.5 PAT

21
13.5
Problem No. 8 : Complete the following balance sheet and profit and loss account based on

Balance Sheet
Amount
Liabilities (000's)
Current liabilities
Long term debts
Equity capital 60,000
Reserve and surplus
Share holder funds 100,000
Total L +E

Profit and Loss Account

Particulars Amount (000's)
Sales 100,000
Less : COGS
Gross profit
Less : S& A expenses
Net profit
a. Current Ratio 1.40 times
b. Debt -equity ratio 0.55 times
c. Total Assets Turnover R 0.5 times
d. Inventory Turnover Rati 7.5 times
e. Receivables Turnover R 5 times
f. Gross Margin Ratio 25%
g. Net Margin Ratio 10%
nd profit and loss account based on the information given as follows:

Amount
Assets ('000s)
Cash
Inventory
Trade receivables
Total Current assets
Fixed assets
Total Assets

(000's)
CA/CL=1.40
D/SHF=0.55
Sales/Total Assets = .5
COGS/Inv = 7.5
Sales/ARec = 5
GP/Sales = 25%
NI/Sales = 10%
s follows:

a. Current Ratio 1.40 times

b. Debt -equity ratio 0.55 times
c. Total Assets Turnover Ratio 0.5 times
d. Inventory Turnover Ratio 7.5 times
e. Receivables Turnover Ratio 5 times
f. Gross Margin Ratio 25%
g. Net Margin Ratio 10%
Problem No. 8 : Complete the following balance sheet and profit and loss account based on

Balance Sheet
Amount
Liabilities (000's)
Current liabilities 45,000
Long term debts 55,000
Equity capital 60,000
Reserve and surplus 40,000
Share holder funds 100,000
Total L +E 200,000

Profit and Loss Account

Particulars Amount (000's)
Sales 100,000
Less : COGS 75,000
Gross profit 25,000
Less : S& A expenses 15,000
Net profit 10,000

a. Current Ratio 1.40 times

b. Debt -equity ratio 0.55 times
c. Total Assets Turnover R 0.5 times
d. Inventory Turnover Rati 7.5 times
e. Receivables Turnover R 5 times
f. Gross Margin Ratio 25%
g. Net Margin Ratio 10%
nd profit and loss account based on the information given as follows:

Amount
Assets ('000s)
Cash 33,000
Inventory 10,000
Trade receivables 20,000
Total Current assets 63,000
Fixed assets 137,000
Total Assets 200,000

(000's)

CA/CL=1.40
D/SHF=0.55
Sales/Total Assets = .5
COGS/Inv = 7.5
Sales/ARec = 5
GP/Sales = 25%
NI/Sales = 10%