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Module 2 - Extra Practice Questions With Solutions

The document contains 6 practice questions and solutions related to working with financial statements. The questions cover topics like inventory turnover, return on equity, profit margin, and debt-to-equity ratios. Formulas and step-by-step workings are provided for each question.

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Yatin Walia
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35 views

Module 2 - Extra Practice Questions With Solutions

The document contains 6 practice questions and solutions related to working with financial statements. The questions cover topics like inventory turnover, return on equity, profit margin, and debt-to-equity ratios. Formulas and step-by-step workings are provided for each question.

Uploaded by

Yatin Walia
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Extra practice questions & solutions

Module 2 – Working with financial statements

1. The Morden Corporation has ending inventory of $407,534, and cost of goods sold for the year
just ended was $4,105,612. What is the inventory turnover? The days' sales in inventory? How
long on average did a unit of inventory sit on the shelf before it was sold?

Inventory turnover = COGS / Inventory


Inventory turnover = $4,105,612 / $407,534 = 10.07 times

Days’ sales in inventory = 365 days / Inventory turnover = 365 / 10.07 = 36.25 days

On average, a unit of inventory sat on the shelf 36.25 days before it was sold.

2. If Garson Rooters Inc. has an equity multiplier of 2.80, total asset turnover of 1.15, and a
profit margin of 5.5 percent, what is its ROE?

ROE = (PM)(TAT)(EM)
ROE = (.055)(1.15)(2.80) = .1771or 17.71%

3. Glenboro Fire Prevention Corp. has a profit margin of 6.80 percent, total asset turnover of 1.95,
and ROE of 18.27 percent. What is this firm's debt–equity ratio?

This question gives all of the necessary ratios for the DuPont Identity except the equity
multiplier, so, using the DuPont Identity:

ROE = (PM)(TAT)(EM)
ROE = .1827 = (.068)(1.95)(EM)

EM = .1827 / (.068)(1.95) = 1.38

D/E = EM – 1 = 1.38 – 1 = 0.38

4. Ethelbert Inc. has sales of $5,276, total assets of $3,105, and a debt–equity ratio of 1.40. If
its return on equity is 15 percent, what is its net income?

ROE = 0.15 = (PM)(TAT)(EM) = (PM)(S / TA)(1 + D/E)

Solving the DuPont Identity for profit margin, we get:

PM = [(ROE)(TA)] / [(1 + D/E)(S)]


PM = [(0.15)($3,105)] / [(1 + 1.4)( $5,276)] = .0368
Now that we have the profit margin, we can use this number and the given sales figure to
solve for net income:

PM = .0368 = NI / S
NI = .0368($5,276) = $194.16

5. Gunton Corp. has net income of $218,000, a profit margin of 8.70 percent, and an accounts
receivable balance of $132,850. Assuming 70 percent of sales are on credit, what are the
Gunton's days' sales in receivables?

This is a multi-step problem involving several ratios. It is often easier to look backward to
determine where to start. We need receivables turnover to find days’ sales in receivables. To
calculate receivables turnover, we need credit sales, and to find credit sales, we need total
sales. Since we are given the profit margin and net income, we can use these to calculate total
sales as:

PM = 0.087 = NI / Sales = $218,000 / Sales; Sales = $2,505,747

Credit sales are 70 percent of total sales, so: Credit sales = $2,505,747(0.70) = $1,754,023

Now we can find receivables turnover by:

Receivables turnover = Credit sales / Accounts receivable = $1,754,023 / $132,850 = 13.20


times
Days’ sales in receivables = 365 days / Receivables turnover = 365 / 13.20 = 27.65 days

6. Firm A and Firm B have total debt ratios of 35 percent and 30 percent and return on assets
of 12 percent and 11 percent, respectively. Which firm has a greater return on equity?

The solution requires substituting two ratios into a third ratio. Rearranging D/TA:

Firm A Firm B
D / TA = .35 D / TA = .30
(TA – E) / TA = .35 (TA – E) / TA = .30
(TA / TA) – (E / TA) = .35 (TA / TA) – (E / TA) = .3
1 – (E / TA) = .35 1 – (E / TA) = .3
E / TA = .65 E / TA = .7
E = .65(TA) E = .7(TA)

Rearranging ROA, we find:

NI / TA = .12 NI / TA = .11
NI = .12(TA) NI = .11(TA)
Since ROE = NI / E, we can substitute the above equations into the ROE formula, which
yields:

ROEa = .12(TA) / .65(TA) = .12 / .65 = 18.46%


ROEb = .11(TA) / .7 (TA) = .11 / .7 = 15.71%

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