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Chapter 2: Q3-4DQ (page 74)
What advantage does the fixed charge coverage ratio offer over simply using times interest earned?
The fixed charges coverage ratio is computed to measure the company’s ability to meet all the fixed financial liabilities rather than just interest expenses.
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In January 2007, the Status Quo Company was formed. Total assets were \(544,000, of which \)306,000 consisted of depreciable fixed assets. Status
Quo uses straight-line depreciation of \(30,600 per year, and in 2007 it estimated its fixed assets to have useful lives of 10 years. Aftertax income has been \)29,000 per year each of the last 10 years. Other assets have not changed since 2007.
c. Now assume income increased by 10 percent each year. What effect would this have on your preceding answers? (A comment is all that is necessary.)
Vriend Software Inc.’s book value per share is \(15.20. If earnings per share is\)1.88 and the firm’s stock trades in the stock market at 3.5 times book value pershare, what will the P/E ratio be? (Round to the nearest whole number.)
Assume the following data for Cable Corporation and Multi-Media Inc.
Capable corporation | Muli-media inc | |
Net income | \(31,200 | \)140,000 |
Sales | 317,000 | 2,700,000 |
Total assets | 402,000 | 965,000 |
Total debts | 163,000 | 542,000 |
Stockholder’s equity | 239,000 | 423,000 |
b. Compute the following additional ratios for both firms:
Net income/Sales
Net income/Total assets
Sales/Total assets
Debt/Total assets
Why is trend analysis helpful in analyzing ratios?
Lemon Auto Wholesalers had sales of \(1,000,000 last year, and cost of goods sold represented 78 percent of sales. Selling and administrative expenses were 12 percent of sales. Depreciation expense was \)11,000 and interest expense for the year was \(8,000. The firm’s tax rate is 30 percent.
a. Compute earnings after taxes.
b. Assume the firm hires Ms. Carr, an efficiency expert, as a consultant. She suggests that by increasing selling and administrative expenses to 14 percent of sales, sales can be increased to \)1,050,900. The extra sales effort will also reduce cost of goods sold to 74 percent of sales. (There will be a larger markup in prices as a result of more aggressive selling.) Depreciation expense will remain at \(11,000. However, more automobiles will have to be carried in inventory to satisfy customers, and interest expense will go up to \)15,800. The firm’s tax rate will remain at 30 percent. Compute revised earnings after taxes based on Ms. Carr’s suggestions for Lemon Auto Wholesalers. Will her ideas increase or decrease profitability?
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