PrinciplesofFinance-WEB-41

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inventory turnover measures the number of times an average quantity of inventory was bought and sold
during the period
liquidity ability to convert assets into cash in order to meet primarily short-term cash needs or emergencies
market value ratios measures used to assess a firm’s overall market price
operating cycle amount of time it takes a company to use its cash to provide a product or service and collect
payment from the customer
price/earnings (P/E) ratio company’s stock price divided by the company’s earnings per share; indicates the
amount investors are willing to pay for one dollar of earnings
profit margin represents how much of sales revenue has translated into income
quick ratio also known as the acid test ratio; ratio used to determine a firm’s ability to pay short-term debts
using its most liquid assets
return on equity measures the company’s ability to use its invested capital to generate income
return on total assets measures the company’s ability to use its assets successfully to generate a profit
solvency implies that a company can meet its long-term obligations and will likely stay in business in the
future
times interest earned (TIE) ratio measures the company’s ability to pay interest expense on long-term debt
incurred
total asset turnover measures the ability of a company to use its assets to generate revenues
CFA Institute
This chapter supports some of the Learning Outcome Statements (LOS) in this CFA® Level I Study Session
(https://openstax.org/r/cfa-study-session11). Reference with permission of CFA Institute.
Multiple Choice
1. Which of the following is financial statement analysis not used for?
a. identifying trends over time
b. benchmarking against other firms
c. complying with SEC (Securities and Exchange Commission) regulations
d. setting budget expectations
2. How is converting financial data to percentages helpful in financial analysis?
a. It makes the figures easier to calculate.
b. It masks actual financial data so the competition can’t see it.
c. It saves time.
d. It makes comparisons to companies of varying sizes possible.
3. What is a common economic influence that has the potential to skew financial analysis figures?
a. past performance
b. inflation
c. Generally Accepted Accounting Principles
d. benchmark data
4. What is the formula for accounts receivable turnover?
a. net credit sales / average accounts receivable
b. total sales / average accounts receivable
c. net credit sales / beginning accounts receivable
d. net cash sales / ending accounts receivable
5. What is the formula for the times interest earned ratio?
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a. net income / interest expense
b. earnings before interest and taxes / interest expense
c. interest expense / earnings before interest and taxes
d. earnings before interest and taxes – interest expense
6. What is the formula for the calculation of earnings per share?
a. (net income + preferred dividends) / weighted average common shares outstanding
b. net income / weighted average common shares outstanding
c. (net income – preferred dividends) / weighted average common shares outstanding
d. (net income – preferred dividends) / treasury shares outstanding
7. Most analysts believe which of the following is true about earnings per share?
a. Consistent improvement in earnings per share year after year is an indication of continuous
improvement in the company’s earning power.
b. Consistent improvement in earnings per share year after year is an indication of continuous decline in
the company’s earning power.
c. Consistent improvement in earnings per share year after year is an indication of fraud within the
company.
d. Consistent improvement in earnings per share year after year is an indication that the company will
never suffer a year of net loss rather than net income.
8. What is the formula for profit margin?
a. net sales / net income
b. cost of goods sold / net sales
c. sales / cost of goods sold
d. net income / net sales
Review Questions
1. Is past performance considered a good indicator of future performance?
2. The Pony Parts Tack Shop had inventory turnover of 12.8, 12.2, and 9.9 over the last three years,
respectively. What can you learn about how well the Pony Parts management team is managing their
inventory using this information?
3. The Pony Parts Tack Shop had total asset turnover of 1.8., 2.1, and 2.4 over the last three years,
respectively. What can you learn about how well the Pony Parts management team is managing their total
assets using this information?
4. Big Box Store Inc. had days’ sales in inventory of 30, 32, and 34 for the last three years. Small Box Store
Inc. had days’ sales in inventory of 40, 38, and 36 for the last three years. What can you infer about the
inventory management for the two companies based on this information? Which company is performing
better?
5. Jackson’s Beef Jerky Shop has a current ratio of 2.35. What does that mean? Is 2.35 a good or bad current
ratio?
6. Jackson’s Beef Jerky Shop has a quick ratio of 1.9. What does that mean? Is 1.9 a good or bad quick ratio?
7. Jackson’s Beef Jerky Shop has a cash ratio of 1.75. What does that mean? Is 1.75 a good or bad cash ratio?
8. You have some funds that you would like to invest. Do some internet research to find two publicly traded
companies in the same industry and compare their earnings per share. Would the earnings per share
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reported by each company influence your decision in selecting which company to invest in?
9. Company A has a market value per share of 19.55 and book value per share of 12.79. If you were an
investor, what would you conclude about the current value of Company A stock?
10. Company B has a price/earnings ratio of 21.2. The current industry average price/earnings ratio is 20.75.
What might an investor conclude about investing in Company B?
11. What are the key elements of the DuPont formula, and how do these components function to help
analysts assess an organization?
Problems
1. Sarah’s Toy Shop has total sales of $100,000, net credit sales of $70,000, beginning accounts receivable of
$20,000, and ending accounts receivable of $30,000. What is Sarah’s accounts receivable turnover?
Assume industry average is 2.9 times. How would you interpret Sarah’s turnover?
2. Fantastic Foods has total assets of $150,000, current assets of $80,000 (current assets includes $30,000 of
cash, $10,000 of short term investments, $20,000 of accounts receivable, and $20,000 of inventory), total
liabilities of $120,000, and current liabilities of $70,000. What is Fantastic Foods’ current ratio?
3. The Big Club has total assets of $150,000, current assets of $80,000 (current assets includes $30,000 of
cash, $10,000 of short-term investments, $20,000 of accounts receivable, and $20,000 of inventory), total
liabilities of $120,000, and current liabilities of $70,000. What is The Big Club’s quick ratio?
4. Giant Sales has total assets of $150,000, current assets of $80,000 (current assets includes $30,000 of cash,
$10,000 of short-term investments, $20,000 of accounts receivable, and $20,000 of inventory), total
liabilities of $120,000, and current liabilities of $70,000. What is Giant Sales’ cash ratio?
5. Bonita’s Bread Company has total debt of $250,000 and total assets of $150,000. What is Bonita’s debt-to-
assets ratio, and what can we infer about Bonita’s company using the ratio?
6. Jai Company has total liabilities of $200,000 and total stockholder equity of $300,000. What is the debt-to-
equity ratio for Jai Company, and what can we infer about the firm using this ratio?
7. Jamilah’s Manufacturing Company has earnings before interest and taxes of $29,000 and interest expense
of $4,000 for the most current period. What is Jamilah’s times interest earned ratio?
8. Sarai’s Sandy Beach Gear has net sales of $100,000, cost of goods sold of $60,000,and net income of
$25,000. What is Sarai’s profit margin?
9. Bob’s Tires Inc. has sales of $100,000, net income of $50,000, beginning asset balance of $200,000, ending
asset balance of $220,000, beginning stockholder equity of $160,000, and ending stockholder equity of
$200,000. What is Bob’s return on total assets?
10. Bob’s Tires Inc. has sales of $100,000, net income of $50,000, beginning asset balance of $200,000, ending
asset balance of $220,000, beginning stockholder equity of $160,000, and ending stockholder equity of
$200,000. What is Bob’s return on equity?
Video Activity
Ratio Analysis—Limitations of Ratios
Click to view content (https://openstax.org/r/ratio-analysis)
1. In the video, Jim walks through several key limitations in the areas of reliability, comparability, relying on
only one data source, and using information based in the past. Which limitation do you feel is the most
worrisome? What might you do to compensate for the limitation you identified?
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2. Outside of the four key areas of limitations, Jim also explores a number of key elements that ratios aren’t
able to convey. What characteristics of a firm would you most want to know about if you were to invest
that you would not be able to glean from ratios? How would you go about gathering that information if
you cannot get it through financial statements and ratio analysis?
The Problem with Earnings per Share (EPS)
Click to view content (https://openstax.org/r/problem-with-earnings)
3. What does Zach DeGregorio cite as the most beneficial characteristics of using EPS in financial analysis?
And the most problematic?
4. After watching the video and listing the key benefits and problems with EPS, how do you feel about the
EPS calculation? Should investors use it? Why or why not? If you were going to invest a large sum of
money in a company, would you use EPS data in your decision-making process? Why or why not?
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Figure 7.1 Time has an impact on the value of money. (credit: modification of "Time is money" by Marco Verch/flickr, CC BY 2.0)
Chapter Outline
7.1 Now versus Later Concepts
7.2 Time Value of Money (TVM) Basics
7.3 Methods for Solving Time Value of Money Problems
7.4 Applications of TVM in Finance
Why It Matters
One of the single most important concepts in the study of finance is the time value of money (TVM). This
concept puts forward the idea that a dollar received today is worth more than, and therefore preferable to, a
dollar received at some point in the future. The three primary reasons for this are that (1) money received now
can be saved or invested now and earn interest or a return, resulting in more money in the future; (2) any
promise of future payments of cash will always carry the risk of default; and (3) it is simple human nature for
people to prefer making their purchases of goods and services in the present rather than waiting to make
them at some future time.
For this reason, it is important to incentivize people to give up their present consumption patterns by offering
them greater value in the future. Based on the concept of TVM, it can be said that a dollar was worth more to
us, and thus carried more value, yesterday than it is to us today. It also then follows that a dollar in our
possession right now carries a greater value for us than a dollar we might receive tomorrow or at some other
point in the future.
The entire concept of the time value of money is particularly important because it allows savers and investors
to make better-informed decisions about what to do with their money. TVM can help a person understand
which option may be best based on the critical factors of overall risk, rates of interest, inflation, and return.
TVM can also be used to help a person understand how much money they’ll need to save in an interest-
bearing account in order to reach a desired financial goal, such as saving $50,000 in 10 years in an account that
earns 4% compound interest each year. TVM is the key underlying principle of such important financial
analytical activities as retirement planning, corporate capital project evaluation, and even deciding on your
Time Value of Money I: Single Payment Value
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	Chapter 6 Measures of Financial Health
	CFA Institute
	Multiple Choice
	Review Questions
	Problems
	Video Activity
	Chapter 7 Time Value of Money I: Single Payment Value
	Why It Matters