Ratio Analysis Problems
1. A firm has the following ratios: ROE=25% (return on equity), ACP=37 days (average
collection period), PM=5% (profit margin), CR=2.4 (current ratio), ATO=2.2 (asset
turnover), and DSI=92 days (days of sales in inventory). Find the firm’s debt-to-asset
(D/A) ratio.
2. a) If the equity multiplier of a company is 3, what is its D/A ratio and its D/E ratio?
b) If the D/A ratio of a company is 60%, what is its EM ratio and its D/E ratio?
c) If the D/E ratio of a company is 1.5, what is its EM ratio and its D/A ratio?
3. A firm has current assets of $560,000 and current liabilities of $200,000. This firm
has decided to change its current ratio to 2.0. To do so, it will change the level of its
short-term loans by $X and make a corresponding change in its cash account by that
same amount. Find the value of $X needed to achieve the firm’s goal. You must
provide an analytical solution.
4. Canes Bank pays its depositors 3% p.a. on their savings accounts, and charges 5% on
its loans to borrowers. The only source of revenue for the bank is from its loan
portfolio, which is 60% of its total assets of $3 billion. What is this bank’s asset
turnover?
5. Some people argue that the DuPont relationship implies that firms should use as
much leverage as possible because, other things being equal, as debt increases so does
the equity multiplier (EM) and, therefore, the ROE also increases. However, in
practice this is not necessarily true. Why not? Be specific and brief.
6. A company has annual sales of $2 million; its annual EBIT is $100,000; its total
assets are $1 million; its cost of debt is 10% p.a.; and its corporate tax rate is 30%.
The company wishes to maximize its ROE by changing its debt level (D), while
keeping total assets constant (i.e., by restructuring its capital structure). To ascertain
the effect of D on the company’s ROE, assume only the following debt levels are
available: a) D = 0; b) D = $250,000; c) D = $500,000; d) D = $750,000. Which of
these debt levels should the company choose to achieve its goal? Does this result
support the popular belief presented in the previous problem?