1. Which of the following types of firms do you expect to have particularly high or low asset turnover? Explain why.
2. Which of the following types of firms do you expect to have high or low sales margins? Why?
3. James Broker, an analyst with an established brokerage firm, comments: “The critical number I look at for any company is operating cash flow. If cash flows are less than earnings, I consider a company to be a poor performer and a poor investment prospect.” Do you agree with this assessment? Why or why not?
4. In 2005 IBM had a return on equity of 26.7 percent, whereas Hewlett-Packard’s return was only 6.4 percent. Use the decomposed ROI framework to provide possible reasons for this difference based on the data below:
NOPAT/Sales 9.0% 2.7%
Sales/Net Assets 2.16 2.73
Effective After-Tax Interest Rate 2.4% 1.1%
Net Financial Leverage 0.42 -0.16
ROE can be decomposed as follows:
5. Joe Investor asserts, “A company cannot grow faster than its sustainable growth rate.” True or false? Explain why.
6. What are the reasons for a firm having lower cash from operations than working capital from operations? What are the possible interpretations of these reasons?
7. ABC Company recognizes revenue at the point of shipment. Management decides to increase sales for the current quarter by filling all customer orders. Explain what impact this decision will have on the following:
Days’ receivable for the current quarter.
Days’ receivable for the next quarter.
Sales growth for the current quarter
Sales growth for the next quarter.
Return on sales for the current quarter.
Return on sales for the next quarter.
8. What ratios would you use to evaluate operating leverage for a firm?
9. What are the potential benchmarks that you could use to compare a company’s financial ratios? What are the pros and cons of these alternatives?
Comparison to Firm’s Prior History.
Comparison to Firm’s Expected or Budgeted Performance.
Comparison to Industry Average.
Comparison to Market.
10. In a period of rising prices, how would the following ratios be affected by the accounting decision to select LIFO, rather than FIFO, for inventory valuation?
Average tax rate
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