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Financial Ratios Argumentative

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• Prepare a ratio analysis for the fiscal year ended Dec 31, 2012. Organize your analysis per the following outline:

(1) Liquidity
– Current ratio: current assets/ current liabilities= 25,000/17,000 = 1.47%
– Quick ratio: current assets-inventory/ current liabilities= 25,000-17,000 / 17,000 = .25 (note: 17,000 cancels itself out)
Comments on liquidity: Cannot tell if these ratios are good or bad without more information on the company’s situation or past years.

(2) Asset management
– Total Asset turnover: sales/ total assets= 10,000/40,000= .25
– Average collection period (ACP): A/R/ average credit sales per day= 3,000/ (10,000/365) = 3,000/ 27 = 111 days
Comments on asset management: Joe’s Is producing $0.25 for each $1 of assets. This cannot be further explained without more information. Joe’s customers take over 111 days to pay their bills.

(3) Debt management
– Debt ratio: total liabilities/ total assets= 20,000/ 40,000= .5 or 50%
– Times interest earned: earnings before interest and taxes(EBIT)/ interest ex.= 3,000/200 = 15

Comments on debt management: Joes is not in large debt because it is not equal to their total liabilities as long as they keep their accounts payable low and do not borrow more money than their assets can outweigh, this includes their long term debt. Joes EBIT could drop 2,800 and they could still make interest payments. Joe’s ratio of 15 means the income is 15 times greater than the annual interest expense.

(4) Profitability
– Net profit margin: Net income/sales= 1,800/10,000= 18%
– Return on Assets (ROA)= Net income/ total assets= 1,800/40,000=.045 or 4.5%
– Return on Equity (ROE)= Net income/ total equity=1,800/20,000= .09 or 9%
– Extended Du Pont equation=
ROE= Net income/sales x Sales/total assets x Total Assets/total (common) equity = .09 = .18 x .25 x 2.0

Comments on profitability to include your comments on the sources of ROE
revealed by the Du Pont equation: The net profit margin shows 18% or $0.18 or each dollar of sales remains after all expenses are paid. Joe’s earns $0.045 or 4.5% for every $1 of assets to generate earnings. ROE is 9% of profit Joes generated with the money shareholders have invested. Du Pont equation: Net profit margin at 18% accounts for a small amount of the ROE. Asset turnover is $0.25 for each dollar of asset generating earnings which is not affecting ROE greatly. The Equity multiplier is the leverage effect in ROE at 2.0. Without the leverage effect ROE would be .045, however, Joe’s currently does not use a lot of debt financing which is why the ROE is already low for the firm’s equity. Overall Joe’s is doing well by not using other people’s money.

(5) Market value ratios
– PE ratio: Stock price/ EPS = $50.00/ 1.80 = $27.77
– Market to book ratio: Stock price/ book value per share= $50/$7=$7.14 Comments on the market value ratios: Without past ratios or other market ratios, Joe’s PE tells us there is a medium expectation for growth of the company and the M/B ratio shows there are intangible assets the firm is not listing.

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