Question

Compute and Interpret Liquidity, Solvency and Coverage Ratios

Information from the balance sheet, income statement, and statement of cash flows for Nike follows. Refer to these financial statements to answer the requirements.

NIKE, INC. Consolidated Statements of Income
Year Ended December 31 (In millions)	2019	2018
Revenues	$39,117	$36,397
Cost of sales	21,643	20,441
Gross profit	17,474	15,956
Demand creation expense	3,753	3,577
Operating overhead expense	8,949	7,934
Total selling and administrative expense	12,702	11,511
Interest expense (income), net	49	54
Other (income) expense, net	(78)	66
Income before income taxes	4,801	4,325
Income tax expense	772	2,392
Net income	$ 4,029	$ 1,933

Consolidated Balance Sheets
May 31 (in millions)	2019	2018
Current Assets
Cash and cash equivalents	$ 4,466	$ 4,249
Short-term investments	197	996
Accounts receivable, net.	4,272	3,498
Inventories	5,622	5,261
Prepaid expenses and other current assets	1,968	1,130
Total current assets	16,525	15,134
Property, plant and equipment, net	4,744	4,454
Identifiable intangible assets, net	283	285
Goodwill	154	154
Deferred income taxes	2,011	2,509
Total assets	$23,717	$22,536
Liabilities and stockholders' equity
Current Liabilities
Current portion of long-term debt	$6	$6
Notes payable	9	336
Accounts payable	2,612	2,279
Accrued pension liabilities	5,010	3,269
Income taxes payable	229	150
Total current liabilities	7,866	6,040
Long-term debt	3,464	3,468
Deferred income taxes and other liabilities	3,347	3,216
Shareholders’ equity
Class A convertible—315 and 329 shares outstanding	--	--
Class B—1,253 and 1,272 shares outstanding	3	3
Capital in excess of stated value	7,163	6,384
Accumulated other comprehensive income (loss)	231	(92)
Retained earnings	1,643	3,517
Total shareholders’ equity	9,040	9,812
Total liabilities and stockholders' equity	$23,717	$22,536

Consolidated Statement of Cash Flows
Year Ended May 31 (in millions)	2019	2018
Cash provided by operations:
Net income	$4,029	$1,933
Adjustments to reconcile net income to net cash provided by operations:
Depreciation	705	747
Deferred income taxes	34	647
Stock-based compensation	325	218
Amortization and other	15	27
Net foreign currency adjustments	233	(99)
Changes in certain working capital components and other assets and liabilities:
(Increase) decrease in accounts receivable	(270)	187
(Increase) decrease in inventories	(490)	(255)
(Increase) decrease in prepaid expenses and other current and non-current assets	(203)	35
Increase (decrease) in accounts payable, accrued liabilities and other current and non-current liabilities	1,525	1,515
Cash provided by operations	5,903	4,955
Cash provided (used) by investing activities:
Purchases of short-term investments	(2,937)	(4,783)
Maturities of short-term investments	1,715	3,613
Sales of short-term investments	2,072	2,496
Additions to property, plant and equipment	(1,119)	(1,028)
Disposals of property, plant and equipment	5	3
Other investing activities.	--	(25)
Cash provided (used) by investing activities	(264)	276
Cash used by financing activities:
Long-term debt payments, including current portion	(6)	(6)
Increase (decrease) in notes payable	(325)	13
Payments on capital lease and other financing obligations	(27)	(23)
Proceeds from exercise of stock options and other stock issuances	700	733
Repurchase of common stock	(4,286)	(4,254)
Dividends—common and preferred	(1,332)	(1,243)
Tax payments for net share settlement of equity awards	(17)	(55)
Cash used by financing activities	(5,293)	(4,835)
Effect of exchange rate changes on cash and equivalents	(129)	45
Net increase (decrease) in cash and equivalents	217	441
Cash and equivalents, beginning of year	4,249	3,808
Cash and equivalents, end of year	$4,466	$4,249

(a) Compute the current ratio and quick ratio for 2018 and 2019. Note: Round answers to two decimal places.

2019 current ratio = Answer
2018 current ratio = Answer

2019 quick ratio = Answer
2018 quick ratio = Answer

Which of the following best describes the company's current ratio and quick ratio for 2019 and 2018?

The current ratio has increased while the quick ratio has decreased in the period from 2018 to 2019 , which suggests the company has a shortage of liquid assets.

Both the current and quick ratios have decreased from 2018 to 2019 however, the company is liquid.

Both the current and quick ratios have increased from 2018 to 2019, meaning the company is liquid.

The current ratio has decreased while the quick ratio has increased from 2018 to 2019, which suggests the company has a shortage of current assets.

(b) Compute total liabilities-to-equity ratio and total debt-to-equity ratio for 2018 and 2019. Note: Round answers to two decimal places.
2019 total liabilities-to-stockholders' equity = Answer
2018 total liabilities-to-stockholders' equity = Answer

2019 total debt-to-equity = Answer
2018 total debt-to-equity = Answer

Which of the following best describes the company's total liabilities-to-equity ratios and total debt-to-equity ratios for 2019 and 2018?

The total liabilities-to-equity ratio has decreased while the total debt-to-equity ratio has increased in the period from 2018 to 2019, which suggests the company has decreased the use of short-term debt financing.

The total liabilities-to-equity ratio has increased while the total debt-to-equity ratio remained the same in the period from 2018 to 2019, which suggests the company has increased the use of short-term debt financing.

Both the total liabilities-to-equity and total debt-to-equity ratios have increased from 2018 to 2019. These increases suggest that the company is less solvent.

Both the total liabilities-to-equity and total debt-to-equity ratios have decreased from 2018 to 2019. The difference between these two measures reveals that any solvency concerns would be for the short run.

(c) Compute times interest earned ratio, cash from operations to total debt ratio, and free operating cash flow to total debt ratios. Note: Round answers to two decimal places.
2019 times interest earned = Answer
2018 times interest earned = Answer

2019 cash from operations to total debt = Answer
2018 cash from operations to total debt = Answer

2019 free operating cash flow to total debt = Answer
2018 free operating cash flow to total debt = Answer

Which of the following describes the company's times interest earned, cash from operations to total debt, and free operating cash flow to total debt ratios for 2019 and 2018? (Select all that apply)
Answer Nike's free operating cash flow to total debt ratio increased over the year 2019 due to increased cash flow from operations and a decrease in debt.
Answer Nike's times interest earned decreased during 2019, due an increase in interest expense.
Answer Nike's cash from operations to total debt ratio increased over the year 2019 due to an increase in cash flow from operations and a decrease in total debt.
Answer Nike's times interest earned increased during 2019, due to an decrease in profitability.

(d) Summarize your findings in a conclusion about the company's credit risk. Do you have any concerns about the company's ability to meet its debt obligations?

Nike's total debt-to-equity is low, thus increasing any immediate solvency concerns. The company's ability to meet its debt requirements will depend on increasing short-term debt.

Nike's quick ratio is low, thus increasing immediate solvency concerns. The company's ability to meet its debt requirements will depend on liquidating inventories for emergency cash.

Nike's times interest earned ratio is strong, thus lessening any immediate solvency concerns. The company's ability to meet its debt requirements will depend on its continued profitability.

Nike's total liabilities-to-equity is high, thus lessening any immediate solvency concerns. The company's ability to meet its debt requirements will depend on its use of equity financing.

Answer 1

a) Compute the current ratio and quick ratio for 2018 and 2019.

Current Ratio: Current Assets / Current Liabilities

2018 = 15,134 / 6,040 = 2.50

2019 = 16,525 / 7,866 = 2.10

Quick Ratio = (Current Assets - Inventory - Prepaid expenses) / Current Liabilities

2018 = (15,134 - 5,261 - 1,130) / 6,040 = 1.44

2019 = (16,525 - 5,622 - 1,968) / 7,866 = 1.13

Both the current and quick ratios have decreased from 2018 to 2019 however, the company is liquid.

b) Compute total liabilities-to-equity ratio and total debt-to-equity ratio for 2018 and 2019.

Total Liabilities to Equity ratio or Total debt to equity ratio = Total liabilities / Shareholders' Equity

2018 = (6,040 + 3,468 + 3,216) / 9,812 = 1.29

2019 = (7,866 + 3,464 + 3,347) / 9,040 = 1.62

Both the total liabilities-to-equity and total debt-to-equity ratios have increased from 2018 to 2019. These increases suggest that the company is less solvent.

c) Compute times interest earned ratio, cash from operations to total debt ratio, and free operating cash flow to total debt ratios:

Times Interest earned ratio = EBIT / Total interest expense

2018 = (4,325 + 54) / 54 = 81

2019 = (4,801 + 49) / 49 = 98.9

Cash from operations to total debt ratio = Cash flow from Operating activities / total debt

2018 = 4,955 / (6,040 + 3,468 + 3,216) = 38.94%

2019 = 5,903 / (7,866 + 3,464 + 3,347) = 40.22%

Free Operating Cash flow to total debt ratio = Free Cash flow / Total debt

2018 = (4,955 - 1,028) / (6,040 + 3,468 + 3,216) = 30.86%

2019 = (5,903 - 1,119) / (7,866 + 3,464 + 3,347) = 32.59%

Nike's times interest earned increased during 2019, due to an decrease in profitability.

d) Summarize your findings in a conclusion about the company's credit risk. Do you have any concerns about the company's ability to meet its debt obligations?

Nike's times interest earned ratio is strong, thus lessening any immediate solvency concerns. The company's ability to meet its debt requirements will depend on its continued profitability.