Question

a) Describe the main categories of financial ratios and discuss how financial ratios can facilitate the financial analysis. [10 marks]

b) Discuss the effect of FIFO (First In First Out) and LIFO (Last In First Out) methods on the balance sheet and income statement during periods of inflation.

c) Describe what are the common-size financial statements and explain why corporations use them.

d) Under what circumstances can a firm increase its share price by cutting its dividend and increasing its investment?

e) How does the growth rate used in the total payout model differ from the growth rate used in the dividend-discount model?

f) State the efficient market hypothesis. What are the implications of the efficient market hypothesis for corporate managers?

g) Explain what is a firm’s weighted average cost of capital (WACC). Explain why it is often used as a discount rate to evaluate projects.

h) What inputs do we need to estimate a firm’s equity cost of capital using the Capital Asset Pricing Model (CAPM)?

i) Explain in detail why projects within the same firm may have different costs of capital.

Answer 1

A) Describe the main categories of financial ratios and discuss how financial ratios can facilitate the financial analysis

The five (5) major categories in the financial ratios list include the following :

Liquidity Ratios. - tests the short term debt paying capacity of the firm

Activity Ratios.- tests the status of operational activities of the firm

Debt Ratios.- tests the long term debt repayment capabilities of the firm

Profitability Ratios. - tests the profit making capacity of the firm

Market Ratios.- helps to compare the firm's performance with that of the market

Financial ratios are extremely helpful in comparison between the firm and the industry, different firms in the same industry and also different periods of the same firm.

It remove the effects of different size of firms and makes them comparable

Helps investors to make decisions accordingly

Helps in financial statement analysis to measure firm's performance across time and compared to other companies