Question

Compute and Interpret Liquidity, Solvency and Coverage Ratios
Selected balance sheet and income statement information from Verizon Communications follows.

($ millions)	2005	2004
Current assets	$ 16,448	$ 19,479
Current liabilities	25,063	23,129
Total debt	39,010	39,267
Total liabilities	101,696	103,345
Equity	66,434	62,613
Earnings before interest and taxes	12,787	12,496
Interest expense	2,180	2,384
Net cash flow from operating activities	$ 22,012	$ 21,820

(a) Compute the current ratio for each year and discuss any trend in liquidity. (Round your answers to two decimal places.)
2005 current ratio = Answer

2004 current ratio = Answer

What additional information about the numbers used to compute this ratio might be useful in helping you assess liquidity? (Select all that apply)
Answeryesno The maturity schedule of current liabilities
Answeryesno The average stock price for the industry
Answeryesno The average current ratio for the industry
Answeryesno The amount of current assets that is concentrated in relatively illiquid inventories

(b) Compute times interest earned, total liabilities-to-equity, and net cash from operating activities to total debt ratios for each year. (Round your answers to two decimal places.)
2005 times interest earned = Answer
2004 times interest earned = Answer

2005 total liabilities-to-equity = Answer
2004 total liabilities-to-equity = Answer

2005 net operating cash flow to total debt = Answer
2004 net operating cash flow to total debt = Answer

Which of the following best describes the extent of Verizon's financial leverage and the company's ability to meet interest obligations?

Verizon's times interest earned ratio has decreased, total liabilities-to-equity has increased, and net operating cash flow to total debt ratio has remained the same, which suggests the company will meet its obligations.

Verizon's times interest earned ratio has increased, total liabilities-to-equity has increased, and net operating cash flow to total debt ratio has decreased, which suggests the company will not meet its obligations.

Verizon's times interest earned ratio has increased, total liabilities-to-equity has decreased, and net operating cash flow to total debt ratio has remained the same, which suggests the company will meet its obligations.

Verizon's times interest earned ratio has increased, total liabilities-to-equity has decreased, and net operating cash flow to total debt ratio has decreased, which suggests the company will not meet its obligations.

(c)Verizon's capital expenditures are expected to increase substantially as it seeks to respond to competitive pressures to upgrade the quality of its communications infrastructure. Which of the following best describes Verizon's liquidity and solvency in light of this strategic direction?

The company's profitability and operating cash flow are fairly strong, both are particularly high in relation to the company's liabilities and interest costs. The capital expenditures can be made with no borrowing or additional equity.

The company's profitability and operating cash flow are fairly weak, both are very low in relation to the company's liabilities and interest costs. The company is on the verge of bankruptcy.

The company's profitability and operating cash flow are fairly weak, both are very low in relation to the company's liabilities and interest costs. The company cannot fund any capital expenditures.

The company's profitability and operating cash flow are fairly strong, neither is particularly high in relation to the company's liabilities and interest costs. The capital expenditures may have to be funded with higher-cost equity.

Answer 1

a) Current Ratio

i) Current Ratio = Current Asset / Current liabilities

2004 = 19,479 / 23,149 = 0.84

2005 = 16448 / 25063 = 0.65

Analysis : A decreading trend could be identified in this case whereby the current ratio of the company has deteriorated from 0.84 in 2004 to 0.65 in 2005.

ii) What additional information about the numbers used to compute this ratio might be useful in helping you assess liquidity? (Select all that apply)
The maturity schedule of current liabilities - Yes  
The average stock price for the industry - No
The average current ratio for the industry - No
The amount of current assets that is concentrated in relatively illiquid inventories - Yes

b) Computation of Ratios

i) Times interest earned = EBIT / Interest Expenditure

2005 times interest earned = 12,787 / 2,180 = 5.87 times
2004 times interest earned = 12,496 / 2,384 = 5.24 times

ii)

2005 total liabilities-to-equity = 1,01,696 / 66,434 = 1.53
2004 total liabilities-to-equity = 1,03,345 / 62,613 = 1.65

iii) net operating cash flow to total debt = net operating cash flow / total debt

2005 net operating cash flow to total debt = 0.56 times
2004 net operating cash flow to total debt = 0.56 times( 0.555 times rounded off)

iv) Which of the following best describes the extent of Verizon's financial leverage and the company's ability to meet interest obligations:

Solution:

Verizon's times interest earned ratio has increased, total liabilities-to-equity has decreased, and net operating cash flow to total debt ratio has decreased, which suggests the company will not meet its obligations

c) Verizon's capital expenditures are expected to increase substantially as it seeks to respond to competitive pressures to upgrade the quality of its communications infrastructure. Which of the following best describes Verizon's liquidity and solvency in light of this strategic direction

Solution:

The company's profitability and operating cash flow are fairly strong, neither is particularly high in relation to the company's liabilities and interest costs. The capital expenditures may have to be funded with higher-cost equity