Question

1. Complete the balance sheet and sales information using the following financial data:

Total assets turnover: 1.6x
Days sales outstanding: 39.5 days^a
Inventory turnover ratio: 5x
Fixed assets turnover: 3.5x
Current ratio: 2.3x
Gross profit margin on sales: (Sales - Cost of goods sold)/Sales = 20%
^aCalculation is based on a 365-day year. Do not round intermediate calculations. Round your answers to the nearest cent.

Balance Sheet
Cash	$		Current liabilities	$
Accounts receivable			Long-term debt	33,750
Inventories			Common stock
Fixed assets			Retained earnings	78,750
Total assets	$225,000		Total liabilities and equity	$
Sales	$		Cost of goods sold	$

Cash	$14,000		Accounts payable	$42,000
Receivables	70,000		Other current liabilities	28,000
Inventories	280,000		Total CL	$70,000
Total CA	$364,000		Long-term debt	140,000
Net fixed assets	126,000		Common equity	280,000
Total assets	$490,000		Total liab. and equity	$490,000
Sales	$280,000
Net income	21,000

2. Commonwealth Construction (CC) needs $1 million of assets to get started, and it expects to have a basic earning power ratio of 15%. CC will own no securities, so all of its income will be operating income. If it so chooses, CC can finance up to 35% of its assets with debt, which will have an 10% interest rate. If it chooses to use debt, the firm will finance using only debt and common equity, so no preferred stock will be used. Assuming a 30% tax rate on all taxable income, what is the difference between CC's expected ROE if it finances these assets with 35% debt versus its expected ROE if it finances these assets entirely with common stock? Round your answer to two decimal places.

  %?

3. The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average, 2.15, without affecting either sales or net income. Assuming that inventories are sold off and not replaced to get the current ratio to the target level, and that the funds generated are used to buy back common stock at book value, by how much would the ROE change? Do not round your intermediate calculations.

a. 19.50%

b. 29.38%

c. 24.08%

d. 29.86%

e. 25.04%

Answer 1

Answer to Question 1:

Total Assets Turnover = Sales / Total Assets
1.6 = Sales / $225,000
Sales = $360,000

Gross Profit Margin on Sales = (Sales - Cost of Goods Sold) / Sales
0.20 = ($360,000 - Cost of Goods Sold) / $360,000
Cost of Goods Sold = $288,000

Days Sales Outstanding = 365 * Accounts Receivable / Sales
39.50 = 365 * Accounts Receivable / $360,000
Accounts Receivable = $38,958.90

Inventory Turnover Ratio = Cost of Goods Sold / Inventories
5 = $288,000 / Inventories
Inventories = $57,600

Fixed Assets Turnover = Sales / Fixed Assets
3.50 = $360,000 / Fixed Assets
Fixed Assets = $102,857.14

Total Assets = Current Assets + Fixed Assets
$225,000 = Current Assets + $102,857.14
Current Assets = $122,142.86

Current Assets = Cash + Accounts Receivable + Inventories
$122,142.86 = Cash + $38,958.90 + $57,600
Cash = $25,583.96

Current Ratio = Current Assets / Current Liabilities
2.30 = $122,142.86 / Current Liabilities
Current Liabilities = $53,105.59

Total Liabilities and Equity = Total Assets
Total Liabilities and Equity = $225,000

Total Liabilities and Equity = Current Liabilities + Long-term Debt + Common Stock + Retained Earnings
$225,000 = $53,105.59 + $33,750 + Common Stock + $78,750
Common Stock = $59,394.41