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# Financial Ratios Question.

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Financial Ratios Question

What are some examples of Valuation Concepts?

#### Solution Preview

Some examples are:

Valuation Ratios
Many valuation ratios exist to judge the value the stock market places on any given company. Three such ratios used in this work are the price/earnings ratio (p/e), the price/sales ratio (p/s), and the price/free cash flow ratio (p/fcf). Other examples not used at his time are price/book and price/cash flow. The three chosen are easily understood and described below. Others can be added later as we become more sophisticated in analyzing valuations. (Much of the following description/definition of terms is cut from yahoo.marketguide and is quoted.)

P/E Ratio
"The Price-to-Earnings (P/E) ratio is the single most widely used measure of a stock's value. That's because the key to stock ownership is the shareholder's stake in a portion of the company's profit stream." The p/e is the price per share divided by the earnings per share.

Price/Sales Ratio
"Price-to-Sales is generally used to evaluate companies that don't have earnings and don't pay dividends. For these companies, you may consider that high multiples of sales and high growth rates suggest optimistic future earnings expectations on the part of investors. Also, earnings can vary widely from one year to the next due to temporary issues, such as reserves or gains and losses on asset divestitures. Sales trends tend to be less volatile. Hence the Price-to-Sales ratio can be useful in situations where the P/E is distorted by unusual swings ...

#### Solution Summary

This solution discusses nine valuation concepts/ratios.

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## Final exam review

Practice Problems for final exam

1. Use the basic accounting equation (Assets=Liabilities + Owners Equity) to answer each of the following questions. Show any calculations you make.

a) The assets of Bugs Bunny Company are \$650,000 and the owners equity is \$360,000. Mr. Bunny wants to know--what is the amount of liabilities?

b) The liabilities and owners equity of Gotitall Company are \$95,000 and \$32,000, respectively. Mr. Gotit wants to know-what is the amount of assets?

c) At the beginning of the year, the Bonnie Company's assets were \$220,000 and its owners' equity was \$100,000. During the year, assets increased \$60,000 and liabilities decreased \$10,000. Billy, the owner, wants to know what the owner's equity is at the end of the year?

2. Congratulations you have been promoted to the position of Chief Financial Officer of The Daily Planet, which produces a newspaper. One of your financial analysts has presented you with a set of comparative ratios for your firm. Since that particular analyst tends to disappear at a moments notice, you decide to check his work. So you need to do the following: First, provide the formula for calculating each of the ratios listed below. Second, his analysis shows the following and you need to decide if it is good news or bad news? Why? Consider each one as an independent case. Assume all else is unchanged.
a. He reports an increase in the average collection period.
b. He reports a decrease in the inventory turnover ratio.
c. He reports a decrease in the times interest earned.
d. He reports an increase in the return on assets ratio.
e. He reports an decrease in the cash coverage ratio.

3. Pat Summers has decided to invest some of her savings in common stock. She feels that the chemical industry has good growth prospects and has narrowed her choice to two companies in that industry. As a final step in making the choice she has decided to perform a comprehensive analysis of the two companies, Morton and Pound. Income Statement and Balance Sheet data for the two companies appear below:

Income Statement

Morton Pound

Net Sales 9,486,200 27,287,300
Cost of Goods Sold 5,812,200 18,372,400
Gross Martin 3,674,000 8,914,900

Operating Expenses
Selling Expenses 1,194,000 1,955,700
Interest Expense 270,000 1,360,000
Income Taxes Expense 450,000 600,000
Total Operating Expenses 3,131,400 8,041,700

Net Income 542,600 873,200

Earnings Per Share \$1.55 \$0.88

Balance Sheet

Morton Pound

Assets

Cash 126,100 514,300
Marketable Securities 117,500 1,200,000
Accounts Receivable 456,700 2,600,000
Inventories 1,880,000 4,956,000
Prepaid Expenses
Total Current Assets 72,600
2,652,900 156,600
9,426,900
Property, Plant & Equipment (Net) 5,342,200 19,356,000
Intangible and Other Assets 217,000 580,000
Total Assets 8,212,100 29,362,900

Liabilities and Stockholders' Equity

Accounts Payable 517,400 2,342,000
Notes Payable 1,000,000 2,000,000
Income Taxes Payable
Total Current Liabilities 85,200
1,602,600 117,900
4,459,900
Bonds Payable
Total Liabilities 2,000,000
3,602,600 15,000,000
19,459,900
Common Stock-\$1 par value 350,000 1,000,000
Paid in Capital in Excess of Par
Value, Common 1,747,300 5,433,300
Retained Earnings 2,512,200 3,469,700
Total Liabilities and Stockholders' Equity 8,212,100 29,362,900

Additional Information: During the year, Morton paid a total of \$140,000 in dividends, and its current market price per share is \$20. Pound paid a total of \$600,000 in dividends during the year and its current market price per share is \$9. Morton has net cash flows from operations of \$771,500 and net capital expenditures of \$450,000. Pound has net cash flows from operations of \$843,000 and net capital expenditures of \$1,500,000. Information pertaining to prior years is not readily available. Assume that all notes payable are current liabilities and that all bonds payable are long-term liabilities. Assume that all assets except property, plant and equipment and Intangible and Other Assets are current assets. No taxes are shown on the Income Statement so they will not be considered in your analysis.

Requirements:

3a) Prepare a common size balance sheet for each company.

3b) Prepare an analysis of liquidity by calculating for each company (a) current ratio, (b) quick ratio, (c) net working capital to assets ratio.

3c) Prepare an analysis of profitability by calculating for each company the (a) operating profit margin, (b) payout ratio.

3d) Prepare an analysis of leverage ratios by calculating for each company the (a) long term debt ratio, (b) total debt ratio (c) debt to equity ratio.

3e) Prepare a presentation to Pat, recommending the company in which she should invest her funds. Defend your recommendation via an analysis of the information calculated in Nos. 3a through 3d above and any other information provided for Morton and Pound. Your analysis should be about 250 words.

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