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Financial statement analysis - homework assignment

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1. (Financial Statement Analysis)

Consider the following sets of financial statements and answer the questions that follow:

a. To which firm would you prefer to lend money? Why?

b. In which firm would you prefer to invest? Why?

2. (Time Value of Money - Monthly Loan Payments)

Best Buy has a flat-screen HDTV on sale for $1,995. If you could borrow that amount from First National Bank of St Louis at 6% for 1 year, what would be your monthly loan payments?

3. (Time Value of Money - Present Value)

You would like to have $1,000,000 accumulated by the time you turn 65, which will be 40 years from now. How much would you have to put away each year to reach your goal, assuming you're starting from zero now and you earn 5% annual interest on your investment?

4. (Risk & Return)

You hold a portfolio of stocks consisting of the following:

Stock Beta Current Value

John Deere 1.0 $20,000
BankAmerica 0.6 $23,000
McDonalds 0.7 $18,000
Boeing 1.1 $16,000
Total: $77,000

a. What is the beta of the portfolio?

b. You have decided to sell Boeing for $16,000 and to use the proceeds to buy $16,000 of Raytheon stock with a beta of 1.5. After the transaction is complete, what will be the new beta of the portfolio? (Disregard any commissions on the buy and sell transactions.)

5. (Risk & Return)

a. Define the Capital Asset Pricing Model.

b. Explain what a stock's "beta" is.

c. If the risk-free rate is 1% and the expected rate of return on the stock market is 7%, what is the required rate of return per the CAPM for a stock that has a beta of 1.2?

6. (Bond valuation)

a. Joe's Company's bonds have 10 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 6%. The bonds have a yield to maturity (YTM) of 9%. Given these conditions, what should be the current price of these bonds?

b. Jane's Company's bonds have 5 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 7%. The bonds have a current market price of $850. Given these conditions, what should be the yield to maturity (YTM) of these bonds?

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Solution Summary

The financial statement analysis for bonds are provided. The current prices are provided. The yield to maturity of the bonds are computed.

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1. (Financial Statement Analysis)

Consider the following sets of financial statements and answer the questions that follow:

a. To which firm would you prefer to lend money? Why?
To lend money, I would like to analyze the following ratios:

1) Current ratio = Current assets/Current liabilities
Harry: 117,948/113,059  1.04
Joe: 207,948/36,059  5.77

2) Quick ratio = [Cash + Marketable securities + Accounts receivable]/Current liabilities
Harry: [45,183 +41,398]/113,059  0.77
Joe: [105,183+21,398]/36,059  3.51

3) Times interest earned ratio = EBIT/Interest expense
Harry: 135,352/6,417  21.09 times
Joe: 71,835/3,827  18.77 times

4) Debt to total assets ratio = Total liabilities/Total assets
Harry: 137,929/244,814  56.34%
Joe: 60,929/244,814  24.89%

Preference:
I would prefer to lend money to Joe's Company. This is because:
* The current ratio of Joe is much higher than Harry's Company. Also, the quick ratio of Joe is much higher than Harry's Company. These ratios indicate that the liquidity position of Joe's Company is much better than Harry's Company.
* Times interest ratio indicates the number of times interest expense is covered in the operating income. Both the companies have a good times interest ratio. Although Harry's ratio is higher than Joe, I would still prefer Joe because of higher liquidity as revealed by current and quick ratios and lesser risk of insolvency as revealed by Debt to assets ratio. Also, a times interest ratio of 18.77 times indicates a good coverage of interest expense.
* The debt to total assets ratio of Joe is lower and better than Harry's Company. Lower the debt content in the capital structure, lower is the risk of the company and the cost of capital and lesser is the risk of the company becoming insolvent. Joe's reliance on debt is only 24.89% as compared to Harry's of 56.34%.

Because of the above reasons, I would prefer to lend money to Joe's Company.

b. In which firm would you prefer to invest? Why?
To invest money, I would like to analyze the following ratios:
1) Gross profit margin = Gross profit/Sales
Harry: 185,978/512,305  36.30%
Joe: 113,461/512,305  22.15%

2) Operating profit margin = EBIT/Sales
Harry: 135,352/512,305  26.42%
Joe: 71,835/512,305  14.02%

3) Net profit margin = Net income/Sales
Harry: 90,254/512,305  17.62%
Joe: 47,605/512,305  9.29%

4) Return on assets = Net income/Total assets
Harry: 90,254/244,814  36.87%
Joe: 47,605/244,814  19.44%

5) Earnings per share:
Harry:  $12.89 per ...

Solution provided by:
Radhika Lakshmi, MPhil
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  • MPhil, Madurai Kamaraj University
  • MCom, Annamalai University
  • IATA, International Air Transport Association
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