Competitive and Ratio Analysis

Question 1

What is the formula to calculate return on investment (ROI)?

Answer 1

Net Income/Total Assets

Question 2

Given the following variables, how do you calculate ROI (Return on investment)?
Sales - $311,000
Variable cost - $250,000
Traceable fixed costs - $50,000
Avg. Invested Capital - $40,000
Interest rate = 10%

Answer 2

Return on investment = Division Income/Avg. Invested Capital

Income = Sales - Variable costs = Contribution Margin - Fixed costs

Average Invested Capital = $40,000

($311,000 - $250,000 - $50,000)/$40,000 = .275

Question 3

When you are given a target capital % of debt, preferred equity, and common equity as well rates for each one of these, how do you calculate weighted average cost of capital? You also need to take into account tax rate.

Answer 3

Sum the totals for each group.

Debt = % of debt x % interest rate x (1 - tax rate)
Common stock = % common stock x % cost of common stock
Preferred stock = % preferred stock x % yield preferred stock
Tax rate only applies to debt

Question 4

What is the formula to calculate residual income? Given the variables provided below.
Operating income = $400
Total assets = $1,600
Required rate of return = 10%

Answer 4

Residual income = Operating income - Required return on invested capital (required rate of return x invested capital)

or

$400 - (.10 x $1,600) = $240

Question 5

You are trying to determine cost of capital. You are given the rates for debt and equity. .8% rate for debt and 10% rate for equity. You are not given weighted for each capital structure, however, you are given debt ratio of 40%. How do you determine weighting for both stocks and debt as well as determine cost of capital?

Answer 5

Debt ratio = 40%; means 40% is debt while 60% is equity.

Stock: .60 x .10
Debt: .40 x .08

Question 6

What is the formula to calculate DuPont ROI?

Answer 6

DuPont ROI = Return on Sales/Asset Turnover

Question 7

How do you calculate Return on Sales? Formula.

Answer 7

Return on Sales = Net Income/Sales

Question 8

How do you calculate Asset Turnover? Formula.

Answer 8

Asset turnover = Sales/Total Assets

Question 9

How do you solve for residual income given the following variables listed below?
Sales = $750,000
Asset Turnover = 1.5
Return on Sales = 8%
Interest rate = 12%

Answer 9

Residual Income Formula
RI = Operating Income - (required rate of return x invested capital)
Step 1: Solve for total assets (invested capita) using asset turnover formula
Asset Turnover = Sales/Total Assets
Step 2: Solve for operating income using Return on Sales formula
Return on Sales = Net Income/Sales
Variables are given for these formulas. Just need to solve for total assets and operating income to use in formula
Step 3: Solve for RI using operating income - (assets x interest rate)

Question 10

What is the formula to calculate economic value added (EVA)?

Answer 10

EVA = Net Profit After Tax - (WACC % x Invested Capital)

Question 11

_______ is equal to net operating profit after taxes plus noncash expenses less capital expenditures and the change in working capital requirements.

Answer 11

Free cash flow

Question 12

_______ is equal to the market value of the firm minus the original investment.

Answer 12

Market value-added

Question 13

______ is equal to net operating profit after taxes minus the cost of capital. It represents the residual income that remains after the cost of all capital, including equity capital, has been deducted.

Answer 13

Economic value-added (EVA)

Question 14

Divisional revenues, $1,000,000; divisional expenses, $500,000; divisional assets, $2,000,000; and the required rate of return is 15%. How would you calculate residual income?

Answer 14

Residual Income = Operating Income - (Assets x required rate of return)

Income = Revenues - expenses

RI = (Revenues - expenses) - (Assets x required rate of return)

Question 15

A divisional manager receives a bonus based on 20% of the residual income from the division. How do you calculate bonus when you have calculated or are given residual income?

Answer 15

RI x Bonus % = Amount of bonus

Question 16

What is the primary disadvantage of using return on investment (ROI) rather than residual income (RI) to evaluate the performance of investment center managers?

Answer 16

ROI may lead to rejecting projects that yield positive cash flows. The company may not want to undertake a project with a lower ROI than its current average even though the project has positive RI.

Question 17

What is the formula to calculate free cash flows? Give the following variables

• Net Operating Income After Tax
• Depreciation expense
• Change in net working capital
• Capital expenditures
• Invested capital
• WACC %

Answer 17

Free cash flow = Net operating income (After tax) + Depreciation expense - Change in net working capital - capital expenditures

WACC and Invested capital excluded

Question 18

What are the two ratios that can be used to calculate ROI?

Answer 18

Return on sales and asset turnover

Question 19

You are trying to calculate sales off of asset turnover ratio (sales/total assets). You are given asset turnover of 2.5. Also, you are beg. book value of asset on January 1st of 22 million and ending book value of asset on December 31st of 18 million. How do you solve for sales and how do you determine what to use for assets?

Answer 19

Asset Turnover = Sales/Total Assets or AVERAGE ASSETS

Asset turnover given of 2.5

Calculate Asset denominator by finding the average asset value. 18 million + 22 million/2.

Question 20

EVA = Net Profit After Tax - (WACC x Invested Capital). You are already given invested capital of 1.2 million in problem and you’re solving for EVA. How do you calculate Net Profit After tax and WACC with the variables given below?

• Pretax profit = 300 million
• Tax rate =40%
• Capital used to generate profits 50% debt, 50% equity
• Cost of debt = 5%
• Cost of equity = 15%

Answer 20

1. Net profit after tax = Pretax profit - (Tax rate x pretax profit)

300 million - (.40 x 300 million)

2. WACC = (.50 x .05) Debt + (.50 x .15) Equity

Question 21

ROI highly related to stock price and ____ value.

Answer 21

shareholder value

Question 22

1. ROI could cause managers to postpone critical expenditures.
2. ROI could cause managers to not accept projects that would be advantageous to the firm.
3. ROI could be affected arbitrarily by allocation of indirect costs.
   These are all limitations or advantages of ROI?

Answer 22

Limitations

Question 23

What is the formula to calculate selling price given gross margin % and cost per unit?
CPU = $89
Gross margin = 40%

Answer 23

SP = CPU/(1 - gross margin)

$89/(1-.40) = $148.33

Question 24

1. Focusing on creating shareholder value
2. Not promoting acceptance of unprofitable projects
3. Encouraging cutting costs
   These are all advantages of what?

Answer 24

EVA (Economic Value added)

Question 25

What is a major disadvantage of EVA?

Answer 25

It fails to reflect all of the ways that value may be created.

Question 26

_____ analysis involves comparisons of results and ratios for the same firm over time.

Answer 26

Horizontal analysis

Question 27

______ analysis involves comparisons of relationships in a firm’s financial statements for a single year.

Answer 27

Vertical analysis

Question 28

_____ analysis involves comparing results and ratios to those of other firms in the same industry. Implies benchmarking.

Answer 28

Cross-sectional analysis

Question 29

Inventory Turnover, Average accounts receivable collection period, and fixed asset turnover are all examples of asset ______ ratios.

Answer 29

Asset utilization ratio

Question 30

Debt to total assets is an example of debt ____ or financial ____ ratios

Answer 30

Debt utilization or financial leverage

Question 31

Aba Caterers quotes a price of $30 per person for a dinner party. This price includes the 6% sales tax and the 15% service charge. Sales tax is computed on the food plus the service charge. The service charge is computed on the food only. How do you go about solving this equation?

Answer 31

F +.15F + .06 (F + .15F)
=
$30.00
Solve algebraically
1.219F = $30

Question 32

How do you calculate Contribution Margin and Gross Margin?

Answer 32

CM = Sales - Variable costs
GM = Sales - COGS

Question 33

Which one of the following factors should NOT be considered a limitation in using quick ratio to evaluate credit worthiness?
A. Accounts Receivable
B. Marketable Securities
C. Inventories

Answer 33

C. Inventories

Inventories are excluded in quick ratio. AR and marketable securities are included*

Question 34

How do you calculate ROI with these four variables?

• Sales
• Operating expenses
• Operating assets beg. of year
• Operating assets end of year

Answer 34

ROI = Net Income/Average assets

NI = Sales - Operating expenses
Average assets = (perating assets beg. of year - operating assets end of year/2)

Question 35

Formula for Inventory Turnover is COGS/Average Inventory. You are trying to determine COGS and Average inventory given the following data. How do you calculate both of these? Inventory Turnover for current year!
Current year Sales
Gross Profit % Current Yr
Prior year Sales
Gross profit % Prior Yr 
BG FG Inv % Prior Yr
END FG Inv % Current Yr

Answer 35

COGS = Current year sales x (1 - Gross Profit % current Yr)

Avg. Inv. = (Beg FG Inv % prior yr x prior year sales) + End FG Inv % Current yr x current year sales)/2