Chapter 5 Exercise

1.
[ROA and ROE Models and Ratio Components] The Salza Technology Corporation successfully
increased its “top line” sales from $375,000 in 2009 to $450,000 in 2010. Net income also increased as
did the venture’s total assets. You have been asked to compare the financial performance between the
two years.
A. Calculate the net profit margin and the sales-to-total-assets ratio for Salza for 2010 using
average total assets. Also calculate the return on total assets in 2010 using average total assets.
B. Calculate the ratios in the ROA model for both 2009 and 2010 using year-end total assets.
Comment on any financial ratio differences.
C. Expand the 2010 ROA model discussed in Part A into an ROE model that includes financial
leverage as measured by the equity multiplier. Use average owners’ or stockholders’ equity in
your calculation.
D. D. Expand the 2009 and 2010 ROA model calculations in Part B into ROE models based on year-
end owners’ or stockholders’ equity amounts.
1 (A)
2010 Net profit margin = Net income/Net sales = 70000/450000 = 15.56%

2010 Sales to total assets ratio = Net sales 2010/Average total assets = 450000/(465000+345000)/2 =
1.11 times
2010 Return on total assets = Net income/ Average total assets = 70000/405000 = 17.28%
1 (B)
2009 ROA = Net profit margin x Sales to total assets ratio = (55000/375000)(375000/345000) = 15.94%
2010 ROA – 17.28%
ROA increased from 2009 to 2010.
1 (C)
ROE = ROA x Equity multiplier = 0.1728 x (405000/312500) = 22.39%
2. [Liquidity and Financial Leverage Ratios] Refer to the Salza Technology Corporation in Problem 1.
A. Using average balance sheet account data, calculate the (a) current ratio, (b) quick ratio, (c)
total-debt-to-total-assets ratio, and (d) the interest coverage ratio for 2010.
B. Repeat the ratio calculations requested in Part A separately for 2009 and 2010 using year-end
balance sheet account data. What changes, if any, have occurred in terms of liquidity and
financial leverage?
2 (A)
2010 Current ratio = Average current assets/Average current liabilities = 270/77.5 = 3.48 times
2010 quick ratio = (Average current assets – Average inventories)/Average current liabilities = 1.19 times
2010 total debt to total assets ratio = 92.5/405 = 22.84%
2010 interest coverage ratio = EBITDA/Interest expenses = 134000/4000 =33.5 times
5. [Cash Burn and Build] Following are two years of income statements and balance sheets for the
Munich Exports Corporation.
A. Calculate the cash build, cash burn, and net cash burn or build for Munich Exports in 2010.
B. Assume that 2011 will be a repeat of 2010. If your answer in Part A resulted in a net cash burn
position, calculate the net cash burn monthly rate and indicate the number of months remaining
“until out of cash.” If your answer in Part A resulted in a net cash build position, calculate the
net cash build monthly rate and indicate the expected cash balance at the end of 2011.
5 (A)
2010 Cash build = Net sales – Increase in receivables = $1600000 - $100000 = $1500000
2010 Cash burn = Income statement based operating, interest and tax expenses + Increase in inventories
– Changes in account payables and accruals + CAPEX (increase in gross asset)
2010 Cash burn = $960000 + $160000 + $150000 + $55000 + $88000 + ($80000+55000) + $120000 -
$70000 = $ 1598000
Net cash burn = $1598000 - $1500000 = -$98000
5 (B)
Net cash burn monthly rate = $98000/12 = -$8166.67/ month

Cash balance at end of 2011 = $50000/$8166.67 = 6.12 months until out of cash
6. [Cash Conversion Cycle] Two years of financial statement data for the Munich Export Corporation are
shown in Problem 5.
A. Calculate the inventory-to-sale, sale-to-cash, and purchase-to-payment conversion periods for

Munich Exports for 2010.
B. Calculate the length of Munich Exports’ cash conversion cycle for 2010.
6 (A)
Inventory to sale = Avg. Inventories/COGS/365 = 510000/960000/365 = 193.91 DAYS

Sales to cash = Avg. Receivables/Net Sales/365 = 57.03 DAYS
Purchase to payment = Avg. Payables+ Avg. Accruals/COGS/365 = 215000/960000/365 = 81.74 DAYS
6 (B)
Cash conversion cycle = 193.91 days + 57.03 days – 81.74 days = 169.2 days
7. [Liquidity Ratios and Cash Burn or Build] The Castillo Products Company was started in 2008. The
company manufactures components for personal digital assistant (PDA) products and for other
handheld electronic products. A difficult operating year, 2009, was followed by a profitable 2010.
However, the founders (Cindy and Rob Castillo) are still concerned about the venture’s liquidity position
and the amount of cash being used to operate the firm. Following are income statements and balance
sheets for the Castillo Products Company for 2009 and 2010
A. Use year-end data to calculate the current ratio, the quick ratio, and the NWC to-total-assets ratio for
2009 and 2010 for Castillo Products. What changes occurred?
B. Use Castillo Products’ complete income statement data and the changes in balance sheet items
between 2009 and 2010 to determine the firm’s cash build and cash burn for 2010. Did Castillo Products
have a net cash build or a net cash burn for 2010?
C. Convert the annual cash build and cash burn amounts calculated in Part B to monthly cash build and
cash burn rates. Also indicate the amount of the net monthly cash build or cash burn rate.
7 (A)
2009 current ratio = 2.41 times

2010 current ratio = 2.42 times
2009 quick ratio = 0.93 times

2010 quick ratio = 0.92 times
2009 NWC to total assets ratio = 1.41 times

2010 NWC to total assets ratio = .1.42 times
No remarkable change has happened from 2009 to 2010. The ratios are quite stable.
7 (B)
Cash build = 1420000

Cash burn = 1525000
Net cash burn = $105000
*Why bank loan is not included in cash burn when it is a current liability is because bank loan belongs to
financing activities in cash flow statement and it actually increases the cash flow.
7 (C)
Monthly cash build = 118333.33

Monthly cash burn = 127083.33
Monthly net cash burn = 8750
8. [Cash Conversion Cycle] Castillo Products Company, described in Problem 7, improved its operations
from a net loss in 2009 to a net profit in 2010. While the founders, Cindy and Rob Castillo, are happy
about these developments, they are concerned about how long the firm took to complete its cash
conversion cycle in 2010. Use the financial statements from Problem 7 to make your calculations.
Balance sheet items should reflect the averages of the 2009 and 2010 accounts.
A. Calculate the inventory-to-sale conversion period for 2010.

B. Calculate the sale-to-cash conversion period for 2010.
C. Calculate the purchase-to-payment conversion period for 2010.
8 (A)
Inventory to sale = 182.5 days
8 (B)
Sales to cash = 58.4 days
8 (C)
Purchase to payment = 83.14 days

9. [ROA Model and Expenses Related to Sales] Use the financial statement data for Castillo Products
presented in Problem 7.
A. Calculate the net profit margin in 2009 and 2010 and the sales-to-total-assets ratio using year-
end data for each of the two years.
B. Use your calculations from Part A to determine the rate of return on assets in each of the two
years for Castillo Products.
C. Calculate the percentage growth in net sales from 2009 to 2010. Compare this with the
percentage change in total assets for the same period.
9 (A)
2009 Net profit margin = -7.22%

2010 Net profit margin = 5%
2009 sales to total assets ratio = 0.9 times
2010 sales to total assets ratio = 1.36 times
1 (B)
2009 ROA = -0.0722 x 0.9 = -6.5%

2010 ROA = 1.36 x 0.05 = 6.80%
1 (C)
Percentage growth in net sales from 2009 to 2010 = (1500000-900000)/900000 = 66.67%

Percentage change in total assets from 2009 to 2010 = (1200000-1000000)/1000000 = 20%

Chapter 5 Exercise

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1.

2010 Net profit margin = Net income/Net sales = 70000/450000 = 15.56%

ROE = ROA x Equity multiplier = 0.1728 x (405000/312500) = 22.39%

Net cash burn monthly rate = $98000/12 = -$8166.67/ month

A. Calculate the inventory-to-sale, sale-to-cash, and purchase-to-payment conversion periods for

Inventory to sale = Avg. Inventories/COGS/365 = 510000/960000/365 = 193.91 DAYS

2009 current ratio = 2.41 times

2009 quick ratio = 0.93 times

2009 NWC to total assets ratio = 1.41 times

Cash build = 1420000

Monthly cash build = 118333.33

A. Calculate the inventory-to-sale conversion period for 2010.

Inventory to sale = 182.5 days

Sales to cash = 58.4 days

Purchase to payment = 83.14 days

2009 Net profit margin = -7.22%

2009 ROA = -0.0722 x 0.9 = -6.5%

Percentage growth in net sales from 2009 to 2010 = (1500000-900000)/900000 = 66.67%

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