CHAPTER 3: FINANCIAL STATEMENT ANALYSIS TOOLS

Instructor’s Manual Problem Set

Solutions can be found in the accompanying Excel files. Note that if you wish to see all of the formulas at once, you may
use the CTRL+` (Control plus grave accent) shortcut key to toggle them on or off.

1. Sweet Dreams Corp. has prepared the following financial statements:

Sweet Dreams Corp. Sweet Dreams Corp.
Income Statement Balance Sheet
For the Year Ended Dec. 31 2017 As of Dec. 31 2017
2017 2016 Assets 2017 2016
Sales 3,074,000 2,567,000 Cash 431,000 339,000
Cost of Goods Sold 2,088,000 1,711,000 Accounts Receivable 503,000 365,000
Gross Profit 986,000 856,000 Inventories 289,000 300,000
Selling and G&A Expenses 294,000 295,000 Total Current Assets 1,223,000 1,004,000
Fixed Expenses 35,000 35,000 Gross Fixed Assets 4,669,000 4,322,000
Depreciation Expense 239,000 223,000 Accumulated Depreciation 2,295,000 2,056,000
EBIT 418,000 303,000 Net Fixed Assets 2,374,000 2,266,000
Interest Expense 93,000 91,000 Total Assets 3,597,000 3,270,000
Earnings Before Taxes 325,000 212,000 Liabilities and Owners' Equity
Taxes 94,000 64,000 Accounts Payable 382,000 270,000
Net Income 231,000 148,000 Short-term Notes Payable 79,000 99,000
Accrued Expenses 159,000 114,000
Total Current Liabilities 620,000 483,000
Long-term Debt 1,023,000 967,000
Total Liabilities 1,643,000 1,450,000
Common Stock 819,000 808,000
Retained Earnings 1,135,000 1,012,000
Total Shareholder's Equity 1,954,000 1,820,000
Total Liabilities and Owners' Equity 3,597,000 3,270,000
a) Set up a worksheet similar to the one in Exhibit 4-4, page 124, and calculate all of the ratios for Sweet Dreams Corp.
b) Verify the change in 2017 Sweet Dreams Corp’s ROE using the Du Pont method.
c) Using the Altman’s model for privately held firms and public ones, calculate the Z-score for Sweet Dreams Corp.
Assume that the market value of Sweet Dreams Corp. is $1,200,000.
d) Calculate Sweet Dreams Corp.’s economic profit for these years and compare it to net income. Assume that the
weighted average cost of capital is 12%.
e) Using the following 2017 industry averages, evaluate Sweet Dreams Corp.’s financial situation. Set up a ratio analysis
system similar to the one in Exhibit 3-6, page 92.
Ratio Value Ratio Value
Current Ratio 2.50x Debt to Equity 0.90x
Quick Ratio 0.60x Long-Term Debt to Equity 40.00%
Inventory Turnover Ratio 6.50x Times Interest Earned 2.50x
Accounts Receivable Turnover Ratio 8.00x Cash Coverage Ratio 3.50x
Average Collection Period 40.00 days Gross Profit Margin 20.00%
Fixed Asset Turnover 2.00x Operating Profit Margin 7.00%
Total Asset Turnover 2.00x Net Profit Margin 5.00%
Total Debt Ratio 50.00% Return on Total Assets 5.00%
Long-Term Debt Ratio 20.00% Return on Equity 8.00%
LTD to Total Capitalization 30.00% Return on Common Equity 10.00%

15
16 Chapter 3: Financial Statement Analysis Tools
Instructor’s Manual Problem Set

2. Powerful Tools Inc., a construction equipment manufacturer, has lost some information on its financial
statements. Help the firm’s financial staff to fill in the missing data using your knowledge of financial ratios.
Powerful Tools Inc. Powerful Tools Inc.
Income Statement Balance Sheet
For the Year Ended December 31, 2017 As of December 31, 2017
2017 2017
Sales Ratio Assets
Cost of Goods Sold Formula Cash 70,000
Gross Profit Ratio Accounts Receivable 50,000
Operating Expenses Formula Inventories Ratio
EBIT Ratio Total Current Assets Formula
Interest Expense Formula Gross Fixed Assets 1,000,000
Earnings Before Taxes Formula Accumulated Depreciation Formula
Taxes Formula Net Fixed Assets Formula
Net Income 50,000 Total Assets Ratio
Liabilities and Owner's Equity
Notes: Tax Rate 40% Accounts Payable 20,000
Short-term Bank Notes Formula
Ratio Value Total Current Liabilities Formula
Inventory Turnover 5.00x Long-term Debt Ratio
Net Profit Margin 7% Total Liabilities Ratio
Total Debt Ratio 60.00% Common Equity Formula
Gross Profit Margin 30.00% Total Liab. and OE Formula
Operating Profit Margin 15.00%
Return on Total Assets 5.00%
Long-Term Debt Ratio 50.00%
a) Using the ratios provided, recreate the financial statements as shown using formulas.
b) Complete the financial statements by using formulas that refer to existing data to fill in the remaining cells.
Chapter 3: Financial Statement Analysis Tools 17
Instructor’s Manual Problem Set

3. Cristal Clear, Inc., a manufacturer of water purification systems, has accidentally erased parts of its 2017 and
2016 financial statements. Help the company fill in the missing data using your knowledge of financial ratios.
Cristal Clear, Inc.
Ratios 2017 2016
Liquidity Ratios
Current Ratio 2.35x Ratio
Quick Ratio Ratio 0.80x
Efficiency Ratios
Inventory Turnover Ratio Ratio 3.50x
A/R Turnover Ratio 14.00x Ratio
Average Collection Period Ratio 40.00 days
Fixed Asset Turnover 15.00x Ratio
Total Asset Turnover Ratio Ratio
Leverage Ratios
Total Debt Ratio 60.00% Ratio
Long-Term Debt Ratio Ratio 35.00%
LTD to Total Capitalization Ratio Ratio
Debt to Equity Ratio Ratio
Long-Term Debt to Equity Ratio Ratio
Coverage Ratios
Times Interest Earned Ratio 4.00x
Cash Coverage Ratio 3.00x Ratio
Profitability Ratios
Gross Profit Margin Ratio Ratio
Operating Profit Margin Ratio Ratio
Net Profit Margin Ratio 3.00%
Return on Total Assets 4.20% Ratio
Return on Equity Ratio 12.00%
Return on Common Equity Ratio Ratio

Cristal Clear, Inc. Cristal Clear, Inc.

Income Statement Balance Sheet
For the Year Ended Dec. 31, 2017 As of Dec. 31, 2017
2017 2016 Assets 2017 2016
Sales Ratio Ratio Cash and Equivalents 46,000 50,000
Cost of Goods Ratio 2,466,000 Accounts Receivable Ratio Ratio
Gross Profit Formula Formula Inventory Formula Ratio
G&A Expenses Formula 207,000 Total Current Assets Ratio Formula
Other Expenses 115,000 Formula Plant & Equipment Formula 435,000
Depreciation Ratio Ratio Accumulated Depreciation 146,000 Formula
EBIT 173,000 Ratio Net Fixed Assets Formula Formula
Interest Expense Formula 54,000 Total Assets Ratio 1,490,000
EBT Formula Formula Liabilities and Owners' Equity
Taxes Formula Formula Accounts Payable Formula 131,000
Net Income 59,500 Formula Short-term Notes Payable 201,000 Formula
Notes Other Current Liabilities 121,000 117,000
Tax Rate 40% Total Current Liabilities 480,000 Ratio
Long-term Debt Formula Formula
Total Liabilities Ratio Formula
Common Stock Formula 408,000
Retained Earnings 199,000 Formula
Total Shareholder's Equity Formula Ratio
Total Liab. and OE Formula Formula
a) Using the ratios provided, recreate the financial statements as shown using formulas.
b) Complete the financial statements using formulas that refer to existing data to fill in the remaining cells.
18 Chapter 3: Financial Statement Analysis Tools
Instructor’s Manual Problem Set

4. The Sophisticated Touch, Co., a catering company, wants to evaluate its historical financial data over the last
five years.
The Sophisticated Touch, Co.
Income Statement
For the Year Ended Dec. 31, 2017
2017 2016 2015 2014 2013
Sales 5,775,000 5,658,000 5,308,500 4,906,000 4,605,000
Cost of Goods Sols 4,875,000 4,793,000 4,393,500 4,056,000 3,702,000
Gross Profit 900,000 865,000 915,000 850,000 903,000
Selling Expenses 330,300 329,000 317,000 313,000 288,000
Gen. and Admin. Expenses 194,000 174,600 157,140 141,426 127,283
Fixed Expenses 100,000 100,000 100,000 100,000 100,000
Depreciation Expense 27,000 23,000 20,000 17,000 15,000
EBIT 248,700 238,400 320,860 278,574 372,717
Interest Expense 85,000 80,000 75,000 75,000 70,000
Earnings Before Taxes 163,700 158,400 245,860 203,574 302,717
Taxes 65,480 63,360 86,051 61,072 90,815
Net Income 98,220 95,040 159,809 142,502 211,902

Notes:
Tax Rate 40% 40% 35% 30% 30%

The Sophisticated Touch, Co.

Balance Sheet
As of Dec. 31, 2017
Assets 2017 2016 2015 2014 2013 2012
Cash and Equivalents 123,000 108,000 91,500 78,000 67,500 54,000
Accounts Receivable 350,000 330,000 320,000 300,000 270,000 250,000
Inventory 654,000 538,500 445,500 375,000 334,500 276,000
Total Current Assets 1,127,000 976,500 857,000 753,000 672,000 580,000
Land and buildings 770,250 672,000 589,500 485,250 430,500 380,250
Machinery and Equipment 593,125 462,000 379,750 290,625 224,250 190,625
Furniture and fixtures 154,050 134,400 117,900 97,050 86,100 76,050
Vehicles 123,240 107,520 94,320 77,640 68,880 60,840
Other Fixed Assets 107,835 94,080 82,530 67,935 60,270 53,235
Accumulated Depreciation 549,000 486,000 420,000 355,500 318,000 258,000
Net Fixed Assets 1,199,500 984,000 844,000 663,000 552,000 503,000
Total Assets 2,326,500 1,960,500 1,701,000 1,416,000 1,224,000 1,083,000
Liabilities and Owners' Equity
Accounts Payable 262,500 234,000 204,000 183,000 153,000 135,000
Short-term Notes Payable 110,000 100,000 70,000 80,000 90,000 70,000
Other Current Liabilities 210,000 180,000 159,000 133,500 115,500 96,000
Total Current Liabilities 582,500 514,000 433,000 396,500 358,500 301,000
Long-term Debt 715,000 551,000 510,500 352,000 301,500 285,500
Total Liabilities 1,297,500 1,065,000 943,500 748,500 660,000 586,500
Common Stock 460,000 414,000 346,000 309,000 254,000 222,000
Pain-in capital 343,000 298,500 252,500 222,500 188,000 165,500
Retained Earnings 226,000 183,000 159,000 136,000 122,000 109,000
Total Shareholder's Equity 1,029,000 895,500 757,500 667,500 564,000 496,500
Total Liabilities and Owners' Equity 2,326,500 1,960,500 1,701,000 1,416,000 1,224,000 1,083,000
a) Set up a ratio worksheet similar to Exhibit 3-6, page 92, and calculate all of the ratios for The Sophisticated Touch,
Co.
b) Verify the change in 2017 Sophisticated Touch, Co.’s ROE using the Du Pont method.
c) Using the Altman’s model for privately held firms and public ones, calculate the Z-score for The Sophisticated Touch,
Co. Assume that the market value of equity is $1,500,000; $1,250,000; $1,000,000; $850,000; and $700,000 for the
years 2017, 2016, 2015, 2014, and 2013 respectively.
d) Calculate the economic profit for these years and compare it to net income. Assume that the WACC is 12% each year.
e) The staff at The Sophisticated Touch, Co. wants to perform a trend analysis with the data generated in the previous
sections of this problem. Create a line chart showing each category of ratios from 2013 to 2017. Make sure to title the
chart and label the axes. Also make a line chart of the Altman’s model for private and public firms from 2013 to 2017.
Chapter 3: Financial Statement Analysis Tools 19
Instructor’s Manual Problem Set

CHAPTER 3: MULTIPLE CHOICE QUESTIONS

1. What should be the formula in B13?
a) =SUM(B2:B4)/(B7+B9)
b) =SUM(B2:B4)/SUM(B7:B9)
c) =(B4-B4)/(B6+B7+B8)
d) =SUM(B2:B5)/(B6+B8+B9)
e) =(B1+B2)/(B6+B7+B8)

Solution: b

2. What should be the formula in B13?

a) =SUM(B2:B4)/SUM(B7:B9)
b) =SUM(B2:B3)/(B6+B7+B8)
c) =(B4-B4)/SUM(B6:B8)
d) =(B1+B2+B3+B4)/(B6+B7+B8+B9)
e) =SUM(B2:B3)/SUM(B7:B9)

Solution: e

3. What should be the formula in B13?

a) =SUM(B7:B10)/(SUM(B2:B5)-B6)
b) =B10/SUM(B2:B5)
c) =B11/SUM(B2:B5)
d) =B10/(SUM(B2:B5)-B6)
e) =B10/SUM(B2:B6)

Solution: d
20 Chapter 3: Financial Statement Analysis Tools
Instructor’s Manual Problem Set

4. What should be the formula in B13?

a) =SUM(B7:B10)/SUM(B11:B12)
b) =SUM(B7:B10)/B11
c) =B10/SUM(B11:B12)
d) =(B3-B4)/(B2+B3-B4)
e) =B10/SUM(B11:B12)

Solution: a

5. What should be the formula in B5?

a) =B2/(B2/(1-B4))
b) =B2/(B3/(1-B4))
c) =B2/(B2-B3/(1-B4))
d) =B2/B2-B3/1-B4
e) =(B2/B2)-B3/(1-B4)
Solution: c

6. What should be the formula in B9?

a) =B2/(B6+B5+B4)
b) =B2/SUM(B5:B8)
c) =B8/SUM(B5:B8)
d) =SUM(B5:B8)/B2
e) =B3/ SUM(B5:B8)

Solution: b

7. What should be the formula in B9?

a) =B5/B2
b) =B6/B2
c) =B6/B3
d) =B2/B6
e) None of the above

Solution: d
Chapter 3: Financial Statement Analysis Tools 21
Instructor’s Manual Problem Set

8. What should be the formula in cell B9?

a) =B7/B3
b) =B3/B7
c) =B4/B7
d) =B7/B2
e) None of the above

Solution: b

9. What should be the formula in cell B9?

a) =SUM(B2:B5)-SUM(B6:B7)+B8
b) =B2+SUM(B4:B5)-SUM(B6:B7)+B8
c) =(B2+B4+B5)+B8-(B5+B6 +B7)
d) =(B2+B4+B5)-B8+(B5+B6)
e) =(B2+B4+B5)+B8-(B6+B7)

Solution: b

10. What would be the result

in cell E2?
a) “Good”
b) “Ok”
c) “Bad”
d) None of the above
Solution: b

11. What is the correct formula for cell B7?

a) =(B2+B3)/(B5-B4)
b) =(B2-B3)/(B5+B4)
c) =(B2-B6)/(B5-B2)
d) =(B2-B3)/(B5-B4)
e) =(B2+B3)/(B5+B4)
Solution: d
22 Chapter 3: Financial Statement Analysis Tools
Instructor’s Manual Problem Set

12. What is the correct formula for cell B7?

a) =B3/(B2-B5)
b) =(B2+B3+B5)/B4
c) =(B2-B5)/B4
d) =(B2-B3)/(B5-B4)
e) =B4/(B2-B5)
Solution: e

13. What is the correct formula for cell B3?

a) =(B2-B3)/B3
b) =1-B3/B2
c) =1-B2/B3
d) =B3/B2-1
e) =(B2-B3)/(B2+B3)
Solution: b