FIN2001 – Financial Management Problem Set 3

Name: Alvaro Antonio Aguilar Fonseca

Please make sure to SHOW your work and answer all parts of each question.

1. Refer to Taco Ball’s income statements from 2020 and 2021 below.

Taco Ball - Income Statements ($000s)

2020 2021
Sales $57,000 $63,000
Cost of goods sold $36,000 $39,000
Selling expense $6,600 $7,500
Administrative expense $2,300 $2,700
Depreciation $2,850 $3,150
Earnings before interest and taxes $9,250 $10,650
Interest expense $1,310 $1,340
Taxable income $7,940 $9,310
Taxes (30%) $2,700 $3,165
Net income $5,240 $6,145

a. Prepare common-size income statements for 2020 and 2021. Keep 2 decimals for
your percentages – 0.00%. For each line item indicate if Taco Ball is doing better,
worse, or the same in 2021 relative to 2020. See suggested format below.

Taco Ball - Income Statements ($000s)

2020 2021 Evaluation
Sales 57,000 100% 63,000 100% -
Cost of goods sold 36,000 63.16% 39,000 61.90% better in 2021
Selling expense 6,600 11.58% 7,500 11.90% Worse in 2021
Administrative expense 2,300 4.04% 2,700 4.29% Worse in 2021
Depreciation 2,850 5.00% 3,150 5.00% Same
Earnings before interest and taxes 9,250 16.23% 10,650 16.90% better in 2021
Interest expense 1,310 2.30% 1,340 2.13% better in 2021
Taxable income 7,940 13.93% 9,310 14.78% better in 2021
Taxes (34%) 2,700 4.74% 3,165 5.02% Worse in 2021
Net income 5,240 9.19% 6,145 9.75% better in 2021

b. Explain why it is useful to express each line item as a percentage of sales.

It is useful because it allows us to better understand in percentage terms how
we are doing in comparison to previous years and tell us where our money is
going.
FIN2001 – Financial Management Problem Set 3

c. Net profit margin is net income as a percentage of sales. Interpret 2021 net
income as a percentage of sales for Taco Ball in words.
For every $1 in sales, we keep 0.0919 in net income.

2. Refer to Taco Ball’s income statement from question 1 and the balance sheet below
(available also on the last page of this problem set for your convenience). Calculate and
interpret the following ratios for 2020 and 2021. Please provide 1-3 sentences for each
interpretation. i.e. indicate what the ratio measures and what the change from 2020 to
2021 suggests.

Taco Bell - Balance sheets

Dec. 31, 2020 and Dec. 31 2021 ($000s)
2020 2021
Assets
Current assets
Cash $4,900 $4,600
Accounts receivable $7,800 $8,900
Inventory $6,700 $7,900
$19,40 $21,40
Total current assets 0 0
Fixed assets
$51,30 $48,40
Net plant and equipment 0 0
$70,70 $69,80
Total assets 0 0

Liabilities & Owners' Equity

Current liabilities
$15,10 $14,40
Accounts payable 0 0
Notes payable $3,800 $3,200
$18,90 $17,60
Total current liabilities 0 0
$24,50 $28,70
Long-term debt 0 0
$37,50 $41,50
Total liabilities 0 0
Owners' equity
$33,20 $28,30
Total owners' equity 0 0
$70,70 $69,80
Total liabilities and owners' equity 0 0

a. Current ratio - Keep 2 decimal places 0.00.

FIN2001 – Financial Management Problem Set 3

Current assets/Current Liabilities.

2020: 19,400/18,900= 1.03
2021: 21,400/17,600=1.22

In 2020 Taco Bell has $1.03 in current assets for every $1 in current
liabilities. In 2021 Taco Bell has $1.22 in current assets for every $1 in
current liabilities. They did better in 2021.
b. Quick ratio - Keep 2 decimal places 0.00.
(Current Assets-Inventory)/Current Liabilities.
2020: (19,400-6,700)/18,900= 0.67
2021: (21,400-7,900)/17,600= 0.77
In 2021, Sans inventory, $0.77 in current assets for every $1 in current
liabilities. In 2020, Sans inventory, $0.67 in current assets for every $1 in
current liabilities. They did better.

c. Debt to equity ratio - Keep 4 decimal places 0.0000 or 0.00%.

Total debt or liability/Total Equity.
2020: 37,500/33,200= 1.1295
2021: 41,500/28,300= 1.4664
In 2021, Taco Bell has $1.4664 in debt for every $1 in equity.
In 2020, Taco Bell has $1.1295 in debt for every $1 in equity.

d. Times Interest Earned ratio - Keep 2 decimal places 0.00.

EBIT/Interest.
2020: 9,250/1,310= 7.06
2021: 10,650/1,340= 7.95
In 2021, Taco Bell can cover interest expense 7.95 times over with pre-tax
earnings. In 2020, Taco Bell can cover interest expense 7.06 times over with
pre-tax earnings. They did better.

e. Interval measure - Keep 2 decimal places 0.00.

Note that we include all operating costs to calculate interval measure
(including selling costs and administrative costs).
Current Assets/average daily operating costs.
Average daily operating costs = operating costs excluding depreciation/365
ADOC: 2020: 44,900 2021: 49,200

2020: 19,400/44,900= 43.21

2021: 21,400/49,200= 43.50
In 2021, Taco bell can keep running for 43.50 days if cash flows start to dry
up. In 2020, Taco bell can keep running for 43.21 days if cash flows start to
dry up. They did better.
FIN2001 – Financial Management Problem Set 3

3. Use Taco Ball’s financial statements (available on the last page of this problem set for your
convenience) to calculate and interpret the following ratios for 2020 and 2021. Please
provide 1-3 sentences for each interpretation. i.e. indicate what the ratio measures and
what the change from 2020 to 2021 suggests.

a. Total asset turnover – keep 2 decimals 0.00.

Sales/Total Assets
20: 57,000/70,700=0.81
21: 63,000/69,800=0.90
In 2021, For every $1 in assets, Taco Bell generated $0.90 in sales.
In 2020, For every $1 in assets, Taco Bell generated $0.81 in sales.
They did better.

b. Days sales in inventory – keep 2 decimals 0.00.

Inventory Turnover= COGS/Inventory
20 (Inv. T) = 36,000/6,700=5.37
21 (Inv. T) = 39,000/7,900=4.94

Days sales in inventory=365days/Inventory Turnover

2020: 365/5.37= 67.97
2021: 365/4.94= 73.88
In 2021, this tells us that, roughly speaking, inventory sits 73.88days on
average before it is sold. In 2020, this tells us that, roughly speaking,
inventory sits 67.97days on average before it is sold.

c. Days sales in receivables – keep 2 decimals 0.00.

Receivables Turnover= Sales/Account Receivables
20: 57,000/7,800= 7.30
21: 63,000/8,900= 7.08

Day sales in receivable= 365days/Receivables Turnover

20: 365/7.30= 50
21: 365/7.08= 51.55
In 2021, on average, it takes Taco Bell 51.55 days to collect its receivables
In 2020, on average, it takes Taco Bell 50 days to collect its receivables.
In 2020 they take fewer days to collect its receivables.

d. Return on Assets – Keep 4 decimal places 0.0000 or 0.00%.

Net Income/Total Assets
20: 5,240/70,700= 7.41%
21: 6,145/69,800= 8.80%
In 2021, for every $1 in assets, Taco bell generated $0.0880 in profit.
FIN2001 – Financial Management Problem Set 3

In 2020, for every $1 in assets, Taco bell generated $0.0741 in profit. They
did better in 2021.

e. Earnings per Share (EPS) – Keep two decimal places $0.00. Taco Ball has 2.5
million of shares outstanding (note that financial statements are expressed in
thousands - $000).
Net Income/Shares Outstanding
20: 524,000/2,500,000= 0.21
21: 614,500/2,500,000= 0.25
In 2021, Taco Bell earned $0.25 for each share of stock outstanding.
In 2020, Taco Bell earned $0.21 for each share of stock outstanding. They
did better in 2021.

4. Refer to Taco Ball’s financial statements (available on the last page of this problem set
for your convenience) to answer the following questions.

a. Calculate Return on Equity (ROE) with the formula Net Income/Total Equity for
2020 and 2021 – Keep 4 decimal places 0.0000 or 0.00%.
20: 5,240/33,200= 15.78%
21: 6,145/28,300= 21.71%

b. Interpret the Return on Equity (ROE) that you calculated above.

According to our book, ROA is a measure of profit per dollar of assets.
In 2021, for every $1 in equity, Taco Bell generated $0.2171 in profit.
In 2020 for every $1 in equity, Taco Bell generated $0.1578 in profit.
As we can there is an increase in 2021, that mean they did better in 2021.

c. Use the DuPont Identity to calculate ROE for Taco Ball for 2021.
(Net Income/Sales)*(Sales/Total Assets)*(Total Assets/Total Equity)
(6,145/63,000)*(63,000/69,800)*(69,800/28,300)= 21.71%

d. Explain how the DuPont Identity may be helpful when calculating ROE – discuss
on the basis of operating efficiency, asset use efficiency and financial leverage (3-
6 sentences). The DuPont Identity tells us that ROE is a factor of three things:
Operating efficiency, that is how well it controls costs. Asset use efficiency, that
is how well it manages its assets. And, financial leverage, that is the equity
multiplier. The DuPont helps us identify where potential problems are. With
this identity is easier and faster to identify a problem than doing full ratio
analysis.
FIN2001 – Financial Management Problem Set 3

5. Taco Ball has asked its new finance intern, Lucy, to assess the firm’s performance on key
activity and profitability ratios – current ratio, inventory turnover, days sales in
receivables, total asset turnover and ROE. Coincidentally, Lucy’s best friend is the CFO at
Toyoda, an automobile manufacturer. Lucy’s friend has been generous enough to share
Toyoda’s 2019 and 2021 ratios with her – provided below. Toyoda’s 2020 ratios were
sent for revision based on an audit. Lucy has compared her friend’s ratios below to Taco
Ball ratios (many of which you calculated for questions 2 and 3). She has concluded that
Taco Ball is doing fantastic on all accounts, especially in relation to 2019.

Toyoda 2019 Ratios 2021 Ratios

Current ratio 0.98 1.07
Inventory Turnover 4.24 4.49
Days sales in receivables 105.43 99.87
Total Asset Turnover 0.71 0.74
Return on equity 12.17% 14.95%

a. Is Lucy right to make such conclusions? Explain in 6-8 sentences.

No, she is not right in making this conclusion. First of all, Taco Bell and Toyoda
are different firms. They Produce different goods. Their cost can be different,
for example Toyoda might do more than Taco Bell does, and this will change
the ratios hugely. In addition, these ratios of Toyota were in 2019 and 2021;
our ratio analysis for Taco Bell is from 2020 to 2021. From my point of view,
she is not making the proper decision.

b. Suggest at least TWO ways in which Lucy can improve her analysis.
Using financial statements from previous years as a comparison is very useful
because it will tell you if your firm is doing good or bad. Compare with similar
firms such as Chipotle one of Taco Bell’s major competitors.
FIN2001 – Financial Management Problem Set 3

Taco Ball - Income Statements ($000s)

2020 2021
Sales $57,000 $63,000
Cost of goods sold $36,000 $39,000
Selling expense $6,600 $7,500
Administrative expense $2,300 $2,700
Depreciation   $2,850 $3,150
Earnings before interest and taxes $9,250 $10,650
Interest expense   $1,310 $1,340
Taxable income $7,940 $9,310
Taxes (30%)   $2,700 $3,165
Net income $5,240 $6,145

Taco Ball - Balance sheets

Dec. 31, 2020 and Dec. 31 2021 ($000s)
Assets Liabilities & Owners' Equity
2020 2021 2020 2021
Current assets Current liabilities
Cash $4,900 $4,600 Accounts payable $15,100 $14,400
Accounts receivable $7,800 $8,900 Notes payable $3,800 $3,200
Inventory $6,700 $7,900
$19,40 $18,90
Total current assets 0 $21,400 Total current liabilities 0 $17,600
 FIN2001 – Financial Management Problem Set 3

Fixed assets Long-term debt $24,500 $28,700

$37,50
Net plant and equipment $51,300 $48,400 Total liabilities 0 $41,500

Owners' equity
$33,20
      Total owners' equity 0 $28,300
$70,70 $70,70
Total assets 0 $69,800 Total liabilities & equity 0 $69,800