Chapter 17 Financial Statement Analysis 813

You have been asked to evaluate the historical performance of the company over the

last five years.

Selected industry ratios have remained relatively steady at the following levels for

the last five years:2006–2010

Rate earned on total assets 12%Rate earned on stockholders’ equity 18%Number of times interest charges earned 2.8Ratio of liabilities to stockholders’ equity 1.6

Instructions1. Prepare four line graphs with the ratio on the vertical axis and the years on the hor-

izontal axis for the following four ratios (rounded to one decimal place):a. Rate earned on total assetsb. Rate earned on stockholders’ equityc. Number of times interest charges earnedd. Ratio of liabilities to stockholders’ equity

Display both the company ratio and the industry benchmark on each graph. That is,

each graph should have two lines.

2. Prepare an analysis of the graphs in (1).

Nike, Inc. , Problem

The financial statements for Nike, Inc., are presented in Appendix E at the end of the

text. The following additional information (in thousands) is available:

Accounts receivable at May 31, 2005 $2,249.9Inventories at May 31, 2005 1,811.1Total assets at May 31, 2005 8,793.6Stockholders’ equity at May 31, 2005 5,644.2

Instructions1. Determine the following measures for the fiscal years ended May 31, 2007 and May

31, 2006, rounding to one decimal place.a. Working capitalb. Current ratioc. Quick ratiod. Accounts receivable turnovere. Number of days’ sales in receivablesf. Inventory turnoverg. Number of days’ sales in inventoryh. Ratio of liabilities to stockholders’ equityi. Ratio of net sales to average total assetsj. Rate earned on average total assets, assuming interest expense is $20.495 million for

the year ending May 31, 2007, and $20.956 million for the year ending May 31, 2006k. Rate earned on average common stockholders’ equityl. Price-earnings ratio, assuming that the market price was $56.75 per share on

May 31, 2007, and $40.16 per share on May 31, 2006.m. Percentage relationship of net income to net sales

2. What conclusions can be drawn from these analyses?

Financial StatementAnalysis

Special Activities

Assume that the president of Garden Isle Brewery made the following statement in the

Annual Report to Shareholders:

SA 17-1Analysis of financingcorporate growth

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814 Chapter 17 Financial Statement Analysis

Tylee Industries, Inc., has completed its fiscal year on December 31, 2010. The auditor,

Holly Marcum, has approached the CFO, Doug Bliss, regarding the year-end receiv-

ables and inventory levels of Tylee Industries. The following conversation takes place:

Holly: We are beginning our audit of Tylee Industries and have prepared ratio analyses to determine if there have been significant changes in operations or financial position. This helps us guide the auditprocess. This analysis indicates that the inventory turnover has decreased from 4.5 to 2.1, while theaccounts receivable turnover has decreased from 10 to 6. I was wondering if you could explain this changein operations.

Doug: There is little need for concern. The inventory represents computers that we were unable to sell dur-ing the holiday buying season. We are confident, however, that we will be able to sell these computers aswe move into the next fiscal year.

Holly: What gives you this confidence?

Doug: We will increase our advertising and provide some very attractive price concessions to move thesemachines. We have no choice. Newer technology is already out there, and we have to unload this inventory.

Holly: . . . and the receivables?

Doug: As you may be aware, the company is under tremendous pressure to expand sales and profits. As a result, we lowered our credit standards to our commercial customers so that we would be able to sell products to a broader customer base. As a result of this policy change, we have been able to expand sales by 35%.

Holly: Your responses have not been reassuring to me.

Doug: I’m a little confused. Assets are good, right? Why don’t you look at our current ratio? It hasimproved, hasn’t it? I would think that you would view that very favorably.

Why is Holly concerned about the inventory and accounts receivable turnover

ratios and Doug‘s responses to them? What action may Holly need to take? How would

you respond to Doug‘s last comment?

SA 17-2Receivables andinventory turnover

The condensed income statements through income from operations for Dell Inc. and

Apple Computer, Inc., are reproduced below for recent fiscal years (numbers in millions

of dollars).

Apple Dell Inc. Computer, Inc.

Sales (net) $57,420 $24,006Cost of sales 44,904 15,852_______ _______Gross profit $12,516 $ 8,154_______ _______Selling, general, and administrative expenses $ 5,948 $ 2,963Research and development 498 782_______ _______Operating expenses $ 6,446 $ 3,745_______ _______Income from operations $ 6,070 $ 4,409_______ ______________ _______

Prepare comparative common-sized statements, rounding percents to one dec-

imal place. Interpret the analyses.

SA 17-3Vertical analysis

“The founding family and majority shareholders of the company do not believe in

using debt to finance future growth. The founding family learned from hard experience

during Prohibition and the Great Depression that debt can cause loss of flexibility and

eventual loss of corporate control. The company will not place itself at such risk. As

such, all future growth will be financed either by stock sales to the public or by inter-

nally generated resources.”As a public shareholder of this company, how would you respond to this

policy?

Harley-Davidson, lnc., is a leading motorcycle manufacturer in the United States. The

company manufactures and sells a number of different types of motorcycles, a complete

line of motorcycle parts, and brand-related accessories, clothing, and collectibles. In

recent years, Harley-Davidson has attempted to expand its dealer network and product

lines internationally.

SA 17-4Profitability andstockholder ratios

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Chapter 17 Financial Statement Analysis 815

Marriott International, Inc., and Hilton Hotels Corporation are two major owners and

managers of lodging and resort properties in the United States. Abstracted income

statement information for the two companies is as follows for a recent year:

Marriott Hilton(in millions) (in millions)

Operating profit before other expenses and interest $1,011 $1,274Other income (expenses) 7 62Interest expense (124) (498)______ ______

Income before income taxes 894 838Income tax expense 286 266______ ______Net income $ 608 $ 572______ ____________ ______

Balance sheet information is as follows:Marriott Hilton

(in millions) (in millions)

Total liabilities $5,970 $12,754Total stockholders’ equity 2,618 3,727_______ _______Total liabilities and stockholders’ equity $8,588 $16,481_______ ______________ _______

The average liabilities, stockholders’ equity, and total assets were as follows:

Marriott Hilton

Average total liabilities $7,250 $ 9,343Average total stockholders’ equity 2,935 3,269Average total assets 6,933 12,612

1. Determine the following ratios for both companies (round to one decimal place afterthe whole percent):a. Rate earned on total assetsb. Rate earned on total stockholders’ equityc. Number of times interest charges are earnedd. Ratio of liabilities to stockholders’ equity

2. Analyze and compare the two companies, using the information in (1).

SA 17-5Comprehensiveprofitability andsolvency analysis

The following information is available for three recent years (in millions except per-

share amounts):2006 2005 2004

Net income (loss) $960 $890 $761Preferred dividends $0.00 $0.00 $0.00Interest expense $36.15 $22.72 $17.64Shares outstanding for

computing earnings per share 280 295 302Cash dividend per share $0.63 $0.41 $0.20Average total assets $5,369 $5,203 $4,392Average stockholders’ equity $3,151 $3,088 $2,595Average stock price per share $56.12 $54.14 $46.87

1. Calculate the following ratios for each year:a. Rate earned on total assetsb. Rate earned on stockholders’ equityc. Earnings per shared. Dividend yielde. Price-earnings ratio

2. What is the ratio of average liabilities to average stockholders’ equity for 2006?3. Explain the direction of the dividend yield and price-earnings ratio in light

of Harley-Davidson’s profitability trend.4. Based on these data, evaluate Harley-Davidson’s strategy to expand to international

markets.

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