Homework Set #1 Submission
Homework Set #1
Directions: Answer the following questions in a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link above.
In your own words, identify two different stock exchanges in the United States. Describe the similarities and differences between the two stock exchanges. Identify one stock from each of the two stock exchanges.
Using the two stocks you identified, determine the free cash flow from 2015 and 2016. What inference can you draw from the companies free cash flow?
Using the 2017 and 2018 financial statements for both stocks, prepare two financial ratios for each of the following categories: liquidity ratios, asset management ratios, and profitability ratios. You should have a total of six ratios for each stock, per year. What challenges, strengths, or weaknesses do you see? Please be articulate.
Evaluating
Financial
Performance
CHAPTER TWO
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The Levers of Financial
Performance
A pilot uses levers to control a the flight of an aircraft.
Operating decisions are the levers by which managers
control financial performance.
In this chapter, we study how financial statements help us to
analyze the performance of the firm.
Our primary tool is ratio analysis.
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
2
Return on Equity
Return on Equity: The most popular measure of
financial performance
?????? =
?????? ????????????
?????????????????????? ? ????????????
?????? =
Why does this
definition
make sense?
$551
$1,863
= 29.6%
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
3
The 3 Determinants of ROE
?????? = ???????????? ???????????? × ?????????? ???????????????? × ?????????????????? ????????????????
?????? =
?????? ????????????
??????????
????????????
×
×
??????????
???????????? ?????????????????????? ? ????????????
How is this a
measure of
leverage?
?????? =
$551
$5,020 $5,091
×
×
$5,020 $5,091 $1,863
= 11.0% × 0.986 × 2.73 = 11.1%
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
4
TABLE 2.1 ROE and Levers of Performance for 10 Diverse
Companies, 2016
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
5
Questions about Table 2.1
Differences in ROE across firms is less than
differences in components. Why?
What is the role of competition in ROE differences?
Is there any reason why profit margin and asset
turnover should be negatively related?
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
6
You try it.
Calculate ROE and the levers of performance.
Selected financial data
($ millions)
Nordstrom
Sales
Net income
Total assets
Shareholders’ equity
Profit margin
Asset turnover
Leverage
ROE
14,757
354
7,858
870
Walmart
485,873
13,643
198,825
77,798
2.4%
1.9
9.0
2.8%
2.4
2.6
40.7%
17.5%
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
7
Profitability Ratios
Profit margin: The fraction of each sales dollar
realized as profits
???????????? ???????????? =
?????? ????????????
??????????
Return on assets: The combined effect of profit
margin and asset turnover
?????? = ???????????? ???????????? × ?????????? ???????????????? =
?????? ????????????
????????????
Gross margin: The contribution to fixed costs and
profits
Are COGS
?????????? ???????????? =
?????????? ????????????
??????????
=
???????????????????
??????????
fixed or
variable?
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
8
Hasbros Profitability Ratios
???????????? ???????????? =
?????? =
?????? ????????????
????????????
?????? ????????????
??????????
=
?????????? ???????????? =
$551
$5,091
=
$551
$5,020
= 11.0%
= 10.8%
???????????????????
??????????
=
$5,020?$2,231
$5,020
= 55.6%
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
9
Breakeven Sales
Use gross margin to calculate Hasbros breakeven
sales volume
?
?
?
Assume COGS are variable and operating expenses
are fixed.
Hasbros 2016 operating costs were $1,968 million.
Since 56% of sales goes to cover operating costs,
breakeven sales volume = $1,968/0.56 = $3,514
million.
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
10
You try it.
Calculate breakeven sales volume for Apple Inc. for 2016.
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
11
Turnover-Control Ratios
Asset turnover: Sales generated per dollar of assets
?????????? ???????????????? =
??????????
????????????
Inventory turnover: Number of times inventory turns
over per year
????????
?????????????????? ???????????????? = ???????????? ??????????????????
Collection period: Average number of days to collect
receivables
What if you
???????????????????? ???????????? =
???????????????? ????????????????????
???????????? ?????????? ?????? ??????
dont know
credit sales?
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
12
More Turnover-Control Ratios
Days sales in cash: Availability of cash relative to
sales
???????? ? ?????????? ???? ??????? =
??????? ?????? ????????????????????
?????????? ?????? ??????
Payables period: Average number of days to pay
accounts payable
What if you dont
???????????????? ???????????? =
???????????????? ??????????????
???????????? ????????????????? ?????? ??????
know credit
purchases?
Fixed-asset turnover: Sales generated per dollar of
fixed assets
?????????? ?????????? ???????????????? =
??????????
?????? ????&??
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
13
Fixed Assets vs. Current Assets
Which is likely to be more sensitive to external
events, current assets or fixed assets?
What is a self-liquidating loan?
? Loan to support current assets
? What happens to AR and inventory when sales go up?
? What happens to AR and inventory when sales go down?
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
14
Hasbros Turnover-Control Ratios
??????????
$5,020
?????????? ???????????????? = ???????????? = $5,091 = 0.99 ??????????
????????
?????????????????? ???????????????? = ???????????? ?????????????????? =
???????????????? ????????????????????
$2,231
$388
= 5.8 ??????????
$1,320
???????????????????? ???????????? = ???????????? ?????????? ?????? ?????? = $5,020/365 = 96.0 ????????
???????? ? ?????????? ???? ??????? =
???????????????? ???????????? =
??????? ?????? ????????????????????
?????????? ?????? ??????
???????????????? ??????????????
???????????? ????????????????? ?????? ??????
??????????
?????????? ?????????? ???????????????? = ?????? ????&?? =
$1,282
= $5,020/365 = 93.2 ????????
$5,020
$267
=
$320
$2,231/365
= 52.4 ????????
= 18.8 ??????????
Does a higher fixed-asset
turnover indicate higher or
lower capital intensity?
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
15
The Cash Conversion Cycle (CCC)
The average length of time between when cash goes out
the door and when it comes back in
CCC= Days inventory outstanding + Collection period
Payables period
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
16
You try it.
Calculate the cash conversion cycle for Hyundai Motor.
Hyundai Motor
Selected financial data
2016 (? billions)
Sales
93,649
Cost of goods sold
75,960
Accounts receivable
Inventory
Accounts payable
8,030
10,524
6,986
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
17
Financial Leverage
What does increased financial leverage do to ROE?
Is increased leverage a good thing?
? Southern Co. vs. Alphabet
? JPMorgan Chase
Have another look at Table 2.1, and describe what
you see, along with an explanation.
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
18
TABLE 2.1 ROE and Levers of Performance for 10 Diverse
Companies, 2016
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
19
Leverage and Liquidity Ratios 1
Balance Sheet Ratios
Debt-to-assets ratio: Percent of assets paid for by
creditors
???????? ???? ???????????? ?????????? =
?????????? ??????????????????????
?????????? ????????????
Debt-to-equity ratio: Financing supplied by creditors for
every dollar from shareholders
?????????? ????????????????????
???????? ???? ???????????? ?????????? = ??????????????????????? ????????????
??
$3,228
=
= 63.4%
??
$5,091
??
$3,228
=
= 173.3%
??
$1,863
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
20
Leverage and Liquidity Ratios 2
Coverage Ratios
Times interest earned: Income available in relation to
interest payments
?????????? ???????????????? ???????????? =
????????
???????????????? ??????????????
Times burden covered: Income available in relation to
all debt service
?????????? ???????????? ?????????????? =
????????
????????????????+
?????????????????? ??????????????????
1??????? ????????
$807
?????? =
= 8.3 ??????????
$97
?????? =
Which coverage ratio is
more important?
Why?
$807
= 2.6 ??????????
$165
$97 +
1 ? 0.224
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
21
Leverage and Liquidity Ratios 3
Market Value Leverage Ratios
Market debt-to-equity ratio: Todays value of financial
burdens compared to shareholders expected value
???????????? ??/?? =
???????????? ?????????? ???? ????????
???????????? ?????????? ???? ????????????
=
???????????? ?????????? ???? ????????
???????????? ???? ??????????? × ?????????? ??????????
Market debt-to-assets ratio: Todays value of financial
burdens compared to value of expected future income
???????????? ?????????? ???? ????????
???????????? ??/?? = ???????????? ?????????? ???? ????????+????????????
What if you dont know
the market value of debt?
??
$3,228
$3,228
=
=
= 33.3%
??
124.5 × $77.79 $9,685
??
$3,228
=
= 25.0%
??
$3,228 + $9,685
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
22
Leverage and Liquidity Ratios 4
Liquidity Ratios
Current ratio: Liquid assets compared to imminent debts
?????????????? ?????????? =
?????????????? ????????????
???????????? ??????????????????????
Acid test (Quick ratio): Very liquid assets compared to
imminent debts
???????? ???????? =
?????????????? ???????????????????????????????
?????????????? ??????????????????????
?????????????? ?????????? =
???????? ???????? =
$3,228
= 2.0 ??????????
$1,618
$3,228 ? $388
= 1.8 ??????????
$1,618
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
23
ROE: The Timing Problem
Is ROE forward-looking?
Does ROE have a long-term perspective?
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
24
ROE: The Risk Problem
Does ROE take into account business risk?
What is the impact of leverage on ROE?
Return on invested capital: A measure of return on capital
independent of the amount of leverage
???????? =
????????(1??????? ????????)
???????????????? ?????????????? ????????+????????????
???????? =
$807(1?0.224)
$522+$1,199+$1,863
= 17.5%
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
25
ROIC Is Not Distorted by Company Financing
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
26
ROE: The Value Problem
Should we calculate return on book equity or market equity?
Earnings yield: ROE using market value of equity instead of book
value
?????? ????????????
??????
???????????????? ?????????? =
=
???????????? ?????????? ???? ???????????? ?????????? ?????? ?????????
Price-to-earnings ratio: Inverse of earnings yield; commonly used
measure of performance
?????????? ?????? ?????????
????? ?????????? =
??????
???????????????? ?????????? =
????? ?????????? =
Is this a better measure of
performance than ROE?
$4.34
= 5.6%
$77.79
$77.79
$4.34
= 17.9 ??????????
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
27
ROE or Market Price?
Which is the better way to measure financial
performance?
We have just discussed problems with ROE.
What about problems with stock price?
? How do operating decision affect stock price?
? Managers (should) know more about the company than
outside investors.
? Stock price depends on many factors outside
managements control.
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
28
Comparing ROE to Stock Price
Market-to-book vs. ROE (weighted-average)
Figures 2.1 and 2.2 coming up
Slope and dispersion (R-squared)?
Where is Hasbro relative to others in Figure 2.1?
Where are Apple and Amazon in Figure 2.2?
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
29
FIGURE 2.1 M/B vs. ROE for 20 Toy/Gaming/Leisure Firms
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
30
FIGURE 2.2 M/B vs. ROE for 82 Large Corporations
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
31
Ratio Analysis
Ratio analysis is the systematic use of the ratios
previously defined to understand financial
performance.
Caveats to keep in mind:
? Ratios dont tell the whole story; theyre more like clues
that point to issues requiring further investigation.
? There are no universally correct values for ratios.
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
32
Using Ratios Effectively
Ratio values need to be understood in context.
It is important to compare ratios to something else.
? Comparable companies
? Changes in a companys ratios over time
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
33
FIGURE 2.3 The Levers of Performance Suggest One Road Map for
Ratio Analysis
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
34
Example of Ratio Analysis
Analyze the profitability measures
? What do the various measures tell you?
? What is Hasbros trend over time?
? How does Hasbro compare to the industry?
Analyze the levers of ROE
? Which levers explain the changes in ROE over time?
Analyze the control ratios
? Is Hasbro managing assets efficiently?
? How do they compare to prior performance and industry
performance?
Analyze the leverage ratios
? Whats the trend in their use of debt?
? How do they compare to the industry?
? Is their amount of leverage concerning?
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
35
TABLE 2.2 Ratio Analysis of Hasbro
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
36
Common Size Financial
Statements
Add insight in analyzing a company
? Helps in recognizing trends over time
? Can compare to other companies without scale effects
What do common-size figures tell you compared to
typical ratios?
? For example, collection period vs. AR/Assets
? For example, inventory turnover vs. Inventory/Assets
What do you learn about working capital
? Fraction of assets that are short-term
What do you learn about COGS?
? Small changes in percentages can be large relative to net
income
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
37
TABLE 2.3 Hasbro Common-Size Balance Sheets
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
38
TABLE 2.3 Hasbro Common-Size Income Statements
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
39
TABLE 2.4 Definitions of Principal Ratios Appearing in Chapter
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
40
TABLE 2.4 Definitions of Principal Ratios Appearing in Chapter
(cont.)
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HIGGINS, ANALYSIS FOR FINANCIAL MANAGEMENT, 12E
Ch. 2
41
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