Fabozzi Frank, Peterson Pamela. Financial Management and Analysis Workbook

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210 QUESTIONS AND PROBLEMS

a. Bank A has offered to lend the ﬁrm the whole amount

for six months at an APR of 16%. The bank will require

a compensating balance of 17% of the face value of the

loan and will charge a $1,000 loan origination fee.

b. Bank B has offered to lend the entire amount for three

months at an APR of 20%. The loan is a discount loan,

and Bank B requires a compensating balance require-

ment of 10%.

c. Bank C has offered to lend the ﬁrm the entire amount for

one month at an APR of 24%. The loan is a single-pay-

ment loan with interest and principal to be paid at the

end of the month. There is no compensating balance

requirement and no loan origination fee.

d. CZ can forgo its supplier discounts for the month. The

credit terms are 3/10, net 45.

Which is the cheapest source of ﬁnancing?

2. The Safe-T Corporation used a repurchase agreement to

meet its need for short-term financing. It received $9.5

million for the sale of $10 million in face value of U.S.

Treasury bills that had a market value of $9.7 million, and

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Management of Short-Term Financing 211

it repurchased the bills thirty days later for $9.6 million.

What is the effective annual cost?

3. Rustee Iron Works is considering using a field warehouse

loan as part of its short-term financing. It will require a

loan of $1 million. Interest on the loan will be at an annual

rate of 11%, single-payment interest, paid at the end of the

year. The field warehouse charges 3.5% of the face value of

the loan, payable at the beginning of the year. What is the

effective cost of the warehousing arrangement?

4. Can-Do Corporation has issued five-month commercial

paper with a $250,000 face value. The firm’s proceeds

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212 QUESTIONS AND PROBLEMS

from the sale of the paper are $237,500. What is the effec-

tive annual cost of this loan?

5. The Bags-O-Chips Company wants to use $800,000 of

accounts receivable to secure financing for the next

month. We’re #1 Finance Company is willing to lend

Chips 65% of the face value of the receivables at 40 basis

points above the prime rate, which is currently 4% APR.

We’re #2 Finance Company will factor Chips receivables,

advancing 80% of the receivables and charging a fee of

2% of Chips total receivables. This fee will be paid up

front. Interest will be at 30 basis points above the prime

rate. We’re #2 also will be performing all credit functions,

saving Chips an estimated $4,000 for the month. Which

arrangement is least costly?

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CHAPTER

213

Financial Ratio Analysis

FILL IN THE BLANKS

Refer to Chapter 22, pages 721–765 in Financial Manage-

ment and Analysis.

1. A(n) ______________ is a mathematical relation between

two quantities. A ﬁnancial ______________ is a(n)

______________ between one bit of ﬁnancial information

and another. Ratios can be classiﬁed according to the way

they are ______________ and the ﬁnancial ______________

they are describing. There are as many different ﬁnancial

ratios as there are possible ______________ of items

appearing on ﬁnancial ______________.

2. Return-on-______________ ratios compare measures of

______________, such as earnings or net income, with mea-

sures of ______________. The return on ______________,

also called the basic earning ______________ ratio, is the

ratio of ______________ earnings to total assets. The return

on ______________ is the ratio of the net ______________

shareholders receive to their ______________ in the stock.

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214 QUESTIONS AND PROBLEMS

3. The method of analyzing ______________ ratios in terms

of ______________ margin and ______________ ratios,

referred to as the ______________ System, is credited to

the E.I. Du Pont Corporation. Du Pont’s management

developed this system of breaking down return ratios into

their ______________ to help managers understand the

“______________” behind the firm’s ______________.

4. ______________ reflects the ability of a firm to meet its

______________-term obligations using those assets that

are most readily converted into ______________. Assets

that may be converted into ______________ in a short

period of time are referred to as ______________ assets;

they are listed in financial statements as ______________

assets. ______________ assets are often referred to as

______________ capital, because they represent the

resources needed for the ______________ operations of the

firm’s long-term capital investments.

5. How much liquidity a firm needs depends on its

______________ cycle. The ______________ cycle is the

duration from the time ______________ is invested in

goods and ______________ to the time that investment

produces ______________. The ______________ the

______________ cycle, the ______________ the amount of

net ______________ capital required.

6. ______________ margin ratios compare components of

______________ with ______________. They give us an

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Financial Ratio Analysis 215

idea of what factors make up a firm’s ______________ and

are usually expressed as a portion of each ______________

of sales. The analyst would focus on ______________

profit (sales less cost of goods sold), a measure of income

that is the direct result of ______________ management.

Comparing ______________ profit with ______________

produces the gross profit margin.

7. ______________ ratios, or turnover ratios, can be used to

evaluate the benefits produced by specific ______________,

such as ______________ or accounts ______________ or to

evaluate the benefits produced by the totality of the firm’s

assets. The ______________ turnover ratio indicates how

quickly a firm has used inventory to generate the

______________ and ______________ sold. The accounts

______________ turnover ratio measures how effectively a

firm uses ______________ extended to customers. The

______________ turnover ratio tells how many times dur-

ing the year the ______________ of a firm’s total assets is

generated in ______________.

8. Financial ______________ is associated with a firm’s abil-

ity to satisfy its ______________ obligations, and is often

measured using the extent to which ______________

financing is used relative to ______________. Financial

______________ ratios are used to assess how much finan-

cial ______________ the firm has taken on. There are two

types of financial ______________ ratios: ______________

percentages and ______________ ratios.

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216 QUESTIONS AND PROBLEMS

9. ______________ coverage ratio, also called times

______________ ratio, measures a firm’s ability to handle

financial ______________. This ratio indicates how well

the firm can meet the ______________ payments associ-

ated with ______________. The ______________ the inter-

est coverage ratio, the ______________ able the firm is to

pay its ______________ expenses.

10.______________ analysis is a method of analysis in which

the components of a financial ______________ are com-

pared with each other. The first step in ______________

analysis is to break down a financial statement—either the

______________ sheet or the ______________ statement—

into its parts. The next step is to ______________ the pro-

portion that each item represents relative to some

______________. In common-size analysis of the

______________ sheet, the benchmark is total

______________. For the ______________ statement, the

benchmark is ______________.

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Financial Ratio Analysis 217

SHORT ANSWER QUESTIONS

Refer to Chapter 22, pages 721–765 in Financial Manage-

ment and Analysis.

1. How is ﬁnancial information presented? How is the infor-

mation classiﬁed?

2. What aspects of operating performance and financial con-

dition do financial ratios evaluate?

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218 QUESTIONS AND PROBLEMS

3. What is the Du Pont System and how is it used?

4. What is the difference between book value and market

value and how does it affect financial ratio analysis?

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Financial Ratio Analysis 219

5. Are there any concerns and/or cautions when using finan-

cial ratios?

PROBLEMS

Refer to Chapter 22, pages 721–765 in Financial Manage-

ment and Analysis.

1. Using Wang Laboratories’ balance sheet and income

statement for the year ending June 30, 1995, shown on

page 773 of Financial Management and Analysis, make

the following calculations assuming a 365-day year, all

sales and purchases are on credit, and that the ﬁnancial

data is in hundreds of thousands:

a. Current ratio

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