CHAPTER 18
Integration of Financial Statement Analysis Techniques

Solutions

  1. C is correct. The ROE has been trending higher. ROE can be calculated by multiplying (net profit margin) × (asset turnover) × (financial leverage). Net profit margin is net income/sales. In 2018 the net profit margin was 2,576/55,781 = 4.6% and the ROE = 4.6% × 0.68 × 3.43 = 10.8%. Using the same method, ROE was 12.9 percent in 2019 and 13.6 percent in 2020.
  2. A is correct. The DuPont analysis shows that profit margins and asset turnover have both increased over the last three years, but leverage has declined. The reduction in leverage offsets a portion of the improvement in profitability and turnover. Thus, ROE would have been higher if leverage had not decreased.
  3. B is correct. The Power and Industrial segment has the lowest EBIT margins but uses about 31 percent of the capital employed. Further, Power and Industrial’s proportion of the capital expenditures has increased from 32 percent to 36 percent over the three years. Its capital intensity only looked to get worse, as the segment’s percentage of total capital expenditures was higher than its percentage of total capital in each of the three years. If Abay is considering divesting segments that do not earn sufficient returns on capital employed, this segment is most suitable.
  4. A is correct. The cash-flow-based accruals ratio = [NI − (CFO + CFI)]/(Average NOA) = [4,038 − (9,822 − 10,068)]/43,192 = 9.9%.
  5. A is correct. The cash-flow-based accruals ratio falls from 11.0 percent in 2018 to 5.9 percent in 2019, and then rises to 9.9 percent in 2020. However, the change over the three-year period is a net modest decline, indicating a slight improvement in earnings quality.
  6. B is correct. Net cash flow provided by (used in) operating activity has to be adjusted for interest and taxes, as necessary, in order to be comparable to operating income (EBIT). Bickchip, reporting under IFRS, chose to classify interest expense as a financing cash flow so the only necessary adjustment is for taxes. The operating cash flow before interest and taxes = 9,822 + 1,930 = 11,752. Dividing this by EBIT of 6,270 yields 1.9.
  7. A is correct. Operating cash flow before interest and taxes to operating income rises steadily (not erratically) from 1.2 to 1.3 to 1.9. The ratios over 1.0 and the trend indicate that earnings are supported by cash flow.