Concept explainers
Given the financial statements for Jones Corporation and Smith Corporation shown here:
a. To which one would you, as credit manager for a supplier, approve the extension of (short-term) trade credit? Why? Compute all ratios before answering.
b. In which one would you buy stock? Why?
a.
To calculate: The relevant ratios so that the decision for the extension of short term trade credit can be taken.
Introduction:
Shortterm trade credit:
It is the type of credit that is granted to a business or an individual or a fixed loan for a period of not more than 12 months or 1 year.
Answer to Problem 37P
The Smith Corporation would get the extension of the short term trade credit as their liquidity ratios are better than those of the Jones Corporation; the suppliers and lenders are most concerned with the liquidity ratios.
Explanation of Solution
Calculation of ratios for the Smith Corporation:
Calculation of current ratio:
Calculation of quick ratio:
Calculation of debt to total asset ratio:
Calculation of times interest ratio:
Calculation of fixed charge ratio:
Calculation of ratios for the Jones Corporation:
Calculation of current ratio:
Calculation of quick ratio:
Calculation of debt to total asset ratio:
Calculation of times interest ratio:
Calculation of fixed charge ratio:
b.
To determine: The company whose stock should be bought.
Introduction:
Stock:
Also termed as ordinary shares, it is a type of security that represents the corporate equity ownership. It is the best means to earn real rate of return ahead of inflation in the long run.
Answer to Problem 37P
The stocks of the Jones Corporation should be bought as their profit margin and return on assets are higher compared to the Smith Corporation; shareholders are mostly concerned with profitability.
But the return on equity is more for the Smith Corporation because it has taken a bigger financial risk. The times interest ratio and fixed charges ratio are higher for the Jones Corporation, which clearly reflects that their interest and fixed charges are well covered.
Explanation of Solution
Calculation of ratios for the Smith Corporation:
Calculation of profit margin:
Calculation of return on assets:
Calculation of return on equity:
Calculation of debt to total asset ratio:
Calculation of times interest ratio:
Calculation of fixed charge ratio:
Calculation of ratios for the Jones Corporation:
Calculation of profit margin:
Calculation of return on assets:
Calculation of return on equity:
Calculation of debt to total asset ratio:
Calculation of times interest ratio:
Calculation of fixed charge ratio:
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Chapter 3 Solutions
FOUNDATIONS OF FINANCIAL MANAGEMENT COD
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