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Capital Investment Appraisal
Aims… For you to be able to understand the
concepts of Payback, ARR, IRR, DCF & NPV
To be able to calculate Investment Appraisal methods.
What is an Investment? What is an Investment?
Any act which involves the sacrifice of an immediate and certain level of consumption in exchange for the expectation of an increase in future consumption.
forgo the present consumption in order to increase resources in future
An investment requires expenditure on something today that is expected to provide a benefit in the future
the decision to make an investment is extremely important because it implies;
the expectation that expenditure today will generate future cash gains in real terms that greatly exceed the funds spent today
What is an Investment? What is an Investment?
Investment Appraisal A means of assessing whether an
investment project is worthwhile or not
Investment project could be the purchase of a new PC for a small firm, a new piece of equipment in a manufacturing plant, a whole new factory, etc
Investment Appraisal Types of investment
appraisal: Payback Period
Average Rate of Return (ARR)
Net Present Value (discounted cash flow)
What factors need to be considered before investing in equipment such as this?
Source: Gergely Erno, http://www.sxc.hu
Investment Appraisal Why do companies invest?
Importance of remembering investment as the purchase of productive capacity NOT buying stocks and shares or investing in a bank!
Buy equipment/machinery or build new plant to: Increase capacity (amount that can be produced)
which means: Demand can be met and this generates sales
revenue Increased efficiency and productivity
Investment Appraisal Investment therefore
assumes that the investment will yield future income streams
Investment appraisal is all about assessing these income streams against the cost of the investment
Not a precise science!
A fork lift may be an important item but what does it contribute to overall sales? How long and how much work would it have to do to repay its initial cost?
Looking at the figures…
A failing farmer wants to investigate the
financial implications of possible farm diversification.
Farm Diversification – the 3 options
Project A B C
Years Goats Poultry Fish hatchery
0 (20,000) (20,000) (10,000)
1 10,000 200 0
2 10,000 200 0
3 5,000 16,000 0
4 5,000 16,000 18,000
Payback 2 years 3 years 3 mths 3 years 7 mths
NPV * 7000 7522 4760
ARR 12.5% 15.5% 20%
So what other factors should
the farmer consider before
deciding on which project to
go with?
What other factors?State of the farming industryPrice of landInterest ratesThe economy – growing or shrinking?The farmers interests – no good doing something the family has no interest in!Competition in areaLevel of demand for each option!
Capital Budgeting
Outcomeis uncertain.
Large amounts ofmoney involved.
Investment involveslong-term commitment.
Decision may bedifficult or impossible
to reverse.
The Five Main Investment Appraisal
Criteria Methods
The Five Main Investment Appraisal
Criteria Methods
Payback Method
Payback method - length of time it takes to repay the cost of initial investment
LBS Ltd uses the payback period as its sole investment appraisal method. LBS invests ¢ ¢ 30,000 to replace its computers and this investment returns ¢ ¢ 9,000 annually for the five years. From the information above evaluate the investment using the payback. Assume that ¢ ¢ 9,000 accrues evenly throughout the year.
Payback Method
Solution Year Yearly cash flow cumulative net cash flow
¢ ¢ ¢¢0 (30,000) (30,000)1 9,000 (21,000)
2 9,000 (12,000)
3 9,000 (3,000)
4 9,000 6,000 5 9,000 15,000
Therefore 3years = 27,000 then 3000/9000 x 12 = 4
Payback period = 3 years 4months
Payback Method
Payback Period
Time period required to recover the cost of the investment from the annual cash inflow produced by the investment.
Amount investedExpected annual net cash inflow
Payback MethodThe length of time taken to repay the initial capital cost
Requires information on the revenue the investment generatesE.g. A machine costs ¢¢600,000It produces items that sell at ¢ ¢ 5 each and produces
60,000 units per year
Payback period will be ?????
2 Years Computed as;
600,000 / 300,000 = 2
Payback Method
Example
Casey Co. is considering an investment of ¢130,000 in new equipment. The new equipment is expected to last 10 years. It will have zero salvage value at the end of its useful life. The straight-line method of depreciation is used for accounting purposes. The expected annual revenues and costs of the new product that will be produced from the investment are:
Sales ¢200,000
Cost of goods sold ¢145,000Depreciation expense 13,000Selling & Admin expense 22,000
180,000Income before income tax
¢20,000Income tax expense
7,000Net Income
¢13,000
Computation of Annual Cash Inflow
Expected annual net cash inflow =Net income ¢13,000Depreciation expense 13,000
¢26,000
Cash Payback Period
130,000 / 26,000 = 5 years
**Operating Cashflow During 2009, RIT Corp. had sales of $798,456. Costs of goods
sold, administrative and selling expenses, and depreciation expenses were $565,600, $98,555, and $89,561, respectively. In addition, the company had an interest expense of $223,544 and a tax rate of 35 percent. What is the operating cash flow for 2009? Ignore any tax loss carry-back or carry-forward provisions.
Operating Cashflow SolutionSales 798,456COGS 565,600Admin & Selling Expenses 98,555Depreciation 89,561Interest Expense 223,544Tax Rate 35%
Operating Cashflow = EBIT + Depreciation - Income Taxes
EBIT = Earnings Before Interest and Taxes
EBIT = Revenue - Operating Expenses
EBIT = Sales -COGS - Admin & Selling Expenses - Depreciation
EBIT = 44,740
Tax 15,659
Operating Cashflow = ((44,740 + 89,561 - 15,659))
118,642118,642
**Cashflow to stockholders & creditors
A. What is the cash flow to stockholders for 2009?
B. What is the cash flow to creditors for 2009?
M & M FoodsFinancial Statements
2008 2009
Sales 6,831 7,866
COGS 4,760 5,236
Interest 331 380
Depreciation 221 289
Cash 450 468
Account Receivables 2,214 2,650
Current Liabilities 991 2,238
Inventory 2,564 2,651
Long-term debt 3,522 2,400
Net fixed assets 5,040 5,542
Common stock 2,365 3,641
Taxes 566 716
SolutionCashflow to stockholders = Cashflow from Assets - Cashflow to Creditors
Cashflow from Assets = Operating cashflow - Net Capital Spending - change in net capital
Cashflow to creditors = Interest - Net new borrowing
Operating Cashflow = Sales -COGS - Depreciation + (Depreciation - Taxes)
Net New Borrowing = 2009 Long term debt - 2008 Long term debt
Net Capital Spending = 2009 net fixed assets - 2008 net fixed assets + 2009 Depreciation
Change in NWC = 2009(cash + A/R + inventory - Current Liabilities)
Minus
2008 (cash + A/R + Inventory - Current Liabilities)
Operating Cashflow = EBIT + Depreciation - Income Taxes
Solution cont’d
Operating Cashflow = Sales-COGS- Depreciation + Depreciation -Taxes
Net Capital Spending = 2009 net fixed assets - 2008 net fixed assets + 2009 Depreciation
Change in NWC = 2009(cash + A/R + inventory - Current Liabilities)
Minus
2008 (cash + A/R + Inventory - Current Liabilities)
Operating Cashflow 1,914
Net Capital Spending 791
Change in NWC (706)
Cashflow from Assets = Operating cashflow - Net Capital Spending - change in net capital
Cashflow from assets 1,829
Net New Borrowing = 2009 Long term debt - 2008 Long term debt
Net new borrowing (1,122)
Cashflow to creditors 1,502 Cashflow to stockholders 327
Payback Period –Uneven Cash Flows
Casey Co. wants to install a machine that costs ¢16,000 and has an 8-year useful life with zero salvage value. Annual net cash flows are:
YearAnnual Net Cash Flows
Cumulative Net Cash
Flows0 (16,000)$ (16,000)$ 1 3,000 (13,000) 2 4,000 (9,000) 3 4,000 (5,000) 4 4,000 (1,000) 5 5,000 6 3,000 7 2,000 8 2,000
YearAnnual Net Cash Flows
Cumulative Net Cash
Flows0 (16,000)$ (16,000)$ 1 3,000 (13,000) 2 4,000 (9,000) 3 4,000 (5,000) 4 4,000 (1,000) 5 5,000 6 3,000 7 2,000 8 2,000
4.2
Payback Period –Uneven Cash Flows
We recover the ¢16,000purchase price between
years 4 and 5, about4.2 years for the payback period.
Consider two projects, each with a 5-year life and each costing ¢6,000.
Project One Project TwoNet Cash Net Cash
Year Inflows Inflows
1 2,000 1,0002 2,000 1,0003 2,000 1,0004 2,000 1,0005 2,000 1,000,000
Would you invest in Project One just because it has a shorter payback
period?
Using the Payback PeriodPayback = 3 years
Payback = 5 years
Payback method
Payback could occur during a year
Can take account of this by reducing the cash inflows from the investment to days, weeks or years.
Payback Method e.g.
Cost of machine = ¢ ¢ 600,000
Annual income streams from investment = ¢ ¢ 255,000 per year
Payback is some where between …Year 2 & year 3 it will pay back – but when?
Income
Year 1 255,000
Year 2 255,000
Year 3 255,000
Payback formula
= 600,000255,000
= 2.35 years
What’s just over a 1/3 of a year?= 4 months
= 2 years and 5 months…
Payback formula
2 years = 255,000 + 255,000 = 510,000
= 2 years & some months….
600,000 - 510,000 = 90,000 still owing
255,000 = 21,25012 months
= 90,000 = 4.235 month 21,250
= 2 years and 5 months…
Average Rate of Return A comparison of the profit generated by
the investment with the cost of the investment
Average annual return or annual profit ARR = --------------------------------------------
Initial cost of investment
Average annual operating income from assetAverage amount invested in asset
Compare accounting rate of return to company’s required minimum rate of return for investments of similar risk.
The minimum return is based on the company’s cost of capital.
Average Rate of Return
Average Investment =
Original Investment + Residual Value2
For Casey, average investment = (¢130,000 + ¢0)/ 2 = ¢65,000
Accounting Rate of Return
Solution to Accounting Rate of Return Problem
Average annual operating income from assetAverage amount invested in asset
¢13,000 / ¢65,000 = 20%
Accounting Rate of Return
The decision rule is: A project is acceptable if its rate of return
is greater than management’s minimum rate of return.
The higher the rate of return for a given risk, the more attractive the investment.
Accounting Rate of Return An investment is expected to yield cash flows of ¢ ¢ 10,000 annually
for the next 5 years.
The initial cost of the investment is ¢ ¢ 20,000 Total profit therefore is: ¢ ¢ 30,000
(50,000-20,000)
Annual profit = ¢ ¢ 30,000 / 5= ¢ ¢ 6,000
ARR = 6,000/20,000 x 100= 30%
Is this a worthwhile return?Need to compare to interest rates
as well alternatives.
ARR- do you need a formula? Total revenue (over lifetime) – purchase price = total profit
Total profit / life time of product = average profit
Average profit / purchase price = ARR x 100
= ARR %
Investment Appraisal
To make a more informed decision, more sophisticated techniques need to be used.
Importance of time-value of money
Discounted Cash Flows
Considers both the estimated total cash inflows and the time value of money.
Two methods1) net present value2) internal rate of return
Purchasing power would have been lost over a year due to inflation
money could have been alternatively invested in say risk-free Government securities
Investment Appraisal
Net Present Value
NPV is today’s value of the difference between cash inflows and outflows projectedat future dates, attributable to capital investments or long-term projects
Net Present Value Takes into account the fact that money's value
change with time
How much would you need to invest today to earn x amount in x years time?
Value of money is affected by interest rates
NPV helps to take these factors into consideration
Shows you what your investment would have earned in an alternative investment regime
Net Present Value e.g. Project A costs ¢ ¢ 1,000,000 After 5 years the cash returns = ¢ ¢ 100,000 (10%)
If you had invested the ¢ ¢ 1 million into a bank offering interest at 12% the returns would be greater - You might be better off re-considering your investment!
Net Present Value The principle: How much would you have to invest now to earn
¢ ¢ 100 in 1 year’s time if the interest rate was 5%?
The amount invested would need to be: ¢ ¢ 95
Allows comparison of an investment by valuing cash payments on the project and cash receipts expected to be earned over the lifetime of the investment at the same point in time, i.e the present.
Net Present Value Future Value
PV = ----------------- (1 + i)n
Where i = interest rate n = number of years
The Present Value of ¢ ¢ 1 @ 10% in 1 year’s time is 0.9090.
If you invested 0.9090p today and the interest rate was 10% you would have ¢ ¢ 1 in a year’s time
Process referred to as: ‘Discounting Cash Flow’
Don’t need to
know this formula!!
Net Present Value Cash flow x discount factor = present value
e.g. PV of ¢ 500 in 10 years time at a rate of interest of 4.25% = 500 x .6595373 = ¢ 329.77
¢ 329.77 is what you would have to invest today at a rate of interest of 4.25% to earn ¢ 500 in 10 years time
PVs can be found through valuation tables (Always given to you in exams!)
Discounted Cash Flow An example: A firm is deciding on investing in an energy
efficiency system. Two possible systems are under investigation
1 yields quicker results in terms of energy savings than the other but the second may be more efficient later
Which should the firm invest in?
Discounted Cash Flow – System A
Year Cash Flow (£) Discount Factor (4.75%)
Present Value (£)(CF x DF)
0 - (600,000) 1.00 -(600,000)
1 +75,000 0.9546539 71,599.04
2 +100,000 0.9113641 91,136.41
3 +150,000 0.8700374 130,505.61
4 +200,000 0.8305846 166,116.92
5 +210,000 0.7929209 166,513.39
6 +150,000 0.7569650 113,544.75
Total 285,000 NPV =139,416
Watch this….
Discounted Cash Flow – System B
Year Cash Flow (£) Discount Factor (4.75%)
Present Value (£)(CF x DF)
0 - (600,000) 1.00 -(600,000)
1 +25,000 0.9546539 23,866.35
2 +75,000 0.9113641 68,352.31
3 +85,000 0.8700374 73,953.18
4 +100,000 0.8305846 83,058.46
5 +150,000 0.7929209 118,938.10
6 +450,000 0.7569650 340,634.30
Total 285,000 NPV =108,802.70
Watch this….
Discounted Cash Flow System A represents the better
investment…. But why?
System B yields the same cash return after 6 years but the NET returns of System A occur faster and are worth more to the firm than returns occurring in future years even though those returns are greater
Absolutely vital to remember this for
evaluation!
What would you prefer…a ¢ ¢ 50
today or ¢ ¢ 100 in 3 years time?
Net Present Value Method Find PV of future cash flows and compare
with capital outlay Interest rate used = required minimum
rate of return Proposal is acceptable when NPV is zero or
positive. The higher the positive NPV, the more
attractive the investment.
Net Present Value We will assume that Casey Co’s annual
cash inflows of ¢26,000 are uniform over the asset’s useful life.
The present value of the annual cash inflows can be computed by using the present value of an annuity of 1 for 10 periods. Assume the company requires a minimum return of 12%.
Net Present ValueCash Flow
When? Type of cash flow
Present value factor
Present value of
cash flows
(130,000) Now (¢130,000)
NPV
26,000 Yrs 1-10
Annuity 5.650 146,900
¢ 16,900
Analysis of the proposal: The proposed capital expenditure is acceptable at a required rate of return of 12%
because the net present value is positive
Net Present Value
When annual cash inflows are unequal, use present value of one tables.
Net Present ValueCash Flow When? Type of
cash flowPV factor Present
value
(130,000) Now ($130,000)
36,000 1 Lump sum .893 32,148
32,000 2 “ .797 25,504
29,000 3 “ .712 20,648
27,000 4 “ .636 17,172
26,000 5 “ .567 14,742
24,000 6 “ .507 12,168
23,000 7 “ .452 10,396
22,000 8 “ .404 8,888
21,000 9 “ .361 7,581
20,000 10 “ .322 6,440
NPV $25,687
,,
Internal Rate of Return Interest yield of the potential investment The interest rate that will cause the
present value of the proposed capital expenditure to equal the present value of the expected annual cash inflows.
Internal Rate of Return STEP 1.Compute the internal rate of return
factor using this formula:
Capital InvestmentAnnual Cash Inflows
130,000 / 26,000 = 5
Internal Rate of Return Method
STEP 2. Use the factor and the present value of an annuity of 1 table to find the internal rate of return.
Locate the discount factor that is closest to 5.0 on the line for 10 periods.
Internal Rate of Return Decision CriteriaThe decision rule is: Accept when internal rate of return is equal
to or greater than the required rate of return
Reject when internal rate of return is less than required rate
Internal Rate of Return –Uneven Cash Flows If cash inflows are unequal, trial and
error solution will result if present value tablesare used.
Use business calculators and electronic spreadsheets
Profitability Index (PI) Measures the benefit per unit cost, based
on the time value of money A profitability index of 1.1 implies that for
every ¢1 of investment, we create an additional ¢0.10 in value
This measure can be very useful in situations where we have limited capital
In other words, PI shows the relative profitability of any project, or the present value per cedi of initial cost
Profitability Index (PI)
PV of future cash flows
Initial Cost
Compute the PI for a project with initial cost of ¢ 130,000 with an NPV of ¢ 16,900
Profitability Index (PI)
Initial cost = 130,000NPV = 16,900
PV of future cash flows = 146,900
Answer
146,900
130,000 = 1.13
Jasper Metals is considering installing a new molding machine which is expected to produce operating cash flows of $78,000 a year for 7 years. At the beginning of the project, inventory will decrease by $19,000, accounts receivables will increase by $24,000, and accounts payable will increase by $18,000.
All net working capital will be recovered at the end of the project. The initial cost of the molding machine is $279,000. The equipment will be depreciated straight-line to a zero book value over the life of the project. The equipment will be salvaged at the end of the project creating a $52,000 aftertax cash flow.
At the end of the project, net working capital will return to its normal level.
What is the Net Present Value of this project given a required return of 14.5 percent?
(B) Calculate the project Profitability Index
**Net Present Value
Solution
Cashflow for initial year CF0
Initial cost (279,000)
Inventory decrease
19,000
Account Receivable increase (24,000)
Account payable increase 18,000
CF0 =
(-279,000 + 19,000 - 24,000 +18,000) (266,000)
Solution cont’d
Cashflow for year 7 CO7
Yearly cashflow 78,000
Salvaged Equipment after tax cashflow 52,000
Inventory decrease (initial year) (19,000)
Account Receivable increase (initial year) 24,000
Account payable increase (initial year) (18,000)
CO7 = (78,000 + 52,000 - 19,000 + 24,000 - 18,000) 117,000
NPV Computation Rate of return r = 14.50% ( r = 0.145) Period/Number of years = n = 7 NPV = CF0 + yearly cashflow * [1 - ((1/(1 + r)^n-1)/r) ] +[ CO7/(1 + r)^n]
Solution cont’d
NPV = (-279,000 + 78,000 * [1-1/(1+0.145)^7-1/0.145] + 117,000/(1 + 0.145)^7
78,555.24
(B)
Profitability Index, PI, is calculated as PV of future cash flows
Initial year cashflow
PV of future cash flows 78,555.24
Initial year cashflow 266,000
PI 0.2953
( C ) An investment project cost $23,500 and has annual cash flows of $6,800 for 6 years. If the discount rate is 20 percent, what is the discounted payback period?
Solution cont’d
PV = Annual cashflow * [1-((1/(1+r)^n))/r)]
Annual cashflow 6,800
Discount rate, r 20%0.2
Period, n 6
PV = 22,613.47
Advantages and Disadvantages of Profitability Index
Advantages Closely related to
NPV, generally leading to identical decisions
Easy to understand and communicate
May be useful when available investment funds are limited
Disadvantages May lead to
incorrect decisions in comparisons of mutually exclusive investments
Payback Accounting Net present Internal rateperiod rate of return value of return
Basis of Cash Accrual Cash flows Cash flowsmeasurement flows income Profitability Profitability
Measure Number Percent Dollar Percentexpressed as of years Amount
Easy to Easy to Considers time Considers timeUnderstand Understand value of money value of money
Strengths Allows Allows Accommodates Allowscomparison comparison different risk comparisons
across projects across projects levels over of dissimilara project's life projects
Doesn't Doesn't Difficult to Doesn't reflectconsider time consider time compare varying risk
value of money value of money dissimilar levels over theLimitations projects project's life
Doesn't Doesn't giveconsider cash annual rates
flows after over the lifepayback period of a project
Comparing Methods
9-73
IRR and Mutually Exclusive Projects Mutually exclusive projects
If you choose one, you can’t choose the other Example: You could have chosen to attend
graduate school at either KNUST or GTUC (Coventry), but not both
Intuitively you would use the following decision rules: NPV – choose the project with the higher NPV IRR – choose the project with the higher IRR
Investment Appraisal Key considerations for firms in
considering use:
Ease of use/degree of simplicity required
Degree of accuracy required
Extent to which future cash flows can be measured accurately
Extent to which future interest rate movements can be factored in and predicted
Necessity of factoring in effects of inflation
Absolutely vital to also
remember this for evaluation!
**More ratio problemsUptown Men's Wear has accounts payable of $4,428,inventory of $15,900, cash of $2,526 fixed assets of $16,800,accounts receivable of $7,814, and long-term debt of $8,400.What is the value of the net working capital to total assetsratio?
SolutionCash 2,526 AR 7,814 Inventory 15,900 Fixed assets 16,800 AP 4,428 Long Term Debt 8,400
Net working capital to Total assets ratio = Net Working CapitalTotal Assets
Net working capital = Current assets - Current liabilitiesCash + AR + Inventory - Accounts payable
21,812
Total Assets = Cash + AR + Inventory + Fixed Assets 43,040
Net working capital to Total assets ratio = 0.51
**Some more ratio issues The Flower Shoppe has accounts receivable of $7,930, inventory of $7,044,
sales of $548,226, and cost of goods sold of $412,899. How many days does it take the firm to both sell its inventory and collect the payment on the sale assuming that all sales are on credit?
Sales 548,226COGS 412,899AR 7,930Inventory 7,044
Days of the year 365
Days in inventory = 365 daysInventory Turnover ratio
Days in inventory = 6.227
Days' Sales in receivables orAverage Collection Period 365 Days
Receivables Turnover ratio
Solution cont’d
Receivables Turnover ratio SalesAccounts Receivable
Days' Sales in receivables orAverage Collection Period 5.280
Total days in Inventory and Receivables11.507
**Some even more ratios A firm has a debt-equity ratio of 67 percent, a total asset
turnover of 1.36, and a profit margin of 9.4 percent. The total equity is $640,115. What is the amount of the net income?
Debt - equity ratio 67%
0.67
Total assets turnover 1.36
Profit Margin 9.40%
0.049
Total Equity 640,511
Solution cont’dDuPont formula on ROE
ROE = (Profit margin)*(Asset turnover)*(Equity multiplier)
Net Income *Sales
Sales *Assets
AssetsEquity
DuPont model tells that ROE is affected by three things:
Operating efficiency, which is measured by net profit margin;
Asset use efficiency, which is measured by total asset turnover;
Financial leverage, which is measured by the equity multiplier;
If ROE is unsatisfactory, the DuPont analysis helps locate the part of the business that is underperforming.
Solution cont’dEquity Multiplier = (1 + Debt to Equity Ratio)
Debt/Equity = 0.67 Debt = Assets - Equity
Assets - Equity =Equity
0.67
Assets - Equity = 0.67 * Equity Assets = (0.67 * Equity) + Equity
Assets = 0.67Equity + Equity Assets = Equity (0.67 + 1)
Return on equity = Profit Margin * Total Assets Turnover * (1 + Debt to Equity Ratio)
(0.094 * 1.36 * (1 + 0.67) 0.1112888
Return on equity = Net IncomeTotal Equity
Net Income = Return on Equity * Total Equity
71,282
**Some more ratio issuesUse the below statements to answer question A to E
TEW COMPANY Balance Sheet
As of December 31, 2007
Assets
Cash 70,000 Accounts Receivable 100,000 Inventory 85,000 PPE, net 455,000 Total Assets 710,000
Liabilities and Stockholders' Equity
Accounts payable 95,000 Accrued expenses 116,000
Long Term Debt 195,000 Common Stock 168,000 Paid-in capital 38,000 Retained Earnings 98,000 Total Liabilities and SE 710,000
TEW COMPANY Income Statement
For the Year Ended December 31, 2007
Sales (all on credit) 800,000
COGS 500,000
Gross Profit 300,000
Sales and Admin Expenses 40,000
Fixed Lease Expense 20,000
Depreciation 80,000
Operating Profit 160,000
Interest Expense 40,000
Profit before Taxes 120,000
Taxes 35% 42,000
Net Income 78,000
(A). Refer to the figure above. The firm's return on equity is
ROE = Net IncomeShareholders' Equity
0.26
B). Refer to the figure above. The firm's average collection period is
Average Collection Period= 365Receivable Turnover ratio
Receivable Turnover ratio Sales on AccountAccounts Receivable
8Average Collection Period= 45.625days
(C). Refer to the figure above. Tew's quick ratio is
Quick Ratio = Current assets - InventoryCurrent Liabilities
170,000 0.806 211,000
(D). Refer to the figure above. The firm's debt to asset ratio is
Debt to Assets ratio = Total DebtTotal Assets
406,000 710,000
0.57
(E). Refer to the figure above. Fixed Charge coverage for Tew Company is
(E). Refer to the figure above. Fixed Charge coverage for Tew Company is
Fixed charge coverage = Earnings before interest and taxes + fixed chargeFixed charges + Interest
160,000 60,000
2.67
Interpretation: EBIT, Taxes, and Interest Expense are taken from the company's income statement.Lease Payments are taken from the balance sheet and are usually shown as a footnote on the balance sheet.The result of the fixed charge coverage ratio is the number of times the company can cover its fixed charges per year.The higher the number, the better the debt position of the firm, similar to the times interest earned ratio.