Fundamentals of Managerial Finnance

Concept Questions:

1.- Financial Ratio Analysis: A financial ratio by itself tells us little about a company because financial ratios vary a great deal across industries. There are two basic group analysis financial ratios for a company. Time trend analysis and peer group analysis. In time trend analysis, you find the ratios for the company over some period, say five years and examine how each ratio has changed over this period. In peer group analysis you compare a company’s financial ratios to those of its peers Why might each of these analysis methods be useful? What does each tell you about the company’s financial health ?

Time trend analysis give us a picture of company’s financial situation over time. Comparing a firm to itself over time and allows to CFO to evaluate whether some aspects of the company such operations, finances or investment activities have changed. Peer group analysis involves comparing the financial ratios and operating performance of a particular firm to set of peer group firms in the same industry. Comparing a firm to its peers allows the CFO to evaluate some aspects of the firm’s operations, finances or investment activities are out of line with the norm and provide a guidance on appropriate actions to take to adjust the ratios if appropriate.Both analysis allow an investigation into what is different about one company from a financial perspective, but neither method gives an indication of whether the difference is positive or negative. For example suppose a company’s leverage ratio is increasing over time. It could mean that the company is facing liquidity problems or it could mean the company is growing in sales so in consequence needs more bank debt.Similar arguments could be made for a peer group comparison. A company with a higher than leverage ratio than its peers could be a bad signal because we evaluate the industry and if we look that the industry did not grew that we expected, that means that the company has a problem of solvency. Finally we can argue that neither analysis method tells us whether a ratio is good or bad, both simply show that something is different and tell us where we have to focus to request for information.

7.- Asset Utilization and EFN : One of the implicit assumptions we made in calculating the external funds needed was the company was operating at full capacity.If the company is operating at less than full capacity, how will this affect the external funds needs?

The assumption that assets are fixed percentage of sales is convenient but it may not suitable in many cases like this, because we assumed that the company is using its fixed assets at 100% of capacity because any increase of sales led to an increase in fixed assets but its not true. For most business, there would be some slack or excess capacity and production could be increased by perhaps running an extra shift. For example