Ratios are mostly calculated using data drawn from the financial statements of a firm. However, another group of ratios, called market-based ratios, relate to a firms observable market value, stock prices, and book values, integrating information from both the market and the firms financial statements.

Consider the case of Green Caterpillar Garden Supplies Inc.:

Green Caterpillar Garden Supplies Inc. just reported earnings after tax (also called net income) of $95,000,000, and a current stock price of $28.50 per share. The company is forecasting an increase of 25% for its after-tax income next year, but it also expects it will have to issue 2,800,000 new shares of stock (raising its shares outstanding from 5,500,000 to 8,300,000).

If Green Caterpillars forecast turns out to be correct and its price-to-earnings (P/E) ratio does not change, what does the companys management expect its stock price to be one year from now? (Note: Round intermediate calculations to four decimal places. Round the expected stock price to two decimal places.)

$23.61 per share

$28 per share

$17.71 per share

$29.51 per share

One year later, Green Caterpillars shares are trading at $54.56 per share, and the company reports the value of its total common equity as $39,192,600. Given this information, Green Caterpillars market-to-book (M/B) ratio is (Note: Do not round intermediate calculations.)

Is it possible for a company to exhibit a negative EPS and thus a negative P/E ratio?

No

Yes

Which of the following statements is true about market value ratios?

Companies with high research and development (R&D) expenses tend to have low P/E ratios.

Companies with high research and development (R&D) expenses tend to have high P/E ratios.

Companies have the opportunity to use varying amounts of different sources of financing to acquire their assets, including internal and external sources, and debt (borrowed) and equity funds.

Company A uses long-term debt to finance its assets, and company B uses capital generated from shareholders to finance its assets. Which company would be considered a financially leveraged firm?

Company B

Company A

Which of the following is true about the leveraging effect?

Interest on debt can be deducted from pre-tax income, resulting in a greater taxable income and a smaller available operating income.

Interest on debt is a tax deductible expense, which means that it can reduce a firms taxable income and tax obligation.

Blue Sky Drone Company has a total asset turnover ratio of 6.00x, net annual sales of $25 million, and operating expenses of $11.25 million (including depreciation and amortization). On its current balance sheet and income statement, respectively, it reported total debt of $2.5 million, on which it pays 11% interest on its outstanding debt.

To analyze a companys financial leverage situation, you need to measure the firms debt management ratios. Based on the preceding information, what are the values for Blue Sky Drones debt management ratios? (Note: Do not round intermediate calculations.)

Ratio

Value

Debt ratio

Options 60.00 / 48.00 / 138.00 / 78.00

Times-interest-earned ratio

Options 90.00 / 37.50 / 50.00 / 25.00

Blue Sky Drone Company raises around ____ from creditors for each dollar of equity. Options 60.00 / 1.80 / 1.50 / 2.10

Influenced by a firms ability to make interest payments and pay back its debt, if all else is equal, creditors would prefer to give loans to companies with ___ times-interest-earned ratios (TIE). Options low / high