Question

a) Complete the following tables:

Item	Value
Current assets	$35,000
Current liabilities	$15,000
Assets	$230,000
Liabilities	$130,000
Equity	$100,000

Ratios	Formula	Calculations	Is it in red or green zone?
Current ratio
Debt-to-asset ratio

Item	Value
Gross revenue	$38,000
Operating expenses	$21,000
Depreciation	$2,000
Interest expense	$4,000
NFIO	$11,000
Nonbusiness income	$17,000
Income Taxes	$2,000
Principal	$13,000
Interest on term loans	$4,000
Family living expenses	$14,000

Ratios	Formula	Calculations	Is it in red or green zone?
Return on assets
Operating profit margin
Asset turnover ratio
Term debt coverage ratio

ANSWER COMPLETELY:

1. How would you summarize the financial position of this farmer?
2. If you are a loan officer, will you give him/her a loan?
3. Show that the Dupont identity for ROA holds. Show your calculations for full credit.

Answer 1

Item Current Asset Current Liability Assets Liabilities Equity Value $ 35,000.00 S 15,000.00 $ 2,30,000.00 $ 1,30,000.00 $ 1,00,000.00 Ratios Current ratio Formula Current Assets Current Liabilities Calculations $35,000 = 2.33 $15,000 Red/Green zone Green, since its more than 1. This means current assets are sufficient to cover current liabilities Green, since its less than 1. This means Total assets are sufficient to cover Total debt Debt-to-asset ratio Total Debt Total Assets $130,000 = 0.57 $230,000

Item Value Gross revenue $38,000 Less: Operating expenses $21,000 Depreciation $2,000 Operating Earnings $15,000 Interest expense $4,000 Net Farm Income from Operations (Net Income) $11,000 Non business income $17,000 Total Income $28,000 Less: Income Taxes $2,000 Principal $13,000 Interest on term loans $4,000 Family living expenses $14,000 Deficit ($5,000)

Ratios Return on assets Formula Net Income Average Total Assets | Calculations $11,000 $230,000 = 0.047 Red/Green zone Will have to compare with other business in industry. We can say it is partially Green because 4.7% return on asset is higher than annual interest rate of 3.07% (calculation of interest $4,000 $120.000 100 = Operating earnings $15,000 Operating profit margin Revenue $38,0000.39 Asset turnover ratio Total Sales Average Total Assets $38,000 $230,000 = 0.17 3.07%) Green, since its positive. Revenue is sufficient to cover operating earnings. Will have to compare with other business in industry. Higher the ratio better the business. Red, since less than 1. This means there is not sufficient cash flow to cover interest and principal payment Term debt coverage ratio Net Operating Income Interest + Principle expense $11.00 $15,000

a) To summarize: the financial position of this farmer is not good. Even though his total assets are sufficient to cover his total debt, his net operating income is not sufficient enough to cover his annual debt service (Interest plus Principle). Further even though the farmer has non business income, his total income is not sufficient enough to cover his family living expense. Thus he has an annual deficit of $5,000/- b) If I was the loan officer, I would deny his, loan due to the reasons specified in (a) c) Dupont identity breaks ROA into different drivers. Thus, investors can look deep into the actual values that give the ROA value. According to Dupont identity: ROA = Net Profit Margin x Asset Turnover Ratio - Total Sales - Asset Turnover Ratio Total Sales - $38,000 - 0 Average Total Assets $230,000 ... Net Operating earnings Net Profit Margin = ? $11,000 Revenue 000 = 0.289 $38,000 ROA=0.17 x 0.289 = 0.0478 This is equal to the ROA we found out earlier. Thus, Dupont identity of ROA holds true.