Tutorial 2 Suggested Solutions.docVIP

Tutorial 2 – Week 3 Lecture 2 – Chapter 2 Review Questions 2-5 Cross-sectional comparisons are made by comparing similar ratios for firms within the same industry, or to an industry average, as of some point in time. Time-series comparisons are made by comparing similar ratios for a firm measured at various points in time. Benchmarking is the term used to describe this cross-sectional comparison with competitor firms. 2-6 The analyst should devote primary attention to any significant deviations from the norm, whether above or below. Positive deviations from the norm are not necessarily favourable. An above-normal inventory turnover ratio may indicate highly efficient inventory management but may also reveal excessively low inventory levels resulting in stock outs. Further examination into the deviation would be required. 2-7 Comparing financial statements from different points in the year can result in inaccurate and misleading analysis due to the effects of seasonality. Levels of current assets can fluctuate significantly, depending on a company’s business, so statements from the same month or year end should be used in the analysis to ensure valid comparisons of performance. 2-8 The current ratio proves to be the better liquidity measure when all of the firm’s current assets are reasonably liquid. The quick ratios would prove to be the superior measure if the inventory of the firm is considered to lack the ability to be easily converted into cash. 2-9 Additional information is necessary to assess how well a firm collects receivables and meets payables. The average collection period of receivables should be compared to a firm’s own credit terms. The average payment period should be compared to the creditors’ credit terms. 2-15 The price/earnings ratio (P/E) is the market price per share divided by the earnings per share. It indicates the amount the investor is willing to pay for each dollar of earnings. It is used to assess the owner’s appraisal of t