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Review for Test 2

Review for Test 2. Farm Management. True False Questions. A Net Capital Ratio of less than 0.4 is preferred by lenders. False: NCR = TA/TL You want TA higher than TL, and a NCR of about 2.5 or higher. Debt-to-Asset should be less than 0.4. True False Questions.

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Review for Test 2

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  1. Review for Test 2 Farm Management

  2. True False Questions • A Net Capital Ratio of less than 0.4 • is preferred by lenders. • False: NCR = TA/TL You want TA • higher than TL, and a NCR of about • 2.5 or higher. Debt-to-Asset should • be less than 0.4

  3. True False Questions • The income statement provides a • good measure of solvency . . . • False: Solvency is measured using • the Balance Sheet. Profit is measured • on the income statement.

  4. True False Questions • If the average borrowing rate for • funds is 8% and the rate of return on • equity is 10%, then the rate of return • on capital will be higher than 10%. • False: If the borrowing rate is less than • ROE, then borrowed money is earning • an average profit. When borrowed money • earns a profit, ROE greater than ROC.

  5. A detailed look Say you have $100,000 in assets. Debt is $50,000 and equity is $50,000. If you have 8% interest rate on your debt, you will pay $4,000 in interest. If your equity capital earns 10%, it will earn $5,000. The rate of return on capital will equal: ROC = (4,000 + 5,000)/$100,000 or 9%

  6. If a firm has any debt If a firm has any debt, ROC will always fall between the interest rate paid on debt and the ROE. So you can line them up. Interest Rate ROC ROE 8% between 10% Borrowed money making money (10% > 8%) and ROE > ROC

  7. The other situation Interest rate = 12% ROE = 8% ROE ROC Interest Rate 8% between 12% Borrowed money losing money (8% < 12%) and ROC> ROE

  8. True False Questions • The balance sheet can be used to find • measures of solvency and liquidity. • True

  9. True False Questions • Income taxes are a non-cash, fixed • expense. • False. Income taxes are a cash • expenditure, but they are not a cost. • Taxes are a civic obligation and are • paid out of profits.

  10. True False Questions • DDB provides faster depreciation in • the earlier years than SL. • True. It is a “fast” depreciation method.

  11. True False Questions • If an asset is sold for exactly book value • net worth won’t change. • True. Here, you exchange one asset for • another one (cash) of equal value.

  12. True False Questions • Adjusted net farm income is the • accounting profit of the farm. • False. Net Farm Income is the accounting • profit of the farm.

  13. True False Questions • It is possible for net farm income to be • positive even if net cash farm income (cash • receipts minus cash expenses) is negative. • True. If crops are produced and stored • instead of sold, there is no cash income, • but asset values increase. If they increase • sufficiently, there will be a positive profit.

  14. True False Questions • If the percent return to capital is higher • than the percent return to equity, borrowed • funds are earning on average a loss. • True • ROE ROC Interest Rate • Put ROC between ROE and Interest Rate. • In this case, that makes ROE < Int Rate. • Which means a loss.

  15. All the dep you have left. Depreciation Problem

  16. Computing fixed interest (OC + SV)/2 *interest rate (50,000 + 15,000)/2 * .05 = 1625 (84,000 + 0)/2 * .05 = 2,100

  17. Current Ratio = CA/CL = 40,000/35,000 = 1.14 Working Capital = CA – CL 40,000 – 35,000 = 5,000 Debt/Asset = 125,00/500,000 = 0.25 Debt/Equity = 125,000/375,000 = 0.33 Debt Structure Ratio = 35,000/125,000 = 0.28 Current Ratio is somewhat weak. Debt/Asset is strong. Potential liquidity problems, but good solvency.

  18. If $15,000 cash is used to pay part of debt, net worth will not change. TA will decrease by the same amount as TL and their difference will not change. Yes, working capital would change. CA would now be 25,000. CL would be 23,000. Working capital would be $2,000. Debt/Asset ratio would change, so would CR

  19. Income Statement • Net farm income from operations= $115,000 + 500 + 1,500 – 65,000 – 10,000= $42,000 • Net farm income = $42,000 +1,000 = $43,000 • ANFI Operations = $42,000 + 5,000 = 47,000

  20. Income Statement • ROA (ANFI Ops – Opp cost Unpaid L&M)/TA (47,000 – 27,500)/200,000 *100% = 9.75% • ROE (NFI Ops – Opp cost Unpaid L&M)/NW ($42,000-27,500)/140,000 *100% = 10.4% • RLM ANFI ops – Opp Cost Capital 47,000 – (200,000*.05) = 37,000

  21. Income Statement • Borrowed money earns a profit • Farm is earning a profit and covering all opportunity costs. • NFI – taxes paid – living expenses 43,000 – 34,000 = $9,000 increase in NW.

  22. Worksheet from depreciation homework

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