Noesis
Level 4 — ApplicationFinancial Ratios

Financial Ratios

⏱ 60 minutes50 marksprintable — key stays hidden on paper

Level 4 (Application: novel/unseen problems, no hints) Time limit: 60 minutes Total marks: 50

Show all working. All monetary figures in ₹ crore unless stated otherwise. Round final ratios to 2 decimal places.

Question 1 — Integrated Ratio Build (12 marks)

Zephyr Ltd reports the following for FY24:

Item Value
Revenue 4,000
COGS 2,600
Operating expenses (excl. depreciation) 500
Depreciation & amortisation 200
Interest expense 100
Tax rate 25%
Shares outstanding (crore) 150
Market price per share ₹ 320
Total assets 5,000
Total equity 2,000
Total debt 1,500

(a) Compute gross margin, operating margin, and net margin. (4) (b) Compute EPS and the P/E ratio. (3) (c) Compute EV/EBITDA (assume cash = 200). (3) (d) A peer trades at a P/E of 30. State one reason Zephyr's lower P/E may not indicate it is cheaper. (2)

Question 2 — DuPont Decomposition & Diagnosis (11 marks)

Two firms in the same sector have identical ROE of 18%. You are given:

Firm A Firm B
Net margin 12% 4%
Asset turnover 0.75 1.50
Equity multiplier ? ?

(a) Using the 3-step DuPont identity, compute the equity multiplier for each firm. (4) (b) State each firm's total-assets-to-equity implied debt reliance and identify which firm carries more financial leverage. (3) (c) A conservative investor prefers the firm whose 18% ROE is least dependent on leverage. Which firm, and justify quantitatively. (4)

Question 3 — Liquidity, Solvency & Turnover (10 marks)

Nova Corp balance-sheet/activity data:

Item Value
Current assets 900
Inventory 400
Current liabilities 500
Annual COGS 3,000
Average inventory 375
Credit sales 4,500
Average receivables 500
EBIT 600
Interest expense 120

(a) Compute current ratio and quick ratio. (3) (b) Compute inventory turnover and days inventory outstanding (use 365 days). (3) (c) Compute receivables turnover and days sales outstanding. (2) (d) Compute interest coverage ratio and comment in one line on solvency. (2)

Question 4 — Valuation & Growth (9 marks)

Orion Tech trades at ₹ 600 with EPS of ₹ 20 and an expected earnings growth rate of 25% per year.

(a) Compute the P/E and PEG ratio. (3) (b) Orion pays a dividend of ₹ 6 per share. Compute dividend payout ratio and dividend yield. (3) (c) A rival, Vega Inc, has P/E 15 and growth 10%. Using PEG alone, which stock is more attractively priced for growth, and what is a key limitation of relying on PEG here? (3)

Question 5 — Free Cash Flow (8 marks)

Helios Ltd for FY24:

Item Value
Operating cash flow 850
Capital expenditure 300
Market capitalisation 11,000
Shares outstanding (crore) 100

(a) Compute free cash flow (FCF). (2) (b) Compute FCF per share and FCF yield. (3) (c) Helios' P/E is 22 while its FCF yield is 5%. Explain briefly why FCF yield can give a different picture of value than earnings-based multiples. (3)

END OF PAPER

Answer keyMark scheme & solutions

Question 1 (12 marks)

(a) Margins (4)

  • Gross profit = 4,000 − 2,600 = 1,400 → Gross margin = 1,400/4,000 = 35.00% (1)
  • Operating profit (EBIT) = Revenue − COGS − OpEx − D&A = 4,000 − 2,600 − 500 − 200 = 700 → Operating margin = 700/4,000 = 17.50% (1.5)
  • Net income: EBT = EBIT − Interest = 700 − 100 = 600; Net income = 600 × (1−0.25) = 450 → Net margin = 450/4,000 = 11.25% (1.5)

Why: margins strip revenue at successive cost layers to isolate cost efficiency (gross), operating discipline (operating), and after-financing/tax profitability (net).

(b) EPS & P/E (3)

  • EPS = Net income / shares = 450 / 150 = ₹ 3.00 (1.5)
  • P/E = Price / EPS = 320 / 3 = 106.67 (1.5)

(c) EV/EBITDA (3)

  • EBITDA = EBIT + D&A = 700 + 200 = 900 (1)
  • EV = Market cap + Debt − Cash = (320×150) + 1,500 − 200 = 48,000 + 1,300 = 49,300 (1)
  • EV/EBITDA = 49,300 / 900 = 54.78 (1)

(d) (2) Lower P/E can reflect lower expected growth, higher risk, or poorer earnings quality — not necessarily undervaluation. A "cheap" multiple may be a value trap; comparison is only valid if growth/risk profiles are similar. (2 for any valid reason)

Question 2 (11 marks)

(a) Equity multiplier (4) DuPont: ROE = Net margin × Asset turnover × Equity multiplier (EM)

  • Firm A: 0.18 = 0.12 × 0.75 × EM → EM = 0.18/(0.09) = 2.00 (2)
  • Firm B: 0.18 = 0.04 × 1.50 × EM → EM = 0.18/(0.06) = 3.00 (2)

(b) Debt reliance (3)

  • EM = Assets/Equity. Firm A: 2.00 (assets = 2× equity → debt ≈ 1× equity). Firm B: 3.00 (assets = 3× equity → debt ≈ 2× equity). (2)
  • Firm B carries more financial leverage (higher equity multiplier). (1)

(c) Conservative choice (4)

  • Firm A achieves 18% ROE with EM only 2.00, driven mainly by a strong net margin (12%). (2)
  • Firm B needs EM 3.00 to reach the same ROE because its margin is thin (4%); more of its ROE is manufactured by leverage. (1)
  • Conservative investor picks Firm A — same return, lower leverage-driven risk. (1)

Question 3 (10 marks)

(a) (3)

  • Current ratio = 900/500 = 1.80 (1.5)
  • Quick ratio = (900−400)/500 = 500/500 = 1.00 (1.5)

(b) (3)

  • Inventory turnover = COGS/avg inventory = 3,000/375 = 8.00 (1.5)
  • DIO = 365/8 = 45.63 days (1.5)

(c) (2)

  • Receivables turnover = credit sales/avg receivables = 4,500/500 = 9.00 (1)
  • DSO = 365/9 = 40.56 days (1)

(d) (2)

  • Interest coverage = EBIT/Interest = 600/120 = 5.00 (1)
  • Comment: coverage of 5× indicates EBIT comfortably services interest → solvency is sound. (1)

Question 4 (9 marks)

(a) (3)

  • P/E = 600/20 = 30.00 (1.5)
  • PEG = P/E / growth(%) = 30/25 = 1.20 (1.5)

(b) (3)

  • Payout ratio = DPS/EPS = 6/20 = 30.00% (1.5)
  • Dividend yield = DPS/Price = 6/600 = 1.00% (1.5)

(c) (3)

  • Vega PEG = 15/10 = 1.50; Orion PEG = 1.20. (1)
  • Orion (lower PEG) is more attractively priced relative to its growth. (1)
  • Limitation: PEG relies on forecast growth (uncertain), ignores risk/quality of growth, and is meaningless for negative/very low growth. (1)

Question 5 (8 marks)

(a) (2) FCF = OCF − CapEx = 850 − 300 = 550 (2)

(b) (3)

  • FCF per share = 550/100 = ₹ 5.50 (1.5)
  • FCF yield = FCF/Market cap = 550/11,000 = 5.00% (or FCF-per-share/price = 5.5/110 = 5%) (1.5)

(c) (3) Earnings can be distorted by non-cash items (depreciation) and accruals, while FCF captures actual cash after reinvestment. A firm with high P/E may still generate strong cash (or vice-versa); FCF yield reveals cash-return quality and dividend/buyback capacity that EPS multiples miss. (3)

[
  {"claim":"Q1 net margin = 11.25%","code":"ni=(4000-2600-500-200-100)*(1-0.25); result = abs(ni/4000-0.1125)<1e-9"},
  {"claim":"Q1 EV/EBITDA = 54.777...","code":"ev=320*150+1500-200; ebitda=700+200; result = abs(ev/ebitda-49300/900)<1e-9"},
  {"claim":"Q2 Firm A EM=2, Firm B EM=3","code":"emA=0.18/(0.12*0.75); emB=0.18/(0.04*1.50); result = abs(emA-2)<1e-9 and abs(emB-3)<1e-9"},
  {"claim":"Q3 quick=1.0, inv turnover=8, DIO=45.625","code":"quick=(900-400)/500; it=3000/375; dio=365/it; result = abs(quick-1)<1e-9 and abs(it-8)<1e-9 and abs(dio-45.625)<1e-6"},
  {"claim":"Q4 PEG Orion=1.2, payout=30%","code":"peg=(600/20)/25; payout=6/20; result = abs(peg-1.2)<1e-9 and abs(payout-0.30)<1e-9"},
  {"claim":"Q5 FCF=550, yield=5%","code":"fcf=850-300; y=fcf/11000; result = fcf==550 and abs(y-0.05)<1e-9"}
]