[akissa]

Hi! I'm working on an assignment that is asking me to state whether the ratio is going to increase, decrease, or stay the same based on the given conditions. I've answered most of them and I wanted to see if anyone could just double check what I have. I'm afraid I might not be fully grasping the ideas. Thanks!

(my answers are in bold)

Case 1. General Motors, Inc. and Ford Motor Company both had a bad year in 2005; the companies’ auto units suffered net losses. The loss pushed some return measures into the negative column, and the companies’ ratios deteriorated. Assume top management of GM and Ford are pondering ways to improve their ratios.

Requirements
Top management wants to know the effects of these transactions (increase, decrease, or no effect) on the following ratios:

a. Current ratio

1. Borrow $100 million on long-term debt. Since this is long-term, the current liabilities would not change, however the current assets will increase. The Current Ratio will increase.
2. Purchase treasury stock for $500 million cash. The current liabilities would not change, however current assets would decrease. The Current Ratio will decrease.
3. Expense one-fourth of the goodwill carried on the books. The current liabilities would not change and the current assets would not change. The Current Ratio is not affected.
4. Create a new auto-design division at a cost of $300 million. The current liabilities would not change, however current assets would decrease. The Current Ratio will decrease.
5. Purchase patents from DaimlerChryslere, paying $20 million. The current liabilities would not change and the current assets would decrease. The Current Ratio will decrease.

b. Debt ratio

1. Borrow $100 million on long-term debt. The total liabilities will increase, however the total assets will decrease. The Debt Ratio will increase.
2. Purchase treasury stock for $500 million cash. The total liabilities would not change, however total assets would decrease. The Debt Ratio will decrease.
3. Expense one-fourth of the goodwill carried on the books. The total liabilities would not change and the total assets would decrease. The Debt Ratio will decrease.
4. Create a new auto-design division at a cost of $300 million. The total liabilities would not change, however total assets would decrease. The Debt Ratio will decrease.
5. Purchase patents from DaimlerChryslere, paying $20 million. The total liabilities would not change and the total assets would decrease. The Debt Ratio will decrease.

c. Return on equity

1. Borrow $100 million on long-term debt. Net Income will not change, and the average common stockholder’s equity will not change. The Return on Equity will not be affected.
2. Purchase treasury stock for $500 million cash. Net Income will decrease, however the average common stockholder’s equity will decrease also. The Return on Equity will decrease.
3. Expense one-fourth of the goodwill carried on the books. Net Income will decrease, however the average common stockholder’s equity will not change. The Return on Equity will decrease.
4. Create a new auto-design division at a cost of $300 million. Net Income will decrease, however the average common stockholder’s equity will not change. The Return on Equity will decrease.
5. Purchase patents from DaimlerChryslere, paying $20 million. Net Income will decrease, however the average common stockholder’s equity will not change. The Return on Equity will decrease.

[morgaine300]

You get the concept of what you're supposed to be doing. Your mistakes seem to always involve the same thing so, in essence, you're really only missing a couple of things.

First, we're going to throw out (4) for the moment. So I'm referring to 1, 2, 3 & 5. The current ratio ones are all correct.

Now debt ratio you're having trouble with. (1) If you'd been correct in the changes, the answer would have been right. However, how does borrowing money decrease assets? As for the rest of them, they're all wrong, for the same reason. Assets is the denominator. If you decrease that, the answer decreases, not increases. (That would even include 4 that I'm leaving out.)

Return on equity you're having some trouble with. For the same reason. Neither purchasing treasury stock nor purchasing a patent is going to change net income. There is no revenue or expense involved in those.

As for (4) -- I have no clue. I have absolutely no idea on the face of this earth what creating a new division in a big giant corporation entails. And I don't think I want to know.