Chapter 6 Problem 14 -- Avon Products


Using the financial statements provided below and any other information you find relevant, answer the following questions:

a. What was the book value of Avon’s shareholders’ equity from 2001 to 2003? What were Avon’s liabilities-to-assets and times-interest-earned ratios in these years? (Use Pretax Income plus Interest Expense as EBIT.) What do these figures suggest about Avon’s use of financial leverage? Consulting Table 6-5 in the text, what bond rating would Avon have in 2002 if the rating were based solely on the firm’s coverage ratio?

To answer these questions, we will need to refer to the financial statements provided. However, since you have not provided the financial statements, I am unable to give the specific book value of Avon's shareholders' equity from 2001 to 2003. But I can guide you on how to calculate the liabilities-to-assets ratio and the times-interest-earned ratio.

To calculate the liabilities-to-assets ratio, you will need to divide the total liabilities by the total assets. The formula is:

Liabilities-to-assets ratio = Total liabilities / Total assets

To calculate the times-interest-earned ratio, you will need to use pretax income plus interest expense as EBIT (Earnings Before Interest and Taxes). The formula is:

Times-interest-earned ratio = EBIT / Interest expense

Using the financial statements, calculate the liabilities-to-assets and times-interest-earned ratios for each year from 2001 to 2003. Then, compare the results to determine Avon's use of financial leverage.

To estimate Avon's bond rating in 2002 based solely on the firm's coverage ratio, refer to Table 6-5 in the text provided. Find the range of values for the times-interest-earned ratio that corresponds to different bond ratings. Based on Avon's times-interest-earned ratio in 2002, determine the likely bond rating for the company.

Apologies again for not being able to provide the exact figures, but I hope this guidance helps you to answer the questions.

To determine the book value of Avon's shareholders' equity from 2001 to 2003, we need to look at the balance sheet for each year.

1. Start by finding the shareholders' equity on the balance sheet for each year. Shareholders' equity is usually listed under the "Equity" section or "Stockholders' Equity" section.

2. Take note of the shareholders' equity figures for 2001, 2002, and 2003.

3. The book value of Avon's shareholders' equity is simply the shareholders' equity figure for each year.

Next, we need to calculate Avon's liabilities-to-assets ratio and times-interest-earned ratio for each year. For these calculations, we will need Avon's liabilities, assets, pretax income, and interest expense.

Liabilities-to-assets ratio:
1. Find the total liabilities on the balance sheet for each year. The total liabilities are usually listed under the "Liabilities" section.
2. Find the total assets on the balance sheet for each year. The total assets are usually listed under the "Assets" section.
3. Divide the total liabilities by the total assets for each year to calculate the liabilities-to-assets ratio.

Times-interest-earned ratio:
1. Find the pretax income (also known as earnings before taxes) on the income statement for each year. The pretax income is usually listed before the line item "Income Tax Expense".
2. Find the interest expense on the income statement for each year. The interest expense is usually listed under the "Interest Expense" line item.
3. Add the pretax income and interest expense together to get EBIT (earnings before interest and taxes).
4. Divide EBIT by the interest expense for each year to calculate the times-interest-earned ratio.

To determine the bond rating based solely on the firm's coverage ratio, we can use Table 6-5 in the textbook. This table provides a mapping of coverage ratios to bond ratings.

1. Find the coverage ratio for Avon in 2002. The coverage ratio is calculated by dividing EBIT by interest expense, as explained earlier.
2. Refer to Table 6-5 in the textbook and find the bond rating corresponding to Avon's coverage ratio.

By analyzing Avon's book value of shareholders' equity, liabilities-to-assets ratio, and times-interest-earned ratio, we can assess Avon's use of financial leverage. A higher liabilities-to-assets ratio and a lower times-interest-earned ratio typically suggest higher financial leverage and greater reliance on debt financing.

Using this information, we can determine Avon's bond rating in 2002 based on its coverage ratio and consulting Table 6-5. The bond rating will provide an indication of Avon's creditworthiness and ability to meet its financial obligations.