andDepreciation,FlexibleBudgets(20totalpoints,4pointseach):
a.Inthepreparationandimplementationofthemasterbudget,whatisthecornerstoneoruniversalstarting Problem1DiscussionQuestionsDealingwithaVarietyofIssues;MasterBudgets,NetPresentValue
pointinthedevelopmentofthemasterbudget?Whatistheinherentironyofthisprocess?
Inthepreparationandimplementationofthemasterbudget,thecornerstoneoruniversalstartingpointinits
developmentisthesalesbudget.Theinherentironyofthisprocessissimple. Asalesbudgetisadetailed
scheduleshowingtheexpectedsalesforthebudgetperiod;typically,itisexpressedinboth dollarsandunits
ofproduction.Anaccuratesalesbudgetisthekeytotheentirebudgetinginsomeway.Ifthesalesbudgetis
sloppilydonethentherestofthebudgetingprocessislargelyawasteoftime.
b.Netpresentvalue(NPV)(alsocalledDCFdiscountedcashflow)analysisisbasedonananalysisofa
projectscashflowsadjustedfortimevalueofmoneyandthecompanyscostofcapitalordiscountrate,to
seeiftheprojectshouldbeacceptedorrejected.Youalsoknowthatdepreciationisanoncashexpense.If
NPV is based on cash flows and if depreciation is a noncash expense, then why do we care about
depreciationmethods(whetherstraightline,accelerated,orMACRS)whendealingwithNPVissues?
IfNPVisbasedoncashflowsandifdepreciationisanoncashexpense,thenwecareaboutdepreciation
methods(whetherstraightline,accelerated,orMACRS)whendealingwithNPVissuesbecauseofthe
natureofdepreciation.Depreciationisanotionalchargewhichacompanyappliesintheirprofitandloss
accounttorecognizethefactthatanassetiswearingoutovertimeandneedstobereplaced.Typicallythe
depreciationchargereflectstherelativeusefullifeofanasset.Ifacompanysimplywroteofftheassetinthe
firstyearitwasacquiredtheywouldnotberecognizingthefactthatitwouldhavesomeusetothemoverthe
remaininglifeoftheasset(i.e.thatthedepreciableassetcanmakethemrevenueandincurexpensesthat
wouldhaveaneffectonprofitandloss).
c.Inthebudgetprocess,youlearnedthatwestartwiththemaster(overall)budgetorforecast.Whatrole
doestheflexiblebudgetplayinthebudgetingprocess?Whyshouldwehaveflexiblebudgetsatall?Isnt
themaster(overall)budgetenough?
Inthebudgetprocess,welearnedtostartwiththemaster(overall)budgetorforecast.Unfortunately,a
masterbudgetisastaticbudgetthatisbasedonaprojectedlevelofoutput,priortothestartofproduction.
Theflexiblebudgetplaysanimportantroleinthebudgetingprocessbecauseitisanevaluationtoolthat
cannotbeproduceduntiltheendoftheproductioncyclewhentheactualcostsofproductionandthe
associatedlevelofsalesintermsofrevenueandunitsareknown.Wehaveflexiblebudgetstoquantifyhow
wellthecostofproductioniscontrolledandtoascertainanynecessaryadjustmenttosalesprices.Amaster
budgetisnotsufficienttomakethosesortofbusinessdecisions.
d.Howcanfinancialleveragebenefitacommonshareholder?Howcanitharmacommonshareholder?
Financialleveragecanbenefitacommonstockholderasthecompanycanusethecapitaltoexpandits
operationsortoinvestinothercompanies.Thisresultsinthemaximizationofshareholderprofit.Financial
leveragecanalsoharmacommonstockholder.Themoredebtinthecapitalstructuresofthefirm,the
greaterthefinancialrisktothelender.Thisresultsinhigheraverageinterestratestobepaidandcapital
restrictionsonthecorporation.Commonstockholdersmaybecomeconcernedanddrivedownthepriceof
thestockbysellingofftheirstakesinthecorporationseekinginvestmentswithlessrisk.
e.Whatistheimpactonnetpresentvalueofanyprojectresultingfromanincreaseinthediscountrate(cost
ofcapital)from10%to16%?Whyisthisso?
Thebiggestdisadvantagetothecalculationofnetpresentvalueisitssensitivitytodiscountrates.Asmall
increaseordecreaseinthediscountratewillhaveaconsiderableeffectonthefinaloutput.
Let'ssayyouweretryingtovalueaninvestmentthatwouldcostyou$4,000upfronttoday,butwasexpected
topayyou$1,000inannualprofitsforfiveyears(foratotalnominalamountof$5,000),beginningatthe
endofthisyear.Ifyouusea10%discountrateinyourNPVcalculation,yourfive$1,000paymentsare
equalto$3,791.00oftoday'sdollars.Subtractingthe$4,000initialpayment,youareleftwithanNPVof
($209.00).Ifyouraisethediscountratefrom10%to16%,yougetaverydifferentNPVresult.Ata10%
discountrate,yourinvestment'scashflowsadduptoapresentvalueof$3,274.00.Subtractthe$4,000initial
costfromthisamount,andyou'releftwithanegativeNPVof($726.00).
Problem2StandardCosts&VarianceAnalysis(28totalpoints,4pointseach):
BrusselsChocolatesofBelgiumusesstandardcostsandaflexiblebudgettocontrolitsmanufactureofits
chocolates.Operatingdataforthelastweekhavebeensummarized.Atotalof4,000boxesofchocolateswere
produced.Atotalof4,300poundsofchocolatecosting 15.5(Euros)werepurchasedandused.Thestandard,
orforecast,pricewas 16.0. Onepoundofchocolateisthestandardallowedquantityperboxofchocolate
made.Directlaboractuallycost 195,200,basedon6,400actualhoursatarateof 30.50perhour,compared
tothestandardrateof 30.00perdirectlaborhour. Thelaborstandardis1.50directlaborhoursperbox.
Variablemanufacturingoverheadcost69,500.Theflexiblebudgetisbasedon10.00perstandarddirectlabor
hour.
Required:Youaretocomputethefollowingvariances:
a. Materialsprice
MaterialsPriceVariance=ActualQuantity(AQ)*(ActualPrice(AP)StandardPrice(SP))
MaterialsPriceVariance=4,300Lbs*(15.516.0)
MaterialsPriceVariance=4,300Lbs*(0.50)
MaterialsPriceVariance=2,150Favorable
b. Materialsquantity(usage).
MaterialsQuantityVariance=StandardPrice(SP)*(ActualQuantity(AQ)StandardQuantity(SQ))
MaterialsQuantityVariance=16.0*(4,300Lbs4,000Lbs)
MaterialsQuantityVariance=16.0*(300Lbs)
MaterialsQuantityVariance=4,800Unfavorable
c. Directlaborrate.
DirectLaborRateVariance=ActualHours(AH)*(ActualRate(AR)StandardRate(SR))
DirectLaborRateVariance=6,400Hours*(30.5030.00)
DirectLaborRateVariance=6,400Hours*(0.50)
DirectLaborRateVariance=3,200Unfavorable
d. Directlaborefficiency(usage).
DirectLaborEfficiencyVariance=StandardRate(AR)*(ActualHours(AH)StandardHours(SH))
DirectLaborEfficiencyVariance=30.00*(6,400Hours6,000Hours)
DirectLaborEfficiencyVariance=30.00*(400Hours)
DirectLaborEfficiencyVariance=12,000Unfavorable
e. Variableoverheadspending.
VariableOverheadSpendingVariance=ActualUnits(AU)*(ActualRate(AR)StandardRate(SR))
VariableOverheadSpendingVariance=6,400Hours*(10.8610.00)
VariableOverheadSpendingVariance=6,400Hours*(0.86)
VariableOverheadSpendingVariance=5,504Unfavorable
f. Variableoverheadefficiency(usage).
VariableOverheadEfficiencyVariance=StandardRate(SR)*(ActualUnits(AU)StandardUnits(SU))
VariableOverheadEfficiencyVariance=10.00*(6,400Hours6,000Hours)
VariableOverheadEfficiencyVariance=10.00*(400Hours)
VariableOverheadEfficiencyVariance=4,000Unfavorable
g. Inwhatareaswouldyouconcentrateyouranalysis(managementbyexception)?
Iwouldconcentratemyanalysis(managementbyexception)onthecostofdirectlabor.
Problem3CapitalBudgeting,NetPresentValue,InternalRateofReturn(32totalpoints,4points
each):
TheAdamsCountyBoardofRepresentativesisconsideringtheconstructionofalongerrunwayatthecounty
airport.Currently,theairportcanhandleonlyprivateaircraftandsmallcommuterjets.Anewlongerrunway
wouldenabletheairporttohandlethemidsizecommuterjetsusedonmanydomesticflights.Datapertinentto
theBoardsdecisionappearbelow:
Costofacquiringadditionallandforrunway:
Costofrunwayconstruction:
Costofextendingperimeterfence:
Costofrunwaylights:
Annualcostofmaintainingnewrunway:
Annualincrementalrevenuefromlandingfees:
$70,000
$200,000
$29,840
$39,600
$28,000
$40,000
Allcostswillbepaidattheinceptionoftheprojectandwillnotbefinancedovertime.Inadditiontotheabove
data,twootherfactshavesurfacedrecently.First,anewsnowplowwillberequiredatacostof$100,000.The
oldsnowplowcanbesoldfor$10,000.Thenew,largerplowwillcost$12,000moreinannualoperatingcosts
thantheoldplow.Second,theBoardbelievesthattheproposedlongrunway,andthemajorjetserviceitwill
bringtothecounty,willincreaseeconomicactivityinthecommunity,whichwillresultin$64,000ofadditional
taxrevenueannuallytothecounty.Forpurposesoftheirfinancialanalysis,theBoardhasdecidedtousea10
yeartimehorizon,andthecountyhasestablisheda12%hurdlerateforcapitalprojects. Sincethisproject
involves a county government (and in a moment of weakminded compassion on my part), taxes are not
involved.
Required:
a. Computethenetinitialtotaloutlayforthelongrunway.
Add:Costofacquiringadditionallandforrunway:
Add:Costofrunwayconstruction:
$70,000
$200,000
Add:Costofextendingperimeterfence:
Add:Costofrunwaylights:
Add:Costofnewsnowplow
Sub:Saleofoldsnowplow
Netinitialoutlayforthelongrunway
b. Computetheannualnetcostorbenefitoftherunway.
Add:Annualincrementalrevenuefromlandingfees:
Add:Additionaltaxrevenueforthecounty
Sub:Annualcostofmaintainingnewrunway:
Sub:Extraannualoperatingcostsofnewplow
Annualbenefitoftherunway
$29,840
$39,600
$100,000
($10,000)
$428,440
$40,000
$64,000
($28,000)
($12,000)
$64,000
c. Prepareanetpresentvalueanalysisoftheproposednewlongrunway.
Netinitialoutlayforthelongrunway
$428,440
Annualbenefitoftherunway
$64,000
Horizontimelineforproject
10years
Countyhurdlerateforcapitalprojects
12.00%
Netpresentvalue
$794,054
d. Determinetheinternalrateofreturn(IRR)fortherunway.
Netinitialoutlayforthelongrunway
Annualbenefitoftherunway
Horizontimelineforproject
Internalrateofreturn
$428,440
$64,000
10years
8.05%
e. ShouldtheBoardapprovethenewrunway?Whyorwhynot?
IftheBoardhasahurdlerateof12%,theBoardshouldapprovethenewrunwaysinceithasasimplerateof
returnof14.94%.Theproposedrunwayalsohasapositivenetpresentvalueandallinitialoutlayscanbe
repaidbeforetheendofthe10yeartimehorizonfortheproject.
f. Whichofthefinancialdataaremostcertaininyouropinion?Whichareleastcertain?Why?
Ofthefinancialdata,Iammostcertainaboutthecostoftheproject.Iamleastcertainoftherevenuesince
itislargelybasedonestimateddata.
g. WhatqualitativefactorsmightyouconsiderasaBoardmemberthatmightimpactyourdecision?
AsaBoardmember,Imightconsiderthefollowingqualitativefactorsthatmightimpactmydecision:(1)
theimprovedvisibilityofthecountyduetotheexpansionofitsrunways(2)thepositiveeffectofadditional
constructionjobsduetotheproject.
h. Whatdoestheannualnetbenefitoftherunwayneedtobeinorderfortheprojecttohaveareturnequalto
thecountys12%hurdlerate?
Theannualnetbenefitoftherunwayneedstobeatleast$51,412.80inorderfortheprojecttohaveareturn
equaltothecountys12%hurdlerate.
Problem4AnalysisandSignificanceofVariousRatios(76totalpoints,4pointseach):
PaulSabinfoundedSabinElectronics10yearsagotoproduceandsellseveralelectronicdevicesonwhichhe
hadsecuredpatents. Althoughthecompanyhasbeenfairlyprofitable,itisnowexperiencingaseverecash
shortage. Forthisreason,itisrequestinga$500,000longtermloanfromGulfportStateBank,ofwhich
$100,000willbeusedtobolstertheCashaccountand$400,000ofwhichwillbeusedtomodernizeequipment.
SabinElectronics2mostrecentfinancialstatementsarebelow:
ComparativeBalanceSheet
Assets: Current:
Cash
MarketableSecurities
AccountsReceivable,net
Inventory
PrepaidExpenses
TotalCurrentAssets:
Property,Plant&Equipment,net
TotalAssets:
2010
2009
$70,000
0
$480,000
$950,000
$20,000
$1,520,000
$1,480,000
$3,000,000
$150,000
$18,000
$300,000
$600,000
$22,000
$1,090,000
$1,370,000
$2,460,000
$800,000
$600,000
$1,400,000
$430,000
$600,000
$1,030,000
Liabilities:
CurrentLiabilities
BondsPayable,12%
TotalLiabilities:
StockholdersEquity:
Preferred,$25Par,8%
CommonStock,$10Par
RetainedEarnings
TotalStockholdersEquity:
TotalLiabilities&StockholdersEquity:
$250,000
$250,000
$500,000
$500,000
$850,000
$680,000
$1,600,000
$1,430,000
$3,000,000
$2,460,000
ComparativeIncomeStatement&StatementofRetainedEarnings
2010
$5,000,000
$3,875,000
$1,125,000
$653,000
$472,000
$72,000
$400,000
$120,000
$280,000
Sales
Less:CostofGoodsSold
GrossProfit
Less:OperatingExpenses
NetOperatingIncome
Less:InterestExpense
NetIncomeBeforeTaxes
Less:IncomeTaxes(30%)
NetIncome
DividendsPaid:
Preferred
Common
TotalDividendsPaid:
NetIncometoRetainedEarnings
RetainedEarnings,Beginning
RetainedEarnings,YearEnd
2009
$4,350,000
$3,450,000
$900,000
$548,000
$352,000
$72,000
$280,000
$84,000
$196,000
$20,000
$20,000
$90,000
$75,000
$110,000
$95,000
$170,000
$101,000
$680,000
$579,000
$850,000
$680,000
Duringthepastyear,Sabinintroducedseveralnewproductlinesandraisedthesellingpricesonanumberofthe
old product lines inorder to improve the profit margin. Sabin alsohired a new sales manager, who has
expandedsalesintoseveralnewterritories.Salestermsare2/10,n/30.Allsalesareoncredit;therearenocash
sales.Thefollowingratiosaretypicaloftheelectronicsindustryduringthe20092010period:
CurrentRatio
AcidTest(Quick)Ratio
AverageCollectionPeriod
AverageSalePeriod
DebttoEquityRatio
TimesinterestEarned
ReturnonTotalAssets
PriceEarningsRatio
2.50
1.30
18days
60days
0.90
6.00
13.00%
12.00
Required:
a. You are the lending executive at the Bank who makes the loan decision. Your newlyhired MBA
businessanalysthaspreparedthefollowingratiosforboth2010and2009:
(1)
Amountofworkingcapital
NetWorkingCapital(2010)=CurrentAssetsCurrentLiabilities
NetWorkingCapital(2010)=$1,520,000$800,000
NetWorkingCapital(2010)=$720,000
NetWorkingCapital(2009)=CurrentAssetsCurrentLiabilities
NetWorkingCapital(2009)=$1,090,000$430,000
NetWorkingCapital(2009)=$660,000
(2)
Currentratio
CurrentRatio(2010)=CurrentAssetsCurrentLiabilities
CurrentRatio(2010)=$1,520,000$800,000
CurrentRatio(2010)=1.90
CurrentRatio(2009)=CurrentAssetsCurrentLiabilities
CurrentRatio(2009)=$1,090,000$430,000
CurrentRatio(2009)=2.53
(3)
Acidtest(quick)ratio
AcidTestRatio(2010)=(Cash+A/R+ShortTermInvestments)CurrentLiabilities
AcidTestRatio(2010)=($70,000+$480,000)$800,000
AcidTestRatio(2010)=$550,000$800,000
AcidTestRatio(2010)=0.69
AcidTestRatio(2009)=(Cash+A/R+ShortTermInvestments)CurrentLiabilities
AcidTestRatio(2009)=($150,000+$300,000+$18,000)$430,000
AcidTestRatio(2009)=$468,000$430,000
AcidTestRatio(2009)=1.09
(4)
Averagecollectionperiod
AverageCollectionPeriod(2010)=365(AccountsReceivableTurnoverRatio)
AverageCollectionPeriod(2010)=365(AnnualCreditSalesAverageAccountsReceivable)
AverageCollectionPeriod(2010)=365($5,000,000(($480,000+$300,000)2)
AverageCollectionPeriod(2010)=365($5,000,000($780,0002))
AverageCollectionPeriod(2010)=365($5,000,000$390,000)
AverageCollectionPeriod(2010)=36512.82
AverageCollectionPeriod(2010)=28.47Days
AverageCollectionPeriod(2009)=365(AccountsReceivableTurnoverRatio)
AverageCollectionPeriod(2009)=365(AnnualCreditSalesAverageAccountsReceivable)
AverageCollectionPeriod(2009)=365($4,350,000(($300,000+$250,000)2)
AverageCollectionPeriod(2009)=365($4,350,000($550,0002))
AverageCollectionPeriod(2009)=365($4,350,000$225,000)
AverageCollectionPeriod(2009)=36519.33
AverageCollectionPeriod(2009)=18.88Days
(5)
Averagesaleperiod
AverageSalePeriod(2010)=365(InventoryTurnoverRatio)
AverageSalePeriod(2010)=365(CostofGoodsSoldAverageInventory)
AverageSalePeriod(2010)=365($3,875,000(($950,000+$600,000)2)
AverageSalePeriod(2010)=365($3,875,000($1,550,0002))
AverageSalePeriod(2010)=365($3,875,000$775,000)
AverageSalePeriod(2010)=3655
AverageSalePeriod(2010)=73Days
AverageSalePeriod(2009)=365(InventoryTurnoverRatio)
AverageSalePeriod(2009)=365(CostofGoodsSoldAverageInventory)
AverageSalePeriod(2009)=365($3,450,000(($600,000+$500,000)2)
AverageSalePeriod(2009)=365($3,450,000($1,100,0002))
AverageSalePeriod(2009)=365($3,450,000$550,000)
AverageSalePeriod(2009)=3656.27
AverageSalePeriod(2009)=58.21Days
(6)
Debttoequityratio
DebttoEquityRatio(2010)=TotalDebtTotalEquity
DebttoEquityRatio(2010)=$1,400,000$1,600,000
DebttoEquityRatio(2010)=0.88
DebttoEquityRatio(2009)=TotalDebtTotalEquity
DebttoEquityRatio(2009)=$1,030,000$1,430,000
DebttoEquityRatio(2009)=0.72
(7)
Timesinterestearnedratios
TimesInterestEarnedRatio(2010)=(NetIncome+Interest)Interest
TimesInterestEarnedRatio(2010)=($280,000+$72,000)$72,000
TimesInterestEarnedRatio(2010)=$352,000$72,000
TimesInterestEarnedRatio(2010)=4.89
TimesInterestEarnedRatio(2009)=(NetIncome+Interest)Interest
TimesInterestEarnedRatio(2009)=($196,000+$72,000)$72,000
TimesInterestEarnedRatio(2009)=$268,000$72,000
TimesInterestEarnedRatio(2009)=3.72
(8)
CommentonwhatyourratioanalysistellsyouaboutSabininternallyandaboutSabincompared
totheindustryinwhichitparticipates.
Sabinis(1)lessliquid,(2)hasahigheraveragecollectionperiod,(3)hasahigheraveragesalesperiod,
(4)isonparintermsofleverage,and(5)payslessinterestthanintheindustryinwhichitparticipates.
(9)
WouldyourecommendthattheBankmaketheloanbasedontheavailabledata? YesorNo?
Whatreasonswouldyougivetosupportyouranswer? WhatqualitativefactorsmightSabinwantto
encouragetheBanktoconsiderinmakingtheloan?
IwouldnotrecommendthattheBankmaketheloanbasedontheavailabledata.Sabinhasliquidity
issuesdirectlyrelatedtoitsabilitytohonoritsshorttermdebtobligationswhichincludestheintereston
bankloans.Improvementsincurrentratio,acidtestratio,receivablesturnoverandinventoryturnover
wouldencouragetheBanktoconsidermakingtheloan.
b. Nowswitchgearsforthissection.Youareanaccountexecutiveforalargebrokeragehouseandoneof
yourclientshasaskedyouforarecommendationonwhethersheshouldpurchasesomeofSabinscommon
stock.YouaskanotherofthenewlyhiredMBAanalystsworkingforyoutopreparesomeanalysis.Youare
theMBAanalystandhereiswhatyouhavebeenrequestedtoprepare:
(1)
Earningspershare. Therehasbeennochangeinpreferredorcommonstockoverthelast2
years.
EarningsPerShare(2010)=(NetIncomePreferredStockDividends)AverageCommonShares
EarningsPerShare(2010)=($280,000$20,000)50,000
EarningsPerShare(2010)=$260,00050,000
EarningsPerShare(2010)=$5.20
EarningsPerShare(2009)=(NetIncomePreferredStockDividends)AverageCommonShares
EarningsPerShare(2009)=($196,000$20,000)50,000
EarningsPerShare(2009)=$176,00050,000
EarningsPerShare(2009)=$3.52
(2)
Thecommonstockdividendyieldratio.Sabinsstockiscurrentlysellingfor$40pershare.Last
year,in2009,itsoldfor$36pershare.
Commonstockdividendyield(2010)=(DividendPayoutRatio*EarningsPerShare)SharePrice
Commonstockdividendyield(2010)=((DividendsNetIncome)*EarningsPerShare)SharePrice
Commonstockdividendyield(2010)=(($110,000$280,000)*$5.20)$40
Commonstockdividendyield(2010)=(0.39*$5.20)$40
Commonstockdividendyield(2010)=$2.03$40
Commonstockdividendyield(2010)=5.08%
Commonstockdividendyield(2009)=(DividendPayoutRatio*EarningsPerShare)SharePrice
Commonstockdividendyield(2009)=((DividendsNetIncome)*EarningsPerShare)SharePrice
Commonstockdividendyield(2009)=(($95,000$196,000)*$3.52)$36
Commonstockdividendyield(2009)=(0.48*$3.52)$36
Commonstockdividendyield(2009)=$1.69$36
Commonstockdividendyield(2009)=4.69%
(3)
Thecommonstockdividendpayoutratio.
Commonstockdividendpayoutyield(2010)=CommonStockDividendsNetIncome
Commonstockdividendpayoutyield(2010)=$90,000$280,000
Commonstockdividendpayoutyield(2010)=33.93%
Commonstockdividendpayoutyield(2009)=CommonStockDividendsNetIncome
Commonstockdividendpayoutyield(2009)=$75,000$196,000
Commonstockdividendpayoutyield(2009)=38.27%
(4)
Thepriceearningsratio.HowdoinvestorsregardSabinscommonstockascomparedtoother
companiesintheindustry?
PriceEarningsRatio(2010)=StockPriceEarningsPerShare
PriceEarningsRatio(2010)=$40.00$5.20
PriceEarningsRatio(2010)=7.69
PriceEarningsRatio(2009)=StockPriceEarningsPerShare
PriceEarningsRatio(2009)=$36.00$3.52
PriceEarningsRatio(2009)=$10.23
(5)
Bookvaluepershareofcommonstock. Whatdoesthedifferencebetweenbookvalueand
marketpriceofthestocksignifytoyou?
Bookvaluepershareofcommonstock(2010)=(TotalEquityPreferredEquity)TotalShares
Bookvaluepershareofcommonstock(2010)=($1,600,000$250,000)60,000
Bookvaluepershareofcommonstock(2010)=$1,350,00060,000
Bookvaluepershareofcommonstock(2010)=$22.50
Bookvaluepershareofcommonstock(2009)=(TotalEquityPreferredEquity)TotalShares
Bookvaluepershareofcommonstock(2009)=($1,430,000$250,000)60,000
Bookvaluepershareofcommonstock(2009)=$1,180,00060,000
Bookvaluepershareofcommonstock(2009)=$19.67
(6)
Forreturnoninvestment(ROI),calculatethecomponents,marginandturnover,andthetotal
ROI.Totalassetsatthebeginningof2009were$2,300,000.
ReturnonInvestment(2010)=NetIncomeCostofInvestment
ReturnonInvestment(2010)=$280,000$400,000
ReturnonInvestment(2010)=70.00%
ReturnonInvestment(2009)=NetIncomeCostofInvestment
ReturnonInvestment(2009)=$196,000$400,000
ReturnonInvestment(2009)=49.00%
(7)
Isthereadifferencebetweenreturnontotalassetsusedinchapter16andtheROIpresentedin
chapter12?Totalassetsatthebeginningof2009were$2,300,000.
ReturnonAssets(2010)=NetIncomeAverageTotalAssets
ReturnonAssets(2010)=$280,000(($3,000,000+$2,460,000)2)
ReturnonAssets(2010)=$280,000($5,460,0002)
ReturnonAssets(2010)=$280,000$2,730,000
ReturnonAssets(2010)=10.26%
ReturnonAssets(2009)=NetIncomeAverageTotalAssets
ReturnonAssets(2009)=$196,000(($2,460,000+$2,300,000)2)
ReturnonAssets(2010)=$196,000($4,760,0002)
ReturnonAssets(2010)=$196,000$2,380,000
ReturnonAssets(2009)=8.23%
Yes,thereadifferencebetweenreturnontotalassetsusedinchapter16andtheROIpresentedinchapter
12.
(8)
Returnoncommonstockholdersequity. Stockholdersequityatthebeginningof2009was
$1,329,000.
Returnoncommonstockholdersequity(2010)=NetIncomeAverageStockholdersEquity
Returnoncommonstockholdersequity(2010)=$280,000(($1,600,000+$1,430,000)2)
Returnoncommonstockholdersequity(2010)=$280,000($3,030,0002)
Returnoncommonstockholdersequity(2010)=$280,000$1,515,000
Returnoncommonstockholdersequity(2010)=18.48%
Returnoncommonstockholdersequity(2009)=NetIncomeAverageStockholdersEquity
Returnoncommonstockholdersequity(2009)=$196,000(($1,430,000+$1,329,000)2)
Returnoncommonstockholdersequity(2009)=$196,000($2,759,0002)
Returnoncommonstockholdersequity(2009)=$196,000$1,379,500
Returnoncommonstockholdersequity(2009)=14.21%
(9)
IsSabinsfinancialleveragepositiveornegative?Pleaseexplain.
Sabinsfinancialleverageispositive.Negativeleverageonlyoccurswhenthecostofborrowingmoney
isgreaterthanthereturnapartymakesonanequityinvestment.
(10) WouldyourecommendthatyourclientpurchaseSabinsstock?Whyorwhynot?
IwouldrecommendthatmyclientpurchaseSabinsstockbecauseitsprofitabilitymeasuredintermsof
(1)EarningsPerShare(2)Commonstockdividendyieldand(3)Returnoncommonstockholders
equityisimprovingfromyeartoyear.
Problem5OutsideSuppliers,ContributionMargin,BreakEvenPoint,RelevantRange,Investment
Centers,ReturnonInvestment(ROI),andTransferPrices(32totalpoints,4pointseach):
TheCanadianInstrumentsCompany(CIC)usesadecentralizedformoforganizationalstructureandconsiders
eachofitsdivisionsasaninvestmentcenter.TheTorontoDivision(TD)iscurrentlyselling15,000airfilters
annually, although it has sufficient productive capacity to produce 21,000 units per year. Variable
manufacturingcostsamountto$21perunit,whilethetotalfixedcostsare$90,000.The15,000airfiltersare
soldtooutsidecustomersat$40perunit.
TheMontrealDivision(MD),alsoapartofCIC,hasindicatedthatitwouldliketobuy1,500airfiltersfrom
TD,butonlyatapriceof$37,sincethisisthepriceMDiscurrentlypayingtoanoutsidesupplierforasimilar
airfilter.Thecompanyhasacostofcapitalof7%.
Required:
a. WhatistheunitcontributionmarginforTDssalestooutsiders?Whatisthebreakevenpointinunitsand
salesdollars?
UnitContributionMarginforTD=SalesPriceperUnitVariableCostperUnit
UnitContributionMarginforTD=$40$21
UnitContributionMarginforTD=$19
BreakevenPointinUnits=TotalFixedCostsUnitContributionMargin
BreakevenPointinUnits=$90,000$19
BreakevenPointinUnits=4,737Units
BreakevenPointinSalesDollars=TotalFixedCostsContributionMarginRatio
BreakevenPointinSalesDollars=TotalFixedCosts($285,000$600,000)
BreakevenPointinSalesDollars=$90,0000.48
BreakevenPointinSalesDollars=$187,500
b. WilltheneworderpushTDoutsideitsrelevantrange?Whyorwhynot?
Yes,theneworderpushTDoutsideitsrelevantrange.Therelevantrangeis thespecifiedrangeof
activityoverwhichavariablecostperunitremainsconstantorafixedcostremains fixedintotal;itis
generallyassumedtobethenormaloperatingrangeoftheorganization.
c. WhatisthepretaxeffectonCICsincomeifMDbuysthe1,500airfiltersinternallyfromTD?
ThepretaxeffectonCICsincomeifMDbuysthe1,500airfiltersinternallyfromTDisthatincome
increasesby$24,000.
d. WhatistheminimumpricethatTDshouldbewillingtoacceptforthese1,500airfilters?
TheminimumpricethatTDshouldbewillingtoacceptforthese1,500airfiltersis$27.Variablecosts
perunitequal$21.Fixedcostsperunitequal$6($90,00015,000units).
e. WhatisthemaximumpricethatMDshouldbewillingtopayforthese1,500airfilters?
ThemaximumpricethatMDshouldbewillingtopayforthese1,500airfiltersis$26.Variablecosts
perunitequal$21.Fixedcostsperunitequal$6($90,000 15,000units).At$27,MDcanproducethe
unitsinhouseatbreakeven.
f. Whatqualitativefactorsshouldbeconsideredinthistypeofdecision,aboveandbeyondanytransferprice
considerations?
Thecompanyshouldconsiderifanysimilarproductfromoutsidemeetstheirqualitystandardsas
wellasthecostoffreightforshipmentofoutsidesuppliesorproducts.
g. SupposethatTDiscurrentlyproducingandselling21,000airfiltersannuallytooutsidecustomers.What
wouldbetheeffectonoverallCICincomeifTDwasrequiredbyexecutivemanagementtosell1,500air
filterstoMDatthe$37perunitprice?
IfTDiscurrentlyproducingandselling21,000airfiltersannuallytooutsidecustomers,theeffecton
overallCICincomeifTDwasrequiredbyexecutivemanagementtosell1,500airfilterstoMDatthe
$37perunitpricewouldbeareductionoffixedcostsperunit.Increaseinunitssoldwouldmakeit
cheapertoselltoMDat$37perunit.
h. Forthispartonly,assumethatTDiscurrentlyearningannualoperatingincomeof$36,000,andTDs
averageinvestedcapitalis$300,000.Thedivisionmanagerhasanopportunitytoinvestinaproposalthat
willrequireanadditionalinvestmentof$20,000andwillincreaseannualoperatingincomeby$2,000.
WhatistheimpactofthisprojectonTDsoverallROI?
ReturnonInvestment=NetIncomeCostofInvestment
ReturnonInvestment=$36,000$300,000
ReturnonInvestment=12.00%
ReturnonInvestment=NetIncomeCostofInvestment
ReturnonInvestment=$38,000$320,000
ReturnonInvestment=11.88%
ThisprojectwoulddecreaseTDsoverallROIby0.12%
Problem6StatementofCashFlow(36points):
WesleyCorpscomparativebalancesheetandincomestatementforthelastyearappearbelow:
BalanceSheet
FortheYearEndedDecember31
Assets
Cash
Accountsreceivable
Inventory
Prepaidexpenses
Longterminvestments
Plantandequipment
Lessaccumulateddepreciation
Totalassets
Liabilities
AccountsPayable
Accruedliabilities
Taxespayable
Bondspayable
Deferredtaxes
OwnersEquity
Commonstock
Retainedearnings
Totalliabilitiesandownersequity
2009
57,000
90,000
30,000
9,000
270,000
450,000
273,000
633,000
2008
23,000
69,000
49,000
15,000
90,000
450,000
231,000
565,000
22,000
31,000
18,000
60,000
39,000
45,000
24,000
25,000
100,000
24,000
140,000
323,000
633,000
110,000
237,000
565,000
IncomeStatement
Fortheyear2009
Sales
Costofgoodssold
Grossmargin
Selling&adminexpenses
Netoperatingincome
Incometaxes
Netincome
850,000
410,000
440,000
280,000
160,000
48,000
112,000
Wesleydeclaredandpaidacashdividendof$26,000during2009,andhasanothercashdividendplannedfor
2011intheamountof$40,000.Wesleyhasalsoplannedtospend$150,000innewcapitalequipmentin2011.
Required:
a. PrepareastatementofcashflowsforWesleyfortheyearendedDecember31,2009.
WesleyCorporation
StatementofCashFlows
FortheYearEndedDecember31,2009
NetIncome$112,000
AdjustmentstoReconcileNetIncometoCashfromContinuingOperations
CashFromOperatingActivities
IncreaseinAccountsReceivable($31,000)
DecreaseinInventory$19,000
DecreaseinPrepaidExpenses$6,000
DecreaseinAccountsPayable($23,000)
IncreaseinAccruedLiabilities$7,000
DecreaseinTaxesPayable($7,000)
IncreaseinAccumulatedDepreciation$42,000
TotalCashfromOperatingActivities$125,000
CashfromInvestingActivities
IncreaseinLongTermInvestments($170,000)
IncreaseinDeferredTaxes$15,000
TotalCashfromInvestingActivities($155,000)
CashfromFinancingActivities
DecreaseinBondsPayable($40,000)
IncreaseinCommonStock$30,000
PaymentofDividends($26,000)
TotalCashfromFinancingActivities($36,000)
TotalCashfromContinuingOperations($66,000)
b. WhatdoesthestatementtellyouaboutWesleysoperations,investments,andfinancingdecisionsin2009?
Simplyput,WesleyCorporationisfinancingitscontinuingoperationswithdebtandequity.