Chapter 16 - 5/0 "7/4 Recent financial statements for...

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Unformatted text preview: 5/0 "7/4 Recent financial statements for Madison Company are given below: Assets __ Cur-rentassets: . ‘ _ - _ -( . . . - -‘ _ _Oash;....’.... . . . . .'_, $_-21_,_000 Accounts receiVable, net'.'._.-.'. . . . .._. . . ._ ' ' ( 160,000 Merchandisejnventory '. . .- . . .... . ._ ‘ _ . 300,000 P‘repaid'expenses. . . . . . . . . ‘. _ - ' ‘ 9,000 - Total currentassets . . . .' . . . . . . I. ; . . . 7 .. _ i' ' "490,000 Property'and equipment, n'et . . . .- . . . . . g " . - _ 810,000 Tdtalassets . . . .- . _. . . . . . . .. ‘ I $1,300,000 Liabilities and,sio'ckhoide‘rstqu'iiy ' ' Liabilities;- . __ - . _ ' _ g .7 ,. _- ‘Current liabilities‘.-.; . . . . . . _. _.,. .-,' . ;- . .-; .- . ._ -_ $' 200,000 _ . Bondspayable', 10% . . . . . . . . . . . . . . . . . , . 300,000 Total'li'apiiiiiesfi...';'-. . .'. ..... . . . . . ' _ - f 500,000 Stockh'olderé'equity: _ - _ _. r ~ _ 1 _ g -_ - ' - - Common 5Stoek,_$5 par. value '. . '. . .' . . . . . . . . , $100,000 - - ',- Retained'earnings’ ~;'.:._ -. . . . . . . ._,'. . . . 1. . 700,000 , Total _SlockholderS"e0uity . . . . . . ..'. . . . . _. . .-. j 5 ' b . _ 300-;000. Toteiiiiabiiiiie's andvsmckmiders'equity . _ ' [$1,000,000 352,1 00,000. (Sales: . . . . i , . . . . . . _ _Go_st of goods'isoldi. .'_. ' ' Gross-margins....3, . . . '._'. ,' . I , .' £40,000 1 selling-and administrative',e:i_pen3es 600:000 ‘ _Net.o'perating.~mo_omei', ' - __ ' _ I lr'iter‘ei'si expensev : ; ._ .. . _._. 30,000 _ Net-income before i‘ax’es .. ;- ._ , 150,000 7 ii” Lorne taxes'--..'..-5.r...-. . ' _ 45,000 Net income. .3: . . " Account balances at the beginning of the company’s fiscal year were: accounts receivable, $140,000; and inventory, $260,000. All sales were-on aCcount. ' Required: Compute financial ratios as follows: Gross margin percentage. Current- ratio. ' Acid-test ratio. Average collection period. Average sale period. Debt-to—equity ratio. Times interest earned. Book value per share. WNQMPPNT“ Eldr7/l 1. Gross margin percentage: Gross margin 2 $840,000 Sales $2,100,000 Gross margin percentage: =40% 2. Current ratio: 3. Acid—test ratio: Cash + Marketable securities + Accounts receivable + Short—term notes Current liabilities _$21,000 + $0 + $160,000 + $0 3 $200,000 Acid test ratio: =O.91 (rounded) 4. Average collection period: Sales on account Average accounts receivable _ $2,100,000 :14 _ ($160,000 + $140,000)/2 365 days Accounts receivable turnover Accounts receivable turnover: Average collection period = =Ldays=26l days (rounded) 5. Average sale period: Cost of goods sold Average inventory : $1,260,000 = ($300,000 + $260,000)/2 365 days 4.5 Inventory turnover: 4.5 Average sale period= =81.1 days (rounded) 6. Debt-to-equity ratio: Total liabilities Stockholders' equity = $500,000 $800,000 Debt-equity ratio: =O.63 (rounded) 7. Times interest earned: Ea min 5 before interest Times interest earned: an 'ncome taxes Interest expense 2 $180,000 = $30,000 6.0 8. Book value per share: Book value per share: Total stockholders equity - Preferred stock Common shares outstanding = $800,000 - $0 20,000 shares* *$100,000 total par value + $5 par value per share 2 20,000 shares =$4O per share 1; Mrs/4 154A Refer to the financial statements for Madison Company in Exercise m. In addition to the data in these statements, assume that Madison Company paid dividends of $3.15 per share during the year. Also assume that the company’s common stock had a market price of $63 per share on June 30 and there was no change in the number-of otitstanding shares of common stock during the fiscal year. Required: 1 Compute the following: 1. Earnings per share. 2. Dividend payou'tsratfio. 3. Dividend yield ratio. 4. Price-eamings ratio. 1. Earnings per share: Net income - Preferred dividends Average common shares outstanding = $105,000 - $0 20,000 shares Earnings per share: =$5.25 per share 2. Dividend payout ratio: Dividend payout ratio: W = =60% Earnings per share $5.25 3. Dividend yield ratio: Dividends per share _ $3.15 Dividend yield ratio- , =5°/o Market price per share $63.00 4. Price-earnings ratio: Priceeamingg ratio: Market price per share : $63.00 = 12.0 Earnings per share $5.25 Ew'fifl lt-m Refer to the financial statements for Madison Company in Exercise m. Assets at the beginning of the year totaled $1,100,000, and the stockholders’ equity totaled $725,000. Required: Compute the following: 1. Return ontotal assets. 2. Return on com-mon stockholders’ equity. 3. Was financial leverage positive or negative for the year? Explain. 1. Return on total assets: Net income + [Interest expense >< (1-Tax rate)] Average total assets Return on total assets: _$105,000 + [$30,000 x (1 - 0.30)] _ ($1,100,000 + $1,300,000)/ 2 _ $126,000 — ——— = 10.5% $1,200,000 2. Return on common stockholders’ equity: Return on common _ Net income — Preferred dividends stockholders' equity — Average total Stockholders' equity — Average preferred stock $105,000 - $0 ($725,000 + $800,000)/2 — $0 _ $105,000 ————=13.8°/ d d $762,500 o(roun e ) 3. Financial leverage was positive because the rate of return to the com— mon stockholders (13.8%) was greater than the rate of return on total assets (10.5%). This positive leverage is traceable in part to the com— pany’s current liabilities, which may carry no interest cost, and to the bonds payable, which have an after-tax interest cost of only 7%. 10% interest rate x (1 — 0.30) = 7% after—tax cost. Pier/(014 1n the right—hand column below, certain financial ratios are listed. To the left of each ratio is a business transaction or event relating to the Operating activities of Graham Company. >0?°.\‘.°‘.U‘7‘>'r°!°i‘ l3. 14. 15. l6. 17. 18. Inventory was sold for cash at a profit. Land was purchased for cash. Inventory was sold on account at cost. Some accounts payable were paid off. A customer paid an overdue bill. A cash dividend was declared, but not yet paid. A previously declared cash dividend was paid. The company’s common stock price increased. The company’s common stock price increased. Earnings per share remained unchanged. Property was sold for a profit. Obsolete inventory was written off as a loss. Bonds were sold with an interest rate less than the company’s return on assets. The company’s common stock price decreased. The dividend paid per share remained the same. The company’s net income decreased, but long-term debt remained unchanged. An uncollectible account was written off against the Allowance for Bad Debts. Inventory was purchased on credit. The company’s common-stock price increased. Earnings per share remained unchanged. The company paid off some accounts payable. Required: Indicate the effect that each transaction or event would have on the ratio listed opposite to it. State the effect in terms- of increase, decrease, or no effect on the ratio involved, and give the reason for your choice. In all cases, assume that the current assets exceed current liabilities both before and after the event or transaction. Use the following format for your answers: Debt-to-equity ratio Earnings per share Acid-test ratio Working capital Average collection period Current ratio Current ratio Book value per share Dividend yield ratio Return on total assets lnventory turnover ratio Return on common stockholders’ equity Dividend payout ratio Times interest earned Current ratio Acid-test ratio Price-earnings ratio Debt-to-equity ratio 10. 11. 12. 13. 14. 15. 16. 17. 18. blb’lgft . Decrease . No effect . Increase . No effect . Decrease Sale of inventory at a profit will be reflected in an increase in retained earnings, which is part of stockholders' equity. An increase in stockholders’ equity will result in a decrease in the ratio of assets provided by creditors as compared to assets provided by owners. Purchasing land for cash has no effect on earnings or on the number of shares of common stock outstanding. One asset is exchanged for another. A sale of inventory on account will increase the quick as- sets (cash, accounts receivable, marketable securities) but have no effect on the current liabilities. For this reason, the acid-test ratio will increase. Payments on account reduce cash and accounts payable by equal amounts; thus, the net amount of working capital is not affected. When a customer pays a bill, the accounts receivable bal- , ance is reduced. This increases the accounts receivable . Decrease Increase . No effect . Decrease Increase Increase Increase No effect Decrease No effect Decrease Increase Decrease turnover, which in turn decreases the average collection pe- riod. Declaring a cash dividend will increase current liabilities, but have no effect on current assets. Therefore, the current ratio will decrease. Payment of a previously declared cash dividend will reduce both current assets and current liabilities by the same amount. An equal reduction in both current assets and cur— rent liabilities will always result in an increase in the current ratio, so long as the current assets exceed the current li— abilities. Book value per share is not affected by the current market price of the company’s stock. The dividend yield ratio is obtained by dividing the dividend per share by'th’e market price per share. If the dividend per share remains unchanged and the market price goes up, then the yield will decrease. Selling property for a profit would increase net income and therefore the return on total asses would increase. A write-off of inventory will reduce the inventory balance, thereby increasing the turnover in relation to a given level of cost of goods sold. Since the company’s assets earn at a rate that is higher than the rate paid on the bonds, leverage is positive, in- creasing the return to the common stockholders. Changes in the market price of a stock have no direct ef- fect on the dividends paid or on the earnings per share and therefore have no effect on this ratio. A decrease in net income would mean less income avail— able to cover interest payments. Therefore, the times— interest—earned ratio would decrease. Write-off of an uncollectible account against the Allowance for Bad Debts will have no effect on total current assets. For this reason, the current ratio will remain unchanged. A purchase of inventory on account will increase current liabilities, but will not increase the quick assets (cash, ac— counts receivable, marketable securities). Therefore, the ratio of quick assets to current liabilities will decrease. The price-earnings ratio is obtained by dividing the market price per share by the earnings per share. If the earnings per share remains unchanged, and the market price goes up, then the price-earnings ratio will increase. Payments to creditors will reduce the total liabilities of a company, thereby decreasing the ratio of total debt to total equity. ...
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This note was uploaded on 08/22/2011 for the course ACCT 2020 taught by Professor Larkin,r during the Spring '08 term at Utah State University.

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Chapter 16 - 5/0 "7/4 Recent financial statements for...

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