Exercises: Chapter 15

QUESTIONS, EXERCISES AND PROBLEMS

Questions
➢  What are the major sources of financial information for publicly owned corporations?
➢  The higher the accounts receivable turnover rate, the better off the company is. Do you agree? Why?
➢  Can you think of a situation where the current ratio is very misleading as an indicator of short-term, debt-paying ability? Does the acid-test ratio offer a remedy to the situation you have described? Describe a situation where the acid-test ratio does not suffice either.
➢  Before the Marvin Company issued $20,000 of long-term notes (due more than a year from the date of issue) in exchange for a like amount of accounts payable, its current ratio was 2:1 and its acid-test ratio was 1:1. Will this transaction increase, decrease, or have no effect on the current ratio and acid-test ratio? What would be the effect on the equity ratio?➢  Through the use of turnover rates, explain why a firm might seek to increase the volume of its sales even though such an increase can be secured only at reduced prices.➢  Indicate which of the relationships illustrated in the chapter would be best to judge:

  • The short-term debt-paying ability of the firm.
  • The overall efficiency of the firm without regard to the sources of assets.
  • The return to owners (stockholders) of a corporation.
  • The safety of long-term creditors' interest.
  • The safety of preferred stockholders' dividends.


➢  Indicate how each of the following ratios or measures is calculated:

  • Payout ratio.
  • Earnings per share of common stock.
  • Price-earnings ratio.
  • Earnings yield on common stock.
  • Dividend yield on preferred stock.
  • Times interest earned.
  • Times preferred dividends earned.
  • Return on average common stockholders' equity.
  • Cash flow margin.


➢  How is the rate of return on operating assets determined? Is it possible for two companies with operating margins of 5 per cent and 1 per cent, respectively, to both have a rate of return of 20 per cent on operating assets? How?

➢  Cite some of the possible deficiencies in accounting information, especially regarding its use in analyzing a particular company over a 10-year period.

Exercises Exercise A Income statement data for Boston Company for 2009 and 2010 follow:

2009 2010
Net sales $2,610,000 $1,936,000
Cost of goods sold 1,829,600 1,256,400
Selling expenses 396,800 350,000
Administrative expenses 234,800 198,400
Federal income taxes 57,600 54,000
Prepare a horizontal and vertical analysis of the income data in a form similar to Exhibit 2. Comment on the results of this analysis.

Exercise B A company engaged in the following three independent transactions:

  • Merchandise purchased on account, $2,400,000.
  • Machinery purchased for cash, $2,400,000.
  • Capital stock issued for cash, $2,400,000.


  1. Compute the current ratio after each of these transactions assuming current assets were $3,200,000 and the current ratio was 1:1 before the transactions occurred.
  2. Repeat part (a) assuming the current ratio was 2:1.
  3. Repeat part (a) assuming the current ratio was 1:2.


Exercise C A company has sales of $3,680,000 per year. Its average net accounts receivable balance is $920,000.

  1. What is the average number of days accounts receivable are outstanding?
  2. By how much would the capital invested in accounts receivable be reduced if the turnover could be increased to 6 without a loss of sales?


Exercise D Columbia Corporation had the following selected financial data for 2009 December 31: Net cash provided by operating activities

Net sales $1,800,000
Cost of goods sold 1,080,000
Operating expenses 315,000
Net income 195,000
Total assets 1,000,000
Net cash provided by operating activities 25,000
Compute the cash flow margin.

Exercise E From the following partial income statement, calculate the inventory turnover for the period.

Net sales $2,028,000
Cost of goods sold:
  Beginning inventory $ 234,000
  Purchases 1,236,000
  Cost of goods available for sale $1,560,000
  Less: Ending inventory 265,200
    Cost of goods sold 1,294,800
Gross margin $ 733,200
Operating expenses 327,600
Net operating income $ 405,600
Exercise F Eastern, Inc., had net sales of $3,520,000, gross margin of $1,496,000, and operating expenses of $904,000. Total assets (all operating) were $3,080,000. Compute Eastern's rate of return on operating assets.

Exercise G Nelson Company began the year 2010 with total stockholders' equity of $2,400,000. Its net income for 2010 was $640,000, and $106,800 of dividends were declared. Compute the rate of return on average stockholders' equity for 2010. No preferred stock was outstanding.

Exercise H Rogers Company had 60,000 shares of common stock outstanding on 2010 January 1. On 2010 April 1, it issued 20,000 additional shares for cash. The amount of earnings available for common stockholders for 2010 was $600,000. What amount of EPS of common stock should the company report?

Exercise I Smith Company started 2011 with 800,000 shares of common stock outstanding. On March 31, it issued 96,000 shares for cash, and on September 30, it purchased 80,000 shares of its own stock for cash. Compute the weighted-average number of common shares outstanding for the year.

Exercise J A company reported EPS of $2 (or ) for 2009, ending the year with 1,200,000 shares outstanding. In 2010, the company earned net income of $7,680,000, issued 320,000 shares of common stock for cash on September 30, and distributed a 100 per cent stock dividend on 2010 December 31. Compute EPS for 2010, and compute the adjusted earnings per share for 2009 that would be shown in the 2010 annual report.

Exercise K A company paid interest of $32,000, incurred federal income taxes of $88,000, and had net income (after taxes) of $112,000. How many times was interest earned?

Exercise L John Company had 20,000 shares of $600 par value, 8 per cent preferred stock outstanding. Net income after taxes was $5,760,000. The market price per share was $720.

  1. How many times were the preferred dividends earned?
  2. What was the dividend yield on the preferred stock assuming the regular preferred dividends were declared and paid?


Exercise M A company had 80,000 weighted-average number of shares of $320 par value common stock outstanding. The amount of earnings available to common stockholders was $800,000. Current market price per share is $720. Compute the EPS and the price-earnings ratio.

Problems Problem A Loom's comparative statements of income and retained earnings for 2010 and 2009 are given below.

Loom Consolidated statement of earnings For the years ended 2010 December 31, and 2009 (USD thousands, except per data share)
  December 31  
(1) (2)
  2010 2009
Net sales $ 2,403,100 $ 2,297,800
Cost of sales 1,885,700 1,651,300
  Gross earnings $ 517,400 $ 646,500
Selling, general and administrative expenses 429,700 376,300
Goodwill amortization 37,300 35,200
Impairment write down of goodwill 158,500 0
  Operating earnings (loss) $ (108,100) $235,000
Interest expense (116,900) (95,400)
Other expense-net (21,700) (6,100)
Earnings (loss) before income tax (benefit) expense, extraordinary item and cumulative effect of change in accounting principles $ (246,700) $133,500
Income tax (benefit) expense (19,400) 73,200
Earnings (loss) before cumulative effect of change in account principles $ (227,300) $60,300
  Cumulative effect of change in accounting principles:
    Pre-operating costs (5,200) 0
  Net earnings (loss) $ (232,500) $60,300
Retained earnings, January 1 680,600 620,300
$ 448,100 $680,600
Dividends 0 0
Retained earnings, December 31 $ 448,100 $680,600
Loom consolidated balance sheet As of 2010 December 31, and 2009 (USD thousands)
  December 31  
(1) (2)
  2010 2009
Assets
Current assets
Cash and cash equivalents $ 26,500 $ 49,400
Notes and accounts receivable (less allowance for possible losses of $26,600,000 and $20,700,000, respectively) 261,000 295,600
Inventories
  Finished goods 522,300 496,200
  Work in process 132,400 141,500
  Materials and supplies 44,800 39,100
Other 72,800 54,800
    Total current assets $ 1,059,800 $ 1,076,600
Property, plant, and equipment
Land $ 20,100 $ 19,300
Buildings, structures and improvements 486,400 435,600
Machinery and equipment 1,076,600 1,041,300
Construction in progress 24,200 35,200
    Total property, plant and equipment $ 1,607,300 $ 1,531,400
Less accumulated depreciation 578,900 473,200
   Net property, plant and equipment $ 1,028,400 $ 1,058,200
Other assets
Goodwill (less accumulated amortization of $257,800,000 and $242,400,000, respectively). $ 771,100 $ 965,800
Other 60,200 62,900
   Total other assets $831,300 $ 1,028,700
     Total assets $ 2,919,500 $ 3,163,500
Liabilities and stockholders' equity
Current liabilities
Current maturities of long-term debt $ 14,600 $ 23,100
Trade accounts payable 60,100 113,300
Accrued insurance obligations 38,800 23,600
Accrued advertising and promotion 23,800 23,400
Interest payable 16,000 18,300
Accrued payroll and vacation pay 15,300 33,100
Accrued pension 11,300 19,800
Other accounts payable and accrued expenses 123,900 77,200
   Total current liabilities $ 303,800 $ 331,800
Noncurrent liabilities
Long-term debt 1,427,200 1,440,200
Net deferred income taxes 0 43,400
Other 292,900 222,300
   Total noncurrent liabilities $ 1,720,000 $ 1,705,900
     Total liabilities $ 2,023,900 $ 2,037,700
Common stockholders' equity
Common stock and capital in excess of par value, $.01 par value; authorized, Class A, 200,000,000 shares, Class B, 30,000,000 shares; issued and outstanding:
Class A Common Stock, 69,268,701 and 69,160,349 shares, respectively $ 465,600 $ 463,700
Class B Common Stock, 6,690,976 shares 4,400 4,400
Retained earnings 448,100 680,600
Currency translation and minimum pension liability adjustments (22,500) (22,900)
     Total common stockholders' equity $ 895,600 $ 1,125,800
       Total liabilities and stockholders' equity $ 2,919,500 $ 3,163,500
Perform a horizontal and vertical analysis of Loom's financial statements in a manner similar to those illustrated in this chapter. Comment on the results of the analysis in (a).

Problem B Deere & Company manufactures, distributes, and finances a full range of agricultural equipment; a broad range of industrial equipment for construction, forestry, and public works; and a variety of lawn and grounds care equipment. The company also provides credit, health care, and insurance products for businesses and the general public. Consider the following information from the Deere & Company 2000 Annual Report:

(in millions) 1997 1998 1999 2000
Sales $12,791 $13,822 $11,751 $13,137
Cost of goods sold 8,481 9,234 8,178 8,936
Gross margin 4,310 4,588 3,573 4,201
Operating expenses 2,694 2,841 3,021 3,236
Net operating income $ 1,616 $ 1,747 $ 552 $ 965
  1. Prepare a statement showing the trend percentages for each item using 1997 as the base year.
  2. Comment on the trends noted in part (a).


Problem C The following data are for Toy Company:

  December 31  
2011 2010
Allowance for uncollectible accounts $72,000 $57,000
Prepaid expenses 34,500 45,000
Accrued liabilities 210,000 186,000
Cash in Bank A 1,095,000 975,000
Wages payable -0- 37,500
Accounts payable 714,000 585,000
Merchandise inventory 1,342,500 1,437,000
Bonds payable, due in 2005 615,000 594,000
Marketable securities 217,500 147,000
Notes payable (due in six months) 300,000 195,000
Accounts receivable 907,500 870,000
Cash flow from operating activities 192,000 180,000
  1. Compute the amount of working capital at both year-end dates.
  2. Compute the current ratio at both year-end dates.
  3. Compute the acid-test ratio at both year-end dates.
  4. Compute the cash flow liquidity ratio at both year-end dates.
  5. Comment briefly on the company's short-term financial position.


Problem D On 2011 December 31, Energy Company's current ratio was 3:1 before the following transactions were completed:

  • Purchased merchandise on account.
  • Paid a cash dividend declared on 2011 November 15.
  • Sold equipment for cash.
  • Temporarily invested cash in trading securities.
  • Sold obsolete merchandise for cash (at a loss).
  • Issued 10-year bonds for cash.
  • Wrote off goodwill to retained earnings.
  • Paid cash for inventory.
  • Purchased land for cash.
  • Returned merchandise that had not been paid for.
  • Wrote off an account receivable as uncollectible. Uncollectible amount is less than the balance in the Allowance for Uncollectible Accounts.
  • Accepted a 90-day note from a customer in settlement of customer's account receivable.
  • Declared a stock dividend on common stock.


Consider each transaction independently of all the others.

  1. Indicate whether the amount of working capital will increase, decrease, or be unaffected by each of the transactions.
  2. Indicate whether the current ratio will increase, decrease, or be unaffected by each of the transactions.


Problem E Digital Company has net operating income of $500,000 and operating assets of $2,000,000.

Its net sales are $4,000,000.

The accountant for the company computes the rate of return on operating assets after computing the operating margin and the turnover of operating assets.

  1. Show the computations the accountant made.
  2. Indicate whether the operating margin and turnover increase or decrease after each of the following changes. Then determine what the actual rate of return on operating assets would be. The events are not interrelated; consider each separately, starting from the original earning power position. No other changes occurred.


(a)Sales increased by $160,000. There was no change in the amount of operating income and no change in operating assets.

(b)Management found some cost savings in the manufacturing process. The amount of reduction in operating expenses was $40,000. The savings resulted from the use of less materials to manufacture the same quantity of goods. As a result, average inventory was $16,000 lower than it otherwise would have been. Operating income was not affected by the reduction in inventory.

(c)  The company invested $80,000 of cash (received on accounts receivable) in a plot of land it plans to use in the future (a nonoperating asset); income was not affected.

(d)The federal income tax rate increased and caused income tax expense to increase by $20,000. The taxes have not yet been paid.

(e)The company issued bonds and used the proceeds to buy $400,000 of machinery to be used in the business. Interest payments are $20,000 per year. Net operating income increased by $100,000 (net sales did not change).

Problem F Polaroid Corporation designs, manufactures, and markets worldwide instant photographic cameras and films, electronic imaging recording devices, conventional films, and light polarizing filters and lenses. The following information is for Polaroid:

(in millions) 2000 1999
Net sales $13,994 $14,089
Income before interest and taxes 2,310 2,251
Net income 1,407 1,392
Interest expense 178 142
Stockholders' equity (on 1998 December 31, $3,988) 3,428 3,912
Common stock, par value $1, December 31 978 978
Compute the following for both 2000 and 1999. Then compare and comment.

  1. EPS of common stock.
  2. Net income to net sales.
  3. Net income to average common stockholders' equity.
  4. Times interest earned ratio.


Problem G The Walt Disney Company operates several ranges of products from theme parks and resorts to broadcasting and other creative content. The following balance sheet and supplementary data are for The Walt Disney Company for 2000.

The Walt Disney Company Consolidated balance sheet For 2000 September 30 (USD millions)
Assets
Cash and cash equivalents $ 842
Receivables 3,599
Inventories 702
Film and television costs 1,162
Other 1,258
  Total current costs $7,563
Film and television costs 5,339
Investments 2,270
Theme parks, resorts, and other property, at cost
  Attractions, buildings, and equipment $16,160
  Accumulated depreciation (6,892)
9,718
Project in process 1,995
Land 597
Intangibles assets, net 16,117
Other assets 1,428
   Total assets $25,027
Liabilities and stockholders' equity
Accounts payable and accrued liabilities $ 5,161
Current portion of borrowing 2,502
Unearned royalties 739
  Total current liabilities $ 8,402
Borrowings 6,959
Deferred income taxes 2,833
Other long-term liabilities 2,377
Minority interest 356
Common shareholders' equity
Common shares ($.01 par value) $12,101
Retained earnings 12,767
Cumulative translation and other adjustments (28)
Treasury shares (740) 24,100
     Total liabilities and stockholders' equity $45,027
  • Net income, $920.
  • Income before interest and taxes, $3,231.
  • Cost of goods sold, $21,321.
  • Net sales, $25,402.
  • Inventory on 1999 September 30, $796.
  • Total interest expense for the year, $598.


Calculate the following ratios and show your computations. For calculations normally involving averages, such as average stockholders' equity, use year-end amounts unless the necessary information is provided.

  1. Current ratio.
  2. Net income to average common stockholders' equity.
  3. Inventory turnover.
  4. Number of days' sales in accounts receivable (assume 365 days in 2000).
  5. EPS of common stock (ignore treasury stock).
  6. Times interest earned ratio.
  7. Equity ratio.
  8. Net income to net sales.
  9. Total assets turnover.
  10. Acid-test ratio.


Problem H Cooper Company currently uses the FIFO method to account for its inventory but is considering a switch to LIFO before the books are closed for the year. Selected data for the year are:

Merchandise inventory, January 1 $1,430,000
Current assets 3,603,600
Total assets (operating) 5,720,000
Cost of goods sold (FIFO) 2,230,800
Merchandise inventory, December 31 (LIFO) 1,544,400
Merchandise inventory, December 31 (FIFO) 1,887,600
Current liabilities 1,144,000
Net sales 3,832,400
Operating expenses 915,200
  1. Compute the current ratio, inventory turnover ratio, and rate of return on operating assets assuming the company continues using FIFO.
  2. Repeat part (a) assuming the company adjusts its accounts to the LIFO inventory method.


Alternate problems Alternate problem A Steel Corporation's comparative statements of income and retained earnings and consolidated balance sheet for 2010 and 2009 follow:

Steel Corporation Consolidated statement of Earnings For the years ended 2010 December 31, 2009 (USD thousands)

  December 31
  (1) (2)
  2010 2009
Net sales $4,876.5 $4,819.4
Costs and expenses:
  Cost of sales $4,202.8 $4,287.3
  Depreciation 284.0 261.1
  Estimated restructuring losses 111.8 137.4
    Total costs $4,598.6 $4,685.8
Income from operations $268.9 $ 133.6
Financing income (expense):
  Interest and other income 7.7 7.1
  Interest and other financing costs (60.0) (46.2)
Loss before income taxes and cumulative effect of changes in accounting $ 216.6 $ 94.5
Benefit (provision) for income taxes (37.0) (14.0)
Net earning (loss) $ 179.6 $ 80.5
Retained earnings, January 1 (859.4) (939.9)
$ (679.8) $ (859.4)
Dividends 0.0 0.0
Retained earnings, December 31 $ (679.8) (859.4)
Steel Corporation Consolidated balance sheet As of 2010 December 31, and 2009
  December 31
  (1) (2)
  2010 2009
Assets
Current Assets
Cash and cash equivalents $ 180.0 $ 159.5
Receivables 374.6 519.5
  Total $ 554.6 $ 679.0
Inventories
  Raw materials and supplies $ 335.5 $ 331.9
  Finished and semifinished products 604.9 534.9
  Contract work in process less billings of $10.9 and $2.3 17.8 16.1
    Total inventories $ 958.2 $ 882.9
Other current assets $ 13.0 $ 7.2
  Total current assets $ 1,525.8 $ 1,569.1
Property, plant and equipment less accumulated depreciation of $4329.5 and $4167.8 $ 2,714.2 $ 2,759.3
Investments and miscellaneous assets 112.3 124.2
Deferred income tax asset – net 885.0 903.2
Intangible asset – Pensions 463.0 426.6
     Total assets $ 5,700.3 $ 5,782.4
Liabilities and stockholders' equity
Current liabilities
Accounts payable $ 381.4 $ 387.0
Accrued employment costs 208.0 165.8
Postretirement benefits other than pensions 150.0 138.0
Accrued taxes 72.4 67.6
Debt and capital lease obligations 91.5 88.9
Other current liabilities 146.3 163.9
  Total current liabilities $ 1,049.6 $ 1,011.2
Pension liability $ 1,115.0 $ 1,117.1
Postretirement benefits other than pensions 1,415.0 1,441.4
Long-term debt and capital lease obligations 546.8 668.4
Other 335.6 388.5
  Total noncurrent liabilities $ 3,412.4 # 3,615.4
Total liabilities $ 4,462.0 $ 4,626.6
Common stockholders' equity
Preferred stock – at $1 per share par value (aggregate liquidation preference of $481.2); Authorized 20,000,000 shares $ 11.6 $ 11.6
Preference stock – at $1 per share par value (aggregate liquidation preference of $88.2); Authorized 20,000,000 shares 2.6 2.6
Common stock – at $1 per share par value/Authorized 250,000,000 and 150,000,000 shares; Issued 112,699,869 and 111,882,276 shares 112.7 111.9
Held in treasury, 1,992,189 and 1,996,715 shares at cost (59.4) (59.5)
Additional paid-in capital 1,850.6 1,948.6
Accumulated deficit (679.8) (859.4)
  Total common stockholders' equity $ 1,238.3 $ 1,155.8
     Total liabilities and stockholders' equity $ 5,700.3 $ 5,782.4
  1. Perform a horizontal and vertical analysis of Steel's financial statements in a manner similar to Exhibit 1 and Exhibit 2.
  2. Comment on the results obtained in part (a).


Alternate problem B Ford Motor Company is the world's second-largest producer of cars and trucks and ranks among the largest providers of financial services in the United States. The following information pertains to Ford: (in millions)

(in millions) 1998 1999 2000
Sales $118.017 $135,073 $141,230
Cost of goods sold 104,616 118,985 126,120
Gross margin $ 13,401 $ 16,088 $ 15,110
Operating expenses 7,834 8,874 9,884
Net operating income $ 5,567 $ 7,214 $ 5,226
  1. Prepare a statement showing the trend percentages for each item, using 1998 as the base year.
  2. Comment on the trends noted in part (a).


Alternate problem C The following data are for Clock Company: Allowance for uncollectible accounts

  December 31
  2011 2010
Notes payable (due in 90 days) $75,200 $60,000
Merchandise inventory 240,000 208,000
Cash 100,000 128,000
Marketable securities 49,600 30,000
Accrued liabilities 19,200 22,000
Accounts receivable 188,000 184,000
Accounts payable 112,000 72,000
Allowance for uncollectible accounts 24,000 15,200
Bonds payable, due 2008 156,000 160,000
Prepaid expenses 6,400 7,360
Cash flow from operating activities 60,000 40,000
  1. Compute the amount of working capital at both year-end dates.
  2. Compute the current ratio at both year-end dates.
  3. Compute the acid-test ratio at both year-end dates.
  4. Compute the cash flow liquidity ratio at both year-end dates.
  5. Comment briefly on the company's short-term financial position.


Alternate problem D Tulip Products, Inc., has a current ratio on 2010 December 31, of 2:1 before the following transactions were completed:

  • Sold a building for cash.
  • Exchanged old equipment for new equipment. (No cash was involved.)
  • Declared a cash dividend on preferred stock.
  • Sold merchandise on account (at a profit).
  • Retired mortgage notes that would have matured in 2011.
  • Issued a stock dividend to common stockholders.
  • Paid cash for a patent.
  • Temporarily invested cash in government bonds.
  • Purchased inventory for cash.
  • Wrote off an account receivable as uncollectible. Uncollectible amount is less than the balance of the Allowance for Uncollectible Accounts.
  • Paid the cash dividend on preferred stock that was declared earlier.
  • Purchased a computer and gave a two-year promissory note.
  • Collected accounts receivable.
  • Borrowed from the bank on a 120-day promissory note.
  • Discounted a customer's note. Interest expense was involved.


Consider each transaction independently of all the others.

  1. Indicate whether the amount of working capital will increase, decrease, or be unaffected by each of the transactions.
  2. Indicate whether the current ratio will increase, decrease, or be unaffected by each of the transactions.


Alternate problem E The following selected data are for three companies:

  Operating Assets Net Operating Income Net Sales
Company 1 $ 1,404,000 $ 187,200 $ 2,059,200
Company 2 8,424,000 608,400 18,720,000
Company 3 37,440,000 4,914,000 35,100,000
  1. Determine the operating margin, turnover of operating assets, and rate of return on operating assets for each company.
  2. In the subsequent year, the following changes took place (no other changes occurred):


Company 1 bought some new machinery at a cost of $156,000. Net operating income increased by $12,480 as a result of an increase in sales of $249,600.

Company 2 sold some equipment it was using that was relatively unproductive. The book value of the equipment sold was $624,000. As a result of the sale of the equipment, sales declined by $312,000, and operating income declined by $6,240.

Company 3 purchased some new retail outlets at a cost of $6,240,000. As a result, sales increased by $9,360,000, and operating income increased by $499,200.

  • Which company has the largest absolute change in:


  1. Operating margin ratio?
  2. Turnover of operating assets?
  3. Rate of return on operating assets?


  • Which one realized the largest dollar change in operating income? Explain this change in relation to the changes in the rate of return on operating assets.


Alternate problem F One of the largest spice companies in the world, McCormick & Company, Inc., produces a diverse array of specialty foods. The following information is for McCormick & Company, Inc.:

2000 1999
(USD thousands)
Net sales $2,123,500 $2,006,900
Income before interest and taxes 225,700 174,700
Net income 137,500 98,500
Interest expense 39,700 32,400
Stockholders' equity 359,300 382,400
Common stock, no par value, November 30 175,300 173,800
Assume average common shares outstanding for 2000 and 1999 are 69,600 and 72,000 (in thousands), respectively.

Compute the following for both 2000 and 1999. Then compare and comment. Assume stockholders' equity for 1998 was $388,100.

  1. EPS of common stock.
  2. Net income to net sales.
  3. Return on average common stockholders' equity.
  4. Times interest earned ratio.


Alternate problem G Parametric Technology Corporation is in the CAD/CAM/CAE industry and is the top supplier of software tools used to automate a manufacturing company. The following consolidated balance sheet and supplementary data are for Parametric for 2003:

Parametric Technology Corporation Consolidated balance sheet For 2003 September 30 (in thousands)
Assets
Current assets
  Cash and cash equivalents $ 325,872
  Short-term investments 22,969
  Accounts receivable, net of allowances for doubtful account of $6,270 183,804
  Other current assets 95,788
   Total current assets $ 628,433
  Marketable investments 26,300
  Property and equipment, net 66,879
  Other assets 203,271
     Total assets $ 924,883
Liabilities and stockholders' equity
Current liabilities
  Accounts payable and accrued expenses $ 77,144
  Accrued compensation 52,112
  Deferred revenue 231,495
  Income taxes 1,601
     Total currents liabilities $ 362,352
Other liabilities 33,989
Stockholders' equity
Preferred stock, $.01 par value; 5,000 shares authorized; none issued
Common stock, $.01 par value; 500,000 shares authorized; 276,053 (2000) and 272,277 (1999) shares issued 2,761
Additional paid-in capital 1,641,513
Foreign currency translation adjustment (12,629)
Accumulated deficit (1,036,456)
Treasury stock, at cost, 6,456 (2000) and 2,113 (1999) shares (66,647)
     Total liabilities and stockholders' equity $ 924,883
  • Net loss, ($3,980).
  • Loss before interest and taxes, ($4,700).
  • Cost of goods sold, $244,984.
  • Net sales, $928,414.
  • Total interest expense for the year, $367.
  • Weighted-average number of shares outstanding, 273,081.


Calculate the following ratios and show your computations. For calculations normally involving averages, such as average accounts receivable or average stockholders' equity, use year-end amounts if the information is not available to use averages.

  1. Current ratio.
  2. Net income to average common stockholders' equity.
  3. Number of days' sales in accounts receivable (assume 365 days in 2003).
  4. EPS of common stock.
  5. Times interest earned ratio.
  6. Equity ratio.
  7. Net income to net sales.
  8. Total assets turnover.
  9. Acid-test ratio.


Alternate problem H Paper Company is considering switching from the FIFO method to the LIFO method of accounting for its inventory before it closes its books for the year. The January 1 merchandise inventory was $864,000. Following are data compiled from the adjusted trial balance at the end of the year:

Merchandise inventory, December 31 (FIFO) $1,008,000
Current liabilities 720,000
Net sales 2,520,000
Operating expenses 774,000
Current assets 1,890,000
Total assets (operating) 2,880,000
Cost of goods sold 1,458,000
If the switch to LIFO takes place, the December 31 merchandise inventory would be $900,000.

  1. Compute the current ratio, inventory turnover ratio, and rate of return on operating assets assuming the company continues using FIFO.
  2. Repeat (a) assuming the company adjusts its accounts to the LIFO inventory method.


Beyond the numbers – Critical thinking Business decision case A The comparative balance sheets of the Darling Corporation for 2011 December 31, and 2010 follow:

Darling Corporation Comparative balance sheets 2011 December 31, and 2010 (USD millions)
2011 2010
Assets
Cash $ 480,000 $ 96,000
Accounts receivable, net 86,400 115,200
Merchandise inventory 384,000 403,200
Plant and equipment, net 268,800 288,000
Total assets $ 1,219,200 $902,400
Liabilities and stockholders' equity
Accounts payable $ 96,000 $ 96,000
Common stock 672,000 672,000
Retained earnings 451,200 134,400
Total liabilities and stockholders' equity $1,219,200 $902,400
Based on your review of the comparative balance sheets, determine the following:

  1. What was the net income for 2011 assuming there were no dividend payments?
  2. What was the primary source of the large increase in the cash balance from 2010 to 2011?
  3. What are the two main sources of assets for Darling Corporation?
  4. What other comparisons and procedures would you use to complete the analysis of the balance sheet?


Business decision case B As Miller Manufacturing Company's internal auditor, you are reviewing the company's credit policy. The following information is from Miller's annual reports for 2008, 2009, 2010, and 2011:

2008 2009 2010 2011
Nets accounts receivable $ 1,080,000 $ 2,160,000 $ 2,700,000 $ 3,600,000
Net sales 10,800,000 13,950,000 17,100,000 19,800,000
Management has asked you to calculate and analyze the following in your report:

  1. If cash sales account for 30 per cent of all sales and credit terms are always 1/10, n/60, determine all turnover ratios possible and the number of days' sales in accounts receivable at all possible dates. (The number of days' sales in accounts receivable should be based on year-end accounts receivable and net credit sales.)
  2. How effective is the company's credit policy?


Business decision case C Wendy Prince has consulted you about the possibility of investing in one of three companies (Apple, Inc., Baker Company, or Cookie Corp.) by buying its common stock. The companies' investment shares are selling at about the same price. The long-term capital structures of the companies alternatives are as follows:

Apple, Inc. Baker Company Cookie Corp.
Bonds with a 10% interest rate $2,400,000
Preferred stock with an 8% dividend rate $2,400,000
Common stock, $10 par value $4,800,000 2,400,000 2,400,000
Retained earnings 384,000 384,000 384,000
Total long-term equity $5,184,000 $5,184,000 $5,184,000
Number of common shares outstanding 480,000 240,000 240,000
Prince has already consulted two investment advisers. One adviser believes that each of the companies will earn $300,000 per year before interest and taxes. The other adviser believes that each company will earn about $960,000 per year before interest and taxes. Prince has asked you to write a report covering these points:

  1. Compute each of the following, using the estimates made by the first and second advisers.


(a)Earnings available for common stockholders assuming a 40 per cent tax rate.

(b)EPS of common stock.

(c)  Rate of return on total stockholders' equity.

  1. Which stock should Prince select if she believes the first adviser?
  2. Are the stockholders as a group (common and preferred) better off with or without the use of long-term debt in the companies?


Annual Report analysis D The following selected financial data excerpted from the annual report of Appliance Corporation represents the summary information which management presented for interested parties to review:

Appliance Corporation Selected Financial Data (USD thousands except per share data)
2010 2009 2008 2007 2006
Net sales $3,049,524 $3,372,515 $2,987,054 $3,041,223 $2,970,626
Cost of sales 2,250,616 2,496,065 2,262,942 2,339,406 2,254,221
Income taxes 74,800 90,200 38,600 15,900 44,400
Income (loss) from continuing operations (14,996) 151,137 51,270 (8,254) 79,017
Per cent of income (loss) from continuing operations to net sales (0.5%) 4.5% 1.7% (0.3%) 2.7%
Income (loss) from continuing operations per share $ (0.14) 1.42 0.48 (0.08) $ 0.75
Dividends paid per share 0.515 0.50 0.50 0.50 0.50
Average shares outstanding (in thousands) 107,062 106,795 106,252 106,077 105,761
Working capital $ 543,431 $ 595,703 $ 406,181 $452,626 $ 509,025
Depreciation of property, plant and equipment 102,572 110,044 102,459 94,032 83,352
Additions to property, plant and equipment 152,912 84,136 99,300 129,891 143,372
Total assets 2,125,066 2,504,327 2,469,498 2,501,490 2,535,068
Long-term debt 536,579 663,205 724,65 789,232 809,480
Total debt to capitalization 45.9% 50.7% 60.0% 58.7% 45.9%
Shareowners' equity per share of common stock $ 6.05 $ 6.82 $ 5.50 $ 9.50
  1. As a creditor, what do you believe management's objectives should be? Which of the preceding items of information would assist a creditor in judging management's performance?
  2. As an investor, what do you believe management's objectives should be? Which of the preceding items of information would assist an investor in judging management's performance?
  3. What other information might be considered useful?


Group project E Choose a company the class wants to know more about and obtain its annual report. In groups of two or three students, calculate either the liquidity, equity, profitability, or market test ratios. Each group should select a spokesperson to tell the rest of the class the results of the group's calculations. Finally, the class should decide whether or not to invest in the corporation based on the ratios they calculated.

Group project F In a group of two or three students, go to the library and attempt to locate Dun & Bradstreet's Industry Norms and Key Business Ratios. You may have to ask the reference librarian for assistance to see if this item is available at your institution. If it is not available at your institution, ask if it is available through an interlibrary loan. (Obviously, if you cannot obtain this item, you cannot do this project.) Then select and obtain the latest annual report of a company of your choice. Determine the company's SIC Code (a code that indicates the industry in which that company operates). SIC Codes for specific companies are available on COMPACT DISCLOSURE, an electronic source that may be available at your library. As an alternative, you could call the company's home office to inquire about its SIC Code. The annual report often contains the company's phone number. From the annual report, determine various ratios for the company, such as the current ratio, debt to equity ratio, and net income to net sales. Then compare these ratios to the industry norms for the company's SIC Code as given in the Dun & Bradstreet source. Write a report to your instructor summarizing the results of your investigation.

Group project G In a group of two or three students, obtain the annual report of a company of your choice Identify the major sections of the annual report and the order in which they appear. Would you recommend the order be changed to emphasize the most useful and important information? If so, how? Then describe some specific useful information in each section. Comment on your perceptions of the credibility that a reader of the annual report could reasonably assign to each section of the report. For instance, if such a discussion appears in the annual report you select, would you assign high credibility to everything that appears in the Letter to Stockholders regarding the company's future prospects? Write a report to your instructor summarizing the results of your investigation.

Using the Internet—A view of the real world Visit the following website for Eastman Kodak Company:

http://www.kodak.com

By following choices on the screen, locate the income statements and balance sheets for the latest two years. Calculate all of the ratios illustrated in the chapter for which the data are available. Compare the ratios to those shown for Synotech as presented in the chapter. Write a report to your instructor showing your calculations and comment on the results of your comparison of the two companies.

Visit the following website for General Electric Company:

http://www.ge.com

By following choices on the screen, locate the income statements and balance sheets for the latest two years. Calculate all of the ratios illustrated in the chapter for which the data are available. Compare the ratios to those shown for Synotech as presented in the chapter. Write a report to your instructor showing your calculations and comment on the results of your comparison of the two companies.

Answers to self-test True-false True. Financial statement analysis consists of applying analytical tools and techniques to financial statements and other relevant data to obtain useful information.

False. Horizontal analysis provides useful information about the changes in a company's performance over several periods by analyzing comparative financial statements of the same company for two or more successive periods.

False. Common-size statements show only percentage figures, such as percentages of total assets and percentages of net sales.

True. Liquidity ratios such as the current ratio and acid-test ratio indicate a company's short-term debt-paying ability.

True. The accrual net income shown on the income statement is not cash basis income and does not indicate cash flows.

True. Analysts must use comparable data when making comparisons of items for different periods or different companies.

Multiple-choice
  1. b. Current assets: $136,000 + $64,000 + $184,000 + $244,000 + $12,000 = $640,000


Current liabilities: $256,000 + $64,000 = $320,000

Current ratio:

  1. c. Quick assets:


$136,000 + $64,000 + $184,000 = $384,000

Current liabilities:

256,000 + $64,000 = $320,000

Acid-test ratio:

  1. Net sales:


$4,620,000

Average accounts receivable:

Accounts receivable turnover:

  1. Cost of goods sold:


$3,360,000

Average inventory:

Inventory turnover:

  1. Income before interest and taxes, $720,000


Interest on bonds, 192,000

Times interest earned ratio: $720,000/$192,000 = 3.75 times

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