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12.10: Chapter 12: Exercises

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    10691
  • 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.

    $2,028,000        1,294,800  $ 733,200  327,600  $ 405,600

    Net sales
    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
    Gross margin
    Operating expenses
    Net operating income

    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

    ($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

    ($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

    ($millions)

    $ 842  3,599  702  1,162  1,258  $7,563  5,339  2,270       1,995  597  16,117  1,428  $25,027    $ 5,161  2,502  739  $ 8,402  6,959  2,833  2,377  356       $45,027

    Assets
    Cash and cash equivalents
    Receivables
    Inventories
    Film and television costs
    Other
    Total current costs
    Film and television costs
    Investments
    Theme parks, resorts, and other property, at cost
    Attractions, buildings, and equipment $16,160
    Accumulated depreciation (6,892)
    9,718
    Project in process
    Land
    Intangibles assets, net
    Other assets
    Total assets
    Liabilities and stockholders’ equity
    Accounts payable and accrued liabilities
    Current portion of borrowing
    Unearned royalties
    Total current liabilities
    Borrowings
    Deferred income taxes
    Other long-term liabilities
    Minority interest
    Common shareholders’ equity
    Common shares ($.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
    • 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

    (USDthousands)

    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
    ($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 stockholdersequity
    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

    ($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:

    $2,400,000  $2,400,000

    Apple,

    Inc.

    Baker

    Company

    Cookie

    Corp.

    Bonds with a 10% interest rate
    Preferred stock with an 8% dividend rate
    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

    ($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