Finansal Yönetim Finance (Eyüp Bastı) Problems - Chapter 2 44 List of Tenns Discussion Questions Practice Problems and Solutions Determination of profitability (L01) Part 2 Financial Analysis and Planning income statement 27 earnings per share 28 price-earnings ratio 28 balance sheet 30 liquidity 30 net worth, or book value 32 statement of cash flows 33 cash flows from operating activities 34 casb flows from investing activities 36 cash flows from financing activities 36 depreciation 39 free cash flow 39 1. Discuss some financial variables that affect the price-earnings ratio. (L02) 2. What is the difference between book value per share of common stock and market value per share? Why does this disparity occur? (L03) 3. Explain how depreciation generates actual cash flows for the company. (L05) 4. What is the difference between accumulated depreciation and depreciation expense? How are tbey related? (L05) 5. How is the il)come statement related to the balance sheet? (L01 &3) 6. Comment on why inflation may restrict the usefulness of the balance sheet as normally presented. (L03) 7. Explain why the statement of cash flows provides useful information that goes beyond income statement and balance sheet data. (L04) 8. What are the three primary sections of the statement of cash flows? In what section would the payment of a cash dividend be shown? (L04) 9. What is free cash flow? Why is it important to leveraged buyouts? (L04) 10. Why is interest expense said to cost the firm substantially less than the actual expense, while dividends cost it 100 percent of the outlay? (La 1) I. LeBron Furniture Company has the following financial data. Prepare an income statement and compute earnings per share. See Table 2- 1 as an example. Sales . .-. Depreciation expense Cost of goods sold .. Interest expense ... Selling and administrative expense . .. . .• • . • . .. . . . . • •..... . .. . . •.. Common shares outstanding ... . ... . . . ••.. . Taxes ... . Preferred stock dividends ..... . ... ... • •......... . • • . .... ....• • . $1.300.000 70.000 800.000 30.000 140.000 60,000 75,000 5,000 Chapter 2 Review of Accounting 2. Northern Energy Company has assets of $7,000,000, liabilities of $4,000,000, and $500,000 in preferred stock outstanding. Four hundred thousand common stock shares have been issued. a. Compute book value per share. b. If the firm has earnings per share of $1.10 and a PIE ratio of 15, what is the stock price per share? c. What is the ratio of market value per share to book value !ler share? SoluUons 1. Sales . .......... . $1,300,000 Cost of goods sold . . . ... . . . . . 800,000 Gross profit. 500,000 Selling and administrative expense . . ... . . . ... .. . . . . .. . . . .. • • .. . . . 140,000 Depreciation expense ............. . .. . .. . . . .. . . 70,000 Operating profit . . , , . , . . , . . . ... . .. . . . , .. . . . . . ... .. . . .. •... ... 290,000 Interest expense . .. . .. .. . 30,000 Earnings before taxes 260,000 Taxes, ,. , ,. " , , . . ,. , ,. , 75,000 Earnings after taxes . . .. .... .. .. . , . , , . , , , , . .. . . .. . .. . . ~ . .. . , . 185,000 Preferred stock dividends . . , . , . . 5,000 Earnings available to common stockholders $ 180,000 Common shares outstanding . . .. .... . . 60,000 Earnings per share , .. , .. , . , $ 3.00 2. a. Use the example material on page 32 to compute book value per share. Total assets , . , , . . , . , . Total liabilities. , , . , , . , Stockholders' equity , . , Preferred stock obligation , . , , , , Net worth assigned to common . , Common shares outstanding . .. . . ... . . . . . . . •. . .. . .. . . ...•.... . , Book value per share . , . , , . , ,_ , , b. EPS X PI E ratio = Stockpriceper share $1.10 X I5 = $16.50 C. Market value Book value $16.50 6.25 2.64X $7,000,000 4,000,000 3,000,000 $ 500,000 2,500,000 400,000 6.25 ~" All Problems are available In Homework Manager. Please see the preface for more Infonnatlon. ~ Determination of profitability (L02 ) Problems 45 1. Rockwell Paper Company had earnings after taxes of $580,000 in the year 2007 Income statement with 400,000 shares of common stock outstanding. On January 1, 2008, the firm (LOl) issued 35,000 new shares. Because of the proceeds from these new shares and other operating improvements, earnings after taxes increased by 25 percent. 46 Income statement (LOJ) Gross profit (LOJ) Income statement (L01) Income statement (LOJ) Income Z4 statement (LO 1) Part 2 Financial Analysis and Planning a. Compute earnings per share for the year 2007. b. Compute earnings per share for the year 2008. 2. Sosa Diet Supplem,nts had earnings after taxes of $800,000 in the year 2008 with 200,000 shares of common stock outstanding. On January 1, 2009, the finn issued 50,000 new shares. Because of the proceeds from these new shares and other operating improvements, earnings after taxes increased by 30 percent. a. Compute earnings per share for the year 2008. b. Compute earnings per share for the year 2009. 3. a. Kevin Bacon and Pork Company had sales of $240,000 and cost of goods sold of $108,000. What is the gross profit margin (ratio of gross profit to sales)? b. If the average finn in the pork industry had a gross profit of 60 percent, bow is the firm doing? 4. Arrange the following income statement items so they are in the proper order of an income statement: Taxes Common shares outstanding Gross profit shares outstanding Interest expense DepreCiation expense Preferred stock dividends Operating profit Sales Gross profit Earnings per share Earnings before taxes Cost of goods sold Earnings after taxes Earnings available to common stockholders Selling and administrative expense 5. Given the following information, prepare in good form an income statement for Goodman Software, Inc. Selling and administrative expense . . . Depreciation expense Sales . . .... .. . . Interest expense . . . . . . . . . . • . . . . . . . . . . • . . . . . . ... . .. . . . . . Cost of goods sold. Taxes .. $ 50,000 80,000 400,000 30,000 150.000 18,550 6. Given the following information, prepare in good form an income statement for the Kid Rock and Gravel Company. Selling and administrative expense. Depreciation expense . .. .. . .. . .. . . . .. . ... .. . . .• . Sales . ... Interest expense . .. . Cost of goods sold. Taxes . . . .. . .... .. . $ 60,000 70.000 470,000 40,000 140,000 45.000 Chapler 2 Review of Account;'lg ~ 7. Prepare in good form an income statement for Virginia Slim Wear. Take your cal­ culations all the way to computing earnings per share. Sales . ... Shares outstanding . .... . ........... . .. ....... . .. .... ... . ... . .. . Cost of goods sold . . . . .................... • . Interest expense ................... •........ Selling and administrative expense. Depreciation expense ..... Preferred stock dividends .......... . . . ...... . Taxes . ........ . $600,000 100,000 200,000 30,000 40,000 20,000 80,000 100,000 8. Prepare in good form an income statement for Franklin Kite Co., Inc. Take your calculations all the way to computing earnings per share. Sales ..... . Shares outstanding .. Cost of goods sold . . .. Interest expense Selling and administrative expense ...... •.... ...... . .•..........•• Depreciation expense ........ . . ..... ... . . ....•. . . . . . . . . . Preferred stock dividends .... . . Taxes ................ . $900,000 50,000 400,000 40,000 60,000 20,000 80,000 50,000 9. Lasar Technology, Inc., had sales of $500,000, cost of goods sold of $180,000, selling and administrative expense of $70,000, and operating profit of $90,000. What was the value of depreciation expense? Set this problem up as a partial income statement, and determine depreciation expenses as the plug figure. 10. The Ace Book Company sold 1,500 finance textbooks for $185 each to High Tuition University in 2008. These books cost Ace $1 45 to produce. Ace spent $10,000 (selling expense) to convince the university to buy its books. In addition, Ace borrowed $80,000 on January 1, 2008, on which the company paid 10 per­ cent interest. Both interest and principal on the loan were paid on December 31, 2008. Ace's tax rate is 25 percent. Depreciation expense for the year was $15,000. Did Ace Book Company make a profit in 2008? Please verify with an income statement presented in good form. 11. Carr Auto Wholesalers had sales of $900,000 in 2008 and their cost of goods sold represented 65 percent of sales. Selling and administrative expenses were 9 percent of sales. Depreciation expense was $ 10,000 and interest expense for the year was $8,000. The firm 's tax rate is 30 percent. a. Compute earnings after taxes. b. Assume the firm hires Ms. Hood, an efficiency expert, as a consultant. She suggests that by increasing selling and administrative expenses to 12 per­ cent of sales, sales can be increased to $1,000,000. The extra sales effort Detennination of profitability (LOI) Detennination of profitability (LO]) Income statement (LOl ) Detennination of profitability (LOl ) Detemullation of profitability (LOl ) 47 48 Balance sheet (L03) Balance sheet and income statement classification (LOJ&3) Part 2 Financial Analysis and Planning will also reduce cost of goods sold to 60 percent of sales (there will be a larger markup in prices as a result of more aggressive selling). Depreciation expense will remain at $10,000. However, more automobiles will have to be carried in inventory to satisfy customers, and interest expense will go up to $15,000. The firm's tax rate will remain at 30 percent. Compute revised earnings after taxes based on Ms. Hood's suggestions for Carr Auto Whole­ salers. Will her ideas increase or decrease profitability? 12. Classify the following balance sheet items as current or noncurrent: Retained earnings Accounts payable Prepaid expenses Plant and equipment Inventory Common stock Bonds payable Accrued wages payable Accounts receivable Capital in excess of par Preferred stock Marketable securities 13. Fill in the blank spaces with categories I through 7. 1. Balance sheet (BS) 2. Income statement (IS) 3. Current assets (CA) 4. Fixed assets (FA) 5. Current liabilities (CL) 6. Long-terrn liabilities (LL) 7. Stockholders' equity (SE) Indicate Whether Item Is on Balance Sheet (BS) or Income Statement (IS) If on Balance Sheet, Designate Which Category Item Accounts receivable Retained earnings Income tax expense Accrued expenses Cash Selling and administrative expenses Plant and equipment Operating expenses Marketable securities Interest expense Sales Notes payable (6 months) Bonds payable, maturity 2009 Common stock Depreciation expense Inventories Capital in excess of par value Net income (earnings after taxes) Income tax payable Chapter 2 Review of Accounting 14. Arrange the following items in proper balance sheet presentation: Accumulated depreciation . . . . . • • . . . . . . . . . • • • . . . . . . . . • • • . . . . . . . . . $200,000 Retained earnings . .......... • . •. .. ....... •........ . . . ......... Cash .... ... . . .. .. ... .. . ... . . . ................ ........ . .. .. . Bonds payable .............. . .. . .. . .... ...................... . Accounts receivable . ..................... . ••........... . . Plant and equipment-original cost. ...... . .. ...... . . ........ . . .. . . Accounts payable . ............. ....... . . .... . Allowance for bad debts . .................................... . Common stock, $1 par, 100,000 shares outstanding .... .. .. . •• •... .. . Inventory . ................... ................. ... . .. .. .. ..... . Preferred stock, $50 par, 1,000 shares outstanding ...... . . . . .••.... .. Marketable securities . ........... .... ..... ............. . • . . . .... Investments .........................................•. Notes payable ... . .......... ............... . ........ . . ... .... . Capital paid in excess of par (common stock) .............. . . ....... . 110,000 5,000 142,000 38,000 720,000 35,000 6,000 150,000 66,000 50,000 15,000 20,000 83,000 88,000 15. Elite Trailer Parks has an operating profit of $200,000. Interest expense for the year was $10,000; preferred dividends paid were $18,750; and common divi­ dends paid were $30,000. The tax was $61,250. The firm has 20,000 shares of common stock outstanding. a. Calculate the earnings per share and the common dividends per share for Elite Trailer Parks. b. What was the increase in retained earnings for the year? 16. Johnson Alarm Systems had $800,000 of retained earnings on December 31 , 2008. The company paid common dividends of $60,000 in 2008 and had retained earnings of $640,000 on December 31 , 2007. How much did Johnson earn dur­ ing 2008, and what would earnings per share be if 50,000 shares of common stock were outstanding? 17. MOZ ar1 Music Co. had earnings after taxes of $560,000 in 2008 with 200,000 shares of stock outstanding. The stock price was $58.80. In 2009, earnings after taxes increased to $650,000 with the sarne 200,000 shares outstanding. The stock price was $78.00. a. Compute earnings per share and the PIE ratio for 2008. The PIE ratio equals the stock price divided by earnings per share. b. Compute earnings per share and the PIE ratio for 2009. c. Give a general explanation of why the PIE changed. 18. Assume for Mozar1 Music Co., discussed in Problem 17, in 2010 earnings after taxes declined to $300,000 with the sarne 200,000 shares outstanding. The stock price declined to $54.00. a. Compute earnings per share and the PIE ratio for 20 I O. b. Give a general explanation of why the PIE changed. You might want to con­ sult page 29 of the textbook to explain this surprising result. Development of balance sheet (L03) 49 Earnings per share and retained earni ngs (L01&3) Earnings per share and retained earnings (L01&3) Price-earnings ratio (L02) Price-earnings ratio (L02) 50 Cash flow (L04) Free cash flow (L04) Part 2 Financial Analysis and Planning 19. Identify whether each of the following items increases or decreases cash flow: Increase in accounts receivable Increase in notes payable Depreciation expense Increase in investments Decrease in accounts payable Decrease in prepaid expenses Increase in inventory Dividend payment Increase in accrued expenses 20. Nova Electrics anticipated cash flow from operating activities of $6 million in 2008. It will need to spend $1.2 million on capital investments in order to remain competitive within the industry. Common stock dividends are projected at $.4 million and preferred stock dividends at $.55 million. a. What is the firm's projected free cash flow for the year 2008? b. What does the concept of free cash flow represent? Depreciation and cash flow (L05) ~ 21. The Rogers Corporation has a gross profit of $880,000 and $360,000 in depre­ ciation expense. The Evans Corporation also has $880,000 in gross profit, with $60,000 in depreciation expense. Selling and administrative expense is $120,000 for each company. Book value (L03) Book value and PIE ratio (L02&3) Book value and market value (L02&3) Book value and PIE ratio (L02&3) Construction of income statement and balance sheet (£01&3) Given that the tax rate is 40 percent, compute the cash flow for both compa­ nies. Explain the difference in cash flow between the two firms. 22. Horton Electronics has current assets of $320,000 and fixed assets of $640,000. Current liabilities are $90,000 and long-term liabilities are $160,000. There is $90,000 in preferred stock outstanding and the firm has issued 40,000 shares of common stock. Compute book value (net worth) per sbare. 23. Tbe Holtzman Corporation has assets of $400,000, current liabilities of $50,000, and long-term liabilities of $100,000. There is $40,000 in preferred stock out­ standing; 20,000 shares of common stock have been issued. Q. Compute book value (net worth) per share. b. If there is $22,000 in earnings available to common stockholders and Holtzman's stock has a PIE of 18 times earnings per share, what is the cur­ rent price of the stock? c. What is Y'e ratio of market value per share to book value per share? 24. Bradley Gypsum Company has assets of $1,900,000, current liabilities of $700,000, and long-term liabilities of $580,000. There is $17.0,000 in preferred stock outstanding; 30,000 shares of common stock have been issued. a. Compute book value (net worth) per share. b. If there is $42,000 in earnings available to common stockholders and Bradley's stock has a PIE of 15 times earnings per share, what is the current price of the stock? c. What is the ratio of market value per share to book value per share? 25. In problem 24, if the firm sells at two times book value per share, what will the PIE ratio be? 26. For December 31 , 2007, the balance sheet of the Gardner Corporation is as follows: Chapter 2 Review of Accounting Current Assets Cash .. . Accounts receivable . . Inventory . ..... . Prepaid expenses .. . . Fixed Assets Plant and equipment (gross) . Less: Accumulated depreciation . . Net plant and assets . Total assets. $ 15,000 22,500 37,500 18,000 $375,000 75,000 300,000 $393,000 Liabilities Accounts payable $ 20,000 Notes payable . 30,000 Bonds payable. 75,000 Stockholders' Equity Common stock . .. $112,500 Paid·in capital . ... 37,500 Retained earnings. 118,000 Total liabilities and stockholders' equity . .... $393,000 Sales for the year 2008 were $330,000, with cost of goods sold being 60 per­ cent of sales. Selling and administrative expense was $33,000. Depreciation expense was 10 percent of plant and equipment (gross) at the beginning of the year. Interest expense for the notes payable was 10 percent, while interest on the bonds payable was 12 percent. These were based on December 31 , 2007, balances. The tax rate averaged 20 percent. Two thousand dollars in preferred stock dividends were paid and $4,100 in dividends were paid to common stockbolders. There were 10,000 shares of com­ mon stock outstanding. During the year 2008, the cash balance and prepaid expenses balance were unchanged. Accounts receivable and inventory increased by 20 percent. A new machine was purchased on December 31 , 2008, at a cost of $60,000. Accounts payable increased by 30 percent. At year-end, De~ember 31, 2008, notes payable increased by $10,000 and bonds payable decreased by $15,000. The common stock and paid-in capital in excess of par accounts did not change. a. Prepare an income statement for the year 2008. b. Prepare a statement of retained earnings for the year 2008. c. Prepare a balance sheet as of December 31, 2008. 51 27. Prepare a statement of cash flows for the Crosby Corporation. Follow the general Statement of cash procedures indicated in Table 2-10 on page 38. flows CROSBY CORPORATION Income Statement For the Vear Ended December 31, 2008 Sales .. . . .. . . Cost of goods sold ....... . Gross profits Selling and administrative expense. Depreciation expense ................ . . . Operating income ..... Interest expense . .. Earnings before taxes . . ...• . .... Taxes . . . .. . ..............•.•. . . .. . .. . ••.. . . . .. . . $2,200,000 1,300,000 900,000 420,000 150,000 330,000 90,000 240,000 80,000 continued (L04) 52 Part 2 Financial Analysis,. and Planning CROSBY CORPORATION Income Statement For the Year Ended December 31 , 2008 Earnings after taxes . ...... .. .... . .. . Preferred stock dividends . .. . .. . . . Earnings available to common stockholders. Common shares outstanding Earnings per share 160,000 10,000 $ 150,000 120,000 $ Statement of Retained Earnings For the Year Ended December 31,2008 Retained earnings, balance, January 1, 2008. Add: Earnings available to common stockholders, 2008 ..... .. .. . Deduct: Cash dividends declared and paid in 2008 Retained earnings, balance,_ December 31, 2008 . Current assets: Cash Accounts receivable (net) Inventory . . Comparative Balance Sheets For 2007 and 2008 Assets Prepaid expenses .... . .. . . . .. . .... . .. . . Total current assets Investments (long-term securiti es) . . .. . .. . .. . . . • Plant and equipment ................ . . Less: Accumulated depreciation Net plant and equipment. Total assets . . Year-End 2007 $ 70,000 300,000 410,000 50,000 830,000 80,000 2,000,000 1,000,000 1,000,000 $1 ,910,000 Liabilities and Stockholders' Equity Current liabilities: Accounts payable Notes payable .. . Accrued expenses. Total current liabilities. Long-term liabilities: Bonds payable, 2012 . .. . . . Total liabilities Stockholders' equity: Preferred stock, $100 per value . Common stock, $1 par value . . . Capital paid in excess of par . .. . . Retained earnings . .... . ... . Total stockholders' equity . Total liabilities and stockholders' equity . . $ 250,000 400,000 70,000 720,000 70,000 790,000 90,000 120,000 410,000 500,000 1,120,000 $1,910,000 1.25 $500,000 150,000 50,000 $600,000 Year-End 2008 $ 100,000 350,000 430,000 30,000 910,000 70,000 2,400,000 1,150,000 1,250,000 $2,230,000 $ 440,000 400,000 50,000 890,000 120,000 1,010,000 90,000 120,000 410,000 600,000 1,220,000 $2,230,000 Chapter 2 Review of Accounting (The following questions apply to the Crosby Corporation, as presented in problem 27.) 28. Describe the general relationship between net income and net cash flows from operating activities for the firm. 29. Has the buildup in plant and equipment been financed in a satisfactory manner? Briefly discuss. 30. Compute the book value per common share for both 2007 and 2008 for the Crosby Corporation. 31. If the market value of a share of common stock is 3.3 times book value for 2008, what is the firm's PIE ratio for 2008? WEB EXERCISE PepsiCo is a company that provides comprehensive financial statements. Go to its Web site, www.pepsico.com.and under "Investors," click on "Annual Reports." Then click on the most current annual report (interactive). Next click on "Financial Reports." I . Indicate the change for the most recent year in (in percentages) for the following: a. Total net revenue b. Net income c. Capital spending d. Dividends paid. 2. Next click on "PepsiCo International" under the "Financial Highlights" menu. Scroll down and indicate what percentage of revenues is provided by Frito Lay North America and what percentage by Latin American Foods. Note: Occasionally a topic we have listed may have been deleted, updated, or moved into a differenl location on a Web site. If you click on the site map or site index, you will be introduced to a table of conte nts which should aid you in finding the topic you are looking for. 53 Net income and cash flows (W I &3) Financing of assets (W3) Book value (L03) PIE ralio (L02) S & P PRO B L EMS \\'\\'\V.mhhe.com/edumarkelinsighl Log onto the S&P Market Insight Web site, www.mhhe.com/edumarketinsight. Click on "Company," which is the first box below the Market Insight title. Type Abercrombie & Fitch's ticker symbol "ANF" in the box and click on Go. Scroll down the left margin and click on "Excel Analytics." At the top of the left margin you will see the Annual Income Statement, Balance Sheet, and Cash Flow Statement. Click on "Ann. Income Statement" and maximize the window at the lOp right-hand corner of the spreadsheet. You will find an Excel workbook with three sheets: (1) Annual Income Statement, (2) % Change, and (3) Key Items. \. Familiarize yourself with the company and after looking at all three sheets, prepare a written analysis of the company over the time period available. When you are done, close the window and click on "Ann. Balance Sheet." 2. How much long-term debt does ANF have? STANDARD & POOR'S