Chapter 15 Financial Statement Analysis
Chapter 15 Financial Statement Analysis Solutions to Questions 15-1 Horizontal analysis examines how a particular item on a fnancial statement such as sales or cost o goos sol !eha"es o"er time# $ertical analysis in"ol"es analysis o items on an income statement or !alance sheet or a single perio# %n "ertical analysis o the income statement& all items are typically state as a percentage o sales# %n "ertical analysis o the !alance sheet& all items are typically state as a percentage o total assets# 15-' By looking at trends, an analyst hopes to get some idea of whether a situation is improving, remaining the same, or deteriorating. Such analyses can provide insight into what is likely to happen in the future. Rather than looking at trends, an analyst may compare one company to another or to industry averages using common-size nancial nancial statements. 15-( Price-earnings ratios reect investors! e"pectations concerning future earnings. #he higher the price-earnings ratio, the greater the growth in earnings investors e"pect. $or this reason, two companies might have the same current earnings and yet have %uite di&erent price-earnings ratios. By denition, a stock with current earnings of '( and a price-earnings ratio of )* would +e selling for '* per share. 15-) rapidly growing tech company would pro+a+ly have many opportunities to make investments at a rate of return return higher than stockholders could earn in other investments. t would +e +etter for the company to invest in such opportunities than to pay out dividends and thus one would e"pect the company to have a low dividend payout ratio. 15-5 #he dividend yield yield is the dividend per share divided divided +y the market price per share. #he other source source of return return on an investment investment in stock stock is increases increases in market value. 15-* $inancial leverage results from +orrowing funds at an interest rate that di&ers from the rate of return on assets ac%uired using those funds. f the rate of return on the assets is higher than the interest rate at which the funds were +orrowed, nancial leverage is positive and stockholders gain. f the return on the assets is lower than the interest rate, nancial leverage is negative and the stockholders lose. 15-+ f the company e"periences e"periences +ig variations in net cash ows from operations, stockholders might +e pleased that the company has no de+t. n hard times, interest payments might +e very di/cult to meet. 0n the other hand, if investments within the company can earn a rate of return that e"ceeds the interest rate on de+t, stockholders would get the +enets of positive leverage if the company took on de+t. 15-, #he market market value of a share share of common stock often e"ceeds e"ceeds the +ook value per share. Book value represents the cumulative e&ects on the +alance sheet of past activities,
15-1
Chapter 15 Financial Statement Analysis
evaluated using historical prices. #he market value of the stock reects investors! e"pectations a+out the company!s future earnings. $or most companies, market value e"ceeds +ook value +ecause investors anticipate future earnings growth.
15-2
Chapter 15 Financial Statement Analysis
15-
) to 1 current ratio might not +e ade%uate for several reasons. $irst, the
composition of the current assets may +e heavily weighted toward slow-turning and di/cultto-li%uidate inventory, or the inventory may contain large amounts of o+solete goods. Second, the receiva+les may +e low %uality, including large amounts of accounts that may +e di/cult to collect.
.xercise 15-1 213 minutes4 1. Sales ales.. .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... 6ost of goods sold. d............................. ...... .... 9ross mar marg gin. n......................... .................. Selling and administrative e"penses: Selling e"penses............................... dministrative e"penses................... #otal #otal selling and administrative e"pens nses es................. .......... ...... .... .... .... ........ ...... .... .... .... ..
Last This Year Year 1**.*5 1**. *5 1** **.* .*5 5 78.)5 7*.*5 87.5 (*.*5 1.*5 18.75
1;.35 1(.75
81.75 3.)5 1.(5 8.5
8).15 ;.=5 1.*5 7.=5
). #he company!s company!s ma>or ma>or pro+lem pro+lem seems to +e the increase increase in cost of goods sold, which increased from 7*.*5 of sales last year to 78.)5 of sales this year. year. #his suggests that the company is not passing the increases in the costs of its products on to its customers. s a result, cost of goods sold as a percentage of sales has increased and gross margin has decreased. Selling e"penses and interest e"pense have +oth increased slightly during the year, which suggests that costs generally are going up in the company. company. #he only e"ception is the administrative e"penses, which have decreased from 1(.75 of sales last year to 18.75 of sales this year. year. #his pro+a+ly is a result of the company!s e&orts to reduce administrative e"penses during the year.
15-3
Chapter 15 Financial Statement Analysis
.xercise 15-' 28* minutes4 1. 6alculation 6alculation of the gross gross margin margin percentage: percentage:
9ross margin Sales ')8,*** ? ? 8(.5 '77,***
9ross margin percentage ?
). 6alculation 6alculation of the the earnings earnings per share: share:
@arnings per share ?
8. 6alculation 6alculation of the price-ear price-earnings nings ratio: ratio: Price-earnings ratio ? ?
Aarket price per share @arnings per share ')7 ? .1 '8.)*
(. 6alculation 6alculation of the the dividend dividend payout payout ratio: Bividend payout ratio ? ?
Bividends per share @arnings per share '*.;3 ? )8.(5 '8.)*
3. 6alculation 6alculation of the the dividend dividend yield yield ratio: ratio:
15-4
Chapter 15 Financial Statement Analysis
Bividend yield ratio ? ?
Bividends per share Aarket price per share '*.;3 ? ).=5 ).=5 ')7.**
.xercise 15-' 2continued4 7. 6alculation 6alculation of the the return return on total assets: assets:
'1,=* C D'** E 21 - *.(*4F ?8.;5 '73,1* 1* C '7,( '7,(* *4 G) 2 '73,
;. 6alculation of the return on common stockholders! e%uity: e%uity: Beginning +alance, stockholders! e%uity e%uity 2a4... 2a4...... ...... ....... ....... ...... ...... ...... ...... ...... ....... .......... ......... ... @nding +alance, stockholders! e%uity 2+4. 2+4... .... .... .... ..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ... verage stockholders! e%uity D2a4 C 2+4FG 2+4FG). )... .... .... .... .... .... .... .... ..... ...... ...... ...... ...... ...... ...... ...... ...... ...... ...... ... verag verage e prefe preferr rred ed stoc stock. k... .... .... .... ..... ...... ...... ...... ...... ... verag verage e comm common on stoc stockho khold lders ers!! e%ui e%uity. ty.
'8=,71 '8=,71* * (1,* (1 ,** * (*,8(3 (*,8 (3 1,** 1, *** * '8=, '8 =,8( 8(3 3
'1,=* - '7* ? (.=5 '8=,8(3
. 6alculation 6alculation of the the +ook value value per share: share:
15-5
Chapter 15 Financial Statement Analysis
Book value per share ? ?
#otal stockholdersH e%uity - Preferred stock
15-6
Chapter 15 Financial Statement Analysis
.xercise 15-( 28* minutes4 1. 6alculation of working capital:
Iorking capital ? 6urrent assets - 6urrent lia+ilities ? ')),7* - '1=,(** ? '8,)* ). 6alculation of the current ratio:
6urrent assets 6urrent lia+ilities ')),7* ? ? 1.1; '1=,(**
6urrent ratio ?
8. 6alculation of the acid-test ratio:
6ash C Aarketa+le securities C ccounts receiva+le C Short-term notes cid-test ratio ? 6urrent lia+ilities '1,** C '* C '=,*** C '* ? ? *.3) '1=,(** (. 6alculation of accounts receiva+le turnover: Sales on account ccounts receiva+le ? turnover verage accounts receiva+le +alance ?
'77,*** ? .3 2'7,3** C '=,***4G)
3. 6alculation of the average collection period: 873 days ccounts receiva+le turnover 873 days ? ? ().= days .3
verage collection period ?
15-7
Chapter 15 Financial Statement Analysis
.xercise 15-( 2continued4 7. 6alculation of inventory turnover: nventory turnover ? ?
6ost of goods sold verage inventory +alance '(8,*** ? 8. 2'1*,7** C '1),***4G)
;. 6alculation of the average sale period:
873 days nventory turnover 873 days ? ? =7.1 days 8.
verage sale period ?
15-8
Chapter 15 Financial Statement Analysis
.xercise 15-) 213 minutes4 1. 6alculation of the times interest earned ratio:
@arnings +efore interest #imes interest ? e"pense and income ta"es earned ratio nterest e"pense ?
'(,1** ? 3.1 '**
). 6alculation of the de+t-to-e%uity ratio: Be+t-to-e%uity ratio ? ?
#otal lia+ilities StockholdersH e%uity ');,(** ? *.7; '(1,**
15-9
Chapter 15 Financial Statement Analysis
.xercise 15-5 213 minutes4 1. 6urrent assets 2'*,*** C '(7*,*** C ';3*,*** C '1*,***4..................................................... 6urrent lia+ilities 2'1,8**,*** J ).34............ Iorking capital............................................. ).
'1,8**,** * 3)*,*** ' ;*,** *
6ash C Aarketa+le securities C ccounts receiva+le C Short-term notes cid-test ratio ? 6urrent lia+ilities ?
'*,*** C '* C '(7*,*** C '* ?1.*( 2rounded4 '3)*,***
8. a. Iorking capital would not +e a&ected +y a '1**,*** payment on accounts paya+le: 6urrent assets 2'1,8**,*** L '1**,***4......................................... '1,)**,*** 6urrent lia+ilities 2'3)*,*** L '1**,***4......................................... ()*,*** Iorking capital................................... ' ;*,*** +. #he current ratio would increase if the company makes a '1**,*** payment on accounts paya+le: 6urrent ratio ?
?
6urrent assets 6urrent lia+ilities '1,)**,*** ?).= 2rounded4 '()*,***
15-10
Chapter 15 Financial Statement Analysis
.xercise 15-* 28* minutes4 1. 9ross margin percentage:
9ross margin percentage?
9ross margin '(*,*** ? ?(*5 Sales '),1**,***
). 6urrent ratio:
6urrent ratio?
6urrent assets '(=*,*** ? ?).(3 6urrent lia+ilities ')**,***
8. cid-test ratio: 6ash C Aarketa+le securities C ccounts receiva+le C Short-term notes cid test ratio? 6urrent lia+ilities ?
')1,*** C '* C '17*,*** C '* ?*.=1 2rounded4 ')**,***
(. verage collection period:
ccounts receiva+le turnover? ? verage collection period ? ?
Sales on account verage accounts receiva+le '),1**,*** ?1( 2'17*,*** C '1(*,***4G) 873 days ccounts receiva+le turnover 873 days ?)7.1 days 2rounded4 1(
15-11
Chapter 15 Financial Statement Analysis
.xercise 15-* 2continued4 3. verage sale period:
nventory turnover?
6ost of goods sold verage inventory
?
'1,)7*,*** ?(.3 2'8**,*** C ')7*,***4G)
verage sale period?
873 days ?1.1 days 2rounded4 (.3
7. e+t-to-e%uity ratio:
e+t-e%uity ratio? ?
#otal lia+ilities StockholdersH e%uity '3**,*** ?*.78 2rounded4 '**,***
;. #imes interest earned: @arnings +efore interest and income ta"es #imes interest earned? nterest e"pense ?
'1*,*** ? 7.* '8*,***
. Book value per share:
#otal stockholdersH e%uity - Preferred stock Book value per share? 6ommon shares outstanding ?
'**,*** - '* ?'(* per share )*,*** sharesM
15-12
Chapter 15 Financial Statement Analysis
M'1**,*** total par value J '3 par value per share ? )*,*** shares
15-13
Chapter 15 Financial Statement Analysis
.xercise 15-+ 2)* minutes4 1. @arnings per share:
@arnings per share? ?
). ividend payout ratio:
ividend payout ratio?
ividends per share '8.13 ? ?7*5 @arnings per share '3.)3
8. ividend yield ratio:
ividend yield ratio?
ividends per share '8.13 ? ?35 Aarket price per share '78.**
(. Price-earnings ratio:
Price-earnings ratio?
Aarket price per share '78.** ? ?1).* @arnings per share '3.)3
15-14
Chapter 15 Financial Statement Analysis
.xercise 15-, 2)* minutes4 1. Return on total assets:
'1)7,*** ?1*.35 '1,)**,***
). Return on common stockholders! e%uity:
Return on common ?
? ?
'1*3,*** ?18.5 2rounded4 ';7),3**
8. $inancial leverage was positive +ecause the rate of return to the common stockholders 218.54 was greater than the rate of return on total assets 21*.354. #his positive leverage is tracea+le in part to the company!s current lia+ilities, which may carry no interest cost, and to the +onds paya+le, which have an after-ta" interest cost of only ;5. 1*5 interest rate E 21 L *.8*4 ? ;5
15-15
Chapter 15 Financial Statement Analysis
.xercise 15- 2)* minutes4 1. Return on total assets:
N Return on ?
'388,*** ?1*.=5 2rounded4 '(,=**,***
). Return on common stockholders! e%uity: verage stockholders! e%uity '8,***,** 2'8,1**,*** C '),=**,***4G)........................ * verage preferred stock 2'**,*** C **,** '**,***4G)................................................... * '),)**,** verage common stockholders! e%uity............ *
Return on common ?
'(;*,*** - '37,*** ?1.5 2rounded4 '),)**,***
8. everage is positive +ecause the return on common stockholders! e%uity 21.54 is greater than the return on total assets 21*.=54. #his positive leverage arises from the longterm de+t, which has an after-ta" interest cost of only .(5 D1)5 interest rate E 21 L *.8*4F, and the preferred stock, which carries a dividend rate of only ;5. Both of these gures are smaller than the return that the company is earning on its total assets thus, the di&erence goes to the common stockholders.
15-16
Chapter 15 Financial Statement Analysis
.xercise 15-1/ 213 minutes4 1. #he trend percentages are:
Sales............................... 6urrent assets: 6ash............................. ccounts receiva+le...... nventory...................... #otal current assets......... 6urrent lia+ilities............. ). Sales: ssets:
Year Year Year Year Year 5 4 3 2 1 1)3.* 1)*.* 11*.* 1*3.* 1**.* *.* =*.* 1*3.* 11*.* 1(*.* 1)(.* 1*.* 1*(.* 11).* 11*.* 1*).* 1*.* 11. 118.1 1*(.1 1*7.=
1**.* 1**.* 1**.* 1**.*
18*.* 1*7.* 1*.* 11*.* 1**.*
#he sales are increasing at a steady rate, with a particularly strong gain in Tear (. 6ash declined from Tear 8 through Tear 3. #his may have +een due to the growth in +oth inventories and accounts receiva+le. n particular, the accounts receiva+le grew far faster than sales in Tear 3. #he decline in cash may reect delays in collecting receiva+les. #his is a matter for management to investigate further.
ia+ilities #he current lia+ilities >umped up in Tear 3. #his was : pro+a+ly due to the +uildup in accounts receiva+le in that the company doesn!t have the cash needed to pay +ills as they come due.
15-17
Chapter 15 Financial Statement Analysis
0ro!lem 15-11 27* minutes4
1. a.
+.
c.
d.
This Year Last Year '),*7*,** '1,(;*,** 6urrent assets 2a4............................. * * 6urrent lia+ilities 2+4......................... 1,1**,*** 7**,*** Iorking capital 2a4 U 2+4................... ' =7*,*** ' ;*,*** '),*7*,** '1,(;*,** 6urrent assets 2a4............................. * * '1,1**,** 6urrent lia+ilities 2+4......................... * '7**,*** 6urrent ratio 2a4 J 2+4....................... 1.; ).(3 Vuick assets 2a4................................
';(*,*** '73*,*** '1,1**,** 6urrent lia+ilities 2+4......................... * '7**,*** cid-test ratio 2a4 J 2+4..................... *.7; 1.*
';,***,** '7,***,** Sales on account 2a4.......................... * * verage receiva+les 2+4.................... '3)3,*** '8;3,*** ccounts receiva+le turnover 2a4 J 2+4................................................... 18.8 17.* verage collection period: 873 days J accounts receiva+le turnover...... );.( days )). days
e.
'3,(**,** '(,**,** 6ost of goods sold 2a4....................... * * '1,*3*,** verage inventory 2+4....................... * ';7*,*** nventory turnover ratio 2a4 J 2+4...... 3.1 7.8 verage sale period: 873 days J inventory turnover....... ;1.7 days 3;.= days '1,3*,** '1,83*,** #otal lia+ilities 2a4.............................. * * '),13*,** '1,=3*,** Stockholders! e%uity 2+4.................... * *
15-18
Chapter 15 Financial Statement Analysis
e+t-to-e%uity ratio 2a4 J 2+4............
g.
15-19
*.7
*.7=
'78*,*** '(=*,*** '=*,*** '=*,*** ;.* 3.(
Chapter 15 Financial Statement Analysis
0ro!lem 15-11 2continued4 ). a.
Aodern Building Supply 6ommon-Size Balance Sheets
6urrent assets: 6ash................................. Aarketa+le securities........ ccounts receiva+le, net. . nventory.......................... Prepaid e"penses............. #otal current assets............. Plant and e%uipment, net.... #otal assets......................... ia+ilities: 6urrent lia+ilities.............. Bonds paya+le, 1)5......... #otal lia+ilities..................... Stockholders! e%uity: Preferred stock, '3* par, 5.................................. 6ommon stock, '1* par.... Retained earnings............. #otal stockholders! e%uity. . . #otal lia+ilities and e%uity....
This Year
Last Year
).85 *.*5 17.85 8).35 *.35 31.35 (.35 1**.*5
7.15 1.35 1).15 )(.)5 *.75 ((.35 33.35 1**.*5
);.35 1.5 (7.85
1.)5 )).;5 (*.=5
3.*5 1).35 87.85 38.5 1**.*5
7.15 13.)5 8;.=5 3=.15 1**.*5
15-20
Chapter 15 Financial Statement Analysis
0ro!lem 15-11 2continued4 +.
Aodern Building Supply 6ommon-Size ncome Statements
Sales........................................... 6ost of goods sold....................... 9ross margin............................... Selling and administrative e"penses..................................
This Year 1**.*5 ;;.15 )).=5
Last Year 1**.*5 *.*5 )*.*5
18.=5 =.*5 1.85 ;.;5 8.15 (.75
11.5 .)5 1.35 7.;5 ).;5 (.*5
8. #he following points can +e made from the analytical work in parts 214 and 2)4 a+ove: a. #he company has improved its prot margin from last year. #his is attri+uta+le primarily to an increase in gross margin, which is o&set somewhat +y an increase in operating e"penses. n +oth years the company!s net income as a percentage of sales e%uals or e"ceeds the industry average of (5. +. #he company!s current position has deteriorated signicantly since last year. Both the current ratio and the acid-test ratio are well +elow the industry average, and +oth are trending downward. t the present rate, it will soon +e impossi+le for the company to pay its +ills as they come due.
15-21
Chapter 15 Financial Statement Analysis
0ro!lem 15-11 2continued4 c. #he drain on the cash account seems to +e a result mostly of a large +uildup in accounts receiva+le and inventory.
15-22
Chapter 15 Financial Statement Analysis
0ro!lem 15-1' 27* minutes4 a. 1.
ividends per share 2a4M.................. Aarket price per share 2+4............... ividend yield ratio 2a4 J 2+4...........
This Year Last Year '8)(,*** ')(*,*** 17,*** 17,*** '8*,*** '))(,*** 3*,*** '7.17
3*,*** '(.(
').17 '(3.** (.5
'1.)* '87.** 8.885
M'1*,*** J 3*,*** shares ? ').17 '7*,*** J 3*,*** shares ? '1.)* c.
ividends per share 2a4................... @arnings per share 2+4..................... ividend payout ratio 2a4 J 2+4.......
').17 '7.17 83.15
'1.)* '(.( )7.5
d.
Aarket price per share 2a4............... @arnings per share 2+4..................... Price-earnings ratio 2a4 J 2+4...........
'(3.** '7.17 ;.8
'87.** '(.( .*
nvestors regard Aodern Building Supply less favora+ly than other companies in the industry. #his is evidenced +y the fact that they are willing to pay only ;.8 times current earnings for a share of the company!s stock, as compared to = times current earnings for other companies in the industry. f investors were willing to pay = times current earnings for Aodern Building Supply!s stock, then it would +e selling for a+out '33 per share 2= E '7.174, rather than for only '(3 per share.
15-23
Chapter 15 Financial Statement Analysis
0ro!lem 15-1' 2continued4 This Year
Last Year '1,=3*,** e. #otal stockholders! e%uity............. '),13*,*** * ess preferred stock...................... )**,*** )**,*** '1,;3*,** 6ommon stockholders! e%uity 2a4. '1,=3*,*** *
3*,*** '8=.**
3*,*** '83.**
#he market value is a+ove +ook value for +oth years. Wowever, this does not necessarily indicate that the stock is overpriced. Aarket value reects investors! perceptions of future earnings, whereas +ook value is a result of already completed transactions.
). a.
' )(*,**
+.
' )(*,**
Chapter 15 Financial Statement Analysis
'1,;7,***4 Return on common stockholders! e%uity 2a4 J 2+4...........................
15-25
17.75
18.(5
Chapter 15 Financial Statement Analysis
0ro!lem 15-1' 2continued4 c. $inancial leverage is positive in +oth years +ecause the return on common e%uity is greater than the return on total assets. #his positive nancial leverage is due to three factors: the preferred stock, which has a dividend of only 5 the +onds, which have an after-ta" interest cost of only ;.)5 D1)5 interest rate E 21 L *.(*4 ? ;.)5F and the accounts paya+le, which may +ear no interest cost. 8. Ie would recommend keeping the stock. #he stock!s downside risk seems small +ecause it is selling for only ;.8 times current earnings as compared to = times earnings for other companies in the industry. n addition, its earnings are strong and trending upward, and its return on common e%uity 217.754 is e"tremely good. ts return on total assets 21*.(54 compares well with that of the industry. #he risk, of course, is whether the company can get its cash pro+lem under control. 6onceiva+ly, the cash pro+lem could worsen, leading to an eventual reduction in prots, a reduction in dividends, and a precipitous drop in the market price of the company!s stock. #his does not seem likely, however, since the company can easily control its cash pro+lem through more careful management of accounts receiva+le and inventory. #he risks associated with retaining the stock seem >ustied in this case +ecause the upward potential of the stock is great if the company gets its pro+lems under control.
15-26
Chapter 15 Financial Statement Analysis
0ro!lem 15-1( 28* minutes4 a. #he market price is going down. #he dividends paid per share over the three-year period are unchanged, +ut the dividend yield is going up. #herefore, the market price per share of stock must +e decreasing. +. #he earnings per share is increasing. gain, the dividends paid per share have remained constant. Wowever, the dividend payout ratio is decreasing. n order for the dividend payout ratio to +e decreasing, the earnings per share must +e increasing. c. #he price-earnings ratio is going down. f the market price of the stock is going down Dsee part 2a4 a+oveF, and the earnings per share are going up Dsee part 2+4 a+oveF, then the priceearnings ratio must +e decreasing. d. n Tear 1, leverage was negative +ecause in that year the return on total assets e"ceeded the return on common e%uity. n Tear ) and in Tear 8, leverage was positive +ecause in those years the return on common e%uity e"ceeded the return on total assets employed. e. t is +ecoming more di/cult for the company to pay its +ills as they come due. lthough the current ratio has improved over the three years, the acid-test ratio is down. lso note that the accounts receiva+le and inventory are +oth turning more slowly, indicating that an increasing portion of the current assets is +eing made up of those items, from which +ills cannot +e paid. f. 6ustomers are paying their +ills more slowly in Tear 8 than in Tear 1. #his is evidenced +y the decline in accounts receiva+le turnover. g. ccounts receiva+le is increasing. #his is evidenced +oth +y a slowdown in turnover and in an increase in total sales. h. #he level of inventory undou+tedly is increasing. ust remained constant, this would +e evidence of a larger average inventory on hand. Wowever, sales are not constant +ut rather are increasing. Iith sales increasing 2and undou+tedly cost of goods sold also increasing4, the average 15-27
Chapter 15 Financial Statement Analysis
level of inventory must +e increasing as well in order to service the larger volume of sales.
15-28
Chapter 15 Financial Statement Analysis
0ro!lem 15-1) 28* minutes4 1. a. 6omputation of working capital: 6urrent assets: 6ash..................................... Aarketa+le securities........... ccounts receiva+le, net...... nventory.............................. Prepaid e"penses................. #otal current assets 2a4...........
' ;*,*** 1),*** 83*,*** (7*,*** ,*** =**,***
6urrent lia+ilities: ccounts paya+le................. ccrued lia+ilities.................
)**,*** 7*,*** 1**,*** 87*,***
Iorking capital 2a4 U 2+4.........
'3(*,***
+. 6omputation of the current ratio:
6urrent ratio?
6urrent assets '=**,*** ? ?).3 6urrent lia+ilities '87*,***
c. 6omputation of the acid-test ratio: 6ash C Aarketa+le securities C ccounts receiva+le C Short-term notes cid-test ratio? 6urrent lia+ilities ?
';*,*** C '1),*** C '83*,*** '(8),*** ? ?1.) '87*,*** '87*,***
15-29
Chapter 15 Financial Statement Analysis
0ro!lem 15-1) 2continued4 ).
The Efect on Workin Curren Acidg t Test Capital atio atio Transaction 2a4 ecreas ecreas ecreas eclared a cash dividend........... e e e 2+4 ncreas Paid accounts paya+le............... 4 ncreas ssued common stock for cash.. . ncrease e ncrease 2k4 ncreas Paid o& short-term notes............
15-30
Chapter 15 Financial Statement Analysis
0ro!lem 15-15 2(3 minutes4 Efect on atio eason !or "ncrease# $ecrease# or %o Efect 1. ecreas Sale of inventory at a prot will +e reected in an e increase in retained earnings, which is part of stockholders! e%uity. n increase in stockholders! e%uity will result in a decrease in the ratio of assets provided +y creditors as compared to assets provided +y owners. ).
Purchasing land for cash has no e&ect on earnings or on the num+er of shares of common stock outstanding. 0ne asset is e"changed for another.
8. ncrease sale of inventory on account will increase the %uick assets 2cash, accounts receiva+le, marketa+le securities4 +ut have no e&ect on the current lia+ilities. $or this reason, the acid-test ratio will increase. (.
Payments on account reduce cash and accounts paya+le +y e%ual amounts thus, the net amount of working capital is not a&ected.
3. ecreas Ihen a customer pays a +ill, the accounts e receiva+le +alance is reduced. #his increases the accounts receiva+le turnover, which in turn decreases the average collection period. 7. ecreas eclaring a cash dividend will increase current e lia+ilities, +ut have no e&ect on current assets. #herefore, the current ratio will decrease. ;. ncrease Payment of a previously declared cash dividend will reduce +oth current assets and current lia+ilities +y the same amount. n e%ual reduction in +oth current assets and current lia+ilities will always result in an increase in the current ratio, so long as the current assets e"ceed the current lia+ilities.
15-31
Chapter 15 Financial Statement Analysis
.
Book value per share is not a&ected +y the current market price of the company!s stock.
15-32
Chapter 15 Financial Statement Analysis
0ro!lem 15-15 2continued4 Efect on atio eason !or "ncrease# $ecrease# or %o Efect =. ecreas #he dividend yield ratio is o+tained +y dividing the e dividend per share +y the market price per share. f the dividend per share remains unchanged and the market price goes up, then the yield will decrease. 1*. ncrease Selling property for a prot would increase net income and therefore the return on total assets would increase. 11. ncrease write-o& of inventory will reduce the inventory +alance, there+y increasing the turnover in relation to a given level of cost of goods sold. 1). ncrease Since the company!s assets earn at a rate that is higher than the rate paid on the +onds, leverage is positive, increasing the return to the common stockholders. 18.
6hanges in the market price of a stock have no direct e&ect on the dividends paid or on the earnings per share and therefore have no e&ect on this ratio.
1(. ecreas e
decrease in net income would mean less income availa+le to cover interest payments. #herefore, the times-interest-earned ratio would decrease.
13.
Irite-o& of an uncollecti+le account against the llowance for Bad e+ts will have no e&ect on total current assets. $or this reason, the current ratio will remain unchanged.
17. ecreas e
purchase of inventory on account will increase current lia+ilities, +ut will not increase the %uick assets 2cash, accounts receiva+le, marketa+le securities4. #herefore, the ratio of %uick assets to current lia+ilities will decrease.
1;. ncrease #he price-earnings ratio is o+tained +y dividing the market price per share +y the earnings per share. f
15-33
Chapter 15 Financial Statement Analysis
the earnings per share remains unchanged, and the market price goes up, then the price-earnings ratio will increase. 1. ecreas e
Payments to creditors will reduce the total lia+ilities of a company, there+y decreasing the ratio of total de+t to total e%uity.
15-34
Chapter 15 Financial Statement Analysis
0ro!lem 15-1* 2=* minutes4 This Year
1. a.
Last Year ' 17,** ' )*,*** * (,*** ;*,** * ' )8,** ' 87(,*** *
'(,7(*,** verage total assets 2+4.................. '3,88*,*** * Return on total assets 2a4 J 2+4....... 7.5 3.15
+.
' 17,**
=.)5
(.=5
c.
everage is positive for this year +ecause the return on common e%uity 2=.)54 is greater than the return on total assets 27.54. $or last year, leverage is negative +ecause the return on the common e%uity 2(.=54 is less than the return on total assets 23.154.
). a.
15-35
')8),*** 3*,***
'1)*,*** 3*,***
Chapter 15 Financial Statement Analysis
+.
outstanding 2+4............................. @arnings per share 2a4 J 2+4............
'(.7(
').(*
ividends per share 2a4................... Aarket price per share 2+4............... ividend yield ratio 2a4 J 2+4...........
'1.(( '87.** (.*5
'*.;) ')*.** 8.75
15-36
Chapter 15 Financial Statement Analysis
0ro!lem 15-1* 2continued4 c.
ividends per share 2a4................... @arnings per share 2+4..................... ividend payout ratio 2a4 J 2+4.......
This Year '1.(( '(.7( 81.*5
d.
Aarket price per share 2a4................ @arnings per share 2+4..................... Price-earnings ratio 2a4 J 2+4............
'87.** '(.7( ;.
Last Year '*.;) ').(* 8*.*5 ')*.** ').(* .8
e.
Stockholders! e%uity....................... ess preferred stock........................ 6ommon stockholders! e%uity 2a4. . .
'8,*(*,** '8,)**,*** * 7**,*** 7**,*** '),((*,** '),7**,*** * 3*,*** '3).**
3*,*** '(.*
15-37
'1,*3*,***
'7*,*** '(,17*,** '3,)3*,*** * )*.*5 )*.;5
Chapter 15 Financial Statement Analysis
0ro!lem 15-1* 2continued4 8. a.
This Year Last Year '),7**,** '1,=*,** 6urrent assets 2a4............................. * * =)*,** 6urrent lia+ilities 2+4......................... 1,8**,*** * '1,8**,** '1,*7*,** Iorking capital 2a4 U 2+4................... * *
+.
'),7**,** '1,=*,** 6urrent assets 2a4............................. * * '1,8**,** 6urrent lia+ilities 2+4......................... * '=)*,*** 6urrent ratio 2a4 J 2+4....................... ).* ).13
c.
'1,))*,** '1,1)*,** Vuick assets 2a4................................ * * '1,8**,** 6urrent lia+ilities 2+4......................... * '=)*,*** cid-test ratio 2a4 J 2+4..................... *.=( 1.))
d.
'3,)3*,** '(,17*,** Sales on account 2a4.......................... * * verage receiva+les 2+4.................... ';3*,*** '37*,*** ccounts receiva+le turnover 2a4 J 2+4................................................... ;.* ;.( verage collection period: 873 days J accounts receiva+le turnover...... 3) days (= days
e.
'(,)**,** '8,8**,** 6ost of goods sold 2a4....................... * * '1,*3*,** verage inventory +alance 2+4.......... * ';)*,*** nventory turnover ratio 2a4 J 2+4...... (.* (.7 verage sales period: 873 days J inventory turnover ratio.................. =1 days ;= days '),3**,** '1,=)*,** #otal lia+ilities 2a4.............................. * *
15-38
Chapter 15 Financial Statement Analysis
'8,)**,** '8,*(*,** Stockholders! e%uity 2+4.................... * * e+t-to-e%uity ratio 2a4 J 2+4............ *.; *.78 g.
15-39
'3)*,*** '8(*,*** '1)*,*** '1**,*** (.8 8.(
Chapter 15 Financial Statement Analysis
0ro!lem 15-1* 2continued4 (. s stated +y Aarva Rossen, +oth net income and sales are up from last year. #he return on total assets has improved from 3.15 last year to 7.5 this year, and the return on common e%uity is up to =.)5 from (.=5 the year +efore. But this appears to +e the only +right spot. Xirtually all other ratios are +elow what is typical for the industry, and, more important, they are trending downward. #he deterioration in the gross margin percentage, while not large, is worrisome. Sales and inventories have increased su+stantially, which should ordinarily result in an improvement in the gross margin percentage as "ed costs are spread over more units. Wowever, the gross margin percentage has declined.
15-40
Chapter 15 Financial Statement Analysis
0ro!lem 15-1+ 28* minutes4 1.
Wedrick 6ompany 6omparative Balance Sheets This Year
6urrent assets: 6ash......................................... 3.75 Aarketa+le securities................ *.*5 ccounts receiva+le, net........... 13.5 nventory.................................. )).5 Prepaid e"penses...................... 1.(5 #otal current assets..................... (3.75 Plant and e%uipment, net............ 3(.(5 #otal assets................................. 1**.*5 6urrent lia+ilities......................... )).5 Bonds paya+le, 1*5.................... )1.15 #otal lia+ilities............................. (8.=5 Stockholders! e%uity: Preferred stock, 5, '8* par value...................................... 1*.35 6ommon stock, '(* par value. . 83.15 Retained earnings..................... 1*.35 #otal stockholders! e%uity............ 37.15 #otal lia+ilities and e%uity............ 1**.*5
Last Year .35 ).*5 1).15 17.15 1.)5 8=.=5 7*.15 1**.*5 1.35 )*.)5 8.;5
1).15 (*.85 .=5 71.85 1**.*5
15-41
Chapter 15 Financial Statement Analysis
0ro!lem 15-1+ 2continued4 ).
Wedrick 6ompany 6omparative ncome Statements
Sales........................................... 6ost of goods sold....................... 9ross margin............................... Selling and administrative e"penses...................................
This Year 1**.*5 *.*5 )*.*5
Last Year 1**.*5 ;=.85 )*.;5
1*.15 =.=5 ).85 ;.75 ).85 3.85
1).35 .)5 ).(5 3.5 1.;5 (.*5
Mue to rounding, gures may not fully reconcile down a column. 8. #he company!s current position has declined su+stantially +etween the two years. 6ash this year represents only 3.75 of total assets, whereas it represented 1*.35 last year 26ash C Aarketa+le Securities4. n addition, +oth accounts receiva+le and inventory are up from last year, which helps to e"plain the decrease in the 6ash account. #he company is +uilding inventories, +ut not collecting from customers. 2See Pro+lem 13-17 for a ratio analysis of the current assets.4 pparently, part of the nancing re%uired to +uild inventories was supplied +y short-term creditors, as evidenced +y the increase in current lia+ilities. ooking at the income statement, the gross margin percentage has deteriorated. 0rdinarily, the increase in sales 2and in inventories4 should have resulted in an increase in the gross margin percentage since "ed manufacturing costs would +e spread across more units.
15-42
Chapter 15 Financial Statement Analysis
0ro!lem 15-1, 2(3 minutes4 1. #he loan o/cer stipulated that the current ratio prior to o+taining the loan must +e higher than ).*, the acid-test ratio must +e higher than 1.*, and the interest on the loan must +e no more than one-fourth of net operating income. #hese ratios are computed +elow:
6urrent ratio ? ?
6urrent assets 6urrent lia+ilities '(83,*** ? 1. 2rounded4 ')(7,***
6ash C Aarketa+le securities C ccounts receiva+le C Short-term notes cid-test ratio ? Current liabilities
=
$105, 000 + $0 + $75,000 + $0 = 0.7 (rounded) $246,000
#he company would not %ualify for the loan +ecause +oth its current ratio and its acid-test ratio are too low.
15-43
Chapter 15 Financial Statement Analysis
0ro!lem 15-1, 2continued4 ). By reclassifying the '7 thousand net +ook value of the old e%uipment as inventory, the current ratio would improve, +ut the acid-test ratio would +e una&ected. nventory is considered a current asset for purposes of computing the current ratio, +ut is not included in the numerator when computing the acid-test ratio.
Current ratio = =
Current assets Current liabilities $435,000 + $68,000 = 2.0 (rounded) $246,000
6ash C Aarketa+le securities C ccounts receiva+le C Short-term notes cid-test ratio ? Current liabilities
=
$105, 000 + $0 + $75,000 + $0 = 0.7 (rounded) $246,000
@ven if this tactic had succeeded in %ualifying the company for the loan, we strongly advise against it. nventories are assets the company has ac%uired to sell to customers in the normal course of +usiness. Zsed production e%uipment is not inventory Yeven if there is a clear intention to sell it in the near future. #he loan o/cer would not e"pect used e%uipment to +e included in inventories doing so would +e intentionally misleading.
15-44
Chapter 15 Financial Statement Analysis
0ro!lem 15-1, 2continued4
Current ratio = =
Current assets Current liabilities $435,000 + $68,000 = 2.0 (rounded) $246,000
6ash C Aarketa+le securities C ccounts receiva+le C Short-term notes cid-test ratio ? Current liabilities
=
($105, 000 + $68, 000) + $0 + $75, 000 + $0 $246,000
= 1.0 (rounded) Wowever, other options may +e availa+le. #he old e%uipment is +eing used to relieve +ottlenecks in the heat-treating process and it would +e desira+le to keep this stand+y capacity. Ie would advise [urgen to fully and honestly e"plain the situation to the loan o/cer. #he loan o/cer might insist that the e%uipment +e sold +efore any loan is approved, +ut she might instead grant a waiver of the current ratio and acid-test ratio re%uirements on the +asis that they could +e satised +y selling the old e%uipment. 0r she may approve the loan on the condition that the e%uipment is pledged as collateral. n that case, [urgen would only have to sell the e%uipment if he would otherwise +e una+le to pay +ack the loan.
15-45
Chapter 15 Financial Statement Analysis
0ro!lem 15-1 27* minutes or longer4 #anner 6ompany ncome Statement $or the Tear @nded ecem+er 81 &e' Sales................................................. '),;**,*** 6ost of goods sold............................. 1,**,*** 9ross margin..................................... =**,*** Selling and administrative e"penses. 33,***
2h4 2i4 2>4 2a4 2+4 2c4 2d4
#anner 6ompany Balance Sheet ecem+er 81 6urrent assets: 6ash............................................... ' *,*** ccounts receiva+le, net................. )**,*** nventory........................................ 8)*,*** #otal current assets........................... 7**,*** Plant and e%uipment......................... =**,*** #otal assets....................................... '1,3**,*** 6urrent lia+ilities............................... ' )3*,*** Bonds paya+le, 1*5.......................... (3*,*** #otal lia+ilities................................... ;**,*** Stockholders! e%uity: 6ommon stock, ').3* par value..... 1**,*** Retained earnings........................... ;**,*** #otal stockholders! e%uity.................. **,*** #otal lia+ilities and e%uity.................. '1,3**,***
15-46
2f4 2e4 2g4 2g4 2%4 2p4 2k4 2l4 2m4 2o4 2n4 2p4
Chapter 15 Financial Statement Analysis
0ro!lem 15-1 2continued4 6omputation of missing amounts:
@arnings +efore interest and ta"es #imes interest earned ? a nterest e"pense . @arnings +efore interest and ta"es ? '(3,*** ? ;.* #herefore, the earnings +efore interest and ta"es for the year must +e '813,*** 2? '(3,*** E ;.*4. +.
?
'),;**,*** ? 13.* verage accounts receiva+le +alance
verage accounts ? '),;**,*** J 13.* ? '1*,*** receiva+le +alance #herefore, the average accounts receiva+le +alance for the year must have +een '1*,***. #he +eginning +alance was '17*,***, so the ending +alance must have +een ')**,***.
15-47
Chapter 15 Financial Statement Analysis
0ro!lem 15-1 2continued4 f.
6ash C Aarketa+le securities C ccounts receiva+le C Short-term notes cid-test ratio? 6urrent lia+ilities 6ash C Aarketa+le securities C ccounts receiva+le C Short-term notes ? ?1.1) ')3*,*** 6ash C '* C ')**,*** C '* ? ')3*,*** E 1.1) ? ')*,*** 6ash ? '*,***
g .
6urrent ratio? ?
6urrent assets 6urrent lia+ilities 6urrent assets ?).( ')3*,***
6urrent assets?')3*,*** E ).(?'7**,*** 6urrent assets ? 6ash C ccounts receiva+le C nventory '7**,*** ? '*,*** C ')**,*** C nventory nventory ? '7**,*** - '*,*** - ')**,*** ? '8)*,*** h 6ost of goods sold nventory turnover? . verage inventory ?
6ost of goods sold 2')*,*** C '8)*,***4G)
?
6ost of goods sold ? 7.* '8**,***
6ost of goods sold?'8**,*** E 7.*?'1,**,***
15-48
Chapter 15 Financial Statement Analysis
0ro!lem 15-1 2continued4 i. 9ross margin ? '),;**,*** L '1,**,*** ? '=**,*** >.
m .
@arnings per share ?
?
'17),*** verage num+er of common shares outstanding
? '(.*3 per share verage num+er of ? '17),*** J '(.*3 per share common shares outstanding ? (*,*** shares #he stock is ').3* par value per share, so the total common stock must +e '1**,***.
15-49
Chapter 15 Financial Statement Analysis
n .
Be+t-to-e%uity ratio ? ?
#otal lia+ilities StockholdersH e%uity ';**,*** ? *.;3 StockholdersH e%uity
StockholdersH e%uity ? ';**,*** J *.;3 ? '**,***
15-50