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Chapter2DiscussionQuestions2-
1.Discusssomefinancialvariablesthataffecttheprice-earningsratio.Theprice-earningsratiowillbeinfluencedbytheearningsandsalesgrowthofthefirmtheriskorvolatilityinperformancethedebt-equitystructureofthefirmthedividendpaymentpolicythequalityofmanagementandanumberofotherfactors.Theratiotendstobefuture-orientedandthemorepositivetheoutlookthehigheritwillbe.2-
2.WhatisthedifferencebetweenbookvaluepershareofcommonstockandmarketvaluepershareWhydoesthisdisparityoccurBookvaluepershareisarrivedatbytakingthecostoftheassetsandsubtractingoutliabilitiesandpreferredstockanddividingbythenumberofcommonsharesoutstanding.Itisbasedonthehistoricalcostoftheassets.Marketvaluepershareisbasedoncurrentassessedvalueofthefirminthemarketplaceandmaybearlittlerelationshiptooriginalcost.Besidesthedisparitybetweenbookandmarketvaluecausedbythehistoricalcostapproachothercontributingfactorsarethegrowthprospectsforthefirmthequalityofmanagementandtheindustryoutlook.Totheextentthesearequitenegativeorpositivemarketvaluemaydifferwidelyfrombookvalue.2-
3.Explainhowdepreciationgeneratesactualcashflowsforthecompany.Theonlywaydepreciationgeneratescashflowsforthecompanyisbyservingasataxshieldagainstreportedincome.Thisnon-cashdeductionmayprovidecashflowequaltothetaxratetimesthedepreciationcharged.Thismuchintaxeswillbesavedwhilenocashpaymentsoccur.2-
4.WhatisthedifferencebetweenaccumulateddepreciationanddepreciationexpenseHowaretheyrelatedAccumulateddepreciationisthesumofallpastandpresentdepreciationchargeswhiledepreciationexpenseisthecurrentyearscharge.Theyarerelatedinthatthesumofallpriordepreciationexpenseshouldbeequaltoaccumulateddepreciationsubjecttosomedifferentialrelatedtoassetwrite-offs.2-
5.HowistheincomestatementrelatedtothebalancesheetTheearningslessdividendsreportedintheincomestatementistransferredtotheownershipsectionofthebalancesheetasretainedearnings.Thuswhatweearnintheincomestatementbecomespartoftheownershipinterestinthebalancesheet.2-
6.Commentonwhyinflationmayrestricttheusefulnessofthebalancesheetasnormallypresented.Thebalancesheetisbasedonhistoricalcosts.Whenpricesarerisingrapidlyhistoricalcostdatamaylosemuchoftheirmeaning–particularlyforplantandequipmentandinventory.2-
7.Explainwhythestatementofcashflowsprovidesusefulinformationthatgoesbeyondincomestatementandbalancesheetdata.Theincomestatementandbalancesheetarebasedontheaccrualmethodofaccountingwhichattemptstomatchrevenuesandexpensesintheperiodinwhichtheyoccur.Howeveraccrualaccountingdoesnotattempttoproperlyassessthecashflowpositionofthefirm.Thestatementofcashflowsfulfillsthisneed.2-
8.WhatarethethreeprimarysectionsofthestatementofcashflowsInwhatsectionwouldthepaymentofacashdividendbeshownThesectionsofthestatementofcashflowsare:CashflowsfromoperatingactivitiesCashflowsfrominvestingactivitiesCashflowsfromfinancingactivitiesThepaymentofcashdividendsfallsintothefinancingactivitiescategory.2-
9.WhatisfreecashflowWhyisitimportanttoleveragedbuyoutsFreecashflowisequaltocashflowfromoperatingactivities:Minus:Capitalexpendituresrequiredtomaintaintheproductivecapacityofthefirm.Minus:Dividendsrequiredtomaintainthepayoutoncommonstockandtocoveranypreferredstockobligation.Theanalystorbankernormallylooksatfreecashflowtodeterminewhetherthereareinsufficientexcessfundstopaybacktheloanassociatedwiththeleveragedbuy-out.2-
10.Whyisinterestexpensesaidtocostthefirmsubstantiallylessthantheactualexpensewhiledividendscostit100percentoftheoutlayInterestexpenseisataxdeductibleitemtothecorporationwhiledividendpaymentsarenot.Thenetcosttothecorporationofinterestexpenseistheamountpaidmultipliedbythedifferenceofoneminustheapplicabletaxrate.Forexample$100ofinterestexpensecoststhecompany$65aftertaxeswhenthecorporatetaxrateis35percent.e.g.$100x1–.35=$
65.Problems2-
1.RockwellPaperCompanyhadearningsaftertaxesof$580000intheyear2003with400000sharesoutstanding.OnJanuary12004thefirmissued35000newshares.Becauseoftheproceedsfromthesenewsharesandotheroperatingimprovementsearningsaftertaxesincreasedby25percent.a.Computeearningspersharefortheyear
2003.b.Computeearningspersharefortheyear
2004.Solution:RockwellPaperCompanya.Year2003b.Year20042-
2.GiventhefollowinginformationprepareingoodformanincomestatementfortheGoodmanSoftwareInc.Sellingandadministrativeexpense$50000Depreciationexpense80000Sales400000Interestexpense30000Costofgoodssold150000Taxes18550Solution:GoodmanSoftwareInc.Sales$400000Costofgoodssold150000GrossProfit250000Sellingandadministrativeexpense50000Depreciationexpense80000Operatingprofit120000Interestexpense30000Earningsbeforetaxes90000Taxes18550Earningsaftertaxes$714502-
3.a.KevinBaconandPorkCompanyhadsalesof$240000andcostofgoodssoldof$
108000.Whatisthegrossprofitmarginratioofgrossprofittosalesb.Iftheaveragefirmintheporkindustryhadagrossprofitof60percenthowisthefirmdoingSolution:KevinBaconandPortCompanya.Sales$240000Costofgoodssold180000Grossprofit$132000b.Withagrossprofit55percentthefirmisunder-performingtheindustryaverageof60percent.2-
4.PrepareingoodformanincomestatementforVirginiaSlimWear.Takeyourcalculationsallthewaytocomputingearningspershare.Sales$600000Sharesoutstanding100000Costofgoodssold200000Interestexpense30000Sellingandadministrativeexpense40000Depreciationexpense20000Preferredstockdividends80000Taxes100000Solution:VirginiaSlimWearIncomeStatementSales$600000Costofgoodssold200000Grossprofit400000Sellingandadministrativeexpense40000Depreciationexpense20000Operatingprofit340000Interestexpense30000Earningsbeforetaxes310000Taxes100000Earningsaftertaxes210000Preferredstockdividends80000Earningsavailabletocommonstockholders130000Sharesoutstanding100000Earningspershare$
1.302-
5.LasarTechnologyInc.hadsalesof$500000costofgoodssoldof$180000sellingandadministrativeexpenseof$70000andoperatingprofitof$
90000.WhatwasthevalueofdepreciationexpenseSetthisproblemupasapartialincomestatementanddeterminedepreciationexpenseastheplugfigure.Solution:LasarTechnologyInc.Sales$500000Costofgoodssold180000GrossProfit$320000Sellingandadministrativeexpense70000DepreciationExpenseplugfigure160000Operatingprofit$900002-
6.TheReidBookCompanysold1500financetextbooksfor$100eachtoHighTuitionUniversityin
2004.ThesebookscostReid$74toproduce.Reidspent$4000sellingexpensetoconvincetheuniversitytobuyitsbooks.InadditionReidborrowed$50000onJanuary12004onwhichthecompanypaid10percentinterest.BothinterestandprincipaloftheloanwerepaidonDecember
312004.Reid’staxrateis25percent.Depreciationexpensefortheyearwas$
8000.DidReidBookCompanymakeaprofitin2004Pleaseverifywithanincomestatementpresentedingoodform.Solution:ReidBookCompanySales1500booksat$100each$150000Costofgoodssold1500booksat$74each111000Grossprofit$39000Sellingexpense4000Depreciationexpense8000Operatingprofit$27000Interestexpense5000Earningsbeforetaxes$22000Taxes@25%5500Earningsaftertaxes$165002-
7.CarrAutoWholesalershadsalesof$900000in2004andtheircostofgoodssoldrepresented65percentofsales.Sellingandadministrativeexpenseswere9percentofsales.Depreciationexpensewas$10000andinterestexpensefortheyearwas$
8000.Thefirmstaxrateis30percent.a.Computeearningsaftertaxes.b.AssumethefirmhiresMs.Hoodanefficiencyexpertasaconsultant.Shesuggeststhatbyincreasingsellingandadministrativeexpensesto12percentofsalessalescanbeincreasedto$
1000000.Theextrasaleseffortwillalsoreducecostofgoodssoldto60percentofsalestherewillbealargermakeupinpricesasaresultofmoreaggressiveselling.Depreciationexpensewillremainat$
10000.Howevermoreautomobileswillhavetobecarriedininventorytosatisfycustomersandinterestexpensewillgoupto$
15000.Thefirmstaxratewillremainat30percent.ComputerevisedearningsaftertaxesbasedonMs.HoodssuggestionsforCarrAutoWholesalers.WillherideasincreaseordecreaseprofitabilitySolution:CarrAutoWholesalersIncomeStatementa.Sales$900000Costofgoodsold65%ofsales585000Grossprofit315000Sellingandadministrativeexpense9%ofsales81000Depreciation10000Operatingprofit224000Interestexpense8000Earningsbeforetaxes216000Taxes@30%64800Earningsaftertaxes$1512002-7Continuedb.Sales$1000000Costofgoodssold60%ofsales600000Grossprofit400000Sellingandadministrativeexpense12%ofsales120000Depreciation10000Operatingprofit270000Interestexpense15000Earningsbeforetaxes255000Taxes@30%76500Earningsaftertaxes$178500Ms.Hood’sideaswillincreaseprofits.2-
8.Classifythefollowingbalancesheetitemsascurrentornoncurrent.RetainedearningsAccountspayablePrepaidexpensesPlantandequipmentInventoryCommonstockBondspayableAccruedwagespayableAccountsreceivableCapitalinexcessofparPreferredstockMarketablesecuritiesSolution:Retainedearnings–noncurrentAccountspayable–currentPrepaidexpense–currentPlantandequipment–noncurrentInventory–currentCommonstock–noncurrentBondspayable–noncurrentAccruedwagespayable–currentAccountsreceivable–currentCapitalinexcessofpar–noncurrentPreferredstock–noncurrentMarketablesecurities–current2-
9.Arrangethefollowingincomestatementitemssotheyareintheproperorderofanincomestatement:TaxesSharesoutstandingInterestexpenseDepreciationexpensePreferredstockdividendsOperatingprofitSalesGrossprofitEarningspershareEarningsbeforetaxesCostofgoodssoldEarningsaftertaxesEarningsavailabletocommonstockholdersSellingandadministrativeexpensesSolution:SalesCostofgoodssoldGrossprofitSellingandadministrativeexpenseDepreciationexpenseOperatingprofitInterestexpenseEarningsbeforetaxesTaxesEarningsaftertaxesPreferredstockdividendsEarningsAvailabletoCommonStockholdersSharesOutstandingEarningspershare2-
10.Identifywhethereachofthefollowingitemsincreasesordecreasescashflow:IncreaseinaccountsreceivableIncreaseinnotespayableDepreciationexpenseIncreaseininvestmentsDecreaseinaccountspayableDecreaseinprepaidexpensesIncreaseininventoryDividendpaymentIncreaseinaccruedexpensesSolution:Increaseinaccountsreceivable–decreasescashflowuseIncreaseinnotespayable–increasescashflowsourceDepreciationexpense–increasescashflowsourceIncreaseininvestments–decreasescashflowuseDecreaseinaccountspayable–decreasescashflowuseDecreaseinprepaidexpense–increasescashflowsourceIncreaseininventory–decreasescashflowuseDividendpayment–decreasescashflowuseIncreaseinaccruedexpenses–increasescashflowsource2-
11.Elitetrailorparkshasanoperatingprofitof$
200000.Interestexpensefortheyearwas$10000;preferreddividendspaidwere$18750;andcommondividendspaidwere$
30000.Thetaxwas$
61250.Thefirmhas20000sharesofcommonstockoutstanding.a.CalculatetheearningspershareandthecommondividendspershareforElitetrailorparks.b.WhatwastheincreaseinretainedearningsfortheyearSolution:EliteTrailorParksa.OperatingprofitEBIT$200000Interestexpense10000EarningsbeforetaxesEBT$190000Taxes61250EarningsaftertaxesEAT$128750Preferreddividends18750Availabletocommonstockholders$110000Commondividends30000Increaseinretainedearnings$80000b.Increaseinretainedearnings=$800002-
12.JohnsonAlarmSystemshad$800000ofretainedearningsonDecember
312004.Thecompanypaiddividendsof$60000in2004andhadretainedearningsof$640000onDecember
312003.HowmuchdidJohnsonearnduring2004andwhatwouldearningspersharebeif50000sharesofcommonstockwereoutstandingSolution:JohnsonAlarmSystemsRetainedearningsDecember312004$800000Less:RetainedearningsDecember312003640000Changeinretainedearnings$160000Add:Commonstockdividends60000Earningsavailabletocommonstockholders$220000Earningspershare2-
13.NovaElectricsanticipatedcashflowfromoperatingactivitiesof$6millionin
2005.Itwillneedtospend$
1.2milliononcapitalinvestmentsinordertoremaincompetitivewithintheindustry.Commonstockdividendsareprojectedat$.4millionandpreferredstockdividendsat$.55million.a.Whatisthefirmsprojectedfreecashflowfortheyear2005b.WhatdoestheconceptoffreecashflowrepresentSolution:NovaElectronicsa.Cashflowfromoperationsactivities$
6.00million-CapitalExpenditures
1.20-Commonstockdividends.40-Preferredstockdividends.55Freecashflow$
3.85millionb.Freecashflowrepresentsthefundsthatareavailableforspecialfinancialactivitiessuchasaleveragedbuyoutincreaseddividendscommonstockrepurchasesacquisitionsorrepaymentofdebt.2-
14.Fillintheblankspaceswithcategories1through7below:
1.BalancesheetBS.
5.CurrentliabilitiesCL.
2.IncomestatementIS.
6.Long-termliabilitiesLL.
3.CurrentassetsCA.
7.StockholdersequitySE.
4.FixedassetsFA.IndicateWhetherItemisonBalanceSheetBSorIncomeStatementIS______________________________________________________________________________________________________________________________IfonBalanceSheetDesignateWhichCategory______________________________________________________________________________________________________________________________ItemAccountsreceivableRetainedearningsIncometaxexpenseAccruedexpensesCashSellingandadministrativeexpensesPlantandequipmentOperatingexpenseMarketablesecuritiesInterestexpenseSalesNotespayable6monthsBondspayablematurity2001CommonstockDepreciationexpenseInventoriesCapitalinexcessofparvalueNetincomeearningsaftertaxesIncometaxpayableSolution:
1.BalanceSheetBS
2.IncomeStatementIS
3.CurrentAssetsCA
4.FixedAssetsFA
5.CurrentLiabilitiesCL
6.Long-TermLiabilitiesLL
7.StockholdersEquitySE2-
14.ContinuedIndicateWhethertheitemisonIncomeStatementorBalanceSheetIftheItemisonBalanceSheetDesignateWhichCategoryItemBSCAAccountsReceivableBSSERetainedEarningsISIncomeTaxExpenseBSCLAccruedExpensesBSCACashISSellingandAdministrativeExpensesBSFAPlantEquipmentISOperatingExpensesBSCAMarketableSecuritiesISInterestExpenseISSalesBSCLNotesPayable6monthsBSLLBondspayableMaturity2009BSSECommonStockISDepreciationExpenseBSCAInventoriesBSSECapitalinexcessofparvalueISNetIncomeEarningsafterTaxesBSCLIncometaxpayable2-
15.TheRogersCorporationhasagrossprofitof$880000and$360000indepreciationexpense.TheEvansCorporationalsohas$880000ingrossprofitwith$60000indepreciationexpense.Sellingandadministrativeexpenseis$120000foreachcompany.Giventhatthetaxrateis40percentcomputethecashflowforbothcompanies.Explainthedifferenceincashflowbetweenthetwofirms.Solution:RogersCorporation–EvansCorporationRogersEvansGrossprofitSellingandadm.expenseDepreciationOperatingprofitTaxes40%EarningsaftertaxesPlusdepreciationexpenseCashFlow$880000120000360000$88000012000060000$400000160000$700000280000$240000$360000$420000$60000$600000$480000Rogershad$300000moreindepreciationwhichprovided$
1200000.40x$300000moreincashflow.2-
16.Arrangethefollowingitemsinproperbalancesheetpresentation.Accumulateddepreciation$200000Retainedearnings110000Cash5000Bondspayable142000Accountsreceivable38000Plantandequipment—originalcost720000Accountspayable35000Allowanceforbaddebts6000Commonstock$1par150000sharesoutstanding150000Inventory66000Preferredstock$50par1000sharesoutstanding50000Marketablesecurities15000Investments20000Notespayable83000Capitalpaidinexcessofparcommonstock88000Solution:AssetsCurrentAssets:CashMarketablesecuritiesAccountsreceivableLess:AllowanceforbaddebtsInventoryTotalCurrentAssetsOtherAssets:InvestmentsFixedAssts:PlantandequipmentLess:AccumulateddepreciationNetplantandequipmentTotalAssets$380006000$720000200000$5000150003200066000$11800020000520000$6580002-
16.ContinuedLiabilitiesandStockholdersEquityCurrentLiabilities:AccountspayableNotespayableTotalcurrentliabilitiesLong-termLiabilitiesBondspayableTotalLiabilitiesStockholdersEquity:Preferredstock$50par1000sharesoutstandingCommonstock$1par150000sharesoutstandingCapitalpaidinexcessofparcommonstockRetainedearningsTotalStockholdersEquityTotalLiabilitiesandStockholdersEquity$3500083000$118000142000$2600005000015000088000110000$398000$6580002-
17.HortonElectronicshascurrentassetsof$320000andfixedassetsof$
640000.Currentliabilitiesare$90000andlong-termliabilitiesare$
160000.Thereis$90000inpreferredstockoutstandingandthefirmhasissued40000sharesofcommonstock.Computebookvaluenetworthpershare.Solution:HortonEnergyCompanyCurrentassetsFixedassetsTotalassets–Currentliabilities–Long-termliabilitiesStockholdersequity–PreferredstockobligationNetworthassignedtocommonCommonsharesoutstandingBookvaluenetworthpershare$320000640000$96000090000160000$71000090000$62000040000$
15.502-
18.TheHoltzmanCorporationhasassetsof$400000currentliabilitiesof$50000andlong-termliabilitiesof$
100000.Thereis$40000inpreferredstockoutstanding;20000sharesofcommonstockhavebeenissueda.Computebookvaluesnetworthpershare.b.Ifthereis$22000inearningsavailabletocommonstockholdersandHoltzman’sstockhasaP/Eof18timesearningspersharewhatisthecurrentpriceofthestockc.WhatistheratioofmarketvaluepersharetobookvaluepershareSolution:HoltzmanCorporationa.TotalassetsCurrentliabilitiesLong-termliabilitiesStockholdersequityPreferredstockNetworthassignedtocommonCommonsharesoutstandingBookvaluesnetworthpershareb.EarningsavailabletocommonSharesoutstandingEarningspershare$40000050000100000$25000040000$21000020000$
10.50$2200020000$
1.10c.Marketvaluepersharepricetobookvaluepershare$
19.80/$
10.50=
1.892-
19.BradleyGypsumCompanyhasassetsof$1900000currentliabilitiesof$700000andlong-termliabilitiesof$
580000.Thereis$170000inpreferredstockoutstanding;30000sharesofcommonstockhavebeenissueda.Computebookvaluesnetworthpershare.b.Ifthereis$42000inearningsavailabletocommonstockholdersandBradley’sstockhasaP/Eof15timesearningspersharewhatisthecurrentpriceofthestockc.WhatistheratioofmarketvaluepersharetobookvaluepershareSolution:BradleyGypsumCompanya.TotalassetsCurrentliabilitiesLong-termliabilitiesStockholdersequityPreferredstockNetworthassignedtocommonCommonsharesoutstandingBookvaluesnetworthpershareb.EarningsavailabletocommonstockholdersSharesoutstandingEarningspershare$1900000700000580000$620000170000$45000030000$
15.00$4200030000$
1.40c.Marketvaluepersharepricetobookvaluepershare$
21.00/$
15.00=
1.402-
20.Inproblem19ifthefirmsellsattwotimesbookvaluepersharewhatwilltheP/EratiobeSolution:BradleyGypsumCompanycontinued2-
21.ForDecember312003thebalancesheetoftheGardnerCorporationisasfollows:CurrentAssetsCash$15000Accountsreceivable22500Inventory37500Prepaidexpenses18000FixedAssetsPlantandequipmentgross$375000Less:AccumulatedDepreciation75000Netplantandassets300000Totalassets$393000LiabilitiesAccountspayable$20000Notespayable30000Bondspayable75000StockholdersEquityCommonstock$112500Paid-in-capital37500Retainedearnings118000TotalliabilitiesandStockholdersequity$393000Salesfor2004were$330000withcostofgoodssoldwas60percentofsales.Sellingandadministrativeexpensewas$
33000.Depreciationexpensewas10percentofplantandequipmentgrossatthebeginningoftheyear.Interestexpenseforthenotespayablewas10percentwhileinterestonbondspayablewas12percent.ThesewerebasedonDecember312003balances.Thetaxrateaveraged20percent.2-
21.ContinuedTwothousanddollarsinpreferredstockdividendwerepaidand$4100individendswerepaidtocommonstockholders.Therewere10000sharesofcommonstockoutstanding.Duringtheyear2004thecashbalanceandprepaidexpensesbalancewereunchanged.Accountsreceivableandinventoryincreasedby20percent.AnewmachinewaspurchasedonDecember312004atacostof$
60000.Accountspayableincreasedby30percent.Atyear-endDecember312004notespayableincreasedby$10000andbondspayabledecreasedby$
15000.Thecommonstockandpaid-incapitalinexcessofparaccountsdidnotchange.a.Prepareanincomestatementfor
2004.b.Prepareastatementofretainedearningsfor
2004.c.PrepareabalancesheetasofDecember
312004.Solution:GardnerCorporation2004IncomeStatementa.Sales$330000Costofgoodsold60%of$330000198000Grossprofit132000Sellingandadministrativeexpense33000Depreciationexpense10%x$37500037500OperatingprofitEBIT61500Interestexpense12000
[1]Earningsbeforetaxes49500Taxes20%9900EarningsaftertaxesEAT39600Preferredstockdividends2000Earningsavailabletocommonstockholder$37600Sharesoutstanding10000Earningspershare$
3.762-
21.Continuedb.2004StatementofRetainedEarningsRetainedearningsbalanceJanuary12004$118000Add:Earningsavailabletocommonstockholders200437600Deduct:Cashdividenddeclaredin20044100RetainedearningsbalanceDecember312004$151500c.2004BalanceSheetCurrentAssetsLiabilitiesCash$15000Accountspayable$26000Accountsreceivable27000Notespayable40000Inventory45000Bondspayable60000Prepaidexpenses18000_______$105000$1260002-
21.ContinuedFixedAssetsStockholdersEquityGrossplant$435000Commonstock$112500Accumulateddepreciation112500
[2]Paidincapitalinexcessofpar37500Netplant322500Retainedearnings151500Totalassets$427500TotalLiabilityEquity$4275002-
22.PrepareastatementofcashflowsfortheJeterCorporation.FollowthegeneralproceduresindicatedinTable2-
10.CrosbyCorporationIncomeStatementFortheYearEndedDecember312004Sales$2200000Costofgoodssold1300000Grossprofits900000Sellingandadministrativeexpense420000Depreciationexpense150000Operatingincome330000Interestexpense90000Earningsbeforetaxes240000Taxes80000Earningsaftertaxes160000Preferredstockdividends10000Earningsavailabletocommonstockholders$150000Sharesoutstanding120000Earningspershare$
1.25StatementofRetainedEarningsFortheYearEndedDecember312004RetainedearningsbalanceJanuary12004$500000Add:Earningsavailabletocommonstockholders2004150000Deduct:Cashdividendsdeclaredandpaidin200450000RetainedearningsbalanceDecember312004$600000ContinuedComparativeBalanceSheetsFor2003and2004Year-End2003Year-End2004AssetsCurrentassets:CashAccountsreceivablenetInventoryPrepaidexpensesTotalcurrentassetsInvestmentslong-termsecuritiesPlantandequipmentLess:AccumulateddepreciationNetplantandequipmentTotalassets$700003000004100005000083000080000200000010000001000000$1910000$1000003500004300003000091000070000240000011500001250000$2230000LiabilitiesandStockholders’EquityCurrentliabilities:AccountspayableNotespayableAccruedexpensesTotalcurrentliabilitiesLong-termliabilities:Bondspayable2004TotalliabilitiesStockholders’equity:Preferredstock$100parvalueCommonstock$1parvalueCapitalpaidinexcessofparRetainedearningsTotalstockholders’equityTotalliabilitiesandstockholders’equity$2500004000007000072000070000790000900001200004100005000001120000$1910000$440000400000500008900001200001010000900001200004100006000001220000$2230000ThefollowingquestionsapplytotheCrosbyCorporationaspresentedinProblem
22.2-
22.ContinuedSolution:CrosbyCorporationStatementofCashFlowsFortheYearEndedDecember312004Cashflowsfromoperatingactivities:NetincomeearningsaftertaxesAdjustmentstodeterminecashflowfromoperatingactivities:AddbackdepreciationIncreaseinaccountsreceivableIncreaseininventoryDecreaseinprepaidexpensesIncreaseinaccountspayableDecreaseinaccruedexpensesTotaladjustmentsNetcashflowsfromoperatingactivitiesCashflowsfrominvestingactivities:DecreaseininvestmentsIncreaseinplantandequipmentNetCashflowsfrominvestingactivitiesCashflowsfromfinancingactivities:IncreaseinbondspayablePreferredstockdividendspaidCommonstockdividendspaidNetcashflowsfromfinancingNetincreasedecreaseincashflows$1500005000020000200001900002000010000400000500001000050000$160000$270000$43000039000010000$30000Thestudentshouldobservethattheincreaseincashflowsof$30000equalsthe$30000changeinthecashaccountonthebalancesheet.Thisindicatesthestatementiscorrect.2-
23.Describethegeneralrelationshipbetweennetincomeandnetcashflowsfromoperatingactivitiesforthefirm.Solution:Cashflowsfromoperatingactivitiesfarexceedsnetincome.Thisoccursprimarilybecauseweaddbackdepreciationof$150000andaccountspayableincreaseby$
190000.Thusthereaderofthecashflowstatementgetsimportantinsightsastohowmuchcashflowwasdevelopedfromdailyoperations.2-
24.HasthebuildupinplantandequipmentbeenfinancedinasatisfactorymannerBrieflydiscuss.Solution:Thebuildupinplantandequipmentof$400000grossand$250000nethasbeenfinancedinpartbythelargeincreaseinaccountspayable
190000.Thisisnotaverysatisfactorysituation.Short-termsourcesoffundscanalwaysdryupwhilefixedassetneedsarepermanentinnature.Thefirmmaywishtoconsidermorelong-termfinancingsuchasamortgagetogoalongwithprofitstheincreaseinbondspayableandtheadd-backofdepreciation.2-
25.Computethebookvaluepercommonshareforboth2003and2004fortheCrosbyCorporation.Solution:BookvaluePershareBookvaluePershare2003BookvaluePershare20042-
26.Ifthemarketvalueofashareofcommonstockis
3.3timesbookvaluefor2004whatisthefirmsP/Eratiofor2004Solution:Marketvalue=
3.3x$
9.42=$
31.09P/Eratio=marketvalue/earningspershare=$
31.09/$
1.25=
24.87ComprehensiveProblemCP2-
1.Additionalproblemnotincludedinthetext:ThechieffinancialofficerofMortonIndustrieswasreviewingtheincomestatementofherfirminpreparationforameetingwiththepresidentofthecompany.TheinformationisshowninExhibit
1.MortonIndustriesIncomeStatementFortheYearsEndedDecember312003200420032004Sales$877200$923147Costofgoodssold343720344160Grossprofits533480578987Sellingandadministrativeexpense8100093237DepreciationExpense112000120000Operatingincome340480365750Interestexpense2233010000Earningsbeforetaxes318150355750Taxes35%111353124512Earningsaftertaxes206797231238Preferredstockdividends2000020000Earningsavailabletocommonstockholders186797211238Sharesoutstanding100000100000Earningspershare$
1.87$
2.11Whatisthepercentageincreaseinsalesbetween2003and2004Whatisthepercentageincreaseinearningsafter-taxbetween2003and2004Assumeyouareaskedwhyearningsaftertaxesincreasedpercentagewisemorerapidlythansales.Takeeachexpenseaccountfromcostofgoodssoldthroughtaxesasapercentageofsalesforeachyearandindicatewhetheritwasacontributorordetractorfromthesuperiorgrowthinearningaftertaxes.Rememberdecliningpercentage“costs”contributetoprofit.Alsolargeamountssuchascostofgoodssoldhaveagreaterimpactthansmalleramountssuchasdepreciationorinterest.Ifcostofgoodssoldcouldbereducedto33percentofsalesin2004whileallelseremainedconstantwiththeexceptionoftaxeswhichremainat35percentofearningsbeforetaxeswhatwouldearningspersharebein2004Nowreturntotheoriginalincomestatementsi.e.disregardquestiond.WhatisthecashflowforeachyearearningsaftertaxesplusdepreciationWhatisthepercentagechangefrom2003to
2004.CP2-
1.ContinuedIn2004adddepreciationtooperatingincometogetcashflowfromoperatingactivities.Thensubtractout$20000forpreferredstockdividendsandassumethereare$40000incapitalexpenditureswhatisfreecashflowAssumeMortonIndustriesisconsideringbuyingallitsstockbackwithborrowedfundsaleveragedbuyback.Oneofthelender’srequirementsisthat10timesfreecashflowfromquestionfmustbeatleastequaltothetotalvalueofthecompany.Thetotalvalueofthecompanyin2004isequaltoearningspersharetimesthefirm’sP/Eratiowhichis19timessharesoutstanding.Figureoutthevalueof10timesfreecashflow.Thenfigureoutthetotalvalueofthefirm.Wouldthefirmmeetthelender’srequirementCPSolution:Sales—2004Sales—2003Change$923147877200$45947Earningsaftertaxes—2004Earningsaftertaxes—2003Change$231238206797$24441CP2-
1.Continuedc.20032004ContributorsCostofgoodssoldInterestexpenseDetractorsSellingandadministrativeexpenseDepreciationexpenseTaxesNote:Becausecostofgoodssoldinvolvesthelargestdollaramountitsimpactismuchgreater.CP2-
1.Continuedd.SalesCostofgoodssold33%GrossprofitsSellingandadministrativeexpenseDepreciationExpenseOperatingincomeInterestexpenseEarningsbeforetaxesTaxes35%ofE.B.T.EarningsaftertaxesPreferredstockdividendsEarningsavailabletocommonstockholdersSharesoutstandingEarningspershare$923147304639618508932371200004052711000039527113834525692620000236926100000$
2.37e.20032004EarningsaftertaxesDepreciationCashflow$206797112000$318797$231238120000$351238Operatingincome—2004+DepreciationCashflowfromoperatingactivities–Preferredstockdividends–CapitalexpendituresFreecashflow$365750120000$4857502000040000$425750CP2-
1.ContinuedFreecashflowMultiplierTotalValueofCompanyEPS—2004P/EStockpriceSharesoutstandingTotalvalueofcompany$42575010$4257500$
2.1119$
40.09100000$4009000Tentimesfreecashflow$4257500isgreaterthanthevalueoftheCompany$4009000sothelendershouldbesatisfied.Cashflow—2004Cashflow—2003Change$351238318797$32441^110%x30000+12%x$75000=$12000^2$75000+$37500=$112500。