Homework Assignment 1 Solution
Chapter 2: Financial Accounting
1a.
Calculate the net profit margin, total asset turnover, assets-to-equity ratio, and ROE
using the data in the following table for firms in the same industry.
Sales
Earnings
available for
common
stockholders
Total assets
Stockholder’s
equity
Axel Co.
$260000
49400
170000
$50000
Blue Co.
150000
9000
80000
50000
Carol Co
100000
10000
100000
94000
David Co.
300000
12000
270000
150000
1b.
Evaluate each firm’s performance relative to the other three firms in the industry.
ANS:
a.
Net profit
margin
Total asset
turnover
Assets–to–Equity
Ratio
ROE
Axel Co.
19%
1.53
3.4
98.8%
Blue Co
6%
1.88
1.6
18.0%
Carol Co.
10%
1.00
1.06
10.6%
David Co.
4%
1.11
1.8
8.0%
b.
• Axel Co. appears to have the best financials
•
Blue Co. has a low net profit margin indicating the need for lower costs or
higher prices.
•
Carol Co. has both a low total assets turnover and a low assets-to-equity ratio.
The low turnover indicates excessive investment in assets. The low assets-to–
equity ratio indicates that the firm is not taking advantage of financial leverage
(debt).
•
David Co. has a lower net profit margin and total asset turnover, but makes
up for these weaknesses by using more financial leverage which is reflected in
its high assets–to-equity ratio, i.e., high risk.
2. Find online the annual 10-K report for Costco Wholesale Corporation (COST) for fiscal year
2015 (filed in October 2015 in EDGAR Database). Answer the following questions from their
balance sheet:
a. How much cash did Costco have at the end of the fiscal year?
b. What were Costco’s total assets?
c. What were Costco’s total liabilities? How much debt did Costco have?
d. What was the book value of Costco’s equity?
ANS.
a. At the end of the fiscal year, Costco had cash and cash equivalents of $4,801 million.
b. Costco’s total assets were $33,440 million.
c. Costco’s total liabilities were $22,597 million, and it had $6,157 million in debt.
d. The book value of Costco’s equity was $10,843 million.
3. Quisco Systems has 6.5 billion shares outstanding and a share price of $18. Quisco is
considering developing a new networking product in house at a cost of $500 million.
Alternatively, Quisco can acquire a firm that already has the technology for $900 million worth (at
the current price) of Quisco stock. Suppose that absent the expense of the new technology, Quisco
will have EPS of $0.80.
a. Suppose Quisco develops the product in house. What impact would the development cost have
on Quisco’s EPS? Assume all costs are incurred this year and are treated as an R&D
expense, Quisco’s tax rate is 35%, and the number of shares outstanding is unchanged.
b. Suppose Quisco does not develop the product in house but instead acquires the technology.
What effect would the acquisition have on Quisco’s EPS this year? (Note that acquisition
expenses do not appear directly on the income statement. Assume the firm was acquired at
the start of the year and has no revenues or expenses of its own, so that the only effect on
EPS is due to the change in the number of shares outstanding.)
c. Which method of acquiring the technology has a smaller impact on earnings? Is this
method cheaper? Explain.
ANS.
a. If Quisco develops the product in-house, its earnings would fall by $500 × (1 – 35%) = $325
million. With no change to the number of shares outstanding, its EPS would decrease by
to $0.75. (Assume the new product would not change this year’s revenues.)
b. If Quisco acquires the technology for $900 million worth of its stock, it will issue $900/18 = 50
million new shares. Since earnings without this transaction are $0.80 × 6.5 billion = $5.2
billion, its EPS with the purchase is .
c. Acquiring the technology would have a smaller impact on earnings, but this method is not
cheaper. Developing it in-house is less costly and provides an immediate tax benefit. The
earnings impact is not a good measure of the expense. In addition, note that because the
acquisition permanently increases the number of shares outstanding, it will reduce
Quisco’s earnings per share in future years as well.
4. The DuPont System allows us to relate the return on total assets and the return on common
equity to various measures of firm characteristics. Consider a firm with a ROA of 0.04.
a.
If you were analyzing a firm that had sales of $12500 and total assets of $10000, how
much in earnings were available for common shareholders?
b.
If the firm had common stockholders’ equity of $3300, what would be the firm’s ROE?
$325
$0.05 6500
=
5.2 = $0.794
6.55
c.
If we compare this firm to another similar firm in the industry we find that the
comparison firm has an ROA and ROE of 0.05 and 0.191663, respectively. Given this
information, calculate the comparison firm’s ratio of total assets to common stock equity.
How does this ratio differ from our firm?
d.
Interpret the performance differences between these firms.
Given
ANS:
a.
earnings available for common shareholders = 0.04 $10000 = $400
b.
ROE = $400 / $3300 = 0.1212 or 12.12%
c.
ROE = ROA A / E
0.191663 = 0.05 A / E therefore, A / E = 3.83326 (virtually the same as for our firm,
i.e. $10000 / $3300 = 3.0303)
d.
The performance differences between these firms are therefore due to the differing
abilities of the two firms to earn returns on their assets The first firm earned only 4
cents on each dollar of assets whereas the comparison firm earned 5 cents on each
dollar of assets, thereby accounting for its greater return on common stockholder
equity.
5. The balance sheets provided for Local Oil Co (2003 and 2004) below, calculate the following
ratios for both 2003 and 2004:
a.
Current ratio
b.
Quick ratio
c.
Debt ratio
d.
Assets–to–equity
e.
Debt–to–equity
Local Oil Co. Balance Sheet 2003 and 2004 ($ in millions)
Assets
2004
2003
Current Assets
Cash and cash equivalents
$ 220
$ 200
Marketable securities
50
40
Accounts receivable
1,750
1,550
Inventories
650
670
Other
150
160
Total current assets
$2820
$2620
Fixed assets
Gross property, plant, and equipment
$9,550
$9,025
Less: Accumulated Depreciation
(3,450)
(3,250)
Net property, plant, and equipment
$6,100
$5,775
Intangible assets and others
750
575
Net fixed assets
$6,850
$6,350
Total assets
$9670
$8970
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable
$1700
$1600
Notes payable
350
600
Accrued expenses
300
300
Total current liabilities
$2350
$2500
Long term liabilities
Deferred taxes
$ 950
$ 900
Long–term debt
2,000
1,800
Total long-term liabilities
$2950
$2700
Total Liabilities
$5300
$5200
Stockholders‘ equity
Preferred stock
$ 240
$ 240
Common stock par value
240
220
Paid-in capital in excess of par
1250
1075
Retained earnings
840
215
Less: Treasury stock
(550)
(480)
Total stockholders‘ equity
$2020
$1270
Total liabilities and stockholders’ equity
$9670
$8970
ANS:
