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3. Which intangible assets are listed on the balance sheet?
4. How much income tax did the company pay?
5. Using the financial ratios discussed in this chapter, answer the following:
a. What is the current ratio?
b. What is the debt-to-equity ratio?
6. What is the basic earnings per share? Diluted earnings per share.
Chapter 17 – Understanding Accounting and Financial Information
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1. How many pizzas can you anticipate selling?
2. What price should you charge per pizza?
3. How much of each raw material do you need to buy?
4. What will be your probable profit?
5. Develop a financial plan for your weekend enterprise.
notes on critical thinking exercise 17-2
1. How many pizzas can you anticipate selling?
2. What price should you charge per pizza?
You could consider several pricing strategies. Chapter 14 covered several possibilities: demand-
Chapter 17 – Understanding Accounting and Financial Information
17–81
INGREDIENT
AMOUNT PER
PIZZA
OUNCES
COST OF
INGREDIENT
COST PER
OUNCE
COST PER
PIZZA
Pizza flour
1/2 lb.
8 oz.
$8.00 per 10 lb.
$0.05
$0.40
Pizza sauce
2 oz.
2 oz.
$4.80 per 64 oz.
$0.075
$0.15
Pepperoni
1/8 lb.
2 oz.
$18.00 per 5 lb.
$0.225
$0.45
Cheese
1/2 lb.
8 oz.
$15.00 per 5 lb.
$0.1875
$1.50
Total
$2.50
After determining the cost of raw materials, a price can be set that covers these costs and provides
the desired profit. Possible prices: $5.00, $7.00, or $9.00.
3. How much of each raw material do you need to buy?
INGREDIENT
AMOUNT
PER PIZZA
OUNCES
POTENTIAL
SALES UNITS
TOTAL OUNCES
NEEDED
TOTAL
POUNDS
Pizza flour
1/2 lb.
8 oz.
400
3,200 oz.
200 lb.
Pizza sauce
2 oz.
2 oz.
400
800 oz.
Pepperoni
1/8 lb.
2 oz.
400
800 oz.
50 lb.
Cheese
1/2 lb.
8 oz.
400
3,200 oz.
200 lb.
SUPPLIES NEEDED
Pizza flour 20 10-lb. bags 20 x $8.00 $160.00
Pizza sauce 12 1/2 64-oz. jars 13 x $4.80 $62.40
Pepperoni 10 5-lb. packages 10 x $18.00 $180.00
Cheese 40 5-lb. packages 40 x $15.00 $600.00
Total cost $1,002.40
4. What will be your probable profit?
5. Develop a financial plan for your weekend enterprise.
PROJECT COSTS
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Cheese 40 5-lb. packages 40 x $15.00 $600.00
Total cost $1,027.40
1. How many pizzas can you anticipate selling?
2. What price should you charge per pizza?
3. How much of each raw material do you need to buy?
INGREDIENT
AMOUNT PER
PIZZA
OUNCES
POTENTIAL
SALES UNITS
TOTAL OUNCES
NEEDED
TOTAL
POUNDS
Pizza flour
1/2 lb.
8 oz.
3,000
24,000 oz.
1,500 lb.
Pizza sauce
2 oz.
2 oz.
3,000
6,000 oz.
Pepperoni
1/8 lb.
2 oz.
3,000
6,000 oz.
375 lb.
Cheese
1/2 lb.
8 oz.
3,000
24,000 oz.
1,500 lb.
SUPPLIES NEEDED
Pizza flour 150 10-lb. bags 150 x $8.00 $1,200.00
Pizza sauce 93.75 64-oz. jars 94 x $4.80 $ 451.20
Pepperoni 75 5-lb. packages 75 x $18.00 $1,350.00
Cheese 300 5-lb. packages 300 x $15.00 $4,500.00
Total cost $7,501.20
4. What will be your probable profit?
17–83
5. Develop a financial plan for your weekend enterprise.
Purchase enough raw materials to make 3,000 pizzas and market aggressively. If sales don’t meet
expectations by the end of the third quarter, lower the price by half. Even at a $5.00 sales price, you will
cover the $2.50 variable cost and make $2.50 profit per pizza.
Name: ___________________________
Notes Receivable 61,200
Insurance Expenses 54,000
Accounts Payable 45,000
Interest Expenses 24,600
Common Stock 1,896,000
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Utilities 8,400
Equipment & Vehicles 1,066,000
Goodwill 90,000
FY 201X
REVENUES
Net Sales $1,053,000
COST OF GOODS SOLD
Beginning Inventory $154,800
General Expenses
Insurance $54,000
Interest Expense 24,600
Rent 13,800
Utilities 8,400
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Fixed Assets
Land $1,500,000
Buildings 1,050,000
Equipment & Vehicles 1,066,000
Total Current Liabilities $60,600
Chapter 17 – Understanding Accounting and Financial Information
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Name: ___________________________
Date: ___________________________
critical thinking exercise 17-4
CALCULATING FINANCIAL RATIOS (ADVANCED)
You are considering investing in Acme Incorporated. The company has provided you with the
balance sheet and income statement for the previous year. The current price of one share of stock is
$46.25. Earning per share last year was $1.86.
1. Calculate the requested financial ratios:
a. Current ratio
2. Would you invest in Acme Incorporated? Why or why not?
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ACME INCORPORATED
STATEMENT OF INCOME
FY 201X
REVENUES
Net Sales $4,090,970
Other Income +104,227
Total Revenue $4,195,197
ACME INCORPORATED
BALANCE SHEET
Total Current Assets $2,066,586
Fixed Assets
Land $510,000
Plant and Buildings 304,096
Equipment 218,500
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TOTAL ASSETS $3,861,217
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
1. Calculate the requested financial ratios.
a. Current ratio. The current ratio is the ratio of the firm’s current assets to its current liabil-
2.086:1
b. Debt-to-equity ratio. The debt-to-equity ratio measures the degree to which the company
0.729 or 72.9%
Chapter 17 – Understanding Accounting and Financial Information
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16.18%
d. Return on equity. Return on equity measures how much was earned for each dollar in-
29.65%
e. Earnings per share. Earnings per share measures the amount of profit earned by a com-
2. Would you invest in Acme Incorporated? Why or why not?
$1.00 of current liabilities. The firms should be able to meet short-term debt payments
easily.
b. The debt–to-equity ratio of 72.9% means that the firm has more equity than debt,
Chapter 17 – Understanding Accounting and Financial Information
Name: ___________________________
Date: ___________________________
critical thinking exercise 17-5
1. What is the net profit (or net loss) for each company?
2. Calculate the return on sales for each company.
4. What is the current ratio for each company?
5. Calculate the return on equity ratio for each company.
6. What is the debt-to–equity ratio for each company?
17–91
7. Calculate the basic earnings per share for each company.
HOTEL N
HOTEL J
HOTEL C
HOTEL W
1. Net income (net profit
or net loss)
2. Return on sales
3. Current ratio
4. Stockholders’ equity
5. Return on equity
6. Debt-to-equity ratio
7. Earnings per share
(basic)
8. Which company would you rather invest in? Why?
HOTEL N
HOTEL J
HOTEL C
HOTEL W
1. Net income (net profit
or net loss)
$ 596,000
$ 198,000
$ 74,345
($545,198)
2. Return on sales
5.9%
5.2%
17.3%
(42.7%)
3. Current ratio
0.83
1.13
0.68
0.76
4. Stockholders’ equity
4,081,000
2,239,000
(194,053)
693,809
5. Return on equity
14.6%
8.8%
Not meaningful
(78.5%)
6. Debt-to-equity ratio
112%
265%
Not meaningful
445%
7. Earnings per share
(basic)
$2.64
$0.51
$2.30
($3.24)
ideal 2.0, is in line with two of the other three companies. Return on equity is healthy and at
the top of the industry, showing that the company has made good use of the funds invested
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HOTEL J Return on sales is in the midrange. Current ratio is at the top of the industry, showing a bet-
ter than average liquidity. Return on equity is not exceptional, but in the midrange for the
industry. The debt-to-equity ratio, however, is alarming. With a debt-to-equity ratio of
tive, but the company is hemorrhaging money. The company’s return on sales shows that
the company is spending almost 43% more than it takes in as revenue—$1.00 in sales costs
the company $1.43.
Hotels C and W are horrible investment candidates. That leaves Hotels N and J. Hotel J is heavily
leveraged and would be more risky. Hotel N is a steady, safe performer. Knowing that there is a direct
buyers to come to the campgrounds. Once a potential customer was at the site, there was much pressure to
buy now, and the campgrounds were quite attractive. Once a customer got home and reconsidered the
investment, though, some backed out of the commitment, and that is where Thousand Trails got into dif-
ficulty.
The company recorded the full price of a membership (about $7,500) as revenue, even though
$29.
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Two years later, the stock had fallen to less than $5, reflecting a 90% drop in earnings reported
1. Thousand Trails did nothing illegal in its reporting of revenues and profits. What does that tell
you about the need to carefully read and analyze income statements before you invest?
2. Can you see how cash flow problems can grow to unbelievable proportions in just a short time,
even when profits look good?
1. Thousand Trails did nothing illegal in its reporting of revenues and profits. What does that tell
you about the need to carefully read and analyze income statements before you invest?
2. Can you see how cash flow problems can grow to unbelievable proportions in just a short time,
even when profits look good?
cy.
Chapter 17 – Understanding Accounting and Financial Information
17–94
bonus case 17-2
MANAGING BY THE NUMBERS
Katherine Potter knew a good thing when she saw it. At least, it seemed so at first. She was trav-
Most customers bought Katherine’s products on credit. They would buy a couple of lamps and a
pot, and Katherine would allow them to pay over time. Some were very slow in paying her, taking six
months or more.
After three years, Katherine noticed a small drop in her business. The local economy was not do-
ing well, and many people were being laid off from their jobs. Nonetheless, Katherine’s business stayed
1. How is it possible to have high sales and high profits and run out of cash?
2. Why did Katherine do better when she raised her prices and refused to sell on credit?
3. What was the nature of Katherine’s problem? Was she correct to go to the banker for help, even
though she owed the bank money? How could she have prevented some of the problems she
eventually found herself faced with?
17–95
1. How is it possible to have high sales and high profits and run out of cash?
2. Why did Katherine do better when she raised her prices and refused to sell on credit?
3. What was the nature of Katherine’s problem? Was she correct to go to the banker for help, even
though she owed the bank money? How could she have prevented some of the problems she even-
tually found herself faced with?
17–96
2010.
ii Lecture Link created by Michael McHugh.
iii Sources: Brady Dennis, “Congress Passes Financial Reform Bill,” The Washington Post, July 16, 2010; Paul Da-
vidson, Paul Wiseman, and John Waggoner, “Will New Financial Regulations Prevent Future Meltdowns?” USA