Chapter 02: Review of Accounting
2-21
Increase in inventory – decreases cash flow (use)
Dividend payment – decreases cash flow (use)
21. Depreciation and Cash flow (LO5) The Jupiter Corporation has a gross profit of
$700,000 and $240,000 in depreciation expense. The Saturn Corporation also has $700,000
in gross profit, with $40,000 in depreciation expense. Selling and administrative expense is
$160,000 for each company.
Given that the tax rate is 40 percent, compute the cash flow for both companies.
Explain the difference in cash flow between the two firms.
2-21. Solution:
Jupiter Corporation – Saturn Corporation
Jupiter
Saturn
Gross profit ………………………………..
Selling and adm. expense ………..
Depreciation ……………………………….
$700,000
160,000
240,000
$700,000
160,000
40,000
Operating profit ………………………….
Taxes (40%) ……………………………….
$300,000
120,000
$500,000
200,000
Earnings after taxes ……………………..
Plus depreciation expense …………….
$180,000
$240,000
$300,000
$40,000
Cash Flow ………………………………….
$420,000
$340,000
Jupiter had $200,000 more in depreciation which provided
$80,000 (0.40 $200,000) more in cash flow.
22. Free cash flow (LO4) Coastal Pipeline, Inc., anticipated cash flow from operating
activities of $8 million in 2010. It will need to spend $1.5 million on capital investments in
order to remain competitive within the industry. Common stock dividends are projected at
$.6 million and preferred stock dividends at $.25 million.
a. What is the firm’s projected free cash flow for the year 2010?
b. What does the concept of free cash flow represent?
Chapter 02: Review of Accounting
2-22. Solution:
Coastal Pipeline, Inc.
a. Cash flow from operations activities $8.00 million
23. Book value (LO3) Landers Nursery and Garden Stores has current assets of $220,000 and
fixed assets of $170,000. Current liabilities are $80,000 and long-term liabilities are
$140,000. There is $40,000 in preferred stock outstanding and the firm has issued 25,000
shares of common stock. Compute book value (net worth) per share.
2-23. Solution:
Landers Nursery and Garden Stores
$220,000
170,000
$390,000
80,000
140,000
$170,000
40,000
$130,000
25,000
Chapter 02: Review of Accounting
24. Book value and market value (LO2 & 3) The Rockford Corporation has assets of
$380,000, current liabilities of $40,000, and long-term liabilities of $70,000. There is
$30,000 in preferred stock outstanding; 20,000 shares of common stock have been issued.
a. Compute book value (net worth) per share.
b. If there is $25,000 in earnings available to common stockholders and Rockford’s stock
has a P/E 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?
2-24. Solution:
Rockford Corporation
$380,000
40,000
70,000
270,000
30,000
$240,000
20,000
$ 12.00
$ 25,000
20,000
$ 1.25
P/E ratio × earnings per share = price
15 × $1.25 = $18.75
c. Market value per share (price) to book value per
share $18.75/$12.00 = 1.56
25. Book value and market value (LO2 & 3) Amigo Software, Inc., has total assets of
$800,000, current liabilities of $150,000, and long-term liabilities of $120,000. There is
$65,000 in preferred stock outstanding. Thirty thousand shares of common stock have
Chapter 02: Review of Accounting
2-25. Solution:
Amigo Software, Inc.
$800,000
150,000
120,000
$530,000
65,000
$465,000
30,000
$ 15.50
$ 48,000
30,000
$ 1.60
P/E ratio × earnings per share = price
20 × $1.60 = $32.00
c. Market value per share (price) to book value per share
$32.00/$15.50 = 2.06
26. Book value and P/E ratio (LO2 & 3) In problem 25, if the firm sells at 2.5 times book
value per share, what will the P/E ratio be? (Round to the nearest whole number.)
2-26. Solution:
Chapter 02: Review of Accounting
2-25
2.5 × book value per share = price
2.5 × $15.4 = $38.75
Price = P/E
Earnings per share
$38.75 = 24.22 P/E ratio
$1.60
round to 24x
27. Construction of income statement and balance sheet (LO1 & 3) For December 31,
2009, the balance sheet of Baxter Corporation was as follows:
________________________________________________________________________
Current Assets Liabilities
Cash …………………………………… $ 10,000 Accounts payable ………….. $ 12,000
Accounts receivable ……………… 15,000 Notes payable ……………….. 20,000
Inventory …………………………….. 25,000 Bonds payable ………………. 50,000
Prepaid expenses ………………….. 12,000
Fixed Assets Stockholders’ Equity
Plant and equipment (gross)…. .. $250,000 Preferred stock………………. 20,000
Less: Accumulated …………….. Common stock………………. 55,000
depreciation ………………………. 50,000 Paid-in capital ……………….. 25,000
Net plant and equipment ………… 200,000 Retained earnings …………. 80,000
………………………………………….. Total liabilities and
Total Assets …………………………. $262,000 stockholders’ equity ……….. $262,000
________________________________________________________________________
Sales for 2010 were $220,000, and the cost of goods sold was 60 percent of sales. Selling
and administrative expense was $22,000. Depreciation expense was 8 percent of plant and
equipment (gross) at the beginning of the year. Interest expense for the notes payable was
10 percent, while the interest rate on the bonds payable was 12 percent. This interest
expense is based on December 31, 2009 balances. The tax rate averaged 20 percent.
Two thousand dollars in preferred stock dividends were paid and $8,400 in dividends were
paid to common stockholders. There were 10,000 shares of common stock outstanding.
Chapter 02: Review of Accounting
2-26
During 2010, the cash balance and prepaid expenses balances were unchanged.
Accounts receivable and inventory increased by 10 percent. A new machine was purchased
on December 31, 2010, at a cost of $35,000.
Accounts payable increased by 25 percent. Notes payable increased by $6,000 and
bonds payable decreased by $10,000, both at the end of the year. The preferred stock,
common stock, and paid-in capital in excess of par accounts did not change.
a. Prepare an income statement for 2010.
b. Prepare a statement of retained earnings for 2010.
c. Prepare a balance sheet as of December 31, 2010.
2-27. Solution:
Baxter Corporation
2010 Income Statement
a. Sales ………………………………………………………. $220,000
Cost of good sold (60%) ……………………………. 132,000
Gross profit …………………………………………. $ 88,000
1 8% × $250,000 = $20,000
2 (10% × $20,000) + (12% × $50,000) = $8,000
Chapter 02: Review of Accounting
2-27
2-27. (Continued)
c.
2010 Balance Sheet
Current Assets
Liabilities
Cash…………..
$ 10,000
Accounts
payable
$15,000
Accounts
receivable……..
16,500
Notes payable….
26,000
Inventory………
27,500
Bonds payable…
40,000
Prepaid
expenses
12,000
_______
$66,000
$81,000
Fixed Assets
Stockholders’ Equity
Gross plant……
$285,000
Preferred stock…
Common stock…
$ 20,000
55,000
Accumulated
depr…………
(70,000)3
Paid in capital in
excess of par…
25,000
Net plant……..
215,000
Retained
earnings
100,000
Total assets…..
$281,000
Total Liability &
Equity………..
$281,000