Chapter 03: Financial Analysis
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31. Inflation and inventory accounting effect (LO5) The Canton Corporation shows the
following income statement. The firm uses FIFO inventory accounting.
CANTON CORPORATION
Income Statement for 2010
Sales ………………………………………………………… $100,000 (10,000 units at $10)
Cost of goods sold ……………………………………… 50,000 (10,000 units at $5)
Gross profit ………………………………………………. 50,000
Selling and administrative expense ……………….. 5,000
Depreciation ……………………………………………… 10,000
Operating profit …………………………………………. 35,000
Taxes (30%) ……………………………………………… 10,500
Aftertax income …………………………………………. $ 24,500
a. Assume in 2011 the same 10,000-unit volume is maintained, but that the sales price
increases by 10 percent. Because of FIFO inventory policy, old inventory will still be
charged off at $5 per unit. Also assume selling and administrative expense will be 5
percent of sales and depreciation will be unchanged. The tax rate is 30 percent.
Compute aftertax income for 2011.
b. In part a, by what percent did aftertax income increase as a result of a 10 percent
increase in the sales price? Explain why this impact took place.
c. Now assume that in 2012 the volume remains constant at 10,000 units, but the sales
price decreases by 15 percent from its year 2011 level. Also, because of FIFO
inventory policy, cost of goods sold reflects the inflationary conditions of the prior
year and is $5.50 per unit. Further, assume selling and administrative expense will be
5 percent of sales and depreciation will be unchanged. The tax rate is 30 percent.
Compute the aftertax income.
3-31. Solution:
Canton Corporation
a. 2011
Sales ………………………….. $110,000 (10,000 units at $11)
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3-42
3-31. (Continued)
b. Gain in aftertax income
2011 $31,150
2010 24,500
Increase $6,650
Increase $6,650 27.14%
Base value (2010) $24,500
==
Aftertax income increased much more than sales because of
FIFO inventory policy (in this case, the cost of old inventory
did not go up at all), and because of historical cost
depreciation (which did not change).
c. 2012
Sales ………………………….. $93,500 (10,000 units at $9.35*)
Cost of goods sold ……….. 55,000 (10,000 units at $5.50)
The low profits indicate the effect of inflation followed by
disinflation.
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32. Using ratios to construct financial statements (LO2) Construct the current assets section
of the balance sheet from the following data. (Use cash as a plug figure after computing the
other values.)
Yearly sales (credit) ………………………………………………………… $420,000
Inventory turnover …………………………..……………………………… 7 times
Current liabilities ……………………………………………………………. $80,000
Current ratio ………………………………………………………………….. 2
Average collection period ………………………………………………… 36 days
Current assets: $
Cash …………………………………………………………… ______
Accounts receivable ………………………………………. ______
Inventory …………………………………………………….. ______
Total current assets ……………………………………. ______
3-32. Solution:
Inventory = $420,000/7
= $60,000
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33. Using ratios to construct financial statements (LO2) The Shannon Corporation has
credit sales of $750,000. Given the following ratios, fill in the balance sheet.
Total assets turnover …………………………... 2.5 times
Cash to total assets ……………………………… 2.0 percent
Accounts receivable turnover ……………….. 10.0 times
Inventory turnover ……………………………… 15.0 times
Current ratio ………………………………………. 2.0 times
Debt to total assets ……………………………… 45.0percent
SHANNON CORPORATION
Balance Sheet 201X
Assets Liabilities and Stockholders’ Equity
Cash ………………………. _____ Current debt …………………………..……….. _____
Accounts receivable …… _____ Long-term debt ……………………………….. _____
Inventory …………………. _____ Total debt …………………………………….. _____
Total current assets … _____ Net worth …………………………..…………… _____
Fixed assets …………….. _____ Total debt and
Total assets …………… _____ stockholders’ equity …………………….. _____
3-33. Solution:
Shannon Corporation
Sales/total assets = 2.5 times
Total assets = $750,000/2.5
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3-33. (Continued)
Fixed assets = Total assets – current assets
Current assets = $6,000 + $75,000 + $50,000
= $131,000
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Shannon Corporation
Balance Sheet 201X
Cash ………………..
$ 6,000
Current debt ……..
A/R …………………
$ 75,000
Long-term debt …
Inventory ………….
$ 50,000
Total debt ………
Total current
assets
$ 131,000
Fixed assets ………
$ 169,000
Net worth …………
Total assets ………
$ 300,000
Total debt and
stockholders’
equity
34. Using ratios to determine account balances (LO2) We are given the following
information for the Pettit Corporation.
Sales (credit) …………………………………………………. $3,000,000
Cash …………………………………………………………….. 150,000
Inventory ………………………………………………………. 850,000
Current liabilities ……………………………………………. 700,000
Asset turnover ……………………………………………….. 1.25 times
Current ratio ………………………………………………….. 2.50 times
Debt-to-assets ratio …………………………………………. 40%
Receivables turnover ………………………………………. 6 times
Current assets are composed of cash, marketable securities, accounts receivable, and
inventory. Calculate the following balance sheet items.
a. Accounts receivable.
b. Marketable securities.
c. Fixed assets.
d. Long-term debt.
3-34. Solution:
Chapter 03: Financial Analysis
3-47
Pettit Corporation
a. Accounts receivable = Sales/Receivable turnover
= $3,000,000/6x
= $500,000
b. Marketable securities = Current assets – (cash +
accounts rec. + inventory)
3-34. (Continued)
c. Fixed assets = Total assets – Current assets
Total assets = Sales/Asset turnover
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35. Using ratios to construct financial statements (LO2) The following information is from
Harrelson, Inc.’s, financial statements. Sales (all credit) were $20 million for 2010.
Sales to total assets ………………………………… 2 times
Total debt to total assets …………………………. 30%
Current ratio …………………………………………. 3.0 times
Inventory turnover …………………………………. 5.0 times
Average collection period ……………………….. 18 days
Fixed asset turnover ………………………………. 5.0 times
Fill in the balance sheet:
Cash …………………………….. ______ Current debt …………………………………. ______
Accounts receivable ……….. ______ Long-term debt …………………………….. ______
Inventory ………………………. ______ Total debt …………………………..………. ______
Total current assets ……….. ______ Equity …………………………………………. ______
Fixed assets …………………… ______ Total debt and equity ……………………. ______
Total assets ………………….. ______
3-35. Solution:
Harrelson Inc.
Sales/total assets = 2
Total assets = $20 million/2
Total assets = $10 million
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3-35. (Continued)
$20 million
Accounts receivable = $1,000,000
360
18
=
Fixed assets = $20 million/5x
= $4 million
Current assets = Total assets – Fixed assets
= $10 million – $4 million
= $6 million
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3-35. (Continued)
Cash………..…..
$ 1.0 million
Current debt………....
$ 2.0 million
Accounts
receivable…..
$ 1.0
Long–term debt.........
$ 1.0
Inventory………
$ 4.0
Total debt…....
$ 3.0
Total current
assets……..….
$ 6.0
Equity.…………
$ 7.0
Fixed assets…..
$ 4.0
Total assets…..
$10.0 million
Total debt and
equity………..
$10.0 million
36. Comparing all the ratios (LO2) Using the financial statements for the Snider Corporation,
calculate the 13 basic ratios found in the chapter.
SNIDER CORPORATION
Balance Sheet
December 31, 2010
Assets
Current assets:
Cash ……………………………………………. $ 50,000
Marketable securities ……………………… 20,000
Accounts receivable (net) ……………….. 160,000
Inventory ……………………………………… 200,000
Total current assets ……………………… $430,000
Investments …………………………………….. 60,000
Plant and equipment …………………………. 600,000
Less: Accumulated depreciation ………. (190,000)
Net plant and equipment …………………. 410,000
Total assets …………………………..………… $900,000
Liabilities and Stockholders’ Equity
Current liabilities
Account payable ……………………………. $90,000
Notes payable ……………………………….. 70,000
Accrued taxes ……………………………….. 10,000
Total current liabilities ………………… 170,000
Long-term liabilities: