978-0078025631 Chapter 15 Solution Manual Part 3

Problem 15-13 (45 minutes)

Effect on

Ratio

Reason for Increase, Decrease, or No Effect

1.

Decrease

Declaring a cash dividend will increase current liabilities,

but have no effect on current assets. Therefore, the

current ratio will decrease.

2.

Increase

A sale of inventory on account will increase the quick

assets (cash, accounts receivable, marketable securities)

but have no effect on the current liabilities. For this

reason, the acid-test ratio will increase. The same effect

would result regardless of whether the inventory was sold

at cost, at a profit, or at a loss. That is, the acid-test ratio

would increase in all cases; the only difference would be

the amount of the increase.

3.

Increase

The interest rate on the bonds is only 8%. Since the

company’s assets earn at a rate of return of 10%, positive

leverage would come into effect, increasing the return to

the common stockholders.

4.

Decrease

A decrease in net income would mean less income

available to cover interest payments. Therefore, the

times-interest-earned ratio would decrease.

5.

Increase

Payment of a previously declared cash dividend will

reduce both current assets and current liabilities by the

same amount. An equal reduction in both current assets

and current liabilities will always result in an increase in

the current ratio, so long as the current assets exceed the

current liabilities.

6.

No Effect

The dividend payout ratio is a function of the dividends

paid per share in relation to the earnings per share.

Changes in the market price of a stock have no effect on

this ratio.

Problem 15-13 (continued)

Effect on

Ratio

Reason for Increase, Decrease, or No Effect

14.

Decrease

Payments to creditors will reduce the total liabilities of a

company, thereby decreasing the ratio of total debt to total

equity.

15.

Decrease

A purchase of inventory on account will increase current

liabilities, but will not increase the quick assets (cash,

accounts receivable, marketable securities). Therefore, the

ratio of quick assets to current liabilities will decrease.

16.

No Effect

Write-off of an uncollectible account against the Allowance

for Bad Debts will have no effect on total current assets.

For this reason, the current ratio will remain unchanged.

17.

Increase

The price-earnings ratio is obtained by dividing the market

price per share by the earnings per share. If the earnings

per share remains unchanged, and the market price goes

up, then the price-earnings ratio will increase.

18.

Decrease

The dividend yield ratio is obtained by dividing the dividend

per share by the market price per share. If the dividend per

share remains unchanged and the market price goes up,

then the yield will decrease.

Problem 15-14 (continued)

2.

The Effect on

Working

Current

Acid-Test

Transaction

Capital

Ratio

(a)

Issued capital stock for cash ………

Increase

(b)

Sold inventory at a gain …………….

Increase

(c)

Wrote off uncollectible accounts ….

None

(d)

Declared a cash dividend …………..

Decrease

(e)

Paid accounts payable ………………

None

Increase

(f)

Borrowed on a short-term note …..

None

Decrease

(g)

Sold inventory at a loss ……………..

Decrease

Increase

(h)

Purchased inventory on account ….

None

Decrease

(i)

Paid short-term notes ……………….

None

Increase

(j)

Purchased equipment for cash ……

Decrease

(k)

Sold marketable securities at a loss

Decrease

(l)

Collected accounts receivable ……..

None

26 Managerial Accounting, 15th Edition

This Year

Last Year

1.

a.

Earnings before interest and income

taxes (a) ……………………………………..………………..

$1,560,000

$1,020,000

Interest expense (b) ………………………..…

$360,000

$300,000

Times interest earned (a) ÷ (b) ………….……………….

4.3

3.4

b.

Total liabilities (a) ………………………………………………….

$7,500,000

$5,760,000

Stockholders’ equity (b) …………………….…….

$9,600,000

$9,120,000

Debt–to-equity ratio (a) ÷ (b) …………….…………….

0.78

0.63

c.

Gross margin (a) ……………………………...

$3,150,000

$2,580,000

Sales (b) ………………………………………..

$15,750,000

$12,480,000

Gross margin percentage (a) ÷ (b) ……...

20.0%

20.7%

d.

Net income ……………………………………

$ 840,000

$ 504,000

Add after-tax cost of interest:

$360,000 × (1 – 0.30) …………………..

252,000

$300,000 × (1 – 0.30) …………………..

210,000

Total (a) ……………………………………….

$ 1,092,000

$ 714,000

Average total assets (b) …………………..

$15,990,000

$13,920,000

Return on total assets (a) ÷ (b) …………

6.8%

5.1%

e.

Net income (a) ………………………………

$ 840,000

$ 504,000

Average total stockholders’ equity (b) …

$ 9,360,000

$ 9,084,000

Return on equity (a) ÷ (b) ………………..

9.0%

5.6%

f.

Leverage is positive for this year because the return on equity

(9.0%) is greater than the return on total assets (6.8%). For last

year, leverage is also positive because the return on equity (5.6%) is

greater than the return on total assets (5.1%).

Problem 15-15 (continued)

This Year

Last Year

2.

a.

Net income (a) …………………………………

$840,000

$504,000

Average number of common shares

outstanding (b) ……………………………..

100,000

Earnings per share (a) ÷ (b) ……………….

$8.40

$5.04

b.

Dividends per share (a) ……………………..

$3.60

$2.52

Market price per share (b) ………………….

$72.00

$40.00

Dividend yield ratio (a) ÷ (b) ………………

5.0%

6.3%

c.

Dividends per share (a) ……………………..

$3.60

$2.52

Earnings per share (b) ……………………….

$8.40

$5.04

Dividend payout ratio (a) ÷ (b) ……………

42.9%

50.0%

d.

Market price per share (a) …………………..

$72.00

$40.00

Earnings per share (b) ………………………..

$8.40

$5.04

Price-earnings ratio (a) ÷ (b) ……………….

8.57

7.94

Notice from the data given in the problem that the typical P/E ratio

for companies in Lydex Company’s industry is 10. Since Lydex

Company presently has a P/E ratio of only 8.57, investors appear to

regard its potential for earnings growth unfavorably relative to other

companies in the industry. That is, investors are willing to pay only

8.57 times current earnings for a share of Lydex Company’s stock, as

compared to 10 times current earnings for a share of stock for the

Book value per share (a) ÷ (b) ……………

Problem 15-15 (continued)

This Year

Last Year

g.

Sales (a) …………………………………………..…………..

$15,750,000

$12,480,000

Average total assets (b) ……………………….….

$15,990,000

$14,690,000

Total asset turnover (a) ÷ (b) ……………….………….

0.99

0.85

4. With respect to profitability, the return on total assets has improved

from 5.1% to 6.8%; however, 6.8% is well below the industry average

of 9.5%. Regarding debt management, the times interest earned ratio

has increased from 3.4 to 4.3; however, 4.3 is below the industry

8.57 is below the industry average of 10. In terms of asset

management, Lydex’s average sale period and average collection period