Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
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
Ratio
(a)
Issued capital stock for cash .........
Increase
Increase
Increase
(b)
Sold inventory at a gain ................
Increase
Increase
Increase
(c)
Wrote off uncollectible accounts ....
None
None
None
(d)
Declared a cash dividend ..............
Decrease
Decrease
Decrease
(e)
Paid accounts payable ..................
None
Increase
Increase
(f)
Borrowed on a short-term note .....
None
Decrease
Decrease
(g)
Sold inventory at a loss .................
Decrease
Decrease
Increase
(h)
Purchased inventory on account ....
None
Decrease
Decrease
(i)
Paid short-term notes ...................
None
Increase
Increase
(j)
Purchased equipment for cash ......
Decrease
Decrease
Decrease
(k)
Sold marketable securities at a loss
Decrease
Decrease
Decrease
(l)
Collected accounts receivable ........
None
None
None
© The McGraw-Hill Companies, Inc., 2015. All rights reserved.
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
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
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
