978-0078025679 Chapter 5 Solution Manual Part 2

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term debt to assets ratio is generally less than 1, the result of

capitalizing leases will be to increase the long-term debt to assets

ratio.

Requirement 2:

A firm’s creditworthiness represents its ability to repay its obligations

on a timely basis. Any information relevant to assessing that ability

perform a “constructive capitalization” of operating leases when

assessing a firm’s creditworthiness. This procedure bases

measures of debt on a pro forma basis, as if the operating leases

had been capitalized.

Standard and Poor’s describes the reasons it constructively

operating lease adjustment therefore seeks to capitalize all

leases, thereby:

 enhancing comparability of operating and financial results

and financial obligations among companies that lease assets

under leases accounted for as operating or financing leases,

significant investment in fixed assets, Company A has the slowest

total asset turnover. Company C has a faster asset turnover ratio

P5–10 Determining profitability

Note to the instructor: The following preliminary calculations provide

needed data for the remainder of the problem.

Year 2

Year 3

Year 4

Average assets = (Beginning assets

+ ending assets)/2

$3,725,818

$3,740,568

$4,070,175

Average common stockholders’

equity = (Beginning equity + ending

equity)/2

2,196,600

2,166,206

2,262,225

EBI = net income + (interest x

(1– tax rate))

325,051

126,822

178,214

Requirement 1:

Year 2

Year 3

Year 4

ROA (EBI/Average assets)

0.087

0.034

0.044

Operating profit margin (EBI/Sales)

0.068

0.029

0.037

Asset turnover (Sales/Average assets)

1.28

1.16

1.18

Requirement 2:

Nucor experienced a substantial ROA decline from Year 2 to Year

3. ROA rebounded slightly in Year 4, but was still significantly below

Year 2 levels. While some of this decline was attributable to slowing

Year 2

Year 3

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Note to the instructor: Nucor had no preferred stock outstanding

during Year 1 to Year 4. The company did not report any

restructuring or other non-operating charges.

P5–11 Business strategy and profit performance

Requirement 1:

Tiffany pursues a classic differentiation strategy: the particular

luxury items sold by Tiffany are simply not available elsewhere.

$1.18 at Signet. This comparatively low asset turnover rate is

consistent with a Tiffany’s strategy of differentiation built around

from 0.84, sales must be have increased by 40.5% (1.18 / 0.84

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1.18).

P5–12 Blockbuster Inc.

Requirement 1:

Cash used for investing activities is a positive number when the firm

raises more cash from investment sales than it uses for new

The company must make sizable debt payments in each of the next

five years, but it has only generated modest cash from operations

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Daley’s current liabilities are increased by the declaration of a cash

dividend. So, this transaction would reduce the current ratio.

Inventory and cost of goods sold are unaffected, so the inventory

turnover ratio is unchanged. Similarly, long-term debt and total

assets are unchanged, so the long-term debt to total assets ratio is

current assets. So, the current ratio falls. The decline in cost of

goods sold, together with the increase in inventory, causes

inventory turnover to fall as well. Because current assets fall, total

assets also fall, so the ratio of long-term debt to total assets

increases.

so there is no change to either of those ratios.

Requirement 4:

Current assets increase, so the current ratio increases. There is no

change in inventory turnover. Because a loss is recorded, the

insurance receivable must be less than the book value of the assets

P5–14 Explaining changes in financial ratios

(AICPA adapted)

1) a,b,d Inventory turnover is defined as the cost of goods sold

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inventory, but in this case were mistakenly recorded as sales and

removed from inventory. Credit memos were not recorded for

2) a,b,e Accounts receivable turnover is net credit sales divided by

average accounts receivable. Recording goods shipped on

consignment before they are actually sold overstates accounts

3) a,b,e If the allowance for doubtful accounts increased in dollars,

but the allowance decreased as a percentage of accounts

4) p The refinancing of short-term debt as long-term debt at a

5) l,p Net income for the year can be found from operating income

less interest expenses and federal income taxes. If operating

6) h Gross margin percentage is defined as gross margin divided

margin is Sales less cost of goods sold, then cost of goods sold

must have also increased by the same proportionate amount.

P5–15 EBITDA and revenue recognition

Requirement 1:

collection period, which rebounds in 2014, but is still significantly

weaker than in 2012. There has also been a noticeable shift in the

composition of receivables (“billed” versus “unbilled”).

Receivable Composition 2012 2013 2014

2012 2013 2014

EBIT $74.8 $75.8 $38.1

Depreciation and amortization $14.8 $15.4 $19.3

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One reason for the increase in days accounts receivable

outstanding is that the percentage of “unbilled” receivables has

increased. Customers do pay unless they are billed!

Requirement 4:

P5–16 Analyzing ratios: Alpine Chemical

(CFA adapted)

Requirement 1:

1,629 + 318

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(Net income + Depreciation expense)/(Long-term debt + Notes

payable)

=

(1,479 + 511)

(1,900 + 1,491) =59%

d) Operating income/sales =

2,458 =13%

19,460

b) Long–term debt/total capitalization measures Alpine’s financial

leverage. A highly leveraged company can find that issuing new

debt is difficult or expensive. Also, a highly leveraged company is

more sensitive to a business downturn.

c) Funds from operations/total debt measures Alpine’s ability to

costs

reduced, to generate the same level of operating income. If Alpine

cannot

raise sales volume or reduce costs, then its ability to issue new debt

without adversely affecting current debt holders is limited.

Requirement 3:

a) EBIT/interest expense. With the exception of 2010, interest

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c) Funds from operations/total debt. The cash flow ratio has been

relatively steady during the past three years and, at 59% in 2014,

would reflect a rating between A and Aa.

P5–17 Determining reportable segments

Requirement 1:

U.S. GAAP requires companies to provide segment information to

make investors and creditors aware of the different operating

similar economic characteristics, products, processes, customers,