Chapter 13
Financial Statement Analysis
Solutions to Questions
13-1 Horizontal analysis examines how a
particular item on a financial statement such as
sales or cost of goods sold behaves over time.
13-2 By looking at trends, an analyst hopes
to get some idea of whether a situation is
improving, remaining the same, or deteriorating.
13-3 Price-earnings ratios reflect investors’
expectations concerning future earnings. The
higher the price-earnings ratio, the greater the
13-4 A rapidly growing tech company would
probably have many opportunities to make
investments at a rate of return higher than
13-5 The dividend yield is the dividend per
share divided by the market price per share. The
13-6 Financial leverage results from
borrowing funds at an interest rate that differs
from the rate of return on assets acquired using
13-7 If the company experiences big
variations in net cash flows from operations,
stockholders might be pleased that the company
has no debt. In hard times, interest payments
13-8 The market value of a share of common
stock often exceeds the book value per share.
13-9 A 2 to 1 current ratio might not be
adequate for several reasons. First, the
difficult to collect.
The Foundational 15
1. The earnings per share is computed as follows:
Net income
Earnings per share =
Average number of common
shares outstanding
$92,400
= = $0.77 per share
120,000 shares
2. The price-earnings ratio is computed as follows:
Market price per share
Price-earnings ratio =
Earnings per share
$2.75
= = 3.57 (rounded)
$0.77
3. The dividend payout ratio is computed as follows:
Dividends per share
Dividend payout ratio =
Earnings per share
$0.55
= = 71% (rounded)
$0.77
The dividend yield ratio is computed as follows:
Dividends per share
Dividend yield ratio = Market price per share
$0.55
= = 20%
$2.75
The Foundational 15 (continued)
4. The return on total assets is computed as follows:
( )
Net income +
[Interest expense × (1 – Tax rate)]
Return on total assets = Average total assets
$92,400 + [$8,000 × (1 – 0.30)]
= =21.5%
$450,000 + $460,000 /2
5. The return on equity is computed as follows:
Net income
Return on =
equity Average stockholders’ equity
$92,400
= = 28%
($320,000 + $340,000)/2
6. The book value per share is computed as follows:
Total stockholders’ equity
Book value per share = Number of common shares outstanding
$320,000
= = $2.67 per share (rounded)
120,000 shares
7. The working capital and current ratio are computed as follows:
$150,000
= = 2.50
$60,000
The Foundational 15 (continued)
8. The acid-test ratio is computed as follows:
Cash + Marketable securities
+ Accounts receivable + Short-term notes
Acid-test ratio = Current liabilities
$35,000 + $0 + $60,000 + $0
= = 1.58 (rounded)
$60,000
9. The accounts receivable turnover is calculated as follows:
Sales on account
Accounts receivable =
turnover Average accounts receivable balance
$700,000
= = 12.73 (rounded)
($60,000 + $50,000)/2
The average collection period is computed as follows:
365 days
Average collection period = Accounts receivable turnover
365 days
= = 28.67 days (rounded)
12.73
10. The inventory turnover is computed as follows:
Cost of goods sold
Inventory turnover = Average inventory balance
$400,000
= = 6.96 (rounded)
($55,000 + $60,000)/2
The average sale period is computed as follows:
365 days
Average sale period = Inventory turnover
365 days
= = 52.44 days (rounded)
6.96
The Foundational 15 (continued)
11. The operating cycle is computed as follows:
Operating cycle = Average sale period + Average collection period
= 52.44 days + 28.67 days = 81.11 days
12. The total asset turnover is computed as follows:
Sales
Total asset turnover = Average total assets
$700,000
= = 1.54 (rounded)
($450,000 + $460,000)/2
13. The times interest earned ratio is computed as follows:
Earnings before interest
expense and income taxes
Times interest =
earned ratio Interest expense
$140,000
= = 17.5
$8,000
14. The debt–to-equity ratio is computed as follows:
Total liabilities
Debt-to-equity ratio = Stockholders’ equity
$130,000
= = 0.41 (rounded)
$320,000
15. The equity multiplier is computed as follows:
Average total assets
Equity multiplier = Average stockholders’ equity
($450,000 + $460,000)/2
= = 1.38 (rounded)
($320,000 + $340,000)/2
Exercise 13-1 (15 minutes)
1.
This Year
Last Year
Sales……………………………………………..
100.0
%
100.0
%
Cost of goods sold …………………………...
62.3
58.6
Gross margin …………………………………..
37.7
41.4
Selling and administrative expenses:
Selling expenses …………………………...
18.5
18.2
Administrative expenses ………………….
8.9
10.3
Total selling and administrative expenses
27.4
28.5
Net operating income ………………………..
10.3
12.9
Interest expense ……………………………..
1.2
1.4
Net income before taxes ……………………
9.1
%
11.5
%
2. The company’s major problem seems to be the increase in cost of goods
sold, which increased from 58.6% of sales last year to 62.3% of sales
this year. This suggests that the company is not passing the increases in
Exercise 13-2 (10 minutes)
1. Calculation of working capital:
Current assets ……………..
$25,080
Current liabilities ………….
10,400
Working capital ……………
$14,680
2. Calculation of the current ratio:
Current assets
Current ratio = Current liabilities
$25,080
= = 2.41 (rounded)
$10,400
3. Calculation of the acid-test ratio:
Cash + Marketable securities
+ Accounts receivable
Acid-test ratio = Current liabilities
$1,280 + $0 + $12,300
= = 1.31 (rounded)
$10,400
Exercise 13-3 (20 minutes)
1. Calculation of accounts receivable turnover:
Sales on account
Accounts receivable =
turnover Average accounts receivable balance
$79,000
= = 7.38 (rounded)
($12,300 + $9,100)/2
2. Calculation of the average collection period:
365 days
Average collection period = Accounts receivable turnover
365 days
= = 49.46 days (rounded)
7.38
3. Calculation of inventory turnover:
Cost of goods sold
Inventory turnover = Average inventory balance
$52,000
= = 5.81 (rounded)
($9,700 + $8,200)/2
4. Calculation of the average sale period:
365 days
Average sale period = Inventory turnover
365 days
= = 62.82 days (rounded)
5.81
Exercise 13-3 (continued)
5. The operating cycle is computed as follows:
Operating cycle = Average sale period + Average collection period
= 62.82 days + 49.46 days = 112.28 days
6. The total asset turnover is computed as follows:
Sales
Total asset turnover = Average total assets
$79,000
= = 1.64 (rounded)
($50,280 + $45,960)/2
Exercise 13-4 (10 minutes)
1. Calculation of the times interest earned ratio:
Earnings before interest
expense and income taxes
Times interest =
earned ratio Interest expense
$6,500
= = 10.8
$600
2. Calculation of the debt-to-equity ratio:
Total liabilities
Debt-to-equity ratio = Stockholders’ equity
$15,400
= = 0.44
$34,880
3. Calculation of the equity multiplier:
Average total assets
Equity multiplier = Average stockholders’ equity
($50,280 + $45,960)/2
= = 1.45 (rounded)
($34,880 + $31,660)/2
Exercise 13-5 (10 minutes)
1. Calculation of the gross margin percentage:
Gross margin
Gross margin percentage = Sales
$27,000
= = 34.2%
$79,000
2. Calculation of the net profit margin percentage:
Net income
Net profit margin percentage = Sales
$3,540
= = 4.5% (rounded)
$79,000
3. Calculation of the return on total assets:
Net income +
[Interest expense × (1 – Tax rate)]
Return on total assets = Average total assets
$3,540 + [$600 × (1 – 0.40)]
= = 8.1%
($50,280 + $45,960)/2
4. Calculation of the return on equity:
Net income
Return on equity =
Average total stockholders’ equity
$3,540
= = 10.64%
($34,880 + $31,660)/2
Exercise 13-6 (15 minutes)
1. Calculation of the earnings per share:
Net income
Earnings per share =
Average number of common
shares outstanding
$3,540
= = $4.43 per share (rounded)
800 shares
2. Calculation of the price-earnings ratio:
Market price per share
Price-earnings ratio =
Earnings per share
$18
= = 4.06 (rounded)
$4.43
3. Calculation of the dividend payout ratio:
Dividends per share
Dividend payout ratio =
Earnings per share
$0.40
= = 9.03%
$4.43
4. Calculation of the dividend yield ratio:
Dividends per share
Dividend yield ratio = Market price per share
$0.40
= = 2.22% (rounded)
$18.00
5. Calculation of the book value per share:
Total stockholders’ equity
Book value per share = Number of common shares outstanding
$34,880
= = $43.60 per share
800 shares
Exercise 13-7 (15 minutes)
1. The trend percentages are:
Year 1
Year 2
Year 3
Year 4
Year 5
Sales …………………………..
100.0
110.0
115.0
120.0
125.0
Current assets:
Cash …………………………
100.0
130.0
96.0
80.0
60.0
Accounts receivable ……..
100.0
115.0
135.0
170.0
190.0
Inventory …………………..
100.0
110.0
115.0
120.0
125.0
Total current assets ………..
100.0
112.6
120.3
133.7
142.1
Current liabilities ……………
100.0
110.0
130.0
145.0
160.0
2.
Sales:
The sales are increasing at a steady and consistent rate.
Assets:
The most noticeable thing about the assets is that the
accounts receivable have been increasing at a rapid
rate—far outstripping the increase in sales. This
disproportionate increase in receivables is probably the
chief cause of the decrease in cash over the five-year
period. The inventory seems to be growing at a well-
balanced rate in comparison with sales.
Liabilities:
The current liabilities are growing more rapidly than the
total current assets. The reason is probably traceable to
the rapid buildup in receivables in that the company
doesn’t have the cash needed to pay bills as they come
due.
Exercise 13-8 (20 minutes)
1. Calculation of working capital:
Current assets ……………..
$115,000
Current liabilities ………….
50,000
Working capital ……………
$65,000
2. Current ratio:
Current assets $115,000
Current liabilities $50,000
3. Acid-test ratio:
Quick assets $41,500
Current liabilities $50,000
4. Debt–to-equity ratio:
Total liabilities $130,000
Total stockholders’ equity $170,000
5. Times interest earned:
Earnings before interest
and income taxes
Times interest earned = Interest expense
$38,000
= = 4.75
$8,000
Exercise 13-8 (continued)
6. Average collection period:
Sales on account
Accounts receivable turnover = Average accounts receivable
$420,000
= = 14
($25,000 + $35,000)/2
365 days
Average collection period = Accounts receivable turnover
365 days
= = 26.1 days (
14 rounded)
7. Average sale period:
Cost of goods sold
Inventory turnover = Average inventory
$292,500
($60,000 + $70,000)/2
365 days
Average sale period = = 81.1 days (rounded)
4.5
8. The operating cycle is computed as follows:
Operating cycle = Average sale period + Average collection period
= 81.1 days + 26.1 days = 107.2 days
Exercise 13-9 (20 minutes)
1. Calculation of the gross margin percentage:
Gross margin
Gross margin percentage = Sales
$127,500
= = 30.36%
$420,000
2. Calculation of the net profit margin percentage:
Net income
Net profit margin percentage = Sales
$21,000
= = 5.0%
$420,000
3. Return on total assets:
( )
( )
( )
Net Income + Interest expense × 1 – Tax rate
Return on =
total assets Average total assets
$21,000 + $8,000 × 1 – 0.30
$26,600
= = 9.2% (rounded)
$290,000
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4. Return on equity:
Net income
=
Return on equity Average common stockholders’ equity
$21,000
Exercise 13-9 (continued)
5. Financial leverage was positive because the return on equity (12.7%)
was greater than the return on total assets (9.2%). This positive
Exercise 13-10 (15 minutes)
1. Earnings per share:
Net income $21,000
Average number of common 6,000 shares
shares outstanding
2. Dividend payout ratio:
Dividends paid per share $2.10
Earnings per share $3.50
3. Dividend yield ratio:
Dividends paid per share $2.10
Market price per share $42.00
4. Price-earnings ratio:
Market price per share $42.00
Earnings per share $3.50
5. Book value per share:
Total stockholders’ equity
Book value per share = Number of common shares outstanding
$170,000
= = $28.33 per share (rounded)
6,000 shares
Exercise 13-11 (15 minutes)
1. Return on total assets:
Net income + [Interest expense × (1 – Tax rate)]
Return on =
total assets Average total assets
$280,000 + [$60,000 × (1 – 0.30)]
Exercise 13-12 (15 minutes)
1.
Current assets
($90,000 + $260,000 + $490,000 + $10,000) …………
$850,000
Current liabilities ($850,000 ÷ 2.5) ………………………….
340,000
Working capital ……………………………………………………
$510,000
2.
Cash + Marketable securities + Accounts receivable
Acid-test =
ratio Current liabilities
$90,000 + $0 + $260,000
= = 1.03 (rounded)
$340,000
3. a. Working capital would not be affected by a $40,000 payment on
accounts payable:
Current assets ($850,000 – $40,000) ………….
$810,000
Current liabilities ($340,000 – $40,000) ………
300,000
Working capital ………………………………………
$510,000
b. The current ratio would increase if the company makes a $40,000
payment on accounts payable:
Current assets
Current ratio = Current liabilities
$810,000
= = 2.7
$300,000