C11.16
(continued)
d.
The debt and debt/equity ratios calculated in part c make sense relative to the student’s
75.1% – 66.8%), the debt/equity ratio could give a naïve observer a false signal that
PepsiCo has 50% more debt in their capital structure than does Coca Cola (calculated
inappropriately, as 302% / 201% = 1.50% as much debt for PepsiCo).
What is important to note is that each ratio must be interpreted in the appropriate
context. In reality, PepsiCo does use financial leverage to a greater extent than does
C11.17.
a.
Note to Instructor: Although students are quite challenged by this case, they generally
prefer not to be provided any “hints” if it is assigned as an individual take-home case. If it
C11.17.
(continued)
WHITTAKER, INC.
Income Statement
For the Year Ended December 31, 2017
$ 55,200
Sales……………………………………………………………………………..
Cost of goods sold ………………………………………………………………
Gross profit………………………..……………………………………………
$680,000
(408,000)
$272,000
WHITTAKER, INC.
Balance Sheet
December 31, 2017
$320,000
Current assets:
Cash……………………………………………………………………………
Accounts receivable, net………………………………………………………
Inventory………………………………………………………………………
Total stockholders’ equity ………………………………………………….
Total liabilities and stockholders’ equity……………………………………….
$148,000
86,000
108,000
$160,000
$480,000
Solution approach: Complete the balance sheet first. There are a variety of ways of
working through the problem, but the balance sheet can be completed rather easily (except
that it takes some effort to separate cash from accounts receivable). Enough information is
One possible sequence of steps:
1. Current ratio = 1.9 to 1, so current assets of $342,000 / 1.9 = $180,000 current
C11.17.
(continued)
5. Total liabilities + total stockholders’ equity = $320,000 + $160,000 = $480,000 total
liabilities and stockholders’ equity. Thus, total assets = $480,000.
4. Debt/equity ratio = 2.0 to 1, so total liabilities of $320,000 / 2 = $160,000 total
6. Retained earnings can now be determined by subtraction = $160,000 – $20,000
– $30,000 = $110,000.
8. Total current assets = $342,000 – $108,000 of inventory = $234,000, which
9. Thus, Cash = $234,000 – $86,000 = $148,000.
$102,000 * 4.0 inventory turnover = $408,000. Alternatively, cost of goods sold =
Sales * (1 – 40% gross profit ratio) = $680,000 * 60% = $408,000.
10. Average accounts receivable = ($114,000 + $86,000) / 2 = $100,000, so Sales =
12. Gross profit = Sales * 40% = $680,000 * 40% = $272,000. Alternatively, gross
profit = Sales – Cost of goods sold = $680,000 – $408,000 = $272,000.
13. Interest expense can be calculated as follows: ($20,000 face amount * 15% * 8/12
14. Times interest earned = 4.45 * $20,000 = $89,000 income from operations.
15. Operating expenses can now be determined by subtraction = $272,000 gross
profit – $89,000 income from operations = $183,000.
from operations – $20,000 interest expense = $69,000.
16. Income before taxes can be determined in a similar manner = $89,000 income
C11.17.
(continued)
17. Income taxes = $69,000 income before taxes * 20% = $13,800.
18. Net income = $69,000 income before taxes – $13,800 income taxes = $55,200.
b.
Current ratio = Current assets / Current liabilities = $342,000 / $180,000 = 1.9
Acid-test ratio = (Cash + Accounts receivable) / Current liabilities
= ($148,000 + 86,000) / $180,000 = 1.3
Accounts receivable turnover = Sales / Average accounts receivable
= $680,000 / (($114,000 + $86,000) / 2)
= $680,000 / $100,000 = 6.8 times
Times interest earned = Earnings before interest and taxes / Interest expense
= $89,000 / $20,000 = 4.45 times
Note that the beginning total assets in the above calculation can be determined by
solving for the missing amount in the statement of retained earnings, as follows:
Beginning total assets, January 1, 2017…….…………… $ ?
+ Net income for the year ………………………….…… 55,200
C11.18.
a.
The other required financial statements in addition to the income statement and balance
sheet are the statement of cash flows and statement of changes in stockholders’ equity
(or the statement of retained earnings). The statement of cash flows discloses the
reporting entity’s cash provided (or used) by operating, investing, and financing
b.
The note disclosures that should be provided by Gerrard Construction Co., include the
following: significant accounting policies (such as depreciation methods used, inventory
valuation methods used, and basis of consolidation), as well as notes that disclose the
company’s effective income tax rate, details of the company’s employee benefit,
2. Average day’s sales = ($64,400,000 annual net revenues / 365 days) = $176,438
d.
1. Debt ratio = Total liabilities / (Total Liabilities + Total stockholders’ equity)
2. Debt/equity ratio = Total Liabilities / Total stockholders’ equity
C11.18.
(continued)
e.
By entering into a long-term capital lease of $8 million, Gerrard Construction Co. would
be increasing its assets (capital lease assets are treated as part of property, plant, and
equipment) and its liabilities by an equal amount, with no effect in stockholders’ equity.
Thus, both the debt ratio and the debt/equity ratio would increase.
f.
The answer to C4.30. i. indicates that dividends declared and paid during the year ended
December 31, 2017 were $1,000,000.
1. Earnings per share of common stock = Net income / Average number of common
shares outstanding = $14,600,000 / 4,800,000 = $3.04
3. Dividends per share of common stock = ($1,000,000 Annual dividends declared /
4,800,000 Average number of shares outstanding) = $0.21
4. Dividend payout ratio = ($0.21 Dividends per share / $3.04 Earnings per share of
Instructor’s Manual / Solutions Manual
TAKE-HOME QUIZ: CHAPTER 11 NAME______________________
Note to Instructor: Use or adapt these questions for an annual report or set of financial
statements that you provide to students. Be sure to include information concerning dividends,
earnings per share, and the year-end market price per share. Require students to prepare an
investment recommendation about the company’s common stock.
There are attached the financial statements and ___-year summary from the 20__ Annual Report
of ______________________________.
Liquidity:
2. Based on the results of your analysis above, assess the company’s overall liquidity position.
3. Explain how working capital and the current ratio are related. Would you expect firms with
large amounts of working capital to always have high current ratios?
Profitability:
4. Calculate ROI, showing margin and turnover, for 20__, 20__, and 20__.
6. Calculate the price/earnings ratio for as many of the past three years as you can.
8. Based on the results of your analysis above, assess the company’s overall profitability.
9. As an investor in this company’s stock, would you be pleased with this year’s dividend yield?
How would your dividend yield “expectations” change, if at all, if the company‘s ROI was
5% higher? Explain.
Chapter 11 Financial Statement Analysis
TAKE-HOME QUIZ: CHAPTER 11 (continued)
Financial Leverage:
10. Calculate the debt ratio (total liabilities to total liabilities and owners’ equity), and the
debt/equity ratio (total liabilities to total owners’ equity) at______________________, 20__.
11. Based on the results of your analysis above, assess the company’s overall leverage position.
What would you estimate the industry averages to be for the debt ratio and debt/equity ratio?
12. Explain the relationship between ROI and ROE, and the concept of financial leverage.
Would you expect the percentage difference between ROI and ROE to be high or low for a
firm that has a high degree of financial leverage?
Activity measures:
14. Based on your analysis above, do you believe that the company is doing an effective job at
managing accounts receivable? What would you estimate the industry averages to be for
accounts receivable turnover and the number of days’ sales in accounts receivable? Explain.
15. Calculate the inventory turnover and the number of days’ sales in inventory (based on a 365–
day year) for the year ended _____________________, 20__.
16. Based on your analysis above, to what extent does the company need to be concerned about
its inventory management policies? In assessing inventory management policies, would you
be more interested in knowing current ratio or acid-test ratio information? Explain.
Overall assessment:
17. Assume that you have $5,000 that you would like to invest in the common stock of a
company. Evaluate the common stock of ____________________________ as a potential