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Solutions Manual, Chapter 15 41
Problem 15-19 (continued)
e. Financial leverage is positive in both years because the return on
equity is greater than the return on total assets. This positive financial
3. All profitability measures and the earnings per share are trending
upwards, which is a good sign. However, the price-earnings ratio has
dropped from 9.18 to 7.14. This decline indicates investor concerns
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42 Managerial Accounting, 16th Edition
Problem 15-20 (45 minutes)
1. The loan officer stipulated that the current ratio prior to obtaining the
loan must be higher than 2.0, the acid-test ratio must be higher than
Current assets
Current ratio =
Current liabilities
Acid-test ratio =
Cash + Marketable securities + Accounts
receivables + Short – term notes receivable
Current liabilities
The company would fail to qualify for the loan because both its current
ratio and its acid-test ratio are too low.
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Solutions Manual, Chapter 15 43
Problem 15-20 (continued)
2. By reclassifying the $45 thousand net book value of the old machine as
inventory, the current ratio would improve, but the acid-test ratio would
be unaffected. Inventory is considered a current asset for purposes of
computing the current ratio, but is not included in the numerator when
computing the acid-test ratio.
Current assets
Current ratio =
Current liabilities
Acid-test ratio =
Cash + Marketable securities + Accounts
receivables + Short – term notes receivable
Current liabilities
Even if this tactic had succeeded in qualifying the company for the loan,
we strongly advise against it. Inventories are assets the company has
acquired to sell to customers in the normal course of business. Used
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44 Managerial Accounting, 16th Edition
Problem 15-20 (continued)
Nevertheless, the old machine is an asset that could be turned into
cash. If this were done, the company would immediately qualify for the
loan because the $45,000 in cash would be included in the numerator in
both the current ratio and in the acid-test ratio.
Current assets
Current ratio =
Current liabilities
Acid-test ratio = Cash + Marketable securities + Current receivables
Current liabilities
However, other options may be available. The old machine is being used
to relieve bottlenecks in the plastic injection molding process and it
would be desirable to keep this standby capacity. We would advise Russ
to fully and honestly explain the situation to the loan officer. The loan
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Solutions Manual, Chapter 15 45
Problem 15-21 (60 minutes or longer)
Pepper Industries
Income Statement
For the Year Ended March 31
Key to
Computation
Sales ……………………………………….. $4,200,000
Pepper Industries
Balance Sheet
March 31
Current assets:
Cash ……………………………………… $ 70,000 (f)
A
ccounts receivable, net …………….. 330,000 (e)
T
T
T
T
T
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46 Managerial Accounting, 16th Edition
Problem 15-21 (continued)
Computation of missing amounts:
a. Earnings before interest and taxes
Times interest earned = Interest expense
Therefore, the earnings before interest and taxes for the year must be
$540,000.
e. Sales on account
Accounts receivable =
turnover
A
vera
g
e accounts receivable balance
A
g
Therefore, the average accounts receivable balance for the year must
have been $300,000. Since the beginning balance was $270,000, the
ending balance must have been $330,000.
f. Cash + Marketable securities + Current receivables
Acid-test ratio= Current liabilities
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Solutions Manual, Chapter 15 47
Problem 15-21 (continued)
Therefore, the total quick assets must be $400,000. Because there are
no marketable securities, no short-term notes receivable, and the
accounts receivable are $330,000, the cash must be $70,000.
g
. Current assets
Current ratio = Current liabilities
Therefore, the current assets must total $880,000. Because the quick
assets (in this case, cash and accounts receivable) total $400,000 of this
amount, the inventory must be $480,000.
h. Cost of goods sold
Inventory turnover = Average inventory
Therefore, the cost of goods sold for the year must be $2,730,000.
j
. Net operatin
g
income = Gross mar
g
in – Operatin
g
expenses
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48 Managerial Accounting, 16th Edition
Problem 15-21 (continued)
k. The interest expense for the year was $80,000 and the interest rate was
10%, the bonds payable must total $800,000.
l. Total liabilities = $320,000 + $800,000 = $1,120,000
m. Net income – Preferred dividends
Earnings per share = Average number of common shares outstandin
g
Therefore, the average number of shares must be 140,000. The stock is
$5 par value per share, so the total common stock must be $700,000
($5 × 140,000 shares).
n.
T
otal liabilities
Debt-to-equity ratio = Stockholders’ equity
Therefore, the total stockholders’ equity must be $1,280,000.
o.
T
otal stockholders’ equity = Common stock + Retained earnin
g
s
g
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Solutions Manual, Chapter 15 49
Problem 15-21 (continued)
p. Total assets = Liabilities + Stockholders‘ equity
This answer can also be obtained using the return on total assets:
Net income + [Interest expense × (1 – Tax rate)]
Return on =
total assets Average total assets
Therefore, the average total assets must be $2,100,000. Since the total
assets at the beginning of the year were $1,800,000, the total assets at
the end of the year must have been $2,400,000 (which would also equal
the total of the liabilities and the stockholders’ equity).
q.
T
otal assets = Current assets + Plant and equipment