Principles of Finance 6e Chapter 7
Besley/Brigham
7-1
CHAPTER 7
ANSWERS
7-1 The four financial statements contained in most annual reports are the balance sheet, income
statement, statement of retained earnings, and statement of cash flows.
7-2 No, because the $20 million of retained earnings probably would not be held as cash. The retained
7-3 Liquidating assets, borrowing more funds, and issuing stock would constitute sources of funds.
Purchasing assets, paying off debt, and stock repurchases would constitute uses of funds. Thus,
the following general rules can be used to determine what changes in balance sheet accounts
represent sources and uses of funds:
7-4 The emphasis of the various types of analysts is by no means uniform nor should it be.
Management is interested in all types of ratios for two reasons. First, the ratios point out
7-5 The most important aspect of ratio analysis is the judgment used when interpreting the results to
reach an overall conclusion concerning a firm’s financial position. The analyst should be aware of,
7-6 Differences in the amounts of assets necessary to generate a dollar of sales cause asset turnover
ratios to vary among industries. For example, a steel company needs a greater number of dollars in
7-7 ROE can be written
equityOwners’
assets Total
assets Total
NI
=
equity Owners’
NI
= ROE
Chapter 7 Principles of Finance 6e
Besley/Brigham
7-2
7-8 (1) Cash, receivables, and inventories, as well as current liabilities, vary over the year for firms with
(2) Common equity is determined at a point in time, say, December 31. Profits are earned over
time; i.e., during the entire year. If a firm is growing rapidly, year-end equity will be much larger
7-9 Net income represents the revenues net of expenses and taxes that the firm generates during a
7-10 Net cash flow is the “bottom–line” amount of cash that the firm generates during an accounting
7-11 Free cash flow measures the cash flow that the firm is free to pay to investors (both bondholders
and stockholders) after considering the cash investments that are needed to continue operations,
7-12 Source(+)
2015 2014 or Use(-)?
Cash $ 400 $ 500 +
Accounts receivable 250 300 +
Inventory 450 400 –
Current assets 1,100 1,200
Net property & equipment 1,000 950 –a
Principles of Finance 6e Chapter 7
Besley/Brigham
7-3
7-13 Total Effect
Current Current on Net
Assets Ratio Income
a. Cash is acquired through issuance
of additional common stock. + + 0
j. Marketable securities are sold below cost. – – –
k. Advances are made to employees. 0 0 0
l. Current operating expenses are paid. – – –
m. Short-term promissory notes are issued to trade creditors
SOLUTIONS
7-1
== 5.2
000,525$
500,312,1$
ratio current
esentPr
Chapter 7 Principles of Finance 6e
Besley/Brigham
7-4
7-2 (1)
= 0.3
sliabilitie Current
assets Current
= 0.3
sliabilitie Current
000,810$
Current liabilities = $270,000
(4)
= 0.5
Inventory
sold goods of Cost
CGS
Sales / 360 ($2,700,000 / 360)
7-3 TIE = EBIT/INT, so find EBIT and INT
Interest = $500,000 x 0.10 = $50,000
Principles of Finance 6e Chapter 7
7-4 ROE = NI/Equity
We need to determine the inputs for the equation from the data that were given. On the left we set
up an income statement, and we put numbers in it on the right:
Sales (given) $10,000
– Operating costs na
EBIT (given) $ 1,000
7-5 Net cash flow = $180,000 + $50,000 = $230,000
7-6 a. NI = (Sales – Operating costs – Interest expense)(1 – T)
$650,000 = (Sales – $1,500,000 – $300,000 – 0)(1 – 0.35)
7-8 We are given ROA = 3% and Sales/Total assets = 1.5x
Chapter 7 Principles of Finance 6e
Besley/Brigham
7-6
We can calculate Zumwalt’s debt ratio in a similar manner, given the facts of the problem. We
are given ROA, which is NI/TA and ROE, which is NI/Equity; if we use the reciprocal of ROE we
have the following equation:
Equity NI Equity 1
Alternative solution:
Using the DuPont equation, we know that
7-9 a. Currently, ROE is ROE1 = $15,000/$200,000 = 7.5%
The current ratio will be set such that 2.5 = CA/CL. CL is $50,000 = $30,000 + $20,000, and
b. (1) Doubling the dollar amounts would not affect the answer; the ROE increase would still
be 5.54%.
7-7
(4) If the stock was selling for twice book value, or 2 x $20 = $40, then only half as many
c. We could have started with lower inventories and higher accounts receivable, then had you
calculate the DSO, then move to a lower DSO which would require a reduction in
receivables, and then determine the effects on ROE and EPS under different conditions.
7-10 a. Sources and Uses of Funds Analysis:
Lloyd Lumber Company
Balance Sheet, 2015
($ millions)
Jan. 1 Dec. 31 Source Use
Cash $ 7 $ 15 $ 8
Marketable securities 0 11 11
Net receivables 30 22 $ 8
Inventories 53 75 22
Total current assets $ 90 $123
Chapter 7 Principles of Finance 6e
Besley/Brigham
7-8
b. Lloyd Lumber Company
Statement of Cash Flows, 2015
($ millions)
Operating Activities:
Net income $ 33
Other additions (sources of cash):
Depreciation $ 10
Long-term Investing Activities:
Acquisition of fixed assets ($ 50)
Financing Activities:
Increase in notes payable $ 12
Sale of long-term debt 16
c. Investments were made in plant and inventories. Funds were also utilized to reduce
accounts payable and other current liabilities and to increase the cash and marketable
7-11 a. Dollars are in millions.
Income Cash
Statement Flows
Sales revenues $12.0 $12.0
Costs, except depreciation = 0.75 x Sales ( 9.0) ( 9.0)
Depreciation ( 1.5) —
Principles of Finance 6e Chapter 7
Besley/Brigham
7-9
b. Depreciation doubles.
Income Cash
Statement Flows
Sales revenues $12.0 $12.0
Costs, except depreciation = 0.75 x Sales (9.0) (9.0)
c. Depreciation halves.
Income Cash
Statement Flows
Sales revenues $12.00 $12.00
Costs, except depreciation = 0.75 x Sales (9.00) (9.00)
Depreciation (0.75) —
7-12 a. Dollar amounts are in millions.
Industry
Argile Average Comment
53$
201$
sliabilitie Current
assets Current
ratio
Current
==
3.79x 3.9x Near average
Accounts receivable $80
Days sales =
175$
assets Fixed
turnover
376$
181$
assets Total
debt Total
ratio
Debt ==
48.14% 43.0% Poor
Chapter 7 Principles of Finance 6e
Besley/Brigham
7-10
376$
assets Total
assets on
c. Ratio 2015 2014 Trend
Current ratio 3.6x 3.8x Worse
Days sales outstanding 43.2 days 41.1 days Worse
d. It would be helpful to know the future plans Argile has with respect to improving its current
7-13 a. Industry
Campsey Average
000,330$
000,655$
sliabilitie Current
assets Current =
1.98x 2.0x
000,336$
receivable Accounts =
500,947$
assets Total
500,607,1$
300,27$
Sales
income Net =
1.7% 1.2%
500,947$
assets Total
Principles of Finance 6e Chapter 7
Besley/Brigham
7-11
300,27$
income Net =
Total assets $947,500
b. For Campsey, ROA = PM x TA turnover = 1.7% x 1.7 = 2.9%.
c. Campsey’s days sales outstanding (DSO) is more than twice as long as the industry average,
d. If 2015 represents a period of supernormal growth for Campsey, ratios based on this year will
7-14 (1) Total liabilities and equity = Total assets = $300,000.
(5) Sales = 1.5 x Total assets = 1.5 x $300,000 = $450,000
(8) Accounts receivable = (Sales/360)(DSO) = ($450,000/360)(36) = $45,000.
7-15 a. Finnerty Industry
Furniture Average
$111
$303
sliabilitie Current
assets Current =
2.73x 2.0x
450$
135$
assets Total
Debt
ratio
Debt ==
30.00% 30.0%
)360/795($
360/Sales
147$
795$
assets Fixed
Sales
turnover
assets Fixed ==
5.41x 6.0 x
795$
Sales
assets Total ==
450$
assets Total
assets total
315$
27$
equity Total
income Net
equity
on turnRe ==
8.57% 12.9%
b. ROA = Profit margin x Total assets turnover
%0.677.1%4.3
450$
795$
==
Finnerty Industry Comment
Profit margin 3.4% 3.0% Good
c. Analysis of the DuPont equation and the set of ratios shows that the turnover ratio of sales