Problem 16-13 (45 minutes)
Effect on
Ratio
Reason for Increase, Decrease, or No Effect
1.
Decrease
The current ratio is obtained by dividing current assets by
current liabilities. Declaring a cash dividend will increase
current liabilities, but have no effect on current assets.
Therefore, the current ratio will decrease.
at cost, at a profit, or at a loss. That is, the acid-test ratio
3.
Increase
The return on equity is obtained by dividing net income by
average stockholders’ equity. The interest rate on the
bonds is only 8%. Since the company’s assets earn at a
rate of return of 10%, positive leverage would come into
effect, increasing the return to the common stockholders.
4.
Decrease
The times interest earned ratio is obtained by dividing
earnings before interest expense and income taxes by
interest expense. A decrease in net income would mean
less income available to cover interest payments.
Therefore, the times-interest-earned ratio would decrease.
Problem 16-13 (continued)
Effect on
Ratio
dividends per share by the earnings per share. Therefore,
Reason for Increase, Decrease, or No Effect
7.
Increase
The inventory turnover ratio is obtained by dividing cost of
goods sold by average inventory. A write-off of inventory
will reduce the inventory balance, thereby increasing the
turnover in relation to a given level of sales.
8.
Decrease
The debt–to-equity ratio is obtained by dividing total
liabilities by stockholders’ equity. Sale of inventory at a
profit will increase net income, which increases retained
earnings and stockholders’ equity. An increase in
stockholders’ equity will decrease the debt–to-equity ratio.
9.
Decrease
The accounts receivable turnover is obtained by dividing
sales on account by average accounts receivable. Extended
10.
Decrease
book value per share.
Book value per share is obtained by dividing total
stockholders’ equity by the number of common shares
11.
No Effect
Book value per share is obtained by dividing total
stockholders’ equity by the number of common shares
outstanding. It is not affected by current market prices for
the company’s stock.
Problem 16-13 (continued)
Effect on
Ratio
Reason for Increase, Decrease, or No Effect
12.
No Effect
Working capital is obtained by subtracting current liabilities
13.
Decrease
Earnings per share is obtained by dividing net income by
the average number of common shares outstanding. The
stock dividend will increase the number of common shares
outstanding, thereby decreasing the earnings per share.
14.
Decrease
reduce the total liabilities of a company, thereby decreasing
The debt–to-equity ratio is obtained by dividing total
15.
Decrease
The acid-test ratio is obtained by dividing quick assets by
current liabilities. A purchase of inventory on account will
increase current liabilities, but will not increase the quick
assets. Therefore, the ratio of quick assets to current
liabilities will decrease.
16.
No Effect
The current ratio is obtained by dividing current assets by
current liabilities. Write-off of an uncollectible account
Problem 16-13 (continued)
17.
Increase
price per share by the earnings per share. If the earnings
The price-earnings ratio is obtained by dividing the market
18.
Decrease
The dividend yield ratio is obtained by dividing the dividend
per share by the market price per share. If the dividend per
share remains unchanged and the market price goes up,
then the yield will decrease.
Problem 16-14 (30 minutes)
1. a. Computation of working capital:
Current assets:
Cash …………………………..…..
$ 50,000
Marketable securities…………..
30,000
Accounts receivable, net ………
200,000
Inventory …………………………
Prepaid expenses ……………….
10,000
Total current assets (a) ………….
Current liabilities:
Accounts payable ……………….
150,000
Notes due in one year …………
30,000
Accrued liabilities ……………….
20,000
Total current liabilities (b) ………
Working capital (a) – (b) ………..
Problem 16-14 (continued)
2.
The Effect on
Working
Current
Acid-Test
Transaction
Capital
Ratio
Ratio
(a)
Issued capital stock for cash ……….
Increase
Increase
Increase
(b)
Sold inventory at a gain ……………..
Increase
Increase
Increase
(c)
Wrote off uncollectible accounts …..
None
None
None
(d)
Declared a cash dividend ……………
Decrease
Decrease
Decrease
(e)
Paid accounts payable ……………….
None
Increase
Increase
(f)
Borrowed on a short-term note ……
None
Decrease
Decrease
(g)
Sold inventory at a loss ……………..
Decrease
Decrease
Increase
(h)
Purchased inventory on account …..
None
Decrease
Decrease
Paid short–term notes ………………..
None
Increase
Increase
(j)
Purchased equipment for cash …….
Decrease
Decrease
Decrease
(k)
Sold marketable securities at a loss
Decrease
Decrease
Decrease
Collected accounts receivable ………
None
None
None
Problem 16-15 (90 minutes)
This Year
Last Year
1.
a.
Earnings before interest and income
taxes (a) ……………………………………
$1,560,000
$1,020,000
Interest expense (b) ………………………
$360,000
$300,000
Times interest earned (a) ÷ (b) ………..
4.33
3.40
Total liabilities (a) ………………………….
Gross margin (a) …………………………..
Sales (b) ……………………………………..
$15,750,000
Gross margin percentage (a) ÷ (b) ……
d.
Net income …………………………………….
$ 840,000
$ 504,000
Add after-tax cost of interest:
$360,000 × (1 – 0.30) ……………………
252,000
$300,000 × (1 – 0.30) ……………………
210,000
Total (a) ………………………………………..
$ 1,092,000
$ 714,000
Average total assets (b) ……………………
$15,990,000
$13,920,000
Return on total assets (a) ÷ (b) ………….
6.8%
5.1%
Net income (a) ……………………………….
$ 9,360,000
$ 9,084,000
Return on equity (a) ÷ (b) ………………..
Problem 16-15 (continued)
This Year
Last Year
2.
a.
Net income (a) ………………………………..
$840,000
$504,000
Average number of common shares
outstanding (b) ……………………………..
100,000
100,000
Earnings per share (a) ÷ (b) ……………….
$8.40
$5.04
Dividends per share (a) ……………………..
Market price per share (b) ………………….
c.
Dividends per share (a) ……………………..
$3.60
$2.52
Earnings per share (b) ………………………
$8.40
$5.04
Dividend payout ratio (a) ÷ (b) ……………
42.9%
50.0%
Market price per share (a) …………………..
Earnings per share (b) ……………………….
Price-earnings ratio (a) ÷ (b) ……………….
e.
Stockholders’ equity (a) ……………………..
$9,600,000
$9,120,000
Number of common shares outstanding
(b) ……………………………………………..
100,000
100,000
Book value per share (a) ÷ (b) ……………
$96.00
$91.20
Problem 16-15 (continued)
Notice that the market value of common stock is below its book value
for both years. This does not necessarily indicate that the stock is
selling at a bargain price. Market value reflects investors’ expectations
concerning future earnings, whereas book value is a result of already
completed transactions and is geared to the past.
This Year
Last Year
3.
a.
Current assets ………………………………….
$7,800,000
$5,940,000
Current liabilities ……………………………….
3,900,000
2,760,000
Working capital …………………………………
$3,900,000
$3,180,000
Current assets (a) ……………………………..
$5,940,000
Current liabilities (b) ………………………….
$3,900,000
$2,760,000
Current ratio (a) ÷ (b) ………………………..
Quick assets (a) ………………………………..
$3,660,000
$3,360,000
Current liabilities (b) ………………………….
$3,900,000
$2,760,000
Acid-test ratio (a) ÷ (b) ………………………
d.
Sales on account (a) ………………………….
$15,750,000
$12,480,000
Average accounts receivables (b) ………….
$2,250,000
$1,680,000
Accounts receivable turnover (a) ÷ (b) …..
7.0
7.4
Average collection period,
365 days ÷ turnover ………………………..
52.1 days
49.3 days
Cost of goods sold (a) ………………………
$9,900,000
Average inventory balance (b) ……………
$3,150,000
$2,160,000
Inventory turnover ratio (a) ÷ (b) ……….
91.3 days
79.3 days
Average sale period ………………………….
91.3 days
79.3 days
Average collection period …………………..
Operating cycle ……………………………….
Problem 16-15 (continued)
This Year
Last Year
Total asset turnover (a) ÷ (b) …………….
4. With respect to profitability, the return on total assets has improved
From a market performance perspective, the earnings per share
increased from $5.04 to $8.40. However, Lydex’s price earnings ratio of
8.57 is below the industry average of 10. In terms of asset
management, Lydex’s average sale period and average collection period
Problem 16-16 (30 minutes)
1.
Lydex Company
Comparative Balance Sheets
This Year
Last Year
Current assets:
Cash ……………………………………………
5.6
%
8.5
%
Marketable securities ………………………
0.0
2.0
Accounts receivable, net …………………..
15.8
12.1
Inventory ……………………………………..
22.8
16.1
Prepaid expenses …………………………...
1.4
1.2
Total current assets …………………………..
45.6
39.9
Plant and equipment, net ……………………
54.4
60.1
Total assets ……………………………………..
100.0
%
100.0
%
Current liabilities ………………………………
22.8
%
18.5
%
Note payable, 10% …………………………...
21.1
20.2
Total liabilities ………………………………….
43.9
Common stock, $78 par value …………..
Retained earnings …………………………..
10.5
56.1
61.3
Total liabilities and equity ……………………
100.0
%
100.0
%
Problem 16-16 (continued)
2.
Lydex Company
Comparative Income Statements
This Year
Last Year
Sales ……………………………………………..
100.0
%
100.0
%
Cost of goods sold ………………………………
Gross margin ……………………………………..
Selling and administrative expenses ………..
Net operating income ………………………….
Interest expense ………………………………..
Net income before taxes ………………………
Income taxes (30%) …………………………...
Net income ……………………………………….
%
3. The company’s current position has declined substantially between the
two years. Cash this year represents only 5.6% of total assets, whereas
it represented 10.5% last year (cash + marketable securities). In
addition, both accounts receivable and inventory are up from last year,
which helps to explain the decrease in the cash account. The company
is building inventories, but not collecting from customers. (See Problem
16-15 for a ratio analysis of the current assets.) Apparently a part of the
financing required to build inventories was supplied by short-term
creditors, as evidenced by the increase in current liabilities.
Problem 16-17 (30 minutes)
a. It is becoming more difficult for the company to pay its bills as they
come due. Although the current ratio has improved over the three years,
the acid-test ratio is down. Also notice that the accounts receivable and
inventory are both turning more slowly, indicating that an increasing
portion of the current assets is being made up of these items, from
which bills cannot be paid.
b. Customers are paying their bills more slowly in Year 3 than in Year 1.
This is evidenced by the decline in accounts receivable turnover.
e. The market price is going down. The dividends paid per share over the
three-year period are unchanged, but the dividend yield is going up.
Therefore, the market price per share of stock must be decreasing.
f. The amount of earnings per share is increasing. Again, the dividends
paid per share have remained constant. However, the dividend payout
ratio is decreasing. In order for the dividend payout ratio to be
decreasing, the earnings per share must be increasing.
Problem 16-18 (60 minutes)
This Year
Last Year
1.
a.
Current assets …………………………………..
$1,520,000
$1,090,000
Current liabilities ……………………………….
800,000
430,000
Working capital …………………………………
$ 720,000
$ 660,000
b.
Current assets (a) ……………………………..
$1,520,000
$1,090,000
Current liabilities (b) …………………………..
$800,000
$430,000
Current ratio (a) ÷ (b) ………………………..
1.90
2.53
Quick assets (a) ………………………………..
$550,000
$468,000
Current liabilities (b) …………………………..
$800,000
$430,000
Acid-test ratio (a) ÷ (b) ………………………
Sales on account (a) …………………………..
$5,000,000
$4,350,000
Average receivables (b) ………………………
Accounts receivable turnover (a) ÷ (b) …..
Average collection period: 365 days ÷
28.5 days
e.
Cost of goods sold (a) ………………………..
$3,875,000
$3,450,000
Average inventory (b) …………………………
$775,000
$550,000
Inventory turnover ratio(a) ÷ (b) …………..
5.0
6.3
Average sales period:
365 days ÷ Inventory turnover ratio ……
73.0 days
57.9 days
Average sale period …………………………...
Average collection period …………………….
28.5 days
Operating cycle …………………………………
Sales (a) ………………………………………….
$5,000,000
$4,350,000
Average total assets (b) ………………………
$2,440,000
Total asset turnover (a) ÷ (b) ……………….
Problem 16-18 (continued)
This Year
Last Year
h.
Total liabilities (a) ………………………………
$1,400,000
$1,030,000
Stockholders’ equity (b) ………………………
$1,600,000
$1,430,000
Debt–to-equity ratio (a) ÷ (b) ……………….
0.88
0.72
Net income before interest and taxes (a) ..
Interest expense (b) …………………………..
Times interest earned (a) ÷ (b) …………….
Average total assets (a) ………………………
Equity multiplier (a) ÷ (b) ……………………
1.80
1.71